The first decision on the leave requirement for a statutory misrepresentation claim under Ontario's statutory secondary market liability regime1 was released in December 2009, together with the companion decision on the certification of that proceeding as a class action. In the decisions in Silver v. IMAX Corporation,2 the court has established a framework that will make it relatively easy for shareholders to pursue class actions against public companies for misrepresentations in their disclosure, through the Securities Act regime or through the certification of common law misrepresentation claims.
Background to the IMAX Decisions
The IMAX case involved alleged misrepresentations made by IMAX in press releases about its 2005 fourth quarter and year-end financial results, and in its 2005 year-end financial statements. The alleged misrepresentations relate to IMAX's reported revenues for 2005, compliance with accounting standards in recording and reporting those revenues, and the number of theatre systems installed by the company. The alleged misrepresentations relate specifically to when the company recognized the revenue from theatre installations. The company was eventually required to restate its 2005 results, and the audit opinion that had been provided by the company's auditors was withdrawn.
The plaintiffs in IMAX sued the company and a number of its officers and directors in a proposed class action, seeking leave to proceed with the claim under the Securities Act regime, and asserting common law misrepresentation claims in respect of IMAX's financial disclosure. The motions for leave to pursue the claim under the Securities Act regime and for certification of the action as a class action were argued together in December 2008, and the court's decisions were released one year later.
The court granted leave to the plaintiffs and in its leave decision established a relatively low threshold for leave to pursue a claim under the Securities Act regime. The low threshold reflects a primarily compensatory approach to the Securities Act regime rather than the primarily deterrence approach intended to encourage better continuous disclosure. The Court also certified common law misrepresentation claims relating to the company's continuous disclosure, making it easier for plaintiffs to pursue securities class actions based on common law claims. If the certification decision in IMAX is upheld on appeal, or followed by another court, it may have the effect of rendering the Securities Act regime superfluous, and expanding the scope of securities class actions.
The Leave Decision
In order for leave to be granted to proceed with claims under the Securities Act regime, a proposed action must be brought in good faith, and must also satisfy a merits test in that there must be a reasonable possibility of success for the plaintiff. The leave requirement is set out in s. 138.8(1) of the Securities Act:
No proceeding may be commenced under section 138.3 without leave of the court granted upon motion to each defendant. The court shall grant leave only where it is satisfied that,
- the action is being brought in good faith; and
- there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.
The Securities Act regime was implemented following studies, consultation and recommendations that Ontario securities law create statutory civil liability for continuous disclosure misrepresentations that were similar to the civil liability that already existed for misrepresentations in a prospectus or other offering document.3 The leave requirement was included in the Securities Act regime as a balancing measure as part of the expansion of civil liability. The regime includes measures that assist plaintiffs, and measures that provide balance for the benefit of defendants. The regime includes, for example, a provision that deems reliance on a misrepresentation which, as discussed in the next section of this article, was intended to facilitate class actions – to allow class action plaintiffs to overcome obstacles that prevented common law misrepresentation claims relating to continuous disclosure from being certified as class actions. In addition, defendants can be held liable for a misrepresentation on a negligence standard, as opposed to the more stringent fraud standard required in the parallel U.S. statutory regime. To provide protection to defendants against unmeritorious claims, the Securities Act regime included the leave requirement, and measures such as a cap on the damages payable by defendants where a misrepresentation is the result of negligence.
The rationale for implementing a secondary market civil liability regime was to improve the quality of continuous disclosure, in furtherance of the twin goals of the Securities Act: promoting investor protection, and fostering fair and efficient capital markets and confidence in capital markets.4 Discussing the rationale for their 1998 proposal for a secondary market civil liability regime (the proposal that formed the basis for the Securities Act regime), the Canadian Securities Administrators noted that:
The quality of continuous disclosure can and should be improved. Institutional investors have characterized the quality of continuous disclosure in Canada as inadequate and inferior to that of the United States. As most trading now takes place in the secondary market in reliance upon continuous disclosure documents, it is important to proceed with civil remedies for investors in the secondary market.5
The introduction of the Securities Act regime as a whole, including the carefully crafted balancing measures described above, was intended primarily to achieve a deterrence rather than a compensatory objective – that is, primarily to encourage better continuous disclosure.6
The leave requirement in s. 138.8(1) of the Securities Act was criticized by the plaintiffs' bar as presenting an unnecessary obstacle to the commencement of class actions, and it was suggested that the leave requirement could prevent meritorious claims from proceeding.7 The decision in IMAX on the leave requirement will may be comforting to those who were concerned that it would inhibit class actions from being commenced or from proceeding beyond the leave stage. The court in IMAX concluded that to succeed at the leave stage of a case and show that there is a reasonable possibility of success at trial, a plaintiff needs to show only that there is something more than a de minimis possibility of success at trial. The court describes this as a "relatively low threshold".8 The low threshold established by the court is surprising in light of the source of the leave requirement.
