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Class Action Decision Considers Secondary Market Misrepresentation Actions

On July 25, 2013, Justice Belobaba of the Ontario Superior Court of Justice released his decision (2013 ONSC 4083) certifying a proposed class action brought by the Ironworkers Ontario Pension Fund against Manulife Financial Corp. and two of its former executives, Dominic D’Alessandro (CEO) and Peter Rubenovitch (CFO). Belobaba J. also granted the plaintiffs leave to commence an action for secondary market misrepresentation under s. 138 of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “Act”).

Background

In early 2004, Manulife added a number of new guaranteed investment products (the “Guaranteed Products”) to its array of segregated funds. Unlike most of its older products, Manulife decided that the Guaranteed Products would not be hedged or reinsured – any risk of equity market fluctuations would be borne entirely by Manulife. The Guaranteed Products were very successful, growing Manulife’s business from approximately $71 billion in early 2004 to approximately $165 billion by the end of 2008. However, almost all (if not completely all) of that business was unhedged and uninsured. When the global financial crisis hit in the fall of 2008 and the Canadian and American equity markets fell by more than 35%, Manulife was badly overexposed.

On February 12, 2009, Manulife released its 2008 annual financial statements which disclosed that corporate profits had fallen by almost $3.8 billion from the previous year ($2 billion of which was attributable to the Guaranteed Products line) and EPS had dropped from $2.78 to $0.32. The statements also noted that Manulife had increased its reserves from $576 million at year-end 2007 to $5.783 billion because of its unhedged exposure to the equity markets. Investors reacted immediately: Manulife’s share price dropped 6% on the date it released its financial statements, fell a further 37% over the following ten days and, by the end of Manulife’s Q1 2009, was trading at $8.92, a 77% decline from its $38.28 trading price six months earlier.

The plaintiffs commenced a proposed class action in July 2009 based on claims of negligence, negligent misrepresentation, unjust enrichment and the secondary market liability provision of the Act. The plaintiffs alleged that while Manulife was entitled to make a business decision not to hedge or reinsure its equity market risk, it had a legal obligation to fully and fairly disclose to investors its decision to abandon such techniques and the resulting risks. The plaintiffs further alleged, among other things, that Manulife consistently misrepresented in its core disclosure documents that it had in place “effective, rigorous, disciplined and prudent” risk management systems, policies and practices.

Discussion

In certifying the action as a class proceeding and granting leave to pursue a s. 138 claim, Belobaba J. focused on two aspects integral to asserting the statutory cause of action: the test for leave to pursue such a proceeding, and the requirement under the Class Proceedings Act, S.O. 1992, c. 6, that the pleadings disclose a cause of action.

Leave Test under Section 138.8(1) of the Act

Belobaba J. discussed at some length the uncertainties surrounding the second branch of the leave test set out at s. 138.8(1) of the Act: that is, that there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff [1]. In Ontario, class action judges have consistently treated the “reasonable possibility” threshold as a relatively low standard, holding that the plaintiff must simply show, based on a reasoned consideration of the evidence, that there is something more than a de minimis possibility of success at trial. On the other hand, courts in British Columbia have viewed the test as a higher standard which is intended to do more than screen out clearly frivolous, scandalous or vexatious actions.

Belobaba J. pointed out that while his opinion was more consistent with the latter interpretation, the debate may have been decided in favour of the more lenient interpretation by the Supreme Court of Canada’s recent decision in R. v. Imperial Tobacco Canada, 2011 SCC 42. In that decision, the Supreme Court held that under the strike-pleadings rule – which allows a claim to be struck if it is plain and obvious, assuming the facts as pleaded to be true, that the pleading discloses no reasonable cause of action – one must only show a “reasonable prospect of success”, which amounts to the same thing as a “reasonable possibility of success” and may effectively render the test under s. 138.8 of the Act a de minimis threshold (as articulated by the Ontario courts). In any event, Belobaba J. held that he would have come to the same conclusion in favour of the plaintiffs under either interpretation of the test.

Certification under Class Proceedings Act

In certifying the action as a class proceeding, Belobaba J. addressed Manulife’s argument that the pleadings did not disclose a cause of action claim in respect of the s. 138 claim because the action was not commenced within three years of the alleged misrepresentations (as required by s. 138.14 of the Act and the Ontario Court of Appeal’s decision in Sharma v. Timminco Ltd., 2012 ONCA 107).

