Radio Shalom, Money and Business – Jack Bensimon, Host
September 15, 2010 -- Show #6 – Banking and Securities Regulatory Compliance
"Disclosure Obligations for Public Companies: To Tell or not To Tell?"
with Jack J. Bensimon, Managing Director, Risk Diagnostics
listen to the show
2010-09-15 : Disclosure Obligations for Public Companies ; Jack Bensimon.MONEY MONEY AND BUSINESS
Public companies have a number of disclosure obligations that must be communicated to the investing public on a regular and continuous basis. These disclosures can include, for example, earnings releases, the exit of C-suite or key executives, the sale of assets or divisions, and environmental disasters.
In Canada National Instrument -51-102 Continuous Disclosure Obligations, requires public companies to disclose in their Management Discussion and Analysis filings. Wide in scope, 51-102 sets out obligations for issuers with respect to financial statements, AIFs, MD&A, material change reporting, information circulars, proxies and proxy solicitation, and other continuous disclosure obligations. Under the legislation, issuers must generally disclose any "material change" in their business. 51-102 defines material change as a "change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer".
This obligation would likely impose a need to discuss the financial and operational impacts the issuer’s business, earnings releases, the hiring or departure of key executives, the sale of assets or divisions, and any environmental disasters. The British petroleum spill is an example of such a disaster requiring public disclosure to the marketplace..How quickly and how much are companies required to publicly disclose? To answer these and other questions about disclosure obligations for public companies, we have our money and business commentator from Toronto presently in our studios, Mr Jack Bensimon from Risk Diagnostics!
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Professional Bio
Our guest today is Jack Bensimon, Managing Director of Risk Diagnostics Inc., an independent securities regulatory compliance consulting firm located in Toronto’s Bay St. core. He has worked in the securities industry for over 17 years, mainly acting as Chief Compliance Officer (CCO) for banks, investment banking and counselling firms, trust companies, and broker-dealers.
His sector coverage spans energy infrastructure, real-estate, financial services, technology, consumer products, and manufacturing. He is dual licensed in Canada and the US, and is knowledgeable on securities laws on both sides of the border. He has testified as an expert anti-money laundering witness in federal court for a major banking litigation case.
He is a graduate of the University of Toronto, The Wharton School, University of Pennsylvania (Investment Management), and is completing his Master of Laws (LL.M.) in Securities Law at Osgoode Hall Law School, York University, on a part-time basis. He can be reached at jbensimon@rogers.com
Disclaimer: The suggestions, views, and experiences presented here are in no way, directly or indirectly, to be interpreted as legal or financial advice.
Segment I: Introduction – NI 51-102 – Continuous Disclosure Obligations,
Under s. 75(1) of the Act and 51-102, issuers are required to generally disclose any "material change" in their business. The TSX and TSX-V have their own policies concerning timely disclosure. Both define "material information" (consisting of material facts and material changes relating to the business and affairs of an issuer) to be "any information relating to the business and affairs of a company that results in or would reasonably be expected to result in a significant change in the market price or value of any of the company’s listed securities." The Act defines material change as a "change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer". 
Disclosure rules are also outlined in the TSX rules and regulations, for reporting issuers listed on that exchange. Under the TSX rules, s. 408 of the TSX Company Manual requires issuers "to disclose material information concerning its business and affairs forthwith upon the information becoming known to management".
Segment III:
Material Information – Mergers & Acquisitions
Material Information – Mergers & Acquisitions
You mentioned earlier this notion of "material fact". Can you expand on this concept, and how it’s relevant for companies making disclosure decisions?
Canadian securities legislation does not require an issuer to promptly disclose all material facts, only material changes. A "material fact" is defined more broadly than a material change. It means any fact that would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities. The Ontario Securities Act ("Act") does not require the immediate disclosure of all material facts, but prohibits insiders from tipping (i.e., making selective disclosure other than in the necessary course of business) or trading based on material facts that have not been generally disclosed.
