By Fiona Lee
Introduction
The statutory civil liability regime in the Securities Act, RSO 1990, c S 5 (“Act”) gave investors a statutory cause of action for misrepresentations made in the secondary market for the first time. In addition to remedying investors, the regime was also designed to be a powerful deterrence tool to prevent issuers from making misrepresentations.
Materiality is a crucial part of the misrepresentation analysis, as it will determine whether legal liability for the alleged misrepresentation will attach. Two tests for assessing materiality - the reasonable investor and the market impact tests - have emerged, confusing issuers, investors and litigants.
At the same time, ESG-related disclosures have exploded in quantity (but not necessarily quality) due to increased demand from investors. This paper will explore the two tests and argue that the distinction between the two tests is most acutely revealed when evaluating ESG-related claims. This paper will argue that the reasonable investor test is better suited to capture materiality when it comes to ESG-claims.
Overview of the statutory civil liability regime
Once an issuer has sold securities in the primary market (directly from the issuer to the investor), investors will sell securities to other investors in the secondary market with no involvement by the issuer.1
An issuer must abide by its continuous disclosure requirements while its shares are traded on the secondary market. Continuous disclosure obligations can be categorized into two broad categories: periodic disclosure and timely disclosure. Under its periodic disclosure obligations, an issuer must make regular disclosures.2 Under its timely disclosure obligations, an issuer must promptly disclose when a material change has occurred in its affairs.3
Stirred to action by serious corporate scandals in the United States,4 the Ontario legislature introduced Bill 198 “An Act to implement budget measures and other initiatives of the Government”, which then amended the Act.5 For the first time, a statutory civil liability regime (the “regime”) was created for misrepresentations in continuous disclosure documents in the secondary market. Following Ontario, other provinces and territories implemented substantially similar provisions.6 Prior to 2005 and before the amendments, only investors in the primary market had a statutory cause of action for misrepresentation claims.
The extension of the statutory cause of action to secondary market investors was significant because traditional common law causes of action did not adequately provide recourse for investors in the secondary market. For example, the tort of negligent misrepresentation would require that investors establish a duty of care and reliance on the misrepresentation, which was very difficult for investors in the secondary market to do. Therefore, many investors who suffered harm in the secondary market did not have access to meaningful remedies.7 In comparison, investors need not establish a duty of care in the statutory civil liability regime and reliance is irrelevant.
Purposes of the Act
The purposes of the Act are (1) to provide protection to investors from unfair, improper or fraudulent practices, (2) to foster fair, efficient and competitive capital markets and confidence in capital markets, (3) to foster capital formation; and (4) to contribute to the stability of the financial system and the reduction of systemic risk.8
Proper disclosure protects investors and fosters fair and efficient capital markets as investors target the most deserving securities and securities are adequately priced. As investors realize that they have necessary information, they grow more confident and consequently, increasingly participate in the capital markets.9
Disclosure also has a corporate governance role. Proper disclosure enhances the accountability of corporate management, encourages more efficient management and discourages fraud.10 In a November 2000 report regarding the statutory civil liability regime, the Canadian Securities Administrators (“CSA”) wrote that the policy basis for the liability limits of the regime was that the primary purpose of the legislation was to provide an “effective deterrent to misrepresentations and failures to make timely disclosure.” Compensation for investor damages was only a secondary objective. Therefore, the regime “may be seen as intended to function as an incentive to investors to act as private enforcers of the public securities disclosure law regime.”11
Elements of statutory civil liability
The regime can be found in Part XXIII.1 of the Act. Section 138.3(1) establishes liability for secondary market disclosure for an issuer or a person who releases a document that contains a misrepresentation. Without regard for whether the person or company has relied on the misrepresentation, the person or company who acquires or disposes of the issuer’s security during the period of time when the document was released and when the misrepresentation is publicly corrected has a right of damages against, among others, the responsible issuer.12
Misrepresentation is defined in the Act as (a) an untrue statement of material fact or (b) an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in the light of the circumstances in which it was made.
