Originally published 23 September, 2005
The recently-proclaimed amendments to the Ontario Securities Act that create causes of action for investors in the secondary market with respect to misleading, insufficient or late disclosure will become effective on December 31, 2005. This update considers how the new regime will affect mutual funds and other investment funds that are reporting issuers.
What are the new rights of action?
Ontario securities law already provides investors who purchase a security offered by a prospectus with a right of action in respect of misrepresentations contained in the prospectus.
The new legislation will now enable investors who acquire or dispose of securities in the secondary markets (i.e., who do not acquire securities directly from the issuer pursuant to a prospectus, but who acquire or dispose of securities in transactions with other investors) to sue "responsible issuers" (which would include mutual funds and other investment funds that are reporting issuers), directors and trustees of investment funds, fund managers and their directors and officers for:
- a misrepresentation in a document, including those filed with the Ontario Securities Commission (such as an annual information form, financial statements, management reports of fund performance, press releases and material change reports) and any other communication the content of which would reasonably be expected to affect the market price or value of a security of the investment fund (which could potentially include sales communications of the investment fund);
- a misrepresentation in a public oral statement; and
- a failure to make timely disclosure of material changes.
The new right of action for a misrepresentation applies in respect of a fact that would reasonably be expected to have a significant effect on the market price or value of a security of the investment fund. This differs from the new right of action for failure to disclose a material change, which, when used in relation to an investment fund, means a change that would be considered important by a reasonable investor in determining whether to purchase or continue to hold securities of the investment fund.
Here are two other key features of the new rights of action:
- Deemed reliance. Unlike at common law, an investor need not, in order to establish liability, prove whether the investor acquired or disposed of the securities in reliance on a particular misrepresentation or on the investment fund’s compliance with its continuous disclosure obligations.
- Inapplicable to prospectus purchases. The new rights of action do not apply to purchases of a security offered by a prospectus during the period of distribution.
How will these new rights of action benefit investors in mutual funds?
Since most mutual funds are typically in continuous distribution and most mutual fund investors purchase mutual fund securities directly from the fund pursuant to the fund’s prospectus rather than from another investor in the secondary market, most mutual fund investors will not be able to rely on the new rights of action in respect of purchases of mutual fund securities. However, mutual fund investors may continue to rely on the existing right of action in respect of misrepresentations in a mutual fund prospectus (which incorporates by reference the fund’s annual information form, annual and interim financial statements and management report of fund performance, but which does not incorporate by reference other types of documents, such as sales communications).
The key benefit that the legislation will provide to mutual fund investors is that, when they dispose of (i.e., redeem) mutual fund securities, they will have a new right of action in respect of misrepresentations in continuous disclosure documents, any written communication (including electronic communication) that would reasonably be expected to affect the market price or value of a security of the investment fund and public oral statements, or where there has been failure to make timely disclosure of material changes.
Investors who purchase mutual fund securities under a prospectus will not have statutory rights of action relating to misrepresentations in non-prospectus documents, misrepresentations in public oral statements or a failure to make timely disclosure of material changes. While misrepresentations in these other types of documents (such as misleading sales communications) do not give rise to the new statutory cause of action for mutual fund purchases, they remain actionable at common law.
How will these new rights of action benefit investors in other investment funds?
The new legislation will have a greater impact for those who invest in publicly-traded investment funds, since initial offerings of these funds’ securities pursuant to a prospectus are usually short-lived and trading in such securities occurs principally in the secondary market. Just as with mutual fund investors, investors in these types of investment funds will continue to have statutory rights of action in respect of purchases of investment fund securities where there is a misrepresentation in the prospectus. However, to the extent that investors in these types of investment funds acquire or dispose of fund securities in the secondary market, these investors will now have rights of action under the new legislation in respect of a misrepresentation in the types of continuous disclosure documents described above and in public oral statements or where there is a failure to make timely disclosure of a material change.
Standards of liability
For a misrepresentation in a "core document," the plaintiff only needs to establish that there was a misrepresentation (core documents include prospectuses, annual information forms and financial statements). For a misrepresentation in a non-core document or in a public oral statement, the plaintiff must establish that there was a misrepresentation and must also prove knowledge, wilful blindness or gross misconduct on the part of the defendant. For actions relating to a failure to make timely disclosure against an investment fund, the fund manager or its officers, the plaintiff only needs to establish that there was a failure to make timely disclosure.
Due diligence defence and fund disclosure practices
The principal defence available to those subject to actions for misrepresentations or a failure to make timely disclosure is the due diligence defence that requires proof that:
- they conducted or caused to be conducted a reasonable investigation before the release of the document, the making of the statement or the failure to make timely disclosure; and
- they had no reasonable grounds to believe that the document or public oral statement contained the misrepresentation or that the failure to make timely disclosure would occur.
In determining whether an investigation was reasonable, the court is directed to consider all relevant circumstances, including "the existence, if any, and the nature of any system designed to ensure that the issuer meets its continuous disclosure obligations."
Investment funds, investment fund managers and their respective directors and officers may wish to examine their continuous disclosure practices to increase their ability to establish a due diligence defence. Specifically, they may wish to develop or enhance:
- written disclosure policies with respect to the review and release of written and oral information relating to the funds;
- policies concerning the appointment of, and guidelines for, spokespersons for the funds;
- procedures to ensure that material changes to the funds are quickly identified and appropriately disclosed;
- practices relating to document production, recordkeeping and record retention; and
- directors’ and officers’ insurance coverage and indemnification arrangements.
John Black is a partner in Osler's Business Law Department. He practises in the areas of corporate finance and mergers and acquisitions, with a particular focus on investment funds, asset management, structured products and public securities offerings. Linda Currie is a partner in the Business Law Department. Her practice is concentrated in the corporate and securities law area with a particular emphasis on financial institutions, investment funds and asset management, and securities regulatory and compliance matters. Lorraine Lynds is an associate practising in the Business Law Department of the firm’s Toronto office. Her practice focuses on mergers and acquisitions, corporate finance and securities, and general corporate matters. Valerie Dyer is a partner in the Toronto office. She specializes in civil litigation, primarily involving corporate and commercial disputes.
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.