APRIL 2005
INVESTMENT MANAGEMENT ADVISORY
Ontario’s New Civil Liability Regime for
Secondary Market Disclosure:
How Will It Apply to Investment Funds?
Recent amendments to the Ontario Securities Act that create a complex new statutory
civil liability regime await proclamation, which is expected to occur as soon as related
regulations are drafted. Part XXIII.1 Civil Liability for Secondary Market Disclosure was
enacted by the Ontario legislature in December 2002 and was amended by legislation
enacted in December 2004.1
The new legislation will give investors trading in the secondary market statutory rights
to sue for misrepresentations in non-prospectus disclosure issued by public companies.
While it was principally designed to resolve a perceived, long-debated problem with
the continuous disclosure of public companies, given the primacy of secondary market
trading, the new legislation will also apply to mutual funds and other investment
funds that are reporting issuers. Managers of investment funds, their directors and
officers and members of fund governance bodies are faced with the potential for
increased liability, particularly since the new legislation is intended to facilitate
investor class action lawsuits in Ontario. It will be important to keep this new
legislation in mind as fund managers prepare the new required disclosure documents
under National Instrument 81-106 Investment Fund Continuous Disclosure, which is
expected to come into force on June 1, 2005.2
This Advisory describes the application of the new legislation to investment funds,
their managers and their respective directors and officers, and explains how the new
civil liability regime fits with the existing statutory rights of action with respect to
prospectus disclosure. We highlight the somewhat anomalous results these rights of
action create for securityholders of investment funds and for industry participants.
Finally, we recommend some practical steps that fund managers can take to address
the additional potential liabilities created by the new regime.
1
Notice of Amendments to the Securities Act and the Commodity Futures Act (2005) 28 OSCB 267. Available on the
OSC Web site www.osc.gov.on.ca. We summarized the new legislation in previously published newsletters:
see, for example, BLG Special Alert – Securities Law Ontario to Implement Liability for Secondary Disclosure and
to Reflect SOx January 2003, Shareholder Class Actions: A New Statutory Regime in Ontario February 2003 and
Further Amendments to Ontario Securities Act Introduced May 2003. Our newsletters are available on our Web
site www.blgcanada.com. See Publications, Capital Markets.
2
See BLG’s Advisories on NI 81-106, including our most recent Advisory, Working with the New Canadian
Continuous Disclosure Rules for Investment Funds Investment Management Advisory April 2005 Borden Ladner
Gervais LLP.
www.blgcanada.com
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
INVESTMENT MANAGEMENT ADVISORY
New Rights for Only Certain Investment Fund Investors
Two groups of investment fund investors will benefit from the new civil liability provisions:
➤ Investors who dispose of (redeem) securities of a mutual fund during a time when there is inaccurate public
information about the mutual fund (within the meaning of the new legislation).
➤
Investors who acquire or dispose of securities of a publicly traded investment fund during a time when there is
inaccurate public information about that investment fund (within the meaning of the new legislation).
The new legislation will not create any new rights for investors who purchase newly issued securities of an investment
fund under a prospectus—this will include most mutual funds—these investors will continue to have the current
statutory rights of action that apply to prospectus disclosure. The new civil liability provisions will not apply when an
investor acquires securities under a prospectus.
Misrepresentations in Investment Fund Disclosure
Ontario’s statutory rights of action for prospectus disclosure, and now for secondary market disclosure, are based on
whether a particular disclosure contains a misrepresentation. Under Ontario securities laws, a misrepresentation
includes a misstatement of a material fact, or an omission to state a material fact that is required to be stated or that
is necessary to make a statement not misleading in light of the circumstances in which it was made. Determining
whether a fact is a material fact depends on whether the fact would reasonably be expected to have a significant effect
on the market price or value of (the) securities (of the issuer). Strictly speaking, information about a mutual fund
would rarely fall within this definition’s market price or value tests, because mutual funds are valued based on the
value of their underlying portfolios. Nevertheless, we believe that securities regulators would take the view that this
term should be interpreted such that a fact about a mutual fund would be a material fact if a reasonable investor
would consider that fact to be important when making a decision to purchase or redeem securities of that fund.
Securities of closed-end funds are generally sold at a fixed price per unit during an initial offering period, and
thereafter they trade on public marketplaces. Therefore the test for misrepresentation and material fact may work for
these investment funds.
