Mitigating litigation risks, enforcement actions for financial institutions

The COVID-19 pandemic, and the economic volatility and uncertainty it has created, has heightened the attention placed on consumer protection in litigation and regulatory activity involving financial institutions (FIs). The economic impact of the pandemic has also increased the risk of corporate misconduct due to conflicts of interest and other business practices that do not put customer’s interests first. These areas are a source of litigation and regulatory enforcement action.

To address this changed reality, FIs should proactively mitigate risks in the following areas.

1. Consumer protection-based litigation and complaints on the rise

A recent increase in consumer protection focused class actions and other litigation have included claims of alleged over-payment of investment fund fees, improper denial of insurance coverage associated with cancelled travel or non-delivery of services due to COVID-19, and investor claims for aborted M&A transactions which would have increased share value. 

Takeaway: To combat this exposure, FIs should consider revising standard form consumer contracts and disclosure documents to ensure clear and complete disclosure of fees, conflicts of interest, exclusions of liability for specific events. FIs may also wish to consider dispute resolution out of court, though any arbitration or other dispute resolution clause will be carefully scrutinized to assess whether it is cost-prohibitive, in light of recent Supreme Court of Canada case law. 

2. FCAC enforcement is likely to increase and have a greater impact

The Financial Consumer Agency of Canada’s (FCAC) enforcement activity is expected to increase, and that it will have a greater impact on regulated entities.

The new federal financial consumer protection framework expanded the scope of the FCAC’s oversight through the introduction of new market conduct obligations which could raise potential class action risks.

Although the Bank Act amendments providing for the banks’ new obligations are not yet in force (regulations are expected later this Fall or in early 2021), the provisions strengthening the role and powers of the FCAC came into effect on April 30. Maximum penalties have been increased from $50,000 to $1,000,000 for an individual and from $500,000 to $10,000,000 for institutions. Although the new penalty maximums were not levied in the three decisions released since the amendment (because the violations occurred before April 30), the penalties imposed in these decisions were, in general, higher than in previous FCAC decisions. In one of the decisions, FCAC imposed the highest penalties ever levied ($450,000 and $400,000, respectively). Fines of this magnitude, and potentially even higher when the new provisions are applied, combined with the new mandatory naming provisions, significantly raises the stakes.

Takeaway: FIs should be mindful of the FCAC’s expanded role and its new powers to sanction by enhancing their compliance with financial consumer protection requirements, particularly the more onerous market conduct obligations that are forthcoming in the new framework. 

3. With corporate misconduct on the rise, detection and liability mitigation is paramount

Corporate misconduct gives rise to liability, including employment discipline, regulatory sanctions, criminal prosecution and class actions or other civil litigation. The ripple effects of misconduct can include litigation and regulatory action, as well as reputational damage associated with public disclosure of the misconduct. 

Past economic downturns have led to an increase in corporate misconduct. Languishing financials and share price can lead to improper adjustments to financial reporting, improper sales practices or public disclosure that glosses over poor results. Employees who are experiencing personal financial strain may have an increased propensity to put their own financial self-interest ahead of client or stakeholder interests, which can lead to misappropriation of corporate opportunities and other personal misconduct. Finally, stressed business partners and clients may breach legal requirements or standards for the same reasons.

These forms of misconduct can have trickle down adverse impacts on consumers and investors, in the form of investment losses, or increased costs of goods and services. Increased regulatory interest in investigating and prosecuting white-collar crime followed the 2008 financial crisis, and regulators are currently on heightened watch for the same types of behaviour seen in 2008. A good example is the U.S. and Canadian securities regulator’s current focus on COVID-19-related investment fraud and misrepresentation. 

Takeaway: FIs can manage the risk created by corporate misconduct by maintaining a strong compliance culture in times of economic stress and by avoiding reducing or cutting internal controls and compliance. Regulators expect regulated institutions to remain vigilant during volatile periods, and our experience is that most corporate misconduct and fraud is attributable to weak controls. Internal reporting (including whistleblower programs), as opposed to external audits, detect the vast majority of corporate misconduct. FIs should ensure that their audit and compliance teams are properly staffed and equipped. Officers and directors should understand if and how a company’s culture is creating or reducing risk. Exemplary “tone from the top” is even more important than usual, especially given many regulators have made it a priority to hold officers and directors personally accountable for corporate wrongdoing.

This article was originally published by The Lawyer’s Daily, part of the LexisNexis Canada Group Inc.

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