SECURITIES REGULATION
Author: Faiz Lalani
Summary: Winter 2012
Professor: Eric Mendelsohn
Table of Contents
Securities Law in Canada, Chapter 1 ........................................................................................................... 2
Purposes of Act .............................................................................................................................................. 3
“trade” ............................................................................................................................................................... 3
“distribution” .................................................................................................................................................. 4
“Security” .................................................................................................................................................................. 5
SEC v Howey ...................................................................................................................................................... 5
State of Hawaii v Hawaii Market Center, Inc. et al [Risk capital approach] .................................... 6
Pacific Coast Coin Exchange of Canada v Ontario (Securities Commission) ................................. 7
SEC v Joiner (1943, USSC) ............................................................................................................................ 8
Securities Reference SCC 2012 ..................................................................................................................... 9
Factum of the Attorney General (Canada) .................................................................................................. 9
Policy ....................................................................................................................................................................... 10
Introductory Chapter ...................................................................................................................................... 10
Chapter 2: History of Securities Regulation............................................................................................ 10
Chapter 3: Regulators and Types of Markets.......................................................................................... 11
The Prospectus Process ...................................................................................................................................... 12
Chapter 4: The Prospectus Process ............................................................................................................ 12
Numbering system .......................................................................................................................................... 18
Exempt Market Transactions ............................................................................................................................ 18
Chapter 5: Exempt Market Transactions .................................................................................................. 18
Jones v F.H. Deacon Hodgson Inc [HCJ] ................................................................................................ 21
Continuous Disclosure ....................................................................................................................................... 22
Chapter 6 – Continuous Disclosure ........................................................................................................... 22
Danier Leather v Kerr SCC [2007] ............................................................................................................ 25
Pezim v British Columbia (Superintendent of Brokers) [1994] SCC .............................................. 26
Re AiT Advanced Information Technologies Corp .............................................................................. 27
YBM Magnex International Inc.................................................................................................................. 28
Corporate Governance ........................................................................................................................................ 28
Chapter Seven: Securities Regulators and Corporate Governance ................................................... 28
Insider Trading ..................................................................................................................................................... 30
Chapter Eight: Insider Trading.................................................................................................................... 30
Re Donnini [2002] OSCB ............................................................................................................................. 31
Civil Liability ........................................................................................................................................................ 32
Chapter Ten: Civil Liability ......................................................................................................................... 32
Secondary Market Liability ..................................................................................................................... 33
Escott v BarChris Construction Corp ........................................................................................................ 33
YBM Magnex International Inc .................................................................................................................. 33
Kerr v Danier Leather [2004] ON Superior Court of Justice ............................................................. 35
Kerr v Danier Leather SCC .......................................................................................................................... 36
Enforcement .......................................................................................................................................................... 37
Chapter Eleven: Enforcement...................................................................................................................... 37
R v Landen (Criminal charges) (ON Sup Ct J) ...................................................................................... 38
Re Canadian Tire Corp (OSCB) ................................................................................................................. 38
Committee for Equal Treatment of Asbestos Minority Shareholders v OSC [2001] SCC ....... 39
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Securities Law in Canada, Chapter 1
- securities regulation pursues three strategies: 1) disclosure of info; 2) registration
reqs; 3) ex post enforcement
What is a security?
- “security”: specifically defined, through enumerated definition in OSA. Broadly
defined in QSA as whatever defined as security in trade, anything other than a
bond, or an investment contract (investment without involvement in biz).
- Examples of securities include: options, futures, and derivatives
- “call option”: permits purchaser to force option writer to sell share for specified
price at or before specified date.
- “put option”: purchaser acquires to force option writer to buy share at specified
price at or before specified date.
- Futures: like option Ks, a futures K sells or buys a currency, commodity, index,
interest rate at a certain point of time, for a specified price.
- Derivatives: value depends on value of another security…really just an option K
or a futures K, or a combination thereof.
- S. 1(1)(a, b, i, n) OSA have broad definitions…new schemes are devised to
escape meaning of OSA
- “commonly known” as security under s. 1(1)(a) means what sophisticated
investor or lawyer would know.
- S. 1(1)(b) basically means anything – so the courts pursue policy-oriented
approach to distinguish a commodity from an investment.
- Most case law focuses on “investment contract” definition.
- In Albino, OSC had three different rulings on whether a compensation package
based on the different in stock price at award date and encashment was a security.
No stock was given. One said it was a constructive security, the other said it was
not, and another found sufficient nexus between the capital markets and the
transaction so as to deem that the OSC could intervene.
- In Universal Settlements International, the question was whther viatical offerings
were securities under the OSA as investment contracts. Three part test form
Howey: i) investment funds with view to profit; ii) common enterprise; iii) profits
derived from the undeniably significant efforts of persons other than investors.
USI conduced pre-purchase diligence and the investors were participating in a
common thereprise where the profits were derived primarily from the efforts of
USI. They are investment contracts.
What is a trade?
- selling and distribution of securities is a trade. But not pledging, unless pledged
by a control person, in which case there seems to be a presumption that a control
person has special information.
- Presale activites also constitute trade, so as to prevent misrep and fraud in
advertising
- In terms of jurisdiction, any offer made to ppl within a jurisidiction – unless
specified that they are not qualified to.
What is a distribution?
- broadly, any new security issued, or when a material controller sells (20%
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ownership).
- A control person has a superior ability to alter value of stock or has superior
information and therefore their sales of securities fall under the OSA. Control
persons must have voting shares (control) to matter. Any material transaction can
also be blocked or fall under the OSC’s jurisdiction. Combinations of persons
bound by agreement to sell may constitute a control person.
What is a reporting issuer?
- Any firm that has issued securities requiring a prospectus, any firm that has filed a
securities exchange take-over bid circular, any stock trading on an OSC exchange,
merged entity that includes an existing or former reporting issuer, any deemed
issuers under OSC orders.
Efficiency: efficient markets theory assumes that market price incorporate information
rapidly. This why, some argue, disclosure requirements are necessary. But if they are prt
of EMT, then the market will divulge info and so regs are extra burdensome. Courts have
been reluctant to embreance EMT in take-over bid cases and in cases where shareholders
dissent to determine stock price.
Materiality: if info is material, must be disclosed. Market impact test determines
materiality in Canada – where info would affect value price of stock; reasonable investor
test in the US – if substantial likelihood that reasonable investor would consider it
important.
Share valuation: Dividends as value: rational investors will value shares at the series of
expectations of dividends. Earnings as value: provide info about future capacity of firms
to pay dividends. Dividends, earnings and Share prices as value:
Purposes of Act
1.1 The purposes of this Act are,
(a) to provide protection to investors from unfair, improper or fraudulent practices; and
(b) to foster fair and efficient capital markets and confidence in capital markets. 1994,
c. 33, s. 2.
