Rahimi v. SouthGobi Resources Ltd.
[Indexed as: Rahimi v. SouthGobi Resources Ltd.]
Ontario Reports
Court of Appeal for Ontario
G.J. Epstein, Hourigan and Paciocco JJ.A.
September 18, 2017
137 O.R. (3d) 241 | 2017 ONCA 719
Case Summary
Securities regulation — Misrepresentation — Statutory cause of action — Leave of court
Company's share price falling after it issued restatement of its 2010 to 2012 financial statements and stated in press release that there were deficiencies in earlier revenue reports. Plaintiff seeking leave to bring secondary market misrepresentation class action against company and its former CFOs and directors. Defendants relying on defence of reasonable investigation and claiming that they issued restatement not because of any securities law requirement but because of pressure from parent company and SEC. Motion judge not erring in granting leave to proceed against company but erring in denying leave to proceed against individual defendants. Motion judge erring in resolving significant credibility issues on basis of limited record. Decision to deny leave as against individual defendants also inconsistent with public policy.
Background
Nature of the Business
The defendant SGR was a coal mining company. A subsidiary of SGR sold coal to customers in China under bill and hold contracts and stockpiled the coal for pickup at a bonded yard. SGR used the International Financial Reporting Standards ("IFRS") to report its revenue, rather than the GAAP method. Under an IFRS recognition rule, revenue from the sale of coal on a bill and hold contract could be recognized as soon as the coal was delivered to the stockpile yard, rather than when the customer retrieved the coal, provided that a reasonable judgment could be made that the risks and rewards of ownership of the coal had been transferred to the customer upon delivery of the coal to the yard and that customer payment was probable.
SGR stopped using bill and hold contracts in mid-2012, and adopted a revenue recognition policy that required delivery of coal to the customer as a prerequisite to recognition. In November 2013, SGR issued a formal restatement of its 2010 to 2012 financial statements. It also issued press releases which stated that SGR's earlier revenue reports were deficient and should not be relied on. SGR's share price dropped significantly.
The plaintiff sought leave under s. 138.8(1) of the Securities Act, R.S.O. 1990, c. S.5 to bring a secondary market misrepresentation class action against SGR and its former CFOs and directors on behalf of all purchasers of SGR shares between March 30, 2011 and November 17, 2013.
The defendants relied on the defence of reasonable investigative efforts under s. 138.4(6)(a) of the Act. They submitted that the financial statements during the class period did not have to be restated and that SGR had no material weaknesses in its internal financial reporting controls, and claimed that the restatement was undertaken not because of any securities law requirement but due to pressure from SGR's parent company and the U.S. Securities and Exchange Commission.
The motion judge granted leave to proceed as against SGR but denied leave to proceed as against the individual defendants, holding that there was no reasonable possibility that the individual defendants would not be able to succeed on a defence of reasonable investigation.
The plaintiff appealed the denial of leave as against the individual defendants, and SGR appealed against the granting of leave as against it.
Held
The plaintiff's appeal should be allowed; SGR's appeal should be dismissed.
In refusing to grant leave to proceed as against the individual defendants, the motion judge erred in treating the motion as a mini-trial and finally resolving significant credibility issues on the limited record before him. He failed to consider compelling evidence that contradicted the defence narrative. The lack of a clear record made it evident that leave had to be granted because there was no certainty that the individual defendants' reasonable investigation defence would succeed.
Moreover, the decision to deny leave as against the individual defendants was inconsistent with the public policy animating the secondary market cause of action and with the fundamental policies underlying securities regulation. At the heart of the defendants' submissions was the remarkable proposition that they should be permitted to evade a potentially meritorious action at the leave stage because they previously made material misrepresentations during a restatement process about their company but were now telling the truth about the same issue.
Continuous disclosure is at the heart of securities regulation and must be scrupulously accurate and fair. There is no room for prevarication and double talk.
With respect to the claim against SGR, the motion judge made no error in determining that there was no certainty at this stage that SGR's reasonable investigation defence would succeed at trial.
Cases Referred To
- Canadian Imperial Bank of Commerce v. Green, 2015 SCC 60
- Cornish v. Ontario (Securities Commission), 2013 ONSC 1310
- Drywall Acoustic Lathing and Insulation Local 675 Pension Fund (Trustees of) v. SNC-Lavalin Group Inc., 2015 ONCA 718
- Goldsmith v. National Bank of Canada, 2016 ONCA 22
- Gould v. Western Coal Corp., 2012 ONSC 5184
- Mask v. Silvercorp Metals Inc., 2016 ONCA 641
- Rahimi v. SouthGobi Resources Ltd., 2016 ONSC 1634
- Theratechnologies inc. v. 121851 Canada inc., 2015 SCC 18
Statutes Referred To
- Courts of Justice Act, R.S.O. 1990, c. C.43, s. 6(2) and (3)
- Securities Act, C.Q.L.R., c. V-1.1, s. 225.4
- Securities Act, R.S.O. 1990, c. S.5, Part XXIII.1, ss. 138.3, 138.4(6)(a), 138.4(7), 138.8
Appeal
APPEAL by the plaintiff from the order of Belobaba J., 2015 ONSC 5948 (S.C.J.) denying leave to proceed with a secondary market misrepresentation claim as against the individual defendants; APPEAL by the corporate defendant from order granting leave to proceed against it.
Counsel:
Michael G. Robb, Paul Bates and Alex Dimson, for appellant.
John A. Campion, Gavin Tighe and Stephanie Clark, for respondents SouthGobi Resources Ltd., Terry Krepiakevich, Matthew O'Kane, Andre Deepwell, Pierre B. Lebel and Gordon Lancaster.
