



COURT OF APPEAL FOR ONTARIO

CITATION: Rahimi v. SouthGobi Resources Ltd., 2017 ONCA 719

DATE: 20170918

DOCKET: C61449

Epstein, Hourigan and Paciocco, JJ.A.

BETWEEN

Paiman Rahimi

Plaintiff (Appellant and

Respondent)

and

SouthGobi Resources Ltd.
, Alexander A.
    Molyneux,
Terry Krepiakevich, Matthew OKane, Andre Deepwell, Pierre B.
    Lebel, Gordon Lancaster
and Deloitte LLP

Defendants (Respondents and

Appellants)

Michael G. Robb, Paul Bates and Alex Dimson, for the
    appellant

John A. Campion, Gavin Tighe,
    and Stephanie Clark, for the respondents SouthGobi Resources Ltd., Terry
    Krepiakevich, Matthew OKane, Andre Deepwell, Pierre B. Lebel, Gordon Lancaster

Heard: June 19, 2017

On appeal from the order of Justice Edward P. Belobaba of
    the Superior Court of Justice, dated November 5, 2015, with reasons reported at
    2015 ONSC 5948.

Hourigan J.A.:

A.

Introduction

[1]

Paiman Rahimi
is the representative plaintiff in a
    putative
secondary market securities class action against the
    respondents SouthGobi Resources Ltd. (SGR), Terry Krepiakevich, Matthew
    OKane, Andre Deepwell, Pierre Lebel, Gordon Lancaster and
Alexander
    Molyneux (collectively, save for Molyneux, the Individual Respondents) and Deloitte
    LLP
.
[1]

[2]

Rahimi sought leave under s. 138.8(1) of the
Securities
    Act
, R.S.O. 1990, c. S.5 (
SA
) to proceed with a
    misrepresentation claim. On the motion for leave, the motion judge permitted
    the claim to proceed as against SGR but not the Individual Respondents, holding
    that there was no reasonable possibility that the Individual Respondents would
    not be able to succeed on a defence of reasonable investigation under s.
    138.4(6)(a) of the
SA.

[3]

Rahimi appeals the motion judges denial of leave as against the
    Individual Respondents (the Rahimi Appeal). SGR brings a separate appeal (the
    Corporation Appeal) against the motion judges ruling granting leave for the
    claim to proceed against it.
[2]


[4]

For the reasons that follow, I would grant the Rahimi Appeal and dismiss
    the Corporation Appeal.

B.

Background

(1)

Nature of the Business

[5]

SGR is
a coal mining company trading on the
    Toronto and Hong Kong stock exchanges. Krepiakevich and OKane are two of its
    former CFOs. Deepwell, Lebel and Lancaster are directors and members of SGRs
    audit committee.

[6]

The entirety of SGRs revenue came from the coal-mining operations in
    Mongolia of its subsidiary SouthGobi Sands LLC (SGS). SGSs main coal mine
    was called Ovoot Tolgoi. SGS was a major coal supplier for the Chinese market
    and, by 2010, all the mines customers were Chinese.

[7]

SGS agreed to what are known as bill and hold contractual arrangements
    with certain of its customers. These customers ordered coal, which SGS
    stockpiled for custom pickup at a bonded yard that was under the control and
    supervision of the Mongolian government. The customers would pay the contract
    price as soon as the coal was delivered to the yard. Under that arrangement,
    they were able to avoid rising prices in coal and have greater flexibility in
    transporting it.

[8]

SGR used the International Financial Reporting Standards (IFRS) to
    report its revenue, rather than the American GAAP method. Under an IFRS
    recognition rule called IAS-18, revenue from the sale of coal on a bill and
    hold contract could be recognized as soon as the coal was delivered to the
    stockpile yard, rather than when the customer retrieved the coal from there,
    provided that a reasonable judgment could be made that the risks and rewards of
    ownership of the coal had been transferred to the customer upon delivery of the
    coal to the yard and that customer payment was probable. Therefore, beginning
    in 2010, SGS implemented the bill and hold arrangements and SGR recognized the
    revenue derived therefrom in the manner dictated by IAS-18.

(2)

Prelude to the November 2013 Restatement

[9]

In March and April 2012, SGRs parent company, Ivanhoe Mines, was
    acquired by Rio Tinto, which subsequently changed its name to Turquoise Hill
    Resources (TQR). PricewaterhouseCoopers (PwC), the long-time auditor for
    TQR, became the auditor for SGR, replacing Deloitte.

[10]

In 2012, a Chinese company attempted to purchase SGR, but the deal was blocked
    by the Mongolian government, which shut down SGSs coal-mining operation in
    Mongolia in May 2012. Ovoot Tolgoi produced no coal from then until September
    2013. Coal prices in China were falling, and by the middle of 2012 SGSs bill
    and hold customers had trouble making timely payments, resulting in a growing
    number of forfeitures of coal and repossessions by SGS. The likelihood-of-payment
    stipulation in IAS-18 was no longer being met for these customers.

[11]

SGR, with approval of PwC, stopped using bill and hold agreements in
    mid-2012. It adopted a revenue recognition policy that required delivery of
    coal to the customer as a prerequisite to recognition. The transfer of title
    provisions in SGSs bill and hold agreements were amended to take effect in
    January 2013, and the change in revenue recognition policy was to be
    implemented on a go-forward basis.

[12]

SGR concluded that there was no need in January 2013 to change its
    earlier financial statements as a result of these subsequent changes in
    operation. PwC, which reviewed the earlier financials from 2010 to mid-2012,
    agreed with this position.

