Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 24 - Evidence
OTTAWA, Tuesday, June 23, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:45 a.m. to examine the state of the financial system in Canada (joint and several liability and professional defendants).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: I want to remind you where we are and describe the process we will follow today.
The committee prepared an options paper and then conducted a series of hearings based on that options paper. Out of that we came up with a proposal for modified proportionate liability which had two unresolved questions. The first was: How, precisely, should the dividing line be drawn between "sophisticated" and "unsophisticated" investor, and what form of net-worth test should be used in making that distinction? The second question was: If you had an insolvent defendant, how should that insolvent defendant's share of responsibility be allocated or re-allocated, if at all, among the remaining solvent defendants?
We then sent our report to the government. The government responded by saying that the government felt we were more equipped to answer these two questions than they were, simply because we had done all the research and held the previous set of hearings. Our purpose this morning is to answer those two questions. It is not to re-open any of the issues which have otherwise been resolved.
In light of that, it struck me as appropriate, and the committee agreed, to follow a round-table table procedure in which each of you would take 10 minutes or less to give your answers to the two questions on the table. Then we will see if a consensus can be reached from your comments. We will allow one or two questions for clarification but, please, restrict your comments to 10 minutes rather than get into detailed discussions at the outset. We want to get all the views on the table before discussing them.
Mr. Krishna is a former colleague of mine from Dalhousie Business School. He will begin.
Mr. Vern Krishna, Professor, Faculty of Law, University of Ottawa; Association of Certified General Accountants of Canada: Honourable senators, I will directly address the two questions before the committee but, if I may, I will put my remarks into some context for the benefit of those present.
The fundamental issue is: Who bears the loss for culpable misfeasance whether that misfeasance is tortious or fraudulent? The question is: How should that loss be distributed between the service provider -- in this case the accountant providing public services -- and the user of those services, whether that user is the direct client or a third-party user such as an investor?
The route towards which the committee is headed of modified proportionate liability is, in the view of the Association of Certified General Accountants of Canada, not necessarily the most beneficial view that can be taken in these circumstances. I shall place my comments in respect of the threshold limit of the sophisticated versus unsophisticated investor in this context. We face three options. First, at one end of the spectrum is the traditional and existing unlimited liability that we presently have in which the thrust and the bulk of the liability attaches to the service provider, subject, of course, to existing legal limits on the burden of proof, on standards, and on the quantum of damages.
Second, at the other extreme of the spectrum, we have the scenario of the limited liability company -- not as the traditional corporation, but the limited liability company as it exists in the United States. It is an entity which provides for entity status with limitation of liability and the very important provision that it acts as a conduit for tax purposes.
The advantage of the limited liability company I think outweighs any of the disadvantages associated with it. The principle disadvantage of the limited liability company from a governmental point of view has always been the tax limitation. It is treated as a separate entity and so it subjects its users to double-taxation, once at the corporate level and then again at the shareholder level. The United States has overcome that disadvantage by treating such entities as a conduit for tax purposes, thereby giving investors the best of both worlds -- limitation of liability and protection of government revenue base in so far as tax is concerned.
Third, the limited proportionate liability approach of this committee lies in between these two extremes. The concern that we have with the threshold question -- as to whether an investor is a sophisticated investor or an unsophisticated investor -- is that, basically, that distinction does not address the fundamental question that is who should bear the liability for the loss. It is, in our view, an approach that will take us down into protracted litigation as to where the dividing line shall be as to who is and who is not a sophisticated investor.
The suggestion has been made, for example, that certain assets be excluded in the determination of whether a person is or is not a sophisticated investor and then the threshold should kick in after the exclusion of certain assets. We ask: Why should any assets be excluded? The exclusion of assets in fact means a radical shift of liability from the service provider to the client or the investor who has suffered the loss. It is a shifting of the loss from the defendant to the plaintiff, but it is not as clear-cut as it would appear to be.
The shifting of the loss is predicated upon the exclusion of assets. There will be litigation as to the definition of those assets, where those assets are placed, in whose title they are held, whether they are held onshore or offshore, and whether they are held in asset protection trusts onshore or offshore. That, at the end of the day, will simply place the plaintiff in the impossible situation of carrying an enormous burden of proof with protracted litigation.
The determination of the threshold itself is not an easy issue, no matter at what amount you put the threshold. If you put it at $100,000 or $150,000 the fact is that the threshold has very little to do with the sophistication of the plaintiff who has suffered the loss. You can have a widow or an orphan who inherits $1 million. Indeed, many will be inheriting more and more money with the passing of this generation. They may have enormous sums of money but, despite the enormity of the amount, they remain comparatively unsophisticated when it comes to these issues.
On behalf of the association, we would urge the committee to reconsider this dichotomy between the sophisticated and the unsophisticated investor with or without the threshold. In the event that the committee does choose to go down that route, we would urge that it not consider the exclusion of any assets from the threshold amount of computation.
At your urging, senator, I shall not address my comments on the other issues which are related to this question but which I think are equally important. I will just mention them in passing. I will not address them unless they are raised in questions later on.
They are issues relating to who is, for the purposes of these amounts, an "innocent" partner. Who is an innocent partner in an organization? There are other issues related to liability for coverage of employees. There are other issues related to the stripping of capital out of enterprises. There are yet other issues related to minimum threshold amounts of insurance, bonding and funds. I shall put those aside for the time being, senator, unless there is further interest during the questioning.
Senator Kenny: Mr. Krishna, are you completely rejecting the concept of the test of sophisticated and unsophisticated investor? It is an easy measure, but are you rejecting the idea of net worth and amount of net worth as the test period?
Mr. Krishna: Yes, senator, I am. We are suggesting that the distinction, the line, between the sophisticated and unsophisticated investor will not be easy to draw. It will be extremely complex. It will invite and give cause for further litigation prior to the determination of the liability issue itself. In effect, we may be headed down the path of two-step litigation rather than single-step litigation.
The degree of that ambiguity is directly proportionate to the amount of the exclusions that you will put between the two lines or between the two sides. The greater the exclusions, the greater the ambiguity.
Senator Angus: Professor Krishna is urging us to move away from where we appear to be in our report.
You have mentioned three alternatives. What would you like to see? The bottom-line proposition put to us was joint and pure. Joint and several is unfair in the modern world and in light of the globalization of the markets and transactions that have taken place. The proposition put to us was that you should go to pure proportionate fault in lieu of joint and several.
We came to our conclusion for reasons based on a whole plethora of evidence. Where are you on this spectrum, if you do convince us to reconsider?
Mr. Krishna: If I was re-making the world in my own image, so to speak?
Senator Angus: Yes.
Mr. Krishna: It would be terribly pretentious of me to attempt to do that. If I had to re-do it, I would urge a move towards the concept of the limited liability company, rather than the LLP.
The Chairman: We cannot do it. It is not part of our jurisdiction.
Mr. Krishna: Whether the partnership is within the federal jurisdiction is also very much an open question. I am not sure that that is as clearly resolved as might be the impression. If I had the choice, in a pure world, the LLC with limitation of liability treated as a conduit would be a better solution. It might involve further participation of other parties.
Senator Angus: In other words, you at least agree that the status quo does have inequities in it and that a change should be made. We are just looking at a practical solution.
Mr. Krishna: That is right. We are not opposed to the concept of limitation of liability. We are opposed more to the fine tuning of the method by which it is delivered.
Mr. Ross Walker, Chairman, Legal Liability Task Force, Canadian Institute of Chartered Accountants: We are pleased to be before you today and wish to say at the outset that we very much appreciate the extensive time and effort that has been put forward by this committee and your staff over the many months considering this proportionate liability issue. We are pleased to address the three outstanding questions your committee has identified to finalize the implementation of a modified proportionate liability proposal. We have submitted a brief which outlines our views and I will briefly comment.
First, having agreed that a distinction between sophisticated and unsophisticated investors should be made on the basis of a net-worth test, you have asked how the net worth of the plaintiff should be defined. In this regard, we believe that our original proposal to the committee remains a good one. That is, the net worth of the plaintiff should be defined as the adjusted net worth, i.e., the aggregate of fair value of all assets less all liabilities at a date immediately prior to the day on which the cause of action arose.
Five categories of assets and related liabilities would be excluded from this calculation: one, the principle residence; two, the residence furnishings; three, automobiles; four, registered retirement savings plans; and five, the present value of pension benefits under a registered pension plan. Excluding these five categories of assets from the calculation of net worth means that the plaintiff would avoid incurring valuation costs associated with them. It also means that assets such as a principal residence, the value of which varies widely depending upon the location, would not be included in this definition of net worth.
