DIVISIONAL COURT FILE NO: 489/17
DATE: 2019-06-03
ONTARIO
SUPERIOR COURT OF JUSTICE
DIVISIONAL COURT
SWINTON, THORBURN and NEWTON JJ.
BETWEEN:
ALFRED HUNG, ALBERT IP, GEORGE HO and ALLEN CHAN
Appellants
– and –
ONTARIO SECURITIES COMMISSION
Respondent
Counsel: Adam Chisholm and Calie Adamson, for the Appellants, Alfred Hung, Albert Ip, George Ho and Allen Chan
M. Britton, Carlo Rossi and Vivian Lee, for the Respondent, Ontario Securities Commission
HEARD at Toronto: April 15 and 16, 2019
THORBURN J.
REASONS FOR DECISION
OVERVIEW
[1] This is an appeal by Allen Chan, Alfred Hung, Albert Ip, and George Ho pursuant to section 9(1) of the Securities Act, R.S.O. 1990, c. S.5 (the “Act”). They appeal the decision on the merits of a Panel of the Ontario Securities Commission dated July 13, 2017 (“the Merits Decision”), and the decision of a second Panel on sanctions and costs dated July 9, 2018 (“the Sanctions Decision”).
[2] In the Merits Decision, the Panel concluded that:
a. The Appellant Chan, as Chairman and CEO of Sino-Forest Corporation (“Sino-Forest”), engaged in dishonest conduct he knew constituted fraud on Sino-Forest investors, contrary to section 126.1(b) of the Act;
b. The Appellant Chan authorized, permitted and acquiesced in Sino-Forest’s failure to state the facts required to be stated in certain documents contrary to section 122(1)(b) of the Act and the public interest;
c. Each of the four Appellants engaged in deceitful or dishonest conduct related to Sino-Forest’s standing timber assets and revenues knowing they constituted fraud, contrary to section 126.1(b) of the Act and the public interest;
d. Each of the Appellants, as executives of Sino-Forest, made misleading or untrue statements or did not state facts necessary to render the statements truthful, contrary to section 122 (1)(b) of the Act; and
e. Each of the Appellants mislead the Commission staff during the investigation, contrary to subsection 122(1)(a) of the Act and the public interest.
[3] Thereafter, the Sanctions Decision, rendered by a different panel, provided that the Appellants be permanently prohibited from trading in or acquiring securities; resign from and be permanently prohibited from becoming a director or officer of any issuer, registrant or investment fund manager; be prohibited from becoming or acting as an issuer, registrant or investment fund manager; disgorge profits; and pay significant penalties and costs of the Commission proceedings.
[4] The Appellants seek:
• An Order setting aside the Merits Decision and dismissing the Statement of Allegations against the Appellants;
• An Order setting aside the Merits Decision and remitting the matter back to the Commission for rehearing; and/or
• An Order setting aside the Sanctions Decision, amending the sanctions order, or remitting this matter back to the Commission for rehearing on sanctions and costs.
THE ISSUES
[5] The central issues on this appeal are:
a) Was the Merits Decision that the Appellants intended to deceive and defraud investors a reasonable conclusion? More specifically, did the Panel fail to consider Chinese business and cultural practices in deciding that some or all of the Appellants had the intention to deceive and defraud Sino-Forest investors?
b) Did two comments made by the Chair during the Merits Hearing create a reasonable apprehension of bias? and/or
c) Were the disgorgement orders and the administrative penalties imposed by the Sanctions Panel reasonable?
BACKGROUND EVIDENCE
Sino-Forest Corporation
[6] Sino-Forest described itself as a leading commercial forest plantation operator in the People’s Republic of China (“China”). Its principal businesses were, among other things, the ownership and management of tree plantations, the sale of standing timber and wood logs, and the complementary manufacturing of downstream engineered wood products.
[7] Sino-Forest’s executive office was in Hong Kong and it maintained additional offices throughout China. Its Head Office was in Mississauga, Ontario.
[8] Sino-Forest was listed on the Toronto Stock Exchange (“TSX”) and subject to Ontario securities law.
The Appellants
[9] The Appellant Chan was born and raised in Hong Kong. He became co-founder of Sino-Forest in 1992. He was Chairman of the Board and Chief Executive Officer until his resignation on August 28, 2011. Chan was deeply involved in the daily operations of Sino-Forest. He was the ultimate decision-maker, and no significant decision was made without his knowledge or approval.
[10] Ip, Hung, and Ho were each senior officers of Sino-Forest who reported directly to Chan.
[11] Ip was Senior Vice-President, Development and Operations North-East and South-West China. He supervised over 1,000 employees with operations across nine provinces in China and was responsible for forest purchases, including standing timber. Ip obtained an engineering degree from the University of Ottawa in 1984.
[12] Hung was Vice-President Corporate Planning and Banking for Sino-Forest for most of the time in question (June 30, 2006 to January 11, 2012). He was responsible for developing financial models for existing and new business and front-line banking relationship management. He oversaw the preparation of cheques for a large number of Sino-Forest subsidiaries and the netting of accounts receivable and payable. He has a Masters in Finance and an MBA, but was not educated in Canada and he did not have Canadian work experience.
[13] Ho was Vice-President Finance and Chief Financial Officer of Sino-Panel. He had ultimate oversight of the accounting personnel at Sino-Forest. He obtained a Bachelor of Commerce from Simon Fraser University and worked in business and accounting firms in Canada and Hong Kong before joining Sino-Forest.
Sino-Forest’s Business Operations
The BVI System
[14] Sino-Forest conducted most of its business through subsidiaries in the British Virgin Islands (“BVIs”).
