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HIGHLIGHTS

• secondary market investors will have statutory right of action for continuous disclosure violations effective December 31, 2005
• the issuer, its directors and officers and other persons connected with the issuer will potentially be liable
• liability will attach for a misrepresentation contained in a document or oral statement or for failure to make timely disclosure of a material change
• due diligence defence and limitations on liability provided

INTRODUCTION

Amendments to the Securities Act (Ontario) will come into force on December 31, 2005 and will provide investors in the secondary market with a statutory right of action against an issuer, its directors and officers and certain other persons connected with the issuer where there exists a continuous disclosure violation.

The statutory right of action was first proposed in 1998. The original proposal arose from the Canadian Securities Administrators' review and support of recommendations contained in the report of The Toronto Stock Exchange Committee on Corporate Disclosure which was chaired by Thomas Allen, Q.C., a Senior Partner at Ogilvy Renault LLP. Ontario is the first province to proclaim such legislation, although British Columbia has passed but not yet proclaimed legislation which provides for liability for secondary market disclosure.

Liability may arise under the new right of action as a result of a continuous disclosure violation of any issuer which is a "reporting issuer" in Ontario or which has a real and substantial connection to Ontario and which has publicly traded securities. The amendments create the new civil right of action in favour of secondary market participants who buy or sell securities (or redeem mutual fund securities) of an issuer during a period in which there exists a continuous disclosure violation. Continuous disclosure violations may result from misrepresentations contained in documents or made in public oral statements or from failure of an issuer to make timely disclosure of a material change. Liability, available defences and caps on liability will depend upon the type of violation and the particular defendant. Whether or not a misrepresentation exists is based on the concept of materiality (i.e., would the information be reasonably expected to have a significant effect on the market price or value of the issuer's securities?).

WHO MAY BE LIABLE?

There is a broad range of potential defendants depending on the type of continuous disclosure violation. The issuer, its directors and officers and certain influential persons associated with the issuer who participated in the disclosure violation may be liable. An influential person is defined as any control person, promoter, or a securityholder holding more than 10% of the voting rights of the securities of the issuer, and in addition, in the case of an investment fund, its manager. Experts, such as lawyers, accountants or financial analysts, may be liable if the misrepresentation originated from an expert's report, statement or opinion which was included, summarized or quoted, with the expert's consent, in the public document or oral statement.

If the misrepresentation is contained in a document released by the issuer or by someone with actual, implied or apparent authority to act on the issuer's behalf, an investor who buys or sells securities of the issuer between the time of release of the document and the time of correction of the misrepresentation has a right of action against the issuer, its directors, each officer who authorized, permitted or acquiesced in the release of the document, each influential person and their directors and officers who knowingly influenced the release, and any expert whose report contained the misrepresentation.

If the misrepresentation is made orally, an action may generally be brought against the same persons. However, the right of action against the directors is more limited and, as in the case of officers, is against only those directors who authorized or acquiesced in the making of the statement. In addition, there is a right of action against the person actually making the public statement. Accordingly, issuers should ensure appropriate corporate disclosure policies are in force and monitored effectively.

Where an influential person or a person with authority to act or speak on behalf of an influential person releases a document or makes a public oral statement relating to the issuer, the issuer and its directors and officers will only be liable if they authorized, permitted or acquiesced in the release of the document or the making of the statement by such influential person.

A claim for a failure to make timely disclosure of a material change may be brought against the issuer, directors and officers who authorized or acquiesced in the failure to make the necessary disclosure and influential persons (and their participating directors and officers) who influenced the non-disclosure.

WHAT MUST BE PROVED TO ESTABLISH LIABILITY?

The new statutory right of action is in addition to the existing right of an investor to bring an action based on misrepresentation at common law. Unlike a common law action, however, there is no need for the investor to establish that they relied upon the misrepresentation when they purchased or sold the securities.

In order to establish liability with respect to a misrepresentation in a document (other than a core document as discussed below) or a public oral statement or a failure to make timely disclosure, an investor would generally have to prove that the defendant: (i) knew of the misrepresentation or failure to disclose material information; (ii) deliberately avoided acquiring knowledge of such violation; or (iii) was guilty of gross misconduct in connection with the violation either through action or a failure to act. The legislation provides a list of relevant circumstances to be considered by a court in determining whether a defendant was guilty of gross misconduct.

There are several exceptions to the general standard of proof. If a misrepresentation is contained in a core document, an investor need not establish knowledge, avoidance of knowledge or gross misconduct of a defendant. Core documents are prospectuses, takeover bid circulars, issuer bid circulars, directors' circulars, rights offering circulars, annual information forms, information circulars, annual and interim financial statements and MD&A. For officers of an issuer and investment fund managers and their officers, a material change report will also be considered a core document.

In addition, the general standard would not apply in a claim against an expert for misrepresentation in a document or public oral statement derived from the expert's report or opinion or in a claim against an issuer, an investment fund manager or their respective officers who participated in a violation involving failure to disclose material information. In these circumstances, the plaintiff would only need to prove that there was a misrepresentation or, in the case of the issuer and its officers, a failure to disclose material information as defined in the legislation.

