The United States Supreme Court takes a new approach on the standards for certification.
The class action is a litigation technique that lends itself well to claims by security-holders against issuers. The classes of purchasers of securities are easily definable, the losses are often all too publicly ascertainable, and the procedural benefits of one large claim (as opposed to a multitude of related actions in various jurisdictions) are clear. Securities class actions can grow, geographically, depending on where the securities were issued. With increased integration of the Canadian and global (particularly American) capital markets, more and larger class action claims by disgruntled shareholders and bondholders can be expected.
Against this backdrop, a key pronouncement has been made by The United States Supreme Court in the much-publicized Amgen Inc. et al. v. Connecticut Retirement Plans and Trust Funds1 (“Amgen”) decision, handed down on February 27, 2013. The court found that proof of materiality is not a prerequisite to certification of a securities class action. This is a significant development, opening the door in the United States to yet greater potential liability for capital markets participants. The decision in the Amgen case gives us cause to examine the regime for certifying securities class actions in both countries. The significance of certification cannot be underestimated.
Most securities lawsuits are based in fraudulent or negligent misrepresentation – the typical scenario is that either the offering documents or the continuous disclosure is alleged to be, by misstatement or omission, incorrect; therefore, the purchaser of the security relied on wrong information when buying or selling, and the issuer is consequently liable for value or opportunity lost.
Materiality is connected to the idea of reliance. For liability to arise, the plaintiff has to prove that they actually relied upon (as in, cared about) the wrong information when making a purchase. At its extremes, reliance is easy to understand. Some parts of the offering or disclosure documents (for example, financial statements) are obviously important. Other parts (the spelling of the surname of the chair of the Audit Committee) are clearly irrelevant, or immaterial, to whether a purchaser will want to buy the securities. Between these extremes, one finds the majority of the documents at issue and a vast grey area of potential reliance, depending both on the nature of the issuer and the nature of the buyer.
The Supreme Court of Canada wisely chose, in the 2011 decision in Sharbern Holding Inc. v. Vancouver Airport Centre Ltd.2 (“Sharbern”) to inculcate a “reasonable investor” test in Canadian securities law. The Sharbern case is discussed here in detail. A statement is “material” if the information in question would matter (i.e., be relied upon) to the reasonable, hypothetical investor when considering the investment. Whether or not the investor actually relied on the information is not considered in the “reasonable investor” test.
This benefits everybody: the investor does not have to establish their particular reliance, which can be complex from an evidentiary standpoint; the issuer is not beset by bizarre investors who purport to care about minutia.
Class actions feature an early stage, known as “certification”, in which the court blesses the class claim as legitimate and as an appropriate means of conduct. Fighting certification can be a worthwhile tactic for the issuer, particularly if the individual plaintiffs lack the means to act on their own accord.
In Ontario, the test for certification is set out in section 5(1) of the Class Proceedings Act.3 A significant part of that test is that “the claims or defences of the class members raise common issues”. The “common issues” requirement is a feature of US law and is the plank on which an absence of materiality could lead to the class remaining uncertified. In short, from the plaintiff’s perspective, there is no such thing as “collective reliance” – either each plaintiff relied on the false information, or they did not. A class composed of individuals who might and might not have relied on the information is not a class with common issues to try in court.
In Canada, one might think that Sharbern delivered a form of “collective reliance” to the benefit of plaintiffs in a class action. With the “reasonable investor” test, the plaintiffs need not worry about their own individual reliance situation. The law is confused, however, thanks to the more recent decision of the Ontario Superior Court of Justice in Green v. Canadian Imperial Bank of Commerce4 (“Green”). In Green, the court denied certification of a class action by CIBC shareholders based on the bank’s exposure to the subprime crisis. The court in Green accepts that Sharbern “re-affirms the need to establish reliance in a common law misrepresentation claim”, but misapplies the reasonable investor test by looking for individual reliance, which cannot be established on a class-wide basis.5
As an aside, the proposed representative plaintiffs in Green might give rise to second thoughts on the merits of the reasonable investor test. Mr. Green was an aficionado of share certificates. The disclosure of CIBC was hardly a factor when deciding whether to add a CIBC share certificate to his collection. The other representative plaintiff, a Mrs. Bell, invested through her husband, leaving the whole task to him. She was therefore totally unaware of what CIBC had disclosed.
The Amgen Decision
Amgen is a biotechnology company. The plaintiffs, a consortium of six state pension and nine state trust funds in Connecticut, alleged that Amgen misrepresented the safety of two anemia drugs it was producing. Clinical trials may have suggested that the drugs could harm cancer patients. The FDA expressed concern about the drugs’ use, causing a 9% drop in Amgen’s share price.