(3)

The November 2013 Restatement

[13]

For reasons that are in contest in this litigation, in spite of the
    January 2013 decision not to alter its earlier financial statements, SGR did
    issue a formal restatement of its prior financial statements on November 8,
    2013 (the Restatement). In a press release, SGR stated that, as a result of a
    review by SGRs auditors for the 2010 and 2011 fiscal years,

The Company has determined that certain revenue transactions
    were previously recognized in the Companys consolidated financial statements
    prior to meeting relevant revenue recognition criteria. These transactions
    relate to coal that had been delivered to the customer's stockpile in a
    stockyard located with the SouthGobi Ovoot Tolgoi mining license area (the
    Stockyard)  The restatement of the Company's consolidated financial
    statements will reflect a change in the point of revenue recognition from: (A)
    the delivery of coal to the customer stockpiles with the Stockyard to (B) the
    loading of coal onto the customer's trucks at the time of collection

Until the recent review, it was determined that a restatement
    of financial statements for the periods prior to the second half of 2012 was
    not required. The restatement of the Company 2011 and 2012 financials in
    order to reflect this change in the point of revenue recognition will in turn
    require restatements to the comparative information in the Company's previously
    filed interim financial statements for 2013.

As a result of the potentially material effects on the
    Companys financial statements, the previous financial information provided by
    the Company in respect of the periods to be covered by the Restated Financials
    are no longer accurate and should not be relied upon.

[14]

Following the November 8 press release, SGRs share price dropped about
    18 per cent.

[15]

SGR released another press release on November 14, 2013 (the November
    14 Press Release) indicating that there was a material weakness in the
    Companys internal controls over the financial reporting. The material
    weakness was explained as a failure to ensure that all aspects of sales
    arrangements were considered in determining the appropriate financial accounting
    in respect of the bill and hold contracts used in Ovoot Tolgoi mining
    operations. There was, in other words, no assurance that the accounting for the
    bill and hold contracts was IFRS-compliant.

[16]

The restatement had a significant impact on SGRs financial reporting,
    decreasing what SGR represented as its gross revenue between late-2010 and
    early 2012:



Relevant Quarter

Original Gross Revenue

Less: Bill & Hold Sales Adjusted Per Restatement

Add: Bill & Hold Sales Adjusted From Earlier Periods

Adjusted Gross Revenue



Q4 2010

$46,314,989

$21,955,661

-

$24,359,328



Q1 2011

$22,843,665

-

$440,874

$23,284,539



Q2 2011

$56,522,889

$28,411,837

$2,534,010

$30,645,062



Q3 2011

$74,239,790

$31,404,960

$18,589,299

$61,424,130



Q4 2011

$63,616,358

$43,311,314

$20,725,082

$41,030,126



Q1 2012

$47,541,686

$37,467,649

$21,391,171

$31,465,208



Q2 2012

$9,884,263

$75,990

$46,217,031

$56,025,304



(4)

The Litigation

[17]

The putative class action was for all purchasers of SGR shares between
    March 30, 2011 and November 17, 2013. The parties agreed that certification
    should await the determination of the issue of leave under the
SA
.

[18]

On the motion for leave, SGR and the Individual Respondents took a very
    unusual position. They relied on the defence of reasonable investigative
    efforts afforded to them by s. 138.4(6)(a) of the
SA
. In support of
    that defence, they submitted that the financial statements during the class
    period did not need to be restated and that SGR had no material weaknesses in its
    internal financial reporting controls. They tendered affidavit evidence that
    the restatement was undertaken not because of any securities law requirement,
    but due to pressure from TQR, PwC and the United States Securities Exchange
    Commission (SEC). They said that in the summer of 2013, the SEC reviewed
    TQRs consolidated financial statements and challenged SGRs earlier revenue
    recognition decisions relating to the bill and hold agreements because they
    were not GAAP-compliant. Rio Tinto, TQR and PwC defended those decisions based
    on their compliance with IFRS. The SEC nevertheless stated that it would not
    approve TRQs third quarter financials unless SGRs bill and hold revenues were
    restated. Significantly, TRQ required this approval to complete a rights
    offering financing venture being planned for November 2013. Under pressure from
    the SEC, TRQ therefore asked SGR to provide the requested restatement in early
    November 2013.

[19]

The motion judge described the situation as follows, at para. 15 of his
    reasons:

The uncontroverted evidence of the defendant directors is that
    SGR reluctantly agreed to restate the 2010 to 2012 financials for three
    reasons: one, to accommodate TQRs dispute with the SEC and allow TQR to
    conclude its rights offering financing; two, to itself avoid default on a
    convertible debenture held by the Chinese Investment Corporation by making a
    required interest payment that depended on financial support from TQR, who would
    only fund the companys operations if SGRs earlier financials were restated;
    and three, because PwC was now taking the position, despite agreeing in 2012
    that no restatements were necessary, that it would not approve SGRs 3Q2013
    financials unless the earlier financials were restated.

[20]

In other words, the Individual Respondents position was that there was
    no misrepresentation during the class period; rather, any potential
    misrepresentation was in the Restatement and/or the November 14 Press Release.

[21]

With respect to the reference in the press release announcing the
    Restatement that SGRs earlier financial statements were no longer accurate
    and should not be relied upon, Lebel, Lancaster and Deepwell swore nearly
    identical affidavits saying that they did not mean to convey that the earlier financial
    statements contained any misrepresentation of revenue. Rather, they asserted
    that the reference to the inaccuracy and unreliability of the earlier financial
    statements flowed,
ipso facto
, from the restatement decision itself.

(5)

The Motion Judges Reasons

[22]

At the first stage of his analysis, the motion judge concluded that the
    misrepresentation claim should proceed because it had a reasonable possibility
    of success. In so concluding, he highlighted the explicit language in the
    Restatement to the effect that SGRs earlier revenue reports were deficient and
    should not be relied on (see para. 38), as well as SGRs statements about deficiencies
    in its earlier revenue reports in the November 14 Press Release.