While Timminco is currently under review by a five-member panel of the Court of Appeal, Belobaba J. agreed with Manulife that he is bound by the current state of the law. However, he also agreed with the plaintiffs’ position that Timminco did not deal directly with the court’s jurisdiction to grant leave nunc pro tunc, and that case law subsequent to Timminco has held that the limitation period in s. 138 of the Act is subject to the special circumstances doctrine (which provides a limited jurisdiction to make orders nunc pro tunc that have the effect of reviving a statute-barred cause of action [2]). On this basis, Belobaba J. concluded that he could not say that it is plain and obvious that the limitation period defence applies and the statutory claim is certain to fail.

Conclusion

Justice Belobaba’s decision, while uncontroversial in its application of current legal principles, stands as an interesting commentary on future potential developments regarding the threshold to be applied in the test for leave under s. 138 of the Act. Indeed, in light of Imperial Tobacco, it may be inevitable that a lower standard emerges which, in Belobaba J.’s words, renders the test for leave “nothing more than a speed bump”. It remains to be seen in future case law whether his premonition proves true.

[1] Belobaba J. held that the first branch – that the action is being brought in good faith – was easily satisfied based on the plaintiffs’ argument and content of their expert reports.

[2] See, e.g., Millwright Regional Council of Ontario Pension Trust Fund v. Celestica Inc., 2012 ONSC 6083 at para. 85.

Class Action Decision Considers Secondary Market Misrepresentation Actions

Court Affirms Standard of Review for Decisions of Securities Commissions is Reasonableness

Background

The Appellants, Sanji Sawh and Vlad Trkulja, who were both mutual fund dealers and exempt market dealers, founded Investment House of Canada (“IHOC”) in 2003. IHOC was a member of the Mutual Fund Dealers Association (“MFDA”), a self-regulatory organization (“SRO”) recognized by the Ontario Securities Commission (the “Commission”).

In 2009, following an investigation into IHOC, the MFDA commenced a disciplinary proceeding in relation to several alleged violations of the MFDA Rules, By-laws or Policies by IHOC and the Appellants. The Appellants and the MFDA subsequently reached a settlement agreement pursuant to which IHOC resigned from the MFDA and wound down, and the Appellants admitted to several contraventions of the MFDA Rules. The settlement agreement was approved by an MFDA hearing panel.

As a consequence of the settlement agreement, the Appellants’ registration as dealing representatives of a mutual fund dealer was suspended. Six weeks after the settlement agreement, the Appellants applied to the Commission to have their registrations reinstated, which was denied. The Appellants requested a review of the decision and, after a six-day hearing before two commissioners, the OSC determined that the Appellants lacked the proficiency and integrity required by sections 27(1) and (2) of the Securities Act, R.S.O. 1990, c. S.5 (the “Act”), to be registered as dealing representatives of a mutual fund dealer, and that reinstatement of their registrations would be otherwise objectionable.

The Appellants appealed to the Divisional Court, arguing that the conduct reviewed by the OSC was almost exclusively conduct that had already been fully investigated by the MFDA – which had not imposed a sanction barring the Appellants from applying for reinstatement of their registrations – and that by refusing their application, the Commission had departed from its established practice of deferring to the determinations made by expert SROs such as the MFDA.

Discussion

In delivering the Panel’s decision, Justice Sachs agreed with the Appellants that the case law surrounding Commission reviews of SRO decisions highlights the importance of deference to an SRO’s findings. In the Appellants’ case, however, the Commission was not conducting a hearing and review of the MFDA’s settlement agreement or the hearing panel’s decision approving that agreement (which, in any event, did not provide that the Appellants’ registration would be reinstated).

Rather, the Commission’s decision was an exercise of its discretion under section 27 of the Act to consider whether the Appellants were suitable candidates for re-registration, over which the Commission has sole jurisdiction (as the MFDA has not been delegated this authority). Justice Sachs held that the Commission’s decision was justifiable and transparent, and met the applicable standard of review of reasonableness.

The Divisional Court’s decision serves as a reminder that SROs derive their jurisdiction by virtue of being recognized by provincial securities commissions and that the power of SROs and their members is always subject to the oversight of those commissions. It also reaffirms the principle, recently expressed in other contexts,[1] that the courts will generally afford considerable deference to the decisions of securities commissions by applying a standard of review of reasonableness.

