In Longair v. Akumin Inc. et al., 2024 ONSC 3675, Justice Akbarali (the “Motion Judge”) granted a number of claims against an Ontario issuer leave to proceed under Part XXIII.1 of the Securities Act, R.S.O. 1990, c. S.5. Her analysis is noteworthy for several reasons: she explicitly accepts that there was a reasonable possibility that the Plaintiff could establish the alleged misrepresentations were corrected through a series of partial corrections. The concept of partial public corrections has been a contentious one in the Ontario jurisprudence that is the subject of conflicting jurisprudence and that the Court of Appeal in Drywall Acoustic Lathing and Insulation, Local 675 Pension Fund v. Barrick Gold Corporation, 2021 ONCA 104 (“Barrick Gold”) explicitly declined to address (at para. 76, FN 9).
The Motion Judge’s analysis contains what is one of the most, if not the most, detailed analysis of econometric expert evidence in the secondary market leave jurisprudence. Specifically, she engages in a detailed consideration of the statistical significance of alleged share price declines and differences in the event windows used by different experts in evaluating the alleged share price declines. Ultimately, she opts not to resolve these differences out of concern that to do so would amount to engaging in an impermissible mini-trial contrary to the Supreme Court of Canada’s guidance in Theratechnologies Inc. v. 121851 Canada Inc., 2015 SCC 18 (at para. 39). The Motion Judge also gives careful consideration to conflicting analysts’ reports relating to certain of the alleged public corrections.
Finally, the Motion Judge also provides a detailed recitation of the law relating to when purchasers on foreign exchanges can be included in Part XXIII.1 proceedings. She declines to adopt a place of trading rule and finds that the Part XXIII.1 scheme allows Ontario courts to exercise long-arm jurisdiction and potentially determine the claims of foreign shareholders, who purchased securities on a foreign exchange, when the issuer has a real and substantial connection to Ontario.
BACKGROUND – THE ALLEGED MISREPRESENTATIONS AND CORRECTIONS
- Akumin Inc.
Akumin Inc. (“Akumin”) is an Ontario-based corporation operating outpatient medical imaging clinics across the United States. Before Q3 2020, Akumin's financial statements were prepared under International Financial Reporting Standards ("IFRS") as it was trading on the Toronto Stock Exchange ("TSX"). However, on September 4, 2020, Akumin was listed on NASDAQ, and from Q4 2020, it began adopting U.S. Generally Accepted Accounting Principles ("US GAAP"). Ernst & Young (“EY”) was Akumin’s auditor at the relevant time and provided clean audit opinions for the Akumin disclosures alleged to contain misrepresentations. EY did not withdraw its unqualified audit opinions.
- Key Events Leading to the Litigation
On June 25, 2021, Akumin announced its agreement to acquire Alliance HealthCare Services Inc. (“Alliance”) for $820 million USD. This acquisition was significant and would expand Akumin’s business significantly, roughly tripling its size. The transaction was expected to close in Q3 2021 and was finalized on September 1, 2021.
Before the Alliance transaction closed, on August 15, 2021, Akumin announced a delay in filing its Q2 2021 financial results due to the need for additional analysis regarding "potential additional credit losses with respect to prior years" (at para. 6). This delay led to Akumin applying for a Management Cease Trade Order ("MCTO") from the Ontario Securities Commission ("OSC").
Subsequently, on October 12, 2021, Akumin disclosed in a bi-weekly update that an additional review had identified issues in recording write-offs and cash collections on acquired accounts receivable balances, impacting current and prior periods. It was determined that adjustments were required to historical implicit price concessions for certain periods, leading to a need for restatements of the financial statements for the periods ended December 31, 2019, December 31, 2020, and Q1 2021. The impact was expected to result in a $25-$30 million negative adjustment to accounts receivable.
Additionally, Akumin identified differences in the accounting treatment of the capitalization versus the repair and maintenance expenses of certain equipment components following the Alliance transaction. This error, referred to as the "PPE error," required further adjustments to the financial statements, including reducing the value of Akumin’s property and equipment and increasing its expenses for the relevant periods.
