Trends in Canadian Securities Class Actions: 1997-2008

By Mark L. Berenblut, Bradley A. Heys, and Svetlana Starykh¹

INTRODUCTION

Securities class actions are a relatively new development in Canada, spurred on by recent legislative changes. Although all but one province had enacted class action legislation by 2004, including Québec in 1978 and Ontario in 1993,² securities claims brought under common law allegations of negligent and fraudulent misrepresentation were not conducive to class actions. More recently, however, amendments to provincial Securities Acts have opened the door to securities class actions. Specifically, four provinces have introduced civil liability for continuous disclosure (CLCD) and a right of action for investors harmed by misrepresentations or failures to make timely disclosure. In Ontario, the first province to amend its Securities Act ("the OSA"), civil liability for continuous disclosure has been in force since December 31, 2005, under Part XXIII.1 of the OSA. Alberta (effective December 31, 2006), Québec (effective November 9, 2007), and British Columbia (effective July 4, 2008) have each enacted substantially similar amendments to their Securities Acts.

Importantly, these amendments to the provincial Securities Acts do not require plaintiffs to prove that they relied on the alleged misrepresentation or omission. In this respect, the litigation environment is now more plaintiff-friendly in Canada than in the US, where the presumption of reliance—based on the "fraud-on-the-market" doctrine that the US Supreme Court endorsed in 1988—is both rebuttable and limited to securities that trade in an efficient market.³ In the era when Canadian securities class actions could only be brought for common law torts of negligent and fraudulent misrepresentation, no such short-cut to showing reliance was available for cases involving allegations regarding continuous disclosures.4 While the gate-keeping procedures and damages limitations accompanying the addition of secondary market liability to the Securities Act may still make these kinds of securities class actions less attractive for plaintiffs to pursue in Canada than the US, the new cause of action and the absence of a requirement to show reliance are strong inducements to new filings.⁵

Although it is still too early to know whether the incidence of securities class actions in Canada will approach that of the US, 2008 saw a substantial rise in filings, an indication that plaintiffs' counsel are prepared to test the new provisions of the Securities Act. First-time allegations contributed to the 2008 activity, with claims involving options backdating and the credit crisis—each of which has fuelled a wave of US litigation—making their Canadian debuts.⁶ In light of the now fertile environment for securities class action litigation in Canada, and coinciding with NERA's new presence in the country, we examine here for the first time trends in Canadian securities class actions.

TRENDS IN FILINGS

Filed in 1997, Carom v. Bre-X was the first securities class action to be brought in Canada.⁷ Before Bre-X, most Canadian class action cases dealt with consumer issues such as defective products. From 1997 through 2007, annual securities class action filings fluctuated in a range from one (in 2000) to five (in 2004)⁸—see Figure 1. In 2008, a record nine new securities class actions were filed, an 80% increase over the previous maximum and a 125% increase over the prior year.

Even with this record level of new cases, Canadian securities class action filings in 2008 amounted to less than 4% of the 255 in US Federal Courts through December 14 of that year.⁹ In part, this reflects the fact that the Canadian market is much smaller—only one-fourth the size of the US in terms of issuers (hence there are fewer litigation targets) and only one-tenth as large in terms of capitalisation (meaning the average target is smaller, and therefore less attractive for plaintiffs).¹⁰ Even controlling for market size, however, securities class action filings are less common in Canada than in the US.

Canada's enabling of securities class actions through the introduction of civil liability for continuous disclosure, intended to facilitate judicial economy, access to justice, and deterrence,¹¹ was accompanied by provisions designed to discourage US-style "strike suits" in Canada.¹² While the market size-adjusted filing rate remains much lower in Canada than in the US, it is growing faster, making it too soon to tell whether the balance has been appropriately struck.

Civil Liability for Continuous Disclosure: The Latest Cases

The first case filed under Part XXIII.1 of the OSA commenced against IMAX Corporation in 2006. Since then, 11 additional cases have been brought under the new provisions of the OSA. The affected issuers are:

• CV Technologies, Inc.
• Southwestern Resources Corp.
• Celestica Inc.
• European Minerals Corporation (now known as Orsu Metals Corporation)
• Gammon Gold Inc.
• TVI Pacific Inc.
• SunOpta, Inc.
• Gildan Activewear Inc.
• Canadian Imperial Bank of Commerce (CIBC)
• Arctic Glacier Income Fund
• American International Group (AIG)

None of the new filings has yet reached the leave application or certification stage. The IMAX case is expected to be the first matter for which the courts will consider the applicable test under the Ontario legislation for the leave application.