“trade”
or “trading” includes,
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(a) any sale or disposition of a security for valuable consideration, whether the terms of
payment be on margin, instalment or otherwise, but does not include a purchase of a
security or, except as provided in clause (d), a transfer, pledge or encumbrance of
securities for the purpose of giving collateral for a debt made in good faith,
(b) any participation as a trader in any transaction in a security through the facilities of
any exchange or quotation and trade reporting system,
(b.1) entering into a derivative or making a material amendment to, terminating,
assigning, selling or otherwise acquiring or disposing of a derivative, or
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(b.2) a novation of a derivative, other than a novation with a clearing agency,
(c) any receipt by a registrant of an order to buy or sell a security,
(d) any transfer, pledge or encumbrancing of securities of an issuer from the holdings of
any person or company or combination of persons or companies described in clause (c) of
the definition of “distribution” for the purpose of giving collateral for a debt made in
good faith, and
(e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in
furtherance of any of the foregoing; (“opération”)
Look up distribution,
“distribution”, where used in relation to trading in securities, means,
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(a) a trade in securities of an issuer that have not been previously issued,
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(b) a trade by or on behalf of an issuer in previously issued securities of that issuer that
have been redeemed or purchased by or donated to that issuer,
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(c) a trade in previously issued securities of an issuer from the holdings of any control
person,
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(d) a trade by or on behalf of an underwriter in securities which were acquired by that
underwriter, acting as underwriter, prior to the 15th day of September, 1979 if those
securities continued on that date to be owned by or for that underwriter, so acting,
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(e) a trade by or on behalf of an underwriter in securities which were acquired by that
underwriter, acting as underwriter, within eighteen months after the 15th day of
September, 1979, if the trade took place during that eighteen months, and
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(f) any trade that is a distribution under the regulations,
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and on and after the 15th day of March, 1981, includes a distribution as referred to in
subsections 72 (4), (5), (6) and (7), and also includes any transaction or series of
transactions involving a purchase and sale or a repurchase and resale in the course of or
incidental to a distribution and “distribute”, “distributed” and “distributing” have a
corresponding meaning; (“placement”, “placer”, “placé”)
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“distribution”
where used in relation to trading in securities, means,
(a) a trade in securities of an issuer that have not been previously issued,
(b) a trade by or on behalf of an issuer in previously issued securities of that issuer that
have been redeemed or purchased by or donated to that issuer,
(c) a trade in previously issued securities of an issuer from the holdings of any control
person,
(d) a trade by or on behalf of an underwriter in securities which were acquired by that
underwriter, acting as underwriter, prior to the 15th day of September, 1979 if those
securities continued on that date to be owned by or for that underwriter, so acting,
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(e) a trade by or on behalf of an underwriter in securities which were acquired by that
underwriter, acting as underwriter, within eighteen months after the 15th day of
September, 1979, if the trade took place during that eighteen months, and
(f) any trade that is a distribution under the regulations,
“Security”
Howey test: 1) invest money, 2) common enterprise – are we talking about vertical or horizontal
common enterprise?, 3) expectation of profit (does it have to be in the form of dividends, higher
share price?) , 4) solely from efforts of others (but if someone has some kind of role in this, then
it’s not solely from the efforts of others).
SEC v Howey
Facts: Howey is a FL citrus growing company, that offers half the groves to the public to
finance its operations. There are two companies: Howey Company, which sells the land,
Howey-on-the-Hills service, which provides a service to culturvate and harvest the
groves. While one may just buy land, the service of Howey is stressed. Separate tracts are
not demarcated. Howey services has leasehold interest 10 yrs and owner cannot enter w/o
permission and no right to specific fruit.
Issue: Whether the land sales contract, warranty deed and service contract together
constitute an investment contract?
Holding: Yes, an investment K.
Ratio: An investment K is scheme where by person invests in a common enterprise and
is led to expect profits from the efforts of another.
Reasoning:
- “Investment contract” in the SEC statute stems from a judicially-determined
understanding of the term. Therefore, see case law.
- Investment contract means a contract, transaction or scheme whereby a person
invests in a common enterprise and is led to expect profits from the efforts of
promoter or third party – whether shown by certificate of shares or nominal
interest in physical assets.
- In the case at bar, companies are offering more than fee simple in land: they are
ofeering opp to contribute money and share in profits.
- All elelments of profit-seeking biz here: investors provide capital and share in
earning and profits; promoters manage, control and operate the enterprise.
- The investors don’t live in the state, know nothing about orange farming. They
technically have the right to use another company, but that’s highly discouraged.
You don’t have access to land to market it. Don’t have entitlements to get
oranges.
- It doesn’t matter that not all buyers engage in service K; Secruties Act governs the
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offer as well as sale of securities.
The test is whether scheme involves an investment of money in common
enterprise with profits to come solely from the efforts of others. Speculative/nonspeculative nature of venture is irrelevant.
State of Hawaii v Hawaii Market Center, Inc. et al [Risk capital approach]
Facts: A person became founder-member distributor by purchasing a $70 worth sewing
machine or cookware set for $320. They earned income by signing up new members – no
income unless they signed up new ppl. A pyramid scheme.
Issue: Whether Founder-Member Purchasing Contract Agreements constitute securities
within meaning of Hawaii Uniform Securities Act?
Holding: Yes, an investment K.
Ratio: Modification of Howey test; more liberal interpretation. Court should focus on the
economic realities of transaction.
Reasoning:
- Investment contracr exists when: (1) provide initial value, (2) this initial value
subjected to risks of enterprise, (3) representations that give rise to reasonable
understanding that valuable benefit will accure, and (4) no control over
managerial decisions of the enterprise.
- It is important to note that Founder-Members did not receive a share in ownership
of HMC.
- You over-pay for goods the store will be selling. Bunch of ways to make money:
sell membership to others but there is a limit to slots.
- It’s not really profit, because ppl only earn on sales they make.
- Howey formula is too narrow in conceiving of “investor”
- Here, investors are not relying on solely the efforts of a promoter; they themselves
receive fruit from their labour as part of the scheme. Howey test, strictly applied,
would not deem these securities.
- Instead, courts should focus on economic realities of transaction, where the
placing of capital in a way to secure income or profit from its employment in an
enterprise.
- [By the court’s logic, then, salesmen only on commission ought to be protected
under securities laws because their efforts are dependent on the manufacturing
company’s management. The logic is the same: these individuals are selling
membership cards to earn commission, but this commission depends on the
managing company’s success].
- Purpose of statute is to (1) prevent fraud and(3) protect public against imposition
of unsubstantial schemes by regulating the transactions aimed at public for risk
capital.
- This is the risk capital approach to investment contracts
- In the case at bar, investors are subject to risk of an enterprise over which they
have no managerial control.
- The firm was trying to raise capital through this system. [but it could equally
argue that it was trying to increase customers…one is revenues, the other is
capital. The lines are blurred. When does a consumer become an investor?)
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Founder-members, some of whom will not try and sell memberships, depend
wholly on enterprise management for future income from their investment. (This
is factually incorrect: you can only earn income by getting other ppl to sign up;
there’s no independent commission).
Moreover, just because HMC offered fixed returns regardless of profits of
enterpirse is irrelevant; what matters is that investor was expecting a return on
investment.
Finally, courts should focus on the degree of control of the investor. The purpose
of statute is to protect investors when they cannot. The members have no
incidents of managerial control: no way to influence utilization of capital.
Pacific Coast Coin Exchange of Canada v Ontario (Securities Commission)
Facts: PCCE would issue certificates of silver coins at margin or one could buy them
whole. The purchaser could sell the coins - to make a profit - to PCCE which did not
agree to repurchase them but said they could and usually did.
Issue: Whether the agreement between the PCCE and its customers is an investment
contract?
Holding: Yes, the shady scheme is a security/investment K.
Ratio: The test for common enterprise: one where the fortunes of investor are interwoven
with the and dependent upon the efforts and success of those seeking the investment or of
third parties.
Reasoning:
(Majority)
- Basic purpose of Securities Act is the protection if investing public through full,
true andf plain disclosure of facts related to securities being issued.
- Act is aimed at arrangements that do not permit customers to know exactly the
value of investment they are making.
- Common enterprise exists where: Investor provides capital and promoter manages
enterprise. The test for common enterprise: one where the fortunes of investor are
interwoven with the and dependent upon the efforts and success of those seeking
the investment or of third parties.
- Ordinary investor depends on the quality of administration of funds by appellant
company. If Pacific does not properly invest pooled deposit, purchaser will obtain
no return on investment. Ordinary investor not sophisticated enough to understand
commodity markets.
- Key to enterprise is efforts of promoter alone.
- It is legislative policy to protect against caveat emptor and therefore courts should
seek to protect.
(Dissent – Laskin, CJ)
- Since the purchasers themselves were responsible for making a profit, based on
market price of silver, it cannot be said that this passes the Howey test.
Notes: The difference between the majority and dissent:
o Laskin says this is a bet based on the market, not the firm
o The key element of the combination of the kind of representations the
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company was making,
SEC v Joiner (1943, USSC)
Facts: Joiner had been promoting and developing this scheme with a partner, Anthony,
had drilling rights leases. To finance test drilling in TX, Joiner Company sold leasehold
subdivisions. It was advertised as an investment.