Material fact is defined in the Act as a fact that would reasonably be expected to have a significant effect on the market price or value of the securities.13
Actions under the regime must receive leave of the court, granted only when the court is satisfied that (a) the action is brought in good faith and (b) there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.14
On an examination of data between 2005 and 2015, Osgoode Canadian Securities Class Actions found that 81% of actions were commenced by retail investors alone, 8% were commenced by both institutional and retail investors, and 11% were commenced by institutional investors alone.15
The line between facts that must be disclosed and facts that need not be disclosed is drawn by materiality. Issuers must only disclose material information. Since liability will only attach to the disclosure of untrue material information, or the omission of material information, materiality is a significant and often litigated element of the misrepresentation claim. Issuers will argue that the alleged fact is not material, and plaintiffs will argue that it is material. Materiality defines the scope of liability, and “defines specific legal obligations.”16
When assessing materiality, Canadian courts have used two different tests, the reasonable investor and the market impact test. This has led to some amount of confusion for litigants, investors and issuers. In reviewing the case law that has applied the two tests, I will argue that in many cases, the two tests can be used interchangeably because what is material under one test will often also be material under the other. However, the distinction between the two tests is made clear when it is applied to ESG claims.
Environmental, Social, Governance
ESG considerations involve how an issuer safeguards the environment, including policies around climate change (environment), how an issuer manages relationships with employers, suppliers, customers, and communities (social), and policies of an issuer as it relates to the issuer’s leadership, executive pay, and internal controls (governance).17
Like all other disclosures, issuers must disclose material ESG facts. ESG-related disclosures are common-place. 92% of issuers studied by the CSA disclosed climate-related risks in their continuous disclosure filings, although on average only 59% of the disclosed risks were relevant, detailed and entity specific, while remaining risks were either boilerplate, vague or incomplete.18
Increasing ESG disclosures increases the possibility of ESG-related misrepresentation claims. Such disclosures will increase in the future for the following reasons. First, investors increasingly demand ESG-related disclosures from companies. Second, in response to that demand, there are regulatory and legislative changes that will mandate the disclosure of ESG-related information. [Paragraphs describing investor demand for ESG-related information and regulatory and legislative changes have been omitted.]
Two Tests for Materiality
In this part of the paper, I will explore the two tests for materiality and explore some of the confusion surrounding the use of the two tests.
Under both tests, the materiality analysis is fact-specific and contextual, and issuers do not have the benefit of hindsight. Actual market price impact is corroborative, but not determinative.19
Market impact test
Material fact is defined in the Act as a fact that would reasonably be expected to have a significant effect on the market price or value of the securities. This formulation of the materiality test, called the market impact test, asks whether a fact would be reasonably expected to have a significant effect on the price or value of the security. The market impact test, as the Ontario Superior Court has once held, is “built into” the definition of a material fact.20
To support a finding of materiality, plaintiffs often present expert evidence in the form of “event studies”. An event study is an analysis that uses statistical methods to determine the impact of an alleged catalyst on the value of a security.21 The event study aims to isolate the alleged catalyst from other noise that might also be impacting the security.
Since the materiality analysis is a contextual exercise without the benefit of hindsight, some critics of the market impact test state that the test may allow issuers to take “too formulaic” an approach in determining what is material.22
While the market impact test is referenced in the material fact definition of the Act, the reasonable investor test is referenced in other sections of the Act. The definition of material change for investment fund issuers reads: “a change in the business, operations, or affairs of the issuer that would be considered important by a reasonable investor in determining whether to purchase or continue to hold securities of the issuer [emphasis added].”
According to renowned academic Ruth Sullivan, a statutory presumption is that if the legislature had intended for the reasonable investor to apply to the material fact definition, it would have used those words, like it did in other provisions of the same Act.23
In 2006, the then Minister of Finance commissioned the Five-Year Committee (“Committee”) to review the Act and make recommendations. In its report, famously called the Crawford Report, the Committee recommended the reasonable investor test be adopted. In support of its recommendation, the Committee stated that the standard should be harmonized with the reasonable investor standard used in the U.S.24 Despite implementing many of the recommendations of the Committee, the Ontario legislature did not amend the material fact definition.25
Reasonable investor test
Despite the clear language of and legislative intent behind the material fact definition, the reasonable investor test is regularly used by Canadian courts in statutory civil liability claims.
The reasonable investor test was taken from TSC Industries, Inc. v Northway, Inc.,26 a Supreme Court of the United States case that interpreted materiality. The Supreme Court of Canada in Sharbern Holding imported the reasonable investor test in the U.S. into Canada.
Sharbern Holding was a case about whether a developer of hotel strata lots in Vancouver was liable for misrepresentation under the B.C. Real Estate Act. Section 75 of the Real Estate Act established liability for material false statements made in a disclosure statement. Unlike the Securities Act, the Real Estate Act did not define materiality and so the Court turned to TSC Industries to apply the reasonable investor test.
