timely disclosure obligations – Coventree decision outlines guiding principles
Directors and senior officers of Canadian public companies are required to make difficult judgments on an on-going basis and few are more challenging, and subject to being second guessed, than determining if a "material change"1 has occurred – which includes a change in the "business, operations or capital" of a company that "would reasonably be expected to have a significant effect on the market price or value" of any of its securities. If a material change occurs, a public company is subject to statutory timely disclosure obligations which require it to forthwith issue a press release disclosing the nature and substance of the change and to file a material change report in respect of such change as soon as practicable and in any event within ten days of the change.2
On November 8, 2011, the Ontario Securities Commission (OSC) issued an order3 imposing sanctions4 on Coventree Inc. (Coventree) and its two most senior officers in connection with the judgments they made in relation to disclosure regarding developments in the asset-backed commercial paper (ABCP) market during 2007 and leading up to the disruption of that market in August 2007. Coventree was the largest non-bank sponsor of ABCP in Canada. Reaching the conclusion that the timely disclosure provisions under the OSA had been breached, the OSC, in a lengthy and important decision issued in late September 20115, canvassed relevant jurisprudence related to timely disclosure and reiterated or outlined certain key principles. Without delving into the facts of the Coventree decision, the purpose of this memorandum is to highlight and discuss those key principles.
Assessing whether a material change has occurred – no deference to be given to judgment of issuer. The assessment of materiality "is a question of mixed fact and law that requires a contextual determination that takes into account all of the relevant circumstances"6. The assessment requires the application of "judgment and common sense" and must not be made technically or supercritically. A "quantitative and qualitative" assessment of the immediate impact, as well as the "likely future effects and consequences",7 of the applicable events or developments is required.
In reviewing whether a material change has occurred, the OSC will review the matter in light of all the facts available to the persons who were charged with making such assessment, and not "against the standard of perfection"8. The assessment is also not made with the benefit of hindsight. Nevertheless, all information that was considered internally at the time judgments were made in connection with disclosure decisions, including email communications, will be taken into account; and such contemporaneous written information will carry more weight than evidence provided subsequently.
Disclosure decisions are not protected by the "business judgment rule", pursuant to which courts generally defer to decisions of directors provided that they have acted on an informed basis, in good faith and in honest belief that the action taken was in the best interest of the company. It is important to note that the OSC held in Coventree that there was no evidence that would lead the panel to conclude that the senior officers of Coventree intentionally breached timely disclosure obligations or attempted to intentionally mislead the investment community.
A change in the business, operations or capital of an issuer is required. An event or development which would reasonably be expected to lead to a significant change in the market price or value of an issuer's securities does not by itself trigger timely disclosure obligations. Such event or development must also have caused a change in the business, operations or capital of the issuer. If, for example, there is a "revenue shortfall… caused by unusually hot weather"9 or other changes in financial results, but there is no change in the business, operations or capital of an issuer, then no timely disclosure will be required.
An external development may cause a material change. An external development will generally not be a material change unless it affects, disproportionately (when compared to other companies in the same business or industry), materially and directly, the business, operations or capital of an issuer.
Risk management strategies may be material changes. Steps taken to guard against risk (or risk management strategies) which are in fact changes to an issuer's business, operations or capital may in and of themselves constitute a material change.
The assessment is objective and should not be determined based on possible future outcomes. Concern about premature disclosure is not a defence. In determining whether a material change occurs, it is critical to remember that the test is objective in nature and should be made at each moment in time without regard to subjective analysis as to future outcomes. Accordingly, if an event has occurred which constitutes a material change, disclosure is required even if it is believed that the effect of the change may be mitigated by future actions.
Regardless of whether there is uncertainty as to the cause, future effect, financial impact or duration of an event or development, such event or development must be disclosed if it constitutes a material change. It is incumbent upon an issuer in such circumstances to make appropriate disclosure with whatever caveats and qualifications are appropriate. An issuer will not subject itself to liability for premature disclosure provided the disclosure is "accurate, balanced and appropriately qualified" and relates to events or developments "that have occurred".10
Previous disclosure of risk is not sufficient. An issuer has an obligation to disclose a material change regardless of whether the change arises from a risk that had been previously disclosed.
Disclosure in a public disclosure document, other than a press release and a material change report, is not sufficient. The disclosure of a material change in a public disclosure document (such as management's discussion and analysis (MD&A)) does not satisfy timely disclosure obligations.
