In Cappelli v Nobilis Health Corp.1 ("Cappelli"), Justice Perell, for purposes of a leave motion under Part XXIII.1 of Ontario's Securities Act ("OSA"), considered the evidentiary value of an issuer's public disclosure that it was restating previous financials and had control weaknesses. His Honour gave less weight to the restatement and admission of control weaknesses than in previous cases where similar disclosures virtually guaranteed that leave would be granted. The approach in Cappelli, if followed in future cases, has the potential to undermine the deterrence objective of Part XXIII.1 of the OSA and investors' ability to recover losses that arise from admitted misrepresentations.
The cause of action under Part XXIII.1 of the OSA for secondary market misrepresentations, requires a misrepresentation and a public correction of that misrepresentation. A misrepresentation exists when there is an untrue statement of a material fact or there is an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in the circumstances it was made. A fact is material if its disclosure would objectively be expected to have a significant effect on the market price or value of the security.2
To advance a claim for damages stemming from a misrepresentation under Part XXIII.1 of the OSA plaintiffs must first pass a preliminary screening test, known as a request for leave. For leave to be granted a court must be satisfied that the plaintiff brought the action in good faith and that there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff and the class. The leave requirement is a preliminary screening mechanism. The Court is required to undertake "a reasoned consideration of the evidence to ensure that the action has some merit... the threshold requires that there be a reasonable or realistic chance that the action will succeed."3
Cappelli concerned a plaintiff's request for leave. At issue, was whether there was some merit to alleged accounting misrepresentations and misrepresentations related to Nobilis' internal financial controls.
The alleged misrepresentations were purportedly corrected by a January 5, 2016 Nobilis press release warning investors not to rely on its previous financials and stating its intention to restate those previous financials. Justice Perell accepted that the January 5, 2016 press release amounted to an admission that the previous financial statements were misrepresented, should no longer be relied upon and that there were deficiencies in its internal financial controls.4
Justice Perell declined to follow past precedent where a financial restatement and admission of control weakness were sufficient to grant leave. His Honour held that a restatement or admission of control weaknesses can, but is not necessarily, sufficient evidence to grant leave.5 For Justice Perell, Nobilis' January 5, 2016 press release amounted to an admission that previous disclosures contained misrepresentations but it did not amount to an admission that those misrepresentations were material. Instead, Justice Perell was persuaded by Nobilis' expert evidence, which showed that the misrepresentations alleged by the plaintiff were not material.6 As a consequence, His Honour refused to grant leave.
By refusing to grant leave in these circumstances, an inordinately high evidentiary burden is set at the leave stage. As previous Courts consistently held prior to Cappelli, a restatement and admission of control weaknesses is very persuasive evidence that there has been a material misrepresentation that is sufficient to satisfy the leave threshold of "some merit".7 The logic behind the approach taken in cases prior to Cappelli is clear. Restatements of previously issued financial statements are required precisely because they are materially misleading.
In fact, this is evident on the facts of Cappelli. Shortly after the January 5, 2016 press release Nobilis filed a material change report with respect to the contents of the press release.8 Material change reports are only required where there has been a material change to the business, operations or capital of the issuer. Materiality for the purposes of a material change is the same as materiality for the purposes of determining a misrepresentation under the OSA.9 Thus, the reporting of a material change is very strong proof that Nobilis' viewed previously issued financial statements as containing material misrepresentations.
This point is exemplified by the reasoning of the Ontario Superior Court and Court of Appeal on a Part XXIII.1 leave motion in Rahimi v SouthGobi Resources Ltd. ("Rahimi"). In that case, the SouthGobi restated its financials and admitted to a weakness in its related internal controls. On the leave motion, the defendants (SouthGobi and certain directors and officers) attempted to resile from the restatement and admitted control weakness by claiming that there had actually been no misrepresentation and that, in any event, a reasonable investigation had been conducted.10
The judge at first instance, Justice Belobaba, explained the flaw in this argument:11
Yet the restatement was explicit. SGR publicly and definitively acknowledged that more than two years of revenues had to be corrected and restated – that the earlier financials were “no longer accurate and should not be relied upon.” And, a few days later, SGR’s management added that there was a “material weakness” in the company’s system of internal financial controls. These are serious pronouncements that may be explained and rebutted on a balance of probabilities by the defendants at trial but on a leave motion they remain significant.
