Reprinted with Permission from the 2006 issue of the Lexpert/ALM Guide to the Leading 500 Lawyers in Canada. (c) Thomson Carswell.
The first three quarters of 2005 saw continued strong growth in the Canadian income fund market. However, in September 2005, the federal government released a discussion paper regarding the taxation of income funds and announced a moratorium on issuing advance tax rulings with respect to income funds and other flow-through vehicles. These events have had the effect of significantly curtailing both initial public offerings and follow-on offerings by income funds, as well as impacting the level of mergers and acquisitions activity by income funds, which typically issue additional units to finance an acquisition. Mergers and acquisitions activity outside of the income fund market has been brisk, with significant transactions such as Noranda’s recapitalization and combination with Falconbridge, Inco’s proposed acquisition of Falconbridge, TUI’s acquisition of CP Ships and Glaxosmithkline’s acquisition of ID Biomedical.
Recent developments of importance include the following:
Ontario Secondary Market Civil Liability
Amendments to the Securities Act (Ontario) in respect of liability for continuous disclosure came into force on December 31, 2005. These amendments created new causes of action for secondary market investors against a wide range of potential defendants with respect to misleading continuous disclosure filings and other documents, public oral statements and omitted material disclosure. They facilitate class-action lawsuits by investors who buy or sell securities of a public issuer that is a reporting issuer in Ontario or has a real and substantial connection to Ontario (a responsible issuer) during the period beginning when a misrepresentation about the issuer is made by persons associated with the issuer in public documents or orally, or when the issuer fails to make timely disclosure of a material change, and ending when the disclosure is corrected or made. The amendments significantly enlarge the personal risk faced by directors and officers.
These amendments increase the risk of class-action lawsuits based on securities violations that have become commonplace in the United States, although there are important points of difference between the new regime in Ontario and the law as it has developed in the United States. In an attempt to limit the volume of meritless strike litigation, the new regime requires that a plaintiff obtain leave of the court before bringing a lawsuit and that it convince the court that the suit is being brought in good faith and has a reasonable possibility of success.
New Rights to Sue for Misrepresentation and Omissions in Publicly Filed Documents and Misrepresentations in Oral Statements
The amendments created new private statutory civil rights of action enabling purchasers or sellers of securities who buy or sell securities during a period that an uncorrected misrepresentation is included in various categories of publicly filed documents or in an oral statement to sue to recover damages (a Misrepresentation Right of Action) against a range of defendants. The potential defendants include the issuer, each director of the issuer, each officer of the issuer who was involved in a decision to release the document and each "influential person" (such as a control person) related to the issuer who knowingly influenced the release of the document or statement. Of particular note for officers is that oral statements made in the course of analyst conference calls and/or scrums could engage liability. In cases where experts are associated with misleading documents or public oral statements, they too can face liability.
The amendments also created similar private rights of action where an issuer fails to disclose a material change that should have been disclosed under securities laws (a Nondisclosure Right of Action). The issuer, officers, directors or other influential persons who influenced or allowed the nondisclosure could all be held liable to a purchaser or seller who buys or sells the issuer’s securities during the period of nondisclosure. This aspect of the new regime represents a significant departure from the US civil liability environment. It recognizes the fact that under Canadian law there is a positive obligation to report material changes. Although 8K reportable events have been expanded in the US, the American regime with respect to timely disclosure still has significant differences from Canadian disclosure requirements.
The period of the misrepresentation for the purposes of the Misrepresentation Right of Action starts on the date that disclosure is made containing a misrepresentation. The period of nondisclosure for the purposes of the Nondisclosure Right of Action starts on the date that the issuer should have disclosed the material change. Both periods end when proper disclosure is made correcting the misrepresentation or omission.
Proof and Standard of Care
With respect to a misrepresentation in a document, the concept of "core document" is integral to the civil liability regime. Core documents engage potentially greater liability than non-core documents. With respect to directors, influential persons and certain other parties, core documents include the annual information form, an information circular, a takeover bid circular, management’s discussion and analysis, a prospectus and annual financial statements. The list of core documents is longer for a responsible issuer and its officers and also includes interim financial statements and material-change reports.
If a misrepresentation is contained in a core document, the plaintiff does not have to prove knowledge of the misrepresentations or negligence but only of the existence of the misrepresentation. To avoid liability, a defendant must demonstrate the exercise of an appropriate level of due diligence or investigation as to the accuracy of the document or statement. Where the misrepresentation is in an oral statement or a document other than a core document, the plaintiff must establish overt misconduct on the part of the defendant or prove that the defendant was aware of the misrepresentation or the failure to make timely disclosure in order to be successful in his or her damages claim.
