Originally published August 2008
On July 8, 2008, new laws came into force in British Columbia that give investors the right to sue public companies, their directors and officers, and certain others when there is misleading information in a publicly disclosed document or a public oral statement, or when there is a failure to make timely disclosure of material changes in the affairs of a company. These new laws harmonize the law in British Columbia with laws already in force in all of the other provinces of Canada. Those associated with public companies should ensure proper measures are taken to protect their company and themselves from these laws.
Investors have long had the right to sue companies and associated individuals for misrepresentations in a prospectus, offering memorandum or take-over bid circular. As a result of the new laws, investors who buy and sell securities of a public company through a stock exchange or other secondary market will now be provided a similar right to sue for misrepresentations in a company's public disclosures. These rights will apply in respect of public companies that are a "reporting issuer" in British Columbia, or other public companies with a real and substantial connection to British Columbia. Similar laws were first introduced in Ontario in 2002. All of the other provinces of Canada have since also introduced similar laws.
While the new laws enable individual investors to sue, so far the only lawsuits that have been commenced in those provinces where similar laws have come into effect are proposed class actions.
What You Can Be Sued For
The new laws create three ways for investors to sue:
Where Documents Released by a Company Contain a Misrepresentation – From the time that a company publicly releases a document that contains a misrepresentation, an investor who trades in the company's securities before the misrepresentation is corrected will have the right to sue. Those at risk of being sued include the company, directors, and officers, influential persons (an insider, a controlling shareholder or a promoter) and experts involved in the release of the document. A "document" includes documents filed with the British Columbia Securities Commission, a stock exchange or a government agency, or any other written communication which could reasonably be expected to affect the market price or value of the securities of the company. A "document" can include postings to a company's website.
Where Public Oral Statements Contain a Misrepresentation – If a person who speaks on behalf of a company makes a public oral statement about the company that contains a misrepresentation, then any investor who traded the company's securities in the period before the misrepresentation was corrected has the right to sue. The company, the person who made the public statement (e.g. investor relations personnel), and directors, officers, influential persons and experts who were involved in the making of the statement are all at risk of being sued. Public oral statements can include statements made at a shareholders' meeting or on an analyst call.
Failure to Make Timely Disclosure of a Material Change – Where a company fails to make timely disclosure of material changes in its affairs, any investor who trades in the company's securities before the change is disclosed has the right to sue. The company, and directors, officers and influential persons who were involved in the failure to disclose may be sued.
An investor does not have to establish that they relied upon the misrepresentation or failure to make timely disclosure.
How Much You Can Be Sued For
The amount an investor is entitled to in a successful lawsuit is based upon the effect the disclosure violation had on the market price for the security. However, no amount will be included to the extent that a defendant proves the change in the market price is unrelated to the disclosure violation.
Where multiple defendants are held liable in a lawsuit, each defendant is liable only in proportion to its relative responsibility. However, defendants (other than the company) who authorized, permitted or acquiesced in the disclosure violation may be liable for the full amount of the lawsuit, jointly and severally. A defendant's liability is also subject to certain limits:
Company – liability may not exceed the greater of $1 million and 5% of its market capitalization.
Individual – liability is limited to the greater of $25,000 and 50% of his or her total compensation from the company and its affiliates during the preceding 12 months (including the value of any options, pension benefits and stock appreciation rights granted during that period).
Expert - liability is limited to the greater of $1 million and the fees earned by the expert from the company and its affiliates during the preceding 12 months.
These limits do not apply to a defendant (other than the company) that authorized, permitted or acquiesced in the disclosure violation, while knowing that it was a disclosure violation.
What Defences You Have If Sued
Defendants will have several defences to a lawsuit, including:
Reasonable Investigation Defence – Defendants will not be liable if they prove that they:
- conducted or caused to be conducted a "reasonable
- had no reasonable grounds to believe that the document or
oral public statement contained a misrepresentation, or that
timely disclosure would not be made.
In determining whether an investigation was reasonable, the court must consider certain factors, including the existence of a system designed to ensure the company meets its continuous disclosure obligations and the reasonableness of the reliance by a defendant on that disclosure compliance system. A written disclosure policy will be essential for a company to rely on this defence.
