*A previous version of this paper was presented at the Canadian Institute Securities Litigation and Enforcement Conference on October 19 and 20, 2010 at Toronto.
Ontario's statutory regime for secondary market liability came into effect in 2006 as a result of amendments to the Securities Act (Ontario) (the "OSA"), creating a statutory cause of action for deficient market disclosure. Other provinces have followed. To date, there has been limited jurisprudence on the new regime. The following represents various issues that may be faced by directors and officers in the context of potential secondary market liability, and provides practical advice on how directors and officers can reduce their risk of being personally liable in a securities class action. The paper concludes with several additional developments in class actions arising from breaches of other statutes that shed light on additional areas of potential liability of officers and directors.
Issue: The Leave Test – Different standards for directors, officers and influential persons
In creating a statutory cause of action for secondary market misrepresentation, the OSA (and comparable legislation across Canada) relieves shareholders from the burden of proving reliance on a public issuer's misrepresentation to succeed in a cause of action for secondary market misrepresentations. To provide some protection for potential defendants from the possibility of unmeritorious proceedings, section 138.8 of the OSA assigns to the courts a "gatekeeper" function: no action may be commenced under section 138.3 without leave of the court. Section 138.8 requires that in order for a court to grant a proposed plaintiff leave to proceed with an action under Part XXIII.1, the court must be satisfied that (1) the action is being brought in good faith; and (2) there is a reasonable possibility that the plaintiff will succeed at trial.
The leave test is an evidence based test. Accordingly, the proposed plaintiff must demonstrate that there is sufficient evidence for a court to conclude that there is a reasonable possibility that the plaintiffs will succeed at trial regarding its claims under section 138.3.
Section 138.3 sets a different standard for directors, officers and influential persons:
138.3 (1) Where a responsible issuer or a person or company with actual, implied or apparent authority to act on behalf of a responsible issuer releases a document that contains a misrepresentation, a person or company who acquires or disposes of the issuer's security during the period between the time when the document was released and the time when the misrepresentation contained in the document was publicly corrected has, without regard to whether the person or company relied on the misrepresentation, a right of action for damages against,
(a) the responsible issuer;
(b) each director of the responsible issuer at the time the document was released;
(c) each officer of the responsible issuer who authorized, permitted or acquiesced in the release of the document;
(d) each influential person, and each director and officer of an influential person, who knowingly influenced,
(i) the responsible issuer or any person or company acting on behalf of the responsible issuer to release the document, or
(ii) a director or officer of the responsible issuer to authorize, permit or acquiesce in the release of the document; and
In respect of directors, and subject to the due diligence defences discussed below, a proposed plaintiff must lead sufficient evidence to establish a reasonable possibility of proving at trial (i) that there was a misrepresentation in a core document; and (ii) the individual was a director of the responsible issuer at the time the document was released. Interestingly, in IMAX,1 the only case that has considered the leave test, the Court did not grant leave to proceed against two external directors. These directors had, in effect, not touched the documents. They had a limited role in respect of financial reporting and knew that the audit committee and the auditors were satisfied on the matters now in issue related to revenue recognition. This was sufficient to establish the reasonable investigation defence even in the absence of an independent investigation. In contrast, directors who were on the audit committee and who had questioned the auditors and financial officers of the Company did not satisfy the requirements of the reasonable investigation test.
In the case of an officer at the leave stage, a proposed plaintiff will have to have sufficient evidence to demonstrate a reasonable possibility that the plaintiff will be able to succeed in demonstrating that the officer in question authorized, permitted or acquiesced in the release of the document. Arguably this requires a plaintiff to demonstrate that the officer in question either played a role, or had an opportunity to have played a role and chose not to, in producing or releasing the disclosure documents. For example, in IMAX, the Court granted leave against the Chief Financial Officer and the Vice-President, Finance, both of whom had signed the core document containing the alleged misrepresentations.2
The test is even more restrictive in the case of an influential person (which includes insiders who are not directors and officers). The plaintiff requires evidence that the influential person "knowingly influenced" the issuer to release the impugned document or knowingly influenced an officer or director of the issuer to authorize, permit or acquiesce in the release of the document.
