In the recent US case of In Re Silver Wheaton Corp. Securities Legislation, CV15-5146-CAS(JEMx) C/W: CV15-5173-CAS(JEMx), June 6, 2016, the US District Court denied a motion by Silver Wheaton Corp. (SW) and three of its executives (the defendants) to dismiss a class action commenced against them. The class action relates to the recent international tax audit of SW by the Canada Revenue Agency (CRA), in which the CRA proposed to add C$715 million to SW’s income and impose transfer pricing penalties of C$72 million. To defeat the motion, the plaintiffs had to demonstrate factual allegations above the speculative level in relation to, among other things, (1) a material misrepresentation or omission and (2) scienter (being a mental state embracing intent to deceive, manipulate, or defraud) (see page 11). The Court found that the plaintiffs met this minimum legal standard on both elements (see page 26). Here are some interesting points (and principles) from the decision:
- The plaintiffs alleged that the defendants made false or misleading statements by either (a) failing to record and recognize a tax liability on SW’s balance sheets or (b) failing to disclose a contingent tax liability in SW’s financial statements (see page 13).
- The Court found that whether the defendants were required to disclose a tax liability under the applicable accounting standards (i.e., GAAP and IFRS) did not depend on whether the Canadian tax courts would ultimately affirm the CRA’s reassessment (see page 13). Rather, the defendants were required first to assume that the CRA would audit SW’s transfer pricing position, and then determine whether it was more likely than not (i.e. more than 50% chance) the CRA would find that SW owed additional income taxes and penalties (see page 14).
- The Court went on to find that even if the defendants were not required to record a tax liability, they were required under GAAP and IFRS to disclose a contingent tax liability unless the possibility that the CRA would reassess SW was remote (see page 16). If such a possibility was not remote, the defendants were required to disclose a contingent liability and estimate the amount of the potential tax reassessment (see page 16).
- On these points the Court concluded that the plaintiffs plausibly demonstrated that the defendants’ reports to the SEC did not comply with GAAP and IFRS, and as such, the reports contained false and misleading information about SW’s financial position (see page 16).
- On the issue of scienter, the Court found a strong inference that the defendants knew or had reason to suspect that a CRA reassessment was possible, if not probable, and yet they took no efforts to incorporate this fact into SW’s financial statements (see page 20). A clean audit opinion from SW’s independent auditors and accountants was of no assistance on this issue (see page 21), in part because of evidence that SW hid information from them (see page 22).