Screening Secondary Market Liability Actions: the Supreme Court Raises the Bar for Plaintiffs
On April 17, 2015, the Supreme Court of Canada (SCC) rendered its opinion in Theratechnologies inc. v. 121851 Canada inc., 2015 SCC 18 (Theratechnologies), its first decision on the Quebec statutory secondary market liability regime adopted in 2007 pursuant to a reform of the Quebec Securities Act (QSA). Like its sister statutes in other provinces, although the QSA regime facilitates a plaintiff’s burden, mostly by presuming that variation in market price is linked to a misinformation or omission, it also imposes an authorization process under which a claimant must establish that its action is brought in good faith and has a reasonable possibility of success.
Adopting a similar approach as the Quebec Court of Appeal, the SCC clarified the test applicable to the authorization of claims pursuant to the QSA by comparing it to the less stringent test applicable to authorization of a class actions in Quebec and by specifying the evidence and the analysis of the evidence to be performed by the court seized with an authorization motion under the QSA.
In contrast with the Quebec Court of Appeal, however, which had authorized the class action claim pursuant to s. 225.4 QSA by the shareholders of Theratechnologies Canada Inc. (Thera), a public company listed on the Toronto Stock Exchange, the SCC reversed on the result and held that the evidence brought forward by the plaintiffs shareholders did not establish a reasonable possibility that the action could succeed.
More precisely, the SCC held that queries made by a regulator, the U.S. Food and Drug Administration (FDA) in this case, during the authorization process of a drug were not material if the issues raised by the regulator had been previously mentioned in public disclosures of the issuer. In this respect, the SCC commented on the expected knowledge of a reasonable investor and concluded that if previous public disclosures made by an issuer addressed certain issues and specified that they were not significant, a reasonable investor should have known that the questions raised by the regulators regarding the same issues were not material.
In doing so, the SCC ruled on whether a material change had occurred, whereas the lower courts had decided that this question should be left for the merits stage. As a result, the SCC confirmed that the analyses of judges deciding motions to pursue secondary market liability claims under the QSA and similar statutes may have to be comprehensive enough to determine whether or not a material change occurred.
Thera develops and markets therapeutic products. Under the QSA, Thera is a reporting issuer which must comply with continuous disclosure obligations. As such, in the event of any non-public material change that would reasonably be expected to have a significant effect on the market price or value of its securities, Thera is obliged to issue a news release disclosing the nature and the substance of this change.
In 2009, Thera filed an application with the FDA for approval of a major drug called Tesamoreline. The ensuing approval process took place in 2009 and 2010 and involved the FDA questioning Thera on the product, including asking about the risks of side effects of the drug. Thera did not disclose to the public the specific questions posed by the FDA, which included queries about the risks of diabetes and cardiovascular diseases. Nor did Thera respond directly to the FDA questions.
The ultimate step of the FDA approval process is a public hearing where all interested parties can be heard. May 27, 2010 was selected by the FDA as the date for the hearing. In accordance with FDA practice, on May 25, 2010, i.e. two days prior to the hearing, the FDA published information compiled at that time in the approval process, including its questions related to the possible side effects of Tesamoreline.
Although Thera did not react to the publication, the information released by the FDA caught the attention of financial analytics companies Bloomberg, Dow Jones, Thomson, and Reuters, which issued news releases about potential risks based on their reading of the questions posed by the FDA. The market reacted intensely to the news releases by the financial analytics companies; Thera’s stock was heavily traded that day and lost 58% of its value. Thera’s stock was the object of a cease trading order on May 27. When trading resumed on May 28, and after Thera confirmed that the FDA had approved Tesamoreline as a new drug, the stock regained its value.
The claimant, 121851 Canada Inc. (121Can), sold its stock at a loss on May 25. In a motion for authorization to pursue a secondary market liability claim under s. 225.4 QSA and to institute a class action filed a few months later, 121 Can alleged a failure on the part of Thera to disclose on a timely basis a material change, i.e. the questions raised by the FDA during the drug approval process.
Lower Courts’ Decisions
- Applicable Test for Authorization
On February 24, 2012, the Quebec Superior Court authorized 121Can’s secondary market liability claim under the QSA.
Although mostly in agreement with the Court below, the Court of Appeal found it necessary to “attenuate” some of the statements made by the Superior Court. In particular, it was of the opinion that the authorization process under the QSAimposes aburden of proof, rather than a mere burden of “demonstration” as suggested by the Superior Court. As a result, the Court of Appeal specified that a claimant under the QSA must present sufficient evidence to establish a reasonable possibility of success, despite the fact that such evidence may vary according to the circumstances.