[15] The Panel accepted that this was because of “restrictions on foreign companies carrying on business in China” prior to 2004. During this time, BVIs could not hold bank accounts in China or bring in foreign currency. Sino-Forest therefore created an off-book system of netting its accounts receivable and accounts payable which involved Sino-Forest customers making payments on behalf of Sino-Forest to its suppliers rather than to Sino-Forest.
[16] The law in China changed in 2004 to permit foreign investment through domestic corporations. As of 2004, wholly owned foreign companies were able to hold bank accounts in China and bring in foreign currency.
[17] Despite this change, the Sino-Forest BVI Model grew rapidly and by 2005, over 90% of Sino-Forest’s recorded revenue for its standing timber business was attributable to the BVI model.
[18] Sino-Forest’s auditors, board of directors, Independent Committee, and outside legal counsel were aware that the BVI system was in place, and Sino-Forest's auditors were aware that money was not leaving the BVI System. Structures such as the BVI System were not uncommon in China.
[19] The evidence at the Merits hearing was that, after an extensive investigation, the Independent Committee was unable to demonstrate the ownership, value or existence of nearly $3 billion in purported timber assets recorded by Sino-Forest using the BVI Model.
The Concept of Guanxi
[20] The Appellants submit that the reason some business arrangements of Sino-Forest were not put in writing until after the purported agreements had been reached is because the Appellants’ relations with others were governed by the Chinese concept of guanxi. The Appellants adduced evidence from four experts about guanxi.
[21] The Appellants suggest that guanxi refers to the concept of drawing on connections in order to secure favours in personal relations. According to the Appellants’ experts, guanxi includes reciprocal obligations to respond to requests for assistance. This reciprocity is implicit, without time specifications, not necessarily equivalent, and socially binding. Favours like assisting a business counterpart establish a new company, signing agreements on behalf of business counterparts and providing assistance in fundraising are common favours known to guanxi.
[22] The Appellants submit that guanxi is essential to business in China and "the lifeblood of both the macro-economy and micro-business conduct". Against the backdrop of guanxi, written contracts do not have the same prominence in China. This has the benefit of reducing transaction costs.
[23] The Appellants submit that guanxi is based in part on the absence of a history of the rule of law in China, such that reliance on individuals compensates for weakness in the rule of law.
[24] The Appellants submit that Sino-Forest would enter into handshake deals for standing timber volumes and complete confirming paperwork afterward and backdate the effective date of the contracts. They suggest that these oral contracts are enforceable under Chinese law. Although subsequently completed contracts sometimes referred to attachments, they were not always attached. The Appellants claim that maps indicating where the timber sites were located were not attached due to security concerns and noted that the Independent Committee in its report noted that forestry experts advised that “this practice is not inconsistent with the practice of other parties in China who buy and sell standing timber without leasing the underlying land”. Ip testified that notwithstanding this issue, Sino-Forest’s Resource Department could get detailed information as to the location when needed.
Opinions from Sino-Forest Advisors
[25] The Appellants point out that neither Ernst & Young nor BDO raised the absence of attachments to contracts as an issue, and a number of legal opinions affirmed Sino-Forest's title to the standing timber it had purchased in the BVI System.
[26] The Respondent points out that in the Merits Decision, the Panel concluded that the third party opinions were all “based on the assumption that Sino-Forest provided complete and genuine disclosure of all relevant documents and facts,” which the third parties did not have when the opinions were provided.
"Plantation Rights Certificates"
[27] One way to validate land and related rights in China was "Plantation Rights Certificates" ("PRCs").
[28] Sino-Forest said it had applied for PRCs for its plantations, obtained approvals for most of its purchased plantations, it did not have all the PRCs due to delays in implementing the new form, and legally owned its purchased plantations. Those statements were untrue:
a. Sino-Forest did not apply for PRCs for approximately 90% of its holdings;
b. Sino-Forest had no approvals and did not legally own those plantations; and
c. The contracts failed to identify the location of the standing timber and although the Appellants suggested that certain maps were subject to restrictions, there is no evidence that Sino-Forest could not have used GPS coordinates or village names to locate the plantations.
[29] Despite a concerted effort and considerable resources, the Independent Committee was never able to establish the ownership, value or existence of $3 billion in standing timber in the BVI Model.
The Muddy Waters Report
[30] Between February 2003 and October 2010, Sino-Forest raised approximately US $3 billion from investors by issuing debt and equity securities. By March 31, 2011, Sino-Forest’s share price had risen 340% and its market capitalization was over CAD $6 billion.
[31] On June 1, 2011, trading in Sino-Forest shares on the TSX closed at CAD $18.21.
[32] On June 2, 2011, Muddy Waters LLC released a report that alleged Sino-Forest was a “near total fraud” and a “Ponzi scheme” (the “Muddy Waters Report”). On the same day, the Board of Directors of Sino-Forest appointed a committee of independent directors to examine and review the allegations made in the Muddy Waters report. The Commission publicly announced on June 8, 2011 that it had commenced an investigation into Sino-Forest and on August 26, 2011, the Commission ordered all trading in Sino-Forest shares to cease.
[33] On June 2, 2011 trading in Sino-Forest shares on the TSX closed at CAD $14.46 and by June 21, 2014, Sino-Forest shares traded at CAD $1.99.
The Commission’s Allegations against the Appellants
[34] In May 2012, the TSX delisted Sino-Forest shares and the Commission commenced a proceeding against Sino-Forest and the Appellants.