Issuers are obligated to comply with the TSX Company Manual ("Manual"), requiring immediate disclosure of both material facts and material changes. The TSX Timely Disclosure Policy is not a legal rule, while the remedies available to the TSX for policy breaches are limited to a temporary trading halt, trading suspension, and/or delisting of the issuer. According to National Policy 51-201 – Disclosure Standards, the OSC requires issuers to comply with the TSX broader timely disclosure requirements and may commence proceedings under its public interest jurisdiction for failure to do so in s. 127 of the Act.Can you give an example of a case or test involving a material fact?
The most important thing to remember about materiality is that the undisclosed fact must be "material" to the investor’s decision. In TSC Industries Inc. v. Northway Inc., 426 U.S. 438 (1976) ("Northway"), the U.S. Supreme Court ruled that the test for materiality is whether there is a substantial likelihood that a reasonable investor would consider the fact of significance in making investment decisions. In Northway, the Court did not require proof of a substantial likelihood that disclosure would have caused the reasonable investor to change his investment decision, but only that the omitted fact would have assumed actual significance. Courts often rule that materiality is often a mixture of law and fact. In the spirit of the market impact test and Wilson being in possession of a take-over bid, this constitutes material non-public information. As a result, the absence of timely disclosure of such information was an omission of a material fact that would likely have market impact and affect investor decision-making.
The decision in R. v. Fingold (1999) 317/96 ("Fingold") illustrates that the standard of proof required for insider trading breaches is on the balance-of-probabilities, while In the Matter of ATI Technologies Inc. (2005) 28/42 ("ATI"), the OSC showed that a higher standard of "clear and convincing proof based on cogent evidence" was required. -criminal offence is committed under s. 122(1) of the Act. The Maxwell decision showed that as a quasi-criminal offence, insider trading offences are held to a higher standard of proof ("beyond a reasonable doubt"). Imax decision illustrates that the courts are not very stringent in interpreting such requirements. Plaintiffs will not be able to rely solely on the allegations in their pleadings, but will have to provide supporting evidence. Section 138.8(2) of the Act provides that the "plaintiff and each defendant shall serve and file one or more affidavits setting forth the material facts upon which each intends to rely." In Ainslie v. CT Technologies Inc. (2006) ("Ainslie"), a defendant can refuse to file an affidavit. By doing so they must be prepared to rely solely on their cross-examination of the plaintiffs to persuade the Court that the test for leave has not been satisfied. The decisions arrived at in both IMAX and Ainslie show that "every document you release or thing you say can and may be used against you, so govern yourself accordingly."
Insider trading is regulated under sections 76 and 134 of the Act as well as s. 423.4 of the Manual.
In R. v. Maxwell (1996) 13 C.L.L.S. O.C.J. ("Maxwell"), the court noted that in meeting the definition of a "material fact", it must meet the market impact test otherwise no quasi
The OSC’s prosecution in R. v. Harper (2000) O.C.J. ("Harper") of two counts of insider trading on the basis of Harper being an insider and selling shares with knowledge of a material fact, shows the responsibility of insiders to contain such information and abstain from trading. The Harper and Fingold cases both failed to establish a defence of reasonable mistake of fact defence. The defence allows defendants to argue they didn’t believe the undisclosed material fact would have an effect on share price. 
How does a public company partially protect itself from shareholder litigation where continuous disclosure breaches are in dispute?
One of the ways a public company can protect itself is by ensuring they have a written policy and procedure for providing continuous disclosure to the marketplace. This policy should contain a number of key elements, including the following:
A policy around selective disclosure for all staff – staff should be prohibited from discussing material, non-public information with anyone outside the Company, including family members, relatives, friends, shareholders, analysts or other third parties.
A policy around the scope and definition of "material information" which staff should familiarize themselves with. The policy should make it very clear that Under Ontario securities laws, information is material if its disclosure is likely to have an impact on the price of a security, or if reasonable investors want to know the information before making an investment decision. Information is material if it would change the total mix of information available regarding the security. Both favourable and unfavourable information can be material, as well as information that forecasts or predicts whether an event may or may not occur.