The Court of Appeal acknowledged that the “reasonable possibility” that a secondary market liability claim will be resolved in favour of the plaintiff under the QSA is more stringent than the class action “colour of right” filtration mechanism of art. 1003 CCP (“the facts alleged seemed to justify the conclusions sought”). However, the Court insisted that a possibility of success is not tantamount to a probability or preponderance of proof. The burden is therefore situated between the simple burden of proving “colour of right” and the more onerous balance of probabilities.
The Court of Appeal described the criterion of a reasonable possibility of success as being more than just an obstacle to frivolous and meritless actions. The QSA filtration mechanism involves a summary appreciation of the alleged right of action to avoid claims with no reasonable chance of success without transforming it into a trial on the merits. The Court cautioned against conceiving the QSA authorization process as a “mini-trial” prior to the institution of the action.
Because Ontario and British Columbia have enacted provisions similar to s. 225.4 QSA, the Court of Appeal relied on cases from those jurisdictions in order to determine the applicable test for authorization. However, the Court mentioned that restraint must be applied when considering the "particularly thorough analyses" conducted in some of the Ontario decisions prior to deciding on authorization (see paras. 125-126). The Court stressed that unlike the QSA and CCP, the Ontario Securities Act and class action certification process contemplate the filing of detailed affidavits and the examination of affiants.
Nevertheless, the Court stated that the authorization judge must ensure that a secondary market liability claim is “supported by real and tangible evidence”, which can take the form of sworn statements, examinations and properly filed exhibits (see paras. 129-31).
- Claim Filed Against Thera
Although 121Can had chosen not to file any sworn statements, the Court of Appeal mentioned that the authorization hearing proceeded on the basis that the exhibits relied upon on both sides (almost 40) were admitted and appropriately filed. The Court also stressed that Thera had filed two sworn statements and the examination before plea of 121Can’s representative.
The Court agreed with the Superior Court that 121Can had demonstrated a reasonable possibility of success for its claim through a well-developed theory of the case (which should be analyzed at the authorization stage). 121Can’s theory was supported by numerous exhibits and by the explanations provided by the representative of 121Can during its examination by Thera. The Court stressed that 121Can’s claim identified a precise event that it alleged should have been disclosed, i.e. the questions raised by the FDA concerning the possible side effects of Tesamoreline. The Court of Appeal confirmed that the lower court was correct in not determining at this stage whether the queries from the FDA could amount to a material change. According to the Court, such a determination must be reserved for the merits.
SCC’s Decision (Reasons by Abella J.; McLachlin, C.J., Rothstein, Cromwell, Moldaver, Karakatsanis and Wagner JJ. concurring)
- Applicable Test for Authorization
The SCC acknowledged that the objective of the regime set out in s. 225.4 QSA is to filter actions to those brought in good faith and which show a “reasonable possibility” of being resolved “in favour of the plaintiff”. The regime, as the SCC noted, reflects an attempt to strike a balance “between preventing unmeritorious litigation and strike suits and, at the same time, ensuring that investors have a meaningful remedy when issuers breach disclosure obligations”.
In line with the Quebec Court of Appeal, the SCC acknowledged that the “reasonable possibility” of success required under s. 225.4 QSA sets out a different and higher standard than the general threshold for authorization of a class action under the CCP (see paras. 35 and 36). This higher threshold requires sufficient evidence to persuade the court that there is a realistic chance that the action will be resolved in favour of the claimant, thus the claimant is required to offer “some credible evidence” in support of its claim. However, the authorization stage is not a trial and the regime aims at preventing costly strike suits and litigation with no or little chance of success. As a result, courts must undertake a reasoned consideration of the evidence in order to ensure that the action has some merit, but should not perform a full analysis of the evidence (see para. 39).
The SCC also acknowledged that lower courts, including in Ontario and British Columbia, had struggled to find the proper balance between applying a simple screening of plainly unmeritorious “strike suits” or, as Justice Belobaba put it in Ironworkers Ontario Pension Fund (Trustee of) v. Manulife Financial Corp. (2013), 44 C.P.C. (7th) 80 (Ont. S.C.J.), applying “a preliminary merits test that should have more bite” (para. 37). Although the SCC did not expressly endorse the latter test proposed by Justice Belobaba, the Court’s subsequent analysis of the claim of 121Can and its view “the threshold should be more than a “speed bump”” (para. 38) arguably espouse a very similar test.
