Class Action Wars: Part 3 Securities Litigation

Defying pundits who were predicting its relegation to little more than a nuisance for corporate defendants, class action securities litigation in Canada, Lazarus-like, has risen from the dead. Breathing new life into what many thought was a legal corpse is last fall’s Ontario Court of Appeal decision permitting the Bre-X class action, based on secondary market losses, to proceed against company insiders and officers on the basis of negligent misrepresentation in conjunction with allegations of conspiracy and fraudulent misrepresentation.

“The door is ajar for securities class actions in negligent misrepresentation,” acknowledges John Campion of Fasken Martineau DuMoulin LLP in Toronto. Campion had quarterbacked the earlier success of various securities houses who fought against certification in the case. Accordingly, his views warrant serious consideration. Campion argues that the appellate decision is “important because most cases in the securities area are in negligent misrepresentation and not in fraudulent misrepresentation, and the problem for defendants is that negligence is a far more sophisticated tool in the hands of plaintiffs’ counsel than fraudulent misrepresentation.” And next comes the curveball for defendants. As Campion points out, in contradistinction to fraudulent misrepresentation, “there are many, many ways to lose negligence cases.”

Not to be upstaged by the Court of Appeal, legislative proposals from the Canadian Securities Administrators (CSA) designed to correct perceived misrepresentation problems in the secondary market—where over 90 per cent of Canadian trading activity occurs—are in the offing. The proposals, national in scope, are aimed at securities issuers, officers, directors, consultants, and professionals implicated in alleged misrepresentations. Under the scheme, which belatedly incorporates the US doctrine of “deemed reliance” or “fraud on the market” 25 years after the US Federal Court first embraced the concept, claimants will no longer have to prove reliance upon misrepresentations. Instead, their mere existence gives rise to a rebuttable presumption that investors relied on them.

The new proposals effectively eliminate the principal common law barrier to domestic class actions based on negligent misrepresentation in the secondary market. Combined with the CSA’s tightened continuous disclosure rules through an Integrated Disclosure System—a regime, according to securities lawyer Simon Romano of Stikeman Elliott’s Toronto office, that will create your basic bureaucratic nightmare—the legislative proposals and the Court of Appeal’s decision have once more set cash registers ringing in the inventive minds of contingency fee driven plaintiffs’ counsel.

The landscape is much changed from the situation less than two years ago when Ontario Superior Court Justice Warren Winkler threw out the case against the brokerage houses in Bre-X. Not long after the company collapsed, a small group of enterprising and talented litigators, relying on their newfound ability to launch class proceedings, had sued everyone in sight—brokers who had promoted the stock, including Nesbitt Burns and ScotiaMcLeod, Bre-X and related companies, company insiders including Messrs. David Walsh, John Felderhof, John Thorpe and Rolando Francisco, and professional firms such as engineering giant SNC-Lavalin Inc. Realistically, however, the people really in the gunsights were defendants with the necessary deep pockets to pay the tab from the astronomical losses relating to a company whose market capitalization had once reached $6 billion. Success against the brokers, and to a lesser extent the insiders, was critical.

It was not to be. The class action suit was launched in 1997. Within a little more than two years, the courts had cut the brokers from the class and severely restricted the lawsuits against the insiders. Unified class actions, the courts decided, were not an appropriate vehicle for complicated lawsuits involving a grab bag of negligent misrepresentations made on an individual basis by numerous brokers to numerous investors. Investors who wished to recover their losses, the courts said, could pursue individual claims on their own—leaving average investors in the same de facto powerless position they were in prior to the enactment of class proceedings enabling legislation.

The plaintiffs applied for leave to appeal the restrictive certification decision of Justice Winkler. But soon afterwards, their lawyers, who according to sources close to the case were mired in political infighting, advised their clients to abandon the appeal against the brokers in return for payment of their legal costs. Because the settlement is subject to a confidentiality agreement, the exact cost is not known. Suffice it to say that the defendants and their lawyers were delighted. “I’m not sure the Bre-X decisions make sense, but they sure are a huge win for brokerage houses and insiders,” said one Bay Street litigator who asked not to be named.