Securities laws distinguish between a "material fact" and a "material change". Can you expand on the "material change" piece, and how this is germane in guiding companies whether disclose or not?
A "material change" is defined as a change in the business, operations, or capital of an issuer that would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities. The definition includes a decision to implement a change by the board or senior management where board confirmation is probable. There is a limited exception to the requirement to disclose material changes immediately. Securities laws allow an issuer to temporarily delay public disclosure by filing a material change report on a confidential basis when the issuer reasonably concludes that the disclosure would be unduly detrimental to its interests, or the material change consists of a decision to implement a change made by senior management who believe board confirmation of the decision is probable and have no reason to believe that persons who know about the material change have used this knowledge in trading the issuer’s securities.
Can you give an example of a "material change", which by definition, is a "material fact"?Let’s take the area of take-over bids in the M&A world. Take-over bids are governed by OSC Rule 62-504 -- Take-Over Bids and Issuer Bids. No material change occurs until an agreement is reached between the parties, while negotiations alone are not a "change in the business, operations, or capital" of the issuer. The OSC will look at the conduct of the negotiation to see if in fact serious issues remained unresolved. Under unusual circumstances, this could occur at the time a letter of intent is signed during a take-over bid. Under s. 408 of the Manual, TSX rules and regulations require immediate disclosure of material information concerning the business and affairs of an issuer as soon as the information is known to management, which may include the following: (a) changes in the share ownership that could affect control of the company, (b) take-over bids, (c) changes in capital structure, or (d) other developments that would reasonably be expected to significantly affect the market price of the issuer’s shares and affect investor’s investment decisions.
Under sections 423.1 and 423.3 of the Manual, disclosure of material information can be delayed for reasons of corporate confidentiality. Although there is no bright-line test to determine which stage of the M&A process in a take-over bid is a material change, negotiations do not need to be disclosed until the parties are committed to proceed with a transaction as evidenced by their actions and where there is a substantial likelihood of the transaction being completed.
Disclosure obligations in the M&A context seems to get a little trickier, as the stage of the merger or acquisition in the transaction may not be all that clear. How do companies guide their disclosure decisions in these cases?
Premature disclosure of a transaction can be potentially misleading and prejudice any existing negotiations between the issuer and other parties to an M&A transaction. It could damage the deal by causing the share price to increase, thereby lowering the premium to market that the buyer is able to offer. This weakens the target’s ability to negotiate a better price owing to the pressure of completing a deal after disclosure is significant.
In AiT, the OSC noted that 3Ms senior management had not been involved in the discussions, and the OSCs conclusion may have differed if negotiations had been led and authorized by 3Ms CEO. The latter assurances were not final and binding. The extensive involvement of AiT’s CEO and its board might have been taken as evidence of AiT’s commitment. Under s. 74(3) of the Act, an issuer can file a material change report on a confidential basis, temporarily delaying public disclosure. Confidential filings illustrate competing policy considerations by recognizing that the public interest for timely disclosure may be outweighed by the detriment to the issuer.
Legislative Overview
When investors by shares in a public company, they expect that disclosure is provided on a regular and ongoing basis. What is meant by the term "continuous disclosure obligations"?
The term "continuous disclosure obligations" means that companies must keep the market informed at all times, on a regular and continuous basis, of important events and transactions taking place. The need to report is very much guided by what is called the market impact test – will the new information likely affect the share price as a result of the disclosure.
What are the key elements that drive public companies to disclose certain news events to investors?
The driving piece of legislation is NI 51-102, Continuous Disclosure Obligations. This is in the Ontario Securities Act, however, since it is a national instrument, it applies to all provinces in Canada. It’s national in scope.
