Securities
Canadian disclosure rules and misrepresentation rules for claims by stock market investors are not as favourable as those in the U.S.. There is still room, however, for compelling cases to be advanced. The Ontario Court of Appeal has left the door open for class proceedings in respect of negligent misrepresentations. See, for example, Carom v. Bre-X Minerals Ltd. (2000), 51 O.R.(3d) 236 (Ont. C.A.) (application for leave to appeal to the Supreme Court of Canada dismissed at [2000] S.C.C. No. 660). Note, however, that in Moyes v. Fortune Financial Corp., Nordheimer J. suggested that Carom must be reevaluated in the light of subsequent decisions of the Supreme Court of Canada (Hollick v. Toronto [2001] 3 S.C.R. 158 and Rumley v. British Columbia [2001] 3 S.C.R. 184). Also see Moyes v. Fortune Financial Corp., [2002] O.J. No. 4297, per Nordheimer J. at para. 31. This decision was upheld on appeal at [2003] O.J. No. 4731.
The classic example of such a claim would be an allegation that a promoter, or perhaps an investment house, misrepresented the status of a project in promotional documents distributed to the entire class. If a claim depends, however, on evidence of reliance on multiple representations by many or all claimants then a class action will not likely be certified.
Enron Corp. filed for Chapter 11 reorganization in the U.S. on December 2, 2001. The case will undoubtedly lead to law reform. The main impact of Enron in Canada may be the termination of multi disciplinary practices. If auditing arms of large accounting firms are to be separated from their consulting practices, there is a good argument to be made that the legal department should also be independent. The European Court of Justice, in February 2002, went so far as to declare profit sharing between accountants and lawyers to be anti-competitive.
The U.S. Congress had been considering revising the Securities Litigation Reform Act of 1995 with a view to making it more difficult to initiate successful security class action lawsuits. The plaintiffs’ bar and their private role in policing the markets are now being given much more respect. Legislative reform may now move in a more liberal direction.
In Ontario class actions for securities fraud are still difficult to maintain (notwithstanding the success of the plaintiffs’ claims in Mondor v. Fisherman, [2001] 15 C.P.R. (4th) 289).
The plaintiffs’ bar in Ontario has not been given any great encouragement by the legislature. There is, as yet, no real prospect that any Canadian jurisdiction will introduce the “fraud on the market” theory. This would remove the need for plaintiffs to prove as part of their case that they relied on the defendant’s representations concerning a security. The focus for now (at the initiative of the Chairman of the OSC and the May 2002 Crawford report) is the push for a national securities regulator and for the OSC and the courts to be able to impose increased penalties for Securities Act violations.
In Carom v. Bre-X Minerals Ltd., Bre-X was supposedly developing a goldmine in Indonesia. The plaintiffs alleged the defendants conspired to manipulate share prices for their own benefit. The defendants allegedly misrepresented the prospects and the investors suffered considerable loss when the share values plummeted after the revelation that the initial reports of significant gold reserves were fraudulent.
On the first certification motion Mr. Justice Winkler restricted the common issues to conspiracy and fraud and refused to certify a common claim for negligent misrepresentations. The case against the brokers, in particular, Nesbitt Burns, was dismissed on consent, without costs. The appeal was dismissed by the Divisional Court against the other defendants.
The decision of the Divisional Court is reported at 46 O.R. (3d) 315. The alleged misrepresentations include 160 or more Bre-X press releases over a four year period. These Bre-X representations were not necessarily consistent with the brokerage representations. The court was concerned, however, that as the plaintiffs bought their shares at different times through different brokerage houses in reliance on different representations that there was no real fabric of common issues. Instead, individual trials were required with respect to each negligent misrepresentation claim. This is to be contrasted with cases like Maxwell v. MLG Ventures Ltd., [1995] O.J. No. 1136 in which a class action was certified with respect to an offering circular and Peppiatt v. Nicol (1993), 16 O.R. (3d) 133, where a class proceeding was certified on the basis of an information package. The class were subsequently sub-divided into subclasses according to the different versions of the information package that the various class members received as per (1996) 27 O.R. (3d) 462.
The court allowed the claim for fraud (as opposed to negligent misrepresentation) to proceed on the basis that “if it was a single lie from the beginning that there was gold in the ground in Busang” reliance and causation could easily be demonstrated on a common basis. The court conceded the irony in giving the insiders a defence to a class action on the basis that they were negligent but not fraudulent.
The Court of Appeal has now corrected this irony and confirmed the negligent misrepresentation case could proceed as a class action. See Carom v. Bre-X (2000), 51 O.R. (3d) 236 (Ont. C.A.). Motion for leave to appeal to the Supreme Court of Canada dismissed (October 18, 2001).
One must be careful in relying on Bre-X, however. Nordheimer J. in Moyes v. Fortune Financial Corp., [2002] O.J. No. 4297, at para. 31 suggested that the issue may have to be reevaluated in light of the recent Supreme Court of Canada decisions in Hollick and Rumley. This decision was subsequently upheld on appeal at [2003] O.J. No. 4731.
