Supreme Court Denies Leave to Applicants Seeking to Challenge Bifurcation of OSC Proceedings

The Supreme Court of Canada recently denied leave to appeal the Court of Appeal for Ontario’s decision in Ontario Securities Commission v. MRS Sciences Inc. (MRI Sciences), which considered the bifurcated nature of proceedings before the Ontario Securities Commission (the OSC). The decision is significant for its judicial endorsement of the OSC’s current two-phased approach of holding an initial hearing to determine the outcome of a proceeding on its merits, and then a subsequent separate hearing to determine sanctions and costs.


On February 2, 2011, an OSC panel comprised of two commissioners released a decision holding that MRI Sciences Inc., as well as a number of related individuals (including the current Applicants for leave), had sold securities without being registered as dealers and traded securities without a prospectus. Shortly after the release of this decision on the merits, the terms of the commissioners on that panel expired; accordingly, the OSC informed the parties that the upcoming sanctions hearing would be presided over by a differently constituted panel.

The Applicants brought a motion before the OSC to dispute the jurisdiction of a differently-constituted panel to preside over a sanctions hearing. The OSC dismissed the motion on December 6, 2011 (the Panel Composition Decision). Subsequent attempts to challenge the Panel Composition Decision before the Divisional Court were dismissed as premature.

The sanctions hearing eventually proceeded in late 2013, and the Applicants were penalized with 10-year trading bans, 10-year director and officer bans, reprimands, administrative penalties and costs.

Judicial History

Following the sanctions hearing, the Applicants commenced an appeal before the Divisional Court to once again challenge the Panel Composition Decision (among other things). At the core of the Applicants’ argument was a provision Statutory Powers Procedures Act (the SPPA) that provides as follows:

If the term of office of a member of a tribunal who has participated in a hearing expires before a decision is given, the term shall be deemed to continue, but only for the purpose of participating in the decision and for no other purpose.[1]

Essentially, the Applicants argued that a merits hearing and a sanctions hearing are functionally two stages of a single quasi-judicial hearing. Therefore, the Applicants argued, the terms of commissioners presiding over the merits hearing should have been extended until the conclusion of the sanctions hearing. In response, the OSC argued that while the merits hearing and the sanctions hearing may be part of the same proceeding, they do not represent a single hearing, and the SPPA provision is therefore inapplicable; indeed, the OSC’s Rules of Procedure clearly contemplate that a proceeding and a hearing are not the same.

In a split decision, the Divisional Court dismissed the appeal. While the majority accepted that the Applicants’ interpretation of the SPPA was reasonable, it held that the OSC’s interpretation was also reasonable, which was sufficient to dismiss the appeal under the applicable standard of review. On further appeal, the Court of Appeal for Ontario agreed enthusiastically with the majority decision of the Division Court, emphasizing that there was no procedural unfairness or breach of natural justice associated with the OSC’s decision to consitute a different sanctions panel.


In refusing leave, the Supreme Court of Canada endorsed the Court of Appeal’s assessment that the current practice of bifurcating proceedings is neither contrary to the SPPA nor is it in conflict with requirements of procedural fairness, even in circumstances where a sanctions panel is differently constituted than the merits panel.

[1] Statutory Powers Procedures Act, RSO 1990, c S 22, s 4.3.

No Common Law Duty of Care Owed by Underwriters to Investors in a Bought Deal: LBP Holdings Ltd. v. Hycroft Mining Corporation, 2017 ONSC 6342

No Common Law Duty of Care Owed by Underwriters to Investors in a Bought Deal: LBP Holdings Ltd. v. Hycroft Mining Corporation, 2017 ONSC 6342

On October 24, 2017, Justice Perell of the Ontario Superior Court of Justice dismissed a motion to certify claims for negligent misrepresentation and negligence against two underwriters primarily on the basis that a class action was not the preferred procedure.[1] The Court also held that the plaintiff’s common law negligence simpliciter claim did not disclose a cause of action. The foreseeability and proximity stages of the Anns v Merton[2] test arguably were not satisfied, and policy factors negated the existence of any duty of care.


Hycroft, formerly Allied Nevada Gold Corp., was a mining company dual-listed on the New York and Toronto stock exchanges. In 2013, Cormark Securities and Dundee Securities (the Underwriters) agreed to a bought deal of Hycroft’s secondary public offering. Under s. 59(1) of the Ontario Securities Act (the Act), an underwriter is required to certify that the prospectus contains full, true and plain disclosure to the best of their knowledge, information and belief.[3]

Hycroft incorporated by reference its most recent Annual Report, Interim Report and MD&As as part of the prospectus. These documents included representations about Hycroft’s gold production and its ability to finance its gold mine. Following the completion of the bought deal, Hycroft shares were resold to purchasers, including LBP Holdings, which asserted that it purchased the shares in reliance upon these representations and the Underwriters’ certification of the prospectus. Following the offering, Hycroft released information about operational problems, which led to a two-day decline of approximately 37% in share value.

LBP Holdings alleged that Hycroft violated disclosure obligations because it failed to include these operational problems that had begun several months before the public offering in its prospectus. LBP Holdings also alleged that the Underwriters breached duties of care owed to class members to conduct reasonable due diligence and ensure that the prospectus was free of any misrepresentation.

Certification Motion

LBP Holdings moved to certify a proposed class action for misrepresentation under s. 130 of the Act and equivalent Securities Acts in other provinces against Hycroft and two of its executives (the Hycroft Defendants), and for negligence and negligent misrepresentation under the common law against the Underwriters.

The certification motion against the Hycroft Defendants was allowed, but the motion against the Underwriters was dismissed on the basis that LBP Holdings 1) had not met the cause of action criterion with respect to its negligence claim, and 2) in any event, had not satisfied the preferable procedure criterion.

No Cause of Action for Negligence: A “Disguised Version” of the Misrepresentation Claim

The Court held that it was plain and obvious that the pleading of negligence had been “dressed up” to hide its real identify as a negligent misrepresentation claim to avoid the necessity of proving reliance. It arose from the same circumstances as the negligent misrepresentation claim, and the alleged duties to properly price the shares and to perform due diligence to ensure comprehensive disclosure of material facts in the prospectus were “inexorably intertwined” with the negligent misrepresentation claim. Accordingly, the negligence claim was subsumed by the negligent misrepresentation claim. Nevertheless, the Court still went on to analyze LBP Holding’s negligence claim as a free-standing claim as part of its reasons for decision.

The negligence claim as pleaded did not fall under any of the five previously recognized categories of claims for which a duty of care had been found with respect to pure economic losses. Thus, the Court applied the following Anns[4] analysis to determine whether a new category was warranted and reached the following conclusions:

  • Was the harm that occurred a reasonably foreseeable consequence of the Underwriters’ acts?

