The Ontario Securities Commission recently published Policy 51-604 – Defence for Misrepresentations in Forward-Looking Information (the “Policy”). The Policy provides guidance to issuers who are attempting to establish a potential defence against their liability to investors with respect to a misrepresentation contained in any forward-looking information (“FLI”) publicly issued by them.
The secondary market liability regime was introduced in Ontario in December 2005 by way of amendments to the Securities Act (Ontario) (the “Act”). The legislation provides a right of action for investors who purchase or sell securities in the secondary market against an issuer, its directors and officers and certain other persons connected to the issuer during a period when the oral or written disclosure of the issuer contained a misrepresentation. The legislation also provides for a so-called “safe harbour” or defence in the event the misrepresentation was contained in FLI included in the disclosure. FLI encompasses all disclosure regarding possible events, conditions or results or operations that is based on assumptions about future economic conditions and courses of action. FLI would include, for example, disclosure of financial outlooks or guidance such as expected revenues, net income, gross margins, earnings per share and research and development spending. The establishment of a specific defence against liability for a misrepresentation contained in FLI recognizes the unique nature of such information.
In order to establish the defence and avoid liability for misrepresentations in FLI, at the time the FLI is released in a disclosure document, the document must contain, “proximate” to the FLI:
- reasonable cautionary language identifying the information as forward-looking and the material factors that could cause results to differ materially from the conclusion, forecast or projection set out in the FLI (“material risk factor disclosure”); and
- a statement of the material factors or assumptions that were applied in drawing such conclusions or making such forecasts or projections (“material assumption disclosure”).
In addition, the issuer or person must have had a reasonable basis for drawing the conclusion or making the forecast or projection set out in the FLI.
In the case of oral statements released to the public, the requirements of the defence are satisfied provided the person making the statement had stated that:
- the oral statement contained FLI; and
- actual results could differ materially from the FLI, material assumptions were applied and information about such assumptions was contained in a “readily available” document. A document filed with the OSC or generally disclosed is deemed to be readily available.
An identical defence was introduced in respect of FLI contained in prospectuses, offering memoranda and take-over bid circulars for investors who acquired securities in the primary market. The defences do not cover FLI contained in financial statements or an IPO document.
The amendments which introduced the defences raised questions and created uncertainty for issuers and their advisors regarding what was required at the time of the release of FLI to allow future reliance on the defences. The Policy provides the OSC’s responses to recurring questions the OSC has received in respect of the defence. While the Policy does not have the force of law, it does outline the OSC’s view on the defence, which hopefully will provide issuers with useful guidance.
The Policy outlines the policy considerations that underly the defence. It states that the animating principles of the defence are to allow an investor who is reading or listening to disclosure containing FLI to understand that it is FLI, to identify the FLI and to understand the material risks underlying and the material assumptions associated with the FLI. In addition, an underlying principle of the defence is that effective disclosure is based on clear presentation and simple language and style.
The Policy then specifically addresses four elements of the defences. First, what is the meaning of the word “proximate” in the context of determining where the prescribed cautionary and risk disclosure must appear in a document? Secondly, what are the necessary material risk factors and material fact/assumptions which must be disclosed in order to rely on the defence? What is the standard to apply in establishing that there was a reasonable basis for the FLI? Finally, how can an issuer comply in practice with the elements of the defence when releasing public oral statements containing FLI?
The Meaning of the Term “Proximate”: Unlike the U.S. safe harbour for FLI, which provides that the FLI must be “accompanied” by the required cautionary language and risk factor disclosure, the Act provides that the cautionary language, the material risk factors and the assumptions be located “proximate” to the FLI. The use of the term “proximate” has caused some uncertainty as to where such language should be located if the issuer wishes to later rely on the defence. Is it critical to invoking the defence that the disclosure appear immediately before or after the relevant FLI? The Policy sets out the OSC’s view that “proximate” does not require immediate juxtaposition of the required language and the FLI.
By way of example, the Policy states that where an issuer’s MD&A has threads of FLI throughout which are subject to common assumptions and risk factors, then a single broader reference prefacing or following such FLI may better serve an investor and should generally satisfy the “proximate” requirement. In addition, it is the OSC’s view that where certain assumptions and risk factors apply to several instances of FLI appearing in a document, then the use of user-friendly cross-referencing is consistent with the “proximate” requirement. The Policy further states the OSC’s view that, generally, the more closely tied a particular risk factor or disclosure is to a particular piece of FLI, the more proximate that disclosure should be.
Material Risk Factor Disclosure: The Policy confirms the OSC’s view that risk factor disclosure should be relevant to the actual FLI and not be merely boilerplate. Due to the use of the word “material” in the defence, an issuer is not required to discuss each and every risk factor that could conceivably cause the results to differ, but an issuer should rather identify significant and reasonably foreseeable factors that could reasonably cause the results to differ materially from the FLI. The OSC’s view is that the failure to include a particular risk factor that ultimately causes the FLI not to be achievable should not necessarily lead to the conclusion that the defence is not available.
Material Assumptions: Similar to risk factor disclosure, when outlining the assumptions used in preparing the FLI, the assumptions outlined should be relevant to the conclusion, forecast or projection. The use of the word “material” means that an exhaustive statement of each and every assumption would not be required to rely on the defence.
Reasonable Basis Requirement: As set out above, in order to rely on the defence, there must have been a reasonable basis for drawing the conclusion or making the forecast or projection set out in the FLI. The Policy sets out the OSC’s view that, in interpreting this standard, the relevant factors would normally include the reasonableness of the assumptions applied and the inquiries made and the process undertaken in preparing and reviewing the FLI.
Public Oral Statements: The Policy clarifies that the deeming provision applicable to the defence for public oral statements should not be considered exhaustive and that in appropriate circumstances, the cautionary statement may be made by another person on behalf of the person who is making the oral statement containing the FLI. The OSC’s view is that a pragmatic approach should be taken.
The Policy demonstrates the OSC’s pragmatic approach to interpreting the defences. It should be remembered that the Policy does not have the force of law and whether or not a defence has been established in a particular case will finally be determined by a court of law.