[23]

The motion judge then turned to the issue of the reasonable
    investigation defence. He did not grant leave as against the Individual
    Respondents because he held that there was no reasonable possibility that they
    would not be able to establish a reasonable investigation defence at trial
    under the
SA
.

[24]

With respect to Krepiakevich and OKane, the motion judge found that
    their uncontroverted evidence was that they carefully analyzed IFRS standards
    against all of the bill and hold contracts created during their respective
    tenures and concluded that the IFRS criteria were properly applied to them. The
    motion judge referred to the factors for the court to consider in determining
    whether there was a possibility that they could succeed on a reasonable
    investigation defence set out in s. 138.4(7) of the
SA
. He held that,
    because the two CFOs had impressive accounting credentials and experience with
    the IFRS standards, their knowledge and experience favoured their defence, as
    did their reasonable reliance on the opinions of the companys auditors,
    Deloitte and PwC.

[25]

With respect to Deepwell, Lebel and Lancaster, the motion judge noted
    that they were on the Board of Directors of SGR in November 2013 during the Restatement
    and the November 14 Press Release. He stated that SGRs admission that its
    prior financials were deficient was inconsistent with a reasonable
    investigation defence. However, he observed that the November 14 Press Release
    was never put to the Board of Directors before being released and was drafted
    exclusively by SGR management. Therefore, he stated at para. 56, there is no
    linkage between the three defendant directors and the reference in the November
    14 news release about a weakness in internal financial reporting controls.

[26]

The motion judge stated that these parties provided credible and
    unchallenged evidence establishing their reasonable investigation defences.
    Deepwell reviewed the opinions of the audit committee and presented them to the
    board. His actions in doing so showed an appropriate degree of attention to the
    reporting of revenue and, in particular, to the reporting of the bill and hold
    contract revenue over the time periods in question. Lebel testified that the Board
    of Directors never had any reasonable grounds to believe that its earlier
    financial statements were untrue. His evidence of what corporate governance and
    accounting procedures were used by SGR was not undermined by cross-examination.
    Lancaster testified that all revenue recognition decisions in respect of the
    bill and hold contracts were only made after review and approval by the
    auditors.

[27]

The motion judge concluded at para. 62:

The defendants evidence taken as a whole shows that the
    individual defendants were fully alive to the bill and hold issues. There were
    visits to Mongolia by the CFO, the audit committee and board, and the external
    auditors. There was thoughtful preparation, review and approval of audit plans
    and draft financial statements and the correction and adjustment of these
    statements as and when needed. I am satisfied on the evidence before me that
    nothing more could have been done by the two CFOs or the three defendant
    directors to ensure the legitimacy and accuracy of the financial representations
    at issue.

[28]

With respect to SGR, the motion judge held that there was a reasonable
    possibility that it would not establish a reasonable investigation defence at
    trial. According to the motion judge, the fact that SGR had issued the
    Restatement was arguably inconsistent with a reasonable investigation defence.
    The Restatement amounted to an acknowledgment of a prior error in a financial
    statement as defined under the IFRS, being an error arising from a failure to
    use or the misuse of reliable information that was available at the time that
    the relevant financial statements were issued, and that could reasonably have
    been expected to be obtained and taken into account in the preparation of those
    financial statements. A prior error thus defined is inconsistent with the
    possibility of a reasonable investigation.

[29]

The motion judge also relied on the fact SGR management announced a
    material weakness in the companys internal financial reporting controls in the
    November 14 Press Release. This admission was found to be inconsistent with the
    companys having performed a reasonable investigation in relation to the
    subject of the alleged misrepresentations.

[30]

Finally, the motion judge noted that there was no evidence from any
    member of SGR management who was in place at the time of the Restatement or the
    November 14 Press Release about the weaknesses in SGRs internal
    revenue-reporting controls to explain why management said what it said.

[31]

Rahimi appeals the motion judges decision on the ground that leave to
    pursue the misrepresentation claim should have been granted in respect of the
    Individual Respondents.  SGR appeals on the ground that leave should have been
    denied as against SGR.

[32]

On its motion for leave to appeal in the Divisional Court, SGR took the
    position that the doctrine of corporate identification merges the mental state
    of the responsible individual within a corporation with that of the corporation
    itself. In short, it submitted that there cannot be a finding that SGR is
    culpable while the individual respondents are exonerated. The Divisional Court
    granted leave to appeal to SGR, finding that there was reason to doubt the
    correctness of the motion judges decision based on the corporate
    identification doctrine.

C.

Issues

[33]

The appeals raise two issues for determination: (i) did the motion judge
    err in denying leave on the claim against the Individual Respondents?; and (ii)
    did the motion judge err in granting leave on the claim against SGR? Below, I
    answer the first issue in the affirmative and the second issue in the negative.

[34]

In summary, with respect to the Individual Respondents, the primary
    error made by the motion judge was treating the leave motion as if it were a
    trial in which he had to finally resolve significant credibility issues on the
    record before him. The motion judge failed to give meaningful consideration to
    gaps in the evidentiary record and the significant credibility issues apparent
    from that record. In particular, he failed to consider compelling evidence that
    contradicted the defence narrative offered by SGR and the Individual
    Respondents on the leave motion. The decision of the motion judge to deny leave
    to as against the Individual Respondents was also inconsistent with fundamental
    policy imperatives that animate securities regulation. With respect to the
    claim against SGR, the motion judge made no error in determining that there was
    no certainty at this stage that SGR's reasonable investigation defence would
    succeed at trial.

D.

Analysis

(1)

Legal Principles

[35]

Before considering the issues in these appeals, it is helpful to review
    the legal principles applicable to leave motions under the
SA
.

