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Green v. CIBC: Court of Appeal Revisits Limitation Period for Secondary Market Securities Class Actions and Limits Common Law Negligent Misrepresentation Class Actions

Overview

The Court of Appeal for Ontario’s recent decision in Green v. Canadian Imperial Bank of Commerce [1] (“Green”) is significant in two respects.

First, the Court clarified the limitation period applicable to securities class actions under the secondary market liability provisions of the Ontario Securities Act [2] (the “Act”).

Second, the Court also determined that common law negligent misrepresentation claims could not be certified as class actions on the basis of “fraud on the market” or “efficient market” economic theories. In other words, the question of individual reliance cannot be supplanted by the notion of inferred group reliance except in very limited circumstances.

Court of Appeal Overrules its Earlier Decision in Sharma v. Timminco

In Sharma v. Timminco [3] (“Timminco”), the Court of Appeal held that a plaintiff in a secondary market misrepresentation claim must obtain leave from the Court to proceed with such a claim within the three-year limitation period established in the Act and that it was not sufficient to simply issue a statement of claim alleging that the defendants were liable under the secondary market provisions of the Act. The Court held that section 28 of the Class Proceedings Act [4] (“CPA”), which suspends the limitation period for claims which are the subject of a class action, did not operate to suspend the limitation period for secondary market liability claims because leave of the Court is required to proceed with such claims. Thus, if a plaintiff had not obtained leave to proceed with the claim within three years of the date the document containing the misrepresentation was released, the claim was time-barred.

In Green, the Court of Appeal determined that its earlier decision in Timminco was incorrect and had the following unintended consequences:

• it deprived class members of an important benefit of the class action regime; that is, the suspension of the limitation period under section 28 of the CPA; and

• it undercut the ability of investors to initiate class actions in compliance with the limitation period.

The Court of Appeal overruled Timminco and held that when a representative plaintiff brings a secondary market misrepresentation class action and pleads the statutory cause of action, the facts on which the claim is based, and the intention to seek leave, the limitation period is suspended. Therefore, a plaintiff has three years from the date a misrepresentation is made to commence a secondary market misrepresentation claim (as opposed to three years to both commence a claim and obtain leave to pursue it).

Reliance in Common Law Negligent Misrepresentation Claims

In addition, the Court of Appeal considered whether common law negligent misrepresentation claims could be certified on the basis of “fraud on the market” or “efficient market” economic theories. Under these theories, it is unnecessary for investors to demonstrate that they relied on the specific alleged misrepresentation in purchasing securities. The question of reliance is significant as securities class actions in Canada which asserted common law negligent misrepresentation claims, typically faltered on the basis that an investor’s reliance was an individual issue unsuitable for determination in a class proceeding. Certain class action judges in Canada, while rejecting the “fraud on the market” theory to supplant an analysis of individual reliance were nonetheless certifying common law negligent misrepresentation claims, even where an investor’s reliance would otherwise be an individual issue.

In Green, the Court upheld the motion judge’s decision declining to certify common law negligent misrepresentation claims on the grounds that reliance was an individual issue. While the Court held that in certain limited circumstances inferred reliance could provide a basis for a negligent misrepresentation claim, and certain issues related to the negligent misrepresentation claim could be certified as common issues, it rejected the inferred reliance argument in the context of the common law negligent misrepresentation claim in Green.

Comment

In Green, the Court of Appeal adopted a purposive approach to class action procedure and focused, in large part, on the objective of providing access to justice for plaintiffs. The Court held that the three-year limitation period for securities class actions will be suspended when a representative plaintiff pleads: the statutory cause of action, the underlying facts, and the intent to seek leave.

However, while the Court made it easier for plaintiffs to proceed with statutory secondary market securities claims, it also imposed a significant limit on common law negligent misrepresentation claims. This distinction is important. The statutory regime imposes limits on damages for responsible issuers, directors, officers, and experts, such as auditors and lawyers, except in the case of fraud. Plaintiffs sought to avoid these damages caps by pursuing common law claims. However, the Court’s decision in Green limits the ability of plaintiffs to pursue such claims.

 

 

[1] Green v Canadian Imperial Bank of Commerce, 2014 ONCA 90 [Green].

 

[2] Securities Act, RSO 1990, c s.5, Part XXIII.1.

 

[3] Sharma v Timminco, 2012 ONCA 107, leave to appeal to SCC refused, [2012] SCCA no 157 [Timminco].

 

[4] Class Proceedings Act, 1992, SO 1992, c 6 [CPA].

 

Green v. CIBC: Court of Appeal Revisits Limitation Period for Secondary Market Securities Class Actions and Limits Common Law Negligent Misrepresentation Class Actions

Supreme Court defers to Securities Commission on the Interpretation of Limitation Periods in Secondary Proceedings

On December 5, 2013, the Supreme Court of Canada released its much-anticipated decision in McLean v. British Columbia (Securities Commission) [1], providing clarity on the limitation period applicable to “secondary proceedings” in the securities enforcement context. Specifically, the principal issue before the Supreme Court was when the 6-year limitation period under the B.C. Securities Act begins to run when one provincial securities regulator wishes to enforce the order of another – as of the date of the underlying misconduct or the date of the extra-provincial order? The BCSC argued that the event giving rise to the proceeding against McLean was not her original misconduct, but rather the fact of having agreed with a securities regulator to be subject to regulatory action. Writing for the majority, Justice Moldaver upheld the BCSC’s order, finding that, on a standard of reasonableness, the interpretation advanced by the BCSC should be given deference.

Background

In 2008, the appellant Patricia McLean entered into a settlement agreement with the Ontario Securities Commission (“OSC”) in respect of misconduct that predated 2001. The salient parts of the resulting OSC order [2] (the “OSC Order”) barred McLean from trading in securities for 5 years, and banned her from acting as an officer or director of certain entities registered under Ontario’s Securities Act for 10 years. In 2010, the BCSC issued a reciprocal order adopting the same prohibitions of the OSC Order pursuant to s. 161(6)(d) of its Securities Act. McLean appealed the reciprocal order on the basis that the relevant limitation period had expired: s. 159 of the B.C. Securities Act provides that proceedings “must not be commenced more than 6 years after the date of the events that give rise to the proceedings”.

The issue before the Supreme Court was whether, for the purposes of s. 161(6)(d) of the B.C. Securities Act, “the events” that trigger the 6-year limitation period in s. 159 was (i) the underlying misconduct that gave rise to the settlement agreement, or (ii) the settlement agreement itself. Under the former interpretation – advanced by McLean – the BCSC order would be statute-barred. If, however, the limitation period clock began to run on the date of the OSC Order (as the BCSC contended), the BCSC order would stand as the proceeding was commenced well within 6 years of the OSC Order.

Discussion

Moldaver J. first focused on the preliminary issue of the appropriate standard of review regarding the BCSC’s order. Contrary to the BC Court of Appeal’s decision, Moldaver J. held that the governing standard of review was one of reasonableness, not correctness, on the basis that the resolution of unclear language in an administrative decision maker’s “home statute” is usually best left to the decision maker. This approach is consistent with recent Supreme Court of Canada jurisprudence (see Alberta (Information and Privacy Commissioner) v. Alberta Teachers’ Association [3]), which held that there is a presumption of reasonableness when it comes to a tribunal’s interpretation of its home statute(s).

With respect to the limitation period issue, although Moldaver J. concluded that “both interpretations are reasonable” and “both find some support in the text, context, and purpose of the statute”, he held that judicial deference must be given to the BCSC’s order:

[40] The bottom line here, then, is that the Commission holds the interpretative upper hand: under reasonableness review, we defer to any reasonable interpretation adopted by an administrative decision maker, even if other reasonable interpretations exist…Judicial deference in such instances is itself a principle of modern statutory interpretation.

[41] Accordingly, the appellant’s burden here is not only to show that her competing interpretation is reasonable, but also that the Commission’s interpretation is unreasonable

According to the Supreme Court, when faced with two competing reasonable interpretations of an administrative body’s “home statute”, the administrator – in this case, the BCSC – with the benefit of its expertise, is entitled to choose between those interpretations and “courts must respect that choice”.

Conclusion

The Supreme Court’s decision reinforces judicial deference when it comes to securities regulators dealing with their own governing statutes and regulations. The resolution of unclear language in a “home statute” is usually best left to administrative tribunals, as a tribunal is presumed to be in the best position to weigh the policy considerations in choosing between multiple reasonable interpretations of such ambiguous language. Although the interpretation of a limitation period was at issue, which is arguably a general question of law, the Court applied a reasonableness standard of review because of the tribunal’s construal of its home statute. This proposition will likely have far-reaching application.

Moreover, an important policy consideration that appears to motivate the decision is the need for inter-jurisdictional cooperation among securities regulators, given the challenges inherent in the decentralized model of securities regulation in Canada. While a securities commission cannot abrogate its responsibility to make its own determination as to whether an order is in the public interest, sections like s. 161(6) of the B.C. Securities Act obviate the need for inefficient parallel and duplicative proceedings – in this case, by providing a triggering “event” other than the underlying misconduct. It remains to be seen whether provinces can “piggy-back” on reciprocal orders sequentially, a question that the court did not want to specifically answer at this time. However, in addressing McLean’s concerns that the interpretation of the BCSC could effectively lead to indeterminate proceedings by provincial securities regulators, the Supreme Court seemed to suggest that an overall reasonableness approach to a regulator’s discretion would alleviate such concerns.

__________________________________________________________

[1] http://canlii.ca/en/ca/scc/doc/2013/2013scc67/2013scc67.html
[2] http://www.osc.gov.on.ca/en/9009.htm
[3] http://www.canlii.org/en/ca/scc/doc/2011/2011scc61/2011scc61.html?searchUrlHash=AAAAAQALMjAxMSBzY2MgNjEAAAAAAQ

Supreme Court defers to Securities Commission on the Interpretation of Limitation Periods in Secondary Proceedings

Securities regulators propose amendments to oil & gas disclosure standards

The Canadian Securities Administrators (CSA) have published for comment proposed amendments to National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities (NI 51-101) and Companion Policy 51-101CP Standards of Disclosure for Oil and Gas Activities (51-101CP). NI 51-101 and 51-101CP set forth the disclosure standards applicable to reporting issuers engaged in oil and gas activities. In the proposed amendments, the CSA target several aspects of the disclosure regime applicable to oil and gas reporting issuers, including the following:

  • The disclosure of resources other than reserves;
  • The disclosure of oil and gas metrics;
  • The disclosure of resources under alternative disclosure regimes; and
  • The refinement of the product type definition.

Disclosure of resources other than reserves: Currently, a reporting issuer can elect to disclose contingent resources or prospective resources in conjunction with its annual filings without triggering any additional reporting obligations. Under the proposed amendments, if a reporting issuer elects to disclose contingent or prospective resources in conjunction with its annual filings then the reporting issuer must also disclose the related future net revenue and the resource estimates must be evaluated or audited by a qualified reserves evaluator or auditor.

Disclosure of oil and gas metrics: Currently, the disclosure of only certain oil and gas metrics (e.g. netbacks, finding and development costs) triggers specific methodology or disclosure requirements under NI 51-101. The CSA are proposing a principle-based approach applicable to the disclosure of all oil and gas metrics. Under the proposed amendments, the disclosure of any oil and gas metric requires the reporting issuer to identify the standard, methodology and meaning of the metric, and to provide a cautionary statement as to the reliability of the metric. In addition, if there is no identifiable standard for the metric, then the reporting issuer must disclose the parameters used in the calculation of the metric and a cautionary statement that the metric does not have any standardized meaning.

Disclosure of resources under alternative disclosure regimes: Currently, if a reporting issuer is subject to an alternative resources disclosure regime, such as that prescribed by the United States Securities and Exchange Commission, then it must obtain exemptive relief to present resources disclosure in accordance with such alternative disclosure regime. Under the proposed amendments, a reporting issuer that is subject to an alternative disclosure regime may present such alternative disclosure provided that the alternative disclosure is accompanied by the disclosure required by NI 51-101; and the alternative disclosure satisfies certain other conditions relating to the adequacy and reliability of the alternative disclosure regime. In addition, the estimates prepared under the alternative disclosure regime must have been prepared or audited by a qualified reserves evaluator or auditor.

Refinement of the product type definition: The proposed amendments reconcile the definition of product type to the definition used in the Canadian Oil and Gas Evaluation Handbook. Under the proposed amendments, the existing distinction based on whether the product is conventional or unconventional is eliminated in favour of using the source and process for recovery of the product in question. In addition, the concept of production group is eliminated.

Other effects of the proposed amendments: Some of the other areas of oil and gas disclosure affected by the proposed amendments include the following:

  • Clarifying the concept of marketability as it relates to the reporting of oil and gas volumes;
  • Clarifying the determination of abandonment and reclamation costs and mandating the disclosure of such costs in the determination of future net revenue and in the presentation of significant factors and uncertainties in annual filings;
  • Clarifying the requirement to obtain a consent from a qualified reserves evaluator or auditor in relation to the qualified person’s report provided in connection with the reporting issuer’s annual filings; and
  • Clarifying the disclosure requirement when a reporting issuer has no reserves.

CSA Request for Comments: The CSA welcome comments on the proposed amendments and have posed five specific questions which commenters may choose to address. The comment period ends on January 17, 2014. The full text of the proposed amendments can be found here.

Securities regulators propose amendments to oil & gas disclosure standards

UPDATE: Zungui Class Action Settlements against Remaining Defendants Approved by Court

**This blog post was co-authored by Dentons’ Michael Schafler and Michael Beeforth.

On August 27, 2013, Justice Perell released his decision (2013 ONSC 5490) approving three settlements valued at $10.85 million, bringing the class action against Zungui Haixi Corp. (“Zungui”) and others to a close. Under the approved settlements, Zungui will pay $8.1 million, auditors Ernst & Young (“E&Y”) will pay $2 million and the company’s underwriting syndicate (CIBC World Markets Inc., Canaccord Genuity Corp., GMP Securities LP and Mackie Research Capital Corporation) will pay $750,000. In an earlier May 2013 decision, Perell J. had certified the class action for settlement purposes in respect of the Zungui and E&Y settlements.

As summarized here, the proposed class action brought by Zungui’s investors stemmed from an August 22, 2011 announcement that E&Y had suspended its audit of Zungui’s 2011 financial statements. The company’s shares immediately dropped by 77% and were subsequently cease-traded. The proposed class was comprised of various groups of investors (each represented by separate counsel), including purchasers in the initial December 2009 IPO, investors who received shares in exchange for securities of a Zungui subsidiary prior to the IPO, and secondary market purchasers.

The proposed plan of distribution under the settlements allocated various levels of compensation to the investor groups depending on, amongst other factors, when investors acquired or sold their shares. The plan did not, however, contemplate any compensation to class members who acquired shares on or following the August 22, 2011 E&Y disclosure (though the settlements included a release of these class members’ claims). One investor who had purchased his shares on August 22, 2011 objected to the fairness of the plan of distribution on the basis that the August 22, 2011 disclosure “[did] not clearly foreshadow the events that followed” and that “there was no way of knowing that the worst possible outcome would come to pass, with investors unable to trade their shares ever again”.

In considering whether the plan of distribution was fair and reasonable, Perell J. noted that if class members such as the objecting investor had appreciated that the parties had only included them in the class as a bargaining chip and would eventually exclude them from the plan of distribution while releasing their claims, those investors would likely have opted out of the class action. As it stood, Perell J. found it “inappropriate and unfair to include August 22, 2011 purchasers as Class Members and then exclude them from the Plan of Distribution”. He thus revised the plan to include August 22, 2011 purchasers but discounted their claims to reflect the increased risk of their investments.

While the precedential value of this decision is likely limited by the fact that the court’s authority to vary the plan of distribution was expressly provided for by the settlement agreements, Perell J. made it clear that he would not have approved the settlements without this authority. Perell J. also noted that s. 26 of the Class Proceedings Act, 1992 provides the court with ample discretion and scope for creativity in determining or approving a plan of distribution where a judgment has been issued. Based on these comments, class counsel would be wise to expressly advise settling class members of the court’s ability to vary distributions, especially in cases involving objecting class members or other potential fairness concerns.

UPDATE: Zungui Class Action Settlements against Remaining Defendants Approved by Court

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

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