In January 2010, potential corporate defendants to class actions breathed a (small) sigh of relief as Justice Perell in Fischer v. IG Investment Management Ltd.1 refused to certify a class action on the basis that a settlement with the Ontario Securities Commission (OSC) had already provided aggrieved investors with a payment of $205.6 million. The decision meant that by participating in a regulatory settlement in which restitution was made to individuals, a corporation could potentially avoid a class action. In the plaintiff-friendly world of class actions, Justice Perell's decision was a welcome change. However, this comfort was short lived. On January 31, 2011, the Ontario Divisional Court overturned Justice Perell's decision and certified the class action.2
In Fischer, the plaintiffs alleged that the defendant mutual fund managers had permitted market timing to occur in the mutual funds which they managed. Market timers purchase mutual funds that they believe are undervalued for a short-term turnaround, by using time zone differences and the fact that the daily value of a mutual fund is only calculated once a day. While this activity is not illegal, the profit made by market timers is at the expense of long-term investors. In November 2003, the OSC launched an investigation into these practices and subsequently took enforcement proceedings against the defendant mutual fund managers for failing to act in the public interest. All of the defendants entered into settlement agreements with the OSC, pursuant to which they paid $205.6 million compensation directly to their investors. Those investors constituted the majority of the proposed class.
The plaintiffs argued that the OSC settlements did not amount to full compensation, as the actual damages could be as high as $831.9 million, based on an expert report filed in evidence. The plaintiffs also relied on the fact that they had not participated in the OSC negotiations, nor were they signatories to the OSC settlement agreements, to argue that they had not yet had their day in court and the action should be certified so the balance of the monies owing could be recovered.
One of the requirements for certification of a class proceeding is that a class action must be the preferable procedure for the resolution of the common issues. The defendants argued that the preferred procedure was the already completed OSC proceeding with the $205.6 million settlement. Justice Perell agreed with the defendants, concluding that the OSC proceedings and settlement agreements had provided access to justice for the investors, and achieved one of the main purposes of a class action: behavior modification.
Justice Molloy, speaking for a unanimous panel of the Ontario Divisional Court, disagreed, finding that Justice Perell's analysis of the impact of the OSC settlement on the issue of preferable procedure was "fundamentally flawed as a question of law." The Court specifically identified three errors made by Justice Perell: "(1) he failed to apply the proper low evidentiary burden on the plaintiffs at this stage; (2) he improperly found that the already completed OSC proceeding was a preferable proceeding for the remaining portion of the plaintiffs' claims going forward; and (3) he erred in law by considering criteria for approval of a settlement at the certification stage."
At the certification stage, there is a very low evidentiary threshold on plaintiffs; they must simply present evidence of "some basis in fact". In this case, Justice Molloy determined that the plaintiffs had satisfied the threshold of showing "some basis" for their position that they were still owed damages in excess of the OSC settlement amounts. Once this was established, the Court found that the purpose of the OSC proceeding and its findings were "wholly irrelevant" to the analysis. This was particularly the case because the OSC settlement agreements specifically contemplated future civil actions.
Justice Molloy acknowledged that in certain circumstances, prior proceedings can be relevant to whether a class action should be certified (for example, where issues of res judicata arise). However, this was not one of those cases; the OSC settlement agreements reserved the rights of individuals to bring other proceedings and did not fully compensate the plaintiffs for their losses. Justice Molloy stated that it was not necessary to decide whether "a fully completed prior proceeding or settlement can ever be considered to be a preferable procedure for an ongoing class proceeding", leaving this question for another day. As such, defendants are left with little guidance on when prior regulatory proceedings or settlements can impact the certification of a class action.
Justice Molloy also found that Justice Perell incorrectly considered and applied criteria that are considered when determining whether to approve or reject a settlement. The effect of doing so "was to force the settlement on the plaintiffs without any consideration of whether it was a fair settlement in all of the circumstances." This was seen as "the worst of all worlds for the plaintiffs", as the fairness of the settlement was not evaluated but was still used to deny certification.
The Divisional Court therefore overturned Justice Perell's decision and certified the action as a class proceeding. The plaintiffs also appealed other aspects of Justice Perell's decision (relating to the class definition and common issues), but the appeal was dismissed on these points.
Based on the above three errors, Justice Molloy concluded that the OSC settlement should not have been taken into consideration and therefore could not be a more preferable procedure. The decision of the Divisional Court appears to be largely based on the fact that the OSC settlement did not provide full recovery to the plaintiffs (based on their assessment of the damages). There was no OSC proceeding to make up the shortfall, nor was there another viable alternative for recovering the shortfall. Justice Molloy stated that unless the plaintiffs "have achieved full, or at the very least substantially full, recovery" they were entitled to certification. While the Court chose not to decide the question of whether a prior proceeding or settlement can ever be considered to be a preferable procedure, this statement suggests that the threshold for a prior proceeding being relevant at certification may be whether it provides "substantially full" recovery.
Nonetheless, the door may not be entirely closed to defendants wishing to argue that a class action is not the preferable procedure. In this case, the regulatory settlement explicitly preserved class members' rights to bring other proceedings. Further, the question of whether a regulatory settlement represents a reasonable compromise of a claim may be a matter of evidence. Justice Molloy seems to assume that whether there is "substantially full" recovery would be based on the plaintiffs' assessment of their own damages. However, few class actions are resolved on the basis of a full recovery. There may be ways to structure regulatory settlements and to provide evidence of their reasonableness that will be acceptable, in the right case, as a basis for a court to conclude that a class proceeding is not the preferable procedure. Given that behaviour modification is a goal of class proceedings (and in some proceedings, the driving goal), the overlap between regulation and litigation arguably should not be ignored.
Regulatory proceedings are often seen as a precursor to class actions. While Justice Perell's decision offered a glimmer of hope for defendants that such a link need not be inevitable, the Divisional Court has certainly taken the shine off that possibility. While not totally extinguished, it appears that a high threshold will have to be met before defendants will be able to invoke a prior regulatory settlement to resist certification.
Footnotes
1. 2010 ONSC 296
2. 2011 ONSC 292
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