According to the reasonable investor test, a fact becomes material when there is a “substantial likelihood” that an omitted fact “would” be considered important.27 The plaintiff is not required to prove that the omitted fact would have caused the reasonable investor to change their vote.28 There must be proof of a substantial likelihood that the omitted fact would have assumed actual significance in the deliberations of a reasonable shareholder.29 Finally, the importance of an omitted fact must be considered in the light of whether it would be viewed by a reasonable investor as having “significantly altered the ‘total mix’ of information made available.”30
The party alleging materiality must provide evidence unless common sense inferences are sufficient.31
In summary, the market impact test asks whether a fact is reasonably expected to have a significant impact on the market value or price of the security. The reasonable investor test asks whether a fact would be viewed by a reasonable investor as having significantly altered the “total mix” of information made available.
Confusion in the case law
Following Sharbern Holding, the reasonable investor test found itself established within the statutory civil liability regime, despite the existence of the statutory market impact test.32 For instance, the Proposed Instrument regarding climate change disclosure references the reasonable investor standard when determining materiality for climate change related disclosures.33 In recent cases, Canadian courts have “oscillated” between the two different tests for materiality, causing confusion to litigants, investors, and issuers.34
Law firms have voiced their concerns with the use of two tests for materiality. In one comment letter to the CSA regarding the Proposed Instrument, a law firm wrote “we wish to note our concerns with what appears to be a shifting standard for materiality under Canadian securities law.” The firm also notes that “while the two tests may appear to be substantially similar, in our view, a reasonable investor test represents a markedly lower standard than a market impact test.” Comment letters to the Crawford Report also noted the existence of the two tests and advocated for setting the standard as one or the other to reduce uncertainty and confusion.35
Courts have used the two tests interchangeably. However, the reasonable investor test and market impact test was distinguished in Cornish. In Cornish, the Divisional Court held that the reasonable investor test set a lower threshold than the market impact test.36 The concern with using the reasonable investor test was that it could “broaden the definition of materiality to matters that are important to an investor in making investment decisions, but that would not reasonably be expected to have a significant impact on the market.”37
The court cited Securities Law and Practice, 2nd ed.:
The effect of focusing on price or value of the securities as the appropriate test may be to exclude, as material changes, matters that may influence, and may therefore be material to, an investor in making decisions but do not have the probable effect of significantly altering market price or value of any securities of the issuer.38
Similarly, in Biovail, it was held that
“If a statement would reasonably be expected to have a significant effect on the market price, then that statement would clearly be important to an investor in making an investment decision … but it does not necessarily follow that a statement that is important to an investor in making an investment decision would reasonably be expected to have a significant effect on the market price or value of a security.”39
In summary, the market impact standard delineates between material and non-material information depending on whether it is reasonably expected to have economic impact. In comparison, a reasonable investor may care about things that either don’t reach the threshold of reasonable expectation of a significant market impact or would not have a market impact.
Importantly, at least one Canadian decision seems to contemplate that a reasonable investor considers more information than purely economic information when making investment decisions.40
In decisions made by the Ontario Securities Commission, the market impact test has been consistently applied.41 Earlier cases from the Ontario Superior Court used the market impact test as the standard for materiality. In Ironworkers Ontario Pension Fund (Trustee of) v Manulife Financial Corp,42 Belobaba J. wrote that
“information is material on a “move the market” or “market impact” standard. The market impact materiality standard is built into the definition of both “material fact” and “material change”… Information that is not material on the market impact standard does not have to be disclosed and cannot give rise to statutory civil liability.”43
Despite this, in the Ontario Superior Court decision of Wong v Pretium Resources,44 the case that eventually became the first-ever to be heard on its merits under a statutory civil liability claim, Belobaba J. applied the reasonable investor test. Belobaba J. first began his analysis with the market impact test, then wrote that:
“the Supreme Court in Sharbern Holding added the following to our understanding of materiality… [emphasis added].”45
Despite stating in Ironworkers that liability is limited to information that would meet the “move the market” standard, Belobaba J. wrote in Pretium Resources that the reasonable investor standard in Sharbern Holding would “add to our understanding of materiality.” This can be confusing since the standards are different - the reasonable investor standard states that if there is a substantial likelihood a reasonable investor would consider the information important in making an investment decision, it is material. In Cornish, the court accepted that information a reasonable investor may consider important in making an investment decision may include more information than those that would be reasonably expected to have a substantial impact on the market price and value of the securities.46
Looking at the words alone, the tests may also differ in terms of degree and scale. The market impact test may set a higher standard because information that would be reasonably expected to have a substantial impact on the market price and value requires that enough investors in the market actually act on their investment decision to cause a substantial impact on the price and value. In comparison, the reasonable investor test only asks whether the investor would consider the information important. There is no need for the reasonable investor to act on the decision.
