New Prospectus Content Guidelines for London Listed Resource Companies
by: Paul Airley, Claire Atkins
On March 23, 2011, the European Securities and Markets Authority (ESMA), the successor entity to the Committee of European Securities Regulators (CESR), published an update of the CESR’s Recommendations (Recommandations) for the consistent implementation of the European Commission's Regulation on Prospectuses, with revised guidance as to the content requirements of prospectuses issued by resource companies, including, for the first time, recommendations as to content requirements of a competent person’s report (CPR). The UK Listing Authority (UKLA) will take the Recommendations into account when deciding whether to approve a prospectus, the publication of which is required for listing on the main market of the London Stock Exchange.
The Recommendations were originally published in February 2005 to enable issuers and their advisors to make judgments about prospectus disclosure in a consistent manner across Europe. Issuers are obliged to prepare prospectuses according to the Recommendations (as revised from time to time) unless they are unsuitable in a particular case.
To ensure appropriate levels of transparency and assurance over reserves and resources figures reported to the market, the Recommendations contain a framework, at paragraphs 131-133, for additional disclosure by mineral companies of reserves and resources information.
In April 2010, following concerns that the original Recommendations lacked clarity compared to regulatory standards in other markets, did not reflect market practice and were not effective in standardizing resource company prospectus disclosure across the European Union (EU), the CESR published a consultation document on a new framework for disclosure. The below considers some of the key provisions of the updated Recommendations.
Mineral companies are now defined as "companies with material mineral projects." Accordingly, companies performing only exploration now fall within the Recommendations, which previously referred to companies whose principal activity is the extraction of mineral resources. The materiality of projects will be assessed having regard to all the company’s mineral projects relative to the issuer and its group as a whole. However, mineral companies that are only issuing wholesale debt will be exempt from these provisions.
Basic Disclosure Requirements for all Prospectuses
The updated Recommendations continue to set out basic disclosure requirements for all prospectuses and issuers must explain any inconsistencies between these disclosures and information already in the public domain.
CPR: New Appendices to the Recommendations
A CPR is now required when an issuer is first admitted to trading (regardless of how long it has been a mineral company; a CPR was previously only required under the Recommendations where the issuer had been a mineral company for less than three years). However, a CPR is not required, in normal circumstances, thereafter. The issuer must have continued to report and publish details of its resources, reserves and results/prospects annually in accordance with one of the specified reporting standards for this exemption to apply. The CESR noted that market practice expects a CPR at float but not generally thereafter and the updated Recommendations are consistent with this practice.
In addition, there are now detailed requirements for the preparation of the CPR, including requirements as to the qualifications of the competent person and the acceptable reporting and valuation standards.
New appendices to the Recommendations set out recommended, rather than compulsory, CPR minimum content. This allows a degree of flexibility in preparing a CPR, which, in particular, addressed concerns that the compulsory inclusion of a valuation of reserves and resources is excessive.
The ESMA decided not to implement the proposed requirement to provide CPRs in three instances: on new assets being acquired where the acquisition is a significant gross change (although basic prospectus disclosure will be required on target assets); where there has been a (material) first-time declaration of new reserves; or where there has been a significant change in reserves levels. However, a CPR will continue to be necessary under the UKLA Listing Rules on a Class 1 acquisition or disposal of mineral resources.
Reporting and Valuation Standards
A list of reserves and reporting codes has been compiled; it includes only oil and gas codes derived from the Society of Petroleum Engineers' PRMS system and mining codes aligned with the Committee for Mineral Reserves International Reporting Standards. The ESMA removed the proposed U.S. mining reporting standards (SEC Industry Guide 7) from the list and Russian and Chinese standards are also excluded.
Cash-Flow Projection and Funding Forecast
Under the original Recommendations, mineral companies without a three-year trading history were required to include a two-year cash-flow projection validated by accountants as well as a two-year funding forecast. In the consultation, CESR proposed to abolish these requirements, and to replace them with a new requirement to include an 18-month forward-looking management-prepared projection where the fundraising proceeds are to be applied towards exploration or development projects.
The ESMA decided to proceed with the proposal to remove the requirement for a cash-flow projection and funding forecast, but not to implement the replacement provision. On reflection, the ESMA considered that general disclosure obligations as to use of proceeds are adequate.
In the face of continuing criticism about its enforcement capability, the Ontario Securities Commission (OSC) and other provincial securities regulators seem determined to toughen their approach by publicizing more aggressively the steps they are taking and resorting to remedies or interpretations of securities law that are likely to be perceived as more muscular than traditional approaches.
One innovation has been to be more direct about measures that are being considered to strengthen enforcement. During a speech delivered in February, the new Chair of the OSC increased the transparency of its enforcement philosophy by floating new ideas including settlements without admissions of liability and clarifying the credit for cooperation process.1
In June and July of this year, in the wake of market turbulence triggered by a short seller who published very negative research concerning a particular issuer (Sino-Forest), the OSC, in another example of increased transparency, not only publicly confirmed that it had quickly commenced an investigation of that issuer but issued an unusual follow-up notice warning other issuers that it would be extending its investigation to others with substantial assets in emerging markets.
In an even more aggressive step, late in August the OSC removed various Sino-Forest officers in connection with a temporary cease trade order. In an embarrassing development for the OSC, the action in relation to the officers had to be withdrawn the same day. Nonetheless, the issuer voluntarily took steps almost immediately to achieve the same result the OSC’s defective order would have accomplished.
The OSC emerging markets investigation extends beyond Sino-Forest and similarly placed issuers to the role played by parties it describes as "gatekeepers": auditors, underwriters and authors of research in relation to such issuers. The risk assessment of certain issuers has been raised in at least one recent investment dealer research update after visiting the properties and checking for related party transactions.
Though perhaps not immediately apparent, this focus on a cross-section of similarly situated public issuers represents an extension of Commission practice in recent years to raise best practice levels by drawing public attention in compliance notices to continuous reporting practices of public companies that regulators, and the OSC in particular, consider deficient.
In an effort to demonstrate that existing provincial securities regulators are becoming more aggressive in pursuing securities violations, the Canadian Securities Administrators (CSA) 2010 Enforcement Report announced the CSA’s intentions to use courts and prosecutions to enforce the securities law instead of relying mainly on public interest proceedings which are perceived to be more lenient and less punitive and to have less deterrent value than prosecutions. Prosecutions can result in criminal records and prison sentences.
In the Western provinces and more recently in New Brunswick, securities commissions are behaving more aggressively through a combination of proceedings and public education against tax and pension related scams and ponzi schemes that are aimed at retail investors and have produced large losses to vulnerable individuals.
The schemes under attack are more sophisticated than offerings of valueless "moose pasture" securities. These more sophisticated scams are not easy to fit within the reach of the securities law. Yet, by characterizing such schemes as "investment contracts" and making that concept more elastic, securities enforcement officials have been able to launch and successfully settle proceedings. The regulators have had success using this approach in cases against self-represented defendants who have not mounted strong attacks on the legal theory being advanced. In such proceedings, commissions have also slammed dubious uses of prospectus and registration exemptions. This has brought more and more activities into the category of egregious securities non compliance.
A few cases illustrate this trend. In the Synergy Group2 decision, affirmed by the Alberta Court of Appeal, the Alberta Securities Commission found that the concept of "profits" includes "financial benefits" in order to determine that the agreements by which investors entered into a tax reduction/rebate scheme would meet the requirements of an investment contract (an investment of money in a common enterprise with expected profits arising significantly from the efforts of others). Gold-Quest 3 was found to be both a ponzi scheme and a pyramid scheme that illegally traded and distributed securities and made misrepresentations to investors. The regulator found in Kustom Design4 that because the money loaned by investors was secured by a promissory note and letters of assignment, it fell within the definition of a security under the Securities Act (Alberta). The Commission also found that the agreements entered into by investors constituted investment contracts.
Other relatively recent trends include:
- increasing reliance on the power in the Securities Act (Ontario) to prosecute frauds (Sextant5, Grmovsek6);
- more frequently initiating criminal proceedings even after a settlement has been reached under securities law with respect to the same conduct (Agnico Eagle7, Grmovsek8);
- pursuing negligence by registrants (especially as regards a want of due diligence in investigating the products they sell) that puts investors at risk (Portus9, Norshield10);
- declaring conduct that is technically lawful to be contrary to the public interest if it violates fundamental securities law principles even if the conduct is not so abusive that it damages any identifiable class (Eugene Melnyk11); and
- more findings that Securities Act (Ontario) breaches by registrants equate to breaches of fiduciary duties owed by those registrants (Sextant12, Norshield13).
1 Wetston, Howard (2011, February). Strong Regulation, Strong Capital Markets. Speech presented to the Economic Club of Canada, Toronto, Ontario.