[1] See, e.g., Cornish v. Ontario Securities Commission, 2013 ONSC 1310 (CanLII) which dealt with continuous disclosure obligations, and Rankin v. Ontario Securities Commission, 2013 ONSC 112 (CanLII) which addressed a settlement entered into between the Appellant and the Commission.

Court Affirms Standard of Review for Decisions of Securities Commissions is Reasonableness

UPDATE: Proposed Class Action Based on Offering Document Misrepresentations Certified for Purposes of Settlement

On May 21, 2013, Perell J. certified a proposed class action against certain defendants in Zaniewicz v. Zungui Haixi Corp. based on misrepresentations in Zungui’s IPO offering documents and other disclosure documents, including its audited and unaudited financial statements (2013 ONSC 2959). Perell J. had previously heard and granted the plaintiffs’ motion for leave to assert a secondary market liability claim under s. 138.3 of the Ontario Securities Act against certain defendants (click here for a summary of that decision).

By the time of the certification hearing, the plaintiffs had reached two settlements covering all of the defendants except for those that comprised the underwriting syndicate for Zungui’s IPO (including CIBC World Markets Inc., Canaccord Genuity Corp., GMP Securities LP and Mackie Research Capital Corporation – collectively, the “Underwriter Defendants”). As such, the motions for certification were brought for settlement purposes and did not address the claims against the Underwriter Defendants.

In certifying the class action against the settling defendants, Perell J. noted that even in situations where certification is sought for settlement purposes, all of the criteria for certification under s. 5(1) of the Class Proceedings Act, 1992, S.O. 1992, c. 6 must still be met (though compliance with the criteria is not as strictly required because of the different circumstances associated with settlements).

It remains to be seen whether the plaintiffs will continue to pursue their claim against the Underwriter Defendants. Given Perell J.’s determination that the proposed class action against the settling defendants satisfied all of the certification criteria (albeit on a less strict evaluation than would be applied in a contested certification motion), it is more likely than not that the plaintiffs would be successful if they moved to certify against the Underwriter Defendants. On the other hand, the plaintiffs have yet to obtain leave to assert a secondary market liability claim against the Underwriter Defendants and, through the proposed settlements, have already recovered half of their estimated damages ($10M as against the plaintiffs’ estimate of $20M). The plaintiffs’ intentions will likely become clearer following the settlement approval hearings on August 26, 2013.

UPDATE: Proposed Class Action Based on Offering Document Misrepresentations Certified for Purposes of Settlement

Class Proceeding against Investment Advisor, Firm and Trustee Certified at the Expense of Individualized Causes of Action

Background

Verbeek was an investment advisor and, at some relevant times, a registered representative of the defendant Dundee Securities Corporation (“Dundee”). According to the plaintiffs’ allegations, between August 1998 and June 2001, Verbeek ran an investment scheme pursuant to which his clients could access money in their retirement savings on a tax-free basis. Under the scheme, Verbeek’s clients would either create a self-directed, locked-in RRSP at Verbeek’s investment firm (such as Dundee) or open a trust account at a third party trustee (such as the defendant Canadian Western Trust Company, or “CWT”). Those RRSP funds were then used to purchase shares in certain Canadian Controlled Private Corporations, or “CCPCs”, which were purportedly qualified investments for locked-in RRSPs. Verbeek’s clients were then to receive loans using the CCPC shares as collateral. The CCPC shares were subsequently found to be worthless, and Verbeek’s clients lost some or all of their money. The plaintiffs also allege that the CCPC shares were not eligible investments for locked-in RRSPs and were immediately taxable, and that the loans were illegal.

The plaintiffs allege that Dundee and CWT are liable on the basis of breach of contract, negligent performance of a service, negligence simpliciter and breach of fiduciary duty. At the certification motion, the plaintiffs sought to certify an overall “Verbeek Class” (which would include all of Verbeek’s clients who participated in the investment scheme) and two subclasses: the “Dundee Subclass” (composed of all Verbeek Class members who participated in the investment scheme while Verbeek was registered at Dundee) and the “CWT Subclass” (composed of all Verbeek class members whose shares were held by CWT).

