Key Takeaways From 2021 Ontario Securities Class Action Decisions

We summarize in this bulletin key securities class action decisions from the last year. These decisions underscore the following:

  • Whether a statement or announcement amounts to a material misrepresentation or a corrective disclosure requires more than a literal interpretation and calls for a deeper and contextual assessment of how the statement may be understood by market participants.
  • General disclosure of litigation risk may be inadequate to disclose the specific risks associated with a particular legal proceeding.
  • What amounts to a material change continues to be highly fact-specific, and there continues to be no bright-line test.

The courts also provided greater certainty on enforcing indemnity clauses in underwriting agreements for defence costs in class actions where there are allegations of intentional wrongdoing.

What Counts as a Corrective Disclosure?

There is not much dispute as to whether there has been a corrective disclosure when the announcement expressly corrects a prior statement. But what about when the announcement is not a “mirror image” of a prior statement? While the courts have previously settled that a public correction does not need to be a direct admission that a previous statement is untrue, the Ontario Court of Appeal provided additional guidance in two 2021 decisions.

In Drywall Acoustic Lathing and Insulation, Local 675 Pension Fund v. Barrick Gold Corporation, 2021 ONCA 104 and in Baldwin v. Imperial Metals Corporation, 2021 ONCA 838, the Ontario Court of Appeal cautioned against relying only on the words of the announcement to determine whether it is corrective. Rather, courts must also assess how the words would be understood and how they might affect the market’s valuation of the securities. The central question is whether the statement was reasonably capable of being understood in the secondary market as corrective, including casting doubt on the reasonableness or accuracy of an earlier disclosure. The court can be asked to infer a correction based on something other than an express corrective statement by the company, coupled with the market’s response.

In both cases, the motion court denied leave to proceed with secondary market misrepresentation claims under Part XXIII.1 of Ontario’s Securities Act, holding that the plaintiffs had failed to establish that the stock drop was attributable to a corrective disclosure. The Court of Appeal overturned both decisions and indicated that determining whether a drop in share prices is attributable to a corrective disclosure requires contextual evidence rather than a simple assessment of the words of the announcement.

Expert Evidence — “Too Much Science and Not Enough Art”

Courts regularly rely on expert evidence to determine whether a pleaded stock drop is attributable to an alleged corrective disclosure. Gowanlock v. Auxly Cannabis Group Inc., 2021 ONSC 4205 highlights that expert evidence must go beyond the words of the announcement and provide a more nuanced consideration of how the market views an announcement.

Auxly announced in February 2019 that a previously announced build-out project it was pursuing stalled amid contract disputes between Auxly and the co-venturer. Within two weeks of the announcement, Auxly’s share price had fallen by about 21%. The plaintiff alleged that this announcement caused the drop by correcting a misrepresentation in the earlier announcement, which failed to disclose problems with the project.

On the leave motion, Auxly called an expert who opined that the stock price drop was not statistically significant once non-company specific developments were factored out of the decline. This opinion supported Auxly’s position that, before the February announcement, the market had already absorbed news about the delay in the timing of the build-out project based on earlier statements by Auxly. In January, Auxly disclosed that the first phase of the project would be completed in 2019. It had previously stated that it would be completed by the end of 2018.

Justice Morgan did not agree with the logic underlying the report or its conclusion, describing the report as suffering from “too much science and not enough art.” He compared it to computer-generated research results in which the researcher has collated and calculated the statistical occurrence of key words and phrases in a database of case law, but has not actually read the cases.

The expert’s failure to expressly consider the possibility that the market may not have understood the information available in January the same way as Auxly contended proved fatal. For example, the expert contended that because analysts did not comment on the January announcement, they must not have viewed a delay in the build-out as important. Justice Morgan commented that while the market’s silence might indicate that it did not believe the information to be important, it might equally mean that the information was made available in an obscured manner such that the market did not recognize its importance.

Disclosing Future Risks Associated with a Legal Proceeding

In Dyck v. Tahoe Resources Inc., 2021 ONSC 5712, the proposed class action alleged that Tahoe Resources’ news release failed to disclose that relief sought in a Guatemalan proceeding included a provisional suspension of its mining licence while the merits of the proceeding were being determined. The interim suspension could last between eight to eighteen months, and if the proceeding were successful its mining licence would likely remain suspended for another six months to a year.

The plaintiffs alleged that when Tahoe Resources announced the Guatemalan court had ordered an interim suspension a couple of months later (followed by a loss in market capitalization of about $1.1 billion), this was corrective of the misrepresentation (by omission) of the prior news release. Tahoe Resources’ initial news release announcing the proceeding had not disclosed a risk of an interim suspension of the licence. It had instead stated that Tahoe Resources was confident the current claim was without merit, including denying the existence of the specific local indigenous people on whose behalf the proceeding was being brought.

