What You Should Do
A highly significant development for Ontario’s capital markets will take place on December 31, 2005, when a new liability-for-disclosure regime comes into force. This regime will facilitate lawsuits by securityholders who buy or sell securities of public companies while there is a continuous disclosure violation.1
A disclosure violation begins when a misrepresentation about the company is made in a public document or a public oral statement, or when the company fails to make timely disclosure of a material change in its affairs. The disclosure violation ends when the disclosure is properly made. Under these circumstances, investors will now have a more powerful tool to suethe company, its directors, certain of its officers and, in some situations, controlling shareholders and experts. This right is not restricted to Ontario residents and will most likely be exercised through class actions.
The new regime contains some similarities to rights of action in the United States under the Securities and Exchange Commission’s Rule 10b-5, and experience there will be relevant. There are, however, also significant differences. One difference, intended to make lawsuits by plaintiffs easier in Ontario, is that under the Ontario regime the plaintiffs need not prove that the defendants intended to deceive, manipulate or defraud, or that they acted recklessly (as must be proven in SEC Rule 10b-5 lawsuits). Another difference is that liability under the Ontario regime is capped: the maximum amount that can be recovered from each director or officer is $25,000 or half of his or her compensation for the past 12 months, whichever is greater. The limit does not apply to those who knowingly violate the disclosure rules. The limit on recovery from the public company itself is higher: $1 million or 5% of the company’s market capitalization, whichever is greater. And the Ontario regime contains two measures to reduce the potential for strike suits (although it remains to be seen how successful these measures will be). First, a plaintiff is required to obtain leave of the court before bringing a lawsuit, and the court will grant leave only if it is satisfied that the suit is being brought in good faith and has a reasonable prospect of success at trial. Second, the court must approve any proposed settlement of a lawsuit (this is also true of an SEC Rule 10b-5 lawsuit that is brought as a class action).
But despite the liability caps and the strike suit protections, the spectre of personal liability being imposed on directors and officers and the increased personal risk are likely to change the corporate disclosure practices of many public companies. These concerns will also reinforce a number of best practices already adopted by some public companies in Canada. The full impact of this new liability regime will not be known until courts have considered its operation in various circumstances and common disclosure practices emerge. In the meantime, if you are a director or an officer of a public company in Canada, you should consider its implications.
Here are some practical issues.
Decisions About When to Disclose Material Changes
Under the regime, making decisions about when to disclose major corporate events will be even tougher because of the higher stakes for directors and officers if they get it wrong.
Securities legislation defines a "material change"—an event that triggers a public disclosure obligation—as a change in the business, operations or capital of the company that would reasonably be expected to have a significant effect on the market price or value of its securities. This definition requires company directors and officers to make a business judgment, either alone or based on information or advice from capital markets professionals. Exercising this judgment is particularly difficult during the negotiation of a significant transaction, when the transaction is approaching agreement but is not yet fully settled. The new legislation may drive companies to disclose negotiations of significant transactions at an earlier stage. Directors and officers often seek advice from the company’s lawyers on both when and what to disclose. While you should continue to do this, acting in accordance with legal advice will not, alone, shield you from liability.
Confidential Material Change Reports
The potential for personal liability may lead to an increase in the filing of confidential material change reports under provisions that have long existed but are seldom used. If your company believes that public disclosure of a pending material event would be unduly detrimental, filing a confidential material change report may offer protection from liability.
This is not complete protection, however, because claimants can challenge the reasonableness of your company’s opinion that it is entitled to make a confidential filing.
Approval of Important Matters and News Releases
Whenever the board approves a material transaction or matter, it should take positive steps to ensure that an accurate news release is issued and a material change report filed on a timely basis. Each news release not reviewed by the board or a board committee before its release should be circulated to directors and reviewed after its release. Directors should act immediately if there is uncertainty about whether a misrepresentation has been made.
Written Disclosure Policy
The legislation invites courts to consider a number of factors in determining whether there is liability. One of these factors is the existence of a suitable system (which in most cases would be documented in a disclosure policy) to ensure compliance with disclosure obligations. A disclosure policy should authorize particular individuals to make statements on behalf of the company. The policy should also set down and assign responsibility for a process for reviewing public disclosure and determining whether a material change has occurred.
It is likely that companies will have to adopt more stringent review procedures before releasing documents such as news releases, material change reports, annual information forms, annual and interim financial statements, annual and interim management’s discussion and analysis, and proxy circulars. For these documents, the review process may approach that used in preparing prospectuses.
The due diligence defence discussed below means that a written disclosure policy is essential for every public company because compliance with an appropriately designed disclosure policy will be the cornerstone in demonstrating due diligence. A disclosure policy is also a key element of the disclosure controls and procedures that the CEO and CFO will need to certify as part of their certification of annual and interim filings beginning with the annual certification for the first financial year ending on or after March 31, 2005.
Public Presentations and Oral Statements
Public presentations and oral statements by people who speak on behalf of the company, including directors and officers, will have to be carefully planned. Impromptu remarks should be avoided. It will be important to make and retain electronic or other 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 or instances of selective disclosure.
Correcting Misrepresentations or the Failure to Make Timely Disclosure
It will be important for directors and officers to immediately take steps to remedy any misrepresentation or failure to make timely disclosure. This will limit exposure to damages because the shorter the disclosure violation period, the smaller the number of investors who will have traded during the period. In addition, a director or an officer who learns of a misrepresentation or failure to make timely disclosure will have a defence if he or she immediately notifies the board and ensures that corrective action is taken. The nature of the corrective action to be taken will depend on the circumstances.
A defence is available against any allegation of a misrepresentation in forward-looking information if (a) reasonable cautionary language (close to the forward-looking information) identifies the material factors that could cause actual results to vary, and (b) a statement is made of the material factors and assumptions that were applied in preparing the forward-looking information. It will not be enough to simply offer up boilerplate cautionary language. The language must be customized to the particular circumstances. There must also be a reasonable basis for any forecast or projection.
Due Diligence Defence
All potential defendants, including the public company itself, may escape liability if they can demonstrate that they took reasonable care. For this due diligence defence to be successful, the director, officer or other defendant must prove that he or she conducted (or caused to be conducted) a reasonable investigation before the release of a document, the making of a public oral statement or the failure to make timely disclosure, and had no reasonable grounds to believe that a disclosure violation would occur.
In practical terms, this requires each public company to design, adopt and adhere to disclosure policies and procedures that are appropriate for that company. The directors are responsible for ensuring that suitable policies and procedures are adopted, and they have an ongoing responsibility to monitor compliance. The board may decide that it is appropriate to assign this function to one or more directors.
If a report of an accountant, actuary, appraiser, auditor, engineer or other expert is to be included, summarized or quoted in a public document or a public oral statement, the company should obtain the written consent of that expert for such publication or statement. And when disclosure is based on a third party’s disclosure that is publicly filed with securities regulators, the disclosure should explicitly refer to the source of the information. Defences are available in each of these cases.
Directors and officers of public companies will face increased personal liability under Ontario’s new liability regime for disclosure violations. You should ensure that your company’s public disclosure practices do not put your personal finances at risk.
1. We provide a summary of this legislation in our client memo no. 2005-38, Ontario's New Law on Liability for Public Company Disclosure Proclaimed into Force on December 31, 2005: Summary of the New Regime, which is available on our website at http://www.torys.com/publications/pdf/CM05-38T.pdf.
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.