Thursday, 22 March 2012 17:36

The Importance of Adequate Compliance Controls for Public Companies

A recent decision of the Divisional Court in Ontario, gives insight into further potential exposure to Public Companies for inadequate compliance controls. The Plaintiffs sought to bring a class action against IMAX, an issuer listed both on the TSE and NASDAQ Exchanges. The case involved the duty to make regular disclosure of information material to the company's business and affairs. IMAX overstated revenues in 2005 by taking into 2005 revenue payments that had not yet been made to IMAX under contracts IMAX had not yet performed fully. This created a problem because it was a change in the revenue recognition policy which was not disclosed in the statements and this approach was not in accordance with GAAP.

Management's purpose in overstating revenues were to meet 2005 plan and position the company as an attractive takeover target. As a result of these actions, the stock price jumped significantly. When in 2006 IMAX announced that it had not found a takeover or merger partner and the SEC was investigating, the stock dropped sharply. The proposed class action plaintiffs had bought shares after the 2005 financials were released and sold the shares after the 2006 announcement. They sought to bring a class action on behalf of themselves and other investors.

This was the first case brought under the new statutory cause of action in misrepresentation found in the OSA. (S.138.8(1)). The Defendants objected to the certification of the class. This motion was a motion for leave to appeal to the Divisional Court. Leave was denied and accordingly the certification order was allowed to stand. The Defendants were ordered to pay costs set at $385,000 to the Plaintiffs on account of the leave to appeal motion. This would be in addition to the costs that they incurred, the costs of the underlying proceedings to date, the costs of defending the class action and the potential liability exposure.

A heavy price to pay for breaching disclosure requirements!

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