Another Nail in the Coffin – Report of C.D. Howe Institute on the Capital Markets Regulatory Authority

For nearly 90 years, many have called for the creation of a single national regulator that would oversee Canada’s capital markets.  Invariably, those attempts have been squelched by constitutional concerns as various provinces and territories have refused to cede jurisdiction to a national regulator.  Nonetheless, in recent years, a newly proposed regulatory body, the Capital Markets Regulatory Authority (CMRA), has been gaining traction.  With a launch date scheduled for late 2018, many long-time advocates of a national regulator feel hopeful that a new era is around the corner.

However, a newly released report from the C.D. Howe Institute suggests that that hope may be misplaced. According to the report, the CMRA, which has the support of the federal government, Ontario, British Columbia, Saskatchewan, Prince Edward Island, and New Brunswick, is the product of significant concessions and compromises, lacks the ability to impose regulatory authority across the country, and may ultimately be unsuccessful.  In particular, the report highlights the following deficiencies with the proposed framework:

  • The CMRA is unlikely to achieve sign-on from all Canadian provinces and territories, particularly Alberta, which has remained steadfast in its opposition of a national regulator, and Quebec, which has successfully challenged the constitutionality of a national securities regulator before the Quebec Court of Appeal.
  • The inability of the CMRA to achieve participation from all jurisdictions constrains the ability of the national regulator to operate smoothly and flexibly. Participating jurisdictions would be forced to align the new legislation and regulations with those of the non-participating jurisdictions, limiting their ability to modernize or streamline the framework.
  • The new body is not likely to increase global competitiveness, despite assertions to the contrary. There is no evidence to suggest that Canada’s current regulatory framework is impeding foreign investment and, in any event, securities regulation tends to have a minimal impact on foreign investment.
  • A national framework would impede certain jurisdictions from developing regulations tailored to their unique, local circumstances and from drawing on their specialized experience and knowledge.
  • Despite lofty goals, none of the proposed provisions targeted at protecting investors have been included in the draft legislation, leading some to question whether the CMRA will constitute a step backwards for investor protection.
  • Contrary to assertions, it is not clear that the proposed national regulator will improve enforcement of securities regulations. Traditionally, the federal government has not demonstrated particular proficiency in enforcing the Criminal Code provisions respecting securities offences. There is nothing to suggest that simply importing the federal government and the relevant Criminal Code provisions into the national regulatory scheme will improve enforcement. In reality, enforcement will likely continue to occur at the provincial and territorial level, particularly in light of the fact that some provinces may opt not to join the CMRA.
  • One of the driving motivators for the creation of the CMRA, particularly in the wake of the global financial crisis, was an opportunity to enhance Canada’s systemic risk regulation. That objective could have been better achieved by creating a new stand-alone risk regulator, rather than embedding enhanced risk regulation into the existing regulatory framework. Such a framework is unnecessarily cumbersome, is not aligned with international best practices, and creates potential blind spots in non-participating jurisdictions.

Ultimately, the report suggests postponing the launch of the CMRA until such time as an independent review has been conducted.

The OSC Explores the Elimination of Embedded Commissions

The Ontario Securities Commission (OSC) hosted a roundtable discussion on September 18, 2017 (the Roundtable Discussion) to help evaluate potential regulatory changes to discontinue embedded commissions in investment funds. The term “embedded commission” refers to the remuneration of dealers and their representatives for mutual fund sales through a commission paid by investment fund managers (for example, deferred sales commissions and annual trailing commissions). The Roundtable Discussion built on the Canadian Securities Administrators’ (CSA) Consultation Paper 81-408, released January 10, 2017, which identified a number of investor protection and market efficiency issues resulting from the practice of dealer compensation through embedded commissions:

  • embedded commissions raise conflicts of interest that misalign the interests of investment fund managers, dealers and representatives with those of investors;
  • embedded commissions limit investor awareness, understanding and control of dealer compensation costs; and
  • embedded commissions paid generally do not align with the services provided to investors.

We have written more extensively about Consultation Paper 81-408, and the potential regulatory changes contemplated therein, here.

The release of Consultation Paper 81-408 spurred a groundswell of input from stakeholders, with the OSC ultimately receiving an unprecedented 142 comment letters in response. At the Roundtable Discussion,  the OSC assembled three panels comprised of key stakeholders, including financial advisors, investment firms and advocacy groups, to reflect more extensively on whether alternatives to an outright ban on embedded commissions might be capable of sufficiently mitigating the OSC’s concerns surrounding the current practice.

