Damage caps and other restrictions for shareholder class actions appear to have worked. Whether that is a good thing depends who you ask
Shareholder class actions, once the boogeyman under the bed on Bay Street, have had almost a decade to take shape in Canada. While few would argue they have lived up to their fearsome advance billing, whether that’s a good thing or a bad thing is still a matter of sometimes heated debate.
Shareholders were given the right to bring class actions in the mid-2000s following a series of Canadian stock-market scandals that angered the investing public.
The prospect of being liable directly to shareholders was supposed to act as an additional deterrent to anyone thinking of breaking the rules.
In a bid to avoid leaving Canada open to the kinds of speculative US-style strike suits that plagued Wall Street a decade earlier – considered by many a form of legal highway robbery – the provinces all shaped their new regimes so shareholders are required to get permission, or leave, from the court before their suit can proceed.
Damages are also capped, sharply limiting the potential upside. In Ontario, for example, which sees roughly 80 per cent of shareholder lawsuits, damages cannot exceed 5 per cent of a company’s market capitalization.
The measures appear to have worked.
Paul Morrison of McCarthy Tétrault LLP – a corporate defence lawyer – says there clearly aren’t as many cases being brought as people had initially feared. Even where cases have been filed, he says, most settle only after many years of litigation and “the amounts for which they are settling are really not that big.”
A snapshot provided by NERA Economic Consulting, which tracks securities class actions, shows there were 11 suits filed in Canada last year. That’s far short of the 221 filed in the United States’ federal court, even taking Canada’s smaller size into account.
None of the cases filed has yet led to a full trial.
Won Kim, of Kim Orr Barristers P.C. – which has been involved in filing a number of high-profile shareholder class actions – believes the suits are not yet working as intended in terms of shareholder protection. “We can do better.”
Joel Rochon, of Rochon Genova LLP, one of the more active class-action boutiques in the country, says his firm has taken on fewer than a dozen shareholder-style lawsuits since the regime was introduced in Ontario in 2005 — roughly only one a year.
“These cases are incredibly costly to mount primarily because of the money spent on experts and investigations,” he says. “It’s not unusual to have an outlay in excess of $1 million or $2 million in major cases — and that’s not counting the time put in. That in itself should be deterrence enough to pursuing frivolous cases.
“I don’t see any highway robbery here. There was only one strike suit ever brought in Canada and that was 20 years ago.”
Marie Audren, regional leader of the class action group at Borden Ladner Gervais LLP in Montréal, says the absence of strike suits suggests the leave requirement and damage caps are doing the job. “It may very well be that these mechanisms prevent them.”
Audren is convinced the provinces got the balance between investor and company protections right. She views the leave requirement as an especially important tool.
“The standard says you have to have a reasonable chance of success at trial and also that you have to take on the suit in good faith — not just to be a nuisance or to get the legal fees.”
But Kirk Baert, who heads the class action group at Koskie Minsky LLP in Toronto, which typically acts for shareholders, believes the provinces have made it too difficult to bring such suits. He says the requirements block not only strike suits, but legitimate claims as well.
Plaintiffs’ firms like Baert’s have to arrange financing or lay out their own money to try for leave and certification without knowing whether their case will even make it into the real starting blocks.
“The motions tend to be three, five, seven days long, with volumes of evidence, just enormously expensive. I think the reason you’re only seeing three or four firms really do much of this work is other firms considering it say the capped damages aren’t big enough for them to bring them.”
The damage caps make it completely uneconomic to bring class actions where they may be needed most, he says: against small-cap and mid-size companies that spend less on compliance and are more likely to try to bend the law.
“No one’s going to bring a $12-million securities case, it’s got to be at least $500 million. And not every securities law problem is a $500-million problem. So the way the [securities] Act is written has the effect of making cases against only the biggest companies the most viable — and the biggest companies don’t tend to be the ones that pull the shenanigans as often.
“You haven’t created much of an incentive to go after the real bad guys. No one’s going to go after a company with a $200-million market cap because damages are limited to $10 million.”
In a $10-million settlement or award, the lawyers would typically get 20–30 per cent, or $2–$3 million, very close to what they would spend to mount that case.
If the provinces wanted to make sure US-style strike suits didn’t take root in Canada, he says, all they had to do was introduce a strict loser-pays cost system — something the US does not have.
“If they’d done that we never would have had the strike suit problem. Instead, what we did is we massively over-reacted and put five things in that are different from the US instead of one. As a result, what you see are fewer than a dozen of these cases being commenced a year under this law, and only half are getting leave, and everything is appealed — so it’s a five-year process to get leave.
“To have a case take five years to decide whether somebody made a misrepresentation – just to get you to the starting process – is not a deterrent.”
David Byers, co-chair of the litigation group at Stikeman Elliott LLP, says they are a deterrent. He says the number of cases filed over the past 10 years may be relatively modest but they “have occupied a lot of time and effort … even though it hasn’t resulted in many payouts that have benefited shareholders.”
That lack of success on the plaintiff side does not mean such suits aren’t having any impact. To the contrary, he says, corporate clients are very aware of them.
“Corporations recognize the potential. Just the fact they’re there and available to shareholders has had the effect of behaviour modification, so I think they do have an enforcement benefit.”
Kim of Kim Orr is convinced shareholder class actions will only have a genuine impact if and when large Canadian institutions begin to lead the charge.
Institutions are the largest stockholders in any listed company, and their knowledge and resources could be a game-changer, he says. But unlike in the US, where institutions like the California Public Employees’ Retirement System (CalPERS) hold companies’ feet to the fire on behalf of all shareholders, he sees a dearth of Canadian institutions willing to get involved in shareholder class actions.
He says it’s partly because the law in the area of shareholder class actions is still so unsettled.
“They’re not going to get involved when the parameters of engagement aren’t defined. These are sophisticated investors who need to make informed decisions justifiable to their management. After 10 years, we have not come up with a test on what is required for leave.”
The courts have also been chilly to institutional involvement, he adds. “Canadian courts have all but said sophisticated investors should bring their own suits, the court has almost deemed class actions are not for institutions. It’s a startling departure from the US.
“So you see institutions like [Ontario] Teachers active in the US but they have yet to take a lead position here. Their involvement could change things dramatically.”
But Linda Fuerst, a partner at Norton Rose Fulbright Canada LLP, says it would be a mistake to think shareholder class actions as they are aren’t already having an effect. “The sky hasn’t fallen in,” Fuerst says, “however, I’d say just the fact these types of claims exist has made certain events, such as a restatement of financial results, much more financially perilous for companies, their directors and officers, and their insurers.
“It’s also made the defence of regulatory or criminal proceedings more complex as well.”
As for strike suits in Canada, Michael Eizenga, partner and head of the class action practice at Bennett Jones LLP, says just because they haven’t made headlines doesn’t mean this kind of litigation isn’t being settled simply because it is a cheaper alternative.
“From the defence perspective, there are a number of cases that get filed and get settled where the risk to the defendant is relatively low.
“The frustration is where you get sued in a case where you have excellent defences and you believe you’d be successful on the merits – the odds are you’d be successful on the merits – but people on all sides are risk averse. So they come to economic resolution.”