In the United States, s. 10(b) of the Securities Exchange Act of 19346 with SEC Rule 10b-57 creates a plaintiff-side obligation to establish reliance; i.e. each purchaser of securities must show they relied on the misrepresentation in question to have a claim against the issuer. As stated above, this is a difficult evidentiary challenge for a potential plaintiff.
The United States Supreme Court created an avenue to avoid that burden in the form of the “fraud on the market” theory of loss. The concept, as described by Justice Blackmun in Basic Inc. v. Levinson8 (“Levinson”), is that the price of a security is a function of the company and its business. Misleading statements therefore have the effect of defrauding purchasers of the delta between the “true” and “fraudulent” share value, regardless of reliance. The fraud on the market theory requires the securities to be traded in an efficient market and that the misrepresentation in question was made publicly. Reliance is not discharged by pleading the fraud on the market theory; rather, it is presumed and demonstrated objectively – a “reasonable investor” standard much like Sharbern.
Amgen is a “fraud on the market” (“FOTM”) case. The United States Supreme Court, in a 6-3 decision written by Justice Ginsberg, found that, as materiality in fraud on the market situations is evaluated according to an objective standard, there can be no doubt that the degree of materiality of Amgen’s misrepresentations on the anemia drugs is a common question to all class members. Either the reliance is objectively reasonable, or it isn’t; the particular degrees of concern of each class member/investor are irrelevant. Amgen, thanks to the alignment of the fraud on the market theory and the reasonable investor test, clarifies the class certification requirement.
FOMO on FOTM?
The courts in Canada have rejected the fraud on the market theory. The most high profile case touching on this issue is Carom v. Bre-X Minerals Ltd.,9 in which the court in Ontario suggests the fraud on the market theory springs from the particular statutory context in which it originated, i.e. the restrictions in Rule 10b-5. This is, arguably, precisely not what the court was seeking to achieve in Levinson. The fraud on the market theory is as much a workaround as a statutory construct. Despite this misunderstanding, it doesn’t exist here.
The absence of fraud on the market in Canada was noted by the court in Green,10 and might be suggested by some as the reason why Amgen is irrelevant in this jurisdiction. This viewpoint would not be accurate. The fraud on the market theory is the device by which the materiality standards in Canada and the United States happen to align. The aims of both courts, we speculate, in both Sharbern and Levinson were the same – to give comfort on what degree of misrepresentation opens the doors to a lawsuit.
Finally, we are not completely without the effect of the fraud on the market theory in Canada. The court in Green observes that s. 138.3 of the Ontario Securities Act,11 (and its equivalents in other provinces) which creates a right of action for misrepresentations operating on secondary market participants, was enacted in part to compensate for the absence of the fraud on the market theory in this country.
Squaring Sharbern and Green so the Result is Amgen
One possible way for the Green and Sharbern decisions to co-exist without confusion would be to have both an objective and subjective test of reliance. The test would have two stages: first, the court would ask if the misrepresentation at issue is one that would concern the reasonable investor (the objective test). If the court found the misrepresentation to be material to the reasonable investor, it would then ask if the actual investors/plaintiffs in fact relied on the misrepresentation. The two-stage test can be summarized by asking “was the plaintiffs’ reliance reasonable?” On the court’s reasoning in Green, there would still be no class action certification as long as any part of the materiality test is subjective.
There are two problems with this two-stage test: one, this was emphatically not what was prescribed in Sharbern, which was both a class action and a decision of the highest court in Canada; and two, this type of test does nothing to encourage accurate disclosure, as it further removes the plaintiffs from being able to sue when the disclosure is faulty.
Another way of squaring the Green and Sharbern decisions would be to ignore the substance of Green and accept the procedure. The result of this approach would be that materiality remains a burden on the plaintiffs at the certification stage of a class action, but the test would be an objective one. The natural evolution from this position is Amgen: if the materiality standard is the same for each investor, and is analyzed objectively, it is a common issue for all investors and would not foil the approval of a class.
The Significance of Amgen for Canadians
Although the Canadian courts need not, and should not, devote much thought to the class action certification procedure in the United States, it is of general concern that dramatic differences do not arise between the process there and here. The United States Supreme Court reached a common-sense decision in Amgen; we would benefit in Canada from evolving our position in that direction.
The United States Supreme Court’s decision also heralds the prospect of yet more securities class actions succeeding in certification there (and consequently, more such actions being started, at least, here, if the securities were also issued into Canada). Although materiality will still need to be proven at the trial of a claim, dropping the examination of the question at the certification stage removes a barrier for plaintiffs seeking to press forward to a settlement. The truth of all class action litigation is that settlement for business or economic reasons, regardless of the merits of the case, is a likely outcome. Class actions are expensive and often damaging to public and investor relations. Fighting certification, from the issuer’s standpoint, can be tantamount to fighting the whole case.