governance practices for public and regulated companies. The impetus behind the enhanced
rules for corporate governance is the perceived need to increase corporate accountability and to
provide transparency for shareholders and members of the public with respect to corporate self
dealing. This is part of a trend by legislators, regulators and corporate activists to impose
increased standardization control in all areas of corporate management. For example, the thrust
of the opposition to shareholders rights plans appears to be an assumption that management will
protect its own interests before the interests of shareholders. Although arm's length negotiated
transactions have become complex and often take months to negotiate, corporate activists often
resist attempts by management to spend sixty days garnering competing bids for the company.
Many of the considerations and findings of the Dey Report
1
and the Saucier Report
2
are based
upon an inherent distrust of management. Both reports conclude that mandatory disclosure of
governance standards will ultimately align the interest of management with the interest of
shareholders generally. In the aftermath of the Saucier Report, objective standards are being
introduced to regulate the composition, duties and expected level of oversight required from
Audit Committees.
Prior to the Dey Report, Canada saw many corporate failures of seemingly successful entities. In
the 1960's there was Atlantic Acceptance Corporation. The 1970's brought the failures of The
Canadian Commercial Bank and Northland Bank, National Business Systems and the Principal
Group. In the 1980's we saw the end of the Financial Trustco and other trust companies.
Cineplex Odeon, Livent, Bre-X and YBM are further examples of corporate failures which have
and continue to dot the Canadian corporate landscape in a decade of increased corporate
disclosure. In a paper called "Holding Audit Committees Accountable"
3
, Neil Campbell
reviewed characteristics that were identified as common to most of the financial collapses which
occurred in the 1980's. The characteristics identified by Mr. Campbell were:
• optimistic annual reports
•clean audit opinions
• management effectively dominating the Board of Directors
• passive or ineffective Audit Committees
•aggressive accounting policies and/or financial improprieties
1
"Where were the Directors? Guidelines for Corporate Governance in Canada", Report of the Toronto Stock
Exchange Committee on Corporate Governance in Canada, December 1994 [ hereinafter the Dey Report].
2
"Beyond Compliance: Building a Governance Culture", Report of the Toronto Stock Exchange Joint Committee on
Corporate Governance, November 2001 [hereinafter the Saucier Report].
3
Neil Campbell, “Holding Audit Committees Accountable” (1990)16 C. D. L. J. 134.
Page 3
Page 2
It is the writer's view that the recent statutory and regulatory regimes do not address many of the
fundamental root causes of corporate failures in Canada. In addition, the enhanced risk of legal
liability for Audit Committee members may discourage qualified individuals from serving on
Boards and Audit Committees. This may result in the new rules of the game having the opposite
of their intended effect.
This paper will review the statutory duties of Audit Committees, the differences in approach
taken by various law makers to the obligations of Audit Committees, and the potential impact of
increased regulation and disclosure requirements. The paper will discuss the status of the
implementation of regulatory changes by stock exchanges in Canada and the U.S., the impact of
the regulatory changes on corporate governance and the resulting increased exposure of Audit
Committee members to liability.
STATUTORY OBLIGATION OF AUDIT COMMITTEES
The Ontario Business Corporations Act
4
("OBCA") requires public corporations to have an
Audit Committee composed of not fewer than 3 directors, the majority of whom are not officers
or employees.
5
Non-offering corporations organized under the OBCA are not required to have
an Audit Committee. The only duty imposed upon Audit Committees under the OBCA is the
duty contained in subsection 158 (2) "to review the financial statements of the corporation and
report thereon to the Board of Directors".
The Canada Business Corporations Act
6
("CBCA") contains similar provisions. However, under
subsection 171(6), the CBCA, additional obligations are imposed on all directors and officers of
a CBCA corporation:
"a director or officer of a corporation shall forthwith notify the Audit Committee and the
auditor of any error or misstatement of which the director or officer becomes aware in a financial
statement that the auditor or former auditor has reported on".