In analyzing the proposed class action, Justice Lauwers found that it met the criteria set out in s. 5 of Ontario’s Class Proceedings Act, 1992, S.O. 1992, c. 6, though he expressed reservations about the fact that the class and sub-class definitions were subjective and referenced the merits of the plaintiffs’ claim, and held that the common questions required some amendment. Accordingly, Justice Lauwers certified the action conditionally pending completion of the above amendments.

Discussion

While Dundee and CWT opposed certification on several bases, the most interesting arguments concerned the requirement that each plaintiff’s individual claim share a common issue.

Dundee argued that the plaintiffs’ allegations of breach of contract, negligence and breach of fiduciary duty would oblige the court to engage in the fact-specific inquiry of assessing the suitability of the individual investments proposed by Verbeek to each of his clients, rendering those causes of action incapable of being common issues. CWT likewise argued that there was no evidentiary basis for determining that the proposed class members all participated in the same investment scheme in the same way for the same purpose.

In rejecting these arguments and holding that the causes of action disclosed common issues, Justice Lauwers rejected the “degree of hyper-commonality” demanded by Dundee and CWT, holding that it is well settled that courts must not set the bar too high on the common issues test. Justice Lauwers approved of the plaintiffs’ position that “the investment scheme was a scam and entirely inappropriate for any investor”, which he found to be a plausible assertion on the evidence. In accepting this simple characterization of commonality, however, Justice Lauwers pointed out that the plaintiffs might be limiting grounds for liability that would otherwise be available to individual class members in separate actions – for example, allegations of a breach of an IA’s duty to know his client.

Justice Lauwers’ decision highlights some of the difficulties associated with asserting individualized causes of action in the IA-client context as “common issues” in a class proceeding. Plaintiffs in such situations will need to determine whether they are willing to sacrifice certain individual causes of action in order to take advantage of the beneficial cost and efficiency aspects of class proceedings.

Class Proceeding against Investment Advisor, Firm and Trustee Certified at the Expense of Individualized Causes of Action

Court Confirms that S. 130 of the Ontario Securities Act Applies Only to Primary Market Purchasers

In the recent decision of Tucci v. Smart Technologies Inc. (2013 ONSC 802), Justice Perell confirmed that the statutory cause of action for misrepresentation in a prospectus (set out in s. 130(1) of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “OSA”)) does not apply to purchasers in the secondary market even when those purchasers buy securities during an ongoing IPO.

Background

In Tucci, the defendant Smart Technologies (“Smart”) filed a prospectus for the purposes of an IPO in respect of which the period of distribution began on July 15, 2010. In addition to Smart, both the defendants Intel Corporation and School S.a.r.L. sold Smart shares pursuant to the IPO. The IPO closed on July 20, 2010. However, prior to closing, the Smart shares began trading on the secondary market (on both the TSX and NASDAQ). The plaintiff alleges that on November 9, 2010, Smart made corrective disclosure in respect of a misrepresentation contained in its prospectus. The plaintiff subsequently commenced a proposed class action asserting a claim for damages under s. 130 of the OSA (as well as similar claims under the relevant sections of other Canadian securities legislation).

At the certification motion before Justice Perell, the defendants consented to certification of the action subject to one contested issue regarding the scope of the plaintiff’s proposed class definition. Section 130(1) of the OSA provides that where a prospectus contains a misrepresentation, “a purchaser who purchases a security offered by the prospectus during the period of distribution or during distribution to the public” has a cause of action against, amongst others, the issuer and underwriters of the securities in question. This statutory cause of action has conventionally been understood to be available only to purchasers buying securities in the primary market, and not purchasers in the secondary market (who have their own statutory cause of action set out in s. 138.1 of the OSA for which leave is required). The plaintiff challenged this conventional understanding by seeking to certify a class which included persons who acquired Smart shares on the secondary market between July 15 and 20, 2010, arguing that during the period of distribution, purchasers in both the primary and secondary markets are similarly situated and, as a matter of public policy, it is desirable to treat similarly-situated persons equally. The plaintiff also sought to distinguish existing Ontario case law restricting the s. 130 cause of action to primary market purchasers on the basis that those cases only addressed secondary market purchasers who bought securities after the primary market distribution had been completed.

