New secondary market liability in Ontario

COMMENTARY

Recent amendments to the Ontario Securities Act created secondary market liability for misrepresentations in corporate disclosure and failures to make timely disclosure. The following provides a high-level overview of the liability provisions and what steps issuers and their insiders can take to reduce the likelihood of lawsuits.

The Ontario Securities Act now imposes liability for misrepresentations in documents released by or on behalf of an issuer, public oral statements by persons with implied or actual authority to speak for the issuer and documents and statements made by “influential persons,” (who are control persons of an issuer, promoters, insiders other than officers and directors and investment fund managers — if the issuer is an investment fund).

Liability also arises for failure to disclose material changes “in the manner required by the act.” This provision means that there will not be liability for failure to make timely disclosure of a material change if the issuer was permitted to keep it confidential pursuant to section 75(3) (and there is a specific defence to this effect), although there would be liability if a confidential material change report was not filed with the commission.

A “document” is any written communication — including in electronic format — that reasonably would be expected to affect the market price or value of the issuer’s securities. It includes any document required to be filed or filed with the commission and any other documents required to be filed under applicable securities or corporate law or the rules of a marketplace.

The right of action is not limited to disclosure violations by Ontario reporting issuers. Any issuer with a “real and substantial” connection to Ontario and publicly traded securities (not necessarily on a market located in Ontario) may be sued.

With respect to misrepresentations in a document, the following may be sued:

* the issuer;

* all directors;

* any officer who authorized, permitted or acquiesced in the release of the document;

* any influential person or director or officer of an influential person who influenced the release of the document; and

* any expert, where the misrepresentation is in a statement, opinion or report of that expert summarized or quoted in the document — provided the expert consented in writing to the inclusion of the summary or quotation and did not withdraw that consent prior to publication.

In the case of public oral statements by someone with authority to speak on behalf of the issuer, the list of defendants is the same, except that directors are liable only if they authorized, permitted or acquiesced in the making of the statement.

In the case of misrepresentations in documents released by an influential person, or public oral statements made by an influential person, the issuer is only liable if an officer or director of the issuer (or manager of an issuer that is an investment fund) authorized, permitted or acquiesced in the release of the document or the making of the statement. In addition, the following are liable:

* the person who made the statement;

* any director or officer of the issuer who authorized, permitted or acquiesced in the release of the document or making of the statement;

* the influential person;

* any director or officer of the influential person who authorized, permitted or acquiesced in the release of the document or the making of the statement; and

* any expert, in the same circumstances as for a misrepresentation in a document released by the issuer.

A person is not liable in the capacity of officer or director of an influential person if that person is also an officer or director of the issuer.

In the case of a failure to make timely disclosure, the following are liable:

* the issuer;

* any director or officer who authorized, permitted or acquiesced in the failure to make timely disclosure; and

* any influential person or director or officer of an influential person who influenced the failure to make timely disclosure.

There are additional hurdles for plaintiffs. The act makes a distinction between “core” and “non-core” documents. Generally, “core” documents are disclosure documents (such as prospectuses and bid circulars) that would normally be reviewed by a board prior to release, and for which there is sufficient lead time before the document must be released to allow an opportunity for a full review of the contents.

In the case of “non-core” documents and oral statements, a defendant (other than an expert) is only liable if he or she was aware of the misrepresentation, deliberately turned a blind eye to it, or was guilty of gross misconduct. The same applies to defendants who are directors of the issuer, influential persons or directors or officers of an influential person (other than an investment fund manager or an officer of an investment fund manager) in the case of a failure to make timely disclosure.

Most significantly for issuers, the legislation contains a number of provisions designed to prevent U.S.-style meritless “strike suits.” Importantly, the legislation contains a due diligence defence if an officer or director, after reasonable investigation, determines that there has been no violation. In determining whether an investigation was reasonable, the legislation directs courts to consider all relevant factors including:

* the nature of the issuer;

* the knowledge, experience and function of the individual defendant;

* the office held by the individual;

* the presence or absence of another relationship of a director with the issuer;

* the existence of any system designed to ensure that the issuer complies with continuous disclosure obligations;

* the reasonableness of reliance on the system and on officers and employees whose duties would give them knowledge of relevant facts;

* the period within which the disclosure was required to be made;

* professional standards applicable to any expert’s report;

* the extent to which the person knew or reasonably should have known the content and medium of dissemination of a document or oral statement;

* the role of the person in the preparation of a document or oral statement; and

* the role of the person in determining that disclosure of a material change was not necessary.

The determination of whether adequate steps have been taken has been deliberately drafted as a fact-specific analysis. For example, the consideration of the period in which disclosure must be made recognizes that for material changes that must be disclosed immediately, there is simply not enough time to perform the same level of due diligence as for a prospectus.

These same factors will be used to determine whether a person is guilty of “gross misconduct,” which is a prerequisite for liability in many cases.

The effect is to minimize the likelihood that a good faith effort to comply with disclosure rules will result in litigation, while increasing the likelihood for companies and persons with a slipshod or cavalier attitude toward compliance. This creates an incentive for companies to have effective disclosure controls in place, which should result in fewer disclosure violations.

Because of this defence, any Ontario reporting issuer or public company with a significant connection to Ontario (as defined in Part XXIII.1 of the Ontario Securities Act) that does not have a disclosure policy should develop and implement one as soon as possible. Companies with disclosure policies shou
ld review them to determine if they are adequate in light of the new liability. The policies should be reviewed and approved by the board of directors, although the board would normally not be involved in all disclosure matters, particularly timely disclosure.

Although many issuers may see such policies as burdensome and bureaucratic, they do serve a purpose and should be viewed as a means to an end. They help focus the company, its management and its employees on complying with applicable disclosure requirements. They help ensure that the company takes a consistent approach to disclosure issues. Finally, they help the company avoid enforcement action, civil liability and damage to reputation arising from disclosure failures.

Management must foster a compliance culture. Disclosure policies will not be effective if they are put in place simply for the sake of having a policy and are subsequently ignored. Arguably, it would be better to have no policy at all than one that is not followed. Not only will failure to follow an established policy without good reason create an increased likelihood of a disclosure failure, it invites plaintiff’s counsel to argue that the failure was intentional, depriving defendants of the statutory caps on damage awards and proportionate liability.

The disclosure policies should be integrated with other corporate policies such as confidentiality, communication, corporate governance, record retention and employee trading policies to ensure consistency and that there are no unintended gaps. They should be integrated with Sarbanes-Oxley compliance policies, if applicable. This will ensure that employees who would not normally be involved with or even read the corporate disclosure policies do not inadvertently expose the company to liability, which is a particular concern given that liability can arise for statements by a person with “apparent authority” to speak for the issuer.

The new provisions for civil liability are intended to foster a culture of compliance in public companies. Companies that take their disclosure obligations seriously and implement effective disclosure policies will have taken a significant step to minimizing the potential liability both of the company and its officers and directors.

— The preceding is an edited excerpt from Getting and Staying Listed in Canada, published by CCH Canada. The author is the general counsel and corporate secretary with the Canadian Trading and Quotation System, a small-cap stock exchange based in Toronto. He can be reached at Timothy.Baikie@cnq.ca