Despite this reasoning, Justice Belobaba refused to grant leave against certain of the individual defendants because, in His Honour's view, they had established a reasonable investigation.
The plaintiff appealed. Justice Hourigan, writing for a unanimous Court of Appeal, agreed with Justice Belobaba on the evidentiary significance that ought to be attributed to a financial restatement and control weakness at the leave stage. However, Justice Hourigan overturned Justice Belobaba on the reasonable investigation point for that very same reason. The restatement and admitted control weakness provide strong evidence of both the existence of a misrepresentation and the failure to conduct a reasonable investigation sufficient for leave to be granted under Part XXIII.1 of the OSA.12
Moreover, refusing leave against some of the defendants in circumstances where the issuer's continuous disclosure documents told one story (admitted misrepresentation and control weakness) and the material filed by the defendants on the leave motion told another (no misrepresentation or control weakness) had the potential to undermine Part XXIII.1 of the OSA's objective of promoting issuer's compliance with continuous disclosure obligations. The Court of Appeal held that:13
Continuous disclosure is at the heart of securities regulation and must be scrupulously accurate and fair. There is no room for prevarication or double-talk...
Continuous disclosure obligations are not a shell game where investors are left to guess where the truth lies. Investors have a right to know a corporation's true state of affairs. In my view, the motion judge failed to consider this policy imperative and rendered a decision with respect to the Individual Respondents that is inconsistent with basic notions of securities regulation. The discrepancy between the position asserted in this litigation and the position taken in the Restatement and the November 14 Press Release is so jarring that the motion judge should not have refused to grant leave to proceed against any of the respondents.
By refusing to accept the defendant's announced restatement and admission of control deficiencies as sufficient evidence of materiality for purposes of leave, Cappelli ignores the logic of the Court of Appeal in SouthGobi and provides for an outcome that is inconsistent with the objective of the statutory regime in Part XXIII.1 of the OSA. Nobilis' announced restatement and admission of material control weaknesses in the January 5, 2016 press release (not to mention the material change report on that subject matter that followed) are inconsistent with its denial that there had been no material misrepresentation on the leave motion. This "jarring" inconsistency should have been significant enough for leave to be granted. Because leave was refused, investors were denied the opportunity to test their allegations on a full evidentiary record at trial in circumstances where the defendant, in its public disclosures, had acknowledge the inaccuracy of its previous financial statements and admitted to control weaknesses. That is, where the defendant, in essence, admitted that there had been a material misrepresentation in its public disclosures.
1. 2019 ONSC 2266
2. OSA, s. 1(1); Nobilis at 145.
3. Theratechnologies Inc. v. 121851 Canada Inc., 2015 SCC 1838 at 38 (emphasis added).
4. Nobilis at 174.
5. Nobilis at 174-175
6. Nobilis at para 176.
7. See e.g.: Silver v Imax Corp., 2009 CarswellOnt 7874 at 208, 351; Middlemiss v. Penn West Petroleum Ltd., 2016 ONSC 3537 at 9; Rahimi v SouthGobi Resources Ltd., 2015 ONSC 5948 at 28. Rahimi v SouthGobi Resources Ltd., 2017 ONCA 719 at 56.
9. Indeed, the failure to disclose a material change is a type of actionable misrepresentation under the OSA. See the definitions of "material change", "material fact" and "misrepresentation" in OSA, s. 1(1).
10. Rahimi, 2017 ONCA 719 at 13-16, 78-79.
11. Rahimi, 2015 ONSC 5948 at 28.
12.Rahimi, 2017 ONCA 719 at 52- 68.
13. Rahimi, 2017 ONCA 719 at 80-81.
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