Securities and Mergers & Acquisitions Bulletin
January 2006
Fasken Martineau DuMoulin LLP
Danier Leather Wins Appeal of Prospectus Disclosure Case
Ontario Court of Appeal overturns earlier class action judgment that Danier made
misrepresentations to IPO shareholders
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Introduction
Background
The Ontario Court of Appeal recently
decided that corporations or other entities
issuing shares or other securities to the
public pursuant to a prospectus are not
obliged under the disclosure requirements
found in the Ontario Securities Act to
update the final prospectus to reflect
changes to material facts. This means that
under the Ontario Securities Act a final
prospectus is required to contain full, true
and plain disclosure of all material facts
as of the date of the final prospectus, but
not thereafter (including the date of the
closing of the offering). Once a receipt for
the final prospectus is issued, only a
material change in the business, operations or capital of the issuer will require
the preparation and filing of an
amendment to the prospectus.
On December 15, 2005, the Ontario Court
of Appeal released a unanimous decision1
overturning a 2004 Ontario Superior
Court of Justice judgment2 whereby
Danier Leather Inc. (“Danier”) (TSX:
DL.SV) and its CEO and CFO were found
liable to investors for an amount totalling
an estimated $15 million related to a
misrepresentation made in Danier’s
prospectus for its $65 million initial
public offering (“IPO”). The trial decision was the first judgment in Ontario
where section 130 of Ontario’s Securities
Act was applied. Section 130 provides
investors who purchase shares pursuant to
a prospectus with the right to sue for
damages if the prospectus contains a
misrepresentation without the need for the
investors to prove that they relied on the
misrepresentation when making their
With important ramifications for the
expected wave of upcoming securities
class action lawsuits, the Court of Appeal
also confirmed that consideration of the
“business judgement rule” is applicable to
the Court’s analysis of a misrepresentation
and
that
considerable
deference should be given to the issuer’s
management in regard to making determinations concerning what constitutes
“material changes” and “material facts.”
1
See: Kerr v. Danier Leather Inc. (Ontario
Court of Appeal) (hereinafter “Kerr v.
Danier Leather”) currently unreported
but
available
online
at:
http://www.ontariocourts.on.ca/decisions/
2005/december/C41880.htm
2
Kerr v. Danier Leather Inc. [2004] O.J.
No. 1916 (Sup. Ct)
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Securities and Mergers & Acquisitions Bulletin
investment decision.3
The investor plaintiffs in Kerr v. Danier Leather
purchased shares in Danier in 1998 under its IPO.
Two weeks before the closing of the IPO, Danier
filed a final prospectus that contained a financial
forecast for the remainder of Danier’s fiscal fourth
quarter. Ten business days after the closing of the
IPO, Danier issued a press release announcing that
“unseasonably warm weather” had reduced the
expected sales of its leather goods. Danier revised
its forecast for the fiscal fourth quarter and the
market price of Danier’s shares fell almost 30% in
the next four days, leaving investors with millions of
dollars in paper losses. However, by the end of the
fourth quarter, the results in the original forecast
contained in the final prospectus were in fact
substantially achieved.
Investors in Danier’s IPO sued for damages pursuant
to section 130 of the Securities Act on the basis that
the prospectus contained an untrue statement of a
material fact and/or omitted a material fact. The
investors in the Danier IPO alleged that when the
IPO closed, the original forecast no longer reflected
management’s best judgement of the most probable
economic conditions and expected results. In fact,
since information regarding sales performance was
available to management of Danier on a daily basis,
the plaintiff investors claimed in part that
management knew at the time of the IPO closing
that there had been a business downturn and that the
forecast contained in the prospectus was not
management’s best estimate. The investor plaintiffs
argued that disclosure (by way of an amendment to
the final prospectus prior to the closing of the IPO)
was required to correct the false and misleading
3
The normal legal test is that a plaintiff must prove
that a misrepresentation existed and that the plaintiff
actually relied on the misrepresentation when the
plaintiff made its investment decision.
2
forecast and that the purchase price of the shares was
artificially high due to the misrepresentation.
The trial judge accepted the plaintiffs’ argument and
held Danier and its CEO and CFO liable for the drop
in the price of Danier’s shares caused by the
misrepresentation.
The trial judge ruled that
investors who bought shares in the IPO and sold
them in the immediate aftermath of Danier’s profit
warning were entitled to recoup their losses. Those
who did not sell their stock were awarded $2.35 per
share in damages - an amount representing the fall in
Danier’s share price after the market had absorbed
the effects of the revised forecast. Danier and its
CEO and CFO appealed. The appellants appealed
the trial court’s judgment on five grounds, only three
of which were addressed by the Court of Appeal.
The Court of Appeal’s Decision
The first ground of appeal was that the trial judge
erred in concluding that, under section 130 of the
Securities Act, Danier had a continuing obligation to
disclose material facts occurring after the date of its
final prospectus and until the date of the completion
of the IPO. The Court of Appeal carefully examined
the distinction between the definitions of “material
change” and “material fact” found in the Securities
Act. For a corporate issuer, a “material change”
means a change (or a decision to implement 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 issuer’s securities.4 A “material fact” is a
broader term and simply means a fact that would
reasonably be expected to have a significant effect
on the market price or value of an issuer’s securities.