Where an error in a financial statement is reported under subsection 171(6), the auditor or former
auditor is required to determine whether or not the error or misstatement is material. In such
circumstances subsection 171(6) does not expressly impose a further duty on the Audit
Committee. However, Section 171(8) of the CBCA imposes a duty on the directors in such
circumstances to prepare and issue revised financial statements or otherwise inform the
shareholders and the Director appointed under the CBCA of the material error or misstatement.
4
R. S. O. 1990, c. B. 16 [hereinafter OBCA].
5
Ibid. at ss. 158(1).
6
R. S. C. 1985, c. C-44 [hereinafter CBCA].
Certain non-offering corporations are subject to similar statutory regimes. For example, the
Federal Trust & Loan Companies Act
7
("LTCA") provides that the directors of a company
governed by the LTCA shall establish an Audit Committee that consists of no less than three
directors. The majority of these directors must not be affiliated with the company and none of
them may be officers or employees of the company or a subsidiary of the company.
8
The Audit Committee's duties are codified in subsection 198(3) of the LTCA and include the
following:
(a)
review the annual statement of the company before the annual statement is
approved by the directors;
(b)
review such returns of the company as the Superintendent may specify;
(c)
require the management of the company to implement and maintain appropriate
internal control procedures;
(c.i) review, evaluate and approve those procedures;
(d)
review such investments and transactions that could adversely affect the well-
being of the company as the auditor or any officer of the company may bring to
the attention of the committee;
(e)
meet with the auditor to discuss the annual statement and the returns and
transactions referred to in this subsection; and
(f)
meet with the chief internal auditor of the company, or the officer or employee of
the company acting in a similar capacity, and with management of the company,
to discuss the effectiveness of the internal control procedures established for the
company.
In addition to the foregoing requirements, companies governed by the LTCA must have a
Conduct Review Committee.
9
The committee must consist of at least three members. The
majority of the members must not be affiliated with the company and none of them may be
officers or employees ofthe company or of a subsidiary of the company.
10
Subsection 199(3) of the LTCA sets forth the duties of the Conduct Review Committee. This
subsection provides that the Conduct Review Committee shall:
7
R. S. C. 1991, c. 45 [hereinafter LTCA].
8
Ibid. at ss. 198(1), 198(2).
9
Ibid. s. 199.
10
Ibid. at ss. 199(1), 199(2).
(a)
require the management of the company to establish procedures for complying
with Part XI (Self Dealing);
(b)
review those procedures; and
(c)
review the practices of the company to ensure that any transactions with related
parties of the company that may have a material effect on the stability or solvency
of the company are identified.
A company with a Conduct Review Committee must also report to the Superintendent of
Financial Institutions on the mandate and responsibilities of the Conduct Review Committee and
the procedures referred to in (a) above.
11
The federalInsurance Companies Act of Canada
12
("ICA") governs all insurance companies
licensed by the federal government. The ICA contains different rules for Audit Committees'
composition based on whether the relevant company is an insurer or an insurance holding
company. In the latter case, no members of the Audit Committee may be officers or employees
of the insurance holding company or any of its subsidiaries. The significantly expanded duties of
the respective Audit Committees set out in subsection 203(3) and subsection 829(3) of the ICA
and include obligations to:
(a)
review the annual statement of the company before the annual statement is
approved by the directors;
(b)
review such returns of the company as the Superintendent may specify;
(c)
require the management of the company to implement and maintain appropriate
internal control procedures;
(c.i)
review, evaluate and approve those procedures;
(d)
review such investments and transactions that could adversely affect the well-
being of the company as the auditor or any officer of the company may bring to
the attention of the committee;
(e)
meet with the auditor to discuss the annual statement and the returns and
transactions referred to in this subsection;
(f)
meet with the chief internal auditor of the company; o r the officer of employee of
the company acting in a similar capacity, and with management of the company,
11
Ibid. at ss. 199(4).
