Shareholder Class Actions: A New Statutory Regime in Ontario

Transcription

1 Shareholder Class Actions: A New Statutory Regime in Ontario Douglas M. Worndl 1 February 2003 Unlike the United States, where the statutorily based fraud on the market doctrine has enabled widespread shareholder class action litigation, the necessity in Canada of establishing actual reasonable reliance by the individual shareholder on alleged misrepresentations contained in secondary market disclosure has stood as a significant barrier to shareholder class actions. However, recently introduced amendments to the Ontario Securities Act which incorporate the notion of deemed reliance by shareholders on secondary market disclosure, will open the door significantly to shareholder class actions in Canada. In this paper, there is a description of the new scheme of statutory civil liability for secondary market disclosure which will be adopted by the new amendments to the Securities Act. Introduction On October 30, 2002, the Government of the Province of Ontario introduced an omnibus budget measures bill 2 which, among other things, proposed significant amendments to the Ontario Securities Act 3. Bill 198 received royal assent on December 9, 2002, and its proclamation into force should occur fairly soon. Key features of the amendments to the OSA include: CALGARY MONTRÉAL OTTAWA TORONTO VANCOUVER Partner,, Toronto Bill 198, Keeping the Promise of a Strong Economy Act (Budget Measures), 2002, First Reading October 30, 2002, Royal Assent December 9, 2002 Ontario Securities Act, R.S.O. 1990, c.s.5, as. am. (the OSA )

2 increasing penalties for non-compliance with the Securities Act creating new offences for securities fraud and making untrue or misleading statements affecting securities expanding the powers of the Ontario Securities Commission (the OSC ) adding for the first time in Canada, statutory civil liability for issuers, directors, officers, control persons, and experts in respect of secondary market disclosure. This paper will focus on the latter feature of the amendments which is the new Part XXIII.1 of the OSA, Civil Liability for Secondary Market Disclosure. As is explained, these amendments will significantly facilitate shareholder class actions in Canada. Background to the Legislative Amendments While the OSA imposes statutory civil liability arising out of misrepresentations in primary market disclosure (ie. liability arising out of misrepresentations in prospectuses, offering memoranda, take-over bid circulars to individuals acquiring securities during the offering period 4 ), there is currently no similar statutory civil liability for secondary market disclosure misrepresentation (i.e., liability arising out of misrepresentations in annual reports, financial statements, press releases, MD&A 5 to those acquiring securities outside of the initial offering period). Instead, investors must rely on common law misrepresentation claims for redress in circumstances where they have suffered losses as a result of inaccurate secondary market disclosure. Given that more than 95 percent of securities trading takes place in the secondary markets, the lack of statutory civil liability for secondary market disclosure misrepresentation has been viewed by many as a significant deficiency in our securities legislation. 4 5 OSA ss. 130, 130.1, 131. MD&A: Management Discussion and Analysis 2

3 The new amendments to the OSA address this deficiency by adopting the November 2000 proposal of the Canadian Securities Administrators (CSA ), which proposal was the most recent of a number of proposals over the last twenty years to extend statutory civil liability to continuous disclosure in the secondary market. 6 The regime provided by the new amendments to the OSA is somewhat complex as there is an attempt to strike a balance by providing a workable system of liability arising out of secondary market disclosure with sufficient strength to encourage capital market players to be diligent and accurate in their disclosure; while attempting to avoid some of the excesses of US style shareholder litigation, and in particular, to avoid strike suits. 7 It is important to understand that the policy basis for the new regime, as reflected by many earlier studies, including the Allen Report, is to address a perceived problem of inadequate secondary market disclosure. Stated another way, the 6 7 In 1979, the federal Proposals for a Securities Market Law of Canada recommended such a regime. In December 1994, the Dey Committee of the Toronto Stock Exchange ( TSX ) recommended that this issue should be returned to the policy agenda. Shortly thereafter the Allen Committee was appointed to review the adequacy of continuous disclosure by Canadian public companies. The Allen Committee s Report, issued in March 1997, concluded that there was evidence of significant disclosure violations and a consequent negative public perception of continuous disclosure requirements that threatened to tarnish the reputation of capital markets and undermine investor confidence. In January 1999, the recommendations of the Allen Committee were endorsed by the Mining Standards Task Force, a joint committee of the Ontario Securities Commission and the TSX, and are the basis of the CSA s proposed civil statutory liability. Most recently, the Five Year Review Committee Draft Report, (May 29, 2002) was a comprehensive review of the provisions of the Ontario Securities Act, which endorsed the CSA and encouraged the governments of Ontario and other CSA jurisdictions to adopt the draft legislation. The strike suit is the securities class action suit brought by entrepreneurial plaintiffs or their lawyers for the purpose of forcing settlements from defendants which are out of proportion to the merits of the claim. Defendants, who may have done no wrong, are forced into settlement to avoid enormous litigation expense and the possibility of a crippling damages award. One commentator described the strike suit as the legalized shakedown of corporations who had suffered market reverses. James Tory, Strike Suits and Judicial Supervision of Class Proceedings: Epstein v. First Marathon Inc., (1999) Queen s Annual Business Law Symposium, Critical Issues in Mergers and Acquisitions, at p.243 3

