Instruments & Other Important Sources of Securities Law



Securities Regulation CAN TOC \o "1-4" Instruments & Other Important Sources of Securities Law PAGEREF _Toc259099277 \h 2Does Securities Law apply to this transaction? PAGEREF _Toc259099278 \h 3What is a Security? PAGEREF _Toc259099279 \h 3What is a Trade? PAGEREF _Toc259099280 \h 5What is a Distribution? PAGEREF _Toc259099281 \h 6What is a Reporting Issuer? PAGEREF _Toc259099282 \h 6What is Materiality? PAGEREF _Toc259099283 \h 6The Prospectus Process PAGEREF _Toc259099284 \h 8How to Raise Capital PAGEREF _Toc259099285 \h 8The Prospectus Process PAGEREF _Toc259099286 \h 8Future-Oriented Financial Information (FOFI) PAGEREF _Toc259099287 \h 12Exempt Market Transactions PAGEREF _Toc259099288 \h 13Resale Rules PAGEREF _Toc259099289 \h 15Incorrect Reliance on Exemptions PAGEREF _Toc259099290 \h 17Continuous Disclosure Requirements PAGEREF _Toc259099291 \h 18Insider Trading PAGEREF _Toc259099292 \h 20Change of Control Transactions PAGEREF _Toc259099293 \h 24Takeover Bids PAGEREF _Toc259099294 \h 25Corporate Governance & Proxy Solicitation PAGEREF _Toc259099295 \h 29Civil Liability PAGEREF _Toc259099296 \h 31Primary Market Liability PAGEREF _Toc259099297 \h 31Secondary Market Liability PAGEREF _Toc259099298 \h 32Enforcement PAGEREF _Toc259099299 \h 35Purpose, Sources & Critique of Securities Regulation PAGEREF _Toc259099300 \h 37Instruments & Other Important Sources of Securities Law IdentifierNameDescriptionNI 31-103Registration Requirements, Exemptions and Ongoing Registrant ObligationsSets out the requirement for all persons trading in securities to be registered, unless an exemption applies. BC Instrument 32-513Registration Exemption for Trades in Connection with Certain Prospectus-Exempt DistributionsExemption from registered dealer requirement for distributions that qualify for a prospectus exemption. NI 41-101General Prospectus RequirementsSets out a uniform approach for filing prospectuses in all provinces and territories in Canada. NP 11-202Process for Prospectus Reviews in Multiple JurisdictionsCreates the passport system for prospectus filing in multiple jurisdictions; one regulator acts as the principal regulator.NI 33-105Underwriting ConflictsRequires that non-independent underwriters fully disclose the relationship between the underwriter and the issuer, and possibly involve an independent underwriter too. NI 44-101Short Form Prospectus DistributionsSets out a uniform approach for filing short-form prospectuses. NI 44-102Shelf ProspectusSets out a uniform approach for filing shelf prospectuses.NI 44-103Post-Receipt PricingSets out a uniform approach for filing post-receipt pricing prospectuses.NI 71-101Multijurisdictional Disclosure SystemPermits issuers in the US and Canada to use the same disclosure forms when selling securities in each other’s markets.NI 45-106Prospectus and Registration ExemptionsSets out exempt market transactions from prospectus requirement. NI 45-102Resale of SecuritiesSets out resale rules for restricted security holders and control persons. NI 51-102Continuous Disclosure ObligationsAn instrument that sets out the periodic and timely continuous disclosure obligations for reporting issuers.NP 51-102Disclosure StandardsA policy that discusses best practices for disclosure. NI 55-102System for Electronic Disclosure by Insiders (SEDI)An instrument that establishes SEDI, the disclosure system for insiders. NI 55-104Insider Reporting Requirements and ExemptionsAn instrument that sets out the disclosure requirements for insiders (what an insider must do to avoid trading illegally as an insider). NP 51-201Disclosure StandardsA policy that sets out the two factors to be examined to determine whether material information has been “generally disclosed” in the context of insider trading. MI 62-104Take-Over Bids and Issuer BidsA multilateral instrument governing takeover bids in BC (note: Ontario has a different rules). NP 62-202Take-Over Bids – Defensive TacticsA policy that sets out the various defensive tactics that a target company may employ in response to a hostile takeover bid. NP 62-203Take-Over Bids and Issuer BidsA policy that outlines how provincial and territorial securities regulators interpret and apply the Bid Regime (including MI 62-104), and provides guidance on the conduct of parties involved in a takeover bid. NI 62-103The Early Warning System and Related Take-Over Bid and Insider Reporting Issues An instrument that sets out the early warning system with takeover bids. Does Securities Law apply to this transaction?What is a Security? Is this a security?Broadly, a security is an instrument sold to raise funds and used to generate profits. Section 1 of the BC Securities Act sets out the defn of “security”, which includes shares, bonds, options & investment contracts. Importantly, Pacific Coin emphasizes that the legislated definition of “security” is not exhaustive, and that one item may qualify as a security under more than one of the fifteen clauses listed in the BCSA s. 1 definition. Purposive approach to interpreting securities law: regulators and courts tend to apply a purposive approach to interpret the open-ended wording in securities legislation, looking to the substance of a transaction rather than simply its form. As De Grandpre for the majority of the SCC stated in Pacific Coast, securities legislation “must be construed broadly, and it must be read in the context of the economic realities to which it is addressed… substance, not form, is the governing factor…" This reflects a primary purpose of securities regulation: to protect investors from parties who seek to take advantage of them. A document, instrument, or writing commonly known as securityBCSA, s. 1, clause (a)A document or instrument that is “commonly known as a security” qualifies as a “security” under BCSA, s. 1, clause (a). This means documents, instruments, or writing “commonly known as a security” by a sophisticated analyst or securities lawyer, not a layperson. In Geldermann, the Quebec Securities Commission held that proof of common knowledge “must be based on an overwhelming set of facts and conclusive evidence”. n/aA document evidencing title to, or an interest in, the capital, assets, property, profits, earnings or royalties of a personBCSA, s. 1, clause (b)A document “evidencing title to… property” qualifies as a “security” under BCSA, s. 1, clause (b). This includes a property interest acquired for the purpose of making an investment, rather than buying a commodity to merely acquire an interest in property. The investment or speculative purpose of the transaction is key. The contract will typically feature performance of a service by others that is meant to increase the value of the property. Note: however, sometimes a purchaser’s motives can be mixed. In Brigadoon Scotch, scotch whiskey warehouse receipts were held to be a security b/c the whiskey was being stored and then sold, on behalf of investors, to blenders who used it to make the final whiskey product. In Swain, a title document providing the purchaser with a half interest in a pair of breeding chinchillas was held to be a security b/c the vendor was to keep the animals, breed them, and then share profits with the purchaser. Rental poolWhiskey warehouse receiptsInterest in breeding chinchillasTitle to a vehicleA document evidencing an option, subscription or other interest in or to a securityBCSA, s. 1, clause (c)A document “evidencing an option, subscription, or other interest in or to a security” qualifies as a “security” under BCSA, s. 1, clause (c). An option is an instrument that gives the holder the right to buy or sell the underlying interest at an agreed price, on or before an agreed date, but does not obligate the holder to do so. An option can be written against virtually any underlying interest, financial or otherwise, whose price is subject to variation. Option KA bond, debenture, note or other evidence of indebtedness, share, stock, unit, unit certificate, etcBCSA, s. 1, clause (d)A share or any debt instrument, including bonds, debentures and notes, qualify as a “security” under BCSA, s. 1, clause (d). Excludes: Insurance contract issued by an insurerEvidence of a deposit issued by savings institutionFull text: “a bond, debenture, note or other evidence of indebtedness, share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription other than (i) a contract of insurance issued by an issuer, and (ii) an evidence of deposit issued by a savings institution.”Shares Promissory note(e.g. A lends money to B)An agreement providing that money received will be repaid or treated as a subscription to shares, stock, units or interests at the option of the recipient or of any person BCSA, s. 1, clause (f)A certificate of interest in an oil, natural gas or mining lease, claim or royalty voting trust certif. BCSA, s. 1, clause (h)An oil or gas royalty or lease or a fractional or other interest in either BCSA, s. 1, clause (i)A permit under the Oil and Gas Activities Act BCSA, s. 1, clause (o)A collateral trust certificate BCSA, s. 1, clause (j)An income or annuity contract, other than one made by an insurer BCSA, s. 1, clause (k)A document evidencing an interest in a scholarship or educational plan or trustBCSA, s. 1, clause (m)A document “evidencing an interest in a scholarship or educational plan or trust” qualifies as a “security” under BCSA, s. 1, clause (m). Note: RESPs qualify as a “security”, but Companion Policy 31-103CP, Registration Requirements and Exemptions at s. 8.19 provides an exemption from the dealer registration requirement for the trade when the plan is created (creation = trade). Self-directed registered education savings plan (RESP)An instrument that is a futures contract or an option that is not an exchange contractBCSA, s. 1, clause (n)A future is a contract to sell a specified asset on a stated date in the future at a state price. Futures can be written against a variety of underlying interests, e.g. currencies, commodities, indexes, interest rates. Although futures contracts are “securities” within the meaning of Canadian securities legislation, publicly traded commodity futures contracts are not subject to securities regulation; subject to special reg.Futures KA profit sharing agreement or certificate BCSA, s. 1, clause (g) [considered redundant b/c of “investment contract” clause]An investment contractBCSA, s. 1, clause (l)An “investment contract” is a catch-all term set out in BCSA, s. 1, clause (l). In Howey, the US Supreme Court defined “investment contract” as “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party”. Howey involved contracts for the sale of units in a citrus grove development and contracts for the cultivation of those groves and remittance of net proceeds to the investor. The Court noted: “Such persons [the investors] have no desire to occupy the land or to develop it themselves; they are attracted solely by the prospects of a return on their investment. […] The investors provide the capital and share in the earnings and profits; the promoters manage, control and operate the enterprise. It follows that the arrangements whereby the investors’ interests are made manifest involve investment contracts, regardless of the legal terminology in which such contracts are clothed.” In Hawaii Market Center, the Hawaii Supreme Court expanded the Howey test for an investment contract. Hawaii Market Center involved a retail store membership program whereby “founder-members” could earn income if they recruited new members and distributed membership cards, i.e. they were not expecting profits “solely from the efforts of the promoter or a third party”. The Court developed the following test for the existence of an investment contract:An offeree furnishes initial value to the offeror [members required to contribute $320 or $820 > not simple purchase of sewing machine, cookware, b/c these amounts far exceeded their wholesale value];A portion of this initial value is subject to the risks of the enterprise [members’ ability to recoup initial investment and earn income inextricably bound to success of the Hawaii Market Center enterprise];The furnishing of the initial value is induced by the offeror’s promises or representations that the offeree will gain some benefit, over and above the initial value, as a result of the enterprise’s operation [members were promised “commissions”/fixed returns]; and,The offeree does not receive the right to exercise practical or actual control over the managerial decisions of the enterprise [members arguably participated in a minor way in operating the enterprise, but Crt focused on the “quality” of participation, not the “quantity]. In Pacific Coast, the Supreme Court of Canada set out the Canadian version of the Howey and Hawaii Market Center tests. Pacific Coin involved the sale of bags of silver coins on margin (the purchaser paid a deposit, and then at a later time could either complete the transaction by paying the remaining amount or selling the bag through the Coin Exchange). The majority set out the Howey test in two questions: Is there a common enterprise? [the Crt said a common enterprise exists where an investor advances money and the promoter has managerial control over the success of the enterprise]Are the profits to come solely from the efforts of others? [the Crt construed “solely” broadly, as in Hawaii Market; if Pacific did not invest the purchaser’s deposit properly, the purchaser would be unable to obtain a return on his or her investment regardless of the market price of silver; also, purchasers on margin did not have the bags of silver]Note: Laskin CJ in dissent said purchase of coins on margin was not an investment K b/c profits from the enterprise only depended on the market price of silver, not on the actions of the Coin Exchange; also, the Exchange had no control over the investment (investors decided when to buy, sell). Units in citrus grove development Retail store membership programPurchase of bags of silver coins on marginSome franchises (where the franchisor retains a huge degree of control relative to the franchisee)Real estate venturesWhat is a Trade?Is this a trade?Whether or not transaction qualifies as a “trade” determines whether that transaction is subject to securities reg. Under s. 34 of the BCSA and NI 31-103, a “trade” triggers the requirement that a registered dealer be involved in the transaction, unless an exemption applies. BC Instrument 32-513 provides that the dealer registration requirement “does not apply to a trade in a security by a person or company in connection with a prospectus-exempt distribution”, provided that the following conditions are met: the person was or is not registered under Canadian or foreign securities legislation; prior to the trade, the purchaser did not advise or recommend to the purchaser that the security being traded is suitable for the purchaser; the person obtained a sign risk acknowledgement form from the purchaser before the purchaser entered into the K to purchase the security; the person does not hold or have access to the purchaser’s assets; the person has not provided financial services to the purchaser other than in connection w/ prospectus-exempt distribution; and, the person has filed a current info report with the regulator.Section 1 of the BC Securities Act sets out seven types of transactions that qualify as trades, the most common one being clause (a) “a disposition of a security for valuable consideration”. Clause (f) also includes in the defn of “trade” any “act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance” of the other six transactions. This definition of “trade” is inclusive, not exhaustive. What qualifies as a “trade”?Clause (a): the sale/disposition of a security for valuable consideration [excluding: the purchase of a security or the transfer/pledge/mortgage/encumbrance of a security for the purpose of giving collateral for a debt, e.g. giving a security as collateral for a loan].Clause (a.1): entering into a futures K.Clause (b): entering into an option that is an exchange K.Clause (c): any transaction in a security through a stock exchange or quotation.Clause (d): the receipt by a registrant of an order to buy or sell a security. Clause (e): the transfer of beneficial ownership of a security to another party under a realization on collateral given for a debt.Clause (f): any act, advertisement, solicitation, conduct or negotiation that is directly or indirectly in furtherance of any activities in clauses (a) through (e). Examples:The granting of stock options to employees or directors [the valuable consideration is the employee/director’s future or current services].Transferring shares from one company that you own to another company that you own, provided there is valuable consideration. Converting a share from one form to another form. Advertising or solicitation directed at investors (even though no securities have actually been sold yet) [this qualifies as an “act in furtherance”; clause (f)].What does not qualify as a “trade”?A gift of securities (no valuable consideration).The inheritance of securities (no valuable consideration).Moving assets from husband to wife in divorce (no valuable consideration).Maybe: drafting an advertisement directed at investors/sending it to the printers, but before actually published [could argue that not enough to qualify under (f)].Trust company managing the portfolios of mutual fund dealers [does not qualify under (f) b/c trade already completed by time trust company becomes involved].What is a Distribution?Is this a distribution?Distributions are a type of trade that trigger the prospectus requirement. Section 1 of the BC Securities Act sets out seven types of transactions that qualify as distributions. This definition of “distribution” is exhaustive (unlike the defns of “trade” and “security”). Note: all distributions involve trades, but not all trades qualify as distributions. What qualifies as a “distribution”?Includes: private placements & public offerings!Clause (a): a trade in the security of an issuer that has not been previously issued.Clause (b): a trade in previously issued security by or on behalf of the issuer (i.e. a reissuance of shares by an issuer). Clause (c): a trade in a previously issued security by a control person [“control person” is defined in s. 1 of the BCSA as a person or group of people who, acting together, hold sufficient shares to “affect materially the control of the issuer”, or where a person or group of people acting together hold more than 20% of voting shares; policy rationale: control persons have ability to influence issuers, selling large % of shares may impact market price, and assumed to have privileged access to special information about the issuer].Clause (f): a transaction or series of transactions that involve further purchases and sales in the course of, or incidental to, a distribution, e.g. if X sells shares to Y, then Y immediately sells those shares to A, B, C > sale from X to Y = distribution.What is a Reporting Issuer?Is the issuer a reporting issuer?Section 1 of the BC Securities Act defines “issuer” as a person who has a security outstanding, is issuing a security, or proposes to issue a security, and “reporting issuer” as an issuer who has filed a prospectus or whose securities have, at any time, been listed on a recognized stock exchange. Whether or not an issuer is required to continually disclose information to the markets and investors depends on whether it is a reporting issuer or a non-reporting issuer. An issuer can also become a reporting