AVAILABLE DEFENCES

There are several defences provided for in the amendments. A person or company will not be liable for damages if the person or company can establish that they undertook a reasonable investigation. In determining whether a due diligence defence has been established the court is directed to consider all relevant circumstances, including the knowledge, experience and function of the defendant, the existence and nature of systems (such as disclosure policies and committees) related to continuous disclosure compliance, and, in the case of an expert, the standards applicable to his or her profession.

Additional defences are available, depending on the type of claim and the circumstances. For example, a defendant may prove that the plaintiff had knowledge of the misrepresentation or the undisclosed material information at the time of their transaction. However, this may be difficult to establish.

There is also a defence against failure to make required timely disclosure if the information has been disclosed by the issuer to the OSC in a confidential material change report and there was a reasonable basis for making confidential disclosure. A defendant, other than the issuer, may also be protected if the defendant did not originally have knowledge of or consent to the violation and the defendant promptly took corrective action immediately upon learning of the misrepresentation or failure to make timely disclosure by informing the issuer's board and, if no corrective action results, the OSC.

The OSC has also recently published OSC Staff Notice 51-711 Refilings and Corrections of Errors which provides guidance to issuers on correcting errors where an issuer has failed to comply with periodic or timely disclosure requirements.

In addition, defendants, other than the particular expert involved, will not be liable if the misrepresentation derived from an expert's report provided that such defendants had no reasonable grounds to doubt its correctness and the expert had not withdrawn his or her consent to the use of the report.

SAFE HARBOUR FOR FORWARD LOOKING INFORMATION

If the misrepresentation is in forward looking information, a person or company will not be liable if they can establish that the document or public statement was accompanied by reasonable cautionary language, a statement of material factors or assumptions and that they had a reasonable basis for drawing the conclusions or making the forecasts and projections set out in the forward looking information.

LIMITATIONS ON DAMAGES AND PROCEDURAL REQUIREMENTS

There is no limitation on the damages that may be payable where the misrepresentation or failure to make disclosure was made knowingly. Liability limits are otherwise provided, effectively making the proposed regime of continuous disclosure liability primarily focussed on deterrence, rather than compensation to investors.

Issuers and influential persons (other than individuals) will have their liability limited to the greater of 5% of their market capitalization and $1 million. The liability of directors and officers of issuers, influential persons who are individuals, directors and officers of influential persons and persons who make an oral statement containing a misrepresentation will be limited to the greater of $25,000 and 50% of their compensation from the particular company and its affiliates during the preceding 12 months.

Where there are multiple defendants, each would bear liability proportionate to their determined share of responsibility for the violation. Where a misrepresentation or failure to make timely disclosure was done with knowledge, the liability would be joint and several.

To ensure that the liability cap is not exceeded when there are multiple actions regarding the same violation, the amount of damages a defendant must pay will be reduced by the amount of any prior award made against, or settlement paid by, the defendant relating to the same violation under a similar action in any Canadian jurisdiction. No reduction is made in respect of U.S. or other foreign actions or settlements relating to the same violation.

In an effort to limit unmeritorious litigation or strike suits, plaintiffs would be required to obtain leave of the court to commence an action. The court would have to be satisfied that the action is being brought in good faith and has a reasonable possibility of success.

WHAT ISSUERS CAN DO TO PREPARE FOR THIS NEW CIVIL LIABILITY REGIME

The introduction of the statutory civil liability regime for secondary market disclosure will provide investors with broader remedies to hold issuers and their directors and officers accountable if information disclosed to the marketplace is false, misleading or untimely. Issuers and responsible persons will have additional reasons to ensure their disclosure is accurate and complete. It is possible that the amendments could be interpreted to apply to misrepresentations contained in documents or statements released or made prior to December 31, 2005.

An overriding principle of the liability regime is that reasonable investigation or due diligence is a defence. With this in mind, appropriate corporate disclosure policies and processes should be in place and corporate personnel and advisors should be aware of such policies and processes and strictly adhere to them. Safeguards should be in place regarding approval of any disclosure to be released. Persons making public statements on behalf of the issuer will need to be vigilant to avoid inadvertent mistakes in any disclosure made.

Particular attention should be given to released information that could be considered forward looking to ensure that cautionary language is included with the written information or referred to (in the case of a public statement). Where information is based on another source, such as an expert's opinion, the source of that information should be clearly identified.

ADDITIONAL INFORMATION

The foregoing is an overview of the new regime. For additional background information on this significant development, please see our earlier publication Ontario Proposes to institute Private Right of Action and Additional Liability for Continuous Disclosure Violations (November 2002).

This newsletter contains general information only. We would be pleased to provide specific and detailed advice upon request.

The purpose of this document is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Ogilvy Renault LLP or any member of the firm on the points of law discussed.

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