4 new ability of shareholders to maintain suit for continuous disclosure violations is really a means to achieving the policy objective of improved secondary market disclosure. What is provided by the new amendments to the OSA is a regime of rebuttable strict liability, with limits of liability, both depending on the nature of the secondary market disclosure and who made or failed to make such disclosure. There is also judicial oversight to confirm the bona fides of shareholder suits before they will be allowed to proceed; and there is a requirement of judicial approval of the settlement of actions which have been allowed to proceed. The principal features of the new regime are described below. Removal of the Reliance Requirement In Canada, shareholder class action litigation has been significantly impeded by the Hercules Management requirement that, in the case of a claim founded in negligent misrepresentation, it must be established that the individual shareholder/claimant actually relied on the misrepresentation complained of in making his or her investment decision, and that such reliance was reasonable. 8 The most significant aspect of the new liability scheme is the removal of actual reliance as a precondition to maintaining suit for misrepresentation in secondary market disclosure. Subject to available defences, 9 if it is established that there was a material misrepresentation in secondary market disclosure which affected the price of a security, then security holders would be entitled to recovery from those responsible for the misrepresentation, regardless of whether an individual investor was even aware of the disclosure. The removal of the reliance requirement opens the door significantly to shareholder class actions in Ontario. 8 9 Hercules Management Ltd. v. Ernst & Young [1997] 2 S.C.R Due diligence defences are described below 4

5 Shareholder class action litigation in the United States is fundamentally based on the doctrine of fraud on the market. In short, the doctrine assumes that all material information disseminated in the capital markets about a particular reporting issuer has been assimilated by the market into the price of the security. Therefore, if there has been a misrepresentation in any material information disseminated about a reporting issuer which, when revealed, results in a change to the value of the security, it is unnecessary for an individual shareholder to prove that he or she was actually aware of the information and relied on it in making an investment decision. The misrepresentation is deemed to have been reflected in the price of the security, and all security holders are deemed to have relied on it in their investment decisions. Canadian courts have explicitly rejected the fraud on the market concept, making it necessary to establish that an individual investor actually relied on the misrepresentation complained of in making an investment decision, and that such reliance was reasonable. 10 The difference between the American fraud on 10 See, for example, Carom v. Bre-X, (1999) 44 O.R. (3d) 173 (S.C.J.); aff d (1999) 46 O.R. (3d) 315 (Div. Ct.); rev., in part, (2000), 51 O.R. (3d) 236 (C.A.), leave to appeal to S.C.C. denied [2000] S.C.C.A. No Note, there has been some recent discussion about the September 25, 2002 decision of the Quebec Superior Court in Beaudoin v. Avantage Link [2002] J.Q. No. 4575, where a shareholder class action was certified where there was a fraud on the market type of pleading. In that case, the respondents moved to strike the pleading on the basis that there was no reasonable cause of action. Mr. Justice Viau allowed the class action to proceed. It is important to note that this certification decision of Mr. Justice Viau, is a procedural decision pursuant to Article 1003 of the Code of Civil Procedure of Quebec which is not subject to appeal, did not consider in its reasons the weight of Canadian authority on the actual reliance requirement with which it is inconsistent, and would not be binding authority in Ontario. While at least one commentator has suggested that Quebec may become the forum of choice for shareholder class actions (Don McGowan, The Lawyers Weekly, February 7, 2003, pp.15-16), there has been no proliferation of securities class actions in Quebec in the four months since Avantage Link. It is important to note also that while Avantage Link may stand for the proposition that a fraud on the market type of pleading may pass muster on a Quebec class action certification motion, there still has been no determination that fraud on the market is part of the law in any jurisdiction in Canada, and the weight of authority is to the contrary. The amendments to the OSA provided by Bill 198 will make deemed reliance by investors in the secondary market part of Ontario law, and for this reason, I would anticipate that Ontario will be the preferred venue for shareholder class actions, at least until other provinces adopt a similar liability regime by amendments to their own securities legislation. 5