12
S.C. 1991, c. 47 [hereinafter ICA].
to discuss the effectiveness of the internal control procedures established for the
company.
For insurance companies, there is an obligation to meet with the company's actuary as well. In
addition to Audit Committee requirements, insurance companies regulated under the ICA are
required to have Conduct Review Committees comprised of not less than 3 directors, a majority
of whom are not officers of employees and are not persons affiliated with the company. The
Conduct Review Committee's obligations are set out in subsection 204(3) of the ICA. The
Conduct Review Committee shall:
(a)
require the management of the company to establish procedures for complying
with Part XI (Trust Indentures);
(b)
review those procedures and their effectiveness in ensuring that the company is
complying with Part XI;
(b.i)
if an insurance holding company or a bank holding company that is widely held
has a significant interest in any class of shares of the company,
(i)
establish policies for entering into transactions referred to in subsection
528.1(1) (Transactions with holding companies); and
(ii)
review transactions referred to in subsection 528.3(1) (Asset transactions);
and
(c)
review the practices of the company to ensure that any transactions with related
parties of the company that may have a material effect on the stability or solvency
of the company are identified.
The company must also report to the Superintendent of Insurance on the mandate and
responsibilities of the Conduct Review Committee.
13
REGULATORY REQUIREMENTS
The Dey Report guidelines suggest that the Audit Committee be composed only of "outside
directors". An outside director is any director who is not a member of management. Although
this requirement was not embodied in the regulations of the Toronto Stock Exchange, the annual
report or management information circular of each TSX company must disclose whether or not it
complies with this Dey Report guideline.
In the United States, a Blue Ribbon Committee was established by the New York Stock
Exchange and the National Association of Securities Dealers to develop recommendations "to
13
empower Audit Committees". The Blue Ribbon Committee's report
14
was issued in early 1999.
The report called for the accounting profession, the Securities and Exchange Commission, the
New York Stock Exchange, and other regulatory agencies to take positive steps to give effect to
its recommendations. The new rules however did not focus on accounting standards. In his
introduction to the report and recommendation of the Blue Ribbon Committee, the co -chair, Ira
Millstein said the goal of the report had not been to "prescribe a list of precise accounting rules
and structures".
15
In other words, changes to GAAP to prevent earnings management were not
the focus of the Blue Ribbon report. Mr. Millstein felt that it was necessary to have flexible
accounting GAAP rules. The Blue Ribbon committee's report was therefore designed to
"improve the process by which the discretion is overseen and exercised". The Blue Ribbon
Committee's recommendations included the following:
•
Corporations listed on the NYSE and Nasdaq are required to have Audit Committees;
•
Except in rare circumstances, these Audit Committees must be solely composed of
directors who qualify as independent;
•
Companies are required to disclose whether or not the members of the Audit Committee
are indeed independent. If there are members who are not independent they must
disclose the relationship of those members as well as why it was determined to be
appropriate to appoint them to the Audit Committee;
•
An Audit Committee must contain at least three directors;
•
Each of the directors of the Audit Committee must be financially literate;
•
At least one member of the Audit Committee must have financial management or
accounting expertise;
•
Each listed company must adopt a formal written charter for its Audit Committee that is
approved by the full Board of Directors. This charter must:
(a)
establish the scope of the Audit Committees’ responsibility,
(b)
establish the process whereby the Audit Committee is to fulfill said
responsibilities; and
(c)
specify that the Audit Committee is ultimately responsible for selecting,
evaluating, overseeing the independence of, and if necessary replacing, the
outside auditors.
14
"Report and Recommendationsof the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit
Committees", Blue Ribbon Committee, February 1999.
There is a requirement for the Audit Committee to make certain disclosures which reveal
the degree of its participation in, and supervision of the production of the company's financial
statements As a part of this disclosure requirement the Audit Committee must provide a letter in
the Form 10K Annual Report and the Annual Report to the Shareholders, which states:
" the Audit Committee, in reliance on the review and discussions conducted with
management and the outside auditors believes that the companies financial statements are fairly
presented in compliance with GAAP in all material respects."