Issues: Whether the leasehold interests, with Joiner having drilling obligations, in
acreage were securities?
Holding: Yes, drilling rights sale was security.
Ratio: The test is what the character of the instrument acceding to terms of offer, plan of
distribution and economic inducements held out to the prospect. Look to the purpose of
the Act in deciding whether something falls under definition.
Reasoning:
- Definition in 1933 Securities Act is broad, like ON’s, but the definition also
includes undivided interests in mineral and drilling rights.
- The interpretive principle to construction of defintions: ejusedam generis – where
enumerated items, things alike. The other principle is expression unius est
exclusion alterius – when smething is specifically identified, you’re excluding
things not identified.
- Joiner argued that since undivided lease rights were explicitly included, divided
were explicitly excluded. They argue that b/c there are criminal penalties, Joiner
argues that statute should strictly interpreted.
- Interpretive tools should be given subject to give the statute its full effect. The
principles are subordinate to the purpose of the statute.
- “Novel, uncommon, or irregular devices, whatever they appear to be, are also
reached if it be proved as matter of fact that they were widely offered or dealt in
under terms or courses of dealing which establish their character in commerce as
investment contracts or as any interest or instrument commonly known as a
"security."”
- Once offer quoted accepted, contract made to make payments, contigent upon
completion of well.
- No info was provided about the business plan
- The test is what the character of the instrument acceding to terms of offer, plan of
distribution, and economic inducements held out to the prospect.
- The court will look to the broader purpose of the statute in deciding whether
something falls under the definition of security.
- Acceptance of the offer quoted made a contract in which payments were timed
and contingent upon completion of the well and therefore a form of investment
contract in which the purchaser was paying both for a lease and for a development
project.
- Ppl were induced to buy, Drilling obligation of Joiner accompanying the lease.
You can’t think of this as independent plots of sea – they needed Joiner’s drilling.
The whole success of the venture depends on the driller.
Notes: Seminal case in securities law. Tells us a great deal about what sec regs is really
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about.
Securities Reference SCC 2012
- CN and ON propose the Act falls under s. 91(2) – trade and commerce – while
QC, QB and others say it falls under 92(13) – property and civil rights
- CN argues: securities markets more national and international, giving rise to
systemic risk.
- Securities: shares, interests in partnerships, and debt instruments
- Primary: where corp issues shares; Secondary: where securities traded
- Lymburn v Mayland [PC (1932)] held that securities fall under s. 92(13) and can
regulate securities without discriminating against federally incorporated comps.
- Provincial and Federal law may govern the same matter, but their jurisdictions are
not concurrent; they are full in their own way.
- So as to prevent the general commerce power from eviscerating provincial
legislative powers, s. 92(2) laws must be “qualitatively different from anything
that could practically or constitutionally enacted” by the provinces.
- Investor protection and efficient markets are provincial domains.
- The Act would impede provincial power to govern property and civil rights with
respect to: registration of powers, SROs, exchanges, clearing agencies, audits. It
duplicates what the provinces do.
- Systemtic risk, however, is a unique concern of the Act. Court agrees it goes
beyond investor protection – and to fostering stability of financial system.
- However, provinces have been regulating within and outside their territories.
- Feds have to show that transformation of securities is such that regulating is not a
concern of a specific industry; it relates to trade as whole.
- Most of the Act replicates day-to-day securities regulation. Sure, aspects of the
Act deal with systemic risk, but they alone do not justify full takeover.
- Evidence does not support link between national interest in efficient capital
markets and registration requirements for securities dealers.
- Problem with the Act is that it will regulate all aspects of securities contrats
within provinces, all public protection and professional competence.
Factum of the Attorney General (Canada)
- Why has the market changed?
- As communication became easier, local markets gave way to regional and then
national ones.
- Process of aggregation and specialization resulted in consolidation of stock
exchanges.
- Capital raised at a national level, outside of province
- Institutional investment vehichles permit small investors to diversify domestic
and foreign holdings, exposing them it risk to capital markets here and abroad
- Regulators must be able to monitor competence and integrity of those who
facilitate transactions
- Increasingly complex securities products – derivatives, quants.
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Automated trading
Savers have moved from deposits to mutual funds
Irony of passport system is that the more interation diminishes local
responsiveness and regulatory experimentation and innovation.
Policy
Introductory Chapter
Sources of securities law
- provincial securities commissions given significant deference
- delegated legislation is key – regulations, etc
- Sources include: provincial securities statutes, regulations and rules (OSC can
make binding rules, post Ainsley), the CSAs national and multilateral instruments
harmozie, and national and local policies (“NP”s provide info on how rules are to
be applied, Staff notices (informal means to communicate w/ market participants
about regulatory issues), Self-regulatory organizations (can discipline members,
like the TSX, or Universal Market Integrity Rules), Appellate Court decisions,
Regulatory Decisions, Orders and Rulings (by the Commission), International
organization of Securities Commissions.
Chapter 2: History of Securities Regulation
- Originally, sec law focused on investor protection.
- Two philosophies underlying sec leg: 1) full disclosure and 2) blue-sky laws
(regulating conduct of securities issuers and require discretionary licencing of
issuers).
- In 19th century England, prospectus didn’t have to be filed, but had to reveal all
company cotnracts, failure resulting in civil liability.
- Directors Liability Act imposed liability on directors and promoters for loss
resulting from untrue statement in prospectus.
- Companies Act expanded liability to promoters for disposition of their shares to
the public.
- The Canadian Companies Acts: borrowed disclosure req from English leg.
- Kansas enacted first blue sky law, requiring consent that company was found and
offering a fair security; state could revoke registration of agent issuers, AG could
begin receivership procedures if company in insolvency or if improper conduct.
- Later, anti-fraud provisions were adopted in the Security Frauds Prevention Act,
creating offences for omission of material facts, outlandish promises,
unconscionable commissions, etc, punishable by fine or imprisonment.
- The OSA was enacted in 1967, focusing on disclosure.
- Kimber Report placed emphasis on efficiency from disclosure – “efficient
investment” requires information. Req for independent audit opinion on
prospectuses.
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Division of powers:
- Mayland , where Act gave power to province to make bond due upon criminal
offence, subjected federally-incorporated companies to provincial legislation.
However, it affirmed that sec leg could encroach on crim law power and therefore
be ultra vires.
- R v Smith: Asked whether anti-fraud provisions in OSA were ultra vires b/c they
were similar to Criminal Code. Provisions were focused on the kind of material;
Criminal Code just imposed offence for fraud. The prov law is not repugnant to
the fed law; therefore, valid.
- R v W. McKenzie Securities Ld: Tdot brokers sold shares to MB resident; brokers
charged with unlawfully trading in MB. Argue that MB law cannot regulate
interprovincial trade. First, court considers the true purpose of Securities
legislation – which is to regulate and supervise conduct of persons trading
securities within the province. The brokers were soliciting in MB, and therefore
fell within the jurisdiction of that Province even though they lived in ON.
- Multiple Access Ltd v McCutcheson: Whether insider trading fell under securities
laws or federal company law? The two laws are valid. They duplicate but do nto
contradict. Mere duplication is not sufficient to invoke doctrine of paramuntcy.
- Québec v OSC: Concerning the validity of extraterritorial application of OSA into
Quebec Crown corp. If prov legislation in pith and substance pursues a valid
provincial power, then its incidental extraterrotiroal effects are valid.
- Global Securities Corp v BCSecCom: Concerning the validity of a section of BC
Securities Act allowing inspection of docs to hand over to foreign regulators.
Accused claimed extra-provincial; Court held that section as valid as it aided in
the pursuit of provincial regulation and also b/c sec reg is interjurisdictional in its
nature (policy).
Charter issues
- BC v Branch: Whether sec reg could compel testimony and permit contempt of
court without criminal protections. If predominant purpose is to enforce
regulations and not to incriminate, then not in violation of s. 7 of the Charter.