6 the market doctrine and the actual reliance requirement of Canadian law is fundamental, and explains in large measure why shareholder class action litigation has not proceeded in Canada in the same manner as in the United States. The deemed reliance provisions in the amendments to the OSA will remove this significant impediment to shareholder class actions in Ontario. Liability The new scheme will provide secondary market investors with a right of action against an issuer of securities, its directors, responsible senior officers, influential persons (a defined term including a control person, promoter, insider and investment fund manager) and experts (a defined term which includes, but is not limited to, accountants, actuaries, appraisers, auditors, engineers, financial analysts, geologists and lawyers.) The right of action will allow secondary market investors to seek compensation for damages suffered at a time when the issuer had made and not corrected an untrue statement of material fact or failed to make required timely disclosure of material changes to its business. In working through this somewhat complex scheme, two principal factors must be considered: the nature of the disclosure containing the misrepresentation; and the specific role or function of the individual or company who is alleged to have participated in the misrepresentation. These two factors will determine burdens of proof and available defences. Four types of disclosure are identified, each giving rise to a right of action for damages against specified individuals: 6

7 1. misrepresentation in documents released by the responsible issuer potential defendants include: the responsible issuer, each director of the responsible issuer at the time the document was released, each officer of the responsible issuer who authorized, permitted or acquiesced in the release of the document; each influential person, and officers and directors of influential persons who knowingly influenced the responsible issuer or a director or officer of the responsible issuer in the release of the document; experts misrepresentations in public oral statements by the responsible issuer potential defendants include: the responsible issuer, the person who made the public oral statement, each director or officer of the responsible issuer who authorized, permitted or acquiesced in the making of the public oral statement; each influential person, and officers and directors of influential persons who knowingly influenced the person making the public oral statement or an officer or director of the responsible issuer authorizing the making of the public oral statement; experts misrepresentations in documents or public oral statements by influential persons potential defendants include: the responsible issuer, the person who made the public oral statement; each director or officer of the responsible issuer who authorized, permitted or acquiesced in the making of the public oral statement; the influential person; officers and directors of the influential person who authorized, permitted or acquiesced in the release of the document or in the making of the public oral statement; experts failure to make timely disclosure of material information by the responsible issuer potential defendants include: the responsible issuer, each director or officer of the responsible issuer who authorized, permitted or acquiesced in the failure to make timely New OSA section 138.3(1) New OSA section 138.3(2) New OSA section 138.3(3) 7

8 disclosure; each influential person, and each officer and director of influential persons who knowingly influenced the responsible issuer or an officer and director of the responsible issuer in the failure to make timely disclosure 14 With respect to each of the types of disclosure there is a right of action for damages for any person or company acquiring or disposing of an issuer s securities during which time the misrepresentation or material non-disclosure went uncorrected: without regard to whether the person or company relied on the misrepresentation. This is the key deemed reliance provision of the new regime. Burdens of Proof and Defences The new liability regime provides for different burdens of proof and due diligence type defences depending on the role of the individual defendant, the nature of the misrepresentation, and whether there has been a failure to make timely disclosure of a material fact or change One way of sorting through these burdens and available defences is to keep in mind that the more serious and considered written misrepresentations or failure to make timely disclosure are treated more harshly (from a defence perspective) than less considered oral misrepresentations or inadvertent failure to make timely disclosure. Within this generalization, one should consider further that those at the heart of disclosure responsibility issuers, directors, and officers will also be subject to a reverse onus of proof, while other defendants will not, depending on the circumstances. 14 New OSA sections 138.3(4) 8