Existing Rights of Investment Fund Investors Purchasing under a Prospectus
Because a mutual fund continuously issues new securities, a mutual fund investor acquires securities pursuant to the
prospectus of the mutual fund. Rarely (if ever) would a person purchase securities of a mutual fund from another
securityholder of that mutual fund in the same way that a person would acquire securities of a public company in the
secondary market. This means that an investor in a mutual fund will likely continue to look to the statutory right of
action provided for in Ontario securities laws if the simplified prospectus (including all documents incorporated by
reference into that prospectus) contains a misrepresentation.
2
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
INVESTMENT MANAGEMENT ADVISORY
Statutory Liability for Mutual Fund Continuous Disclosure
Under the simplified prospectus system for mutual funds, mutual fund investors have the existing statutory right
of action in Ontario to sue for damages for misrepresentations contained in non-prospectus documents, such as
financial statements, material change reports and proxy circulars, if they purchased securities at a time when
these documents contained a misrepresentation. Under National Instrument 81-106 annual and interim
management reports of fund performance will also be incorporated by reference into a mutual fund’s simplified
prospectus. Because these continuous disclosure materials are incorporated by reference into a mutual fund’s
simplified prospectus and so legally form part of the prospectus, a misrepresentation in any of these documents
will allow an investor to exercise the statutory right of action for misrepresentations in a prospectus.
If a securityholder of a mutual fund sues for damages
inaccurate public information about the closed-end fund
resulting from a misrepresentation in the simplified
(within the meaning of the new provisions) at the time
prospectus, including any of the documents incorporated
that they trade in those securities.
by reference, he or she is deemed to have relied on the
misrepresentation and may claim damages from the
However, a securityholder of a mutual fund will only
fund, the manager and the directors of the manager who
have rights of action under the new legislation to sue for
signed the prospectus, along with any other signatory to
damages if he or she disposed of securities of the fund
the prospectus, among others, each of whom has
(redeems) at a time when there is inaccurate public
specified defences. Alternatively, the securityholder may
information about the mutual fund (within the meaning
seek to rescind his or her purchase. It is generally
of the new provisions).
accepted that if the securityholder rescinds the purchase,
Under the new legislation, actual reliance is not relevant
he or she cannot also sue for damages.
in a suit for a misrepresentation. Subject to available
A securityholder in a closed-end fund also has a right to
defences, if it is established that there was a material
sue for damages if he or she purchased under the
misrepresentation in the disclosure of a fund,
prospectus of the fund during its distribution period and
securityholders (in the case of mutual funds, only
that prospectus contained a misrepresentation.
redeeming securityholders) would be entitled to recover
from those responsible for the misrepresentation,
regardless of whether the securityholders were even
New “Civil Liability” Rights
aware of the disclosure at the time of the acquisition or
sale (or redemption).
After the initial offering period, securityholders of
closed-end funds generally acquire and dispose of
Investors will be entitled to exercise the new right of
securities based on secondary market disclosure in ways
action if they redeemed securities of a mutual fund or
similar to public companies. Therefore, like investors in
purchased or sold securities of a closed-end fund during
public companies, investors in closed-end funds may sue
a time when any of the following documents or public
for damages under the new legislation if there is
oral statements contained a misrepresentation:
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
3
INVESTMENT MANAGEMENT ADVISORY
➤ Documents publicly released by the fund or by the
officers of the manager, the directors or trustees of a
fund manager (defined as an influential person);
fund and possibly the members of a fund
including any current prospectus, any current
governance body. Examples include statements
annual information form, material change reports,
made by a senior officer of the manager of a fund
annual and interim financial statements of the
on a business television program, at an investor
fund, the new continuous disclosure documents
seminar or securityholder meeting or at some other
required by National Instrument 81-106, press
public forum.
releases and, arguably, sales communications (see
the text box below). Documents can be in either
Investors will also have a right of action under the new
printed or electronic form.
legislation if they redeemed securities of a mutual fund
or purchased or sold securities of a closed-end fund at a
➤ Public oral statements made by a person with actual,
implied or apparent authority to speak on behalf of
time when the fund had not made timely disclosure of
a material change.
