Canada: Civil Liability For Public Company Secondary Market Disclosure

CIVIL LIABILITY

Incorrect Disclosure

A company’s public continuous disclosure record is incorrect if:

(a) the company, or a person (representative) with actual, implied or apparent authority to act or speak on behalf of the company, releases a public document or makes a public oral statement that relates to the business and affairs of the company and contains a misrepresentation; or

(b) a person (influential person) who is in a position to influence the conduct of the company (eg, an insider, a 20% shareholder or a promoter of the company), or a representative of an influential person, releases a public document or makes a public oral statement that relates to the business and affairs of the company and contains a misrepresentation.

Incomplete Disclosure

A company’s public continuous disclosure record is incomplete if the company does not make timely disclosure of a material change in the business and affairs of the company.

Right of Action

Effective January 1, 2006, a person (securityholder) who buys or sells securities of a public company that has a real and substantial connection to Ontario (eg, a reporting issuer in Ontario) at a time when the company’s public continuous disclosure record is incorrect or incomplete will, depending on the circumstances, have a right of action for damages against one or more of the following persons (defendants):

in the case of incorrect disclosure involving:

(1) a public document released by the company or a representative of the company or a public oral statement made by a representative of the company:

  • the company,
  • in the case of a public document, the directors of the company and those officers of the company who authorized, permitted or acquiesced in the release of the document,
  • in the case of a public oral statement, those directors and officers of the company who authorized, permitted or acquiesced in the making of the statement,
  • each influential person and those of its directors and officers who knowingly influenced the release of the public document or the making of the public oral statement, and
  • each expert (eg, an accountant, actuary, engineer, geologist or lawyer) who expertized the public document or the public oral statement (ie, consented to the use of a summary or quote from a report, statement or opinion of the expert in the document or statement);

(2) a public document released by an influential person or a representative of an influential person, or a public oral statement made by a representative of an influential person:

  • the influential person,
  • those directors and officers of the influential person who authorized, permitted, or acquiesced in the release of the public document or the making of the public oral statement,
  • if a director or officer of the company authorized, permitted or acquiesced in the release of the public document or the making of the public oral statement, the company and those of its directors and officers who authorized, permitted or acquiesced in the release of the document or the making of the statement, and
  • each expert who expertized the public document or the public oral statement; and

in the case of incomplete disclosure:

  • the company,
  • those directors and officers of the company who authorized, permitted or acquiesced in the failure to make timely disclosure, and
  • each influential person and those of its directors and officers who knowingly influenced the failure to make timely disclosure.

PROCEDURAL MATTERS

An action may not be commenced without the leave of the Ontario court. The court may only grant leave if it is satisfied that the action is being commenced in good faith and has a reasonable possibility of success.

The limitation period for commencing an action is the earlier of three years after the date of the incorrect or incomplete disclosure and six months after a press release is issued announcing that the Ontario court has granted another security holder leave to commence an action in respect of the incorrect or incomplete disclosure.

The Ontario Securities Commission (OSC) may intervene in an application for leave to commence an action and in the action itself.

The Ontario court must approve any proposed settlement of an action. The prevailing party in an action is entitled to costs as determined by the court.

BURDEN OF PROOF

Incorrect Disclosure

In an action against any defendant for incorrect disclosure in a public document (core document) that the company is required to prepare and file with the securities regulatory authorities on a regular basis (eg, an annual information form, annual and interim financial statements and related MD&A and a material change report), a securityholder need only prove that it purchased or sold securities of the company at a time when the company’s public continuous disclosure record was incorrect.

In an action against any defendant for incorrect disclosure in a non-core document or a public oral statement, the securityholder must also prove that the defendant knew that the document or statement contained a misrepresentation, deliberately avoided acquiring that knowledge or was guilty of gross misconduct in connection with the release of the document or the making of the statement.

Incomplete Disclosure

In an action against the company or an officer of the company for incomplete disclosure, a securityholder need only prove that it purchased or sold securities of the company at a time when the company’s public continuous disclosure record was incomplete.

In an action against any other defendant for incomplete disclosure, the securityholder must also prove that the defendant knew of the change and that it was material, deliberately avoided acquiring that knowledge or was guilty of gross misconduct in connection with the failure to make timely disclosure.

DEFENCES

Defendants have a variety of possible defences, including the following:

(a) knowledge of plaintiff: the plaintiff was aware of the incorrect or incomplete disclosure; (b) due diligence: the defendant conducted or caused to be conducted a responsible investigation and had no reasonable grounds to believe that there was incorrect disclosure or that timely disclosure would not be made;

(c) experts: the defendant relied upon a report, statement or opinion of an expert, did not know and had no reasonable grounds to believe that the report, statement or opinion contained a misrepresentation and the public document or public oral statement fairly represented the report, statement or opinion; and

(d) no knowledge and corrective action: except in the case of the company, the incorrect or incomplete disclosure occurred without the knowledge or consent of the defendant and, when it became aware of the incorrect or incomplete disclosure, the defendant took prescribed corrective action.

There is no liability for incomplete disclosure if the company makes a confidential disclosure filing with the OSC and prescribed conditions are met. The use of confidential disclosure filings will likely have limited utility for companies that are also subject to the securities laws of foreign jurisdictions that do not permit confidential disclosure filings.

There is no liability for a conclusion, forecast or projection in forward looking information contained in a public document or public oral statement if, proximate to the forward looking information, the document or statement contains reasonable cautionary language, states the material factors or assumptions that were applied in drawing the conclusion or making the forecast or projection and identifies the material factors that could cause actual results to differ materially from the conclusion, forecast or projection, and there is a reasonable basis for drawing the conclusion or making the forecast or projection.

LIABILITY

If guilty, the defendants will be liable for any loss in value of the securities purchased or sold by the securityholder that is attributable to the incorrect or incomplete disclosure. Generally, each defendant will only be liable for its proportionate share of the loss (ie, to the extent that it has contributed to the loss) as determined by the court.

The following are the limits of a defendant’s liability:

(a) the company or a corporate influential person: the greater of C$1 million and 5% of the defendant’s market capitalization;

(b) an individual: the greater of C$25,000 and 50% of the individual’s compensation from the company or the influential person and its affiliates for the 12 months preceding the violation; and

(c) an expert: the greater of C$1 million and the expert’s revenues from the company and its affiliates for the 12 months preceding the violation.

If a defendant has knowingly made incorrect or incomplete disclosure, proportionate liability and the foregoing limits may not apply and the defendant may be fully liable for the entire loss.

COMMENTS

Most actions are likely to be class actions. The procedural rules described above should discourage strike suits. Before January 1, 2006 (when the civil liability regime comes into effect), public companies should review and, if necessary, revise their existing public disclosure to deal with any possible disclosure deficiencies.

Public companies should develop (and review periodically) formal procedures for the public disclosure of company information, whether in public documents or public oral statements. They should also consider establishing a formal disclosure committee to review and approve all public disclosure of company information.

Conditional letters of intent in connection with M&A transactions involving public companies (particularly those that contain indicative pricing) are more likely to be disclosed (on the basis that failure to do so may constitute incomplete disclosure).

Significant shareholders of public companies may no longer wish to have their directors and officers serve as directors and officers of the company.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2005 McMillan Binch Mendelsohn LLP

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