Panel 1: Capping or Standardizing Trailing Commissions

This panel considered whether the imposition of either a capped or a standardized rate for annual trailing commissions[1] could sufficiently mitigate the conflicts of interest associated with such fees. The panel was largely skeptical of this approach, suggesting that even with a standardized or capped rate for trailing commissions, conflicts of interest would persist: investment dealers would still be incented to sell mutual funds carrying trailing commissions as opposed to other investment vehicles. The panel also expressed concerns that a price-setting function was outside of the OSC’s mandate and would result in undue regulatory burden.

Panel 2: Discontinuing, or Implementing Additional Standards for the Use of the Deferred Sales Charge Purchase Option

This discussion explored whether the elimination of the deferred sales charge (DSC) purchase option[2] for dealer compensation could meaningfully mitigate bias in investment recommendations. The panel focused extensively on the rationale for the DSC model, and potential consequences of its discontinuance. Viewpoints on this topic diverged significantly. Detractors of the DSC model opined it serves no real purpose in the current market, suggesting instead that the model is simply a relic from days when front-end commissions were typically much higher than they are now. Conversely, proponents countered that the DSC model promotes better access to financial advice, particularly for investors with smaller accounts, and noted that the DSC model encourages saving and a long-term investment strategy.

Panel 3: Enhancements to Disclosure and Choice for Investors

This discussion considered whether enhanced awareness and choice for investors, including through offering alternative payment options such as a direct fee arrangements, might be the appropriate way forward. Many panellists felt strongly that investors should be afforded the opportunity to pay through either embedded commissions or a direct fee model according to their circumstances, and that that the elimination of choice would lead to diminished access to advice (particularly for smaller investors). Others noted that the Client Relationship Model 2, which imposes additional disclosure standards on dealers, remains in its infancy, and encouraged the OSC to adopt a “wait and see” approach to whether such disclosure standards might assuage concerns associated with embedded commissions.

Next Steps

Despite the diversity of viewpoints expressed at the Roundtable Discussion, the OSC has made very clear that regulatory change with respect to embedded commissions is coming. What that change will look like, however, remains largely unknown. Moving forward, the OSC has indicated that it intends to make recommendations regarding regulatory adjustments to the CSA in early 2018; dealers, fund managers, and other stakeholders should be aware of these impending changes and keep apprised of the CSA’s progress in this area.

[1] A trailing commission is an annual commission paid by investment management companies to financial advisers usually calculated as a percentage of the value invested by client.

[2] A DSC is a commission paid by an investment fund to a dealer at the time of purchase. Under the DSC model, an investor may or may not later be required to by a redemption fee to redeem his or her investment; the longer an investment is held, the lower the redemption fee becomes, eventually reducing to zero after a predetermined number of years (usually seven).

When is a Foreign Issuer a “Responsible Issuer” for the Purpose of Part XXIII.1 of the Ontario Securities Act?

In Yip v. HSBC Holdings plc et al., 2017 ONSC 5332, Justice Perell was called upon to determine the jurisdictional reach of the Ontario courts to protect Canadian and foreign investors when the defendant is a foreign corporation whose shares do not trade on a Canadian stock exchange.

Yip, an Ontario resident who purchased shares of HSBC Holdings (Holdings) on the Hong Kong Stock Exchange, asserted both a statutory secondary market and a common law misrepresentation claim against Holdings and one of its former employees, alleging that he and other purchasers on foreign exchanges were misled by certain representations made by Holdings. Yip maintained that Holdings, a U.K. public issuer whose shares trade on exchanges including in the U.K., the U.S. and Hong Kong, but not in Canada, was a “responsible issuer”.

Based upon a substantial evidentiary record, Holdings moved to dismiss Yip’s action on the grounds that the Ontario court lacked jurisdiction simpliciter, or in the alternative, to stay it on the basis that Ontario was forum non conveniens.  Yip brought a cross-motion for a declaration that Holdings was a “responsible issuer” under s. 138.8 of the Ontario Securities Act (the Act). Justice Perell determined both motions in favour of Holdings, finding as follows.

Jurisdiction to Decide Jurisdiction

As a preliminary matter, Justice Perell agreed with Yip that “the court has jurisdiction to determine whether it has jurisdiction”. The power to make a declaration at the instance of any party with an interest in the subject-matter of the declaration exists whether or not there is a cause of action .

