On November 2, 2021, the Ontario Divisional Court dismissed a motion for leave to appeal the decision of Justice Morgan, who granted leave to the plaintiff to commence an action under section 138.3 of the Ontario Securities Act (OSA) against Canadian cannabis producer Auxly Cannabis Group Inc. (Auxly).
The Plaintiff’s Allegations
The plaintiff alleged that in its 2018 Q3 Management Discussion and Analysis (MD&A), Auxly made misrepresentations about a cannabis facility build-out project (the Project), which it had previously announced it was pursuing with its co-venturer, FSD Pharma Inc. (FSD). The MD&A contained statements that the facility was to become “the largest indoor cannabis facility in the world”, the Project was moving along quickly, and the joint venture was a “key development” in Auxly’s business plans.
FSD is the subject of a separate securities class action alleging that it made misrepresentations in relation to the same Project. Refer to our blog post here on Miller v FSD Pharma, Inc, 2020 ONSC 4054 (Miller).
The plaintiff alleged that Auxly failed to disclose significant issues with the Project in its MD&A, including that it was behind schedule, there had been contractual breaches by FSD, and there was substantial risk that the entire Project would be terminated. It was not until approximately three months later, on February 7, 2019, that Auxly issued a press release (the Press Release), which disclosed that the Project was stalled and that there were contractual breaches by FSD that ultimately resulted in Auxly terminating the joint venture.
In the ten days following the Press Release, Auxly’s share price declined by approximately 21%. The plaintiff claimed that the information contained in the Press Release prompted Auxly’s share price to drop, which in turn caused financial losses to investors.
The ONSC Decision
Justice Morgan granted the plaintiff’s motion under section 138.8(1) of the OSA, finding that there was at least a reasonable possibility that that plaintiff would prevail in his claim that Auxly had made material misrepresentations in its public disclosures that caused him loss.
In reaching this determination, Justice Morgan agreed with Auxly’s submission that while the 21% drop in share price after the Press Release “may be an indicator of a material change”, it was necessary to examine it in context in order to identify what prompted the decline in share price. However, he disagreed with the logic and conclusions of a report prepared by an expert economist retained by Auxly indicating that the drop in share price did not relate to a public correction. The expert opined that the market had already absorbed the news about a delay in the Project’s timing and relied upon a press release issued by FSD on January 8, 2019 (the FSD Press Release) as having revealed the delay in the Project.
The expert made no indication that he was aware of Justice Morgan’s ruling from roughly a year prior in Miller in which the disclosure of said information, buried in a footnote within the “otherwise distractingly positive” FSD Press Release, was held to be too obscure to instigate an immediate reaction in the market. The corrective disclosure “was as physically unobtrusive as could be—one had to literally read the ‘fine print’ to even see it let alone to register its significance” and also downplayed the seriousness of the Project’s delay.
Justice Morgan found it “surprising” that the expert did not reference Miller in his report, considering the decision squarely addressed the identical events and the identical press release on which his report relied. As a result, leave was granted under the OSA.
Justice Morgan’s decision in Gowanlock confirms the message he previously sent in Miller that issuers’ attempts to obscure or bury bad news in their public disclosure documents carries significant risk. Further, courts will closely scrutinize the factual basis for expert reports filed in opposition to motions for leave.
The author would like to thank Colleen Dermody for her contribution to this article.