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Different Approaches to Granting Leave to Securities-Holders for Bringing Actions Against Issuers

Published: 06/22/2010

By Ellen Bessner, Myroslav Chwaluk, Peter Henein

Courts in Ontario and the United States have come to opposite conclusions on the question of whether a security-holder ought to have standing to sue a reporting issuer. Why does the Ontario Superior Court of Justice decision of Silver v. IMAX Corp., [2009] O.J. No. 5573 (S.C.J.) (“IMAX”) substantially differ in its result from the United States District Court for the Southern District of New York decision of Plumbers & Steamfitters Local 773 Pension Fund v. Canadian Imperial Bank of Commerce, 2010 US Dist. LEXIS 25041 (U.S. District Court – Southern District of New York) (“CIBC”)? CIBC is a recent case which reinforces a longer line of cases in the US regarding securities class actions. However, IMAX is the leading case in Ontario on the issue of granting leave.

The IMAX action was commenced in 2006. It is the first, and remains the leading case interpreting the leave provisions of Part XXIII.1 of the Ontario Securities Act (the “OSA Leave Provisions”). In the IMAX case, the plaintiffs owned publicly traded securities of IMAX Corporation, a dually-listed issuer in the business of entertainment technology. IMAX disclosed positive results in its 2005 annual financial information. IMAX subsequently disclosed that the United States Securities and Exchange Commission was inquiring into deficiencies in IMAX’s disclosure and accounting practices. As a result of this announcement, the value of IMAX’s securities dropped sharply, and IMAX eventually revised and restated its financial results for 2005 as being worse than it previously announced. The plaintiffs alleged that IMAX misrepresented its true financial position. The plaintiffs moved pursuant to the OSA Leave Provisions, which create a statutory civil right of action for misrepresentations made by an issuer in its continuous disclosure documents or statements. The plaintiffs claimed damages from IMAX for the negative impact its financial restatement had on the value of IMAX’s securities. The plaintiffs sought leave to bring an action pursuant to the OSA Leave Provisions and also sought to certify a global class action on behalf of investors in IMAX. Both the motion for leave to bring the action and the motion for certification were granted in the plaintiffs’ favour in December, 2009.

While the facts in the CIBC decision were similar to those in the IMAX case, the result was different. In CIBC, a union pension plan which held securities in CIBC initiated a class action against CIBC in the United States. The plaintiffs alleged that CIBC misled investors in CIBC’s public disclosure between May 2007 and May 2008 with respect to CIBC’s exposure to assets backed by subprime residential mortgages. During the 2007-2008 time-period, the value of those assets dropped and, as a result, the value of CIBC’s shares dropped as well. The plaintiffs commenced an action against CIBC pursuant to Rule 10b-5 of the United States Securities Exchange Act of 1934 (“Rule 10b-5”). CIBC brought a motion to dismiss the suit, claiming that the plaintiffs failed to plead the necessary elements to make out a claim under Rule 10b-5. The US judge agreed with the defendants and dismissed the claim in its entirety.

These decisions leave issuers and aggrieved security-holders asking why, if the facts in both CIBC and IMAX were fairly similar, were the results so different?

The OSA Leave Provisions provide a self-contained, “specific and comprehensive code” that grants security-holders of an issuer a statutory right of action against the responsible issuer and certain individuals for misrepresentations in the issuer’s continuous disclosure. In contrast, Rule 10b-5 in the US is a broad, anti-fraud, provision that has been imputed to grant a private right of action to security-holders against issuers. The US rule requires the plaintiff in its pleadings to “state with particularity facts giving rise to a strong inference that the defendant acted with the requisite state of mind.” This state of mind, called “scienter” in the US, does not exist in Canadian law and comprises the largest difference between securities class actions launched in the United States and Ontario (or other provinces with similar statutory civil liability regimes for secondary disclosure). In CIBC, Judge Pauley noted:

To state a claim for misrepresentation under Section 10(b) and Rule 10b-5, a plaintiff must allege that each defendant "(1) made misstatements or omissions of material fact, (2) with scienter, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relied, and (5) that the plaintiff's reliance was the proximate cause of its injury."

In the IMAX leave motion, the defendants urged Justice van Rensburg to adopt the US scienter concept as a component of the test for leave. As the Ontario judge wrote:

The respondents in effect are urging the court to adopt, in addition to the statutory leave test, the requirement for pleading "scienter" in fraud on the secondary market claims, as they are put forward in US jurisdictions …the legislative history of the Ontario statutory remedy reflects an informed decision to put in place a screening mechanism that differs from the US pleadings-based approach. The CSA noted that the Ontario proposed legislation, as a specific and comprehensive code, was fundamentally different from Rule 10b-5, which is a general anti-fraud rule from which the courts have implied a right of action. The key element of intent or recklessness that a plaintiff must establish to succeed in a Rule 10b-5 action need not be proved in an Ontario statutory proceeding, where the mental element is the absence of due diligence.

Accordingly, Justice van Rensburg found the IMAX pleadings were not deficient for a failure to plead scienter, and further, explicitly rejected the argument that the plaintiffs must show intent or recklessness on the part of the defendants. The pleadings alleged a misrepresentation, and the Ontario court held that the action was brought in good faith with a reasonable possibility the claim could succeed at trial which met the test for leave under the OSA Leave Provisions. The claim could therefore proceed. This is opposite to what Judge Pauley wrote in CIBC:

A well-pled scienter allegation "state[s] with particularity facts giving rise to a strong inference" that the defendants had "'a mental state embracing [the] intent to deceive, manipulate, or defraud.'" … In addition, "the scienter element can be satisfied by a strong showing of reckless disregard for the truth."

In Judge Pauley’s view, the plaintiffs in CIBC failed to plead scienter as required, and for that reason the claim was dismissed in its entirety.

The IMAX and CIBC decisions highlight the differences between bringing securities class actions for misrepresentation in Ontario and the US. While the statutory civil liability regime in Ontario has a formal leave requirement, the IMAX decision sets the bar low for obtaining that leave. On the other hand, motions to dismiss securities class actions for deficient pleadings remain a substantial barrier to bringing securities class actions to trial in the US. These considerations impact both issuers and potential securities class action litigants. They will influence the choice of venue for litigants and shape the defences of responsible issuers and directors and officers. While the immediate rash of securities class actions feared when the OSA Leave Provisions came into force has not materialized, the low bar set in IMAX for obtaining leave may yet lead to a greater number of securities class actions brought by security-holders against issuers for misrepresentations made in secondary market disclosure in Ontario.