51-102 contains detailed provisions outlining and providing guidance as to whay and how public companies should disclose information to investors. There are no quick and dirty answers (as is normally the case in securities law cases) to guide public companies as to what and when news events should be disclosed. Securities regulators defer much of the judgment to senior management and the board of public companies. Even with the best of minds, legal counsel, and the best of intentions, sometimes companies get it right, and sometimes they can get it wrong.
It sounds like with all this discretion conferred on the board to make such disclosure decisions there may be a lot of uncertainty in companies refraining to disclose certain information. Do securities laws address these legal uncertainties, and how are they deal with?
There is some uncertainty in the legislation, but that is the nature of our securities regulatory regime in Canada – it is largely based on a principles-based-regulation, which means we outline broad principles and allow some flexibility and judgment in companies making independent and informed decisions. Unlike in the Us where they have very much a rules-based-regulation system, there is far less flexibility and discretion in making such decisions by public companies.
Effective November 2009, TSX issuers require shareholder approval when the number of securities issued in payment for an acquisition exceeds 25% of the number of outstanding securities of the issuer, for an acquisition target that is a private or a public company. The TSX policy has limited force by itself, while the OSC can sanction issuers for violations of TSX policy even without violations of the Act. Part XX of the Act requires that a take-over bid is triggered when an offer is made to purchase voting or equity (fully participating) securities of a company if on completion of the purchase the purchaser would own or control 20% or more of the outstanding securities of the class.
A fundamental objective of the Canadian take-over bid regime is the equal treatment of shareholders of a target company. In HudBay Minerals Inc. (Re) (2008) ("HudBay"), the OSC overturned the TSX decision issuing an order requiring HudBay to obtain approval of HudBay shareholders before the issuance of HudBay shares with the proposed acquisition of Lundin Mining Corp. The OSC concluded that allowing the transaction to proceed without HudBay shareholders approval would significantly undermine the "quality of the marketplace" and would not accord HudBay shareholders fair treatment. The decision in HudBay demonstrates the OSC's increasing receptiveness to fairness complaints from activist shareholders.
Insider trading has to come into effect in the take-over disclosure regime. What should public companies watch for in this area?
A policy around the scope and definition of "non-public information". Material information is considered "non-public" unless and until it has been disclosed by the Company by means of a non-exclusionary, broad public dissemination. This may include a widely circulated press release, OSC/TSX filing, publicly accessible webcast, or conference call.Finally, a policy around the potential consequences for breaches of selective disclosure. The risks for breaches of selective disclosure may range from imprisonment, regulatory fines or penalties, temporary stock halt, issuer delisting, legal and administrative costs, and unfavourable press. Any of these penalties or sanctions may damage the Company’s reputation. If the Company chooses to selectively disclose material non-public information, it will proceed on a widely disseminated basis through a press release or publicly accessible webcast, as soon as possible
What statutory remedies are available to investors if they believe a public company has failed to disclose material changes to the marketplace in a timely manner?
The new statutory regime as outlined in Part XXIII.1 of the Act, attaches a "deemed reliance" feature to any misrepresentation made in publicly released corporate disclosures, including both written and public oral statements, made by any "responsible" issuer. Investor plaintiffs are not required to demonstrate reliance upon a misrepresentation when seeking damages for related investment losses. This is the most significant impediment to certification of such actions in Canada. Part XXIII.1 of the Act provides investors with the right of action against an issuer and other responsible parties for damages if they acquire or dispose of an issuer’s securities during a period of time when there is (1) an uncorrected misrepresentation in a document released by the issuer; or (2) in a public statement made relating to the affairs of the issuer; or (3) if the issuer fails to make timely disclosure of a material change.
What is the burden of proof that will be required under the new statutory regime?
The burden of proof varies depending on the type of defendant (e.g., responsible issuer, director, officer, or other prescribed defendant), and the type of document (i.e., core document versus non-core document). The burden of proof is higher, however, for non-core documents, such as a press release or certification of financial statements. The plaintiff is required to prove that the defendant had knowledge, deliberately avoided acquiring knowledge or through action, or failure to act, and is guilty of gross misconduct in connection with the disclosure violation.