the fund or by the manager (as an influential
person), which likely would include the senior
Misrepresentations in Sales Communications
It is not clear whether the legislative drafters intended that the new legislation would give investors statutory rights
of action for misrepresentations contained in sales communications of mutual funds, since the language used in the
legislation does not work particularly well for mutual funds. Misrepresentations in written communications
(including documents in electronic form) that are made available to the public and the content of which would
reasonably be expected to affect the market price or value of a security of the responsible issuer [the fund] will give
investors rights under the new legislation if they redeemed mutual fund securities during the time that the written
communication contained the misrepresentation. As we explain with the definition of material fact, market price or
value tests of the nature used in the definition of written communications do not work well in the context of mutual
funds. Nevertheless, we recommend that fund managers treat sales communications with the same degree of due
diligence as for other written disclosure documents.
We point out below other anomalous results of the new legislation. Significantly, investors purchasing mutual
funds will not have statutory rights of action in respect of misrepresentations contained in sales communications,
since sales communications are not incorporated by reference into simplified prospectuses and therefore are not
included under the statutory right of action for misrepresentations in prospectuses.
4
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
INVESTMENT MANAGEMENT ADVISORY
Potential Liability of Industry
Participants under the New Civil
Liability Regime
5 percent of its "market capitalization" (which is not
defined) and $1 million. Liability limits for other
individuals or entities will also be available. However,
there may be no limitation on damages exposure if a
person or company was complicit in the
The important elements of the new civil liability regime
misrepresentation or failure to make timely disclosure.
are as follows.
➤
Potential defendants in an action taken by a fund
➤
Proportionate liability, as opposed to joint and several
liability generally will be found by a court, in
investor could include (i) the fund, (ii) directors and
appropriate circumstances. In the case of a
officers of the fund (which will include the directors
misrepresentation or a failure to make timely disclosure,
of a corporate fund and the trustees of a trust fund,
if a court determines that a particular defendant, other
and may include members of fund governance
than the fund, knowingly authorized, permitted or
bodies), (iii) the manager, and (iv) each director and
acquiesced in the making of the misrepresentation or
officer of the manager.
failure to make timely disclosure, the entire amount of
➤
the assessed damages may be recovered from that
Depending on the role of the individual defendant,
defendant.
the nature of the misrepresentation, the type of
document or oral statement and whether there has
been a failure to make timely disclosure of a material
fact or change, different burdens of proof and due
diligence defences will be available.
➤ Calculations of damages depend on whether the
What’s Missing for Mutual Fund
Investors—and for the Mutual Fund
Industry?
It is difficult to say how the new legislation will apply in
plaintiff acquired or disposed of the issuer’s
practice to mutual funds, or who will be liable, since it
securities during the period of time following the
appears that it was not drafted with mutual funds in mind.
misrepresentation or failure to make timely
However, we offer the following observations relevant to
disclosure, and before the correction of the
the mutual fund industry:
inaccurate disclosure. A court is given discretion to
set "just" compensation when there is no "trading
➤
The existing statutory rights of action concerning
price" (which is not yet defined) for securities—this
prospectus disclosure contain no statutory limits on
would presumably apply to mutual funds.
liability such as those provided for in the new
legislation. No statutory guidance is given about the
extent of expected due diligence for prospectus
➤ As an influential person, a fund manager would have
its liability limited to the greater of $25,000 and 50
disclosure the way there is for secondary market
percent of the aggregate of the manager’s
disclosure.
compensation from the investment fund and its
affiliates, but the investment fund (as the responsible
issuer) would have its liability limited to the greater of
➤
A securityholder of a mutual fund who purchases a
security will have no statutory rights under Ontario
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
5
INVESTMENT MANAGEMENT ADVISORY
securities laws (whether under the existing
according to detailed rules set out in National
prospectus scheme or the new secondary market
Instrument 81-102 Mutual Funds; however, given the
scheme) to sue for damages based on
likely effect of the new legislation, fund managers
misrepresentations contained in sales
should consider instituting enhanced review
communications, public oral statements or a failure
procedures for sales communications. This could
to disclose a material change, unless the
include senior officer sign-off on all sales
misrepresentation or failure to disclose also
communications prior to their release and periodic
amounted to a misrepresentation in the simplified
review by the board or fund governance body.
prospectus (which includes the documents
incorporated by reference). Instead, purchasing
mutual fund investors must continue to rely on
common law rights to sue for misrepresentations or
for the failure to disclose , without the benefit of any
➤
Fund managers should implement new policies
concerning spokespersons for the funds and for the
fund manager, given the new liability for
misrepresentations contained in public oral
statutory scheme.
statements. Fund managers should make their
➤ Redeeming mutual fund securityholders will have
employees and members of fund governance bodies
different and arguably additional rights from
aware of these policies and the consequences of any
purchasing mutual fund securityholders.
breach.
