Publication

Introduction and background

On October 30, 2002, the Ontario government introduced Bill 198, an omnibus bill implementing various measures contained in the 2002 Budget and proposing amendments to 29 different statutes. Bill 198 includes important proposed amendments to the Securities Act (Ontario) ("OSA"), which would implement a regime of statutory liability for fraud, market manipulation and the making of misleading or untrue statements and a private right of action for breaches of the OSA's continuous disclosure rules. The private right of action was first proposed by the various provincial securities administrators ("CSA") in 1998. Ontario is the first province to introduce such proposals.

Bill 198 also grants several new powers to the Ontario Securities Commission ("OSC"), including: (i) the power to compel issuers to deliver all relevant documents required pursuant to a continuous disclosure review; (ii) the power to levy administrative penalties of up to $1 million for failure to comply with the OSA and to issue disgorgement orders in respect of profits resulting from non-compliance; (iii) additional rule-making authority in respect of audit committee composition, functioning and responsibilities, including certification of reports; and (iv) new rule-making authority in respect of internal control systems and disclosure controls that are to be implemented by issuers, including requiring Chief Executive Officers and Chief Financial Officers to provide certifications as to such systems and controls.

Bill 198 also proposes to increase stated maximum fines and terms of imprisonment for various offences and to create two new statutory offences, one involving fraud and the other involving knowingly making material misleading or untrue statements about an issuer. These offences are not subject to the same defences as apply to the new private civil remedy for continuous disclosure breaches.

The original CSA proposal for a private right of action in respect of continuous disclosure violations arose from the CSA's review and support of the recommendations contained in the March 1997 final report of The Toronto Stock Exchange Committee on Corporate Disclosure. This committee was established by the TSE in 1994 under the Chairmanship of Thomas Allen, Q.C., a Senior Partner of Ogilvy Renault. Andrew Fleming, another Senior Partner of Ogilvy Renault, was also a member of the Allen Committee. The CSA proposal was re published in November 2000 after comments received on the initial proposal were reviewed. No additional comments were solicited and no timetable for implementation by the various provincial governments had been given.
It appears that, in light of the continuing high profile incidents of misrepresentations and questionable disclosure by public companies in Canada, the Ontario government was prepared to act on the OSC's recommendations. Bill 198 proposes to implement, with only minor changes, the text of the CSA's 2000 proposal. Certain key definitions in the 2000 proposal are not included in Bill 198; the OSC is given the ability to settle the definitions pursuant to its rule-making powers. No draft implementing rule has yet been published.

Content of the proposal - overview

The provisions would apply to any issuer (called a "responsible issuer") which is a "reporting issuer" in Ontario or which otherwise is a public company with a substantial connection to Ontario. They would also apply to mutual funds and the related investment fund manager and its directors and officers. It is unclear how these provisions will apply to non-Ontario companies with operations in Ontario but whose securities do not trade in Ontario.

Bill 198 creates a new civil right of action in favour of secondary market participants who buy or sell securities (or redeem mutual fund securities) of the responsible issuer during a period in which there exists a continuous disclosure violation. Such violations would result from: (i) a misrepresentation in a public written document (not restricted to securities filings); (ii) a misrepresentation in a public oral statement by a person with actual, implied or apparent authority to speak on behalf of a responsible issuer; or (iii) failure of an issuer to make required timely disclosure. The remedy would not apply to purchases under a prospectus, private placements or takeover bids, where statutory civil liability and other remedies already exist.

The concept of a "misrepresentation" and a timely disclosure obligation depend on the materiality of the information. Bill 198 (similar to the CSA 2000 proposal) does not change the concept of "materiality" in Ontario, except to remove a retroactive component from the definition. It otherwise retains the reference to information that is expected to have a significant effect on the market price or value of the responsible issuer's securities. Accordingly, Bill 198 does not adopt earlier proposals to conform the concepts to the standard applicable in Quebec and the United States (which refer to information which would be considered important in the total mix of information available to a reasonable investor).

A broad range of potential defendants could be sued, depending on the type of continuous disclosure violation. These include the issuer's directors and officers and also include those "influential persons" associated with the responsible issuer who participated in the disclosure violation. "Influential persons" include control persons, promoters, investment fund managers (in the case of mutual funds) and insiders (other than the issuer's directors and officers), such as 10% or greater shareholders. Expert advisors to a responsible issuer can be defendants, provided that the misrepresentation originated from their report, statement or opinion which is included, summarized or quoted in the public document or statement and provided that they had consented in writing to such use. Expert liability can therefore be circumscribed. For these purposes, an expert could include any person or company whose profession gives authority to their views, including auditors, lawyers, geologists, actuaries and financial analysts.