Many matters could constitute material facts without
necessarily constituting material changes. The Court
of Appeal accepted that a change to a company’s
forecasted financial results is likely a material fact,
4
Section 1(1) of the Securities Act
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but it is not by itself a material change. The Court of
Appeal found there was no obligation under section
130 or elsewhere to disclose any new material fact
that may arise after obtaining a receipt for the final
prospectus and before the closing of an IPO unless
the fact constitutes a material change.5 The Court of
Appeal noted that the Securities Act has a “complete
code of prospectus disclosure”6 requiring: (i) full,
true and plain disclosure of all material facts to be
included in a prospectus on the date it is finalized;7
and (ii) an amendment to a prospectus where a
material change occurs after the receipt for the
prospectus but prior to the completion of the
distribution of the securities under the prospectus.8
In effect, the Court of Appeal found that the trial
judge erred by reading the prospectus and related
disclosure requirements as though the prospectus
were to be effectively signed on the date of the IPO
closing instead of on the date of the final prospectus.
The Court of Appeal also found that if the Ontario
Legislature had intended to require issuers to
disclose material facts occurring between the date a
receipt is given for a prospectus and the end of the
distribution period, it would have expressly said so
in the Securities Act as it does for material changes.
Since prospectuses must be updated during the
period of distribution only for material changes but
not for material facts, purchasers of IPO shares are
not entitled to assume that no new material facts
have occurred that would reasonably be expected to
have a significant impact on the market price or
value of those shares after the date of the final
prospectus and prior to the date on which they
acquire the shares under the prospectus.9
5
6
3
The Court of Appeal recognized that securities
regulators and the Toronto Stock Exchange (“TSX”)
have adopted policies incorporating disclosure
obligations going beyond those in securities
legislation. One example is National Policy 51-201
- Disclosure Standards (“NP 51-201”), which deals
with timely disclosure. Section 4.5 of NP 51-201
acknowledges that the TSX has a policy requiring
listed companies to make timely disclosure of all
“material information,” which includes both
“material facts” and “material changes” relating to
the business and affairs of the company.10 NP 51201 states that it expects listed companies to comply
with the TSX’s requirements. Another example of
the requirements of regulatory policy exceeding the
disclosure requirements found in the Securities Act
is National Policy 48 (“NP 48”), which deals with
the preparation and disclosure of future-oriented
financial information (“FOFI”). NP 48 also goes
beyond legislative requirements. Part 7 of NP 48
addresses “Updating FOFI.” Section 7.1(1) states:
When a change occurs in the events or in the
assumptions used to prepare FOFI that has a
material effect on such FOFI, such a change shall
be reported in a manner identical to that followed
when a material change occurs as defined under
the Securities Legislation and Securities
Requirements.
The scope of “change” in subsection 7.1(1) of NP 48
appears to be broader than “material change” under
the Securities Act. Failure to comply with regulatory
policies such as NP 51-201, the TSX’s requirements
or NP 48 may invite an administrative proceeding
before a provincial securities regulator.11 However,
See para. 89 and 128 of Kerr v. Danier Leather
10
See section 408 of the TSX Company Manual
See para. 91 of Kerr v. Danier Leather
11
For example, in Re Royal Trustco Limited, Kenneth
Allan White, and John Merton Scholes (1981) 2
OSCB 322C, the OSC considered whether the
directors of a reporting issuer had an obligation to
update information previously disclosed in a
7
Section 56(1) of the Securities Act
8
Section 57(1) of the Securities Act
9
See para. 87 and 128 of Kerr v. Danier Leather
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Securities and Mergers & Acquisitions Bulletin
the Court of Appeal in Kerr v. Danier Leather
agreed with the trial judge and acknowledged that
policy statements issued by securities regulators are
not law. Policy statements may be relied on in
proceedings before a securities regulator, but they
cannot be used as the basis for an action for
prospectus misrepresentation under section 130 of
the Securities Act.12
The second ground of appeal was that the trial judge
erred in concluding that Danier’s prospectus
contained an implied representation that its forecast
was objectively reasonable. The Court of Appeal
found that “there was no basis upon which the trial
judge could have properly concluded that the
Forecast [in Danier’s prospectus] contained an
implied representation of objective reasonableness.”13 The Court of Appeal found that the
existence of such an implied representation was an
issue of fact rather than an issue of law and that the
trial judge could not have properly concluded that
the forecast in Danier’s prospectus contained such a
representation.
The third ground of appeal was that the trial judge
made a palpable and overriding error in assessing the
objective reasonableness of the forecast without
considering the business judgement of Danier’s
senior management and the fact that, in the end,
Danier came close to actually achieving its
forecasted financial results. The Court of Appeal
decided that since the forecasted results represented
“one of several reasonable alternatives” and was
“within a range of reasonableness,” the trial judge
directors' circular in response to a take-over bid. The
OSC stated as follows: "The [OSC] is of the view
that there is in Ontario today a duty to update
information previously communicated when that
information in the light of subsequent events and
absent further explanation, becomes misleading."
