Canada: The Facebook IPO: Danier Revisited

It was hailed as the most anticipated IPO of "recent history" but quickly became, over the course of mere weeks, the subject of class actions, regulatory interest and even preliminary inquiries by congress. Worse still, it appears to have tainted the company and could well add to the perception that in capital markets the deck is stacked in favour of select investors. It is, if nothing more, a cautionary tale for businesses of all types. What reminders can we take from the saga of this social network giant?

The Facebook IPO

Details are still emerging but we are beginning to get a clearer view of the allegations stemming from the IPO. On May 18, 2012 Facebook CEO Mark Zuckerberg rang the opening bell on the NASDAQ and, soon after, 421 million shares of Facebook common stock were sold to the public at a price of $38 per share. The pricing valued the company at more than $100 billion. The stock rose briefly above $40 but has since fallen to $27.

It was only a few days after the IPO that allegations of impropriety began to emerge. Accounts differ but the gist of the claim appears to be that while Facebook warned in its prospectus of the risk of increased use of mobile platforms – where its ability to sell advertisements "is unproven" – they did not detail the nature or extent to which these factors had already prompted a "severe and pronounced" reduction in revenue. This information was allegedly material and was claimed to have been selectively disclosed to underwriters who, in turn, are said to have conveyed the information to choice clients.

The result has been a wave of allegations by various investors against the company and the underwriters.

Reminders For Canadian 'Friends'

The Facebook IPO is quickly becoming a cautionary tale for both reporting issuers and companies contemplating the transition to public status. With such a glaring example of the fallout from allegations of improper disclosure it is worth reviewing what disclosure obligations companies have particularly during the lead up to an offering.

In Kerr v. Danier Leather Inc. the Supreme Court of Canada clarified much of the ambiguity in this area of the law and provided important practical direction for companies to follow during an offering:

  1. A prospectus must include full, true and plain disclosure of all material facts at the time of its filing and receipt. A material fact is defined as a fact that significantly affects, or would reasonably be expected to have a significant effect, on the market price or value of any securities of the issuer.
  2. Where a material adverse change occurs after a preliminary prospectus has been filed and receipted, or where a material change occurs after a final prospectus has been filed and receipted, an amended preliminary prospectus or a final prospectus, as the case may be, will need to be filed. A "material change" is defined as a change to 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 securities of the issuer.

Amending a Prospectus

In short, anytime a prospectus is filed it must accurately disclose all material facts. It need only be supplemented with further disclosure, however, in response to a material adverse change between the time of a preliminary prospectus and a final prospectus, and a material change between the time of a final prospectus and the completion of the distribution of securities under the prospectus. A change in a material fact alone does not trigger an amendment.

Hence the sixty-four thousand dollar question – or, as alleged in the case of Facebook and its underwriters, a potentially multi-million dollar question – under Canadian rules if the disclosure that's alleged to have been omitted consisted of new financial results that differ materially from what was reflected in a prospectus, do such results amount to a material fact or a material change?

The net effect of the commentary in the Danier case is that material financial results, although they may be material facts, may not in and of themselves amount to a material change. However, the material result could stem from a material change in the business, operations or capital of the issuer or as a consequence of the results, the company could decide to effect such a material change. The key point, though, is that a material change arises from the underlying change to the business, operations or capital and not the results themselves.

Continuous Disclosure Obligations

Outside of the context of a public offering, under securities laws a company is required to disclose all material changes through the issuance of a press release and the filing of a material change report.

Separate and apart from the securities law requirements, companies cannot lose sight of the requirements of The Toronto Stock Exchange (TSX). The TSX imposes its own criterion for disclosure, referred to as "material information", that encompasses both material fact and material change. It defines material information as any information relating to the business or affairs of a company that results in or would reasonably be expected to result in a change in the market price or value of any of the company's listed securities. The TSX requires immediate disclosure, by way of a press release, of all material information.

The humbling of this online giant reminds us all of the importance of exercising sound judgment in ensuring that all applicable disclosure obligations are met.

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