The AiT case was one where OSC Staff got it wrong. The decision of the OSC, delivered in early 2008, triggered a sigh of relief from the securities bar because it confirmed what most practitioners had considered to be best practices with respect to disclosure issues. In essence, it was OSC Staff's position that AiT had a legal obligation to disclose a potential M & A transaction as a material change at some point in time well before the transaction was announced. The OSC, in rejecting the Staff's case, clarified the difference between a material change and a material fact, when a material change occurs (and accordingly when public disclosure is required) and the need to balance the importance of keeping the market informed versus the potential damage caused by premature disclosure. While the OSC stated that a material change can occur before definitive agreements are executed, the AiT decision showed that OSC Staff, in their allegations, were trying to set the bar too high with respect to timely disclosure. The matter of Rex Diamond Mining Corporation (Rex), on the other hand, is a case where OSC Staff got it right. The Rex case serves as a prime example of public disclosure that fell well short of best practices.
In the 1990s, Rex, a public mining company, obtained two mining leases from the Sierra Leone Government. The leases had a high potential value to Rex and, without them, Rex did not have the ability to produce diamonds in Sierra Leone. Beginning in 2003, Rex started to receive notices from the Government indicating that the leases might be cancelled. By the end of 2003, after Rex had already received three warning letters, it became aware of a Notice of Tender which announced that the Government was seeking tenders from mining companies with respect to one of the areas where Rex previously held mining rights. Rex did not issue a news release or file a material change report with respect to any of these notices.
OSC Staff alleged that Rex breached section 75 of the Securities Act (the "Act") by failing to issue a news release and file a material change report in respect of these events. Staff also took the position that Rex breached section 75 of the Act by failing to file a material change report (although it did issue a news release in April 2004) after the Government issued a Tender Evaluation in March 2004 which declared that another company was granted mining rights where Rex previously held rights. In addition, Staff alleged that there was misleading disclosure in Rex's public filings during the period from February 2003 to November 2003 with respect to Rex's operations in Sierra Leone, and that Rex, along with its CEO and CFO, provided misleading statements to Market Regulation Services Inc. (RS) with respect to the leases.
DECISION & LEGAL IMPLICATIONS
On August 21, 2008, the OSC delivered its decision and concluded that it was likely that there was a material change in the business, operations or capital of Rex when Rex received the following correspondence from the Government:
- The first warning letter of January 2003 which advised Rex that the Minerals Advisory Board recommended to the Minister of Mineral Resources that Rex's leases be cancelled because Rex did not comply with the conditions set out in the leases; and
- The second warning letter of April 2003 which advised Rex that its leases were not in good standing and that Rex failed to honour its financial obligations.
More importantly, the OSC concluded that material changes did occur in the business, operations or capital of Rex when:
- Rex received the final notice warning letter of June 2003 from the Government which advised Rex that it had 90 days to comply with the conditions of the leases or otherwise the leases would be revoked;
- Rex became aware of the Notice of Tender in December 2003; and
- The Government issued the Tender Evaluation in March 2004.
The OSC said that Rex should have issued a news release and filed a material change report following each of these three events and that, by failing to do so (though it did issue a news release in April following the Tender Evaluation in March 2004), Rex breached section 75 of the Act and acted contrary to the public interest. Rex should have issued a material change report when it initially learned that there was a risk that it would lose the leases, upon actual cancellation of leases, and when negotiations commenced to get the leases reinstated. This is because the loss of a right to mine for diamonds would impact the operations of a diamond exploration company such as Rex and this, in turn, would affect Rex's ability to generate profits and its share price would be affected accordingly.
The OSC also found that Rex acted contrary to the public interest by providing inaccurate and incomplete disclosure regarding its operations in Sierra Leone in each of its public filings of February, August and November of 2003. While Rex's public filings did refer to some political uncertainty in Sierra Leone, they generally had an optimistic tone and did not mention the very possible risk of losing the valuable leases. The OSC emphasized that all relevant information should be contained in an AIF, not just positive information.
In addition, the OSC found that Rex acted contrary to the public interest when it provided RS with an inaccurate and incomplete chronology of events. In order for the OSC and self-regulatory organizations such as RS to monitor market participants, those involved in the capital markets must co-operate and provide accurate information to the regulators. RS falls within the framework of securities regulation, and it is equally important that market participants provide full and accurate information to RS in response to inquiries.
Finally, the OSC found that Rex's CEO authorized or permitted, and Rex's CFO acquiesced in the company's conduct and thereby acted contrary to the public interest. Rex's CEO testified that only the shareholders who asked about Sierra Leone and the Notice of Tender were told about the problems with the leases. The OSC stated that it should not be necessary for individual shareholders to make specific inquiries to the company's officers in order to find out information which should be made public by the company. Selective disclosure to certain investors does not promote truthful and accurate disclosure to the capital markets as a whole.
Other observations of the OSC in its reasoning include the following:
- The value of mining assets is highly relevant in a material change determination (the leases had a high potential value to Rex, and developments concerning them would be of interest to shareholders.)
- If investors are justifiably concerned about the estimated mineral content of mining property, so too must they be entitled to know whether the company holds that asset at all. (The Notice of Tender applied to mining areas previously belonging to Rex which signaled that Rex's leases had been revoked. The loss of the leases eliminated any potential for Rex to generate future revenue from those operations and constituted a change in Rex's operations.)
- With respect to market impact and whether or not a material change had occurred, the OSC's view was that abnormal fluctuations in share prices, volume and the number of trades per day demonstrated market impact, and indicated that the market was reacting to something. (Investors had an interest in Rex's operations in Sierra Leone and they traded accordingly when they became aware of rumours regarding Sierra Leone. Following the April news release, there was an 18% decrease in the value of Rex's shares accompanied by a very high volume of trading - the market was reacting to the announcement that Rex lost the leases.)
The purposes of the Act as set out in section 1.1 are to: (1) provide protection to investors from unfair, improper or fraudulent practices, and (2) foster fair and efficient capital markets and confidence in capital markets. These are largely achieved through truthful and accurate disclosure. Because disclosure plays such an important role in ensuring that the capital markets are functioning on current, truthful and accurate information, it is essential that all market participants follow best disclosure practices. The decision in Rex underscores the importance of timely public disclosure and demonstrates that best disclosure practices dictate that, when in doubt, an issuer should err on the side of disclosure.