Written By Robert W. Staley and Derek J. Bell

For better or worse, Canadian courts and Canadian securities regulators have gained ground in bridging the regulatory gap between Canada and the United States. During the last year, securities regulators ignored the recommendation of their staff and blocked Conrad Black's proposed privatization of Hollinger Inc., securities class actions are starting to take off , significant fines imposed by securities regulators have been upheld by the courts, and new legislation will be enacted in Ontario to impose civil liability on market participants for making misleading public disclosure. While Canada may not yet be quite ready to impose American-style 25-year sentences for market fraud, Canadian securities law is clearly flexing its muscles with respect to those who behave in a manner that is contrary to the public interest.

Regulators Flex Muscles: OSC Says No to Conrad Black

In a decision released on March 27, 2005, the Ontario Securities Commission (the OSC) refused to go along with its staff 's recommendation to permit Conrad Black, Ravelston Corp. and their affiliates (the Black Group) to take Hollinger Inc. (Inc.) private.

Inc. had been subject to a management cease-trade order (the MCTO) for being in default of its annual filing requirements. The Black Group needed to have the MCTO lifted or varied in order for the going private transaction to proceed.

OSC staff supported the Black Group's application to have the MCTO lifted: "Minority Shareholders should be allowed to determine for themselves whether or not they want to remain shareholders of Hollinger." The OSC panel disagreed with staff . Criticizing a deficient valuation opinion and the absence of a recommendation to minority shareholders by the directors, the OSC concluded that it was not satisfied that the going private transaction would not be prejudicial to the public interest. The OSC questioned how any shareholder could make a meaningful choice to vote in favour of the going private transaction:

"[L]egitimate concerns are raised as to how the shareholders of Hollinger Inc. will be in any better a position to make an informed decision on the merits of the GPT than were the directors of Hollinger Inc."

The OSC was particularly disturbed by alleged efforts to influence the independent valuator and the independent privatization committee in recommending the going private transaction to shareholders. The OSC held:

"When a related party attempts to exert undue influence, examples of which are set out above, and regardless of whether such apparent attempts are successful, shareholders' confidence in the integrity of the safeguards may, justifiably, be undermined. On a macro level, such conduct, if tolerated or condoned through an exercise of discretion in favour of the responsible party, serves to undermine confidence in the fairness and integrity of the capital markets overall."

Accordingly, the OSC took the rare step of disagreeing with a staff recommendation of this kind, and it refused to modify the MCTO to permit the going private transaction to proceed to a vote of shareholders. Two days later, Inc. sued Black and his affiliates to recover $636 million for management fees and non-competition payments, and less than a month later, Black's holding company Ravelston Corp., entered into receivership.

Regulators Flex Muscles (2): OSC Successfully Prosecutes Rankin of Tipping

On July 15, 2005, the Ontario Court of Justice convicted Andrew Rankin of ten counts of providing insider information, contrary to Section 76(2) of the Ontario Securities Act. Rankin was charged with ten counts of insider trading and ten counts of illegally tipping insider information about pending mergers and acquisitions to a long time friend, before that information was made public. The friend, Daniel Duic, settled with the OSC Staff and testified against Rankin.

After a six-week hearing, Justice R. Khawly released his decision. The judge was particularly unimpressed with Rankin's explanations, finding that “Mr. Rankin laid waste to his own credibility.” The judge commented that Rankin knew full well what the "minefields" were in the case and "[i]nstead of gingerly avoiding them he marched head on into them."

That said, the judge was not particularly impressed with the OSC's witnesses, in particular Rankin's former colleagues at Dominion Securities, who testified about various alleged past incidents involving Rankin. Dismissing their evidence as being motivated by "an agenda, an image to protect, a lawsuit to be vigilant about, and for the underlings, job security to be mindful of," the judge found that Dominion Securities "is partly the author of their misfortune and are unreliable as balanced evaluators."

The OSC's star witness—Duic—fared only slightly better. The judge chastised the OSC for making the deal with Duic, commenting: "The optics of the deal with Duic are terrible. This man pockets 4 1/2 million dollars in illegal gains, and he gets to keep most of it and walk the streets a free man." The judge also noted that "at times [Duic] tailored his evidence to what he thought the OSC needed to hear."

However, in the end, the judge accepted Duic's evidence that Rankin voluntarily passed on material insider information. However, on the charges of insider trading, the judge commented on the "dearth of evidence" and even the OSC prosecutor admitted that Rankin did not trade "directly."

