Securities class actions harder to launch after Supreme Court ruling

A ruling by the Supreme Court of Canada that dismissed a proposed securities class action against a Montreal pharmaceutical company will likely make it more difficult for investors to launch these kinds of lawsuits in the future, say class action and securities lawyers.

In a ruling that marked the first time the nation’s highest court examined a case involving secondary securities market liability regimes, the SCC held that in order for plaintiffs to be able to proceed with a securities class action they must provide courts with “sufficient evidence” to show a “realistic chance” of success.

“The threshold should be more than a ‘speed bump,’” said Justice Rosalie Abella in a 7-0 decision in Theratechnologies Inc. v. 121851 Canada, 2015 SCC 18. “What is required is sufficient evidence to persuade the court that there is a reasonable possibility that the action will be resolved in the claimant’s favour.”

Many provinces, including Quebec, Ontario, Alberta, and British Columbia, introduced in the previous decade amendments to provincial securities statutes to allow plaintiffs to sue reporting issuers for alleged secondary market misrepresentation such as failing to report a material change. But in order to eliminate groundless so-called “strike suits,” plaintiffs under most provinces’ securities legislation must obtain leave or a judicial green light from the court before bringing a secondary market misrepresentation claim. Since then, the courts have been grappling with the screening mechanism or ground rules for securities class actions.

Theratechnologies, a pharmaceutical company listed in the Toronto Stock Exchange, became embroiled in a securities class action after it applied to the U.S. Food and Drug Administration for a new drug aimed at reducing excess abdominal fat among HIV patients. As part of its approval process, the FDA referred questions about the drug, including possible side effects, to an advisory board. The FDA published the questions on its website. When analysts published reports on this development, the company’s shares dropped by more than 50 per cent. Two days later, the FDA advisory committee unanimously voted in favour of approving the new drug application, and Theratechnologies’ share price soon recovered.

Source: Trends in Canadian Securities Class Actions: 2014 Update by Nera Economic Consulting
Source: Trends in Canadian Securities Class Actions: 2014 Update by Nera Economic Consulting

A class action was then brought under the Quebec Securities Act (Act) over the drop of the share price. The suit, launched on behalf of shareholders by a numbered holding company that held stock in Theratechnologies, claimed that the possible side effects of the medication and the FDA’s questions about its side effects constituted a material change in the business, operations, or capital of Theratechnologies and that it had failed to disclose that change.

Lower courts in Quebec had given the go-ahead to the securities class action but the Supreme Court overruled them. Under s.225.4 of the Act, in order for an action to be authorized the action must be filed in good faith and there must be a reasonable possibility that it will be resolved in favour of the plaintiff. While the SCC agreed with the Quebec Court of Appeal that the “reasonable possibility” criterion sets out a higher standard than the general threshold for the authorization of a common law class action, the SCC held that the threshold had not been met in this case. The SCC held that the FDA’s questions were a routine aspect of the approval process, and not a material change in the company’s business. A case with a realistic chance of success requires the claimant to offer both a plausible analysis of the applicable legislative provisions and some credible evidence in support of the claim, without mushrooming into a mini-trial, according to the SCC.

Securities class action. Stats. 2014. Nera
Source: Trends in Canadian Securities Class Actions: 2014 Update by Nera Economic Consulting

“The test is absolutely higher following the SCC ruling,” said Garth Myers, class action counsel with Koskie Minsky LLP in Toronto. “There are many outstanding cases in Ontario and across the country relating to misrepresentations in issuer public disclosure that are the subject of many class actions such as the Theratechnologies case. So courts across the country will be looking to this decision for guidance on the appropriate test to apply in similar circumstances.” But because the application of s.225.4 of the Act is still novel, it remains to be seen how the lower courts will apply the SCC’s interpretation of the “reasonable possibility” criterion, added Myers.

Since the SCC ruling raises the bar for plaintiffs both in Quebec and the rest of Canada to obtain authorization from the courts, it will likely be more difficult for investors to launch securities class action suits, according to Pierre Lefebvre, a Montreal lawyer with Fasken Martineau DuMoulin LLP who successfully represented Theratechnologies in the case. “Without conducting a mini-trial, as the SCC put it, plaintiffs will have to demonstrate to the court that they have a reasonable chance of success which means that they will have to have present credible evidence to convince a judge,” said Lefebvre. “They will have to work much harder to find credible evidence and to establish a good case. That will force plaintiffs to think twice before launching such an action.”

But Dimitri Lascaris, a plaintiffs-side securities class action lawyer with Siskinds LLP who acted for a Quebec investors’ rights group that intervened in the Theratechnologies case, is far from convinced that the higher bar will lead to fewer securities class actions. “It’s all going to depend on how lower courts interpret it,” said Lascaris. “But at the end of the day, if you have a case that on its face appears meritorious and you have credible evidence to support it, you are going to get leave. If you have a slim case, with no or marginal evidence to support the case, you are not going to get leave. That’s just the reality. Cases are going to be decided by the facts and the evidence, and the nuances of the leave test are not going to have I think long term implications.”

Securities class action. Stats. 2014. Nera III
Source: Trends in Canadian Securities Class Actions: 2014 Update by Nera Economic Consulting

The SCC ruling is disappointing because it focused almost exclusively on the screening mechanism to prevent “unmeritorious litigation” to the detriment of the underlying objective behind the Quebec Securities Act and similar legislation in other provinces, said Montreal lawyer Michel Savonitto who acted for the numbered company. Up until the amendments, Canadian investors in the secondary trading market like the stock market did not have access to a statutory cause of action when they suffered losses as a result of breaches of continuous disclosure requirements. In common law jurisdictions, investors had to rely on the tort of negligent misrepresentation, which required that investors prove that they had relied on the misinformation or omission of information to their detriment. That was extremely difficult to prove, and essentially put “meaningful redress” out of reach for many who were harmed by dubious disclosure practices, noted Justice Abella.