2 Synergy Group (2000) Inc. v. Alberta (Securities Commission), 2011 ABCA 194.
3 Re Gold-Quest International Corp., 2010 ABASC 18.
4 Re Kustom Design Financial Services Inc., 2010 ABASC 179.
5 Sextant Capital Management Inc et al (2011), 34 OSCB 5863.
6 Stanko Joseph Grmovsek and Gil I. Cornblum (2009), 32 OSCB 9038.
7 R. v. Landen, 2008 ONCJ 561 (CanLII).
8 Ibid note 6.
9 Madhavi Acharya-Tom Yew, "Failed hedge fund co-founder gets four years in jail" The Toronto Star (26 May, 2011).
10 Norshield Asset Management (Canada) Ltd. et al. (2010), 33 OSCB 2139.
11 Biovail Corporation, Eugene N. Melnyk et al (2010), 33 OSCB 8914.
12 Ibid note 5.13 Ibid note 10.
On August 12, 2011, the Canadian Securities Administrators (CSA) published for comment the Implementation of Stage 2 of Point of Sale Disclosure for Mutual Funds. This request for comments proposes changes to National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81-101), Form 81-101F3 Contents of Fund Facts Documents (NI 81-103F3) and Companion Policy 81-101CP Mutual Fund Prospectus Disclosure.
1. Substance and Purpose of Stage 2 of Point of Sale Disclosure for Mutual Funds
The CSA believes that the fund facts document (Fund Facts) is central to the point of sale disclosure framework. The Fund Facts is in plain language, no more than two pages double-sided, and highlights information that is important to investors. The proposed implementation of Stage 2 of Point of Sale Disclosure for Mutual Funds will replace the prospectus delivery requirement under securities legislation, with a requirement that the Fund Facts be delivered in place of the prospectus within two days of the purchase of a mutual fund.
2. History of the Amendments
On October 24, 2008, the Joint Forum of Financial Market Regulators published a framework paper (Framework) with the aim to harmonize the disclosure regime of mutual funds and segregated funds. In order to achieve this, the Framework focused on three main principles: providing investors with key information about a fund; providing the information in a simple, accessible and comparable format; and providing the information before investors make their decision to buy. An article discussing the Framework is available here.
Concurrent to the release of the Framework, CSA Notice 81-318 Request for Comment — Framework 81-406 Point of sale disclosure for mutual funds and segregated funds was published, requesting comments on issues related to the implementation of the Framework and its principles. On June 19, 2009, proposed amendments were published. An article discussing the proposed amendments is available here.
Stage 1 of Point of Sale Disclosure for Mutual Funds came into force on January 1, 2011, and required that all mutual funds subject to NI 81-101 file a Fund Facts for each series or class of a mutual fund concurrent with the filing of the simplified prospectus and annual information form. Stage 1 also required that a Fund Facts be sent to investors free of charge upon request. An article discussing the implementation of Stage 1 is available here.
3. Proposed Implementation of Stage 2 of Point of Sale Disclosure for Mutual Funds
The proposed amendments to NI 81-101 require delivery of the most recently prepared Fund Facts, for the applicable class or series in all instances where the prospectus would otherwise be required to be delivered, although the prospectus and the simplified prospectus must be sent to investors free of charge upon request. Delivery of the Fund Facts must be made within two days of the purchase of the mutual fund. The CSA has published Staff Notice 81-321 Early Use of the Fund Facts to Satisfy Prospectus Delivery Requirements, which provides guidance on key terms and conditions that the CSA will consider in an application to permit the use of the Fund Facts to satisfy the current prospectus delivery requirements, prior to the implementation of this stage.
The amendments also restrict the documents that may be attached to, or bound with, the Fund Facts on delivery. A Fund Facts may only be attached or bound with:
- the confirmation of purchase;
- another Fund Facts of a mutual fund that is required to be sent to the investor;
- the simplified/multiple prospectus or the annual information form of the mutual fund;
- management reports of fund performance; and
- financial statements of the mutual fund.
None of the attachments may be placed in front of the Fund Facts other than a confirmation of purchase, front cover or table of contents. Non-educational material, such as promotional brochures, may be delivered with the Fund Facts provided that it is not included within, wrapped around, or attached or bound to the Fund Facts.
When the Fund Facts is delivered in place of the simplified prospectus, legislative amendments will be sought (where necessary) in order to preserve an investor’s right to:
- damages or to rescind the purchase if the investor does not receive the Fund Facts; and
- withdraw from the purchase within two business days of receiving the Fund Facts.
As the Fund Facts is incorporated by reference into the simplified prospectus, the existing statutory rights for misrepresentation in a prospectus will apply for any misrepresentations in the Fund Facts.
The proposed amendment will make minor changes to NI 81-101F3 to clarify that all fees and expenses payable directly by an investor when buying, holding, selling or switching units or shares of the mutual fund must be disclosed in the Fund Facts.
The proposal also provides a mutual fund with the option to include the fund identification code for the class or series. Mutual funds that wish to include the fund identification code prior to the implementation of Stage 2 may submit an application letter, with the prospectus requesting a variation in the requirements of NI 81-103F3 to include the relevant fund codes for the class or series of the fund described in the fund facts document. This relief will generally be evidenced by way of receipt.
The CSA has stated that the final stage involves reviewing comments submitted and publishing the proposed requirements to implement point of sale delivery for mutual funds. During this stage, the CSA will also consider point of sale delivery for other types of publicly offered investment funds, and intends to seek further feedback on the content of the Fund Facts, in particular the presentation of risk and the inclusion of a benchmark.
Comments on the Implementation of Stage 2 of Point of Sale Disclosure for Mutual Funds must be received by November 10, 2011.
B.C. Securities Commission Adopts Additional Disclosure Requirements for Private Placements
by: Shawn Doyle, Sven O. Milelli, Brian Vick
The British Columbia Securities Commission (BCSC) has adopted amendments (the Amendments) to National Instrument 45-106 – Prospectus and Registration Exemption (NI 45-106), which will take effect on October 3, 2011. The Amendments will introduce a separate new form, Form 45-106F6 – British Columbia Report of Exempt Distribution (the New Form), which will replace Form 45-106F1 for the purposes of reporting B.C. exempt distributions (sometimes referred to as private placements). The New Form will require certain issuers to provide more disclosure to the market regarding insiders, registrants and promoters purchasing securities. In particular, the additional disclosure requirements are significant for non-reporting issuers other than investment funds that are managed by fund managers registered in Canada (Exempt Funds). Such issuers must disclose: (i) the names, municipalities and countries of residence of their insiders and promoters; (ii) the number and types of securities controlled or owned by such insiders and promoters, including securities purchased in the exempt distribution being reported; and (iii) the total price paid for all of the securities owned or controlled by such insiders and promoters, including securities purchased in the exempt distribution being reported. In addition, all issuers other than Exempt Funds must indicate whether the purchasers of securities in a private placement are registrants or insiders of the issuer. The companion policy to NI 45-106 has also been amended to make it clear that if a private placement is reportable in British Columbia and in one or more other Canadian jurisdictions, the issuer must file the New Form with the BCSC and file Form 45-106F1 in the other applicable jurisdictions. The Amendments do not, however, alter the circumstances in which a private placement must be reported in British Columbia. The types of exempt distributions that are reportable continue to be governed by Part 6 of NI 45-106 and include, among others, private placements made in reliance on the exemptions for accredited investors and for family, friends and business associates; the offering memorandum exemption; and the minimum investment amount exemption. Such distributions are reportable in British Columbia if (i) the relevant securities are sold to purchasers resident in British Columbia or (ii) the issuer has a significant connection to British Columbia1. When the Amendments were proposed last year, the BCSC also made a proposal to begin publishing the full content of each filed New Form, including information regarding purchasers (which, under the New Form, is to be collected in respect of all issuers2 other than Exempt Funds), on its website. However, in response to privacy concerns raised by several commenters, the BCSC has adopted a modified version of its original proposal. In particular, the BCSC will publish online only information regarding non-individual purchasers, but will make certain information regarding individual purchasers available to the public at its offices. This information will include the individual’s name and whether or not he or she is an insider or registrant, but will not include his or her residential address. The BCSC has also amended NI 45-106 to impose a prohibition on the use of information made available at its offices other than for a person’s own investment research concerning the relevant issuer. McCarthy Tétrault Notes 1 The existence of any of the following factors would generally indicate that an issuer has a "significant connection" to British Columbia and that a distribution by it would be deemed to be made from British Columbia: (i) the issuer’s "mind and management" is primarily located within British Columbia (e.g., the issuer’s head office or the residences of its key officers and directors are located in British Columbia); (ii) the business of the issuer is administrated from, and the operations of the issuer are conducted in, British Columbia; or (iii) acts, advertisements, solicitations, conduct or negotiations in furtherance of the distribution take place in British Columbia. Whether or not an issuer has a significant connection to British Columbia, if a private placement by a non-reporting issuer (other than an Exempt Fund) is reportable in British Columbia, the information regarding insiders and promoters must be included in the New Form. 2 In the case of an offering that is reportable in British Columbia due to the issuer having a significant connection to British Columbia, information must be collected and reported regarding all purchasers. For issuers without a significant connection to British Columbia, such information must be collected and reported only in respect of those purchasers who are resident in British Columbia.
The British Columbia Securities Commission (BCSC) has adopted amendments (the Amendments) to National Instrument 45-106 – Prospectus and Registration Exemption (NI 45-106), which will take effect on October 3, 2011. The Amendments will introduce a separate new form, Form 45-106F6 – British Columbia Report of Exempt Distribution (the New Form), which will replace Form 45-106F1 for the purposes of reporting B.C. exempt distributions (sometimes referred to as private placements). The New Form will require certain issuers to provide more disclosure to the market regarding insiders, registrants and promoters purchasing securities.