Accordingly, Justice Khawly convicted Rankin of ten counts of tipping and found him not guilty on all of the charges of insider trading. On October 27, 2005, Justice Khawly sentenced Rankin to a term of six months' imprisonment, which was considerably less than the three-to-five year term sought by the OSC. No fines were imposed on Rankin either. Still, Rankin claims the sentence was too severe and has announced his intention to appeal both the conviction and the sentence.

Appellate Courts Let Regulators Flex Muscles: Courts of Appeal Say Yes to Lengthy Suspensions

Following last year's Supreme Court of Canada decision in Re Cartaway, the Ontario Court of Appeal overturned a Divisional Court decision in Donnini v. Ontario (Securities Commission) (2005) 250 D.L.R. (4th) 195, and restored a sentence imposed by the OSC against Piergiorgio Donnini. In June 2002, a panel of the OSC found that Donnini, formerly Yorkton Securities Inc.'s head trader, had made a series of insider trades and, in so doing, acted in a manner that violated the Securities Act and the public interest. Three months later, the OSC imposed its sentence: a 15-year suspension of Donnini's registration, plus the OSC's costs of the investigation. The divisional court upheld the conviction but reduced the period of the suspension to four years.

The court of appeal not only dismissed Donnini's further appeal of his conviction, it restored the original suspension of 15 years while remanding the issue of costs back to the OSC for a further hearing. The court said that the OSC was entitled to a "high level of deference" from the court, and while acknowledging that a 15-year sentence was "a substantial penalty," it would not interfere with the OSC's decision to impose it.

The British Columbia Securities Commission's suspension and administrative penalty was also upheld in Hogan v. British Columbia Securities Commission, 2005 BCCA 53. In that case, the BCSC imposed a suspension order of ten years plus an administrative penalty of $25,000. The trader, who, at the time of the appeal, was unemployed and a part-time student with no ability to pay the monetary penalty, pleaded for the fine to be reduced. The court of appeal disagreed: The trader's Internet "pump and dump" misrepresentations were a "considerable danger to the public," warranting "a strong deterrent message." The sentence was upheld.

Increasingly confident that their sentences will be upheld on appeal, regulators have meted out their maximum punishments on several occasions in 2005, notably in British Columbia:

• On October 3, 2005, the B.C.S.C. imposed the maximum penalty against a man found to have committed securities fraud. Citing his "long and egregious history of fraudulent and abusive trading," the B.C.S.C. ordered Michael Mitton to pay a $250,000 administrative penalty and permanently banned him from the capital markets.
• On September 14, 2005, the B.C.S.C. imposed the maximum administrative penalty of $250,000 against Paul Maudsley and banned him from trading for life after finding that he had committed fraud with respect to certain mutual fund redemptions.
• On June 8, 2005, the B.C.S.C. ordered Carey Dennis to pay a $200,000 administrative penalty and banned him from the securities market for 30 years after finding that he had committed fraud as a mutual fund salesman.

Brokers Given Immunity When Flexing Muscles: Court of Appeal Says No to Lawsuit Against Gatekeeping Stockbroker

Stockbrokers in Ontario must maintain a compliance department to monitor trading in their clients' accounts. Brokers are considered to be "gatekeepers" and have a responsibility to ensure that illegal trading does not occur. Where they fail, stockbrokers can be disciplined by the Investment Dealers Association and the OSC. And, as the Ontario Court of Appeal ruled in Venture Capital USA Inc. v. Yorkton Securities Inc. (2005), 4 B.L.R. (4th) 324, when stockbrokers do freeze client accounts, clients will have a difficult time seeking legal recourse against the broker.

In Venture Capital, the broker froze Venture Capital's account after it learned that the principal behind Venture Capital had a criminal record (extortion and RICO offences, among others). Further, Venture Capital intended to conduct several significant trades that Yorkton feared would run afoul of U.S. securities laws. The broker froze the account; the client sued.

Yorkton pointed to a clause in its account agreement, which expressly permitted Yorkton to freeze accounts and in which the client waived any liability of Yorkton for doing so. The trial judge interpreted that clause narrowly, limiting waiver only to certain inapplicable circumstances. She then imposed an implied term requiring the broker to give "notice" before suspending a client's account. Yorkton having breached the implied notice requirement, the trial judge awarded damages to the client of approximately US$500,000.

The court of appeal vacated the judgment. The court found that the waiver clause was entirely unambiguous and that the trial judge had erred in creating an implied term. The Court of Appeal held:

"Large volume transactions involving large sums of money proceed at a rapid pace, and the risks are high. In my view, the agreement between the broker and the client should be interpreted in a manner that affords the broker burdened with the gatekeeper function latitude to refuse suspect transactions despite a lack of clear proof of illegality.”