9 By way of example, a director of an issuer at a time when there was a misrepresentation in a core document 15 such as a prospectus or an offering memorandum, will be strictly liable subject to proving the elements of a due diligence type defence. In contrast, if the misrepresentation was in a public oral statement 16 for example, an issuer s CFO makes a misrepresentation while being interviewed during a television broadcast then the plaintiff must prove that the CFO knew that the oral statement contained a misrepresentation when he made it; deliberately avoided acquiring knowledge that the oral statement contained a misrepresentation; or was guilty of gross misconduct in connection with the making of the oral statement. 17 Where an action is brought for a misrepresentation contained in a non-core document, or in a public oral statement, a person or company is not liable unless the plaintiff proves that the person or company knew of the misrepresentation, deliberately avoided acquiring knowledge of the misrepresentation; or by acting or failing to act was guilty of gross misconduct in connection with the release of the misrepresentation. 15 The legislation distinguishes between core documents and other (non-core) documents: Core documents: includes a prospectus, take-over bid circular, issuer bid circular, directors circular, rights offering circular, management discussion and analysis, annual information form, information circular annual financial statement, and in the case of an officer of a responsible issuer, a material change report. Other (non-core) documents: includes all types of documents not classified as core documents, required to be filed with the Commission; not required to be filed with the Commission and that are filed with the Commission, or are filed or required to be filed with a government agency under applicable securities or corporate law or with any stock exchange; or any other communication the content of which would reasonably be expected to affect the market price or value of a security Public oral statement: means an oral statement made in circumstances in which a reasonable person would believe that information contained in the statement will become generally disclosed These three elements of the plaintiff s burden of proof knowledge, wilful blindness, gross misconduct will be repeated elsewhere in the statute 9

10 The plaintiff need not prove these elements of knowledge, wilful blindness or gross misconduct with respect to misrepresentations in non-core documents or public oral statements if the defendant is an expert, as defined by the legislation; however, as described below, the liability of experts is somewhat limited. 18 Similarly, the plaintiff need not establish these elements in respect of misrepresentations contained in core documents where the legislation presumes liability subject to available defences. Where an action is brought for failure to make timely disclosure, a person or company is not liable unless the plaintiff proves that the person or company knew, at the time the failure to make timely disclosure first occurred, of the change and that the change was a material change; deliberately avoided acquiring knowledge of the material change; or by acting or failing to act was guilty of gross misconduct in connection with the failure to make timely disclosure. The plaintiff need not prove these elements of knowledge, wilful blindness or gross misconduct in respect of a failure to make timely disclosure if the defendant is a responsible issuer or an officer of a responsible issuer, or an investment fund manager or officer of an investment fund manager. In such cases, if a failure to make timely disclosure has been established, there is a presumption of liability subject to any of the defences available under the proposed regime. 19 Expert Liability Expert is a defined term meaning a person or company whose profession gives authority to a statement made in a professional capacity by the person or company. A non-exhaustive list of experts includes, accountants, actuaries, New OSA section 138.4(1),(2) New OSA section (4), (5) 10

11 appraisers, auditors, engineers, financial analysts and lawyers. There is provision for the liability of experts for misrepresentations in documents and public oral statements provided that: the misrepresentation is also contained in a report, statement, or opinion made by an expert the misrepresentation includes, summarizes or quotes from the expert report, statement, or opinion; and if the misrepresentation is made by someone other than the expert, the expert consents in writing to the use of the expert report, statement or opinion. Therefore, for an expert to be strictly liable for his or her opinions which are quoted or summarized by others, then the expert must have consented in writing to such use of his or her opinion. When the consent is given for the use of the expert opinion, the opinion is treated in a manner similar to a core document. It is a considered opinion, and the expert, by providing consent to its use, is mindful that the opinion will be relied upon, not only by the issuer (to whom the consent would be given) but by those individuals to whom the issuer is communicating the expert s opinion. Therefore, as noted above, the plaintiff is not required to prove the expert s knowledge of the misrepresentation, wilful blindness, or gross misconduct. If an expert report, opinion or statement contains a misrepresentation, and it is quoted or summarized with the consent of the expert, then there is a presumption of liability subject to available defences. These provisions circumvent the substantial protections provided to auditors by Hercules Management. 11