There is No Place of Trading Requirement in s. 138.3 of the Act

Justice Perell noted that unlike the U.S. statutory cause of action for misrepresentation in continuous disclosure, which applies only to the purchase or sale of a security on an American stock exchange or a securities transaction occurring within the U.S. (see Morrison v National Australia Bank, 130 S. Ct. 2869), and also unlike s. 130 of the Act which has a “place of trading” qualification, under s. 138.3 there is no requirement for a trade within the territorial jurisdiction  of the court.

His Honour identified three circumstances in which an Ontario court will have jurisdiction simpliciter over a foreign corporate defendant:

  1. where the foreign corporation’s securities trade in Ontario’s secondary market;
  2. where the foreign corporation’s securities trade both in Ontario’s secondary market and also in foreign secondary markets; and
  3. in some cases, where the foreign corporation’s securities do not trade in Ontario’s secondary market, but the corporation has a “real and substantial connection” to Ontario, as determined by the application of the test in Club Resorts Ltd. v. Van Breda, 2012 SCC 17.

This case fell within the third category. However, Holdings was found not to have a real and substantial connection to Ontario for the following reasons:

  • Holdings did not carry on business in Ontario. It had no physical presence in Ontario accompanied by any sustained degree of business activity within the province.  Although Holdings’ subsidiary, HSBC Canada, did carry on business in Ontario, those activities did not constitute Holdings carrying on business within the province and there was no basis for piercing the corporate veil.
  • Holdings did not commit a common law or statutory tort in Ontario. Its disclosures were prepared in the U.K. for the purpose of complying with the disclosure laws of the jurisdictions where its shares traded.  It had no reason to believe that it was subject to the securities laws of Ontario governing disclosure. In that regard, Justice Perell agreed that caution should be exercised against “creating what would amount to forms of universal jurisdiction in respect of tort claims arising out of categories of business or commercial activity”. If Holdings was obliged to comply with Ontario’s disclosure laws, it would also be obliged to comply with the laws of other countries that regulate their own domestic stock exchanges regardless of whether the shares traded on those exchanges.

Comity Plays a Key Role in the Forum Non Conveniens Analysis When the Matter Involves an International Matrix of Securities Law Regimes

Justice Perell also concluded that even if he was wrong in finding that there was no jurisdiction simpliciter, the U.K., rather than Ontario, was the natural forum for resolving the dispute. Ontario was forum non conveniens.

In reaching that conclusion, His Honour repeated the findings of the Ontario Court of Appeal in Kaynes v. BP, PLC, 2014 ONCA 580 that “the global regulation of the secondary market in securities is based on the principle that securities litigation should take place in the forum where the securities transaction took place”.  This is consistent with the approach taken by the United States Supreme Court in Morrison.

Accordingly, it was not unfair to “expect Mr. Yip and all of the putative Class Members who used foreign exchanges to look to the foreign courts to litigate their claims where the defendant is a foreign corporation whose shares do not trade on a Canadian exchange”.


The author would like to thank Joseph Palmieri, Student-At-Law, for his contribution to this article.

FCAC and IIROC to join forces

On September 12, 2017, the Financial Consumer Agency of Canada (FCAC) and the Investment Industry Regulatory Organization of Canada (IIROC), two otherwise independent regulators, announced that they signed a memorandum of understanding (MOU) to coordinate regulatory oversight and strengthen consumer/investor protection. We have made inquiries and have learned that the MOU is not publicly available; we have therefore not been able to review its provisions.

Both regulators protect the interests of financial consumers, however, their mandates and jurisdictions are different. IIROC is a national self-regulatory organization that oversees provincially regulated investment dealers. The FCAC is the federal financial institutions consumer protection regulator and is mandated to supervise federally regulated financial institutions’ compliance with consumer protection measures.

According to the press releases regarding the MOU, it will enable the FCAC and IIROC to exchange pertinent information and improve regulatory oversight capacity. This collaboration will increase detection of wrongdoings and subsequent regulatory responses. Lucie Tedesco, Commissioner at FCAC expects that the MOU will keep “[FCAC] in pace with emerging trends and issues” and reinforce consumer protection.

This MOU may have been entered into in connection with an ongoing investigation of bank practices that was commenced in the Spring of this year following reports related to allegations that certain employees of banks were pressured to upsell to consumers and meet unrealistic sales targets.

Under its governing legislation, the FCAC is permitted to share information with other agencies that supervise financial institutions, if the FCAC is satisfied that the information will be treated as confidential by the agency.   IIROC’s by-laws provide for exchange of information agreements, but do not include a requirement that IIROC be satisfied that the information will be treated as confidential.

