State of Securities Class Actions

Jeffrey Leon and Jonathan Bell | September 14, 2009

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In 2006, Ontario amended the Securities Act of Ontario (OSA) implementing a regime for civil liability for secondary market disclosure. The regime provides for a statutory cause of action for secondary market misrepresentation that relieves shareholders of the duty of proving they relied on a public issuer’s misrepresentation.  In an effort to protect potential defendants from unmeritorious proceedings, the new regime assigned Ontario courts a ‘gatekeeper' function: no action may commence without leave of the court.

In order to grant leave, the court must be satisfied that:

1. the action is being brought in good faith; and
2. there is a reasonable possibility that the plaintiff will succeed at trial. 

Considering the potential cost and process ramifications, the courts are still trying to determine how to most appropriately exercise this gatekeeper function. Two recent cases, Silver v. Imax Corp. and Ainslie v. CV Technologies Inc., highlight the need for courts to clearly articulate the scope and quantity of evidence required prior to deciding whether to grant leave.

IMAX

In Silver v. Imax Corp., the plaintiffs brought a motion to compel answers from the respondents after being faced with refusals during cross-examination on affidavits. They relied on the general rule that a deponent may be asked any questions within his or her knowledge that have a "semblance of relevance" to any issue on the motion.

However, based on the new sections (Section 138.8) in the OSA, the respondents argued that the leave requirement required a stricter test. There were, as of yet, no defendants to the statutory claims, as leave had not yet been granted to bring the action. As a general rule, a plaintiff should not be able to compel production and disclosure from a mere prospective defendant.

Further, the respondents’ argued that the "semblance of relevance" test would completely undermine the purpose of the court's gatekeeper function, as it would compel proposed defendants to undertake costly examination proceedings before the plaintiffs had been granted leave.

Justice van Rensburg of the Ontario Superior Court rejected the respondents’ arguments. She ruled that subsection 138.8(3) expressly permits cross-examination in accordance with the rules of court and accordingly is only limited by the "semblance of relevance" test. 

At least in part, van Rensburg relied on the fact that a ruling on the propriety of a question on cross-examination does not determine the admissibility of such evidence at the hearing itself.

The respondents could still argue that any evidence elicited on examination is inadmissible as irrelevant to the determination of the leave motion.

If the statutory scheme was designed to avoid undue and premature burdens on defendants, this would be a classic case of closing the barn door after the horse has already escaped. The coercive aspect of securities class actions could remain and defendants could still be pressured into quick settlements to avoid the cost of an expansive examination process.

A motion for leave to appeal the IMAX decision was dismissed.

CV Technologies

Justice Lax in CV Technologies took a different approach.

The plaintiffs argued that subsection 138.8(2) of the OSA compelled each of the proposed defendants to file an affidavit so that he or she could be cross-examined. The proposed defendants argued that this approach was an unjustified effort to dictate what evidence they could rely upon in responding to the plaintiffs’ motion for leave.

Justice Lax noted that the OSA sections were enacted to protect defendants from coercive litigation and to reduce their exposure to costly proceedings. Therefore, no onus is placed upon proposed defendants by section 138.8, nor are defendants required to assist the plaintiffs in securing evidence. Putative plaintiffs are required to demonstrate the propriety of their proposed secondary market liability claim before a defendant is required to respond. Interpreting subsection 138.8(2) in this manner is consistent with the underlying policy rationale of imposing a gatekeeper mechanism.

While the plaintiffs relied on the IMAX decision, in Justice Lax's view, Justice van Rensburg’s decision was based on a determination that it would be unfair to allow proposed defendants to file evidence asserting statutory defences but be immune to having that evidence tested by cross-examination. Justice Lax concluded that the plaintiffs’ approach would considerably lower the bar (set by the legislature in section 138.8).  Requiring each defendant to produce evidence would serve no purpose other than to expose those defendants to a costly discovery process, which was clearly not the legislature’s intent.

The court accordingly concluded that a proposed defendant must only file an affidavit when he or she intends to rely on evidence of material facts in response to the motion for leave.

On February 11, 2009, Justice Bellamy granted leave to appeal Justice Lax's decision in CV Technologies on the basis that the IMAX and CV Technologies decisions contained contradictory conclusions regarding subsection 138.8(2) of the OSA.

The matter likely will be dealt with by the Divisional Court in the Fall of 2009.

Moving Forward

To date, IMAX and CV Technologies are the only two decisions regarding the procedural requirements for a leave motion under section 138.8 of the OSA.  Considering the apparent contradictions between the two decisions, there is need for judicial clarification on the issue.  In the interim, proposed defendants responding to motions for leave will need to carefully consider what evidence they wish to rely upon and how this upcoming decision will impact the scope of their disclosure obligations.

Secondary market class actions can and will perform important functions in protecting the integrity of capital markets and providing at least partial compensation to those harmed by wrongful conduct. However, the gatekeeper provision is a necessary and justified part of the process to avoid abuse and excess that can be detrimental to public issuers and their shareholders.

The underlying intent of the legislation should be at the forefront of any interpretive exercise: to allow secondary market class actions to proceed only if the proposed plaintiffs have a sufficient evidentiary base to meet the leave burden, without in effect transferring this burden to the potential defendants through premature, costly, intrusive and potentially harmful disclosure obligations.

It must be recognized, however, that adopting this approach may result in the court's acceptance of a lesser evidentiary burden on plaintiffs in granting leave. Of key importance will be how courts balance the competing interests at stake in performance of the gatekeeper function.

Jeffrey Leon is a partner at Bennett Jones LLP, and Jonathan Bell is an associate at Bennett Jones LLP.