issuer through a merger, amalgamation, or arrangement of securities, or if the issuer is deemed to be a reporting issuer by the regulator. An issuer that has filed and obtained a receipt for final prospectus is a reporting issuer even closing/distribution of the securities did not take place. What is Materiality? Materiality: the Market Impact Test & the Reasonable Investor TestSection 1of the BCSA defines:“material change” as “a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of a security of the issuer”; and,“material fact” as “a fact that would reasonably be expected to have a significant effect on the market price or value of securities. In Danier Leather, the SCC said that material changes are inward looking and material facts are outward looking, e.g. in Danier Leather, a change in weather forecast was held to be a material fact, but not a material change, and so Danier was not required to disclose this material fact in order to meet its disclosure obligations. In YBM Magnex, the Ontario Securities Commission said that if the decision whether a piece of information or event qualifies as material is border-line, then the information should be considered material and disclosed. [note: TSX-listed issuers must disclose changes to “material information” > includes both material changes and material facts]When advising clients about the materiality of historic/existing information (e.g. past financial or assay results, completed business transactions, etc), it is important to look at both the market impact test and the reasonable investor test: Market Impact TestInfo is material if it is reasonable to expect that the release of that information would impact the market price of the security.Reasonable Investor TestThe reasonable investor test is used in the United States, and is now making its way to Canada: information is material if the reasonable investor would consider the information important to an investment decision. This test was applied by the SCC in the context of BC’s Real Estate Act in Sharbern, 2011 SCC 23. The SCC said: “an omitted fact is material if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available”.When advising clients about the materiality of potential/future information (e.g. a pending merger, or a pending lawsuit), it is important to look at the probability/magnitude test:Probability/Magnitude TestThe materiality of a potential future event depends on (a) an assessment of the probability that the event will occur having regard to all the known or ascertainable facts, and (b) an assessment of the magnitude or significance of the change, in terms of whether the information would be viewed by reasonable investors as important information for making a decision to buy, sell, or continue to hold their securities. This test was articulated by the Ontario Securities Commission in YBM Magnex. The Prospectus ProcessHow to Raise CapitalThree ways a company can raise capital (= primary market transactions)i. Initial Public OfferingAn initial public offering (IPO) involves the issuance of securities by a company to the public for the first time. Pros: issuer can access the broadest possible market for its securities, enhancing its capacity to raise capital; investors enjoy enhanced liquidity for the issuer’s securities b/c tradable on public markets; the value of securities can be established and other financings facilitated more efficiently. Cons: an IPO qualifies as a distribution, so triggers the prospectus requirement; the prospectus process and continuing disclosure obligations can be very costly and time-consuming (involving lawyers, underwriters, accountants, and other specialists), especially for small issuers (high opportunity cost to comply with regulations); there may be increased delays for issuers seeking regulatory approval in multiple jurisdictions; IPOs tend to be time sensitive so a failure to meet the opportune market window can impact the price of securities as well as the issuer’s overall business strategy; IPOs can lead to increased public scrutiny of an issuer’s financial results, management and director performance, executive compensation, etc; and, finally, IPOs can increase issuer’s vulnerability to takeovers. ii. Subsequent Public OfferingA subsequent public offering involves the issuance of securities by an already-public issuer (i.e. a reporting issuer). Pros: issuer can raise more money; the issuance of a new set of securities still qualifies as a distribution and so triggers the prospectus requirement, however, reporting issuer may be able to file a short form prospectus. iii. Private PlacementA sale of securities effected by means of an exemption from the prospectus requirement, set out in NI 45-106. Pros: issuing securities without filing a prospectus greatly reduces the cost of obtaining capital. Cons: must qualify for an exemption. The Prospectus ProcessWhen a prospectus is requiredSecurities legislation (s. 61 of the BCSA) prohibits an issuer from distributing a security unless a prospectus is filed with the regulator and receipted, or unless the distribution is exempt from the prospectus requirement (either by qualifying for exemption listed in NI 45-106, or applying for discretionary exemption from regulator under s. 76 of the BCSA).A prospectus is required for:IPOs;Subsequent public offerings;Some secondary offerings (e.g. resale by control person). NI 41-101 sets out the general requirements for the prospectus process. Other national instruments and policies are aimed at facilitating filing across multiple jurisdictions, e.g. NP 11-202, Process for Prospectus Reviews in Multiple Jurisdictions. A prospectus provides investors with detailed information about the issuer so that they can make informed valuation and investment decisions. Prospectuses are designed as an instrument to increase public confidence in public offerings and to enhance the transparency of market transactions. Content As per s. 63(1) of the BCSA, the overriding principle of prospectus disclosure is “full, true and plain disclosure of all material facts relating to the securities”. Section 1 of the BCSA defines “material fact” as “a fact that would reasonably be expected to have a significant effect on the market price or value of securities”. The issuer’s CEO, CFO, and two directors, as well as the issuer’s underwriters, must certify that the prospectus includes this full, true and plain disclosure (gives rise to liability). To satisfy this requirement, a long-form prospectus must generally include:The issuer’s business plan, and its current and expected activities;Financial statements;The issuer’s capital structure;Estimated proceeds of the issue;Planned purpose for utilization of the capital;Underwriting agreement;Description of the factors that could make the security risky;Disclosure of the estimated net proceeds to be received.Junior issuers (defined in NI 41-101 as an issuer who is not yet a reporting issuer and whose consolidated assets and revenue are both less than $10,000,000) must disclose additional information, including the total funds available and a breakdown of those funds, estimated consolidated working capital up to the most recent month before filing, and total other funds available to be used to achieve the principal purpose identified by the issuer. In preparing a prospectus, the issuer must apply plain language principles, including using short sentences, everyday language, the active voice, avoidance of superfluous words, avoiding boilerplate wording, avoiding multiple negatives, etc. PartiesThere are three main parties in the offering process:The issuer;The underwriter(s):The investors.Stage 1: Secure an underwriterThe first step in the prospectus process for an issuer is to secure the services of an underwriter. Underwriters are the critical link between issuers and investors, and are often referred to as the “gatekeepers” of securities law. As the Ontario Securities Commission stated in YBM Magnex: “The underwriter stands between the issuer and the public as an independent, expert party in bringing new securities to the market. In a sense the underwriter and the issuer are joint venturers, but in another more important sense they must be adversaries. That is the underwriter must seek out and question all relevant and material facts concerning the issuer and reasonably ensure himself that these facts are fully and truly set before the investing public.”Most public offerings are underwritten by investment banking firms. Types of Underwriting AgreementsThere are a variety of underwriting agreements:Agency Agreement: In an agency agreement, the underwriter promises to use its “best efforts” to sell the securities as an agent for the issuer. The underwriter takes a commission on the securities that it actually able to sell. Securities are sold directly by the issuer to investors. Timing: agency agreement signed right before the final prospectus is filed.Pros for underwriter: not stuck with any securities at the end of the day. Firm Commitment: In a firm commitment, the underwriter agrees to purchase the issuer’s securities and resell them; this agreement is not signed by the underwriter until The underwriter receives a fee based on a percentage of the issue price. An underwriter may agree to a firm commitment where they are confident that they can make a profit b/w issue price and sale price (“spread”). Securities sold by issuer to underwriter, and from underwriter to investors. Timing: firm commitment agreement signed right before the final prospectus is filed.Pros for underwriter: can begin to “test the waters” after the preliminary prospectus is filed. Cons for underwriter: may be stuck with unsold securities. Bought Deal: In a bought deal, the underwriter agrees to purchase a large block of the to-be issue securities before the issuer files its preliminary prospectus. Securities sold by issuer to underwriter, and from underwriter to investors.Timing: bought deal agreement signed before preliminary prospectus has been filed!Pros for issuer: cash comes to the issuer faster. Cons for issuer: must qualify for short form prospectus process; must immediately issue and file a news release; short form preliminary prospectus must be filed w/in 4 days of entering into bought deal K. Pros for underwriter: reduces the risk of offering b/c the underwriter can canvass potential purchasers, or “test the waters”, before the preliminary prospectus is filed. Cons for underwriter: may be stuck with unsold securities.Cons for investors: a purchaser has no remedy of rescission against the issuer for misrepresentations in the prospectus (as in Danier Leather); this is b/c the underwriter, not the issuer, sells the securities. An Underwriter’s Obligations and Exposure to RiskRisk of being stuck with unsold securities: In the case of a firm commitment or bought deal, the underwriter bears the risk of not selling the securities (it cannot return the unsold securities to the issuer).Due diligence: The underwriter must perform due diligence on the issuer. The importance of due diligence was highlighted in YBM Magnex: underwriters must be on the lookout for red flags, and must avoid automatic reliance on statements by the issuer’s directors, officers, and counsel. Going back to the idea of underwriters as “gatekeepers”.Underwriters’ certificate: The underwriter must sign an underwriter’s certificate, certifying that the prospectus contains full, true and plain disclosure of all material facts related to the securities offered by the prospectus to the best of the underwriter’s knowledge, information and belief. Liability: The underwriter may be liable for any misrepresentations in the prospectus. How an Underwriter Can Limit Their Risk Termination clauses: The underwriter can include a market-out clause and a disaster-out clause in the underwriting agreement. With a market-out clause, the underwriter can terminate the agreement if it determines, acting reasonably, that the securities cannot be marketed profitably (Retrieve Resources was a BC case in which the Court considered the meaning of a market-out clause: “state of financial markets” held to mean the financial market into which specific shares were placed, not the financial markets as a whole). With a disaster-out clause, the underwriter can terminate the agreement if a significant event affects the issuer’s business or capital markets. The underwriter may also include other termination clauses, including regulatory-out, due diligence-out, and tax-out clauses. Invite other underwriters: The underwriter may lessen their risk by inviting other dealers into the offering (together, the purchasers are jointly and severally liable). Due diligence: The underwriter can lessen their risk by performing adequate due diligence. Underwriter not liable if conducted “reasonable investigation to provide reasonable grounds for belief that there was no misrepresentation”. Indemnity from the issuer: The underwriter can include an indemnity clause in the underwriting agreement, e.g. issuer indemnifies the underwriter from and against all losses, claims, damages, liability, reasonable costs & expenses. Accumulate sufficient expressions of interest before signing underwriting agreement: Before signing a firm commitment agreement, the underwriter should solicit expressions of interest and not enter into the agreement unless sufficient interest (at least equal to the amount of securities being offered). Minimizes risk of unsold securities. Lockups and blackout periods: The underwriter can require that issuer, major shareholders, principal officers & directors not sell securities for specified # days after IPO w/o underwriter’s consent (to prevent market disruptions).Disclosure of conflict of interests: A potentially non-independent underwriter (e.g. where underwriter = subsidiary of a bank to which issuer owes money) should make disclosures pursuant to NI 33-105, Underwriting Conflicts, and, if necessary, involve an independent underwriter. Stage 2: File preliminary prospectus & issuance of receipt by regulatorNI 41-101 sets out the required form and content of a long-form preliminary prospectus. As per s. 63(2) of the BCSA, the preliminary prospectus must “substantially comply” with the rules governing the final prospectus; however, a preliminary prospectus need not disclose certain information including the offering price of securities. As per s. 63(1) of the BCSA, the prospectus must provide “full, true and plain disclosure of all material facts relating to the securities”. Stage 3: Comments and revisions during waiting periodOnce the issuer has filed the preliminary prospectus and the regulator has issued a receipt, a mandatory waiting period begins. NI 41-101 defines “waiting period” as the time between the issuance of a receipt by the regulator for a preliminary prospectus, and the issuance of a receipt by the regulator for a final prospectus. This waiting period can be <10 days for short form prospectuses, or as long as several months for smaller issuers or issuers who have no history in the market.Limited advertising and communication w/ investors to gauge interest: During the waiting period, the issuer’s communications w/ potential investors is limited. The preliminary prospectus may only be distributed to prospective purchasers who, unsolicited, express an interest in purchasing the security. Advertising is limited to alerting the public of the existence of the preliminary prospectus and where they can locate it. Any advertising that can reasonably be considered to be in furtherance of an issue of securities is prohibited (Cambior). All advertisements must include the disclaimer set out in 13.1(1) of NI 41-101. Rationale: concern that public may take info in the preliminary prospectus as a final representation as to the accuracy of info underpinning the offer, before it has been vetted by regulators. Review process by the regulator: During the waiting period, the regulator engages in selective review of the preliminary prospectuses that are filed to determine whether they comply w/ all statutory, regulatory requirements. If an issuer filed in multiple jurisdictions, the primary regulator will provide the majority of comments (note: ON). Comment letter to the issuer: Once the review process is complete, the regulator sends a comment letter to issuer advising it of any required revisions or additional information. Ongoing obligation to amend the prospectus during the waiting period: During the waiting period, the issuer has an ongoing obligation to amend the prospectus if there are any material changes to its business or affairs. [below]Issuer’s ongoing obligation to amend preliminary prospectus during waiting period: MATERIAL ADVERSE CHANGEIf there is a material adverse change between filing the preliminary prospectus and the issuance of a receipt for the final prospectus, the issuer must file an amendment to the prospectus as soon as practicable and within 10 days after the change occurs, as per NI 41-101, ss. 6.5. Section 1of the BCSA defines:“material change” as “a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of a security of the issuer”; and,“material fact” as “a fact that would reasonably be expected to have a significant effect on the market price or value of securities”. In Danier Leather, the SCC said that material changes are inward looking and material facts are outward looking, e.g. in Danier Leather, a change in weather forecast was held to be a material fact, but not a material change, and so Danier was not required to disclose this material fact in order to meet its disclosure obligations. In practice, it is important to look at both the market impact test and the reasonable investor test for materiality: Market Impact TestInfo is material if it is reasonable to expect that the release of that information would impact the market price of the security.Reasonable Investor TestReasonable investor test is used in the United States, and now making its way to Canada: info is material if the reasonable investor would consider the info important to an investment decision. This test applied by the SCC in the context of BC’s Real Estate Act in Sharbern, 2011 SCC 23: “an omitted fact is material if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available”.Stage 4: File final prospectus & issuance of receipt by regulatorThe final prospectus is an amended version of the preliminary prospectus; must contain final pricing info and audit reports. Stage 5: Distribution of securities once receipt for final prospectus issuedOnce the final prospectus has been filed and a receipt issued, securities may be lawfully sold. There is push towards closing!The final prospectus must be delivered before any purchase contract is entered into, or no later than midnight on the second business day after entering into an agreement, as per s. 83(1) of the BCSA. Investors have a 2 business day “cool down” period following receipt of the final prospectus during which they can exercise a right of rescission, as per s. 83(3) of the BCSA. [note: you want these 2 days to elapse before closing!]As per NI 44-101, s. 8.2, if securities are being distributed on a best efforts basis, the distribution must cease within 90 days after the date of receipt for the final prospectus, unless an amendment to the final prospectus was filed and a receipt for the amendment received. The total period of distribution cannot exceed 180 days after the receipt for the final prospectus. Issuer’s ongoing obligation to amend the final prospectus: ANY MATERIAL CHANGEIf there is a material change (beneficial and