[35] The Commission made four sets of allegations against the Appellants regarding their conduct from June 30, 2006 to January 11, 2012 including the following:
• The Appellant Chan committed fraud by concealing his substantial personal interest in Sino-Forest’s purchase of a controlling interest in another forestry company Greenheart and making materially misleading statements in Sino-Forest’s public disclosure;
• All four Appellants engaged in deceitful and dishonest conduct that caused assets and revenue from the purchase and sale of standing timber to be fraudulently overstated;
• All four Appellants made materially misleading statements and/or failed to disclose material facts in Sino-Forest’s public disclosure record related to its standing timber business, putting investor interests at risk; and
• All four Appellants misled Commission staff during the investigation of this matter.
THE MERITS DECISION
Conclusions of the Merits Panel
[36] After a 188 day hearing on the merits, the hearing panel (the “Merits Panel”) found that the Appellants orchestrated an elaborate, premeditated, and coordinated fraud to overstate the assets and revenue of Sino-Forest (“Standing Timber Fraud”). The Merits Panel found that the cumulative loss of the Standing Timber Fraud amounted to CAD $6 billion in equity market capitalization, making it one of the largest corporate frauds in Canadian history: See the Merits Decision at para. 1068.
[37] The Merits Panel found that each of the Appellants engaged in the fraud knowing their conduct was deceitful, dishonest, and would put investors’ pecuniary interests at risk. Each engaged in deceitful or dishonest conduct regarding Sino-Forest’s timber assets and revenue which they knew amounted to fraud. In respect of four transactions, Chan authorized making statements that were materially misleading regarding Sino-Forest’s ownership of assets and its revenue. Ip and Ho knowingly acquiesced to the making of those statements, knowing they would mislead investors, and Hung permitted the statements to be made and acquiesced to inclusion of those statements. In making statements in respect of Sino-Forest’s internal controls, Chan engaged in fraud in respect of the Greenheart transactions, and all of the Appellants mislead the Commission about the wrongful activities: See Merits Decision at paras. 1493-1496.
Merits Panel Assessment of Fraud
[38] The Merits Panel found that the three elements necessary to perpetrate the frauds were present, those being: (1) undisclosed control; (2) a deceitful documentation process; and (3) undisclosed internal control weaknesses. The Panel further found that “all three elements combined created the necessary infrastructure for the continued perpetration of the fraud in this case over the Material Time": See the Sanctions and Costs Decision at paras. 22 and 55-58.
1. Undisclosed Control of Customers and Suppliers
[39] The Merits Panel found that Sino-Forest controlled or had significant influence over customers and suppliers it held out to be at arm's length. For example:
a. Chan knew Sino-Forest controlled or was related to purportedly independent customers and suppliers. He hid this from investors and others responsible for Sino-Forest's disclosure. “Sino-Forest reported to investors that assets and revenue were the result of arm’s length transactions. They were not.”
b. Chan presented an investment ownership to Sino-Forest (the “Greenheart transaction”) but concealed his interest thereby enriching himself by almost CA $40 million and putting investor interests at risk: See the Merits Decision at paras. 1068-1069.
c. The Appellants “actively hid information from the audit committee, Board and auditors about the nature of Sino-Forest’s relationships with these companies”. This was true not only of the Greenheart transaction but also of the four frauds sets out below: See the Merits Decision at paras. 1039 and 1074-1080.
2. Deceitful Documentation Process
[40] The Merits Panel also found that the Appellants batched and backdated documents to substantiate purchase and sales transactions, including documents that purported to be independent confirmation of transactions from third parties. The Panel found that this process was used to “obscure the truth about ownership of assets and revenue recognition”: See Merits Decision at para. 1050.
[41] Documentation to support four fraudulent transactions was created to deceive Sino-Forest’s CFO and auditors. These sales contracts had no economic substance and resulted in Sino-Forest’s overstatement of revenue by approximately US $30 million in Q4 2009. This revenue did not exist: See Merits Decision at para. 1078. In particular:
a) In the Dacheng Transaction, Sino-Forest recorded the sale of the same assets in the BVI Model and WFOE model (the other business model Sino-Forest used). The BVI subsidiaries' purchase of these assets inflated Sino-Forest’s reported assets in the 2008 financial statements by US $30 million. The sale of the assets in the BVI Model was also false and resulted in an overstatement of Sino-Forest’s revenue in the 2009 financial statements by approximately US $48 million. The Merits Panel found that Ip and Ho participated in orchestrating this fraud;
b) In the 450 Transactions, Sino-Forest reverse-engineered purchase and sale transactions in the WFOE Model and used a circular flow of funds to support fictitious transactions. The 450 Transactions resulted in the overstatement of revenue by approximately US $30 million in Q4 2009. Ip and Ho were closely involved in the reverse-engineering of the 450 transactions and executing the circular flow of funds. Chan was closely involved in the 450 transactions and knew that the circular flow of funds resulted in transactions that resulted in no economic substance;
c) In the Gengma #1 Transactions, Sino-Forest created fictitious purchase contracts in the BVI Model to inflate the value of the assets on its financial statements in 2007, 2008, and 2009. Sino-Forest then created fictitious sales contracts that inflated its revenue in 2010 by US $231 million. Chan and Ip's involvement in the Gengma #1 Transactions was clear; and
d) In the Gengma #2 Transactions, Sino-Forest created fictitious purchase contracts that inflated the value of assets in Sino-Forest's financial statements in 2007 and 2008 and created fictitious sales contracts that misstated revenue on Sino-Forest's financial statements between March 2008 and November 2009 by a total of approximately US $49 million. Like the Gengma #1 Transactions, Chan and Ip's involvement in the Gengma #2 Transactions was clear: See Merits Decision at paras. 1074-1097.
