Q&A: Disclosure of Internal Investigations

(August 11, 2018). Morganti & Co has received several inquiries from investors as to when companies must disclose internal investigation. The following note is our Firm’s general approach.

Question: When does a reporting issue have the affirmative duty to disclose internal investigations?

The answer of this question should commence with examining whether the internal investigation is a material fact. Here, we are guided by Sharbern Holding Inc. v. Vancouver Airport Centre Ltd, 2011 SCC 23, paragraphs 59-61, as to whether a fact (e.g., such as an internal investigation) rises to a level of being an material fact requiring disclosure. Whether the management believes an internal investigation will not result in anything different than the then total mix of information about that particular topic concerning the investigation should not influence the company’s disclosure requirements. Kerr v. Danier Leather Inc., 2007 SCC 44, at paragraph 55.

In Pretium Resources, Inc., the mining company was conducting an internal investigation with a third-party engineering firm based upon adverse facts learned by its own employees and consultants. While the internal investigation was ongoing Pretium Resources released bullish statements about the topic of the investigation but omitted to disclose that it had been sitting on adverse facts about the topic and was engaging in an internal investigation. Management chose not disclose because it relied upon its business judgment to determine that the adverse facts did not appear reliable. (Decision at paragraph 15) The court released a decision following the guidance of Sharbern Holdings Inc. and Kerr finding that if the investor proceeded to a trial there would be reasonable possibility of success that the investor could establish that the internal investigation was a material fact requiring disclosure and, therefore, Pretium Resources violated its continuous disclosure requirements exposing itself to compensate investors for their losses. (Decision at 24). You may read the decision here.

Contrasting Pretium Resources, Inc., there is MDC Partners, Inc. MDC Partners was conducting an internal investigation because it was served with a subpoena from a securities regulator. When the securities regulator and corresponding internal investigation was disclosed several months later the market sold off the securities by over 28%. After a review of Sharbern Holdings, Kerr, that court extended the reading of Part IV of the Securities Act to apply to foreign securities regulators therefore not requiring MDC Partners to disclose the adverse fact that it was served a subpoena and conducing an internal investigation. (Decision at paragraphs 81-84 and, importantly 108). The court dismissed the plaintiff’s motion to proceed towards trial with the statutory claim and granted the motion to dismiss with the proceeding with prejudice. You may read the decision and order here [inset the same 2 documents from earlier]

Answer: Unless the internal investigation arises from being served with a subpoena from a domestic or foreign securities regulator, reporting companies, defined by the Ontario Securities Act, should make disclosure of an internal investigation when the company choses to release a statement(s) that concerns the same topic as the internal investigation. In making the timely disclosure the company can disclose the managements’ views as to why the internal investigation may or may not result in a certain manner. See, Pretium Resources, Inc., Decision at paragraphs 38-39.

Next month we will explore the meaning of an internal investigation.