On November 8, 2021, Akumin disclosed that the PPE error would result in a reduction of the net book value of property and equipment by approximately $19 million. A week later, on November 15, 2021, Akumin released its Q2 2021 financial results and filed the restatements, which reflected these adjustments.
- Claims by the Plaintiff
The Plaintiff, based on a common set of misrepresentations, advanced causes of action for three offerings of Akumin securities under Part XXIII of the Securities Act, common law misrepresentation claims, and secondary market misrepresentation claims under Part XXIII.1 of the Securities Act.
The Plaintiff alleged that Akumin made six misrepresentations. Specifically, the Plaintiff alleged that Akumin: 1) overstated accounts receivable; 2) overstated revenue; 3) overstated PPE; 4) overstated shareholders’ equity; 5) failed to comply with IFRS; and 6) misrepresented the effectiveness of its internal controls over financial reporting and disclosure controls and procedures.
The Plaintiff alleged that EY made misrepresentations as EY: 1) had no reasonable basis for its unqualified audit of Akumin’s at issue financial statements; and 2) falsely represented that its audits complied with generally accepted auditing standards and PCAOB standards.
- Public Corrections and Market Impact
The Plaintiff alleged that the misrepresentations were publicly corrected on August 15, October 12, November 8, and November 15, 2021, by various disclosures made by Akumin related to various accounting restatements resulting in a material impact on the price of Akumin securities.
LEGAL PRINCIPLES APPLICABLE TO THE PART XXIII.1 LEAVE ANALYSIS
- Overarching legal principles for Part XXIII.1 leave motions
The Court summarized the law with respect to motions for leave under Part XXIII.1, which requires a plaintiff to establish two criteria to be granted leave to proceed with their action:
138.8 (1) No action may be commenced under section 138.3 without leave of the court granted upon motion with notice to each defendant. The court shall grant leave only where it is satisfied that,
(a) the action is being brought in good faith; and
(b) there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff.
The Court identified the following as the most important principles:
- to establish a reasonable possibility of success requires both a plausible analysis of the legislation and some credible evidence in support of the claim without turning the leave motion into a mini-trial;
- The prohibition against mini-trials requires the Motion Judge to keep in mind the relatively low merits-based threshold of a reasonable possibility of success;
- Attempts to resolve contentious issues arising from conflict credible evidence amounts to a mini-trial; and
- The completeness of the record should affect how the Motion Judge proceeds;
- in evaluating the evidence, the Court must engage in some weighing of the evidence and scrutinize the entire body of evidence including its credibility and reliability;
- the qualitative analysis of whether a claim has a reasonable chance of success must be undertaken for each alleged misrepresentation;
- the Court must be mindful of the fact that the motion is determined on a paper record without discovery; and
- where there are contentious issues of credibility, the Motion Judge must themselves if those issues can be resolved on the existing record.
- Materiality is market based
Only material misrepresentations are actionable. The materiality analysis is objective, contextual, fact specific, and considered from the perspective of what a reasonable investor would consider important in deciding to invest and the price at which to invest. Specific evidence on materiality is not always necessary – in a proper case, the objective importance of facts or omissions can be inferred as a matter of common sense. Share price movement does not conclusively determine materiality.
- Public corrections, when not facially obvious, must be evaluated based on the understanding of the secondary market and need not be ‘material’
The Motion Judge frames the correction analysis as focusing on whether the alleged correction “was reasonably capable of being understood in the secondary market” as correcting the misleading aspect of the misrepresentation, relying on the Court of Appeal’s decisions in Barrick Gold and Baldwin v. Imperials Metals Corporation, 2021 ONCA 838 (“Baldwin”) (at paras. 52-55). Where the alleged correction does not “on its face” reveal the existence of the alleged misrepresentation, the Court must engage in a “reasoned consideration of evidence of the context” in which the correction was made and how the market would understand it. There must be a linkage or connection between the alleged correction beyond coincidence in subject matter alone. The correction analysis is not merely semantic but focuses on how a correction “would be understood in an efficient market and also requires a statistical analysis of the effect of the correction.”