[42] The Merits Panel held that Sino-Forest’s deceitful documentation process “calls into question the assets and revenue Sino-Forest recorded in the BVI Model during the Material Time. This significantly put the pecuniary interest of Investors at risk.” The Panel held that, “approximately 70% of the total timber holdings by hectare that Investors were led to believe they owned through Sino-Forest and approximately 70% of the revenue the company recognized between 2007 and 2010 cannot be verified”: See Merits Decision at para. 1052.
[43] The Merits Panel found that Chan, Ip, and Hung were the architects of the deceitful documentation process: See Merits Decision at para. 1053. The Merits Panel found that Sino-Forest made materially misleading statements in its short form prospectuses, financial statements, MD&As and AIFs issued. The materially misleading statements fell into three categories: (i) statements regarding ownership of assets and revenue recognition; (ii) the effects of the Four Frauds on the reported revenue of Sino-Forest; and (iii) statements regarding internal controls.
[44] Ip sub-certified Sino-Forest's disclosure when he knew it was not accurate: See the Merits Decision at para. 1044.
[45] Ip also created the deceitful documents in respect of the four examples of fraudulent transactions and executed the circular flow of funds pertaining to the 450 Transactions. He approved the opening of bank accounts used to facilitate the circular flow of funds and monitored those bank accounts. The Appellants knew the circular flow of funds resulted in sales transactions which had no economic substance, and knew the resulting overstatement of revenue on Sino-Forest’s financial statements deprived investors by putting their pecuniary interests at risk: See Merits Decision at paras. 1081-1082.
[46] Ho was on the committee with responsibility for oversight of completeness, accuracy and timeliness of the disclosure made by Sino-Forest. He certified Sino-Forest’s disclosure was accurate while knowing it was not. Ho took no steps to correct the inaccurate disclosure, thereby putting Investors’ pecuniary interests at risk and knowing related-party transactions would call into question the assets and revenue of Sino-Forest: See Merits Decision at para. 1047.
[47] Hung had a role in the creation of Sino-Forest’s audit confirmation letters, yet he allowed misleading disclosure to be issued by the company: See the Merits Decision at paras. 1046-7.
3. Internal Control Weaknesses
[48] The Merits Panel also found that Sino-Forest dishonestly concealed internal control weaknesses, which obscured the true nature of the transactions and prevented the detection of the deceitful documentation process. In particular, Sino-Forest failed to disclose the extent to which the duties were centralized in Hung, who effectively controlled the entire documentation process underlying the BVI Model: See Merits Decision at paras. 1064-1067 and 1103.
[49] Hung knew his role in the internal control was weak because of concentration of duties. He knew this was a key element of the standing timber fraud, and went along with Chan’s failure to remediate this internal control weakness: See Merits Decision at paras. 1103 and 1261.
[50] The Panel held that Chan knew of and was directly responsible for the failure to remediate the internal control deficiency: See Merits Decision at paras. 1053-1069.
Misleading Commission Staff
[51] The Panel held that during the course of Commission Staff's interviews conducted during the investigation, the Appellants misled Staff. Chan and Ho misled Staff regarding Sino-Forest’s control over one its largest suppliers, Huaihua City Yuda Wood Co. Ltd. The Merits Panel found that Chan was aware that Sino-Forest, through Ho, controlled at least two of Yuda Wood's bank accounts, but told Staff that no Sino-Forest employee controlled any aspect of Yuda Wood's business.
[52] In his interview Chan was asked on "numerous times and in various ways" if Sino-Forest had any control over Yuda Wood. Chan unequivocally denied that Sino-Forest had any control over the supplier, when the Panel held he knew that to be false. The Panel also concluded that Ho misled Staff regarding the control that he had over certain aspects of the supplier's businesses, and Ip and Hung misled Staff about the deceitful documentation process.
JURISDICTION
[53] This court has jurisdiction to hear this Appeal. In this case, the Appellants appeal pursuant to s. 9 of the Act which allows a person directly affected by a final decision of the Commission to appeal to the Divisional Court.
THE STANDARD OF REVIEW
[54] The standard of review to be applied to these decisions is reasonableness.
[55] A tribunal is not required to answer every submission or review all evidence in arriving at its decision. In order to successfully challenge a decision as unreasonable, there must be no line of analysis that could reasonably have led to the Panel’s conclusions: See Ryan v. Law Society (New Brunswick), 2003 SCC 20 at para. 55.
[56] There is no standard of review to be applied to the issue of procedural fairness in respect of the claim of reasonable apprehension of bias. Instead, the court determines whether the requisite level of procedural fairness has been accorded, with reference to the factors in Baker v. Canada (Minister of Citizenship and Immigration), 1999 CanLII 699 (SCC), [1999] 2 S.C.R. 817.
ANALYSIS OF THE ISSUES ON APPEAL
The First Issue: The Reasonableness of the Finding that the Appellants intended to commit Fraud
Establishing Fraud
[57] The Appellants claim the Merits Panel finding that they intended to commit fraud was unreasonable because the Panel erred in finding that they had the mens rea necessary to commit fraud. No issue was taken with respect to the Panel’s finding that the actus reus was established.
[58] Section 126.1(1)(b) of the Act prohibits conduct relating to securities that a person or company knows or reasonably ought to know would perpetrate a fraud on a person or company.[^1]
[59] Although “fraud” is not defined in the Act, several Commission decisions have adopted the definition from the Supreme Court of Canada’s decision in R. v. Théroux, 1993 CanLII 134 (SCC), [1993] 2 S.C.R. 5. In that case, the Court held that the actus reus of the offence of fraud is established by proof of:
the act of deceit, falsehood or some other fraudulent means; and
deprivation caused by the prohibited act, which may consist of actual loss or the placing of the victims’ pecuniary interest at risk.
