Beginning on December 31, 2005, the Ontario "Securities Act" began to impose civil liability for misrepresentations in secondary market disclosure, greatly expanding the liability of reporting issuers and their officers and directors for their communications with investors and potential investors.
It was recognized that this could cause issuers to severely restrict disclosures regarding the future, as such statements are inherently uncertain, due to the potential liability. The Supreme Court of Canada confirmed in Kerr v. Danier Leather Inc. that a forecast (and by implication other forward-looking information) can constitute a misrepresentation for which there is liability under the Act. "Forward-looking information" can be valuable information to the market and is important to informed investment decisions. In order to encourage issuers to continue to provide this information, a "safe harbour" defence from liability under the Act for forward looking information was created at the same time, provided that specific statutory requirements are met. it should be noted that actions based on fraud or negligent misstatement under tort law are not affected by the safe harbour.
The Ontario Securities Commission has recently issued a policy statement relating to this safe harbour defence. While the Policy may not have the force of law, it expresses the Commission's views on how issuers can meet the requirements of the safe harbour, which may be of some weight when an issuer seeks to rely on the defence in court.
A discussion of the safe harbour and the guidance from the OSC is set out below, followed by a discussion of practices that can be used to ensure that the safe harbour can be relied upon.
Forward-Looking Information And The Safe Harbour
What Is Forward Looking Information (FLI)?
Forward-looking information means disclosure:
- regarding possible events, conditions or results of operations
- that is based on assumptions about future economic conditions and courses of action and
FLI includes future oriented financial information with respect to prospective results of operations, financial position or cash flows that is presented either as a forecast or a projection.
The breadth of what constitutes FLI has not been considered in any Canadian jurisprudence to date, but given the policy rationale for the safe harbour, an expansive interpretation is not unwarranted. It would generally encompass "soft" information that is "predictive" of the future based on the assessments and beliefs of management.
What Is The Safe Harbour?
To rely on the safe harbour, an issuer must satisfy the following elements of the defence:
- cautionary language must appear "proximate" to the FLI disclosed by the issuer
- the disclosure must identify "material" factors that could cause future developments to differ from the expectations or projections in the FLI
- the disclosure must include a statement identifying the material assumptions that led to a the prediction, forecast or projection in the FLI, and
- an issuer must have a "reasonable basis" for the FLI
Public oral statements containing forward-looking information must also contain cautionary language that is similar to that which is required of disclosure documents. However, the Act takes a more flexible approach to oral statements, since in practice it would often be awkward to ensure full compliance in the delivery of public oral statements.
In this circumstance, the safe harbour requirements can be satisfied if (i) the person makes a cautionary statement that the oral statement contains forward-looking information; (ii) states that the actual results could differ materially and that certain material factors or assumptions were applied; and (iii) states that additional information about the material factors and assumptions is contained in a readily-available document or in a portion of such a document and identifies that document or that portion of the document.
It should be noted that issuers are currently required to essentially comply with the safe harbour in respect of material FLI pursuant to their general continuous disclosure obligations under National Instrument 51-102 ("NI 51-102").
However, the safe harbour does not operate to eliminate liability for FLI that is contained in:
- Financial statements filed under securities laws, or
- Any document released in connection with an IPO
What Clarifications Has The OSC Provided In The Policy?
1. The "Proximate" Requirement
The Policy acknowledges that the interpretation of the word "proximate" was subject to some uncertainty. In the Commission's view, "proximate" in this context does not require the immediate juxtaposition of information. In other words, an issuer is not required to identify each and every statement of forward-looking information and immediately specify each of the risk factors and assumptions applicable to the statement. Rather, a single broad reference identifying the applicable assumptions and risk factors will generally satisfy the "proximate" requirement of the defence.
The Policy also suggests that, as a general principle, the proximity of a risk factor or assumption to a particular forecast or projection depends on how closely-tied the former is to the latter. In other words, if the disclosure of risk factors is closely connected to a forward-looking statement, but does not appear immediately before or after the forward-looking statement, it is advisable for the issuer provide a cross-reference or footnote that connects the risk factor or assumption to the forecast or projection.
Of note, the OSC provided its view (in the notice of implementation of the Policy) that incorporation by reference of more lengthy discussions of risk factors and assumptions would, in appropriate circumstances, be permissible from a policy perspective.