The basis for liability, types of available defences and caps on liability vary among the types of possible defendants and claims. Where there are multiple defendants, each would bear liability proportionate to their determined share of responsibility for the violation. However, in the case of a "knowing" misrepresentation (e.g. fraud) or "knowing" failure to make timely disclosure, the liability would be joint and several and the liability caps would not apply.

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 is 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. Interestingly, notwithstanding the large number of inter-listed issuers, no such 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. In granting leave, the court would have to be satisfied that the action: (i) is being brought in good faith; and (ii) has a reasonable possibility of success. In addition, any such litigation, including class actions, will be subject to a "loser pays" costs award and, in keeping with general class action legislation in Ontario, court approval of any proposed settlement of an action is required. It can be expected that approval would be denied where the terms or circumstances of the settlement (i.e., solely or primarily the payment of the plaintiffs' costs, including lawyers' contingency fees) indicate that the litigation was a "strike suit".

Potential defendants

For misrepresentations contained in documents made publicly available by a responsible issuer or by someone with actual, implied or apparent authority to act on its behalf (a "responsible person"), potential defendants include: (i) the responsible issuer; (ii) its directors; (iii) its officers who authorized, permitted or acquiesced in the release of the document; (iv) each "influential person" and their directors and officers who knowingly influenced the release; and (v) to the extent indicated above, each expert whose report contained the misrepresentation.

For misrepresentations contained in public oral statements, a similar group is potentially liable (though only those directors who participated or acquiesced in the act), with the addition of the responsible person making the public statement, even if such person is not a corporate officer. Accordingly, investor relations personnel should be briefed on this exposure and the available defences.

Similar potential defendants (including the "influential person" and those of its directors and officers who participated) arise where an "influential person" (or a responsible person on behalf of the "influential person") releases the document or makes the public statement relating to the responsible issuer. However, in such situations, the responsible issuer and particular directors and officers of the responsible issuer can only be liable if they authorized, permitted or acquiesced in the release of the document or making of the statement by the "influential person".

For violations relating to a failure to make timely disclosure, the responsible issuer, participating directors and officers and influential persons (and their participating directors and officers) who influenced the non-disclosure may be liable.

Basis for liability and burden of proof

Common law actions in Canada for misrepresentation in the secondary markets, while theoretically possible, have been difficult to bring as a result of the difficulty in establishing the requisite duty of care, reliance on the misrepresentation by the plaintiff and the requisite causal link between the misrepresentation and the damage suffered. The causation and reliance requirements have also been a significant procedural impediment to proposed class actions, given that each individual member of the proposed plaintiff class would have to prove reliance on each alleged misrepresentation.

It is important to note that Bill 198 preserves the right of plaintiffs to bring common law actions, alone or in parallel with a proceeding under the new statutory civil remedy. This strategy may be adopted by plaintiffs seeking to advance a claim which is not subject to the statutory defences or liability limits. Certain recent decisions in Ontario and Quebec permitting class certification of secondary market claims may herald a newly receptive attitude of the courts to common law claims.

Subject to the discussion of defences that follows, the proposed private civil remedy attempts to overcome the traditional common law limitations, as it applies regardless of whether the plaintiff (who need only have bought or sold securities during the relevant period) relied on the misrepresentation or was prejudiced by the failure to disclose material information. Furthermore, the plaintiff is not required to prove negligence in order to establish liability, in keeping with the absence of a requirement to establish a duty of care in respect of the specified potential defendants.

With respect to the issue of establishing causation and the quantification of damages, the proposal attempts to overcome the current difficulties faced by secondary market purchasers by providing that damages are to be calculated with respect to the change in price of the responsible issuer's security, during the relevant period,  regardless of general market trends and other correct information about the responsible issuer that may also be influencing its trading price. While damages will not include any amount the defendant proves is attributable to a change in the market price of the securities that is unrelated to the misrepresentation or the failure to make timely disclosure, proving this may be a difficult task.

Generally, in order to establish liability with respect to a misrepresentation in a document (other than a "core document" ) or with respect to a public oral statement or with respect to a failure to make timely disclosure, the plaintiff would 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) is guilty of "gross misconduct" in connection with the violation. The proposed legislation provides a list of relevant circumstances to be considered by a court in determining whether a defendant is guilty of gross misconduct.

