REGULATORY LIABILITY OF DIRECTORS AND OFFICERS
By Peter Wardle, Helen Daley and Simon Bieber
In the current environment, officers and directors of public companies must not only be aware of
their potential civil liability, including claims under the Class Proceedings Act
, but also that their
actions will be scrutinized by securities regulators. The Ontario Securities Commission's
mandate is to provide protection to investors from unfair, improper or fraudulent practices and to
foster fair and efficient capital markets and confidence in capital markets.1 It is important that
officers and directors of public companies, and their counsel, bear in mind the Commission's
public interest mandate, which involves more than simply prosecuting breaches of specific
provisions of the Securities Act
and ensuring that aggrieved shareholders have obtained redress.2
Rather, the Commission's focus is to ensure that necessary action is taken to protect the Ontario
capital markets from any threat of future harm posed by the individual whose actions are in
This paper will discuss the regulatory liability of officers and directors in connection with public
offerings of securities.
CONNECTION WITH PUBLIC OFFERINGS
The Enforcement Provisions of the Act
The Commission has three statutory tools available to enforce compliance with Ontario securities
1. Prosecution before the Ontario Court of Justice under s.122 of the Act
prosecution is subject to the Provincial Offences Act
and a conviction carries a
maximum fine of $5 million (or triple the profit made or loss avoided in the case of
insider trading) and up to five years imprisonment.
Section 1.1, Ontario Securities Act
R.S.O. 1990, c. S. 5 as amended (the "Act"
Indeed, although s. 128 of the OSA
allows the Commission to apply to the Superior Court for, inter alia
, an order of restitution or damages, the Commission has, as a
general rule, left such actions to the aggrieved shareholders themselves.
2. Administrative sanctions after a hearing before the OSC itself pursuant to s.127 (the
"public interest" jurisdiction of the OSC).
3. Declaratory, injunctive and other orders (including the possibility of requesting
restitution and/or damages) before the Superior Court of Justice.3
One of the offences created under s.122(1) is the making of a statement in a prospectus (and
certain other enumerated documents) that "in a material respect and at the time and in light of the
circumstances under which it is made, is misleading or untrue or does not state a fact that is
required to be stated or that is necessary to make the statement not misleading". That section
also makes any contravention of Ontario securities law an offence.4 Subsection (3) specifically
deals with directors and officers and provides that where they authorize, permit or acquiesce in
the commission of an offence under subsection (1) by the company (whether nor not a charge has
been laid or a finding of guilt has been made against the company) they are guilty of an offence.
As this section creates a provincial offence, with penal consequences attached, guilt must be
proven according to the rules of criminal evidence and beyond a reasonable doubt. Charter
rights apply and the section provides for a due diligence offence.5
While s.122(3) appears to relate to criminal proceedings, an identical provision is contained in
s.129.1. This applies more generally to administrative proceedings under s.127, and states that
officers who acquiesce, permit or authorize the corporation's non-compliance with securities law
are deemed not to have complied with securities law themselves.
The OSC's second option is its public interest jurisdiction under s.127. This jurisdiction is very
broad. The section simply provides:
"The Commission may make one or more of the following orders if in its opinion it is in the public interest to make the order or orders
." (Emphasis added.)
OSA sections 122, 127 and 128.
Defined as the Act
, the Regulations
, and any decision of the commission or a director to which a person or company is subject. Other offences include, for example,
fraud and market manipulation (section 126.1).
See Section 122(2)
The section then goes on to list a number of possible orders, including restrictions or suspensions
of registration rights, trading rights and the right to exemptions under the Act
, the right to review
the practices and procedures of market participants, the right to make orders in respect of certain
documents, including prospectuses (including an order of amendment) and the right to prohibit
persons from holding office as directors or officers of an issuer. The Commission may also
order a respondent to pay the investigation and hearing costs.6 The Commission's jurisdiction
under s.127 was described in the following manner by the Supreme Court of Canada and in
Committee for the Equal Treatment of Asbestos Minority Shareholders v. The Queen in Right of
Quebec et al
…The public interest jurisdiction of the OSC is not unlimited. Its precise nature and scope should be assessed by considering s.127 in context. Two aspects of the public interest jurisdiction are of particular importance in this regard. First, it is important to keep in mind the OSC's public interest jurisdiction is animated in part by both the purposes of the Act
described in s.1.1, namely "to provide protection to investors from unfair, improper or fraudulent practices" and "foster fair and efficient capital markets and confidence in capital markets". Therefore, in considering an order in the public interest, it is an error to focus only on the fair treatment of investors. The effect of an intervention in the public interest on capital market efficiencies and public confidence in the capital market should also be considered.
