Protecting Investors

Neil Gross

Neil Gross is the executive director of the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada). During his 30 years as a lawyer, he specialized in investment malpractice litigation and securities law.

Overcautious courts are erecting barriers to securities class actions, even though these lawsuits are essential for maintaining the integrity and fairness of our capital markets

By Neil Gross |

Class action lawsuits allow justice to be done in cases where significant wrongdoing harms a lot of people, even where individual losses aren't large enough to make it worthwhile or sensible for each harmed person to pursue a lawsuit of their own.

In addition, class actions are efficient. They allow courts to address once, in a single trial, all the legal and factual issues that dozens, hundreds or even thousands of claims have in common. This isn't just an economical use of judicial resources; it also eliminates the problem of separate trials coming to different conclusions based on the same evidence — something that, ideally, should never happen.

And, of course, the aggregate amounts involved in class actions often are very large, so law firms are willing to handle these cases under contingency fee arrangements that make it possible for people of modest means to seek compensation when they otherwise simply could not afford to do so.

All of this is particularly important for investors and capital markets. Class actions are well suited to dealing with claims that alleged misstatements or disclosure failures have harmed investors by affecting stock, bond or commodity prices, even by just a few ticks. Without class actions, this sort of wrongdoing could, and likely would, go largely unpunishedor at least un-rectified in an economic sense. That's because securities regulators usually confine their enforcement efforts to pursuing market bans or levying fines, and they generally shy away from instituting proceedings for the purpose of compensating harmed investors.

Securities class actions, therefore, act as a vital bulwark in maintaining integrity and fairness in our capital markets system. These lawsuits are important because they protect investors' economic interests, and thereby help foster public confidence in our capital markets.

Unfortunately, in Canada, this is not being optimized. If anything, the situation is quite the opposite.

Canadian legislators and judges seem to worry — a lot — that securities class actions will be used as a means to extort unjustified settlements on meritless claims. It's a concern borne of the fact that class actions typically are complex in nature and expensive to defend, which puts defendant companies under pressure to settle every class action claim even if they consider the claim to be completely bogus.

As a result, not unlike many other countries, we have legislated thresholds intended to screen out meritless class actions at a very early stage. But in Canada, judicial interpretations from our highest courts have turned this threshold test into more of a semi-impermeable membrane than a screen. Cases here get tossed out not only where defendants demonstrate that the claim is utterly devoid of merit and can't possibly succeed at trial, but also where plaintiffs are unable to prove from the outset that their claim has a "realistic chance" of succeeding. So only cases pre-judged as "realistic" get to go forward.

Moreover, our courts have shown that dire consequences may befall those who fail to make it through the screening process. Judgments have awarded defendants huge recoveries of the costs they incurred on motions to shut down securities class actions, and very recently an unsuccessful plaintiff was ordered to pay a substantial amount — some would say a punitive sum — for costs of an appeal from a decision screening out a securities class action.

In practice, these costs awards have to be paid by the law firms pursuing the case on a contingency basis, and that means the costs awards can and likely will have a chilling effect on securities class actions generally as fewer lawyers may be willing to take on the added risk of this liability. Cases that have arguable merit but that aren't tidy, sure-fire winners will be less likely to be pursued.

It's understandable, perhaps, that our courts regard these outcomes as fair and appropriate because judges naturally focus on balancing the interests of the litigants who appear before them. But there are more interests at stake that need to be weighed here. In particular, careful regard must be given to the broader public interest and, more specifically, the need to foster a robust class action system in order to protect all investors and preserve confidence in our capital markets.

If courts don't seem to see this bigger picture, it's not their fault. They aren't mandated or equipped to be full-fledged policymakers, so it's hard for them to find the public policy sweet spot between being prudent and being too cautious. They can only interpret and apply the statutory language that legislators have given them to determine how narrow or wide open the door will be for securities class actions.

Accordingly, it's really up to legislators to fix the present problem. They need to amend their Securities Acts to make sure the lifeblood of this critical mechanism for maintaining market integrity continues to flow. A clear signal must be sent back to the courts saying: We want the door to be more open, and the barrier lower.
 

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