The SEC accepted and adopted rules based upon the recommendations contained in the Blue
Ribbon Committee's report. As a result, in late 1999, the U.S. Securities and Exchange
Commission ("SEC") adopted several new rules which included recommendations regarding the
Audit Committees.
16
The SEC's attack on earnings management and deceptive accounting
practices heightened when reports permeated the media that "even the bluest of the blue chip
companies, General Electric, was allegedly manipulating its financial statements to smooth its
earnings and report numbers that were neither too lo w nor too high…temptations were great and
the pressures to manage earnings strong. The incentive for a company's management to make its
numbers remains intense as the market routinely punishes the stock of companies that miss
quarterly expectations by as little as a penny".
17
Accordingly, the new rules ensure that:
•
Increased scrutiny will be made over the identity and qualification of members of the
Audit Committee;
•
Increased scrutiny of each action taken by the Audit Committees of companies impacted
by the rule will occur; and
•
Audit Committees will be expected to have a higher level of knowledge and insight to the
disclosures and activity of management.
The Saucier Report
is
a review of the impact of the Dey Report by a joint committee of the
Toronto Stock Exchange, the Canadian Venture Exchange, (now the TSX Venture Exchange),
and the Canadian Institute of Chartered Accountants. The Saucier Report focuses on corporate
governance and does not speak to the failures of GAAP to adequately protect the investing
public. Instead, the Saucier Report merely tweaks the Dey Reports findings. The report
concludes that it is better to force changes in corporate governance by requiring additional
disclosure rather than by regulation of activities
18
.
16
Gary S. Rowland, "Earnings Management, the SEC, and Corporate Governance: Director Liability Arising from
the Audit Committee Report", (2002) 102 C. L. R. 168.
17
Ibid.
18
Supra note 2.
In May, 2002, based on the recommendations in the Saucier Report the TSX released draft
amendments to the TSX Manual affecting companies listed on the exchange and Tier I
companies on TSX Venture Exchange as well. These changes are based on the Saucier Report
and remain guidelines with respect to which companies must disclose their degree of
compliance. The amendments affecting Audit Committees may be summarized as follows:
•
Introduction of financial literacy requirements for Audit Committee members;
•
Requirement that one member of the Audit Committee have accounting or related
financial expertise;
•
The Audit Committee should be composed of only unrelated directors (manual originally
said outside directors);
•
Each Board shall determine the definition of and criteria for "financial literacy" and
"accounting or related financial expertise"; and
•
The Board should adopt a charter for the Audit Committee which sets out the roles and
responsibilities of the Audit Committee.
COMMON LAW
Recent decisions in the Ontario Courts indicate that directors can be sued personally for
negligence or negligent misrepresentation, even where they have acted in good faith within the
scope of their duties, and where they believed they were acting in the best interest of their
corporations. In response to this trend of the increasing liability of directors of corporations in
Ontario, directors must look beyond the potential statutory liabilities imposed on them when
performing their duties. They must now also seriously consider whether their actions could
expose them to personal liability under the common law.
NEGLIGENCE
Negligence is the failure to exercise that care which the circumstances demand. It may consist of
not doing something which should have been done (non-feasance) or doing something which
should not have been done or should have been done differently (misfeasance). Negligence
implies recklessness or carelessness with respect to the manner in which one conducts their
activities, with harm resulting to another as a direct result of this carelessness.
Negligence generally involves five stages: duty of care, standard of care and breach, causation,
remoteness and defenses. For a defendant to be liable for negligence, the court must find all of
the following:
• that the defendant owed the plaintiff a duty of care;
• that the defendant breached the standard of care required by that duty in the
circumstances;
Page 9
• that this breach was a cause of the damage;
• that the damage was not too remote from the cause to be remediable; and
• that damage recognized by law as compensable occurred.