In particular, the additional disclosure requirements are significant for non-reporting issuers other than investment funds that are managed by fund managers registered in Canada (Exempt Funds). Such issuers must disclose: (i) the names, municipalities and countries of residence of their insiders and promoters; (ii) the number and types of securities controlled or owned by such insiders and promoters, including securities purchased in the exempt distribution being reported; and (iii) the total price paid for all of the securities owned or controlled by such insiders and promoters, including securities purchased in the exempt distribution being reported. In addition, all issuers other than Exempt Funds must indicate whether the purchasers of securities in a private placement are registrants or insiders of the issuer.
The companion policy to NI 45-106 has also been amended to make it clear that if a private placement is reportable in British Columbia and in one or more other Canadian jurisdictions, the issuer must file the New Form with the BCSC and file Form 45-106F1 in the other applicable jurisdictions. The Amendments do not, however, alter the circumstances in which a private placement must be reported in British Columbia. The types of exempt distributions that are reportable continue to be governed by Part 6 of NI 45-106 and include, among others, private placements made in reliance on the exemptions for accredited investors and for family, friends and business associates; the offering memorandum exemption; and the minimum investment amount exemption. Such distributions are reportable in British Columbia if (i) the relevant securities are sold to purchasers resident in British Columbia or (ii) the issuer has a significant connection to British Columbia1.
When the Amendments were proposed last year, the BCSC also made a proposal to begin publishing the full content of each filed New Form, including information regarding purchasers (which, under the New Form, is to be collected in respect of all issuers2 other than Exempt Funds), on its website. However, in response to privacy concerns raised by several commenters, the BCSC has adopted a modified version of its original proposal. In particular, the BCSC will publish online only information regarding non-individual purchasers, but will make certain information regarding individual purchasers available to the public at its offices. This information will include the individual’s name and whether or not he or she is an insider or registrant, but will not include his or her residential address. The BCSC has also amended NI 45-106 to impose a prohibition on the use of information made available at its offices other than for a person’s own investment research concerning the relevant issuer.
McCarthy Tétrault Notes
1 The existence of any of the following factors would generally indicate that an issuer has a "significant connection" to British Columbia and that a distribution by it would be deemed to be made from British Columbia: (i) the issuer’s "mind and management" is primarily located within British Columbia (e.g., the issuer’s head office or the residences of its key officers and directors are located in British Columbia); (ii) the business of the issuer is administrated from, and the operations of the issuer are conducted in, British Columbia; or (iii) acts, advertisements, solicitations, conduct or negotiations in furtherance of the distribution take place in British Columbia. Whether or not an issuer has a significant connection to British Columbia, if a private placement by a non-reporting issuer (other than an Exempt Fund) is reportable in British Columbia, the information regarding insiders and promoters must be included in the New Form.
2 In the case of an offering that is reportable in British Columbia due to the issuer having a significant connection to British Columbia, information must be collected and reported regarding all purchasers. For issuers without a significant connection to British Columbia, such information must be collected and reported only in respect of those purchasers who are resident in British Columbia.
On June 17, 2011, the Canadian Securities Administrators (CSA) published for comment revised Proposed Amendments to National Instrument 54-101 – Communications with Beneficial Owners of Securities of a Reporting Issuer (NI 54-101), National Instrument 51-102 – Continuous Disclosure Obligations and other related policies that are designed to further enhance the shareholder voting communication process (collectively, Revised Proposed Amendments). The original proposed amendments to NI 54-101 were first published on April 9, 2010 and as a result of the 27 comments received, the CSA released the Revised Proposed Amendments. See our previous articles,"CSA Proposes Amendments to Streamline Communication with Beneficial Owners" and "Reaction to CSA’s Proposed Amendments to the Beneficial Owner Communication Process" on the initial proposed amendments to NI 54-101 regarding the comments thereto for more information.
The most significant features of the Revised Proposed Amendments are changes to the availability of and the standardization to the "notice-and-access" mechanism to send proxy-related materials to shareholders, in connection with either annual or special meetings. In conjunction with this mechanism, shareholders will be provided with access to information circulars in connection with shareholder meetings either online or, upon request, by paper copy. In addition, the Revised Proposed Amendments simplify the process by which beneficial owners are appointed as proxy holders in order to attend and vote at shareholder meetings and require enhanced disclosure regarding the beneficial owner voting process.
Impact of Revised Proposed Amendments on Notice-and-Access Procedures
The "notice-and-access" procedure provides a reporting issuer the ability to deliver proxy-related materials by sending a notice package to all shareholders informing them that proxy-related materials are filed on SEDAR under the reporting issuer’s profile and enclosing the relevant voting document. The Revised Proposed Amendments now: (i) allow issuers to use: "notice-and-access" for all meetings; and (ii) require that the notice package be sent to all shareholders and contain the foregoing items, accompanied only by a plain-language explanation of the notice-and-access mechanism, which explanation is also required to be posted on the reporting issuer’s website. In the event a reporting issuer wishes to include additional materials in the notice package sent to shareholders, a hard copy of the information circular would also need to be included.
Pursuant to the Revised Proposed Amendments, management of a reporting issuer that wishes to use notice-and-access for the first time will be required to post a document on a website explaining notice-and-access in plain language, and to issue a news release with respect to such anticipated use not more than six months nor less than three months before the expected date of the first meeting for which notice-and-access will be used. The Revised Proposed Amendments permit reporting issuers to obtain standing instructions from registered holders (and intermediaries from beneficial owners) with respect to receiving paper copies of the information circular in the notice package. To facilitate effective integration of the Revised Proposed Amendments, annual instructions to receive annual reports will constitute instructions to include a paper copy of the information circular in the notice package where the reporting issuer uses notice-and-access.
For SEC issuers that comply with the notice-and-access procedures in the U.S., the Revised Proposed Amendments provide an exemption from complying with the Canadian requirements to such SEC issuers only if they have a limited Canadian presence.
The Revised Proposed Amendments also discuss:
- additional guidance in the companion policy to NI 54-101 on factors reporting issuers should take into account when deciding when and how to use "notice-and-access" ;
- certain other changes to the technical aspects of the beneficial owner communication procedures including for example:
- where a reporting issuer uses notice-and-access, permitting a reporting issuer to abridge the date for determining shareholders entitled to vote and receive notice to not less than 30 days before the meeting date, and the sending of the notification of meeting and record dates under Section 2.2 of NI 54-101 to not less than 30 days before the meeting date in order to enable shareholders to have sufficient time to request and receive a paper copy of the information circular if they so desire in advance of the meeting;
- limiting delivery of the notice package to shareholders to prepaid mail or courier; and
- introducing a deadline of three of four business days before the 30th day before the meeting date by which a reporting issuer must provide materials for forwarding to intermediaries.
- enhanced disclosure of the voting process by requiring reporting issuers to disclose use of "notice-and-access".
Other Changes to Beneficial Owner Proxy Appointment Process
The Revised Proposed Amendments suggest that unless a beneficial owner has instructed otherwise, where an intermediary appoints a beneficial owner or nominee as a proxy holder, such person also be given the authority to attend, vote and otherwise act for and on behalf of the intermediary in respect of all matters that come before the applicable meeting (and not just those on the voting form).
Deadline for Comments
The deadline for the submission of comments on the Revised Proposed Amendments is August 16, 2011. We would be pleased to raise with the CSA, on your or your company’s behalf, any comments you may have on the Revised Proposed Amendments or on the proxy voting system as a whole.
On July 15, 2011, the Canadian Securities Administrators (CSA) published the summary of the results of their annual continuous disclosure (CD) review program of reporting issuers (other than investment funds) for fiscal year 2011 in CSA Staff Notice 51-334 – Continuous Disclosure Review Program Activities for the fiscal year ended March 31, 2011 (Staff Notice).
Under the CD review program, the CSA conducts both "full reviews" and "issue-oriented reviews" in order to identify material disclosure deficiencies in a reporting issuer’s continuous disclosure record. The summary of the CSA’s findings is provided to (i) help reporting issuers understand and comply with their disclosure obligations; and (ii) give examples of areas of common deficiencies.
This year’s issue-oriented reviews were conducted in the following areas: International Financial Reporting Standards (IFRS) transition disclosure (see CSA Staff Notice 52-320 and CSA Staff Notice 52-326); certification (see CSA Staff Notice 52-327); oil and gas technical disclosure; corporate governance disclosure (see CSA Staff Notice 58-306); material contracts; and review of press releases and complaints lodged by investors and other external stakeholders. See our related article, "CSA Staff Conducts IFRS Transition Disclosure Review," dated August 26, 2010.
In Canada, there are approximately 4,100 reporting issuers, not including investment funds. The number of "full reviews" conducted in fiscal 2011 was 436, a decrease of 17per cent from the previous year, while the number of "issue-oriented reviews" was 915, an increase of 11 per cent. See our article for last year’s review.
In their review, the CSA identified common material deficiencies in the areas of MD&A, financial statements and regulatory compliance.
- using non-GAAP financial measures without an explanation of why the non-GAAP financial measure is meaningful to investors;
- missing clear quantitative reconciliations from non-GAAP financial measures to the most directly comparable measure calculated in accordance with Canadian GAAP;
- failing to identify material forward-looking information in disclosure and using boilerplate language instead of describing the material factors or assumptions used to develop the forward looking information;
- referring to immaterial information without inclusion of material information in the discussion of operations in a reporting issuer’s most recently completed financial year;
- providing inadequate disclosure regarding liquidity fluctuations, particularly in the case of reporting issuers with negative cash flows from operations or negative working capital positions or, reporting issuers that have breached their debt covenants; and
- failing to disclose or analyze items or events that have had a material impact in the fourth quarter of a reporting issuer’s financial year.