The statutory language of the Act draws the border of legal obligations as any information that will meet the “move the market” standard, and any information that does not fit within those borders will not give rise to statutory civil liability. Since there is possible liability, where the border is drawn exactly is important for litigants, issuers and investors to know.
Since there is confusion around which test is the applicable test, litigants will expend resources on advocating for the test that works better for them. For example, the plaintiff in Miller advocated for the reasonable investor test instead of the narrower market impact test, while the defendant advocated for the opposite.47 The state of confusion regarding the correct test turns the materiality analysis into a two-step test, where the question of which test is the correct one must be answered before the materiality analysis can begin.
In Miller, the Ontario Superior Court attempted to settle the confusion between the two tests by declaring that the market impact test was correct. Miller was the first case to explicitly recognize the existence of the tests and the conflict between them.48
In Miller, Morgan J. wrote that the fact that Form 51-102F1 (the form outlining what the contents of a company’s MD&A should be) used the reasonable investor reflected that the reasonable investor might be investing or divesting because of a “broad array of concerns - economic, ethical, environmental, political, religious, etc.”49
Further, Morgan J. wrote that the language of the material fact definition was a “policy choice” that limited actionable statements to misrepresentations that “strike at the one interest which can generally be counted on - i.e. the interest of an investor in a financial return.”50 Morgan J. held that the market impact test was the correct test to be applied.
Despite Miller, several court decisions since then have applied the reasonable investor test. This includes the Ontario Court of Appeal 2021 decision of Wong v Pretium Resources. In a footnote, van Rensberg J. acknowledged the existence of the two tests but wrote that the reasonable investor standard would be used in this case because both parties had agreed to it and the analysis would not change regardless of which test was used.51
While the use of the two tests have caused confusion, I will argue that the use of the reasonable investor language is not contrary to the statutory market impact test. However, the area where the choice between two tests is most crucial is in ESG-related misrepresentation claims.
Two ways to get to the same conclusion
Cornish was the decision that described the differences between the two tests. In Cornish, the appellant claimed that the Ontario Securities Commission had erred by applying the reasonable investor test instead of the statutory market impact test.52 While the Commission had made several references to the reasonable investor, the court determined that the Commission had not made an error because it did not rely on factors that, while possibly important to investors, could not reasonably be expected to affect the market.53
The court wrote:
“there is nothing objectionable to the foregoing references to the reasonable investor or shareholder. They simply reflect the reality that the market impact test subsumes the perspective of the reasonable investor. That is, the determination of whether the disclosure of information would reasonably be expected to have a significant effect on the market price or value of a security turns on whether or not it can be reasonably expected to affect the investment decisions of reasonable investors or shareholders [emphasis added].”54
Therefore, the court in Cornish seems to contemplate the reasonable investor test in two ways. In one way, as described in the above paragraph, the court contemplates the reasonable investor test as a part of the market impact test. That is, the market is made up of reasonable investors, so if a reasonable investor finds something important, the market will also be impacted. Or, the reasonable investor would consider information that would impact the market to be important. This formulation of the reasonable investor test will limit materiality to matters that would move the market.
In this case, references to the reasonable investor would not be in error since it would meet the market impact standard. If the references to the reasonable investor were made in terms of information that would be reasonably expected to substantially move the market, using the language of the reasonable investor test is permissible. While the use of the reasonable investor language has caused much confusion, this understanding of the reasonable investor is aligned with the statutory market impact test. The use of the reasonable investor is used as a tool to apply the market impact test, or, as Cornish put it, a “perspective” from which the court can better assess materiality under the market impact test.55 As s. 4.1 of National Policy 51-201 - Disclosure Standards states, “despite these differences, the two materiality standards are likely to converge, for practical purposes, in most cases.”56
This understanding of the test limits the reasonable investor to someone who cares only about information that would substantially impact the economic value of their securities. In addition, this understanding of the test requires that it is expected that investors “react negatively” to the information.57 Unlike the reasonable investor test formulation of Sharbern Holding, it is not enough that the information merely “alter[s] the total mix of information.”58
In the second way, the court accepts that the reasonable investor may have considerations that are important to them in making an investment decision, but this would not move the market. For instance, Biovail and Cornish both described the reasonable investor test as “broader” than the market impact test.59 Miller contemplated that the reasonable investor can be investing for a variety of reasons, including ethical, social and political reasons.60
The second formulation of the test, which contemplates the reasonable investor as someone who may consider information in making their investment decisions that would not be reasonably expected to move the market, is different from the market impact test. This formulation of the test is important to a discussion on ESG-related misrepresentation claims.