We would not be opposed to using a straight monetary threshold to define net worth, providing the threshold was suitable, say the level of about $200,000. However, we believe that an adjusted net-worth test with its exclusions is the best approach.
We understand that others may propose that caps be placed on the exclusions and that an income test also be applied. While both of these have merit, this would require valuations to determine whether an individual's assets fall above or below the capped level, and the definition of annual income could be complex. We feel, therefore, that an approach based solely on adjusted net worth is the best solution.
The second question that you have asked is what threshold value should be used to separate a sophisticated plaintiff from an unsophisticated one. We believe that, after deducting the five exclusions outlined above, the threshold value should be set at $100,000. This approach would result in a very high percentage of individual investors being defined as unsophisticated and, therefore, benefiting from the protection of joint and several liability. A 1997 analysis of the investable assets of Canadians found that there are 7.9 million individuals with investable assets. Of these, 1.5 million have investable assets of over $100,000 and 6.4 million have investable assets under $100,000. It is these 6.4 million individuals, over 80 per cent, that would be deemed unsophisticated investors under this proposal.
Third, you have asked how the risk of a defendant insolvency should be allocated among plaintiffs and remaining co-defendants. I should like to emphasize that we believe that the proposals being considered today are generous in determining which individuals should be considered sophisticated plaintiffs. It should, therefore, be unnecessary to provide further protection from risk to sophisticated investors. However, since your committee has determined that some halfway house is necessary, we ask that the reallocation be set as low as possible. A reallocation on a proportionate basis, based on the court's determination of each party's contribution to the loss, would be an acceptable compromise. Using this approach, if, for example, the auditor were found responsible for 20 per cent of the loss, and all of the other co-defendants were insolvent, the auditor would be obliged to pay a total of 36 per cent, that being the original 20 per cent plus 20 per cent of the shortfall of 80 per cent.
We would be pleased to answer any questions the committee may have.
Senator Meighen: Would you deal with Professor Krishna's objection that some of these exclusions would be difficult to define?
Mr. Walker: I would take a contrary view. I believe one of the best features of the exclusions is that they would remove many of the complications. The principle residence, furnishings, automobiles, registered retirement savings plans and pension plan would be excluded from the calculation. That makes it much simpler. We are dealing with other assets in determining what net worth is and I would be surprised if much litigation would result from having these exclusions in place. They simplify the process rather than make it more complicated.
The Chairman: In the second question, the committee asked how an insolvent defendant's loss should be reallocated. Your preference is zero reallocation. In the absence of zero, there is the formula contained in your letter.
Mr. Walker: We feel that that is an appropriate compromise. Frankly, it is considerably better than the position we are in now.
Senator Meighen: Professor Krishna that did not take a position on that.
The Chairman: No, he did not.
The third witness this morning is Mr. Joe Oliver.
Mr. Joseph J. Oliver, President and Chief Executive Officer, Investment Dealers Association of Canada: Mr. Chairman, senators, I appreciate very much the opportunity to appear before your committee. This is an important and complex issue and we value the opportunity to participate in the discussion and in the debate.
The IDA is Canada's national self-regulatory organization for the securities industry. Our member firms constitute well over 90 per cent of the business activity and capital in the securities industry.
The IDA is fully supportive of the concept of a move from joint and several to proportionate liability. We are less enthusiastic about the separation between sophisticated and unsophisticated investors, and are not clear on the conceptual justification for that, although there may be some practical reasons that motivate that distinction. I understand the ground rules are not to review that decision.
I do, however, feel compelled to say that it is our view that, while the emphasis in the recommendation deals specifically with errors or omissions in financial information issued under various federal statutes, it is important to note that many others provide valuable financial advice to federally incorporated or federally regulated entities.
The federal statutes -- the Canada Business Corporations Act, the Bank Act, the Trust and Loan Companies Act, and the Insurance Companies Act -- involve members of our association. Each of the statutes contains compulsory acquisition provisions which may result in the need to establish a fair value for securities issued by the companies. We obviously regularly provide advice in these matters and provide the vast bulk of the fairness opinions to public companies.
As well, our members become involved in the valuation process of mutual insurance companies, or we will be involved in that process when these companies undergo demutualization pursuant to the provisions of the Insurance Companies Act. In these cases our members perform a valuable service to Canadian investors and the Canadian capital markets, and we believe that they should receive the same benefit of proportionate liability as recommended for auditors who prepare financial statements for federal companies.
Our strong view is that the benefit of proportionate liability ought to be made available to all professional advisors involved in assisting clients meeting statutory obligations under federal statutes.
The recommendation as currently worded is fairly exclusionary, from the perspective of our members. Probably just a few words would make a difference in terms of the application but not in terms of the policy thrust. The difficulty is that the fairness opinions and valuations that our members generate would not be covered by financial information issued under the acts. However, if the words "contained in any document" were added prior to the words "issued under," then there is some possibility that there would be an inclusion. We understand, of course, that, in many cases, we are dealing with provincial statutes which are not relevant to this committee's direct consideration. However, we are very mindful of the precedents that can be set here.
There are two types of precedent. The first is the move from joint and several liability to proportionate liability, which is very constructive, and hopefully the provincial legislatures will take account of that. However, there is another precedent under which the professional defendant would be covered, and it is in that context that it is important to consider other professional defendants in addition to auditors. That point is very important from our perspective.
You asked three questions, the first of which relates to how the net worth of a plaintiff should be defined. We support the approach taken in the U.S., specifically under the Private Securities Litigation Reform Act of 1995 which includes all assets in the calculation of net worth. The conceptual advantage of that is that it creates a consistent basis of comparison. It is an equal one. It does not distinguish between individuals based on their asset mix. Whether someone holds more or less cash at a particular moment in time, or has more in real estate or in RRSPs, may be a judgment call on the market, and seems to us not to be relevant in the determination of net worth. As well, to take that approach would not encourage some of the artificial practices that potential defendants might engage in to protect their legal position.
As to the threshold value to distinguish between sophistication and lack of sophistication, I should say I was for a time the executive director of the Ontario Securities Commission and, in that role, participated in some discussions which the OSC had relating to the definition of sophistication. There, of course, the thrust was not related to a defence in a legal suit but rather to the information that would need to be provided. It involves the fundamental distinction between who can participate in a private placement and who cannot. I think we all understood that a financial threshold was a rather rough proxy for sophistication. To get sophistication, you actually have to speak to the individual, perhaps give them a little examination. Clearly, that is a totally impractical method of determining who amongst the Canadian investors is sophisticated. We understand you have to move to some sort of test, but we must acknowledge that whatever test we come to will be rather rough, and there will clearly be people above a certain level who, as previous witnesses have stated, may have come into money through inheritance or a lottery win or whatever, and are not sophisticated, and others who perhaps have benefited from a costly education, do not have the net worth but probably do have the sophistication. Thousands of examples can be cited as to why a particular number does not work. Nevertheless, I think we are driven to come up with one.
We believe that a $200,000 figure, taking into account the first point that it would include all assets, is a reasonable proxy for substantial knowledge in conducting financial affairs and making business decisions. The U.S. act has $200,000 as a figure. I do not think there is any need to do any translation into Canadian dollars because the U.S. numbers related to their standard of living, and I do not believe a global number is appropriate for sophistication. You must look at each country and determine what the standard of living is in disposable income to determine whether it is appropriate. Too high a number would mean too many people would be defined as unsophisticated investors and would undermine the basic principle. It does not have too much meaning at a certain point.
The third question was how the risk of a defendant's insolvency should be allocated among sophisticated plaintiffs and the co-defendants that remain. Our position is that, to preserve the integrity of the principle being put forward, which is proportionate liability, that should be maintained in this case whether a defendant or group of defendants cannot meet their financial obligations. We also believe that the sophisticated plaintiff -- and we are only dealing here now with a sophisticated plaintiff -- ought to bear the risk of the insolvency of a co-defendant. To start sharing in that is really to revert to the principle of joint and several liability and all the difficulties that flow from that, such as the strike suits and so on.
As I pointed out in an earlier letter, for a long time it has been the accepted practice in the securities industry to rely on proportionate liability in underwriting transactions. The TSE committee on corporate disclosure made recommendations about the Ontario Securities Commission Task Force on Small Business Financing. I hope we will not retread that ground. I think this goes to the heart of that principle.
Those are my comments.
Senator Meighen: The basis for the dollar figures in the securities legislation in Canada is the same as what we are talking about -- sophisticated versus unsophisticated investors.