- omitting the required disclosure in connection with the measurement of inventories; and
- providing generic disclosure of related party transactions without identifying the nature of the transaction and the description of the relationship with the related party.
Regulatory Compliance Deficiencies
- providing inadequate disclosure of performance goals or similar conditions as well as the benchmark group used for specific levels of compensation in executive compensation disclosure.
The results of the annual CD program provide guidance for reporting issuers in terms of navigating through their continuous disclosure obligations and avoiding inadequate disclosure. In particular, with the changeover to IFRS, reporting issuers should pay particular attention to describing the impact on their financial statements and operations in their transition disclosure and to the different requirements of the new system when preparing disclosure materials. For 2012, the CSA will continue to focus on IFRS transition.
Drafting Tips for Reporting Issuers
Reporting issuers should review their disclosure and take note of the suggestions offered in the Staff Notice when preparing this year’s disclosure documents. The following tips can be derived from a review of the Staff Notice.
- If non-GAAP financial measures are used, ensure that an explanation of why the non-GAAP measure is meaningful to investors is included, together with a clear quantitative reconciliation from the non-GAAP financial measure to the most directly comparable measure calculated in accordance with the issuer’s GAAP presented in the financial statements.
- Include a non-boilerplate list of factors and assumptions supporting management’s assessments if forward-looking information is included.
- Provide a balanced discussion of the issuer’s results of operations, including quantification of all material variances and an analysis of the reasons for the changes discussed.
- Identify any known or expected fluctuations and trends in the issuer’s liquidity and disclose any defaults or risk of defaults of debt covenants and how the issuer intends to cure the default or otherwise address the risk.
- Discuss and analyze events that had a material impact in the issuer’s fourth quarter; if a separate fourth quarter MD&A is filed, ensure it is adequately referenced.
- If benchmarking is used by the issuer, disclose the name of all the individual companies included in the benchmark group and discuss why those companies were selected to be part of the group.
- Disclose performance goals or similar conditions that are either quantitative or qualitative performance targets achieved by the issuer on which the issuer has based its decision to award compensation. If a target is based on a subjective measure, ensure that the analysis and discussion clearly discloses that compensation decisions with respect to this target are not based on objective identifiable measures.
We would be delighted to assist you in the preparation of disclosure or to provide further guidance regarding the Staff Notice.
To view the Staff Notice, click here.
The Ontario Securities Commission (OSC) recently released the results of its preliminary review of Ontario reporting issuers’ first International Financial Reporting Standards (IFRS) interim financial reports for the quarter ended March 31, 2011. As well, in IFRS Release No. 2 – A Reminder Before You File Your First IFRS Interim Financial Report, the OSC released a tip sheet to assist issuers in ensuring that they include certain elements in their first IFRS interim financial reports (the Tip Sheet). Both documents are available at this website, recently established by the OSC to provide, in one place, information and guidance to assist issuers with the transition to IFRS.
In its IFRS Release No.1 – Filing Deficiencies in Issuers’ First IFRS Interim Financial Reports (the Release), OSC Corporate Finance has identified three recurring deficiencies made in IFRS filings to date:
- missing IFRS 1 reconciliation disclosures as required by paragraph 32 of IFRS 1 First Time Adoption of International Financial Reporting Standards;
- missing opening IFRS statement of financial position on the face of the financial statements, as required by subsection 4.3(2)(e) of National Instrument 51-102 Continuous Disclosure Obligations (NI 51-102); and
- missing statement of changes in equity as required by subsection 4.3(2)(b) of NI 51-102 and paragraph 20(c) of IAS 34 Interim Financial Reporting.
The OSC noted that the majority of these deficient filings appear to have been reviewed by the issuer’s auditor, since the filings did not include the accompanying notice required by subsection 4.3(3) of NI 51-102 when an interim review has not been performed. If the filings are not reviewed by the auditor, issuers should ensure that they include this required notice.
The Release reminded issuers to ensure that their internal control over financial reporting (ICFR) and disclosure controls and procedures (DC&P) are robust enough to address changes resulting from IFRS transition. The OSC recommended that where necessary, issuers should establish or modify specific ICFR and DC&P in order to prepare its financial statements in accordance with IFRS and securities legislation.
Additional suggestions and reminders are noted in the Tip Sheet, including, with respect to IFRS 1, reconciliations, notes to the interim financial report, unreserved statements of compliance with IAS 34 Interim Financial Reporting, and disclosure regarding accounting policies.
Issuers that have yet to report their interim IFRS financial reports should carefully review the guidance and suggestions offered in the Release and the Tip Sheet. Further guidance on IFRS reports and disclosure is available by clicking here.
Cash Shells on the London Market
by: Paul Airley, Claire Atkins
Cash shells or SPACs (special purpose acquisition companies) are purpose-built vehicles with a stock market quote and a board of directors, but no active business and no assets other than a strong management team with specific sector expertise and the funds raised from financial backers (which will typically include management). The structure gives managers a ready-made stock market listing, a cash war chest and an acquisition currency at a time when, owing to global financial circumstances, the cost of financing is high and transactions are difficult to execute.
Cash shells were all the rage on the AIM market of the London Stock Exchange (LSE) six years ago, arriving in such numbers that the LSE was forced to tighten the rules to safeguard the market’s reputation. In March 2005 alone, 31 cash shells rushed to list to beat the introduction of the rule changes the following month, which stipulated that a cash shell must raise a minimum of £3 million, a figure deemed high enough to require at least some institutional interest.
2010 and 2011 have seen a number of cash shells not only returning to AIM, but, for the first time, obtaining admission to the Official List of the United Kingdom Listing Authority (UKLA) by way of a Standard Listing. The timing of the appearance of these cash shells is a function of the regulatory environment of these markets and the volatile nature of the present economic climate. The cash shell structure is designed to take advantage of any dislocation in the market to acquire assets at favourable prices. When asset valuations start to rise, the opportunity for these acquisition vehicles could well disappear.
The Regulatory Environment
Access to the Premium Listing tier of the Official List, whereby the issuer is subject to onerous eligibility and continuing obligation requirements and is potentially eligible for inclusion in the FTSE indices, is not possible for a cash shell; there are a number of entry requirements that a shell company simply would not be able to satisfy, which do not apply to Standard Listing or to AIM applicants. In particular, a Premium Listing applicant is required to have unqualified, consolidated, independently audited accounts covering a three-year period; a revenue earnings record in respect of at least 75 per cent of its business for a three year period; and a history of control over the majority of its assets for at least a three-year period.
AIM cash shells are more heavily regulated than those with a Standard Listing. In the last 18 months, management teams and their financial backers have increasingly been making a virtue of the minimal regulatory requirements applicable to cash shells with a Standard Listing while raising very significant amounts of money on IPO. The key factor, as is made explicit in the listing documents, is that a Standard Listed issuer is not required to obtain shareholder approval for the acquisition of a target.
While a Standard Listing applicant must prepare a prospectus that is approved by the UKLA, it otherwise benefits from the relaxation of a number of rules that are applicable to Premium Listed and/or AIM companies. A Standard Listed cash shell is not:
- required to appoint a financial advisor or sponsor on IPO or on a continuing basis (an AIM company is required to appoint a "nominated advisor" (or "nomad") at all times);
- subject to the "Listing Principles" set out in the UKLA Listing Rules;
- subject to any minimum fund raising requirement (other than to have a market capitalization of £700,000 as set out in the UKLA Listing Rules applicable to all Official List companies);
- required to set out a formal investing policy or to implement it within any particular time frame (it follows that a change in investing policy is not subject to shareholder approval, nor is its ongoing validation in the event of failure to implement it within a stated period);
- subject to the restrictions on share dealing (by the issuer or management);
- subject to restrictions as to the price and nature of share issuances or buy backs (although a Standard Listed issuer must publish a prospectus if it issues, over a 12-month period, further securities represent 10 per cent or more of the securities of a class already admitted to trading);
- required to adhere to certain specific ongoing disclosure requirements (other than the general obligation to disclose price-sensitive information);
- required to seek shareholder or sponsor approval for related party transactions or (a nomad must confirm to an AIM listed issuer that such a transaction is fair and reasonable insofar as the shareholders are concerned and certain prescribed details of the transaction must be notified to the market);
- required to offer pre-emption rights to shareholders (indeed, typically any statutory pre-emption rights are disapplied prior to the IPO in connection with consideration shares issued on an acquisition); or
- required to comply with any corporate governance codes (although certain disclosures as to internal control and risk management procedures must be made in the issuer’s annual report).
In practice, issuers tend to voluntarily commit to certain standards or restrictions in relation to some of the above points, although the UKLA has no power to police compliance with such commitments.
It is usual for an issuer to state that it will seek a Premium Listing for the enlarged group following the acquisition.
Notable Transactions Involving Standard Listed Cash Shells
Horizon Acquisition Company plc raised £417.7 million on its IPO and Standard Listing in February 2010. Horizon has achieved its investment goal by acquiring APR Energy, a Florida-based temporary power provider, in June 2011 for £527 million (£221 million in cash and £306 million in Horizon shares).In June 2010 came the IPO and Standard Listing of Nat Rothschild’s Vallar plc raising £687 million to fund acquisitions in the metals and mining industry. June 2011 saw the acquisition by Vallar of PT Bumi Resources Minerals Tbk, an international mining company, and a reorganization resulting in the introduction of Bumi plc as the new Premium Listed parent company. The acquisition price represented a total consideration of £1.27 billion.