ESG-claims and materiality
As an example, consider a Canadian issuer who has traditionally had manufacturing factories in Canada. As part of cost-cutting initiatives, the issuer moves its manufacturing facilities to another country, one with less stringent labor protections and laws. As a result, laborers in that country working for the Canadian issuer work under difficult conditions (but not illegal conditions). In its public disclosure documents, the issuer states that it treats all its employees with respect.
When news breaks of the difficult conditions outside of Canada suffered by the employees along with other information, shareholders bring an action under the statutory civil liability regime, claiming that they have suffered losses based on misrepresentation by omission in the public disclosures. The issuer claims that the drop in share price is better attributed to other factors, and not the information about labor conditions.
Under the market impact test, it is possible that the omitted information (labor conditions) would not meet the threshold. Given that the move out of the country was part of cost-cutting initiatives, it may not be reasonably expected that the market price or value would be substantially impacted negatively (causing damage to investors). Therefore, the issuer would have no obligation to disclose this information.
Under the reasonable investor test, the investors could argue that it is substantially likely that the reasonable investor would consider this information important in making their investment decision because the reasonable investor does not want to invest in companies whose employees are treated poorly. The reasonable investor may also be concerned about the potential (but possibly remote) risk of litigation or reputational risk. Under the reasonable investor test, the issuer may have an obligation to disclose the information.
In the next section, I will argue that more ESG-related claims may meet the reasonable investor standard than the market impact standard. In doing so, I will discuss the characteristics of ESG claims that make it difficult for them to meet the market impact standard.
Characteristics of ESG claims
The Initiative for Responsible Investment at the Hauser Center for Nonprofit Organizations at Harvard University states the following characteristics of ESG issues.
First, they tend to be qualitative and not readily quantifiable in monetary terms. Second, they relate to externalities not well captured by current market mechanisms. Third, they relate to wider elements of the supply chain. Fourth, they have a medium- to long-term horizon. Finally, they are increasingly the subject of policy and debate by legislators and regulatory agencies.61
These characteristics of ESG claims make it difficult for materiality to be established under the market impact test. Cornish has warned against the use of actual market impact evidence to support materiality under the market impact test when the information is disclosed with other information, since the market reaction to the combined disclosure may not be a reliable indicator of market impact of the disclosure.62
Therefore, courts have rejected evidence of actual market price drops where there is other information that could have contributed to the drop (noise).63 Given that ESG issues tend to have impact in the medium- or long-term, it is possible that there is so much noise in the interim that courts will find it difficult to link the alleged price drop to the ESG issue.
Secondly, ESG claims are qualitative than quantitative in nature and relate to externalities not well captured by current market mechanisms. Therefore, the nature of ESG claims makes it difficult for a more quantitative test like the market impact test to support a finding of materiality. For example, ESG claims may carry real reputational risk or the risk of litigation or regulatory proceedings. However, these risks may not translate into a reasonably foreseeable likelihood of a significant impact on the market price or value of the shares.
There can be two arguments in support of the market impact test as the correct standard for ESG claims.
First, it can be argued that ESG claims do lead to real economic impact. For example, Mark Carney, former governor of the Bank of England, has defined liability risk as “the impact that could arise tomorrow if parties who have suffered loss or damage from the effects of climate change seek compensation from those they hold responsible. Such claims could come decades in the future, but they have the potential to hit carbon extractors and emitters - and, if they have liability insurers - the hardest.” Larry Fink wrote in his 2019 letter to CEOs that “climate risk is investment risk.”64
Therefore, it can be argued that ESG issues can lead to real economic impact. However, such risks are sometimes too far off (“could come decades in the future”) and speculative to perhaps meet the market impact test. ESG issues also include issues that investors just care about, which the market impact test would not consider material in and of itself.65
Second, the language of the market impact test may contemplate the consideration of information that is not limited to potential economic impact. The market impact test considers information material if it would be reasonably expected to have a significant effect on the market price and value of a security. The separation of price from value in the language may indicate that a security has value beyond or outside of its price. This argument has been made at least once before, by the Commission in Cornish, when it wrote:
“One must also consider whether particular information would reasonably be expected to have a significant effect on the ‘value’ of securities even if that disclosure would not, for some reason, be expected to affect the market price of securities.”66
While it is an interesting argument, the market impact test is generally understood to be limited to economic impact. It is also difficult to define what the intrinsic “value” of a security would be, outside of its price and without a perspective to value it from. It is instead preferable to discuss what a reasonable investor would consider important in valuing the security.