After these requirements have been satisfied, negligence will have been established, but the
defendant will then have an opportunity to present any defenses which may be available. In the
case of a directors liability, in the past it was a defense for the directors to have been acting
within the scope of duties but there is a shifting trend towards holding directors responsible for
all tortious acts, no matter what the circumstances surrounding them.
DUTIES OF DIRECTORS GENERALLY
The OBCA and the CBCA each impose two general types of obligations upon directors in
connection with their management of a corporation's business and affairs:
1.
A fiduciary obligation to act honestly, in good faith and in the best interests of the
corporation; and
2.
A duty to exercise the care, diligence and skill that a reasonably prudent person would
exercise in comparable circumstances.
19
The first obligation placed upon a director is one of a fiduciary nature. This is a flexible concept,
sometimes described as a duty of loyalty and good faith. It is explained in many statutes as the
duty to act "honestly and in good faith with a view to the best interests of a corporation". This
type of duty is only imposed in certain circumstances within certain types of relationships. These
relationships generally exhibit three characteristics as set out in LAC Minerals v. International
Corona Resources Ltd.
20
:
1.
the fiduciary has scope for the exercise of some power or discretion;
2.
the fiduciary can unilaterally exercise this power or discretion so as to affect the
beneficiary's legal or practical interests; and
3.
the beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the
discretion or power.
19
Supra note 4 at 134(1)(a)-(b). Also see supra note 6 at s. 122(1)(a)-(b).
20
(1989), 61 D. L. R. (4
th
) at 63 (S.C.C.).
The relationship of a corporation and its directors clearly satisfies this description. It is
important to distinguish however, that the directors owe a fiduciary duty to the corporation, not
its shareholders.
Standard of care is the second obligation imposed upon a director. The minimum standard of
care owed by a director has now been codified in both the OBCA and the CBCA. Under both
statutes each director is required to "exercise the care, diligence and skill that a reasonable
prudent person would exercise in comparable circumstances.”
A reasonably prudent person in the position of a director would be expected, at a minimum, to
attend diligently to the managerial and other duties imposed by statute. This is inconsistent with
the director taking a passive or reactive role. A director or officer who, without reasonable cause
fails to meet the statutory standard of care, diligence and skill will not only be guilty of an
offence under the OBCA and the CBCA, they will also be personally liable to the corporation in
tort for damages flowing from the breach of that duty. Recovery of damages may be sought by
the corporation or, where the corporation neglects to act, by shareholders acting in a
representative capacity.
Prior to the reform of the corporate statutes in the 1970's the standard required of directors was
generally accepted to be the essentially subjective standard articulated in the leading English
decision, Re: City Equitable Fire Insurance Co. Ltd.
21
which stands for the proposition that "a
director need exhibit only that degree of care and skill that might be expected of a person with
the knowledge and experience of the director in question". The present standard being that of a
reasonably prudent person in comparable circumstances is more objective and somewhat higher.
As a result of the Saucier Report, changes have been implemented to require disclosure of
whether an Audit Committee member has a specific level of sophistication or skill. By indicating
that a higher level of skill is required among directors serving on the Audit Committee and by
specifically outlining the duties of the Audit Committee, the standard of care placed upon them
becomes more stringent.
For example, the Audit Committee should now have one director with accounting or related
financial experience on its Board. This director would be expected to employ his or her
specialized skills when acting as director. All Audit Committee members should be financially
literate. The standard of care that such individuals must comply with is considered in relation to
this skill and so a higher standard of care may be expected from a person who in fact possesses
greater knowledge or skill. This change has the potential to leave many skilled individuals
simply unwilling to take on the potential liability risks that come with the position of a director.
The relationship of a director to the corporation has been addressed by corporate law, by the
securities regulators and in the corporate governance literature. All directors are subject to the
same standard of care, however the statutory requirement for directors to exercise the "care,
diligence and skill that a reasonably prudent person would exercise in comparable
21
[1925] 1 Ch. 407 (Eng. C. A.).
circumstances" may mean that the greater familiarity that inside directors have with day-to-day
operations creates circumstances for them that are different from those of the outside directors.