Marwyn Partners plc obtained a Standard Listing in January 2011, raising a relatively modest £6 million; Marwyn is presently concluding a further placing and recommended offer for Praesepe plc, a gaming company, for a total consideration of approximately £39 million. The IPO in February 2011 of Justice Holdings Limited launched by, among others, Nicolas Berggruen, the billionaire backer of hedge fund GLG and Pearl Insurance, raised £900 million. Vallares plc, the second of Nat Rothchild’s vehicles, raised £1.35 billion in June 2011. It will focus on oil and gas assets. Both Justice and Vallares have yet to make acquisitions.
These listings, together with the record of successfully completed acquisitions, represent some of the most significant recent transactions in the London market and clearly show that the cash shell concept, particularly by way of Standard Listing, remains compelling in current market conditions.
Sunrise, sunset. Perhaps a matchmaker would have helped. The saga of the dispute between Ventas, Inc. and Health Care Property Investors, Inc. arose five years ago when Sunrise Senior Living Real Estate Investment Trust’s "board of trustees determined that a strategic sale process of its assets would be beneficial to its unitholders, thus effectively putting Sunrise ‘in play’ on the public markets" (per Blair J.A. for the Ontario Court of Appeal) in Ventas, Inc. v. Sunrise Senior Living Real Estate Investment Trust, 2007 ONCA 205 (CanLII) at para. 2. The Court of Appeal upheld the decision of Pepall J. given two weeks earlier (2007 CanLII 8934 (ONSC)) that Sunrise was obligated to enforce the Standstill Agreement which was entered into by HCP (the unsuccessful auction participant) with the result that HCP was disqualified from pursuing a topping bid that it had announced in a press release.
This was not the end of the story. As a result of the release of the United States Court of Appeal’s decision affirming the Kentucky jury award of $101 million dollars to Ventas for tortious interference with a prospective advantage in (6th Cir, May 17, 2011), a little more light has been shed on this battle. This compensatory award was effectively the difference between Ventas’ original bid in the auction based on $15/unit and what it felt it had to increase it by $1.50 to overcome the uncertainty as to approval by the Sunrise unitholder vote created by HCP’s proposed conditional offer of $18. As the sun starts to set, this epic is approaching Götterdämmerung for HCP because the litigation continues and is coming to a crescendo. It is still now just twilight, rather than darkness. But surely there will be darkness once these gods and giants have finished fighting each other.
The reader may wish to refer to my reflections: "Does the Left Hand Know What the Right Hand is Doing?" in Volume 4, Issue 3 of McCarthy Tétrault’s Litigation Co-Counsel May 20, 2011 as to the elements of the Canadian tort of unlawful interference with economic relations (in that article I observed that two panels of the Ontario Court of Appeal had mysteriously come out with different standards for this tort within 10 days of the release of their reasons, with the two panels sharing a common member). The U.S. Appeal Court reviewed the law of Kentucky in this regard and determined that there had been express adoption of certain sections of the Restatement (Second) of Torts issued by the American Law Institute.
Section 766B: Intentional Interference With Prospective Contractual Relation
One who intentionally and improperly interferes with another’s prospective contractual relation…is subject to liability to the other for the pecuniary harm resulting from loss of the benefits of the relation, whether the interference consists of (a) inducing or otherwise causing a third person not to enter into or continue the prospective relation or (b) preventing the other from acquiring or continuing the prospective relation.
Section 767: Factors in Determining Whether Interference is Improper
In determining whether an actor’s conduct in intentionally interfering with a contract or a prospective contractual relation of another is improper or not, consideration is given to the following factors:
- the nature of the actor’s conduct;
- the actor’s motive;
- the interests of the other with which the actor’s conduct interferes;
- the interests sought to be advanced by the actor;
- the social interests in protecting the freedom of action of the actor and the contractual interests of the other;
- the proximity or remoteness of the actor’s conduct to the interference; and
- the relations between the parties.
It was observed that improper interference under Section 766B requires the plaintiff to "show malice or some significantly wrongful conduct" with unlawful means being defined as including fraud, deceit or coercion. Relying on Section 768, the U.S. Appeal Court noted that in the case of a tortious interference claim between competitors, plaintiffs are held to a more exacting standard as competition is not an improper basis for interference. The U.S. Appeal Court stated:
As the district court observed, to ignore HCP’s breach of its contract with Sunrise would "create an artificial reality within the case." (…HCP’s breach of its Standstill Agreement with Sunrise illuminates the anti-competitive activities in which HCP engaged and is central to an understanding of Ventas’ allegations of fraud and deception. As Ventas argued at trial, HCP misled the market by making public statements that were contrary to its obligations under the Standstill Agreement without disclosing the existence of the agreement or other relevant information. See, e.g., Hornung, 754 S.W.2d at 859 ("[M]alice may be inferred in an interference action by proof of lack of justification.").
There was a "Comedy of Errors," not restricted to HCP’s activities, but also reaching over to those of Sunrise and of Ventas. They include the following:
(a) An auction process would ordinarily suggest that the rules of the game are the same for all bidders as set out in Maple Leaf Foods. Blair J.A. in Ventas noted at para. 56:
An auction process is well-accepted as being one — although only one — "appropriate mechanism to ensure that the board of a target company acts in a neutral manner to achieve the best value reasonably available to shareholders in the circumstances"; Maple Leaf Foods Inc. v. Schneider Corp. 1998 CanLII 5121 (ONCA), 1998 CanLII 5121 (ONCA), (1999), 42 O.R. (3d) 177 at 200 (C.A.).
(b) However, in this case as set out at page 3 of the U.S. Appeal Court reasons:
The auction procedures required each participant to sign a confidentiality agreement, which included a standstill provision ("Standstill Agreement") that would, among other things, prohibit the participant from making or announcing any bid outside of the auction process for a period of 18 months following the conclusion of the auction. The Standstill Agreement also proscribed any actions that would require Sunrise to publicly announce a bid outside of the auction process.
As invitees to the preliminary stages of the auction, both Ventas and HCP independently negotiated and entered into Standstill Agreements with Sunrise. Neither was a party to the other’s Standstill Agreement. HCP’s Standstill Agreement permitted HCP to make only one final bid, but Ventas’ Standstill Agreement permitted Ventas to make a second final bid if Sunrise accepted a competing offer after Ventas made its initial final bid.
Thus there would not appear to have been a level playing field for these two bidders. While Ventas knew rules applicable to Ventas and while HCP knew the rules applicable to HCP, it appears that neither knew the rules applicable to the other. So possibly Ventas had a handicap advantage even if it were not aware of that advantage until much later in the game.
(c) Ventas assumed when it negotiated the purchase agreement with Sunset to acquire the assets of Sunrise that HCP’s standstill obligations would also fall away. If that had been the case, then HCP would have been permitted to make a topping bid with Ventas having the comfort of a break fee in the event HCP was eventually successful in a bidding war.
(d) If the auction were designed to maximize value for the equity holders, why did Sunrise agree in Section 4.4 of the Ventas Purchase Agreement to enforce any standstill obligations then remaining outstanding, particularly when it seems that Ventas assumed that HCP had a standstill obligation that was identical to that of Ventas’s and that would fall away on the conclusion of an agreement by someone to buy the assets of Sunrise? This seems contrary to a fiduciary out condition situation that is so valuable to the beneficiaries of an enterprise that has put itself into play.
(e) SSL was an operator of many retirement facilities, including those of Sunrise and some of HCP. Perhaps HCP picked an unnecessary fight with SSL (or at least was attempting to wage war on two fronts) that prevented it from making an unconditional offer. Coming to a deal with SSL was essential to success on the part of any bidder. The HCP CEO had to acknowledge he was playing hardball with SSL.
(f) Once it had a signed deal with Ventas which was publicly disclosed, Sunrise advised HCP that HCP must still honour its standstill obligations. However, some weeks after that caution, Sunrise suggested to HCP that it might want to make a bid. This strikes me as remarkably peculiar behaviour. However Ventas did not take Sunrise to task in any litigation. It therefore seems that Ventas did not want to fight a two enemy war, particularly when such a fight would likely have alienated the Sunrise unitholders who had yet had to approve the deal.
(g) HCP jumped in with both feet (perhaps positioning one of those appendages in its mouth) with a public announcement that it was making an $18 bid without mentioning that it would be conditional on reaching a deal with SSL. The press release advised of a proposed "acquisition that reflects its significantly higher price and is otherwise identical to the agreement between Sunrise and Ventas." Subsequently the condition was disclosed.
(h) HCP indicated in a press release that it had sent a signed unconditional offer to Sunrise. However, its CEO had to admit in testimony that a signed offer had never been sent nor had he been authorized to send one.
(i) HCP’s CEO also had to admit that HCP had wanted to hurt Ventas by making it pay more than the $15/unit Ventas had signed up for. No doubt this was a "Eureka!" moment for Ventas’s counsel in cross-examination.
(j) Sunrise issued a press release that Sunrise would not consider HCP’s offer until "such time as it receives a confirmation from HCP that their proposal is not conditional on [HCP] reaching an agreement with [SSL]." However, there was nothing said about this being a breach of the Standstill and Section 4.4 of the Ventas Purchase Agreement, which required Sunrise to enforce any continuing standstill obligations of any party.
