In a recent judgment that is sure to become a landmark in the growing field of Canadian securities class actions, the Ontario Court of Appeal has confirmed that the statutory cause of action for secondary market misrepresentations can be asserted against issuers whose shares are listed solely on a foreign exchange. The ruling in Abdula v. Canadian Solar opens a deep gap between the Canadian and American approaches to the extraterritorial limits of such claims, and is likely to solidify Ontario’s reputation as the new ”hot spot” for securities class actions.
I summarized the background to Canadian Solar in a previous post. Briefly, the case involves a proposed class action by an Ontario investor against an issuer and two of its officer/directors. The claim alleges liability under inter alia s. 138.3 of the Ontario Securities Act, based on overstatements of the issuer’s financial results in continuous disclosure documents and investor conference calls.
The issuer is a Canada Business Corporations Act company whose shares are publicly traded on the NASDAQ alone, and its principal place of business – where the majority of its manufacturing operations and executives are situate – is in China. The disclosure documents in question were filed exclusively with the United States Securities and Exchange Commission rather than any Canadian securities regulator, and the issuer is not a “reporting issuer” under the Ontario Securities Act. However, there are also several points of contact between the claim and Ontario (e.g., some of the impugned documents indicated that they were issued in Ontario, the issuer has its registered and “principal executive” offices in Ontario, the issuer has previously engaged in various business projects in Ontario and raised capital from Ontario investors through private placements, and the plaintiff is an Ontario resident who purchased his shares from a computer in Ontario through a Canadian brokerage). It appears to have been conceded by the defendants on appeal that the issuer possessed a “real and substantial connection to Ontario”, and the Court of Appeal expressly agreed with this proposition. (para. 9)
In the court below, Taylor J. found that the cause of action in s. 138.3 was applicable to the issuer on these facts. In doing so, he rejected the argument that the issuer could not be a “responsible issuer” as required by s. 138.1, which provides:
“responsible issuer” means,
(a) a reporting issuer, or (b) any other issuer with a real and substantial connection to Ontario, any securities of which are publicly traded; …
According to Taylor J., it was possible for the issuer to fall within subsection (b) of this definition, even though none of its shares are publicly traded on an Ontario or even Canadian exchange.
On appeal, the defendants focused on arguing that an implied limitation should be read into the definition of responsible issuer in s. 138.1, so that subsection (b) is limited to “any other issuer with a real and substantial connection to Ontario, any securities of which are publicly traded in Canada“. However, this implied limitation was rejected by the Court of Appeal, who unanimously affirmed Taylor J.’s ruling.
The Court’s reasons, written by Hoy J.A., focus primarily upon the application of s. 138.1 to foreign-listed issuers as a matter of statutory interpretation. Hoy J.A. reviewed much of the legislative history surrounding Part XXIII.1 of the Securities Act, together with the statutory context surrounding s. 138.1, and concluded that they do not disclose an intention to exclude claims against non-reporting issuers whose securities are not publicly traded upon a Canadian exchange. In doing so, Hoy J.A. made at least three interesting points.
First, she rejected the argument that the Supreme Court of Canada’s ruling in Unifund precludes s. 138.1 from applying to foreign-listed issuers. As I discussed in my previous post, the Supreme Court in Unifund held that provincial legislation may be constitutionally inapplicable to extraterritorial matters that do not possess a “sufficient connection” to the enacting province. Hoy J.A. found that a sufficient connection between the issuer and Ontario was present in Canadian Solar, observing:
I agree with the motion judge that here, unlike in Unifund, there is a sufficient connection between Ontario and Canadian Solar to support the application of Ontario’s regulatory regime to Canadian Solar. The general principles with respect to extra-territorial regulation do not require that the definition of “responsible issuer” be interpreted as confined to issuers any of whose securities are publicly traded in Canada. …
Unifund is clearly distinguishable from Mr. Abdula’s case. As stated by the motion judge at para. 43 of his reasons, Mr. Abdula’s case deals with an Ontario plaintiff seeking to have Ontario law apply to a defendant carrying on business in Ontario.
…It is a CBCA corporation with its registered office, its principal executive office and business operations in Ontario.