Mr. Oliver: The result is different.
Senator Meighen: The $97,000 or the $150,000. We have some precedent.
Mr. Oliver: There is some precedent. It is related to whether they should be permitted to buy private placements.
Senator Meighen: Underlying that is whether they are sophisticated enough to do so, to put it crudely.
Mr. Oliver: Yes, senator, that is exactly right.
Senator Angus: Welcome to the committee, Mr. Oliver. You have brought an interesting new perspective to the debate.
If I understood you well, the issue of other defendants is your main thrust, and the net should be extended. The Bre-X litigation is ongoing, as is other litigation with a host of players, including lawyers, land surveyors and assayers. Could you enumerate? Are we asking that Nesbitt Burns and Midland and Merrill be included and benefit from this?
Mr. Oliver: Please understand that we are not trying to create a defence for anyone with respect to their fault.
Senator Angus: You are looking for consistency.
Mr. Oliver: That is right. We are not trying to create any defence for anyone who does something deliberately. Beyond that, if someone is responsible for 50 per cent, we are not trying to create any defence with respect to that 50 per cent. We are talking only about the proportion of the damages which that person or firm did not cause.
The extent to which an individual defendant, who might be an investment dealer, is responsible when an issuer goes bankrupt would be determined by the court. Then I am saying that that defendant should be held responsible only for the amount that their fault caused. This is in the context of a fairness opinion or a valuation, something that emerges from or is contained in a document issued under the federal acts in question.
Senator Angus: It could be anyone who participates in developing the prospectus or the financial statements. It is not always the same, but depends on the nature of the issue and the underlying assets.
Mr. Oliver: I do not think that we are talking about financial advisors or underwriters performing a defined task in the context of documents provided or information contained in any document issued under these acts. We are not going beyond that. Of course, what you do here will not directly impact on that kind of lawsuit, because that relates to another regime.
The Chairman: Just so we are crystal clear, our previous recommendation talked about "finance information issued under", and then we listed a series of acts. Your recommended change is "financial information contained in any document issued under those acts". In other words, if the act requires a particular type of financial document, that is okay.
Mr. Oliver: That is correct.
The Chairman: I wanted to be sure I understood.
Senator Angus: It goes to the disclosure documents. Plaintiffs, whether sophisticated or unsophisticated, may claim that the information upon which they based their decision was wrong, insufficient or in some way culpable. We are talking about information made available to the investor in the disclosure process. It could be anyone.
Mr. Oliver: It would be anyone who signs the document. It cannot be anyone else.
I want to be clear on something. I have tried to suggest a few words that would broaden the coverage somewhat, but that does not represent our real desire in this matter. We have been consistent throughout the letters we have provided to your committee. We agreed with the thrust that the accounting profession should benefit from the move from joint and several to proportionate liability, but we did not believe at any time that only professional defendants should be covered. We felt and continue to believe that our member firms, when providing this kind of financial information and advice, should also benefit in the same way because the same principles apply. I will let the lawyers speak for themselves.
Senator Angus: You are a lawyer. Do you not think that they should be covered? Perhaps they should not be covered.
Mr. Oliver: I do not see a distinction there necessarily, so I would think so.
Senator Angus: You would.
The Chairman: We will now move on to the last two witnesses. Mr. John Campion appeared at our previous hearings as an expert witness, and we have invited him back today.
Please proceed, Mr. Campion.
Mr. John Campion, Fasken Campbell Godfrey: Mr. Chairman, Mr. Robin Roddy is with me today. He has helped me with the preparation of the written materials. Before I embark upon a review of the opinions contained in those materials, I should like to make a few observations.
We are obviously in the area of public policy, and the area we are now talking about is necessarily arbitrary. We are making choices that do not fit neatly into principles all of the time. My submissions attempt to add some notion of those principles while recognizing always that there is a degree of arbitrariness underlying all of the technicalities with which we are dealing.
Some of that arbitrariness is dealt with in the IDA's presentation. It does seem remarkably arbitrary that one group of professionals would find themselves exempted from the joint and several system and put into a proportionate liability system.
Before I go too far, I must declare a conflict. I am counsel to Nesbitt Burns in the Bre-X matter, as you will see in two of the items I have placed in front of you, and I wish to take this opportunity to declare that conflict. I do not want to deal with that topic, but I do want to put my submissions in a slightly larger context.
When I last appeared here, the Supreme Court of Canada had not dealt with the issues of liability against auditors and, in particular, duty of care, at least not in the Hercules Managements decision. However, I reminded the committee at that time that there was a great narrowing of whether auditors would be liable and who could actually claim against auditors. That narrowing has continued, although, in my respectful opinion about what the court had to say, the Hercules Managements case did nothing more or less than what previously had been stated in lower-court decisions. They just changed the way in which they got there.
At Tab 1, I have included an excerpt from a book I co-authored which deals with auditors. There is a discussion of the Hercules case to the extent that any members of the committee wish to have it. That discussion of the Hercules case under "duty of care" occurs at pages 16 to 18 of Tab 2. It is a difficult task to become part of the group of plaintiffs who can actually sue auditors. That fact has been confirmed since we last met.
At Tabs 2 and 3 of my brief, there are reasons for the decision of Mr. Justice Winkler in the Bre-X litigation. I was counsel, so I do not wish to re-argue any of those points or make any comment other than to say that they exist. In that case, the plaintiffs relied upon the Competition Act to found a cause of action for which there are no guidelines as to how the Competition Act will work through the system. All the notions of duty of care that add the protection that I mentioned do not presently exist, although there is no substantive decision on how the Competition Act will actually operate.
To give you a simple idea of how broad that scope is, section 52(1), the major section of the Competition Act which is touched upon there, states:
52(1) No person shall, for the purpose of promoting, directly or indirectly, the supply or use of a product or for the purpose of promoting, directly or indirectly, any business interest...
(a) make a representation...that is false...
That section has been disconnected from the notion of competition and arguably disconnected, therefore, from the fundamental underlying purpose of the Competition Act as you read it.
The court dealt with whether or not it must be connected to some form of anti-competitive behaviour. Basically, they said, "That is for the trial judge to determine. If the accountants were feeling comfortable when they read the Hercules Managements Ltd. case, they would feel less comfortable in looking at the prospect of the Competition Act coming to bear on economic loss for negligent misstatement. We find ourselves in that legal area where there is indeterminate liability to an undetermined number of people", which is the danger that this is meant to address.
With those openings comments, I will take you quickly through the opinions contained in the paper. There is not time to give you the rationale that lies behind these opinions. To some extent, in this case, I am speaking not only as a person who has written on the topic but also as a litigator. I heard Mr. Krishna's comments and I recognize that they will create a set of issues which will have to be litigated. Therefore, more time and more expense will be involved in the litigation process.
The submissions made here try to take account of that problem and simplify them as much as possible <#0107> and, that is what I urge you to do -- in order to diminish the number of technical issues that arise in what, effectively, is a side bar to the main thrust. That is to say, you want a regime of proportionate liability as opposed to joint and several liability. You are attempting to make a separation between "sophisticated" and "unsophisticated" for obvious public policy reasons and to obtain some form of fairness for those who are unsophisticated. Once you have taken that step, however, you are into the area of totally arbitrary decisions, and you are choosing in your area as opposed to the technical area. These are public policy decisions and you are adding that component. I can only comment upon the fact that they are public policy decisions which are your area of expertise, not mine.
First, I accept the notion of "sophisticated" versus "unsophisticated". You want to have that concept available, somehow. Second, I also accept "net worth" as you directed us to do so, but once you get to net worth, the connection between sophisticated and unsophisticated net worth is inferential and arbitrary at best. However, that does not mean it should be rejected. The amount chosen should be decided only after careful consideration on a public policy level concerning who is really captured in a net worth concept.
Let us assume that it is all property. Is $300,000 the bench mark, or is it $200,000 or $100,000? If you have a notion of who is in and who is out -- perhaps this could be done through Statistics Canada -- you should chose your number accordingly. I do not think that I can give you any assistance in choosing the number other than to say that $300,000 is a mark which will largely capture the sophisticated on one side. Whether it puts the unsophisticated below $300,000 is where the arbitrariness arises. You should make your decisions in this regard or recommend that the legislators who will undertake this task should provide further choices. You should not chose strictly on a number basis but on the principle of who will be in and who will be out. This process should be done in some organized fashion.