12
See paras. 101 to 104 of Kerr v. Danier Leather
13
See para. 142 of Kerr v. Danier Leather
4
erred in law by failing “to give any deference to the
business judgment of Danier’s senior management.”14
This decision in the Danier matter has important
implications for participants in the Canadian capital
markets.
Implications of the Court of Appeal
Decision
For issuers and underwriters, the most significant
implication of the Court of Appeal’s decision is that
the exposure to potential statutory liability for a
misrepresentation in a prospectus is more limited
than that found in the trial decision. Issuers and
their advisors can focus on the date of the final
prospectus when considering if their prospectus
contains full, true and plain disclosure of all material
facts. Although the practice may not be consistent
with NP 51-201 or the TSX’s disclosure
requirements, an issuer does not need to disclose a
new material fact arising after the date of the final
prospectus unless such a fact also constitutes a
“material change.”
It is important to point out that, although one may
understand the difference between the definitions of
“material fact” and “material change,” in practice it
is often difficult to conclusively make determinations in regard to these terms - as anyone who has
attempted to apply these definitions in real situations
will know. Determining the materiality of
information is clearly an area where judgement and
experience are of great value. In making materiality
judgements, it is necessary to take into account a
number of factors that cannot be captured in a
simple bright-line standard or test. These include the
nature of the information itself, the volatility of the
issuer’s securities and prevailing market conditions.
The materiality of a particular event or piece of
14
See para. 170 and 175 of Kerr v. Danier Leather
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Securities and Mergers & Acquisitions Bulletin
information may vary between issuers according to
their size, the nature of their operations and many
other factors. Similarly, whether an event constitutes
a “change” in the business, operations or capital of
the issuer can also be subject to considerable
deliberations.15 Readers are encouraged to contact
their legal counsel for advice and assistance.
For investors, the implication of the Court of
Appeal’s decision in Kerr v. Danier Leather is that
purchasers of securities pursuant to a prospectus
may no longer assume that a final prospectus
contains full, true and plain disclosure of all material
facts as at the day of the closing of their purchase.
Assuming no amendment to the prospectus is filed,
the date of the final prospectus is the relevant date
for providing this disclosure and for any recourse
that section 130 of the Securities Act may provide.
Civil Liability for Secondary Market
Disclosure
The Court of Appeal’s decision in Kerr v. Danier
Leather will likely have interesting implications for
Ontario’s new statutory civil liability regime for
secondary market disclosure which came into force
on December 31, 2005.16 The Court of Appeal
agreed that the change in Danier’s forecast did not
constitute a material change and it gave considerable
deference to Danier’s management in regard to their
decision-making process and analysis of determining
what matters constituted material facts and material
changes. The Court of Appeal specifically rejected
the argument that the business judgement rule has no
application to the analysis of a misrepresentation.17
15
For example, see Pezim v. British Columbia
(Superintendent of Brokers), [1994] 2 S.C.R. 557,
where the Supreme Court of Canada held that a
change in assay and drilling results was a “material
change” in the company's assets.
16
See Part XXIII.1 of the Securities Act
17
See para. 159 of Kerr v. Danier Leather
5
The Court of Appeal quoted an earlier judgment
with approval:
The business judgment rule protects Boards and
directors from those that might second-guess
their decisions. The court looks to see that the
directors made a reasonable decision, not a
perfect decision. This approach recognizes the
autonomy and integrity of a corporation and the
expertise of its directors. They are in the
advantageous position of investigating and
considering first-hand the circumstances that
come before it and are in a far better position
than a court to understand the affairs of the
corporation and to guide its operation.18
Therefore, it is predicable that future defendants,
both under section 130 as well as the new statutory
civil liability regime for secondary market
disclosure, will be making reference to the Court of
Appeal’s decision in Kerr v. Danier Leather and
arguing that considerable deference should be given
to the issuer’s management in regard to making
determinations concerning what constitutes material
changes and material facts.
Stay tuned - The plaintiffs who purchased Danier’s
IPO shares have 60 days to decide if they are going
to seek leave to appeal to the Supreme Court of
Canada. For more information on the subject of this
bulletin, please contact the authors or any member of
Fasken Martineau’s Securities and Mergers &
Acquisitions Group or Securities Litigation Group.
Geoff A. Clarke
Tel. 416-868-3524
Christine P. Tabbert
Tel. 416-865-4465
gclarke@tor.fasken.com
ctabbert@tor.fasken.com
18
See para. 158 of Kerr v. Danier Leather which quotes
from UPM-Kymmene Corp. v. UPM-Kymmene
Miramichi Inc. (2002), 214 D.L.R. (4th) 496 (Ont.
Sup.Ct.J.), aff’d [2004] 250 D.L.R. (4th) 526 (C.A.).
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are not legal opinions and readers should not act on the basis of these articles without first consulting a lawyer who will provide analysis and advice on a
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