The investors’ remaining recourse was against the insiders, but not for negligent misrepresentation. Justice Winkler had ruled that the case against the insiders could proceed by way of class action, but only on the basis of conspiracy and fraudulent misrepresentation. The difficulty for the plaintiffs was that fraud and conspiracy were difficult to prove. The RCMP, maintaining that their investigators were hampered by uncooperative witnesses and red tape arising from the international nature of the case, decided not to lay criminal charges. And the Ontario Securities Commission (OSC) is pursuing charges against only one individual, Bre-X Vice-President John Felderhof. The offences of insider trading and non-disclosure with which Felderhof is charged, however, are not Criminal Code offences. Consequently, Felderhof, who lives in the Cayman Islands and has denied any knowledge of the fraud, cannot be extradited or compelled to testify in Canada. So far, he has not appeared at his ongoing trial in Ontario’s Provincial Court of Justice. Making the case even harder for the plaintiffs, Bre-X CEO David Walsh died of natural causes in 1998 and the geologist alleged to have contaminated the gold samples either committed suicide or accidentally fell to his death from a helicopter just as the scandal broke. With the principal players and allegations of negligent misrepresentation out of the way, the plaintiffs’ case was clearly an uphill battle.

In December 1999, the Divisional Court upheld Justice Winkler’s decision that the class action against the insiders could not proceed in negligent misrepresentation. The decision left Donald Jack of Toronto’s McDonald & Hayden LLP, one of the lawyers acting for the plaintiffs, in a pessimistic frame of mind. “The insiders are now in a position where they can defend the fraud claim by saying: ‘I wasn’t fraudulent, I was sloppy,’ and not worry about the consequences of being sloppy,” he said.

From the perspective of plaintiffs’ class action counsel, the damage was not limited to Bre-X. All was not well on other fronts. Equally noteworthy was the abysmal failure of US-style “strike suits” seeking to block (unless significant payments were made) high-profile corporate mergers and acquisitions. In the most publicized example, David Klein of Vancouver’s Klein Lyons, with the assistance of the much feared American class action powerhouse Milberg Weiss Bershad Hynes & Lerach LLP, attacked the National Bank of Canada’s merger with First Marathon Inc. Similarly, Vancouver’s Ward Branch in tandem with Beattie & Osborn LLP in the US, attacked the BAT plc acquisition of Imasco Limited. And in what was technically a derivative claim on the class action strike suit model, Klein, again with an assist from Milberg Weiss, challenged as inadequate the price agreed to by the International Comfort Products Corporation (ICP) Board of Directors in the context of a takeover by Titan Acquisitions Ltd. (Titan). All three actions failed. Miserably.

In ICP, Oslers’ Larry Lowenstein, Laura Fric and Allan Coleman, acting for ICP, and Stikeman Elliott’s David Byers and Adrian Lang, representing Titan, achieved a settlement dismissing the action without costs.

In Stern v. Imasco, Oslers’ Lyndon Barnes, Mark Gelowitz and Allan Coleman, acting for Imasco and its management directors, joined with David Byers, Adrian Lang and Katherine Kay of Stikes, who represented BAT, and Joseph Groia, then of Heenan Blaikie and now of Groia & Company, who represented Imasco’s independent directors. The multi-firm defence team convinced Justice Peter Cumming that the claim against BAT and the directors of Imasco disclosed no cause of action. Cumming allowed the class action to proceed against Imasco, but dismissed all claims for injunctive relief and accelerated disclosure. Soon after the release of Cumming’s decision, the case settled for payment of the plaintiff’s disbursements.

But…when Klein subsequently asked Cumming to approve a settlement in Epstein v. First Marathon Inc. that would have paid $190,000 to his law firm and nothing to the class, Cumming refused to sanction the agreement notwithstanding that all parties had consented. Justice Cumming then dismissed the case, directing that there was “to be no payment of any monies to Klein Lyons, under the Settlement Agreement or otherwise, as a consequence of the dismissal of the action.”

