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OSC Disclosure Obligations Under the Securities Act (Ontario)

On January 11, 2013, the Ontario Superior Court of Justice (Divisional Court) delivered its decision in Re Rankin, upholding the decision of the Ontario Securities Commission (the “Commission”) dismissing an Application to set aside an order in which it approved a settlement agreement between Commission Staff and the appellant, Andrew Rankin (“Rankin”).

Rankin was managing director of the mergers and acquisitions branch of RBC Dominion Securities. Charged with ten counts of insider trading and ten counts of tipping under ss. 76(1) and (2) of the Securities Act, R.S.O. 1990, c. S.5 (the “Act”), he was ultimately convicted of all ten counts of tipping but was not convicted of insider trading.

Rankin committed these offences by providing confidential information to Daniel Duic, (“Duic”), an acquaintance who himself was in negotiations with the Commission and subsequently settled with it. Duic provided evidence on which the trial judge relied to convict Rankin, sentencing him to 6 months’ imprisonment.

On November 9, 2006, Rankin’s conviction was overturned and a new trial was ordered by Justice Nordheimer of the Superior Court of Justice. Before the commencement of the new trial, on February 19, 2008, Commission Staff reached a settlement agreement with Rankin, which included an admission of guilt. The Commission approved the settlement agreement on February 21, 2008, and released reasons on March 17, 2008.

In August, 2008, Rankin learned that in late 2007, Duic had been under investigation for committing a “technical breach” of his settlement agreement by engaging in trading contrary to the Cease Trade Order included in his settlement agreement.

Rankin brought an Application challenging the Commission’s decision to approve the settlement agreement pursuant to s. 144 of the Act on the basis that the failure of Commission Staff to disclose the investigation against Duic resulted in manifest unfairness to Rankin in deciding to enter into the settlement agreement. The Commission rejected Rankin’s Application.

On appeal, the Divisional Court held that the Commission’s decision not to revoke the settlement agreement was reasonable. The Divisional Court concluded that the information in question would not likely have materially impacted Rankin’s defence strategy, apart from calling Duic’s credibility into question. It further found that the Commission was correct to conclude that the omission of such information did not cause manifest unfairness to Rankin.

Justice Matlow dissented. According to Justice Matlow, it was essential that Rankin be fully apprised of the evidence against him, including the full scope and nature of the investigations against Duic. Furthermore, held Justice Matlow, the Commission erred in considering whether information relating to the investigation against Duic was “crucial information in connection with the negotiation of the Rankin Settlement Agreement” instead of information relevant to Rankin’s decision to enter into the settlement agreement. As Matlow J. put it,

[t]he Commission’s formulation of the test required the Commission to determine whether or not the undisclosed information, as at the time when Rankin agreed to the settlement, “would likely have affected the outcome of the Rankin Administrative Proceeding“. Not only was this requirement irrelevant to the merits of Rankin’s motion before the Commission but, because it called for the Commission to make a determination, as at that time, of the likely outcome of a future hearing, first assuming that Rankin did not have the undisclosed information and then comparing it on the assumption that he did, it was unworkable.

According to Justice Matlow, Rankin should have been provided with all information relevant to his decision to enter into the settlement agreement, not merely that information which was crucial to its negotiation.

Commentary:

The result of the Court’s split decision in this case raises many questions. What rights do persons accused of offences under the Act have to disclosure of the case against them? If an accused person faces possible incarceration resulting from breaches of the Act, should criminal law disclosure obligations not apply to Commission Staff?

The decision of the Divisional Court in this case would suggest the answer is “no”.

If an accused person enters a guilty plea in the criminal context because the crown does not disclose material information relevant to the case against the accused, the accused may succeed in having the guilty plea withdrawn. To do so, the accused must prove (a) that the Crown did not meet its disclosure obligations; and (b), that on a balance of probabilities the lack of disclosure impaired the accused’s right to make full answer and defence (see R. c. Taillefer (2003), 179 C.C.C. (3d) 353 (SCC)).

The Divisional Court distinguished the present case from pure criminal cases, indicating instead that proceedings before the Commission are administrative and quasi-criminal. In such context, the Divisional Court suggested, the public interest does not require the setting aside of the settlement agreement, and concluded that from the perspective of a reasonable person, if disclosed, the information would not have affected the outcome of the proceedings.

This case highlights the distinction between the prosecution’s criminal and quasi-criminal disclosure obligations. Given that an accused person prosecuted under criminal or quasi-criminal charges may suffer the same punishment, namely, a loss of liberty, one might reasonably ask why a distinction exists between the crown’s disclosure obligations in each circumstance.

This question is not resolved by the court in this case, and it appears that at least for the time being, the prosecution will be subject to a lower standard of disclosure in quasi-criminal proceedings than in criminal proceedings, notwithstanding that proceedings under each regime may impose similar if not identical punishments on those convicted.