(k) It was not until five days after Sunrise’s initial press release, and once Ventas had stumbled (like the derelict seaman blessing unawares the water serpents in the Rime of the Ancient Mariner) across the fact that HCP’s standstill obligations did not drop away, that Ventas appreciated that it had to take further remedial action. It issued a press release that Ventas would increase its offer to $16.50 in recognition that in the events leading up to unitholders’ approval vote sufficient proxies had been deposited to defeat the Ventas deal (notwithstanding the Pepall J. and Ontario Court of Appeal decisions that Sunrise had to enforce the HCP standstill obligations and that a bid from HCP would not be allowed). Ventas felt that this bump was needed to salvage the Sunrise deal and to protect its own reputation. Clearly, it was the good fortune of Ventas to have put that boilerplate into the purchase agreement even if it had assumed HCP’s standstill obligations would have fallen away.
The end result was that the vote turned around in favour of Ventas’ $16.50 bid. Litigation proceeded in Kentucky with Ventas suing HCP. The U.S. Appeal Court is not the final chapter; this court allowed the cross-appeal of Ventas ruling that there was sufficient evidence of fraud to submit the issue of punitive damages to the jury. This issue was remitted back for trial. Given the admissions made in the earlier trial, one may anticipate that HCP may well have serious concern about a very substantial award. One may recall that a Mississippi jury in a breach of contract concerning a single funeral home (where the compensatory damages were assessed at $6 Million) awarded $500 Million of punitive damages, thereby forcing Loewen Group Inc., a Canadian company, into protracted insolvency protection. So it will be awhile yet before the twilight after sunset turns to darkness and all one will hear are the cries of the dying gods and giants. At that stage one may recall the sign off of the radio commentator Paul Harvey: "And now you know the rest of the story."
Lessons to be learned
i) Ventas is now frequently cited as guiding authority as to commercial contract interpretation. Blair J.A. at para. 24 agreed with the view of Pepall J. as to how a commercial contract is to be interpreted:
- as a whole, in a manner that gives meaning to all of its terms and avoids an interpretation that would render one or more of its terms ineffective;
- by determining the intention of the parties in accordance with the language they have used in the written document and based upon the "cardinal presumption" that they have intended what they have said;
- with regard to objective evidence of the factual matrix underlying the negotiation of the contract, but without reference to the subjective intention of the parties; and
- (to the extent there is any ambiguity in the contract)in a fashion that accords with sound commercial principles and good business sense, and that avoids a commercial absurdity.
However, one may wrestle with the point of intention in the case of Section 4.4 of the Ventas Purchase Agreement in light of the assumption of Ventas about HCP’s standstill obligations falling away.
ii) Meaningless redundant boilerplate may not be meaningless. While reading page after page of mind-numbing prose may be a cure for insomnia, parties should be grateful for their commercial counsel being awake and careful in discovering hidden traps/treasures.
(iii) Participants in an auction should ensure that the rules of the game are the same for all — or at least have disclosure that a rival may have a lower hurdle to jump.
(iv) In turn, where a fiduciary out is negotiated, the company in play should avoid putting in artificial/unnecessary barriers that may discourage or prevent others from making a topping offer that would enhance value.
(v) Having agreed to a certain course of action, a party should carry out its obligations under that agreement in good faith or face the consequences of breach. Under other fact circumstances Ventas may have determined that it would have been in its interests to sue Sunrise and its management for encouraging HCP to make a bid notwithstanding HCP’s continuing standstill obligations.
(vi) One should avoid U.S. jury trials, particularly if one is a foreign defendant.
(vii) One should not play unnecessary hardball with a party whose support one needs; nor should one make promises one cannot keep; nor should one make untrue statements. These actions can come back to haunt the actor.
(viii) Consider the consequences pursuant to securities legislation of making a press release containing material misinformation.
Perhaps an admonition for HCP and anyone else who wants to play hardball by interfering with economic relations is that which Shakespeare wrote, not in Julius Caesar: "Cry ‘Havoc’, and let slip the dogs of war", but rather his view in Cariolanus: "Do not cry havoc, when you should but hunt with modest warrant."
Management in public companies often struggles to determine how much or how little to disclose in connection with offerings of securities. Until now, other than market practice there has been little judicial guidance to assist management in making decisions. In Sharbern Holding Inc. v. Vancouver Airport Centre Ltd., 2011 SCC 23, the Supreme Court of Canada has recently provided such guidance by examining the test of what constitutes a "material false statement" under securities statutes.
The facts of Sharbern are sadly familiar: market optimism leads to a crash, which leads to litigation as disappointed investors seek to recoup their losses. In the mid-1990s, investors were tripping over themselves to invest in hotels near the Vancouver airport. There was much enthusiasm, with rosy projections of future profits. At the height of the boom, a developer built two interconnected hotels — one a Marriott, the other a Hilton — and sold each of the hotels to public investors through strata lots. The developer remained as manager of both hotels once they were constructed.
However, by 2001 the bubble had burst, and the Richmond, B.C. hotel market was one of the weakest in Canada. Unhappy investors in the Hilton property brought a class action against the developer, alleging non-disclosure under securities law, specifically whether the developer was liable for making material false statements in the offering memorandum and disclosure statement used to sell the Hilton strata lots. (They also alleged common law negligent misrepresentation and breach of fiduciary duty, but those allegations are not considered in this article.)
At trial, the plaintiffs succeeded. They convinced the trial judge that the developer had a conflict of interest because it had guaranteed a return to the Marriott investors but not to the Hilton investors, and because the developer had charged a lower management fee to the Hilton hotel than it did to the Marriott (the concern being that the developer would have an incentive to favour the Marriott in order to earn the higher fee). This conflict of interest had not been included in the disclosure statement provided to the Hilton investors under the applicable legislation. On appeal, the B.C. Court of Appeal reversed. A further appeal was heard by a full nine-member panel of the Supreme Court of Canada. In a unanimous decision authored by Justice Rothstein, the Supreme Court affirmed the B.C. Court of Appeal’s decision and dismissed the class action claim.
Although the provisions considered by the Supreme Court were under the British Columbia Real Estate Act (now repealed), which imposed liability for a "material false statement," the court’s description of the test of materiality in disclosure documents is relevant under securities legislation generally. Specifically, the court emphasized five points.
The "Reasonable Investor Standard"
First, materiality is to be determined objectively, from the perspective of a reasonable investor.
The Two-Part "Substantial Likelihood" Test
Second, a fact omitted from a disclosure document is material if there is a substantial likelihood that it would have been considered important by a reasonable investor in making an investment decision. It is not sufficient that the fact merely might have been considered important. In this regard, the Supreme Court adopted the test set out by the Supreme Court of the United States in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 428 (1976), and noted that the materiality standard is a balance between too much and too little disclosure. Too little disclosure is obviously problematic, but so is too much: it is not in the interests of investors to be buried in an avalanche of trivial information.
Third, the issue is not whether the fact would have changed the investment decision of the reasonable investor, but whether there is a substantial likelihood that the fact would have assumed actual significance in a reasonable investor’s deliberations.
Fourth, materiality depends on the specific facts, determined in light of all relevant considerations and the surrounding circumstances forming the total mix of information made available to investors. The approach adopted by the Canadian Securities Administrators in National Policy 51-201 Disclosure Standards (July 12, 2002) and by the United States Securities and Exchange Commission in SEC Staff Accounting Bulletin: No. 99 — "Materiality" (August 12, 1999) — a fact-driven and contextual approach — was endorsed.
Burden is on the Plaintiff
Fifth, a plaintiff alleging non-disclosure has the onus of proving materiality and must lead evidence on the point, except where common sense inferences are sufficient.
Applying these principles, the Supreme Court held that the trial judge had made three legal errors in finding the developer’s alleged conflict of interest to be material. First, she erroneously concluded that the conflict of which the plaintiffs complained was inherently material. This conclusion implied that issuers have an obligation to disclose all facts in order to permit investors to sort out what is material and what is not — an approach that would result in excessive disclosure by overwhelming investors with information. In turn, this outcome would impair, rather than enhance, investors’ ability to make decisions. Second, the trial judge reversed the onus of proof, requiring the developer to show that the conflict of interest was not material rather than requiring the plaintiffs to show that it was. Third, she failed to consider all the evidence available to her on the issue of materiality.
The Supreme Court was not only critical of the trial judge but also critical of the plaintiffs, noting that they had failed to adduce sufficient evidence, including expert evidence, to support their allegations of material non-disclosure. The Supreme Court set out evidence which, had it been adduced, might have led to a conclusion of materiality. The plaintiffs could have shown that potential investors who knew of the alleged conflict of interest declined to invest or expressed concern. The plaintiffs could have shown that potential investors declined to invest because they found that there was insufficient disclosure. The plaintiffs could have shown that once the Hilton investors learned of the alleged conflict of interest they had expressed concerns about it. The plaintiffs could have shown that the developer did not act diligently and in good faith in managing the Hilton hotel, or that the developer actually acted on the conflict of interest to the detriment of the Hilton investors. The absence of evidence of this type was fatal to the plaintiffs’ claims of materiality.