Despite their unquestionable success in the strike suit litigation, Lowenstein was less than sanguine about the future. “Class actions are going to become a way of life in the Canadian courts, and even their colleagues’ narrow losses will cause inventive plaintiffs’ counsel to follow in the path of the obstacles,” he said. Still, by the middle of 2000, plaintiffs’ counsel were in disarray. Some counsel, such as the highly regarded J.J. Camp, Q.C. of Camp, Fiorante Matthews in Vancouver, whose class action practice focuses on mass torts, even applauded the result in First Marathon: “If a plaintiff’s lawyer behaves as did the lawyer in First Marathon, he deserves to be treated in exactly same way that the plaintiff’s lawyer in that case was treated, and that will be an enormous deterrent to other lawyers inclined to behave in the same way.”

New actions were few and far between. All was quiet on the securities class litigation front through to the spring and summer of 2000. Then came October and the Ontario Court of Appeal’s decision in Bre-X. One can imagine Mr. Lowenstein wondering aloud why he has to be right all the time.

There are those, primarily defence lawyers, who say that all is well. They argue that the Court of Appeal decision represents nothing more than a pragmatic approach to case management in class action cases, one that recognizes the illogic of separating negligent misrepresentation from fraudulent misrepresentation, torts which differ in their material elements only as to the defendant’s state of mind.

“I do not agree that there is sufficient difference between the plaintiff’s claims in fraudulent misrepresentation and negligent misrepresentation to justify certification of the former and non-certification of the latter,” wrote Justice James MacPherson for a unanimous Court of Appeal which included Justices George Finlayson and Kathryn Feldman. “In my view, the creation of such a dichotomy in this litigation is an error in logic, in principle, and in policy.”

According to Vincent O’Donnell, Q.C., of Lavery, de Billy in Montreal, this passage indicates the “very narrow basis” of the decision. “The Court of Appeal intervened because the court below had certified the case on three other causes of actions, so why not a fourth?” says O’Donnell. H. Douglas Stewart, Q.C. of Chappell Bushell Stewart LLP, who represents defendant Bresea Resources Ltd., points to the same passage in support of his view that Bre-X neither reopens the door for secondary market litigation against brokers or for negligent misrepresentation as a stand alone cause of action in cases involving large numbers of defendants. “The Court of Appeal has not interfered with the judgment of Justice Winkler regarding the action against the brokers,” O’Donnell argues, going on to add: “so the atmosphere has not changed and the brokerage world is still happy with the result in the case.”

At most, says Joseph Groia, who represents John Felderhof, the Court of Appeal has created a two-tiered approach to certification. “If you have a case based simply on negligent misrepresentation, you use the old test that Justice Winkler used,” Groia argues. “But if there are other claims involved, it becomes a matter of judicial economy and efficiency.” James C. Tory at Torys agrees: “Simply put, the latest judgment is not a big deal in terms of opening the doors.”

So, there you have it. Some of the top securities litigators have said, essentially, no sweat. No big deal. But, it was a big enough deal to have led the defendants to seek leave to appeal to the Supreme Court of Canada. In his factum on the leave application, Robert Potts of Blaney McMurtry LLP, who represents John Thorpe, submits that the Court of Appeal’s decision undermines the substantive law regarding negligent misrepresentation, particularly the doctrine of reliance. Brian Bellmore of Bellmore & Moore, who represents Rolando Francisco, is concerned that the Court of Appeal reached its decision notwithstanding that the plaintiff’s claim was based on over 160 representations occurring over four or five years. “Previous authority would not have allowed such a claim to proceed because class actions would not have been the preferable procedure in a case where the representations are different and occur at different points in time in different circumstances that affect the defendants in different ways.”

The divergence of opinion is remarkable. The latest Bre-X judgment, explains Don Jack, recognizes that certification can be a way of reducing multiple representations to a smaller number of relevant statements. And multiple representations are now a regular feature of securities cases, underscoring Bre-X’s importance. One lawyer on the case calls the ruling a “landmark” and claims that Justice Winkler, widely respected for his mastery of class action law and procedure, is “absolutely dumbfounded” by the decision. That would not surprise Vincent O’Donnell in Montreal, who says the “striking” element of the Court of Appeal’s ruling is that “it meant overturning the court below.”

