YBM Case Study: Anatomy Of A Securities Class Action Settlement

1. INTRODUCTION

   In February 2002, the parties to several actions which arose out of the meteoric rise and fall of the fortunes of YBM Magnex International, Inc. ("YBM") announced a settlement agreement (subject to court approval) following a three-week settlement conference. Two of those actions were Ontario class actions. Therefore, the proposed settlement required court approval pursuant to s. 29(2) of the Class Proceedings Act ("CPA"), which contributed to the substance, form, and structure of the settlement agreement. The unique aspects of the YBM settlement and its complexities are best understood with some knowledge of the background of YBM and the allegations made against the numerous defendants in the YBM class actions.

2. BACKGROUND TO YBM

   YBM is an Alberta corporation (now in receivership), which had its head office in Newtown, Pennsylvania. It purported to be involved in the manufacture and global distribution of magnets and magnetic products, bicycles, computer software, and oil. On July 18, 1994, YBM issued 4 million common shares to the public and became a junior capital pool corporation pursuant to the regulations of the Alberta Stock Exchange. Thereafter, its shares began trading on the Toronto Stock Exchange ("T.S.X.") on March 7, 1996. YBM's shares were also traded over the counter on the New York Stock Exchange.

   On May 13, 1998, a search warrant of YBM's head office was executed as a result of the coordinated efforts of the Organized Crime Strike Force of the United States Attorney's Office, the Federal Bureau of Investigation, and several other United States government agencies. That day, the Ontario Securities Commission ("O.S.C.") issued a cease trading order in respect of YBM's shares. Those shares have ceased to trade ever since.

   The Court of Queen's Bench of Alberta appointed a receiver, on December 8, 1998, to protect YBM's existing assets, to monitor and assess its Eastern European operations, and to prepare a plan of distribution of the net assets of YBM.

   On June 7, 1999, YBM, through its Receiver, pleaded guilty in the United States District Court to a multi-object conspiracy to commit fraud, which included fraudulent, manipulative, and deceptive devices in the purchase and sale of YBM securities and the filing of reports with securities regulators which contained material misrepresentations and omissions during the period 1993 to 1998.

   Thereafter, three class actions were commenced - one in the United States District Court of the Eastern District of Pennsylvania and two in the Ontario Superior Court of Justice. In all three class actions, allegations were made that YBM failed to disclose material information to the public and made misrepresentations regarding YBM's financial statements. It was also alleged that YBM conducted very little legitimate business and was, in fact, a money laundering operation carried on by members of organized crime.

3. THE THREE CLASS ACTIONS

   1. Prospectus Class Action (Royal Trust Corporation of Canada et al. v. Igor Fisherman et al.)

      The proposed representative plaintiffs commenced the action on their own behalves and on behalf of the members of the class of persons in Canada who purchased or acquired common shares of YBM distributed pursuant to a YBM prospectus dated November 17, 1997, and suffered a loss. They claimed damages in the amount of $125 million for negligent misrepresentation at common law, misrepresentation under s. 130 of the Ontario Securities Act (and the comparable Acts in British Columbia, Alberta, and Québec), and negligence. The defendants were YBM's officers and directors, auditors, lawyers, and financial advisors/underwriters of the prospectus financing. In essence, the allegations were that, had the defendants acted competently and in accordance with their duties to the class members, the prospectus would not have been receipted by the O.S.C., the class members would not have purchased their shares, and they would not have suffered a loss.

   2. General Class Action (Roger Mondor v. Igor Fisherman et al.)

      The other Ontario class action (referred to as the "General Class Action" to distinguish it from the "Prospectus Class Action") was brought by the proposed representative plaintiffs on their own behalves and on behalf of each and every person, wherever resident, who dealt in shares of YBM between March 7, 1996 (the date the shares began to trade on the T.S.X.) and May 14, 1998. The plaintiffs claimed damages in the amount of $750 million and sought a variety of other relief, including a declaration that certain directors, officers, and YBM's auditors breached the misleading advertising section [s. 52(1)] of the Canada Competition Act R.S.C. 1985, c. C.-34, by representing in various statements, press releases, prospectuses etc., that YBM was a legitimate business with income only from legitimate business activities (referred to in the Statement of Claim as "the Representation"), a declaration that the Representation was made negligently or fraudulently or recklessly, and a declaration that certain of the defendants were involved in a conspiracy to deceive the class members for the purpose of maintaining and increasing the price of YBM shares by the issuance of false statements etc. and by their failure to make required timely disclosure of material developments. The defendants were most of same persons and entities named as defendants in the Prospectus Class Action.

