NEW LIABILITY FOR CORPORATE DISCLOSURE IN ONTARIO On December 31, amendments to the Ontario Securities Act will create secondary market liability for misrepresentations in corporate disclosure and failures to make timely disclosure, (collectively, “disclosure failures”). This article provides an overview of the new provisions, while next month an article will provide suggestions for corporate procedures and policies to avoid liability. The new provisions are the result of a long process. In 1997, the Toronto Stock Exchange’s Committee on Corporate Disclosure (commonly called the Allen Committee after its Chair Thomas Allen) released its report Responsible Corporate Disclosure: A Search for Balance. The Committee found that compliance with disclosure requirements was on balance good, but identified enough problematic disclosure to justify additional remedies for investors suffering losses attributable to disclosure failures. The Committee was also aware of the litigation environment in the United States, where class actions are often launched immediately following a large drop in a company’s stock price. Therefore, it recommended that any legislation imposing new liability provisions also contain safeguards to, as much as possible, discourage the filing of meritless cases or result in financial ruin for issuers and other defendants. Significantly, the Act provides for a due diligence defence. The intent was to provide enough risk of liability that companies and insiders would have an incentive to fully comply with disclosure obligations. The Committee also recommended that disclosure provisions be strengthened and that an integrated disclosure system be implemented so that companies can issue shares at any time without filing a prospectus, relying on their disclosure record. They further recommended that the definition of material fact, which was “a fact that has or reasonably would be expected to have a significant effect” on a security’s price, be amended to remove the retrospective aspect. The concern was that liability could arise for something that affected the market price even though no one reasonably would have foreseen that result. The new provisions are the last part of the recommendations to be implemented. The definition of “material fact” was changed in 2003. In 2004, the Canadian Securities Administrators adopted National Instrument 51-102, which created comprehensive and uniform continuous disclosure requirements for reporting issuers. Although the OSC had previously requested comment on an integrated disclosure regime, it appears unlikely to pursue the issue. Instead, the CSA have -2- adopted National Instrument 44-101, which allows Canadian-listed reporting issuers with an active business to use short-form prospectuses. The following is an overview of the new provisions. It should be remembered that the Act creates new liability but does not affect any other rights of actions or defences a plaintiff or defendant may have. To What Does Liability Attach? The act imposes liability for misrepresentations in documents released by or on behalf of an issuer, public oral statements by persons with implied or actual authority to speak for the issuer and documents and statements made by “influential persons,” (who are control persons of an issuer, promoters, insiders other than officers and directors and investment fund managers if the issuer is an investment fund). Liability also arises for failure to disclose material changes “in the manner required by the Act.” This provision means that there will not be liability for failure to make timely disclosure of a material change if the issuer was permitted to keep it confidential pursuant to section 75(3) (and there is a specific defence to this effect), although there would be liability if a confidential material change report was not filed with the Commission. A “document” is any written communication, including in electronic format, that reasonably would be expected to affect the market price or value of the issuer’s securities. It includes any document required to be filed or filed with the Commission and any other documents required to be filed under applicable securities or corporate law or the rules of a marketplace. Who Has a Cause of Action? Any person who acquired or disposed of the issuer’s securities between the time the document was released or the statement was made and the time it was publicly corrected or, in the case of a failure to make timely disclosure, between the time it should have been disclosed and the time it was disclosed may bring an action. Reliance on the misrepresentation or completeness of the issuer’s disclosure record is not a condition. -3- Leave of court must be granted to commence an action. The court may only grant leave if it is satisfied the action is brought in good faith and there is a reasonable possibility of success. Certain transactions are excluded, either because they have their own liability provisions or because of the nature of the relationship between the issuer and the purchaser. These include purchasers under a prospectus, acquisitions or dispositions under a take-over bid or issuer bid and exempt distributions under section 53 or 62 of the Act. Note that while purchasers under a prospectus or bid circular are not included, a misrepresentation in those documents that affects the market price of an issuer’s security will give rise to liability to secondary market buyers and sellers. Who Can Be Sued? The right of action is not limited to disclosure violations by Ontario reporting issuers. Any issuer with a “real and substantial” connection to Ontario and has publicly traded securities (not necessarily on a market located in Ontario) may be sued. With respect to misrepresentations in a document, the following may be sued: • The issuer • All directors • Any officer who authorized, permitted or acquiesced in the release of the document • Any influential person or director or officer of an influential person who influenced the release of the document • Any expert, where the misrepresentation is in a statement, opinion or report of that expert summarized or quoted in the document, provided