Increased Enforcement Activity Resulting in More Securities Class Actions

Sino-Forest Corp.’s shares plummeted after Carson Block and Muddy Waters’s earlier sensational allegations of fraud. On June 8, 2011, the OSC confirmed that it was investigating and that afternoon Sino-Forest shareholders launched a class action. The $6.5 billion class action against Sino-Forest, its directors, officers, auditors, underwriters and consultants is based on misrepresentations in the company’s disclosure.

The Sino-Forest case is an example of how increased enforcement activity and the availability of a statutory cause of action are resulting in more securities class actions. Recent judgments of Ontario courts interpreting the statutory provisions for civil liability for secondary market disclosure give investors greater access to the courts. This trend increases the exposure to risk faced by issuers of securities, directors, officers, and underwriters. Knowledge and experience in enforcement actions is essential to help issuers of securities, directors, officers and underwriters defend against these cases.

The controversial twin decisions of the Ontario Superior Court of Justice in IMAX¹ to grant leave to commence a class action under section 138 of the Securities Act and to certify a global class remain the law in Ontario after leave to appeal to the Divisional Court was denied. The relatively low threshold that investors must meet to get leave to commence a securities class action was confirmed by Arctic Glacier² which adopted the reasoning in IMAX.

IMAX

The Leave Decision

In IMAX, the court held that the “good faith” element of the statutory test for leave requires the plaintiffs to establish that they are bringing their action in the honest belief that they have an arguable claim and for reasons that are consistent with the purpose of the statutory cause of action, and not for an “oblique or collateral purpose”.

The “reasonable possibility” element of the test requires the plaintiffs to establish “something more than a de minimis possibility or chance that the plaintiff will succeed at trial” and it must be based on a reasoned consideration of the evidence.

The Certification Decision

A global class including foreign investors who acquired IMAX securities on the TSX and NASDAQ was certified. The court observed the integration of Canadian and American capital markets, the legitimate bases for enforcement in both Canada and the US by regulatory claims and by civil claims and concluded that there is no prohibition against overlapping class proceedings.

The barrier which had previously kept investors from success in common law class actions was removed. The court held that the plaintiffs did not need to plead that each investor relied on the misrepresentations. Instead, the plaintiffs could prove reliance at trial by relying on the efficient market theory which assumes that misrepresentations are reflected in the share price.

Companies and their officers and directors may owe a duty of care to investors where the representations are made as part of continuous disclosure obligations prescribed by the Securities Act and the intended recipients of such disclosure are the investing public.

Arctic Glacier

The Leave Decision

Arctic Glacier adopted the low threshold and the rationale for it established by IMAX. In IMAX, the court reasoned that the statutory provisions for civil liability for secondary market disclosure are remedial in recognition of the obstacles to pursing claims for secondary market misrepresentation under common law. The leave test should therefore be interpreted to permit access to the courts by shareholders with legitimate claims.

The Certification Decision

The class was certified. The Superior Court of Justice recognized that the case law on the issue of whether the plaintiffs have to prove individual reliance is “in a state of evolution” but distinguished the case factually on the basis that the alleged misrepresentations made in the core documents are consistent and repetitive and could essentially be treated as one.

Canadian Securities Class Actions are on the Rise

Securities class actions commenced in Canada are continuing to increase. Eight securities class actions were filed in 2010. By the end of 2010, there were a record 28 active Canadian securities class actions. Last year, five securities class action claims settled in Canada for a total of approximately $67.5 million, with an average settlement of $13.5 million. Settlements continue to be significantly higher in the US than in Canada. The highest settlements recorded in Canada are for the cross-border actions against Nortel, which settled for approximately $2.5 billion. The highest domestic settlement was awarded in the Portus case for approximately $611 million. In contrast, all of the top 10 settlements in the US now exceed $1 billion.³

Investors do not appear to be deterred by either the damages cap of 5% of the issuer’s market capitalization imposed by the Securities Act⁴or historically lower Canadian settlements. The low threshold to commence an action means that issuers of securities, directors, officers and underwriters are exposed to a greater risk of being sued and with greater enforcement activity the number of securities class actions will continue to increase.

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¹ Silver v. IMAX , [2009] O.J. No 5573 (Sup.Ct. J.)[Leave to Commence Class Action under s.138 of the Ontario Securities Act ]; [2009] O.J. No 5573 (Sup.Ct. J.) [Certification]; leave to appeal to Div. Ct. denied [2011] O.J. No. 656.

² Dobbie v. Arctic Glacier Income Fund, [2011] O.J. No 932 (Sup.Ct. J.).

³ NERA Economic Consulting, Trends in Canadian Securities Class Actions: 2010 Update (January 31, 2011).

⁴ Section 138.7 of the Securities Act. For officers and directors of the issuer, the cap is the greater of $25,000 or 50% of the aggregate of the directors’ or officers’ compensation.