In this context, the issue of note-taking and independent expert advice will be discussed below.
Issue: What defences are available to directors and officers to the statutory cause of action?
The same defences are available to directors, officers and influential persons. There are specific defences regarding forward-looking information and confidential disclosure being made to the regulator. More generally, subsection 138.4(6) of the OSA provides a reasonable investigation defence: a person or company is not liable in relation to a misrepresentation if that person or company proves that (i) before the release of the document or the making of the public oral statement containing the misrepresentation, the person or company conducted or caused to be conducted a reasonable investigation, and (ii) at the time of the release of the document or the making of the public oral statement, the person or company had no reasonable grounds to believe that the document contained the misrepresentation.
Subsection 138.4(7) provides that the court should consider the following factors when determining whether an investigation was reasonable:
(a) the nature of the responsible issuer;
(b) the knowledge, experience and function of the person or company;
(c) the office held, if the person was an officer;
(d) the presence or absence of another relationship with the responsible issuer, if the person was a director;
(e) the existence, if any, and the nature of any system designed to ensure that the responsible issuer meets its continuous disclosure obligations;
(f) the reasonableness of reliance by the person or company on the responsible issuer's disclosure compliance system and on the responsible issuer's officers, employees and others whose duties would in the ordinary course have given them knowledge of the relevant facts;
(g) the period within which disclosure was required to be made under the applicable law;
(h) in respect of a report, statement or opinion of an expert, any professional standards applicable to the expert;
(i) the extent to which the person or company knew, or should reasonably have known, the content and medium of dissemination of the document or public oral statement;
(j) in the case of a misrepresentation, the role and responsibility of the person or company in the preparation and release of the document or the making of the public oral statement containing the misrepresentation or the ascertaining of the facts contained in that document or public oral statement; and
(k) in the case of a failure to make timely disclosure, the role and responsibility of the person or company involved in a decision not to disclose the material change.
In IMAX, the Court rejected the defendants' arguments that the Court should incorporate the business judgment rule in applying the reasonable investigation defence.3 The Court held that the onus on establishing the defence was on the defendants and that creating a standard of deference to a director or officer's decision would be both unnecessary and inconsistent with the scheme and purpose of the statutory remedy.
Issue: Defensive D&O Practices – Having the evidence to defend your role in the disclosure process
There has long been a debate among those involved in corporate governance on the advisability of officers and directors maintaining records and notes of their activities and if so, in what detail. Note taking is always seen as a double edged sword: a director or officer may be able to rely on notes at a later date but those same notes are likely producible in certain regulatory investigations or litigation proceedings and, if not prepared with care and accuracy, may ultimately hurt rather than help one's position.
On balance, in the current environment of litigation and regulation, officers and directors are best served by maintaining detailed records and notes of their conduct, roles and responsibilities on significant issues within the company. Assuming that one is doing her job with due care and attention, it is better for an officer or director to be able to show what she did at the time in question and why she did it. This is especially true in the context of the reasonable investigation defence under subsection 138.4(6) of the OSA. The onus is on the defendants to demonstrate that they conducted a reasonable investigation into the underlying issue giving rise to the purported misrepresentation. Accurate notes and/or records can provide the evidence needed to establish such a defence.
However, it is important to recognize that such note taking should not amount to keeping multiple sets of minutes. There should be only one set of minutes. Every director should review those minutes to ensure accuracy. The notes are for the purpose of documenting one's own conduct and participation. To repeat, the notes must be factual and made with care. They must be accurate and complete. Careless or "joking" comments "sink ships" and lawsuits. Care also must be exercised in keeping notes so as not to jeopardize claims to privilege that might otherwise be asserted by a company or individuals.
Additional defensive practices that can be employed include:
- There should be descriptions of the various roles and
responsibilities of officers and senior management that clearly
articulate what roles, if any, each individual plays regarding
public disclosure documents.