[36]

Part XXIII.1 of the
SA
creates a regime governing civil liability
    for misrepresentation on the secondary securities market. Section 138.3 creates
    a cause of action for misrepresentation, but s. 138.8 requires the plaintiff to
    first obtain leave of the court to commence the action. Subsections (1)-(3) of
    s. 138.8 provide:

(1) No action may be commenced under section 138.3
    without leave of the court granted upon motion with notice to each
    defendant.  The court shall grant leave only where it is satisfied that,

(a) the action is being brought in good faith; and

(b) there is a reasonable possibility that the
    action will be resolved at trial in favour of the plaintiff.

(2) Upon an application under this section, the
    plaintiff and each defendant shall serve and file one or more affidavits
    setting forth the material facts upon which each intends to rely.

(3) The maker of such an affidavit may be examined on
    it in accordance with the rules of court.

[37]

The Supreme Court of Canada addressed the proper interpretation and
    application of s. 138.3(1) in
Canadian Imperial Bank of Commerce v. Green
,
    2015 SCC 60, [2015] 3 S.C.R. 60. It adopted the same interpretation it
    previously gave to the virtually identical s. 225.4 of Quebecs
Securities
    Act
, C.Q.L.R., c. V-1.1, in
Theratechnologies Inc. v. 121851 Canada Inc.
,
    2015 SCC 18, [2015] 2 S.C.R. 106.

[38]

These cases establish that for there to be a reasonable possibility that
    a misrepresentation action will be resolved at trial in favour of the plaintiff
    under s. 138.8(1)(b), there must be a reasonable or realistic chance that it
    will succeed, and the plaintiff must offer both a plausible analysis of the
    applicable legislative provisions, and some credible evidence in support of the
    claim:
Green
, at para. 121. The plaintiff must adduce sufficient
    evidence to persuade the court that there is a reasonable possibility that the
    action will be resolved in the [plaintiffs] favour:
Theratechnologies
,
    at para. 39.

[39]

The civil liability regime in Part XXII.1 of the
SA
was enacted
    in 2002 following a series of high profile misrepresentations and questionable
    disclosure practices among publicly traded companies in Canada during the
    1990s. Regulatory sanctions available at the time were perceived as inadequate
    deterrents for these wrongs. Common law remedies for negligent
    misrepresentation  which required investors to prove detrimental reliance on
    an alleged misrepresentation  were perceived as too onerous for a legal
    proceeding to be feasible. Accordingly, the Part XXII.1 regime was designed to
    provide more effective deterrence for wrongful conduct on the part of
    corporations by making it easier for investors to obtain compensation for
    misrepresentations, who are not required to prove detrimental reliance under
    the regime: see
Theratechnologies
, at paras. 28-29, 33; and
Green
,
    at paras. 63-65.

[40]

The leave requirement in s. 138.8 was added in response to a concern
    that a lack of safeguards in the Part XXII.1 regime would unfairly expose
    securities issuers and long-term shareholders to the volatility of share prices
    engendered by unmeritorious, frivolous, and costly secondary market
    misrepresentation claims:
Goldsmith v. National Bank of Canada
, 2016
    ONCA 22, 128 O.R. (3d) 481, at para. 27. U.S.-style strike suits, or
    meritless actions launched in order to coerce targeted defendants into unjust
    settlements, undermine the integrity of Ontarios capital markets:
Green
,
    at paras. 67-68. The leave requirement is therefore intended to function as a
    screening mechanism so that only actions that have a reasonable possibility
    of success are permitted to proceed and unmeritorious litigation, and the time
    and expense it imposes on defendants, is avoided or brought to an end early in
    the litigation process:
Theratechnologies
, at paras. 30 and 38.

[41]

In light of these policy objectives, the statutory cause of action in
    the Part XXII.1 regime balances provisions that facilitate a plaintiffs
    remedy, such as deemed reliance on the misrepresentation, against protections
    for defendants, including the leave requirement and the reasonable
    investigation defence:
Theratechnologies
, at para. 179; and
Drywall
    Acoustic Lathing and Insulation, Local 675 Pension Fund (Trustees of) v.
    SNC-Lavalin Group Inc
., 2015 ONCA 718, 340 O.A.C. 271, at para. 49.

[42]

The reasonable investigation defence is contained in ss. 138.3(6) and
    (7):

(6) A person or company is not liable in an action
    under section 138.3 in relation to,

(a) a misrepresentation if that person or company
    proves that,

(i) before the release
    of the document or the making of the public oral statement containing the
    misrepresentation, the person or company conducted or caused to be conducted a
    reasonable investigation, and

(ii) at the time of
    the release of the document or the making of the public oral statement, the
    person or company had no reasonable grounds to believe that the document or
    public oral statement contained the misrepresentation; or



(7) In determining whether an investigation was
    reasonable under subsection (6)  the court shall consider all relevant
    circumstances, including,

(a) the nature of the responsible issuer;

(b) the knowledge, experience and function of the person
    or company;

(c) the office held, if the person was an officer;

(d) the presence or absence of another
    relationship with the responsible issuer, if the person was a director;

(e) the existence, if any, and the nature of any
    system designed to ensure that the responsible issuer meets its continuous
    disclosure obligations;

(f) the reasonableness of reliance by the person
    or company on the responsible issuers disclosure compliance system and on the
    responsible issuers officers, employees and others whose duties would in the
    ordinary course have given them knowledge of the relevant facts;

(g) the period within which disclosure was
    required to be made under the applicable law;

(h) in respect of a report, statement or opinion
    of an expert, any professional standards applicable to the expert;

(i) the extent to which the person or company
    knew, or should reasonably have known, the content and medium of dissemination
    of the document or public oral statement;

(j) in the case of a misrepresentation, the role
    and responsibility of the person or company in the preparation and release of
    the document or the making of the public oral statement containing the
    misrepresentation or the ascertaining of the facts contained in that document
    or public oral statement; and

(k) in the case of a failure to make timely
    disclosure, the role and responsibility of the person or company involved in a
    decision not to disclose the material change.