The judgment of the court was delivered by
HOURIGAN J.A.:
A. Introduction
[1] Paiman Rahimi is the representative plaintiff in a putative secondary market securities class action against the respondents SouthGobi Resources Ltd. ("SGR"), Terry Krepiakevich, Matthew O'Kane, Andre Deepwell, Pierre Lebel, Gordon Lancaster and Alexander Molyneux (collectively, save for Molyneux, the "individual respondents") and Deloitte LLP.
[2] Rahimi sought leave under s. 138.8(1) of the Securities Act, R.S.O. 1990, c. S.5 ("SA") to proceed with a misrepresentation claim. On the motion for leave, the motion judge permitted the claim to proceed as against SGR but not the individual respondents, holding that there was no reasonable possibility that the individual respondents would not be able to succeed on a defence of reasonable investigation under s. 138.4(6)(a) of the SA.
[3] Rahimi appeals the motion judge's denial of leave as against the individual respondents (the "Rahimi appeal"). SGR brings a separate appeal (the "corporation appeal") against the motion judge's ruling granting leave for the claim to proceed against it.
[4] For the reasons that follow, I would grant the Rahimi appeal and dismiss the corporation appeal.
B. Background
(1) Nature of the Business
[5] SGR is a coal mining company trading on the Toronto and Hong Kong stock exchanges. Krepiakevich and O'Kane are two of its former CFOs. Deepwell, Lebel and Lancaster are directors and members of SGR's audit committee.
[6] The entirety of SGR's revenue came from the coal-mining operations in Mongolia of its subsidiary SouthGobi Sands LLC ("SGS"). SGS's main coal mine was called Ovoot Tolgoi. SGS was a major coal supplier for the Chinese market and, by 2010, all the mine's customers were Chinese.
[7] SGS agreed to what are known as "bill and hold" contractual arrangements with certain of its customers. These customers ordered coal, which SGS stockpiled for custom pickup at a bonded yard that was under the control and supervision of the Mongolian government. The customers would pay the contract price as soon as the coal was delivered to the yard. Under that arrangement, they were able to avoid rising prices in coal and have greater flexibility in transporting it.
[8] SGR used the International Financial Reporting Standards ("IFRS") to report its revenue, rather than the American GAAP method. Under an IFRS recognition rule called IAS-18, revenue from the sale of coal on a bill and hold contract could be recognized as soon as the coal was delivered to the stockpile yard, rather than when the customer retrieved the coal from there, provided that a reasonable judgment could be made that the risks and rewards of ownership of the coal had been transferred to the customer upon delivery of the coal to the yard and that customer payment was probable. Therefore, beginning in 2010, SGS implemented the bill and hold arrangements and SGR recognized the revenue derived therefrom in the manner dictated by IAS-18.
(2) Prelude to the November 2013 Restatement
[9] In March and April 2012, SGR's parent company, Ivanhoe Mines, was acquired by Rio Tinto, which subsequently changed its name to Turquoise Hill Resources ("TQR"). PricewaterhouseCoopers ("PwC"), the long-time auditor for TQR, became the auditor for SGR, replacing Deloitte.
[10] In 2012, a Chinese company attempted to purchase SGR, but the deal was blocked by the Mongolian government, which shut down SGS's coal-mining operation in Mongolia in May 2012. Ovoot Tolgoi produced no coal from then until September 2013. Coal prices in China were falling, and by the middle of 2012, SGS's bill and hold customers had trouble making timely payments, resulting in a growing number of forfeitures of coal and repossessions by SGS. The likelihood-of-payment stipulation in IAS-18 was no longer being met for these customers.
[11] SGR, with approval of PwC, stopped using bill and hold agreements in mid-2012. It adopted a revenue recognition policy that required delivery of coal to the customer as a prerequisite to recognition. The transfer of title provisions in SGS's bill and hold agreements were amended to take effect in January 2013, and the change in revenue recognition policy was to be implemented on a go-forward basis.
[12] SGR concluded that there was no need in January 2013 to change its earlier financial statements as a result of these subsequent changes in operation. PwC, which reviewed the earlier financials from 2010 to mid-2012, agreed with this position.
(3) The November 2013 Restatement
[13] For reasons that are in contest in this litigation, in spite of the January 2013 decision not to alter its earlier financial statements, SGR did issue a formal restatement of its prior financial statements on November 8, 2013 (the "restatement"). In a press release, SGR stated that, as a result of a review by SGR's auditors for the 2010 and 2011 fiscal years:
The Company has determined that certain revenue transactions were previously recognized in the Company's consolidated financial statements prior to meeting relevant revenue recognition criteria. These transactions relate to coal that had been delivered to the customer's stockpile in a stockyard located with the SouthGobi Ovoot Tolgoi mining license area ("the Stockyard") . . . The restatement of the Company's consolidated financial statements will reflect a change in the point of revenue recognition from: (A) the delivery of coal to the customer stockpiles with the Stockyard to (B) the loading of coal onto the customer's trucks at the time of collection . . .
Until the recent review, it was determined that a restatement of financial statements for the periods prior to the second half of 2012 was not required. The restatement of the Company 2011 and 2012 financials in order to reflect this change in the point of revenue recognition will in turn require restatements to the comparative information in the Company's previously filed interim financial statements for 2013.
As a result of the potentially material effects on the Company's financial statements, 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.
[14] Following the November 8 press release, SGR's share price dropped about 18 per cent.