- All officers and directors should be aware of the Company's
disclosure obligations. Officers and directors should keep apprised
of recent developments and changes in the law. Reporting services,
articles or select law firm bulletins may assist.
- Companies should establish a formal compliance and monitoring
- Companies, directors and officers should know when and how to
make use of internal counsel, external counsel, advisors and
experts. This may be critical in subsequently establishing a
defence. Directors must think and act with independence.
- Increasingly, directors are retaining professional consultants
to assist and advise in the carrying out of their duties and
obligations as directors. It is important to understand the issues
and to ensure the right questions are asked.
- Appropriate insurance coverage is essential. This will be
covered as a separate topic below.
Issue: How does the damages cap under section 138.7 affect officers and directors?
Section 138.7 of the OSA provides that the damages charged against any individual or company shall be capped unless the plaintiff proves that the individual or company authorized, permitted or acquiesced in the making of the misrepresentation (or the failure to make timely disclosure) while knowing that it was a misrepresentation or failure to make timely disclosure, i.e., fraud. In the case of an officer or director, absent proof of the knowledge of the misrepresentation or failure to make timely disclosure the damages are capped at the greater of $25,000 and 50% of the aggregate of the director's or officer's compensation from the reporting issuer or its affiliates.
Given the existence of the cap on damages, and absent fraud, there is a very real question of whether or not officers or directors should always elect to defend claims brought under section 138 where the cost of defence may exceed the potential liability. However, this may be reputational issues for both individuals and the company that make assisting a defence advisable even if not economic. In some instances, proposed class plaintiffs may only be electing to add certain directors and officers as proposed defendants for reasons of discovery which they hope to use against the reporting issuer. This may raise questions with respect to good faith, which is a further requirement for leave being granted.
It should be noted that most proposed actions under the Part XXIII.1 cause of action have been accompanied by the common law claims of negligence and negligent misrepresentation. The common law claim of negligent misrepresentation was certified in the IMAX case. There is obviously no damages cap on the common law claims. While there is a significant difference between a claim being certified and plaintiffs' ultimately succeeding on their common law negligent misrepresentation claim, certification of the common law claim in such circumstances seems inconsistent with prior rejections by Ontario courts of a "fraud on the market" theory. In fact, part of the impetus for part XXIII.1 of the OSA was to overcome the hurdle of reliance in such common law claims by removing that requirement.
Issue: When might law firms be liable for their lawyers serving as directors?
In Allen v. Aspen Group Resources Corporation et al.4, Justice Strathy certified a class action related to purported misrepresentations contained in a circular for a takeover bid. The most relevant defendants for current purposes are WeirFoulds LLP and its partner Wayne Egan, external corporate counsel for Aspen and a director during the relevant period. The Court warned of the possible ramifications of external corporate counsel sitting on the board of a corporation:
It seems to me that it is arguable that a lawyer who, through his or her law firm, acts as external corporate counsel to a corporation and who also sits on the corporation's board, may well be acting in the ordinary course of the law firm's business when he or she takes a seat at the boardroom table. Indeed, such a relationship with the corporation may be encourages by the law firm to strengthen the relationship with the client, to raise the profile of the lawyer and the law firm and to increase business. To the extent there are risks for the lawyer and the law firm, they undoubtedly can be offset by appropriate liability insurance.5
In relation to WeirFoulds LLP and Wayne Egan, the pleadings were found to disclose a cause of action indicating that the law firm could become liable for the acts of Mr. Egan in his capacity as a director.
While it is important to remember that the class action was only certified and that the law firm has not been found liable, the case does serve as warning for law firms. Partners who are considering serving as directors need to ensure that there are clear delineations between their role as a partner of a law firm and their role as a director of a company in their personal capacity. Steps need to be taken in the corporate process to make it clear that the individual is serving as a director in his or her personal capacity and not as a partner of a law firm.