[60] In order to establish deceit and falsehood, the Court held that "all that need be determined is whether the accused, as a matter of fact, represented that a situation was of a certain character, when, in reality, it was not". As to "other fraudulent means," the issue is "determined objectively, by reference to what a reasonable person would consider to be a dishonest act". The concept is intended to encompass all other means, other than deceit or falsehood, which can be properly characterized as dishonest including the non-disclosure of important facts, the unauthorized diversion of funds and the unauthorized arrogation of funds or property: See Théroux, supra, at paras. 17 and18.
[61] The second element, deprivation, is established by proof of detriment, prejudice or risk of prejudice to the economic interests of the victim caused by the dishonest act. It is not necessary to prove that an accused ultimately profited or received an economic benefit or gain from the conduct or that actual deprivation occurred: See Théroux, supra, at paras. 16, 19 and 27.
[62] The mens rea of fraud is established by proof of:
subjective knowledge of the prohibited act; and
subjective knowledge that the prohibited act could have as a consequence, the deprivation of another (which deprivation may consist of knowledge that the victim’s pecuniary interests are put at risk): See Théroux, supra, at para. 23.
[63] Knowledge of a dishonest act or acts can be inferred from the facts available at the time the actions were taken. It is not necessary to show precisely what was in the mind of the accused at the time of the fraudulent acts: See Théroux at para. 27.
Analysis of the Evidence
[64] The Appellants do not challenge the findings that the dishonest acts were committed or that investors lost money.
[65] They dispute that the Appellants intended to commit fraud. They claim that in deciding that the Appellants intended to commit fraud, the Merits Panel rejected consideration of Chinese business and cultural practices, which “fatally impacted the Commission’s determination of mens rea”: See Appellants’ Factum at para. 7.
[66] The Appellants claim that “while saying it was ‘cognizant’ of ‘cultural and geographic issues’, the Merits Panel also rejected Messrs. Ip, Ho, and Hung’s argument that ‘the environment in which Sino-Forest operated forms the factual circumstances surrounding the actions of the [Appellants] and must be given due consideration.” The Appellants’ further claim that the Merits Panel “found that it was not appropriate in assessing Mr. Chan’s conduct to consider…the ‘significantly different business and cultural environment’, particularly in the resource sector in China.”: See Appellants’ factum at para. 91.
[67] The Appellants specifically cite the following issues that they say, demonstrate that the Merits Panel did not take into consideration Chinese business, cultural, and legal practices:
a. The Chinese business reasons for carrying on the BVI system;
b. The fact that some of the Appellants were not engaged by Sino-Forest when the BVI system was designed;
c. Why BVI companies like Sino-Forest did not retain maps;
d. The roles of Chinese tax, cash flow and accounts receivable issues;
e. The permissibility of oral contracts and knowledge that the written agreements were backdated; and
f. How Chan beneficially owned two companies as a result of his assistance to others setting up companies in accordance with guanxi: See Appellants’ Factum at para. 97.
[68] In order to succeed on the appeal of the Merits Panel decision, the Appellants must establish that the Panel’s conclusion that the Appellants intended to commit fraud was unreasonable. This means that there must be “no line of analysis capable of upholding the decision”: See Cartaway Resources Corp. (Re), 2004 SCC 26 at para. 49 and Re Donnini, 2005 CanLII 1622 (ON CA), [2005] O.J. No. 240 (Ont. C.A.).
[69] The Appellants claim their four experts, qualified in Chinese law, cultural and business practices in China, gave evidence about the concept of guanxi, foreign exchange regulation and the use of BVIs, tax regulation, business structures and email usage: See paras. 117, 134, 146, 347-349, 381, 475-480 of the Merits Decision. The Appellants claim this evidence serves to refute the claim that the Appellants knew their actions could deprive others.
[70] I disagree.
[71] The Merits Panel did consider the issue of whether and if so, the extent to which Chinese business and or cultural practices were adopted by the Appellants and why.
[72] They correctly noted however, that an intention to commit fraud is made out where there is subjective knowledge of the prohibited act, and subjective knowledge that the prohibited act may result in deprivation or risk of deprivation to investors. An individual’s personal assessment of the morality or honesty of their conduct or hope that there will be no actual deprivation is irrelevant: See Théroux, supra, at para. 26.
[73] The Merits Panel conducted a detailed review of the circumstances of the transactions. In so doing, at para. 350 of the Merits decision, the Panel held that:
The Panel is cognizant of cultural differences that companies encounter globally; however, Sino-Forest was listed on the TSX, was an Ontario reporting issuer, raised US $3 billion of capital from Investors, and was required to issue financial statements prepared in accordance with Canadian generally accepted accounting principles. For the purposes of our analysis, Ontario securities law is paramount and overrides any explanations for illegal conduct being excusable in the name of guanxi, however it is defined. (Emphasis added)
[74] The Merits Panel considered the reason Sino-Forest initially conducted its business through BVIs. However, it noted that the law changed in 2004 to permit foreign investment through domestic corporations and permitted them to hold bank accounts in China and bring in foreign currency. The Merits Panel also considered that, although the Independent Committee investigating Sino-Forest and its transactions spent CA $50 million, it was unable to demonstrate ownership, value or existence of almost $3 billion in timber assets recorded by Sino-Forest using the BVI model. The Merits Panel noted that Hung controlled the documentation process underlying the BVI System including the recording of purchases, sales and settlement: See Merits Decision at paras. 129, 659, 662, 691-692, and 1064-1066.