Second, it is important to recognize that s.127 is a regulatory provision. In this regard, I agree with Laskin J.A. that "the purpose of the Commission's public interest jurisdiction is neither remedial nor punitive; it is protective and preventative, intended to be exercised to prevent likely future harm to Ontario capital markets"…the focus of regulatory law is on the protection of societal interests, not punishment of an individual's moral faults.
…[T]he purpose of an order under s.127 is to restrain future conduct that is likely to be prejudicial to the public interest in fair and efficient capital markets. The role of OSC under s.127 is to protect the public interest by removing from the capital markets those whose past conduct is so abusive as to warrant apprehension of future conduct detrimental to the integrity of the capital markets: Re Mithras Management Ltd.
(1990), 13 O.S.C.B. 1600 …
Sections 127 and 127.1 of the Act
In summary, pursuant to s.127(1), the OSC has the jurisdiction and the broad discretion to intervene in Ontario capital markets if it is in the public interest to do so. However, the discretion to act in the public interest is not unlimited. In exercising its discretion, the OSC should consider the protection of investors and the efficiency of and public confidence in, capital markets generally. In addition, s.127(1) is a regulatory provision. The sanctions under the section are preventative in nature and prospective in orientation. Therefore, s.127 cannot be used merely to remedy securities act misconduct alleged to have caused harm or damages to parties or individuals.7
As should readily be apparent, sections 122 and 127 have very different purposes: the
punishment of quasi-criminal conduct on the one hand and the regulation of conduct to protect
the public interest on the other. The courts have been respectful of the remedial flexibility which
has granted the Commission in carrying out its various functions. In Wilder v. Ontario
, the Ontario Court of Appeal rejected an argument that allegations
made against the respondent Wilder which mirrored precisely the language in s.122(1)(a) could
not be pursued in a regulatory hearing pursuant to s.127 because the subject matter fell squarely
and exclusively within the offence created by s.122. The court held that the legislature had
clearly manifested its intention to provide the OSC with a range of alternative remedial options.
Wilder's argument that he was being denied the burden of proof as well as evidentiary and
Charter benefits available under s.122 was rejected on the basis that there was no criminal
sanction attached to a s.127 order.9
The final and probably least familiar enforcement section is s.128, which permits the
Commission to apply to the Superior Court for a declaration that a person or company has not
complied with or is not complying with Ontario securities law. If the court makes the
declaration, a number of remedies may be granted including restitution and damages. The
Commission has not made use of this provision very often. With the advent of class proceedings
and the development of an experienced plaintiff's bar, the use of this section will undoubtedly
decline further. Indeed, in the recent case of YBM Magnex International Inc
, (discussed further
(2001), 199 D.L.R. (4th) 577 at paras. 41-45 (hereinafter "Asbestos
(2002), 53 O.R. (3d), 519
In practice, the Commission will often proceed with both s. 122 and s. 127 proceedings in respect of the same matter, especially in insider trading cases: see Re
(2002) 25 O.S.C.B. 1183
the staff had indicated in a Notice of Hearing commenced under s.127 that it intended to
apply to the Superior Court for further relief under s.128 in the event an order was made by the
Commission under s.127. During the course of the s.127 hearing, a number of class proceedings
commenced in both Canada and the United States settled. In the context of the settlement,
Commission staff were asked to agree not to pursue their s.128 remedies should the civil
settlement be approved by the court. They agreed to do so.