[15] SGR released another press release on November 14, 2013 (the "November 14 press release") indicating that there was "a material weakness in the Company's internal controls over the financial reporting". The "material weakness" was explained as a failure to ensure that "all aspects of sales arrangements were considered" in determining the appropriate financial accounting in respect of the bill and hold contracts used in Ovoot Tolgoi mining operations. There was, in other words, no assurance that the accounting for the bill and hold contracts was IFRS-compliant.
[16] The restatement had a significant impact on SGR's financial reporting, decreasing what SGR represented as its gross revenue between late-2010 and early 2012.
(4) The Litigation
[17] The putative class action was for all purchasers of SGR shares between March 30, 2011 and November 17, 2013. The parties agreed that certification should await the determination of the issue of leave under the SA.
[18] On the motion for leave, SGR and the individual respondents took a very unusual position. They relied on the defence of reasonable investigative efforts afforded to them by s. 138.4(6)(a) of the SA. In support of that defence, they submitted that the financial statements during the class period did not need to be restated and that SGR had no material weaknesses in its internal financial reporting controls. They tendered affidavit evidence that the restatement was undertaken not because of any securities law requirement, but due to pressure from TQR, PwC and the United States Securities Exchange Commission ("SEC"). They said that in the summer of 2013, the SEC reviewed TQR's consolidated financial statements and challenged SGR's earlier revenue recognition decisions relating to the bill and hold agreements because they were not GAAP-compliant. Rio Tinto, TQR and PwC defended those decisions based on their compliance with IFRS. The SEC nevertheless stated that it would not approve TRQ's third-quarter financials unless SGR's bill and hold revenues were restated. Significantly, TRQ required this approval to complete a rights offering financing venture being planned for November 2013. Under pressure from the SEC, TRQ therefore asked SGR to provide the requested restatement in early November 2013.
[19] The motion judge described the situation as follows, at para. 15 of his reasons:
The uncontroverted evidence of the defendant directors is that SGR reluctantly agreed to restate the 2010 to 2012 financials for three reasons: one, to accommodate TQR's dispute with the SEC and allow TQR to conclude its rights offering financing; two, to itself avoid default on a convertible debenture held by the Chinese Investment Corporation by making a required interest payment that depended on financial support from TQR, who would only fund the company's operations if SGR's earlier financials were restated; and three, because PwC was now taking the position, despite agreeing in 2012 that no restatements were necessary, that it would not approve SGR's 3Q2013 financials unless the earlier financials were restated.
[20] In other words, the individual respondents' position was that there was no misrepresentation during the class period; rather, any potential misrepresentation was in the restatement and/or the November 14 press release.
[21] With respect to the reference in the press release announcing the restatement that SGR's earlier financial statements were "no longer accurate and should not be relied upon", Lebel, Lancaster and Deepwell swore nearly identical affidavits saying that they did not mean to convey that the earlier financial statements contained any misrepresentation of revenue. Rather, they asserted that the reference to the inaccuracy and unreliability of the earlier financial statements "flowed, ipso facto, from the restatement decision itself".
(5) The Motion Judge's Reasons
[22] At the first stage of his analysis, the motion judge concluded that the misrepresentation claim should proceed because it had a reasonable possibility of success. In so concluding, he highlighted "the explicit language" in the restatement to the effect that SGR's earlier revenue reports were deficient and should not be relied on (see para. 38), as well as SGR's statements about deficiencies in its earlier revenue reports in the November 14 press release.
[23] The motion judge then turned to the issue of the reasonable investigation defence. He did not grant leave as against the individual respondents because he held that there was no reasonable possibility that they would not be able to establish a reasonable investigation defence at trial under the SA.
[24] With respect to Krepiakevich and O'Kane, the motion judge found that their uncontroverted evidence was that they carefully analyzed IFRS standards against all of the bill and hold contracts created during their respective tenures and concluded that the IFRS criteria were properly applied to them. The motion judge referred to the factors for the court to consider in determining whether there was a possibility that they could succeed on a reasonable investigation defence set out in s. 138.4(7) of the SA. He held that, because the two CFOs had impressive accounting credentials and experience with the IFRS standards, their knowledge and experience favoured their defence, as did their reasonable reliance on the opinions of the company's auditors, Deloitte and PwC.
[25] With respect to Deepwell, Lebel and Lancaster, the motion judge noted that they were on the board of directors of SGR in November 2013 during the restatement and the November 14 press release. He stated that SGR's admission that its prior financials were deficient was inconsistent with a reasonable investigation defence. However, he observed that the November 14 press release was never put to the board of directors before being released and was drafted exclusively by SGR management. Therefore, he stated, at para. 56, "there is no linkage between the three defendant directors and the reference in the November 14 news release about a weakness in internal financial reporting controls".
[26] The motion judge stated that these parties provided credible and unchallenged evidence establishing their reasonable investigation defences. Deepwell reviewed the opinions of the audit committee and presented them to the board. His actions in doing so showed an appropriate degree of attention to the reporting of revenue and, in particular, to the reporting of the bill and hold contract revenue over the time periods in question. Lebel testified that the board of directors never had any reasonable grounds to believe that its earlier financial statements were untrue. His evidence of what corporate governance and accounting procedures were used by SGR was not undermined by cross-examination. Lancaster testified that all revenue recognition decisions in respect of the bill and hold contracts were only made after review and approval by the auditors.
[27] The motion judge concluded, at para. 62:
The defendants' evidence taken as a whole shows that the individual defendants were fully alive to the "bill and hold" issues. There were visits to Mongolia by the CFO, the audit committee and board, and the external auditors. There was thoughtful preparation, review and approval of audit plans and draft financial statements and the correction and adjustment of these statements as and when needed. I am satisfied on the evidence before me that nothing more could have been done by the two CFOs or the three defendant directors to ensure the legitimacy and accuracy of the financial representations at issue.