No. In the circumstances of a bought deal, an underwriter would not anticipate that purchasers would be relying on it to act as a gatekeeper to prevent the harm of buying Hycroft’s shares at an inflated price “beyond and distinct” from its duties of care under s. 130 of the Act and its common law duties with respect to misrepresentations in the prospectus.[5]

  • Was there sufficient proximity between the Underwriters and prospective investors?

No. Underwriters are not hired to provide an opinion or to develop an investment transaction or scheme. They are hired “essentially to be distributers of another’s goods often as sales agents, or as in the immediate case, by assuming the risks of a bought deal.”[6] Unlike issuers and auditors, underwriters make a “weak representation” that the prospectus contains full, true and plain disclosure to the best of their knowledge, information and belief. They do not make strong representations of the nature made by “the promoters, auditors, lawyers and experts involved in the creation of the investment.”[7] As such, there was insufficient proximity.

  • Are there any overriding policy considerations to negate any prima facie duty of care?

Yes. Extending an underwriter’s liability for pure economic loss beyond its current liability under statutory and common law misrepresentation claims would:

(a) deter useful economic activity where the parties are best left to allocate risks through the autonomy of contract, insurance, and due diligence;

(b) encourage a multiplicity of inappropriate lawsuits;

(c) arguably disturb the balance between statutory and common law actions envisioned by the legislator; and

(d) introduce the courts to a significant regulatory function when existing causes of action and the marketplace already provide remedies.[8]

For these reasons, at least within the bought deal context, the Underwriters did not owe LBP Holdings a duty of care in negligence simpliciter.

Too Many Individual Issues

The Court further held that, in any event, the constituent elements of the torts involved – particularly reliance, causation and damages – were matters that raised highly individual issues. Applying Musician’s Pension Fund of Canada v Kinross Gold Corp[9], the inevitably of trying these individual issues substantially diminished the productivity, manageability and benefits of a class proceeding. Further, pursuing the potential individual actions (with an average claim of USD $300,000) against the Underwriters with other putative class members joined as co-plaintiffs was an economically viable alternative.

As a result, the Court held that none of the factors of the preferability analysis enumerated by the Supreme Court of Canada in AIC Limited v Fisher[10] – i.e. judicial economy, behaviour modification and access to justice – was present to justify a class proceeding.


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



[1] LBP Holdings Ltd v Hycroft Mining Corporation, 2017 ONSC 6342 [LBP Holdings].

[2] Anns v Merton, [1978] AC 728 (HL).

[3] Securities Act, RSO 1990, c S5.

[4] Anns, supra note 2.

[5] LBP Holdings, supra note 1 at para 136.

[6] Ibid at para 142.

[7] Ibid at para 142.

[8] Ibid at para 135.

[9] 2014 ONCA 901.

[10] 2013 SCC 69.

CSA Clarifies Disclosure Requirements for Issuers with U.S.-Based Marijuana Activities

The regulatory environment for U.S.-based marijuana-related operations remains uncertain. At present, marijuana-related activities that are legal under U.S. state law remain illegal under U.S. federal law. Issuers in Canada connected to U.S. marijuana operations remain unsure of their disclosure obligations to Canadian investors and have sought clarification on what constitutes appropriate and timely disclosure. Recently, in the face of this uncertainty, the Canadian Securities Administrators (“CSA”), an umbrella organization of provincial and territorial securities regulators, has provided some much needed guidance.

On October 16, 2017, the CSA published Staff Notice 51-352[1], which outlines disclosure expectations for issuers that presently have — or are engaged in developing — marijuana-related activities within U.S. states that have authorized such activity (“U.S. Marijuana Issuers”). In addition to outlining its general disclosure expectations, the CSA provided specific disclosure requirements that apply depending on how U.S. Marijuana Issuers conduct operations or are otherwise involved in the U.S. marijuana industry.

All U.S. Marijuana Issuers

For the CSA, U.S. Marijuana Issuers must describe the nature of their involvement in the U.S. marijuana industry and explain that marijuana remains illegal under U.S. federal law. In addition, all U.S. Marijuana Issuers must state that the federal government’s forbearance of enforcement is subject to change, and must disclose the resultant risks, including the risk of adverse enforcement action. Further, U.S. Marijuana Issuers must state whether and how its marijuana activities are consistent with any U.S. federal enforcement priorities. The CSA also expects all issuers to identify financing options available to them in support of continuing operations, and detail their ability to access public and private capital.

U.S. Marijuana Issuers must also include at least one of three types of disclosures, each of which relates to an issuer’s industry involvement – direct, indirect, or ancillary.

Issuers with Direct Involvement

Direct industry involvement arises when an issuer (or a subsidiary that it controls) is involved in cultivating or distributing marijuana under a U.S. state license.[2]

Issuers with direct involvement must both detail and confirm how they comply with licensing and regulatory requirements enacted by the applicable U.S. state. These issuers must provide specifics of their program and procedures for monitoring compliance with U.S. state law on an ongoing basis, and disclose facts surrounding any material non-compliance, material citations, or notices of violation.

Issuers with Indirect as well as Ancillary Involvement

Indirect industry involvement refers to instances where an issuer has a non-controlling investment in an entity that otherwise has direct involvement in the U.S. marijuana industry.[3]

U.S. Marijuana Issuers with indirect industry involvement must detail the regulations that apply in the U.S. states in which their investee(s) operate, and provide reasonable assurance that the investee’s business complies with applicable licensing and regulatory requirements within the relevant U.S. states. U.S. Marijuana Issuers with ancillary industry involvement are also required to provide a form of assurance similar to the latter.

In short, CSA Staff Notice 51-352 provides much-needed guidance on disclosure obligations. Through its Staff Notice, CSA Staff has provided U.S. Marijuana Issuers with disclosure benchmarks directed at assisting investors make sound investment decisions in light of the shifting U.S. regulatory environment. CSA Staff expect U.S. Marijuana Issuers to always remain sensitive of their obligation to evaluate, monitor, and reassess risks on an ongoing basis in order to supplement, amend prior disclosures, and communicate material changes to investors.


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

[1]Canadian Securities Administrator (CSA), “CSA Staff Notice 51-352: Issuers with U.S. Marijuana-Related Activities” <>.

[2] Ibid.

[3] Ibid.

Alberta Securities Commission Policy 15-601: Credit for Exemplary Cooperation in Enforcement Matters

In October 2017, the Alberta Securities Commission (ASC) released ASC Policy 15-601: Credit for Exemplary Cooperation in Enforcement Matters.  According to the ASC, Policy 15-601:

… provides clarity and transparency regarding the circumstances under which ASC staff will consider exercising their discretion to grant credit to those individuals or entities that provide exemplary cooperation to ASC staff in the course of enforcement matters. This exemplary cooperation is cooperation above and beyond mere compliance with obligations under Alberta securities laws.[1]

Policy 15-601 follows the issuance of the ASC Three-year Strategic Plan F2018-2020[2], which had followed a consultation and review process conducted in 2016.