Suggested Disclosure Practices for Fund
Industry Participants
Fund managers and their directors and officers, the
directors and trustees of funds and members of fund
governance bodies may consider bolstering existing good
disclosure practices to accommodate the exposure
represented by the new legislation. We list some
suggestions below:
➤
➤ Fund managers should consider implementing general
written disclosure policies and procedures regarding
their funds and should consider seeking input from
fund governance bodies about those policies and
procedures. Members of fund governance bodies
should also consider developing policies and
procedures concerning their own oral or written
communications. Setting standards and adhering to
them will be an important part of establishing that the
fund manager, its directors and officers, any directors
Fund managers should carefully monitor whether a
material change to an investment fund has occurred,
since investors will have rights to sue for damages if
they redeemed mutual fund securities or purchased or
or trustees of the fund and members of a fund
governance body took the reasonable investigative
steps necessary to demonstrate appropriate due
diligence.
sold closed-end fund securities at a time when a
material change was undisclosed.
➤
6
Mutual fund sales communications must be prepared
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
INVESTMENT MANAGEMENT ADVISORY
Parallel Legislation in British Columbia
and other Provinces
Ontario schemes differ, they would both significantly
expand the current remedies available to investors in
public investment funds.
In our September 2004 Advisory New Securities Legislation
in British Columbia: How will it affect mutual funds and
pooled funds, and their managers, portfolio advisers and
distributors?, we described the enhanced investor remedies
in British Columbia’s proposed new Securities Act, which
received Royal Assent in May 2004 but has yet to be
proclaimed in force. Implementation of this legislation
was originally scheduled for November 2004 but has been
delayed. If implemented, this legislation would provide
investors in B.C. with an expanded right to sue for
damages for misrepresentations made by public mutual
funds or their managers about the funds in any document
filed or otherwise generally disclosed, or in an oral
statement if it was reasonably foreseeable that this
information would be disclosed. Although the B.C. and
It is worth noting that the Uniform Securities Act proposed
by the Canadian securities regulators in January 2004
included a secondary market civil liability regime that was
based on Ontario’s new legislation. The uniform securities
legislation would resolve the issue discussed in our text
box about misrepresentations in mutual fund disclosure
documents by adopting a "reasonable investor standard"
for the definitions of material change and material fact.
The Canadian regulators have not publicly discussed the
status of this project since September 2004 and, given the
continued discussions at both provincial and federal levels
around a single securities regulator, we do not expect
much progress to be made quickly (if at all) on uniform
securities legislation.
Ontario’s new legislation is complex and is not easily applied to mutual funds, or even, as we outline in this Advisory, to
closed-end funds. We will keep you posted on developments in this area, including when the new legislation in Ontario
and/or British Columbia is proclaimed in force.
If you have any questions about Ontario’s new legislation or how it will apply to your business, please contact your usual
lawyer in BLG’s Investment Management Group or one of the following Investment Management Group leaders:
➤ John E. Hall
National Leader
416-367-6643
jhall@blgcanada.com
➤ Brad J. Pierce
Calgary Regional Leader
403-232-9421
bpierce@blgcanada.com
➤ Richard J. Shannon
Montréal Regional Leader
514-954-3103
rshannon@blgcanada.com
➤ Jeremy S.T. Farr
Ottawa Regional Leader
613-787-3511
jfarr@blgcanada.com
➤ Lynn M. McGrade
Toronto Regional Leader
416-367-6115
lmcgrade@blgcanada.com
➤ Jason J. Brooks
Vancouver Regional Leader
604-640-4102
jbrooks@blgcanada.com
BORDEN LADNER GERVAIS LLP
INVESTMENT MANAGEMENT ADVISORY
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