A close reading of MacPherson’s reasons may very well support Don Jack’s interpretation as to the decision’s impact on secondary market securities class litigation. Among the reasons for his conclusions, Justice MacPherson cites the “conscious attempt by the Ontario legislature to avoid setting the bar for certifications too high” so that plaintiffs need not present “absolutely identical issues of fact or law.” And, Justice MacPherson goes on to note that, certification should be ordered if the resolution of the common issues would advance the litigation: “Resolution through the class proceeding of the entire action, or even resolution of particular legal claims in the action, is not required.” Further: “Certification can be the preferable procedure in situations far short of final resolution of the lawsuit.”

Paul Pape in Toronto was the plaintiffs’ counsel who argued the Bre-X appeal. He is generally credited with having done a masterful job. Pape argues that the end result of the Court of Appeal’s decision is that so long as there is a common factual or legal issue that would advance the litigation, the case can be certified in negligent misrepresentation alone. “In Bre-X, the common issue is the date on which the defendants should have known there was no gold in mineable quantities, even though that date may vary from defendant to defendant,” Pape explains. “Any statement made after the ‘should have known’ date constitutes negligence.” >

MacPherson’s reasoning may well stand for the proposition that complexity in itself (in this case, the complexity of determining individual ‘should have known’ dates) is not a bar to certification regardless of the cause of action. “All you need for a case to be certified in a secondary market situation is a common issue, a lowest common denominator, not a common answer,” Pape says. “From the broker’s perspective, that question relates to the date they should have known there was no gold.” Arguably, that may be an easier question to answer for the brokerage industry than for individual insiders—which raises the specter that the brokers may not be out of it just yet.

“If negligent misrepresentation is floating around out there, I’m worried that my clients may find themselves back in the litigation as third parties,” says one lawyer who represented the brokers and, in the same breath, requested that his name not be used. It is perfectly clear how high the stakes are.

But John Campion remains convinced that Winkler’s reasoning holds for the brokers. “The idea of the ‘should have known’ date works with fraud, but it doesn’t work with negligence,” he maintains. Importantly, Campion points out that the plaintiffs, facing up to 4,000 separate brokers as sources of various misrepresentations, were unable to come up with a “litigation plan” that satisfied Winkler.

Exactly. Even before the Court of Appeal released its decision, Nigel Campbell at Blakes in Toronto persuasively argued that the full impact of securities class litigation could not be ascertained until the plaintiffs’ bar overcame “a certain inertia.” As explained by Campbell: “Class actions are so fraught with procedural difficulty that there’s no momentum. The details are still being worked out in the personal injury and product liability areas.” Benjamin Zarnett at Goodmans LLP, who represented brokers TD Securities Inc., Midland Walwyn Inc. and Levesque Beaubien Geoffrion Inc. in Bre-X, was of a similar view. “Plaintiffs have been unable to formulate viable plans for presenting the issues involved in a way that makes certification the preferable approach for dealing with common issues and individual issues effectively and efficiently. But when they finally come up with such a plan, it will be a precedent to which all the other securities cases can point.”

Arguably the appellate decision in Bre-X provides the necessary momentum and precedent. Campion emphasizes the decision’s practical significance. “Negligence misrepresentation is now included in the circle of class proceedings. Bre-X certainly gives rise to the possibility that where common issues are identified in a negligent misrepresentation matter, the case can be properly certified.” And, as one other defence counsel, perhaps opportunistically, puts it: “Success in any field prompts other counsel to put their foot in the door.”

These types of cases garner large headlines, observes Vincent O’Donnell in Montreal. “But the press generally isn’t there when plaintiffs lose,” he adds. “So the investing public gets the overall impression that a windfall’s available whenever a stock’s gone down a few points.”

Well, unless you have been on Pluto for the last couple of months, you will have noticed that the markets are down more than a few points. From the perspective of investors and plaintiffs’ counsel, then, the latest decision in Bre-X and the new proposals from the CSA have arrived, it would appear, in a most timely fashion. The anticipatory ringing of cash registers is practically deafening.

Julius Melnitzer is a Toronto legal affairs writer.