In its proposal for a secondary market civil liability regime, the Canadian Securities Administrators stated that its leave requirement was based on the Ontario Law Reform Commission's 1982 Report on Class Actions,9 which included a preliminary merits test as part of its proposed class action certification procedure similar to the leave requirement under the Securities Act regime.10 The Ontario Law Reform Commission report included a detailed discussion of the reasonable possibility of success standard, including an explanation of where that standard lies on the spectrum of available merits tests. The reasonable possibility of success standard proposed by the Ontario Law Reform Commission lies between a prima facie case and a triable issue: a plaintiff must show more than the existence of a triable issue but need not show that she has a prima facie case.11 The reasonable possibility of success standard adopted by the Canadian Securities Administrators in their proposal for statutory civil liability for continuous disclosure misrepresentations requires that a plaintiff show more than just the need for a trial to resolve a genuine issue – that is, she must do more than the equivalent of meeting the burden to defeat a summary judgment motion – however, there is no need for a plaintiff to prove her case with certainty or to show a high degree of probability of success.
The court in IMAX reviewed this background to the leave requirement in the Securities Act regime, but concluded that the test to be applied was not a demanding one. Rather than taking guidance from the source of the leave requirement, which suggests a test more demanding than a de minimis possibility of success, the court reasoned as follows to conclude that the test imposed only a relatively low threshold:
A "possibility" is something that is possible. "Possible" has been defined as "capable of existing, happening or being achieved" and "that may exist or happen, but that is not certain or probable". Unlike a "probable" event, a possible event does not have to be more likely than not to occur, and may in fact be unlikely or improbable. If one were dealing only with the plaintiff's possibility of success at trial, one would ask whether the plaintiff "may" or "could" be successful. That is, is there evidence that, if believed, would support the plaintiff's action?
The word "possibility" in s. 138.8 is modified by the adjective "reasonable". ...
... "Reasonable" is used instead of "mere" to denote that there must be something more than a de minimis possibility or chance that the plaintiff will succeed at trial. The adjective "reasonable" also reminds the court that the conclusion that a plaintiff has a reasonable possibility of success at trial must be based on a reasoned consideration of the evidence.12
While the court in IMAX refers to the fact that the Securities Act regime was intended primarily to deter poor disclosure and only secondarily to provide compensation, the relatively low threshold the court has established to satisfy the leave requirement reflects a primarily compensatory approach.
In setting out the leave test in IMAX, the court has also provided additional guidance on the role of the due diligence defence and the treatment of officer and director defendants. This guidance also makes the leave test easier for plaintiffs to satisfy. The Securities Act regime provides a defence to a misrepresentation claim if the defendant can show that in making the misrepresentation in question, it exercised due diligence. At the leave stage of the proceeding, a defendant resisting leave on the basis of this defence must show that the evidence of due diligence precludes the possibility of the plaintiff succeeding at trial. This is a heavy onus for the defendant to meet. In connection with the due diligence defence, the court also rejected the argument that business judgment deference should apply to the court's assessment of the reasonableness of the defendant's due diligence efforts. The other principle protection for defendants in the Securities Act regime is the damages cap that limits recovery in the case of a negligent misrepresentation, but does not apply to an individual who was involved in disclosure decisions and knew about a misrepresentation. The court in IMAX held that it was not appropriate to consider at the leave stage of the proceeding whether there is a reasonable possibility the plaintiff will succeed in showing a knowing misrepresentation on the part of an individual defendant. If leave is granted to proceed against an individual, there will always be a risk that damages awarded at trial will not be capped.
Certification of Common Law Misrepresentation Claims
The Court in IMAX certified the plaintiffs' claims based on the Securities Act regime, and also certified the common law misrepresentation claims. The certification of the common law claims conflicts with other class action decisions addressing the certification of misrepresentation claims, and if the decision is not reversed on appeal it could render the Securities Act regime superfluous and expand the scope of securities class actions.