adverse) between issuance of a receipt for the final prospectus and the completion of the distribution, the issuer must file an amendment to the prospectus as soon as practicable and within 10 days after the change occurs, as per NI 41-101, ss. 6.6. If amended final prospectus is filed, 2 day right of rescission “restarts” for investors.Section 1of the BCSA defines:“material change” as “a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of a security of the issuer” (e.g. mining licence cancelled b/c of coup d’état); and,“material fact” as “a fact that would reasonably be expected to have a significant effect on the market price or value of securities” (e.g. mine strike in Bolivia; weather forecast; coup d’état). In Danier Leather, the SCC said that material changes are inward looking and material facts are outward looking, e.g. in Danier Leather, a change in weather forecast was held to be a material fact, but not a material change, and so Danier was not required to disclose this material fact in order to meet its disclosure obligations. In practice, it is important to look at both the market impact test and the reasonable investor test for materiality: Market Impact TestInfo is material if it is reasonable to expect that the release of that information would impact the market price of the security.Reasonable Investor TestReasonable investor test is used in the United States, and now making its way to Canada: info is material if the reasonable investor would consider the info important to an investment decision. This test applied by the SCC in the context of BC’s Real Estate Act in Sharbern, 2011 SCC 23: “an omitted fact is material if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available”.Alternatives to traditional long form prospectus: ways to save time and moneyShort Form Prospectus (*only available to reporting issuers w/ good disclosure record)NI 44-101 sets out the requirements for filing a short form prospectus. Reporting issuers with a good continuous disclosure record may qualify to file a short form prospectus in Form 44-101F1. A short form prospectus incorporates the reporting issuer’s disclosure record “by reference”. The filing process for a short form prospectus is similar to that for a long-form prospectus, but the waiting period is far shorter (as per NP 11-202). Pros: can expedite the raising of capital, and can lower the cost of making an offering. Rationale: issuers who are already reporting issuers must abide by continuous disclosure obligations, e.g. filing annual information forms, which provide extensive information for investors re: the issuer’s history, business plan, finances; public protected by prior vetting of disclosure and the specific requirements of the SFP process. Shelf Prospectus (*only available to reporting issuers w/ good disclosure record)NI 44-102 sets out the requirements for filing a shelf prospectus. Reporting issuers that are eligible for the short form prospectus process are also eligible to file shelf prospectuses. A shelf prospectus allows an issuer to file a short form-style prospectus and then leave it “on the shelf” for up to 25 months. At any point in those 25 months, the issuer can take the securities “off the shelf” and distribute them. Pros: can expedite the raising of capital, can lower the cost of making an offer > to distribute securities, the issuer only needs to prepare an information supplement, which does not required review by regulators. Cons: risk of “market overhang” (share price dropping in anticipation of forthcoming issuance of shares). Rationale: same as for SFPs > for reporting issuers for which there is considerable information in the market. Post-Receipt Pricing Prospectus (*available to all issuers, but only for specific transaction + single type of security)NI 44-103 sets out the requirements for filing a post-receipt pricing prospectus. All issuers are eligible for the PREP prospectus process, but it may only be used for a specific transaction and a single type of security (in contrast to shelf prospectuses, which may be used for multiple types of securities. The PREP process allows issuers to file a base prospectus (long or short form) without including price and related information. A PREP prospectus cannot be used for a rights offering, and can be kept “on the shelf” for 90 days (far less than 25 months for shelf prospectuses). This shelf life can be extended if the issuer files a supplemental PREP prospectus. To distribute securities, the issuer must prepare an information supplement to distribute to prospective purchasers, but this need not be reviewed by regulators. Multijurisdictional Disclosure System (*for offerings in US and Canada)NI 71-101 sets out the requirements for distributions in Canada and the US. Under the MJDS, issuers from the US and Canada can use the same disclosure forms when selling securities in each other’s markets. Passport SystemNP 11-202 sets out the passport rule for filing a prospectus in multiple jurisdictions. The aim of the passport system is to streamline the regulator review and comments process. Under the passport system, the issuance of a receipt for a preliminary prospectus by the primary regulator is deemed to be receipt of the preliminary prospectus in all passport jurisdictions (*these jurisdictions must be listed in the primary regulator’s receipt). The primary regulator will provide the bulk of the comments during the waiting/review period. However, Ontario has not signed on to NP 11-202. If issuer files a prospectus in multiple provinces including Ontario, the dual prospectus system applies and there are two principal regulators (Ontario Securities Commission + other primary regulator).Future-Oriented Financial Information (FOFI)Financial Forecasts: FOFIWith the regulator’s approval, a prospectus may include financial forecasts. However, if there are any changes to the forecast’s underlying assumptions or if external events cause the issuer to revise the forecast, the issuer must update the FOFI. An issuer must also address the FOFI in its quarterly filings of financial statements. Exempt Market TransactionsPolicy Objectives of Exempt Market TransactionsSecurities legislation (s. 61 of the BCSA) prohibits an issuer from distributing a security without a prospectus unless the distribution is exempt from the prospectus requirement (either by qualifying for an exemption listed in NI 45-106, or applying for a transaction-specific discretionary exemption from the regulator under s. 76 of the BCSA). An issuer can rely on as many exemptions as applicable. Raising capital via a distribution that qualifies as an exempt market transaction is known as a “private placement”. If the issuer fits the “spirit” of one of the exemptions, but does not fall squarely within it, consult w/regulator and apply for a discretionary exemption under s. 76 of the BCSA (if “spirit” fits, regulators more likely to grant discretionary exemptions).Policy objectives of exempt market transactions involve balancing investor protection (full and true disclosure) and public interest in market efficiency (the high cost and delay of preparing a prospectus):Need to provide flexibility to address specific problems faced by startup, small, and medium-sized issuers in generating initial amounts of capital. [private issuer; family, friends and business associates; accredited investor]Acknowledgement that some wealthy or sophisticated investors are able to make investment decisions without the information provided in a prospectus, and so prospectus requirements can be relaxed to promote market efficiency. Based on assumption that investors capable of acting rationally in their own economic self-interest, and will seek out any information that they deem relevant to their decision-making. [accredited investor; minimum amount exemption]Desire to reduce costs for issuers where there is no countervailing concern about investor protection b/c issuer is issuing securities to those with whom they have a pre-existing relationship. Based on assumption that investors in a pre-existing relationship have access to adequate current info re: issuer. [family, friends and business associates]Acknowledgement that some safe securities (e.g. government bonds) do not require a prospectus [govt incentive]Small and Medium-Sized Enterprises or Startup Issuer ExemptionsPrivate Issuer ExemptionNI 45-106s. 2.4Maximum of 50 securities holders who are not the public: the issuer cannot have more than 50 securities holders, excluding former and current employees; the offering cannot be “to the public”, meaning that all security holders must have a relationship w/ the issuer, its directors, officers, or control persons, or must be an accredited investor (someone sophisticated, well-off enough to bear invstmt risk). Note: this is a qualitative/subjective test, not an objective test!Common bonds test: In Piepgrass, the Alberta CA held that investor farmers “were not in any sense friends or associates of the accused, or persons having common bonds of interest or association”, therefore offering was “to the public” > no exemption. “Need to know” test: This test is whether potential investors “need to know” the kind of information that a prospectus would provide. Restrictions on transfer: the issuer’s constating document must include limits on transfer (i.e. the securities cannot be bought or sold w/o approval of directors). The issuer cannot be a reporting issuer or an investment fund. The issuer must be a private issuer. Family, Friends, and Business Associates Exemption*everywhere but ON!NI 45-106s. 2.5Investors must be a spouse, a family member, a “close personal friend”, or “a close business associate” of the founder, the directors, executive officers, or control persons. Note: this is a qualitative/subjective test, not an objective test!NI 45-106CP s. 2.7 defines “close personal friend” as “an individual who knows the director, executive officer, founder or control person well enough and has known them for a sufficient period of time to be in a position to assess their capabilities and trustworthiness”. NI 45-106 CP s. 1.10 recommends that issuers obtain signed statements from purchasers describing the purchaser’s relationship, and should not rely on representations, e.g. “I am a close personal friend of the director”.The issuer can be private (non-reporting) or public (reporting). No limit on number of securities holders. Not available in Ontario.The issuer cannot rely on advertising or an agent to facilitate the transactions (goes against the “spirit” of this exemption). Founder, Control Person, and Family ExemptionNI 45-106s. 2.7A variation of the Family, Friends, and Business Associates Exemption, only available in Ontario. Key difference: this exemption does not allow sales to close friends or close business associates.Wealthy & Sophisticated Investor ExemptionsAccredited Investor ExemptionNI 45-106s. 2.3Investors must be accredited investors. An investor qualifies as “accredited” if they meet one of the following objective tests, set out in s. 1.1 of NI 45-106:Asset Test #1: if the person (either alone or w/ spouse) has financial assets (excludes principal residence) that exceed $1,000,000. Asset Test #2: if the person (either alone or w/ spouse) has net assets in excess of $5,000,000 (factoring in debt, all assets, incl. principal residence. Income Test: if the person has a net income that exceeds before tax $200,000 (alone) or $300,000 (w/ spouse). Otherwise sophisticated investors: financial institutions such as banks, loan or trust companies, insurance companies, and credit unions, pension funds and mutual funds, and various levels of government.The issuer can be private (non-reporting) or public (reporting). No limit on number of securities holders. Minimum Amount Investment ExemptionNI 45-106s. 2.10Investors must pay a minimum of $150,000 in cash, and must purchase as principals (not as agents for a group; i.e. group of people cannot pool their money).*an objective/quantitative test, not a subjective/qualitative one!The issuer can be private (non-reporting) or public (reporting). No limit on number of securities holders.Pre-Existing Relationship ExemptionsDividends ExemptionNI 45-106s. 2.31Applies to the issuance of securities to investors as payment of dividends in lieu of cash (this qualifies as a distribution). Trades to Employees ExemptionNI 45-106s. 2.24Applies to the issuance of securities to employees, e.g. as a form of compensation or as an incentive for future performance. Employees includes: directors, officers, consultants.Issuer and Affiliates ExemptionNI 45-106ss. 2.8, 2.15Applies to the issuance of securities by issuer to itself, or to an affiliate of the issuer. Business Combinations and Reorganizations ExemptionNI 45-106s. 2.11Applies to the issuance of securities to creditors in exchange for the issuer’s debt obligations as part of a reorganization. Rationale: regulators do not want to add to difficulties of an issuer in financial distress, and creditors may have enhanced access to info about issuer in their debt agreements. Takeover Bids ExemptionNI 45-106s. 2.15Applies to the issuance of securities in connection with a takeover bid. Conversions or Exchanges ExemptionNI 45-106s. 2.42Applies to the conversion or exchange of existing securities to new securities.Rights Offering ExemptionNI 45-106s. 2.1Applies to a rights offering that gives investors the right to buy additional securities based on the number of securities the investor currently holds.Rationale: the investors already made a decision to hold securities, so no additional disclosure needed for a rights offering. This exemption does not apply if the rights offering is to effect a “major financing” (exercise of rights would result in 25%+ of # of outstanding securities in the class). “Safe” Securities ExemptionGovt Debt Securities ExemptionNI 45-106s. 2.34Applies to the issuance of debt securities by the federal or provincial governments, other foreign governments with an approved credit rating, financial institutions, etc. Govt Incentive Security Exemption OSC Rule 45-501Government Incentive Securities = tax shelters created by the govt to promote activities of junior exploration issuers in the resource sector and northern communities. “Securities as Payment” ExemptionsAsset Acquisition ExemptionNI 45-106s. 2.12Applies to the issuance of securities as payment by the issuer for assets, provided the value of those assets exceeds $150,000. Petroleum, Natural Gas and Mining Properties ExemptionNI 45-106s. 2.13Applies to the issuance of securities as payment by the issuer to acquire petroleum, natural gas, or mining properties. No minimum value!Offering Memorandum ExemptionOffering Memorandum ExemptionNI 45-106s. 2.9The issuer must file an offering memorandum in the prescribed form, 45-106F2.For qualified reporting issuers: a shorter form memorandum is allowed, similar to the short form prospectus, incorporating info by reference.For non-qualified issuers: full-length memorandum required (looks a lot like a long-form prospectus!). Investors must sign a risk acknowledgement statement. The issuer can be private (non-reporting) or public (reporting). No limit on number of investors, or how much money can be raised. Not available in Ontario (can only be used in ON w/ another exemption).The information disclosed in an offering memorandum will generally attract liability. Section 2.9(8) provides that an offering memorandum must contain a certificate that states the following: “This offering memorandum does not contain a misrepresentation.” Discretionary ExemptionIf an issuer is unable to qualify for an exemption listed in NI 45-106, it may apply for a transaction-specific discretionary exemption from the regulator under s. 76 of the BCSA. The regulator will determine whether granting the exemption would be “prejudicial to the public interest”. If the issuer fits the “spirit” of one of the exemptions, but does not fall squarely within it, consult w/regulator and apply for a discretionary exemption under s. 76 of the BCSA (if “spirit” fits, regulators more likely to grant discretionary exemptions).Resale RulesResale RulesIf an investor purchased securities in the exempt market and now wants to sell those securities, the investor must either (a) find a purchaser who qualifies for an exemption, keeping the securities in the exempt market, or (b) satisfy the resale rules set out in NI 45-102 in order to sell the securities in the public market. The resale rules bridge the gap between the exempt market and the public market. Is the investor a control person, or not?Section 1 of the BCSA defines “control person” as:a person who holds a sufficient number of voting rights attached to all outstanding voting securities of the issuer to affect materially the control of the issuer, ORa group of people, acting in concert, which together holds a sufficient number of voting rights attached to all outstanding voting securities of the issuer to affect materially the control of the issuer.If a person or group of people hold more than 20% of the voting rights attached to all outstanding voting securities of the issuer, they are deemed to be a control person (in the absence of evidence to the contrary). Restricted/exempt security holder who is not a control person: the applicable resale ruleIf an investor who is not a control person purchased securities in the exempt market and now wants to sell those securities, the investor must either (a) find a purchaser who qualifies for an exemption, keeping the securities in the exempt market, or (b) satisfy the applicable resale rule set out in NI 45-102 in order to sell the securities in the public market. Identify the exemption under which the restricted securities were issued.If this exemption is listed in Appendix D of NI 45-102, the resale rule in s. 2.5 of NI 45-102 apply. Accredited Investor ExemptionFamily, Friends, Business Associates Exemption Founder, Control Person, Family Exemption (ON)Affiliates ExemptionOffering Memorandum ExemptionMinimum Amount Investment ExemptionAsset Acquisition InvestmentPetroleum, Natural Gas, Mining ExemptionIf this exemption is listed in Appendix E of NI 45-102, the resale rule in s. 2.6 of NI 45-102 apply.Private Issuer ExemptionDividends ExemptionRights Offering ExemptionBusiness Combination & Reorg ExemptionTakeover Bid ExemptionTrades to Employees ExemptionThe resale rule in s. 2.5 of NI 45-102 provides for a “restricted period”. Six conditions must be met to satisfy this resale rule and transform the restricted securities into free-trading securities. Seasoning period: the issuer (who originally issued the restricted securities) must be a reporting issuer (i.e. public) for at least 4 mos, i.e. this issuer had to comply with continuous disclosure requirements for min 4 mos. **4 mos + day since distribution: the security holder must wait four months plus a day since the initial distribution date before reselling.**Legend: the certificate representing the security must include a “legend” that sets out when the initial distribution date was and earliest date for resale.The trade must not be a control distribution, i.e. the security holder must not be a control person.There must be no extraordinary effort to prepare the market in advance of the trade, e.g. no advertising If the security holder is an insider or officer of the issuer, they must have no reasonable grounds to believe the issuer is in default of securities legislation.