12 Defences Where there is a presumption of liability (for example, where there has been a misrepresentation in a core document; or liability of a responsible issuer or an officer of a responsible issuer for failure to make timely disclosure) certain due diligence type defences are available. In relation to a misrepresentation in a document or a public oral statement, a defendant is not liable if it can prove that it conducted or caused to be conducted a reasonable investigation and, at the time of the release of the document or the making of the public oral statement, the defendant had reasonable grounds to believe that there was no misrepresentation. 20 Similarly, in relation to a failure to make timely disclosure, a defendant is not liable if it can prove that it conducted or caused to be conducted a reasonable investigation and that it had reasonable grounds to believe that there would be no failure to make timely disclosure. 21 The reasonableness of the investigation or whether a party is guilty of gross misconduct is to be determined by a court having regard to the relevant circumstances including a number of enumerated factors. 22 A defence to all types of misrepresentation or failure to make timely disclosure is available if it can be proved by the defendant that the plaintiff had knowledge of the misrepresentation or the non-disclosure when making his or her investment decision New OSA section 138.4(6)(a) New OSA section 138.4(6)(b) New OSA section 138.4(7) New OSA section 138.4(5) 12

13 Damages The new legislation contains a somewhat complex damages assessment mechanism which provides for different damages calculations depending on whether the plaintiff acquired or disposed of the issuer s securities during the period of time following the misrepresentation or failure to make timely disclosure, and before the correction of the inaccurate disclosure record. Stated another way, damages are essentially based on the difference in the price paid for the securities during the period when the disclosure was inaccurate, and the market value of the securities after the disclosure record. is corrected 24 Consider the following examples: A misrepresentation is made, or there is a failure to make a disclosure of a material change on day X. A public correction of the misrepresentation or disclosure of the material change is made on day Y. An individual acquires securities after day X but before day Y i.e., during a period when there is inaccurate disclosure about the responsible issuer: If the individual disposes his securities after day Y but within 10 trading days of day Y, damages shall equal the difference between the average price paid for the securities by the individual and the price received by the individual upon disposition. If the individual does not dispose of his securities after day Y, damages shall equal the number of securities acquired by the individual between X and Y multiplied by the difference between the average price paid for the securities by the 24 New OSA s.138.5(1),(2) 13

14 individual and, if there is a published market for the securities, the average trading price of the issuer s securities for the 10 trading days following the correction of the disclosure record on day Y. 25 An individual disposes of securities after day X but before day Y during a period when there is inaccurate disclosure about the responsible issuer: If the individual acquires securities after day Y but within 10 trading days of day Y, damages shall equal the difference between the average price received for the securities by the individual between X and Y and the price paid by the individual in the acquisition of securities after day Y. If the individual does not acquire any securities after day Y, damages shall equal the number of securities disposed of by the individual between X and Y, multiplied by the difference between the average price received for the securities by the individual and, if there is a published market for the securities, the average trading price of the issuer s securities for the 10 days following the correction of the disclosure record on day Y New OSA s.138.5(1). Note, I have attempted to simplify the damages calculation sections in this explanation. The proposed revisions to the OSA include an adjustment for prices paid for securities on acquisition to include commissions paid; but no adjustment for commissions on prices received on disposition; all taking into account the result of hedging or other risk limiting transactions. Also, where securities are disposed of more than 10 trading days after day Y, there is another mechanism for calculating damages. New OSA s.138.5(2). The proposed revisions to the OSA include an adjustment for prices received for securities on disposition deducting commissions paid; but no inclusion for commissions paid on subsequent acquisition; all taking into account the result of hedging or other risk limiting transactions. Also, where securities are acquired more than 10 trading days after day Y, there is another mechanism for calculating damages. Note also, trading price is a term which has to be defined; however CSA proposed a somewhat complex definition, dealing with various scenarios, such as where there is a published market closing price of the securities under consideration, where there is no published market closing price, where the securities are thinly traded, and where they are not traded at all during the material period of time. Where there is a published market closing price, and the shares are traded on more than one-half of the trading days during which the price is considered, the trading price is the average closing price on each day there is trading in the securities weighted by volume of securities traded on each day during the period under consideration. It is expected that the CSA definition will be adopted as part of a regulation to the OSA. 14