- Claim Filed Against Thera
Unlike the Court of Appeal, the SCC pushed the analysis of the evidence further and found that in this case 121Can had not met its burden of proof in that it had not provided any evidence of a material change in Thera’s operations, capital or business that could have triggered timely disclosure obligations.
Although it did not specifically say so, the SCC rejected the Quebec Court of Appeal’s view that the determination of whether the questions raised by the FDA concerning the possible side effects of Tesamoreline amounted to a material stage had to be reserved for the merits.
The SCC concluded that the FDA briefing materials, including the FDA’s question respecting glucose intolerance and development of diabetes, did not constitute a material change for two reasons: first, these side effects had already been disclosed in the results of the clinical trial and second, there is no evidence that the fact that the FDA was asking these question was not part of its regular and routine process.
The SCC ruled that the side effects are not, in themselves, a material change merely because Thera had previously disclosed that it was monitoring some of them closely, particularly blood sugar and diabetes. In addition, the clinical studies explicitly found that these side effects were not significant. As a result, a “reasonable investor who read Thera’s news releases would have known” that these side effects existed and were not material.
In addition, the SCC held that the fact that the FDA had asked these questions is not a material change. In doing so, the SCC provided its interpretation of the Canadian Securities Administrators (CSA)’s National Policy 51-201 - Disclosure Standards (NP 51-201). The SCC rejected 121Can’s view that because NP 51-201 includes, among its list of potentially “material” information, “any development that affects the company’s resources, technology, products or markets”, the market’s reaction demonstrated that the FDA’s concerns about side effects constituted a material change. The SCC reiterated the difference between material facts and material change and refused to accept this interpretation of NP 51-201, notably noting that it would expand the statutory obligations of timely disclosure beyond what the Quebec legislator had intended.
The SCC analogized the FDA preoccupations in this case to the intra-quarterly results in Kerr v. Danier Leather Inc.,  3 S.C.R. 331, which the Court found “did not constitute a material change to the business, operations or capital of the company because the warm weather that triggered the drop in sales was external to the company and its business” (para. 50).
Finally, the Court questioned the utility that a press release by Thera about the FDA preoccupations would have had and cautioned against the “risks of excessive disclosure” which can “simply … bury the shareholders in an avalanche of trivial information — a result that is hardly conducive to informed decision making” (para. 55, internal references omitted).
Conclusion and Comments
Public issuers and class action defence lawyers will certainly welcome the SCC’s decision and its interpretation of the disclosure requirements, as well as its comments about the expected knowledge of reasonable investors.
Although it agreed with the Quebec Court of Appeal that the QSA filtration mechanism should not be transformed into a mini trial on the merits, the SCC disagreed that determining whether the queries from the FDA could amount to a material change crossed into the merits territory. As such, Justice Belobaba’s words of “a preliminary merits test that should have more bite” may aptly describe the test applied by the SCC in this case.
More broadly, the decision can be viewed as another effort on the part of the SCC to promote procedural tools which can lead to preliminary dismissal of actions, in continuation with its earlier decisions in Hryniak v. Mauldin, 2014 SCC 7, and Attorney General of Canada v. Confédération des syndicats nationaux, 2014 SCC 49.
The SCC does not provide guidance as to the role of evidence where the authorization process under the QSA coincides with that applicable to class actions in Quebec. Evidence is required under the former regime, while severely restricted under the latter. Given overlapping substantive issues in both authorization processes, Quebec courts may have to establish guidelines as to how evidence is submitted and considered in this new context.
Application to the Common Law
On February 12, 2015, the Supreme Court of Canada heard the appeals arising from a trilogy of securities class action cases, Green v. CIBC, Silver v. IMAX and Celestica v. Millwright Regional Council of Ontario Pension Trust Fund. While the main issue to be addressed relates to the application of the limitation period in the context of the Ontario Securities Act and the Class Proceedings Act (for a summary of the issues, please refer to our post here), the standard of the test for leave as set out in the Securities Acts of the common law provinces remains unsettled.
Theratechnologies may offer some insight to practitioners and market participants alike who are anxiously awaiting guidance from the Court on the proper interpretation of the leave test.
 2013 QCCA 1256. For an analysis of and comments on the Quebec Court of Appeal decision, see our earlier post here.