Prior to the release of Policy 15-601, it had been the stated practice of the ASC to allow credit to those who “fully cooperate with ASC staff in enforcement matters in a timely manner.” According to the ASC, Policy 15-601 now “explains the use of discretion by ASC staff when considering the appropriate enforcement action and assessing the appropriate sanction for misconduct.”

Application and Purpose of Policy 15-601

Policy 15-601 does not apply to any matter that results in quasi-criminal or criminal proceedings. Section 10 of the Policy sets out certain factors that may give rise to quasi-criminal or criminal investigation (for example, conduct that involved fraud).

The Policy states that its purpose is to explain “the benefits of cooperating with ASC staff and the factors ASC staff consider when determining whether that cooperation earns Credit in enforcement matters.” “Credit” is defined as something that “may include” any of the actions enumerated in section 12.  Section 12 sets out examples of credit for “Exemplary Cooperation”, which in turn is defined as including the actions in section 6.

“Exemplary Cooperation”

Section 6 sets out “What the ASC Expects” in terms of earning Credit for Exemplary Cooperation.[3]  This includes “Self-reporting”[4]; full disclosure; full cooperation; making employees, officers and directors available for interviews[5]; and the taking of “Corrective Action”.[6]

Credit for Exemplary Cooperation

Section 12 of Policy 15-601 provides that if there has been Exemplary Cooperation, ASC staff may, among other things, narrow the scope of staff’s allegations; proceed on the basis of a joint recommendation for sanction, or limit the costs that they would ordinarily seek.[7]

Section 20 provides that the ASC may disclose or publicize examples of Credit that have been granted for Exemplary Cooperation.

No Enforcement Action Agreements

Policy 15-601 provides that in very limited circumstances ASC staff may agree to take no enforcement proceedings.  Staff’s considerations will include whether there has been Exemplary Cooperation, the nature of the impugned conduct and resulting harm, and whether the conduct has been stopped and harm rectified.

Settlement Agreements and Agreed Statements of Fact

While Policy 15-601 contemplates that ASC staff have the discretion to enter into agreed statements of fact or make joint submissions on sanction, it emphasizes that an ASC Hearing Panel is not obliged to accept either.

No ASC Policy on No-Contest Agreements or Whistleblowing – Yet

At the time of this publication, the ASC is developing, but has not finalized, policies on no-contest settlement agreements and whistleblowing.

While it remains to be seen, we expect that the ASC will determine to allow no-contest or no- admission settlement agreements in limited circumstances – something far short of what we have seen allowed by the SEC and perhaps short of that allowed by the OSC.[8]  No-contest/no-admission settlements can be very significant to market participants who seek to narrow their exposure to follow-on litigation such as class actions.

The ASC has stated that it is considering the development of a whistleblower program to motivate people within organizations to provide tips regarding serious violations of Alberta securities law. We expect that the ASC will issue a whistleblower policy which provides for confidentiality and protection of retribution, but does not provide for financial rewards.[9]



[1] ASC Notice dated October 16, 2017.


[3] Section 11 sets out instances where no Credit will be given.  In general terms, section 11 contemplates conduct that is to the opposite effect of the conduct contemplated by section 6.

[4] “Self-report” means “voluntarily reporting yourself for your own possible securities misconduct or breach of Alberta securities laws, including reporting any of your conduct that may be harmful to the Alberta capital market or contrary to the public interest.”  Sections 15 through 17 provide for certain conduct that must take place in order to Self-report as contemplated by the Policy.  One requirement is that the self-reporter must attend an interview with ASC staff to provide further information and respond to questions.

[5] Section 7 provides that if requested, the ASC may issue a summons or production order before anyone is required to speak to the ASC or provide documents.  (These are often requested to afford the witness available protection under applicable evidence statutes.)  Section 7 provides that such a request will not been seen as a failure to cooperate so long as the witness is cooperative in scheduling and attending the interviews or providing the records within a reasonable time.  Section 7 concludes: “Everyone is expected to be forthright and forthcoming when speaking to ASC staff.”

[6] “Corrective Action” means Voluntary and timely conduct aimed at reducing harm done to participants in the Alberta capital market and preventing future breaches of Alberta securities laws.  “Voluntary” means something not required by law.  This is reinforced in section 8, which states: “Compliance with Alberta securities laws alone is not Exemplary Cooperation and will not earn any Credit.”

[7] Section 13 provides for the receipt of partial Credit for Exemplary Cooperation that was not initially given but was later given.

[8] The Ontario Securities Commission has allowed such settlements since 2014, and at the time of publication it is our information that there have been 9 such settlements.

SEC action against hedge fund raises difficult questions for investment advisers

The SEC recently extracted a settlement from a hedge fund that raises difficult compliance-related questions for investment advisers. On August 21, 2017, Deerfield Management Company L.P. (“Deerfield”), a hedge fund and registered investment adviser, paid approximately $4.6 million to settle SEC charges that Deerfield failed to create and enforce policies and procedures reasonably designed to prevent the misuse of material, nonpublic information in violation of Section 204A of the Investment Advisers Act of 1940. The allegations centered on confidential information that Deerfield analysts had obtained from a political intelligence firm. The SEC had previously charged certain of those analysts with insider trading which is likely why the SEC took an aggressive posture with the firm.

The SEC ignored the concept of risk-based compliance controls

Although Deerfield had extensive compliance controls concerning interactions with experts from “expert networks,” the controls were less robust for dealings with more general types of research firms, such as political intelligence firms. Expert networks are companies that have affiliations with experts in various types of industries, some of whom may work at public companies. Expert networks make their experts available for consultation in return for a fee. When engaging with experts from expert networks, Deerfield’s compliance controls included conducting due diligence to evaluate the expert network’s compliance controls, providing oral admonitions to the expert not to disclose inside information, and summarizing the interaction in an internal database. In contrast, when engaging with research firms, Deerfield only required its analysts to demonstrate that the research firms “observe policies and procedures to prevent the disclosure of material non-public information.”  Deerfield’s compliance manual did not specify how this was to be done. Moreover, Deerfield employees were expected to identify potential issues of concern and report them to supervisors.

A few years ago the SEC scrutinized several hedge funds for using expert networks as a way to attempt to gain material, nonpublic information about the employers of certain of the experts.1 Therefore, it is not surprising that Deerfield, like many hedge funds, implemented enhanced controls around the use of expert networks. Indeed, the SEC surely would have criticized Deerfield had the firm not done so.