Sharbern Holding Inc. v. Vancouver Airport Centre Ltd. makes it more difficult for plaintiffs to recover damages under securities legislation. The concept of materiality has been interpreted robustly, the onus of proving materiality has clearly been placed on the shoulders of plaintiffs, and subject to a limited exception plaintiffs are required adduce evidence (including expert evidence) in support of an allegation of materiality. Yet while making life more difficult for plaintiffs, the decision does not necessarily make life easier for issuers. While Sharbern makes clear that it is not necessary for issuers to disclose every imaginable fact that might be considered in an investment decision, it also makes clear that issuers have an obligation not to defeat the purpose of disclosure by bombarding potential investors with a blizzard of non-material information.
McCarthy Tétrault Notes
Sharbern is important for two reasons. First, it provides guidance to issuers on how to approach disclosure. Second, it clarifies that plaintiffs need to prove whether a fact is material.Sharbern imposes burdens on plaintiffs and issuers alike — on plaintiffs to prove that an undisclosed fact really mattered, and on issuers to get the balance right by disclosing everything that is material but without inundating potential investors with non-material information.
Ontario Court of Appeal Narrowly Interprets Exemptions to Franchisors’ Disclosure Obligations
by: Jane A. Langford, Jameel Madhany, Adam Ship
Franchisors’ disclosure obligations may be triggered even where a franchisee is assigning its interest in a franchise to a third party. The Ontario Court of Appeal recently considered the circumstances in which a franchisor will be exempt from the disclosure obligations contained in the Arthur Wishart Act (Franchise Disclosure) (the Act). The case holds important lessons to franchisors that facilitate the purchase of their existing franchises by new prospective franchisees.
The Court’s decision in 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd. (Springdale Pizza) makes clear that the exemption from disclosure obligations contained in section 5(7)(a)(iv) of the Act — which applies where the "grant of the franchise is not effected by or through the franchisor" — is now limited to situations where the franchisor is nothing more than a "passive participant" in the sale of a franchise.
In Springdale Pizza, a prospective franchisee approached a franchisor with the intention of purchasing a Pizza Depot franchise. The franchisor directed the purchaser to an existing franchisee that was trying to sell its franchise. While the transaction was essentially an assignment of the franchise interest from the previous owner to the purchaser, the franchisor also required the buyer to execute two additional documents: an undertaking to car wrap all delivery vehicles with the Pizza Depot brand, and an acknowledgment that the franchisor was not substantiating or verifying the sales figures reported by the previous owner.
The sale was completed but, several months later the purchaser sought rescission of the agreement on the basis that they had not received a disclosure document from the franchisor. The Act permits rescission of a franchise agreement up to two years after its execution, if the franchisor never provided a disclosure document, unless one of the Act’s exemptions from disclosure applied in the circumstances.
The franchisor maintained that it was not required to provide a disclosure statement on the basis of the exemption in section 5(7)(a)(iv) of the Act. It was the franchisor’s position that this transaction was effected by or through the previous franchisee and that the franchisor only exercised its right, pursuant to section 5(8) of the Act, to act reasonably in approving (or disapproving) the resale of the franchise.
The Court of Appeal disagreed. The Court held that given the objective of the Act, which is to rectify power imbalances in franchise relationships through disclosure obligations, this exemption from disclosure should be interpreted narrowly to apply only where the franchisor is merely a "passive participant" in the sale of the franchise.
In this case, the franchisor’s role in the sale of the franchise exceeded that of a passive participant. In particular, the franchisor:
- directed the prospective buyer to a specific franchisee that was looking to sell its franchise;
- was involved in the negotiations;
- required the purchaser to actively seek its consent, as opposed to merely exercising its right of refusal enshrined in section 5(8) of the Act (even though the agreement stipulated that the franchisors’ consent could not be unreasonably withheld); and
- required the purchaser to execute two additional documents that had not been executed by the previous franchisee.
Collectively, these steps constituted "active" participation such that the "grant of the franchise" was "effected by or through the franchisor." The disclosure obligations in the Act therefore applied. The Court did pause to say that each circumstance on its own may be insufficient to reach this conclusion, but taken together, the circumstances support the finding that the franchisor went beyond a passive role in the transaction.
Franchisors wishing to avoid the obligation to provide disclosure statements to new franchisees in these kinds of buy/sell transactions, must maintain a truly "passive" role in the transaction.
Parties to a franchise relationship should also consider what effect this decision will have on the other exemptions from disclosure obligations in section 5(7) of the Act. It is reasonable to assume that they will also be interpreted in a very narrow manner.
When the first overtime class actions broke onto the Canadian legal scene in 2007, observers wondered whether this signalled a move toward the class action culture to which U.S. employers have grown accustomed. With the expanded right to overtime under the new federal Fair Labour Standards Act 1(FLSA) — known as the "FairPay Rules" — adopted in 2004, the incidence of overtime class actions has mushroomed in the U.S. To date, attempts to follow this trend in Canada have been met with a lukewarm reaction from the courts. In those cases where overtime class actions have been certified, appeals are pending on the certification decisions, and we have yet to see a case go to trial on the merits.
But while mass overtime claims have occupied our attention over the past several years, that is not the only use for class action proceedings in employment-related claims. The increasing use of class action proceedings to contest unjust dismissals, workplace discrimination — or changes to pension and benefits that affect large groups of employees — could be a concern for all employers, even those who are not at particular risk of overtime claims.
Although the mere mention of a class action is enough to strike terror in the hearts of employers, there may be cases in which class action proceedings may actually serve as a vehicle for achieving final resolution of employment liabilities.
Status of Pending Overtime Class Actions
In stark contrast to the stream of overtime class action cases that make headlines in the United States, there are only four cases pending in Canada where a decision has been rendered — or is expected to be rendered shortly — on certification2.
Fresco v. Canadian Imperial Bank of Commerce3, a $651-million claim on behalf of current and former non-management, non-unionized retail branch employees who were allegedly required or permitted to work overtime without additional pay as required under the Canada Labour Code.
In June 2009, the Ontario Superior Court of Justice refused certification on the basis that the claims of the class members did not raise a common issue that would sufficiently advance litigation proceedings if determined on a class-wide basis. In essence, because there was no evidence of a systemic practice of unpaid overtime, the case would break down into individual inquiries, which was not appropriate for class proceedings. This decision was upheld by the Divisional Court in September 2010 and has now been appealed to the Court of Appeal for Ontario, with a hearing set for September 14-16, 2011.
Fulawka v. The Bank of Nova Scotia4, a $350-million claim (including $100 million of punitive damages) on behalf of full-time employees who were allegedly required to work overtime without additional pay due to systemic deficiencies in the application of the Bank’s overtime policies.
The class action was certified by the Ontario Superior Court of Justice on February 19, 2010. The case was distinguished from Fresco on the basis that there was evidence of systemic deficiencies resulting in ongoing unpaid overtime. This decision was appealed to the Divisional Court. The hearing took place on December 1-3, 2010, and the judgment is under reserve5.
McCracken v. Canadian National Railway Company6, a $300-million claim (including $50 million of punitive, aggravated and exemplary damages) on behalf of over 1500 "first-line supervisors" who were allegedly misclassified as "managers" and wrongly denied payment of overtime.
The class action was certified by the Ontario Superior Court of Justice on August 17, 2010. As in Fulawka, this case was distinguished from Fresco on the basis that it raised a systemic deficiency in CN’s classification of employees as being exempt from statutory overtime provisions (i.e., a "misclassification" case as opposed to an "off-the-clock" case, where employees allege that they were required to work additional hours). The certification decision has been appealed to the Divisional Court. Written materials have been filed with the court, and a hearing is expected before the end of this year.
Rosen v. BMO Nesbitt Burns7, in which compensation is sought on behalf of current and former Investment Advisors and Financial Advisors who were allegedly misclassified as being exempt from overtime pay and were expected to work up to 80 hours per week.
A Statement of Claim was initially filed on February 8, 2010. Certification materials have been filed, but there is no decision yet on certification.
Non-Overtime Employment Class Actions
As noted at the outset, there are many examples of class actions that have been allowed to proceed in Canada in matters involving allegations of unjust dismissal, discrimination, as well as in pension and benefits cases. Of these, the pensions and benefits cases have traditionally been the most fertile ground for class action proceedings, with claims for negligence, breach of contract and/or breach of fiduciary duty, often in cases where benefits are unilaterally changed, reduced or terminated, or where there is a funding shortfall.
The gravitation towards class proceedings in these cases can likely be explained by the requirement that, to be certified, class action claimants must demonstrate that the case raises "common issues" to be determined by the court. Most employment-related claims will come down to an analysis of individual facts and circumstances, and are unlikely to lend themselves to class proceedings. However, in any case where the individual claims rest on a pivotal decision or action of the employer, or where they are based on a systemic fault in the employer’s workplace policies, a class action could be an appropriate vehicle.
Plaintiffs’ counsel seem keen to explore this avenue. Of particular note, business closures and staff reductions following the recent economic downturn have spawned a wave of unjust dismissal class actions.
This trend is of concern to employers, especially when we consider the most recent case hitting headlines in the U.S. — the certification of the largest-ever employment discrimination case against Wal-Mart, which involves an estimated 1.5-million-member class8.
As well, employers can be stuck with a huge bill for court costs if they unsuccessfully defend a certification motion. In the McCracken case, plaintiff’s counsel was awarded the largest cost award in Canadian legal history ($740,000) after winning the certification motion9.