The Standard to Which Directors and Officers Will be Held in Regulatory Proceedings
Most business corporation statutes impose two obligations upon directors and officers. First, a
good faith obligation: to act honestly and in good faith with a view to the best interests of the
corporation. Second a diligence requirement: to exercise the care, diligence and skill of a
reasonably prudent person in comparable circumstances.10
Recent jurisprudence would suggest that this statutory standard is relevant, but perhaps not
sufficient of itself, to the determination of a director or officer's regulatory liability. Four cases
are of note in clarifying the standards for directors and officers in respect of regulatory liability:
In Standard Trustco
11 a federally incorporated trust company which was also a reporting issuer
experienced serious financial problems. Its federal regulator, the Office of the Superintendent of
Financial Institutions ("OSFI") became concerned about certain accounting practices,
particularly loan loss provisions. On June 24, 1990, the trust company's parent was to release
unaudited interim financial statements. The Superintendent of OSFI attended a board meeting at
which he expressed concerns. He urged that an audit be performed on the interim financial
results. Despite these views, the Board approved the unaudited financial statements and a press
release was made showing modest profits. No mention was made of the financial problems or
OSFI's concerns. When the audited financial statements were eventually prepared, they
disclosed a massive loss.
Canada Business Corporations Act
, R.S.C. 1985, c.C-44, as amended, s.122(1). Most of the provincial statues including the O.B.C.A. contain identical language.
Re Standard Trustco et al.
(1992) 15 O.S.C.B. 4332
A s.127 hearing was held to determine whether the Commission should exercise its public
interest jurisdiction against the company and certain officers and directors. It was clear that the
press release was materially misleading. The real question was who bore responsibility.
As described earlier in this paper, the OSC noted that the obligation to make timely and accurate
financial disclosure rested ultimately with the directors but in practice was shared by the
directors, audit committee members and certain members of senior management. In determining
the standard of care applicable, the Commission specifically referred to the statutory standard12,
however, it went on to say:
In addition, securities regulators through legislation, policies and decided cases have enunciated what they consider to be appropriate standards of conduct for directors and officers of public companies, which may go beyond the requirements of corporate law in order to protect the public interest.…
In making our decision in this matter we had to go beyond whether the respondents complied with the O.B.C.A. and the L.T.C.A. We had to determine whether the conduct of the respondents was contrary to the public interest.13
The Commission then went on to analyze whether the conduct of the directors and officers met
this public interest standard. A number of points are important.
First, in reaching the conclusion that the directors failed to exercise the prudence and diligence
they ought to have exercised, the Commission took into account the fact that almost all, if not all,
of the directors had backgrounds which suggested they were a relatively sophisticated group.
This holding is in keeping with an established line of jurisprudence which holds that while
directors must act reasonably (an objective standard), they are to be judged in comparison with
what a person with their specific background and experience would do (which introduces a
subjective element to the assessment).14 In the absence of any statutory rules establishing
minimum qualifications for directors, it is submitted that this is a fair standard which, if properly
applied, will not compromise the quality of corporate decision making.
In the instant case, the applicable statute was the Loan and Trust Corporations Act
which imposed a standard of a "prudent director" rather than a "prudent person".
The OSC made specific note of the fact that this difference in language was intended to reflect a greater standard necessary for deposit taking institutions.
Standard Trustco, supra.,
See also Re Soper and The Queen
(1997) 149 D.L.R. (45th), 297 (F.C.A.) and in Re City Equitable Fire Insurance Company Limited
, 1 Ch. 407
Second, the Commission in Standard Trustco
took a sceptical look at the director's reliance on
management. It held that directors should not rely on management unquestioningly where they
have reason to be concerned about the integrity or ability of management or where they have
notice of a particular problem relating to management's activities. It is clear from this decision
that directors will only be able to rely upon management where such reliance is reasonable.
Similarly, the decision makes clear that reliance upon the opinions of auditors, lawyers or other
outside consultants will only be acceptable where it is reasonable in all of the circumstances. In
, an examination of the alleged reliance upon the lawyer is instructive. Neither
management nor the Board sought advice on the disclosure issue from the company's general
counsel, who was fully briefed and had a general understanding of the continuous disclosure
obligations of the company. Instead, the general counsel was asked to call the outside lawyer at
his cottage to brief him. The briefing was, to use a euphemism, "selective". A suggestion was
made that OSFI was backing off on the numbers. On the basis of this briefing, the lawyer
advised senior management that it was not necessary to make disclosure of OSFI's concerns.
Most tellingly, earlier that day, the Board had already decided to authorize the release of the
interim financial statements to the public before the lawyer's advice was ever obtained
Board was criticized for all of this and specifically for failing to hear the advice for themselves.
