Compared to the circus south of the border, Canada is a quiet backwater when it comes to securities litigation. However, the times may now be changing
After watching the US revamp safe harbour rules to open up communications between companies and investors, Canadian pundits are proposing sweeping new laws. But these could prove counterproductive, filling lawyers' coffers and tying-up management in court for years.
IROs are outraged by the proposed changes, predicting that they will curtail communications with the financial community. At the centre of the debate are two Toronto Stock Exchange initiatives intended to improve, not strangle, corporate disclosure. The first was the report released last November proposing guidelines for companies to draw up written policies on disclosure, confidentiality and insider trading.
Analysts and IROs are balking at some of the recommendations, with one irate IRO claiming that the new regulations will stop companies commenting on even the most mundane topics. 'We don't want our CFO refusing to comment when some analysts ask whether he is comfortable with earnings estimates or not,' he said. 'It will be hard to know where to draw the line, and conservative managers will tend to become much more tightlipped in the face of such rules.'
About a month after the November recommendations, the TSE released its sprawling 120-page report entitled Toward Improved Disclosure. This opus was prepared by a committee chaired by Tom Allen, a securities lawyer with Davies Ward & Beck in Toronto. The Allen Report recommends civil liability for improper disclosure by companies, including continuous disclosure. Annual reports, press releases and discussions with analysts as well as the media would now all come under greater scrutiny. As it is, companies are liable only for improper disclosure in prospectuses and circulars.
In response to the November report, the Canadian Investor Relations Institute (Ciri) argued that while companies should not tell analysts what forecasts to use, confirming that their earnings projections are in line or in outer space is standard practice in most developed markets - including the US. Also, as one IRO interjected at Ciri's seminar on disclosure at its May annual conference in Toronto, 'The recommendations would set us back to the 1970s when all the power rested with the legal eagles. Their advice has always been the same: Don't say anything. This is a backwards view. Lawyers should help companies create a mosaic of soft information.'
As for the 120-page Allen Report, Ciri reacted even more strongly to the committee's view that 'there is a perception that there are problems with the adequacy of disclosure'. In its response issued at the end of May, Ciri noted that most public companies act honestly, responsibly and in good faith when it comes to disclosure practices: 'A few instances of abuse do not warrant the profound recommendations of the report.' Ciri adds that there are already sufficient means in provincial securities policy to solve any existing problems.
'Canadian disclosure standards are high by any measure,' asserts Bill Rowe, director of IR at Nova Corp, a Canadian blue chip energy company. 'Disclosure by TSE companies has improved over the last 25 years. We have simply to ensure that companies are educated on existing practices. The challenges we face as IR professionals are already massive, and civil liability would give corporate counsel the ultimate weapon: Do we want the CEO in court or out in the market adding value to shareholders? It's clear that such a regime would constrain disclosure in a way that would not be positive.'
'We did not start out believing in widespread non-compliance when looking at disclosure rules,' explains Timothy Blaikie, the TSE's director of regulatory and market policy. 'However, we saw problems at the margins and there is no current remedy. All the TSE could do is suspend or delist the company, which punishes the shareholders we are trying to protect. We could ask the Ontario Securities Commission (OSC) to take action, but besides being chronically underfunded, the OSC takes a restricted view of disclosure. On the other hand, somebody who loses money as a result of a violation may have more incentive to take action than the regulators.'
The TSE committee's work on regulatory practices first began in June 1994, after which there followed 18 months of meetings in a number of different venues. In the end the Allen Committee found that Canada's provincial securities commissions spend their time looking mainly at primary market issues, mostly ignoring trading in the secondary market, along with the flow of company information to analysts and investors. This was something Allen and his colleagues were intent on repairing.
As noted above, IROs are most concerned, that the recommendations of the TSE will inhibit the flow of communications. Take the idea, for instance, that one-on-one meetings between companies and their investors should be banned. 'The reality of the marketplace demands such meetings take place. We maintain that they can be both meaningful in content and consistent with existing disclosure environments,' note the watchdogs at Ciri.