OSC Disclosure Obligations Under the Securities Act (Ontario)

Cornish v. Ontario Securities Commission

On March 19, 2013, the Ontario Superior Court of Justice (Divisional Court) released its judgment in Cornish v. Ontario Securities Commission, on appeal from a decision of the Ontario Securities Commission (the “Commission”) issued September 28, 2011. The appeal concerned the Commission’s interpretation and application of the term “material change” in the Securities Act, R.S.O. 1990, c. S.5 (the “Act”) and the obligations of reporting issuers to disclose such material changes.

This case provides greater insight and certainty into the meaning of “material change” and the obligations of reporting issuers when such changes occur.

Facts

Cornish was President and CEO of Coventree Inc. (“Coventree”), a niche investment bank specializing in structured finance. Coventree managed and administered ten separate trusts commonly called “conduits” which issued asset-backed commercial paper debt instruments (“ABCP”).

On January 19, 2007, the Dominion Bond Rating Service (“DBRS”) issued a press release in which it changed its credit rating criteria for certain credit arbitrage transactions. The effect of this change was to require Coventree to secure an unattainable type of liquidity to back credit arbitrage transactions going forward. Before this change, the now DBRS-restricted type of credit arbitrage transactions represented 40% of the conduits’ assets, and their use was the largest contributor to Coventree’s growth.

Coventree referred to the DBRS press release in a letter to its shareholders on February 14, 2007, and again in its second quarter Management’s Discussion & Analysis (“MD&A“), publicly filed on May 14, 2007. It stated that the DBRS January Release would “have the effect of reducing the profitability of the Company by substantially curtailing its ability to grow, if not halt in the short term, its credit arbitrage business.”

In July 2007, Coventree took various steps to attempt to address the lack of demand for new ABCP. However, on August 13, 2007, the market for Coventree-sponsored ABCP collapsed, and Coventree’s ABCP investors could not sell or redeem their ABCP instruments. Cornish prepared and issued a press release disclosing the market disruption as a material change.

The Commission found that Coventree breached the Act by failing to issue a news release and failing to file a material change report about the DBRS January Release. The Commission reached this conclusion despite the fact that Coventree’s mentions of the DBRS January Release in its February 14, 2007 letter to shareholders and in its May 14, 2007 MD&A did not result in any significant change in the price of Coventree shares.

Material Change Analysis

Section 75 of the Act requires “forthwith” disclosure of material changes to a reporting issuer’s business, operations or capital. Section 1.1 of the Act defines “material change as”

[A] change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer.

Regarding the application of s. 75 of the Act, the court in this case states:

The first part of the analysis under s. 75 of the Act requires a determination as to whether a change in the “business, operations or capital” of the issuer has occurred and, if so, when. The second part of the analysis requires an assessment of whether the change was material in the sense that it “would reasonably be expected to have a significant effect on market price or value of the securities.”

The court clarified that the appropriate test to be applied in determining materiality is the “market impact test” which considers what effect certain facts, events or developments would reasonably be expected to have had on the market price or value of Coventree shares.

The court also identified governing principles in applying s. 75 of the Act, and determining if a material change has occurred. The following are the most salient principles identified by the court:

1. Materiality should be assessed objectively from the perspective of an investor and prospectively through the lens of expected market impact. A super critical interpretation of the meaning of “material change” does not support the goal of promoting disclosure or protecting the investing public. If the decision is borderline, the information should be considered material.

2. “Assessments of materiality are not to be made against a standard of perfection or with the benefit of hindsight.”

3. “When a reporting issuer is considering material change disclosure it must apply an objective test as to the expected market impact as it will not have the benefit of actual market impact information.”

4. “Materiality is a highly contextual issue that requires the commission to apply statutory obligations to a particular company in the context of its industry and the market. No single factor will be determinative of whether a material change occurred. In making determinations about materiality common sense must prevail in assessing the broader factual context or the ‘total mix’.”

5. “Since materiality is highly contextual there is no bright line test to determine whether a material change has occurred. That assessment depends on particular circumstances and events.”

6. “A disclosure obligation arises when the material change actually occurs and if the financial impact is experienced at a later date the disclosure obligation is not delayed to that later date.”

7. “The determination of whether a material change has occurred does not require deference to the business judgment of management.”

8. “The commission does not always need evidence of effect on market price to find a material change” has occurred.

Additionally, the court explained why evidence as to an actual impact on the market price of shares is not necessary to prove that a material change has occurred. In the absence of an actual impact on market price, a careful analysis of detailed evidence of the reporting issuer’s business and operations, market conditions and various other market-related factors would be sufficient. As an expert tribunal, the Commission merely applies its expertise to the evidence before it to explain why a lack of change in share price was not determinative of a material change issue.

This case provides greater certainty to reporting issuers in determining their obligations to disclose material change. Notwithstanding that Coventree did in fact inform its shareholders of the likely impact of the DBRS January Release, Coventree did not go far enough in reporting the material change. Based on the principles identified by the court with respect to the application of s. 75 of the Act, reporting issuers faced with similar material changes will not satisfy their obligations under the Act if they fail to file a material change report and news release. Their obligations are not lessened even if an actual change in share value does not result from the material change.

Cornish v. Ontario Securities Commission