The Motion Judge rejected Akumin’s argument that a disclosure that does not have a statistically significant share price decline cannot be corrective. She held that this was not necessary and that Akumin’s argument muddles the materiality of a misrepresentation with the materiality of the correction and would not serve the legislative purpose of the Part XXIII.1 regime of incentivizing fair and accurate disclosure. Rather than a siloed approach, the correction analysis is contextual.
THE PART XXIII.1 LEAVE ANALYSIS
Following the recitation of the applicable legal principles, the Motion Judge analyzed each element of the leave test for the misrepresentation claims against the issuer and auditor, namely:
- Is there a reasonable possibility the alleged misrepresentations were untrue?
- Were the misrepresentations material and were they publicly corrected?
Due to the position taken by Akumin that a correction must be associated with a statistically significant share price decline, the Motion Judge felt it was necessary to analyze materiality and public correction together.
- The Akumin misrepresentations
Is there a reasonable possibility that the alleged Akumin misrepresentations were untrue?
The Motion Judge had little difficulty determining that there was a reasonable possibility that the alleged Akumin misrepresentations were untrue. Akumin restated its financial statements and disclosed weaknesses in its internal controls. She held that there was credible expert evidence that such restatements were by definition under US GAAP and IFRS acknowledgments of past erroneous statements. The relevant expert evidence identified specific ways in which the alleged misrepresentations violated IFRS and US GAAP. This evidence was sufficiently credible and reliable to establish a reasonable possibility the plaintiff would prove the impugned statements were untrue.
Are the alleged Akumin misrepresentations material and were they publicly corrected?
This was the primary battleground for the motion based on the position taken by Akumin. Akumin argued that only one date, August 15, 2021, had a statistically significant share price decline and that this disclosure did not correct any of the alleged misrepresentations. The August 15, 2021 disclosure informed the market that Akumin’s Q2 2021 financial report would be delayed and that Akumin would be seeking a MCTO from the OSC. This posed a risk to closing the Alliance deal. Akumin in effect argued that this disclosure did not contain the restatements of past financial statements that corrected the alleged misrepresentations. Akumin also took the position that its credit loss risk was well known and they had previously taken an accounts receivable write-down so disclosure about further potential credit losses would not “have taken the market by surprise” or been understood as a new risk (at para. 89). The other alleged corrections provided the market with the information about the restated financials but were not associated with a statistically significant share price decline.
In contrast, the Plaintiff argued that the August 15, 2021 disclosure put the market on notice of the risk of additional credit losses which would negatively affect accounts receivable, revenue, and shareholders’ equity. The Plaintiff also argued that the October 12, 2021 share price decline was statistically significant when a two day event window was used for the event study of that date, as had been employed by the Plaintiff’s expert. Finally, the Plaintiff argued that the last two allege corrections were partial corrections that did not result in statistical share price declines as the market had already fully digested the information about Akumin’s financial errors.
The Motion Judge determined that the August 15, 2021 disclosure “on its face called into question prior financial period reporting as it related to credit losses” (at para. 95). Relying on the Plaintiff’s expert evidence, it was reasonably possible the secondary market would have understood this as correcting past reporting of accounts receivable with effects on revenue and shareholders’ equity. The Motion Judge held that to determine otherwise would be erroneous and contrary to the Court of Appeal’s guidance in Baldwin as it would permit Akumin “to escape liability by making vague or general disclosures” (at para. 96).
The Motion Judge engaged in a detailed analysis of the econometric evidence before the Court, akin to what is often seen in U.S. securities litigation but seldom in Canadian decisions:
August 15, 2021 disclosure: both experts found a statistically significant share price decline using either a one-day or a two-day event window. The Plaintiff’s expert attributed this to the accounting issues that were disclosed while the Defendant’s expert argued there was no economic correspondence between the misrepresentations as the disclosure was not understood by the secondary market to relate to an upcoming restatement. In rejecting Akumin’s position, the Motion Judge looked to analysts’ reports discussing the disclosure that paid attention to credit losses and noted that Akumin’s share price did not completely recover following the close of the Alliance transaction, as it would have been expected to if the risk to that transaction was the primary reason for the August 15, 2021 share price decline.