Issue: Insurance, Insurance, Insurance
In today's litigation and regulatory environment, no one should be a director or officer at a public corporation without ensuring that appropriate and adequate directors and officers liability insurance is, and remains, in place. D & O liability policies have proven to be problematic in the past in terms of, for example: the scope of coverage and the existence of securities entities coverage; the adequacy of coverage; inappropriate exclusions; the existence and sufficiency of defence costs provisions; and the interplay between coverage for civil and regulatory proceedings. Other issues can arise in the context of settlement that should be, to the extent possible, anticipated in advance and provided for in the policy. Have the proposed policy reviewed by knowledgeable counsel. Directors and officers should consider having independent representation from the company in negotiating D & O coverage. Independent directors in particular should ensure the limits that apply to them are adequate, through a carve-out or otherwise.
Consideration should also be given by directors and officers to obtaining a contractual indemnity, over and above that provided in the corporation's by-laws or in applicable legislation. Such indemnities can be tailored to meet the specific concerns of directors and officers, and in particular, the concerns of independent directors. Here again, independent legal advice should be sought. Consideration should also be given to potential exposure to the liability of international subsidiaries. Does the insurance policy respond to potential liability in relevant jurisdictions? Are there local laws that may affect the ability to call on contractual or statutory indemnities?
Issue: Considerations for officers and directors in parallel criminal, civil and regulatory proceedings
There are various considerations that officers and directors must consider during parallel criminal, civil and regulatory proceedings. One consideration that must be considered is how a strategy in one jurisdiction may affect disclosure in another. For example, the facts stipulated in a criminal plea agreement or in a regulatory settlement, in Canada and in foreign jurisdictions, may be evidence in a leave proceeding in an Ontario securities class action. Officers and directors should ensure that all of their lawyers in every jurisdiction cooperate to ensure that all potential consequences are considered before any decision is made.
Additionally, there is case law (see Fischer v. IG. Investment Management Ltd. et al6) standing for the proposition that OSC proceedings and settlement agreements provide access to justice to Ontario investors such that a securities class action may not be necessary. This clarifies an important aspect of the interrelationship between regulatory proceedings and class actions. Respondents may find it appropriate to negotiate settlements with regulatory bodies rather than contest allegations. In some circumstances there may be an opportunity, as part of such a settlement, to compensate directly those allegedly harmed by the conduct in issue. To do so potentially provides the ability to resolve issues on an appropriate basis in a regulatory context. It allows respondents to be proactive and choose to do "the right thing" at an early stage. The decision in Fischer confirms that such a process need not pave the way for future class proceedings. Indeed, it may create an opportunity to avoid future litigation.
Issue: Unavailability of Due Diligence Defence For Other Statutory Breaches?
On October 1, 2010, the Ontario Superior Court of Justice rendered a decision in the matter of Jeffrey and Rudd v. London Life Insurance et al.7 In this class action,8 the plaintiffs alleged that the acquisition of London Insurance Group ("LIG") by Great-West Life Assurance Company ("GWL") involved a number of breaches of the Canadian Insurance Companies Act ("ICA").9
The class proceeding arose out of the 1997 $2.9 billion acquisition of LIG by GWL and its parent, Great-West Lifeco Inc. ("GW Lifeco"). The fundamental dispute between the parties related to the partial funding of the acquisition price by the participating policy accounts of both GWL and LL. Under the ICA, a participating policy is defined as an insurance policy that entitles the holder to participate in the profits of the company. For this added benefit, participating policyholders pay higher premiums. The ICA regulates the operation of these policies.
Of particular concern for the purposes of this paper, in addition to finding the defendants had breached provisions of the ICA, the Court found a breach of subsection 166(2) of the ICA notwithstanding that the directors and officers of the defendants relied upon the independent actuary report in approving the acquisition. This breach was entirely dependent on the defendants' breaches of sections 462, 331(4) and 458 of the ICA, as the Court found that the business judgment rule does not provide directors and officers with any protection in the case of a statutory breach.
In this case, this conclusion was of little practical importance: the Court had already found that the defendants had breached three provisions of the ICA, and given that the directors and officers were not named as defendants, no damage award was made against them personally, and the breach of subsection 166(2) did not give rise to any further liability.