It should be noted that this aspect of the decision is entirely consistent with Blair v. Consolidated
, the leading case on the ability of a director or officer of a corporation to rely upon
legal advice. In that case the Supreme Court of Canada held that the ability of a director to rely
upon advice should depend upon whether the lawyer was fully informed of the facts, whether the
advice was ostensibly credible to a layperson and whether the issue was within the lawyer's area
Another important feature of the Standard Trustco decision is the Commission's commentary
upon the defence advanced by certain respondents that they had told the regulator (OSFI) that
they were going to release the financial results and the regulator did not object. The Commission
held that, although it may have been appropriate for the directors to consider what the regulator
said, it was up to the directors to make the decision relating to disclosure, not the regulator. In
other words, the buck stopped with them.
(1993) 106 D.L.R. (4th) 193 at pp. 205-210
Finally, it is of interest to note the distinctions made by the Commission between various
members of the Board and management. First, it held that members of the audit committee
should bear somewhat more responsibility than the other directors because they had a greater
opportunity to obtain knowledge about and to examine the affairs of the company than non-
members had. The Chief Executive Officer and the controlling shareholder were accorded the
most responsibility because they were largely in control at Board meetings and they appeared to
be the ones who determined that the financial statement should not be released. With respect to
outside directors, the Commission said the following:
Outside directors should play an important and effective role on a Board because of their separation and independence from management. They should ask questions of management and others in order properly oversee the company's operations and disclosure, particularly where they have notice that the company may have serious financial problems. In some cases it is appropriate for outside directors to make enquiries and have discussions in the absence of management where they have a concern about something which management has done. In this case, the outside directors failed to fulfil their role.
With respect to the officers, the Commission analyzed in some detail their individual role or
function within the company and accorded responsibility in relation to their specific duties.
They did take note of the fact that one of the officers (Seago) appeared to play a relatively
subordinate role, at least in comparison to other officers, and the Commission was therefore
inclined to attribute less responsibility to him.
The second case of note which has considered the question of the standard of conduct applicable
to directors in the context of regulatory proceeding is the decision of the Alberta Securities
Commission in Re Cartaway Resources Corp.16
That case cited the Standard Trustco
approval. It contrasted two decisions of the civil courts applying the "business judgment rule",
which essentially holds that as long as the process employed in reaching a decision was rational
or employed in good faith in order to advance business interests, the decision cannot incur
liability on the part of directors. In Revelstoke Credit Union v. Miller17
Chief Justice McEachern
(2000), 9 A.S.C.S. 3092 (hereinafter "Re Cartaway
(1984) 24 B.L.R. 271,
stated that the directors of a credit union were entitled to leave the management of the credit
union to the manager and:
They [the directors] could only be faulted if something actually came to their attention which should have put them on notice, or if they failed to ensure the systems in place were adequate.
It also referred to Caremark International Inc. Derivative Litigation18
, one of the leading U.S.
cases applying the "business judgment rule", which stated that regardless of whether a judge or
jury, considering the matter after the fact, believed the decision to be wrong, stupid or egregious,
there was no liability as long as a rational process was employed in good faith to advance
corporate interests. The Alberta Commission purported to distinguish between these decisions
(which employed what it described as the "negligence test") and the Standard Trustco
(which applied what it referred to as the "regulatory test"). The Commission went on to describe
this distinction as follows:
The distinction between the regulatory test and the negligence test may be illustrated by the following example: a director makes a stupid, egregious decision, employing a process that was either rational or employed in good faith in order to advance corporate interests. The director would not be civilly liable to the corporation because the corporation chooses its own directors and it cannot properly hold those directors to an objective standard of prudence or due diligence beyond the Caramark
criteria. If, however, an objective evaluation of the decision shows it to be contrary to the public interest, or a violation of securities law, then regulators may have a right and a duty to intervene in order to protect the integrity of the markets. The director's good faith, or reliance on a rational process, may be relevant factors to be considered, but they do not necessarily determine whether the decision is contrary to the public interest or a violation of securities law.19
After citing the principle in the Gordon Capital
case that the fact that the respondent may have
acted with a malevolent motive or inadvertently is not determinative of the regulator's right to
exercise its regulatory power,20 the Alberta Commission then concluded on this point as follows:
(1996), 698 A. (2d) 959
Re Cartaway, supra.