[75] Second, in respect of the Four Transactions, the Merits Panel found fictitious purchase contracts were created by the Appellants, knowing the contracts would inflate Sino-Forest’s financial statements: See Merits Decision at paras. 1074-1097.
[76] Third, the Merits Panel noted that although the Appellants suggested there were reasons for them to conduct business with non-arms’ length parties because of guanxi, the Appellants misled investors by reporting to them that the transactions were arms’ length transactions when the Appellants knew they were not. Through this misleading disclosure, Sino-Forest deceived investors about the accuracy and reliability of information reported in its financial statements, and investors did not get the information they required to make informed decisions to buy, sell or hold Sino-Forest securities: See Merits Decision at para. 1038.
[77] Chan knew Sino-Forest controlled its largest supplier, but hid this information from investors and from others involved in Sino-Forest’s disclosure to investors. While Chan was allowed to have an ownership in more than one company, he was required to disclose this when Sino-Forest was entering a transaction with another company in which he held an interest (the Greenheart transaction). Chan’s concealment of that interest resulted in his reaping significant personal financial gains. Moreover, Chan directed when and how the related companies in which he had an interest disposed of Sino-Forest shares. A portion of the proceeds were donated to a university where Chan obtained a fellowship: See Merits Decision at para. 1040.
[78] Fourth, the Merits Panel found that even if maps could not be attached, the site should be able to be found using other methods such as GPS coordinates, nearby villages etc. However, “approximately 70% of the total timber holdings by hectare that Investors were led to believe they owned through Sino-Forest and approximately 70% of the revenue the company recognized between 2007 and 2010 cannot be verified.”: See Merits Decision at para. 1052.
[79] All of the documentation was prepared by Sino-Forest alone and contracts and supporting documentation were backdated and signed after quarter-end: See Merits Decision at paras. 134, 538, 558 and 1050-1052.
[80] Fifth, the Appellants did not provide full disclosure to auditors, investors, or legal counsel. As such, those opinions cannot be relied upon, and the Appellants knew they could not be relied on by investors but said nothing: See Merits Decision at para. 1068.
[81] Sixth, The Merits Panel found that the Appellants misled Staff during its investigation and permitted or acquiesced in the disclosure of Sino-Forest documentation that was materially misleading.
[82] In assessing the allegations against Chan in particular, the Panel noted at paras. 190 and 191 that:
Sino-Forest business operations were located in mainland China which is a significantly different business and cultural environment than Ontario. Because Sino-Forest was engaged in the resource sector, it was particularly difficult, if not impossible, for it to divorce itself from this environment and simply impose North American business standards.
[However]… No matter what business Sino-Forest was engaged in, it was Chan’s responsibility to ensure that Sino-Forest complied with Province of Ontario securities legislation as set out in the [Ontario] Securities Act. [Emphasis added]
[83] Similarly, in respect of the allegations against the Appellants Ip, Ho and Hung, the Merits Panel held at para. 1250 of their decision that:
Ip, Ho and Hung submit the environment in which Sino-Forest operated forms the factual circumstances surrounding the actions of the Respondents and must be given due consideration (Peoples Department Store Inc. (Trustee of) v. Wise, 2004 SCC 68, para. 63). The Panel is cognizant of cultural and geographic issues, but Ontario securities laws apply to reporting issuers in Ontario, which included Sino-Forest.
[84] The Panel rejected the Appellants’ submission that they did not know they were putting investors’ pecuniary interests at risk because their actions were carried out for a bona fide business purpose. The Panel held at para. 1073 of the decision that:
[W]e find the actions of the [Appellants] in the three elements of the standing timber fraud and the four examples of fraud were not carried out for bona fide business purposes.
Chan, Ip, Ho and Hung dishonestly concealed key facts relating to Sino-Forest’s disclosure of ownership of assets and recorded revenue. They knew their conduct put the pecuniary interests of investors at risk.
[The Appellants] dishonestly concealed key facts relating to Sino-Forest’s disclosure of ownership of assets and recorded revenue. They knew their conduct put the pecuniary interests of investors at risk.
[85] There was ample support for the Panel’s conclusion that the Appellants had the intention to commit fraud and deceive investors:
a. The Appellants engaged with non-arms’ length parties to enter into paper transactions with Sino-Forest. Those agreements greatly increased Sino-Forest’s stated assets and revenue.
b. The Appellants batched and backdated documentation to support those oral agreements and neither disclosed nor explained this.
c. Sino-Forest’s auditors and lawyers were not provided with full disclosure about the transactions.
d. No independent documentation existed to substantiate billions of dollars of record transactions.
e. Over 70% of the tree plantations could not be located and Sino-Forest could not establish the value or existence of $3 billion in standing timber it purported to own.
f. The Appellants concealed material information relating to Sino-Forest’s ownership of assets and revenue and they knew and acquiesced to Sino-Forest’s dissemination of misleading information, including assertions that Sino-Forest had applied for PRCs for its plantations, had received PRCs for most of the plantations and that it legally owned its plantations. This information was provided to and relied upon by Sino-Forest auditors and legal advisors.