15 Assessed damages shall not include any amount that a defendant proves is attributable to a change in the market price of securities that is unrelated to the misrepresentation or failure to make timely disclosure. 27 Therefore, in an example of a plaintiff acquiring securities for $10 per share during the time when the issuer s disclosure record was inaccurate; and, during the 10 trading days after the disclosure record was corrected, the average trading price of the issuer s shares was $5 per share, then, subject to the defendant s evidence to the contrary, the plaintiff s damages are $5 per share multiplied by the number of shares affected. The damages determination would then boil down to a battle of valuation experts with the defendant having the onus of proving that the decline in share price from $10 to $5 per share was attributable to factors other than the market assimilating the correction of the inaccurate disclosure record (i.e., the defendant would try and prove the price change was due in whole or in part to a general down turn in the market, or due to a down turn in the sector within which the issuer operates, or for some other reason.). The damages assessment calculations are designed to be purely compensatory and do not make provision for punitive damages; however, the new scheme does not derogate from any other rights that a plaintiff or a defendant may have. That is, an investor is free to pursue traditional common law remedies, including punitive damages; however, such remedies cannot be grounded in the new statutory scheme. 28 The extent to which common law remedies will be pursued in addition to Bill 198 relief remains to be seen, and of course, will depend on the facts of the individual case, and whether the actual reliance requirement necessary to sustain common law negligent misrepresentation can be proved New OSA s.138.5(3) New OSA s

16 Liability Limits Among the features of the proposed legislation designed to prevent the perceived excesses of U.S. securities litigation are those provisions limiting the liability of defendants. Liability limits vary depending on the individual or entity: 29 Defendant Liability Limit Responsible issuer The greater of 5% of its market capitalization and $1 million Director and officer of responsible issuer The greater of $25,000 and 50% of the aggregate of the director s or officer s compensation 30 from the responsible issuer and it affiliates Influential person who is not an individual The greater of 5% of its market capitalization and $1 million Influential person who is an individual Director or officer of an influential person Expert The greater of $25,000 and 50% of the aggregate of the influential person s compensation from the responsible issuer and its affiliates The greater of $25,000 and 50% of the aggregate of the director s or officer s compensation from the influential person and its affiliates The greater of $1 million and the revenue that the expert and the affiliates of the expert have earned from the responsible issuer and its affiliates during the 12 months preceding the misrepresentation New OSA section definition liability limit New OSA section definition Compensation : compensation received during the 12 month period immediately preceding the day on which the misrepresentation was made or on which the failure to make timely disclosure first occurred, together with the fair market value of all deferred compensation including, without limitation, options, pension benefits and stock appreciation rights, granted during the same period, valued as of the date that such compensation is awarded 16

17 Persons or companies making public oral statements not referred to above The greater of $25,000 and 50% of the person s or company s compensation from the responsible issuer and its affiliates The liability cap is to have national application such that there is a reduction from the cap of amounts awarded against defendants or settlements paid by defendants in other Canadian jurisdictions in respect of the same misrepresentation or failure to make timely disclosure. 31 It must be noted that the liability limits do not apply if the plaintiff proves that the person or company (who is not the responsible issuer) knowingly made or acquiesced in the making of the misrepresentation or the failure to make timely disclosure. 32 Proportionate Liability Not Joint and Several Except Where Knowledge of Misrepresentation or Failure to Make Timely Disclosure In order to mitigate the problem of corporate defendants with deep pockets being forced to pay for damages caused primarily by others, the legislation provides for proportionate liability as opposed to joint and several liability. 33 However, in the case of a misrepresentation or a failure to make timely disclosure, if a court determines that a particular defendant, other than the responsible issuer, knowingly authorized, permitted or acquiesced in the making of the misrepresentation or failure to make timely disclosure, the whole amount of the assessed damages can be recovered from that defendant. Where there has been more than one defendant against whom such a finding has been made, then liability for damages will be joint and several among such defendants New OSA s (1) New OSA s (2) New OSA s (1) New OSA ss (2),(3) 17

