The new Part XXIII.1 of the Ontario Securities Act (Act), which provides a statutory right of action against reporting issuers, their officers and directors, and other related parties for misrepresentations in secondary market disclosures, came into force on December 31, 2005. Since that time, numerous secondary market misrepresentation claims have been initiated in the Province. However, before a plaintiff may proceed with a claim under Part XXIII.1, he or she must first obtain leave of the court. Until now, no court had determined the issue of leave.
On December 14, 2009, Justice Van Rensburg's much anticipated decision with respect to the leave application in Silver v. IMAX was released. She determined that leave should be granted. Justice Van Rensburg also released companion reasons certifying a class action based on common law and statutory claims on behalf of a global class of IMAX investors.
As the first judicial interpretation of the test for leave and the first certification of a class advancing the new statutory cause of action, both decisions are groundbreaking and likely to arouse controversy. Justice Van Rensburg's interpretation of the test for leave suggests that it may not present a serious hurdle to plaintiffs seeking to bring a claim based on secondary market misrepresentations. Indeed, this first decision on the issue has set the bar quite low.
Similarly, the certification of a worldwide class of investors may make Ontario a jurisdiction of choice for future securities class action claims, even when a significant proportion of investors reside outside of the province or even outside of Canada. Although it is anticipated that appellate courts will weigh in on several aspects of the leave and certification decisions, we can expect the increase in securities class action litigation that was sparked by the enactment of Part XXIII.1 of the Act to continue.
Misrepresentations Alleged and Defences Raised
The proposed representative plaintiffs are Ontario residents who purchased IMAX shares over the TSX just days before the company issued a press release announcing that it was responding to an informal SEC inquiry regarding the timing of its revenue recognition. Following the press release, the value of IMAX shares dropped 40%.
The plaintiffs allege that IMAX and certain of its officers and directors improperly recognized revenue for sales and leases of IMAX theatre systems and thereby misrepresented the true state of the company's revenues in its 2005 annual financial results and certain press releases. Key evidence relied on by the plaintiffs in support of their claim was the fact that in 2007, IMAX restated its financial results for several years, including 2005, and subsequently acknowledged that there had been an error in revenue recognition.
The defendants rely on the "reasonable investigation" defence available under Part XXIII.1 of the Act. They assert that they conducted a reasonable investigation into IMAX's revenue recognition policies and practices. They also assert that they reasonably relied on the advice of IMAX's auditors about the company's recognition of revenue associated with sales and leases of IMAX theatre systems in its 2005 financial results.
The Leave Decision
Justice Van Rensburg granted leave for the plaintiffs' statutory claims to proceed against IMAX and all of the individual respondents, except two outside directors. In granting leave for the significant majority of the plaintiffs' claims, Justice Van Rensburg interpreted and applied the two elements of the statutory test for leave: (1) that the action is brought in good faith; and (2) that the plaintiffs have a reasonable possibility of success at trial. She set a low threshold for both elements.
To satisfy the good faith element of the test, Justice Van Rensburg stated that plaintiffs must establish
She found affidavit evidence that the plaintiffs had a personal financial interest in the outcome of the proceedings and that they had altruistic reasons for commencing the action (such as holding the respondents accountable for misrepresentations to the public and "sending a message" to other directors and officers) to be sufficient evidence of their good faith.
Justice Van Rensburg indicated that, in the absence of any prior interpretation of the leave test, her analysis would be informed by reference to the somewhat analogous leave requirement that must be met before a derivative action may be brought. However, she rejected the respondents' arguments that the "good faith" element of the leave test under Part XXIII.1 of the Act should be as high a threshold as it must in the derivative action context.
Justice Van Rensburg also found that the second branch of the leave test – whether the plaintiffs' claim has a reasonable possibility of success at trial – required a preliminary analysis of the merits of the case. In conducting this analysis, she determined that the court is required to evaluate and weigh the evidence at hand but that it must be mindful of the limitations of the application process.
She held that to satisfy the second branch of the test for leave, plaintiffs must "put forward the evidence they rely on as to the misrepresentation, and the extent of knowledge or participation required for non-core documents and liability for officers." In response, the respondents are permitted to adduce evidence of the statutory defences available to them under Part XXIII.1 of the Act.