The Audit Committee members are more likely to be viewed as inside directors and thus more
will be expected of them. This idea was reflected in the OSC's decision in Standard Trustco
Ltd.
22
where the tribunal was of the opinion that:
“members of the Audit Committee bore more responsibility than the other directors
because they had a greater opportunity to obtain knowledge about the corporation and to
examine its affairs, as a result more was expected of the Audit Committee members in respect of
overseeing the financial reporting process.”
23
As is apparent, these increased standards imposed on directors create an increased expectation of
their conduct. Failure to meet these heightened standards, whether through action or, as is more
likely, inaction, can lead to liability for negligence.
PEOPLES JEWELLERS
While there are a number of cases which deal with actions against individuals as officers, to date
there have been few Canadian legal actions prosecuted against directors in their position as
directors and there do not appear to be any against individuals in their capacity as members of
Audit Committee of a Canadian corporation. However, regulatory tribunals have commented on
the obligations of Audit Committee members.
Typically, the success of an action against an officer of a corporation will turn on the specific
facts of the case. In the case of Scotia McLeod Inc. vs. Peoples Jewellers Ltd.
24
, all the directors
of Peoples Jewellers were sued when a prospectus delivered in connection with a debenture
offering failed to disclose an agreement in which the company could become liable for
obligations of certain other companies, the Court found that:
" the decided cases in which employees and officers of companies had been found
personally liable for actions extensively carried out under a corporate name are fact specific. In
the absence of findings of fraud, deceit, dishonesty or wanting authority on the part of employees
or officers, they are also rare. Those cases in which the corporate veil has been pierced usually
involve transactions where the use of the corporate structure was a sham from the outset or was
an afterthought to a deal which had gone sour. There is also a considerable body of case law
where injured parties to actions for breach of contract have attempted to extend liability to the
principals of the company by pleading that the principals were privy to the tort of inducing
breach of conduct between the company and the plaintiff; see Ontario Store Fixtures Inc. vs.
Mmmuffins Inc. (1989), 70 O.R.(2d) 42 (H.C.J.), and the cases referred to therein. Additionally,
22
Re Securities Act, R. S. O. 1990, C. S. 5 [hereinafter Standard Trustco].
23
Ibid. at 245.
24
(1996) 26 O.R. (3d) 481 [hereinafter Peoples Jewellers]
there have been attempts by injured parties to attach liability to the principals of failed businesses
through insolvency litigation. In every case, however, the facts giving rise to personal liability
were specifically pleaded. Absent allegations which fit within the categories described above,
officers or employees of limited companies are protected from personal liability unless it can be
shown that their actions are themselves tortious or exhibit a separate identity or interest from that
of the company so as to make the act or conduct complained of their own".
25
In other words, in Ontario, there is no common law right of action against an officer or employee
without some special circumstances wherein the act of an individual goes beyond his or her
ordinary roles. By contrast, directors have a major role in the decision making of a corporation.
However, as Finlayson, J. noted in Peoples Jewellers:
"this does not mean, however that if the actions of the directing minds are found wanting,
that personal liability will flow through the corporation to those who caused it to act as it did. To
hold the directors of Peoples personally liable, there must be some activity on their part that
takes them out of the role of directing minds of the corporation".
26
In the Peoples Jewellers, negligent misrepresentation claims were made against two directors
who were the most senior executive officers of Peoples Jewellers. Claims against other directors
were dismissed because no claims of negligence were made against them. However, in an
appeal contesting a dismissal against the two senior officers, the appeal was allowed even though
the judge was of the view that the "appellants are attempting to stretch the envelope of available
jurisprudence to encompass the acts…..of these two directors".
27
ADGA SYSTEMS
In 1999 the Court of Appeal for Ontario made a judgement which expanded the circumstances
under which a court may impose personal liability on officers and directors for actions taken in
the course of their ordinary duties. This decision in ADGA Systems International Ltd. v. Valcom
Ltd.
