ONCA considers the “reasonable investigation” defence in securities class actions

In Rahimi v SouthGobi Resources Ltd., 2015 ONSC 5948, the Superior Court granted leave to the Plaintiff pursuant to s. 138.8 of the Ontario Securities Act to commence an action for misrepresentation against the Defendant corporation, SouthGobi Resources Ltd., but not against certain of its officers and directors.

The Plaintiff appealed the motion judge’s decision, while SouthGobi brought a separate appeal with respect to the decision to allow the claim against it to proceed. The Court of Appeal granted the Plaintiff’s appeal and dismissed SouthGobi’s appeal. In granting the Plaintiff’s appeal, the Court of Appeal noted that SouthGobi and the Defendant officers and directors took a “very unusual position” on the leave motion. In this case, SouthGobi had published a restatement wherein it acknowledged that its previously issued financial statements “were no longer accurate and should not be relied upon.” On the motion, the Defendants advanced a due diligence defence under section 138.4(6) of the Securities Act known as the “reasonable investigation” defence, and in support of that defence, argued that the financial statements did not, in fact, need to be restated. The Defendants claimed that SouthGobi had been forced to make these announcements due to certain external pressures placed on the company that had not been publicly disclosed, including from the U.S. Securities and Exchange Commission.The motion judge accepted this argument and found that the Plaintiff had no reasonable prospects of success against the company’s officers and directors since they would be able to make out the reasonable investigation defence. On the basis of affidavits filed by the officers and directors of the company, the motion judge concluded that they had diligently reviewed the relevant accounting issues and reasonably relied on the findings of the company’s auditors at the time the financial statements had been released, thereby making out the defence.

The Court of Appeal strongly disagreed with the motion judge’s decision to refuse leave to proceed against the officers and directors, and found that there were numerous reasons why they could not establish the reasonable investigation defence at the leave stage. The Court of Appeal’s reasons focused on the inconsistency between, on the one hand, the language in SouthGobi’s restatement which was “powerful evidence that strongly contradicts a defence of reasonable investigation”, and, on the other hand, the defence narrative offered on the motion. The Court found that this inconsistency gave rise to serious issues of credibility which had not been fully addressed in the Defendants’ evidence. The Court also identified other deficiencies in the Defendants’ evidence. The Court of Appeal stated that “[i]n the face of the limited record and significant credibility issues, the proper course for the motion judge was not to do the best he could on the available record, treating the motion as if it were a mini-trial. Rather, the lack of a clear record makes evident that leave must be granted because there is no certainty that the reasonable investigation defence will succeed.”

Finally, the Court of Appeal found that the inconsistency between SouthGobi’s public statements and the Defendants’ position on the motion raised public policy concerns. Specifically, the Court of Appeal determined that the motion judge, in refusing to grant leave to proceed against the officers and directors, had failed to consider the policy imperative that “continuous disclosure obligations are not a shell game where investors are left to guess where the truth lies.”

The SouthGobi appeal decision gives guidance on the reasonable investigation defence and the evidentiary onus placed on the Defendants in the context of a leave motion. It is part of developing jurisprudence in respect of securities misrepresentation class actions and the relevant provisions of the Ontario Securities Act.