Moreover, those engaged in securities issuing have less degree of expectation of
privacy. The statute is there to protect ivnestors and foster confidence in the
system.
Structure of the regulatory regime
- There have been many calls for a national regulator
- Porter Report: prov sec coms have less resources, and differences between prov
sec coms. Goal is to register interprovincial and international issuers. BUT: other
said it would lead to too amny regulators, and inter-governmental conflict.
- CANSEC proposal: feds would have delegated authority to apply prov law. But
prov ministers would have tremendous power.
- Proposals for a Securities Market Law for Canada:
Chapter 3: Regulators and Types of Markets
- Accding to Congressional Report, securities laws exist to enforce disclosure so
that markets can signal the correct value.
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Efficient Market Theory says ppl rational and info is all that is needed; however,
if ppl not rational as behaviourial finance suggests, then info disclosure is not
enough.
It’s a challenge balancing investor protection and efficient markets.
Tech is changing stock markets; it is more global and national, borderless fluidity.
This has led to greater harmonization of rules across jurisdictions, with Intl Org of
Securities Commissions as harmonizer.
Evidence that Canada has a national securities market 1) 2/3 of 7600 reorting
issuers are reporting issuers in more than one jurisdiction; 2) all listed companies
are interprovincial de facto; 3) Vast majority of Cdn mutual funds offer in all
provinces.
Primary market: distribution by issuer or underwriter
Secondary market: where stock is traded after distribution. Seucrities of a
reporting issuer can be traded. Where issuer becomes “reporting issuer” after
prospectus offering, reporting issuer is subject to continuous disclosure
obligations.
Marketplace operations controlled by sec regs. See OSA, “marketplace”
SRO: exchanges are self-regulators, who have been delegated authority by
primary regulator. IIROC is another example, regulating dealers and trading
activity in equity and debt. However, sec law allows sec regulators to apply to
review any decisions, direction or ruling of an SRO.
TSX Exchange has senior equities while TSX Venture has junior equities for
early-stage companies. The Bourse de Montréal engages in derivative securities
and options trading.
QTRS = operating facilities that permit dissemination of price quotations for the
purchase and sale of securities and reports of completed transactions in the
securities for use of registered dealers.
ATS = Alternative trading systems. Computer-based system.
The Passport System: one sec reg authority acts as the principal regulator for all
materials relating to filing, except ON. Allows multiple prospectus filing in one
go. However, if you file with ON, you have access to whole CDN market through
passport system.
IIROC = regulates dealers for good character, conducts financial compliance
reviews to ensure firms have enough capital, conducts biz compliance to check
firms have procedures to properly supervise handling of client accounts, conducts
market surveillance.
The Prospectus Process
Chapter 4: The Prospectus Process
- sec law prohibits any person or issuer from distributing a security or trading in a
security where the trade would be a distribution UNLESS a prospectus is filed
and receipted or distribution is exempt.
- Prospectuses reduce information asymmetry
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Common features of different forms of prospectuses: prelim and final filings,
regulatory oversight, right of withdrawal and recission for investors under certain
circumstances, and statutory liability for misrep and ommissions in prospectus.
- Prelim prospectus: no audit report required. May exclude info w/ respect to price
to underwriter and offering price. Where material change, amendment must be
filed.
- Persons w/ controlling interest required to file prospectus.
- Traditional, long-form prospectus reqs for IPOs only; Short Form Prospectuses
permitted for lower market cap firms as well as large ones, reducing admin
burden.
- IPO = first offering of securites; primary offering is first offering of a particular
set of securities by an issuer already in the market (reporting issuer)
- Four stages in prospectus: 1) development and filing of prelim and issuing receipt
by sec regulator; 2) comments and revisions during filing period; 3) filing of final
prospectus and issuing of receipt; 4) distribution of securities once receipt is
issued.
- Generally, prospectuses discuss business plan and current and expected activities,
financial statements, describes capital structure of issuer, underwriting agreement,
and description of factors that could make the security risky.
- Required to disclose net proceeds to be received or minimum amount in case of
non-fixed price distribution.
- Junior issuers have to disclose more detailed info about total operating costs and
expenditures necessary…what they’ll do with the money
- Venture issuers with little revenue must disclose exploration/development costs,
admin expenses.
- Issuers must use plain language: short sentences, avoid superfluous!
Underwriter
- Underwriter: determines price and terms of offering; governance advice. “Best
efforts” where underwriter takes commission; “firm commitment” where
underwriter buys all securities and sells them; or can simply agree to sell at issue
price and charge a fee. Underwriter has to ensure the info is full, true to the best
of its knowledge.
- In Kerr v Danier Leather, purchasers had bought shares from underwriter; it later
turned out the issuer had misrepresented. Purchasers wanted recission from issuer,
but court held could not rescind shares. However, in YBM Magnex International
court held underwriters to a high standard and thus liable.
- Market-out and disaster-out clauses in underwriting agreements: market-out
where securities can’t be marketed; disaster-out where significant event affects
issuer’s busness or capital markets.
- Non-independent underwriters have to make certain disclosures if there is a
conflict of interest CP 33-105CP to NI 33-105
Prelim prospectus
- Form 41-101F1 outlines prelim reqs.
- No price disclosure req unless disclosed in another jurisdiction
- Special disclosure reqs for asset-backed securities (s. 10.3) and derivatives (s.
10.4).
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Sec Comm has to issue receipt unless it is determined against public interest and
must provide prospectee opportunity to be heard.
Waiting period “quiet period”
- Between issuance of receipt of prelim and issuance of receipt of final
- 10 working days
- OSC does not study all prelims…only those with high risk factors are throroughly
reviewed. First, all Short Form and Long Form go through basic review; then
criteria for detailed review applied.
- Once review done, regulator sends revisions to issuer or any required info
- During waiting period, permissible to distribute a notice/ad to identify security;
must state price, from where a prelim can be obtained and where purchases may
be made.
- Issuer and underwriter can solicit expressions of interest; securities may not be
distributed until final prospectus receipt (s. 53 OSA). Why allow this? To give
investors time to consider offering.
- For small issuer or new market entrant, receipt process can take several months
until regulator satisfied that statutory reqs met
- Director of OSC can order cease of solicitation activities where she determines
that prelim is defective, s. 68 OSA
- Allowed to solicit expressions of interest but not further trade: so can advertise
prospectus but not the security…
- No person may trade in security until final receipt, s. 53 (this includes solicit)
- But can solicit expressions of interest, s. 65(2)
Final Prospectus
- Sale can begin once receipt received. In dual process, if OSC says “clear for final”
then deemed receipt if principal regulator issues receipt. NI 41-101, s. 8.2(1)
- For amendments, Director must issue receipt unless there are proper grounds and
opportunity to be heard. NI 41-101 s, 6.5.
- Failure to get receipt for final prospectus before distribution is cease trade and
other orders, s. 127.
Short form prospectus
- For repeat issuers, rationale being issuer info is in the public domain
- NI 44-101 is for Short Form Prospectus Distribtuions
- Qualification to issue: already reporting issuer, timely filing, listed on eligible
exchange for short form, and is not solely cash owner.
- Separate rules exist for non-convertible securities: mainly, not subject to down
grade by rating org
- Should have an AIF (Form 44-101F1): requires disclosre of each principal
purpose for use of net proceeds, for asset-backed securities more info required
(nature, pool of assets, structure and dedicated cash flows, third party or internal
support arrangements established to protect holders), rights attached
- Must disclose any proposed acquisition that reasonably person would think is
likely to be completed
- Also must include risk factors
- Must disclose info about underwriter (1.10, NI 44-101F1)
- NP 11-202 sets out Process for Prospectus Reviews in Multiple Jurisds.
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Response in 10 working days, best efforts
3 days for short form and shelf prospectuses
Issuer can file summary statement, which must comply with regulations;
purchaser must be informed in statement of ability to obtain full prospectus, liable
for misrep.