Perhaps the most worrying idea about civil liability for company management concerns the horrendous damages that could be awarded, says Philip Anisman, a securities lawyer in Toronto who worked on the TSE task force. Such losses can impact investors as well as the company and the committee recommends that proportional liability be capped at 5 per cent of market capitalisation. The sums could still be staggering for large cap stocks listed on North American exchanges. Canadian judges may not be prone to handing out large settlements, but the mere threat is enough to send management scurrying for cover.
'It's surprising that the new recommendations are founded upon what the TSE describes as problems at the margin,' counters Margaret Cohen, Ciri counsel and the former OSC deputy director. 'The recommendations are indeed radical, and would require a complete overhaul of securities legislation to correct problems that are deemed marginal at most. There are other avenues available to the OSC to deal with this issue.'
Cohen cites 1994 legislation as greatly enhancing OSC enforcement capabilities, but adds that the legislation of that time was never fully brought to bear on Canadian disclosure. She also points out that the US system for civil liability in continuous disclosure has taken four decades to develop and that a number of unresolved issues still remain. 'The regime proposed by the TSE report would import many of the American ambiguities to Canada,' says Cohen. 'It would be years before there was clear guidance.'
David Mills, chairman of the issues committee at Ciri, says the solution is to educate, not litigate. And most listed companies seem to agree with him. 'Those companies that do not meet disclosure requirements fully and promptly are usually newly public companies that are unfamiliar with the rules,' he says. Mills helped author Ciri's response to the Allen Report, which emphasises that the proposed rules could cause companies to restrict communications with analysts, rating agencies and others.
This would clearly be counter-productive. 'Boards of directors will be concerned that company spokespersons could create liability for them,' Ciri noted in its submission to the TSE. That concern might lead to 'uninformative legal boilerplate'. Instead, Ciri suggests, companies should meet with the investment community to develop guidelines that will work for both parties.
'There is a sense that we are trying to accomplish the same thing in the end,' notes Mills. 'We are all concerned about insider trading, selective disclosure and levelling the playing field for the retail and institutional investors. The reality of the marketplace dictates that issuers, analysts and regulators have to draw up a set of guidelines that they will all be happy with. If not, they will find themselves at loggerheads for some time. No-one wants that.'
As for the investment analysts, they prefer initiatives aimed at improving the volume and usefulness of disclosure, notes Rossa O'Reilly, managing director of CIBC Wood Gundy. 'We are concerned if the proposals become heavy-handed because the end result may be the opposite of what is desired. With non-material inside information, requiring universal distribution would cause the volume of information to drop substantially. Companies should have an open door policy, without the requirement that any titbit be universally distributed. The cost of conveying information will have a direct impact on its availability - and less information can only be counter-productive.'
This isn't the first time companies have beheld the ominous spectre of civil liability. In fact, it has returned to haunt them every five years since 1979. That year, civil liability came up as part of a proposed federal securities law. In 1984, the OSC made a liability proposal, but then chose to withdraw the recommendation at the last moment. Then in 1989 an OSC report suggested civil liability be extended to continuous disclosure. In return all issuers would have had access to the prospectus disclosure system which is currently limited to just the major companies.
The idea of liability for continuous disclosure was raised by the Day Committee report on corporate governance in 1994. It was brought up again by OSC chairman Edward Waitzer in a speech made in that year. But by that time the TSE task force was already up and running: 'Just a happy coincidence,' notes Blaikie.
The TSE hoped its recommendations would enjoy more success than earlier proposals but in late June Waitzer revealed that most issuers' comments were opposed to civil liability; and it seems unlikely that the recommendations will see the light of the day.
But even if civil liability is not passed this time around, the issues it raises seem impossible to put to rest. The conflicting interests certainly look irreconcilable; but then, with lawyers drawing up the proposals, that may be inherent in the game plan.