In resisting leave, Tahoe Resources relied, in part, on its risk disclosures in public disclosures. Justice Glustein held that there was a reasonable possibility a trial judge would find that Tahoe Resources’ public disclosures had only disclosed general threats relating to mining companies in Guatemala, including the possibility that licences could be contested, but failed to disclose the specific risk of a lengthy suspension from the proceedings. Furthermore, a trial judge might find that the potential consequences of the litigation went beyond the general risk levels disclosed, particularly considering evidence supporting the position that litigation increased the risk of suspension relative to the general risks that the market already understood.

In terms of the specific news release announcing the proceeding, Justice Glustein similarly noted that it was reasonably possible that a trial judge could find it lacked sufficient information for readers to understand that a provisional suspension of the licence was being sought, the risk of suspension and the potentially significant length of any such suspension. The Court observed that such an interpretation was consistent with the absence of a statistically significant price reaction following the initial news release.

Tahoe Resources had further submitted that, when it issued the initial news release, the forward-looking risk of suspension proceedings was uncertain. Part 4A.2 of National Instrument 51-102 provides that a reporting issuer must not disclose forward-looking information “unless the issuer has a reasonable basis for the forward-looking information.” Justice Glustein held that there was a reasonable possibility that a trial court could find Tahoe Resources had a reasonable basis to conclude that it was highly likely that Guatemalan court could grant the provisional suspension and that there was a risk of a definitive suspension. Further, Tahoe Resources had made forwarding-looking disclosure as to the possible length of suspensions in its subsequent news release after the interim suspension was granted suggested. This suggested that Tahoe Resources could have formed a reasonable basis to provide forward-looking information as to the duration of a suspension.

The Court added that issuers are not absolved from disclosure of material facts simply because the risk has not yet arisen, noting, “Laws governing the disclosure of forward-looking information are not intended to operate as a license for reporting issuers to withhold disclosure of material information relating to risks affecting a business’ operations.”  

What Counts as a “Change” for Purposes of a Material Change?

Securities commissions have previously noted that there is no bright-line test for what counts as a “change” under securities legislation. Whether an event amounts to a change to the business, operations or capital of an issuer is highly dependent on the circumstances of each case. This was front and centre in Peters v. SNC-Lavalin Group Inc., 2021 ONSC 5021, in which the plaintiff sought leave to proceed with a statutory claim under Part XXIII.1 of the Securities Act for an alleged failure to disclose a material change in a timely manner.

SNC-Lavalin faced criminal charges for allegedly bribing government officials in Libya. On September 4, 2018, SNC-Lavalin’s legal counsel was informed by officials with the Public Prosecution Service of Canada (“PPS”) that the director of the PPS would not invite SNC-Lavalin to negotiate a Remediation Agreement. Intensive discussions followed with SNC-Lavalin’s counsel seeking to address the director of the PPS’s concerns about extending an invitation to negotiate. SNC-Lavalin also continued its lobbying efforts directed at the government for a Remediation Agreement. On October 10, 2018, SNC-Lavalin issued a press release that the director of the PPS had decided not to extend to it an invitation to negotiate a Remediation Agreement. Following that announcement, SNC-Lavalin’s share price fell by 13%. Shortly thereafter, a proposed class action was commenced alleging that SNC-Lavalin failed to disclose a material change in September when PPS officials first informed it that the PPS would not invite it to negotiate a Remediation Agreement.

In denying leave, Justice Perell concluded that the September message received by SNC-Lavalin’s counsel was not a “change” requiring disclosure under the Securities Act and, even if it was a change, it was not a material change to the company’s operations, capital or business. Justice Perell disagreed with the plaintiff that the September message changed SNC-Lavalin’s prospects of being invited to negotiate a Remediation Agreement, noting it “was never a sure thing or a done deal.”

Justice Perell also accepted that there was no finality in the September 4 message that could demarcate that a change had occurred, commenting, “SNC’s prospects of receiving an invitation to negotiate a Remediation Agreement were always challenging, and without the benefit of hindsight … SNC’s prospects of achieving a Remediation Agreement did not materially change because the message received on September 4, 2018 was a part of the dynamic ongoing situation that … is not over until it is over.” In that vein, Justice Perell noted that the case law affirms that the requirement to make timely disclosure of a material change is not an obligation to provide running commentary on the company’s progress or to comment on internal or external events that may impact the company’s performance.

Justice Perell clarified that, despite the foregoing, he was not raising a “sufficient certainty argument” as a general principle or bright-line test. He noted that certain types of information will immediately influence a change to the issuer’s business, operations or capital. In such a situation, the information does not need to ripen further, and the “it’s not over until it’s over argument” does not work. By contrast, SNC-Lavalin never presumed (or communicated that it presumed) it would inevitably achieve a Remediation Agreement. All that investors, analysts, the media and the public knew was that it was eager and anxious to negotiate a Remediation Agreement. Any risk to SNC-Lavalin’s business, operations or capital because of a conviction was already well known to the public through many instances of public disclosure.

