Canada: OSC’s Coventree Decision Provides Guidance On Disclosure Obligations

Copyright 2011, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Securities Regulation, November 2011

The Ontario Securities Commission (the OSC) has released its reasons for decision In the Matter of Coventree Inc., Geoffrey Cornish and Dean Tai. The decision examines whether Coventree Inc. complied with its disclosure obligations in its prospectus relating to the initial public offering of its shares on the Toronto Stock Exchange (TSX) in 2006 and its timely disclosure obligations in 2007 prior to the market for certain asset-backed commercial paper (ABCP) freezing up on August 13, 2007. It also examines whether Geoffrey Cornish and Dean Tai in their capacities as senior officers and directors of Coventree violated the Securities Act (Ontario) (the Act) and whether Coventree made misleading statements in presentations to ABCP investors it delivered in April 2007.

In its conclusions, the OSC found that Coventree breached its timely disclosure obligations as a reporting issuer and that Cornish and Tai authorized, permitted or acquiesced in Coventree's non-compliance with those disclosure obligations. In addition, the OSC found that the conduct of Coventree, Cornish and Tai in contravening the Act was contrary to the public interest. The OSC imposed sanctions including administrative penalties totalling C$2.25-million, and prohibiting each of Cornish and Tai from acting as a director or officer of a reporting issuer (other than Coventree) for a period of one year.

Significance of Decision

The decision consolidates the OSC's interpretation of prospectus and timely disclosure requirements. It also demonstrates that the OSC is prepared to find against officers and directors involved in breaches of continuous disclosure requirements. This bulletin catalogues some of the OSC's findings in this regard.

Surrounding Facts and Circumstances Noted by the OSC

The decision, which exceeds 150 pages in length, provides a detailed, fact-based chronology of the events and failures relating to Coventree's disclosure determinations leading up to the ABCP market freezing up on August 13, 2007. The following background information, in particular, provides context to the OSC's conclusions that the Act was contravened in this case.

Coventree appeared to be the only third-party sponsor of ABCP in Canada that was a "reporting issuer" under the Act. Third-party sponsored ABCP was issued by special purpose vehicles (each referred to as a "conduit") sponsored by a non-bank or third-party entity, such as Coventree. The conduit, rather than the sponsor, was considered the issuer of the ABCP. The ability of Coventree-sponsored conduits to reissue and sell ("roll") ABCP as it matured was a critical part of Coventree's business.

Unlike holders of ABCP, which traded on an exempt basis, the shareholders of Coventree were entitled to the ordinary protections afforded to public company shareholders by securities laws, in terms of primary disclosure in the prospectus under which Coventree's shares were initially sold and secondary disclosure in the form of timely and periodic continuous disclosure.

The over-the-counter market for ABCP was very opaque. There was no public reporting of the prices at which transactions in ABCP were effected, there were no securities law filings required in connection with the sale or trading of ABCP and there was no disclosure required with respect to the attributes of, or assets backing, ABCP. As a result, investors relied heavily on the credit rating of the ABCP and had limited ability to carry out their own due diligence with respect to the ABCP and the assets backing it.

Dominion Bond Rating Service Limited (now DBRS Limited) (DBRS) was the only rating agency to provide ratings for the ABCP issued by Coventree-sponsored conduits. On November 10, 2006, DBRS issued a letter (the DBRS November Letter), which included a statement of DBRS's intention to take a "measured" and more restrictive approach with respect to a certain class of ABCP transactions in which Coventree-sponsored conduits were active and which class generated a substantial portion of Coventree's revenues.

On January 19, 2007, DBRS announced (the DBRS January Announcement), in effect, a change to its rating methodology, which meant that certain ABCP transactions would not be rated by DBRS in the future unless the transaction had the benefit of more stringent liquidity arrangements. The decision indicates that such liquidity arrangements were not available to Coventree-sponsored conduits.