note 17 at pp. 42-43
Gordon Capital Corp. v. Ontario Securities Commission
(1990), 13 O.S.C.B. 2035, affirmed (1991) 14 O.S.C.B. 2713
In this case, we apply the regulatory test described in Standard Trustco
: whether a director exercises appropriate prudence and due diligence, which will be determined having regard to the particular circumstances of the director
, the information available and the systems in place to deal with such information. Bearing in mind the distinction between the regulatory test and the negligence test described above, it is also useful to consider the factors described in Revelstoke
in determining whether a director has exercised appropriate prudence and due diligence under the particular circumstances of the case.21 (Emphasis added.)
It is not entirely clear from this decision precisely how the "regulatory test" differs from the
"negligence test". If it simply means that a stupid or egregious decision cannot be defended on a
purely subjective basis, that is clear enough. However, a careful reading of both Standard
and Re: Cartaway
appear to acknowledge that a director's particular circumstances and
background ought to be taken into account in judging his conduct against a standard of
reasonableness. This is essentially consistent with the standard applied in civil cases.
The facts of YBM
for present purposes may be briefly stated. The company, YBM Magnex
International Inc. ("YBM") which was originally incorporated in Alberta, became a reporting
issuer in Ontario in 1996 and its shares were subsequently listed for trading on the TSX. In
November, 1997 YBM raised $100 million through a prospectus offering. In May, 1998 the
company's head office in Pennsylvania was raided by the FBI, and shortly thereafter trading in
its shares was suspended. In June, 1999 YBM, through its Receiver, pleaded guilty to securities
fraud in the United States.
YBM had its origins in eastern Europe; it was created out of a group of affiliated companies
originally operated from Hungary. A number of its founding shareholders are alleged to have
been members of organized crime. In the summer of 1996 YBM's board of directors became
aware that YBM was the subject of an ongoing investigation conducted by the U.S. Department
of Justice. Subsequently, a Special Committee of the board of directors was formed to
investigate the situation. Ultimately, in early 1997 the Special Committee retained an
independent consulting firm, Fairfax, to conduct an investigation. In April, 1997 the results of
Re Cartaway supra.,
at p. 43
that investigation were summarized in a draft report of the Special Committee to the Board.
Following the preparation of the draft Special Committee report, a decision was made by
management and the Board to proceed with the public offering. Public disclosure in connection
with the offering (in particular, by way of an annual information form (or AIF) incorporated in
the preliminary prospectus and final prospectus) referred only obliquely to the work of the
Special Committee and the findings of Fairfax.
Enforcement proceedings were initiated by staff against YBM, its officers and directors, and two
investment dealers who underwrote the 1997 offering.22 Staff's primary allegation was that
YBM filed a preliminary and final prospectus that failed to contain full, true and plain disclosure
of all material facts, particularly the mandate and information obtained by and findings of the
Special Committee. The directors and officers were alleged to have authorized, permitted or
acquiesced in YBM's failure to make full disclosure. Staff's secondary allegation was that YBM
had failed to comply with continuous disclosure obligations in failing to disclose in April, 1998
that Deloitte & Touche LLP (U.S.) advised the company that it would not perform any further
services for YBM until YBM completed an in-depth forensic examination addressing Deloitte's
The YBM hearing took over 124 hearing days, and is probably the most ambitious enforcement
proceeding ever mounted by Commission staff. The hearing panel's decision was released on
June 27, 2003. Orders under s.127 of the Act were made against a number of the respondents,
including a number (but not all) of the members of YBM's board of directors. The Commission
concluded that YBM had failed to make full, true and plain disclosure as required by the Act.
The Commission also appears to have concluded that YBM's officers and directors authorized,
permitted or acquiesced in YBM's failure.23 From the standpoint of this paper, the significant
part of the decision is the section which examined whether the directors (and one officer) had a
due diligence defence based on their actions including: forming the special committee, hiring
outside investigators, relying on the special committee's report, and obtaining legal advice as to
what disclosure should be made about the Special Committee's work.
