Securities Class Actions Update: The Market is Still Wide Open1
Jeffrey S. Leon, Sarah J. Armstrong and Tracy A. Pratt2
Two significant Ontario securities class action decisions were released in 2004. The first
is Mr. Justice Lederman’s decision in Kerr v. Danier Leather.3 Danier Leather is the first class
action trial of a misrepresentation claim under section 130 of the Securities Act (Ontario)4 (“the
Securities Act”). Second is the ruling in Shaw v. BCE,5 in which the Court of Appeal upheld the
lower court’s decision striking out the representative plaintiffs’ claims of misrepresentation and
oppression.
Although currently under appeal, the Danier Leather decision provides a detailed judicial
analysis of misrepresentation under section 130 of the Securities Act and, in particular, of the
disclosure obligations respecting forward-looking statements. Like the Danier Leather ruling,
the Shaw decision deals with disclosure issues but in a secondary market context. In upholding
the decision below, which struck out the representative plaintiffs’ misrepresentation and
oppression claims, the Court of Appeal decision reflects the significant barriers and risks that
exist for plaintiffs seeking to recover in class actions based on secondary market transactions.
It appears, however, that amendments to the Securities Act will be proclaimed into force
in the first quarter of 2005. Among other things, the amendments will create a statutory regime
1
An earlier version of this paper was presented at the Canadian Institute’s 15th Annual Securities Superconference
on February 18, 2005. For a more thorough general discussion of securities class actions in Canada, see Jeffrey
S. Leon and Sarah J. Armstrong, “In the Market for Fraud and Other Corporate Failures: Recent Developments
in Securities-Related Class Actions in Canada” (2003) 27 Advocates’ Quarterly at 259.
2
Jeff Leon and Tracy Pratt are partners and Sarah Armstrong is an associate in the Litigation and Dispute
Resolution Department at Fasken Martineau DuMoulin LLP.
3
(2004), 46 B.L.R. (3d) 167 (S.C.J.) (hereinafter referred to as “Danier Leather”)
4
R.S.O. 1990, c.S. 5.
-2for civil liability for misrepresentations made in the secondary market. This change is expected
to spawn a series of securities class action lawsuits proceeding by statute for deemed reliance on
material misrepresentations and thereby eliminating the major hurdle plaintiffs often face in class
actions based on secondary market transactions. In light of these imminent amendments, the
Danier Leather decision may become an important judicial guide to interpreting the new
legislative provisions.
In this paper, we review the two cases described above and the pending amendments to
the Securities Act. We also comment on the relatively low activity in the Canadian securities
class actions field to date and some of the possible reasons why plaintiffs have been choosing
thus far to bring their actions elsewhere. We also review some other developments in the case
law relating to class actions generally and to the potential liability of corporate officers and
directors. Given these developments over the past year, and the legislative changes expected in
the coming months, companies and their officers, directors, advisors and insiders should take
stock of their procedures and standards for disclosure control and ensure that a process is in place
for demonstrating that the appropriate standard of due diligence has been met in relation to
public disclosures.
KERR v. DANIER LEATHER: CLARIFICATION OF THE LAW ON FORWARDLOOKING STATEMENTS
The plaintiffs in the Danier Leather case were investors who purchased Danier Leather
Inc. (“Danier”) shares pursuant to the company’s 1998 initial public offering (“IPO”). Danier’s
IPO final prospectus (“the Prospectus”) receipted May 6, 1998 contained Danier’s actual
financial results for Q1, Q2 and Q3, 1998 and a forecast of financial results for Q4, 1998 and the
5
[2004] O.J. No. 3109 (Ont.C.A.)
-3fiscal year ending June 27, 1998 (“the Original Forecast”). The IPO closed on May 20, 1998,
about seven and a half weeks into the fourth quarter. However, an intra-quarterly sales report
from Danier, dated May 16, 1998 (“the May 16th Report”), revealed that the Toronto based
company would not meet the projections made in the Original Forecast.
Danier’s senior
management concluded that the intra-quarterly numbers were seasonal distortions and, therefore,
that the numbers did not have to be disclosed to Danier’s advisers and underwriters. In addition,
the CEO and CFO remained of the view that the Original Forecast was achievable for a number
of reasons including sales promotions that were planned for the end of the quarter. Notably, they
did not discuss the matter with professional advisors at this point.
Post the IPO date, poor sales from Danier’s Victoria Day Sale prompted the CEO and
CFO to engage in a further examination of Danier’s financial situation. They concluded that the
unseasonably hot weather across most of Canada caused the company’s decline in sales. On
May 26, 1998, Danier informed its underwriters that the company might not meet the Original
Forecast if the hot weather persisted. On May 29, 1998, management sought legal counsel. On
June 4, 1998, about two weeks after the IPO closing, Danier announced revisions to the Original
Forecast. The revisions were attributed to unseasonably warm weather in most of its markets
and included a twenty-eight percent reduction in quarter revenues, a threefold increase of net loss
for the quarter and an EBITDA forecasted loss of $1 million (contrasted to the $445,000 profit in
the Original Forecast).
Notwithstanding the revised forecast, Danier substantially achieved the results of the
Original Forecast by the end of the fourth quarter and the fiscal year-end. Nevertheless, in the
fall of 1998, a group of investors who purchased shares pursuant to the IPO brought a class
proceeding against Danier. The investors alleged that Danier’s failure to disclose the May 16th
-4Report in a timely manner constituted a misrepresentation. Danier argued that they had not made
the alleged misrepresentations. Moreover, and in any event, the year-end results validated the
numbers in the Prospectus and thus, the plaintiffs had not suffered any damages.
Mr. Justice Lederman of the Ontario Superior Court of Justice agreed with the investors
and found Danier, its President/CEO (who was also a member of the board) and its CFO liable
for misrepresentation. The Court found that the disclosure of the May 16th Report was necessary
to make the company’s forecasts of financial results for Q4, 1998 and the fiscal year ending June
27, 1998 not misleading as of the May 20, 1998 closing of the IPO. The investors were awarded
an estimated $11 million in damages, plus interest and costs.