Shelf Prospectus
- NI 44-102
- Can file prospectus and then let it sit for up to 25 months before distribution
- Applies to any eligible short form prospectus distribution
(PREP) Post-receipt pricing prospectus
- NI 44-103
- The post-receipt pricing (PREP) procedures allow companies to file a final
prospectus that omits pricing and related information. Once pricing is determined,
a supplemented PREP prospectus that contains all of the omitted information is
filed with the OSC and provided to purchasers.
- Alternative to long form
- For specific transaction for a single security
- Can be on shelf for 90 days
- Subject to the prospectus form it is made under (short or long), NI 41-101, and
supplement or varied by the Instrument and implementing law of jurisdiction.
- In base PREP, don’t need to include how many/price securities bought by
underwriters. Supplemental PREP must cover that info
Seasoned issuers
- In US, get WKSI (well known seasoned issuers) status, allowing for automatic
shelf registration
- Unlimited securities for unlimited period
- Periodic public reports satisfy their continuous disclosure reqs
Multijurisdictional Disclosure System
- MJDS permits US and Cdn issuers to use same forms
- NI 71-101, NI 11-202
- US disclosure docs can be submitted in Canada; exemption from insider reports.
- When SEC gives receipt, principal Cdn regulator will and other passport
jurisidictions will deem receipt.
Capital Pool Companies
- Companies with only cash and no business operations
- Can be listed on TSX under CPC Operating Agreement by ON, BC, AB, SK, MB.
- TSX Venture does primary analysis.
Certification
- CEO, CFO + 2 directors must certify it discloses full, true and plain material
facts,
- Selling securityholder liable for misrep in prospectus even if not certified; but
may sometimes be required to certify
- Where an entity establishes a special purpose issuer to act as dedicated
securitization vehicle, the entity must certify the prospectus.
Material Fact and Material Change
- In OSA, means fact that would reasonably be expected to have a significant effect
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on the market price or value of securities
- AB, SK and MB is both retrospective and prospective – that significantly effects
or would effect
- Material information standard used by TSX, blend both fact and change.
- Item is considered material if it is probable that its imission or misstatement
would influence or change an investment decision with respect to security
- Take into account quant and qual.
- For forward-looking info, must not include unless reasonable basis
- Identify material riks factors that could cause material difference in forwardlooking info
- If any change in forward-looking info, must disclose in CD (MD&A supplement)
- Obligation to disclose material change during prospectus and distribution process
- “Material change” means a change in biz, ops, capital of issuer that would
reasonably be expected to have significant effect on market price or value of
security or decision to implement such change by directors or though to be
probably approved by Board acceding to senior mgmt.. “Market impact test”
- Must file amendment if material change between filing prelim and final within 10
days of change (NI 41-101)
- S. 57 OSA: if material adverse change must file as soon as practicable.
- If after final receipt issue but before distribution, must amend within 10 days.
- Where confidential material change report filed during distribution, issuer must
cease distribution until material change is generally disclosed and amendment to
prospectus is filed or if decision to implement change has been rejected
- Material contract: must be filed, Ks to which issuer is party to,
- Must disclose risk factors such as: general biz, enviro and health, reliance on key
personnel, regulatory, econ or political constraints and financial history.
- Period between receipt of prelim and end of distribution period cannot be more
than 12 months, creating real possibility of material change
- Material fact: any fact that would reasonably be expected to significantly affect
market price.
- Material change: only applies to changes
- In Kerr v Danier Leather, SCC affirmed that caveat emptor did not guide sec
regs; obligation to disclose material facts and change indicates this.
Future-Oriented Financial Information
- FOFI should include risk of forecast; but companies have incentives to inflate
projections; so law imposes civil liability for misrep
In Kerr v Danier Leather, issuer failed to correct financial forecast during distribution
period.
- Plaintiffs alleged that material changes between filing date and closing date were
not disclosed – i.e., decline in leather sales.
- Revenues were 24% below projections.
- Did not disclose this until June (closed late-May). Right after announcement,
share price fell.
- S. 57(1) only requires disclosure of material change; not facts. Material relates to
change in business, operations or capital. Material fact relates to all material
information at single point in time. This distinction exists to relieve issuers of
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continuous obligation to report every single change in political, economic and
social developments.
- S. 57(1) does not cover external factors to the business – only its internal
decisions.
- In the case at bar, the financial forecast was an implied representation of objective
reasonableness, only at the time of the filing – no requirement to update.
- Disclosure decisions are legal obligations and the business judgment rule cannot
be invoked to defend.
YMB Magnex International: materiality
- Test for materiality is objective. Investor wants to know facts that would
reasonably be expected to significantly affect the market price or value of the
securities.
- Moreover, in the instant case, reasonableness of judgement called into question by
lack of independence of mandate of YBM’s underwriter
Prospectus Requirements In A Secondary Offering
- A prospectus is required where sale of previously issued securities by a person
“distributing” with no exemption
- Who? Control persons (sufficient voting rights/20% voting rights); any
combination of person with such control.
- Why do control persons have to issue prospectus? They have influence over
issuer, can affect market price, and exit has impact on market perception.
Information asymmetry.
- Issuer and directors and officers must supply the info and certificates to allow
holder to sell. Where issuer does not cooperate, Director can order to do so or
order exemption (s. 64, OSA).
Refusal to Issue Receipt for a Prospectus
- Director can only deny if: in public interest, or statements are misleading, false or
deceptive; contains a misrepresentation; or unconscionable consideration or given
for promotional purposes or for acquisition of property.(s. 61, OSA)
- Can also refuse receipt if funds raised insufficient to accomplish purpose stated in
prospectus
- Past conduct of offier, director, promotor or controlling holder also can restrict
receipt if issuer will not conduct with integrity and best interests. See NI 41-101.
- Aren’t these restrictions indicative of blue-sky laws?
Right To Withdraw Or Recission
- Investors that have made an order for securities have cooling off period to
consider final prospectus once receipt issued and prospectus delivered. They have
right to withdraw or recission.
- Form 41-101F1, Info required: Item 30 is rights of withdrawal
- Misrep permits recission.
Passport System and Prospectus Process
- MI 11-102 (passport system) and NI 11-202 (process for prosecptus review in
multiple jurisdictions)
- Principal regular will usually be where participant’s head office located.
- Deemed receipt in passport jurisdiction and discretionary exemption from OSC.
- To meet reqs, filer must file onSEDAR the prelim or pro forma prospectus in both
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the local and principal jurisdiction.
- If refused, notified through SEDAR. Then NI will not apply and filer may deal
separately with local jurisdiction or any non-principal separately.
Lapse Dates and Refiling of Prospectus
- Lapse date = 12 months after date of most recent final prospectus relating to the
security
- Cannot distribute if lapsed; must file new prospectus
- Pro forma prospectus (long form without certificates) if delivered 30 days before
lapse date permits distribution for a futher 12 months + issue final prospectus no
later than 10 days later + receipt issued within 20 days after lapse date
Proposed National Securities Legislation
Numbering system
• The first digit relates to the subject matter category into which the instrument has been
classified. The nine subject matter categories are:
1. Procedures and Related Matters
2. Certain Capital Market Participants (Self-Regulatory Organizations, Exchanges and
Market Operations)
3. Registration Requirements and Related Matters (Dealers, Advisers and other
Registrants)
4. Distribution Requirements (Prospectus Requirements and Prospectus Exemptions)
5. Ongoing Requirements for Issuers and Insiders (Continuous Disclosure)
6. Take-over Bids and Special Transactions
7. Securities Transactions Outside the Jurisdiction
8. Investment Funds
9. Derivatives
Exempt Market Transactions
Chapter 5: Exempt Market Transactions
- Exempt transactions are more flexible and cost effective
- NI 45-106 governs exempt primary market transactions
- Resale rules prevent “backdoor underwriting”, see NI 45-102
- “closed system”: need to provide prospectus, or qualify for exemption or resale
exemptions; apply for discretionary exemption from prospectus req (OSA s. 74)
- MB and YK are open, don’t regulate downstream sale unless trade made by
control person
- Four policy objectives of exempt transactions: (1) to address needs of SMEs and
start-ups. Accredited investor and “family, friends and business associates
exemptions fix this. (2) Sophisticated investors don’t need extensive disclosure,
since they are rational. (3) Issuing securities to ppl with pre-existing relationship
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is exempt b/c they have info. Employees, family, business associates and existing
shareholders fall under this. (4) Govt bonds and debentures are exempted,
including provinces, municipal corps, ON school boards, financial instututions,
charitable issuers.
Where risk to investor low, disclosure can be dispensed with. Relationship
between risk and disclosure.
Regitration Exemptions: Exempted issuers and investors are still trading and so
will require registration reqs, unless exempted from registration. (1) Even if
private sale of securities, must check for legal req for registration even if no
prospectus. Registration exemptions found in s. 34 and 35 of OSA and Rules 45501, 45-502 and 45-503.
Private Issuer Exemption (NI 45-106, s. 2.4): Exists to foster entrepreneurial
activity. Not reporting issuer or investment fund; whose shares subject to transfer
in constituting docs or shareholder agreement; are beneificially owned by not
more than 50 persons, not including employees and former employees. Pierces
corporate veil to see real beneificial owners. Prospectus req does not apply to
distribution to: director/officer/control person of issuer, family member, “security
holder of the issuer”, accredited investor, where majority of beneificial owners are
in the categories above, “a person that is not the public”.
What is “not the public”? R v Piepgrass, AB Court of Appeal held distributing
securities to farmers, who were former biz associates, issuer had dealings with
constituted non-exempt transaction. They were not friends or associates. Need
“common bonds”, as friends and associates would not need prospectus.. This rule
exists b/c you are not likely to take advantage of friends, etc.
Family, Friends and Business Associates Exemption (NI 45-106, s 2.5): Except
in ON, prospectus requirement does not apply to family, friends, associates.
Should obtain signed statements from purchasers to ensure exemption. Also,
issuer can use registrants, finders and ads to solicit purchasers. Required,
however, to file report in jurisdiction of distribution no later than 10 days after
distribution, s NI 45-106, s. 6.1.
Founder, Control Person and Family Exemption (NI 45-106, 2.7): Available
in ON only. Prospectus distribution does not apply to founder of issuer, affiliate
of a founder of issuer, family of officer/director or founder of issuer, or control
person of issuer. ON does not allow distribution to close friends and business
associates.
Government Incentive Security Exemption (OSC Rule 45-501): A security in
a partnership that invests in a security, issued by a company that will renounce in
favour of security holder Canadian exploration expense amounts. Essentially a tax
shelter for junior explorers in resource sector. Max 75 investors may be solicited,
max 50 investors who purchase, each investor must have access to info
substantially similar to prospectus, investor must have net worth/investment
experience/investment advisor consultation/director/officer. No publicity or
advertising allowed.
Accredited Investor Exemption (NI 45-106, s. 2.3): Includes Canadian financial
institution, BDC, adviser or dealer in Canada, the Govt of Canada and its crown
corps, municipal corps, any govt of any jurisdiction. Pension fund, individual
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with net financial assets of $1000000, individual with net income before taxes of
$200 000 in 2 recent calendar yrs, individual with $500 000 net assets, a corp with
$5 000 000 in net assets on financial statements…
Securities can be bought and sold by accredited investors w/o triggering
prospectus or resale requirement!
Minimum Amount Investment Exemption (NI 45-106, s. 2.10): Not less than
$150 000 in cash paid, security of a single issuer, and does not apply to corporate
person constituted solely to purchase securities on reliance of this exemption.
Required to file report to benefit from exemption.
Pre-existing Relationship with Issuer Exemption: Dividends (NI 45-106,
s.2.31) issued as securities are exempted. Business Reorganizations (NI 45-106 s.
2.11) are exempted. Issuers in distress don’t have to worry about compliance.
Conversion or Exchange of Securities (s. 2.42) are exempted. Convertible shares
are exempted for obvious reasons. Must tell regulator written notice of amount,
date, nature, conditions of trade. Regulator can object within 10 days. Rights
offerings (s. 2.1): Req of written notice to regulato who can object, issuers
required to respect NI 45-101. Regulators will object if used for major financing:
not exceeding 25% of outstanding shares.
Exemption for Trades to Employees (NI 45-106, s. 2.24): enables issuer or a
control person to distribute securities to employees or employees of affiliates.
Participation must be voluntary.
Offering Memorandum ExemptionL Prospectus exemption does not mean no
disclosure req. Lax eligibility req: eligible investors, with less asset value than
accredited investors. Qualifying issuers, who have AIFs and SEDAR filings, use
one form (45-106F3) while others use 45-106F2. The latter form is similar to
prospectus, while the former allows issuer to use existing market info, in ON
offering memo req for GIS exemptions. S. 130 OSA deals with statutory right of
action for deficiencies in offering memos.
Discretionary Exemptions: Under s. 74, can apply for exemption from
regulator.
RESALE RULES: Arises where purchaser who bought under exemption wants
to resell, or holder of private issuer security wants to resell but private issuer no
longer “private”. This rule prevents backdoor underwriting and promotes
disclosure. Restriction on periods of resale lower value of shares, creating
incentive for issuers to do public offering.
S. 2.5 NI 45-102 applies to exempt transactions more susceptible to being abused
by issuers or initial purchasers. Capital-raising exemptions attract s. 2.5 and
private issuer exemption attracts s. 2.6. Restricted period of four months applies
to resale under s. 2.5.
S. 2.5 covers both issuer distribution and reseller of security. S. 2.6 imposes no
restriction period on initial purchaser who wants to sell in Canada.
Seasoning period ensures subsequent purchasers have access to adequate info.
Restricted period calculated by determining time from date issuer distriubed to the
purchase by the initial purchaser.
No unusual effort may be made to prepare market; no extraordinary commission
or consideration may be paid to qualify for s. 2.5 and 2.6.
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Resale rules for control persons: More stringent rule for control persons – those
who can materially affect issuer or hold 20% voting rights.
Options available to control persons: (1) issue pursuant to prospectus, (2) seek
discretionary exemption, (3) sell to another who qualifies for exemption, (4)
follow s. 2.8 of NI 45-102.
S. 2.8: Four month restriction period + four month seasoning period. Two filing
reqs: Form 45-102F1 in SEDAR and insider reporting reqs.
Incorrect Reliance on Prospectus Exemption: Jones v F.H. Deacon Hodgson
Inc: Whether sale of shares contravenes s. 53 of OSA for failure to file
prospectus? Prohibition against distribution without prospectus is meant to protect
public, making the sale of such securities unlawful. Case dealth with absolute
failure to file prospectus where required; something not directly contemplated by
civil remedies section of OSA. Those seeking remedy for such distributions are
not time barred.
Jones v F.H. Deacon Hodgson Inc [HCJ]
Facts: Defendant is an investment dealer which caused a private company (B) to be
created for the purposes of investing in an oil exploration company. Defendant offered
B’s shares. B did not file prospectus. Purchaser seeking declaration that share purchase
was void and return of money.
Issue: Whether sale of shares in contravention of s. 53 (prospectus req) is void?
Holding: Yes, void.
Ratio: A security sold w/o prospectus is void.
Reasoning:
- Defendant brings motion to dismiss the action on ground it is statute-barred.
- S. 71 requires dealer to deliver prospectus
- S. 133 creates civil liability for dealer who fails to deliver prospectus.
- S. 138 provides max three year limitation for right of action.
- Plaintiff not relying on s. 133; relies solely on s. 53, which gives right to CML
right of action; s. 138 does not apply.
- Defendant argues that no civil remedy lies for s. 53; only criminal penalty.
- Court holds that cause of action does lie for breach of s. 53.
- Filing of prospectus is fundamental to protection of the public
- It is a matter of public policy; it is void, not just voidable.
- No cause of action exists for failure to provide prospectus under civil liability part
of Act.
- Act does not expressly deny CML cause of action (umm, see Danier Leather for
rejection of this notion).
- Cumulative effect of precedent is that sale of securities prohibitied by Act is void.
- Also, here, s. 71(1) does not exist as a remedy b/c issuer did not produce one! So
it’d be impossible for dealer to produce one.
- Obiter: while decision prevents seller from enforcing illegal K, it also prevents
purchaser from enforcing K. Purchaser may, however, choose not to exercise
remedy to continue to hold shares and recover price paid in unjust enrichment.
But vendor cannot rely on void transaction to profit.
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Notes: Mendelsohn finds this judgment problematic because it presumably gives an
equity shareholder preference over creditors – forever.
Continuous Disclosure
Chapter 6 – Continuous Disclosure
- CD allows issuer to efficetively and cost efficiently raise capital – investors would
have disincentive to provide capital without it (specious arg)
- It’s vital for secondary market
- CD facilitates new issuances b/c it allows issues to use short-form, PREP or
MJDS forms
- Full and timely disclosure can increase financial analyst coverage, ensure
appropriate risk premiums, and encourage better capital allocation
- Failure to disclose would impair investor confidence, resulting in higher cost of
capital through lower trading prices and lower credit rating. Will also lead to civil
liability.
- Disclosure also facilitates corp governance – monitoring tool to oversee corporate
managers, signalling devise.
- Homer Kripke: argues that investors care about annual reports, not Form 10K.
Enterprise value is subjective, like beauty. Accounting should move towards more
detail, stuff ppl care about – no use in imposing standars. Disclosure should be
oriented towards the sophisticate dperson, who will filter info for lay person.
- Disclosure reqs are aimed at transparency and creating a “level playing field” for
investors in their assessment of the risks and benefits of investing in securities of
an issuer (fairness in the ideological argument for CD?)
Continuing enhancement of the disclosure system
- intl move to enahce CD to restore public confidence in capital markets
- But does this enhanced information really provide investors with info that allows
them to realistically assess the risks and benefits of investing in a firm?
- There is also debate abour moving toward a principled approach, instead of rules
based.
- New policy of best practices in disclosure: NO 51-201
- Companies should have written disclosure poloices and a senior officer must have
oversight of the policy Policy must specify financial, operational, and structural
data that companies must release in a fair and careful manner. Material info that
must be disclosed includes changes to: accounting polocies, changes in ratings,
and any exceptions to corp ethics or practices for key employees. All info should
be filed in SEDAR. Another disclosure system is the System for Electronic
Disclosure by Insiders (SEDI).
Materiality
- NI 51-102 defines material change as change in the business, operations or capital
22
of the issuer that would reasonably expected to have a significant effect on the
market price or value of any of the securities of the reporting issuer.
- TSX requires disclosure of material information – both change and fact.
- S. 407 TSX manual: material info is any info related to the business and affairs of
a company that results in or would reasonably be expected to result in significant
change in the market price or value of any of the company’s listed securities.
Where there are rumours and speculation, market surveillance may require an
announcement be by the company whether such rumours and speculation are
factual or not.
- S. 408: Immediate disclosure. Must disclose material info fortwith upon becoming
known to management, or if known already then when it becomes apparent to be
material.
- S. 409: companies not req to disclose external development unless they have
direct effect on the business or affairs that is both material and has an
ucharacteristic effect from that on other businesses in the same industry. So,
basically, exceptional stuff.
- Changes likely to trigger prompt disclosure: changes in share ownership that
affect control of company; changes in corp structure; take-over bids or issuer bids;
major acquisitions or dispositions; changes in capital structure; significant
borrowing; sale of addition securities; new techs; significant contracts; changes in
capital investment plans; changes in mgmt.; significant litigation or
labour/supplier disputes…
- Forecasts of earnings need not be disclosed, exrept for significant change in the
near future.
National Instruments and Multilateral Instruments
- NI 51-202 harmonizes CD obs
- NI 71-201 harmonizes US and Cdn CD obs
- Sector-specific CD obs: NI 51-101 for oil and gas; NI 43-101 for mineral projects
Timely and Periodic Disclosure Reqs
- Whrre disclosure is periodic, timelines are set out
- Where disclosure related to material changes, timely disclosure can mean
fortwith, as soon as practicable or not later than 10 days depending on the
jurisdiction.
- Periodic disclosure includes: quarterly and annual financial statements, MD&A,
Annual Information Form, and info circulars in connection w/ proxy soliciations
for general meetings of shareholders.
- Who must disclose?
- A reporting issuer; issuer can seek to be deemed reporing issuer or seek to not be
one any more if in public interest,
- What must be disclosed?
- Financial statements: quarterly and annual…director/officer certification req and
review but audit committee, in accordance with IFRS. Must be filed within 90
says after end of its most recently completed financial years. For interim filings,
45 days.
- Venture issuers have more time (a third more) and are exempt from filing an AIF.
But thye must, as increased CD, disclose expensed exploriation and development
23
costs, R&D costs.
- Must disclose if problems with auditor: if auditor disagreed, or was changed and
why.
- All must disclose executive compensation but for those who don’t, special rules
apply s. 11.6 NI 51-102. You have to explain the rationales behind compensation
and even have a performance graph, comparing the stock value over a five-year
period to the increase in executive compensation!
In the Matter of Research in Motion Limited et al
- RIM’s Board approved of a stock option plan. Options were to be priced at the
money – exercise price per share is equal to closing market price of shares on the
last trading day immediately preceding the date of the grant. Several members of
Board selected the most favourable pricing for options – lowest share price was
chosen in hindsight in order to set grant date and exercise price. This amounted to
incorrect dating practices. RIM’s periodic filings, prospectuses, financial
statements, annual reports and mgmt. info circulars therefore contained
misleading or untrue statement that Options were priced at FMV of RIM’s
common shares at the date of the grant and that they following the Plan. OSC
charged them with violating s. 122 of OSA for misleading statements.
- Management Discussion and Analysis: discusses financial statements and
provides mgmt’s insights into how the issuer is likely to perform on a goingforward basis. It is a prospective and retrospective analysis. Reqs set out in part 5
of NI 51-102. What is material? – “would a reasonable investor’s decision
whether or not to buy, sell or hold securities in your company likely be influenced
or changed if the information in question was omitted or misstated?” Must also
include the capital structure of the issuer.
- Annual Information Form: Very detailed info about the history, operations and
financial affairs of the reporting issuer. Must be filed within 90 days after end of
most recently completed financial year of issuer. NI 52-110 Audit Committees
sets out what must be included in AIF with respect to audit committee – must
address any oversight issues or disagreements between audit committee and board
of directors. AIF also requires disclosure of social and enviro policies as well as
risk factors such as enviro, health and political considerations.
- Information Circulars and Proxy Solicitation Rules: Mixed corp and securities
law. Specifies to whom proxies and circulars are to be issued, their filing and the
content of proxies. Part 9, NI 51-102: mgmt. must send proxy form to registered
shareholder for meetings; others soliciting proxies must do so as well. Content:
specify meeting that proxy applies to and contain space for designating a proxy
nominee, instructions on how to exercise right to proxy,
- According to NI 54-101 CP issuer must ask intermediaries for the information of
beneficial shareholders and intermediaries are required to respond with the info
within three business days of receipt.
Material Change Reporting:
- Premise is that CD is essential to promote active capital markets and investor
protection
- Means change in business, operations or affairs of issuer that would reasonably be
expected to have a significant effect on the market price or value of the securities
24
– or a decision to implement such a change
- S, 75 OSA imposes reporting req once material change occurs. Must file as soon
as practicable and within ten days of date on which change occurs.
- May apply for non-disclosure if disclosure would be unduly detrimental and no
persons with knowledge have made use of knowledge.
- S. 76(1): prohibition on trading where knowledge of material fact or change not
generally disclosed.
- S. 76(2) No tipping: when person in a special relationship with reporting issuer
shall inform another of material change or fact before general disclosure.