In the matter of the Securities Act R.S.O. 1990, c.S.5 as amended and YBM Magnex International Inc., et al
") (discussed released June 27, 2003)
In its decision, the Commission noted the various approaches taken by regulators to the due
diligence defence in prior jurisprudence, including Cartaway
and Gordon Capital
. Although in
s.127 proceedings there was no specific due diligence defence provided in the Act
"an order in the public interest may not be justified against a director, officer or underwriter if
their investigation and belief was reasonable. In some cases, the investigation or belief may have
been unreasonable but the facts will not otherwise call for an order against the public interest".24
According to the hearing panel, this was not a civil proceeding and resort to the statutory
standard of care under business corporations statutes was not appropriate. It was best from the
regulatory perspective to examine the reasonableness of the respondents' conduct and their belief
"from the perspective of a prudent person in the circumstances".25 This entailed both objective
and subjective elements, including the directors or officers degree of participation, access to
information and skill.
In its analysis of the obligations of directors and officers the Commission also made a number of
important observations, as follows:
while directors are not obliged to give continuous attention to the company's affairs, they have to react to events (their duties are "awakened") and must be active, not passive;
not all directors stand in the same position, and more may be expected of those with superior qualifications (for example, those with legal training);
more may be expected of inside directors (or outside directors who sit on committees) than outside directors;
directors may rely on the members of a special committee if that committee is compromised of disinterested directors; and
directors may rely on management and on outside professional advisors, provided that reliance would be unreasonable if the director was aware of facts or circumstances of such character that a prudent director would not rely on the advice.26
The Commission also made some important findings about the conduct of the YBM Board as a
whole. It held that the Special Committee process was flawed in a number of ways, including:
the choice of Owen Mitchell, (a director but also key member of the First Marathon underwriting
team), as chair, the failure of the Committee to follow-up on many issues raised by its initial
investigation, the absence of other committee members at key meetings with the outside
investigators, Fairfax, and the failure to obtain independent counsel for the committee.
The Commission criticized the quality of the legal advice the Board received on a number of
issues, particularly on the disclosure to be made of the Special Committee mandate and findings
in YBM's annual information form. The Commission questioned whether the Board's reliance
on counsel was reasonable. Finally, the hearing panel suggested that the full Board should have
met with Fairfax.
The Commission also examined the conduct of individual Board members with respect to the
primary allegations advanced. It reserved its harshest criticism for Mitchell, who the
Commission determined was in a conflict of interest, given his role in the underwriting
syndicate, as Mitchell would expect to earn substantial fees if the offering proceeded. As an
experienced officer and director, Mitchell "should have known better". The hearing panel
concluded that his conflict adversely affected Mitchell's judgment in many ways (such as failing
to provide the Special Committee report to the full Board). While Mitchell had taken a number
of positive steps towards uncovering information critical to the business, "the risk at issue left
little margin for error".27 A defence of due diligence was unavailable to him.
In a much different category was David Peterson, a former Premier of Ontario who was a YBM
board member but did not sit on the Special Committee. Peterson took an active role on the
YBM board, questioned management and considered carefully the issues raised by the Special
Committee's work. However, the Commissioners criticized Peterson for what can only be
described as his poor judgment in failing to properly identify Mitchell's conflict and in relying
too much on others with respect to the critical issue of disclosure of the Special Committee's
findings. Moreover, given his background, experience and qualifications, the hearing panel was
"disappointed" that he did not do more. Peterson had a due diligence defence available to him,
but just barely.
The Commission also went through a similar analysis for a number of other directors, concluding
that a due diligence defence was available to several outside directors (including one member of
the Special Committee) but not another member of the Special Committee who was unable to
demonstrate active involvement in its affairs. On the second subsidiary issue raised by the
hearing several directors (including Mitchell) were also found to have no due diligence defence
It should be noted that the Commission dealt relatively leniently with YBM's Chief Financial
Officer, Gatti, by holding that he was inexperienced, acted in good faith, and was entitled to rely
upon more experienced members of management, the Special Committee, and their advisors.
In the end result, orders under section 127 were made against a number of officers and directors
of YBM, including a prohibition against acting as a director or officer of a reporting issuer for a
period of time and a significant costs award.
