In 2005, Bay Street law firm Stikeman Elliott LLP published a paper titled "Litigation Unleashed," which suggested that a massive wave of securities litigation was coming and, for good measure, featured an awesome lightning bolt on its cover.
It was typical of the alarmist response from the business elite and their consultants and advocates to changes that year to the Ontario Securities Act, which made it easier for shareholders who bought stock on the "secondary market," such as a stock exchange, to sue companies for making misrepresentations to investors.
Early each year, economic consulting firms that advise defendants in securities class actions publish reports on the state of the practice area in the United States and Canada. One such firm, NERA Economic Consulting, reported on Thursday that only nine securities class action cases were filed in Canada in 2012, down sharply from 2011, when NERA reported a record 15 new filings.
That higher number, however, constituted a mere 54 per cent of U.S. filings in 2011, even after adjusting for the size of Canada's much smaller capital market. Nonetheless, NERA's report for 2011 sounded an alarm: According to that study, it was "beyond question" that the 2011 uptick in filings was not a "transient phenomenon." NERA blamed the usual suspects: purportedly plaintiff-friendly courts, "multimillion-dollar settlements (and class counsel fee awards)," and Canada's supposedly lax certification standards compared with the United States.
So why the substantial drop in filings in 2012? What happened? We can think of four potential explanations.
The first, perhaps cynical, explanation is that much of the initial panic came from the business elite, which has an obvious interest in fewer shareholder suits, and periodically warns of economic catastrophe in order to deter legislatures from facilitating such suits. The spectre of a wave of "strike suits" is powerful imagery, but is divorced from the reality in Canada.
A second possibility is that the plaintiffs' bar has limited resources: 2011 involved more than increased securities class action filings, it involved unprecedented filings, such as the case against Sino-Forest Corp., one of the largest and most complex actions ever filed in Canada, and more than a dozen complex but smaller cases. A small number of firms have the capability to litigate such complex cases.
A third possible explanation might be that 2012 saw some negative developments in the practice area. In February, 2012, the Ontario Court of Appeal released its decision on Timminco, restricting the amount of time litigants have to bring secondary market securities class actions. And in September, the Western Coal class action was dismissed, in a rather dramatic fashion, which may have caused some plaintiffs' firms to become more reluctant to pursue securities class actions.
There is, however, a fourth possibility: The reforms to the Securities Act are working. Fresh research in the United States by professors Stephen Choi, of the New York University School of Law, and Adam Pritchard, of the University of Michigan Law School, shows that securities class actions provide at least as much deterrent – if not more – than enforcement actions by the U.S. Securities and Exchange Commission.
We believe that the spectre of multimillion-dollar lawsuits, years of litigation and reputational damage to culpable defendants have helped deter stock fraud. We believe that there are fewer filings because there are fewer good cases, and there are fewer good cases because more of Ontario's public companies are complying with their disclosure obligations. This is precisely what Ontario intended when it modernized the Securities Act in 2005.
So, to all the well-behaved companies in Ontario: Good job. To those that are thinking of harming their investors: Think twice.