Simplicity is the key here. For example, you may exempt property. In my respectful submission, you should not have any exemptions. It should all be included. Save yourselves the pain of trying to stipulate what is included and what is not. By so doing, you immediately get into creative arrangements made by investors. Obviously, each exemption suffers from both definition and valuation. I do not believe that you should be creating further reasons to have family-law-type litigation in the commercial context where net worth is the main issue. As you may be aware, that topic is extremely burdensome for the courts to deal with. There are long lists of property, and so on, and all kinds of creative ways that values are considered. Either it is all included or it is all taken out. Make it simple so that you do not add to commercial litigation a further burden on business in Canada and doing business in Canada.
In terms of the simplicity, you may wish to consider the whole notion of family property itself. In Ontario, for example, when you are dealing with a residence, a spouse has a right to 50 per cent of the net value of that family property. You may wish to take that single issue into account. When it comes to family property, the title holder is not necessarily the key but it recognizes the fact that a spouse will own 50 per cent.
I have created a new concept that has not been presented to the committee before. Footnote 6, on page 6, deals with a residual discretion. That discretion is exercised judicially, where a person is beyond the $300,000 mark or some other mark, but still states that he or she is unsophisticated. That person has a high burden to prove that, but a discretion will capture those people. If someone came forward who was an unsophisticated person but, for some set of reasons that are unpredictable, he has a net worth above the level that you set, then you may wish to use discretion to avoid real unjust treatment to the unsophisticated. That is a possibility. The words "just and reasonable so to do" are commonly used, so let the courts use their discretion; do not try to do it yourselves. That might be a way out of the arbitrary nature of the $300,000 without creating a whole set of rules which become burdensome.
I deal differently with the risk of defendants and other defendant insolvency. The whole reason we are here dealing with proportionate liability as opposed to joint and several liability arises from the fact that there is a potential insolvency of another defendant because they do not have the funds, or whatever. To add what is effectively the reallocation clawback cuts into the very policy that you have decided to adopt. There is no rational reason to do so. This is found at pages 7 and 8 of my brief. I see no reason to go backwards to the reallocation clawback.
That is another unnecessary complication. You made a public policy decision on proportionate liability; that is, that you pay that for which you are liable. If that is the decision, leave it there and do not make it more arbitrary, confusing and more litigious by making an exception if someone is insolvent. The whole reason you are there is because they are insolvent.
It is a public policy decision to cut the baby in half, which is what the clawback does, but I do not see any rationale for it. I must stress that the reason this has come to be is that massive litigation of millions or billions of dollars has come into play in North America, including Canada. However, it is exceedingly rare that these cases ever go to court or people pay those kinds of damages. It is once in a decade or once in five decades that we will have problems such as the 1989 property values issues which caused much of what we are speaking of now.
If you are going to go this route, do not try to make it more or less arbitrary because you think there will be a plethora of litigation. Very few cases of this size have actually gone to trial.
On the last issue of the fraud and dishonesty exception, in my respectful submission it is a sensible thing to have. However, the definition in your report is such that it gives rise to a very ambiguous exception. I deal with the ambiguity in the last two pages of my submission. I recommend that you use the Private Securities Litigation Reform Act of 1995, of American distinction, which states that, only if the trier of fact specifically determines that such person knowingly committed a fraud do you consider the exception or not. You do not use the words "involved in" or "arise out of" because, for instance, if management were fraudulent and the auditors were simply negligent in not capturing the fraud or something else, the auditors are necessarily involved in, or the losses arise out of, the fraud. The auditors will be captured even though they were only negligent. This is just a matter of terminology but, in my respectful submission, as a matter of public policy, you should say that the fraud exception only goes to those against whom fraud has been found, not in circumstances out of which they arise.
I apologize for going on for so long. I did want to put it in a broader context. Again, while I do adopt the notion that all professionals should be in, wherever possible, in the financial area, I must declare my conflict in the Nesbitt Burns situation.
Senator Kenny: Mr. Campion, my question has to do with your one small exemption on the ownership of residences. You suggested that spouses may have an interest in that. Would spouses not have an interest in many other things that might eventually arise? Why would you exempt only the residence?
Mr. Campion: I was suggesting all family property. You would simply adopt the 50-per-cent issue in all family property as defined by any family law reform act.
Senator Kenny: I misunderstood you. I thought you were referring only to residence.
Mr. Campion: That was just an example.
Senator Meighen: What is your view of the change suggested by the IDA, contained in any document, to broaden the scope of professionals who would be caught or who would be able to take advantage of this change?
Mr. Campion: I have considered the wording. I recommend that the committee choose the concept and not the words. If your goal is to make it as broad as is reasonably possible, having regard to the federal jurisdiction, then say so, and someone in the legislative drafting area will no doubt add the words that fit that category. If you try to wordsmith this complexity, you may accidentally include some and exclude others. I say choose what you want and let the legislative draftspeople help out with the words.
Senator Meighen: You urge a residual discretion capability. Can you give examples of other areas where this is present?
Mr. Campion: Yes, I am referring to the oppression remedy in defining who is in and who is out; who can be a complainant. Obviously one area is the whole notion of injunctive relief, where they consider a number of complex factors, both positive and negative, and try to come to a conclusion on whether someone should have an extraordinary remedy. There are many others, but those are two very important ones where courts exercise, on a regular basis, a discretion which, in this case, is a discretion only on top of a presumption. In short, very solid evidence must be put forward.
Senator Austin: Mr. Campion, assume that the investor has inherited money, does not understand the management of it, and therefore has employed professional advice to assist him in making decisions. Is that a sophisticated investor under your definition?
Mr. Campion: That is the value of "just and reasonable". My own view is that is a sophisticated investor. The just and reasonable concept would be developed to capture or not capture that person. It seems sensible that a person with multi-millions of dollars and all the advice in the world who just decides they want nothing to do with their investments and therefore sits out, unsophisticated and unknowing, cannot benefit from this. This is why the threshold test is important. It is a presumption that you are, and you must meet that presumption with solid evidence. It would be a balancing act. In my view, that would still be a very sophisticated investor.
Senator Callbeck: You are saying that you would set a figure -- $300,000 for example -- and that there would be a clause giving the court discretion.
Mr. Campion: Discretion to add to the unsophisticated group only.
Senator Callbeck: Yes. Anyone with more than $300,000 would have the opportunity to prove that they were unsophisticated?
Mr. Campion: Yes. It would have to be a very high threshold once you are over it, though.
Senator Meighen: Suppose that someone, because of their own stupidity rather than lack of sophistication, who has been active in the market for a long time, managed to work their net asset down to below $300,000. Is it your view that the court should not have the discretion to move them from below $300,000 back up to the sophisticated category?
Mr. Campion: That is my view. It is a process of simplicity. What you are in effect doing is creating an odd exemption.
Senator Meighen: Either way?
Mr. Campion: Yes, either way.
Senator Meighen: That is what I did not understand. I thought it was one way.
Mr. Campion: My proposal is one way, but the overall process of using net worth and sophisticated and unsophisticated is itself an oddity. It is a very arbitrary decision.
In my view, if you are under it, fine. You would just as soon have people able to avoid the proportionate liability regime. If there are a few extra in there, that is the price of having an arbitrary regime. You do not want to create litigation that goes on forever on this issue alone.
However, I did want to capture someone who could normally be in the unsophisticated range but, for some bizarre reason, is over the limit. You might want to put them back in that special category for some reason. I am not quite sure what that reason would be, but rather than having a totally arbitrary decision, someone can make the determination that, although there is a high threshold, that person will be put into the unsophisticated regime because of their special circumstances.
You are basically giving them extra permission. However, you would not want it to go the other way because, if a person puts him or herself in a position below $200,000 and happens to be otherwise sophisticated, you are simply making a public policy decision.
Senator Angus: This is a new thing you have added.
Mr. Campion: It was my notion to try to create a little bit of flexibility in what was otherwise an over-the-bar-or-not problem.
The Chairman: Speaking as a non-lawyer, I would say that it does what section 1 of the Charter of Rights and Freedoms does to the Charter; that is, introduces a degree of flexibility which the U.S. does not have.
Our final witness this morning is Ms Alison Manzer from the Canadian Bar Association.
This is your third appearance before us on this subject. You will pleased to know that this will be the last time, because we will be finishing our study today.
Ms Alison Manzer, Chair, Committee on Financial Institutions Legislative Reform, Canadian Bar Association: Mr. Chairman, the Canadian Bar Association has made quite fulsome arguments or presentations before the committee on many of the topics that were reintroduced by the speakers today. As a consequence, we have taken a very unusual approach for lawyers, in that we have taken the questions presented at face value. We have addressed both our brief and the comments that I have been asked to make directly to the questions. We will therefore be brief and pointed.