Therefore, while there are tailwinds from regulators and investors leading to the disclosure of more ESG-related information, the current statutory test for materiality is at odds with the increased disclosure. Put a different way, the market impact test determining materiality (and therefore the scope of legal liability) can deem information immaterial when reasonable investors would deem it material. Issuers are then able to omit information or state untrue information to the detriment of investors.
Reasonable investor test
The reasonable investor test is better suited to evaluate ESG-related misrepresentation claims for the following reasons. First, the test can take into account the attributes and qualities of the reasonable investor. Second, the conception of a reasonable investor can evolve with evidence of changing standards of materiality. Third, the reasonable investor can have certain expectations.
First, who the reasonable investor is, the attributes and qualities of the reasonable investor, is important because it will determine whether something is important to that investor, and therefore, whether liability will attach to the omission or misstatement of it.
For example, an argument has been made that the reasonable investor can be analogized to the reasonable person as defined in tort law. In tort law, the reasonable person is “a hypothetical person used as a legal standard, especially to determine whether someone acted with negligence: specif., a person who exercises the degree of attention, knowledge, intelligence, and judgment that society requires of its members for the protection of their own and others’ interests.”67 If the reasonable person in tort law pays attention to the consequences of their decision and recognizes the likely effect on others and understands how society expects and exercises judgment, the reasonable investor, by analogy, could act according to similar principles.68
Such an argument is debatable since the reasonable person in tort law was developed according to negligence law and according to different principles. However, such arguments highlight the fact that how “reasonableness” is understood can sometimes be a policy choice.
Interestingly in Canada, as described above, some decisions have contemplated the reasonable investor to be concerned with more things than information that may have a significant impact on the security’s price or value (economic impact). Since there is empirical evidence that investors increasingly demand ESG information, there can be an argument that the reasonable investor cares about ESG issues and that they are material. This is the argument made by some scholars.69
Second and related to the first argument, it can be argued that the reasonable investor standard may evolve over time as investors evolve over time. It allows for the possibility that empirical evidence of changing investor preferences can lead us to change our understanding of the reasonable investor. Therefore, the increasing demand for ESG information by investors can ground a finding of materiality in ESG claims under the reasonable investor test, because it can be shown that investors do consider the information important when making an investment decision.
Finally, in Paniccia, the reasonable investor was described to have certain expectations of its issuer.70 Paniccia was a decision under the statutory civil liability regime, where the plaintiff brought a class action for multiple misrepresentations, including the failure to disclose the issuance of a subpoena by the SEC requiring the issuer to produce information relating to the company’s expense and accounting practices.71
There, the court stated that the reasonable investor would expect that the company would respond to the subpoena, cooperate with the investigator, and conduct an internal investigation.72 Since this was done, there was no misrepresentation. The principle distilled from this reasoning may be that the reasonable investor can have certain expectations about how an issuer will behave. Following this principle, an argument may be made that the reasonable investor would reasonably expect that an issuer be in accordance with certain reporting obligations (like the Proposed Instrument) and not make misleading statements as part of those reporting obligations. Therefore, the reasonable investor test may have certain expectations, and once those expectations are not met, conduct falling under those standards can be material to the reasonable investor.
One potential challenge to the reasonable investor test is the argument that assuming efficient securities markets, if reasonable investors genuinely care about ESG issues, then the information should have a market impact. That is, if the ESG disclosure do not affect the demand for an issuers’ securities, it would suggest that reasonable investors do not actually find the information important.
However, courts have accepted that reasonable investors can care about information that may not necessarily move the market.
In addition, actual market impact (or lack thereof) is not determinative of the materiality analysis. For example, in Gowanlock v Auxly Cannabis Group,73 Morgan J. held that the lack of adverse market response was because the negative information was obscured by overwhelmingly positive pieces of information. The market could not absorb the information because it did not notice it.74 Therefore, lack of market impact did not determine materiality.75 The court cannot reason backwards from a share price drop (or lack thereof) to infer materiality. Specific to ESG claims, as argued above, market efficiency is not a perfect proxy for materiality.
If the purpose of the Act is investor protection and protecting the efficiency of the capital markets, the statutory civil liability regime must be given the flexibility to find materiality in ESG claims, considering the unique characteristics of those claims. Otherwise, investors will not be able to rely on such information when making their investment decisions and will be trading on incomplete information. This will impact the efficiency of the capital markets.76
While any kind of increased disclosure may lead to an increase in costs, the underlying premise of the statutory civil liability regime remains the same. If an issuer wishes to make itself more attractive to investors who care about ESG issues, it must not make misleading or false statements in its disclosures causing harm to investors.