The prospects for Canadian securities class actions received a boost in late 2008 with a ruling in the IMAX case. Plaintiffs had brought an application to the Ontario Superior Court of Justice relating to certain refusals regarding their efforts to cross-examine a defence expert and a law clerk employed by one of the defendants' counsel, each of whom had submitted affidavits. The court held that the plaintiffs were entitled to a certain amount of discovery at this stage of the proceedings, and the decision was upheld on appeal.

This outcome is in contrast to the US, where discovery is stayed under the Private Security Litigation Reform Act (PSLRA) while a motion to dismiss is pending. For parallel US-Canada actions, the IMAX ruling may enable plaintiffs to do an end-run around the discovery stay provisions of the PSLRA by bringing an action north of the border. The recent filing in Ontario of a class action against AIG may be an example of this tactic.¹³

While the IMAX ruling may open the door to some early discovery, a subsequent ruling in Ainslie v. CV Technologies et al., may make it difficult for plaintiffs to discover enough to satisfy the leave application requirement to demonstrate "a reasonable possibility that the action will be resolved at trial in favour of the plaintiff."¹⁴ The plaintiffs in CV Technologies sought to compel each defendant to file affidavit evidence and/or be examined. In rejecting their application, Madam Justice Lax held that the legislation places no onus on defendants to assist plaintiffs in securing evidence upon which to base an action. Rather, plaintiffs are required to demonstrate the propriety of their proposed claim before a defendant is required to respond.¹⁵

Types of Allegations

Allegations in Canadian securities class actions mainly focus on improper accounting, misleading earnings guidance, insider trading, product/operational defects, and customer/vendor issues. The distribution of allegations by type in cases filed from 1997 through 2008 is illustrated in Figure 2.¹⁶ As in the US, the largest group of allegations, comprising 26% of the Canadian total, relate to accounting misstatements.¹⁷ Another 16% involve earnings guidance, and 13% cite insider trading.

Credit Crisis Cases

Two Canadian cases filed in 2008, the CIBC and AIG securities class actions, stem from the current credit crisis. In the US, this crisis has driven 2008 securities class actions filings to the highest level in six years.¹⁸ Although the crisis had its origins in the US subprime mortgage market, it has had global ramifications from which Canadian issuers and investors have certainly not been immune. The freeze-up and subsequent restructuring of the market for non-bank-sponsored Asset Backed Commercial Paper (ABCP) is just one example of how the crisis has affected Canadian financial markets.

Allegations in Canadian securities class actions mainly focus on improper accounting, misleading earnings guidance, insider trading, product/operational defects, and customer/vendor issues.

Stock prices around the globe have been affected by the exposure of public companies to mortgage-related securities. In the US, the first credit crisis-related securities class action, involving subprime lender New Century Financial, was filed in February 2007. The first such Canadian case was filed in July 2008, with allegations relating to CIBC's exposure to subprime mortgage loans.¹⁹

Options Backdating Cases

In the US, the first options backdating case was filed in May 2005. The number of such US filings peaked at 24 in 2006, but new cases continue to be brought, with nine in 2007 and five in 2008.²⁰

We are aware of only two Canadian cases with options backdating allegations. Involving TVI Pacific Inc. and Gammon Gold Inc., both were filed in 2008, some three years after the inception of such litigation in the US.

The paucity of Canadian options backdating cases to date may reflect the fact that Canadian regulators have not conducted the kind of large-scale investigations of options granting practices that were undertaken by the United States Securities and Exchange Commission (SEC).²¹ Nevertheless, we understand that Canadian plaintiffs' counsel has identified approximately 50 TSX-listed companies that are suspected of having manipulated stock options between 1987 and 2005.²² These companies are said to have received letters from plaintiffs' counsel alleging that stock options are likely to have been manipulated, demanding an independent investigation into the companies' stock options practices, and threatening legal action if no such investigation is conducted.²³ These overhanging threats of litigation suggest that options manipulation cases may become a larger component of Canadian class action filings in the future.

Filings by Economic Sector

Securities class action filings in Canada have been brought against companies in 13 different economic sectors.²⁴ Issuers in the financial, energy, and non-energy minerals sectors together account for almost 43% of filings. The distribution of cases by industry is illustrated in Figure 3.

Nearly one-quarter of Canadian cases involve companies in the financial sector. Of these, the largest group—including an ongoing market timing matter—have mutual funds as the defendant issuer. Another three financial sector cases—those against CIBC, AIG, and FMF Capital—relate to subprime mortgage loans.