The Horror Show Continues: Application of the Limitation Period in s. 138.14 of the Ontario Securities Act in Kaynes v BP, PLC

In Kaynes v. BP, P.L.C. [2017] ONSC 5172, Justice Perell characterizes his decision about the operation of the limitation period set out in s. 138.14 of Part XXIII.1 of the Ontario Securities Act (the Act) as “the latest sequel or prequel in what has turned out to be the case law equivalent of a horror-movie franchise”.


The decision arises from a Rule 21 motion brought by BP for a ruling that the putative class members’ statutory misrepresentation claims were statute-barred under s. 138.14.  The motion was brought prior to argument of the motion for leave under s. 138.8.


On November 15, 2012, the plaintiff, Kaynes, commenced a proposed class action on behalf of  Canadian shareholders of BP.

Pursuant to s. 138.3 of the Act, Kaynes alleged that BP was liable for 14 secondary market misrepresentations made during the period from May 8, 2007 to April 15, 2010.  Of the 14 alleged misrepresentations, 3 were made in early 2010.  There was no suggestion that those three claims were statute-barred at the time of the issuance of the statement of claim.  However, the remaining 11 misrepresentations were all made more than three years prior to the issuance of the claim.

Fortuitously, the plaintiff served his motion for leave on November 16, 2012, one day after the issuance of the claim. Tolling agreements entered into while forum motions were being pursued suspended the operation of the limitation period between December 22, 2012 and September 22, 2015.  However, by September 2015, when those agreements terminated, it was arguable that the limitation period for the three alleged misrepresentations made in 2010 had expired.  A subsequent Tolling Agreement entered into in September 2016 provided that it did not revive any claim barred by any limitation period running between September 22, 2015 and September 29, 2016.

The Alleged Misrepresentations Made More than 3 Years Prior to the Issuance of the Statement of Claim Were Statute-Barred

BP successfully argued that the 11 alleged misrepresentations made prior to 2010 were out of time because they were made more than 3 years prior to the issuance of the statement of claim.

Interpretation of s. 138.14: An Event-Triggered Limitation Period

In response, Kaynes submitted that as a public correction of a misrepresentation is a constituent element of the cause of action, the limitation period did not begin to run until BP publicly corrected its statements on April 21, 2010. On that basis, as the claim was commenced within 3 years of the correction, the limitation period had not expired.

The Court disagreed, finding that Kaynes’ argument ignored the fact that s. 138.14 is an “event-triggered” limitation period, not a “claim-based” limitation period.  As such, the court could not impose a discoverability requirement.  To interpret s. 138.14 in the manner suggested by BP would obliterate the legislative policy for introducing that provision and would be contrary to how that provision has been discussed, interpreted and applied by the courts.

Purpose of s. 138.3(6)

Kaynes further asserted that the limitation period had not expired because all 14 misrepresentations should be treated as a single, continuous misrepresentation pursuant to s. 138.3(6) of the Act. On that basis, the limitation period would not begin to run until the final misrepresentation.

Justice Perell also rejected that argument, stating that that interpretation of s. 138.3(6) would effectively obliterate the operation of s. 138.14 and “the clear policy of the Legislature that no action shall be commenced under s. 138.3 after three years from the first release of the misrepresentation”.  Moreover, the legislative purpose in enacting s. 138.3(6) was to protect defendants from multiple liability for disclosure violations that were so interconnected to be considered a single disclosure violation, rather than to safeguard plaintiffs’ claims from the running of the limitation period.  Accordingly, it was not plain and obvious that s. 138.3(6) “brought back from the dead” the 11 statute-barred misrepresentation claims made more than 3 years prior to the issuance of the statement of claim.

The Representations Made in 2010 Were Saved by the Availability of the Nunc Pro Tunc Doctrine

BP unsuccessfully argued that the Tolling Agreement foreclosed the plaintiff from relying upon the doctrine of nunc pro tunc to save the 3 alleged misrepresentation claims arising from representations made in 2010 that were arguably statute-barred by virtue of the lapse of the Tolling Agreement in 2015 and the expiry of the limitation period.

Justice Perell disagreed with the suggestion that the Tolling Agreement operated to foreclose the plaintiff from relying upon the nunc pro tunc doctrine articulated in Green v. C.I.B.C., 2015 SCC 60, the purpose of which is “to backdate the leave order to a time when viable claims were not statute-barred”.  In Green, the Supreme Court of Canada determined that in certain circumstances, it was open to a court to grant leave to a plaintiff nunc pro tunc to assert Part XXIII.1 statutory misrepresentation claims that would otherwise be statute- barred, provided that the notice of motion for leave had been delivered before the limitation period had tolled.

