Shareholder class action certified

The decision by Justice Edward Belobaba of the Ontario Superior Court of Justice certifies the class action and grants leave to pursue

a claim under the sections of the Ontario Securities Act and similar legislation in other provinces dealing with secondary market liability. It’s likely that the decision will be appealed.

Litigation in this area is relatively new; there are only a few other situations in which class actions based on secondary market liability under Ontario’s Securities Act have been defended, following changes to that legislation in 2005. These include Silver v. IMAX Corp. and Sharma v. Timminco Ltd. The changes allow shareholders who buy shares on the stock market to sue a company for what the shareholders believe were misrepresentations or failures to disclose information that could have materially affected the value of their shares.

In a note on the late July decision, Dugal v. Manulife Financial Corp., Ryan Morris and Sean Boyle of law firm Blake Cassels and Graydon LLP, commented: “The Dugal decision is noteworthy as it raises a number of significant issues that are ripe for consideration by an appellate court and that will be of interest to public issuers who are defending, or may be targets of, secondary market securities class actions.”

The Dugal class action is restricted to shareholders who held Manulife shares between April 1, 2004, and Feb. 12, 2009; the plaintiffs allege that Manulife failed to disclose the seriousness of its exposure to equities markets and interest rate risks during that period. According to the allegations, which have not been proven, Manulife consistently made misrepresentations in its core financial documents that it had “effective, rigorous, disciplined and prudent risk-management systems, policies and practices” in place. The documents referred to in the suit include annual financial statements, annual information forms, management discussions and prospectuses.

Manulife has responded that: there was no failure to disclose; the market was fully aware of Manulife’s hedging strategies; and the market crisis of late 2008 was completely unforeseeable. The firm also believes the “plaintiffs are relying on hindsight to suggest that Manulife should have been able to predict the crisis.”

In a comment by email, Graeme Harris, Manulife vice president of communications, stated: “The company believes that its disclosure satisfied applicable disclosure requirements and intends to vigorously defend itself against any claims based on these allegations.”

Manulife’s exposure to the guaranteed products under discussion was significant. The firm had assets under management held in these products that increased to almost $165 billion at the end of 2008 from $71 billion in early 2004. The plaintiffs allege that, because Manulife did not hedge or reinsure the risks associated with these products adequately, “the risk of fluctuations in the equity market and in generating the money needed to provide the promised return on the guaranteed products would be fully borne by Manulife itself.”

By the end of 2008, more than 95% of the guaranteed value associated with Manulife’s guaranteed products remained unhedged and uninsured. This exposure proved disastrous for the firm during the crisis of late 2008, when equities markets dropped by more than 35%.

Manulife’s 2008 financial statements, released on Feb. 12, 2009, reported a loss of $3.8 billion, with almost $2 billion attributed to its guaranteed products. Due to the unhedged exposure, Manulife had to increase its reserve requirements by more than 10 times to $5.8 billion at the end of 2008 from $526 million at the end of 2007. As a result, Manulife’s risk rating was placed on review for a possible downgrade by rating agency Moody’s Investors Service Inc.

A dramatic decline in the value of Manulife’s shares followed. By the end of March 2009, the shares had tumbled to $8.92 each, down from $38.28 six months earlier.

The court decision notes that on Feb. 12, 2009, D’Alessandro spoke with analysts in a conference call during which he said: “We were late in activating our hedging program. We had it ready to go; we hired all the people, set up all the systems. But it took us a while – longer than we should have – to get it going. And the markets got away from us. No one expected them, as I said in the last call, to collapse quite as significantly as they have.”

Manulife says that its 2008 financial statements did not reveal any “truths” and were not “corrective” of any previous disclosures the company had made, as the plaintiffs allege. Rather, Manulife says, the 2008 statements represented timely and accurate information as it became available: “The decline in the stock price was nothing more than the reaction by the market to the timely and accurate disclosure by Manulife of its yearend 2008 results.”

Belobaba noted in his decision that the dispute centred on “four discernible questions: did Manulife materially misrepresent the nature and extent of its exposure to the equity market or was this already known in the market; was Manulife required to disclose the impact on net income of a 20% or 30% equity market decline or was the 10% disclosure sufficient; was the financial crisis of 2008 so unprecedented and unforeseeable that no disclosure obligations could arise from there; was any ‘truth revealed’ on Feb. 12, 2009, that could reasonably be viewed as a ‘correction’ of earlier misrepresentations?”

Belobaba stated that he was “satisfied that the plaintiffs have established a reasonable possibility of success at trial, certainly on the more than a chance standard” in certifying the class action.

In their note on the decision, Morris and Boyle refer to the current legal debate over whether a higher or lower “threshold” should be applied to the possibility of success at trial: they note that Belobaba uses the “higher threshold” approach.

However, according to Harris’s email comment: “This is a procedural decision based on a very low threshold for leave and certification in Ontario. This is not a determination on the merits of the claim.”

He further stated that “this lawsuit commenced after an enforcement notice by staff of the Ontario Securities Commission in June 2009. The investigation was closed by the OSC without action against the company or any individual.”

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