[86] The Merits Panel did not reject evidence of Chinese business and cultural practices. During the 188 day hearing, the Merits Panel heard days of evidence from experts in Chinese business, culture and legal practices. However, the Merits Panel concluded on the basis of considerable evidence that the Appellants knew investors’ financial interests were put at risk by their acts, whether or not those acts were done in accordance with Chinese cultural or business practices. The Merits Panel concluded that:
Sino-Forest was listed on the TSX, was an Ontario reporting issuer, raised US $3 billion of capital from Investors, and was required to issue financial statements prepared in accordance with Canadian generally accepted accounting principles. For the purposes of our analysis, Ontario securities law is paramount and overrides any explanations for illegal conduct being excusable in the name of guanxi, however it is defined,
This conclusion was reasonable.
[87] In arriving at this conclusion, the Merits Panel was not rejecting Chinese business and cultural practices, but simply saying that while such practices might explain the Appellants’ behaviour, they cannot excuse illegal acts, as the Appellants, as senior executives, had a responsibility to ensure that Sino-Forest complied with Ontario securities law.
[88] That responsibility did not change because Sino-Forest operated in China. Regardless of where Sino-Forest conducted its business, as a company listed on the TSX, Sino-Forest was required to comply with Ontario securities laws and as senior executives of Sino-Forest, the Appellants had a responsibility to comply with Ontario securities laws. This responsibility overrides any other explanation for illegal conduct.
[89] For these reasons, the Merits Panel decision that the Appellants had the requisite intention to commit fraud was reasonable and the argument that the Merits Panel failed to establish that the Appellants had the mens rea to commit fraud is rejected.
The Allegation of Reasonable Apprehension of Bias
[90] The Appellants claim the Chair of the Merits Panel made comments that are sufficiently concerning that they raise a reasonable apprehension of bias.
[91] First on the third day of the hearing, the Chair of the Merits Panel brought up a document on his computer. The document was an agreement for a purchase of trees by Sino-Forest. The Chair received a technical error on his screen and the following exchange took place:
Chair: I have an indication “false”.
Mr. Craig: False?
Chair: Yes.
And later…
Chair: What concerns me, Mr. Craig, it I didn’t –I don’t understand how they knew.
[92] When the Appellants’ counsel questioned him about the remark, the Chair stated that,
Chair: Oh, the intent of that remark was I don’t know how they knew that I was false. It was a sort of an aside that I guess everybody missed.
Ms. Cole (Counsel): Thank you.
Chair: Does that work for you?
Ms. Cole: I think so. Thank you very much.
[93] No further discussion was had about the remark and the hearing continued for a further 184 days.
[94] The Appellants suggest that the only reasonable inference to be drawn from that comment is that the Chair was asking how his computer knew that the agreement being introduced was “false”: See Appellants’ Factum at para. 28.
[95] Second, the Appellants submit that during Ip’s cross-examination on a particular contract, an objection was made by the Appellants’ counsel. During the objection, the Chair encouraged the staff lawyer to “Stick with him [Ip]” in the cross-examination.
[96] The Appellants submit that the above exchanges would lead a reasonable person to conclude that the hearing was not free from bias: See Appellants’ Factum at para. 114.
[97] I disagree.
[98] The first excerpt involved the Chair’s difficulty accessing an electronic hearing brief. When questioned about his remark, the Chair explained it and the explanation was accepted by counsel. She made no request for his recusal. On this appeal the Appellants’ counsel fairly conceded that counsel at the hearing seemed to accept the Chair’s explanation.
[99] Secondly, in respect of the remark to “stick” with Ip, it is plausible that the Chair was indicating that staff should stay with Ip by referring to the contract that he was referring to. No objection was taken to this remark at the hearing.
[100] The threshold for finding a reasonable apprehension of bias is high, and the remark must be one where an informed person, viewing the matter realistically and practically, would conclude that it is unlikely the decision-maker would decide fairly: See Roberts v. R., 2003 SCC 45, [2003] 2 S.C.R. 259 at para. 60.
[101] I also note that a party seeking recusal has an obligation to make the request at the earliest practicable opportunity. This was not done.
[102] For these reasons, I find there was no reasonable apprehension of bias. This ground of appeal is rejected.
The Allegation that Sanctions were Excessive
[103] The Appellants submit that the sanctions imposed by the Panel were unprecedented and excessive because:
a. The Sanctions Panel ordered disgorgement without there being any causal link between the amounts to be disgorged and the Appellants’ non-compliance;
b. The Sanctions Panel ordered that the Appellants disgorge all of their remuneration without addressing the specific findings against each Appellant, their respective roles, terms of engagement with Sino-Forest and duties; and
c. The Commission improperly based its decision to award administrative penalties on the fact that the Appellants resided outside of North America.
[104] After conducting a hearing and taking into consideration the findings of the Merits Panel, the Sanctions Panel ordered that:
a) The Appellants permanently cease trading or acquiring securities;
b) The Appellants resign from any position as a director or officer of any issuer, registrant or investment fund manager;
c) The Appellants be permanently prohibited from becoming or acting as a director or officer of any issuer, registrant, or investment fund manager;
d) The Appellants Chan, Ip, Hung, and Ho pay administrative penalties in the amount of $5,000,000; $2,650,000; $2,000,000; and $2,000,000 respectively;
e) The Appellants Chan, Ip, Hung, and Ho disgorge to the Commission $60,288,253; $1,859,710; $1,268,373; and $1,214,883, respectively;
f) Chan pay the costs of the Commission in the amount of $2,038,704;
g) Ip pay the costs of the Commission in the amount of $1,529,028 for which he shall be jointly and severally liable with Chan;
h) Hung pay costs to the Commission of $1,019,352 for which he shall be jointly and severally liable with Chan and Ip; and
i) Ho pay costs to the Commission of $509,676 for which he shall be jointly and severally liable with Chan, Ip, and Hung.