**If these six conditions are met, these formerly restricted securities may be resold in the public market. **If these six conditions are not met, the resale is deemed to be a distribution and the prospectus requirement is triggered. The resale rule in s. 2.6 of NI 45-102 provides for a “seasoning period”. Five conditions must be met to satisfy this resale rule and transform the restricted securities into free-trading securities. Seasoning period: the issuer (who originally issued the restricted securities) must be a reporting issuer (i.e. public) for at least 4 mos, i.e. this issuer had to comply with continuous disclosure requirements for min 4 mos. Legend: the certificate representing the security must include a “legend” that sets out when the initial distribution date was and earliest date for resale.The trade must not be a control distribution, i.e. the security holder must not be a control person. There must be no extraordinary effort to prepare the market in advance of the trade, e.g. no advertising. If the security holder is an insider or officer of the issuer, they must have no reasonable grounds to believe the issuer is in default of securities legislation.**If these five conditions are met, these formerly restricted securities may be resold in the public market. **If these five conditions are not met, the resale is deemed to be a distribution and the prospectus requirement is triggeredIf the applicable resale rule cannot be satisfied, see if the exemption in s. 2.7 of NI 45-102 applies. Under this exemption, the resale rules in 2.5 and 2.6 do not apply if the issuer became a reporting issuer after the distribution date by filing a prospectus and is a reporting issuer at the time of the resale trade. [note: if the issuer is not a reporting issuer, and does not become one, the restricted security holder is confined to selling his or her securities in the exempt market to an exempt buyer, or selling in the public market via a prospectus]If all else fails, sell the restricted securities to another investor who qualifies for an exemption. These securities remain in the exempt market. Restricted/exempt security holder who is a control person: the applicable resale ruleIf a control person purchased securities in the exempt market and now wants to sell those securities, he or she must either:file a prospectus, e.g. include his or her securities as part of a secondary offering by the issuer, apply for a discretionary exemption from the regulator under s. 76 of the BCSA, though unlikely one will be granted,find a purchaser who qualifies for an exemption, keeping the securities in the exempt market, or satisfy the five resale conditions set out in s. 2.8 of NI 45-102 in order to sell the securities in the public market. Control persons are subject to more onerous resale rules when selling securities in the public market. Rationale: regulators are concerned with information asymmetry and the possibility that control persons may be selling into the marketplace on the basis of information not generally available to investors. Five resale conditions for a control distributionThe issuer (who originally issued the restricted securities) must be a reporting issuer (i.e. public) for at least 4 months, i.e. this issuer had to comply with continuous disclosure requirements for min 4 months. The control person has held the restricted securities for at least 4 months. There must be no extraordinary effort to prepare the market in advance of the trade, e.g. no advertising. There must be no extraordinary commission paid to a person or company in respect of the trade. The control person must have no reasonable grounds to believe the issuer is in default of securities legislation.Other requirementsIn addition to meeting the five conditions for a control distribution set out in s. 2.8 of NI 45-102, the control person must also:Sign Form 45-102F1, Notice of Intention to Distribute Securities, and then file it within one business day of signing;File Form 45-102F1 on SEDAR at least seven days before the control person intends to sell the securities; and,Within three days of completing the trade, file an insider report (Form 55-102F2 or Form 55-102F6). Incorrect Reliance on ExemptionsWhat happens if an issuer or restricted/exempt security holder screws up, i.e. doesn’t get an exemption right?If an issuer or restricted security holder improperly relies on an exemption from the prospectus requirement, the consequences are potentially significant. In Deacon Hodgson, the Court held that a failure to file a prospectus renders the contracts of purchase and sale null and void, and that no limitation period applies. That a remedy for failure to file a prospectus is never statute-barred indicates how fundamental the provision of a prospectus is to securities regulation.Continuous Disclosure RequirementsAll reporting issuers must comply with continuous disclosure requirementsAll reporting issuers must comply with the continuous disclosure requirements set out in NI 51-102, Continuous Disclosure Obligations. There are two aspects of a reporting issuer’s ongoing disclosure obligations:Periodic disclosure of interim and annual financial statements and accompanying reports; and,Timely and accurate disclosure of material changes experienced by the issuer. Rationale: providing investors with transparent and efficient access to information about reporting issuers in order to enhance investor protection and maintain investor confidence in the capital markets. Continuous disclosure is also significant b/c 94% of all capital market activity in Canada takes place in secondary markets (where there is no prospectus requirement). Finally, continuous disclosure can facilitate the raising of capital through the issuance of new securities b/c reporting issuers with good continuous disclosure records may be eligible to file short form prospectuses under NI 44-101, or offering memoranda under the s. 2.9 prospectus exemption in NI 45-106. Selective disclosure and a reporting issuer’s failure to meet its continuous disclosure requirements can result in: (a) lost of investor confidence, (b) lower trading prices, (c) a lower credit rating, (d) higher cost of capital, and (e) civil liability. A reporting issuer’s periodic disclosure requirementsA reporting issuer must comply with four periodic disclosure requirements:Quarterly and annual financial statements;Management Discussion and Analysis (MD&A) to accompany quarterly and annual financial statements;Annual Information Form (AIFs);Information Circulars and Proxy Solicitation before shareholder meetings. 1. Financial Statements (each quarter + annually)Under ss. 4.1 and 4.3 of NI 51-102, all reporting issuers must file quarterly annual statements and annual audited financial statements. These financial statements must generally include: an income statement, a balance sheet, a statement of retained earning ,and a cash flow statement. 2. MD&A (each quarter + annually)Under s. 5.1 of NI 51-102, all reporting issuers must prepare and file a Management Discussion and Analysis in Form 51-102F1 to accompany its quarterly and annual financial statements. The MD&A should analyze the financial statements, discuss the dynamics of the business, discuss current or pending obligations and liabilities, and provide management’s insight on how the issuer is likely to perform in the future. 3. AIF (annually)Under s. 6.1 of NI 51-102, all reporting issuers (excluding Venture issuers) must prepare and file an Annual Information Form. An AIF is similar to a prospectus b/c it requires detailed disclosure of the reporting issuer’s history, operations, and financial affairs, including a discussion of the issuer’s prospects, disclosure of social and enviro policies that are fundamental to the issuer’s operations, and disclosure of risk factors such enviro and health risks or political considerations. 4. Information Circulars and Proxy SolicitationUnder s. 9.1 of NI 51-102, all reporting issuers must distribute a proxy form and information circular to all registered holders of voting securities in advance of a shareholder meeting. The form allows someone to vote on the shareholder’s behalf, and the information circular sets ou the date and time of the meeting, and matters to be acted on at the meeting, plus supporting info.A reporting issuer’s timely disclosure requirements of MATERIAL CHANGESUnder s. 7.1 of NI 51-102, a reporting issuer also has an ongoing obligation to make timely and accurate disclosure of material changes that affect the reporting issuer. When a material change occurs, the reporting issuer must:Immediately issue and file a news release disclosing the nature and substance of the material change; and,As soon as practicable, or w/in 10 days of material change occurring, file a Material Change Report, Form 51-102F3. Rationale: timely disclosure of material changes = essential to promotion of active capital markets and investor protection. How to determine if a change is a material change that requires timely disclosure under s. 7.1 of NI 51-102Section 1.1 of NI 51-102 defines “material change” as “a change in the business, operations or capital of the reporting issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the reporting issuer”. A number of cases have considered the definition of material change:In Pezim, the SCC held that the definition of “material change” had three elements. The change must be: (a) in relation to the affairs of the issuer, (b) in the business, operations, assets or ownership of the issuer and (c) material, i.e. would reasonably be expected to have a significant effect on the market price or value of the securities of the issuer. The SCC concluded that Pezim’s assay and drilling results amounted to a material change b/c it was a change in “assets”. In Danier Leather, the SCC distinguished between material facts (which need not be disclosed on a continuing basis, except for TSX-listed reporting issuers who must disclose changes to “material information”), and material changes. The SCC said that “material change” is limited to a change in the business, operations or capital of the reporting issuer, that this this limitation is a deliberate, policy-based “attempt to relieve reporting issuers of the obligation to continually interpret external political, economic and social developments as they affect the affairs of the business, unless the external changes will result in a change in the business, operations or capital of the issuer”. The SCC concluded that unseasonably warm weather (an external factor) was a “material fact”, but not a “material change”, and so Danier’s failure to disclose this fact did not amount to a breach of its continuous disclosure obligations. In AiT, the Ontario Securities Commission held that the determination of whether a material change has occurred is not a “bright-line” test b/c the determination of a material change is a question of mixed fact and law. The OSC held that, in the context of a proposed merger and acquisition, whether or not this proposed transaction constitutes a material change depends on whether a “decision to implement” the transaction has taken place (even though tsx itself has not yet occurred). The OSC said: “where the proposed transaction is speculative, contingent and surrounded by uncertainties, a commitment from one party to proceed will not be sufficient to constitute a material change”. The OSC concluded that AiT should have disclosed the potential acquisition by Motorola as soon as the decision to proceed was made > should not have waited until final acquisition agreement was signed (breach of timely disclosure obligation). In YBM Magnex, the Ontario Securities Commission applied the probability/magnitude test to determine whether a contingent future event had become sufficiently crystallized such that YBM had to disclose this possibility as a material change. The issue in YBM Magnex was whether YBM’s potential inability to file its audited statements by the May 20 deadline (and therefore face a cease trade order) after its audit was suspended on April 20 constituted a material change. The OSC found that this was a material change: the magnitude of the potential cease trade order was “self-evident”, and that it was sufficiently probable that YBM would be unable to obtain an audit opinion in time to make its May 20 deadline. YBM only disclosed the audit suspension 18 days after it occurred. The OSC found that YBM failed to disclose the material change forthwith/as soon as practicable.Additionally: NP 51-201, Disclosure Standards discusses best practices for disclosure, and encourages reporting issuers to err on the side of disclosure. This policy includes a list of recommendations re: materiality for reporting issuers, including adopting a formal disclosure policy, having a special management committee focused only on disclosure matters, restricting the number of people who can speak on behalf of the reporting issuer, adopting a written policy on how to respond to rumors. Public Policy Considerations in the Continuous Disclosure RegimeThe continuous disclosure regime is aimed at enhancing the transparency of financial reporting as part of an effort to protect investors + increase confidence in capital markets; however, there are still considerable barriers to meaningful participation. As the number of national and multilateral instruments increase, it becomes increasingly difficult for investors to discern whether an issuer has met its disclosure obligations. The diversity and complexity of reporting documents makes information inaccessible to small investors who do not have the time or resources to scrutinize disclosures. The definition of “material” focuses on events or transactions that might affect the issuer’s market price or value; as a result, investors may not be exposed to externalized social, economic or environmental costs, which do not fall into the definition of “material”. That said, the new AIF Form 51-102F2 now requires that reporting issuers disclose social and enviro policies that are fundamental to the issuer’s operations, as well as environmental and health risks, and political and economic conditions, that would likely influence an investor’s decision to purchase securities. [will be interesting to see how issuers, regulators, and courts interpret these expanded disclosure requirements]Insider TradingWhat is insider trading?Insider trading involves the purchase or sale of securities of a company effected by or on behalf of a person whose relationship to the company is such that she or he will likely have access to relevant information concerning the company that is not known to the public. As the 1965 Kimber Report suggested, not all insider trading is improper, e.g. it is not improper for an insider to buy or sell securities in his own company. In response, a two-pronged legislative developed:Legal Insider Trading: Trading by insiders is legal if they report trades within a certain time period and these trades are not based on undisclosed material information.Illegal Insider Trading: Trading by insiders is illegal where an insider, or any other person in a “special relationship” with the issuer, trades based on undisclosed material information or informs anyone (i.e. tipping), other than in the necessary course of business, of undisclosed material information. Rationale for regulating insider trading: fairness > to ensure that as much information as possible is available to investors; to maintain investor confidence in the capital markets, i.e. they should feel confident that there is a level playing field, and that individuals w/ access to confidential information will not benefit from their special relationship w/ the issuer; finally, aim to make capital markets free and open, where the price of a security is based on fullest possible knowledge of all relevant facts.[Arguments against regulating: insiders should benefit from access to confidential info as a reward for work + incentive for continued performance for company, shareholders; also, regulation is expensive and detections are rare > no “smoking gun”.]Legal Insider TradingDefinition of “insider”Section 1 of the BCSA defines “insider” as:A director or officer of the issuer;A director or officer of a person that is itself an insider or subsidiary of the issuer;A person that has indirect or direct control over, or beneficial ownership of, more than 10% of voting rights attached to all the issuer’s outstanding voting securities;An issuer that has purchased, redeemed or otherwise acquired its own securities; or, A person designated as an insider by the regulator “in the public interest” under BCSA s. 3.2.Insider reporting requirements: upon becoming an insider + subsequentlyWithin 10 calendar days of becoming an insider of a reporting issuer, the insider must file an initial Insider Trading Report (ITR). Under s. 3.2 of NI 55-104 and s. 87 of the BCSA, the issuer must disclose their beneficial ownership of, or control or director over, securities of the reporting issuer, and any interest in, or right or obligation associated with, a related financial instrument involving a security of the reporting issuer. ITRs are available to the public online on SEDI, the System for Electronic Disclosure by Insiders. Within 5 days of any subsequent change (e.g. exercising an option, or buying or selling securities of the reporting issuer), the insider must file a new ITR, disclosing the change, as per s. 3.3 of NI 55-104 and BCSA s. 87. Exemptions to the insider public reporting requirementsThe following exemptions apply to insiders, relieving of them of their reporting requirements:No securities: an insider is exempt from filing insider reports if they have no ownership, direction or control over any of the reporting issuer’s securities.A change that affects everyone: an insider is exempt from filing an insider report if the change is one that affects all holders of a class of securities equally, or is available to all securities of a class (e.g. stock dividend, amalgamation). Note: though insiders are not required to file, the reporting issuer must file within a report w/in 1 business day. Non-executive officer: a director or officer of a subsidiary of the reporting issuer is exempt unless they have access to, in the ordinary course of business, undisclosed material information. This exemption does not apply if the subsidiary is a major subsidiary whose assets = at least 10% of the reporting issuer. Also, a director or officer of an affiliate of the reporting issuer is exempt unless they have access to undisclosed material information. This exemption does not apply if the affiliate is a material contractor/supplier for the reporting issuer. Eligible institutional investors: an institutional investor may be exempt if it files an early warning report (upon acquiring more than 10% shares + every additional 2% acquired), and do not have access to material undisclosed info. Discretionary exemptions: under s. 91 of the BCSA, the regulator may grant a discretionary exemption to insiders where it would not be prejudicial to the public interest to do so; insiders may apply for a discretionary exemption. Consequences of failure to file insider reportsUnder BCSA s. 155(1), if an insider fails to file a required insider trading report, that issuer has committed an offence and may be liable, under s. 155(2), to a fine of not more than $3 million, or to no more than 3 years imprisonment, or both. The regulator may also make an order for compliance under s. 157(1), or an enforcement order, including a cease trade order, under s. 161.Illegal Insider TradingFor there to be a claim against X for illegal insider trading under s. 57.2 of the BCSA, three