Exposure to secondary market civil liability has always been a possibility for public companies and others. Common law causes of action for misrepresentations or failures to make timely disclosure have always been available to investors, as long as they were able to prove all the elements of a misrepresentation claim. What has not been available to investors in Ontario, or at least not easily available, are class actions based on secondary market misrepresentations, or failures by issuers to make timely disclosure. A successful claim in common law fraud or negligent misrepresentation requires proof of actual reliance by investors on the alleged misrepresentation. The reliance element of those common law claims creates a challenge to certify a lawsuit as a class action as it gives rise to individual issues – namely, proof of reliance by each investor in a proposed class on the alleged misrepresentation.13
Prior to IMAX, courts had refused to certify common law misrepresentation claims because of the need to prove reliance by each class member, thereby making these claims unsuitable for the class action procedure.14 The courts in Ontario rejected attempts to introduce into common law misrepresentation claims a "fraud on the market" theory of liability from securities class actions brought under U.S. securities statutes:
The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the company and its business... Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements... The causal connection between the plaintiffs' purchase of stock in such a case is no less significant than in the case of direct reliance on misrepresentations.15
The fraud on the market theory eliminates the need for proof of individual reliance, facilitating the certification of class actions.
The impetus for the creation of the Securities Act regime was to address the difficulty that plaintiffs had in pursuing common law misrepresentation claims. In proposing the model for the Securities Act regime, the Canadian Securities Administrators noted that secondary market investors had no effective redress through private rights of action.16 An earlier report by the Toronto Stock Exchange Committee on Corporate Disclosure noted that the remedies that had been available to investors who are injured by misleading disclosure were so difficult to pursue and establish, that they were as a practical matter largely academic.17 Amendments to the Securities Act were required to provide an effective remedy in respect of secondary market misrepresentations, through a statutory cause of action that included deemed reliance and facilitated class actions:
... it usually would not be worthwhile to pursue a class action under civil liability for a misrepresentation absent a provision in the legislation similar to the provision found in provincial securities legislation for a misrepresentation in a prospectus, which deems the plaintiff to have relied on the misrepresentation in the prospectus.18
The courts in Ontario before the IMAX decisions had also recognized the problem that the implementation of the Securities Act regime was intended to remedy. In approving a settlement in Lawrence v. Atlas Cold Storage Holdings Ltd., the court noted that:
Shareholder class actions are not common in Ontario. The reason often given is that the "fraud on the market" theory has been rejected as a matter of Canadian law ... As most trading occurs in the secondary market, the requirement to prove reliance has proven to be a significant impediment to the certification of class actions based on misrepresentations as the trading in the secondary market is anonymous.
Amendments to the OSA [i.e., the Securities Act] seek to respond to these problems... Section 138.3 of the OSA facilitates the use of class actions in the secondary market in a similar fashion, but this regime has a number of obstacles, including a requirement to obtain leave to commence proceedings.19
The court's certification decision in IMAX expands the common law to fill a gap already addressed by the implementation of the Securities Act regime. In certifying common law misrepresentation claims in IMAX, the court accepted the plaintiffs' argument that reliance can be inferred from the fact that members of the class relied on the alleged misrepresentations by purchasing their IMAX shares in an efficient market where, according to the efficient market theory, the price of a security reflects information about the security, including the issuer's disclosure. The court went further and held that it may be possible to infer "group reliance" on the part of the class as a whole, subject to the ability of defendants to rebut this inference.
Certifying common law misrepresentation claims on the basis of a rebuttable inference of group reliance on an efficient market is not different in principle from certifying a class action based on fraud on the market, a theory that has been expressly rejected by the courts in Ontario. In rejecting the fraud on the market theory in Carom v. Bre-X Minerals Ltd., the court noted that U.S. courts also rejected the importation of that theory into the common law, for reasons that are relevant to the court's decision in IMAX:
(1) The argument that the common law should be reshaped in order to remove barriers to the utilization of class action procedures was rejected because the court found that rule 10b-5 [of the Securities Exchange Act of 1934] and other state statutory securities law causes of action could be asserted in a class action.
(2) Courts should be hesitant to impose new tort duties involving complex policy decisions which are more appropriately the subject of legislative deliberation and resolution.
(3) The common law torts have none of the counterbalances that affect an action under rule 10b-5, such as a shorter limitation period and the absence on punitive damages.
(4) Adopting the theory into the common law would negate two significant limitations that the federal courts had imposed on rule 10b-5 actions, namely the requirement of proof: (i) that the plaintiff had actually purchased or sold securities; and (ii) of scienter on the part of the defendant.20
In considering whether to certify the common law misrepresentation claims in IMAX, the court could have adopted those reasons for denying certification: the existence of the Securities Act regime made the extension of the common law unnecessary; the extension of the common law was the subject of legislative deliberation and resolution; and common law misrepresentation claims have none of the counterbalances that a claim under the Securities Act regime have and eliminate the restrictions on such a claim imposed by the leave requirement and the damages cap.