the expert consented in writing to the inclusion of the summary or quotation and did not withdraw that consent prior to publication In the case of public oral statements by someone with authority to speak on behalf of the issuer the list of defendants is the same except that directors are liable only if they authorized, permitted or acquiesced in the making of the statement. In the case of misrepresentations in documents released by or public oral statements made by an influential person, the issuer is only liable if an officer or director of the -4- issuer (or manager of an issuer that is an investment fund) authorized, permitted or acquiesced in the release of the document or the making of the statement. In addition, the following are liable: • The person who made the statement • Any director or officer of the issuer who authorized, permitted or acquiesced in the release of the document or making of the statement • The influential person • Any director or officer of the influential person who authorized, permitted or acquiesced in the release of the document or the making of the statement • Any expert, in the same circumstances as for a misrepresentation in a document released by the issuer A person is not liable in the capacity of officer or director of an influential person if that person is also an officer or director of the issuer. In the case of a failure to make timely disclosure, the following are liable: • The issuer • Any director or officer who authorized, permitted or acquiesced in the failure to make timely disclosure • Any influential person or director or officer of an influential person who influenced the failure to make timely disclosure There are additional hurdles for plaintiffs. The Act makes a distinction between “core” and “non-core” documents. Generally, “core” documents are disclosure documents (such as prospectuses and bid circulars) that would normally be reviewed by a board prior to release and for which there is sufficient lead time before the document is required to be released that there is an opportunity for a full review of the contents. In the case of “non-core” documents and oral statements, a defendant (other than an expert) is only liable if he or she was aware of the misrepresentation, deliberately turned a blind eye to it or was guilty of gross misconduct. The same applies to defendants who are directors of the issuer, influential persons or directors or officers of an influential person (other than an investment fund manager or an officer of an investment fund manager) in the case of a failure to make timely disclosure. -5- The factors for determining gross misconduct are the same as for determining whether a reasonable investigation has been made. What Defences Are Available? • The defendant conducted a reasonable investigation and had no reason to believe there was a disclosure failure (suggested policies and procedures to establish a reasonable investigation will be provided in an article to be published next month) • All or part of the plaintiff’s losses were due to market factors not related to the disclosure failure • The plaintiff knew of the disclosure failure at the time of the acquisition or disposition • The defendant reasonably believed the issuer was entitled to keep details of a material change confidential under the Act and the issuer complied fully with the requirements, including disclosing the information promptly if it discovered a leak • The misrepresentation concerned forward-looking information (other than forward-looking information in financial statements required to be filed or in an IPO prospectus) that was accompanied by meaningful cautionary language and an analysis of the factors that may cause results to differ from predictions and provided that the defendant had a reasonable basis for making the statement (note the recent Ontario case of Kerr v. Danier Leather Inc. in the context of a prospectus offering which held that as of the date of the final prospectus management had updated, undisclosed forecasts that were more negative than those disclosed) • The misrepresentation was made by an expert, the defendant had no reason to suspect that there was a misrepresentation and the disclosure accurately set out the statement by the expert • The defendant did not know and had no reasonable grounds to believe that the document containing the misrepresentation would be released (this is not applicable for documents required to be filed with the Commission) • The misrepresentation was originally contained in a document prepared by an unrelated party that was filed with a securities regulatory authority or a marketplace, the misrepresentation was uncorrected at the time the issuer released the document or made the statement and at that time the defendant was unaware of the misrepresentation • The defendant was originally unaware of the disclosure failure and upon becoming aware, made efforts within the issuer to correct the failure and, -6- if unsuccessful, notified the Commission (unless prohibited by law or professional confidentiality rules). How Are Damages Calculated? • If the securities are sold within 10 days of the correction of the disclosure failure, the plaintiff’s losses net of hedging activity. • Otherwise, the lesser of actual losses net of hedging activity and losses that would have occurred had the securities been sold at the average trading price on the principal market for the securities for the 10 trading days following the correction. What Are The Limits on Damages? • For issuers and influential persons who are not individuals, the greater of $1 million and 5% of its market capitalization • For defendants who are individuals, other than experts, the greater of $25,000 and 50% of the person’s compensation for the preceding 12 months • For experts, the greater of $1 million and the revenue earned from the issuer in the preceding 12 months. Liability is proportionate rather than joint and several unless the disclosure failure was intentional, in which case the damage caps also do not apply. These provisions do not apply to the issuer, which will always have proportionate liability subject to the cap.