Canadian public issuers have been concerned for several years about the repercussions of recent legislative amendments creating statutory causes of action for secondary market investors. We are about to find out whether that apprehension is justified.
McCarthy Tétrault is counsel to the proposed defendant issuer at the forefront of this developing area of law, and our report follows.
Although class action legislation was passed in Ontario in 1992, and gradually thereafter across Canada, the courts have limited the impact of such statutes on Corporate Canada in one area — by generally refusing to certify securities misrepresentation cases as class actions. Investors were thus blocked from advancing cases arguing that misleading continuous disclosure statements to the market could be commonly received and relied upon by all share purchasers, supporting a class-wide damages award.
Through the late 1990s, various commissions — and ultimately, the Canadian Securities Administrators — sought to overcome that common law barrier by proposing amendments to the provincial Securities Acts to create a statutory cause of action for secondary market misrepresentations.1 The key innovation for investors was the proposed provision to allow such a lawsuit to be prosecuted against issuers and their executives without proof that any investor either received or relied upon the alleged misrepresentation.2 A strong reaction from issuers and their counsel resulted in an amendment to the draft law to require a shareholder to obtain leave of the court to commence such an action.3 Even with this counterbalance in place, legal commentators and issuers braced for an onslaught of litigation when the draft legislation began to be passed into law (first in Ontario on December 31, 2005).4
However, the expected mass of cases simply did not materialize. Indeed, over the past three years, only 14 or so such cases have been proposed by plaintiffs’ counsel (all in Ontario), and not a single case has yet been the subject of a court’s decision on a leave to proceed motion.
The rationale for this surprisingly slow break from the gate would appear to be twofold: first, the relentlessly rising markets featured few of the sudden, precipitous drops in share price that would ground a valuable damages award; and second, experienced class action plaintiffs’ counsel did not know how stringently the leave to proceed test would be interpreted and applied by the courts, and finding out — by funding the test case to establish those principles, through a leave motion and likely at least one appeal — would have been an expensive proposition.
Those restraints have now been broken.
It is not news that the share prices of Canada’s companies have taken a serious beating, with a concomitant increase in the scrutiny brought to bear on any divergence between past public disclosure and the details in current battered financial statements. What is news is that since May 2008, the first two preliminary decisions in statutory secondary market misrepresentation cases have been now released, and the first leave motion was recently argued, with decision pending.5
The two interlocutory decisions (that is, rulings on issues preliminary to a leave to proceed hearing) illustrate well the reason shareholders and their litigators have moved slowly in this new area. In the first case – Silver v. IMAX - the judge decided that the Ontario Securities Act amendments granted "special powers" to shareholders seeking to be plaintiffs. The main one was the right to demand that the target issuer produce any information or documents, whether public or confidential, which could possibly be relevant to the allegations made in the proposed Claim against the company.6 However, in the second case – Ainslie v. CV Technologies7 — a different judge came to the opposite conclusion, reasoning that until leave was granted, the litigating shareholders could not force the company and its directors and senior officers to divulge a single fact or document related to the draft allegations against them.
While the context of the motions differed, the fundamental question before the two judges was the same: "Is the leave test a sword for investors (to cut away the traditional barriers to pre-suit shareholder access to details of corporate decision-making), or a shield for issuers (to protect the integrity of their internal operations unless and until the investors seeking to be plaintiffs demonstrate some merit to their allegations of wrongdoing)? These decisions deepen the uncertainty over the future of this statutory cause of action.8
In that hearing, the shareholders’ counsel argued that the statutory requirement to prove a "reasonable possibility" of success at trial meant only that they had to show success was a "mere possibility." Moreover, they argued that since the company had restated its financials for the relevant period, it had admitted a misrepresentation to the market, and the judge should expressly disregard the evidence before the court supportive of the various statutory defences available to the issuer and its executives, and simply grant leave. Counsel for those proposed defendants argued that the plaintiffs carried a substantial onus, and were required to demonstrate, based on a practical appraisal of the evidentiary record, that their allegations had obvious merit, especially in the face of the clear and cogent statutory defences of due diligence, and reliance upon the company’s auditors, advanced by the named directors and officers.
The narrow point to take from the two procedural decisions to date is that issuers responding to a leave motion in a proposed secondary market misrepresentation claim under any Securities Act have a stark choice to make: to either assemble affidavits attacking the key allegations and asserting the statutory defences, and then submit to cross-examination; or to remain silent, rebuff any attempt to review their corporate records and recollections, and argue in court that the investors lack a sufficient independent evidentiary record to demonstrate a "reasonable possibility" of success at trial.
In the wider context, the real issue at the heart of this debate is whether Canadian courts will conclude that their role is to bar to door to cases with dubious factual weight, or to help investors to force their way in. Since the first leave hearing in Canada was argued in the IMAX case in late December 2008, that decision, when released, will be an important milestone in reaching the answer to that question, and an indicator of the volume of cases yet to come.
McCarthy Tétrault acts for the proposed defendants in the IMAX matter, and for proposed defendants in three of the other outstanding statutory s.138.3 Securities Act cases.