One of the bases for alleging that Deerfield’s controls were deficient with respect to consultations with research firms, including political intelligence firms, was that the controls were not as rigorous as the controls for consulting with expert network firms. Pointing to the heightened controls in place for utilizing the services of expert networks as a way of demeaning the controls in place for research firms seems like a false, misleading and troubling comparison. Unlike expert networks, research firms do not retain the services of other individuals employed by public companies, who often have access to their employer’s material, nonpublic information. As the risks of utilizing research firms and expert networks are fundamentally different, one would naturally expect that the control structures would also be different.

The charges are not consistent with the factual allegations

The SEC contended that Deerfield did not enforce its policies and procedures with respect to the engagement of a political intelligence firm (the “Research Firm”) because Deerfield supposedly ignored several purported red flags that suggested the Research Firm might be improperly sharing material, nonpublic information with Deerfield analysts. One such red flag was the fact that the Research Firm’s Chief Compliance Officer was also its political intelligence analyst. Despite the conflict of interest created by a Chief Compliance Officer overseeing their own work, Deerfield continued to work with the Research Firm.

The SEC also alleged that several communications with the Research Firm, which were forwarded to Deerfield management, including the Chief Compliance Officer and General Counsel, were red flags because they contained potential insider information. A careful reading of the selected examples, however, raises questions as to whether the emails actually were suggestive of the Research Firm providing material, nonpublic information in breach of confidentiality obligations. For example:

  • In July 2010, the Research Firm emailed several Deerfield analysts about a forthcoming Centers for Medicare and Medicaid Services (“CMS”) regulation, saying, “ . . . I just heard from a reliable CMS source the reg is likely coming out today after 4pm.”  Noticeably absent from the SEC’s allegations was any suggestion that the Research Firm had obtained and/or communicated the substance of the not-yet-released regulation.
  • In September 2010, a Deerfield analyst circulated a summary of a conversation he had with the Research Firm. The analyst noted that the Research Firm had a contact on the inside of a closed-door meeting, and that certain government regulations would be announced in 2011 to be implemented in 2012. The SEC did not explain how the Research Firm stating that regulations would be announced within the following year with an effective date another year after that constituted material, nonpublic information.
  • In September 2011, a Deerfield analyst emailed the Research Firm regarding an anticipated coverage decision by Medicare, asking, “Is it already public or did you just hear about it from CMS guys?”  The SEC did not allege that this information was non-public.

Far from being indicative of the Research Firm providing sensitive information in breach of confidences, the emails seem more consistent with a political intelligence firm providing insight derived from general market intelligence that it had been able to gather. It is hardly surprising that these three isolated emails did not trigger alarm bells within Deerfield’s management. This demonstrates the real risk of the SEC being willing to twist emails and other documents out of context to try to force a settlement as regulated entities, such as hedge funds, are often reluctant to litigate against their regulators.

The SEC further alleged that other communications between Deerfield and the Research Firm contained material, nonpublic information that resulted in trading activity by Deerfield. For example:

  • In May and June 2012, the Research Firm provided Deerfield analysts with specific information about confidential CMS plans to cut Medicare reimbursement rates for certain radiation oncology treatments. Deerfield then shorted the stock of two companies that offered products and services related to radiation oncology, resulting in a profit after CMS publically announced the rate cut.
  • In May and June 2013, the Research Firm provided Deerfield analysts with specific information regarding a proposed 12% reduction in Medicare reimbursement rates for certain kidney dialysis treatments, services and drugs. Deerfield then shorted the stock of a company that offered products and services related to kidney dialysis, resulting in a profit after CMS publically announced the 12% cuts.
  • In November 2013, the Research Firm then provided Deerfield with specific information regarding confidential CMS plans to implement the above-mentioned 12% cut over a four-year period, instead of at one time. Deerfield bought shares in a company that provided products and services related to kidney dialysis. The decision to phase-in the cuts over a 4-year period was received positively by the market, so Deerfield profited after CMS publically announced the plan.

As a result of this alleged insider trading, Deerfield realized almost $4 million in profits from May 2012 to November 2013. Deerfield agreed to a civil money penalty of $3,946,267, disgorgement of $714,110, and prejudgment interest of $97,585.

While the above emails may be suggestive that the Deerfield analysts engaged in insider trading, they do not support the allegation that Deerfield did not enforce its policies and procedures because there is no indication that Compliance personnel or others in management knew or should have known of the emails. The SEC alleged that Deerfield’s controls were flawed because Deerfield required its employees to self-report incidents of third parties improperly sharing information with them. That reasoning is seriously flawed. The SEC would surely be quick to fault any adviser’s policies that did not require employees to report instances of potential wrongdoing.

Moreover, the SEC’s allegation on this point is undercut by the comparison to Deerfield’s policies with respect to expert networks, which required analysts to describe their interactions with expert networks in a database. The SEC specifically praised Deerfield’s expert network’s policy for this feature. Aside from such data input necessarily being subjective and dependent on the employee’s discretion and accurate self-reporting, it is implausible to believe that an analyst who was going to engage in illegal insider trading would then consciously create a company record essentially confessing to the fact that he/she was receiving material, nonpublic information from a third party.

The practical reality of this enforcement action appears to be that the SEC was looking to for a way to hold Deerfield accountable for what the SEC believed to be illegal tipping and trading by the Research Firm and Deerfield analysts, respectively. In order to back into a theory of liability against the firm, the SEC apparently took a creative and aggressive view of evidence to justify bringing an enforcement action.

Practical implications for investment advisers

The manner in which the SEC justified bringing this enforcement action raises some difficult and troubling questions for investment advisers. Specifically, if an adviser is supposed to tailor its compliance policies and procedures to address known risks and areas of regulatory concern – as Deerfield did with expert networks – how does the adviser prevent the SEC from arguing that the adviser’s compliance controls were unreasonably designed because violations occurred in other parts of the business that did not present the same types of elevated risks? 2

While the SEC took a dim view of Deerfield’s alleged reliance on self-reporting by analysts, self-reporting is a necessary component of most compliance programs. To protect against scrutiny and second-guessing, advisers should provide regular training on their policies, including helpful tips and suggestions on what to look for and what to do. Including such practical guidance in the compliance manual is another technique that can create favorable impressions with the SEC. Finally, advisers would be well-served to implement practices that demonstrate they are actively looking for indicia of potential policy violations, such as targeted electronic communication reviews that may be focused not only on key words, but tied to timely trades.