28
has far reaching implications.
In this case ADGA and Valcom were competitors vying for the same contract. The Department
of Supply and Services called for tenders and asked the tendering parties to provide the names
and qualifications of at least 25 senior technicians so that it could be determined whether the
tendering party was competent to perform the work required. ADGA had 45 such employees
while Valcom was alleged to have none. ADGA claimed the ability to prove that Valcom,
through its sole director and two senior employees set out to convince ADGA’s technical staff to
25
Ibid. at 490.
26
Ibid. at 479.
27
Ibid. at 491.
28
(1999), 43 O. R. (3d) 101 (C.A.), leave to appeal to S. C. C. denied, [hereinafter ADGA].
let Valcom use their names on Valcom’s tender and to come work for Valcom if the tender was
successful. 44 of ADGA’s technical staff agreed to this and Valcom was the successful bidder.
ADGA claimed that by inducing the ADGA employees to breach the fiduciary duty that they
owed to ADGA, the Valcom director and two employees committed a tort for which they should
be personally liable.
In finding for ADGA the Court of Appeal stated:
“there is no principled basis for protecting the director and employees of Valcom from
liability for their alleged conduct on the basis that such conduct was in pursuance of the interest
of the corporation”.
29
Prior to ADGA, there was a trend in the lower courts to dismiss claims against officers and
directors if their conduct was within the ordinary course of their duties and their actions were
directed towards the best interests of the corporation. Based on the line of cases including
Peoples Jewellers, the courts would only “pierce the corporate veil” in cases where the directors
had acted fraudulently, deceitfully, or had sought to advance their personal interests outside the
scope of their duties.
In obiter, this case acknowledges:
“that for policy reasons the law as to the allocation of responsibility for tortious conduct
should be adjusted to provide some protection for employees, officers or directors, or all of them,
in limited circumstances where, for instance, they are acting in the best interest of the
corporation with parties who have voluntarily chosen to accept the ambit of risk of a limited
liability company…..the creation of such a policy should not evolve from the facts of this
case”.
30
The Court continued on to say:
“businesses cannot function efficiently if corporate officers and directors are inhibited in
carrying on a corporate business because of a fear of being inappropriately swept into lawsuits,
or, worse, are driven away from involvement in any respect in corporate business by the
potential exposure to ill-founded litigation".
Despite the statement above, the director of Valcom was ultimately found liable and litigation
against corporate directors is on the upswing, in light of the expandry role of class actions in the
litigation landscape and the increased accountability derived from ADGA and the new regulatory
corporate governance regimes.
29
Ibid. at 113.
30
Ibid. at 113.
The decision in the ADGA case significantly expands the opportunities for plaintiffs to assert
claims against officers and directors in certain circumstances. Even the common law has
followed the trend of increasing the standards imposed on directors and therefore opening them
up to increased liability.
STANDARD TRUST
In 1992 hearings were held by the Ontario Securities Commission under section 128 of the
Securities Act of Ontario with respect to allegations made against the directors of Standard Trust
and the OSC reviewed the role of the Audit Committee.
31
In that case, directors of Standard
Trust had permitted unaudited interim financial statements to be released and dividends declared
notwithstanding the concerns of the Superintendent of Financial Institution ("OSFI"). Members
of the Audit Committee were advised of the concerns raised by the OSFI regarding their loan
loss provisions. The regulator also requested that it have the opportunity to address the directors
of the corporation at the next Board meeting. Prior to such address, the directors passed the
resolutions relating to the release of financial statements and the declaration of dividends after
having been apprised of the matters which would be addressed. OSFI's presentation included an
expression of concerns about various accounting practices and concerns that cash receipts were
not sufficient to meet cash expenses. A full audit of interim statements and a review of the six
month statement prior to release of the financial statements were suggested. However, the Board
of Directors of Standard Trust did not take heed of OSFI's comments and did not make any
changes to its approval of the financial statements or dividend declaration.
