Securities misrepresentation class action gone wrong – Superior Court denies leave under section 138.3 of Ontario Securities Act and denies certification of remaining claims – Securities law companies / commercial law

In Badesha group against Cronos, Morgan J. dismissed the plaintiff’s motions for leave to prosecute for misrepresentation under Part XXIII.1 of the Ontario Act
Securities Act (“AOS“) and for certification in accordance with Class Actions Act, 1992. The case raises interesting questions about how a plaintiff should argue a securities misrepresentation claim and pursue a motion for authorization, and also deals with how corporate defendants should treat a plaintiff’s representative proposed in the context of such a request.

This was a case of restatement relating to certain financial transactions undertaken by Cronos, a cannabis company, resulting in incorrectly recognized revenue in its first, second and third quarters of 2019. The company subsequently admitted in statements retired financial statements and management reports.1 that, related to the revenue recognition issues, there were significant weaknesses in his internal controls over financial reporting, which he previously disclosed to be working. The complainant filed a complaint.

On a motion for leave like this, the court must assess whether the action was brought in good faith and whether there is a reasonable possibility that the plaintiff will succeed at trial. If the applicant succeeds in meeting these requirements, they can pursue the legal cause of action and the court proceeds to their certification analysis.

While the aspect of good faith is rarely controversial, here the defendants “embarked on a rather aggressive challenge. [the plaintiff] as not up to the task. Among other things, the lawyer aggressively cross-examined the plaintiff “on areas which were clearly privileged”, disputed details including the spelling of the plaintiff’s name on the front of the plea, and criticized the plan. litigation as deficient. All this was rightly qualified by the court of approach “absurd” which did not even ” [the plaintiff’s] integrity and good faith. “

However, a point to remember – especially in the context of a retail investor action on the subject of consumer protection – is that the requirement of good faith is fundamental. Complainants in cases like these rely on their lawyers to navigate the complex web of corporate law, securities regulation and accounting standards. They do not write legal documents and do not define litigation tactics. The good faith test is to determine whether the plaintiff has a genuine intention to pursue a well-founded claim and whether he has not instituted a prosecution for ancillary purposes. As the court said here, this is the “total sum” of the requirement.

However, the motion turned in favor of the defendants on the second branch of the leave test: does the plaintiff have a reasonable possibility of success at trial. In order to establish a reasonable possibility of success, a claimant must establish that the alleged misrepresentation is material. Because the
AOS definition of a “false statement” contains within it the materiality requirement, any alleged false statement must be material if it is to establish liability under Art. 138.3 (1).

Under the AOS, a “material fact” is a fact which can reasonably be expected to have a material effect on the market price or the value of the security in question. Materiality can be assessed in a number of ways, one of which is to assess the market impact of a public correction. If the impact is significant and attributable to the alleged misrepresentation, then that misrepresentation was likely material. On this metric, the evidence in court indicated a lack of materiality. Of the five dates that the complainant’s expert declared were public corrections, three showed no statistically relevant movement in the share price, one showed a decline due to unrelated news, and the last had takes place on a volatile day with a drop and then a recovery in the share price. Finally, all of the alleged corrective disclosures occurred during a period of unusual market-wide volatility as news entered the market regarding the severity of the COVID-19 pandemic. All this led the court to consider that the market was not concerned with the false statements complained of by the plaintiff.

The court also observed that the accounting questions reformulated by Cronos were “relatively obscure”, with “market analysts generally perceiving them as insignificant in both the long and the short term.” While it is not clear that the court relied on the analysts’ statements in reaching its final conclusion on the petition, the author notes that this would violate the rules of evidence against hearsay. These analysts did not testify to their belief and were not cross-examined.

In any event, when considering the plaintiff’s claim, Justice Morgan noted that there were over 570 individual misrepresentations alleged in the Cronos core documents, each of which was reiterated, augmented or supplemented in statements and certifications by the individual defendants, so that in total there were “allegations of just under 8,000 false statements covered by the plaintiff’s pleadings”. Although the
AOS allows the misrepresentation to be grouped together, the pleading of the plaintiff requested a declaration that these multiple misrepresentations were to be treated as distinct and liable to action in themselves.

But why did the complainant plead his case in this way? By formulating part XXIII.1 of the AOS, our legislators have capped the damages available to plaintiffs under s. 138.7-a defendant-friendly law intended to balance the scales of justice in light of a plaintiff’s alleged confidence in public disclosure under the law. In theory at least, there are creative ways to get around this damage cap, but Cronosshows that this is much more difficult to achieve in practice without an overwhelming volume of expert evidence. In cross-examination, the applicant’s expert conceded that he had not performed an analysis of the significance of the alleged false statements. Rather, he proceeded to a “collective or global assessment” which was contrary to the cause argued by the plaintiff. According to Justice Morgan, this was a “fatal flaw”.

Moreover, the reformulation itself was not considered by the court as sufficient proof of materiality in itself. Under the circumstances, there was a lack of market impact, and Justice Morgan wrote that “the evidence that does exist is weak and tends to confuse movements in stock prices on a market scale.” Authorization was refused.

Turning to certification, Morgan J. considered the plaintiff’s common law claims for negligent misrepresentation and oppression pursuant to the Business Corporations Act. These claims were quickly rejected on the grounds that the claimant had failed to invoke adequate and precise material facts to substantiate his claim.

Essentially, the court found that the misrepresentation claim against Cronos, whether framed in statutory or common law terms, lacked particulars as to which of the many alleged misrepresentations caused the loss of the plaintiff. The court further observed that eleven individual defendants had been prosecuted, without specific allegations, finding that:

it is elementary that, except in the event of material damage to property, the persons holding a corporate office are not responsible for an offense committed by the company if it is not “demonstrated that their acts are themselves tortious or present an identity or interest distinct from that of the company in order to make the act or behavior complained of their own

In the author’s opinion, this analysis is undoubtedly erroneous because it is well established that the signing of a certificate is an independent tort, whether or not it is a step taken for a corporate purpose. .

With respect to the oppression claims argued against the individual defendants, the court considered the legal test that requires that the oppressive conduct be properly attributable to the Director and that the imposition of personal liability be “appropriate in the circumstances”. Here too, Justice Morgan ruled that there was no such content in the pleadings and therefore that these claims were no more viable than the claims provided for by law.

We’ll be keeping an eye on the roll to see if this decision is appealed.


1 The management report (MD&A) is a section of a company’s annual report or quarterly report where executives analyze the company’s performance.

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