In comprehensive reasons, the court allowed the appeal and dismissed the action with costs.

Warrantholders Flex Muscles in an Unfair Plan of Arrangement

Companies will frequently use provincial corporate statutes to effect a takeover without the rigidities of a formal takeover bid. Effecting a takeover through a corporate plan of arrangement is always possible, but as ID Biomedical Corporation (IDB) and GlaxoSmithKline plc (GSK) discovered in December 2005, minority securityholders can strike back by opposing the fairness hearing.

In ID Biomedical Corporation v. GlaxoSmithKline plc, 2005 BCSC 1748, GSK sought to purchase all of the outstanding common shares of IDB for CDN $35.00 – a premium of more than $4 from the last trading price of the shares on the TSX prior to the announcement. GSK also sought to purchase all of the outstanding common share purchase warrants issued in 2003, for a price of CDN $5.33 – a significant discount from the 2003 Warrants' last trading price of CDN $9.22 prior to the announcement.

Two 2003 Warrant Holders opposed the application to approve the plan of arrangement. They complained that the purchase price compensated the warrantholders only for the intrinsic value of the warrants, and gave them nothing for the time value of the warrants. They complained that they received no dissent rights – whereas shareholders did. Shareholders also received a fairness opinion, whereas warrantholders did not.

In comprehensive reasons released on December 13, 2005, Justice Tys of the B.C. Supreme Court agreed that the plan of arrangement, as structured, was unfair to the 2003 Warrant Holders. He found that the plan failed to compensate the warrant holders for the time value of their warrants – usually measured by the Black-Scholes model. Justice Tys held:

"In viewing the differences between the 2003 Warrants and the Common Shares and, in particular, the fact that the Plan of Arrangement represents a discount to the holders of the 2003 Warrants but a premium to the Common Shareholders, I am not satisfied that the Plan of Arrangement as a whole is fair and reasonable. As a result, I am not prepared to approve the Plan of Arrangement in its present form."

The parties subsequently agreed that 2003 Warrant Holders would be paid CDN$9.20 – resulting in a payment of more than $10 million to warrant holders – and given a dissent right. Justice Tys approved the order, as amended.

Bondholders Flex Muscles in Nova Scotia Oppression Case

In a move that harmonizes the Nova Scotia Companies Act with its Ontario and federal counterparts, the Supreme Court in Nova Scotia found that a bondholder can be a "complainant" entitled to the oppression remedy in Harbert v. Calpine Canada Energy Finance II ULC, 2005 NSSC 211 (S.C.). The court found that "upstreaming"— replacing the debtor company's valuable assets with worthless promissory notes from the company's controlling shareholders—unfairly prejudiced the interests of the debtor company's bondholders.

However, in this case, some of the bondholders purchased their bonds after becoming aware of the upstreaming. Can a complainant "buy" an oppression remedy? The case law across Canada is mixed—and the Nova Scotia Supreme Court decided that a complainant cannot do so:

"[A]s a general rule, a complainant that decides to become a security holder knowing that the impugned conduct was occurring cannot be said to have had reasonable expectations to the contrary and consequently, in the circumstance of the very act or conduct that was expected, maintain that it has been oppressed."

Giving Investors New Muscles to Flex: New Laws Imposing Civil Liability for Disclosure Misrepresentation

The Ontario government's Bill 198—passed almost three years ago—finally came into force on December 31, 2005. The amendments to the Securities Act impose civil liability on issuers who make misrepresentations in publicly filed continuous disclosure statements or in oral statements made publicly or who fail to make timely and accurate disclosure of material information. Secondary market civil liability will have national reach because the amendments will apply to every issuer whose shares are listed on the Toronto Stock Exchange and every other publicly traded issuer with a substantial connection to Ontario.

The amendments include a provision to prevent "strike suits" by requiring individuals to seek leave of the court before commencing an action. Liability is capped at $1 million or 5 percent of the issuer's market capitalization. The Bill 198 amendments will also create a new "fraud on the market" offence and increase the fines and administrative penalties the OSC may impose. Similar legislation has been passed in British Columbia but has not yet been proclaimed in force.