As the plaintiff had not expressly agreed in the Tolling Agreement that he could not rely upon the nunc pro tunc doctrine, and had commenced the motion for leave before the expiry of the limitation period, he was not foreclosed from relying upon that doctrine if he succeeded in getting leave to bring the statutory claim.  As such, those misrepresentation claims were not necessarily statute-barred.


The 11 alleged misrepresentation claims arising from statements made prior to 2010 were “already impotent” by the time that Kaynes commenced his proposed class action, and “could not be made fertile” by operation of s. 138.3(6).

However the 3 alleged misrepresentation claims arising from statements made in 2010 were “immunized” by the fact that Kaynes had served his notice of motion for leave in a timely fashion, thereby preserving his ability to seek to rely upon the nunc pro tunc doctrine.


In any circumstance where the doctrine of nunc pro tunc may be available, defendants would be well advised to include specific language in tolling agreements excluding its application.


The author would like to thank Joseph Palmieri, Student-At-Law, for his contribution to this article.



Third party litigation funding of class actions in Ontario: “A work in progress”

In the most recent Ontario decision on third-party litigation financing, Justice Perell provides further guidance concerning the circumstances in which such funding arrangements will receive court approval.

In Houle v. St. Jude Medical Inc., 2017 ONSC 5129, Bentham IMF Capital Inc. (Bentham), an Australian-based litigation financing firm, entered into a financing agreement with Mr. and Mrs. Houle, plaintiffs in a proposed class action alleging negligent manufacture and distribution of implantable cardiac defibrillators and failure to warn of rapid, premature battery depletion.

Pursuant to the agreement, Bentham committed to pay, on a non-recourse basis:

  1. the disbursements incurred by class counsel up to a prescribed amount, after which amount class counsel would fund the disbursements;
  2. any costs assessed against the Houles;
  3. any security for costs; and
  4. 50% of the reasonable docketed time of class counsel up to a prescribed maximum amount.

The architecture of Bentham’s contingency fee was straightforward: the later the stage at which the action is resolved, the larger the contingency fees that Bentham would receive. Bentham’s payout ranged from 20% to 25% of the proceeds depending upon when the matter was resolved. A retainer agreement with class counsel mirrored those terms of the litigation funding agreement, also providing for a higher fee recovery for class counsel the later the case is resolved.  Combined, Bentham and class counsel’s contingency fees ranged between 30% to 38% of the litigation proceeds.

Justice Perell reviewed existing case law concerning the circumstances in which third party funding agreements have been approved in the class action context.  According to Justice Perell, in general, such agreements must not be champertous or illegal, and must be a fair and reasonable arrangement that facilitates access to justice while protecting the interests of the defendants.  In the class action context, such arrangements may be justified as a matter of expediency.

The principles that must be satisfied in order for a court to approve a third-party funding agreement were enumerated as follows:

  1. The third-party funding agreement must have procedural, technical, and evidentiary requirements that enable the court to scrutinize the agreement. This includes evidence of the plaintiff’s receipt of independent legal advice about the agreement, disclosure to the court of the retainer agreement with class counsel and the third party funding agreement, and the willingness and ability of the third-party funder to post security for costs;
  2. The third-party funding must be necessary;
  3. The third-party funder must make a meaningful contribution to access to justice or behaviour modification;
  4. The litigation funder must not be overcompensated given the particular circumstances of the case for assuming the litigation risks, in whole or in part. Justice Perell characterized this as the “penultimate-predominant factor”, because over-compensation moves the funder into the role of a champertor.
  5. The funding agreement must not interfere with the lawyer-client relationship, including retention by the plaintiffs of autonomy, control and carriage of the litigation; and
  6. The funding agreement cannot be not illegal on some basis independent of champerty and maintenance.

Upon review, the Bentham funding agreement failed the fourth and fifth conditions. It ran the risk of overcompensating Bentham and interfered with the lawyer-client relationship.

In determining that Bentham ran the risk of being overcompensated, Justice Perell took issue with the fact that Bentham’s recovery was uncapped, leaving open the possibility that Bentham could be rewarded more than the Class Proceedings Fund levy and that its ultimate recovery may be unfair and disproportionate because it could not be adjusted by the scrutiny of the court.