October 12, 2021 disclosure: In a MCTO status update, Akumin disclosed that there were expected negative adjustments to its accounts receivable, there was an error in valuing PPE, that financial statements for FY 2019, 2021 and Q1 2021 would have to be restated, and that the Q2 2021 financial results would be delayed until sometime before November 15, 2021. Akumin conceded some aspects of the disclosure were corrective but argued they were not material. Akumin argued that a one-day event window should be used in the event study of the share price impact of this disclosure, which resulted in a non-statistically significant decline, while the Plaintiff argued a two-day event window, resulting in a statistically significant decline, was appropriate.
November 8, 2021 disclosure: This disclosure confirmed that Akumin’s restated filings and Q2 2021 results would be released on November 15, quantified the PPE error as a negative adjustment of approximately $19 million, and disclosed that their Q3 results would be delayed until mid-December. The parties agreed that there was no statistically significant share price decline. The Defendant argued that this meant that the PPE error was not material while the Plaintiff argued that the PPE error was material but had already been priced into the Akumin share price following the previous disclosure – a “truth-on-the-market” argument.
November 15, 2021 disclosure: Akumin released its Q2 2021 report and restated financials, all of which lowered Akumin’s accounts receivable, PPE valuation, revenue, and shareholders’ equity. Once again, the parties disagreed on the appropriate event window for this date. The Plaintiff’s expert used a four-day event window that did not result in a share price decline once again due to the truth-on-the-market theory. Akumin’s expert used a one-day event window and found a statistically significant share price increase arguing that this meant that the restatement was, in fact, a positive change relative to market expectations. The analysts’ reports surrounding this date were mixed: some raised their target price, another was neutral, and one lowered its target price.
The Motion Judge found that there was a reasonable possibility that the Plaintiff would prove the alleged disclosures were material and were partial corrections. In reaching these determinations, the Motion Judge found that both parties had plausible theories explaining the market’s understanding of these disclosures that are supported by expert and documentary evidence. However, she declines to resolve the differences between expert opinions to avoid engaging in an impermissible mini-trial at the leave stage.
The Motion Judge had difficulty with the suggestion that a public correction, without a statistically significant share price decline, would serve as a useful time post for calculating damages under Part XXIII.1 and how such a correction would serve the goals of the Part XXIII.1 scheme. But determined that on a leave motion it was not appropriate to resolve these questions without the benefit of a full record.
Akumin advanced an argument with respect to class members who were noteholders as Akumin notes did not trade in an efficient market. Akum argued that the noteholders could not prove a reasonable possibility that the statements were material to the notes due to the lack of an event study and argued that the statutory scheme required an efficient market for relief to be available to a securityholder. The Motion Judge accepted the Plaintiff’s argument that, pursuant to s. 138.5(1)(2)(ii)(B) of the Securities Act, the Court can look to other evidence to determine materiality at the leave stage. The record contained evidence that the note prices declined after the August 15, 2021 disclosure and Moody’s Investor Services released a number of reports commenting negatively on the notes, which was sufficient at the leave stage.
- The EY misrepresentations
Is there a reasonable possibility that the alleged EY misrepresentations were untrue?
The EY misrepresentations were wholly derivative of the Akumin claims. EY disputed this criterion but failed to produce its audit file. The Plaintiff’s expert could not opine on whether applicable auditing standards were complied with as a result but opined that based on publicly available documents there was a reasonable possibility that EY did not comply with US GAAS and/or PCAOB standards. The Motion Judge found that while this opinion was somewhat speculative, it did include credible evidence that EY failed to comply with applicable standards. Given that the Motion Judge must be cognizant of the evidence not before her, like the audit file, and that the standard at leave is a low one, this was sufficient to establish a reasonable possibility at trial that the EY representations were not true.