No doubt reflecting the importance of the sector to the Canadian economy, almost 20% of cases involve resource companies, among them Bre-X Minerals Ltd., Naxos Resources Ltd., Southwestern Resources, TVI Pacific, Inc., Canadian Superior Energy, PetroKazakhstan/CNPC, Gammon Gold Inc., and European Minerals Corporation (now known as Orsu Metals).

TRENDS IN RESOLUTIONS

One of the guiding policy objectives of the OSA amendments would seem to be deterrence—that is, providing incentives for issuers and other parties in the know to more diligently and rigorously comply with their secondary market disclosure obligations. Consistent with this objective, the CLCD provisions of the OSA limit the liability of responsible issuers, directors, officers, and other potential defendants where plaintiffs cannot establish that the misrepresentation or omission was made knowingly.²⁵ The liability limit for an issuer is the greater of $1 million or 5% of market capitalisation as measured over the 10 trading days prior to the class period.²⁶ Too few cases have settled to date to assess whether the limitations on liability are binding, and if so, under what circumstances.

Verdicts

While the vast majority of securities class action cases in both Canada and the US result in settlements, a small fraction of cases do go to trial. In Canada, the Danier Leather case, which was brought under the prospectus liability provisions (section 130) of the OSA rather than the new secondary market liability provisions, is the first, and so far only, verdict in a securities class action for misrepresentation in Canada. In that case, the court found that neither the company nor its senior officers were liable for failing to update earnings forecasts included in the IPO prospectus with information that defendants learned after the filing of the prospectus but prior to the conclusion of the offering period. This ruling was upheld by the Supreme Court of Canada.²⁷

Settlements

Since class action legislation was first enacted in Canada, 20 securities class action cases have settled (see Tables 1 and 2).²⁸ Only one—the Southwestern Resources case, which settled for $15.5 million prior to any application for leave or certification—involved a case brought pursuant to the new securities legislation.

Perhaps not surprisingly, cross-border cases tend to result in larger settlements than Canadian-only cases. Among the nine settled cross-border cases, the average settlement is $322 million and the median is $46 million (see Table 1). The average is skewed by two Nortel settlements for $1.3 billion and $1.2 billion. In domestic shareholder class actions, the average settlement is $73 million and the median is $14 million (see Table 2). Aggregate settlements to date are $3.6 billion, almost 80% of which is accounted for by cross-border cases.

The existence of cross-border cases reflects the fact that many major Canadian public corporations are listed on US exchanges. These companies face the risk of securities litigation on both sides of the border. Settlements in US-only cases, which can be substantially larger than in Canada-only cases, are not reflected in the figures cited above. An extreme example is the US $2.4 billion settlement paid by CIBC in the Enron US-only class action, which alone amounts to almost as much as the $2.9 billion total of settlements in all cross-border cases to date.

Claimed Losses and Settlements

In contrast to the US, some Canadian provinces, such as Ontario, require the statement of claim to specify a damages amount. Of the cases that have settled and for which complete data are available, the average settlement value as a percent of the amount claimed (excluding punitive damages) is approximately 16%.

For cross-border cases, the average settlement rate is 13.7% of the amount claimed and tends to be higher for cases with larger claim amounts. The median settlement rate is 11.2%. See Table 1 and Figure 4.

For domestic cases, the average settlement rate is 18.0% of the claimed amount, a figure heavily influenced by the high settlement rates in the Portus Alternative Asset Management (38.2%) and Atlas American RSP Index Fund (89.8%) cases. The median settlement rate is 7.2%. See Table 2 and Figure 5.

LOOKING FORWARD

Securities class actions for secondary market violations are new to Canada. Compared to the US, the total number of securities class action filings to date is miniscule, even taking into account the smaller size of the Canadian market. Nevertheless, the plaintiffs' bar is more active than ever, with a record number of new filings during 2008, many of them brought under the new amendments to the provincial securities legislation. Until new-provision cases proceed to adjudication in the leave and certification stages, it remains to be seen whether the gate-keeping aspects of the new amendments to the legislation, as interpreted by the courts, will meaningfully hinder the ability of plaintiffs to prosecute securities class actions in Canada.

Allegations relating to the credit crisis and options backdating have generated a great deal of securities class action litigation in the US, but so far there has been little action along these lines north of the border.

In terms of settlements, 2008 was a big year, with almost $890 million in total payments consented to for Canadian securities class actions (including cross-border and domestic cases), the most in any year except 2006, when the Nortel cases settled.29 Currently, there are approximately $3 billion in claims across 21 active Canadian securities class actions (see Table 3). Although there are 10 cases involving claims of at least $100 million (excluding punitive damages) and settlements to date have sometimes been a high portion of the claimed amount (as high as 29% for cross-border cases and 90% for domestic cases), it seems unlikely that we will see an increase in the aggregate settlement amount in 2009. Even a higher-than-average settlement rate of 20% would produce only about $600 million in settlements if all pending cases (and no new ones) settled in 2009, an unlikely prospect.