In his decision, Justice Lederman conducts a comprehensive analysis of the elements of
the various forms of misrepresentation under section 130 of the Securities Act. Section 130 of
the Securities Act provides, in part, as follows:
Where a prospectus together with any amendment to the prospectus
contains a misrepresentation, a purchaser who purchases a security
offered thereby during the period of distribution or distribution to the
public shall be deemed to have relied on such misrepresentation at the
time of purchase and has a right of action for damages against…
Section 1(1) of the Securities Act defines “misrepresentation” as follows:
(a) an untrue statement of material fact, or,
(b) an omission to state a material fact that is required to be stated or that
is necessary to make a statement not misleading in the light of the
circumstances in which it was made.
Justice Lederman makes a number of important findings relating to section 130,
particularly as it applies to forward-looking information. His Honour held that the Original
-5Forecast was a statement of material fact. In order to constitute a “material fact”, a forecast must
significantly affect or would reasonably be expected to have a significant effect on the market
price or value of the securities issued or prospectus to be issued.6 Justice Lederman went on to
explain that, if the Original Forecast is a material fact, then the information in the May 16th
Report that seriously puts in question the accuracy of the Original Forecast could be expected to
have the same effect and are therefore material facts as well.7
According to the decision, the guidepost for materiality is “probability (that the event will
occur)/magnitude (of the event) test”.8 In other words, the court must find that a reasonable
investor would likely consider the interim performance important to the overall mix of
information available. Materiality can also be gauged by the market reaction to the ultimate
disclosure of previously omitted facts.
Materiality may be easier to establish in the
circumstances of an IPO prospectus because the publicly available information regarding the
share value is limited and, therefore, there is greater possibility of misleading the IPO prospectus
reader.
Notably, Justice Lederman held that the Original Forecast did not constitute a
misrepresentation since management believed that it reflected their best judgment. Before the
IPO closed, however, the CEO and CFO breached their obligations under section 130 when they
chose not to disclose the Q4 results that were necessary to make the Original Forecast not
misleading. Notwithstanding the analysis conducted by the CEO and the CFO, the Court held
that their belief that the Original Forecast was achievable was not objectively reasonable.9 In
6
Ibid. at para. 76.
Ibid. at para. 183.
8
Ibid. at para. 175.
9
Ibid. at paras. 262, 263 and 269.
7
-6coming to this decision, among other things, the Court looked to the views and beliefs of other
members of management.
Subsection 130(5) of the Securities Act provides directors and officers with a “reasonable
investigation” defence. Subsection 130(5) provides as follows:
No person or company, other than the issuer or the selling security
holder, is liable under subsection (1) with respect to any part of the
prospectus or the amendment to the prospectus not purporting to be made
on the authority of an expert and not purporting to be a copy of or an
extract from a report, opinion or statement of an expert unless he, she or
it,
(a) failed to conduct such reasonable investigation as to provide
reasonable grounds for a belief that there had been no misrepresentation;
or
(b) believed that there had been a misrepresentation.
Section 132 of the Securities Act provides that the degree of reasonableness required in the
“reasonable investigation” defence is that of a “prudent person in the circumstances of the
particular case”. In determining reasonableness, the court will look to, by way of example, the
extent of the individual’s involvement/participation, the individual’s position in the company, the
individual’s expertise/skill and the individual’s access to pertinent information and data. Inside
directors will be held to a “stringent standard of reasonableness”.
Here, the plaintiffs were able to establish to the Court’s satisfaction that senior
management failed to conduct a reasonable investigation. The Court also noted that they failed
to consult with any professional advisors about the impact of the information in the May 16th
Report on the Original Forecast and its potential impact on the price of shares. Taken together,
these facts meant that the defendants had not met the standard expected of senior management.
-7For the officers and directors of Danier, even achieving the projected results did not excuse the
defendants’ failure to make timely disclosure.
Justice Lederman’s decision on damages is novel. While section 130 of the Securities
Act establishes a right to damages for misrepresentation, it does not specify a particular measure
of damages, other than to say in subsection 130(9) that damages are capped at the offering price
of the securities. Justice Lederman held that the measure of damages should be the offering
price of the securities less the post-misrepresentation price. As such, the Court sought to arrive
at the real value of the shares at the time of purchase free of the misrepresentation (with any
necessary adjustment if the defendant proved that the depreciation was due to some other factor)
and it attempted to put the plaintiffs in the position they would have been in had the
misrepresentation not occurred.
Applying this formula to the case, Justice Lederman awarded an estimated $11 million in
damages to the class (plus interest and costs). This figure was comprised of $2.35 per share
calculated by reducing the purchase price of Danier shares on May 20, 1998 ($11.25) by the
post-misrepresentation price on June 10, 1998 ($8.90).
This calculation was based on a
statistical model introduced by the plaintiffs’ expert by which it was calculated that the true
value of the shares at the time of the IPO was $8.90 rather than $11.25. On this basis, Justice
Lederman held that shareholders who continued to own shares after June 10, 1998 should receive
damages of $2.35 per share, whether or not they had sold their shares. In contrast, those who
sold shares between June 4, 1998 and June 10, 1998 would receive the actual difference between
$11.25 and the selling price.
-8Notably, the plaintiffs were entitled to recover damages even if they had not sold their
shares and thereby crystallized their loss. Arguably, damages were awarded to investors where
they may not have suffered any actual losses.
Mr. Justice Lederman’s decision in Danier Leather constitutes the first time a trial court
has undertaken a thorough interpretation of the prospectus misrepresentation provisions in a
Canadian Securities Act. It is also the first time a Canadian court has determined that investors
who bought under a prospectus are entitled to damages for misrepresentation and then gone on to
calculate the losses arising from such misrepresentation. The ruling is on appeal to the Ontario
Court of Appeal.
Public companies and their officers, directors, senior management and advisors should be
aware of the implications of the Danier Leather decision because it sets an exacting standard of
continuing scrutiny of the accuracy of forecasts and disclosure on issuers and senior management
intimately involved in an IPO. The forward-looking information at issue in the case was
contained in an IPO prospectus but the principles set out in the case will likely have much
broader application. We expect that the decision in Danier Leather will have implications for
issuers, their directors, officers and underwriters. Most importantly, the case’s findings and
rulings should encourage a higher level of caution by issuers and senior management,
particularly in the context of an Ontario IPO.