Restatements Are Not Always Material for Purposes of Misrepresentation Claims

Badesha v. Cronos Group, 2021 ONSC 4346 exemplifies that motions for leave to proceed with a statutory secondary market misrepresentation claim are not mere bumps in the road but call for a meaningful review of the evidence filed to determine whether the claim has a reasonable possibility of success.

In mid-March 2020, Cronos announced it would be restating previously issued unaudited financial statements for the first three quarters of 2019. Two weeks later, it released restated interim financial statements and MD&As. A class action suit followed. On the leave motion, the plaintiffs argued that the restatements spoke for themselves in demonstrating the materiality of the alleged misrepresentations and that there was no need to answer how the alleged public corrections were understood in the secondary market.

Justice Morgan disagreed that there was no need to address how the alleged public corrections were understood in the secondary market, as this is an indispensable aspect of the materiality analysis. Specifically, the Court noted that it is possible there were misrepresentations in the form of inaccuracies in financial statements, but that they had negligible market impact and so were not material in the Securities Act sense of the term. Justice Morgan commented that, while from an accounting point of view the very act of restating a financial statement indicates a material error in the original, from a legal point of view the existence of a restated financial statement is only evidence, not automatic proof, of materiality.

Cronos’ expert stressed that, as it was still a young company in the process of expanding its business and markets, Cronos’ prospects in the market were not based on short-term revenue. Some analysts described the restatement as a sign of Cronos’ health as a corporation and asserted that Cronos’ delay in filing its 2019 financial statements was an opportunity to buy Cronos. Analysts further reported that the bulk sale exchange transactions that prompted the need to restate the financials were an insignificant portion of Cronos’ business and assets. Moreover, of the five dates on which the plaintiff’s expert said Cronos disclosed public corrections, three of them showed no statistically relevant movement in share price. One showed a drop attributable to the unrelated news. The fifth incident was a volatile day, with the share price losing and recovering in interim trading, which could not be accounted for by the news in Cronos’ disclosure. Furthermore, the alleged collective disclosure occurred during a period of unusual volatility as markets came to understand the seriousness of COVID-19 in February and March 2020.

Indemnifying Underwriters’ Defence Costs Where Intentional Wrongdoing Is Alleged

Underwriting agreements invariably include indemnity clauses in favour of the underwriter in the event of litigation from the distribution. However, will those indemnity clauses be enforced where the alleged conduct includes intentional wrongful acts by the underwriter? That issue arose in Clarus Securities Inc. v. Aphria Inc., 2021 ONSC 3720.

The plaintiff brought a prospectus misrepresentation claim under s. 130 of the Securities Act, alleging a failure to disclose facts relevant to the value of shares in a company acquired by Aphria. The claim included an assertion that the disclosed value of the shares was the product of manipulation of the share price by the underwriters.

The underwriting agreement included an indemnity clause that required Aphria to indemnify the underwriters for defence costs for every claim arising out of the performance of professional services rendered or otherwise in connection with the matters referred to in the agreement until a “court of competent jurisdiction in a final judgment that has become non-appealable shall determine that such Losses were solely caused by the negligence, willful misconduct or fraud of the Indemnified Party.”

Aphria covered the underwriters’ defence costs until the plaintiff delivered an expert report in connection with the certification proceedings. The report detailed particulars of the market manipulation claim. After it was delivered, Aphria told the underwriters it would not reimburse any expenses associated with the market manipulation allegations. Aphria contended that, in negotiating the indemnity, the parties did not contemplate requiring the issuer to indemnify the underwriters for the consequences of actions taken by the underwriters without the issuer’s knowledge and prior to their engagement by it. In its view, the indemnity provision of the agreement was functionally like a contract of insurance, and similar considerations should apply to its interpretation.

Justice Dunphy disagreed and noted that the underwriting agreement reflected a commercial bargain and that the underwriters should be considered “innocent until proven guilty” and are entitled to the payment of defence costs arising until the exclusion event. The Court commented that, “There is no mandatory rule of public policy that prohibits the parties from agreeing to the payment of defence costs of an unproven claim which, if proven, may potentially provide grounds to invoke a coverage exclusion or even constitute a provincial offence.” The payment of defence cost was not seen as detracting from the gatekeeper role and high standards expected of underwriters as there is “no want of incentives to underwriters to fulfil their roles honestly and diligently,” including eventual damages that may amount to many multiples of the defence costs paid along the way or the fees earned and potentially severe regulatory or even criminal sanctions.