Footnotes

^{1 Mr. Berenblut is a Senior Vice President, Mr. Heys is a Vice President, and Ms. Starykh is a Consultant at NERA. The authors thank Ward Branch, Jake George, Marcia Kramer Mayer, and Robert Patton for helpful comments on earlier drafts of the paper. In addition, we thank Tara Poranganel, Nicole Roman, Carlos Soto, Nii Nookwei Tackie, and other NERA researchers for their assistance.}

^{2 Nova Scotia is the most recent province to enact a class action statute, leaving only Prince Edward Island and the three territories without such legislation. Other jurisdictions that have enacted class action statutes include: Québec (1978), Ontario (1993), British Columbia (1995), Saskatchewan (2002), Newfoundland (2002), Manitoba (2002), and Alberta (2004). Class proceedings have also been available before the Federal Court since 2002.}

^{3 Basic v. Levinson, 485 U.S. 224, 108 S.Ct. 978, 99 L.Ed.2d. 194 (1988).}

^{4 Carom v. Bre-X Minerals Ltd., (1998), 27 C.P.C (4th) 73 (Ont. Ct. (Gen. Div.)) (pleadings amendment). Note that deemed reliance was a feature of the prospectus liability provisions of the OSA prior to the amendments.}

^{5 The most notable gate-keeping mechanism is the requirement that plaintiffs seek leave of the court to bring a class action by demonstrating both that the action is brought in "good faith" and that there is a reasonable possibility of success at trial. Other deterrents to bringing class actions in Canada as compared to the US are limitations on damages and rules entitling the successful parties to have their legal costs paid by the unsuccessful parties (Section 138.11 of the OSA specifically overrules the Class Proceedings Act on this point).}

^{6 Dr. Stephanie Plancich and Svetlana Starykh, "2008 Trends in Securities Class Actions: Annual Filings Are at the Highest Level in Six Years, Driven by the Credit Crisis, While Median Settlement Values Stay Steady," December 18, 2008. The NERA study can be found here:http://www.nera.com/image/PUB_Recent_Trends_Report_1208.pdf .}

^{7 Carom v. Bre-X, supra note 3. US filings against Canadian issuers listed on US markets began before Bre-X and continue. Such filings are outside the scope of this report.}

^{8 We have collected data from multiple sources, including RiskMetrics Group/Securities Class Action Services (SCAS), Factiva, Bloomberg, FactSet Research Systems, Inc., SEC filings, Canadian Legal Information Institute (CanLII) databases, plaintiff counsel websites, and the public press. In compiling our filing data, we have sought information on all unique class actions alleging damages with regard to the purchase, ownership, or sale of securities. We report a single filing that potentially is related to an alleged fraud if multiple statements of claims are filed in different jurisdictions.}

^{9 Dr. Stephanie Plancich and Svetlana Starykh, "2008 Trends in Securities Class Actions: Annual Filings Are at the Highest Level in Six Years, Driven by the Credit Crisis, While Median Settlement Values Stay Steady," December 18, 2008, p. 2, Figure 1. The NERA study can be found here: http://www.nera.com/image/PUB_Recent_Trends_Report_1208.pdf .}

^{10 On November 30, 2008, the number of listed companies was 6,457 on the NYSE, NASDAQ, and AMEX markets combined as compared to about 1,600 on the Toronto Stock Exchange (TSX). At the same date, the total market capitalisation of listed issuers was approximately US$1.05 trillion on the TSX versus approximately US$11.6 trillion on the NYSE, NASDAQ, and AMEX combined. Sources: for Canada, Toronto Stock Exchange Statistics – November 2008, Toronto Stock Exchange, November 2008; for US, World Federation of Exchanges, Monthly Statistics, November 30, 2008, available online at http://www.world-exchanges.org/statistics/ytd-monthly.}

^{11 "The purposes of class action legislation are:}

^{12 "Strike suits" is a derogatory term for cases of questionable merit whose filing is presumed to be motivated by the prospect for contingency fees. Features of the provincial litigation designed to discourage such suits are noted in fn. 5.}

^{13 Note that AIG is not a reporting issuer in Ontario. The OSA provisions for civil liability for continuous disclosure provisions apply not only to issuers reporting in Ontario, but also to issuers who have "a real and substantial connection to Ontario." OSA, s.138.1 (definition of "responsible issuer") and s.138.3.}

