Modern Times (1936): The investors are the victims

(October 3, 2019). None of us enjoy getting kicked in the face from an investment gone bad.  It hurts more when the investment goes bad when the company’s share price drops from an announcement admitting that before you made the investment it was already being investigated for accounting irregularities.  What about when Canadian courts, supported by your provincial tax dollars, deny you access to justice to bring a foreign defendant to court for your financial losses while the the court refers to you as the unreasonable investor?

The Ontario Securities Commission appears to have regulations that allows companies to omit ongoing regulatory investigations from investors!  Hey, we did not support those politicians that voted in favour of that legislation — legislation likely backed by multinational insurance companies and now uber wealthy Canadians residing in Switzerland (e.g., I smell the stench of certain cannabis companies hiding behind Bay Street law firms).

Sadly, Panicci v MDC Partners, Inc. (“MDC”), 2018 ONSC 3470, certain Ontario Courts appear to have embraced this pro-business anti-investor concept but, in doing so, misunderstood the U.S. Securities and Exchange Commission’s silence as acquiescence of the corporation’s non-disclosure. Compare, SEC v. Mylan N.V., 19-cv-02904 (D.D.C. 2019).

On October 5, 2014, the Securities and Exchange Commission served a subpoena on MDC requiring it to produce documents and testimony with respect to an investigation relating to: (a) reimbursement of expenses incurred by Mr. Nadal; (b) accounting for goodwill; (c) certain other accounting practices; and (d) the trading in its securities by third parties. MDC did not immediately publicly announce the service of the subpoena, and on October 29, 2014, it released a News Release entitled, ‘MDC Partners Inc. Reports Strong Results for the Three and Nine Months ended September 30, 2014.’ There was an accompanying Management Presentation.  Thereon after, after reading MDC’s then most recent quarterly report  the plaintiff purchased shares of MDC.

After the market closed on April 27, 2015, MDC released a Statement indicating that the SEC had served a subpoena in an investigation into MDC’s disclosure practices relating to: (a) reimbursement of expenses incurred by Mr. Nadal; (b) accounting for goodwill; (c) certain other accounting practices; and (d) the trading in its securities by third parties. The Statement also indicated that MDC had formed a Special Committee of independent directors to investigate the matters raised by the SEC’s subpoena and they were implementing new policies and procedures. The price of MDC’s shares immediately dropped 28%.

The plaintiff alleged that the SEC’s investigation was a material fact requiring disclosure in all of MDC’s quarterly reports released after it received the subpoena.  Indeed, the plaintiff argued it was common sense that knowing that MDC was under SEC investigation for accounting irregularities would have significantly altered the total mix of information available to the market.

During early 2018, the Ontario court harshly rejected the plaintiff investor’s submissions.  Although the court suggested that receiving the SEC’s subpoena could be a material fact, investors were kicked in the teeth for not having a reasonable possibility that they were mislead.  Wait… why would an investor invest hard earn-money into a company being investigated (accurately or inaccurately) for accounting irregularities?

The Ontario court wrote, “the flaw” in the Ontario investor’s submissions:

The SEC never took issue with the timing of MDC’s disclosure of the subpoena and rather noted that MDC’s formation of the Special Committee and its internal investigation were remedial acts that prompted the SEC to resolve the investigation.

Under the Ontario Securities Act, no person or company may disclose the nature or content of an investigation order, the nature or content of any demands for production, or the fact that any document was produced to an investigator, at any time, except to counsel. To disclose the existence of an investigation, including any request for and production of documents, the issuer must first obtain an order from the Commission authorizing the disclosure on the grounds that it is in the public interest. The Guidelines for Staff Disclosure of Investigations, set out in Staff Notice 15-703, indicate that the “general rule” is that there will be no public disclosure of information about an on-going or closed investigation.

In my opinion, there was no misrepresentation and no withholding of a material fact between the time the subpoena was served on MDC and April 27, 2015 when MDC disclosed the service of the subpoena. The mere service of a subpoena does not trigger a duty to disclose, and as noted above, the law is that, generally speaking, the existence of an investigation is a confidential matter that ought not to be disclosed and that disclosure requires the approval of the regulator.

A reasonable investor would not expect a company to immediately report the service of subpoena. What a reasonable investor would expect is that the company would respond to the subpoena, cooperate with the investigator, and conduct an internal investigation and then determine whether there was a material fact to correct or a material change to report to its investors. This is precisely what occurred in the case at bar.

It is the author’s opinion that MDC’s submissions emphasized the pro-business Ontario regulation of not having to disclose regulatory investigations (even if they would be deemed material facts) and the Court put substantial weight on the SEC’s silence (pointing out that MDC was listed on both stock exchanges).

It appears that the U.S. SEC did not appreciate MDC’s conduct as reflected by the millions worth of legal time (multi-year investigation) invested in the investigation and millions in fines collected from MDC.  More importantly and hopefully why  honest hard-working investors will not be denied access to justice as in Paniccia v. MDC Partners, Inc., the U.S. SEC filed an investor complaint against Mylan N.V. (“Mylan”) for securities fraud on the same basic material facts.

Mylan was under regulatory investigation for accounting violations and incorrectly misclassifying one of its top selling product. However, Mylan omitted to disclose the ongoing adverse regulatory investigation from its quarterly reports.  Subsequently, news reports confirmed the regulatory investigation.  The markets were spooked by the possible outcome of the regulatory investigation and sold off Mylan’s shares resulting in a 4.7% drop in price.

The SEC’s complaint against Mylan correctly alleges that:

“A public company facing a material loss contingency, such as arising from a [] government investigation, is required under accounting principles and the securities laws to (1) disclose the loss contingency if a loss is at least reasonably possible, and (2) record an accrual for the estimated loss if a loss is probable and reasonably estimable. Contrary to these requirements, Mylan failed in its quarterly, annual and other reports, to disclose the loss contingency or accrue for the loss until it announced a settlement with the regulator” [i.e., approximately a month after the media reported the investigation].

SEC v. Mylan N.V., 19-cv-02904 (D.D.C.). Mylan did not dispute the charges that it mislead investors and paid a $30 million fine.

Morganti & Co. completely and thoroughly embraces the SEC’s position. Honest hardworking investors should not be afraid to invest in public companies that list their securities on domestic and foreign stock exchanges.  The direct conflict between the OSC’s regulations and the U.S. SEC’s litigation positions will very likely lead to increase civil litigation especially when the targeted public company lists its securities on both Canadian and U.S. stock exchanges.

 

Modern Times (1936)