2. Risk Factor Disclosure
The statutory defence for misrepresentations in FLI is not available to an issuer that fails to identify "material" factors that could cause future developments to differ from the expectations or projections identified in a disclosure document. The Policy indicates that these should be relevant and not boilerplate in nature.
However, the Policy states that this should not require an issuer to disclose every possible factor that could cause actual results to differ from anticipations. According to the Commission, the inclusion of the word "material" suggests that only significant and reasonably foreseeable factors that may cause results to differ from projections are required to be disclosed. Consequently, the failure to include a factor that in fact causes a forward-looking statement to be inaccurate should not necessarily mean that the defence is unavailable. So, while the business judgment rule may not longer be applicable in the context of an issuer's continuous disclosure obligations following the decision of the Supreme Court in Danier, the Commission recognizes that there will need to be a degree of judgment in identifying the material factors. How much judgment, if any, a court may permit remains to be seen.
3. Assumption Disclosure
The defence for misrepresentations in FLI requires an issuer to include a statement identifying the material assumptions that lead to a certain forecast or projection. The Policy states that the word "material" should be read to indicate that an issuer need not provide an exhaustive list of each and every factor or assumption; rather, an issuer is only required to disclose the assumptions that are relevant and material to the forecast or projection and that it in fact applied. Again, how much judgment, if any, a court may permit in selecting the assumptions remains to be seen. Arguably, the assessment of what is material in this case should be less subject to uncertainty as all assumptions should be known.
4. "Reasonable Basis"
The Policy states that the interpretation of this reasonableness standard will be guided by the following factors:
- the reasonableness of the assumptions applied in drawing a certain conclusion or making a certain forecast or projection; and
- the inquiries made and the process followed in preparing and reviewing the forward looking information.
The OSC has indicated in response to public comments that while the process used may be relevant to establishing a reasonable basis, it is not determinative.
The OSC is not of the view (stated in the notice of implementation of the Policy) that issuers must explicitly state that they have a reasonable basis for the FLI.
5. Oral Statements Containing Forward-Looking Information
Some market participants had questions regarding whether each person making oral statements needs to reiterate the required cautionary statements. According to the Policy, the Commission supports a pragmatic interpretation of the Act, allowing, for instance, one person to issue the required cautionary statements on behalf of another speaker who makes a forward-looking statement, in appropriate circumstances.
6. Duty to Update
There is a duty to update FLI imposed under NI 51-102. The Commission has stated that it does not believe that the safe harbour requires issuers to update their FLI. The lack of a duty to update is explicit in the safe harbour provisions of US securities legislation.
Best Practices For FLI
As noted above, FLI, other than that required by MD&A, generally does not need to be disclosed. In addition, the content of FLI does not exist separate and apart from the opinions and personal views of management and directors of a reporting issuer (based to a greater or lesser extent on existing facts). Internal controls and disclosure controls and procedures should not (and likely could not), therefore, be relied upon to identify FLI or ensure that the prerequisites to the safe harbour are met. A simple framework consisting of identification, assessment and monitoring can help issuers comply with NI 51-102 and limit their exposure to secondary market liability.
A cursory survey of the ways in which issuers identify their FLI makes clear that many issuers are not meeting the requirements for the safe harbour (assuming the disclosure contains FLI) and that there is much room for improvement. The mandatory requirements of NI 51-102 make this a more important disclosure issue. Issuers will often use one of the following methods in their written disclosure:
- references to lists of words that refer to the future in some manner such as "believe," "estimate," "anticipate," "plan," "predict," "may," "hope," "can," "will," "should," "expect," "intend," "is designed to," "with the intent," "potential," the negative of these words or such other variations thereon or comparable terminology
- statements indicating that the disclosure may or does contain FLI without any specific identification other than to possibly exclude statements of historical fact
- references to the FLI with some level of specificity to the FLI
Also noteworthy is that many issuers have adopted a US style approach to FLI, even to the extent of using the US phrase when referring to FLI (i.e., "forward-looking statements").
While the Policy does not take the position that each statement must be identified, using the above approaches clearly does not comply with the safe harbour or NI 51-102. Jurisprudence in the US suggests that boilerplate disclosure and/or disclosure that does not change over time are likely not sufficient to rely on the US equivalent to the safe harbour.