[43]

In
Gould v. Western Coal Corp.
, 2012 ONSC 5184, 7 B.L.R. (5th)
    19, at para. 267, Strathy J. (as he then was) stated that the reasonable
    investigation defence has two requirements: (1) the defendant must have
    conducted a reasonable investigation or caused such an investigation to be conducted;
    and (2) the defendant had no reasonable grounds to believe that the defective
    public document contained a misrepresentation.

[44]

The operation of the reasonable investigation defence under s.
    138.3(6)(a), in the context of a motion for leave to commence a
    misrepresentation action, was not before the Supreme Court in either
Theratechnologies
or
Green
. In its own decision in
Green
(2014 ONCA 90, 118
    O.R. (3d) 641, at para. 94), this court endorsed the test Strathy J adopted for
    determining whether to grant leave to a plaintiff under s. 138.8 where the
    defendant asserts a defence of reasonable investigation. The test asks whether there
    is a reasonable possibility that the defendant will not be able to establish
    one or more of the branches of the reasonable investigation defence at trial.

[45]

There is, therefore, an underlying balancing inherent in the legal
    standard for obtaining leave to pursue the secondary market misrepresentation cause
    of action created by Part XXII.1 of the
SA
. On the one hand, the standard
    is designed to provide aggrieved investors with an effective remedy. On the
    other hand, issuers must be protected from unmeritorious claims and frivolous
    strike suits. A motion judge hearing a leave application must balance these
    competing policy imperatives. She must vigilantly implement the screening
    mechanism of the leave requirement under s. 138.8 while at the same ensuring that
    the secondary market remedy is not rendered illusory through the elimination of
    potentially meritorious claims.

[46]

Although this is a relatively new cause of action, the case law provides
    guidance on how the motion judge is to discharge these competing duties. The court
    must undertake a reasoned consideration of the evidence to ensure that the
    action has some merit:
Theratechnologies
, at para. 38. This must
    include some weighing of the evidence that both parties are required to proffer
    under ss. 138.8(2) and (3) and scrutiny of the entire body of evidence, not
    just the evidence of the plaintiff viewed in isolation. To achieve the
    objective of the leave requirement,

the motion judge must do more than simply ascertain whether the
    plaintiff has presented evidence of a triable issue. Instead, the motion judge
    must review all the evidence adduced by both parties to ascertain whether there
    is a reasonable or realistic chance that the action will succeed.

Mask v. Silvercorp Metals Inc.
, 2016 ONCA
    641, 132 O.R. (3d) 161, at para. 43.

[47]

The balancing exercise was described by Abella J. in
Theratechnologies

at para. 39:

A case with a reasonable possibility of success requires the
    claimant to offer both a plausible analysis of the applicable legislative
    provisions, and some credible evidence in support of the claim. This approach,
    in my view, best realizes the legislative intent of the screening mechanism: to
    ensure that cases with little chance of success  and the time and expense they
    impose  are avoided. I agree with the Court of Appeal, however, that the
    authorization stage under

s.
    225.4

should not be treated as a
    mini-trial. A full analysis of the evidence is unnecessary.  If the goal
    of the screening mechanism is to prevent costly strike suits and litigation
    with little chance of success, it follows that the evidentiary requirements
    should not be so onerous as to essentially replicate the demands of a trial. To
    impose such a requirement would undermine the objective of the screening
    mechanism, which is to protect reporting issuers from unsubstantiated strike
    suits and costly unmeritorious litigation. What

is

required
    is sufficient evidence to persuade the court that there is a reasonable
    possibility that the action will be resolved in the claimants favour.

[48]

To be clear, the motion judges duty to scrutinize the entire record is
    not restricted to a review of the evidence filed on the motion. The motion
    judge is also obligated to consider what evidence is
not
before her. She
    must be cognizant of the fact that, at the leave stage, full production has not
    been made and the defendant may have relevant documentation that has not been produced
    or relevant evidence that has not been tendered. Consideration of these
    evidential limitations of the leave stage is important because they can work to
    the prejudice of plaintiffs who have potentially meritorious claims.

[49]

Equally important is the requirement that the motion judge thoroughly
    examine the state of the evidence to determine whether there are contentious
    issues of credibility that impact on the decision whether to grant leave. Where
    such credibility issues are extant, the motion judge must ask herself whether
    they can be resolved on the existing record.

[50]

In the present case, the motion judge found that Rahimi had established
    a
prima facie
case in his misrepresentation claim. The real issue was
    whether there was a reasonable possibility that SGR and the Individual
    Respondents will not be able to establish one or more of the branches of the
    reasonable investigation defence at trial. In the face of the limited record
    and significant credibility issues, the proper course for the motion judge was
    not to do the best he could on the available record, treating the motion as if
    it were a mini-trial. Rather, the lack of a clear record makes evident that the
    leave must be granted because there is no certainty that the reasonable
    investigation defence will succeed.

(2)

Reasonable Investigation Defence of the Individual Respondents

[51]

With respect, I am of the view that the motion judge erred in law in
    treating the motion as a mini-trial in which his function was to determine
    contentious issues of credibility. He compounded that error by conducting a
    review of the credibility issues that failed to properly consider the gaps in
    the evidence and the evidence that conflicts with the contents of the
    affidavits filed on the leave motion. In particular, he failed to take into
    account the following issues.

[52]

First, nowhere in the documents produced by SGR and the Individual
    Respondents is there any contemporaneous document that is consistent with the Individual
    Respondents current narrative that they objected to the Restatement and  were
    of the view that the November 14 Press Release was inaccurate.