Nevertheless, the possible implications of the Court's decision are noteworthy. Specifically, while the Court addressed the validity of the business judgment rule in relation to subsection 166(2), it did not consider the "safe harbour" provision under section 220 of the ICA.10 Subsection 220(1) provides, among other things, that a director, officer or employee has fulfilled her duty under subsection 166(2) if she exercised the care, diligence and skill that a reasonably prudent person would have exercised in comparable circumstances, including reliance in good faith on a report of a person whose profession lends credibility to a statement made.
By failing to consider this provision, and concluding that the defendants' breaches of the ICA inevitably led to a breach of subsection 166(2) by the directors and officers, the Court appears to have indicated that a statutory breach trumps any due diligence defence by a director or officer. Such an interpretation may be in contradiction to a plain reading of the ICA, and comparable provisions in the corporate law statutes. More importantly, if directors and officers were held to be in breach of subsection 166(2) every time a company breaches a provision of the ICA, with no due diligence defence, directors and officers could be subject to significant indeterminate liability.
This will be an important issue that directors and officers, and particularly officers and directors of insurance companies governed by the ICA, will want to follow on the appeal of this case.
In Jellema v. American Bullion Minerals Ltd.,11 the British Columbia Court of Appeal held that the oppression remedy could be suitable for a class action. The Court followed the Ontario Court of Appeal's decision in Stern v. Imasco Ltd.,12 which held that oppression actions may or may not be personal in nature. The Court held that oppression actions involving private companies are likely to be personal in nature and therefore unsuitable for certification. In other cases, however, the class action legislation will be "complimentary and facilitative to achieving the objectives of the oppression remedy provisions". The Court also held that the Class Proceedings Act is to be interpreted in a broad and remedial manner, and that the plaintiffs' case was the type of case in which the benefits and protections of a class action are appropriate: it concerns a publicly-traded company that has numerous shareholders; the plaintiffs hold only a small percentage of the outstanding shares and without the benefits of certification, may well be unable to afford to continue the action; the oppressive conduct alleged is not personal in nature but is of the kind that would affect all of the shareholders; and if granted, a remedy would benefit all shareholders in the form of increased value for their shares. Thus, officers and directors of publicly traded companies may well be subject to class actions under the oppression remedies.
While recent developments in Canadian law have given rise to novel issues for directors and officers in the context of potential secondary market liability and other statutory sources of liability in a class actions context, best practices remain the same. Officers and directors need to remain current on their personal duties and responsibilities as well as the company's disclosure obligations and should stay current on these obligations. Directors and officers need to ensure that the company implements a formal compliance and monitoring program and that there is accurate record keeping to document compliance with statutory obligations. Directors should consider making effective use of external consultants to assist and advise in the carrying out of their duties and obligations. And of course, appropriate insurance coverage is a necessity.
1. Silver v. IMAX,  O.J. No. 5573 [IMAX].
2. Ibid. at para. 353.
3. Ibid. at para. 376.
4. Allen v. Aspen Group Resources Corporation et al., December 4, 2009 (Sup. Ct. J.)
5. Ibid. at para. 71.
6. Fischer v. IG Investment, 2010 ONSC 296 (Sup. Ct. J.) [Fischer].
7. 2010 ONSC 4938.
8. The action had been certified pursuant to the Class Proceedings Act, 1992, S.O. 1992, c. 6 [CPA] by a judgment released on February 29, 2008: Jeffrey and Rudd v. London Life Insurance Co. (2008), 89 O.R. (3d) 686 (Sup. Ct.), aff'd (2008), 59 C.P.C. (6th) 30 (Ont. Div. Ct.).
9. S.C. 1991, c. 47 [ICA].
10. It should be noted that the Court had previously considered the safe harbour provisions in relation to s. 166(1) of the ICA.
11. Jellema v. American Bullion Minerals Ltd., 2010 BCCA 495
12. Stern v. Imasco Ltd.,  1 B.L.R. (3d) 198.
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.