The disclosure of earnings forecasts in an IPO is not mandatory under the Securities Act.
Therefore, careful consideration should be given to the benefit and risks of including forwardlooking information in a prospectus. If included, such information must be accurate as of the
date of the IPO closing. Senior management must give continuing attention to any subsequent
-9facts that emerge prior to the date of closing and seek the appropriate consultation with
professional advisors. Danier management’s failure to inform, and consult with, counsel, the
auditors and the underwriters (and the company’s Board of Directors), appears to have weighed
heavily against meeting the reasonable prudence standard.
The decision also suggests that to the extent that cautionary language is used to try to
negate the materiality of forward-looking information, such language must go beyond boilerplate
text. In particular, issuers would be wise to include a list of more specific risk factors that could
have an impact on whether the company achieves it earnings forecasts. Finally, the decision
implies that anything that can be done to decrease the number of days between the filing of the
final prospectus and date of closing will minimize the risks associated with contrary information
becoming available in the interim.
SHAW v. BCE
In stark contrast to the success achieved by the plaintiff investors in Danier Leather, the
representative plaintiffs in Shaw v. BCE were unsuccessful again in 2004, this time at the Ontario
Court of Appeal. In Shaw v. BCE, the Court of Appeal upheld the decision below that struck out
the representative plaintiffs’ misrepresentation and oppression claims. The Court relied heavily
on the cautionary language included in the relevant offering document with respect to the
prospects of Bell Canada International Inc. (“BCI”) to demonstrate that the plaintiffs had no
reasonable expectation that BCI would be stable following the Recapitalization Plan that was the
subject of the action.
On September 27, 2002, Wilfred Shaw, a common shareholder of BCI, filed a $1 billion
lawsuit against Bell Canada Enterprises (“Bell”) and its failed subsidiary BCI. The Statement of
- 10 Claim alleged misrepresentation and oppression in connection with the issuance of BCI common
shares in February 2002 as part of BCI’s refinancing effort as it reorganized under court
protection from creditors. A class action was brought on behalf of all persons who owned BCI
common shares on December 3, 2001.
The defendants successfully moved to strike the Statement of Claim on the basis that it
disclosed no reasonable cause of action.10 Justice Farley commented at the outset that the
Statement of Claim had been poorly framed.11 On the misrepresentation claim, the pleading had
to set out, with careful particularity, all of the elements of the misrepresentation claim. Justice
Farley held that it did not even appear that Shaw had claimed that he relied on any of the alleged
misrepresentations in making his investment decision. Accordingly, the Statement of Claim
disclosed no reasonable cause of action for misrepresentation. 12
The pleading also was deficient on the oppression remedy claim because it did not allege
that the class had “reasonable expectations”. Justice Farley observed that the pleadings merely
enumerated a “wish list” without providing any support for it and that this wish list did not
provide the basis for an oppression claim.13
Given his ruling, Justice Farley did not have to consider the test for certification.
Nevertheless, His Honour noted that Shaw had not proved that the class was an identifiable one,
that there were common issues, that a class action was the preferable procedure for pursuing this
action or that Shaw was an appropriate representative plaintiff. Shaw was given leave to amend
10
Shaw v. BCE Inc., [2003] O.J. No. 2695 (S.C.J.).
Ibid. at para. 3.
12
Ibid. at paras. 11 and 12.
13
Ibid. at paras. 14-17.
11
- 11 his pleading but was also cautioned by Justice Farley that the Statement of Claim required major
revisions and that it might not survive if the same allegations were repackaged under fresh labels.
In November of 2003, Justice Farley considered a further application by Bell and BCI for
an order striking Shaw’s Amended Statement of Claim as well as a further claim brought by
another plaintiff, Cameron Gillespie.14 Justice Farley struck out Shaw’s amended claim without
leave to further amend. The revised pleading essentially repeated the same allegations, this time
claiming that the company’s Recapitalization Plan and its implementation constituted oppression
of minority shareholders. In deciding that the plaintiffs had not put forward any new substantive
allegations of oppression in their amended pleading, Justice Farley stated: “You must not put
new wine in old bottles; even more so, you must not in a legal sense attempt to put the same old
wine in the same old bottles (even if there has been an attempt to change the superficial
appearance of that wine and those bottles). That would not be permitted pursuant to the doctrine
of res judicata”15.
The Court held that the amended pleading still failed to disclose a reasonable cause of
action in oppression as the transactions complained of benefited the minority shareholders.
There were three main reasons for this finding as follows:
1.
Shaw’s amended claim in oppression was premised on an allegation that reasonable
expectations as to BCI’s financial stability were not met by the defendants, but those
expectations, as pleaded, could not reasonably have arisen from the documents relied
upon (principally the Rights Offering Prospectus);
14
15
Shaw v. BCE Inc. (2003), 42 B.L.R. (3d) 107 (S.C.J.).
Ibid. at para. 8.
- 12 2.
Shaw failed to plead a prima facie case in oppression. The recapitalization transactions,
on their face, were beneficial to BCI and to its minority shareholders; and
3.
Shaw failed to plead all of the constituent elements of his cause of action. Specifically,
the allegedly oppressive conduct of the defendants was not connected in the pleading to
any loss sustained by the plaintiffs.16
Justice Farley also struck out a virtually identical Statement of Claim naming Cameron
Gillespie as plaintiff. Presumably this Claim was an attempt to deal with the issue identified in
Justice Farley’s initial decision that Shaw may not be an appropriate representative plaintiff.
Justice Farley found, however, that, for all material purposes, Shaw and Gillespie were
interchangeable and that they were, in practical effect, the alter egos of each other.
Justice Farley struck the Gillespie claim because he had not pleaded a reasonable cause of
action that could be maintained against the defendants. In addition, his claim had a res judicata
problem, being a privy of Shaw. Justice Farley held that the claim was an abuse of process.
Since, for all material purposes, Shaw and Gillespie were interchangeable, it was inappropriate to
give Gillespie leave to amend his Statement of Claim in the circumstances.17
Costs in the amount of $27,500 were awarded to each of BCI and Bell. The plaintiffs
were held jointly and severally liable for costs of $12,500 to each of BCI and Bell. Shaw and
Gillespie were further responsible for $7,500 to each of Bell and BCI on an individual basis. If
Shaw and Gillespie split the payments equally, they will each pay $27,500 but if one does not
pay, the other would be exposed to costs totalling $40,000.