[28] With respect to SGR, the motion judge held that there was a reasonable possibility that it would not establish a reasonable investigation defence at trial. According to the motion judge, the fact that SGR had issued the restatement was arguably inconsistent with a reasonable investigation defence. The restatement amounted to an acknowledgment of a "prior error" in a financial statement as defined under the IFRS, being an error arising from (at para. 65) "a failure to use or the misuse of reliable information that was available at the time that the relevant financial statements were issued, and that could reasonably have been expected to be obtained and taken into account in the preparation and presentation of those financial statements". A prior error thus defined is inconsistent with the possibility of a reasonable investigation.
[29] The motion judge also relied on the fact SGR management announced a material weakness in the company's internal financial reporting controls in the November 14 press release. This admission was found to be inconsistent with the company's having performed a reasonable investigation in relation to the subject of the alleged misrepresentations.
[30] Finally, the motion judge noted that there was no evidence from any member of SGR management who was in place at the time of the restatement or the November 14 press release about the weaknesses in SGR's internal revenue-reporting controls to explain why management said what it said.
[31] Rahimi appeals the motion judge's decision on the ground that leave to pursue the misrepresentation claim should have been granted in respect of the individual respondents. SGR appeals on the ground that leave should have been denied as against SGR.
[32] On its motion for leave to appeal in the Divisional Court, SGR took the position that the doctrine of corporate identification merges the mental state of the responsible individual within a corporation with that of the corporation itself. In short, it submitted that there cannot be a finding that SGR is culpable while the individual respondents are exonerated. The Divisional Court granted leave to appeal to SGR, finding that there was reason to doubt the correctness of the motion judge's decision based on the corporate identification doctrine.
C. Issues
[33] The appeals raise two issues for determination: (i) Did the motion judge err in denying leave on the claim against the individual respondents? (ii) Did the motion judge err in granting leave on the claim against SGR? Below, I answer the first issue in the affirmative and the second issue in the negative.
[34] In summary, with respect to the individual respondents, the primary error made by the motion judge was treating the leave motion as if it were a trial in which he had to finally resolve significant credibility issues on the record before him. The motion judge failed to give meaningful consideration to gaps in the evidentiary record and the significant credibility issues apparent from that record. In particular, he failed to consider compelling evidence that contradicted the defence narrative offered by SGR and the individual respondents on the leave motion. The decision of the motion judge to deny leave to as against the individual respondents was also inconsistent with fundamental policy imperatives that animate securities regulation. With respect to the claim against SGR, the motion judge made no error in determining that there was no certainty at this stage that SGR's reasonable investigation defence would succeed at trial.
D. Analysis
(1) Legal Principles
[35] Before considering the issues in these appeals, it is helpful to review the legal principles applicable to leave motions under the SA.
[36] Part XXIII.1 of the SA creates a regime governing civil liability for misrepresentation on the secondary securities market. Section 138.3 creates a cause of action for misrepresentation, but s. 138.8 requires the plaintiff to first obtain leave of the court to commence the action. Subsections (1)-(3) of s. 138.8 provide:
138.8(1) No action may be commenced under section 138.3 without leave of the court granted upon motion with notice to each defendant. The court shall grant leave only where it is satisfied that,
(a) the action is being brought in good faith; and
(b) there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.
(2) Upon an application under this section, the plaintiff and each defendant shall serve and file one or more affidavits setting forth the material facts upon which each intends to rely.
(3) The maker of such an affidavit may be examined on it in accordance with the rules of court.
[37] The Supreme Court of Canada addressed the proper interpretation and application of s. 138.3(1) in Canadian Imperial Bank of Commerce v. Green, 2015 SCC 60. It adopted the same interpretation it previously gave to the virtually identical s. 225.4 of Quebec's Securities Act in Theratechnologies inc. v. 121851 Canada inc., 2015 SCC 18.
[38] These cases establish that for there to be a reasonable possibility that a misrepresentation action will be resolved at trial in favour of the plaintiff under s. 138.8(1)(b), "there must be a reasonable or realistic chance that it will succeed", and the plaintiff must "offer both a plausible analysis of the applicable legislative provisions, and some credible evidence in support of the claim": Green, at para. 121. The plaintiff must adduce "sufficient evidence to persuade the court that there is a reasonable possibility that the action will be resolved in the [plaintiff's] favour": Theratechnologies, at para. 39.
[39] The civil liability regime in Part XXIII.1 of the SA was enacted in 2002 following a series of high-profile misrepresentations and questionable disclosure practices among publicly traded companies in Canada during the 1990s. Regulatory sanctions available at the time were perceived as inadequate deterrents for these wrongs. Common law remedies for negligent misrepresentation -- which required investors to prove detrimental reliance on an alleged misrepresentation -- were perceived as too onerous for a legal proceeding to be feasible. Accordingly, the Part XXIII.1 regime was designed to provide more effective deterrence for wrongful conduct on the part of corporations by making it easier for investors to obtain compensation for misrepresentations, who are not required to prove detrimental reliance under the regime: see Theratechnologies, at paras. 28-29, 33; and Green, at paras. 63-65.
[40] The leave requirement in s. 138.8 was added in response to a concern that a lack of safeguards in the Part XXIII.1 regime would unfairly expose securities issuers and long-term shareholders to the volatility of share prices engendered by unmeritorious, frivolous and costly secondary market misrepresentation claims: Goldsmith v. National Bank of Canada, 2016 ONCA 22, at para. 27. U.S.-style "strike suits", or meritless actions launched in order to coerce targeted defendants into unjust settlements, undermine the integrity of Ontario's capital markets: Green, at paras. 67-68. The leave requirement is therefore intended to function as a "screening mechanism" so that only actions that have a reasonable possibility of success are permitted to proceed and unmeritorious litigation, and the time and expense it imposes on defendants, is avoided or brought to an end early in the litigation process: Theratechnologies, at paras. 30 and 38.