Finally, the Proposed Instrument’s definition of materiality uses the reasonable investor test.77 Using the reasonable investor test in misrepresentation claims would be consistent with how issuers must disclose information under the Proposed Instrument.
It is important to note that the market impact test is the statutory test. As noted by some commentators, any shift from that standard would be “fundamental” and would “require an extensive consultation process.78 The solution is therefore that the legislature amend the statutory standard to be the reasonable investor test, at least in terms of ESG-related misrepresentation claims, acknowledging the unique features of ESG claims.
Any expansion of materiality must also not disregard administrative costs on issuers. Complying with disclosure standards can be extremely costly in terms of lawyers’ fees and other costs. However, in terms of climate-related disclosures, some issuers already abide by international climate disclosure standards.79
Conclusion
In conclusion, the reasonable investor test allows for a more flexible and nuanced analysis of whether a particular ESG claim is material to investors. It aligns with the growing trend of investors prioritizing ESG issues in their investment decisions and issuers including more ESG issues in their disclosures.
In combination with increasing voluntary and mandated ESG disclosures, the statutory civil liability regime should live up to the task of protecting investors and ensure that investors can have confidence that what they read is not false or misleading. The test for materiality should align with actual expectations and demands of investors.
Endnotes
1 David Johnston, Kathleen Rockwell & Christie Ford, “Canadian Securities Regulation”, 5
th ed (Toronto: LexisNexis, 2014) at para [Canadian Securities Regulation].
2 “
Continuous disclosure” (last visited 24 April 2023), online: “Ontario Securities Commission”; periodic disclosure documents include annual and interim financial statements and annual information forms.
3 Canadian Securities Regulation,
supra note 1.
4 The corporate accounting scandal of Enron was the “driving force” behind the “Sarbanes Oxley” legislation. See Howard Rockness & Joanne Rockness, “Legislated Ethics: From Enron to Sarbanes-Oxley, the Impact on Corporate America” (2005) 57:1 Journal of Business Ethics 31.
6 All provinces drafted substantially similar provisions. See e.g.
British Columbia Securities Act, RSBC 1996 c 418, Part 16,
Securities Act (Alberta), RSA 2000 cS-4, Part 17.01.
7 Joseph Groia & Pamela Hardie, “Securities Litigation and Enforcement”, 2
nd ed (Toronto: Thomson Reuters, 2012) at p. 352.
8 Securities Act, RSO 1990, c S.5, s 1(1) [Act].
9 Theratechnologies inc v 121851 Canada Inc, 2015 SCC 18 at para 26 [Theratechnologies].
10 Ibid at para 26, “Canadian Securities Regulation”,
supra note 1, Steve Lydenberg, “On Materiality and Sustainability: The Value of Disclosure in the Capital Markets”, Initiative for Responsible Investment Hauser Center for Nonprofit Organizations at Harvard University, (September 2012) [On Materiality].
11 H. Garfield Emerson & Geoff A Clarke, “Bill 198 and
Ontario’s Securities Act: Giving Investors and the OSC Added Muscle” (presented at the 3
rd Annual Directors’ Governance Summit, 17-19 Nov 2003) [unpublished].
12 Only misrepresentations in a non-core document requires that the plaintiff prove that the person or company had knowledge that the document contained the misrepresentation. See
Act,
supra note 7, s 138.4(1).
13 For misrepresentations in a document that is not a core document or misrepresentations in a public oral statement, the plaintiff must prove that the person or company knew that the document or public oral statement contained the misrepresentation, deliberately avoided acquiring knowledge of the misrepresentation, or was guilty of gross misconduct in connection with the release of the misrepresentation. Core documents are defined in the Act as, among others, a prospectus, a take-over bid circular, issuer bid circular, management’s discussion and analysis, annual information forms, and annual financial statements.
14 Act,
supra note 7,s. 138.8(1).
15 “
Key Findings” (last visited 24 April 2023), online: Osgoode Canadian Securities Class Actions.
16 Ruth Jebe, “The Convergence of Financial and ESG Materiality: Taking Sustainability Mainstream” (2019) 56:3 American Business Law Journal 645 at p. 647.
18 Consultation Climate-Related Disclosure Update and CSA Notice and Request for Comment Proposed National Instrument 51-107 – “Disclosure of Climate-Related Matters” at p. 4 [CSA Notice].