We felt that the report of the IDA was well presented; however, we were disappointed with the inclusion of only a very limited number of professionals in the proportionate liability regime. For fairly obvious reasons, which we have expressed with great force previously, we do not believe that that protection should be so limited.
As I make my comments, I would ask you to keep in mind that we have no set measurement for sophistication. I think that word was well chosen. At best, in such a case, one must use some proxy for sophistication. If it is difficult to measure the reasonable man, think how difficult it would be to measure the sophisticated man.
We took a further step. The Canadian Bar Association felt that some consistency in the presentations to you would be helpful. Therefore, we met with the CICA, and the consistency in our recommendations is not an accident; it is deliberate. Rather than appearing collusive, we felt that some discussion, some sharing of expertise and information, and some negotiation, if you wish, over some of the issues to be presented would be of benefit to you.
Regarding the issue of net worth and how it should be defined, you actually ask lawyers to do the very difficult task of interpreting rather than simply presenting financial information. However, that being said, we will attempt to do so.
We think that there are five criteria which should be kept in mind when determining what would be a suitable level for net worth and what should be included or excluded in net worth. We did not attempt simply to take a number from the air or to say that in the United States they are using "X" dollars. Instead, we thought about what criteria should be used to make what will amount to a rule of thumb. We suggest that this is somewhat less arbitrary than what exists today. There have to be some underpinnings to the numbers chosen.
First, for a law to be applied well, as opposed to well-drafted, there must be clear, precise, objective tests. Therefore, we would sacrifice, perhaps, an element of fairness or an element of discretion for simplicity and for an objectiveness to the test. If, at best, it is a rule of thumb, at least make it a rule of thumb that is easy to interpret and to apply.
Second, we feel that there must be a benefit of clarity and certainty. As parties go to litigation, they must understand whether or not they will fit under the test or the criteria that will be put before them as hurdles when they engage in the litigation process. Clarity and certainly will reduce the likelihood of an increase in litigation.
However, any test that will be applied in a fashion similar to that within the securities industry will not only look at the accumulation of assets, but will consider that accumulation of assets as a proxy for sophistication and, therefore, as a test for the ability to bear the risk of loss.
Being lawyers, we could not dismiss the application of precedent. Accordingly, we felt that we must look to other, parallel models. This has two benefits. First, that one can look at the application and interpretation of parallel legislation will increase certainty in new legislation. Second, since it is highly unlikely that each and every one of the parallel tests would have been pulled from the air, we can have the benefit of some considerable thought by others.
We have kept in mind at all times that this committee had accepted that the concept of proportionate liability in the present environment was a more effective and appropriate way to allocate risk coming out of litigation. However, by inserting the word "modification", this committee indicated that it had considered that there should be protection. From my attendance at these hearings, my perception is that that protection should be for those most vulnerable elements in society, as is the case in the securities industry.
In this type of litigation, we believe that the majority of average Canadians would, in fact, fall below the threshold and would be considered unsophisticated. We cannot use a definition of sophistication that would make 90 per cent of the population sophisticated and 10 per cent not. We felt that that would be a perversion of the concept.
Accordingly, we used two bases to try to set our number. The first was the CICA'S statistical analysis which they have given to you. The second, which is perhaps a hokey test, but which is also one that has stood me in good stead over the years and which I often find persuasive, was to imagine what amount of financial worth the average person would equate with sophistication. I grew up in a pretty ordinary house in a very ordinary neighbourhood and I continue to live in an ordinary neighbourhood. As I looked at the numbers, I tried to imagine what the people I speak to daily would think. I am not talking about the people I speak to at the corner of Bay and King, but the people I speak to when I drive home to Georgetown, or the people who were across the road from where I grew up in Dartmouth, Nova Scotia. Cast back and think about where you come from and perhaps that will help you to decide what is reasonable and unreasonable.
With respect to the most vulnerable elements of society, the fifth element we considered was that people should have a reasonable expectation of being able to continue their current lifestyle. That is the very purpose of much of the protection that we have put forward.
Bearing in mind that we believe exclusions are appropriate, we selected the number $100,000. That is not an arbitrary number, nor one that the CICA thrust at us. We selected it based on statistical analysis and on my experience and the experiences of people with whom I spoke. Those who have been able to accumulate $100,000 outside of the assets we believe should be excluded are the people who are recognized in Canadian society as being able to achieve financial health and, likely, financial sophistication.
We believe that exclusions are appropriate for three reasons. Again, that was not something that the CICA thrust at us. First, we desired simplicity and a clear and objective test. Eliminating the most difficult to value of the assets added to the simplicity of the test. Generally speaking, investments outside the ones we recommend should be excluded are those most easily valued.
Second, we wanted to take into account the desirability of maintaining a lifestyle. The assets that we have suggested should be excluded are the matrimonial home, the automobile -- and those who may wish to think a car is a luxury obviously do not live where I live -- and the RRSP, since the entire RRSP program has been designed to provide retirement comfort for Canadians. We are sacrificing tax income for that very purpose.
Having looked at parallel models, the Canadian Bar Association has suggested in our written materials that some consideration be given to implementing caps to ensure that there is no abuse by people hiding their wealth in a $5 million home. We suggest that an alternate income test for people whose net worth or income exceeds a certain level might address some of the concerns that have been raised about people who deliberately deplete their net worth. Whether we like it or not, society equates earning power and assets with sophistication.
We also looked at the issue of reallocating liability, that is, the clawback. Although I may agree with many of the comments made by others about whether or not it is suitable, we took the question at face value.
However, if we recognize that the base is proportionate liability, then a clawback or a reallocation should also recognize the proportionate nature of the liability. We are talking about the shortfall in recovery of the consequence of the defendant's inability to contribute. We suggest that the amount of any shortfall be reallocated among the parties based upon the percentage that they were required to contribute in the first place. The court would be required to determine the percentage for which they are responsible. It would be a perversion of the process to determine that the 10-per-cent party were responsible for 100 per cent because the 90-per-cent party had become insolvent. We would essentially have eliminated proportionate liability. We suggest that you take the same proportion, apply it to the shortfall and come up with a fair and balanced -- although to some extent still arbitrary -- test to be applied.
Senator Angus: You acknowledge that you had close collaboration with the CICA. That was partly at our request, and we appreciate it. You have come with a view on the reallocation and on the exclusions.
Ms Manzer: Yes.
Senator Angus: This morning you have heard others saying, "but consistent with your principle of simplicity". Everyone mentioned the word "simplicity" today. Where would you stand on just a number as opposed to a number net of exclusions and no reallocation?
Ms Manzer: I have difficulty going for a number without exclusions, because I still feel that the exclusion method is both fairer and easier to apply. My suggestion would be that it must be considerably in excess of $100,000. My prejudice would be to take into account what I would otherwise exclude, so my level would probably be in the range of $300,000, the same as the IDA's number.
Senator Angus: I wanted clarification, because you go back to the "Main Street" test, whether it is Georgetown or Dartmouth, but the bottom is $300,000.
Ms Manzer: Yes.
Senator Angus: Can you live without any reallocation?
Ms Manzer: My preference would be no reallocation.
Senator Meighen: We are dealing with the quirks of lawyers, and lawyers can always find a way around things. At least, that is the common view. Do you think that including exclusions, if I can express myself thus, makes it more difficult or easier to find a way around?
Ms Manzer: I suggest that it reduces the temptation to find a way around. It reduces the temptation to move assets in order to defeat the test, because people are left with the basis for maintaining a reasonable lifestyle and with the assets that tend to be the most important to them.
Senator Austin: I observe, then, that you are moving from a test of sophistication to a public policy view that each investor, however sophisticated, is entitled to protect a minimum net worth.
Ms Manzer: We recognize that that has been the thrust in Canada over recent years and we expected that it was probably a more palatable solution for persons looking at the legislative change.
The Chairman: It is an underlying principle or condition of the legislation of several financial institutions.
Senator Meighen: Garnishment of wages.
Senator Austin: It is called the "too-small-to-fail" test.
[Translation]
Senator Hervieux-Payette: Regardless of the formula used, when setting monetary amounts, would you not recommend that the legislator adopt a dual threshold formula so that in five or ten years' time, if the legislation has not been amended, these amounts would still be considered reasonable? There is a tendency at times to enact legislation which provides for specific amounts when it comes to fines or so forth, amounts which may no longer be relevant five or ten years down the road. As a result, the original intent of the legislation is forgotten.