In addition, various provisions of the funding agreement were found to unduly interfere with the lawyer-client relationship and the Houles’ autonomy as the genuine plaintiffs, leaving the impression “that the Houles and Class Counsel have promised to prosecute the proposed class action as much, if not more, on behalf of Bentham than on behalf of the class members”.  His Honour noted, however, that certain of the clauses that were objectionable in this case would not necessarily be offensive in other class actions, such as where the representative plaintiff had been recruited and had little “skin in the game”, because his damages were trivial and the behaviour modification goal might be better achieved by accepting the involvement of a non-party with an entrepreneurial motivation to pursue the wrong-doer. This was not such a case.

While the agreement was not approved by the court, Justice Perell indicated that he would be prepared to approve it if the objectionable features that he identified were addressed.

The author would like to thank Saam Pousht-Mashhad, student-at-law, for his contribution to this article.



Reasonable diligence and good faith, no excuse for CFOs under IIROC regulatory regime

In Sutton (Re), the Investment Industry Regulatory Organization of Canada’s (IIROC) found that individuals with regulatory functions in securities industry may not enjoy immunity for errors where they acted in good faith and with reasonable diligence.

Sutton was a specialist in the field of securities industry regulation. From March 2003 until July 2012, he acted as the CFO for First Leaside Securities Inc., which was a part of the First Leaside Group of Companies. As part of his role, Sutton was required to monitor First Leaside Securities Inc.’s policies and procedures to ensure that it complied with the financial rules about the pricing of its unlisted securities.

For financing, the First Leaside Group issued fund units at $1.00. The issue before IIROC was whether Sutton, as CFO of First Leaside Securities, breached IIROC Dealer Member Rule 38.6(c) by failing to ensure that these fund units were properly priced on client account statements.

Sutton’s position was that there was an active market for the fund units and that the securities’ $1.00 price was the result of that active market. He opined that he did not need to take any further steps to determine a price. The Hearing Panel was unpersuaded :

61 […] Infrequent transactions at a fixed price, offered by the issuer of the Fund Units, for the ultimate purpose of maintaining the price and utilizing funds which were obtained from other investors for such purchases has none of the hallmarks of an active market.

In responding to the argument that individuals with regulatory functions in the securities industry should enjoy a degree of immunity from errors, the Hearing Panel acknowledged SEC statements and sentiments that compliance officers should not have to fear enforcement actions if they perform their responsibilities diligently, in good faith, and in compliance with the law.

Nevertheless, the Hearing Panel found that Sutton breached the IIROC Dealer Member Rule 38.6(c) because the fund units were not properly priced. The Hearing Panel opined that if immunity were afforded, it would be contrary to the purpose of having a CFO supervise pricing. As such, the absence of intentional wrongdoing or mens rea, or the fact that Sutton may have acted with reasonable diligence were not considered a defence by the Hearing Panel.

The Hearing Panel ruled that, if required, a Sanction Hearing will take place at a date and place to be determined.


The author would like to thank Saam Pousht-Mashhad, Articling Student, for his contribution to this article.

You Get it Right and it’s Still a Misrepresentation: the Paradox in Pretium

A gold mining company chooses not to disclose preliminary mineral sampling results that it viewed as unreliable. Further testing eventually proves the preliminary sample to be inaccurate. In Wong v Pretium Resources, 2017 ONSC 3361 the Ontario Superior Court of Justice granted leave for a plaintiff to proceed with a securities class action under s. 138.3 of the Ontario Securities Act (the OSA) alleging secondary market misrepresentation for failing to disclose the preliminary results. What gives?

Is there gold in the hills?

Pretium Resources (Pretium) is a mineral exploration company listed on the TSX and NYSE that operated a gold mine in northern B.C. The mine’s feasibility was predicated on a mineral resource estimate. Pretium agreed to extract a large bulk sample to validate the estimate to be carried out by a well-known mining consulting firm. First, however, Pretium decided to conduct a much smaller, and less reliable, “tower” sample as the bulk sample would be delayed.

The tower sample failed to substantiate the resource estimate and the consultant urged Pretium to disclose the results to the market. Pretium disagreed that the results of the tower sample were material. The consulting firm would later resign over the disagreement. Pretium disclosed the consultant’s resignation along with the reasons for the resignation to the market, and its shares dropped by over 50%.

As it turns out, Pretium was correct all along. The bulk sample confirmed the validity of the mineral resource estimate. Nevertheless, the company was hit with a class action for an alleged misrepresentation by not disclosing the tower sample results and the consultant’s findings and concerns.

Subjectivity and materiality

In order to obtain leave, the plaintiff needed to prove that its case was not so weak and not so successfully rebutted that there was no reasonable possibility of success. Pretium argued that there was no misrepresentation and relied on the reasonable investigation defence under s. 138.4(6) of the OSA.