Are the alleged EY misrepresentations material and were they publicly corrected?
EY argued, successfully, that its audit statements were not material or publicly corrected. EY did not withdraw its unqualified audit opinions and it was not disputed that an auditor could meet applicable standards when evaluating statements that ultimately turn out to be erroneous and require restatement. The Plaintiff argued, unsuccessfully, that the restatements were corrective of EY’s audit representations and that materiality could be inferred as a matter of common sense as the market places greater reliance on audited financial statements because they are audited. The Motion Judge found there was little evidence speaking to EY’s statements and that materiality could not be inferred as a restatement alone is not sufficient to prove materiality.
CERTIFICATION
Following a determination that leave ought to be granted under Part XXIII.1, the certification analysis is generally perfunctory. However, the proposed class action included American purchasers of Akumin securities and there is a detailed analysis of whether claims could be asserted on behalf of the American securityholders.
- Claims by American securityholders are properly included
The class definition proposed by the Plaintiff was not limited to Canadian shareholders. In challenging the certification of the claims on behalf of American shareholders (accounting for 43% of the volume of secondary market trading), the Defendants argued that American law applies to these claims and the Plaintiff failed to properly plead American law. The Plaintiff and the Defendants both led expert evidence of American law. The Defendants’ expert deposed that an American court would exercise jurisdiction over the American shareholders and apply federal securities law to their claims and that not all facts necessary to establish liability under American law were pleaded. The Plaintiff’s expert opined that the limitation period under American law had expired and there was no American proceeding, meaning that American shareholders would not be able to recover their losses if excluded from this claim.
The Motion Judge reviewed the extensive jurisprudence confirming that there was no place of trading qualification for the Part XXIII.1 cause of action. Akumin made a forum non conveniens and comity argument, which the Motion Judge rejected as Akumin had a real and substantial connection to Ontario, there was no comity concern as there was no competing proceeding and there could not be one due to the expiry of the limitations period. In any event, if there was a competing action, double recovery could be addressed at a later stage as it has been in other securities class actions.
EY advanced a choice of law argument that secondary market claims ought to be subject to the law of the jurisdiction of the place of trading. Akumin was subject to continuous disclosure requirements of multiple jurisdictions and the related claims ought to be, as well. The Plaintiff argued that Part XXIII.1 had extra-territorial application and did not have a place of trading qualification and that in appropriate cases, “an Ontario court is obliged to apply Ontario law to an appropriate extra-territorial claim” (at para. 175, quoting from another decision related to Canadian NASDAQ purchasers). As a result, the Motion Judge held that the American purchasers should be included in the action.
CONCLUSION
The decision of the Motion Judge provides a clear and complete summary of the law applicable to Part XXIII.1 leave motions. Her analysis of the issue of partial public corrections provides much needed clarity on this aspect of the legislative scheme. However, given the existence of conflicting jurisprudence (such as the decision of Strathy J., as he then was, in Dugal v. Manulife Financial, 2011 ONSC 6761 at para. 37 holding that a partial correction is merely a further misrepresentation) it will eventually be necessary for the Court of Appeal to weigh in to truly resolve this issue for the securities bar.
While the detailed analysis of the expert econometric evidence in this decision may, at first blush, suggest Ontario Courts are moving toward an American approach to secondary market claims that frequently involves protracted battles of experts at preliminary stages, the Motion Judge’s determination that such conflicts cannot be resolved without an impermissible mini-trial may result in the opposite.
Finally, the decision provides the clearest statement yet of the breadth of the Part XXIII.1 regime and its application to extra-territorial claims. This will surely be relied upon by plaintiffs in essentially every action involving a cross-listed issuer to seek certification of a global class and may also incentivize bringing proceedings on behalf of shareholders of corporations that have a “real and substantial connection” to a Canadian jurisdiction even when they do not trade on a Canadian exchange.
Any article or other information or content expressed or made available in this Section is that of the respective author(s) and not of the OBA.