This aspect of the IMAX certification decision may result in more securities class actions being brought outside the Securities Act regime, where plaintiffs are not tested at the leave stage and their damages are not capped. The possibility that plaintiffs can pursue common law misrepresentation claims through class actions could ultimately make the Securities Act regime superfluous.
1.The statutory civil liability regime for continuous disclosure misrepresentations is found in Part XXIII.1 of the Securities Act, R.S.O. 1990, c. S.5, as amended (i.e., ss. 138.1 to 138.14 of the Securities Act). The regime was implemented by amendments to the Securities Act introduced by Bill 198, Keeping the Promise for a Strong Economy Act (Budget Measures), 2002. The amendments came into effect at the end of 2005.
2. Silver v. IMAX Corporation,  O.J. No. 5573 (Ont. S.C.J.) [IMAX (the leave decision)]; Silver v. IMAX Corporation,  O.J. No. 5585 (Ont. S.C.J.) [IMAX (the certification decision)].
3. A recommendation for civil liability for a continuous disclosure misrepresentation was made in P. Anisman, Proposals for a Securities Market Law for Canada (Ottawa, Ont.: Consumer and Corporate Affairs Canada, 1979) and in the later reports cited infra in notes 5 and 17.
4. See s. 1.1 of the Securities Act.
5. Canadian Securities Administrators, "Proposal for a Statutory Civil Remedy for Investors in the Secondary Market," (2000) 23 O.S.C.B. 1.
6. See on this point M. Condon, "Rethinking Enforcement and Litigation in Ontario Securities Regulation," (2006) 32 Queen's L.J. 1 at 41: "the legislators are more interested in achieving goals of management or key shareholder deterrence rather than compensation".
7. See, for example, P. Anisman, "Securities Class Actions: Ontario's Limited Liability Regime for the Secondary Market," 3rd National Symposium on Class Actions, April 7, 2006.
8. Supra note 2, IMAX (the leave decision) at para 25.
9. Ontario Law Reform Commission, Report on Class Actions, 3 vols. (Toronto, Ont.: Ministry of the Attorney General (Ontario), 1982).
10. Ultimately, that test was not included in the Class Proceedings Act, 1992, S.O. 1992, c. 6.
11. Supra note 9 at 324.
12. IMAX (the leave decision), supra note 2 at paras. 320-322, 324.
13. Supra note 10, see s. 5(1) of the Class Proceedings Act, 1992.
14. The law in this area has been widely canvassed, including the interplay between certification decisions (Carom v. Bre-X Minerals Ltd.,  O.J. No. 1662, 44 O.R. (3d) 173 (S.C.J.), aff'd  O.J. No. 5114, 46 O.R. (3d) 315 (S.C.J. Div.Ct.), rev'd  O.J. No. 4014, 51 O.R. (3d) 236 (C.A.) and Moyes v. Fortune Financial Corp.,  O.J. No. 4297, 61 O.R. (3d) 770 (S.C.J.)) and pleadings decisions (CC&L Dedicated Enterprise Fund (Trustee of) v. Fisherman,  O.J. No. 4620, 18 B.L.R. (3d) 260 (S.C.J.) and Lawrence v. Atlas Cold Storage Holdings Inc.,  O.J. No. 3748 (S.C.J.)). The court considered this jurisprudence in IMAX (the certification decision), supra note 2 at para 40.
15. Carom v. Bre-X Minerals Ltd.,  O.J. 4496, 41 O.R. (3d) 780 (S.C.J.) at para 17 [Carom]. The quotation is from Basic Inc. v. Levinson, 485 U.S. 224 at 241-42 (1988).
16. Supra note 5, Canadian Securities Administrators, "Proposal for a Statutory Civil Remedy for Investors in the Secondary Market."
17. Toronto Stock Exchange Committee on Corporate Disclosure, Final Report: Responsible Corporate Disclosure: A Search for Balance (Toronto, Ont.: The Toronto Stock Exchange 1997) at vii.
18. Ibid. at 12.
19. Lawrence v. Atlas Cold Storage Holdings Ltd., 2009 CanLII 55128 at paras. 8-9 (S.C.J.).
20. Supra note 15, Carom, at para. 25.
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