Securities class actions hitting mining companies hard (March 07, 2011)

A disproportionate number of mining companies have been subject to securities class actions in recent years in Canada. Each action raises different facts and complaints about “misleading” disclosure. The impact on stock price and the resulting “losses” claimed by investors can vary widely. However, some lessons can be learned from what we have seen to date both in minimizing the chances of such actions and in responding strategically if proceedings are commenced.

A new regime of statutory secondary market liability was introduced in most provinces in Canada in recent years. Securities class actions for misrepresentations in documents or public statements made in the “secondary” market (not in a prospectus, offering memorandum or circular) tend to be referred to across the country as “Bill 198 actions” (the number of the bill passed in Ontario in 2005). 

While a great flood of secondary market securities class actions was originally predicted by legal commentators, there has been a gradual increase in the Bill 198 class actions commenced, with about six to eight such new actions in each of 2008, 2009 and 2010. According to National Economic Research Associates (NERA) in Trends in Canadian Securities Class Actions: 2010 Update, twenty-five Bill 198 cases had been launched in total in Canada by the end of 2010. There have been at least two more in which notice was given in January 2011.

The legislation includes what was intended to be a safeguard to prevent opportunistic, non-meritorious “strike” suits by requiring a representative plaintiff to obtain leave from the court to proceed with the statutory causes of action. The legal test for a court to grant leave to proceed under the securities legislation generally has been interpreted to be quite low. It requires only that a proposed plaintiff show that (i) the action “is being brought in good faith” and (ii) “there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff” (s.138.8 of the Ontario Securities Act).

If such leave of the court is granted, and subject to certification as a class proceeding under provincial legislation, an action then follows typical litigation steps such as disclosing documents, examination for discovery and trial (or settlement along the way).  Plaintiffs have a huge advantage when suing under the securities legislation in that the plaintiff does not have to prove any reliance on the public document or public statement made by the company. In the contrasting common law regime, plaintiffs cannot recover damages unless they can prove that they read/heard and relied on the document or statement in making their decision to purchase the security. The concept of damages owing only arises with this reliance on the false or misrepresented statement. 

The courts have set a low threshold for leave to proceed with Bill 198 actions to date.  The decision on the long-awaited IMAX motion for leave to appeal to the Divisional Court, Silver v. Imax Corp., [2011] O.J. No. 656, was released on Feb. 14. It is the first secondary market case to be considered in an appeal context.

One part of the leave to appeal test is whether there are conflicting decisions in the lower courts and therefore an appeal court ought to hear the appeal in order to correct or clarify the law. Justice Corbett decided, however, that since this is the first decision under the Securities Act, there are clearly no conflicting decisions justifying an appeal. Corbett also concluded there was no reason to doubt the correctness of the lower court IMAX decision granting leave (the second part of the leave to appeal test). Market participants must therefore wait for future cases to get further clarification at the appeal level.

Until then, companies will continue to face the substantial risk of an action or a threatened action after a stock drop on modified or updated news.  There are many examples where notice of an intended action is released shortly after a stock drop following news. As a result of such notices, companies find themselves quickly having to defend their disclosure to investors and the media while conducting an investigation into the alleged misrepresentation or omission.

The risks and costs to public companies and their directors, officers, agents and experts arising from either “corrected” or “updated” disclosure are considerable, especially since plaintiff counsel routinely monitor public company stock drops and company disclosure that preceded such drops.

The risks are particularly great for companies that release forward-looking information, and more so for companies in the resource sector where they are required by securities regulation to disclose technical reports that include estimates of reserves, costs timelines and such. Companies governed by National Instrument 43-101, for instance, must comply with the many specific disclosure standards it contains.

These kinds of estimates and forecasts are inherently subject to ordinary course modification and updates. Assumptions and external factors may change, new or better test and cost data will become available, and unanticipated developments and costs will occur over the life of a mining or resource project from prefeasibility to feasibility and development stages. These are facts that NI 43-101 mandates to be disclosed so that investors are kept informed of material information on material projects. These examples of continuous disclosure are not proof of prior misrepresentations, but they are often met with great suspicion by plaintiff counsel.

A company can, therefore, in good faith and with reasonable due diligence, publish information that later changes without any negligence or other fault causing the modified information. When the updated information is published and it causes a stock drop, however, plaintiff’s counsel may proclaim that “the truth has been revealed” and sue, alleging misrepresentation in the earlier disclosure. A disproportionate number of Bill 198 proceedings to date have been in the resource sector. The extent of forward-looking information is a factor in many of these.

Public companies expect to be accountable for actual material mistakes that may sometimes occur and must be corrected to inform shareholders. They also disclose comprehensive risk factors and warnings so investors are aware of the risks in the investment. To their great frustration, however, modifications, updates or developments in their disclosure may be treated as “mistakes” or “corrections” without regard to adequate facts.

The fact that so few cases have gone to the courts leaves defendants with little judicial guidance on how the legislative standards and defences will be interpreted. Many companies will understandably wish to resolve litigation early to get on with business, to minimize cost, and to address the reputational harm and risk that comes with the huge amounts ordinarily claimed in these class actions. Of note, while the claims are often in the tens or hundreds of millions of dollars, the known Bill 198 settlements to date range from about $1.3 million to $28 million (the largest two settlements being for global classes). It is a great frustration to companies that the public launch of a huge claim often gets more attention than the subsequent settlement at substantially lower amounts.

Prevention is mostly about taking adequate care in the accuracy of published data along with appropriate, clear disclaimers. However, whenever modified or updated information is being published that is reasonably likely to be seen as negative in the market, particular attention must be given to what and how much is said. Often, the explanation or context can make a difference in how such statements will be interpreted by litigants and courts after the fact. Companies have to disclose with a clear eye on their obligations to investors and securities regulation, while realizing that certain kinds of statements may be later int
erpreted as an admission by plaintiffs.

To date, it is clear that the motions for the certification process and the securities statutory leave requirements can themselves become very costly and time consuming.  Inevitably, there will be defendants who choose to defend the merits rather than settle.  From a strategic perspective, those defendants with strong merits may choose to move forward faster to adjudication on the substantive rather than the procedural issues. This will provide important guidance in future cases. Ultimately, litigation-related decisions are mostly about what lets companies and their directors/officers get on with business.

– The author is a partner and head of the securities litigation practice at Gowlings’ Toronto office, which she joined in 2008. Formerly the deputy director of Enforcement and Chief Litigation counsel at the Ontario Securities Commission, Kelley litigated some of the most complex securities cases in recent years, including the OSC intervention on Danier Leather at the Supreme Court of Canada.

Gowlings is an international law firm with seven offices in Canada, as well as offices in London and Moscow. With recognized strength in business law, advocacy, and intellectual property, Gowlings provides dedicated industry expertise in the energy, infrastructure, mining, financial services, life sciences and technology sectors. For more information, visit www.gowlings.com.