elements must be met:Special relationship: X must be in a special relationship with the reporting issuer;Material information: the knowledge on which X purchased or sold the reporting issuer’s securities must meet the materiality threshold (i.e. it must be a material fact, or a material change); and, Not generally disclosed: the information relied on by X in the purchase or sale of the reporting issuer’s securities must not be information that has been generally disclosed. Element 1: X must be in a SPECIAL RELATIONSHIP with the reporting issuerUnder s. 3 of the BCSA, for X to be in a “special relationship” with the reporting issuer, X must be:A person or company who is an insider, affiliate, or associate of the reporting issuer, s. 3(a)(i);A person or company who is proposing to make a take-over bid of the reporting issuer, s. 3(a)(ii);A person or company who is a merging or amalgamating with the reporting issuer, s. 3(a)(iii);A person or company who is engaged in or proposes to engage in any business or professional activity with or on behalf of the reporting issuer, or with or on behalf of a person or company who is proposing to make a take-over bid of, or merging or amalgamating with, the reporting issuer, s. 3(b); [e.g. lawyers, accountants!]A director, officer, or employee of the reporting issuer, s. 3(c);A director, officer, or employee of a person or company proposing to make a take-over bid, or merging or amalgamating with the reporting issuer, s. 3(c);A person or company that has learned of a material fact or a material change from any other person or company who is in a special relationship with the reporting issuer, where that person or company knew or ought to have reasonably known that the other person or company was in a special relationship with the reporting issuer, s. 3(e). Note: this defn is a lot broader than the defn of “insider”! Includes: employees, lawyers, accountants, some third parties….Element 2: X traded based on knowledge of MATERIAL INFORMATIONSection 1 of the BCSA defines:material change as “a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of a security of the issuer”.reporting issuer’s potential inability to file audited financial statements > cease trade order in YBM Magnex;potential acquisition of the reporting issuer by Motorola in AiT;new drilling and assay results in Pezim;material fact as “a fact that would reasonably be expected to have a significant effect on market price or value of securities”. potential second financing deal for a reporting issuer in Donnini;unseasonably warm weather in Danier Leather;There are two tests to determine the materiality of historic/existing information:Market Impact Test: Info is material if it is reasonable to expect that the release of that information would impact the market price of the security. Reasonable Investor Test: The reasonable investor test is used in the United States, and is now making its way to Canada: information is material if the reasonable investor would consider the information important to an investment decision. This test was applied by the SCC in the context of BC’s Real Estate Act in Sharbern, 2011 SCC 23. The SCC said: “an omitted fact is material if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available”.There is one test to determine the materiality of future/potential information:Probability/Magnitude Test: The materiality of a potential future event depends on (a) an assessment of the probability that the event will occur having regard to all the known or ascertainable facts, and (b) an assessment of the magnitude or significance of the change, in terms of whether the information would be viewed by reasonable investors as important info for making a decision to buy, sell, or continue to hold their securities. This test was applied by the OSC in an insider-trading context in Donnini. In Donnini, the issue was whether knowledge of a potential financing deal for a company, Kasten, which was negotiating the deal with Yorkton (a company for which Donnini was a director and the fourth largest shareholder) constituted material information. Donnini learned about this second financing in a 3-min “hallway” conversation and then traded Kasten stock based on this info. The OSC found that this was material info b/c negotiations for this financing were “sufficiently advanced”.Element 3: the material information relied on by X to trade was NOT GENERALLY DISCLOSEDIn Harold P Connor, the OSC identified 2 factors to determine whether material info has been “generally disclosed”: The information must reach the marketplace: the material information must be disseminated to the trading public.Investors must have reasonable time to analyze the information: the trading public must have sufficient time to digest the information given its nature and complexity. In Harold P Connor, a press release was issued but insufficient time passed after the issuance before the defendant traded. The OSC found the defendant guilty of illegal insider trading, and also recommended that insiders wait a minimum of 1 full trading day after the release of information before trading.These two factors are now embodied in NP 51-201, Disclosure Standards. TippingLiability for X, the tipper:For there to be a claim against X for tipping under s. 57.2 of the BCSA, three elements must be met:Special relationship: X (the tipper) must be in a special relationship with the reporting issuer;Shared material information: X (the tipper) informed Y (the tippee) of a material fact or material change other than in the necessary course of business (e.g. the tipper’s lawyers, partners, suppliers, vendors, etc); and, Not generally disclosed: the material information passed on by X to Y has not been generally disclosed. X will be guilty of tipping even if Y (the tippee) did/does not know that X was in a special relationship w/ the reporting issuer. Liability for Y, the tippee: For there to be a claim against Y (the tippee) for illegal insider trading or tipping under s. 57.2 of the BCSA:Y must know that X (the original tipper) in a special relationship with the reporting issuer; or,Y ought reasonably to have known that X (the original tipper) was in a special relationship with the reporting issuer. This liability for Y is based on the definition of “special relationship” in s. 3(e) of the BCSA.Y (the tippee) will not be guilty of illegal insider trading or tipper if Y did not know, and should not reasonably have known, that X was in a special relationship with the reporting issuer.Defences for Illegal Insider Trading & TippingPossible defences for illegal insider trading and tipping are set out in s. 57.4 of the BCSA, including:X reasonably believed that the material information had been generally disclosed prior to trading;X made a reasonable mistake of fact, e.g. reasonably believed info would not have substantial effect on share price.X shared the information with Y as part of the necessary course of business. Reasonable Belief that Info DisclosedReasonable Mistake of FactNecessary Course of BusinessTo establish this defence, the onus is on X to prove that he or she had a reasonable belief that the info was “generally disclosed”. In Harold P Connor, the OSC identified 2 factors to determine whether material info has been “generally disclosed”: Info must reach the marketplace.Investors must have reasonable time to analyze the information. In Harold P Connor, a press release was issued but insufficient time passed after the issuance before the defendant traded. The OSC found the defendant guilty of illegal insider trading + recommended that insiders wait a min of 1 full trading day after release of info before trading.In Green, the issue was whether info of a possible takeover was adequately disclosed. The defendants notified Green of possible takeover in very general terms. Green brought an action against them for insider trading. The ONCA found that the very general letter to Green was inadequate general disclosure b/c it failed to include sufficient details. To establish this defence, the onus is on X to prove that he or she had a reasonable belief that the information would not have a substantial effect on the company’s share price (or made another reasonable mistake of fact). In Fingold, Cineplex’s 4th quart results were unexpected and disappointing. Fingold, a director of Cineplex, sold shares in Cineplex that belonged to two companies he controlled. Trial judge found that, although the results were material info, Fingold made a reasonable mistake of fact and so was not liable for illegal insider trading. In Harper, a company obtained bad assay results from 800 soil samples. These bad results were not disclosed. Harper had a special relationship w/ the company, and sold his shares. Harper argued that he had a reasonable belief that the results did not constitute material info based on advice from project geologist. But ON court concluded that Harper failed to establish that he had a reasonable belief that the soil samples were not material. NP 51-201 sets out when the necessary course of business defence is available. The question of whether something is in the necessary course of business is a question of mixed fact and law that must be determined on a case-by-case basis and in light of the policy reasons underlying the tipping provisions (level playing field, equal access to info). In Royal Trustco, the disclosure of info to a shareholder as part of an attempt to defend against a takeover bid was not found to fall w/in the defn of “necessary course of business”. Enforcement of Illegal Insider Trading/TippingThe following sanctions may apply if X is found guilty of illegal insider trading or tipping in contravention of BCSA s. 57.2.Administrative Sanctions under the BCSA (most common)X may face administrative sanctions under the BCSA. Under s. 161, the regulator may make various enforcement orders when it is in the public interest to do so. For example, the regulator may suspend, restrict or terminate the X’s registration, exclude X from trading in BC markets, remove X or prohibit X from acting as a director or officer of an issuer, or reprimand X. Under s. 162, the regulator may impose fines up to $1 million for each contravention of the Act if it determines that doing so is in the public interest. For example, Donnini was subject to a 15 year suspension for illegal insider trading. Criminal Sanctions under the Criminal CodeX may be prosecuted under the s. 382.1 of the Criminal Code. Prohibited insider trading under s. 382.1(1) is an indictable offence, and the offender may be liable to imprisonment for a term not exceeding 10 years. Tipping under s. 382.1(2) is a hybrid offence for which the offender may be liable to imprisonment for a term not exceeding 5 years. The prosecution must establish that the accused knowingly used or passed on undisclosed material information. Quasi-Criminal Sanctions under the BCSAX may be prosecuted under the quasi-criminal provisions set out in s. 155 of the BCSA. Under s. 155(5), the maximum penalty for a contravention of s. 57.2 is a fine not more than the greater of $3 million and an amount equal to triple any profit made by X thanks to the contravention, or imprisonment for not more than 3 years, or both. Civil Court Proceedings X may face civil court proceedings initiated by the regulator if it determines that it is in the public interest to do so. Under s. 157 of the BCSA, the regulator may apply to the BC Supreme Court for an order that X has contravened a provision in the act, an order that X pay the regulator any amount obtained, directly or indirectly, as a result of the contravention, an order setting aside a trade, or an on order that X otherwise rectify the contravention to the extent that rectification is possible. Statutory Civil LiabilityX may face civil liability. Section 136 of the BCSA provides that a plaintiff may recover losses against X. The amount payable by X would be the less of the losses incurred by the plaintiff or an amount determined in accordance to the regulation (but a change in market price unrelated to the material information is not attributable to damages). Change of Control TransactionsOptions if client is interested in acquiring control of another issuerChange of Control TransactionsThere are a variety of change of control transactions that a client can employ if they are interested in acquiring control of another issuer:Asset purchase deal: an asset purchase deal is a change of control transaction by which the offeror acquires some or all of the target’s assets. Following the transaction, the target continues to exist. The offeror need not acquire the target’s liabilities, lawsuits, etc. However, advantageous tax benefits/deductions available to the target will likely be non-transferrable to the offeror. Amalgamation: an amalgamation is a process by which two companies merge and carry on as one. Can be carried out under s. 269 of the BCBCA, s. 181 of the CBCA, or a similar provision in other corporate statutes. An amalgamation must be adopted by shareholders in a special resolution. An information circular setting out the details of the proposed amalgamation must also be circulated to shareholders in advance of meeting to approve the amalgamation. [note: all assets, liabilities, lawsuits, etc transferred/shared with an amalgamation]Plan of arrangement: a plan of arrangement is a court-supervised change of control transaction that can be carried out under s. 192 of the CBCA, s. 288 of the BCBCA, or a similar provision in other corporate statutes. The court is concerned with ensuring that shareholders get the information they need to make a reasoned decision, that this information is provided to them in a timely manner, and that the process for determining their collective decision is fair. An information circular must be distributed to all security holders in advance of the meeting to approve the arrangement. A plan of arrangement requires a special resolution (typically 2/3 of shareholders at meeting). If approved by the court, a plan of arrangement is a single step transaction, i.e. the offeror will be able to acquire 100% of the target’s shares at closing [versus takeover bid, which is a two step transaction]. Typically, a plan of arrangement is only possible in a friendly situation, where the target’s board and management support the transaction [if hostile, takeover bid is the preferable option]. In BCE, the SCC held that in order to obtain court approval for a plan of arrangement, the offeror had to establish: (1) that the statutory requirements were satisfied, e.g. there was an information circular and a special resolution vote; (2) that the application for the plan of arrangement was put forward in good faith; and, (3) that, applying the business judgment test, the arrangement was “fair and reasonable”, e.g. the arrangement has a valid business purpose, dissenting shareholders have access to appraisal remedies. [note: all assets, liabilities, lawsuits, etc transferred/shared with a plan of arrangement] Takeover bid: a takeover bid occurs when a corporation (the bidder) makes an offer to purchase outstanding shares of another corporation (the target). An offer qualifies as a takeover bid if it, on its own or in combination with shares already held by the bidder, result in the bidder acquiring 20% or more of the target’s shares. In BC, takeover bids are governed by MI 62-104 (takeover bid rules that apply to all jurisdictions except ON), NP 62-203 (policy related to the interpretation of the Bid Regime), NP 62-202 (defensive tactics for target company), NI 62-103 (early warning system), and s. 300 of the BCBCA. A takeover bid may be either hostile (when target management and board does not support the bid), or friendly (when target management and board approve the bid and cooperate the bidder in selling the tendering offer to shareholders). The rules regulating takeover bids aim to protect the interests of target shareholders: to ensure that they are treated fairly, that they have full info in making their decisions regarding the bid, and that they have ample opportunity to consider the bid. [note: all assets, liabilities, lawsuits, etc of the target become those of the bidder through a takeover bid]3 obligations: equal treatment, disclosure, timingExemptions from formal takeover bid requirementsEarly warning system (10% > and every subsequent 2%)Possible defensive tactics by target board in hostile takeoverProxy contest: change of control of a target company can also take place via a proxy contest. A proxy contest can enable a current shareholder to gain control of a company without an actual takeover, or can lay the groundwork for executing a (hopefully) friendly takeover bid later on. For example, activist Canadian Pacific Railway shareholder Bill Ackman (who controlled 14% of CP shares through his company Pershing Square) successfully won a proxy contest in 2012. Ackman was able to introduce his own slate of friendly directors. Of course, prior to launching a proxy contest, a dissident or activist shareholder should attempt to negotiate with management and the board. If negotiations fail, under s. 9.1(2) of NI 51-102, a dissident shareholder (or any other party, other than management) may solicit proxies from other shareholders. The proxy must typically be accompanied by an information circular. The definition of “solicitation” is key to determining whether the information circular requirement applies to a dissident shareholder. Section 1.1 of NI 51-102 defines “solicit, in connection with a proxy” as including any request for a proxy, any request not to execute a proxy form or to revoke a proxy, and any communication with a shareholder that a reasonable person would relate to giving, withholding, or revoking a proxy. This requirement to send an information circular along with a proxy solicitation does not apply to non-management if: (a) under s. 9.2(2), the total number of shareholders who proxies are being solicited is no more than 15 (rationale: recognizes the opportunity for one-on-one discussion between 15 or fewer people); or, (b) under s. 9.2(4), the solicitation is made to the public by broadcast, speech, or publication, and the person has filed info. The content requirements for a non-management information circular are also less onerous than the content requirements for a management info circular; however, all info circulars must contain enough info to allow a reasonable shareholder to make an informed decision. Finally, the shareholder may rely on Notice-an-Access, set out in s. 9.1.1 of NI 51-102. Notice-and-Access is a mechanism by which a person or company soliciting proxies may distribute the proxies and their information circulars electronically, rather than by hard copy. But to date, there has only been 174 electronic proxy solicitations – this is a small number given thousands of proxy solicitations that are actually performed. As system becomes better developed, use will likely increase.