Class-Action Plaintiffs Flex Muscles with New Securities Class Proceedings

In part because of Justice Lederman's decision in Danier Leather (which was overturned: see below), and in part in anticipation of the coming into force of Bill 198, a number of securities class actions were launched in 2005. In general, these class actions tended to follow paths already forged by U.S. class-action plaintiff s' counsel. For example:

• In late 2004, class actions were launched in Saskatchewan, Ontario and Quebec against Conrad Black, Hollinger Inc., Ravelston Corp. and others, alleging various misrepresentations. The statement of claim bears many features similar to complaints previously issued in the United States.
• In January 2005, a $100 million class action was launched in Ontario against marine transportation company CP Ships, alleging misrepresentations in press releases and annual and interim financial reports. This case followed similar actions launched in New York in mid-2004.
• In March 2005, a $3 billion class-action lawsuit was launched against Nortel Networks Corp.., its former CEO Frank Dunn and others, alleging misrepresentation, oppression and breach of the Competition Act relating to statements made in 2003–2004. The Ontario action parallels similar actions launched in New York in September 2004.
• In September 2005, a $100 million class action was launched in Ontario against Canadian pharmaceutical company Biovail Corp. and certain of its officers and directors for false and misleading financial statements. The Canadian action followed multiple similar U.S. class actions, which are ongoing.

While most of these "copycat actions" are styled on their U.S. counterparts, there is no sign, at least yet, that the Canadian class-action plaintiff s' bar is adopting some of the highly aggressive tactics used in the U.S., such as the routine filing of multiple securities class actions every time a negative announcement or restatement is made by a public company. That said, with some class counsel now naming plaintiff s simply as "John D" (or, in the Hollinger example, "John D Corporation"), that day may not be far away.

Putting on the Brakes (1): Court of Appeal Reverses Danier Leather

As was generally anticipated by the securities litigation bar, the Court of Appeal reversed Justice Lederman's decision in Kerr v. Danier Leather, released on December 15, 2005.

The Court began its analysis by focusing on the legislation itself – which permits a purchaser of securities to recover damages resulting from a misrepresentation contained in a prospectus. A "misrepresentation" is defined as "an untrue statement of material facts" or "an omission to state a material fact". As acknowledged by the trial judge himself, the prospectus at issue contained no untrue statements or omissions of material facts. The legislation contains no additional disclosure obligations, other than to report "material changes" (again, of which there were none). Accordingly, the Court of Appeal found that Justice Lederman erred by ruling that Danier Leather had violated the Act.

The Court of Appeal also overturned Justice Lederman in three other respects. First, the Court of Appeal held that the trial judge erred in finding that a forecast contained in Danier Leather's prospectus contained an implied representation of "objective reasonableness". Second, the Court of Appeal found that the trial judge erred in ignoring the fact that Danier actually achieved the results stated in their Forecast – a point that the trial judge found "immaterial". Third, the Court of Appeal found that the trial judge gave insufficient weight to the "business judgment" of senior management, stating: "A forecast is a quintessential example of the exercise of business judgment. This business judgment must be considered".

The Court also considered the $1 million "premium" awarded to the representative plaintiff s in costs – an award decried by the class defence bar as a "million dollar tip". The Court of Appeal commented: "Although we think it doubtful that a premium can be properly awarded in a class proceeding (where there are other cost mechanisms to deal with the risk of litigation), here too it is unnecessary for us to decide the issue."

Putting on the Brakes (2): OSC Loses Prosecution Against Ho

On the regulatory front, 2005 was not a year of total success for the securities regulators. Most notably, in reasons released on October 14, 2005, the Ontario Securities Commission dismissed a high-profile insider trading case against ATI Technology Inc.'s board member and CEO, K.Y. Ho, and his wife, Betty Ho. The OSC panel heard 19 days of evidence, much of which was hearsay evidence offered by OSC staff's investigators.

OSC staff lost on almost every count. The panel found that there was no reliable evidence that Ho had knowledge of the alleged undisclosed material fact (i.e., that ATI would fail to meet market expectations of its revenues and earnings for its third quarter ended May 31, 2000, at the time he donated ATI shares to charity and Mrs. Ho sold ATI shares in the open market). The panel also gave much of the evidence adduced by staff 's investigators— being e-mails written by persons not called by OSC staff to testify—"little weight." The panel also decided that Mr. Ho's donations of shares to three charities were not "sales" of those shares for the purpose of the insider trading prohibitions in Section 76 of the Securities Act. OSC staff 's reaction to the panel's decision to dismiss all of the allegations against Mr. and Mrs. Ho was to state that "[w]e would not be doing our job of enforcing the capital markets if we only brought cases that were clear winners." Indeed.