What happens when a prospectus forecast is not met? The Ontario Court of Appeal recently provided some guidance to public company directors and officers on this issue in a case where the prospectus forecast was actually achieved in the end (Kerr v. Danier Leather Inc.).
SHAREHOLDERS’ ACTION FOR MISREPRESENTATION
Financial forecasts were included with a company’s final prospectus prior to its initial public offering (IPO). At the time the final prospectus was issued, the company had the financial results for the first 3 quarters of the year and a forecast of results for the fourth quarter. Between the time the prospectus was issued and the closing of the IPO two weeks later, sales were slower than expected. The company’s CEO and CFO were aware of the slowdown but believed that if the company took aggressive measures, the forecasted sales might still be achieved. No steps were taken to issue a public statement about the slowdown or to correct the prospectus. Shortly after the IPO, the company revised its fourth quarter forecast downward and issued a press release. The share price dropped. Shareholders brought a class action suit in response, alleging that the prospectus contained a material misrepresentation. They pointed to the drop in share price as proof that the diminished sales forecast was material to the market.
The company’s executives truly believed the sales forecast could be achieved at the time of the IPO and, in fact, by the end of the fourth quarter, the company was able to substantially achieve the forecasted sales. Furthermore, the prospectus contained all the standard cautions that the forecast could prove to be inaccurate.
The trial court found in favour of the shareholders. The Court of Appeal overturned the trial decision. It found:
- The Securities Act only requires prospectus amendments for "material changes". The trial judge erred when he read the prospectus as though it was signed on the date of closing instead of on the date of receipt.
- In most cases a prospectus forecast can be taken to contain implied representations that it represents management’s best judgment, that it was prepared using reasonable care and skill, and that management believed it to be reasonable. In this case, there was no implied representation that the forecast was objectively reasonable.
- Some deference should be made to senior management’s business judgment. Their honest belief that the forecast could be achieved was within the range of reasonable alternative opinions open to business people in their position.
SOUND BUSINESS JUDGMENT
Experienced business executives can take some comfort in providing prospectus forecasts. However, the fact that the forecast was substantially achieved was an important consideration in this case, giving weight to the claim that sound business judgment had been used. But what about a case where the forecast is not substantially achieved? The Court of Appeal has left the door open to shareholder class actions in such circumstances.
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