Would you consider including an indexation provision for exclusions? What should the legislator incorporate into the legislation to ensure that it remains relevant year after year? Inflation is not a consideration today, but if, in a few years' time, we find ourselves grappling with an annual inflation rate of 5 or 10 per cent, what steps will be taken to adjust the exclusions or the recommended amounts?
By the way, I agree with Ms Manzer's suggestion that there should be different thresholds, rather than one set amount, but the fact remains that in ten years, these amounts will no longer be relevant.
[English]
Ms Manzer: Evolution of the economics in society is a chronic problem. I am glad that you mentioned that the current environment makes it somewhat harder to focus, as a practicality, on the fact that we can have economic change that would be that drastic over the relatively short period of approximately ten years, which is the usual cycle for review of this type of legislation.
Those types of problems can be solved in several ways. Accelerating formulas can be included in the legislation, although I cannot be a fan of accelerating formulas. These types of formulas can be re-addressed more frequently than legislative review would accommodate by putting them to the prescription of regulation, of policy and guidelines, or orders in council. Numbers in the formulas become very difficult to apply and can be perverted much more easily than set numbers. In Canada, we are becoming quite adept at finding means of updating those matters which require updating. It is rare now for a lawyer going through law to find abuse such as the 25-cent fine which occasionally would have turned up in older statutes. We seem to be accommodating the need to change through using these other vehicles quite readily now.
Mr. Walker: I believe it is a very interesting point and possibly a problem. However, I think that it becomes much less of a problem under the exclusion model. An adjustment over a longer period of time would be appropriate because changes in the value of the house would have no influence on the formula.
Senator Kenny: Honourable senators, I wish to ask the last witness if she could elaborate a little more on why certain assets should be excluded. It seems to me that it is making arbitrary decisions about how people choose to live and how people wish to go through life. While your values may be appropriate and may represent the majority of the population, conceivably, there are people who choose to live quite frugally and who choose to drive inexpensive vehicles and, therefore, who would be penalized for those choices they had made. However, those who lived in expensive houses, and in fact consumed much of their wealth along the way, would not absorb the same sort of penalty.
Ms Manzer: Initially, when looking at the issue we had to recognize and come to grips with the fact that any test of this nature would be arbitrary in some circumstances. It is impossible to draft law that can be applied openly, evenly and fairly to all persons. When determining which assets to recommend be excluded, we attempted to recognize those assets which Canadian law already grants special status through special tax treatment and through other programs which tend to encourage, particularly through tax incentives, their accumulation. These are the assets which the majority of Canadians tend to consider key to the maintenance of lifestyle.
I reiterate that we addressed the question as it was presented to us. I am not a fan of a net-worth test. I believe an asset-accumulation test is far better. We are not proposing a test of solvency. We are proposing a test of sophistication. To me, the most sophisticated people are those who can accumulate assets using the income or assets of others, who can accumulate a considerable amount of debt against those assets and who, accordingly, have little net worth but access to the assets.
There is arbitrariness in the choice of any test. The assets we chose for exclusion were those most commonly recognized in Canadian society, by most law and by our tax system, as suitable for exclusion.
Senator Kelleher: Mr. Campion raised the spectre of the provisions of the Family Law Act. In your opinion, what effect, if any, would that have on the items that you propose be excluded?
Ms Manzer: The reference to family law and the matrimonial home, which were fairly close in conjunction, although not necessarily tied together, is there because of the special recognition that family law gives to the matrimonial home in most jurisdictions in Canada. Family planning is a problem in any type of approach to recover damages from litigation. Judgment-proofing is a chronic fact of life in Canada. It is a matter that I would suggest should be considered before other committees at other times, because it is becoming, in the judgment of many, abusive. Without a much broader review, I do not believe that you will be able to prevent the judgment-proofing of any asset.
The exclusion of family assets limits the temptation to plan in that manner. It also limits the difficulty of treading on provincial legislation, which tends to recognize the sanctity of certain assets, such as the home. I do not believe anything more than the exclusions we have suggested need be done.
Senator Callbeck: I should like to hear the witnesses comment on Mr. Campion's suggested definitions of sophisticated and unsophisticated investors. Should we set a figure and then add a clause giving the courts discretion?
Mr. Walker: The CICA would not be opposed to setting a figure, assuming the figure were reasonable. Frankly, we do think it simplifies the situation to exclude a number of the assets that are being proposed. With respect to the suggestion that the court would then be able to adjudicate and to determine that someone should be moved from one threshold to another, the difficulty I have is that it creates additional uncertainty for litigants about where they will stand. It is another test of sophistication, I suppose, and yet it would not make for a clear understanding of who is in and who is out.
Mr. Oliver: Creating what is in effect a rebuttable presumption of sophistication over the threshold does, I agree, create uncertainty. It is too broad. The word "sophistication" is very subjective. It can have a lot of different meanings. I am not sure what most people would understand it to convey. I think that there is a very real risk that litigation could result in massive exclusion, and that sort of rebuttable presumption could easily be rebutted.
Regarding matrimonial property and so on, the fact that spouses are, generally speaking, dealing with the totality of the property, not just the part in which each may have an ownership, is what is relevant when we are looking at a proxy for sophistication. Whether they actually own 100 per cent or 50 per cent is not really the issue. They are dealing with the totality of those assets, which I think is important. The exclusion based on what an individual might be perceived to need to live has built into it some potential biases of a regional nature or of an age nature or of a cultural nature. We know that houses are more expensive in some parts of the country than in others and that younger people typically will have a much higher proportion of their assets in housing initially. I do not know what that has to do with sophistication at all. I believe it has nothing to do with it, in fact. I do not find that very compelling.
Mr. Krishna: We find Mr. Campion's suggestion to be very helpful if we are going to go down this route. Accepting the arbitrary nature of any threshold test does simplify the process. It addresses the point raised earlier that, by holding certain assets, a person will fall into the inclusionary or the exclusionary class, such as, for example, a home owner versus a renter. A renter who saves money in investments falls into one category. An investor who chooses to invest in the matrimonial home falls into another category across the line.
Mr. Campion's comment, however, should be interpreted in the context of another issue which he raised at least tangentially. The oppression remedy, for example, is a two-threshold test for litigation and it is inordinately complex. It is related to another issue: Who will carry the burden of proof to show whether a person is sophisticated or unsophisticated? Who will determine on which side of the line that person should be placed? What are the presumptions? Generally speaking, in threshold tests, the burden of proof is on the more powerful. For example, the securities industry is a large institution which can be challenged regarding its limitations on private placements.
I am a little concerned about whether we are talking about protecting the defendant or the plaintiff with these exclusions in the threshold tests and limits. Some comments have been made about protecting lifestyle, et cetera. Those are defendant-oriented protections. When we are talking about a sophisticated investor or unsophisticated investor, are we not talking about the potential plaintiff and which side of the line that person will be on? Why would the exclusions protect or not protect or expose the investor? I think that has to be borne in mind.
Finally, in the area of litigation, what happens to the person who is just on the other side of the threshold line, whether that line is $100,000 or $200,000 or $300,000?
The Chairman: That is life.
Mr. Krishna: Of course, that is life, but it will involve a lot of jockeying for litigation status, to go from one side of the line to the other. Depending on whether one is at $301,000 or $299,000, the remedies are quite different, and then one faces a threshold disaster for the sake of a thousand dollars on either side. Those are related issues.
The Chairman: In response to your latter point, those of us who have been involved in making public policy understand that regardless of the area, the minute you draw a line, there is always someone just over the line. You learn to live with that because otherwise you would never draw a line and most public policy would not be made. That is life.
Senator Austin: This committee has talked about the social interest in preserving the viability of debtors so that their continued maintenance does not fall upon society. That was the point contained in the presentation by the Canadian Bar Association and in other presentations.
I ask this speculatively. Is this committee is not chasing false prey when it looks at the issue of sophistication? Professor Krishna mentioned problems that relate to this point.
I would like to go back to my quip of a few minutes ago about the too-small-to-fail concept. If we pursue this policy, are we simply trying to say that we will not reduce the net worth of an individual, whether plaintiff or defendant, below a certain level, because it is not good public policy to make people indigent in this particular case? I suppose it is not good politics, either.
Why does the committee want to bother with the concept of sophisticated or unsophisticated investors? Whether we use net worth or asset accumulation as a test, why do we not simply say that $500,000 is untouchable? I am not totally clear on the difference between net worth and asset accumulation. Perhaps someone could help me there.