16
17
Ibid. at para. 10.
Ibid. at paras. 16 to 18.
- 13 The plaintiffs appealed. The Court of Appeal found that the Statements of Claim were
properly struck out pursuant to Rule 21 without further leave to amend. Justices Sharpe,
Simmons and Lang agreed with Justice Farley that the claims failed to disclose a reasonable
cause of action. The Court of Appeal also dismissed the appeal against Justice Farley’s costs
order and held that the respondents were entitled to their costs of the appeal, fixed at $25,000 to
each respondent to be paid by the appellants on a joint and several basis.
The decisions in both Danier Leather and Shaw v. BCE highlight the importance of
accurate disclosure in public offering documents. In Shaw v. BCE, the Court of Appeal relied
heavily on the cautionary language included in the relevant offering document respecting the
prospects of BCI to demonstrate that the plaintiffs had no reasonable expectation that BCI would
be stable following the Recapitalization Plan that was the subject of the action. Specifically, the
Court said:
The bold type on the face page of the Prospectus made it crystal clear
that BCI faced a significant financial crisis and that the Rights offered
were speculative investments with a significant element of risk….The
Prospectus specifically cautioned BCI investors that the significant
increase in the number of shares was likely to have a negative effect on
the price of the shares; that BCE had no obligation to fund BCI after the
implementation of the Recapitalization Plan; that BCI would require
further additional capital in the near future; and that BCI might need to
18
secure protection from its creditors.
According to the Court of Appeal, these cautionary statements in the prospectus completely
undermined the claim that BCI shareholders had a reasonable expectation that BCI would be
financially stable following the Recapitalization Plan.
18
Ibid. at para. 6.
- 14 The forecasts at issue in Danier Leather, made in connection with the company’s IPO,
were not sufficient to absolve the defendants in that case from liability for not disclosing known
financial results that were materially at variance with the Original Forecast. In contrast, the BCI
offering prospectus contained clear and repeated warnings about the very possibility on which
the minority shareholders’ decision was based. The legal effect of the cautionary language used
in these two cases should provide corporations and their advisors with guidance as to their
disclosure requirements going forward and as to what courts will consider to be appropriately
specific cautionary language.
EXPECTED AMENDMENTS TO THE SECURITIES ACT (ONTARIO)
In 2002, the Ontario government enacted the Keeping the Promise for a Strong Economy
Act (Budget Measures Act) (“Bill 198”). Bill 198 provided for amendments to the Securities Act,
including the creation of a statutory regime for civil liability for misrepresentations made in the
secondary market. Some of the changes to the Securities Act provided for in Bill 198 were
proclaimed into force in April 2003, but this did not include the amendments concerning civil
liability for secondary market disclosure. In May 2003, the government introduced Bill 41,
which provided for certain technical amendments to the proposed statutory liability regime in
Bill 198. Bill 41 effectively died, however, with the dissolution of the legislature when the
general election was called.
On November 22, 2004, the McGuinty government re-introduced a series of technical
amendments to the Bill 198 provisions relating to the Securities Act by way of Bill 14919. The
government also announced its intention to implement the Bill 198 regime for civil liability for
- 15 secondary market disclosure. Bill 149 received Royal Assent on December 16, 2004 and it is
widely expected that the changes to the Securities Act will be proclaimed into force in early
2005.
Unquestionably, these legislative changes will broaden the scope for plaintiffs’ class
actions in the securities area, particularly in the secondary market. As noted above, the existing
Securities Act establishes civil liability for primary market disclosure contained in a company’s
public disclosure documents (e.g. prospectuses, offering memoranda and take-over bid circulars).
The proposed amendments create civil liability for secondary market disclosure to the public that
can reasonably be expected to affect the ongoing trading price of securities in the public markets.
The types of disclosure contemplated include both documentary and oral public disclosures by
the Responsible Issuer and its representatives in the form of documents such as press releases,
press conferences, annual reports and financial statements.
These changes will give investors a cause of action against a company when the company
fails to make timely disclosure of material information or when the company’s continuous
disclosure contains a misrepresentation. Most importantly, the amendments will effectively
result in individual secondary market investors no longer having to prove their reliance on
misrepresentations or failures to disclose in order to establish liability. Rather, reliance will be
“deemed”, in much the same way that it currently is for misrepresentations in the primary market
for securities.
19
Bill 149, An Act to Implement 2004 Budget Measures, Enact the Northern Ontario Grow Bonds Corporation Act,
2004 and Amend Various Acts, 1st Sess., 38th Leg., Ontario, 2004 (Royal Assent - December 16, 2004).
(hereinafter “Bill 149”).
- 16 More specifically, the proposed amendments provide that where a Responsible Issuer, or
a person with actual, implied or apparent authority to speak on behalf of the Responsible Issuer,
issues a written communication or makes a public oral statement that contains a
misrepresentation, investors who trade in the specified securities before the misrepresentation is
corrected publicly will be deemed to have relied on the misrepresentation. The changes also are
notable in that they broaden the scope of potential defendants that will be exposed to liability.
The amendments provide a right of action not only against the Responsible Issuer and its officers
and directors but also against other “influential persons” and “experts” who reported on or
consented to the use of the misrepresentation.20
A similar deemed reliance provision provides investors with a right of action for
misrepresentations made by or on behalf of “influential persons” in documents or public oral
statements about the Reporting Issuer. The definition of “influential persons” in the Bill includes
insiders who are not a director or senior officer of the responsible issuer, thereby opening up the
possibility of civil liability for insiders under the Securities Act. In addition, there is a provision
that requires Responsible Issuers to make timely disclosure of material changes and provides a
corresponding deemed reliance provision for investors who relied upon the Responsible Issuer’s
representations. In other words, investors will be justified in assuming that Responsible Issuers
have complied with the timely disclosure requirements.