   3. United States Class Action (John Paraschos et al. v. YBM Magnex International, Inc. et al.)

      A class action was commenced in the United States District Court for the Eastern District of Pennsylvania on behalf of all persons and entities (except certain insiders) that acquired YBM common shares between January 19, 1996 (the date of an earlier prospectus) and May 14, 1998, against many of the same defendants as in the Ontario class actions. It was alleged that certain information made available to members of the public was intended to and did deceive the investing public in that it contained misrepresentations and material omissions and that the market price of YBM shares was artificially inflated as a result. The action was dismissed on December 5, 2000, for reasons of comity; the Court determined that Canada had the greater connection to the matters in issue in the action. The plaintiffs' motion for a reconsideration of the decision was denied. Their appeal to the Court of Appeals for the Third Circuit was pending at the time of the settlement in February 2002.

4. YBM SETTLEMENT CONFERENCE

   The two Ontario class actions were case managed together, along with two other actions commenced by YBM's Receiver/Independent Litigation Supervisor (appointed by the Court for the purpose of prosecuting litigation on behalf of YBM) by the Honourable Mr. Justice Cumming. By the time these actions were settled (over three years after they were commenced), pleadings had not yet closed, productions had not been exchanged, and examinations for discovery had not yet been scheduled. The parties agreed to participate in a mediation in April 2001, however, it was not successful. Some of the defendants had brought Rule 21 motions, which were denied.1 The certification motions had been scheduled but not yet heard.

   Only six months after the first unsuccessful mediation effort, in November 2001, several of the defendants sought and obtained an order from Cumming J. directing the parties to appear before the Honourable Mr. Justice Winkler for a pre-trial conference pursuant to Rule 50.01 to consider the possibility of settlement of any or all of the issues in the class actions.

   The pre-trial conference took place on January 16, 17, 18, 21, and 22, 2002. Counsel for the parties in the U.S. Class Action and YBM's Receiver were invited to participate in the pre-trial conference and did so. On February 7, 2002, settlement of all three class actions and YBM's actions was achieved, subject to the approval of the Ontario, Alberta, and Pennsylvania Courts. Thereafter, several months were spent by all counsel papering the settlement, which involved primarily drafting the consent Judgment to be submitted to Cumming J. for approval in May 2002.

   The fact that an earlier mediation effort did not get off the ground demonstrates many of the difficulties in moving parties towards settlement in these kinds of cases. Many of the factors that motivate parties to consider settling class actions, as well as factors that can be obstacles are set out below. Some of them were, no doubt, present in the YBM case.

   Among the most important motivations to settlement is the significant costs associated with prosecuting or defending a class action regardless of the perceived merits of the claim or defence. The quantum of damages typically sought in the statement of claim in a securities class action is large, making the stakes sufficiently high for all parties that numerous interlocutory motions and appeals on those motions are perceived to be worthwhile and therefore seem inevitable. As a result, a lengthy period of time may pass between the time the statement of claim is issued and pleadings are closed, during which time the parties' costs are increased significantly and there are numerous delays in having the action tried on its merits. For example, it is not uncommon in class actions for defendants to bring motions under Rule 21, challenging the statement of claim on the basis that it discloses no reasonable cause of action. These motions often involve complex and novel points of law and, consequently, are subject to appeals. Also, the recent cases in which substantial costs awards have been made against plaintiffs in class actions will likely motivate plaintiffs in future to consider early settlement.2

   Common obstacles to settlement, which were present in the YBM class actions, include a lack of information about the merits of the claim and defences, multiple parties with conflicting interests, and similar...