The Court emphasized that the materiality standard that calls for the disclosure of information is focused on information that a reasonable investor objectively would consider important in making an investment decision, not information that the issuer subjectively believed or did not believe to be true. The Court reasoned that the findings of an expert mining consulting firm going to the heart of Pretium’s business model was information that was important to investors in deciding whether to invest and at what price. The Court noted that Pretium had every right to qualify such information with its own opinions regarding the accuracy of the testing and the true mineral content of the mine in their disclosure, but failing to disclose the information in the first place was potentially a misrepresentation.

The Court’s decision may be surprising and suggest that the leave test is a low bar, but there are some important facts which may help explain the result. In particular: Pretium publicly announced the involvement and reputation of the consulting firm, previous disclosure referenced the tower sample as an integral part of the testing procedure, and the consultant genuinely believed in the integrity and reliability of the tower testing method. Once Pretium built up the credibility of the testing process and the consultant’s involvement to gain leverage in the market, it was tricky to argue that the outcome of the testing and the consultant’s advice were immaterial.

Curiously, just a month before the Ontario decision, a parallel securities class action in the U.S. was dismissed. It remains to be seen whether the Ontario Superior Court of Justice’s decision in Pretium will be subject to an appeal.

The author would like to thank Alexandre Kokach, Articling Student, for his assistance in preparing this post.

Second Circuit overturns precedent regarding scope of tipper/tippee insider trading liability

In the recent divided opinion in United States v. Martoma,1 the Second Circuit overturned its 2014 opinion in United States v. Newman2 regarding the test for tipper and tippee liability in insider trading cases. The majority opinion reasoned that last year’s Supreme Court decision in Salman v. United States3 is inconsistent with Newman’s requirement that, in the absence of quid pro quo, there be a meaningfully close relationship between the tipper and tippee to support an inference of a gifting of the material, nonpublic information in order for insider trading liability to attach. The majority opinion upheld the insider trading conviction of Mathew Martoma, the former portfolio manager at SAC Capital Advisors LP, despite the nonexistence of a proven close relationship between Martoma and the source of the confidential information.

The test for analyzing tipper and tippee liability can be complicated. In 1983, the Supreme Court in Dirks v. SEC4 established the test for tipper liability as “whether the insider personally will benefit, directly or indirectly from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach [by the tippee].”5 Dirks then listed factors where one can infer a personal benefit, including “when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.”6

Martoma managed an investment portfolio focused on pharmaceutical and healthcare companies. Doctors who were involved in a clinical trial for two pharmaceutical companies developing an experimental drug improperly provided Martoma with confidential information about the results of the trial. Based on that information, Martoma advised his boss to trade on the securities for those two pharmaceutical companies. Those trades generated US$80 million in gains and more than US$190 million in losses avoided.

After Martoma’s conviction for insider trading, the Second Circuit reversed the insider trading convictions of two traders in Newman because the government failed to prove that the tipper who initially disclosed the material, non-public information received any personal benefit in exchange for doing so. In elaborating on the Dirks test, the Second Circuit held that a tipper does not derive a personal benefit when he gifts material nonpublic information “in the absence of proof of a meaningfully close personal relationship [between the tipper and the tippee] that generates an exchange that is objective, consequential and represents at least a potential gain of a pecuniary or similarly valuable nature.”7

Based on the Newman decision, Martoma appealed his conviction arguing that the jury had not been properly instructed and the evidence was insufficient. While Martoma’s appeal was pending, the Supreme Court issued the decision in Salman, which held that “Dirks specifies that when a tipper gives inside information to ‘a trading relative or friend,’ the jury can infer that the tipper meant to provide the equivalent of a cash gift. In such situations, the tipper benefits personally because giving a gift of trading information is the same thing as trading by the tipper followed by a gift of the proceeds.”8 The Supreme Court rejected the Newman decision “[t]o the extent the Second Circuit held that the tipper must also receive something of a ‘pecuniary or similarly valuable nature’ in exchange for a gift to family or friends, . . . this requirement is inconsistent with Dirks.”9

The Supreme Court did not address Newman’s holding that the “gift” analysis requires the existence of a “meaningfully close personal relationship” between the tipper and tippee. Nevertheless, the Second Circuit reversed its existing precedent, explaining that “following the logic of the Supreme Court’s reasoning in Salman, interpreting Dirks, we think that Newman’s ‘meaningfully close personal relationship’ requirement can no longer be sustained.” In a footnote, however, the majority stated that it did not hold that the relationship between the tipper and tippee cannot be relevant to the jury in assessing whether information was disclosed. Of course, this begs the question of what type of relationship is needed to support a valid inference that the tipper intended to provide a gift to the tippee by supplying material, nonpublic information. The Second Circuit had attempted to bring clarity to this issue in Newman but has now taken a step backward, thereby leaving it to prosecutors to fill the void. In such circumstances, over-prosecution becomes a real and meaningful risk.