Why get into these arbitrary tests? We ask a court to look at someone and say they are sophisticated or unsophisticated. What is the purpose of that? Is it simply to protect a basic net worth and then to move into policy issues?
Senator Angus: Net worth is not being protected. Let us take Professor Krishna's example of the senior citizen who has been living on an inheritance. It is over $500,000, and let us say that there is zero recovery and that senior has lost everything. If, however, the amount had been only $500,000, that person would have retained everything. A franchise or a deductible would be needed, I suppose.
I would like to put a general issue on the table for discussion because I think Mr. Campion opened up a whole new horizon with this residual discretion. This is right out of left field, but what would you think if we said that this will be left to the discretion of the court, and the court is directed to apply the following guidelines, whatever they may be. We might also refer to the plaintiff, who is entitled to joint and several, and then list the guidelines -- level of sophistication, state off well-being, and so on. Is there something there?
Mr. Campion opened the door to that. I agree that it makes no sense to exclude really unsophisticated people by some arbitrary number.
Mr. Campion: Senator, there is a choice of how one goes about creating an exemption from the exemptions -- which is the double negative we are working with -- and allowing someone back in who goes over the threshold. I would start out with a threshold and stick to it very strongly in keeping with the principle of simplicity. The idea of adding criteria to those who are over the limit but somehow remain unsophisticated is a perfectly sensible thing to do.
It comes down to what type of public policy you want to adopt. Once you decide that, the actual wordsmithing is relatively simple. A list of categories is a sensible and helpful way to proceed, in my view. By stating it as baldly as I did here, I simply wanted to raise the concept, rather than get into the choices you might make once the concept was further analyzed. I accept your notion of restricting the criteria in some fashion to ensure that those who jump back into the unsophisticated category are doing so in a way that is predictable and highly exceptional.
Ms Manzer: With the caveats that Mr. Campion has added to the manner in which the legislation would be drafted, it would be manageable and workable. Consistency of application would be developed quickly enough.
The only concern that arises from giving the courts discretion is that there is some arbitrariness until precedent settles down. If we set the onus on the person seeking to avoid the application of the threshold, it would be very workable legislation.
Senator Kenny: Except possibly at the extremes, I have great difficulty finding a correlation between net worth and sophistication.
The Chairman: We should not get hung up on the word "sophistication", which came from the committee. In deposit insurance there is a ceiling of $60,000, and in various pieces of Canadian and U.S. financial institution and regulatory legislation there is a threshold. We needed a word to describe people on one side of the line or the other. We picked the word sophistication.
Senator Kenny: I have always taken it as a code word for folks who can take care of themselves. That is what we are trying to define. I have difficulty associating net worth with people who can take care of themselves. I cannot find a way to correlate it.
I am much more comfortable with Ms Manzer's suggestion of asset or wealth accumulation as a test. The folks who have the capacity to go out and create wealth for themselves over a period of time demonstrate sophistication, directly or indirectly. It could be that through blind luck someone won a lottery. Maybe that is an exception that one could demonstrate to the judge.
Senator Angus: Some of the poorest people we know are sophisticated investors who made a poor choice.
Senator Kenny: Their net worth is low perhaps because they are leveraged. That is the convenient way to be. In fact, perhaps that is an intelligent way to be in some markets.
Aside from Ms Manzer, have other members of the panel reflected on this? If so, what are your reflections?
The Chairman: Can we be absolutely precise? I want to be sure I understand your question. The question relates to the proposal that Mr. Campion originally put on the table and that Ms Manzer commented on, which is that there would be a threshold, and the discretion would rest with the judge.
Senator Kenny: That is nowhere near my question, Mr. Chairman.
The Chairman: Perhaps you could be precise with your question.
Senator Kenny: I will do my best.
I suggest that we discard the concept of net worth altogether and instead look at a history or a track record over a certain period of years. In that time, has the individual had the capacity to create wealth and to develop assets? In other words, if one can go from x to 10x over a period of time, I presume they are fairly sophisticated and have some skills at doing that. Is that a reasonable test?
The Chairman: Could that test be applied?
Senator Kenny: First, is it reasonable; and, second, is it simple enough to apply?
Mr. Campion: Yes, such a test is workable and applicable, but it would increase the nature of the litigation. The value of the threshold concept is that a public policy decision affects how litigation is dealt with . It is reasonable, and it is a matter of public policy choice. I think that, with some form of discretion to avoid an injustice, the threshold remains an attractive alternative. However, the system you described could be worked just as easily as the threshold-test system. It has a cost.
Ms Manzer: I believe you were focusing on the point that I raised. If we accept the fact that it will be necessary to use financial accumulation as a test for sophistication -- and whether we like it or not financial accumulation has become the most common test -- then perhaps net worth, that is, assets less liabilities, is not the appropriate test.
Extreme sophistication is evident in the accumulation of assets with corresponding liabilities. That is an easier test to utilize because it is a straight asset-value test. It is no different than the calculation used for net worth. Liabilities are simply not subtracted.
If you move in that direction, I think that you should also look at the suggested alternative of an income test. It is difficult in this society to contend that someone with an income of $250,000 or $300,000 would not meet the sophistication level, because society rewards capability, and most capability tends to lean towards sophistication on an income basis.
Senator Meighen: I still have some difficulty with the exclusions. Ms Manzer made the case that it would make things simpler rather than more complicated. What about the question of provincial jurisdiction? Obviously a number of these things fall under provincial jurisdiction. Whatever our view about the wisdom of including exclusions, would we not avoid that problem to a greater extent by having no exclusions?
Mr. Campion: Constitutionally, yes.
Senator Meighen: I was asking constitutionally.
Mr. Campion: If you are referring to property rights and civil rights, which are the main issues, then the answer is yes.
The Chairman: I am not a lawyer, but surely the federal government can exclude anything without getting into constitutional tests. It is not a question of shifting the constitution; it is simply a question of deciding what will be excluded and not excluded. I do not see why it is a constitutional question.
Ms Manzer: That simply avoids discussion of the issue. If a monetary formula is set to establish something within federal powers, whether the provinces deal with that asset on the basis of ownership or occupation is irrelevant for the tests.
Mr. Campion: It arises in a manner similar to that of a civil remedy arising from the Competition Act. I take your point that it seems that use of this form of property formula would not enter into that sphere. The creation of an exemption or inclusion for a litigant might raise an issue with respect to the whole regime which deals with the recovery of damages. The question is whether or not this notion of dealing with property would in any way put it off-side constitutionally.
I think you are right, Mr. Chairman, that it is unlikely to do so. However, if it were a problem, the less that sphere is entered, the more likely it is that the problem can be avoided.
Mr. Krishna: I wish to address the threshold issue by coming back, Mr. Chairman, to your perfectly appropriate comment that in all public policy decision-making one draws a line and then falls on one side of the line or the other. I want to return to this limit and threshold amount because, in public policy making, the issue we face is who should bear the loss, the defendant accountant or the plaintiff. As a tangential comment, I think it should be extended to all professions and not be limited to accountants.
We try to avoid, wherever possible, threshold disasters, where a plaintiff loses all rights of remedy by being $1 on the wrong side of the limit. For example, a plaintiff with $299,999 has the right of unlimited liability joint and several, but by having an asset accumulation of $1 more has a substantially reduced right. In my day job, where I am a tax lawyer, we call that a threshold disaster, and we write all of our legislation to avoid threshold disasters.
It depends on whether one is defendant-oriented or plaintiff-oriented, but we would want to protect the individual investor who, but for $1, would have had all of the remedies, and now, by an accident of computation of net worth with exclusions, inclusions, and other formulae, is in trouble. That person would certainly want to get rid of that extra dollar immediately in order to have the full remedy.
The Chairman: Is your problem solved by the judicial discretion question raised by Mr. Campion?
Mr. Krishna: That type of judicial discretion goes a long way towards addressing that concern in these extreme cases and therefore has a great deal of merit. Mr. Campion also raised a useful presumption, because it should not be too easy to get in under that discretion.
Mr. Walker: Our counsel, Mr. Ron Brown from Blake Cassels, is with us today. One of the issues we asked him to consider is the constitutionality of this. In the opinion of Blake Cassels, constitutionally, the test would not be an issue of deductions or no deductions, but of merely arriving at a figure.
The Chairman: Three of us are not lawyers, and there has been conflicting evidence from the lawyers, so I would like to have some clarification specifically on this point. Mr. Krishna suggested that exclusions would generate a lot of litigation. Ms Manzer argued that exclusions would not generate a lot of litigation because one would not have to start valuing houses and so on. I think it would help us if we understood the consensus of the witnesses on that question.