[41] In light of these policy objectives, the statutory cause of action in the Part XXIII.1 regime balances provisions that facilitate a plaintiff's remedy, such as deemed reliance on the misrepresentation, against protections for defendants, including the leave requirement and the reasonable investigation defence: Theratechnologies, at para. 179; and Drywall Acoustic Lathing and Insulation Local 675 Pension Fund (Trustees of) v. SNC-Lavalin Group Inc., 2015 ONCA 718, at para. 49.
[42] The reasonable investigation defence is contained in s. 138.4(6) and (7):
138.4(6) A person or company is not liable in an action under section 138.3 in relation to,
(a) a misrepresentation if that person or company proves that,
(i) before the release of the document or the making of the public oral statement containing the misrepresentation, the person or company conducted or caused to be conducted a reasonable investigation, and
(ii) at the time of the release of the document or the making of the public oral statement, the person or company had no reasonable grounds to believe that the document or public oral statement contained the misrepresentation; or
(7) In determining whether an investigation was reasonable under subsection (6) . . . the court shall consider all relevant circumstances, including,
(a) the nature of the responsible issuer;
(b) the knowledge, experience and function of the person or company;
(c) the office held, if the person was an officer;
(d) the presence or absence of another relationship with the responsible issuer, if the person was a director;
(e) the existence, if any, and the nature of any system designed to ensure that the responsible issuer meets its continuous disclosure obligations;
(f) the reasonableness of reliance by the person or company on the responsible issuer's disclosure compliance system and on the responsible issuer's officers, employees and others whose duties would in the ordinary course have given them knowledge of the relevant facts;
(g) the period within which disclosure was required to be made under the applicable law;
(h) in respect of a report, statement or opinion of an expert, any professional standards applicable to the expert;
(i) the extent to which the person or company knew, or should reasonably have known, the content and medium of dissemination of the document or public oral statement;
(j) in the case of a misrepresentation, the role and responsibility of the person or company in the preparation and release of the document or the making of the public oral statement containing the misrepresentation or the ascertaining of the facts contained in that document or public oral statement; and
(k) in the case of a failure to make timely disclosure, the role and responsibility of the person or company involved in a decision not to disclose the material change.
[43] In Gould v. Western Coal Corp., 2012 ONSC 5184, at para. 267, Strathy J. (as he then was) stated that the reasonable investigation defence has two requirements: (1) the defendant must have conducted a reasonable investigation or caused such an investigation to be conducted; and (2) the defendant had no reasonable grounds to believe that the defective public document contained a misrepresentation.
[44] The operation of the reasonable investigation defence under s. 138.4(6)(a), in the context of a motion for leave to commence a misrepresentation action, was not before the Supreme Court in either Theratechnologies or Green. In its own decision in Green v. Canadian Imperial Bank of Commerce, 2014 ONCA 90, at para. 94, this court endorsed the test Strathy J. adopted for determining whether to grant leave to a plaintiff under s. 138.8 where the defendant asserts a defence of reasonable investigation. The test asks whether there is a reasonable possibility that the defendant will not be able to establish one or more of the branches of the reasonable investigation defence at trial.
[45] There is, therefore, an underlying balancing inherent in the legal standard for obtaining leave to pursue the secondary market misrepresentation cause of action created by Part XXIII.1 of the SA. On the one hand, the standard is designed to provide aggrieved investors with an effective remedy. On the other hand, issuers must be protected from unmeritorious claims and frivolous strike suits. A motion judge hearing a leave application must balance these competing policy imperatives. She must vigilantly implement the screening mechanism of the leave requirement under s. 138.8 while at the same ensuring that the secondary market remedy is not rendered illusory through the elimination of potentially meritorious claims.
[46] Although this is a relatively new cause of action, the case law provides guidance on how the motion judge is to discharge these competing duties. The court must undertake "a reasoned consideration of the evidence to ensure that the action has some merit": Theratechnologies, at para. 38. This must include some weighing of the evidence that both parties are required to proffer under s. 138.8(2) and (3) and scrutiny of the entire body of evidence, not just the evidence of the plaintiff viewed in isolation. To achieve the objective of the leave requirement:
. . . the motion judge must do more than simply ascertain whether the plaintiff has presented evidence of a triable issue. Instead, the motion judge must review all the evidence adduced by both parties to ascertain whether there is "a reasonable or realistic chance that the action will succeed."
Mask v. Silvercorp Metals Inc., 2016 ONCA 641, at para. 43.
[47] The balancing exercise was described by Abella J. in Theratechnologies, at para. 39:
A case with a reasonable possibility 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. This approach, in my view, best realizes the legislative intent of the screening mechanism: to ensure that cases with little chance of success -- and the time and expense they impose -- are avoided. I agree with the Court of Appeal, however, that the authorization stage under s. 225.4 should not be treated as a mini-trial. A full analysis of the evidence is unnecessary. If the goal of the screening mechanism is to prevent costly strike suits and litigation with little chance of success, it follows that the evidentiary requirements should not be so onerous as to essentially replicate the demands of a trial. To impose such a requirement would undermine the objective of the screening mechanism, which is to protect reporting issuers from unsubstantiated strike suits and costly unmeritorious litigation. 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.
[48] To be clear, the motion judge's duty to scrutinize the entire record is not restricted to a review of the evidence filed on the motion. The motion judge is also obligated to consider what evidence is not before her. She must be cognizant of the fact that, at the leave stage, full production has not been made and the defendant may have relevant documentation that has not been produced or relevant evidence that has not been tendered. Consideration of these evidential limitations of the leave stage is important because they can work to the prejudice of plaintiffs who have potentially meritorious claims.
[49] Equally important is the requirement that the motion judge thoroughly examine the state of the evidence to determine whether there are contentious issues of credibility that impact on the decision whether to grant leave. Where such credibility issues are extant, the motion judge must ask herself whether they can be resolved on the existing record.
[50] In the present case, the motion judge found that Rahimi had established a prima facie case in his misrepresentation claim. The real issue was whether there was a reasonable possibility that SGR and the individual respondents will not be able to establish one or more of the branches of the reasonable investigation defence at trial. In the face of the limited record and significant credibility issues, the proper course for the motion judge was not to do the best he could on the available record, treating the motion as if it were a mini-trial. Rather, 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.
(2) Reasonable Investigation Defence of the Individual Respondents
[51] With respect, I am of the view that the motion judge erred in law in treating the motion as a mini-trial in which his function was to determine contentious issues of credibility. He compounded that error by conducting a review of the credibility issues that failed to properly consider the gaps in the evidence and the evidence that conflicts with the contents of the affidavits filed on the leave motion. In particular, he failed to take into account the following issues.
[52] First, nowhere in the documents produced by SGR and the individual respondents is there any contemporaneous document that is consistent with the individual respondents' current narrative that they objected to the restatement and were of the view that the November 14 press release was inaccurate.
[53] To the contrary, the minutes of a conference call meeting of the SGR board of directors held the day before the restatement show that the management of SGR approved the restatement with the full support of the board of directors. There is no indication of any objection to the restatement and no reference to a belief among the individual respondents and/or SGR that a restatement was unnecessary. There is also no reference in any of the documents produced by SGR from that time that the individual respondents objected to the statements made regarding internal revenue recognition controls in the November 14 press release.
[54] Similarly, two PwC reports to SGR's audit committee on the restatement process, dated November 13, 2013 and December 6, 2013, do not contain any indication that the individual respondents or SGR were reluctantly agreeing to the restatement. Nor do the reports evidence any dissention on the part of the individual respondents regarding the contents of the November 14 press release.
[55] The only time the individual respondents' narrative is articulated is in the affidavits filed in response to the leave motion. The lack of contemporaneous evidence consistent with the central component of the defence asserted by SGR and the individual respondents raises a serious credibility issue. The motion judge never averted to this issue in his analysis.
[56] Second, the failure to correct or clarify raises another important credibility issue. The individual respondents take the position that the November 14 press release is false because there were never any material weaknesses in SGR's internal revenue reporting controls. Yet, the concession of these weakness by SGR in the press release is significant. The information was disclosed because SGR deemed it material. If it were false information, as the individual respondents now assert, SGR and those individual respondents still employed by it had an obligation to take steps to have SGR correct that false information. That was not done by SGR, and there is no evidence that any of the individual respondents sought such a correction.
[57] With respect to the restatement itself, the individual respondents' reinterpretation of what appear to be clear words in the accompanying press release seems at first blush to be inconsistent with a duty of plain and frank disclosure: see Cornish v. Ontario (Securities Commission), 2013 ONSC 1310, at paras. 38-40, cited in Theratechnologies, at paras. 25-26. Recall that the press release announcing the restatement stated that the relevant financial statements could not be relied upon and were to be restated. Those words would suggest that there was a problem with the previous statements. Nowhere in the press release was there any suggestion that the financial statements were reliable and that the restatement was being made for other reasons.
[58] But even accepting the interpretation that the individual respondents now give to the words used in the press release, there would still be an obligation to clarify them. The individual respondents are now suggesting that the words used by SGR to explain the restatement are to be interpreted in a manner that would appear to be inconsistent with their plain meaning. In those circumstances, SGR had an obligation to clarify what it really meant. Again, that was not done and there is no evidence that the individual respondents took steps to make that happen.
[59] There would appear to be an available inference on these facts that no correction to the public record was made because the position now taken by the individual respondents is not truthful. That inference could certainly be rebutted at trial, but on the face of the record on the leave motion it could not be definitively resolved. Again, the motion judge failed to avert to this significant credibility issue in his analysis.
[60] Third, the individual respondents all attach significant importance to the fact that at the relevant points throughout the class period they relied on the advice of SGR's external auditors, being first Deloitte and later PWC. However, there is no affidavit evidence filed by Deloitte or PWC. It is, therefore, not possible on this record for Rahimi to meaningfully challenge the reliance argument made or to probe the specific instructions and corresponding advice between SGR and its auditors.
[61] Fourth, in their affidavits filed on the leave motion, the individual respondents assert that one of the primary reasons for the restatement was that the SEC required that revenue be reported in accordance with GAAP. In other words, it is not that there was an error in revenue recognition under IFRS; the change was made because GAAP was thrust upon them and they had no choice but to accept it.
[62] This position is not consistent with what is disclosed in the board of directors minutes from the meetings that took place at the time of the restatement. There is no reference to a move to GAAP, much less a forced move.
[63] Similarly, in PwC's November 13, 2013 and December 6, 2013 reports to SGR's audit committee, there is no reference to GAAP. Instead, as stated in the December 6, 2013 report, PwC reported that "[m]anagement has reviewed its historical revenue recognition approach and concluded that it is not appropriate under IFRS". Later in the same report, PwC stated that they had "assessed whether the adjustments have been accounted for and disclosed in accordance with IFRS standards on correction of errors".
[64] An expert accounting report prepared by Stuart Harden and filed by Rahimi on the leave motion also casts doubt on the individual respondents' explanation of the restatement based on a forced changeover to GAAP. The report states:
No mention, in either the required disclosures regarding the nature of the restatement or the Independent Auditor's Reports of either PwC or Deloitte, is made of a change in accounting principle, either mandated by IFRS, or voluntarily adopted by the company. In fact, the required disclosures and Independent Auditor's Reports refer to "corrections" and "errors".
I understand from the affidavits and exhibits I have read that the United States Securities and Exchange Commission raised issues with the Company's parent and grandparent, each of which prepared their consolidated financial statements in accordance with USGAAP, about the revenue recognition policies applied at SouthGobi.
If the Company's restatement was required for the sole purpose of reporting revenue retrospectively on the basis of USGAAP consistent with the parent and grandparent, the restatement would have been identified as a voluntary change in accounting principle and the disclosures and auditors' opinions would have noted that the Company's restated consolidated financial statements were fairly stated in accordance with the IFRS except for the recording of revenue in accordance with USGAAP. This was not the case.
Accordingly, I conclude that the recognition of revenue at the time that coal was loaded onto customers' trucks during the restatement period (fourth quarter of 2010 through the second quarter of 2012) was determined by the company, and the company's auditor's, to be the appropriate policy in accordance with IFRS and, therefore, the restatement was identified as a correction of an error and not a change in accounting principle.
The Company could have, if permitted under its regulatory requirements, adopted USGAAP in its entirety by retrospective restatement. Similarly, if permitted under their regulatory requirements, the parent and grandparent could have reported the Company's revenue in accordance with USGAAP with explanation that the Company's separate reporting was in accordance with IFRS and disclosed the magnitude of the differences. Both of these options would be consistent with the notion that revenue recognition principles under USGAAP and IFRS, when applied to the Company's transactions, result in different answers. However, the reporting methodology adopted by the Company (i.e. restatement due to errors) is not consistent with that notion but rather the notion that revenue recognition principles for USGAAP and IFRS, when applied to the Company's transactions, produce similar results.
[65] This is expert evidence that directly calls into to question the veracity of the position taken by the individual respondents that a forced move to GAAP was a prime factor behind the restatement. There is also no mention of such a forced move in the expert accounting report prepared by Michael Garvey and filed by the respondents on the leave motion. This, too, casts doubt on the evidence relied upon by the motion judge.
[66] There is a further problem with the motion judge's treatment of the expert testimony I have just described. He found that it was unnecessary to consider the expert evidence filed by the parties because their evidence was a matter of common sense. With respect, understanding the process leading up to the restatement is not a matter of common sense. It requires consideration the specific language used in the restatement, as well as the accounting principles regarding when such restatements are necessary and how they are to be carried out. The motion judge erred in not taking this evidence into account.
[67] Counsel for SGR and the individual respondents take the position that whatever is said in the restatement and the November 14 press release is only relevant to whether the financial statements contained a misrepresentation. He argued that the restatement and the November 14 press release are irrelevant to the defence of reasonable investigation.
[68] I disagree. When a corporation says 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, this is powerful evidence that strongly contradicts a defence of reasonable investigation. The evidence is relevant not only to the directors and officers who were involved in the restatement, but also to the directors and officers who were involved earlier in the class period. This is because the restatement and the November 14 press release are evidence that the financial statements were unreliable throughout the class period, thereby calling into question the reasonableness of the investigation by all of the individual respondents.
[69] To the extent the motion judge considered the discrepancy between the disclosure in November 2013 and the individual respondents' current narrative at all, he distinguished between SGR and the individual respondents on the basis that the November 14 press release was prepared by management and the individual respondents had no involvement in its preparation. This distinction is problematic for three reasons.
[70] First, prior to the issuance of the November 14 press release, SGR had repeatedly represented to the market that its internal financial reporting controls were adequate. If, as the individual respondents would now have us believe, the information in the November 14 press release was false, they had an obligation to correct that false information. As discussed above, the fact that the individual respondents failed to correct what they now say was false material information raises a serious unresolved credibility issue.
[71] Second, the documentary evidence is clear that Lebel, Deepwell and Lancaster were intimately involved in the restatement process. It is evident from the board of directors' minutes from the meeting the day before the restatement that both management and the board of directors were devoting a great deal of time to managing this issue and were working closely with the auditors and external legal counsel as part of that process. The suggestion that management issued the November 14 press release without audit committee approval would appear to be inconsistent with the crisis management process reflected in the board of directors' minutes. While it may be that the members of the audit committee had no involvement in the issuance of the November 14 press release, at this stage it is impossible to be certain; as the motion judge found, there was no evidence from any member of SGR management who was in place at the time of the November 14 press release to explain why management said what it said.
[72] Third, focusing on who issued the November 14 press release misses the point. It is the content of the release that is important. The release contained a significant admission of a major problem with the company's previous internal revenue-reporting controls. If true, this evidence would appear to be inconsistent with a reasonable investigation defence on behalf of both SGR and the individual respondents.
[73] In any event, the individual respondents do not assert that they are in a different position than SGR. To the contrary, their mutual counsel submits that they are indistinguishable and that there is no legal difference between the actions of the individual respondents and SGR.
[74] I also agree with Rahimi's submission that the factors relied upon by the motion judge as militating in favour of granting leave to proceed against SGR -- a failure to use or the misuse of reliable available information, the admission of compromised internal financial reporting controls and the lack of explanation from management about the restatement -- are equally applicable on the issue of leave to proceed as against the individual respondents.
[75] In summary, this was not a case where there was truly uncontroverted evidence adduced by a defendant in support of a reasonable investigation defence. This was a case where there was conflicting evidence emanating from SGR on that key issue for determination. The motion judge erred in accepting the denials asserted by the individual respondents without considering the lack of production, the absence of evidence from PWC and Deloitte and the unqualified statements made in the restatement and the November 14 press release. In coming to these unwarranted evidentiary conclusions regarding the credibility of the individual respondents as if the leave stage constitutes a mini-trial, the motion judge failed to properly implement the screening mechanism of the leave requirement in s. 138.8 of the SA by foreclosing a misrepresentation claim that has a reasonable possibility of success. The residual credibility problems with the individual respondents' central defence, which could only be determined at trial, meant that this was not a case in which the policy objective of the leave requirement of protecting defendants from unmeritorious claims would be advanced by denying leave to Rahimi's claim on the basis of that defence.
(3) Reasonable Investigation Defence of SGR
[76] The next issue for determination is whether the motion judge erred in granting leave to Rahimi to pursue his claim as against SGR.
[77] For the reasons given above, I am of the view that the motion judge did not err in granting leave as against SGR. This is a case filled with credibility issues and gaps in the evidentiary record. It is not possible on this record to be satisfied that there is no reasonable possibility that SGR would not be able to succeed on a defence of reasonable investigation under s. 138.4(6)(a) of the SA.
(4) Public Policy
[78] There is a further and, in my view, more troubling flaw in the motion judge's reasons, which arises from the very unusual facts of this case. The decision to deny leave as against the individual respondents is inconsistent with the public policy animating the secondary market cause of action and with the fundamental policies underlying securities regulation, including protection of the investing public and maintaining the integrity of the capital markets. At the heart of the submissions made by SGR and the individual respondents is the rather remarkable proposition that they should be permitted to evade a potentially meritorious action at the leave stage because they previously made material misrepresentations during a restatement process about their company but they are now telling the truth about the same issue.
[79] Although one might imagine a situation where a securities issuer who released a restatement is permitted to later resile from that restatement, the evidence on a leave motion would have to be very strong because the conflicting positions raise serious credibility issues. As a necessary first step, the issuer would have had to have taken action to correct the restatement that they are resiling from. SGR has not done so. Instead, we have a situation where its disclosure documents tell one story and their court filings tell an opposite story. They cannot have it both ways.
[80] Continuous disclosure is at the heart of securities regulation and must be scrupulously accurate and fair. There is no room for prevarication or double-talk. The importance of continuous disclosure was recognized by Abella J. in Theratechnologies, at paras. 25-26:
Both periodic and timely disclosure obligations are designed to increase fairness in the secondary market:
[Continuous disclosure] . . . is designed to create a "level playing field" where all investors have access to the same information and all pricing and investment decisions are made from the same starting point. Of course, investors may still value securities differently, depending on how they interpret that information. Different investors have different goals, typically balanced between risk and return. Riskier investments generally yield higher returns, and vice versa. Securities regulation does not tell investors what to do, nor steer them toward or away from particular investments. It should, however, ensure that they have enough information to assess properly the risks involved and make fully informed decisions.
As a result, the policy of ensuring this "level playing field" reified in statutory continuous disclosure obligations has been called "the most fundamental principle of securities regulation": Cartaway Resources Corp. (Re), [2000] B.C.S.C.D. No. 92 (QL), at para. 216; Cornish v. Ontario Securities Commission, 2013 ONSC 1310, 306 O.A.C. 107 (S.C.J.) at para. 40.
Disclosure also supports capital market efficiency by helping investors target the most deserving securities and enhancing the accountability of corporate management: Cornish, at para. 40. As investors realize that they have the necessary information, they become more confident in the securities market, and their consequent increased participation leads to more efficient markets.
[81] Continuous disclosure obligations are not a shell game where investors are left to guess where the truth lies. Investors have a right to know a corporation's true state of affairs. In my view, the motion judge failed to consider this policy imperative and rendered a decision with respect to the individual respondents that is inconsistent with basic notions of securities regulation. The discrepancy between the position asserted in this litigation and the position taken in the restatement and the November 14 press release is so jarring that the motion judge should not have refused to grant leave to proceed against any of the respondents.
E. Disposition
[82] I would allow the Rahimi appeal, set aside that part of the motion judge's order denying leave to proceed against the individual respondents, make an order granting leave to proceed against the individual respondents and grant Rahimi leave to file a statement of claim in the form attached as Schedule "A" to his notice of appeal. I would dismiss the corporation appeal.
[83] The parties may make written submissions on the issue of the costs of the appeals and the leave to appeal motion in the Divisional Court.
Plaintiff's appeal allowed; corporate defendant's appeal dismissed.
Notes
1 Molyneux is a former CEO of SGR who lives in Taiwan. The action at issue in these appeals as against him has been adjourned until he has been properly served under the rules of private international law. Deloitte LLP served as an auditor for SGR for a period of time captured in these appeals. The action against it has been settled.
2 Because that ruling was interlocutory, it was only properly appealable to the Divisional Court with leave. Stewart J. granted leave in a decision dated May 24, 2016: see Rahimi v. SouthGobi Resources Ltd., 2016 ONSC 1634 (Div. Ct.). On September 12, 2016, this court ordered the corporation appeal to be heard together with the Rahimi appeal, on consent of the parties, pursuant to s. 6(2) and (3) of the Courts of Justice Act, R.S.O. 1990, c. C.43.
