Torys Quarterly: The Cross-Border Update
With the recent volatility in the capital markets, and the promise of more public offerings from emerging industry sectors, it is important for underwriters to understand the scope of their potential liability in the underwriting process.
In this article, we review and compare the statutory and common law liability of underwriters in both Canada and the U.S., highlighting key legal developments in the area (including recent limits placed on Canadian underwriter liability). We conclude with some practical advice.
The Canadian Perspective
The securities legislation of each province in Canada includes a statutory civil cause of action against underwriters for misrepresentations made in prospectuses, without regard to whether the purchaser relied on the misrepresentations. Remedies available to investors include rescission or damages. A number of statutory defences are available to underwriters including, most notably, a due diligence defence.1
Plaintiffs have sought, but not succeeded, to expand the scope of secondary market statutory civil liability claims against underwriters.
In contrast, the legislation does not list underwriters as potential parties who may be sued for misrepresentation by purchasers who bought securities in the open market. Recently, however, plaintiffs have sought, but not succeeded, to expand the scope of secondary market statutory civil liability claims against underwriters:
- In Goldsmith v. National Bank of Canada,2 the plaintiffs sought to characterize an underwriter as a "promoter," which is one of the parties that is subject to liability under the provincial securities acts.3 The court concluded that, on the facts of the case, the underwriter could not be considered a promoter — promoters need to do more than merely provide financing to an issuer or exercise influence over decision makers.
- In LBP Holdings v. Allied Nevada Gold Corp,4 the plaintiffs argued that underwriters should be characterized as "experts" under securities legislation.5 The court rejected this argument, finding that (i) in order for an expert to be found liable, the disclosure must repeat a misrepresentation contained in an expert's statement, and (ii) more broadly, the legislature did not intend for underwriters to be subject to statutory secondary market liability.
The U.S. Perspective
The U.S. has long provided investors with a statutory private right of action against underwriters for material misstatements and omissions in registration statements, prospectuses and oral statements made in connection with the sale of securities.6 As in Canada, buyers need not prove that they relied on the misrepresentation, and an underwriter is strictly liable unless it reasonably believed the statements to be true as a result of its due diligence. State "blue sky" laws also provide remedies in certain instances where the federal laws may not.7
As in Canada, U.S. buyers need not prove that they relied on the misrepresentation, and an underwriter is strictly liable unless it reasonably believed the statements to be true as a result of its due diligence.
A secondary market purchaser in the U.S. can assert a claim against an underwriter if it can trace its purchase to a material misrepresentation in a registration statement. However, claims based on a misrepresentation in a prospectus are available only to purchasers of the initial offering.
Underwriters are also subject to liability in the U.S. for fraudulent misrepresentations and omissions upon which a purchaser relied,8 and class action plaintiffs often can establish reliance through a "fraud-on-the-market" theory, which Canadian courts have not adopted.
Common Law Liability
The Canadian Perspective
In addition to statutory liability, underwriters in Canada may face liability for negligent misrepresentation at common law. The premise of such claims is that the prospectus contained misrepresentations, contrary to the underwriters' certificate, indicating that the prospectus made full, true and plain disclosure.
Underwriters are hired essentially to be distributors of another's goods, and only make "weak" representations that the prospectus contains full, true and plain disclosure.
Recently, in LBP Holdings, plaintiffs sought to expand underwriter liability at common law by arguing that underwriters owed a duty of care to shareholders to properly price shares and to perform due diligence to ensure the prospectus made full, true and plain disclosure.
The court declined to impose the proposed duty of care on the underwriters. Factors relevant to the court's decision not to impose a duty of care included that:
- an underwriter would not anticipate that purchasers would rely on it to prevent the harm of buying shares at an inflated price, separate and apart from its duties under the Ontario Securities Act and existing common law duties;
- underwriters are hired essentially to be distributors of another's goods, and only make "weak" representations that the prospectus contains full, true and plain disclosure;
- imposing a duty of care could (a) deter useful economic activity where the parties are best left to allocate risks through the autonomy of contract, insurance, and due diligence; (b) encourage a multiplicity of inappropriate lawsuits; and (c) disturb the balance between statutory and common law actions envisioned by the legislator.
The U.S. Perspective
Long-standing and robust statutory remedies available to U.S. investors mean that common law claims for negligent misrepresentation, though available, play a limited role. New York's state law often governs claims against U.S. underwriters; there, a duty of care arises only where there exists a special or fiduciary relationship between the buyer and seller. Because an arm's-length business relationship between an underwriter and a buyer typically does not constitute a special relationship, negligent misrepresentation claims are difficult to maintain.
Practical Advice for Underwriters
On both sides of the border, securities class actions remain relatively common. To reduce the chances they are made party to a claim, underwriters should:
- conduct thorough due diligence of the issuer, including a considered business due diligence review by the underwriters and calls with management and auditors, documentary due diligence by underwriters' counsel, review of all disclosure incorporated by reference into the offering document, and factual back-up review;
- for forward-looking statements and opinions, understand and document the basis for management's subjective belief of a statement of opinion, verify embedded factual assertions within statements of opinion, and ensure that adequate disclaimers and appropriate cautionary language regarding underlying assumptions are stated;
- confirm consistency of any roadshow scripts and other marketing materials with the offering documents and any incorporated disclosures regarding the issuer;
- be aware that direct representations made to investors may give rise to common law liability and should be avoided;
- a clear description in the underwriting agreement about the services they are providing to the issuer is included, and avoid any language which suggests that services or duties are owed to investors;
- clarity among syndicate members as to how legal fees and liability associated with any litigation will be borne; and
- information provided by underwriters to the issuer in the course of preparing the prospectus or registration statement is well-sourced and documented.
1 Underwriters will not be found liable if they prove that, after conducting a reasonable investigation, they had reasonable grounds to believe that the prospectus did not contain a misrepresentation.
2 2016 ONCA 22.
3 "Promoter" is defined in Ontario's Securities Act as (i) a person or company who, acting alone or in conjunction with one or more other persons, companies or a combination thereof, directly or indirectly, takes the initiative in founding, organizing or substantially reorganizing the business of an issuer or (ii) a person or company who, in connection with the founding, organizing or substantial reorganizing of the business of an issuer, directly or indirectly, receives in consideration of services or property, or both services and property, 10 per cent or more of any class of securities of the issuer or 10 per cent or more of the proceeds from the sale of any class of securities of a particular issue, but a person or company who receives such securities or proceeds either solely as underwriting commissions or solely in consideration of property shall not be deemed a promoter within the meaning of this definition if such person or company does not otherwise take part in founding, organizing, or substantially reorganizing the business.
4 2016 ONSC 1629 ("LBP Holdings"). Torys represented the underwriters, Cormark Securities Inc. and Dundee Securities Limited.
5 "Expert" is defined in Ontario's Securities Act as a person or company whose profession gives authority to a statement made in a professional capacity by the person or company, including, without limitation, an accountant, actuary, appraiser, auditor, engineer, financial analyst, geologist or lawyer, but not including a designated credit rating organization.
6 Securities Act of 1933, §§ 11-12
7 See, e.g., Hays v. Ellrich, 31 N.E.3d 1064 (Mass. 2015) (observing that the Massachusetts Uniform Securities Act has a longer limitations period than its federal counterpart and that the federal period can begin to run earlier than the state period.)
8 Securities Exchange Act of 1934, § 10(b)
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.