On March 19, 2013, the Ontario Superior Court of Justice (Divisional Court) released its judgment in Cornish v. Ontario Securities Commission, on appeal from a decision of the Ontario Securities Commission (the "Commission") issued September 28, 2011. The appeal concerned the Commission's interpretation and application of the term "material change" in the Securities Act, R.S.O. 1990, c. S.5 (the "Act") and the obligations of reporting issuers to disclose such material changes.
This case provides greater insight and certainty into the meaning of "material change" and the obligations of reporting issuers when such changes occur.
Facts
Cornish was President and CEO of Coventree Inc. ("Coventree"), a niche investment bank specializing in structured finance. Coventree managed and administered ten separate trusts commonly called "conduits" which issued asset-backed commercial paper debt instruments ("ABCP").
On January 19, 2007, the Dominion Bond Rating Service ("DBRS") issued a press release in which it changed its credit rating criteria for certain credit arbitrage transactions. The effect of this change was to require Coventree to secure an unattainable type of liquidity to back credit arbitrage transactions going forward. Before this change, the now DBRS-restricted type of credit arbitrage transactions represented 40% of the conduits' assets, and their use was the largest contributor to Coventree's growth.
Coventree referred to the DBRS press release in a letter to its shareholders on February 14, 2007, and again in its second quarter Management's Discussion & Analysis ("MD&A"), publicly filed on May 14, 2007. It stated that the DBRS January Release would "have the effect of reducing the profitability of the Company by substantially curtailing its ability to grow, if not halt in the short term, its credit arbitrage business."
In July 2007, Coventree took various steps to attempt to address the lack of demand for new ABCP. However, on August 13, 2007, the market for Coventree-sponsored ABCP collapsed, and Coventree's ABCP investors could not sell or redeem their ABCP instruments. Cornish prepared and issued a press release disclosing the market disruption as a material change.
The Commission found that Coventree breached the Act by failing to issue a news release and failing to file a material change report about the DBRS January Release. The Commission reached this conclusion despite the fact that Coventree's mentions of the DBRS January Release in its February 14, 2007 letter to shareholders and in its May 14, 2007 MD&A did not result in any significant change in the price of Coventree shares.
Material Change Analysis
Section 75 of the Act requires "forthwith" disclosure of material changes to a reporting issuer's business, operations or capital. Section 1.1 of the Act defines "material change as"
[A] change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer.
Regarding the application of s. 75 of the Act, the court in this case states:
The first part of the analysis under s. 75 of the Act requires a determination as to whether a change in the "business, operations or capital" of the issuer has occurred and, if so, when. The second part of the analysis requires an assessment of whether the change was material in the sense that it "would reasonably be expected to have a significant effect on market price or value of the securities."
The court clarified that the appropriate test to be applied in determining materiality is the "market impact test" which considers what effect certain facts, events or developments would reasonably be expected to have had on the market price or value of Coventree shares.
The court also identified governing principles in applying s. 75 of the Act, and determining if a material change has occurred. The following are the most salient principles identified by the court:
- Materiality should be assessed objectively from the perspective of an investor and prospectively through the lens of expected market impact. A super critical interpretation of the meaning of "material change" does not support the goal of promoting disclosure or protecting the investing public. If the decision is borderline, the information should be considered material.
- "Assessments of materiality are not to be made against a standard of perfection or with the benefit of hindsight."
- "When a reporting issuer is considering material change disclosure it must apply an objective test as to the expected market impact as it will not have the benefit of actual market impact information."
- "Materiality is a highly contextual issue that requires the commission to apply statutory obligations to a particular company in the context of its industry and the market. No single factor will be determinative of whether a material change occurred. In making determinations about materiality common sense must prevail in assessing the broader factual context or the 'total mix'."
- "Since materiality is highly contextual there is no bright line test to determine whether a material change has occurred. That assessment depends on particular circumstances and events."
- "A disclosure obligation arises when the material change actually occurs and if the financial impact is experienced at a later date the disclosure obligation is not delayed to that later date."
- "The determination of whether a material change has occurred does not require deference to the business judgment of management."
- "The commission does not always need evidence of effect on market price to find a material change" has occurred.
Additionally, the court explained why evidence as to an actual impact on the market price of shares is not necessary to prove that a material change has occurred. In the absence of an actual impact on market price, a careful analysis of detailed evidence of the reporting issuer's business and operations, market conditions and various other market-related factors would be sufficient. As an expert tribunal, the Commission merely applies its expertise to the evidence before it to explain why a lack of change in share price was not determinative of a material change issue.
This case provides greater certainty to reporting issuers in determining their obligations to disclose material change. Notwithstanding that Coventree did in fact inform its shareholders of the likely impact of the DBRS January Release, Coventree did not go far enough in reporting the material change. Based on the principles identified by the court with respect to the application of s. 75 of the Act, reporting issuers faced with similar material changes will not satisfy their obligations under the Act if they fail to file a material change report and news release. Their obligations are not lessened even if an actual change in share value does not result from the material change.
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