On May 11, 2011, the Supreme Court of Canada released its decision in the class action proceeding Sharbern Holding Inc. v. Vancouver Airport Centre,1 in which it assessed materiality in the context of disclosure to investors. The Sharbern decision considers this issue in the unusual context of the disclosure regime under British Columbia's now-repealed Real Estate Act; but the decision does not change existing disclosure obligations under provincial securities laws. However, it will be an important decision in prospectus and continuous disclosure cases under the Ontario Securities Act and other provinces' securities legislation, and should provide insight into the way courts will assess materiality, which may assist issuers faced with difficult disclosure decisions.
Background to the Decision
The plaintiffs were a class of investors who had purchased strata lots in a hotel developed by Vancouver Airport Centre Ltd. (VAC). The investments were made pursuant to a disclosure statement that was a combination of an offering memorandum under the B.C. Securities Act and a disclosure statement under the B.C. Real Estate Act. VAC's disclosure statement was intended to satisfy the disclosure requirements of both statutes. The investments proved disappointing as a result of changed market conditions. The investors sued VAC, alleging, among other things, that the disclosure statement contained a misrepresentation and VAC was therefore liable under the disclosure regime of the Real Estate Act.
The key questions in the case concerned how materiality was to be assessed by the Court, the plaintiff's burden of proof and the application of the due diligence defence.
Materiality and Disclosure
Similar in some respects to the Ontario Securities Act, the Real Estate Act required specified matters to be disclosed to investors, and provided that if any "material false statement" was contained in the disclosure statement, a land developer such as VAC could be liable to investors.
The Supreme Court emphasized the importance of materiality standards for identifying information that must be disclosed.
The Court confirmed that companies are not required to provide unlimited disclosure to investors, noting that disclosure obligations have been enacted to provide a balance between too much and too little disclosure, and that it is not in the interests of investors to be buried in an avalanche of trivial information. The materiality standard is important for distinguishing what must be disclosed from what need not be disclosed. Unlike the Ontario Securities Act, the Real Estate Act did not define "material". To measure materiality, the Supreme Court adopted the "reasonable investor" standard, derived from U.S. securities law. The reasonable-investor standard differs from the market-impact standard of materiality imposed by the Ontario Securities Act for the purposes of civil liability. For an omission or a misstatement in disclosure to give rise to civil liability under the Ontario Securities Act, the omission or misstatement must be reasonably expected to have a significant effect on the market price or value of a security. The reasonableinvestor standard is concerned with information that the investor would have found important in making an investment decision with respect to a security, but that is not necessarily information that could affect the market price or value of the security. Although this standard is not applicable in the context of civil liability in Canada, it was applied by the Ontario Securities Commission in assessing an issuer's continuous disclosure filings in its Re Biovail Corporation decision2 and is the materiality standard applied in U.S. securities law for the purposes of civil liability. The Court assessed and applied the reasonable-investor standard in this case, in the absence of direction in the Real Estate Act. This decision should not change existing disclosure obligations under securities laws.
The Supreme Court articulated a two-step analysis in assessing materiality. A court must (1) look at the information that was disclosed to investors at the time they made their investment decision; and (2) then consider the omitted information against the backdrop of what was disclosed, with a view to assessing whether the information significantly altered the total mix of information available. As part of the second step of the analysis, a court should normally consider contextual evidence that would help to place the omitted information in a broader factual setting, such as the economic conditions at the time of investment. A court may also consider evidence of concurrent or subsequent conduct or events that would shed light on the behaviour of persons in the same or similar circumstances, such as the behaviour of actual investors who possessed the omitted information. The Supreme Court stated that the predominant focus in assessing the materiality of information must be on a contextual consideration of what information was disclosed and what information is alleged to have been omitted.
With necessary modifications, a similar approach can be taken in assessing materiality when the allegation involves misstated information: (1) look at the information that was disclosed, and (2) consider the misstated information against the backdrop of what was disclosed. In the assessment of materiality in any disclosure case, a defendant is entitled to rely on the broader informational context in which the disclosure was made, such as the information that investors have from sources other than the disclosure document, and common knowledge that investors should have.
Burden of Proof
The Supreme Court in Sharbern made clear that an investor alleging a disclosure misrepresentation has the burden of proving both that there had been a misrepresentation and that it was material; the company does not have the burden of proving that its disclosure was accurate or that the alleged omission or misstatement was immaterial.
Due Diligence Defence
The Supreme Court also considered the due diligence defence provided under the Real Estate Act. Like the due diligence defences available under the Ontario Securities Act, the Real Estate Act's due diligence defence involved both a subjective and an objective element: the defendant was required to show (1) that it subjectively believed that the representations it made were true, and (2) that it objectively had reasonable grounds for such belief.
As set out in Sharbern, in applying a due diligence defence, the question is not whether the company's conclusions regarding its disclosure were reasonable; the question is whether, at the time the disclosure was made, the company believed its representations and whether that belief was based objectively on reasonable grounds. Evidence supporting the reasonable grounds for belief in the accuracy of disclosure could include common industry practice.
Some Implications of the Decision
Where issuers are faced with challenging disclosure decisions, the Sharbern case suggests that issuers should continue to think about contextual factors and information, such as market conditions, in determining whether to disclose. In addition, if the results of a reasonable investigation suggest disclosure of certain information is unnecessary, the Court's decision in Sharbern increases the chances of a due diligence defence succeeding.
1 2011 SCC 23.
2 Re Biovail Corporation (2010), 33 O.S.C.B. 8914.
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