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CIVIL LIABILITY - Secondary market disclosure - Elements - Release of document that contains a misrepresentation - Persons liable - Defences

Wednesday, October 04, 2017 @ 8:31 AM  


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Appeal by the plaintiff, Rahimi, from the dismissal of his motion for leave to bring a secondary market misrepresentation action against the individual defendants and appeal by the corporate defendant from the order granting the plaintiff leave to proceed with the claim against it. The corporate defendant, SouthGobi Resources Ltd. (SGR), was a coal mining company. The individual defendants were two of its former CFOs and three directors and members of SGR’s audit committee. In November 2013, SGR issued a formal restatement of its prior financial statements (Restatement). In a press release, SGR stated that as a result of a review by SGR’s auditors for the 2010 and 2011 fiscal years, certain revenue transactions were previously recognized in the Company's consolidated financial statements prior to meeting relevant revenue recognition criteria and that previous financial information provided by SGR in respected of periods to be covered by Restated Financials were no longer accurate and should not be relied upon. A subsequent press release indicated that there was a material weakness in SGR's internal controls over financial reporting. The company's share price consequently dropped dramatically. The plaintiff alleged misrepresentation in the earlier financials and sought to bring a class action to recover damages for losses sustained by putative class members. On the plaintiff’s motion for leave to bring a secondary market securities class action, the defendants submitted that the original financials were true when made, and a reasonable investigation precluded a finding of liability. They further submitted the Restatement reflected a change of judgment by auditors that management and the board were forced to accept. The motions judge granted leave to bring the action against SGR, but not against the individual defendants. The judge found that the individual defendants presented compelling evidence that the earlier financials complied with the rules of revenue recognition, having been subjected to diligent corporate review and supported by clean and unqualified audit opinions. He further found, however, that the corporate defendant publicly and definitively acknowledged that two years of revenues had to be corrected and restated, as the earlier financials were no longer accurate. With respect to the individual defendants, the motion judge found that they were protected by the reasonable investigation defence under s. 138.5(6)(a) of the Securities Act and that any action against them had no reasonable possibility of success. The plaintiff appealed, arguing that leave should have been granted against the individual defendants. SGR appealed on the ground that leave should have been denied against it. It argued that SGR could not be found culpable while the individual respondents were exonerated, as the doctrine of corporate identification merged the mental state of the responsible individual with that of the corporation itself.

HELD: Appeal by the plaintiff allowed and appeal by SGR dismissed. With respect to the individual defendants, the judge erred in treating the motion for leave as if it were a mini-trial in which he was to determine contentious issues of credibility. He compounded the error by failing to give meaningful consideration to the gaps in the evidence and the evidence that conflicted with the contents of the affidavits filed on the leave motion. He failed to consider compelling evidence that contradicted the defendants’ narrative. Accordingly, this clearly was not a case where there was truly uncontroverted evidence adduced by a defendant in support of a reasonable investigation defence. In addition, the decision to deny leave against the individual defendants was inconsistent with the fundamental policy imperatives of securities regulation, which included protection of the investing public and maintaining the integrity of the capital markets. With respect to the claim against SGR, the judge made no error in determining that there was no certainty that SGR’s reasonable investigation defence would succeed at trial.

Rahimi v. SouthGobi Resources Ltd., [2017] O.J. No. 4829, Ontario Court of Appeal, G.J. Epstein, C.W. Hourigan and D. Paciocco JJ.A., September 18, 2017. Digest No. TLD-Oct22017008