Although the list of words used in boilerplate FLI disclaimers may not, as discussed above, be sufficient to permit an issuer to avail itself of the safe harbour, such words can be important for identification purposes in determining whether an issuer is meeting its obligations under NI 51-102 and satisfying the prerequisites to the safe harbour. Much FLI will be obvious in that it explicitly refers to a future time period. However, there may be cases where this is not as obvious and looking for words such as these that imply a future orientation may readily identify potential instances of FLI.
The disclaimer that many issuers use often implies that FLI is contained in the disclosure, identifiable by the words or by not being a statement of historical fact. The work is often left to the reader. Issuers must clearly identify their FLI, not just because they are required to do so, but because it would be impossible to meet the defence without consideration of each such statement whether the rest of the prerequisites have been met for that statement.
Once FLI has been identified, the first question is whether the FLI is material. If it is not, then the statement will not be subject to NI 51-102 and, if the statement is not true, it should not constitute an actionable misrepresentation. Unfortunately, while this assessment involves the exercise of judgment, that judgment, no matter how reasonable, will not shield a wrong decision on the part of management. Questions of disclosure are not shielded by the business judgment rule that applies to most other decisions made by issuers. A conservative approach to materiality when assessing FLI is recommended.
If the FLI is material, then issuers need to determine:
- Who is responsible for the inclusion of the FLI in the
- Confirm that the responsible person had a reasonable basis for the content of the FLI
- If it is not clear that the there was a reasonable basis, the FLI should be removed from the disclosure
- Other circumstances may warrant modifications to the FLI
- If it is not certain who the responsible person is, the content
should be assessed by an appropriate member of management to
determine whether the FLI can or should be retained for the
disclosure in question
- Whether or not the components of the safe harbour discussed
above are included in the disclosure
- If one or more components is present, the content should be confirmed as being complete and accurate with or through the responsible person
- If one or more components is not present, the responsible
person should provide, or arrange to have provided, the required
content to be included in the disclosure
- Whether the risk factor disclosure can reasonably be regarded as those material factors that could cause the FLI to be false
- Whether the factors and assumptions underlying the FLI are in fact those that are most material and relevant to the factors and assumptions applied to generate the FLI in question
Monitoring And On-Going Assessment
While there is no requirement to update FLI to take advantage of the safe harbour, an issuer's FLI should be monitored on an ongoing basis to determine which FLI can be considered "current" for the following reasons:
- As a matter of good disclosure practice:
- to ensure that statements that are obviously not going to be true can be superseded or "retracted" through subsequent disclosure
- to be able to better assess the risks involved in the issuers
business generally and in the types of FLI disclosed by the issuer
specifically, with the hope that FLI can become more accurate or at
least better explained and disclaimed
- To comply with the requirements in NI 51-102 to provide updates for FLI in the issuer's MD&A
To accomplish this, a "log" of FLI that an issuer releases, which would contain the content, the safe harbour components and the responsible person, may be helpful to establish a risk management process to supplement disclosure controls and procedures, to track statements that could be the source of liability and to assist in the required updating in MD&A.
In addition, directors and officers of issuers can avoid liability if, after becoming aware of a misrepresentation, they take certain steps, including notice to the board of directors. This can be helpful as another defence if the safe harbour cannot be relied on.
It should be noted that while there has been a similar safe harbour under US securities laws for over 10 years, the practice there may not be entirely useful in guiding issuers in Canada. There are three key differences:
- The US safe harbour does not require the disclosure of the material factors and assumptions underlying the FLI, making the disclosure different.
- There is no liability in the US if the plaintiff cannot prove that the FLI was made without knowledge that it was false or misleading, which provides an additional avenue to avoiding liability other than technical compliance with the safe harbour.
- There is no duty to update in the US. In Canada, for secondary market liability purposes, there is similarly no duty to update, but NI 51-102 does impose a duty to update, generally in the issuer's MD&A.
In the notice of implementation of the Policy, the OSC indicated that issuers will need to assess the regimes in both countries (if reporting in both countries) and should not expect that compliance with the US will be sufficient for purposes of the Act.
Simon Flood, an associate with Cassels Brock, assisted in the preparation of this article.
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.