One of the obvious lessons from YBM is that it is not enough for a board to set up a process to
deal with a disclosure issue – that process must be carried out scrupulously from beginning to
end, on the assumption that it may be examined later. The idea of a Special Committee made
sense: it fell down in the execution. The appointment of Mitchell as chair, the failure of the
other members to participate in its work, lack of independent legal advice available to the Special
Committee, and the sloppy handling of the Report all were serious deficiencies which made it
difficult for the Board to argue that it could reasonably rely on the Committee's work.
The second lesson of YBM is that reliance on professional advisors – such as lawyers – takes a
director only so far. The hearing panel was obviously unimpressed with the quality of the legal
advice provided by YBM's counsel, Wilder, particularly on the key issue of disclosure. It was
not enough for directors to rely on his advice – they had an obligation to second-guess it and, if
necessary, to override it.
On October 1, 2003, a truck carrying an anti-depressant drug known as Wellbutrin XL ("WXL"),
which was manufactured by Biovail Corporation ("Biovail") was involved in an accident on its
way to delivering WXL to one of Biovail's significant customers, GlaxoSmithKline Inc.
("GSK"). The accident occurred at the end of the third quarter ("Q3") of Biovail's fiscal year.
28 In the matter of the Securities Act R.S.O. 1990, c.S.5 as amended and Biovail Corporation., et al
(hereinafter "Biovail") (decision released September 30, 2005)
Immediately following the accident, Biovail made a number of public disclosures stating, among
other things (collectively, the "Statements"):
That as a result of the accident, the WXL that the truck was carrying would have
to be returned to Biovail's manufacturing facility for inspection;
That Biovail would miss its projected earnings for Q3 (the "Earnings Miss");
That some of the Earnings Miss was attributable to the accident because Biovail
expected to recognise revenue from the sale of the WXL that the truck was carrying in
Q3 but would no longer be able to do so (because the WXL was being returned to Biovail
for inspection); and
That the expected revenue from the WXL involved in the accident was between
The OSC's Staff alleged that the Statements were materially misleading or untrue and that
Eugene Melynk ("Melynk"), Biovail's Chairman and CEO, authorized, permitted or acquiesced
in Biovail making the Statements. More specifically, Staff took the position that the expected
revenue from the shipments to GSK that were involved in the accident could not have been
recognized in Q3 and, therefore, it was materially misleading and contrary to the public interest
to attribute any of the Earnings Miss to the accident. Staff's allegations rested primarily on two
Biovail's contract with GSK contained a delivery term that "BIOVAIL shall
deliver all PRODUCT to GSK F.O.B., GSK's facilities in the U.S.A. (freight collect).
[Emphasis added]. Staff took the position that this delivery term meant that title to the
WXL did not transfer from Biovail to GSK until it was actually delivered to GSK's
facilities in the U.S. and, as a result, Biovail could not recognise revenue until delivery
was complete; and
Biovail's Q3 ended on September 30, 2003, and the trucks were in transit on
October 1, 2003. Because Biovail could not recognise revenue until delivery was
complete and there was no prospect of that occurring on or before September 30, 2003,
the revenue from the product that was involved in the accident could not properly be
recognized in Q3.
Therefore, Staff took the position that the accident could not have contributed to the Earnings
Miss and the Statements were materially misleading, thereby violating section 122 of the Act
and contrary to the public interest under section 127 of the Act
In respect of section 122 of the Act, the Commission determined that the Statements were
misleading but that, technically, section 122(a) only applies to materials, evidence or information
that are "submitted to the Commission". The Commission determined that the documents in
which the Statements were made were filed on SEDAR but not "submitted to the Commission"
and, therefore, Bioval and/or Melnyk had not violated section 122(a).29 Furthermore, the
statements were not "required to be filed" under Ontario securities law and hence Bioval and/or
Melnyk had not violated section 122(b).
The OSC then addressed whether it could still sanction Melnyk for acting contrary to the public
interest notwithstanding that the Statements did not contravene Ontario's securities laws (i.e.
section 122). The Commission determined that "there should be no doubt. that the Commission
is entitled to exercise its public interest jurisdiction where any inaccurate, misleading or untrue
public statement is made, whether or not that statement contravenes Ontario securities laws."
