The Court of Appeal’s decision in Rahimi v. SouthGobi Resources Ltd., 2017 ONCA 719 ("SouthGobi ") provides guidance with respect to the evidentiary burden on defendants who are relying on the reasonable investigation defence to defeat a leave motion.
SouthGobi involved exceptionally unusual facts. The story starts in a very usual way: SouthGobi announced that its financial statements were being restated, that it had weaknesses in its internal controls over financial reporting (“ICFR”), and that its previous financial statements should not be relied upon. The stock price plummeted and a class action was commenced under s. 138 of the Securities Act against the company and several individual directors and officers (collectively, the “defendants”).
Then the story takes an unusual twist. In court filings, the defendants took the position that the financial statements were not inaccurate and did not need to be restated. They submitted that the company only restated its financial statements because it needed to complete a financing and the SEC and others would not let the financing proceed unless they issued the restatement.
The motion judge allowed the claim to proceed as against SouthGobi but denied leave as against the individual defendants on the basis of the reasonable investigation defence. Both the plaintiff and the company appealed.
Two issues were considered on appeal by the Court: (i) did the motion judge err in denying leave against the individual defendants?; and (ii) did the motion judge err in granting leave against the company?
The Court of Appeal overturned the motion judge’s decision as against the individual defendants and granted the plaintiffs leave to proceed against all of the defendants. In essence, the Court of Appeal held that in circumstances where there has been a restatement and public admission that there were weaknesses in the company’s ICFR, the evidence will need to be very persuasive that the reasonable investigation defence will succeed.
The Court of Appeal made a number of statements in this regard, but to properly understand them, a little more context is required. A few of the key facts are as follows:
- While the defendants were taking the position that the financial statements were not inaccurate and that there were no materials weaknesses in the company’s ICFR, neither the company nor the individual defendants provided any evidence that they had objected to the restatement or the subsequent press release; nor did they “correct” what they were now asserting was a false press release. The position taken by the parties in the litigation versus the restatement and press release was “so jarring”, according to the Court of Appeal, that the motion judge should have granted leave against all of the defendants.1
- The individual defendants also argued that they relied on the advice of the company’s external auditors throughout the class period. No affidavit evidence was filed by either Deloitte or PWC in this respect, however.
- In their affidavits filed on the leave motion, the individual defendants asserted that one of the primary reasons for the restatement was that the SEC required revenue to be reported in accordance with GAAP. Not all of the evidence filed, however, was consistent with this position. For example, the Board of Directors minutes from the meetings that took place at the time of the restatement made no reference to GAAP or to a SEC-mandated move. In addition, expert evidence filed by the plaintiff called into question the truthfulness of the individual defendants’ assertion.
The above facts all raised credibility issues that the Court found were not considered by the motion judge. It was not a case where there was truly uncontroverted evidence adduced by a defendant in support of a reasonable investigation defence.
Writing for the Court, Justice Hourigan noted that a motion judge must weigh and scrutinize the evidence put forward by both parties, not just that of the plaintiff. In so doing, however, the motion judge is not restricted to a review of the evidence filed on the motion. According to Justice Hourigan:
[The motion judge is also obligated to consider what evidence is not before her. She must be cognizant of the fact that, at the leave stage, full production has not been made and the defendant may have relevant documentation that has not been produced or relevant evidence that has not been tendered. Consideration of these evidential limitations of the leave stage is important because they can work to the prejudice of the plaintiffs who have potentially meritorious claims.2]
Equally important, according the Court, is an examination of any credibility issues. Where these are significant, as the Court found was the case here, the proper course for a motion judge is not to treat a leave motion as a mini-trial and make a decision based on the limited record before her, but rather to grant leave because there is no certainty that the reasonable investigation defence will succeed.3 In holding that the motion judge erred in the above respect, the Court further noted that he should have considered “the gaps in the evidence and the evidence that conflicts with the contents of the affidavits filed on the leave motion.”4
With respect to the restatement and the press release, the Court held that this was “powerful” evidence that the financial statements of the company were unreliable throughout the class period. Such evidence, it noted, “strongly...contradict[ed] a defence of reasonable investigation”.5
SouthGobi is a case with unique and unusual facts, and therefore its application as precedent may be limited. However, the decision is a useful addition to the jurisprudence interpreting the leave standard in s. 138 cases, and reinforces the fact that the Court will take an objective view of the totality of the evidence, and of the gaps in the evidence, and consider whether it is reasonable in the circumstances to shut the case down before a full record is made available to plaintiffs.