In a lengthy dissent, Judge Pooler explained how the majority ignored precedent and “significantly diminishes the limiting power of the personal benefit rule and radically alters insider-trading law for the worse.”10 Those who find themselves caught in the crosshairs of an insider trading investigation will undoubtedly raise many of Judge Pooler’s points until further clarity can be obtained in the appellate courts.

1 US v. Martoma, No. 14- 3599 (2d. Cir. Aug. 23, 2017).
2 773 F.3d 438 (2d Cir. 2014).
3 137 S. Ct. 420 (2016).
4 Dirks v. SEC, 463 US 646 (1983). A person who provides material, nonpublic information to another who trades is a “tipper” and the recipient of that material, nonpublic information who then trades is a “tippee”.
5 Id. at 662.
6 Id. at 664 (emphasis added).
7 United States v. Newman, 733 F.3d at 452.
8 137 S. Ct. at 428.
9 Id.
10 US v. Martoma, No. 14- 3599 (2d. Cir. Aug. 23, 2017).

Canadian Securities Administrators to regulate Cryptocurrency Offerings and Crypto-Investment Funds

2017 has been an extraordinary year for cryptocurrencies.[1] The recent increase in the number of cryptocurrency offerings reflects a dramatic shift in investor-attitudes towards the crypto-economy. However, the increased popularity of initial coin offerings (ICO), initial token offerings (ITO) and cryptocurrency investment funds has triggered a wave of regulatory responses, from the USA to Singapore and to, most recently, Canada.[2]

On August 24, 2017, the Canadian Securities Administrators (CSA) announced that securities law requirements may now apply to cryptocurrency offerings (ICOs and ITOs) involving persons or companies conducting business from within Canada or with Canadian investors.[3]  According to CSA Staff Notice 46-307 – Cryptocurrency Offerings,[4] securities law will apply to cryptocurrency offerings when the cryptocurrencies can be properly categorized as securities.

To determine whether a cryptocurrency is properly classified as a security, the CSA will focus on the substance of a given transaction, considered in its totality, as opposed to its mere form.[5] Typically, cryptocurrencies that are offered through an exchange and traded, or that are subject to fluctuations in value and speculation by investors will have the character of securities. However, the concept of securities has an expanded meaning in the Canadian context.  For example, cryptocurrencies may also constitute securities if they are exchanged in the context of transactions or arrangements involving an investment contract.[6]  An investment contract exists when there is an investment of money in a common enterprise with the expectation to profit significantly from the efforts of others.[7]  In such a case, securities law will likely apply.

In the CSA’s view, every cryptocurrency offering is unique and must be assessed on a case-by case-basis. As an example, the CSA suggests that securities law would not necessarily apply where an individual simply purchases coins or tokens to “play video games on a platform” but would apply if, instead, the value of the coins or tokens “is tied to the future profits or success of a business”.[8]

Aside from dealing with ICOs and ITOs, cryptocurrency investment funds, which allow investors to pool their capital and allocate their individual investments between various cryptocurrencies, will also be subject to various securities laws requirements, especially when dealing with retail investors and cryptocurrency exchanges.[9]

Without a doubt, this is an exciting time for fintech businesses. However, going forward, businesses that plan on offering cryptocurrencies and cryptocurrency investment funds should be attuned to their potential securities market obligations at home and abroad.  In Canada, businesses must consider whether they are subject to securities law, including any prospectus and dealer registration requirements. In addition, businesses should be aware of the possibility that a planned arrangement or transaction might constitute an “investment contract”, and therefore fall within the expanded meaning of a “security”.[10]  The CSA is encouraging businesses contemplating cryptocurrency offerings to contact their local securities regulatory authority to discuss how to comply with securities laws.[11]

The author would like to thank Blanchart Arun, student-at-law, for his contribution to this article.





[5] Ibid.

[6] Ibid.

[7] Ibid; see also Pacific Coast Coin Exchange v Ontario (Securities Commission), [1978] 2 SCR 112.

[8] Ibid.

[9] Ibid.

[10] Ibid.

[11] Ibid.