While she commented on the evidence that the parties are required or permitted to adduce on the leave motion, Justice Van Rensburg did not articulate the evidentiary threshold that the plaintiffs are required to meet to show a reasonable possibility of success at trial. One may infer from the evidence to which she referred in support of her conclusion, however, that the evidentiary threshold for the second branch of the leave test is quite low. For example, Justice Van Rensburg concluded that there was sufficient evidence to support a finding that there was a material misrepresentation in the company's annual filings and associated press releases based on the facts that the company had subsequently restated its financial statements and acknowledged that the original statements had not been compliant with GAAP. With regard to the director defendants, no further evidence was cited as a basis for the conclusion that there was a reasonable possibility that the statutory claims would be successful at trial (subject to any statutory defence they might advance).
With regard to the officer respondents (against whom there must be proof that they permitted, authorized or acquiesced in the release of the statement containing the misrepresentation), their roles as CFO and VP Finance, their involvement in the company's year-end accounting process, and the fact that they signed certain disclosures at issue, were found to constitute sufficient evidence to justify granting leave to pursue statutory claims against them.
In contrast to the low threshold which plaintiffs have to meet in order to show a reasonable possibility of success at trial at the leave stage, Justice Van Rensburg determined that, in order to defeat a leave motion, the respondents must meet a much higher evidentiary threshold. The court must "be satisfied that the evidence in support of such a defence at the preliminary merits stage will foreclose the plaintiffs' reasonable possibility of success at trial". Although all defendants put forward evidence of their reasonable investigation, only two outside directors who were not on the audit committee and who had a limited role in respect of the company's financial reporting succeeded in establishing that there was no reasonable possibility of success against them at trial.
The Certification Decision
Justice Van Rensburg certified a class action based on common law claims of negligent misrepresentation, fraudulent misrepresentation and conspiracy as well as the statutory cause of action pursuant to Part XXIII.1 of the Act on behalf of a global class of IMAX investors. Two aspects of the certification decision are almost certain to prove controversial.
First, Justice Van Rensburg concluded that the plaintiffs' common law claims of negligent and fraudulent misrepresentation raised common issues that were suitable for certification. She accepted that the reliance element of these torts had been satisfied by the plaintiffs' pleading that all class members relied on the misrepresentations and other misstatements "by the act of purchasing IMAX securities" based on an "efficient market theory." This aspect of the decision is likely to attract criticism because it does not follow authorities which hold that common law claims for negligent and fraudulent misrepresentation are inappropriate for certification.
Ontario courts have consistently held that individual investors asserting such claims must demonstrate that they relied on the representations and the issue of reliance requires individual determination. In most instances, the need to conduct individual hearings on the issue of reliance will make a class proceeding unmanageable. Indeed, many would argue that Part XXIII.1 of the Act was enacted precisely because of the practically insurmountable hurdle that the common law presents for the certification of misrepresentation claims. In other words, if common law claims for misrepresentation could be certified so easily, it would have been unnecessary for the Legislature to have enacted Part XXIII.1. Likewise, it would be unnecessary for investors to resort to it.
Second, Justice Van Rensburg certified a global class of IMAX investors. She acknowledged that global classes are unusual in Canadian law, noting that there are no reported Ontario appellate court decisions reviewing the certification of a global class. Nevertheless, she found that a global class should be certified on the basis that the conduct of the defendants had a real and substantial connection to Ontario. Amongst other connections to the Province, IMAX is a reporting issuer under the Ontario Securities Act whose shares trade on the TSX. Justice Van Rensburg concluded that the consideration of potential conflict of law issues raised by a global class, such as whether or not including the claims of foreign class members would have to be determined on the basis of foreign laws, was premature until the defendants plead the laws of other jurisdictions in their statement of defence.
Significance of the Decisions
While they are only the first of many decisions we can expect from Ontario courts (including our Courts of Appeal) interpreting the provisions of Part XXIII.1 of the Act, the decisions of Justice Van Rensburg in Silver v. IMAX may be expected to encourage the commencement of more securities class action litigation in the Province. In light of the low bar that has been set for the leave test, we can expect to see an increase in the number of actions filed pursuant to Part XXIII.1 of the Act. The certification of a global class of investors will no doubt add fuel to the fire. Interesting conflicts of laws issues will most certainly be raised in litigation to come when parallel proceedings on behalf of overlapping global classes in both Canada and the United States reach the resolution and enforcement stages.
Catherine Weiler is an associate in the Litigation Department in the firm's Toronto office. Andrea Laing is a partner in the Litigation Department of the firm's Toronto Office.
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