The SCC ruling turns back the clock to an era before the legislative amendments were introduced to make it easier for investors to launch securities class actions suits, asserts Savonitto. “With the decision that was rendered, it seems to me that they have taken from one hand what they previously gave on the other because the way the test has been interpreted is so restrictive that it will be just as difficult to seek redress as was the case before (the legislative amendments),” said Savonitto. “Even though the SCC warns that it should not be a mini-trial, for all intents and purposes it will be almost like a trial because it will be necessary for plaintiffs to introduce credible evidence. Will this mean that plaintiffs will have to introduce expert evidence? That will be extremely onerous for small investors who are considering launching a class action suit.”

Pendulum swings back in favour of issuers in securities class actions

Nearly a year after a handful of decisions seemingly leaned towards a permissive approach in securities class actions for misrepresentations in public disclosure, the pendulum seems to have swung back after a couple of recent court decisions tilted in favour of issuers.

In a 163-page ruling Justice George Strathy of the Ontario Superior Court this week dismissed a secondary market securities class action against CIBC because the plaintiffs had failed to obtain the required leave to proceed with the action within the three-year period mandated by the Ontario Securities Act (OSA). Justice Strathy pointed out that he would have certified the action and allowed it to proceed to trial if he had not found the limitation period had expired.

The ruling stems from a landmark decision issued by the Ontario Court of Appeal earlier this year. The appeal court ruled that plaintiffs seeking to commence actions under the OSA for misrepresentations by public companies in their secondary market disclosures must obtain judicial leave within three years of the misrepresentation. The ruling in Sharma v. Timminco Limited, 2012 ONCA 107, hailed by defence bar and bemoaned by class action plaintiff lawyers, will likely lead to some proposed claims awaiting a hearing and decision on leave to be statute-barred.

“The decision doesn’t seem to deal with the realities of the problem which is corrective disclosure doesn’t appear immediately after the misrepresentation,” said Kirk Baert, a partner with Koskie Minsky LLP in Toronto, before adding that the ruling appears to be rewarding companies who take longer to correct the misstatements. “It may be years after and in fact may be outside of the three years before the truth ever comes out. At the very least when you file your claim that should stop the time from running because that’s the way it works with every other type of limitation period.”

In the proposed $520 million class action, the proposed representative plaintiff issued a statement of claim on May 2009 but had not obtained leave to proceed with the statutory misrepresentation claim within the three-year limitation period set out in s. 138.14 of Part XXIII.1 of the OSA. The lower court held that section 28 (1) of the Class Proceedings Act (CPA), which provides for the suspension of the limitation period applicable to a cause of action asserted in a class proceeding, applies to “any limitation period applicable to a cause of action.” But in overturning the lower court decision, the Court of Appeal found that s. 138.14 was “clearly designed” to ensure that secondary market claims proceed with dispatch, and the necessary leave motion should be sought expeditiously. “To suspend that limitation period with no guarantee that the s.138.3 cause of action, including the prerequisite leave motion, will be proceeded with expeditiously is inconsistent with that purpose,” wrote Justice S.T. Goudge in a unanimous 12-page judgment.

“This ruling is going to put a lot of pressure to get plaintiffs to get these motions heard and resolved,” remarked Michael Robb, a partner with Siskinds LLP in London. “It is going to put a lot of pressure on courts to hear these motions because the court is going to have to adjudicate these motions in order to preserve limitation periods, and there is nothing a plaintiff can do on his own like a normal case to stop that time from running.”

Common sense prevailed, says Ellen Bessner, a litigation partner with Cassels Brock & Blackwell LLP. Describing it as good news for issuers, Bessner says the ruling provides clear guidance on the conduct of secondary market securities class actions. “As Mr. Justice Goudge points out if you hadn’t sought leave then you don’t have a claim under the OSA, and if you don’t have a claim under the Act you can’t extend the limitation period because there is no claim – it seems like common sense to me.”

Before Part XXIII.1 of the Ontario Securities Act came into force and created civil liability for secondary market disclosure, Canadian investors did not have a viable recourse for misrepresentations  or omissions in public disclosure documents in the secondary market. Unlike in the primary market, where securities are bought from the issuer or its underwriter in an initial distribution through an initial public offering, the secondary market deals with subsequent trades between purchasers and sellers of securities that have already been issued and distributed to the public. The vast majority of trading in the capital markets takes place in the secondary markets. Since the passage of Bill198, comparable legislation has been adopted in most of the other provinces.

But while the Ontario statutory remedy for secondary market liability has been in force since 2005, relatively few class action cases have been heard by the courts and none have gone to trial. In a groundbreaking case rendered on December 2009, Ontario Superior Court Justice Katherine M. van Rensburg certified a class-action law suit against IMAX Corp., a ruling that was upheld after another Ontario Superior Court judge dismissed the motion for leave to appeal. The second securities class action  that was given the green light under the relatively recent investor protection legislation pitted investors against the Arctic Glacier Income Fund. A year ago Justice Wolfram Tausendfreund of the Ontario Superior Court of Justice granted leave under the OSA for the plaintiffs to bring a $165-million action against the Income Fund for misrepresentation in the secondary market, certified common law misrepresentation claims alongside statutory claims, and held that the Ontario-based representative plaintiffs had standing to advance statutory claims on behalf of a global class, which includes members not resident in Canada.