[53]

To the contrary, the minutes of a conference call meeting of the SGR Board
    of Directors held the day before the Restatement show that the management of SGR
    approved the Restatement with the full support of the Board of Directors. There
    is no indication of any objection to the Restatement and no reference to a
    belief among the Individual Respondents and\or SGR that a restatement was
    unnecessary. There is also no reference in any of the documents produced by SGR
    from that time that the Individual Respondents objected to the statements made
    regarding internal revenue recognition controls in the November 14 Press
    Release.

[54]

Similarly, two PwC reports to SGRs audit committee on the Restatement
    process, dated November 13, 2013 and December 6, 2013, do not contain any
    indication that the Individual Respondents or SGR were reluctantly agreeing to
    the Restatement. Nor do the reports evidence any dissention on the part of the
    Individual Respondents regarding the contents of the November 14 Press Release.

[55]

The only time the Individual Respondents narrative is articulated is in
    the affidavits filed in response to the leave motion. The lack of
    contemporaneous evidence consistent with the central component of the defence
    asserted by SGR and the Individual Respondents raises a serious credibility
    issue. The motion judge never averted to this issue in his analysis.

[56]

Second, the failure to correct or clarify raises another important
    credibility issue. The Individual Respondents take the position that the
    November 14 Press Release is false because there were never any material
    weaknesses in SGRs internal revenue reporting controls. Yet, the concession of
    these weakness by SGR in the Press Release is significant. The information was
    disclosed because SGR deemed it material. If it were false information, as the
    Individual Respondents now assert, SGR and those Individual Respondents still
    employed by it had an obligation to take steps to have SGR correct that false
    information. That was not done by SGR, and there is no evidence that any of the
    Individual Respondents sought such a correction.

[57]

With respect to the Restatement itself, the Individual Respondents
    reinterpretation of what appear to be clear words in the accompanying press
    release seems at first blush to be inconsistent with a duty of plain and frank disclosure:
    see
Cornish v. Ontario (Securities Commission)
, 2013 ONSC 1310, 306
    O.A.C. 107 (Div. Ct.), at paras. 38-40, cited in
Theratechnologies
, at
    paras. 25-26. Recall that the press release announcing the Restatement stated
    that the relevant financial statements could not be relied upon and were to be
    restated. Those words would suggest that there was a problem with the previous
    statements. Nowhere in the press release was there any suggestion that the
    financial statements were reliable and that the Restatement was being made for
    other reasons.

[58]

But even accepting the interpretation that the Individual Respondents
    now give to the words used in the press release, there would still be an obligation
    to clarify them. The Individual Respondents are now suggesting that the words
    used by SGR to explain the Restatement are to be interpreted
in a manner that would appear to be inconsistent with
    their plain meaning. In those circumstances, SGR had an obligation to clarify
    what it really meant. Again, that was not done and there is no evidence that
    the Individual Respondents took steps to make that happen.

[59]

There would appear to be an available inference on these facts that no correction
    to the public record was made because the position now taken by the Individual
    Respondents is not truthful. That inference could certainly be rebutted at
    trial, but on the face of the record on the leave motion it could not be definitively
    resolved. Again, the motion judge failed to avert to this significant
    credibility issue in his analysis.

[60]

Third, the Individual Respondents all attach significant importance to
    the fact that at the relevant points throughout the class period they relied on
    the advice of SGRs external auditors, being first Deloitte and later PWC.
    However, there is no affidavit evidence filed by Deloitte or PWC. It is,
    therefore, not possible on this record for Rahimi to meaningfully challenge the
    reliance argument made or to probe the specific instructions and corresponding
    advice between SGR and its auditors.

[61]

Fourth, in their affidavits filed on the leave motion, the Individual Respondents
    assert that one of the primary reasons for the Restatement was that the SEC
    required that revenue be reported in accordance with GAAP. In other words, it
    is not that there was an error in revenue recognition under IFRS; the change
    was made because GAAP was thrust upon them and they had no choice but to accept
    it.

[62]

This position is not consistent with what is disclosed in the Board of
    Directors minutes from the meetings that took place at the time of the
    Restatement. There is no reference to a move to GAAP, much less a forced move.

[63]

Similarly, in PwCs November 13, 2013 and December 6, 2013 reports to SGRs
    audit committee, there is no reference to GAAP. Instead, as stated in the
    December 6, 2013 report, PwC reported that [m]anagement has reviewed its
    historical revenue recognition approach and concluded that it is not
    appropriate under IFRS. Later in the same report, PwC stated that they had assessed
    whether the adjustments have been accounted for and disclosed in accordance
    with IFRS standards on correction of errors.

[64]

An expert accounting report prepared by Stuart Harden and filed by
    Rahimi on the leave motion also casts doubt on the Individual Respondents
    explanation of the Restatement based on a forced changeover to GAAP. The report
    states:

No mention, in either the required disclosures
    regarding the nature of the restatement or the Independent Auditors Reports of
    either PwC or Deloitte, is made of a change in accounting principle, either
    mandated by IFRS, or voluntarily adopted by the company. In fact, the required
    disclosures and Independent Auditors Reports refer to corrections and
    errors.

I understand from the affidavits and exhibits
    I have read that the United States Securities and Exchange Commission raised
    issues with the Companys parent and grandparent, each of which prepared their
    consolidated financial statements in accordance with USGAAP, about the revenue
    recognition policies applied at SouthGobi.

If the Companys restatement was required for
    the sole purpose of reporting revenue retrospectively on the basis of USGAAP
    consistent with the parent and grandparent, the restatement would have been
    identified as a voluntary change in accounting principle and the disclosures
    and auditors opinions would have noted that the Companys restated
    consolidated financial statements were fairly stated in accordance with the
    IFRS
except for
the recording of revenue in
    accordance with USGAAP. This was not the case.