Coventree argued that, since a development was disclosed in its second quarter MD&A and, following its release, there was no significant change in the market price of the company's shares, the development could not have constituted a material change. The OSC noted that there could be numerous reasons why such disclosure did not have a significant effect on the market price of the shares (including that merely disclosing the development in the MD&A may lead the market to believe that the development is not a material change). The OSC also noted that, in any event, a development which has a significant effect on the "value" of an issuer's securities also constitutes a material change and therefore there need not be a significant effect merely on the market price of the shares of an issuer for there to be a material change.
Would the information be important in making an investment decision? An event or development that would be important to a shareholder or investor in making an investment decision with respect to an issuer's securities would, as a matter of common sense, reasonably be expected to have a significant effect on the market price or value of such securities.
Conflict of interest – outside legal advice. In circumstances where those charged with discharging the duty to comply with timely disclosure obligations have a conflict of interest (such as significant shareholdings), obtaining "objective outside legal advice" will be of assistance in addressing such conflict.
Impact on third parties of disclosure not relevant. The fact that disclosure could severely damage an issuer or have a material adverse impact on the markets or third parties is not relevant to the determination of whether compliance with timely disclosure obligations is required.11 Timely disclosure obligations are for the benefit of an issuer's existing and potential shareholders.
In considering and relying upon the Coventree decision in assessing timely disclosure obligations, we would note two practical matters.
In Coventree, the OSC reiterated its position that, in determining whether an issuer has met its timely disclosure obligations, the OSC will not do so with the benefit of hindsight. We would point out, however, that such determination will be made in light of all the facts that were available to the persons responsible for assessing whether a material change had occurred. In considering such facts, the OSC will place more reliance on contemporaneous documents and written information (including emails) than on evidence given at a subsequent hearing. Accordingly, the OSC will be reviewing and interpreting written documents and information that were prepared without the benefit of hindsight, often on the basis of unstated previous discussions and understandings between the sender and recipient and on the belief that such documents would not be reviewed by third parties. In interpreting such documents and related information, even the most well-meaning adjudicator's views may be impacted by events and developments which occurred subsequent to the relevant period. As a result, we believe that in assessing whether a material change has occurred, it is critical that the decision of the public company be made carefully keeping in mind that, if such decision is subsequently subject to regulatory review, hindsight may play a role (whether or not so acknowledged) in determining whether statutory timely disclosure obligations were satisfied.
It is clear that the OSC will not show deference to decisions made by directors or senior officers with respect to timely disclosure obligations, regardless of whether they acted in good faith. We would nevertheless suggest that if such decision makers exercise their duties following the receipt of, and in accordance with, "objective outside legal advice", a decision so made may put them in a far better position if they find themselves before a securities regulatory authority.
by Paul D. Davis, Stephen Genttner and Matthew Langford
1 Securities Act, R.S.O. 1990, c. S.5, s. 1(1) [OSA].
2 Ibid., s. 75.
3 Re Coventree Inc., Geoffrey Cornish and Dean Tai, (2011) 34 O.S.C.B. 11374.
4 Sanctions against Coventree included a cease-trade order, as administrative penalty of $1,000,000 and $250,000 in costs. Sanctions against each of Mr. Cornish (President and director) and Mr. Tai (CEO and director) included administrative penalties of $500,000, orders to resign from positions held as a director or officer of a reporting issuer and a one-year prohibition from becoming or acting as a director or officer of a reporting issuer (other than Coventree). These sanctions were considerably less severe than OSC staff's request.
5 Re Coventree Inc., Geoffrey Cornish and Dean Tai, (2011) 34 O.S.C.B. 10209 [Coventree].
6 Ibid., at para. 156.
7 Ibid., at para. 638.
8 Ibid., at paras. 160-161; and see Re YBM Magnex International Inc. (2003), 26 O.S.C.B. 5285.
9 Coventree, ibid at para. 140, citing Kerr v. Danier Leather Inc., 2007 SCC 44,  3 S.C.R. 331, paras. 47 and 48.
10 Coventree, ibid at para. 637.
11 An issuer may avail itself of the confidential material change reporting provisions of the OSA, if available in the circumstances. See OSA, supra note 1, ss. 75(3)-(5).
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a cautionary note
The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.
© McMillan LLP 2011