On August 7, a three-member panel of the British Columbia Securities Commission unanimously dismissed allegations that Canaco Resources Inc. and four of its directors contravened the B.C. Securities Act by failing to immediately disclose positive drill results emanating from the company’s marquee property.
Canaco was a TSX-V issuer with a property in Tanzania known as Magambazi on which it had made a gold discovery. On December 3, 2010, its board issued a significant number of options to directors and management. At the time of those grants, the company had in its possession undisclosed drill results from eight drill holes. In internal emails, the directors described the results as “just beautiful, “spectacular” and “fantastic news”.
Canaco disclosed the drill results in three separate news releases on December 6, 9 and 22, 2010 (that is, after the option grants). Two of those news releases described the drill results as “spectacular”. On each of the three days that the drill results were announced, the stock price rose. On two of those days, the price increases were significant. The TSX-V subsequently ordered the company to re-price the options to reflect the (much higher) market price following dissemination of the news releases.
The Notice of Hearing alleged that the Respondents breached s. 85 of the Securities Act by failing to disclose the drill results immediately and that the directors acted contrary to the best interests of Canaco by issuing themselves stock options with knowledge of the undisclosed drill results.
The Notice of Hearing characterized the drill results as “material facts or material changes that would reasonably have been expected to have had, and did have, a significant effect on the market price or value of Canaco’s shares.” The core of the executive director’s case was that the favorable characterizations of the drill results in the directors’ emails and in the news releases, as well as the market price spikes on the days the drill results were disclosed, demonstrated that the drill results were material. In addition, the Notice of Hearing alleged that the Respondents attempted to maintain an elevated stock price by staggering the disclosure of the drill results.
The Respondents, meanwhile, claimed that the drill results were not material, since the drill results came from holes drilled within the then-known and publicly-disclosed boundaries of the Magambazi deposit. Accordingly, all of the drill results were from “infill” holes.
Ultimately, the executive director’s case turned on whether the drill results were material. Based on detailed evidence from management and two independent experts, the BCSC panel concluded that the drill results did not significantly change the tonnage, grade or value of the deposit and were, therefore, not material.
In reaching its conclusion, the panel made a number of findings that will be of particular interest to issuers and their professional advisers.
According to the panel, the materiality test requires issuers to assume that the market is generally efficient. In a generally efficient market, all value-relevant information is quickly reflected in the price of the security. It follows that, in assessing whether a fact would reasonably be expected to affect significantly the value of a security, management is simultaneously answering the question of whether that fact would reasonably be expected significantly to affect the security’s market price.
This finding suggests that management is not required to crystal-ball the stock market and is entitled instead to focus on whether the undisclosed fact changes the value of the business. That judgment will generally be within management’s area of expertise, thus reducing the risk of making materiality judgments. However, a note of caution: the panel dealt with the market price question separately, as though the question were not foreclosed by the required assumption of market efficiency. This apparent dissonance in the reasons will have to be worked out in a future case.
The panel also found that a Commission review of disclosure decisions is to be made without the benefit of hindsight: actual market movements following disclosure are irrelevant (tellingly, the BCSC’s reasons make no mention of the price changes on the days the news releases were disseminated). This finding is a break from prior Securities Commission decisions in B.C. and elsewhere, which permitted the use of hindsight to “corroborate” conclusions reached on the basis of other evidence. As such, this finding further reduces the risk of making materiality judgments.
Characterization of facts
The panel also found that the manner in which an issuer’s management (or others, such as the TSX-V) characterize the allegedly material facts, whether in internal communications or in public disclosures, is irrelevant to the assessment of materiality. The panel’s rejection, in its materiality analysis, of evidence of management’s use of superlatives thus reduces the risk of management becoming ensnared by unguarded internal communications.
Finally, the panel found that an issuer does not violate the Securities Act by staggering the disclosure of non-material information. This finding will give comfort to managements in trying to manage news flow.
The Staff did not base any allegations on the fact that two of the three news releases had characterized the drill results – though infill and non-material – as “spectacular”. Nor did the panel did address that issue.
In future cases of this sort, one might expect the Staff both to challenge the finding in this case that the use of such language is irrelevant, and, in the alternative, to allege that the use of superlatives to describe non-material information is contrary to the public interest. Issuers would be well advised to practice caution in this respect.
Hein Poulus, Q.C. of Stikeman Elliott LLP acted as counsel to Canaco Resources Inc. and Andrew Lee Smith.