Canada: Civil Liability for Continuous Disclosure Violations - Part 2

All potential defendants in a claim that a disclosure violation occurred have a defence if they can prove that, before the disclosure violation occurred, the defendant conducted a reasonable investigation and, at the time of the disclosure violation, the defendant had no reasonable grounds for believing that a disclosure violation would occur (the so-called "due diligence defence"). The factors that a court must take into account, in determining whether the due diligence defence has been established, include the existence and the nature of any system designed to ensure that the issuer meets its continuous disclosure obligations, and the reasonableness of reliance by the defendant on the issuer’s disclosure compliance system. The implementation of a suitable disclosure policy and the establishment of a disclosure committee are important elements of satisfying these criteria.

A disclosure policy is a written policy that provides an explanation of the issuer’s reporting obligations and commitments. It should be prepared with the intention that it will be distributed to directors, senior officers and all other employees of the issuer who in the ordinary course may be privy to material information about the issuer. Because of the potentially broad group that will have to apply the disclosure policy, the policy should be made to be reader-friendly and relatively concise; the policy should not be a comprehensive and detailed summary of every element of the issuer’s disclosure obligations. While a disclosure policy of this sort will likely trigger questions that will require deeper analysis from time to time, that analysis will be carried out by a smaller group, typically the "disclosure committee" (described below), counsel and (potentially) the board.

There are a number of key items that a disclosure policy should address, including:

• Timely Disclosure - The disclosure policy should summarize the issuer’s obligations to disclose material changes and material facts (referred to as material information) in a timely fashion, providing examples of the types of developments that may be considered material. This will help officers and employees to be sensitive to timely disclosure issues and to bring potentially material developments to the attention of the appropriate officers. Since material developments can arise unpredictably, it is important that officers and employees have an understanding of the issuer’s obligations so that potentially material information is "communicated up" through the organization, and nothing material falls through the cracks.
• Approval and Release Process - The disclosure policy should set out the approval process to be followed prior to the release of material information or the release of periodic disclosure documents (including annual and interim financials, MD&A, AIFs, proxy circulars and related materials). It should describe which of these matters require board or audit committee approval (the tendency now is for most, if not all, material matters to go to the board, either pursuant to the disclosure policy itself, or as a result of an issuer’s more general governance policies). The disclosure policy should also describe which officers in the organization have the authority to approve a release and who the issuer’s authorized spokespersons are. The policy may also contemplate certificates of the CEO and CFO (and of the disclosure committee) to the board, backing up the appropriateness of disclosure made in periodic disclosure documents. Certificates of this sort would be additional to those required annually of the CEO and CFO with respect to disclosure controls. The process followed by the CEO and CFO in providing any of this certification forms the foundation of the due diligence defence.
• Documentary Process - Many current disclosure committees act on an informal basis. It is important, however, in establishing the due diligence defence, to have documentary evidence of the process that was followed in considering disclosure issues. As a result, practices should change and steps should be taken to ensure that there is evidence to support the process and reasoning of disclosure committees.
• Forward-Looking Information - The disclosure policy should describe the cautionary language that will accompany any forward-looking information (be it documentary or oral disclosure). This is important since, if appropriate cautionary language accompanies forward-looking information, it is a defence to a claim that there was a misrepresentation in that information. Existing practices with respect to cautionary language (typically, the inclusion of non-specific and repetitious boilerplate) are generally inadequate to establish this defence.
• Contact with Analysts, Investors and the Media - The policy should address disclosure to, and discussions with, analysts, investors and the media. This includes the process for conference calls held in connection with annual and quarterly earnings results and major corporate developments (for example, public announcement of when those calls will take place, ensuring that a replay of the call is available on the issuer’s website). It should also include procedures for disclosure at investor presentations and one-off discussions with analysts and investors. In addition to ensuring that no misrepresentations occur, this element of the policy also assists in avoiding any selective disclosure of material information (i.e. disclosing material information to a limited number of people prior to its having been generally disclosed by the issuer), a serious securities law offence. Companies should consider a blackout period during periods of preparation of annual or interim financials, or finalizing material developments, during which discussions with analysts and investors are prohibited or extremely limited. Careful scripting of what will be said, and debriefing after the fact (about what was said), may be helpful at other times.
• Website Disclosure - As issuers increasingly promote their websites as a source of on-going disclosure, a summary of the relevant procedures to follow prior to posting business or financial information on the issuer’s website should be included in the disclosure policy. The procedures will largely track the approval and release process described above as the considerations are very similar. While material information should always be released by news release prior to posting on a website, information placed by an issuer on its website will be considered "released" by the issuer, making it subject to the civil liability regime.
• Rumours - The disclosure policy should describe the process for dealing with any rumours that arise, including who is authorized to comment publicly on them. The policy may also contemplate monitoring of chat room discussions so the issuer can determine whether any rumours are developing, but a typical policy will forbid further participation in chat rooms.

An important adjunct to the disclosure policy is the establishment of a disclosure committee, specifically charged with responsibility for ensuring proper implementation of the disclosure policy and otherwise ensuring compliance with disclosure laws. The committee is usually made up of three or four members of senior management, typically the CEO, the CFO and the general counsel and perhaps a senior investor relations officer. In addition to implementing the disclosure policy, the committee also acts as a direct conduit to the board by bringing to the board’s attention potential material developments in a timely fashion and otherwise ensuring that the board is provided with all relevant disclosure material for the board’s review and approval.

Some issuers have also been adding an independent board member to the committee to give the board a direct and unfiltered window into disclosure issues. The most difficult issue that typically arises is whether a development is material or potentially material and at what stage it needs to be disclosed. This is an issue on which some boards would prefer to have direct input as matters arise. In certain cases, the board member on the committee is fixed, while in others it is a floating member (i.e., a committee meeting must have at least one (or two) board (or specified board committee) member(s) present).

In our view, it is not necessary for an independent board member to be on the disclosure committee in order for the board to be able to rely on the committee as an element of establishing the due diligence defence, as long as the board has reasonable confidence that the committee is appropriately performing its duties, including bringing relevant information to the board’s attention in a timely fashion. If red flags arise, a board will have to do more than simply rely on management in order to establish the due diligence defence. Having a board member on the disclosure committee will potentially increase the risk of liability of that director. However, that risk may be worth taking in order to establish the diligence of the board. If the practice becomes prevalent, an issuer that has not adopted the practice may have difficulty establishing the due diligence defence.

A well-thought out disclosure policy, and a responsible disclosure committee, will go a long way towards establishing a due diligence defence to a misrepresentation claim. Public companies should carefully consider whether their current policies and practices are adequate.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.