The OSC found:
"we are of the opinion, in relying on management to the extent they did and only taking
the steps they did, the respondent directors failed to exercise the kind of prudence and due
diligence that they ought to have exercised given the information they had…. In reaching this
conclusion, we have taken into account the fact that almost of the directors, if not all, had
backgrounds which suggested that they were a relatively sophisticated group".
32
This comment supports the conclusion that the level of knowledge or sophistication of a director
will impact the regulatory liability of such director. In addressing concerns relating to the Audit
Committee's conduct, the OSC stated:
…in our opinion the members of the Audit Committees should bear somewhat more
responsibility then the other directors for what occurred at the Board meetings on July 24, 1990,
not because there was greater standard of care imposed on them, but rather because their
circumstances were different. As members of the Audit Committees, they had a greater
opportunity to obtain knowledge about and examine the affairs of the company than non-
31
Supra note 22.
32
Ibid. at 245.
members had. As a result, more was expected of them in respect of overseeing the financial
reporting process and warning other directors about problems.
33
CONCLUSIONS
Members of the Audit Committee carry significantly more responsibilities then they did even
five years ago. Although to date there are no Canadian cases imposing civil liability on Audit
Committee members in their capacity as such, the potential for such litigation in the future has
increased due to the enhanced standard of care required of members of the committee. Directors
who serve on the Audit Committee will have increased exposure to liability based upon the
expectations and enhanced duties imposed by regulators.
Tortious conduct can be comprised of either malfeasance of non-feasance. In situations where
non-feasance gives rise to liability, claims may be made that the failure to act is, in itself,
negligence. The increased qualifications and heightened expectations of Audit Committee
members may make it easier for claimants to successfully claim negligence as a result of Audit
Committee members' failure to act in accordance with objective standards as set out in the new
guidelines.
It is the view of this writer that the impact of the changes in corporate governance will not bring
their intended results. As stated by Catherine McCall of corporate activist Fairvest Corporation,
"Interestingly, the proposed rules are similar to those that failed to protect Enron shareholders".
34
The increased exposure of Audit Committee members to liability will inevitably discourage the
most talented people from sitting on Audit Committees. Changes to GAAP would be a far better
preventive to corporate abuses. Unfortunately, current litigation such as the U.S. litigation
against Arthur Anderson focuses on their shredding of Enron corporate documents and not on
their accounting practices which permit questionable off balance sheet transactions to be
considered permissible. Although generally accepted accounting principles are changing, it
appears that they will remain rules based in North America. There are no proposals to simplify
financing reporting or to replace rules based GAAP with a subjective fairness opinion in the
European tradition. Until changes are made, creative minds will continue to find methods to
circumvent the rules. As reported in an editorial in the Toronto Globe and Mail, Jim
Greenwood, a Pennsylvania congressman recently corporate debacles like Enron will continue to
surface with or without new governance rules. The question that should be asked is whether or
33
Ibid. at 245.
34
Catherine McCall, "Improving the Workings of Audit Committees in Canada" 2002 14 Corporate Governance
Review 3 at page 7.
not directors should be burdened with increased legal exposure as an indirect result of the
increased regulation of Audit Committees and the increased obligations imposed upon their
members. If there is increased reluctance to serve on Boards, the answer should be "No".
Boards of Directors should not be hampered in recruiting top talent.
Tulisan ini adapted from:
MICHAEL S. SLAN
FOGLER, RUBINOFF LLP
Suite 4400, P.O. Box 95, Royal Trust Tower
Toronto-Dominion Centre
Toronto, Ontario, Canada M5K 1G8
Telephone: 416 864-9700 Fax: 416 941-8852
www.foglerubinoff.com
* The writer would like to acknowledge the contributions and assistance in drafting and editing this paper from
Fogler, Rubinoff LLP partner Bonnie Fish and law student Joy Avzar.
:::: tHe fRienDLy kinDLy cHeeRy giRL ::::
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