Commencing in July 2007 and culminating on August 13, 2007, some of Coventree's dealers began reporting difficulties in rolling some Coventree-sponsored ABCP. Notwithstanding these increasing difficulties, it appeared to the OSC that prior to August 13, 2007, all maturing Coventree-sponsored ABCP was, in fact, rolled or taken into dealer inventory. On August 13, 2007, while some Coventree-sponsored ABCP was rolled, the dealers were not able to place all of the maturing Coventree-sponsored ABCP. When it became clear on August 13 that not all Coventree-sponsored ABCP would be rolled, Cornish contacted Market Regulation Services to request a halt in the trading of Coventree shares on the TSX.


Generally, the issues considered by the OSC were not whether Coventree breached its disclosure obligations to the detriment of investors in the ABCP issued by conduits that Coventree sponsored. Rather, at issue was principally whether Coventree breached its disclosure obligations under the Act to the detriment of securityholders of Coventree itself. Specifically, the OSC made the following determinations:

  1. The DBRS November Letter was not a material fact that was required to be disclosed in Coventree's IPO prospectus.
  2. The DBRS January Announcement was a material change with respect to Coventree that was required to be disclosed by Coventree.
  3. When Coventree disclosed, in certain presentations it made to ABCP investors on April 25 and 26, 2007, the overall exposure (rather than on a conduit-by-conduit basis) of Coventree-sponsored conduits to U.S. subprime mortgages, Coventree did not make a misleading statement that contravened the Act.
  4. By the close of business on August 1, 2007, certain events and developments had occurred, which, taken together, constituted changes in Coventree's business or operations that would reasonably be expected to have had a significant effect on the market price or value of Coventree shares. Those events and developments therefore constituted a "material change" as defined in the Act with respect to Coventree that was required to be disclosed by Coventree.
  5. Cornish and Tai authorized, permitted or acquiesced in the non-compliance by Coventree with its disclosure obligations referred to in sub-paragraphs (b) and (d).
  6. The conduct of Coventree, Cornish and Tai in contravening the Act was contrary to the public interest.


The decision explains the circumstances and facts surrounding the determinations by the OSC that Coventree, Cornish and Tai breached the Act. Although these determinations are highly fact specific, the decision includes a number of statements of principle and guidance that will be relevant to all reporting issuers and the individuals who make disclosure decisions on behalf of such issuers, including the following:

Determinations of Materiality in the Context of Disclosure

  • Objective Test: The test of materiality is objective. Decisions regarding materiality should not be affected by the subjective assessment or optimistic views of company executives.
  • Not Backward-Looking: Assessments of materiality are not to be made with the benefit of hindsight. All one can do in assessing whether a material change has occurred is to consider the events and developments as they exist at the relevant time. In the case of Coventree, the OSC indicated that the OSC must not make its determinations with the benefit of the hindsight that the ABCP market freeze up occurred on August 13, 2007.
  • Prospective Impact: In assessing whether changes in Coventree's business were material, Coventree was required to consider the likely future effects and consequences of those changes on its business, both as a quantitative and qualitative matter. The OSC pointed out that this requirement is not the same as requiring premature disclosure of uncertain future events or predicting future financial performance. The OSC characterized the requirement as necessitating an assessment of the significant effects and consequences that changes in Coventree's business or operations may have going forward.

