Over the past several years, the Ontario Securities Commission (OSC) has entered into several significant enforcement settlements that have punished various disclosure and other violations by Canadian public companies and their insiders. These enforcement proceedings show the personal risks of liability to public company insiders for securities violations are steadily rising. More directors are being swept into proceedings and there is a broader range of officers being affected who formerly figured as marginal players because they did not profit directly. Now all of these players can face proceedings because of a want of diligence. Highly publicized recent settlements such as those so far in 2009 involving Research in Motion Limited (RIM) and Biovail Corporation are merely the latest examples of this trend which has developed over the last three or four years.
In RIM, an enforcement settlement approved by the OSC in February, 2009, the issue was the manner in which stock option grant dates were selected. The settlement agreement states that in many instances option grant dates were selected improperly so that, with hindsight, options became more attractively priced than permitted under the stock-option plan. As a result, employees including senior officers and others realized larger monetary rewards on exercise than was envisaged under the company’s stock option plan and the excess benefit was not properly disclosed in continuous disclosure filings.
What is significant about RIM is that:
- the focus of securities regulators was not only on compliance with the provisions of the stock option plan but the quality of documentation (e.g. authorizing resolutions) prepared to show changes under the plan;
- regulators focused not just on the undisclosed financial benefit to option recipients but on the resultant flaws in the public company continuous disclosure filings as a result of the option disclosure;
- a failure to represent option dating accurately was treated in effect as a multiplicity of errors based on the number of separate disclosure documents that were made misleading by each disclosure;
- flawed continuous disclosure filings were treated as evidence of a want of internal controls;
- the want of internal controls also made CEO and CFO certificates as to the accuracy of public filings wrong;
- the number of parties sharing responsibility for the option disclosure practices was broad: responsibility extended not just to those officers who were directly responsible for option pricing but to senior officers who benefitted from it or made option grant decisions and to directors on the compensation committee;
- it was not enough for regulators that the insiders who benefitted from the dating practices returned realized benefits or decided to forego the exercise of options – extra penalties were imposed;
- though RIM voluntarily conducted an internal review of its option dating practices at very significant cost and took corrective action including reconstituting its board of directors to include more independent directors and adding a lead director, it was still required to submit to an independent review of its practices. Up until now, where a board has appeared to investigate and remedy conduct proactively, its members have customarily escaped proceedings; (e.g. Nortel Networks, 2007; Bennett Environmental, 2006);
- the two most senior officers bore the brunt of financial responsibility for the episode by releasing financial benefits but were also made to bear the bulk of the financial responsibility for the costs of the investigation;
- two other officers also had to pay significant amounts (in one case well above $1.5 million in respect of investigation costs and penalties);
- the individual respondents were specifically prohibited from seeking or accepting indemnity;
- even ex-directors had to agree to take remedial education courses.
In another 2009 case, Biovail Corporation, a series of officers were involved to various degrees in misleading disclosures including revenue recognition errors in the financial statements. The OSC sought and obtained enforcement penalties from a range of officers including two who asserted they did not have complete access to all facts and relied on senior management for their information. These officers were disciplined in effect for negligence or a lack of vigilance in verifying or following up on information they were given.1
That Ontario securities regulators are willing to target top management as well as more junior participants who had knowledge of key facts is now clear from a number of cases based on flawed public company disclosures (ATI Technologies,2 AiT3 (settlement ultimately reversed), YBM Magnex4 or questionable judgments about materiality with a resultant failure to disclose (Rex Diamonds Mining Company,5 Bennett Environmental,6 Agnico Eagle7).
It is noteworthy that even where significant penalties have been visited upon officers, the public companies themselves also have faced significant penalties. Biovail entered into a settlement agreement in January, 2009 in which it agreed to payments for third parties and for OSC investigation costs of $6.5 million and to extensive consultant review of its internal accounting controls, policies and procedures and a further consultant to report on the quality of Biovail training of personnel responsible for discharging financial and reporting requirements.8 Establishing a special committee to undertake an investigation and sharing the results with regulators have limited director liability or avoided charges against non-executive directors in Nortel,9 ATI Technologies10 and Bennett Environmental11 but such favourable treatment of directors is unlikely to continue in the future.