In Ontario Securities Commission v. Tiffin,[1] the Ontario Court of Appeal recently confirmed that a secured promissory note is a “security” under the Securities Act (Ontario) (the Ontario Act), and declined to import the “family resemblance test” from US securities law to read down the definition of “security”.

Background

Daniel Tiffin (Tiffin) and his company Tiffin Financial Corporation (TFC) borrowed $700,000 from friends and clients. They issued promissory notes as evidence of this indebtedness. Tiffin and TFC issued the promissory notes when they were subject to a cease trade order from the Ontario Securities Commission (OSC), which prohibited them from trading in securities or relying upon any exemption under Ontario securities laws. The OSC charged Tiffin and TFC for trading in securities without registration, distributing securities without filing a prospectus, and trading in securities while prohibited.

Lower Court Decisions

After trial in the Ontario Court of Justice, Tiffin and TFC were acquitted based on a finding that the promissory notes were not securities because they resembled notes secured by a lien on small business assets. Although the trial judge accepted that the Ontario Act is a “catch and exclude” regime, which is defined by a broad definition of “security” and broad exemptions, he held this interpretation would render the definition overly broad and was against the intent of the Ontario Act. In reaching this conclusion the trial judge applied the American “family resemblance” test from Reeves v. Ernst & Young (1990), 494 U.S. 56, (Reeves).

On appeal, the Superior Court of Justice held that the trial judge erred in applying the test in Reeves. The Superior Court disagreed that promissory notes, which fall within the statutory definition, should be excluded based on judicially established criteria. The Court also concluded that the broad definition of security in the Ontario Act was intentional and consistent with the remedial purpose of the securities regime.

Ontario Court of Appeal

The central issue before the Court of Appeal was whether the promissory notes at issue fell within the definition of “security” in the Ontario Act. The Court of Appeal concluded that they were securities since the Ontario Act defines “security” to include, among other things, “a bond, debenture, note or other evidence of indebtedness”.

Applicability of American “family resemblance” test

The American “family resemblance” doctrine treats an instrument as a security for the purposes of the US legislation unless it bears a strong resemblance to judicially recognized “families” of instruments that are not securities. Courts look to various factors including (1) motivation of the parties, (2) plan of distribution, (3) reasonable expectations of the investing public, and (4) existence of other applicable regulatory schemes that would reduce risk.

The Court of Appeal said that American securities law can be useful in some cases when interpreting Ontario’s securities legislation because the regimes have similar purposes and intend to address similar issues. The mechanics of the regimes, however, are different. In this case, the following key differences between the Ontario and U.S. securities law regimes militated against importing the American “family resemblance test” to interpret the definition of “security” under the Ontario Act:

1. The definition of security in the Securities Exchange Act of 1934, 15 U.S.C. 78a (the U.S. Act) is exhaustive except for a contextual qualification discussed below. It begins with the language “security means”. In contrast, the definition of security in the Ontario Act begins with “security includes” which is not exhaustive, thereby demonstrating breadth in interpretation.
2. Definitions in the U.S. Act are preceded by the phrase “unless the context otherwise requires”, which the U.S. Supreme Court in Reeves relied upon to justify a narrowing of the definition of security. As there is no such phrase in the Ontario Act, the definition of security could not be narrowed through judicially created exemptions.
3. The U.S. Act and the Ontario Act have taken different approaches to defining short-term debt instruments. The former includes exclusions for commercial instruments such as “any note, draft, bill of exchange, or banker’s acceptance which has a maturity at the time of issuance of not exceeding nine months.” In contrast, the Ontario Act expressly captures a similar class of instruments within the definition of “security” but provides an exemption from prospectus and registration requirements when such securities are traded or distributed.

Availability of Exemptions

The Court of Appeal rejected an argument by Tiffin and TFC that the test in Reeves should apply because the terms of the OSC’s cease trade order removed their ability to rely upon the otherwise available exemptions under the Ontario Act’s ‘catch and exclude’ regime. The Court reasoned that the appellants’ “quarrel is properly directed at the [cease trade] order, not the definition of security in the Act”, noting that they did not avail themselves of procedures available to exempt specific trades or vary the cease trade order.

The Court of Appeal noted when considering the appellants’ appeal from the sentence that regulatory offences are prosecuted because compliance is necessary to achieve public interest goals, not because the underlying conduct is inherently abhorrent.

Takeaways      

1. As a general proposition, U.S. securities law remains relevant to assist in the interpretation of Canadian securities law. U.S. securities law may be followed in Canada when the underlying policy mirrors that of the Canadian securities regime. For instance, Canadian jurisprudence on the meaning of the term “investment contract” in the definition of “security” has considered and followed the US Howey and Hawaii decisions.[2]
2. U.S. securities law will likely not be relied upon as a basis to limit the scope of statutory Canadian securities law. In Tiffin, the Court of Appeal held that “there is no indication that the legislator intended short-term debt instruments to be understood as anything other than securities”[3] and “[t]here is simply no indication that the Ontario legislator wished to determinatively distinguish between commercial and investment instruments as courts have held in the United States.”[4] Given the clear legislative intent in the Ontario Act, the Court of Appeal was loathe to “raise a risk of unintended consequences and litigation inherent when tinkering with a definition central to a complex regulatory scheme”.[5] The fact that money was raised through the issuance of notes in the face of a cease trade order might also have influenced the outcome.
3. Ontario’s legislative ‘catch and exclude’ regulatory scheme which is built on a broad definition of security with tailored exemptions from particular parts of the statute can provide the OSC Staff with more latitude in  asserting that new instruments  fit within the definition of security in the Ontario Act. The fairness and correctness of this approach is being carefully watched in the regulation of digital and crypto currency trading.

 

[1] 2020 ONCA 217.

[2] In Pacific Coast Coin Exchange v. Ontario Securities Commission, [1978] 2 SCR 112, the Supreme Court held that to determine the existence of an “investment contract”, one must consider whether the offering involves (1) an investment of money (2) in a common enterprise (3) with an expectation of profit (4) to come significantly from the efforts of others.

[3] 2020 ONCA 217 at para. 44.

[4] 2020 ONCA 217 at para. 45.

[5] 2020 ONCA 217 at para. 48.