However, a plaintiff would not be required to prove these elements to demonstrate liability for: (i) misrepresentations contained in "core documents"; (ii) a claim against an "expert" for misrepresentation in a document or public oral statement derived from the expert's report or opinion; or (iii) a claim against a responsible issuer or against an officer of a responsible issuer 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 responsible issuer and its officers, a failure to disclose material information as defined in the legislation.

Defences

The principal defence available to all defendants is a "reasonable investigation" (or due diligence) defence, with the court 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, their professional standards. It is noteworthy that the CSA (and Bill 198) rejected a request by the CICA that mere compliance with generally accepted accounting and auditing standards should provide a defence for auditors.

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 also prove difficult to establish and it is unlikely that the provision would allow an imputation of knowledge based on the mere availability of alternative sources of information in the market. Nevertheless, the availability of this defence still raises potential individual issues that might weigh against proceeding as a class action.

Certain other defences are provided for, pertaining to forward-looking information and information disclosed to the OSC in a confidential material change report but not yet disclosed to the public. A defendant may also be protected if he did not originally have knowledge of or consent to the violation and he promptly takes corrective action immediately upon learning of the misrepresentation or failure to make timely disclosure, including informing the responsible issuer's board and, if no corrective action results, the OSC.

In addition, defendants, other than the particular expert involved, are not liable if the misrepresentation originated in an expert's report and the other defendants had no reasonable grounds to doubt its correctness and provided that the expert had not withdrawn its consent to the use of its report.

Liability caps

Except in the case of "knowing" violations, for which there is no liability cap and in respect of which liability is joint and several with all other defendants, liability limits are provided for, effectively making the proposed regime of continuous disclosure liability primarily focussed on deterrence, rather than compensation to investors in the market.

Responsible issuers and "influential persons" (other than individuals) are liable for up to the greater of 5% of their market capitalization and $1 million.

Directors and officers of responsible issuers, "influential persons" who are individuals, directors and officers of "influential persons" and other persons making a public oral misrepresentation are liable for up to the greater of $25,000 and 50% of their compensation from the particular company and its affiliates during the preceding 12 months.

"Experts" are liable for up to the greater of $1 million and the revenue earned by the expert or its affiliates from the responsible issuer during the preceding 12 months.

Differences in the proposal from rule 10b 5 liability in the united states

 In the United States, Rule 10b 5, promulgated under the Securities Exchange Act of 1934 ("1934 Act"), provides for a broadly worded general anti-fraud rule. The rule was originally intended solely to create a statutory offence not giving rise to a private right of action. However, over the years, U.S. courts have inferred a private right of action from the language and extensive litigation over several decades has refined the issues of who bears liability and the nature of such liability.

Bill 198, on the other hand, attempts a "made in Canada" solution to the problem. The proposed legislation clearly defines the violations which give rise to liability, sets guidelines on the extent of liability and provides defences intended to ensure protection from frivolous litigation. Whether the objective of certainty has been achieved in all cases is a moot point; however, it is at least clear that Canadian courts will have more definitive guidelines for enforcing liability under the regime than are afforded in the United States under the jurisprudential approach to developing the remedy. It is interesting to note that most of the procedural measures introduced by the Private Securities Litigation Reform Act of 1995 in the United States to cure perceived abuses of the 10b 5 liability regime have been reflected in Bill 198. In addition, the requirement that the plaintiff must obtain leave of the court to commence an action is a further safeguard. To obtain such leave the plaintiff must lead evidence that demonstrates that the plaintiff's claim "has a reasonable possibility of success." This could mean that the plaintiff must lead at least some evidence of the alleged wrongdoing before proceeding with an action. The opportunity to test the merits of the plaintiff's case at an early stage and at relatively little cost should protect against frivolous law suits supported by little or no evidence brought only to obtain a quick settlement.

Bill 198's procedural safeguards and substantive defences may impose a discipline on the use of the private right of action not found in the United States. Then again they may not - the challenge will be to seek a balance acceptable not only to issuers but also to other market participants.

1. Typically stated to begin on the date of the purchase or sale of securities and to end on the tenth trading day after the public correction.  

2. "Core documents" include prospectuses, takeover bid circulars, issuer bid circulars, directors' circulars, rights offering circulars, annual information forms, information circulars and the annual report, including financial statements and MD&A and, with respect to officers of a responsible issuer (and investment fund managers), include interim financial statements and material change reports; the OSC is given rule-making power to prescribe additional documents as "core documents". Notably, the additional defences available in the case of "non-core" documents will be available for non-securities regulatory filings and documents filed in court proceedings that the issuer would not have prepared with a view to liability in the securities markets.

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