^{14 OSA, s.138.8(1).}

^{15 Ainslie et al. v. CV Technologies Inc. et al. (Court file no. 07-CV-336986 PD1), decision dated December 3, 2008}

^{16 Most shareholder class action statements of claim have multiple allegations. We examine the distribution of all 77 allegations in the 42 cases filed in Canada from 1997 through 2008. To code allegations in cases for which we do not have a statement of claim, we researched news stories and reviewed complaints involving parallel actions, if any, in the US.}

^{17 Dr. Stephanie Plancich, Svetlana Starykh, and Brian Saxton, "2008 Trends: Subprime and Auction-Rate Cases Continue to Drive Filings, and Large Settlements Keep Averages High," 29 July 2008, p. 9, Figure 9. That NERA study can be found here: http://www.nera.com/image/BRO_Recent_Trends_8.5x11_0808.pdf.} Note that it does not tally insider trading allegations. Allegations related to merger integration issues, which the US study does find, are not present in any of the Canadian statements of claim that we reviewed.

^{18 Plancich and Starykh, 2008, op cit.}

^{19 The FMF Capital class action, involving the demise of the US subprime lender, may have been an early indicator of the trouble to follow. Filed in January 2006, this case had already settled prior to the wave of credit crisis litigation that continues in the US. For more details about this case, see: http://www.nera.com/image/Case_Closed_Subprime_FMF_0808_final.pdf .}

^{20 Note that, because there is often no significant stock price reaction following disclosures relating to backdating, many options backdating cases are brought as derivative actions rather than securities class actions. Our focus in this paper is on securities class actions and we have omitted derivative cases. For more details about options backdating cases, see "Options Backdating: A Primer," by Dr. Patrick Conroy, Matthew Evans, and Dr. Sunil Panikkath, October 5, 2006. This NERA study may be found here: http://www.nera.com/image/PUB_Backdating_Part_1_Primer_SEC1381_Jul2007-FINAL.pdf.}

^{21 Canada was the first major jurisdiction to require the expensing of all stock-based compensation awards based on fair value rather than intrinsic value (the use of the intrinsic value method was eliminated from CICA Handbook Section 3870 in November 2003). As compared to intrinsic value expensing, fair value expensing provides less incentive for issuers to engage in backdating rather than, say, grant options with below-market strikes. As a result, it may be that companies reporting under Canadian GAAP were less apt to engage in options backdating than those reporting under US GAAP. For answers to some frequently asked questions relating to accounting for options and options backdating, see "Backdating Options: Frequently Asked Accounting Questions", by Dr. Thomas L. Porter, available online here: http://www.nera.com/image/PUB_BackdatingOptionsFAAQ_Final_2.08.pdf.}

^{22 Melnitzer, Julius. "Manipulation 'serious problem'; Canada rife with option backdating, lawyers conclude", National Post, September 19, 2007, p. FP1.}

^{23 Many of these allegations may be brought as derivative actions rather than shareholder class actions.}

^{24 This analysis is based on the economic sector classification of FactSet Research Systems, Inc.}

^{25 OSA, s.138.7.}

^{26 Unless otherwise indicated, all dollar amounts in this study are expressed in Canadian dollars.}

^{27 Kerr v. Danier Leather Inc., [2007] 3 S.C.R. 331, 2007 SCC 44. Two other shareholder class actions have been dismissed by the court: Pente Investment Management Ltd. v. Schneider Corp. (dismissed in 1998) and Stern v. Imasco Ltd. (dismissed in 1999). Both of these cases involved oppression claims relating to proposed corporate acquisitions.}

^{28 Hollinger International, Inc. and Crocus Investment Fund are settled with respect to only some defendants.}

^{29 Note that approximately two-thirds of this, $611 million, was from one case—the Portus Alternative Asset Management case.}

NERA Provides Economic Analysis for Class Action Securities Cases in Canada and the US

NERA experts provide insight and analysis in securities litigation and other areas. Along with assessing class certification issues, market efficiency, materiality, loss causation, likely settlement ranges, and alleged damages in securities class actions, we are retained by corporations, governments, and law firms to conduct financial investigations, provide GAAP and GAAS analysis, value businesses, and quantify damages in complex commercial litigation.

NERA experts have opined in several of the Canadian cases mentioned above as well as in numerous class actions in the US. NERA has been analysing trends in securities class actions for more than 15 years and in addition to this Canadian Trends report, produces two studies on the topic annually in the US.

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