1 See, e.g., SEC Charges Hedge Fund Firm CR Intrinsic and Two Others in $276 Million Insider Trading Scheme Involving Alzheimer’s Drug, U.S. Sec. & Exch. Comm’n Press Release (November 20, 2012), available at; see also SEC Charges Hedge Fund Managers and Traders in $30 Million Expert Network Insider Trading Scheme, U.S. Sec & Exch. Comm’n Press Release (February 8, 2011), available at

2 Regulators have often emphasized the importance of risk-based compliance protocols. See, e.g., Assistant Attorney General Leslie R. Caldwell Delivers Remarks at the Compliance Week Conference, U.S. Dep’t of Justice (May 19, 2015), available at; see also U.S. Dep’t of Justice and U.S. Sec. & Exch. Comm’n, A Resource Guide to the U.S. Foreign Corrupt Practices Act at 56 (2012), available at

Stay of Securities Prosecution For Delay: Application of the Jordan framework to Regulatory Offences Punishable by Imprisonment

In one of the first decisions in Canada applying the Supreme Court of Canada’s new Jordan framework for the measurement of unconstitutional Crown delay to prosecutions for breach of securities law, the Superior Court of Quebec has upheld a stay issued by the provincial Court of Quebec in Autorité des marchés financiers c. Desmarais. The stay had been issued on grounds that the case was not sufficiently complex to require an extension of time for the Crown before trial and that the presumptive 18-month ceiling on Crown delays should be enforced.

In Desmarais the Autorité des marchés financiers (AMF) charged six defendants with a variety of offences, including failing to issue a prospectus in connection with a distribution of securities and providing false or misleading information to investors. The offences were punishable by a maximum fine of $5,000,000 and a maximum term of imprisonment of 5 years less one day.

The Jordan decision, which imposes an 18-month ceiling on trial delays attributable to the Crown in provincial courts (30 months in Superior Courts), permits extensions only in cases of sufficient complexity or in other exceptional circumstances.  In the Desmarais decision, the Superior Court of Quebec, sitting in appeal of the provincial court’s decision, found that there was no palpable and overriding error in the provincial court’s finding that the proceeding did not rise to the level of a “particularly complex case” as required in Jordan, even despite the submissions of the AMF that the trial would feature 131 charges against 6 defendants, 35-40 witnesses, and a forensic accounting expert. In coming to the decision the provincial court judge had concluded the case did not have many different elements that would be difficult to disentangle, the issues in the case would become focused once evidence was gathered, and the defences of the multiple defendants were very similar.  The judge wrote as well that neither the length of the trial nor the number of motions and witnesses necessarily rendered the questions in the litigation more complex for the purposes of the Jordan analysis.

The Supreme Court of Canada’s 2016 decision in R. v. Jordan significantly altered the framework for determining unconstitutional delay under s. 11(b) of the Charter of Rights and Freedoms, in the prosecution of criminal offences. The previous framework, set out in R v. Morin, required a contextual balancing of four factors: (1) the length of the delay; (2) waiver of time periods by the defendant; (3) the reasons for the delay, including the inherent needs of the case, defence delay, Crown delay, institutional delay, and other reasons for delay; and (4) prejudice to the accused’s interests in liberty, security of the person, and the right to a fair trial. Jordan, however, moved away from this contextual balancing approach which focused on “prejudice”, and set instead a clear ceiling for trial delays attributable to the Crown, set at 18 months in the provincial courts and 30 months in the superior courts, except in exceptional circumstances.  (Crown delay is calculated as the time between the charge and the actual or anticipated end of trial, subtracting for any delays waived or caused solely by the defendant).  If more than 18 months (30 months in Superior Court) are required, the Crown bears the onus of demonstrating the presence of exceptional circumstances, which may arise either from “discrete events” (medical emergencies of participants in the trial, for example), or “particularly complex cases”.

The early jurisprudence under Jordan suggests the new framework may apply not only to criminal offences but also regulatory offences punishable by imprisonment, and to corporations as well as individuals. In R v. Live Nation Canada Inc., for example, Nakatsuru J. applied the framework to offences under Ontario’s Occupational Health and Safety Act, in ruling explicitly that the Jordan framework may apply to regulatory offences under provincial statutes as well as criminal offences, and also to corporate as well as the individual defendants.  In Jeux sur mesures Maxima inc. c. Québec (Autorité des marchés financiers), the Court applied the new framework in the context of a prosecution alleging breach of securities law, granting an extension in that case pursuant to a separate transitional scheme set out in Jordan to deal with cases where the charges pre-dated the Supreme Court’s decision.


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

A Cautionary Tale for Defendants Opposing Certification

Perhaps in tongue and cheek, perhaps not, Perell J. begins his decision in Berg v. Canadian Hockey League, 2017 ONSC 5382, by quoting Winston Churchill’s famous World War II speech :

We shall defend our island, whatever the cost may be, we shall fight on the beaches, we shall fight on the landing grounds, we shall fight in the fields and in the streets, we shall fight in the hills; we shall never surrender.

The quote sets upon the razor sharp line between zealous advocacy and over pleading – dubbed “Churchillian resistance”[1] –  in certification motions.

In Berg, the Plaintiffs’ main claim was that Canadian and American hockey clubs in both the Ontario Hockey League and the Canadian Hockey League do not pay their players minimum wage and overtime pay under employment standards statutes. In addition, they advanced claims of (1) breach of statute, (2) breach of contract, (3) breach of duty of honesty, (4) good faith and fair dealing, negligence, (5) conspiracy and (6) unjust enrichment and waiver of tort.

The parties produced phenomenal amounts of evidence resulting in three days of oral arguments. The Plaintiffs were ultimately successful in certifying their action for breach of employment law statutes and unjust enrichment against the Canadian teams, but not the American teams.

No Novelty and Public Interest

In awarding costs, Perell J. promptly rejected the arguments for novelty and public interest litigation to reduce costs, stating that it was “disingenuous for both parties to suggest that this litigation is other than self-interested commercial litigation about enforcing an employment contract.”[2]

This resistance in recognizing public interest to reduce or eliminate cost awards is echoed in Perell J.’s recent decision in Das v. George Weston Limited, 2017 ONSC 5583. In it, he dismissed a proposed class action relating to the collapse of the Rana Plaza building in Bangladesh where 1,130 people died and 2,520 people were seriously injured. Joe Fresh Apparel Canada Inc., a subsidiary of Loblaws, purchased clothes from a manufacturer who owned a factory in the Rana Plaza. The Plaintiff received financial support from the Law Foundation of Ontario’s Class Proceedings Fund. The Fund argued that there should be no cost orders because the action was brought in the public interest and because the action raised many novel issues and its outcome was impossible to predict. Perell J., having regard for the way the case was aggressively pleaded and prosecuted, found that the Plaintiffs’ claims were not novel in the requisite legal sense.[3]

An Expensive Cost Award

In Berg, Plaintiffs sought a partial indemnity cost of $1,212,065.63 for a certification motion; the Defendants, the Ontario Hockey League and the Canadian Hockey League, submitted that there should be no cost award. Defendant American Teams of the Ontario Hockey League against whom the action was not certified sought costs of $224,362.91.

Perell J. awarded the Plaintiffs $1,212,065.63, all inclusive, $500,000 payable forthwith with the balance of $712,065.63 payable to the Plaintiffs if they succeed at the issues at trial. He also awarded the American Teams $200,000, which was credited against the award made against the commonly represented Defendants.