Material Changes

  • External Factors: Where an external event or development has a direct effect on, and changes or interferes with the business or operations of, an issuer, that external event or development can give rise to a change in the issuer's business or operations for purposes of the definition of "material change" in the Act.
  • The OSC also stated that the published guidance set forth in section 4.4 of the Canadian Securities Administrators' National Policy 51-201 – Disclosure Standards (i.e., that companies are not generally required to interpret the impact of external political, economic and social developments on their affairs) is premised on the assumption that investors will be aware of external economic developments and their general effects on reporting issuers. Where those developments occur, and do not have an uncharacteristic effect on a particular issuer, it may be that no material change disclosure by such issuer is required. In the case of Coventree, the OSC indicated that the international credit crisis in 2007 affected the Canadian ABCP market and that those events and developments were external and beyond Coventree's control. However, Coventree shareholders had very limited knowledge of the ABCP market and of events and developments affecting that market and would not have known or been able to fully assess the implications of those events and developments on Coventree and its business. As such, the OSC concluded that neither such section of the National Policy, nor the principles reflected therein, applied in the circumstances.
  • Existing Risk Factor Disclosure: Disclosure of a risk to which a business is subject is different than the occurrence of an event reflected in the risk factor. When an event that is material to the business occurs and gives rise to a material change, an issuer will have a disclosure obligation regardless of whether the risk giving rise to the material change had been previously identified and disclosed. The previous disclosure of risk factors does not affect or qualify an issuer's obligation to disclose material changes when they occur.
  • No Change in Market Price: The lack of impact on market price when a change is disclosed does not necessarily mean that the change disclosed was not material. The "material change" test is an objective test that focuses on both the market price and value of the relevant shares. Clearly, if disclosure when made actually has a significant effect on the market price of securities, that is strong evidence suggesting that the test for materiality may have been satisfied at an earlier time. However, the converse is not necessarily the case. There may be different explanations why particular disclosure has no market impact – in the case of Coventree, the OSC indicated that Coventree shareholders did not know how important the relevant transactions were to Coventree's business. When considering whether certain facts constitute a "material change", one must also consider whether particular information would reasonably be expected to have a significant effect on the "value" of securities, even if for some reason that disclosure would not be expected to affect their market price.
  • Outside Legal Advice: The decision includes commentary by the OSC that, as the controlling shareholders of Coventree, Cornish and Tai had a potential conflict of interest in deciding whether to disclose information that could have a material adverse effect on the market price of Coventree shares. According to the OSC, obtaining objective outside legal advice would have assisted in addressing that conflict.

Implications for Directors/Officers of Disclosure Breaches by Issuers

After concluding that Coventree breached its timely disclosure obligations, the OSC held that, in light of their roles in the timely disclosure decisions by Coventree, each of Cornish and Tai "authorized, permitted or acquiesced" in the breaches by Coventree and, as a result, each was individually deemed to have breached the Act's timely disclosure requirements.

This finding was made notwithstanding the fact that there was no evidence before the OSC that either Cornish or Tai intentionally breached the Act or attempted to intentionally mislead public shareholders or investors. This factor is not surprising in light of the OSC's view that the threshold for liability under the relevant section of the Act is relatively low, in that merely acquiescing or passively consenting without protest will satisfy the applicable requirements. The OSC also indicated that, in these circumstances, more is expected of directors and officers who have superior qualifications, such as experienced business people, and more is expected of inside directors, such as Cornish and Tai, who have much greater involvement in corporate decision-making and much greater direct access to corporate information.

In addition, the OSC found that the conduct of Cornish and Tai (in addition to Coventree) in contravention of the Act was contrary to the public interest. The basis for this finding appears to be that the OSC "considers the failure to make timely disclosure in accordance with section 75 of the Act, and the making of inaccurate, misleading or untrue disclosure, to be contrary to the public interest."


On November 9, 2011, the OSC announced that it had issued an order imposing sanctions following a sanctions hearing held on October 26 and 27, 2011. The OSC did not, at that time, issue reasons for imposing the sanctions, but indicated that reasons would be issued in due course.

In the order, the OSC imposed, among others, the following sanctions:

  • that Coventree pay an administrative penalty of C$1-million, that each of Cornish and Tai pay an administrative penalty of C$500,000, and that Coventree pay C$250,000 of the costs incurred by the OSC in connection with the hearing;
  • that trading in any securities by Coventree cease, and that Coventree be prohibited from making use of any securities law exemptions, in each case until such time as Coventree is wound-up;
  • that each of Cornish and Tai resign any positions he may hold as a director or officer of a reporting issuer, other than Coventree; and
  • that each of Cornish and Tai is prohibited from becoming or acting as a director or officer of a reporting issuer, other than Coventree, for a period of one year.

Coventree issued a press release on October 24, 2011 indicating that Staff of the OSC had requested that Coventree, Tai and Cornish each pay an administrative penalty of C$5-million and jointly pay C$1.5-million in costs. The Coventree press release also indicated that Staff had requested that Tai and Cornish be prohibited from seeking or accepting any indemnification from Coventree in relation to any administrative penalty ordered by the OSC against them. In contrast, the OSC's sanction order indicated that it was not intended to prevent Cornish or Tai from making any claim for indemnity from Coventree in respect of the amounts payable by them pursuant to their administrative penalties.

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.

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