In 1988, Madam Justice Southin, as she then was, was judging a massive pump and dump case involving microcap issuers that was orchestrated in Vancouver, United Services Funds (Trustee of) v. Lazzell  B.C.J. No. 743, 28 B.C.L.R. (2d) 26.
Although 33 years old, the case should be required reading for capital markets participants for an understanding of the unique typologies of the architecture of pump and dump schemes carried out in British Columbia.
Some issuers in British Columbia have no interest in getting a business going
In the reasons for decision, Madam Justice Southin describes British Columbia promoters as follows, writing (paraphrased):
‘There is a world of difference between the practice of persons promoting a company in which they invest their own money and which they truly intend to make into a successful business and the practice of persons promoting stock as it appears to be carried on by some people in British Columbia. Some promoters have no interest in getting a business going. Their only interest is running up the price of the stock and unloading it on others.’
And so there you have it.
In 1988 and continuing to today, in Vancouver, the game may not always be about running a successful business in the capital markets for some people – it’s about earning revenues from pumping stocks and dumping them on innocent investors.
In this case, Madam Justice Southin quoted a song about the Vancouver capital markets called “Howe Street” that she appears to have heard in a Vancouver theatre about an investor who invested on a tip from a Vancouver stock promoter and got “screwed” when the promoter skipped town.
You may be wondering how they do it – how have they done it for decades?
9 not-so-easy steps to perpetrate securities fraud
Madam Justice Southin describes in the reasons for decision of the case, how such frauds on the market are perpetrated in nine not-so-easy steps:
- Control persons operate behind the scenes who call the shots – they never appear on the documents for securities law disclosure purposes so that a securities regulator doesn’t necessarily know that they are involved;
- Using beneficial ownership structures and aliases, the control persons obtain control of the issued and outstanding shares;
- Appoint what Madam Justice Southin termed a “tame board of directors”, whom she called “monkeys”;
- Issue press releases and periodic required disclosure documentation to give the impression of corporate success as well as file material information (or as Madam Justice noted, not file material information that ought to be filed);
- Line up a brokerage house “related in spirit to the monkeys”, she wrote, to feed stock through, without questions being asked;
- Use a jurisdiction with an under-funded agency with oversight over brokers that lacks resources to detect unusual dealings on the market;
- Use Toronto secret undisclosed powerful promoters in the mix whose names never appear in print, who handle or cause to be handled, all of the administrative work for a group of microcap issuers such promoters are promoting;
- For some of the issuers, line up mining claims on certain properties which she noted, as is usual with such companies, won’t amount to anything; and
- The control persons, as undisclosed insiders, pay to have the stock promoted and cash out when it is high, never filing as insiders.
Liability on other directors of issuers for hidden insiders
In United Services Funds, the defendants were found liable for, among other things, acting as undisclosed insiders. Madam Justice Southin noted that under the Securities Act of British Columbia, the “law considers that investors have a right to know who has control and who is an insider…which are material matters.” (See from paragraph 5 onwards in this article in respect of the role of transparency and disclosure in securities law for issuers, enacted to replace caveat emptor in the public company realm).
She went on to discuss the liability of all directors of issuers in British Columbia who acquiesce in respect of such conduct.
She held that while not every director of every issuer in British Columbia who knows that the material provisions of the Securities Act are being breached by the issuer and/or another person (in this case, a hidden person ostensibly unconnected to the issuer), are themselves guilty of an offense, if their silence in respect of statutory breaches is an act of assistance or their silence in respect of the stock price shooting up for no legit reason tied to a breach of the Criminal Code of Canada is of assistance, such directors may be liable for losses in pump and dump schemes.
In the United Services Funds case, the directors were indeed held liable for losses suffered by investors by the wrongful conduct of the hidden undisclosed insiders and control persons. Their silence was a breach of their duties as directors under the corporate legislation and their silence assisted wrongful conduct to continue.
In essence, where she got to as a matter of the law of acquiescence, was that a breach of corporate law by the on-paper directors led to the not-on-paper hidden control persons being able to commit securities law offenses and enabled Criminal Code violations, and ergo, those on-paper directors were liable for the conduct of the not-on-paper hidden control persons.
Dusting off key 33-year-old case
While United Services Funds remains the law in British Columbia in respect of the liability in the capital markets of directors of microcap issuers who acquiesce or remain silent in the face of market manipulation and hidden control persons, the case seems to have remained buried in the law books.
It might be a good time to dust it off and use it because this is one of the most important cases in securities fraud litigation in Canada.
The case is valuable not just in respect of understanding the unique typologies of the architecture of pump and dump schemes carried out in British Columbia to this day, but also for acquiescence law applied to hold directors of issuers in British Columbia accountable to investors who suffer losses tied to material breaches of the Securities Act, who invest in microcap companies believing that they are investing in a viable enterprise.
Be a real director or be a monkey and get ready to pay
If there is a take-away from this case, it may well be that the message from the Supreme Court of British Columbia is that a person can be a director of an issuer and speak up for compliance with the law when it comes to insiders and hidden control persons, or such a person can be a monkey and get ready to pay investors some serious coin for their losses if things go wrong.