Where Corrective Action Taken – A defendant (other than the company) is not liable if the disclosure violation was made without the knowledge or consent of the defendant, and if after the defendant became aware of the disclosure violation, the defendant notified the board of directors of the company of the disclosure violation. If no correction is made by the company within two business days, the defendant must notify the British Columbia Securities Commission of the disclosure violation.
Forward Looking Information - There will be no liability for a misrepresentation in forward-looking information if:
- it contains reasonable cautionary language identifying
the forward looking information;
- it identifies the material factors that could cause
actual results to differ materially from the forecast or
- it states the material factors or assumptions that were
applied in making the forecast or " projection;
- there is a reasonable basis for making the forecast or
Reasonable Reliance on Experts - There is no liability for non-experts for any document that includes, summarizes or quotes from a report, statement or opinion made by an expert who gave consent to the use of it, provided the defendant did not know, and had no reasonable grounds to believe, that there had been a misrepresentation made on the authority of the expert, and the report, statement or opinion made by the expert is fairly represented.
In the United States, there has been a history of class actions being brought against public companies in the hope that the companies will agree to an early settlement. These "strike suits" are often initiated immediately following any sudden drop in the trading price of a company's securities.
The new laws contain procedural safeguards designed to prevent strike suits. First, leave to proceed must be obtained from the court in order to commence a lawsuit. The court will only grant leave if it is satisfied that the action is being brought in good faith, and there is a reasonable possibility that the plaintiff will succeed at trial. Second, court approval is required before a lawsuit can be discontinued, abandoned or settled.
The new laws include a "loser pays" costs rule, which is also designed to discourage the bringing of strike suits. The new laws provide that the prevailing party in any lawsuit is entitled to costs, and the court must order costs against the losing party in any lawsuit (including any class action). In the United States, the losing party in a class action is generally not required to pay the costs of the successful party.
What You Should Do About These Changes
Directors and officers of public companies will want to review their company's disclosure practices to minimize their exposure under these new laws, including:
- Ensure that your company has a formal, written
disclosure policy. At a minimum, this policy should
state who is authorized to make public statements on behalf
of the company, and establish a system of review and approval
for documents that are released to the public. This policy
may also clarify the process that the company uses to ensure
public oral statements are not made by company
representatives without prior vetting, or without subsequent
review to ensure an absence of misrepresentations.
- Educate those who decide when material changes
will be disclosed of the new risks. Those
individuals who decide when material changes in the affairs
of a company will be disclosed will now be at risk of being
personally liable if they do not disclose material changes on
a timely basis. These individuals should understand what
constitutes a "material change", as well as when
and how that change should be disclosed.
- Correct disclosure violations promptly.
When a disclosure violation is discovered, immediate steps
should be taken to correct the error. Only investors who
trade the company's securities while the disclosure
violation exists are allowed to sue under the new laws, so
prompt corrective action will minimize the number of
potential investors who can sue.
- Plan and Record Public Presentations and Oral
Statements. Public presentations and oral statements
by people who speak on behalf of the company, including
directors and officers, should be carefully planned and
scripted. It is important to make and retain records of
public presentations and oral statements. Those responsible
for corporate disclosure should review these records
immediately after the public presentation or statement to
identify and correct any misrepresentations.
- Review Director & Officer Insurance
Coverage. Review your director and officer insurance
coverage to ensure it covers liability for these types of
claims and that the coverage is adequate.
About Trevor Scott
Trevor Scott is a solicitor at Farris and provides strategic and legal advice in diverse business areas. He has extensive experience in debt and equity financings for public and private companies, representing both issuers and investment banks. He also regularly advises on business acquisitions, divestments and take-over bids, including compliance issues with the Competition Act and assisting foreign investors with Investment Canada Act matters. Trevor also advises on corporate governance matters.
If you wish to discuss any aspect of this commentary, please contact Trevor Scott or any member of Farris' Securities Practice Group.
© 2008 Farris, Vaughan, Wills & Murphy LLP
This summary is necessarily of a general nature and should not be construed as the giving of legal advice. You are urged to seek legal advice on areas of specific interest or concern.