In rejecting the plaintiff’s submissions, Justice Perell held that a secondary market purchaser does not purchase securities offered by a prospectus but, rather, purchases securities offered by a secondary market vendor, likely at a different price and on different terms of sale than primary market purchasers. Justice Perell also noted that the plaintiff’s “strained interpretation” would have the anomalous result that some s. 130 claimants (the secondary market purchasers) would not have the alternative statutory right of rescission which is only available against the issuer, selling security holders and underwriters (and not secondary market vendors). In the result, the plaintiff’s proposed class definition was revised by excluding secondary market purchasers.

Commentary

This result is consistent with previous decisions, including Menegon v. Philip Services Corp. (2001 CanLII 28396 (ON SC)), in which FMC’s J.L. McDougall and Michael Schafler successfully argued that extending s. 130 to secondary market purchasers could expose issuers and their advisors to indeterminate liability, as primary market purchasers might sell their purchased securities during the period of distribution to secondary market purchasers, who may themselves resell the securities several times.

Court Confirms that S. 130 of the Ontario Securities Act Applies Only to Primary Market Purchasers

Court of Appeal Agrees to Reconsider Timminco

On February 6, 2013, the Court of Appeal for Ontario agreed to review its much discussed decision in Sharma v. Timminco Limited (2012 ONCA 107).

Background

Timminco concerned a proposed class action in which the plaintiff sought to assert a claim for secondary market misrepresentation pursuant to section 138.3 of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “OSA”), for which leave of the court is required under s. 138.8(1). Section 138.14 of the OSA provides that an action under s. 138.3 must be commenced within three years of the date of the alleged misrepresentation (or within six months following the issuance of a news release disclosed that leave has been obtained, whichever occurs first). The plaintiff had asserted in his Statement of Claim that he intended to seek leave as required by the OSA but, for various reasons, had not obtained leave by February 2011 (when the three-year limitation period was about to expire). The plaintiff thus sought and obtained an order declaring that the limitation period had been suspended by s. 28(1) of the Class Proceedings Act, 1992, S.O. 1992, c. 6 (the “CPA”), which provides that “any limitation period applicable to a cause of action asserted in a class proceeding is suspended in favour of a class member on the commencement of the class proceeding”. The defendants appealed to the Court of Appeal on the issue of whether pleading the intention to seek leave was sufficient to suspend the limitation period. The Court of Appeal overturned the initial decision, concluding that without leave having been obtained, no cause of action under s. 138.3 was being “asserted” so as to engage s. 28(1) of the CPA. As such, the cause of action for secondary market misrepresentation was not a legal right and could not be enforced. The Supreme Court of Canada declined to review the decision.

Since its release in February 2012, Timminco has attracted criticism from the plaintiffs’ bar which argues that the court’s approach has proven to be unworkable given the inherent delays in the court system, and the ability of corporate defendants to exacerbate those delays. In contrast, the defence bar has praised Timminco as providing certainty.

In the meantime, two further secondary market liability cases had come before the Court of Appeal on appeal: Green v. Canadian Imperial Bank of Commerce (2012 ONSC 3637), in which Justice Strathy reluctantly declined to certify a class action because it was time-barred by the three-year limitation period; and Silver v. IMAX (2012 ONSC 4881), in which Justice van Rensburg granted an order issuing retroactive leave under s. 138.8 of the OSA to allow the claim to proceed. IMAX is particularly interesting in that oral argument on the leave application had concluded before – and Justice van Rensburg’s decision was released after – the three-year limitation had expired. At the request of the plaintiffs in both cases, the Court stated that it would appoint a special five-judge panel to hear the two appeals and reconsider the issues raised by Timminco. The panel is set to convene in May 2013.

Commentary

Limitation periods are meant to provide certainty by representing an ultimate cut-off for potential legal proceedings. Recent legislative reforms were aimed at making Ontario’s limitation period laws even stricter by eliminating the “special circumstances” doctrine. IMAX represents a departure from this trend and a step back towards the “special circumstances” doctrine. On the other hand, Timminco seemed harsh. What, specifically, has motivated the Court of Appeal to reconsider the issue is not known. Typically, however, full panels of the Court of Appeal are convened to reconsider decisions that have sparked public debate, which has been the case here. It may be that the Court of Appeal wishes to clarify its prior ruling – for example, by promulgating a new test for these types of cases. It may also be that the Court overrules itself. Our own view is that the Court may well provide clarification as to the meaning of the word “asserted” found in s. 28(1) of the CPA; the Court may, for example, hold that the launching of a leave motion under s. 138.3 of the OSA should suffice to suspend the applicable limitation period, since that step is akin to “asserting” a claim within the meaning of s. 28(1) of the CPA. It may also hold that as long as the motion is heard before the limitation period expires, the limitation period will have been complied with.