In Berg, Perell J. ultimately concluded that both parties were equally responsible for transforming the certification motion from a procedural motion into a substantive motion where both parties attempted to justify both their legal and their moral positions. Quoting himself in the reasons for the decision, Perell J. wrote that “both sides baited the other and both sides took the bait – hook, line, sinker, and litigation fishing boat.”[4]

This case serves as a stark reminder that a certification motion under the Class Proceedings Act, 1992 is procedural law, not substantive law and that Defendants should adopt a tempered approach in mounting a defence at the certification stage.

The author wishes to thank Saam Pousht-Mashhad, Student-At-Law, for his contribution to this article.

[1] Berg v. Canadian Hockey League, 2017 ONSC 5382, at para. 20.

[2] Berg v. Canadian Hockey League, 2017 ONSC 5382, at para. 39

[3] Das v. George Weston Limited, 2017 ONSC 5583, at paras 130-131.

[4] Berg v Canadian Hockey League, 2017 ONSC 2608 at para. 14.

Mitigating Securities Litigation Risk From Software Problems

Public companies can face significant securities litigation risk over defective algorithms, data errors and software glitches. As securities class action filings continue to increase across the board, plaintiffs lawyers have attacked numerous companies over stock price declines that occur after software problems are revealed. Recent court decisions denying dismissal in securities class actions against Fitbit and OSI Systems illustrate the risks that technology companies face when there is a gap between their public disclosures and the actual status of their software, including undisclosed defects in software algorithms. Short sellers have also targeted companies with negative investigatory “reports” over alleged software problems and data errors, which can trigger securities lawsuits and U.S. Securities and Exchange Commission investigations if the stock price falls after the short-seller report. Even companies that follow best practices in software development can face securities liability for unexpected problems if they do not also follow best practices from a disclosure standpoint. Fortunately, companies can mitigate the risk of shareholder litigation by enhancing their cautionary disclosures, carefully scrutinizing their affirmative statements (including in analyst call Q&A) to avoid overstating the capabilities or development status of new software, and developing a robust crisis management plan to ensure appropriate disclosures in the immediate aftermath of a software problem.


By design, securities fraud claims are difficult for plaintiffs to plead and prove, and the mere fact that a company experiences unexpected software or technology problems is generally insufficient to establish liability. As one court aptly noted,
That a new program has kinks does not make a positive statement about the [software] false. If that were the case, the federal securities laws would prevent software companies from making any positive statements about new software.
In re Siebel Systems Inc. Securities Litigation, No. C 04-0983, 2005 WL 3555718, at *4 (N.D. Cal. Dec. 28, 2005) (dismissing securities complaint despite allegations that new software product “was a disaster”). Companies have frequently succeeded in obtaining dismissal in other “software glitch” or “defective algorithm” cases where the disclosures adequately warned investors about potential problems or where plaintiffs failed to supply adequate evidence that executives knew of the problems before they were publicly disclosed.[1]

Nonetheless, technology companies can increase their securities litigation risk by overpromising their software capabilities, understating or concealing known problems, or continuing to repeat positive statements about the technology without accounting for changed circumstances.

The Fitbit Litigation

The 2016 opinion denying dismissal in the Fitbit securities litigation illustrates the liability risks when a company touts the accuracy of an algorithmic software device that turns out to be less accurate than hoped. See Robb v. Fitbit Inc., 216 F. Supp. 3d 1017 (N.D. Cal. 2016). During the year before its initial public offering, Fitbit introduced a new proprietary heart rate tracking function called PurePulse for the company’s smartwatch fitness wristbands. Id. at 1026. The company marketed the new technology using the slogan, “Every Beat Counts,” and issued a press release stating that PurePulse “applies Fitbit’s finely tuned algorithms to deliver heart rate tracking 24/7” and uses “[s]uperior heart rate tracking technology” to “offer continuous, automatic heart rate tracking all day, all night and during workouts so you never miss a beat.” Id.

The IPO prospectus stated that “[w]e dedicate significant resources to developing proprietary sensors, algorithms, and software measurements to ensure that our products have highly accurate measurements” and “feature proprietary and advanced sensor technologies and algorithms as well as high accuracy and long battery life.” Id. at 1027. The IPO prospectus also stated that the devices containing the PurePulse technology were “the primary drivers of our revenue growth in the first quarter of 2015” and were thus a critical component to the company’s business success. Id. at 1022-23. The company later issued a secondary offering prospectus claiming that “Fitbit’s proprietary PurePulse heart rate technology has been updated to provide users with an even better heart rate tracking experience during and after high intensity workouts like boot camp and Zumba.” Id. at 1028. The stock price later fell after a series of public disclosures suggesting that PurePulse had significant accuracy problems, including a class action by Fitbit customers and the announcement of unfavorable study results by a local television station, which included a heart error rate that the station described as “bordering on dangerous.” Id. at 1023. Shareholder class action litigation soon followed.

In denying the defendants’ motion to dismiss, the district court found that certain statements by Fitbit that the devices could “automatically and continuously track their heart rate during everyday activity and exercise” were actionable misstatements of fact in light of the significant accuracy problems that were later revealed. As often occurs in securities litigation, the plaintiffs relied heavily on allegations by anonymous former employees or contractors, including a data scientist hired on a contract basis to develop quality-assurance analytics for Fitbit devices and a contract fitness tester who logged the heart rate results from testers who exercised while wearing Fitbit devices. Id. at 1032. Both “confidential witnesses” alleged that they reported significant accuracy problems to Fitbit’s chief operating officer by June or July 2015. See id. The company, however, continued to make public disclosures that PurePulse provided “highly accurate measurements.” Id. at 1027. The district held that the “confidential witness” allegations — along with the admitted importance of PurePulse to Fitbit’s revenue growth — sufficiently demonstrated management’s awareness of the alleged accuracy problems to support a strong inference that Fitbit’s continued public disclosures regarding the “accuracy” of PurePulse were intentionally or recklessly false. See id. at 1032-33.

The court also rejected Fitbit’s argument that the cautionary disclosures in Fitbit’s IPO prospectus adequately warned investors about the possibility of accuracy issues, noting that the cautionary language only acknowledged “past” claims about the inaccuracy of Fitbit devices and merely stated that “[i]f our products fail to provide accurate measurements … we may become the subject of negative publicity” and litigation, and that “our brand, operating results, and business could be harmed.” Id. at 1035 (emphasis in original). As the court reasoned, the cautionary language “does not disclose that there were presently, at the time of the IPO, indications that Fitbit’s heart rate monitoring technology was inaccurate, as the Amended Complaint alleges.” Id. The cautionary language thus did not cleanse the alleged falsity of Fitbit’s affirmative statements regarding the accuracy of PurePulse. See id.