Accordingly, I conclude that the recognition
    of revenue at the time that coal was loaded onto customers trucks during the
    restatement period (fourth quarter of 2010 through the second quarter of 2012)
    was determined by the company, and the companys auditors, to be the
    appropriate policy in accordance with IFRS and, therefore, the restatement was
    identified as a correction of an error and not a change in accounting
    principle.

The Company could have, if permitted under its
    regulatory requirements, adopted USGAAP in its entirety by retrospective
    restatement. Similarly, if permitted under their regulatory requirements, the
    parent and grandparent could have reported the Companys revenue in accordance
    with USGAAP with explanation that the Companys separate reporting was in
    accordance with IFRS and disclosed the magnitude of the differences. Both of
    these options would be consistent with the notion that revenue recognition
    principles under USGAAP and IFRS, when applied to the Companys transactions,
    result in different answers. However, the reporting methodology adopted by the
    Company (i.e. restatement due to errors) is not consistent with that notion but
    rather the notion that revenue recognition principles for USGAAP and IFRS, when
    applied to the Companys transactions, produce similar results.

[65]

This is expert evidence that directly calls into to question the
    veracity of the position taken by the Individual Respondents that a forced move
    to GAAP was a prime factor behind the Restatement. There is also no mention of
    such a forced move in the expert accounting report prepared by Michael Garvey
    and filed by the respondents on the leave motion. This, too, casts doubt on the
    evidence relied upon by the motion judge.

[66]

There is a further problem with the motion judges treatment of
    the expert testimony I have just described. He found that it was unnecessary to
    consider the expert evidence filed by the parties because their evidence was a
    matter of common sense. With respect, understanding the process leading up to
    the Restatement is not a matter of common sense. It requires consideration the
    specific language used in the Restatement, as well as the accounting principles
    regarding when such restatements are necessary and how they are to be carried
    out. The motion judge erred in not taking this evidence into account.

[67]

Counsel for SGR and the Individual Respondents take the position that
    whatever is said in the Restatement and the November 14 Press Release is only
    relevant to whether the financial statements contained a misrepresentation. He
    argued that the Restatement and the November 14 Press Release are irrelevant to
    the defence of reasonable investigation.

[68]

I disagree. When a corporation says in its continuous disclosure that
    its financial statements cannot be relied upon and that there is a material
    weakness in its internal financial reporting controls, this is powerful
    evidence that strongly contradicts a defence of reasonable investigation. The
    evidence is relevant not only to the directors and officers who were involved
    in the Restatement, but also to the directors and officers who were involved
    earlier in the class period. This is because the Restatement and the November
    14 Press Release are evidence that the financial statements were unreliable
    throughout the class period, thereby calling into question the reasonableness
    of the investigation by all of the Individual Respondents.

[69]

To the extent the motion judge considered the discrepancy between the disclosure
    in November 2013 and the Individual Respondents current narrative at all, he
    distinguished between SGR and the Individual Respondents on the basis that the
    November 14 Press Release was prepared by management and the Individual
    Respondents had no involvement in its preparation. This distinction is
    problematic for three reasons.

[70]

First, prior to the issuance of the November 14 Press Release, SGR had
    repeatedly represented to the market that its internal financial reporting
    controls were adequate. If, as the Individual Respondents would now have us
    believe, the information in the November 14 Press Release was false, they had
    an obligation to correct that false information. As discussed above, the fact that
    the Individual Respondents failed to correct what they now say was false
    material information raises a serious unresolved credibility issue.

[71]

Second, the documentary evidence is clear that Lebel, Deepwell and
    Lancaster were intimately involved in the Restatement process. It is evident
    from the Board of Directors minutes from the meeting the day before the
    Restatement that both management and the Board of Directors were devoting a great
    deal of time to managing this issue and were working closely with the auditors
    and external legal counsel as part of that process. The suggestion that
    management issued the November 14 Press Release without audit committee approval
    would appear to be inconsistent with the crisis management process reflected in
    the Board of Directors minutes. While it may be that the members of the audit
    committee had no involvement in the issuance of the November 14 Press Release,
    at this stage it is impossible to be certain; as the motion judge found, there was
    no evidence from any member of SGR management who was in place at the time of
    the November 14 Press Release to explain why management said what it said.

[72]

Third, focussing on who issued the November 14 Press Release misses the
    point. It is the content of the release that is important. The release
    contained a significant admission of a major problem with the companys
    previous internal revenue-reporting controls. If true, this evidence would
    appear to be inconsistent with a reasonable investigation defence on behalf of
both
SGR and the Individual Respondents.

[73]

In any event, the Individual Respondents do not assert that they are in
    a different position than SGR. To the contrary, their mutual counsel submits
    that they are indistinguishable and that there is no legal difference between
    the actions of the Individual Respondents and SGR.

[74]

I also agree with Rahimis submission that the factors relied upon by
    the motion judge as militating in favour of granting leave to proceed against SGR
     a failure to use or the misuse of reliable available information, the
    admission of compromised
internal
    financial reporting controls and the lack of explanation from management about
    the restatement 
are equally applicable on the issue of leave to
    proceed as against the Individual Respondents.