Senator Austin talked about the public policy and political implications in favour of a long list of exclusions. Frankly, from the standpoint of optics, there are huge positive benefits to a long list. However, I am trying to understand the question of $100,000 with exclusions versus $300,000 without exclusions. Which of those two alternatives would minimize litigation, given that that is our desire? The evidence is quite conflicting. Can we reach a consensus? This question is important to the committee.
Mr. Oliver, I know you are a lawyer, but if your legal counsel wishes to comment on that, they are more than welcome.
Ms Manzer: We decided that having exclusions contributed to simplicity and, therefore, likely reduced litigation. I should repeat that, in my view, increasing certainty and increasing simplicity reduces the likelihood of litigation. The only litigation that could increase would be litigation that challenges the application of the threshold. There would only be challenges if the application of the threshold is unclear.
Our belief is that having exclusions would make that a simpler task, particularly with regard to the home, which is one of the most difficult assets to value. If it is to be included in the threshold amount, it must be valued. At that point, regional disparities appear, since the home is the asset whose value is most affected by location.
The Chairman: So that I am clear on your latter point, you said that a $300,000 limit with no exemptions would leave the plaintiff in an outport of Newfoundland a lot better off than the plaintiff in Toronto.
Ms Manzer: I indicated to you great reluctance to have a test without exclusions for that very reason.
Senator Meighen: Did you say that it is difficult to value a house? Whether it is accurately done or not, it is done every day in a variety of circumstances.
Ms Manzer: The key word is "accurately". Having been in the financial world for a few years, I know which appraiser to ask, depending on the valuation that I want.
Mr. Campion: In coming to grips with this, one must ask how often a debate will arise. Whether the limit is $100,000 or $300,000, debate will arise only when a person is close to the line. There probably will not be that many people involved in a net-worth analysis. Most people will be clearly on one side of the threshold or the other. It will not often be necessary to analyze the position of a plaintiff who wants to fit into the unsophisticated category; rather, it will be easy to predict. That is the first point.
Second, although it probably will not make any difference, the exclusion carries with it only a reallocation public policy cost, which you probably recognized. For example, for whatever reason, people may think that they want to fit in the category of unsophisticated investor.
In choosing the exclusionary system, you will have an economic impact. Will it be a big one? I suspect not. I doubt very much that anybody thinks about it, but it will have an impact on sophisticated investors who try constantly to shove themselves into an unsophisticated category by shifting assets into the hands of others or by making sure the family home is elsewhere.
Do you want to have an economic impact? That is your choice.
As opposed to valuing the home, simply excluding the home means one step fewer, one issue fewer to fight about. If the family home or the pension is excluded, they are not put on the list of valuation. Therefore, that aspect of the litigation would be simplified. Overall, it seems neutral.
Senator Meighen: I can see the argument, although I do not know that I agree with it. If we start excluding automobiles, why not boats, depending upon what part of the country we are dealing with? Are not we dealing with chicken feed here?
Mr. Campion: I would see it that way, because I am not in favour of the exclusionary formula. You should set a limit that captures the household value. That seems to be simpler, easier and more comprehensive. It is relatively neutral, and it will happen so seldom. Since the whole process is arbitrary, a choice has to be made, and the issue is simplicity.
Mr. Oliver: I want to reiterate a point I made before and to raise another issue in this context. Equal and consistent comparison of individuals cannot be maintained with that mix of assets. I have difficulty with that concept. As we get into the details, the difficulties become increasingly more apparent.
The basic concept here is just. It is equitable, in that one is responsible for one's own fault, not for someone else's fault. That is what motivates consideration of the question of moving from joint and several to proportionate liability.
When we look at these issues, we should keep that principle in mind and only by exception move away from it. It is obvious that a $200,000 limit, without any exclusions, will produce a certain number of Canadians who will fall into the category; $100,000 with exclusions will produce another number of them. I am not sure which would produce more. I am not clear about whether your committee has in mind that only 20 per cent of the people should fall into the so-called unsophisticated category or whether 80 per cent should fall into that category.
Senator Oliver: We do not have a percentage.
Senator Angus: It does not matter. It is a concept.
Mr. Oliver: It does matter, however, if the approach that is generated takes into account the vast majority of Canadians and it constitutes such a significant exception that it undermines the basic principle that I thought motivated it.
The Chairman: If the number is $1 million, it is obviously ridiculous.
Mr. Oliver: Also, Mr. Campion said that there will not be many people whose net worth will be so close as to trigger a problem, but if we are talking about 80 per cent or 50 per cent of the population, we are talking about millions and millions of people. I think that a lot of people could be caught, especially in the context of class action suits, and so on. I do not think it is that unlikely that this discretionary item will trigger a lot of litigation, inquiry and uncertainty.
Following up Mr. Campion's earlier comment about making it very restricted, I am not clear about what criteria -- that is, if we gave criteria to a judge -- would be used. Are we asking people to produce their university degrees to see whether they specialized in finance or economics, or are we looking at the history of their investing? If we look only at assets, we are biased against people who use a lot of leverage. I am not clear about what criteria would constitute a conception that would not be extraordinarily subjective.
Mr. Walker: You wanted to discuss this primarily with the lawyers. Could I ask Mr. Brown, of Blake Cassels, to comment on this.
The Chairman: Mr. Krishna, would you like to comment on this?
Mr. Krishna: In my professional life, I deal with the Income Tax Act, which is put forward in a multi-volume series every year. It has a great deal of line drawing, classification and characterization.
My professional observation is that, generally speaking, the more classifications and lists one has, and the more lines one is therefore required to draw, the more complex the situation becomes.
Second, I endorse Mr. Campion's suggestion that one is inevitably drawn into the behavioural response that the legislation introduces in a plaintiff's or a defendant's behaviour; that is, one begins to readjust ones life and ones structures to respond to the particular legislation in place, be it matrimonial, securities, asset or income. We can always arrange our affairs and we spend our professional lives giving advice on these matters to make people either have a large number of assets, if that is suitable, or be completely judgment proof, if that is required.
Finally, I endorse Senator Angus's comment that once you begin to include assets of a specific type, for example, household furnishings with art included, or automobile exclusions with aircraft excluded, you begin down a path, as many have suggested, of arbitrary exclusions and inclusions. Although a certain amount of arbitrariness is inevitable, a point is reached where excessive arbitrariness can make the substructure of the legislation meaningless.
Mr. Ron Brown, Blake, Cassels & Graydon, Legal Counsel to the Canadian Institute of Chartered Accountants: Mr. Krishna has suggested that having these exclusions to the net test -- in other words, having an adjusted net-worth test -- is likely to lead to protracted litigation in order to define what goes in and what falls outside. We believe it is just the opposite. By having clear-cut definitions of assets and liabilities which would be excluded from net worth, all evaluations and questions would be avoided. What is left would be the investment portfolio and the stamp collection of the plaintiff, not all the normal, everyday assets for which there are no ready markets that can value them. Appraisers would have to be hired. We think it is easier. We do not believe it would lead to additional litigation.
We also believe that investors will not arrange their affairs to be unsophisticated plaintiffs. We are talking about a CBCA corporation. It has a special circumstance of misleading financial information resulting in a multimillion dollar lawsuit where the defendants are not available to pay the entire claim. That is the only event in which these unsophisticated, as opposed to sophisticated, plaintiffs will be paid. I cannot imagine investors making an investment decision with the thought that they will arrange their affairs such that they will be considered unsophisticated.
Senator Meighen: You are arguing, as I understand it, that the exclusions would not unduly complicate matters?
Mr. Brown: No, they would simplify matters.
Senator Meighen: I am not sure about that, and I am particularly not sure regarding automobiles and home furnishings. If I bought your argument with the exception of those two, would that destroy the concept?
Mr. Brown: No. You can include or exclude whatever assets you like. It seemed to the CICA that the best thing would be to exclude the normal home-type assets which every household has, rather than investment assets. Every household has a car and furnishings.
Senator Meighen: But you do not deal with boats, et cetera?
Mr. Brown: No, and we do not deal with summer cottages.
Senator Meighen: I do not see why an automobile is included. I think it is unnecessary.
Mr. Brown: It could easily be excluded. It would not affect the concept at all.
The Chairman: On behalf of the committee, and indeed the government, I want to thank all of the groups that took the time to prepare briefs, consult among yourselves and come here today. We appreciate that.
The committee continued in camera.