[105] In determining the appropriate sanctions to be imposed, the Sanctions Panel explained that it was guided by the purposes of the Act, which include protecting investors from unfair, improper, or fraudulent practices, as well as fostering fair and efficient capital markets and confidence in those markets, the seriousness of the conduct, the level of the Appellant’s activity in the market place, and whether the sanctions imposed will deter others from engaging in similar abuses of the capital market: See the Sanctions Decision at paras. 85-88.
[106] It also noted at para. 104 of its decision that:
[P]rohibitions on market participation, including director and officer bans, will have very little deterrent effect since the [Appellants] reside outside of North America and are very unlikely to seek to participate here again or be accepted in the Canadian business community.
In this case, the administrative penalties we have determined to impose are required given both the magnitude of the consequences that flowed from the [Appellants’] misconduct as well as the more limited deterrent effect market prohibitions will have.
[107] The Commission must “consider the protection of investors and the efficiency of, and public confidence in, capital markets generally”. In so doing, the Commission has broad discretion to impose sanctions, and its exercise of discretion is afforded substantial deference: See Committee for Equal Treatment of Asbestos Minority Shareholders v. Ontario (Securities Commission), 2001 SCC 37 at para. 45.
[108] The general principles that underlie the imposition of sanctions for conduct that violates the Act are set out in section 1.1 of the Act as follows:
The purposes of this Act are,
(a) to provide protection to investors from unfair, improper or fraudulent practices; and
(b) to foster fair and efficient capital markets and confidence in capital markets.
[109] For the reasons that follow, I find that the sanctions were reasonable, and there is no principled basis upon which this Court should interfere with the sanctions imposed by the Panel:
a. The Sanctions Panel drew a causal link between the misconduct and the amounts of the sanctions imposed. For example, the Panel found that Chan made almost CA $40 million from the Greenheart [transaction] and that “but for Mr. Chan’s presentation of his conflicted transaction without disclosing his personal interest in it, the opportunity would never have arisen, and Fortune Universe and Montsford would not have obtained the Sino-Forest shares at the time of the Second and Third Transactions …It is incongruous to suggest Mr. Chan did not obtain these shares as a result of his non-disclosure of his interest in Greenheart which put the pecuniary interests of investors at risk…”. Moreover, the Panel found that Chan’s improper conduct was directly related to the Sino-Forest share price. Given this evidence and the fact that Chan had a fiduciary responsibility to protect investors, the Panel held that these were the amounts obtained by virtue of his non-compliance with Ontario securities law, and they should be disgorged: See Merits Panel decision at paras. 1390-1395. This decision was reasonable;[^2]
b. The decision to require the Appellants to disgorge their compensation from Sino-Forest is also reasonable as the Sanctions Panel held that as a result of their conduct, approximately 70% of Sino-Forest’s total timber holdings and the revenue claimed between 2007 and 2010 could not be realized. During this time they received compensation from Sino-Forest which they would not otherwise have received (as evidenced by the fact that they no longer received it when the company collapsed and the shares were delisted);
c. Third, deterrence is an “appropriate and perhaps necessary consideration” when imposing sanctions, as securities regulators exercise a public interest jurisdiction: See Cartaway Resources Corp (Re) at para. 60. In exercising its jurisdiction, the Sanctions Panel recognized that in circumstances such as this where the individuals reside outside of North America and have no interest in continuing to participate in the Canadian market, financial penalties are particularly important to deter them and others from engaging in fraud. This, coupled with the enormity of the fraud, provided reasonable grounds for the imposition of the financial sanctions imposed: See Re Rowan, 2010 ONSC 7029 at para. 22.
d. Lastly, the Sanctions Panel noted the “enormity of the effects” of the Appellants’ conduct.
[110] In conclusion, the Sanctions Decision was reasonable. The Sanctions Panel identified the principles at play and explained the reasons for the decision, and there is no principled basis upon which to interfere with their decision. The Sanctions Panel has wide discretion to impose a sanction, provided there is a principled reason for so doing. There was in this case with respect to the disgorgement orders and the administrative penalties
CONCLUSION
[111] For these reasons, this appeal is dismissed.
[112] If the parties cannot agree on the disposition of costs of the appeal, the Respondent shall file its written submissions within fifteen days of receipt of these reasons and the Appellants shall file their written submissions within fifteen days thereafter. No reply submissions are to be filed without leave of the court. No party’s submissions shall exceed ten pages in length.
THORBURN J.
I agree
SWINTON J.
I agree
NEWTON J.
Date of Release: June 3, 2019
DIVISIONAL COURT FILE NO.: 489/17
DATE: 2019-06-03
ONTARIO
SUPERIOR COURT OF JUSTICE
DIVISIONAL COURT
THORBURN, SWINTON and NEWTON JJ.
BETWEEN:
ALFRED HUNG, ALFRED IP, GEORGE HO, and ALLEN CHAN
Appellants
– and –
ONTARIO SECURITIES COMMISSION
Respondent
REASONS FOR JUDGMENT
Thorburn J.
Date of Release: June 3, 2019
[^1]: Section 126 reads as follows: (1) A person or company shall not, directly or indirectly, engage or participate in any act, practice or course of conduct relating to securities or derivatives of securities that the person or company knows or reasonably ought to know, (b)...perpetrates a fraud on any person or company.
[^2]: The Quadrexx Hedge Capital Management Ltd. (Re), 2018 ONSEC 3 decision cited by the Appellants, is distinguishable from the case before us as in Quadrexx, the Respondent disclosed his interest in the other company for the second valuation but had not disclosed at the time of the first valuation. As such, he was only ordered to pay the difference between the two valuations.