19 Cornish v Ontario Securities Commission, 2013 ONSC 1310 at para 56 [Cornish].
20 Ironworkers Ontario Pension Fund (Trustee of) v Manulife Financial Corp, 2013 ONSC 4083 at footnote 28.
23 Ruth Sullivan, “Statutory Interpretation in a New Nutshell” (2003) 82 R du B can 51 at 60 [Sullivan 2003]
24 “Five Year Review Committee Final Report – Reviewing the
Securities Act (Ontario)” (Toronto: Queen’s Printer, 2003) at 149 [Crawford Report].
25 Standing Committee on Finance and Economic Affairs, “Report on the Five Year Review of the
Securities Act”, 1
st Session, 38
th Parliament, 53 Elizabeth II.
26 TSC Industries, Inc. v Northway, Inc, 426 US 438 (1976) [TSC Industries].
27 Sharbern Holdings v Vancouver Airport Centre, 2011 SCC 23para 49 [Sharbern Holding].
32 While the Act references the market impact test, Form 51-102F1, the form for Management Discussion and Analysis, and Form 51-102F2, the form for Annual Information Forms, references the reasonable investor test for assessing materiality.
33 CSA Notice,
supra note 19.
34 Carlo Di Carlo & Spencer Bass, “A Tale of Two Tests; The Test for Materiality Under S. 138.3 of the
Ontario Securities Act” (2022) 53 Adv Q 32 [A Tale of Two Tests].
36 Cornish,
supra note 43 para 75.
38 V. Aloini, “Securities Law and Practice”, 2
nd ed. (Toronto: Carswell, 1984) at p. 18-14.
39 Biovail Corp., Re, 2010 ONSEC 21 at para 73 [Biovail].
40 Miller v FSD Pharma, 2020 ONSC 4054 at para 62 [Miller]. It can be noted that this formulation of the reasonable investor differs from how U.S. courts have traditionally contemplated the reasonable investor. In the U.S., the reasonable investor is generally understood to be an economic being that is “presumed to operate rationally to maximize returns in the marketplace.” See Tom C. W. Lin, “Reasonable Investor(s)” (2015) 95 Boston University Law Review 461 at p. 467.
41 “The Tale of Two Tests”,
supra note 56 at p. 37.
44 Wong v Pretium Resources, 2017 ONSC 3361.
46 Cornish,
supra note 43.
47 Miller,
supra note 62 at paras 66-67.
48 The Tale of Two Tests,
supra note 56 at p. 42.
49 Miller,
supra note 62 at para 62.
51 Wong v Pretium Resources, 2022 ONCA 549.
52 Cornish,
supra note 43 at para 23.
56 National Policy 51-201 – Disclosure Standards at s 4.1.
57 Cornish,
supra note 43at para 77.
58 TSC Industries,
supra note 50.
59 Biovail,
supra note 62 at para 73, Cornish,
supra note 43 para 75.
60 Miller,
supra note 62 at para 62.
61 On Materiality,
supra note 11 at p. 37.
62 Cornish,
supra note 43 at para 59.
64 2019 Letter,
supra note 21.
65 Michal Barzuza, Quinn Curtis & David H Webber, “The Millennial Corporation” (2021) Working Paper.
66 Cornish,
supra note 43 at para 69.
67 On Materiality,
supra note 11 at p. 13.
69 The New “Reasonable Investor”,
supra note 25.
70 Panccia v MDC Partners, 2018 ONSC 3470 at para 115.
75 Relatedly, courts have also held that a fact was
not material despite actual market impact. For example, in “Pretium Resources”, despite what was described by the appellant as a “precipitous” share price drop, the court did not find materiality because the appellant did not explicitly tie the drop to the alleged misrepresentation. See e.g. “Pretium Resources”,
supra note 52.
76 Critics of ESG disclosures argue that the proposal will open the floodgates to politically motivated securities lawsuits that do not ultimately serve investors’ interests and would impose burdensome disclosure and litigation costs on issuers. While these concerns are legitimate, the reasonable investor test has been applied in the context of U.S. securities laws for years. It is an objective standard, based on what a reasonable investor would consider important in making an investment decision.
77 CSA Notice,
supra note 19.
78 Robin Upshall, Sarah Powell & Zachery Silver, Davies Ward Phillips & Vineberg LLP, “Climate-related Disclosure Update and CSA Notice and Request for Comment – Proposed National Instrument 51-107 Disclosure of Climate-related Matters” Comment Letter, (16 Feb 2022).