Court of Appeal Agrees to Reconsider Timminco

Deloitte & Touche Inc. Seeks to Discontinue Class Action Against Bre-X Principals

Deloitte & Touche Inc. (“Deloitte”), the long-acting trustee for the Estate of Bre-X Minerals Ltd., has brought motions in the Alberta and Ontario courts seeking leave to discontinue the class action litigation that it has been prosecuting against, amongst others, former Bre-X principal John Felderhof and his ex-wife Ingrid Felderhof, as well as the Estate of founder and CEO David Walsh.

As a brief background, in October 1997, an action was commenced in Alberta by investors who lost money on the collapse of Bre-X. In November 1997, the Alberta Bankruptcy Court authorized Deloitte to prosecute the class action on behalf of these investors; shortly thereafter, Deloitte was granted carriage in Ontario in January 1998 (collectively, the “Deloitte Action”). The Deloitte Action asserted that John Felderhof failed to promptly disclose material changes relating to Bre-X’s gold mining properties, and that he conspired with others to deceive investors by issuing false statements, announcements and press releases.

Deloitte’s motions for discontinuance are being brought for two reasons: Deloitte no longer has the financial resources to prosecute the Deloitte Action, and it believes that there is no reasonable prospect of significant recovery from the Felderhofs or the Walsh Estate. Deloitte’s motions are opposed by David Carom, one of the plaintiffs in a second class action against the Felderhofs and the Walsh Estate which, until recently, was in a litigation partnership with the Deloitte Action.

In anticipation of Deloitte’s Ontario discontinuance motion hearing (currently scheduled for March 4, 2013), Mr. Carom recently brought a cross-motion seeking an order that Ingrid Felderhof and Jeannette Walsh (David Walsh’s widow) attend to be examined as witnesses under Rule 39.03 of the Rules of Civil Procedure, and that Ingrid Felderhof allow class counsel to obtain an appraisal of a property in the Cayman Islands. Deloitte opposed the cross-motion based on its concern that its discontinuance motion could be affected in the event that either of the proposed witnesses failed to comply with any order made by the court.

At the cross-motion hearing (2012 ONSC 7278), Perell J. held that since neither of the proposed witnesses had actually been served with a summons, the appropriate decision was to adjourn the cross-motion to allow Mr. Carom to serve summonses. Perell J. noted, however, that had summonses been served, he saw no basis for striking them out. With respect to the request for an appraisal, Perell J. dismissed the motion without prejudice due to the lack of advice concerning his jurisdiction to make such an order, noting that Ingrid Felderhof was not a party to the Ontario litigation.

Deloitte & Touche Inc. Seeks to Discontinue Class Action Against Bre-X Principals

Court Confirms No Need for Defendants to Lead Evidence in Motion for Leave under Part XXIII.1 of the Ontario Securities Act

In the recent decision of Dugai, Murphy v. Manulife Financial Corporation (2013 ONSC 327), the Divisional Court confirmed the principle that defendants have no obligation to lead evidence on a motion for leave to assert a cause of action for secondary market misrepresentation under s. 138.8(1) of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “Act”).

In Dugai, the plaintiff investors proposed a class action alleging inadequacies in the defendant corporation’s Risk Management Policies and Practices, including a cause of action for secondary market misrepresentation under Part XXIII.1 of the Act (for which they require leave under s. 138.8(1)). After being advised that the defendants did not intend to file any affidavits on the leave motion (currently scheduled for March 2013), the plaintiffs summoned two Manulife employees under Rule 39.03 of the Rules of Civil Procedure to provide relevant evidence for use during the leave motion. The defendants brought a motion to quash the summonses, and the plaintiffs brought a cross-motion to compel the defendants to file affidavits. Belobaba J. granted the defendants’ motion and dismissed the cross-motion; the plaintiffs sought leave to appeal in the Divisional Court.