In Menegon v. Philip Services Corp. (January 9, 1993, Ont. C.A.), a purchaser of securities in the open market commenced a proposed class action claiming damages for negligent misrepresentation. Menegon attempts to invoke s. 130 of the Securities Act (establishing a civil cause of action where a prospectus contains a misrepresentation and establishing ‘deemed reliance’ in those circumstances) was unsuccessful. Section 130 did not clear the cause of action for the benefit of purchasers of shares in the secondary market. Furthermore, the Canadian underwriters and the auditors could not be liable for negligent misrepresentation based on policy considerations as set out by the Supreme Court of Canada in Hercules Management Ltd. v. Ernst & Young, [1997] 2 S.C.R. 165.
The motions judge (Gans J.) not only refused to certify but dismissed the claim. The Court of Appeal confirmed the reasoning of Cumming J. in Mondor v. Fisherman, [2001] 15 C.P.R. (4th) 289 (Ont. Sup. Ct.) that the American “fraud on the market” theory was not part of Canadian law. Cumming J. had, however, dismissed the motion to strike the pleading in that case as the allegation of negligent misrepresentation had been sufficiently pleaded. The difference in Menegon was the nature of the pleadings. It was essential to plead material facts which could give rise to a duty of care to the plaintiff on the part of the auditors or the Canadian underwriters. This was missing. It appears from the reasons that a major difference in the pleadings was that in Mondor the plaintiffs alleged that the defendants intended that the public would rely upon the audited financial statements when making investment decisions.
It should also be noted that the Court of Appeal has more recently liberalized the law in respect of class actions generally, and Menegon should be reviewed carefully in light of subsequent Supreme Court of Canada decisions, such as Cloud and Hollick and subsequent Court of Appeal for Ontario decisions, including Cassano and Markson.
The decision of Justice Lederman in Kerr v. Danier Leather Inc., [2004] O.J. No. 1916, represented the first securities class action trial in Canada. Danier Leather Inc. was ordered to pay damages to the 5,000,000 members of the class who still owned shares purchased in the initial public offering on May 20, 1998. Judgment was based on the company’s failure to correct misleading projections in its prospectus. The claim was prosecuted based on misrepresentations pursuant to s. 130 of the Act. Section 130(1) states:
“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 if it was a misrepresentation at the time of purchase and has a right of action for damages. . .”
In addition, the CEO and CFO were personally found liable for misrepresentation for failing to meet the standard expected of a reasonably prudent person in their positions and the circumstances of the case.
In a stunning reversal, however, the Court of Appeal for Ontario ((2005), 205 O.A.C. 313, 2005 CarswellOnt 7296, 261 D.L.R. (4th) 400, 11 B.L.R. (4th) 1, 77 O.R. (3d) 321)) and the Supreme Court of Canada (2007 CarswellOnt 6445 2007 SCC 44, J.E. 2007-1969, 87 O.R. (3d) 398 (note), 36 B.L.R. (4th) 95, 48 C.P.C. (6th) 205, 368 N.R. 204, 286 D.L.R. (4th) 601) overturned the decision and not only rejected the plaintiffs’ claims but also awarded costs (which will be in the millions of dollars) against the plaintiffs.
The Ontario Securities Act was amended by Bill 198 which received Royal Assent on December 9, 2002 and came into force on December 31, 2005. The legislation creates a civil cause of action irrespective of whether the plaintiff actually relied on misrepresentations in disclosure documents. The remedy is far from perfect, however. Plaintiffs have to obtain leave of the court to commence an action for misrepresentation. The plaintiffs must satisfy the court that the action has been instigated in good faith and the plaintiffs have a reasonable possibility of success. Furthermore, damages are capped at 5% of market capitalization or $1,000,000.00, whichever is greater. Market capitalization is to be defined in the regulations. Directors, officers and ‘’influential persons’ have their liability capped at $25,000.00 or 50% of the individual’s compensation, whichever is greater. There are also limits on the liability of experts. The limits will not apply in certain circumstances, primarily involving fraud.
The new liability provisions focus on a company’s failure to disclose material changes in its affairs on a timely basis. In Ontario (unlike the United States, under SEC Rule 10b-5) one need not prove that the defendants intended to deceive, manipulate or defraud or that they acted recklessly. Furthermore, although the liability limits (set out above) are not found in the United States, it should be noted that the Ontario limits do not apply to those who knowingly violate the disclosure rules.
A material change (which must be disclosed) is one that would reasonably be expected to have a significant effect on the market price or value of the company’s security. One may find companies filing confidential material change reports more often than has historically been the case, although the plaintiffs may yet challenge whether it was appropriate to make a confidential filing.
Defence counsel have advised Ontario corporations that they must now adopt more stringent review procedures before releasing documents, such as press releases, material change reports and similar documents. Indeed, it has
been suggested that the review process may approach that which is used in preparing prospectuses.
For cases dealing with the application of the oppression remedy to class proceedings see Stern v. Imasco, [1999] O.J No. 4235, Thermadel Foundation v. Third Canadian Investment Trust Ltd., (1998) 38 O.R. (3d) 749 (Cumming J.), Shaw v. BCE Inc. et al. And Gillespie v. BCE Inc. et al.