The concept of deemed reliance has been included to make it easier to bring a class action in a securities-law context. For many years, deemed reliance has been a feature of the already existing statutory remedy for misrepresentations that are contained in a prospectus.
To the extent that a plaintiff is seeking monetary damages, the new legislation places limits on liability for damages for misrepresentation or failure to make timely disclosure. Specifically, the total liability of the responsible issuer or influential person (if the influential person is not an individual) may not exceed the greater of five per cent of its market capitalization and $1 million. The total liability of each director, officer and influential person (if the influential person is an individual) ordinarily may not exceed the greater of $25,000, and 50 per cent of the aggregate of that person’s total compensation from the responsible issuer and its affiliates during the 12-month period immediately preceding the day on which the misrepresentation was made or the failure to make timely disclosure occurred. In some cases there will be no limits on liability, such as where a director authorized, permitted or acquiesced in the making of a misrepresentation.
A safe harbour has been created for forward-looking information, including earnings guidance. Subject to certain exceptions, forward-looking information will not give rise to liability if the following three conditions are met: The forward-looking information, when given, is accompanied by cautionary language that the information is forward looking; the information includes an analysis of the material factors or assumptions that were used to arrive at the forward-looking statements; and the person making the forward-looking statement must also have had a reasonable basis for the conclusion drawn or projection or forecast given. The requirement to state significant assumptions to obtain the benefit of the safe harbor is a distinction between the Canadian and US rules.
Action Required by Issuers
In light of these potential new liabilities, issuers and their directors and officers should make sure everyone in their organization is aware of the new regime; review their disclosure practices and update their written policies to ensure that they are effective in producing timely, accurate public filings and that they allow the full range of potential defendants to defend themselves if they are joined in litigation; revamp processes that are in place to monitor the effectiveness of their disclosure system and practices by controlling the manner in which information, including forward-looking information, is disseminated and verified; and review and update their directors and officers protective measures.
Proposed Changes to US Securities Offerings Process
In July 2005, the US Securities Exchange Commission (the SEC) released a wide-ranging set of rules that are expected to have a significant impact on the US public offering process. The rules, which will become effective on December 1, 2005, will reform the registration, communication and public offering process under the Securities Act of 1933 by broadening the extent of communications permissible before and during an offering, liberalizing the rules governing shelf-registration statements, eliminating the need to physically deliver final prospectuses in most cases, changing the liability regime for material misstatements in prospectuses and requiring additional disclosures in periodic reports. The Canadian Securities Administrators (CSA) have not made any changes to securities laws in Canada in response to the changes to the US offering regime but have indicated that they will consider changes to Canada’s offering systems in response to the SEC’s new rules as appropriate. The CSA has indicated that it has confirmed with staff of the SEC that the new US rules will not adversely affect the Canada/US multi-jurisdictional disclosure system. However, we believe that these new rules will raise issues for Canadian issuers and underwriters that are involved in cross-border securities offerings and who wish to avail themselves of the SEC reforms, particularly those relating to permissible communications during the offering process. For example, written communications or road show presentations that are designed to take advantage of the more liberalized US regime may not be permissible in Canada, thereby complicating the offering process pending similar changes in Canada.
Changes to Short-Form Prospectus System
On December 30, 2005, the CSA replaced a package of instruments relating to the short-form prospectus offering system. The new instruments modify the qualification, disclosure and other requirements of the short-form prospectus system and permit more reporting issuers to use the short-form prospectus system by eliminating the minimum market capitalization requirement and the requirement that the issuer be a reporting issuer for a certain length of time before it can use the short-form prospectus system. The new instruments also eliminate duplication and inconsistencies between the short-form prospectus system and the recently adopted changes to the continuous disclosure regime in Canada, thereby better integrating the disclosure regimes for primary and secondary markets.
The new instruments also extend the period during which pre-marketing of a bought deal in Canada may occur prior to the filing of a preliminary prospectus, from two business days to up to four business days following the execution of an enforceable purchase agreement between the issuer and the underwriters. Similarly, that agreement must require the issuer to file and obtain a receipt for a preliminary short-form prospectus within four business days of entering into the agreement. Although this change will provide issuers and underwriters with more time in which to conduct due-diligence investigations and prepare the prospectus and other relevant offering materials, it may also extend the period in which a bought deal can be completed and the period during which underwriters are obligated to purchase securities under the offering.
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.