[Going-private transaction: a transaction by which a reporting issuer becomes a private entity (no continuous disclosure requirements, less cost and administrative burden). This can be accomplished through either a takeover bid (the issuer attempts to buy shareholders out of their shares), or a squeeze-out merger.]Any change of control transaction will require some kind of information circular to allow investors to make an informed decision, whether for a shareholder vote at a meeting or for an offer to tender in a bid.Important disclosure requirement for offeror/bidder who completes a “significant acquisition”Under s. 8.2 of NI 51-102, Continuous Disclosure Obligations, a reporting issuer who completes a “significant acquisition” must file a Business Acquisition Report within 75 days after the date of the acquisition. For non-Venture reporting issuers, a significant acquisition is one that satisfies one of the following three significance tests with a 20% change threshold set out in s. 8.3 of NI 52-102: Asset test: if the reporting issuer’s proportionate share of consolidated assets of the business/related businesses exceeds 20% of the consolidated assets of the reporting issuer (calculated using the audited financial statements of the issuer and the business/related businesses for the most recently completed financial year that ended before the date of acquisition). Investment test: if the reporting issuer’s consolidated investments in and advances to the business/related businesses at the date of acquisition exceed 20% of the consolidated assets of the reporting issuer as of the last day of the more recently completed financial year before the date of acquisition. Income test: if the reporting issuer’s proportionate share of the consolidated income from continuing operations of the business/related businesses exceeds 20% of the consolidated income from continuing operations of the reporting issuer (calculated using the audited financial statements of the reporting issuer and the business/related businesses for the most recently completed financial year that ended before the date of acquisition).For Venture-listed reporting issuers, a significant acquisition is one that satisfies one of the following three significance tests with a 40% change threshold set out in s. 8.3 of NI 52-102: Asset test: if the reporting issuer’s proportionate share of consolidated assets of the business/related businesses exceeds 40% of the consolidated assets of the reporting issuer (calculated using the audited financial statements of the issuer and the business/related businesses for the most recently completed financial year that ended before the date of acquisition).Investment test: if the reporting issuer’s consolidated investments in and advances to the business/related businesses at the date of acquisition exceed 40% of the consolidated assets of the reporting issuer as of the last day of the more recently completed financial year before the date of acquisition. Income test: if the reporting issuer’s proportionate share of the consolidated income from continuing operations of the business/related businesses exceeds 40% of the consolidated income from continuing operations of the reporting issuer (calculated using the audited financial statements of the reporting issuer and the business/related businesses for the most recently completed financial year that ended before the date of acquisition).Takeover BidsWhat is a takeover bid?A takeover bid occurs when a corporation (the bidder) makes an offer to purchase outstanding shares of another corporation (the target). An offer qualifies as a takeover bid if it, on its own or in combination with shares already held by the bidder, result in the bidder acquiring 20% or more of the target’s shares. If a bidder is acting “jointly and in concert” with another person or company, s. 1.8(3) of MI 62-104 provides that both the bidder and the person with whom they are acting jointly and in concert with must count their shares together (including shares that the bidder or other person have the option to acquire) when determining if the 20% threshold has been reached. In BC, takeover bids are governed by MI 62-104 (takeover bid rules that apply to all jurisdictions except ON), NP 62-203 (policy related to the interpretation of the Bid Regime), NP 62-202 (defensive tactics for target company), NI 62-103 (early warning system), and s. 300 of the BC Business Corporations Act.The full definition of “takeover bid”, set out in 1.1 of MI 62-104, is as follows: “an offer to acquire outstanding voting securities or equity securities of a class made to one or more persons, any of whom is in the local jurisdiction or whose last address as shown on the books of the offeree issuer is in the local jurisdiction, where the securities subject to the offer to acquire, together with the offeror’s securities, constitute in the aggregate 20% or more of the outstanding securities of that class of securities at the date of the offer to acquire but does not include an offer to acquire if the offer to acquire is a step in amalgamation, merger, reorganization, or arrangement that requires approval in a vote of security holders”. A takeover bid may either be: Hostile: when target management and/or the target board does not favour the bid.Friendly: when target mngmt and board approve the bid + cooperate with the bidder in selling it to target shrehldrs. The primary goals of takeover bid legislation are to encourage takeover bids and to protect investors. Takeover bids tend to lead to increased share prices for target shareholders. Firms run by inefficient managers lead to depressed stock prices that do not exhibit the true value of the firm > replacing inefficient mngmnt can enable a firm to operate more efficiently overall. The bidder’s obligations during a “formal” takeover bid: equal treatment, disclosure and timingThe rules regulating takeover bids aim to protect the interests of target shareholders: to ensure that they are treated fairly, that they have full info in making their decisions regarding the bid, and that they have ample opportunity to consider the bid. Bidder’s Equal Treatment ObligationsDuty to Make Bid to All Security Holders: Under s. 2.8 of MI 62-104, a bidder must make their offer to all shareholders of the class of securities subject to the bid who are in the local jurisdiction. Section 135 of BCSA gives a civil right of action to shareholders who were entitled to receive the offer, but did not in receive it.Pro Rata Takeup: a pro rata takeup (aka a partial bid, or proportionate takeup) is when a bidder seeks to acquire less than 100% of the outstanding shares of the target. Under s. 2.26(1) of MI 62-104, the bidder must purchase shares from tendering shareholders on a proportionate basis, i.e. purchase the same proportion of shares from all tendering shareholders according to the number of shares that each shareholder tendered. Identical Consideration: under s. 2.23 of MI 62-104, all target shareholders must be offered identical consideration, e.g. if a shareholder tendered before the bidder raised the offer price, that shareholder is entitled to the higher offer price. Rationale: shareholders should not be disadvantaged for tendering early. Prohibition Against Collateral Benefits: except employment compensation/benefit or severance arrangements where the employee owns less than 1% of the target shares, s. 2.25 of MI 62-104 prohibits bidders from making side deals with certain shareholders, e.g. control persons, to give them any collateral benefit for their shares (includes money, tangible gifts). Bidder’s & Target Directors’ Disclosure ObligationsBidder’s Takeover Bid Circular: To launch a takeover bid, the bidder must either (a) deliver a takeover bid circular to all target shareholders under ss. 2.9(1)(b) and 2.10(3) of MI 62-104 [traditional takeover bid by mail-out], or (b) publish an announcement in a major daily newspaper and, within two days of receiving a list of the target shareholders from the target company, must deliver a takeover bid circular to all target shareholders under ss. 2.9(1)(a) and 2.10(2) [public advertisement takeover bid]. A takeover bid circular must contain enough info to allow target shareholders to make an informed decision about the offer and the bidder. Liability for misrepresentations in a takeover bid circular:Section 155(1)(b) of the BCSA makes it a quasi-crim offence to fail to deliver a bid circular.Section 132(1) of the BCSA imposes primary market liability on the bidder and the bidder’s directors for misrepresentations contained in a takeover bid circular.Section 140.3 of the BCSA imposes secondary market liability for misrepresentations contained in a takeover bid circular (considered a “core document”). Under BCSA s. 161, the regulator may also take administrative action (i.e. make an enforcement order like a cease trade order) if the contravention of securities law violates public interest. Directors’ Circular: No later than 15 days after a takeover bid has been launched, the target board of directors must prepare and deliver a directors’ circular to all target shareholders under s. 2.17 of MI 62-104. This circular must recommend to security holders that they either accept or reject the bid, and state the reasons for this recommendation, or explain why the board is not making a recommendation. Liability for misrepresentations in a directors’ circular:Section 155(1)(a) of the BCSA makes it a quasi-criminal offence to fail to “file, provide, deliver or send a record that is required to be filed, provided, delivered or sent under the Act”.Section 132(3) of the BCSA imposes primary market liability for misrepresentations in a circular on all directors and officers who signed it.Section 140.3 of the BCSA imposes secondary market liability for misrepresentations contained in a directors’ circular (considered a “core document”). Under BCSA s. 161, the regulator may also take administrative action (i.e. make an enforcement order like a cease trade order) if the contravention of securities law violates public interest. Bidder’s Variation of Terms: Under s. 2.12 of MI 62-104, if a bidder changes its offer in any way after the takeover bid has been launched (e.g. change price, add another form of consideration), the bidder must issue a news release and deliver a notice of variation to all target shareholders whose securities were not taken up before the date of the variation (and shares cannot be tendered and taken up for min 35 days after the bid is launched). If a bid was commenced by way of public advertisement, and the variation occurs before the bidder has distributed the takeover bid circular to target shareholders, the bidder must publish an ad summarizing the change, file and deliver a notice of variation to the target company, and then send the takeover bid circular, along with the notice of variation, to the target shareholders w/in 2 days of receiving the list of target shareholders from the target company, as per s. 2.14 of MI 62-104. Changes trigger 10 day withdrawal right for target shareholders.Early Warning System: Under s. 5.2 of MI 62-104, any person who acquires control of over 10% of voting or equity securities must file an early warning report and issue and file a news release on SEDI (System for Electronic Disclosure by Insiders), identifying the person who has made the acquisition and the extent of control. For every subsequent 2% acquired, another report and news release must be filed . Rationale: this disclosure provides targets with a heads up about potential takeovers (aka “creeping takeover bids” > potential bidder slowly approaches 20% threshold). Bidder’s Timing Obligations35 Days: Under s. 2.28 of MI 62-104, a bid must remain open to target shareholders for at least 35 days. For traditional takeover bid, 35 days begins to run when takeover bid circular mailed out to target shareholders (after the target’s transfer agent provides the list of target shareholders to the bidder; can take up to 10 days to produce). For public ad takeover bids, 35 days begins to run when ad is published (faster! advantage!).10 Day Withdrawal Right: Under s. 2.30 of MI 62-104, target shareholder have a right to withdraw their tender for 10 days following any change to the terms of the bid (other than an increase in price). Bidder’s Option to Extend the Offer Expiration Date: A bidder can extend the date on which the offer is set to expire in order to give shareholders more time to tender their shares. However, under s. 2.32(4) of MI 62-104, before a bidder can extend the timeline, it must first take up all securities that have already been tendered (unless the bid is extended while shareholders still enjoy a withdrawal right, as per 2.32(6)). Exemptions from “formal” takeover bid requirements1. Normal Course of Purchase Exemptions. 4.1, MI 62-104Under the Normal Course of Purchase Exemption, a “creeping” bidder can acquire 5% of any class of the target’s outstanding voting or equity securities each year (12 month period). The “creeper” needs to file early warning reports and news releases as per s. 5.2 of MI 62-104, but need comply with the “formal” takeover bid requirements. Conditions/restrictions: *if the bidder is acting jointly and in concert with any other actor, their securities are considered together; *the securities of the target company must be listed on a stock exchange; *the value of consideration paid by the “creeper” cannot exceed the market price of the target securities on the date of acquisition. 2. Private Agreement Exemptions. 4.2, MI 62-104Under the Private Agreement Exemption, a bidder can enter into agreements to buy target securities with up to 5 target shareholders (e.g. 5 target shareholders may control 80% of shares).Condition/restriction: *the value of consideration paid by the bidder cannot exceed 115% of the market price of the securities calculated based on a 20 business day trade average. 3. Non-Reporting Issuer Exemptions. 4.3, MI 62-104Under the Non-Reporting Issuer Exemption, if the target company is not a reporting issuer, the bidder is exempt from the formal takeover bid requirements.Condition/restriction: *this exemption only applies if the target company is a non-reporting issuer with no more than 50 shareholders (excluding current and former employees). If the target company is a non-reporting issuer with more than 50 shareholders (excluding current and former employees), the formal takeover bid requirements apply! 4. Foreign Takeover Bid Exemptions. 4.4, MI 62-104Under the Foreign Takeover Bid Exemption, the formal takeover bid requirements do not apply if the target securities are primarily traded on a foreign stock exchange and the target company has a de minimis number of securityholders in Canada. 5. De Minimis Takeover Bid Exemptions. 4.5, MI 62-104Under the De Minimis Exemption, the formal takeover bid requirements to do not apply if there are fewer than 50 shareholders in a particular province that hold, in aggregate, less than 2% of the outstanding shares of the target class.Condition/restriction: *the bidder must still offer these shareholders terms that are no less favourable than the terms offered to target shareholders in other provinces. 6. Other exemptionsThere may also be exemptions prescribed by regulation, or under the Multijurisdictional Disclosure System (MJDS). Challenges that a bidder may face when attempting a takeover bidCompliance with the formal takeover bid requirements, including the distribution of the takeover bid to all target shareholders, the 35 days window, and liability for misrepresentations. Lack of information. In a hostile takeover bid, the bidder will not have access to some important financial info. The target may open up a “data room” of otherwise confidential info for a takeover auction or alternative friendly bidders.Defensive tactics by the target company. In a hostile takeover bid, the target board or mngmt may employ defensive tactics in attempt to block the bid, e.g. bringing in White Knight, sale of the Crown Jewel, or trigger of SRP/Poison Pill. Bidding war. Because of the 35 day window during which a takeover bid must remain open, other bidders may make alternative offers. A bidding war may lead to over-valuation; the target may pay more than originally intended.Target directors’ duties & possible defensive tacticsDirectors’ Duties & the Business Judgment RuleIn BCE, the SCC held that directors owe a fiduciary duty to the corporation, not to shareholders. In fulfilling this duty, directors must act in the best interests of the corporation by considering all stakeholder interests. Under the business judgment rule, courts will defer to decisions made by directors provided that they acted prudently and in the best interests of the corporation. In the context of takeover bids, there is a tension between directors’ duty to act in the best interests of the corporation, and securities legislation which provides that the final decision respecting a takeover bid must rest with shareholders. There is also an underlying tension between what matters courts should deal with (e.g. fiduciary matters and corporate law), and what matters securities regulators should deal with (e.g. takeover bid tactics). [in the US, the Revlon duty applies: directors of US corporations have a duty to act in the best interests of the corporation, but when a change of control transaction takes place this duty shifts to maximizing shareholder value; e.g. the adoption of a poison pill = breach of the directors’ fiduciary duty b/c it ends an active auction and fails to maximize the offer price for shareholders]Defensive tactics that target directors and management can adopt to ward off a hostile takeover bidThe various defensive tactics that a target company can employ in response to a hostile takeover bid are set out in NP 62-202.White Knight: find a friendly alternative bidder who is able trump the original bidder’s offer, or include a break fee in the agreement with the White Knight (the target company must pay the White Knight if its bid is unsuccessful). Shareholder Rights Plan/Poison Pill: the target company may already have a shareholder rights plan in place; if not, board may call a meeting for shareholders to approve a tactical shareholder rights plan > gives target shareholders, except the bidder, the right to acquire more target shares at a reduced price > can result in massive dilution of shares. A bidder can apply to have a shareholder rights plan set aside by the regulator (usually a matter of when, not if). Sale of the Crown Jewel: the target company can sell off its most valuable asset to make the target less attractive; a scorched-earth policy; but, under corporate law, sale of undertaking (“all or substantially all of the assets of a corp”) requires shareholder approval by special resolution (may not be possible/not time for this in a hostile situation). Target Buyback/Issuer Bid: the target company can attempt to self-launch a competing bid for its own shares > instead of tendering to third party, target shareholders have the choice of tendering to the issuer/target itself. Tough!Break Fee: this is a defensive tactic that may be used in conjunction with a White Knight > a break fee adds to the cost of the acquisition by any bidder other than the White Knight (and induces the White Knight to enter into an agreement w/ the target company in the first place). Corporate Governance & Proxy SolicitationCorporate GovernanceCorporate governance involves the regulation of the affairs of corporations. The four sources of corporate governance in Canada are: (a) corporate legislation, like the BC Business Corporations Act, (b) securities legislation, like the BCSA, (c) the rules and policies of stock exchanges, and (d) proxy advisory firms, e.g. ISS and Glass Lewis.The trend in securities-side regulation of corporate governance has been towards compliance or explanation: in other words, the regulators will make a recommendation, and if a company chooses not to comply with the recommendation they must explain why, i.e. “comply, or explain”.Under corporate legislation, companies are required to have shareholder meetings at least once