Class Action as an Instrument for Settlement
While being the target of a class action is generally not a happy occurrence, there may be cases where it can serve as a tool for employers in non-unionized environments to achieve an effective settlement of potential employment claims.
In Corless v. KPMG LLP,10 a former employee of KPMG brought a proposed class action on behalf of former employees who were allegedly not paid for overtime hours they had worked. After the action was filed, KPMG undertook a review of its overtime policies and concluded that certain employees had indeed not been properly compensated for overtime.
Before the certification was even argued, the parties negotiated and agreed on a formula for calculating overtime compensation to settle the case, conditional on court approval. At KPMG’s request, they also agreed to amend the class to include current as well as former employees. They then jointly requested that the Ontario Superior Court of Justice (i) certify the class action based on the amended definition of the class, and (ii) approve the settlement negotiated by the parties. After reviewing the facts against the applicable legal analysis, the court concurrently certified the action and approved the settlement.
This is an example of how employers may use class proceedings as a creative tool for crystallizing their liability and achieving an orderly, efficient settlement in cases where they are exposed to multiple related claims.
Tips for Employers
The analysis of these cases serves to provide employers with certain reminders:
Even though Canadian employers have not been hit as hard as their U.S. counterparts, the threat of class action proceedings in employment-related claim remains. At least two mass overtime cases have been certified and, unless overturned on appeal, will proceed. That said, employers who do not consider themselves at risk of overtime actions are not out of the woods.
Any employment claims that result from systemic deficiencies or faults in the workplace could be the proper subject of class proceedings.
Furthermore, employers faced with potential employment liabilities should consider whether class proceedings, or other procedural options, could be used to their advantage.
1 29 USC, ch. 8.
2 There are, however, a number of other claims that have been filed as class action proceedings, but that have not yet progressed beyond the initial procedural stages of the certification.
3 2009 CanLII 31177 (ONSC); 2010 ONSC 1036 (CanLII); 2010 ONSC 4724 (CanLII).4 2010 ONSC 2645 (CanLII); 2010 ONSC 1148 (CanLII).
5 On June 3, 2011, as this article went to print, the Ontario Divisional Court released its judgment upholding the certification. The Court agreed with the Ontario Superior Court that, in light of the alleged systemic wrongs, there were common issues, the determination of which would advance the claim of every class member. See the full text of the judgment at:  O.J. No. 2561 (QL).
6 2010 ONSC 4520 (CanLII); 2010 ONSC 6026 (CanLII).
7 Ontario Superior Court No. 10-396685 00CP.
8 On June 20, 2011, as this article was in print, the United States Supreme Court overturned the two lower court decisions certifying the employment discrimination claim by female employees against Wal-Mart. In refusing to certify the class action, the Court found that the numerous individual claims of discrimination did not meet the commonality requirement for a class action, as each claim would require its own analysis. This is consistent with the trends we have seen in the Canadian courts.
9 See note 5.
10 2008 CanLII 39784 (ONSC).
Social Media in the Workplace: Facebook Profiles Are Not Private
by: Amélie Lavertu
A recent decision from the Commission des lésions professionnelles (CLP) concludes that the information found on a Facebook account is not private, considering that numerous people may have access to this information. The Landry et Provigo Québec inc. decision was made after an employee filed Facebook pages from her colleagues’ Facebook profiles as evidence supporting her allegation of psychological harassment. The employer objected to this evidence, arguing that it was not a complete representation of all communications exchanged, that it constituted hearsay, and that the production of this evidence breached the Charter of Human Rights and Freedoms because it violated the privacy rights of third parties. The employer argued that the communications exchange on the Facebook page of a third party are of private nature, and that to produce such communications as evidence violated the Charter. Finally, the employer argued that the document did not meet the criteria under Section 2855 of the Civil Code of Québec regarding the production of material things. The employee submitted that the documents filed as evidence were complete, since they included the names and the pictures of the individuals who wrote the comments, as well as the dates and times the comments were posted on Facebook. The employee also submitted that this evidence did not constitute hearsay since the employer was free to contact the individuals concerned and to summon them as witnesses. According to the CLP, based on an Act to Establish a Legal Framework for Information Technology (IT Act), Facebook is a technology-based document having an equivalent legal value to documents on paper or on any other medium. The employee had produced as evidence only the Facebook pages of her colleagues featuring comments about her. The CLP concluded that even if not all the pages publishing comments on a certain day are produced, this does not mean the document is incomplete, as long as the pages produced are complete. The CLP also concluded that according to the IT Act, the party contesting the admission of the document bears the burden of proving that the document’s integrity has been affected. Regarding the hearsay argument, the CLP concluded that the reliability of Facebook pages is sufficiently guaranteed and that the employer has the opportunity to summon the authors of the comments to appear at the hearing. Therefore, Facebook evidence cannot be dismissed as being hearsay. As to the argument regarding the breach of privacy rights, the CLP explained how Facebook works and noted that the employee respected the functions of Facebook: she had access to her colleagues’ comments filed as evidence because she became Facebook friends with a colleague who had these mutual colleagues on her friends list. The interaction between Facebook users is fundamental to such a social network. The CLP made an interesting distinction, noting that each comment on Facebook is made on a personal basis but is not made on a private basis. A person who holds a Facebook account allows his or her friends to view his or her comments and allows the friends of his or her friends to view comments he or she posts on the walls of his or her friends. The CLP stated that this situation is far from being private. The CLP concluded that what is on Facebook is not private, taking into account the number of people who may have access to the content. The Facebook pages filed as evidence were not protected under the privacy rights of third parties. This decision is consistent with recent decisions of the Ontario Superior Court, which have concluded that a Facebook user cannot have any serious expectation of privacy given that numerous people (i.e., a number of friends) are granted access to a person’s page. One Ontario decision even underlines the fact that a party who maintains a limited-access Facebook profile stands in no different position from one who sets up a publicly available profile. The primary purpose of Facebook is to allow people to share information about how they lead their social lives. To allow an individual to hide behind the privacy controls that he or she sets on such a website risks depriving a party of access to material that may be relevant to ensuring a fair trial. We will have to wait to see whether other Québec tribunals will follow the approach taken by the CLP. Tips for Employers This case serves to remind employers of the following:
A recent decision from the Commission des lésions professionnelles (CLP) concludes that the information found on a Facebook account is not private, considering that numerous people may have access to this information.
The Landry et Provigo Québec inc. decision was made after an employee filed Facebook pages from her colleagues’ Facebook profiles as evidence supporting her allegation of psychological harassment. The employer objected to this evidence, arguing that it was not a complete representation of all communications exchanged, that it constituted hearsay, and that the production of this evidence breached the Charter of Human Rights and Freedoms because it violated the privacy rights of third parties. The employer argued that the communications exchange on the Facebook page of a third party are of private nature, and that to produce such communications as evidence violated the Charter. Finally, the employer argued that the document did not meet the criteria under Section 2855 of the Civil Code of Québec regarding the production of material things.
The employee submitted that the documents filed as evidence were complete, since they included the names and the pictures of the individuals who wrote the comments, as well as the dates and times the comments were posted on Facebook. The employee also submitted that this evidence did not constitute hearsay since the employer was free to contact the individuals concerned and to summon them as witnesses.
According to the CLP, based on an Act to Establish a Legal Framework for Information Technology (IT Act), Facebook is a technology-based document having an equivalent legal value to documents on paper or on any other medium. The employee had produced as evidence only the Facebook pages of her colleagues featuring comments about her. The CLP concluded that even if not all the pages publishing comments on a certain day are produced, this does not mean the document is incomplete, as long as the pages produced are complete. The CLP also concluded that according to the IT Act, the party contesting the admission of the document bears the burden of proving that the document’s integrity has been affected.
Regarding the hearsay argument, the CLP concluded that the reliability of Facebook pages is sufficiently guaranteed and that the employer has the opportunity to summon the authors of the comments to appear at the hearing. Therefore, Facebook evidence cannot be dismissed as being hearsay.
As to the argument regarding the breach of privacy rights, the CLP explained how Facebook works and noted that the employee respected the functions of Facebook: she had access to her colleagues’ comments filed as evidence because she became Facebook friends with a colleague who had these mutual colleagues on her friends list. The interaction between Facebook users is fundamental to such a social network.
The CLP made an interesting distinction, noting that each comment on Facebook is made on a personal basis but is not made on a private basis.
A person who holds a Facebook account allows his or her friends to view his or her comments and allows the friends of his or her friends to view comments he or she posts on the walls of his or her friends. The CLP stated that this situation is far from being private. The CLP concluded that what is on Facebook is not private, taking into account the number of people who may have access to the content. The Facebook pages filed as evidence were not protected under the privacy rights of third parties.
This decision is consistent with recent decisions of the Ontario Superior Court, which have concluded that a Facebook user cannot have any serious expectation of privacy given that numerous people (i.e., a number of friends) are granted access to a person’s page. One Ontario decision even underlines the fact that a party who maintains a limited-access Facebook profile stands in no different position from one who sets up a publicly available profile. The primary purpose of Facebook is to allow people to share information about how they lead their social lives. To allow an individual to hide behind the privacy controls that he or she sets on such a website risks depriving a party of access to material that may be relevant to ensuring a fair trial.
We will have to wait to see whether other Québec tribunals will follow the approach taken by the CLP.
Tips for Employers
This case serves to remind employers of the following: