SUPERIOR COURT OF JUSTICE - ONTARIO

COURT FILE NO.: C-710-10
DATE: 2014-09-09

RE: Tajdin Abdula, Plaintiff

AND:

Canadian Solar Inc., Shawn Xiaohua Qu and Arthur Chen, Defendants

BEFORE: The Honourable Mr. Justice G. E. Taylor

COUNSEL:
A. Dimitri Lascaris, Douglas Worndl and Anthony O’Brien, Counsel, for the Plaintiff

Bryan Finlay, Q.C., Michael Statham and Anastasija Sumakova, Counsel, for the Defendants

HEARD: July 28, 29, 30, 31 and August 1, 2014

Ruling re Leave to commence statutory cause of action

Introduction

[1] The plaintiff brings this action as a shareholder of Canadian Solar Inc. seeking damages and other relief for alleged misrepresentations by Canadian Solar and two of its officers and directors which artificially inflated the share price of Canadian Solar’s publicly traded stock and which resulted in damages to shareholders when the misrepresentations were revealed.

[2] In this motion, the plaintiff seeks leave to pursue an action for damages for misrepresentation pursuant to s. 138.3 of the Ontario Securities Act (OSA). As originally framed the motion also sought certification as a class proceeding in relation to the statutory cause of action (should leave be granted) and for claims of common law misrepresentation and an oppression remedy pursuant to the Canadian Business Corporations Act (CBCA). When it became apparent that it would not be possible, in the time reserved, to complete submissions on the leave motion and the certification motion, counsel agreed, at my suggestion, that submissions on the leave motion be completed and the certification aspect of the motion be adjourned to a later date.

[3] This is my ruling on the motion for leave to commence a statutory cause of action pursuant to s.138.3 of the OSA.

Evidentiary Background

[4] Canadian Solar is incorporated pursuant to the CBCA. The executive offices of Canadian Solar are located in Ontario. The shares of Canadian Solar are traded on the NASDAQ exchange. Its shares are not traded on any Canadian exchange. Canadian Solar is not a reporting issuer pursuant to the OSA although the Court of Appeal in an earlier proceeding in this action determined that it is a responsible issuer under the OSA: Abdula v. Canadian Solar Inc., 2012 ONCA 211, [2012] O.J. No. 1381.

[5] During the proposed class period, Shawn Xiaohua Qu was Canadian Solar’s President and Chief Executive Officer and Chairman of its Board of Directors. During the same period, Arthur Chien was Canadian Solar’s Chief Financial Officer and was a member of its Board of Directors.

[6] The plaintiff acquired shares in Canadian Solar between May 26, 2009 and June 1, 2010. This is the “Class Period” proposed by the plaintiff for the purpose of certification as a class proceeding. The plaintiff continued to own his shares in Canadian Solar on June 1, 2010.

[7] On May 26 or 27, 2009, Canadian Solar filed its Unaudited Condensed Consolidated Statements of Operations and Balance Sheets for the first quarter of 2009 (Q1 2009) with the United States Securities and Exchange Commission (SEC). The defendant Qu signed the accompanying report on behalf of Canadian Solar. On the same day, Canadian Solar issued a press release entitled “Canadian Solar Reports First Quarter 2009 Results” reporting on the Q1 2009 financial results. The press release was stated to be issued in Toronto. In the document entitled Reconciliation of US GAAP Gross Profit, there was a statement that Canadian Solar’s Unaudited Condensed Consolidated Financial Statements were prepared and presented in accordance with US GAAP. There was also a conference call held on May 26, 2009.

[8] On June 8, 2009, Canadian Solar filed its annual report and Audited Consolidated Financial Statements for the fiscal year 2008 with the SEC. These documents were contained in a Form 20-F filed pursuant to the Securities Exchange Act of 1934. The annual report was signed by the defendant Qu on behalf of Canadian Solar. The annual report contained the following statement at page 3: “All audited financial statements are prepared and presented in accordance with U.S. GAAP”.

[9] The annual report contained a number of further statements. At page 20 the following was stated:

We are subject to reporting obligations under U.S. securities laws. The SEC, as required by Section 104 of the Sarbanes-Oxley Act of 2002 or the Sarbanes-Oxley Act, adopted rules requiring every public company to include a management report on its internal control over financial reporting in its annual report, which contains management’s assessment of the effectiveness of its internal control over financial reporting. In addition, an independent registered public accounting firm must report on the effectiveness of the company’s internal control over financial reporting. Our management has concluded that our internal control over financial reporting was effective as of December 31, 2008.

At page 49, under the heading Revenue Recognition the following statement was made:

We only recognize revenues when prices to the seller are fixed or determinable, and collectibility is reasonably assured.

At page 90 the following statement was made:

Based on this assessment, management concluded that our internal control over financial reporting was effective as at December 31, 2008 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

In the Attestation Report of the Independent Registered Public Accounting Firm at page 91, the following assertion was made:

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Lastly, at page 92 the report stated:

There were no adverse changes in our internal controls over financial reporting that occurred during the period covered by this annual report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. As a result, the independent registered public accounting firm, has concluded that we maintained, in all material respects, effective internal control over financial reporting as at December 31, 2008.

[10] Similar, if not identical, statements were also contained in the Notes to Consolidated Financial Statements for the fiscal year 2008 which accompanied the annual report.

[11] On August 6 or 7, 2009, Canadian Solar filed its Unaudited Condensed Consolidated Statements of Operations and Balance Sheets for Q2 2009 with the SEC. The defendant Qu signed the accompanying report on behalf of Canadian Solar. On the same day Canadian Solar issued a press release entitled “Canadian Solar Reports Second Quarter 2009 Results” reporting on the Q2 2009 financial results. The press release was stated to be issued in Ontario, Canada.

[12] On October 13 or 14, 2009, Canadian Solar filed with the SEC its Unaudited Condensed Consolidated Financial Statements for the six-month period ended June 30, 2009 and its Selected Consolidated Financial and Operating Data and Management’s Discussion and Analysis of Financial Condition (MD&A) for the six-month period ended June 30, 2009, together with other documents. The Notes to the Unaudited Condensed Consolidated Financial Statements assert that they have been prepared in accordance with US GAAP. The defendant Qu signed the accompanying report on behalf of Canadian Solar.

[13] The MD&A repeated at page 12 that the financial statements were prepared in accordance with US GAAP. Also at page 12 of the MD&A the following statement was made:

We only recognize revenue when prices to the seller are fixed or determinable, and collectibility is reasonably assured.

[14] On October 15, 2009, Canadian Solar issued a Prospectus Supplement. The Prospectus Supplement incorporated by reference Canadian Solar’s annual report for the fiscal year ended December 31, 2008, its financial statements for Q1 2009, Q2 2009 and it financial statements for the six month period ending June 30, 2009, all of which had been previously filed with the SEC.

[15] On November 17, 2009, Canadian Solar filed its Unaudited Condensed Consolidated Statement of Operations and Balance Sheets for Q3 2009 with the SEC. The defendant Qu signed the accompanying report on behalf of Canadian Solar. On the same day Canadian Solar issued a press release entitled “Canadian Solar Reports Third Quarter 2009 Results and Issues 2010 Guidance” reporting on the Q3 2009 financial results. The press release was stated to be issued in Ontario, Canada. There was also a conference call held on November 17, 2009.

[16] On March 3, 2010, Canadian Solar filed its Unaudited Condensed Consolidated Statement of Operations and Balance Sheets for Q4 2009 with the SEC. The defendant Qu signed the accompanying report on behalf of Canadian Solar. On the same day Canadian Solar issued a press release entitled “Canadian Solar Reports Fourth Quarter 2009 Results and Full Year 2009 Results” reporting on the Q4 2009 and full year 2009 financial results. The press release was stated to be issued in Ontario, Canada. There was also a conference call held on March 3, 2010 in which the individual defendants participated.

[17] On June 1, 2010, Canadian Solar issued a press release entitled “Canadian Solar Updates 1Q10 Performance; Postpones June 2 Quarterly Call” stating that it had received a subpoena from the SEC requesting documents relating to certain sales transactions in 2009. The press release reported that Canadian Solar had postponed the release of its full financial results for Q1 2010 and that an investigation by the Audit Committee of the Board of Directors was ongoing. Finally, the press release stated that it might be necessary to revise the previously reported net revenues for Q4 2009 and the fiscal year 2009 as follows:

The Company may revise the 4Q09 net revenues numbers due to the company’s intention to recognize sales only after receiving full cash payments from certain customers and due to certain subsequent return of goods after the quarter end. These sales transactions are deferred to Q1 and Q2 of 2010. Full year 2009 net revenues may be revised accordingly.

The press release was stated to be issued in Ontario, Canada. The defendant Qu signed the accompanying report on behalf of Canadian Solar.

[18] On June 2, 2010 the price of Canadian Solar’s shares fell by approximately 15% which represented a loss of market capitalization of approximately $70 million.

[19] On August 19, 2010 Canadian Solar issued a press release entitled “Canadian Solar Reports 1Q10 Unaudited Results and FY09 Audited Results” in which it reported that it was revising its financial results for Q4 2009. It also reported on major changes, provisions and allowances compared with the results announced in the March 3, 2010 press release. The press release was stated to be issued in Ontario, Canada. The defendant Qu signed the accompanying report on behalf of Canadian Solar.

[20] Also, on August 19, 2010, Canadian Solar filed its annual report and Audited Consolidated Financial Statements for the fiscal year 2009 with the SEC. As a result of the revised financial statements, net revenues were reduced by approximately 32.8 million and net income was reduced by approximately $30 million with the result that the originally reported net profit for Q4 2009 was converted into a net loss.

[21] At page 90 of the annual report is the following statement:

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. As required by Section 404 of the Sarbanes-Oxley Act of 2002 and related rules promulgated by the Securities and Exchange Commission, our management assessed the effectiveness of internal control over financial reporting as of December 31, 2009 using the criteria set forth in the report “Internal Control-Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission (known as COSO). Based on this evaluation, management concluded that our internal control over financial reporting was not effective as of December 31, 2009 due to the following four material deficiencies identified:

• The control designed to ensure that all revenue recognition criteria were met prior to recognizing revenue did not operate effectively.

• An appropriate control was not designed to ensure that estimated sales returns were recorded.

• There is a lack of control procedures to ensure that long-term purchase commitments are evaluated and appropriately accounted for in the appropriate accounting period.

• The control designed to ensure that significant subsequent events were properly identified, analyzed and, where appropriate, recorded in the Company’s consolidated financial statements, did not operate effectively.

We have concluded that these deficiencies constitute four material weaknesses.

[22] At page 92 of the annual report the following statement is found:

There were no changes in the design in our internal controls over financial reporting that occurred during the period covered by this annual report that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. As identified in Management’s Annual Report on Internal Control over Financial Reporting, several material weaknesses were identified in our internal control as of December 31, 2009. Our plans for remediating such material weaknesses, which would constitute changes in our internal control over financial reporting, are also enumerated in that report.

[23] On May 17, 2011, Canadian Solar filed its annual report and Audited Consolidated Financial Statements for the fiscal year 2010 with the SEC. At page 97 of the annual report is the following statement:

In 2009, Management identified material weaknesses related to the following items:

• The control designed to ensure that all revenue recognition criteria were met prior to recognizing revenue did not operate effectively.

• An appropriate control was not designed to ensure that estimated sales returns were recorded.

• There is a lack of control procedures to ensure that long-term purchase commitments are evaluated and appropriately accounted for in the appropriate accounting period.

• The control designed to ensure that significant subsequent events were properly identified, analyzed and, where appropriate, recorded in the Company’s consolidated financial statements, did not operate effectively.

During 2010, Management has taken the following steps to remedy the identified material weaknesses:

• Hired That additional credit control personnel and revise the standard operating procedures related to customer credit assessment and revenue recognition;

• Established a sales return reserve policy to account for any non-routine sales returns after period end;

• Improved internal communication protocols for timely recording and disclosure of financial transactions; and

• Reviewed and revised the current checklists used to ensure adequate controls to capture possible material accounting adjustments subsequent to the balance sheet date to the date of reporting.

[24] In May, 2012, the SEC instituted proceedings against Deloitte Touche Tohmatsu, Certified Public Accountants, for an alleged willful failure to provide audit work papers in relation to independent audit work for an entity identified as “Client A”. In other documents, “Client A” has been identified as Canadian Solar. The Order Instituting Administrative Proceedings makes reference to an SEC investigation which began in April 2010 into potential accounting fraud by “Client A”. In January, 2014, SEC Administrative Law Judge Cameron Elliott issued a decision sanctioning Deloitte Touche Tohmatsu for failing to cooperate with the SEC investigation into “Client A” in relation to “financial fraud, focusing on revenue recognition issues for the period 2008 to 2010”.

[25] The plaintiff retained Cyrus Khory of Froese Forensic Partners as an expert in the field of accounting. Mr. Khory is a Chartered Accountant, a Chartered Business Valuator, a Certified Public Accountant in the State of Illinois, a Certified Fraud Examiner and is Certified in Financial Forensics by the American Institute of Certified Public Accountants.

[26] According to Mr. Khory, Canadian Solar’s original Q4 2009 financial statements which were released on March 3, 2010 were not prepared in accordance with US GAAP and were materially misstated. In his opinion, the original Q4 2009 financial statements were materially misstated as result of inappropriately reporting revenue for which collection was not reasonably assured, failing to report a loss on a firm purchase commitment and failing to properly report reserves for sales returns. He stated that he did not have sufficient information to opine as to whether an accounting issue related to the reporting of an allowance for supplier advances, as reported by Canadian Solar, was also a material misstatement in the original Q4 2009 financial statements.

[27] Mr. Khory also concluded that the four material internal control deficiencies identified by Canadian Solar’s management and its external accountants existed prior to December 31, 2009 and that two of the control deficiencies existed throughout 2009. The control deficiencies that existed throughout the year were that an appropriate control was not designed to ensure that estimated sales returns were recorded and that there was a lack of control procedures to ensure that long-term purchase commitments were evaluated and appropriately accounted for in the appropriate accounting period.

[28] The plaintiff also retained Professor Douglas Cumming, a Professor of Finance and Entrepreneurship at York University’s Schulich School of Business as an expert in the field of stock market efficiency and materiality. In the opinion of Professor Cumming, Canadian Solar’s shares traded in an efficient market between May 26, 2009 and June 1, 2010 in that the share price quickly incorporated any new public information. Further, in the opinion of Professor Cumming, the alleged misrepresentations in the present case were material to investors and that the significant decline in the price of Canadian Solar’s shares on June 2, 2010 was as a result of the corrective disclosure made on June 1, 2010.

[29] Finally, the plaintiff retained Professor Adam Pritchard, a Professor of Law and Director of Empirical Studies at the University of Michigan law school as an expert in the field of US securities law and securities class actions. Professor Prichard reviewed Canadian Solar’s Prospectus Supplement issued on October 15, 2009 which incorporated by reference Canadian Solar’s Audited Consolidated Financial Statements for the fiscal year 2008. Professor Prichard relied on the opinion of Mr. Khory that the four material internal control deficiencies identified by Canadian Solar as existing as at December 31, 2009, also existed during Q4 2009 and that two of the control deficiencies existed throughout 2009. In the opinion of Professor Prichard, Canadian Solar had an obligation to disclose in the Prospectus Supplement that there were deficiencies in its internal control over financial reporting and that the omission to do so was materially misleading.

[30] The defendants did not file any material in response to the leave a motion.

Were there Material Misrepresentations and Should leave be Granted?

[31] Part XXIII.1 of the OSA requires that leave be obtained before commencing an action for liability based on misrepresentation in secondary market disclosure. Before granting such leave, the court must be 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.

[32] Section 1.1 of the OSA specifies the purposes of the Act to be:

a) to provide protection to investors from unfair, improper or fraudulent practices; and

b) to foster fair and efficient capital markets and confidence in capital markets.

[33] In Kerr v. Danier Leather Inc., 2007 SCC 44, [2007] 3 S.C.R. 331, the Supreme Court of Canada stated at paragraph 32:

The Securities Act is remedial legislation and is to be given a broad interpretation: Pezim v. British Columbia (Superintendent of Brokers), 1994 103 (SCC), [1994] 2 S.C.R. 557. It protects investors from the risks of an unregulated market, and by its assurance of fair dealing and by the promotion of the integrity and efficiency of capital markets it enhances the pool of capital available to entrepreneurs. The Act supplants the "buyer beware" mind set of the common law with compelled disclosure of relevant information. At the same time, in compelling disclosure, the Act recognizes the burden it places on issuers and in Part XV sets the limits on what is required to be disclosed.

[34] Specifically in reference to the statutory cause of action in Part XXIII.1 of the, OSA, the Court of Appeal in Green v. CIBC, 2014 ONCA 90, [2014] O.J. No. 419 stated at paragraph 36 that:

The new statutory claim for misrepresentation in the secondary market under s. 138.3 of the Securities Act was intended to be remedial legislation with the twin goals of a) facilitating and enhancing access to justice for investors, and b) deterring corporate misconduct and negligence. By removing the need to prove reliance by an individual investor in order to obtain a remedy, the new action makes it easier and more cost-effective for investors to prove their claims. It thereby achieves compensation for investors (although with a damages cap), and by so doing, discourages corporate actors from making misrepresentations in their post-prospectus continuous disclosure.

[35] It is with these overriding principles in mind that I approach the issue of whether leave should be granted to the plaintiff in this case to proceed with the statutory cause of action.

[36] In the present case, Canadian Solar concedes that the plaintiff is acting in good faith in bringing the action. Therefore, the issue to be addressed is whether there is a reasonable possibility that the plaintiff will be successful at trial.

[37] In Green, the Court of Appeal articulated the test to be applied for the granting of leave to commence a statutory cause of action under the OSA as follows at paragraphs 86 to 88 as follows:

The phrase "reasonable prospect of success" was used by McLachlin C.J. in Knight v. Imperial Tobacco Canada Ltd, 2011 SCC 42, [2011] 3 S.C.R. 45 (also called R. v. Imperial Tobacco Canada Ltd.) where, in reference to a motion to strike a claim, the Chief Justice stated the test to be whether "the claim has any reasonable prospect of success". She described its effect as "weeding out the hopeless claims and ensuring that those that have some chance of success go to trial" (para. 19). Again, at para. 20, she refers to claims that have "a reasonable prospect of success" and "a reasonable chance of success.

It is apparent that the terms "prospect" and "chance" are being used by the Chief Justice as synonyms, and I would include the term "possibility" as another one.

The purpose of the leave provision under Part XXIII.1 of the Securities Act is to discourage and eliminate bad faith strike suits that do not have a reasonable possibility of being successful. The statute asks the leave judge to first determine good faith, then whether there is a "reasonable possibility" that the action will be resolved at trial in favour of the plaintiff, i.e. that the plaintiff's case will be successful -- a reasonable possibility of success. In order to make that determination, the motion judge applies the same test that is used for determining whether the claim has a reasonable prospect of success for the purpose of certification. As the Chief Justice has described it, the purpose is to weed out hopeless claims and only allow those to go forward that have "some chance of success".

[38] Further, in Green, the Court of Appeal approved of the approach adopted by Strathy J. (as he then was) in Green v. CIBC, 2012 ONSC 3637, [2012] O.J. No. 3072 at paragraph 93 (of the Court of Appeal decision) as follows:

I am satisfied that Strathy J. applied the correct level of scrutiny when deciding whether leave should be granted in respect of each of the plaintiffs' claims. At para. 374, after discussing the legislative and interpretive history of the leave test, he summarized the way he would approach the analysis as follows:

In my view, considering the purpose of the leave test and its legislative history, it would be unfair to the parties and to the court to expect the motion judge to engage in a finely calibrated weighing process. It seems to me that I should simply ask myself whether, having considered all the evidence adduced by the parties and having regard to the limitations of the motions process, the plaintiffs' case is so weak or has been so successfully rebutted by the defendant, that it has no reasonable possibility of success.

[39] Strathy J., in Green at paragraph 377 suggested the approach to be followed on the application for leave, which approach, I assume from the above passage, was approved by the Court of Appeal. Strathy J. stated:

I begin with the observation that although s. 138.8(1) speaks of whether the action has a reasonable possibility of success, each representation must be examined, in relation to each defendant, to determine whether the plaintiffs' claim in respect of that representation, has a reasonable possibility of success against that defendant. That analysis also requires that I determine whether there is a reasonable possibility that the defendant will not be able to establish the reasonable investigation defence - i.e., that the person conducted a reasonable investigation and had no reasonable grounds to believe that the document or statement contained a misrepresentation. The analysis should therefore pro-cede as follows:

(a) identify the representation at issue;

(b) determine whether it was a core document or a non-core document or public oral statement;

(c) determine whether there is a reasonable possibility that the plaintiff will establish at trial that the document or statement contains a misrepresentation of material fact;

(d) determine, in the case of each individual defendant, whether there is a reasonable possibility that the plaintiff will establish at trial that the defendant authorized, permitted or acquiesced in the release of the document or the making of the statement;

(e) in the case of non-core documents or public oral statements, determine whether there is a reasonable possibility that the plaintiff will establish at trial that each individual defendant knew of the misrepresentation, deliberately avoided acquiring knowledge, or was guilty of gross misconduct in connection with the release of the document or the making of the misrepresentation;

(f) determine whether there is a reasonable possibility that the defendants will not establish the reasonable investigation defence with respect to the misrepresentation - that is, that they conducted a reasonable investigation and had no reasonable grounds to believe that the document or public oral statement contained a misrepresentation.

[40] Accordingly, I must examine each of the claims of the plaintiff and decide if, on the basis of the record before me, if there is a reasonable possibility that the plaintiff will be successful at trial.

Conclusion

[82] For the foregoing reasons, the plaintiff is granted leave pursuant to section 138.8 (1) of the OSA to pursue a statutory cause of action against Canadian Solar and the individual defendants for alleged misrepresentations contained in Canadian Solar’s original Q4 2009 financial statement, the press release and conference call associated with the release of the Q4 2009 financial statements and for alleged misrepresentations contained in the Prospectus Supplement filed on October 15, 2009. Leave is refused and the motion is dismissed with respect to alleged misrepresentations contained in Canadian Solar’s Q1, Q2 and Q3 2009 financial statements and with respect to the alleged misrepresentation relating to revenue recognition in Canadian Solar’s financial statements for the fiscal year 2008.

[83] Subject to any contrary submissions by counsel, I propose to deal with costs of the motion for leave together with costs of the motion for certification once that motion has been argued.

G. E. Taylor J.

Date: September 9, 2014