a year. Two things must happen at an annual general meeting: (1) the election of directors, and (b) appointment of auditors. Corporate legislation requires that shareholders be given proper notice of shareholder meetings. Securities legislation requires that companies solicit proxies in advance of shareholder meetings (set out in Part 9 of NI 51-102, Continuous Disclosure Obligations).Options for a dissatisfied shareholderSome reasons for shareholder dissatisfaction: executive compensation, stock options, corporate governance issues (e.g. board does not have any independent directors), disclosure and regulatory issues.If a shareholder is dissatisfied with the board or management, they have a number of options:Go to the chair of the board to express concerns and try to negotiate a change to management or board membership: Most management and board membership are brought about this way, i.e. they do not happen through a full blown proxy contest. Can be most cost effective, efficient way. Important: talk to other shareholders beforehand! Ambush the end of the AGM. This will only work if the company does not have an advance notice policy, and if the dissident shareholder can rely on the information circular exemption in s. 9.2(2) of NI 51-102 that applies there are no more than 15 shareholders. Risk: management may find out in advance and postpone the meeting (and adopt an advance notice policy, as was the case in Mundoro). An ambush is not as cheap as a negotiated settlement, but less expensive than a full blown proxy contest.Solicitation at the AGM. Wait until the AGM and solicit then. Risk: board will likely get one postponement. Full blown proxy solicitation by requisitioning a shareholders’ meeting. Must meet the requirements set out in corporate legislation to requisition a meeting. It also depends whether an AGM will be called soon anyways. Risk: management will not comply w/ statutory timing requirements. Also, can take up to 4 months to requisition meeting, and the dissident must comply with thes rules governing proxy solicitation (see below). Key: the dissident must assemble a good slate of directors, and in recruiting candidates must perform due diligence. General hurdles that a dissident may face: Management control of the processManagement’s defensive tactics, e.g. the ability to postpone meetings, adopt an advance notice policyManagement’s use of entrenchment devices, e.g. staggered boards, advance notice policyScorched earth tacticsThe issuance of shares to friendly investorsProxy SolicitationSection 116 of the BCSA defines “proxy” as “a completed and executed form of proxy by which a security holder has appointed a person as the security holder’s nominee to attend and act for the security holder and on the security holder’s behalf at a meeting of security holders”. Section 1.1 of NI 51-102 includes an identical definition of “proxy”.Management Proxy Solicitation (mandatory)Under s. 9.1(1) of NI 51-102, if management of a reporting issuer gives notice of a meeting of its registered holders of voting securities, management must, at the same time or before giving notice, “send to each registered holder of voting securities who is entitled to notice of the meeting a form of proxy for use at the meeting”. Under s. 9.1(2), this proxy must be accompanied by an information circular. The requirement to provide an information circular also applies to all proxy solicitations by management, as per the definition of “solicit” in s. 1.1 of NI 51-102. In Smoothwater Capital, a dissident launched a proxy contest by requisitioning a shareholder meeting under corporate legislation; in response, management issued a news release. The dissident argued that management’s news letter qualified as a “solicitation” (b/c it encouraged shareholders not to execute the dissident’s proxy form), and so management’s failure to provide an information circular constituted a violation of securities law. The Ontario court found that the issuance of a single news release to clarify the record did not amount to a solicitation; however, the court noted that, had there been subsequent news releases, this may have qualified as a solicitation. In Pacifica Papers, management obtained “lock-up” agreements from a number of shareholders (assurance that these shareholders would given management their proxies) in advance of sending out an information circular. A dissident argued that management obtaining lock-up agreements amounted to solicitations, and that these illegal solicitations should render a shareholder vote related to a plan of arrangement invalid. Though the BCSA and BCCA refused to render the shareholder vote invalid, the courts (confusingly!) suggested that the lock-up agreements amounted to solicitation of proxies, that proxies are always revocable, and that there is no requirement to send an information circular to shareholders prior to soliciting proxies. Dissident Proxy Solicitation (optional)Under s. 9.1(2) of NI 51-102, if a dissident shareholder (or any other party, other than management) solicits proxies, the proxy must be accompanied by an information circular. The definition of “solicitation” is key to determining whether the information circular requirement applies to a dissident shareholder. Section 1.1 of NI 51-102 defines “solicit, in connection with a proxy” as including any request for a proxy, any request not to execute a proxy form or to revoke a proxy, and any communication with a shareholder that a reasonable person would relate to giving, withholding, or revoking a proxy. This requirement to send an information circular along with a proxy solicitation does not apply to non-management if:under s. 9.2(2), the total number of shareholders who proxies are being solicited is no more than 15 (rationale: recognizes the opportunity for one-on-one discussion between 15 or fewer people); or,under s. 9.2(4), the solicitation is made to the public by broadcast, speech, or publication, and the person has filed info.The content requirements for a non-management information circular are also less onerous than the content requirements for a management info circular; however, all info circulars must contain enough info to allow a reasonable shareholder to make an informed decision. Notice-and-AccessNotice-and-Access is a mechanism by which a person or company soliciting proxies may distribute the proxies and their information circulars electronically, rather than by hard copy. This is set out in s. 9.1.1 of NI 51-102. But to date, there has only been 174 electronic proxy solicitations – this is a very small number given the thousands of proxy solicitations that are actually performed. As the Notice-and-Access system becomes better developed, its use will likely increase. Major Recent Developments in Corporate GovernanceProhibition on staggered boards: introduced in 2012 by the TSX. A staggered board, e.g. where 1/3 of directors are elected each year, and the other 2/3 carry on with their 3 year terms. Rationale for prohibition: staggered boards can have a chilling effect on proxy contests b/c you cannot get rid of the whole board at once. Majority voting for election of directors: introduced in 2012 by the TSX. Under existing corporate law, a majority of votes is not required to win a directorship; rather, voting involves a “first-past-the-post” system. Under majority voting system, every director who is elected must have a majority of the votes cast. [comply, or explain situation?]Prohibition on slate voting: introduced in 2012 by the TSX. Slate voting = where a shareholder has the option of ticking all the boxes, or none. Rationale for prohibition: slate voting prevents shareholders from voting for some directors, but not all of them. Advanced notice requirements: supported by ISS and Glass Lewis. This requirement prevents the nomination of directors in a meeting (an ambush or stealth proxy contest; the requirement that notice of proposed nominees be circulated before a shareholder meeting. In Mundoro, the BCSC found that advanced notice was in the best interest of shareholders, and was not a form of director entrenchment. ~500 Cdn companies have adopted this requirement.Say-on-pay policies: supported by ISS and Glass Lewis. Executive compensation falls within management’s mandate but some large companies have been adopting say-on-pay policies, giving shareholders a say re: exec compensation. ~130 companies adopted say-on-pay policies in 2013. Gender equality on boards: currently before the OSC; the requirement that companies adopt policies to help move towards gender equality. [another comply, or explain situation?]Director independence: the recommendation that the boards of TSX-listed companies have majority independent boards, an independent chair, an audit committee, and a board mandate. Audit committees are already required by corporate and securities legislation. Independence is defined in NI 52-110 as the absence of any material relationship between a director and the issuer that, in the view of the issuer’s board of directors, could reasonably be expected to interfere with the exercise of the director’s independent judgment, e.g. compensation, employment, consulting. Civil LiabilityPrimary Market Liability Civil Liability for Misrepresentations in a Prospectus or Offering MemorandumThe BCSA provisions dealing with primary market liability are set out in Part 16, ss. 131 through 140. Section 1 of the BCSA defines “misrepresentation” as “an untrue statement of a material fact, or an omission to state a material fact that is required to be stated, or necessary to prevent a statement that is made from being false or misleading in the circumstances in which it was made”. Purchasers are deemed to have relied on a misrepresentationUnder BCSA s. 131, every person who purchased a security via a distribution (i.e. with a prospectus) is deemed to have relied on the misrepresentation. In other words, the plaintiff does not need to prove that they relied on the misrepresentation. Classes of people who can be held liable for a misrepresentationUnder s. 131 of the BCSA, purchasers have a right of action against:The issuer;The directors of the issuer at the time the prospectus was filed;The underwriters;Every person who signed the prospectus (i.e. the CEO, the CFO, and two directors);Any other person who consented to disclosure in the prospectus, e.g. third party experts, auditors, lawyers (but s. 131(2) limits the liability to misrepresentations contained in the reports/opinions/statements that they prepared).Liability is joint and severalAs per s. 131(11), the liability for these classes of people is joint and several (exception: each underwriters’ liability is limited to the portion of the distribution underwritten by it, as per s. 131(9)). Types of reliefA plaintiff can seek two types of relief:Damages: calculated based on the difference between the price paid for the securities and their value once misrep was disclosed (Danier Leather). But per s. 131(13), plaintiff cannot recover more than price they paid for the securities.Rescission: only available against the issuer, or the underwriter in the case of a “bought deal”; rescission involves the return of the shares to the issuer in return for the money paid by the plaintiff. Defences for Misrepresentations in a Prospectus or Offering MemorandumA. Actual KnowledgeUnder s. 131(4), a defendant is not liable if the defendant establishes that the purchaser purchased with knowledge of the misrepresentation. [very difficult to establish!] B. No KnowledgeUnder s. 131(5)(a), a defendant is not liable if the prospectus was filed without their knowledge. However, to rely on this defence, upon becoming aware that the prospectus was filed, the defendant must have given reasonable general notice of their lack of knowledge. e.g. director who didn’t sign the prospectus was out of the country when it was filed, didn’t knowe.g. expert provided info to issuer on belief it would not be published in prospectus > but publishedC. Withdrawal of ConsentUnder s. 131(5)(b), a defendant is not liable if they withdrew their consent to the prospectus upon becoming aware of any misrepresentation, and gave reasonable general notice (e.g. news release) of their withdrawal and the reason for it. e.g. something new comes to light so the auditor withdraws their financial report D. Reliance on ExpertUnder s. 131(5)(c), the defendant is not liable if they did not believe, and had no reasonable grounds to believe that the part of the prospectus related to an expert report, opinion or statement contained a misrepresentation. e.g. issuer, directors or officers rely on an expert, and had reasonable grounds to believe that the expert was capable of providing proper info, but it turns out expert made a misrepresentation E. Expert’s DefenceUnder s. 131(5)(d), a defendant who is an expert is not liable for a misrepresentation if the prospectus did not fairly represent their report, opinion, or statement. For this defence to apply, the expert must have:had reasonable grounds to believe that the relevant part of the prospectus did fairly represent their report, opinion, or statement; ORas soon as practicable upon becoming aware of the misrepresentation, advised the regulator and given reasonable general notice that they were withdrawing their expertise. e.g. expert saw draft of prospectus, approved it, but then language was changed after the factF. Forward-Looking InfoUnder s. 131(8.1) and (8.2), the defendant is not liable for a misrepresentation in forward-looking information (FOFI) if the defendant proves that the document contained reasonable cautionary language, that the material factors and assumptions underlying the FOFI were set out, and that the defendant had a reasonable basis for drawing such conclusions. G. Due DiligenceTHE MOST IMPORTANT DEFENCE!Not available to the issuer!Under s. 131(7), a defendant (other than the issuer!) is not liable if they believed that there was no misrepresentation and conducted “a reasonable investigation to provide reasonable grounds for a belief that there had been no misrepresentation”. e.g. if director, officer, underwriter, expert performed reasonable due diligence, may not be liableIn BarChris, a construction company prepared a prospectus that contained a number of misrepresentations. The US District Court applied an objective approach to the due diligence defence, asking what a reasonable director would have done in the circumstances. A director with poor English skills was permitted to simply rely on counsel and underwriters for due diligence. Court said: “The liability of a director who signs a prospectus does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading.” In YBM Magnex, material information about an organized crime investigation was omitted from YBM’s offering document. The OSC applied a objective and subjective approach, holding different directors to different standards depending on their ability, experience, involvement. OSC concluded: “…we are satisfied that significant efforts were made by the Directors to ascertain the facts and assess their materiality. However, we find that the process adopted by the Directors to support their judgment and belief that… the disclosure provided was full, true and plain, was deficient.” Secondary Market LiabilityCivil Liability for Misrepresentations in Continuous Disclosure Documents & Failure to Make Timely DisclosureThe BCSA provisions dealing with secondary market liability are set out in Part 16.1, ss. 140.1 through 140.94. Liability for misrepresentations in continuous disclosure docs is especially important b/c the vast majority of all securities trades (94%) take place in the secondary market.Section 1 of the BCSA defines “misrepresentation” as “an untrue statement of a material fact, or an omission to state a material fact that is required to be stated, or necessary to prevent a statement that is made from being false or misleading in the circumstances in which it was made”. Activities that trigger secondary market liabilityA misrepresentation or omission released by or on behalf of the “responsible issuer”, under ss. 140.3(1) and (2) of the BCSA; e.g. in a document, on its website, or in a public oral statement.A misrepresentation or omission released by an “influential person”, including a control person, a promoter, or an insider who is not a director or officer of the responsible issuer, under s. 140.3(4) of the BCSA; e.g. in a document or in a public oral statement. A failure to make timely disclosure of a material change, under s. 140.3(4) of the BCSA. Classes of people who can be held liable for a misrepresentationUnder s. 140.3 of the BCSA, a person who buys or sells a security between the time the misrepresentation was made and the time when the misrepresentation was publicly corrected has a right of action against:The “responsible issuer” (this includes all reporting issuers, and any other issuer with a “real and substantial connection to BC whose securities are publicly traded).The directors and officers of the responsible issuer at the time the document was released; if public oral statement, misrepresentation by influential person, or failure to disclose material change, then liability is limited to those directors and officers who authorized, permitted, acquiesced to doc/statement/influential person.Each influential person who knowingly influenced the responsible issuer to release the document, make the public oral statement, or fail to disclose, or who knowingly influenced a director or officer of the responsible issuer to authorize, permit, or acquiesce to the release of the document/the making of the public statement/failure to disclose.Experts, where the misrepresentation was contained in a report, statement or opinion made by the expert, and where the report or oral statement contained, summarized or quoted from the expert’s report, statement or opinion. Liability is proportionate (except where defendant had knowledge)Except where a defendant, other than the responsible issuer, knew of a misrepresentation or failure to make timely disclosure, liability is proportionate (not joint and several! this is huge!), as per s. 140.6 of the BCSA. Plaintiff must get leave of the court to commence an action under s. 140.3As per s. 140.8 of the BCSA, a plaintiff cannot commence an action under the secondary market liability provisions until they have obtained leave of the court. The court will grant leave if it is satisfied that the action was brought in good faith, and there is a reasonable possibility that the action will be resolved at trial in favour of the plaintiff. Recently, Green v CIBC raised the bar for obtaining leave; the ONCA found that the plaintiff must show a reasonable possibility of success, not just a mere possibility of success (as was the case in IMAX). The burden of proof for core vs non-core documentsSection 140.4 distinguishes between “core documents” and “non-core documents”. Burden of proof for “core documents”: Section 140.1 defines “core documents” as including:prospectusestakeover bid circularsdirectors’ circularsmanagement’s discussion and analysis (MD&A)annual information form (AIF)annual financial statementsinterim financial statementsinformation circularsThe burden of proof for core documents is simply existence of a misrepresentation; i.e. the plaintiff does not need to prove that the defendant knew or should have known about the misrepresentation > the plaintiff only needs to prove that there was a misrepresentation.Burden of proof for “non-core documents” & public oral statements: Non-core documents include