Publication
title
Ontario's New Civil Liability Regime for Continuous Disclosure Violations - as it Relates to Mutual Funds
DATE
October 31, 2005
EXPERTISE
Introduction
Amendments to the Securities Act (Ontario) will come into force on December 31, 2005. The regime created by these amendments will provide investors in reporting issuers (including investors in public mutual funds) with a statutory right of action against a public mutual fund, a fund manager, their respective directors and officers and certain other persons connected with the mutual fund during a period when there is a continuous disclosure violation.
The statutory right of action, first proposed in 1998, was designed to target disclosure violations by public companies. The regime, however, also applies to mutual funds that are reporting issuers in Ontario, even though it does not account for or accommodate the differences between public companies and mutual funds in some fundamental areas.
The Existing Right of Action
The new regime does not apply to the purchase of a mutual fund security issued pursuant to a simplified prospectus during the period of distribution. Since most, if not all, mutual fund securities are purchased under a prospectus, the purchase will not be covered by the new regime. Rather, investors who purchase mutual fund securities pursuant to a prospectus will continue to have the statutory rights available to them under the prospectus, which include a right of action for a misrepresentation in the prospectus or any document incorporated by reference.
The documents incorporated into the simplified prospectus by reference include the annual information form, financial statements and management reports of fund performance.
The purchaser under a prospectus need not show actual reliance on the misrepresentation and the damages claim may be made against the mutual fund, the manager, its directors and any other signatory to the prospectus.
The New Right of Action
The new right of action will extend to investors in mutual fund securities who redeem their securities during a period when there is a continuous disclosure violation.
Continuous disclosure violations may result from misrepresentations contained in documents, misrepresentations made in public oral statements, or from failure of a mutual fund to make timely disclosure of a material change.
Whether or not a misrepresentation exists in a written document or an oral statement is based on whether there is a misstatement of a material fact, or an omission to state a material fact that is required to make a statement not misleading. Determining what is a material fact depends on whether the fact would be reasonably expected to have a significant effect on the market price or value of the issuer's securities. However, information about a mutual fund would generally not be expected to have a significant effect on the market price or net asset value of the mutual fund securities, because mutual funds are valued based on the net asset value of their underlying portfolios. It may be that the interpretation taken by the securities regulators and the courts will be to tailor the test currently applied to determine whether material changes have occurred in the context of mutual funds - that being, would a reasonable investor consider the fact to be important when making a decision to redeem securities.
All documents that are filed or required to be filed with the Ontario Securities Commission will be subject to the regime, including simplified prospectuses and documents incorporated by reference. As well, all sales communications will most likely be subject to the regime, although this is uncertain since the test to be applied to determine if such a communication is caught is the same test discussed above for determining a material fact (in this case, would the communication reasonably be expected to affect the market price or value of the security), a test that is not easily applied to mutual funds.
Potential defendants to an action for a continuous disclosure violation might include a broad range of persons depending on the type of continuous disclosure violation.
If a misrepresentation is contained in a document released by the mutual fund or by someone with actual, implied or apparent authority to act on the fund's behalf, an investor who redeems securities of the fund between the time the document is released and the time the misrepresentation is corrected has a right of action against the fund, each director of the fund at the time the document was released, each officer who authorized, permitted or acquiesced in the release of the document, the fund's manager and its directors and officers who knowingly influenced the release, and any expert whose report contained the misrepresentation.
If a misrepresentation is made orally, an action may generally be brought against these same persons, although to have potential liability in respect of a public oral statement, a director must have authorized, permitted or acquiesced in its making. In addition, there is a right of action against the person who made the public statement. Accordingly, fund managers should ensure appropriate disclosure policies and procedures are in force and monitored effectively.
Where a person with authority to act or speak on behalf of the fund manager releases a document or makes a public oral statement relating to the mutual fund, the mutual fund, its manager and their respective 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.
A claim for the failure of a fund to make timely disclosure of a material change (such as, for example, the issue of press releases and the filing of material change reports) may be brought against the mutual fund, directors and officers who authorized, permitted or acquiesced in the failure to make the necessary disclosure and fund managers (and their directors and officers) who knowingly influenced the non-disclosure.
It is not clear how independent committee members will be impacted by the new regime. One possible interpretation could be to categorize such members as directors in certain circumstances and, if and to the extent they are categorized as such, they would face potential liability.
The potential liability, and available defences and caps on liability, will depend upon the type of violation and the particular defendant.
Due diligence or reasonable investigation is a defence to liability under the new regime. It is therefore important to have appropriate disclosure policies and procedures in place and to ensure that corporate personnel and advisors are aware of such policies and procedures and adhere to them strictly. Any disclosure to be released should be subject to an approval process that includes legal review. Persons making public statements on behalf of the mutual fund will need to be vigilant to avoid inadvertent mistakes in any disclosure made.
As a last note, it is possible that the amendments could be interpreted to apply to misrepresentations contained in documents or statements released or made, or to a failure to make timely disclosure, prior to December 31, 2005, if any such misrepresentations have not been publicly corrected by that date. Accordingly, mutual funds, fund managers, directors, officers and boards of governors will have additional reasons to ensure that their disclosure is accurate and complete.
Additional Information
The foregoing is a brief discussion of how the new civil liability regime will apply to mutual funds. For a fuller overview of the new regime, which includes a discussion of what must be proved to establish liability and the available defences, click here to see our earlier publication New Legislation for Liability for Continuous Disclosure Violations in Force on December 31, 2005 (August 25, 2005). Investment funds other than mutual funds should make reference to the earlier publication.
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.
Ogilvy Renault LLP is a full-service law firm with approximately 445 lawyers, patent agents and trade-mark agents. Founded in 1879, the Canadian-based firm has offices in Toronto, Montréal, Ottawa, Québec, Vancouver and London, UK. Ogilvy Renault proudly serves a diverse client base that includes many Fortune 500 and FT 500 organizations. For more information, please consult ogilvyrenault.com.
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Cathy Singer
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Marc Duquette
Montréal
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Jean Daigle
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