In upholding Belobaba J.’s decision and dismissing the plaintiffs’ application, Harvison Young J. agreed with his analysis that the two issues on motion – whether defendants are required to serve and file affidavits on a s. 138.1 motion, and the availability of Rule 39.03 summmonses in such circumstances – have already been fully adjudicated. Both judges drew particular attention to the decision of Lax J. in Ainslie v. CV Technologies (2008), 93 O.R. (3d) 200 (S.C.J.), one of the first actions brought under Part XXIII.1 of the Act. In Ainslie, FMC’s Robb Heintzman and Matthew Fleming successfully argued that the Act only requires a defendant to file an affidavit where it intends to lead evidence in response to a leave motion, and that allowing the plaintiffs to examine the defendants in the absence of such affidavit evidence would amount to an abuse of process, as it would afford the plaintiffs greater rights of discovery than in an action where it is unnecessary to obtain leave.

Harvison Young J. concluded that the number of recent cases which accepted and applied the reasoning in Ainslie “overwhelming supports the motion judge’s interpretation of s. 138.8 that it does not require the defendants to deliver affidavits or to be subjected to cross examination when they do not intend to lead evidence in response to the leave motion”.

Court Confirms No Need for Defendants to Lead Evidence in Motion for Leave under Part XXIII.1 of the Ontario Securities Act

Leave to Assert Secondary Market Liability Claim under Part XXIII.1 of the Ontario Securities Act Granted in Proposed Class Action

In Zaniewicz v. Zungai Haixi Corp (2012 ONSC 6061), Perell J. heard and granted the plaintiffs’ unopposed motion for leave to assert a secondary market liability claim under section 138.3 of Part  XXIII.1 of the Ontario Securities Act, R.S.O. 1990, c. S.5 (the “Act”).

The defendant corporation, Zungui, is an Ontario public company that indirectly owned a shoe company incorporated and operating in the People’s Republic of China, and was a reporting issuer under the Act. The individual defendants Fengyi Cai, Jixu Cai, and Yanda Cai (the “Cai Brothers”), who were directors and/or officers of Zungui, were varyingly responsible for approving, or overseeing the audit committee’s approval of, both Zungui’s audited annual financial statements and its unaudited interim financial statements.

In December 2009, Zungui raised approximately $40 million in Ontario’s capital markets through an initial public offering. In Zungui’s financial statements, Zungui and the Cai Brothers represented to the investing public that the financial statements presented Zungui’s financial position fairly in all material respects, and that Zungui’s IPO offering documents contained full, true and plain disclosure of all material facts relating to the offering of securities.

On August 22, 2011, Zungui issued a press release announcing that Ernst & Young (“E&Y”), its auditor, had suspended its audit of Zungui’s financial statements for the year ended June 30, 2011. Zungui’s shares immediately lost 77% of their value, and are now virtually worthless. The Ontario Securities Commission commenced an investigation and, in February 2012, ruled that the Cai Brothers had engaged in conduct contrary to the public interest. The investigation also revealed that when E&Y resigned on September 23, 2011, it advised that all audit opinions that formed part of the IPO prospectus and Zungui’s June 2010 financial statements could no longer be relied upon.

In their claim, the plaintiffs alleged that Zungui’s financial statements (both those contained in its IPO prospectus and others later prepared and disseminated in the secondary securities market) were neither accurate nor reliable, and that the Cai Brothers made misrepresentations in Zungui’s secondary market continuous disclosure documents.

In order for leave to be granted under section 138.8 of the Act, a plaintiff must demonstrate that (i) the proposed action is brought in good faith, and (ii) there is a reasonable possibility that the proposed action will be resolved at trial in the plaintiffs’ favour. In granting leave, Perell J. noted that Part XXIII.1 mandates a preliminary, low-level merits based leave test and that, as at the date of writing, three Ontario courts had considered the test and agreed that the standard is a “relatively low threshold” depending “on the evidence that the parties put before the court” (as described in Silver v. Imax Corporation (2009), 66 B.L.R. (4th) 222 (Ont. S.C.J.)). Perell J. held that there was no reason to doubt the plaintiffs’ good faith and that, while the evidence adduced by the plaintiffs would have satisfied the second arm of the test, the Cai Brothers had been noted in default and their deemed admissions of the factual allegations in the Statement of Claim were sufficient to satisfy the section 138.8 test.

Leave to Assert Secondary Market Liability Claim under Part XXIII.1 of the Ontario Securities Act Granted in Proposed Class Action