Accordingly, the Commission concluded that even if the Statements did not technically violate
section 122, the Commission could nonetheless use its "public interest" power to sanction
Melnyk for authorizing, acquiescing in or permitting the Statements if the Commission found
that the Statements were inaccurate, misleading or untrue.30
It was Melynk's position that he relied upon others at the company, particularly the Chief
Financial Officer, and was entitled to rely upon their advice. Further, Melynk claimed to be
unaware of the terms of shipment of the WXL and to have not been directly involved in the
preparation of at least some of the statements.
The Commission discussed the responsibilities of officers and directors as it relates to disclosure
and the "public interest". The Commission explained that "officers and directors have a central
29 Melynk, supra
at para 370
30 Melynk, supra
at para 383
role to play in ensuring that corporate disclosure is accurate and not misleading or untrue."
Furthermore, officers and directors with "superior qualifications" or inside directors are held to a
higher standard in ensuring that those disclosure requirements are met.
The Commission clarified that in assessing whether a director or officer has acted contrary to the
public interest, the OSC should consider whether the individual officer or director acted with
"due care and diligence." If so, the Commission "would not conclude that it is in the public
interest to issue an order against him under section 127."
Regarding Melnyk, the Commission determined that as CEO and Chairman, Melnyk (i) had
access to all information he required; (ii) was directly involved in and made decisions in respect
of the content of Biovail's public disclosures; and (iii) was responsible for final approval of the
Statements. Furthermore, the Commission found that Melnyk was a "hands on" CEO who was
directly involved in both the "conduct of Biovail's business" and its disclosure decisions.
Accordingly, he had a "heavy responsibility" to ensure that the Statements were accurate and he
could not simply rely on others to do so.
Melnyk did not provide any significant evidence of "due diligence" aside from asserting that he
relied on other senior officers who were, according to Melnyk, better informed than he was. The
Commission concluded that this did not satisfy Melnyk's onus of demonstrating "due care and
diligence." Based on that conclusion and its finding that Melynk "acquiesced, authorized or
permitted" the release of Statements that were misleading, the Commission concluded that
Melnyk acted contrary to the public interest.
The key point of this decision is that a heightened threshold for "due care and diligence" will
apply to an officer or director who (i) is involved in the company's business and disclosure
decisions; (ii) bears responsibility for disclosure decisions; and/or (iii) has access to the
information required to confirm whether a statement is accurate. This threshold will not be met
by asserting reliance on others.
In considering the conduct of an officer and director under section 127 of the Act
, the OSC does
not apply the legal standard of due care and diligence that might apply, for example, in a civil
claim under the Ontario Business Corporations Act
. In YBM
, the panel applied a "prudent
person" test with objective and subjective elements. This may well be different from the
objective test recently formulated by the Supreme Court of Canada in People's Department
Stores Inc. v. Wise
31. The jury is still out as to whether as a practical matter the Commission
applies a higher standard than the courts. Many observers felt that the YBM
particularly Peterson, were held to too low a standard, given the circumstances of that case. It
remains to be seen whether the Commission will apply these principles on a consistent basis in
31 2004 S.C.C. 68
Senate Hearing Thank you for your time in reading this letter, as well as for your aspirational guidance in the matter at hand. My formal studies as an undergraduate, Graduate and PhD have focused on cannabis, cannabinoids and their impact on health. My education, and through a decade of experience presenting at conferences and interacting with other medical professionals on this particular subject matter, have given me a wealth of knowledge. I've been blessed and honored to have been surrounded by great scientific minds in the field of cannabinoid research. As such I have the honor of occasionally standing on those same shoulders to report their findings. In doing so, it is my personal hope that I might be able to confer some greater understanding of a misunderstood subject, to individuals like you who might make a real difference in the lives of severely ill residents. The way that humans tend to externally stimulate their endocannabinoid systems is by taking (or applying) compounds produced by the Cannabis plant. First, unlike most other drugs and even a substance like water, these naturally-occurring phytocannabinoid compounds have no achievable lethal dose. They are amongst the safest compounds known to science. They are amongst the least physically addictive substances known. For the State of Pennsylvania and it's esteemed legislators – A quick pharmacology lesson:
i e A d d ho ho N A.Prof. Wei Liu (刘威) Dept. of Electronics and Information Eng. Huazhong University of Science and Technology r ng i n i A d hoc ne