18 Co-defendants may seek contribution and indemnity from each other. 35 Avoiding Strike Suits Judicial Screening of Claims and Settlements The draft legislation embodies the Allen Report s conclusion that statutory civil liability will have little effect without the availability of shareholder class actions. However, shareholder class actions, which are seen by the Allen Report as necessary to achieve the policy objectives, raise the spectre of strike suits. In order to avoid strike suits, the proposed legislation provides for a screening mechanism whereby plaintiffs must obtain leave of the court to commence an action. The test for obtaining leave requires the plaintiff to prove to the court that (i) the action is brought in good faith, and (ii) it has a reasonable possibility of success at trial. The application to commence a suit under these provisions must be supported by affidavit evidence; in other words, the plaintiff or representative plaintiff must provide persuasive evidence to satisfy the two part test. 36 It is noteworthy that this preliminary merits test is the same test recommended by the Ontario Law Reform Commission in its 1982 Report on Class Actions. 37 The fact that, contrary to the Commission s 1982 recommendation, the test was not incorporated in the Ontario Class Proceedings Act, points to the obvious observation that judicial approval of a shareholder action under the amended OSA is different from certification under the Class Proceedings Act. In a certification motion under the Class Proceedings Act, the merits of the plaintiff s case is not scrutinized except to the extent that the pleadings must disclose a cause of action. In contrast, the leave application under the OSA will New OSA s (4) New OSA s Ontario Law Reform Commission, Report on Class Actions (Ontario Ministry of the Attorney General: 1982), Volume 2, Chapter 7 18

19 require something more namely, a consideration with the benefit of evidence of whether the plaintiff s case has a reasonable possibility of success at trial. In addition to the plaintiff s evidence, each defendant is required to serve and file one or more affidavits setting forth the materials upon which they intend to rely on the leave application. It is not sufficient for the defendant to wait and see what evidence the plaintiff has provided and make a determination as to whether it should file any evidence in reply. Rather, the scheme requires the defendants to file evidence and subject themselves to cross-examination which will assist plaintiffs in obtaining evidence that is in the control of defendants. One can imagine how this would work in a case where there is a claim of failure to make timely disclosure of a material change. The plaintiff would have evidence of the disclosure of the material change when the disclosure is finally made (i.e., the poor financial information about the issuer is disclosed to the market). The plaintiff would also know of the market s reaction to the disclosure (i.e., a decline in the share price). However, the plaintiff will not have access to evidence about when the material change occurred, who knew about it, and what were the events that led to the decision to make the required disclosure. This latter evidence would be in the control of the defendant, and the plaintiff, through cross-examination, would essentially be able to discover the defendant on these issues. As an additional wrinkle, the Ontario Securities Commission is to be served with materials in support of the application for leave to commence suit, and it may intervene in the leave application, and the suit itself. It is unclear exactly what role the OSC would play in such an intervention; however, given that the policy rationale for the new right of action is to improve secondary market disclosure, it is logical that any Commission intervention would be to assist plaintiffs in proving their case New OSA s (2); s

20 To further discourage entrepreneurial strike suit litigation, it is proposed that all settlements be court approved on such terms as the court thinks fit 39. The standard of approval would appear to be substantially the same as that required in the approval of class proceedings in Ontario, namely, on such terms as the court considers appropriate 40, however the approval under the OSA will consider whether there are other proceedings pending in other jurisdictions in Canada where plaintiffs seek relief arising out of the same misrepresentation or failure to make timely disclosure. Conclusion The new civil liability regime provided by the amendments to the OSA is complex. The complexity is due in large measure to the competing policy objectives of encouraging better continuous disclosure, while attempting to avoid the spectre of US style strike suits and causing undue harm to innocent incumbent shareholders of companies whose officers and directors may be guilty of some malfeasance. The striking of a balance between these competing interests has resulted in the various burdens of proof, defences, liability limits and idiosyncratic procedural safeguards which have been described above. Therefore, a certain amount of painstaking deconstruction of the statute will be necessary in order to determine rights, remedies and defences available to parties. Things to watch for include: the proclaiming in force of the amendments to the OSA New OSA s Class Proceedings Act, 1992, s.29(1) 20

21 regulations under the OSA defining the meaning of market capitalization and trading price (relevant to the determination of damages and limits of liability) the first leave applications under the new civil liability regime. 21