[75]

In summary, this was not a case where there was truly uncontroverted
    evidence adduced by a defendant in support of a reasonable investigation
    defence. This was a case where there was conflicting evidence emanating from SGR
    on that key issue for determination. The motion judge erred in accepting the
    denials asserted by the Individual Respondents without considering the lack of
    production, the absence of evidence from PWC and Deloitte and the unqualified
    statements made in the Restatement and the November 14 Press Release. In coming
    to these unwarranted evidentiary conclusions regarding the credibility of the
    Individual Respondents as if the leave stage constitutes a mini-trial, the
    motion judge failed to properly implement the screening mechanism of the leave
    requirement in s. 138.8 of the
SA
by foreclosing a misrepresentation
    claim that has a reasonable possibility of success. The residual credibility
    problems with the Individual Respondents central defence, which could only be
    determined at trial, meant that this was not a case in which the policy
    objective of the leave requirement of protecting defendants from unmeritorious
    claims would be advanced by denying leave to Rahimis claim on the basis of
    that defence.

(3)

Reasonable Investigation Defence of the Individual Respondents

[76]

The next issue for determination is whether the motion judge erred in
    granting leave to Rahimi to pursue his claim as against SGR.

[77]

For the reasons given above, I am of the view that the
    motion judge did not err in granting leave as against SGR. This is a case
    filled with credibility issues and gaps in the evidentiary record. It is not
    possible on this record to be satisfied that there is no reasonable possibility
    that SGR would not be able to succeed on a defence of reasonable investigation
    under s. 138.4(6)(a) of the
SA.

(4)

Public Policy

[78]

There is a further and, in my view, more troubling flaw in the motion
    judges reasons, which arises from the very unusual facts of this case. The
    decision to deny leave as against the Individual Respondents is inconsistent
    with the public policy animating the secondary market cause of action and with
    the fundamental policies underlying securities regulation, including protection
    of the investing public and maintaining the integrity of the capital markets.
    At the heart of the submissions made by SGR and the Individual Respondents is
    the rather remarkable proposition that they should be permitted to evade a
    potentially meritorious action at the leave stage because they previously made
    material misrepresentations during a restatement process about their company
    but they are now telling the truth about the same issue.

[79]

Although one might imagine a situation where a securities issuer who
    released a restatement is permitted to later resile from that restatement, the
    evidence on a leave motion would have to be very strong because the conflicting
    positions raise serious credibility issues. As a necessary first step, the
    issuer would have had to have taken action to correct the restatement that they
    are resiling from. SGR has not done so. Instead, we have a situation where its disclosure
    documents tell one story and their court filings tell an opposite story. They
    cannot have it both ways.

[80]

Continuous disclosure is at the heart of securities regulation and must
    be scrupulously accurate and fair. There is no room for prevarication or
    double-talk. The importance of continuous disclosure was recognized by Abella
    J. in
Theratechnologies
at paras. 25-26:

Both periodic and timely disclosure obligations are designed to
    increase fairness in the secondary market:

[Continuous disclosure]  is designed to create a level
    playing field where all investors have access to the same information and all
    pricing and investment decisions are made from the same starting point. Of
    course, investors may still value securities differently, depending on how they
    interpret that information. Different investors have different goals, typically
    balanced between risk and return. Riskier investments generally yield higher
    returns, and vice versa. Securities regulation
does
not tell investors what to do, nor steer them toward or away from particular
    investments. It should, however, ensure that they have enough information to
    assess properly the risks involved and make fully informed decisions. [Footnote
    omitted; Johnston, Rockwell and Ford, at p. 249.]

As a result, the policy of ensuring this level playing field
    reified in statutory continuous disclosure obligations has been called the
    most fundamental principle of securities regulation:

Cartaway
    Resources Corp.
(Re)
, [2000] B.C.S.C.D. No. 92 (QL), at para.
    216;

Cornish
    v. Ontario Securities Commission

(2013), 2013 ONSC 1310 (CanLII),

306 O.A.C. 107 (S.C.J.)
, at para. 40
.

Disclosure also supports capital market efficiency by helping
    investors target the most deserving securities and enhancing the accountability
    of corporate management:

Cornish
,

at
    para. 40. As investors realize that they have the necessary information, they
    become more confident in the securities market, and their consequent increased
    participation leads to more efficient markets: Johnston, Rockwell and
    Ford, at p. 249.

[81]

Continuous disclosure obligations are not a shell game where investors
    are left to guess where the truth lies. Investors have a right to know a
    corporations true state of affairs. In my view, the motion judge failed to
    consider this policy imperative and rendered a decision with respect to the
    Individual Respondents that is inconsistent with basic notions of securities
    regulation. The discrepancy between the position asserted in this litigation
    and the position taken in the Restatement and the November 14 Press Release is
    so jarring that the motion judge should not have refused to grant leave to
    proceed against any of the respondents.

E.

disposition

[82]

I would allow the Rahimi Appeal, set aside that part of the motion
    judges order denying leave to proceed against the Individual Respondents, make
    an order granting leave to proceed against the Individual Respondents and grant
    Rahimi leave to file a statement of claim in the form attached as Schedule A
    to his notice of appeal. I would dismiss the Corporation Appeal.

[83]

The parties may make written submissions on the issue of the costs of
    the appeals and the leave to appeal motion in the Divisional Court.

Released: G.E. September 18, 2017

C.W. Hourigan J.A.

I agree. Gloria Epstein
    J.A.

I agree. David M. Paciocco
    J.A





[1]

Molyneux is a former CEO of SGR who lives in Taiwan. The
    action at issue in these appeals as against him has been adjourned until he has
    been properly served under the rules of private international law. Deloitte LPP
    served as an auditor for SGR for a period of time captured in these appeals.
    The action against it has been settled.



[2]
Because that ruling was interlocutory, it was only properly appealable to the
    Divisional Court with leave. Stewart J. granted leave in a decision dated May
    24, 2016: see 2016 ONSC 1634 (Div. Ct.). On September 12, 2016, this court
    ordered the Corporation Appeal to be heard together with the Rahimi Appeal, on
    consent of the parties, pursuant to ss. 6(2) and (3) of the
Courts of
    Justice Act
, R.S.O. 1990, c. C.43.