The OSI Decision

Another district court reached a similar outcome in a class action against OSI Systems over alleged problems with the development of software algorithms for full-body-image airport security scanners. See Roberti v. OSI Systems Inc., No. CV 13-9174-MWF (VBKx), 2015 WL 1985562 (C.D. Cal. Feb. 27, 2015). The company publicly stated that the technology was “undergoing its final testing as we speak,” that the company expected that the government “will be looking at potential orders within the next few months,” and that “we’ve completed our side” of the software development. Id. at *7. As in the Fitbit litigation, however, the plaintiffs presented allegations from various anonymous former employees who claimed that “the algorithm [for the software] was behind” by about a year, that the company “cherry-picked” the machines it sent to the government for testing so that more problematic machines were concealed, and that problems with the software development were documented in the company’s internal defect tracking database, which was allegedly accessible to all OSI management. Id. at *2. The government eventually sent OSI’s subsidiary a show cause letter alleging that the subsidiary had not timely disclosed the problems encountered in the development process, to which the subsidiary responded by conceding that it “became aware of an issue related to software under development months ago and promptly notified the [Transportation Security Administration].” Id. at *3. Two months later, the TSA canceled its contract with OSI’s subsidiary. Id. The court denied dismissal, holding that the “confidential witness” allegations and TSA correspondence raised a strong inference that OSI’s public disclosures about “final testing” and having “completed [its] side of the software development” were knowingly or recklessly misleading.

Takeaways and Best Practices

The Fitbit and OSI cases provide important lessons for companies that face risks from software development problems or defective algorithms. Companies can mitigate their securities litigation risk by keeping the following principles in mind:

  • Companies should include robust cautionary disclosures in Form 10-K filings and offering documents regarding the potential for errors or defects in software programs (including both existing and future programs) and the difficulties inherent in the development process for new software. Companies, however, should not expect that generalized warnings about potential problems will insulate them from liability when they know of actual problems that already pose material risks to investors.
  • Companies should be particularly careful when making definitive positive statements about the accuracy or functionality of software products (for example, when stating that a product is “highly accurate” or when assuring that a specific product development timeline will be achieved). As a practical matter, the more definitive a company’s affirmative statements are, the greater duty a company has to modify its disclosures when problems arise. By contrast, companies that provide more qualifications or caveats when making affirmative statements have greater margin for error and flexibility to address subsequent problems.
  • Companies should implement adequate disclosure controls and channels of communication to ensure that significant software problems are promptly communicated to senior management and disclosure counsel, so that the company has adequate time to assess the impact of such problems on its public disclosures.
  • When material problems arise, companies should review past statements regarding software capabilities or the timeline for product development to determine whether they were rendered false or misleading in light of the problems that are discovered. Companies frequently get in trouble for repeating affirmative statements contained in prior press releases or disclosures that may no longer be accurate in light of subsequent developments.
  • Companies should be particularly mindful of disclosures made in analyst calls (especially Q&A), statements to the press and informal investor presentations, as many companies do not apply the same rigor to these types of less formal disclosures as they do to SEC filings.
  • Companies should assume that employees involved in software development may voluntarily disclose details about software problems to plaintiffs lawyers and regulators, including details about management’s knowledge of alleged problems. Companies should also assume that sophisticated short sellers are scrutinizing their disclosures and will pounce without warning if they find a vulnerability.
  • Companies should develop a robust crisis management plan in the event software errors arise, including plans for ensuring that the disclosures regarding such events accurately reflect the information available to management, avoid unfounded speculation, do not unduly minimize the problem, and do not overpromise with respect to future remediation or investigation efforts.


Gerard G. Pecht is a partner in Norton Rose Fulbright’s Houston office. He is also global head of the firm’s dispute resolution and litigation practice group and head of the regulation, investigations, securities and compliance (RISC) practice group.

Peter A. Stokes is a partner in Norton Rose’s Austin office and is a member of the RISC practice group.
[1] See, e.g., Ho v. Flotek Industries Inc., No. 4:15-CV-3327, 2017 WL 1240111 (S.D. Tex. Mar. 29, 2017) (granting dismissal where allegations failed to show advance knowledge by company’s executives regarding “mistakes in [the] algorithm” for the company’s software); Shemian v. Research In Motion Ltd., No. 11 Civ. 4068, 2013 WL 1285779, at *2 (S.D.N.Y. Mar. 29, 2013) (allegations that the defendants “miscalculated and poorly executed on the development of new [software] products” insufficient to show fraud absent allegations that executives knew of problems at the time of the company’s disclosures); Wozniak v. Align Technology Inc., 850 F. Supp. 2d 1029, 1040-41 (N.D. Cal. 2012) (granting dismissal where company disclosed “the jury is still out” on the beta test of software that the plaintiffs alleged was difficult to use). See, e.g., Ho v. Flotek Industries Inc., No. 4:15-CV-3327, 2017 WL 1240111 (S.D. Tex. Mar. 29, 2017) (granting dismissal where allegations failed to show advance knowledge by the company’s executives regarding “mistakes in [the] algorithm” for the company’s software); Shemian v. Research In Motion Ltd., No. 11 Civ. 4068, 2013 WL 1285779, at *2 (S.D.N.Y. Mar. 29, 2013) (allegations that the defendants “miscalculated and poorly executed on the development of new [software] products” insufficient to show fraud absent allegations that executives knew of problems at the time of the company’s disclosures); Wozniak v. Align Technology, Inc., 850 F. Supp. 2d 1029, 1040-41 (N.D. Cal. 2012) (granting dismissal where company disclosed “the jury is still out” on the beta test of software that the plaintiffs alleged was difficult to use).

Canadian Securities Regulators Announce Prohibition of Binary Options

Securities regulatory authorities for all Canadian jurisdictions, save for British Columbia, (the Participating Authorities) announced the implementation of Multilateral Instrument (the Instrument) and Companion Policy 91-102 on the Prohibition of Binary Options on September 28, 2017.

Binary options are defined in the Instrument as a contract or instrument that provides for only a predetermined fixed amount if the underlying interest meets one or more predefined conditions, and zero or another predetermined amount if it does not. Essentially, this definition captures a range of products that are based on the outcome of a yes/no proposition, also referred to as fixed-return options, digital options or all-or-nothing options. The return is based on whether an underlying asset, event or value meets one or more predetermined conditions as specified in the contract or instrument, during the time period specified therein. The binary options are exercised automatically once the contract or instrument is entered into, either entitling the buyer to the set amount once the predetermined condition is met, or stripping the buyer of the same if they are not. An example of a yes/no proposition on which a binary option could be based is whether or not the value of the Canadian dollar will be above US $0.75 on a particular day. The buyer would choose an outcome and receive an entitlement or be obliged to pay the fixed monetary amount based on their choice of the proposition.