news releases, investor presentations etc. Section 140.4 provides that the burden of proof for non-core documents and public oral statements is that there was a misrepresentation and the defendant knew, or should have reasonably known, that this misrepresentation existed. [this is a higher burden of proof than that for core documents”]Limits on damages that the plaintiff can recoverFor misrepresentations or failure to disclose made unknowingly, liability is capped, as per BCSA s. 140.7(1). Also, liability is proportionate, as per BCSA s. 140.6(1).For the responsible issuer, liability is capped at the greater of 5% of its market cap (# of common shares outstanding multiplied by the market price/share) or $1 million.For directors and officers, liability is capped at the greater of 50% of the aggregate of the defendant’s compensation from the issuer and its affiliates or $25,000.For experts, liability is capped at the greater of the revenue that the expert and its affiliates earned from the issuer and its affiliates during the 12 months preceding the misrepresentation or $1 million. For people who made a public oral statement (other than directors, officers, or experts), liability is capped at the greater of 50% of the aggregate of the defendant’s compensation from the issuer and its affiliates or $25,000.For misrepresentations or failure to disclose made knowingly, liability is not capped, as per BCSA s. 140.7(2). This means that a plaintiff can claim the whole amount of damages. Also, liability is joint and several, as per BCSA s. 140.6(3). Defences for Misrepresentations in Continuous Disclosure Documents & Failure to Make Timely DisclosureA. Actual KnowledgeUnder s. 140.4(5), a defendant is not liable if the defendant establishes that the plaintiff bought or sold with knowledge that the document or public oral statement contained a misrepresentation, or with knowledge of the material change. [very difficult to establish!] B. Due DiligenceUnder s. 140.4(6)(a), a defendant is not liable for a misrepresentation if they prove that before the release of the document or the making of the public oral statement, the defendant conducted or caused to be conducted “a reasonable investigation” and at the time of the release or statement “had no reasonable grounds to believe” that the document or oral statement contained a misrepresentation. Under s. 140.4(6)(b), a defendant is not liable for a failure to make timely disclosure if they prove that before the failure to make timely disclosure occurred, the defendant conducted or caused to be conducted “a reasonable investigation” and “had no reasonable grounds to believe that a failure to make timely disclosure would occur”. Factors a crt will consider relevant when determining whether an investigation was reasonableSection 140.4(7) sets out a list of factors that a court will consider in determining whether an investigation was reasonable under s. 140.4(6). These factors include:The knowledge, experience, and function of the defendant;The office held by the defendant (if the defendant is an officer);The presence or absence of another relationship w/ the responsible issuer (e.g. officer, employee, shareholder), if the defendant is a director;The existence (if any) of any system designed to ensure that the responsible issuer meets its continuous disclosure obligations;The reasonableness of the defendant’s reliance on the responsible issuer’s disclosure compliance system and on the responsible issuer’s officers, employees and others whose duties would ordinarily have given them knowledge of relevant facts;For expert reports, what professional standards are applicable to expert defendant;In the case of misrepresentation, the role and responsibility of the defendant in preparing and releasing the document, making the public oral statement, or ascertaining the facts contained in the document or public oral statement;In the case of failure to make timely disclosure, the role and responsibility of the defendant involved in the decision not to disclose the material change. These factors attempt to strike a balance – in some companies it is not reasonable to assume that every director or officer is involved in disclosure decision. EnforcementEnforcement PowersInvestigative Powers BCSA Part 7Section 142 of the BCSA gives the regulator very broad investigative powers. Notably, there is no evidentiary threshold that must be met before the regulator can begin an investigation. In Deloitte, the OSC sought evidence from the issuer’s auditor as part of an investigation into the issuer’s compliance w/ continuous disclosure requirements. The SCC held that OSC’s request was reasonable but that the auditor should have had opportunity to mount a full answer and defence. Administrative Enforcement PowersBCSA ss 161, 162Sections 161 and 162 of the BCSA gives the regulator the power to make a variety of enforcement orders and impose fines where it is in the public interest to do so. Examples of enforcement orders:Cease trade order, s. 161(1)(b);Resignation of a director or officer, s. 161(1)(d)(i);Orders prohibiting persons from becoming:a director or officer of any issuer, s. 161(1)(d)(ii);a registrant or promoter, s. 161(1)(d)(iii);acting in a management or consultative capacity in the markets, s. 161(1)(d)(iv);engaging in investor relations activities, s. 161(1)(d)(v);Power to reprimand, s. 161(1)(j);Power to impose fines of up to $1 million per contravention, s. 162. Section 161 is not exhaustive. Also, the regulator may commence an enforcement action even in absence of express breach of Act or rules. To meet the “residual public interest test”, the conduct or transactions must clearly be demonstrated to be abusive of shareholders in particular and capital markets in general (Canadian Tire).Judicial review of regulator decisions: BC Court of AppealUnder s. 167, decisions by the regulator may be appealed to the BCCA with leave of the court. In Donnini, Yorkton CEO Paterson settled his illegal insider trading allegations with the OSC with a $1 million voluntary payment and an order prohibiting him from being a director or officer for 2 years. Donnini refused to settle, was found guilty of illegal insider trading, and subject to a 15 year prohibition on trading and being a director or officer (this effectively ended his career in the securities industry). Donnini appealed, but the ONCA upheld the OSC’s decision to issue Donnini the 15-yr suspension. The ONCA said: “There is no doubt that the 15-year suspension of Donnini’s registration is a substantial penalty. However, the Commission took into account the appropriate factors in imposing such a severe sanction – Donnini’s senior position at Yorkton, his experience in the industry, his other misconduct in the market and, perhaps most importantly, the devastating impact insider trading can have on the integrity of the market and on investor confidence.” Quasi-Criminal Enforcement PowersBCSA s 155Section 155(1) creates quasi-criminal liability for contravening particular sections of the Act (e.g. illegal insider trading and tipping), or for failing to comply with an order made under the Act. The particular sections that give rise to quasi-criminal liability include:Requirement to be registered in order to trade, act as an advisor, act as an investment fund manager, or act as an underwriter (s. 34);Requirement to file a prospectus in the required form when distributing a security, unless exempted under the Act (s. 61);Prohibition against insider trading and tipping (s. 57.2);Requirement to provide continuous disclosure of material changes (s. 85);Requirement to file initial and subsequent insider reports (s. 87);Filing to file, provide, deliver, or send a record that is required to be filed, provided, delivered, or sent under the Act. Section 155(2) provides that a person who commits a quasi-criminal offence under the Act may be liable to a fine of not more than $3 million, or to imprisonment for not more than 3 years, or both. Standard of proof is beyond a reasonable doubt. Criminal Enforcement PowersCriminal Code The Criminal Code is rarely used to enforce compliance with securities law. That said, there are a number of provisions in the Code that relate to securities regulation, including:It is an indictable offence to create a false prospectus with the intent to induce investors, under s. 400 of the Code.It is an indictable offence to defraud the public of any money, property, or valuable security, under s. 380(1) of the Code. It is an indictable offence who mails letters or circulars designed to deceive or defraud the public, under s. 381 of the Code. It is an indictable offence to buy or sell a security knowingly using inside information, under s. 382.1 of the Code. Remember: standard of proof is beyond a reasonable doubt. **Criminal enforcement versus quasi-criminal enforcement**Criminal Code offences generally include a higher threshold. For example, for illegal insider trading under s. 382.1 of the Code, the prosecution must prove that the accused “knowingly” used inside information to trade. Under securities legislation, the regulator need to establish that the accused knew that another party was in a special relationship, or that the material information was not disclosed; enough that accused ought to have known.The Code refers to issuers generally, not just reporting issuers.Under the Criminal Code, the various relationships with an issuer that prohibit individuals from using insider information to trade includes shareholders, but appears to not include holders of non-share securities, such as debt or unit holders. Civil Enforcement PowersBCSA s 157Under s. 157 of the BCSA, the regulator may apply to the BC Supreme Court for an order that a person has contravened a provision in the act, an order that the person pay the regulator any amount obtained, directly or indirectly, as a result of the contravention, an order setting aside a trade, or an on order that the person otherwise rectify the contravention to the extent that rectification is possible.Purpose, Sources & Critique of Securities Regulation Purpose underlying securities regulationThe two primary purposes of securities regulation are:Protect investors. Investor protection goes hand in hand with maintaining public confidence in capital markets. The prospectus requirement, continuous disclosure, and takeover bid provisions all focus on investor protection. Promote fair and efficient capital markets. There is an inherent tension between these two goals. The pendulum tends to swing back and forth: following a period of very lax securities regulation, regulation will be ramped up. Sources of securities lawRegulation of securities markets and securities trading in Canada is accomplished by way of:Statute: all provinces and territories have legislation governing the issuance of securities and the operation of securities markets. The general move in securities legislation has been towards a more principle-based approach, rather than process/rule-based regulation. The Criminal Code also creates some securities-related offences.Regulations and rules: securities acts typically include a regulation-making power, as well as a rule-making power for the provincial/territorial regulator. For example, s. 184 of the BCSA grants the BCSC the power to make rules on matters not contemplated in the Act thanks to a basket provision. BC also has a Rule Making Procedure Regulation, enacted under the BCSA, which sets out the procedures that the regulator must follow when making rules (designed to ensure transparency and consultation in the rule-making process). Notably, not all regulators have a similar rule-making power, i.e. they must rely on non-binding policy, or prov legislature to enact amendments to the legislation. National and multilateral instruments: the Canadian Securities Administrators (CSA) is an umbrella organization of provincial and territorial securities regulators that promulgates national and multilateral instruments in an attempt to reduce the amount of duplication required of market participants (e.g. if an issuer wants to sell securities in more than one province or territory). A national instrument is an instrument that has been agreed to by all provinces and territories, e.g. NI 45-106, Prospectus and Registration Exemptions. A multilateral instrument is an instrument that has been agreed to by some but not all the provinces and territories, e.g. MI 62-104, Take-Over Bids and Issuer Bids. The instruments created by the CSA are intended to be binding on all market participants in the provinces and territories that have implemented them. However, the instruments themselves do not have legal force; these instruments must be enforced by rules or policies in participating jurisdictions. National and local policies: the CSA produces national policy statements, e.g. NP 51-102, Disclosure Standards. Policies are intended to provide guidance to market participants concerning the exercise of regulatory discretion. A provincial rule or CSA instrument may also include a companion policy (CP), which elaborates on the meaning of the rule or instrument and provides examples of its application for guidance. Staff notices: notices are a mechanism for the CSA and regulators to communicate with market participants in an even more informal way than policy statements. Staff notices typically address emerging regulatory problems that have yet to become the subject of a policy or rule. Self-regulatory organization rules or policies: there are a number of self-regulatory organizations (SROs) in Canada, for example the TSX stock exchange, and the Mutual Fund Dealers Association (MFDA). SROs have the power to discipline members for breaches of securities law, including the SRO’s own rules and policies. Some SROs, like the Investment Industry Regulatory Organization of Canada (IIROC), also regulate securities markets by setting “universal market integrity rules” (UMIRs). Judicial decisions: appellate courts have the power to review the decision-making and regulatory activities of provincial and territorial securities regulators. Regulatory decisions and orders: provincial and territorial regulators have the power to hold hearings to review decisions made by regulatory staff. The decisions from these hearings can help market participants understand how regulators interpret legislation or rules, and apply them in specific factual circumstances. Finally, some guidance may come from the International Organization of Securities Commissions (IOSCO), an international organization whose members’ goal is “to cooperate together to promote high ethical standards or regulation in order to maintain just, efficient and sound markets”. Structure of the regulatory regime Securities regulation is administrated by expert tribunals: the provincial and territorial securities commissions. Significant power and autonomy are granted to these regulators to interpret, elaborate on, and apply securities statutes, regulations, and rules. In total, there are 13 separate regulators, some of which are very sophisticated, others which are very unsophisticated. Critique of our regulatory regime & recommendationsSecurities trading first began in Canada in 1832, when shares of Canada’s first railroad were traded by a small group of brokers in Montreal. Since then, securities regulation has undergone a number of overhauls. The need for greater harmonizationWhile the aim of the Canadian Securities Administrators (CSA) has been to streamline securities regulation across the country (e.g. by introducing national and multilateral instruments and policies, and databases like SEDAR and SEDI) and reduce the amount of duplication required of market participants (e.g. by developing the Passport System for prospectus filing), there is still a need for greater harmonization. Due to the plurality of regulators and levels of sophistication, the public is afforded different levels of investor protection, depending on the jurisdictions. There are also continuing inefficiencies associated with the cost of keeping 13 separate regulators in operation, procedural delay, the ongoing use of local rules, and varying interpretations of national instruments. Canadian capital markets are 1/15th the size of US capital markets, yet we have 13 different statutes and regulators (the US has a single primary securities regulator, the Securities and Exchange Commission). The cost of market participation for junior companiesThere is still a very high cost for junior companies who want to access the capital markets. For example, there are high financial and administrative costs associated with the prospectus requirement and a reporting issuer’s continuous disclosure obligations. Some prospectus exemptions, e.g. the private issuer exemption, or the family, friends and business associates exemption, are designed to foster entrepreneurial activity by lowering the barriers for small and medium-sized enterprises or startup issuers. But arguably still more can be done. New exemptions, e.g. crowd funding (MB currently only jurisdiction).Infrequent enforcement of illegal insider tradingIn 2002, the CSA established an Insider Trading Task Force, which suggested that Canadian markets may frequently be victimized by illegal insider trading activities. Convictions for illegal insider trading are rare, which means that the laws themselves have little deterrent value. As McNally and Smith suggest, “a lack of enforcement may send a signal to market participants that insider trading is not a serious crime”. Enforcement of illegal insider trading and tipping could be improved by developing more effective monitoring and detection tools. The need for a national regulatorSince the Royal Commission on Price Spreads in 1935, committees and working groups have recommended creating a federal securities regulator. For example, in 2003, the Wise Persons’ Committee recommended establishing a single “Canadian Securities Commission”. Canada is the only industrialized country without a national securities regulator. Under then federal Minister of Finance Jim Flaherty, the current federal government introduced a draft federal Securities Act. In the 2012 Federal Budget, Flaherty said: a “common securities regulator would give Canada a competitive advantage by reducing unnecessary compliance costs for issuers, strengthening our ability to response to financial instability, enhancing enforcement and better serving the needs of all Canadians”. On reference in 2011, the Supreme Court of Canada held that this draft Act was ultra vires the federal government, but left the door open for a cooperative approach to national securities regulation. Currently, BC and Ontario have agreed to establish a cooperative capital markets regulator, which could be operational as early as 2015. This common regulator would administer a single set of rules and have a single set of fees.Division of powersUnder s. 91 of the Constitution Act, 1867, the federal government is given fairly broad powers, including jurisdiction over trade and commerce. Under s. 92, the provincial governments are given the power to regulate property and the ownership of assets. In Manitoba v Canada (1929), the Privy Council held that the capacity of a Dominion company to raise capital through the sale of shares was within provincial jurisdiction and so ultra vires the federal government. Other cases have dealt with the overlap between provincial securities regulation and federal criminal law, as well as jurisdictional issues ................
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