The subject matter of Part XXIII.I is a remedy to investors for misrepresentation in certain issuers’ secondary market disclosure. In this case, at least some of that disclosure emanated from Ontario. That, together with the relationship of Canadian Solar to Ontario, constitutes a sufficient connection between Ontario and Canadian Solar to potentially subject Canadian Solar to a statutory cause of action pursuant to Part XXIII.I of the OSA. … (paras. 41 and 47-49)
Second, Hoy J.A. held that restricting s. 138.1 to Canadian-listed issuers was not mandated by the possibility of overlapping claims in other jurisdictions. The fact that s. 138.7 of the Securities Act, reduces the cap on an issuer’s liability by the damages assessed under comparable legislation in other Canadian provinces and territories, but not by the damages assessed under foreign statutory claims like SEC Rule 10b-5, was not determinative:
The fact that s. 138.7 does not reduce the cap by damages assessed under s. 10(b) of the Securities Exchange Act of 1934 does not indicate that s. 138.3 is confined to issuers that are reporting issuers in a Canadian jurisdiction or issuers any of whose securities are listed on a Canadian stock exchange. A significant number of Canadian issuers are listed both on the TSX and an American exchange. Counsel for Canadian Solar agrees that such issuers fall within the definition of “responsible issuer”. They are exposed to litigation under both s. 138.3 of the OSA and s. 10(b) of the Securities Exchange Act of 1934. Damages assessed against them under s. 10(b) of the Securities Exchange Act of 1934 do not statutorily reduce the cap on their liability under s. 138.3 of the OSA. Section 138.3 applies even where the issuer may be sued in both Canada and the U.S. (para. 77)
Third, the Court rejected the analogy to cases like Pearson v. Boliden Ltd., which hold that the statutory cause of action for primary market misrepresentations (in provisions like s. 130 of the Securities Act) only applies where the distribution through which the investor acquires its shares takes place within the enacting province. According to Hoy J.A., “[t]he reasoning in these cases is not applicable to the statutory cause of action for misrepresentations in secondary market disclosure”. (para. 82)
Canadian Solar marks the first time that an appellate court has considered the extraterritorial reach of statutory secondary market claims in Canada. In doing so, the Court of Appeal rejected a bright line test that would preclude such claims from applying to non-reporting issuers whose shares are not publicly traded on a Canadian exchange. The significance of this ruling is at least twofold.
First, the approach taken in Canadian Solar stands in sharp contrast to the one taken by the United States Supreme Court in Morrison v. National Australia Bank Ltd. In Morrison, the U.S. Supreme Court adopted a clear “transactional test” to the extraterritoriality of Rule 10b-5, which restricts such claims to situations involving “the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States”. In doing so, the Supreme Court rejected decades of lower court jurisprudence that had adopted varying iterations of “(1) an ‘effects test,’ ‘whether the wrongful conduct had a substantial effect in the United States or upon United States citizens,’ and (2) a ‘conduct test,’ ‘whether the wrongful conduct occurred in the United States.’”
Since the U.S. courts are thus no longer inclined to extend Rule 10b-5 claims to foreign-listed issuers (as least where the plaintiff’s purchase of securities did not otherwise take place in the United States), the Ontario Court of Appeal has opted for a considerably broader model of extraterritoriality, one which could make Canada the venue of choice for securities class actions involving issuers who are not listed on a American exchange. Further, because both U.S. and Ontario courts are now willing to apply their respective statutory causes of action to issuers listed (and listed solely) on U.S. exchanges, there is a significant potential for overlapping and inconsistent results, which as the Court noted in Canadian Solar are not addressed under provisions like s. 138.7 of the Securities Act. This would seem contrary to Unifund, where the Supreme Court of Canada held that the principles of “order” and “fairness” which inform the territorial limits upon provincial legislative power require that “[s]uch ‘competing exercises’ of regulatory regimes ‘must be avoided’”, and cautioned that “[t]he cost of such regulatory uncertainties undermines economic efficiency”. (para. 71) It also seems inconsistent with the Supreme Court of Canada’s post-Unifund judgment in Imperial Tobacco, where in upholding the constitutional validity of a statutory cause of action with extraterritorial effects the Court emphasized that it ”respects the legislative sovereignty of other jurisdictions”, and that “no territory could possibly assert a stronger relationship to that cause of action than” the enacting province. (para. 38)
It is curious that the Court of Appeal did not directly address these constitutional principles of order and fairness in its judgment. Indeed, despite purporting to find that the application of s. 138.3 to foreign-listed issuers is consistent with Unifund, the word “constitution” does not appear once in the Court’s reasons.
Second, the Court in Canadian Solar offered very little guidance regarding precisely when foreign-listed issuer will possess a “real and substantial connection” with Ontario sufficient to justify the application of Part XXIII.1 of the Securities Act. Instead, it simply listed several connecting factors that in its view were significant on the facts of the case before it, without attributing a particular or hierarchical weight to any of them (e.g., the place where the plaintiff was resident, the place where the issuer had its offices, and the place where the misrepresentations were made). One wonders whether the Court’s judgment would have been different if the defendants had challenged the application of s. 138.3 to the issuer after certification, where the effective claimants would have included not just the Ontario-resident plaintiff, but also investors resident in other countries. Could the fact that a foreign issuer possesses a significant asset in Ontario (e.g., a mine), sufficient to give it a “real and substantial connection” with the province in abstract terms, really permit a foreign claimant to assert s. 138.3 against the foreign issuer in respect of shares purchased on a foreign exchange?
In many respects, the test that emerges from Canadian Solar is similar to the “conduct” and effects” tests previously applied by the U.S. circuit courts, which were frequently maligned for the uncertainty and unpredictability they produced. It is to be hoped that courts in future cases will provide clearer guidance as to precisely what types and degrees of contract with Ontario are necessary in order for the s. 138.3 action to apply. Presumably, there must come a point at which the connection is too tenuous to sustain the claim, even if the issuer possesses some link with the province. As the U.S. Supreme Court said in Morrison:
…it is a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States. But the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case. …
ONCA Court File No.: C54372
Date of Decision: March 30, 2012