Jeff Cossette on Canada's new civil liability for officers and directors
For the first time in Canadian capital markets history, the distressing threat of being personally sued for misleading secondary market investors is a day-to-day reality for directors, certain officers and spokespeople – including IROs.
The new amendments to the Ontario Securities Act, effective from December 31, 2005, are supposed to foster confidence in the market by giving investors a statutory right to sue for damages when disclosure is false, insufficient or late. Companies not aligned with best practices will find the market a harsh mistress. Rather than just another rule, many are calling it a new regime. But are Canadian capital markets – and IROs – ready for civil liability?
They ought to be. The burner warmed to the concept in 1998 and there have since been umpteen conferences, seminars and consultations on this new disclosure ‘litigation exposure’. Prodded politically forward by big-name accounting scandals, the door to class action lawsuits is now officially open in Canada, and corporate disclosure practices are adjusting to a world where the consequences for alleged poor diligence are up close and personal.
‘It is unfortunate it has come to this,’ says Peter McBride, vice president of IR and public affairs at Theratechnologies. He warns of a potential ‘disclosure chill’ as firms add even more layers of internal checks to investor communications.
‘If you are working on the premise that it’s always safer to say nothing than say something that might provoke a lawsuit, one possible outcome is that there will be less good information rather than more,’ McBride says. ‘It slows down the quality of the work IR people do. This is regrettable because the IR profession has for years been doing all it can to promote high-quality disclosure. These are just measures to prevent faulty disclosure.’
One key area exposed to a possible disclosure chill is guidance, and IROs are wondering whether forward-looking information is covered by the new law. ‘Directors and officers could immediately see this as a reason to stop giving guidance,’ notes Paul Bell, vice president of IR at Canadian Pacific Railway. ‘It has the potential to get out of hand and the IR profession won’t necessarily be better for it. The entire way we work with the Street could be changed.’
However, Bell believes the law’s intent is not to stop companies from giving guidance. ‘There appears to be a precedent case that suggests this law is aimed at misrepresentation of fact,’ he says. ‘And a forecast is by nature an aspiration, not a fact. It is incumbent on IR professionals to point that out.’ The solution to the problem, he adds, is to ensure appropriate legal disclaimers are made clear in presentations.
Being civil
Except in cases of fraud, the statute caps penalties. For all plaintiffs of the same violation, issuers can be on the hook for the greater of C$1 mn or 5 percent of market capitalization. For individuals, it is generally the greater of C$25,000 or half that person’s total compensation from that issuer for the last twelve months prior to the infringement.
Gary Luftspring, managing partner at law firm Goodman and Carr, says people are taking ‘undue comfort’ in the caps. ‘You will see all kinds of funny claims alleging fraud,’ he notes. ‘For settlement purposes there will be claims for millions, if not billions, of dollars.’
Luftspring is equally skeptical about the ‘leave of the court’ provisions in the new law. To discourage frivolous lawsuits, a plaintiff must present sufficient evidence to obtain leave of the court to start an action. But there’s a cross-border wrinkle. In the US, says Luftspring, the original motion to dismiss is based entirely on the plaintiff’s evidence. ‘Defendants have no obligation to put anything forward,’ he points out. ‘In Canada, under the new law, defendants must put in an affidavit – and that exposes somebody to cross-examination.’
The result, Luftspring predicts, is that Americans will use Canadian law to ‘kick the tires’. ‘The US guys are looking at Canada as a potential route to get discovery,’ he says. ‘They are thinking, Before we even do a class action in the US, why don’t we seek leave to start an action in Canada? Whether we win or lose that motion for leave, we can then commence our action in the US with a whole pile of information.’
For inter-listed companies, this poses the strategic question of whether to defend the leave application. ‘The gatekeeper provision will become irrelevant because nobody will ever defend,’ Luftspring concludes.
So how can corporates and individuals protect themselves? Insurance is a good start but even there Luftspring sees significant issues as to whether directors should have separate insurance from the company’s. ‘All parties should look closely at their insurance,’ he warns. ‘Most products are self-cannibalizing on a first-come, first-served basis. Sometimes the entity coverage and the insider coverage can eat up all the money before it ever gets to the outside people.’
Luftspring questions the idea of ‘enough insurance’. ‘Sometimes you look at the insurance and think it just encourages a lawsuit,’ he comments. ‘All products are different and brokers sometimes have a conflict of interest. I tell people they had better think twice about being a director, especially of a cross-listed company. And IR people don’t necessarily want to share their limits with the corporation.’
There is, of course, one surefire way to shield yourself from personal liability: get rid of your assets. ‘You can give it all to your spouse,’ suggests Luftspring. ‘But that also has risks.’
Another method, of course, is to ensure your disclosure is lily-white. Compliance with the Toronto Stock Exchange’s (TSX) timely disclosure policy (in sections 406-423 of the TSX company manual) is an effective tool here. Meanwhile, the new civil remedy regime sets out specific defenses to claims of misrepresentation or the failure to make timely disclosure. Chief among them is proving due diligence and that prior to the alleged transgression there was a ‘reasonable investigation’ so there were no reasonable grounds to believe there was any hanky-panky.
‘The most important thing to have is a good disclosure policy and a system to vet documents,’ says Catherine Anderson, a lawyer with Farris Vaughan Wills & Murphy. ‘Some companies, particularly smaller ones, still don’t have a written disclosure policy.’
Many companies have systems in place for financial statements requiring CEO and CFO certification. Proper disclosure compliance protocols are now necessary for controlling press statements, including those made during quarterly conference calls with analysts and investors, so be sure your disclosure policy is a living document that includes practices mindful of a due diligence defense. Directors must ensure a policy is in place and monitor it. A formal disclosure committee to review timely disclosure of material changes might include representatives from accounting, general counsel, risk management, internal audit and investor relations.
In the meantime, nobody is certain how things will play out, and the fear of the unknown haunts many an IRO. Perhaps class action lawyers are waiting to pounce on the first earnings restatement. ‘It will be interesting to see which cases make it to court and why,’ says Bell. ‘Whatever happens, for the average IRO it just means more work.’