Several defences are made available to Responsible Issuers under the new legislation,
including a due diligence defence and the ability to prove that the plaintiff knew about the
20
“Expert” is defined in Bill 149 as “a person or company whose profession gives authority to a statement made in a
professional capacity by the person or company, including without limitation, an accountant, actuary, appraiser,
auditor, engineer, financial analyst, geologist or lawyer, but not including an entity that is an approved rating
organization for the purposes of National Instrument 44-101 of the Canadian Securities Administrators.
- 17 misrepresentation when he or she bought or sold the securities in question. The availability of a
due diligence defence raises important issues as to what evidence will be required to establish
proper due diligence. Internal disclosure procedures must satisfy the appropriate standard in
order to survive an ex post facto examination.
It is critical for companies to implement
appropriate disclosure controls and procedures and to monitor and review the effectiveness of
those controls and procedures. Other defences relating to corrective action, misrepresentations
by persons without the requisite authority to make the statement in question and “reasonable
reliance” on the work of experts are also part of the legislation.
Further, in the most recently proposed version of the amendments, individuals and
companies are not liable for misrepresentation in forward-looking information if they prove that
the document containing the forward-looking information contained “reasonable cautionary
language identifying the forward-looking information as such” and a statement of the material
facts and assumptions used to come up with the projections. To successfully rely on this
defence, the individual or company must show that they had a “reasonable basis” for drawing the
conclusions or making the forecasts and projections that they did. Individuals can refer to
disclosure in a company’s public filings. Moreover, and perhaps most significant from a liability
perspective, the misrepresentation will still have to be material.
In an attempt to avoid concerns regarding unmeritorious “strike suits”, the new legislative
provisions incorporate some protection from frivolous or unmeritorious suits. Plaintiffs must
obtain leave of the court to commence proceedings and the court must approve all settlements. In
order to obtain leave, a plaintiff would be required to demonstrate a “reasonable possibility” that
the claim would succeed and that he/she had commenced the action “in good faith”.
- 18 While it has been suggested that the leave application could simply be heard at the same
time as the certification motion, it is submitted that this need not be the case. The proposed
merit-based test for leave may require a higher threshold than the test for certification in order to
achieve its “gatekeeper” objective.
The proposed legislation also creates a liability limit for issuers set at the larger of $1
million or five per cent of the issuer’s market capitalization. For directors, officers or “influential
persons”, the limit is set at the larger of 50% of the individual’s compensation or $25,000. The
limit for “experts” is set at the greater of all revenue earned by the expert from the issuer over a
12-month period or $1 million. These limits would not apply in cases where the plaintiffs could
not prove knowledge (i.e., fraud). This provision may have the undesirable effect of encouraging
plaintiffs to allege fraud wherever possible. This might well create a strong impetus to settle
regardless of the merits. On the other hand, it might leave directors and officers without
insurance to respond to a successful claim. It is also noteworthy that damages are to be assessed
on a proportionate basis as opposed to a joint and several basis. This avoids unfairness to the
traditional defendants with deep pockets.
The proposed legislation should have a significant impact on the volume of securities
class action litigation in Ontario. The changes will facilitate actions based on misrepresentations
made in the secondary market about statements made in disclosure documents or public oral
statements and about failures to make timely disclosure of a material change.
It is a
controversial proposal and not without practical shortcomings. On balance, it can legitimately be
argued that statutory reform is justified.
- 19 It is not readily apparent, in the context of modern day capital markets, why distinctions
should be drawn between investment in the primary and secondary markets. From a litigation
perspective, however, the secondary market is more unwieldy. It will be for the courts to
achieve the appropriate balance by avoiding undue litigation abuse while giving investors an
effective remedy where justified. Depending upon how it is applied, the “good faith/reasonable
possibility” test may, or may not, be a high enough standard. The standard should be sufficiently
high to avoid situations where companies, officers, directors and others are unjustifiably exposed
to significant liability that will force early settlements, regardless of the merits. Such protections
are necessary to preserve the integrity of the capital markets and not to discourage unduly the
involvement of talented people in them.
A fair balance must be struck between investor
protection and fostering a market where participants can still be attracted to take on the task of
attempting to create shareholder value.
THE STATUS OF THE BUSINESS JUDGMENT RULE
One of the concerns with Justice Lederman’s decision in Danier Leather is whether his
reasoning erodes the effectiveness of the business judgment rule by, in effect, second-guessing
the views of senior management with the benefit of hindsight. The business judgment rule has
recently been affirmed by the Supreme Court of Canada in Peoples’ Department Stores v.
Wise,21 although the Court signalled a shift from the traditional formulation of the rule. This is
particularly important in the context of due diligence defences in class proceedings when board
processes and decision-making may be subject to greater scrutiny by the courts.
21
(2004), 244 D.L.R. (4th) 564 (S.C.C.).
- 20 Wise Stores Inc. (“Wise”) acquired Peoples’ Department Stores Inc. (“Peoples”) from
Marks & Spencer Canada Inc. The Wise brothers were majority shareholders, officers and
directors of Wise and the only directors of Peoples. In early 1994, the Wise brothers decided to
implement a joint inventory procurement policy whereby the two companies would divide
responsibility for purchasing. Before the end of that year, both companies declared bankruptcy.
Peoples’ trustee filed a petition against the Wise brothers, claiming that they had favoured the
interests of Wise over Peoples to the detriment of Peoples’ creditors in breach of their duties
under section 122(1) of the Canada Business Corporations Act (“CBCA”).
The trustee claimed, in the alternative, that the Wise brothers had, in the year preceding
the bankruptcy, been privy to transactions in which Peoples’ assets had been transferred for
conspicuously less than fair market value within the meaning of section 100 of the Bankruptcy
and Insolvency Act (“BIA”).
The trial judge found the Wise brothers liable on both grounds.
The Court of Appeal set aside the decision and the trustee appealed to the Supreme Court of
Canada.
The issue considered by the Supreme Court was whether the inventory procurement
policy implemented by the Peoples Board of Directors amounted to a breach of their duties as
directors under subsection 122(1)(a) or (b) of the CBCA. The Supreme Court also considered
the claim under section 100 of the BIA. The Supreme Court dismissed the appeal and held, in a
unanimous decision, that the directors of the two corporations did not breach their statutory
duties as they had made an honest attempt to redress the corporation’s financial problems.
The most obvious point the Supreme Court makes in Peoples is that directors do not owe
fiduciary duties to a company’s creditors. The fiduciary duty set out in subsection 122(1)(a) of
- 21 the CBCA, and paralleled in most provincial corporate statutes, requires that directors and
officers act honestly, in good faith and in the best interests of the corporation.
The Court distinguished the fiduciary duty owed by directors to the corporation under
subsection 122(1)(a) of the CBCA from the standard of care set out in subsection 122(1)(b) of
the CBCA to “exercise the care, diligence and skill that a reasonably prudent person would
exercise in comparable circumstances.” According to the Supreme Court, this latter general duty
of care is owed not only to the corporation but to a broader group of stakeholders, an open-ended
group that includes creditors and, presumably, shareholders.
The way in which the Supreme Court interpreted the content of the general duty of care
in subsection 122(1)(b) is equally significant.
Before Peoples, it was commonly held by
Canadian courts that the duties owed by directors under the CBCA, and the provincial corporate
statutes, were measured on a subjective or subjective-objective standard. That is, the duties
owed by directors varied with the individual director’s experience and expertise. In Peoples, the
Court changed directions, stating that the standard of care imposed on directors for breaches of
their statutory duties of care is an objective standard that takes into consideration the
circumstances but not the individual experience and expertise of the director.
In Peoples, the Supreme Court reaffirmed the traditional rule of deference to business
decisions called the “business judgment rule”. The Court recognized that: “Many decisions
made in the course of business, although ultimately unsuccessful, are reasonable and defensible
at the time they are made. Business decisions must sometimes be made, with high stakes and
under considerable time pressure, in circumstances in which detailed information is not
available. It might be tempting for some to see unsuccessful business decisions as unreasonable
- 22 or imprudent in light of information that becomes available ex post facto.” This is a significant
reaffirmation of the rule that courts ought to resist second-guessing reasonable (even if
imperfect) business decisions.
What the Supreme Court did in Peoples, however, was to emphasize the process followed
in reaching the business decision in addition to the result of the decision. This focus on process,
which is closer to the approach followed by American courts, highlights the importance of
prudence and procedure in business decision-making. Corporate decision-makers should take
particular note of this development, as their decisions may, in the future, be examined by the
courts on the basis of the process followed, the information considered and the advice that was
considered in reaching the decision.
In the context of class proceedings, whether in the primary market or the secondary
market, shareholders will now be able, in theory, to sue directors by alleging a failure to meet
this general duty of care. Regardless of the new legislative provisions, it can now be argued that
a claim can be based on negligence rather than a negligent or fraudulent misrepresentation. In
the result, it may no longer be necessary to prove reliance on a misrepresentation. It has been
this requirement that has deterred securities class actions because of the individual nature of the
cause of action.
The implications of this for directors are somewhat daunting and there is the potential to
seriously erode the re-emphasis placed by the Supreme Court on the business judgment rule. If
all a shareholder has to do to hold a director liable is prove, with the benefit of hindsight, that the
director made a bad decision and that the shareholder suffered a loss as a result, then the
exposure of directors will increase dramatically.
- 23 In our view, such a result would be unjustifiable and would have a negative effect on the
functioning of the capital markets. It is becoming increasingly difficult to find qualified and
creative people to serve as directors of public companies. Indeed, with reference to the standard
of a “reasonably prudent person” it has been suggested that a “reasonably prudent person”
would, by definition, not serve as a director of a public company given the potential exposure to
liability, the risk of damage to their reputation and the difficulty in obtaining adequate insurance
coverage.
It remains to be seen how our courts will interpret the Peoples decision given these
market-based realities. Nevertheless, the Peoples case has important implications for the process
and procedure followed by corporations and their officers and directors. Some recommendations
in this regard are made in the concluding section of this paper.
THE FUTURE OF SECURITIES CLASS ACTIONS IN CANADA
Despite the well-publicized failure of companies such as YBM and Bre-X and a series of
more recent corporate scandals involving companies such as Nortel and Hollinger, a relatively
small number of securities class actions have been commenced in Canada and even fewer have
been certified by Canadian courts. In the primary market, despite statutory causes of action and
codified duties of continuous disclosure, there have only been a handful of shareholder class
actions to date. The Danier Leather decision described above, if upheld by the Court of Appeal,
may encourage further litigation. In the secondary market, certification has proven difficult for
plaintiffs who base their claims in misrepresentation. This is due, in large part, to the rejection
by Canadian courts of the “fraud on the market” theory and the requirement that each investor
prove “reasonable reliance” on a material misrepresentation. When proclaimed into force, Bill
- 24 198 will provide a statutory basis for such misrepresentation actions relating to the secondary
market.
It appears that many plaintiffs are choosing not to litigate their securities class actions in
Canada.
Recently, a number of large Canadian institutional investors such as the Ontario
Teachers’ Pension Plan and the Ontario Municipal Employees Retirement Plan have opted to
commence actions in the United States. We have also seen cases such as Hollinger and Nortel
being pushed along vigorously in the United States while their companion Canadian cases have
all but stalled. What follows is a discussion of various aspects of the Canadian class action
landscape that may contribute to this situation.
Acceptance of United States Jurisdiction
Justice Cullity's decision, released January 13, 2004, in Parsons v. McDonald's
Restaurants of Canada Ltd.22 indicates that Canadian courts are willing to accept settlements in
U.S. class actions as binding on Canadian class members and, in appropriate cases, as a bar to
further action in Canada.
Two actions, Parsons and Currie, were commenced against McDonald's Restaurants of
Canada on behalf of all customers of McDonald's in Canada who purchased food and
participated in games or contests conducted by McDonald’s for promotional purposes in its
restaurants between January 1, 1995 and December 31, 2001. The proceedings were commenced
after a senior employee of Simon Marketing was indicted for embezzling prizes allocated to
McDonald’s games. There was also an allegation that McDonald’s had directed that large prizes
would not be available in Canada.
- 25 A similar class action had been commenced in the U.S. on behalf of all customers of
McDonald's who had paid money for McDonald's food in order to get a game piece during the
period in issue. A settlement was reached in the U.S. action in April 2002 and the released
claims would have covered each of the claims subsequently pleaded in the Parsons and Currie
actions (although not all the material facts on which they were based were pleaded in the U.S.
action). A number of Canadians, including Parsons, objected unsuccessfully to the settlement in
the U.S. action.
In Ontario, the defendants moved to dismiss both the Parsons and Currie actions, or in the
alternative to have the actions stayed, on the grounds that there was a class action settlement in
the United States which purported to include and bind Canadians in the class. The defendants
submitted that the order approving the settlement in the American action and the releases signed
pursuant to that settlement meant that the issues were subject to res judicata and that the
plaintiffs were estopped from bringing the actions.
The Ontario Superior Court stayed the Parsons action and excluded the Canadian
objectors, including Parsons, from the class in Currie on the basis that Parsons and the objectors
had voluntarily submitted to the jurisdiction of the Illinois court in objecting to the American
action. The Court dismissed the defendants’ motion in the Currie class action and that action
was allowed to proceed in Canada. The Ontario Court of Appeal, in a decision dated February
16, 2005, recently upheld this decision and allowed the Currie class action to proceed.23
The Court of Appeal’s decision makes it clear that, in appropriate cases, Ontario law
should give effect to foreign class action judgments. However, as Justice Sharpe explained, the
22
[2004] O.J. No. 83 (S.C.J.)
- 26 rules about recognizing and enforcing foreign judgments should take into account certain unique
features of class action proceedings: “Before enforcing a foreign class action judgment against
Ontario residents, we should ensure that the foreign court had a proper basis for the assertion of
jurisdiction and that the interests of Ontario residents were adequately protected”.24
More
specifically, there must be: (a) a real and substantial connection linking the cause of action to the
foreign jurisdiction, (b) the rights of non-resident class members are adequately represented, and
(c) non-resident class member must be accorded procedural fairness, including adequate notice.25
In the Currie action, the requirement of adequate notice was not satisfied. Justice Cullity
of the Superior Court of Justice held (and the Court of Appeal agreed) that it would be unjust to
find that the Canadian members of the class in the U.S. action were bound by the settlement
because they had not received adequate notice of the proceeding and of their right to opt out.
The notice dissemination in Canada was so woefully inadequate that it would offend the rules of
natural justice to make the order in the U.S. action binding on the Canadian members of the
putative class in the U.S. action other than those who objected and thereby submitted to the
jurisdiction of the U.S. court. This reasoning suggests that, had there been adequate notice of the
proposed settlement in Canada, it is possible that all Canadian members of the putative class
would have been bound by the settlement approved by the Illinois court. It will be interesting to
watch whether this approach, which effectively accepts the jurisdiction of American courts over
Canadian class members, is upheld by Canadian courts in the future.
23
Currie v. McDonald’s Restaurants of Canada Ltd., [2005] O.J. 506 (C.A.).
Ibid. at para. 17.
25
Ibid. at para. 30.
24
- 27 No National Class Actions Procedure
Canadian class actions face difficult jurisdictional issues. For some time, the Canadian
class actions landscape included only Quebec, British Columbia and Ontario. During this early
period, Canadian courts were receptive to the idea of a “national class” of plaintiffs and readily
acknowledged that the “access to justice” objectives of class actions were well served by the
certification of national classes of plaintiffs.
Since these early decisions, however, Saskatchewan, Manitoba, Alberta, Newfoundland
and the Federal Court of Canada have either enacted class action legislation or changed their
rules to accommodate class proceedings. This proliferation of class proceedings legislation has
compounded the procedural and practical hurdles posed by the concept of national or interjurisdictional classes.
These hurdles were brought to light in a series of actions against the pharmaceutical
company Bayer in relation to its cholesterol-lowering drug, Baycol. The claims, which were
started in Quebec, Ontario, Manitoba, Saskatchewan, British Columbia and Newfoundland,
respectively, all allege that Baycol causes damage to muscle tissue, resulting in serious sideeffects, the most severe of which can lead to kidney failure and death.
In the Newfoundland proceeding, the defendant sought to dismiss or permanently stay the
proceeding in light of the potentially national scope of the Manitoba proceeding.26
The
defendant argued that the Newfoundland proceeding was unnecessarily duplicative, wasteful of
resources and raised the risk of inconsistent judgments. The defendant’s motion was dismissed
on the basis that the Manitoba and Newfoundland actions remained distinct until a common class
- 28 had been certified. The Court also held that the defendants did not suffer prejudice from the
potentially overlapping class proceedings.
Eventually, the plaintiffs’ in the corresponding Ontario proceeding moved for approval of
a settlement that was supported by counsel in the Quebec and British Columbia actions and
opposed by counsel in the Manitoba, Saskatchewan and Newfoundland actions.27 The Ontario
Court was willing to overlook the problem of overlapping proceedings, indicating that if a multijurisdictional class was certified which overlapped with a proceeding in a different province, the
class definition could be amended. The Court also stated that other provinces had the authority
to deprive the Ontario settlement of its own effect by ignoring the multi-provincial settlement
reached in Ontario and certifying an action within their own jurisdiction.
It is clear that some mechanism is needed to deal with the increasingly complex multiprovincial class action landscape in Canada.
In the United States, for example, a multi-
jurisdictional litigation procedure is often utilized in the class action context to transfer to a
single federal judge all pending federal civil cases of a similar type. A judicial panel of seven
judges then decides whether or not to transfer the cases. A judge also sets down ground rules,
deadlines and procedures, which assists in the coordination of complex actions filed in multiple
states.
This type of multi-jurisdictional litigation procedure, if developed in the Canadian
context, would seem to be particularly appropriate for securities class actions if a national system
of securities regulation is instituted.
In response to the creation of “magnet” jurisdictions in the United States which have
resulted in class action abuses by being so “plaintiff friendly” that settlements get approved with
26
Pardy v. Bayer Inc., [2004] N.J. No. 124 (N.L.S.C.).
- 29 large fees to lawyers and little, if any, benefit to class members, the U.S. Congress enacted in
February 2005 “The Class Action Fairness Act of 2005”. The Act expands federal jurisdiction
over large, interstate class actions.
It also precludes harassment of local businesses by
prohibiting “tricks” used by counsel to avoid federal court, institutes protections for class
members to ensure that the benefit they receive is proportionate to counsel fees and facilitates
unclaimed settlement funds being directed to charitable organizations.
Difficulties at Certification and Threat of Costs Awards
Two Ontario decisions in 2004 highlight that, in Ontario, success for plaintiffs in class
action suits may be more difficult and risky. In Caputo v. Imperial Tobacco,28 certification was
denied to a group of smokers and ex-smokers on the basis that they had not been precise enough
in defining the common interests of the class, they had not set out a solid evidentiary foundation
for their claim and they failed to put forward a workable litigation plan that reflected the massive
size of the undertaking they had proposed to engage in.
In Pearson v. Inco,29 the Ontario Divisional Court upheld a costs award of $184,332 to
the defendant company on an unsuccessful certification motion. It is now clearly settled that, in
Ontario, class action plaintiffs are not exempt from the usual “loser pays” system of awarding
costs.30 This type of costs award at the certification stage will, no doubt, give plaintiffs’ counsel
reason to pause before proceeding to certification with a weak case.
27
Coleman v. Bayer Inc., [2004] O.J. No. 1974 (S.C.J.).
[2004] O.J. No. 299 (S.C.J.).
29
[2004] O.J. No. 317 (Div.Ct.).
30
See Justice Nordheimer’s decision in Gariepy v. Shell et al., [2002] O.J. No. 3495 (S.C.J.). Also see the decision
of the Divisional Court on the appeal of Justice Nordheimer’s refusal to certify the action, [2004] O.J. No. 5309
(Ont. Div. Ct.).
28
- 30 Will Quebec Remain More Fertile Ground for Class Actions?
Changes to the procedure for certification (or “authorization”, as it is referred to in
Quebec) of class actions in Quebec have made Quebec relatively more fertile ground for
plaintiffs seeking to bring class action lawsuits. On January 1, 2003, the provisions of Quebec’s
Code of Civil Procedure (“CCP”) on class actions were changed to restrict the ability of a
defendant to file written material to oppose a plaintiff’s motion for certification. This leaves the
defendant with only oral submissions at the certification hearing (if the defendant is granted
leave to make submissions) to put forward its position. The requirements that the plaintiff must
meet in order to bring a motion for certification are also more relaxed in Quebec.
The legality of these provisions is currently being challenged in the Quebec Court of
Appeal. The challengers maintain that the relevant provisions of the CCP are unconstitutional
because they violate procedural rights protected by the Quebec Charter of Human Rights and
Freedoms. In foregoing the usual requirement that a motion alleging facts be supported by one
or more affidavits, the CCP deprives the respondent on an authorization motion of any control
over the allegations. The CCP also prevents the respondent from putting forward its own version
of the case, except with permission of the court.
Unless this constitutional challenge is
successful, we expect to see Quebec continue as a relatively more active site of class action
activity in Canada.
Pending Securities-Related Cases
Notwithstanding the barriers to bringing securities class actions in Canada, there are
several proposed class actions currently pending before the courts. These cases, which have yet
to be certified, involve a number of prominent Canadian corporations, including CP Ships,
- 31 Canadian Superior Energy, Atlas Cold Storage, Nortel, Hollinger and several institutions that
were the subject of regulatory proceedings in relation to allegations of market timing.
The class action proceedings relating to market timing will be interesting from a legal
point of view because there is no specific law against the practice referred to as “market timing”.
The plaintiffs will, no doubt, make the argument that professionals have a duty to act in the best
interests of investors, including long-term investors. There also are issues respecting damages.
These actions will raise interesting issues relating to the implications of settling regulatory
proceedings on subsequent class proceedings and the extent to which information obtained and
admissions made in the course of reaching regulatory settlements (recorded in Orders, Agreed
Statements of Fact etc.) can be used as evidence in subsequent civil proceedings. Also at issue is
the extent to which regulatory settlements with the stated intention of “compensating” investors
should be accounted for when determining outstanding civil liability to the same investors.
CONCLUSION
As noted above, it has become increasingly important for directors, officers, senior
management, insiders and professional advisors to ensure that the appropriate controls and
standards are in place relating to disclosure and other matters to maximize the ability to rely on a
due diligence defence in securities class actions. The following are some suggested guidelines
and issues to promote good corporate governance and good practices consistent with exercising
due diligence:
1.
question and assess the adequacy and accuracy of the process for producing
continuous disclosure documents and for timely reporting of material changes;
- 32 2.
ensure board meetings permit open and detailed questioning with the opportunity to
assess the quality of the responses;
3.
consider periodic meetings with outside auditors;
4.
consider retaining outside advisors (lawyers, investment bankers, etc.) for
independent directors;
5.
obtain an understanding of the adequacy and appropriateness of the company’s
internal control systems and practices relating to finances and other matters;
6.
insist on appropriate certification by management of the accuracy of documents;
7.
understand and evaluate the process followed by the company in releasing
information to the public relating to operational results, financial results and other
matters, such that the appropriate controls are in place to ensure the accuracy of the
statements made;
8.
require that full and complete briefing materials are provided sufficiently prior to
board meetings so as to enable proper review;
9.
attend all board meetings and, if in doubt, ask;
10.
if materials require an explanation or should be supplemented then insist that
explanations and additional material be forthcoming;
11.
keep track of, and follow up on, outstanding items;
- 33 12.
ensure that the company has in place appropriate document production and retention
policies and that it follows best practices;
13.
consider keeping your own notes so that you will have a record relating to your
conduct and the steps you took;
14.
consider having a specific disclosure committee that reviews the scripts and prepares
the presenters to answer the questions that will likely be asked; and
15.
consider the amount and scope of the directors and officers insurance (and in
particular, the exclusions) and the availability of indemnification (from the company,
from third parties or from a specially designated trust).
While there are no guarantees, following these and similar best practices and procedures will
maximize the opportunity to take advantage of a due diligence defence. Perhaps more
importantly, following best practices and procedures will help avoid situations likely to give
rise to shareholder complaints and concerns with ensuing litigation. In today’s corporate
governance environment one must be vigilant, even in the face of pressure to be “a part of the
team”, to safeguard against and be prepared to respond to the risk of litigation. Your good
reputation demands it.