Investment in binary options is often a very high risk proposition and, thus, it often attracts perpetrators of fraud. The Canadian Securities Administrators receive a significant number of complaints from binary options investors, particularly from those trading on online platforms. Such platforms operate as unregistered dealers, and are often based off-shore. The purpose of the Instrument, as stated by the Participating Authorities, is to protect would-be investors from such high risk investments and events of fraud.

The Instrument prohibits advertising, offering, selling and otherwise trading binary options to an individual and to a person or company that was created, or is solely used, to trade binary options. The prohibition is limited to binary options that have a term of maturity of less than 30 days. A binary option trader may receive an exemption from a regulator or a securities regulatory authority, depending on the province, unless they seek to operate in Quebec where no exemptions are allowed.

The prohibition comes into force on December 12, 2017, or, in the case of Saskatchewan, on the day the regulations are filed with the Registrar of Regulations.

The full texts of Multilateral Instrument 91-102 and Companion Policy 91-102 can be accessed here.


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

No Room for Double Talk: The Ontario Court of Appeal Addresses Restatements, the Reasonable Investigation Defence and the Test for Leave in Rahimi v. SouthGobi Resources Ltd.

The recent decision of the Ontario Court of Appeal in Rahimi v. SouthGobi Resources Ltd., 2017 ONCA 719 provides further guidance concerning the role of the judge on a motion for leave to commence a secondary market class action pursuant to s. 138.8(1) of the Securities Act (the Act) and the application of the defence of reasonable investigation.

In particular, the decision stands for the following:

  1. On a motion for leave under s. 138.8, the motion judge’s obligation is to critically scrutinize the entire body of evidence filed on the motion, including gaps in the evidence filed by the defendants. If contentious issues of credibility cannot be resolved on the record before the court, the motion for leave should succeed;
  2. The defence of reasonable investigation mayl be difficult to establish where a corporation has issued a restatement. An acknowledgement by a corporation in its continuous disclosure “that its financial statements cannot be relied upon and that there is a material weakness in its internal financial reporting controls… is powerful evidence that strongly contradicts a defence of reasonable investigation” both by the corporation and its officers and directors; and
  3. Defendants who defend a leave motion by advancing a position that is unsupported by any contemporaneous evidence should not expect to succeed in defeating leave.


SouthGobi Resources (SGR) is a coal mining company  listed on the TSX and the Hong Kong exchange. SouthGobi Sands LLC (SGS), a subsidiary of SGR,  processed its sales of coal using “bill and hold” contracts – an arrangement which allowed SGS to bill its customers before delivery was taken. SGR’s revenues were comprised solely of SGS’ sales, which SGR reported in accordance with International Financial Reporting Standards (IFRS). IFRS allowed SGR to recognize revenue from SGS’ bill and hold contracts prior to receiving payment, provided that title transferred to the customer and payment could be reasonably expected.

In 2012, varying economic conditions resulted in many of SGS’ bill and hold customers being unable to make payments. At that time, SGR stopped using bill and hold arrangements and adopted a revenue recognition policy that required delivery of coal to the customer as a prerequisite to revenue recognition. SGR determined that there was no need to amend its 2010 – 2012 financial statements as a result of this change.

Notwithstanding this decision, on November 8, 2013, SGR issued a formal restatement of its prior financial statements. In its press release of that date, it stated that as a result of a review by its auditors, it had determined that certain transactions had previously been recognized prior to meeting relevant revenue recognition criteria. Following that announcement, SGR’s share price dropped by 18%.

On November 14, 2013, SGR released a second press release, referencing a “material weakness in the Company’s internal controls over the financial reporting” and stating that “the previous financial information provided by the company in respect of the periods to be covered by the restated financials are no longer accurate and should not be relied upon.” The adjustments to SGR’s gross revenue between 2010 and 2012 proved significant. For instance, in Q4 of 2010, SGR’s original gross revenue of $46,314,989 plummeted to $24,359,328.

Rahimi sought leave under s. 138.8(1) to proceed with a misrepresentation claim on behalf of all shareholders who purchased SGR’s shares between March 30, 2011 and November 17, 2013 against SGR, its former chief financial officers and certain board members (collectively, the Individual Respondents).

The Motion For Leave

On the motion for leave, the respondents relied upon the defence of reasonable investigation pursuant to s. 138.4(6)(a) of the Act.

In support of what the Court referred to as “a very unusual position,” the respondents asserted that contrary to the company’s announcements in 2013, the financial statements did not need to be restated, and that SGR had no material weaknesses in its internal reporting controls. Rather, the change in the company’s revenue recognition policy purported to be the consequence of external pressures, including the refusal of the United States Securities Exchange Commission to approve SGR’s financials unless they were compliant with Generally Accepted Accounting Principles (GAAP). The respondents also asserted that they did not mean the November 14 press release to convey that the earlier financial statements contained any misrepresentation of revenue.

The motion judge determined that Rahimi’s claim presented “a reasonable possibility of success,” granted the motion for leave against SGR based on the language in the restatement and in the November 14 press release about deficiencies in its earlier revenue reports, but refused to grant leave against the Individuals Respondents, concluding that there was no reasonable possibility that they would not be able to establish a reasonable investigation defence at trial. The chief financial officers named as defendants has carefully concluded that the IFRS criteria were properly applied, and had reasonably relied upon the company’s auditors.  With respect to the directors named as defendants, the November 14 press release was never put to them, and they had no reasonable grounds to believe that the company’s prior financial statements were untrue.

The Appeal

Rahimi appealed the decision not to grant leave against the Individual Respondents and SGR appealed the decision to allow leave against the company. Rahimi’s appeal succeeded, and the appeal by SGR failed.

The Court of Appeal considered the application of the defence of reasonable investigation in the context of a leave motion, stating that where defendants advance a reasonable investigation defence, the motion judge must ask whether they “will not be able to establish one or more of the branches of the reasonable investigation defence at trial.” This task involves a review of the evidence filed on the motion, as well as a consideration of the evidence which is not before the judge or has yet to be produced.

The Court found that the motion judge failed to acknowledge the limited record and erred in treating the leave motion like a mini-trial. The motion judge failed to account for gaps in the Individual Respondents’ evidence, the existence of other information in the record inconsistent with the evidence of the Individual Respondents which raised credibility issues, and their failure to provide contemporaneous evidence that was consistent with their affidavit evidence, finding that “the lack of a clear record makes evident that the leave must be granted because there is no certainty that the reasonable investigation defence will succeed.” Further, if, as the Individual Respondents asserted, the information in the company’s November 14 press release was false, there was an obligation to correct the information. As disclosure is at the heart of securities litigation, it must be scrupulously accurate and fair. There is no room for prevarication or double-talk”.

Ultimately, the Court concluded that the discrepancy between the position advanced by the Individual Respondents at the leave motion and the company’s position in the restatement and November 14 press release was “so jarring” that the motion judge should not have refused to grant leave against any of them.


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