Are investors required to obtain a leave of the court?
The statute provides no guidance as to what type of evidence will enable a Court to determine whether the leave application is satisfied. It allows plaintiffs to gather evidence that they could use at trial if leave is granted. On the other hand, if the defendants do not present the evidence, leave will be granted with minimal effort on the part of the plaintiff, as demonstrated in the Silver v. IMAX Corp (2008) ("IMAX") decision to grant leave application. This poses a unique risk to issuers because of what is likely to materialize at the certification stage of an Ontario class action.
The new regime requires an investor to first obtain leave of the court before starting an action, including a proposed class action. Section 138.8 of the Act provides that the court shall grant leave only where it is satisfied that "the action is being brought in good faith; and there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff." Actions cannot be started without leave of the Court and may not be discontinued without court approval. The court will not decide the issues set out, but only decide whether there is a "reasonable possibility" of the claim succeeding. This lower threshold puts issuers in a bind. If they provide the evidence to use as a defence they are providing plaintiffs with the building blocks to support their case by allowing them to cross-examine the defendants and their experts.
What is the scope of liability under the new statutory liability regime available to investors?
Under s. 138.3(4) of the Act, the universe of potential parties liable include the issuer and each director and officer of the issuer who authorized, permitted or acquiesced in the failure to make timely disclosure.
The Supreme Court of Canada decision in Kerr v. Danier Leather Inc. (2004) S.C.C. 44 ("Danier") was instructive in calculating damages. In the case of a failure to make timely disclosure, an investor must prove that the company knew of the change and that the change was a material change, that the company deliberately avoided acquiring knowledge of the change or that the change was a material change, or that the company was guilty of gross misconduct in connection with the failure to make timely disclosure.
Damages will be assessed in favour of investors who acquire or dispose of securities after the release of a misrepresentation or after a failure to disclose a material change.
What are the liability caps under the new statutory liability regime?
There are liability limits for various defendants that are applied where the actual damages are greater than the liability limits. The total liability of an issuer is limited to the greater of $1M or 5% of its market cap. The liability limit for an individual director or officer is the greater of $25K or 50% of his total 12-month compensation from the issuer and its affiliates. In this case, the liability limit would be the greater of 5% of $2B (i.e., $100M) or $1M.
These liability limits do not apply, other than to the issuer, to a defendant who "authorized, permitted or acquiesced" in the misrepresentation or the failure to make timely disclosure while "knowing" that it was such, or who "influenced" the event while knowing that it was a misrepresentation or a failure to make timely disclosure. As a result of the liability caps, investor plaintiffs are expected to allege a knowing misrepresentation, so as to avoid the liability limits placed on persons other than the issuer.
What are the legal implications of the new statutory liability regime?
The statute provides no guidance as to what type of evidence will enable a Court to determine whether the leave application is satisfied. It allows plaintiffs to gather evidence that they could use at trial if leave is granted. On the other hand, if the defendants do not present the evidence, leave will be granted with minimal effort on the part of the plaintiff, as demonstrated in the Silver v. IMAX Corp (2008) ("IMAX") decision to grant leave application. This poses a unique risk to issuers because of what is likely to materialize at the certification stage of an Ontario class action.
The
Segment V: Summary – Tying it All Together
What are the key elements that investors need to focus on in determining if a public company, for which an investor has shares in, have breached their continuous disclosure obligations?
What are the key elements that public companies need to consider in evaluating if, when, and how disclosures should be made to the marketplace?
Do you anticipate increased shareholder litigation for potential breaches of continuous disclosure obligations?
The securities laws essentially prescribe that the driving force behind any disclosure decision be based on two key elements: (1) is the information considered material?; and (2) does the new material information represent a material change in the business?Can you briefly expand on this subtle, but yet important difference between "material information" and "Material changes"?
