Reporting issuers are subject to various disclosure obligations under securities laws in respect of material information. The Supreme Court of Canada’s analysis of whether the respondents in Sharbern Holdings Inc. v. Vancouver Airport Centre made “material false statements” provides helpful guidance to issuers in analyzing their disclosure obligations in various circumstances, such as in a prospectus or continuous disclosure document. Although the main cause of action in the case was brought under the now-repealed British Columbia Real Estate Act, much of the Court’s analysis was drawn from Canadian and American securities law jurisprudence dealing with the question of materiality. The Court drew direct parallels between the disclosure document involved in the case and disclosure requirements arising under securities laws.
The respondent in the case, Vancouver Airport Centre (VAC), developed and sold strata units in two hotels in the Vancouver airport area in the 1990s, one a Marriot Hotel and the other a Hilton Hotel. Investors in the Marriott Hotel entered into management agreements with VAC under which they agreed to a 5% management fee and were guaranteed a 12% return. VAC was also entitled to an incentive fee of 25% of the amount by which the Marriot investors’ net annual return on investment exceeded 8%. The Hilton Hotel management agreements did not provide for a guaranteed return to investors, although the management fee was a lower 3% of gross rental revenues. While the disclosure documents noted that VAC was managing both hotels, no disclosure was made regarding the differences in the compensation arrangements set out in the Marriott Hotel and Hilton Hotel management agreements.
By 2001, the bottom had fallen out of the Vancouver hotel market and Hilton investors had suffered significant losses. Sharbern Holdings Inc. was one of those investors. In 2003, it brought a class action against VAC. One of the claims was that VAC made “material false statements” by failing to disclose the differing management compensation arrangements, which, according to Sharbern, put VAC in an actual or potential conflict of interest by giving it an incentive to favour the Marriot over the Hilton.
Rothstein J., writing for a unanimous Court, held that the test for materiality requires a balance between too much and too little disclosure. When allegations involve an omitted fact, a court must take an objective approach from the perspective of a reasonable investor. The omitted fact is material if there is a substantial likelihood a reasonable investor would have (not might have) considered it important in making his or her decision. That is, the omitted fact is material if there is a substantial likelihood that a reasonable investor would have viewed its disclosure as having significantly altered the “total mix” of information made available. It is important to note that the omitted fact does not have to change a reasonable investor’s decision; it must be substantially likely that it would assume actual significance in his or her decision making process.
Given that materiality is determined objectively from the perspective of a reasonable investor, the subjective views of the issuer do not factor into the analysis. The analysis requires the application of a legal standard to a specific set of facts. In this respect, Rothstein J. reiterated the Court’s holding in earlier cases that it will not defer to management’s business judgment when it comes to determining whether disclosure obligations have been carried out. The first step in the analysis is to establish the factual backdrop by reviewing all the information that was disclosed. The next step is to determine the importance of the undisclosed information to a reasonable investor by placing the undisclosed information against the backdrop of the disclosed information. Evidence of external factors, such as general market trends at the time of disclosure, and behavioural evidence, may be led to inform this analysis by providing more context.
Applied to the facts, the Court held that the differing compensation arrangements, and VAC’s failure to disclose such differences, must be considered against the backdrop of the information disclosed about the Hilton. This includes the disclaimer that VAC was managing both the Marriott and the Hilton, and that VAC’s obligations to the Hilton may be impeded by its obligations to the Marriott. The Court also considered the strong economic environment at the time the disclosures were made, the fact that the largest non-affiliated investor in the Hilton had knowledge of the Marriott arrangements and had also invested in the Marriott, and the fact that the Hilton investors had not reacted strongly when first informed of the guarantee in favour of the Marriott investors.
Finally, the Court confirmed that the party alleging the breach of the disclosure obligation carries the burden of proving materiality, except where common sense inferences can be made. Given the complex circumstances of the case, the Court concluded such common sense inference could not be drawn. The Court held in favour of the respondents on the basis that Sharbern had not adduced evidence at trial capable of supporting the allegation that the omitted information was material and therefore needed to be disclosed.
A failure to disclose will not allow an investor to recover in respect of a bad investment1 unless the investor can demonstrate, or a common sense inference can be drawn from the facts, that there is a substantial likelihood a reasonable investor would have considered it important in making his or her decision. The clear statements of principle made by the Supreme Court provide very useful guidance to management at public companies in determining what disclosure should be made, or need not be made, in its public disclosure documents.