- S. 76(4): Defence. Not in contravention if person or company proves they
reasonably believed material info had been generally disclosed.
- This scheme (s. 75-76) creates overall obligations to disclose material change in
the affairs of a reporting issuer.
- NI 51-102, Part 7L if material change occurs, must file a news release as soon as
practicable or within ten days.
Disclosure of Significant Acquisition
- All reporting issuers required to file business acquisition report (BAR) within 75
days after date of acquisition of a business or related businesses under NI 51-102,
s. 8.3.
- There is an Asset Test, an Investment Test, and an Income Test – about 20
percent of acquired business needed to acquired for significance.
Rumours
- NP 51-201 sets standards for disclosure
- Allowed to keep info confidential where immediate release would be unduly
detrimental to company’s interests – might interference with specific objective,
ongoing negotiations.
- If news leaked, then company should make full public announcement
Conclusion
- Periodic disclosure: financial statements, MD&As and AIFs
- Timely: material change
- Three public policy issues: (1) complex and fragmented info; (2) too much
codification, not principled; (3) concerns that CD obs met to the letter but no the
spirit or intent of legislation.
- Companies not required to discuss externalized costs; material change is internal.
BUT, slow shift towards enviro and social policy declarations.
Danier Leather v Kerr SCC [2007]
Facts: Danier filed prospectus but its sales forecast was adjusted post-filing.
Issue: Is Danier liable for misrepresentation pursuant to s. 130(1) of OSA?
Holding: No.
Reasoning:
- Statute removes caveat emptor
- When a prospectus is accurate at the time of filing, s. 57(1) of the Act limits the
obligation of post-filing disclosure to notice of a “material change”, which the Act
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defines in s. 1 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 any of the securities of the issuer”.
Misrepresentation is “an omission to state a material fact that is necessary to make
a statement not misleading in the light of the circumstances in which it was made.
An issuer has no similar express obligation to amend a prospectus or to publicize
and file a report for the modification of material facts occurring after a receipt for
a prospectus is obtained that do not amount to a “material change” within the
meaning of the Act.
A “material fact” is defined in the Act more broadly than a “material change” and
includes “a fact that significantly affects, or would reasonably be expected to have
a significant effect on, the market price or value of . . . securities”.
A change in intra-quarterly results is not itself a change in the issuer’s business,
operations or capital and, for that matter, does not necessarily signal that a
material change has occurred.
The trial judge, having also found the forecast to be objectively reasonable as of
the filing date, erred in proceeding to test the objective reasonableness of the
forecast at the date of closing, and assessing damages for its perceived
deficiencies as of that later date. The forecast did carry an implied representation
of objective reasonableness rooted in the language of the prospectus, but this
implied representation extended only until the prospectus was filed
Prospective buyers were entitled to assume no material changes had occurred to
material facts disclosed in the prospectus between the filing date and the closing
date.
The distinction between material facts and changes is a deliberate one: it attempts
to relieve reporting issuers of the obligation to continually interpret external
political, economic and social developments as they affect the affairs of the issuer
– unless there is a change in the business, operations or capital of the issuer.
The disclosure requirements under the Act are not to be subordinated to the
exercise of business judgment. It is for the legislature and the courts, not business
management, to set the legal disclosure requirements.
Alternative argument: statute does not reverse common law principle that requires
a representations that becomes untrue to the maker’s knowledge to be corrected
before it is acted upon. The common law does not require a prospectus, does not
make distinctions between material facts and changes, and does not create a
scheme of compelled disclosure – it is the Act that settles the policy.
Notes:
Pezim v British Columbia (Superintendent of Brokers) [1994] SCC
Facts: Allegations that respondents had violated continuing and timely disclosure reqs
and insider-trading provisions.
Issue: Whether the respondents are in violation CD obs and insider-trading prohibitions?
Holding: Yes; Court of Appeal erred in interfering with Commission’s finding. Directors
of the issuer have a positive duty to inquire about material changes and to ensure that any
such changes are disclosed prior to the transaction.
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Reasoning:
- Material fact is broader than material change – fact includes any fact that can
reasonably be expected to significantly affect the market price or value of the
securities of an issuer, not just changes in biz of issuer.
- Courts should give deference to Commission in its findings of fact.
- Even so, the Court of Appeal’s findings were wrong. Court can’t claim no change
in company’s assets when it is discovered that some of its property had minerals
where there was no known before.
- The scheme of the Act is to seek full, true and plain disclosure of all material
facts.
- The Commission also found that issuer did not disclose share options transactions
as soon as practicable; issuer contends the words have a different meaning when
an issuer is about to engage in a securities transaction.
- Commission found that issuer engage in trading of securities prior to disclosure of
material changes.
- SCC admits it’s hard to know what constitutes material change but recommends
the use of an early warning system to confidentially disclose info to the
Commission as in ON.
- Court of Appeal failed in appreciating special knowledge and sophistication of the
Commission; failed to recognize the Legislature’s intent to confer public interest
mandate on Commission; there being no reviewable error of law, Court of Appeal
erred in interfering with Commission’s findings.
Notes:
Re AiT Advanced Information Technologies Corp
Facts: A merger with 3M.
Issue: Whether directors were in breach of OSA for authorizing/acquiescing in AiT’s
failure to disclose forthwith merger transaction with 3M as a material change?
Holding: There is no bright line rule for what constitutes material change. You need
substantial likelihood that proposed transaction will be completed for negotiations for a
material transaction to constitute a material change required to be disclosed.
Reasoning:
- Materiality test is objective and one of market impact. Investor wants to know
facts that would reasonably be expected to significantly affect the market price or
value of securities.
- It is important to not only consider the transaction itself but also negiations
underway to effect transaction. Sometimes, existence of negotiations would affect
stock price and would therefore be material (but can only be material if
underlying transaction itself would be material.)
- In the case at bar, negotiations were material to AiT: potential acquisition would
affect market value of AiT’s shares and were therefore material. Especially given
that AiT is such a small issuer.
- There is no bright line test for materiality; all depends on circumstances.
- An intention by a company to do something that, once implemented, would
constitute a material change in the affairs of the reporting issuer, but which at the
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time the intention is formed – for reasons beyond control of company – is not
capable of achievement is not ordinarily a material change. A decision by the
Board to pursue potential transaction that is not within its control would not
ordinarily be material change unless Board has reason to believe that other party
is also committed to completing the transaction.
You need substantial likelihood that proposed transaction will be completed – that
is, sufficient signs of commitment on behalf of all parties involved with the
transaction.
YBM Magnex International Inc.
Facts: Accounting firm D&T refused to perform any further audit procedures until YBM
carried out investigation into certain questionable practices and relation to organized
crime. Only following the completion of the investigation could D&T issue opinion on
1997 financial statements and be associated w 1996 financial statements.
Issue:
Holding:
Reasoning:
- The test for materiality in the Act is objective and is one of market impact.
- US courts have applied the probability/magnitude test – analyzes the current
value of info as it affects price of securities discounted by changes of it occurring.
- The definition of material change acts as a brake on premature disclosure – it
requires an exercise in judgment. If the decision is borderline, then info should
considered material and disclosed. “A supercritical interpretation of the meaning
of material change does not support the goal of promoting disclosure or protecting
the investing public?’
- The req for annual independent audit is to provide public with independent and
objective check on fairness of presentation of company’s financial position.
- YBM was facing a cease-trade if the financial statements were not filed on time.
- The question is, was the audit suspension a change in biz, operations or capital of
issuer so as to reasonably expected to have significant effect on market price.
- Court agrees that probability/magnitiude from US is useful tool in this context. It
was probable that YBM would be unable to obtain audit opinion and meet its
filing deadline and would lilely face cease trade order. That would be a material
change.
- They issued a press release 18 days after notice of the audit suspension – OSC
contended this was not “forthwith” as under s. 75(2).
- Court agrees they failed to file disclosure forthwith.
Corporate Governance
Chapter Seven: Securities Regulators and Corporate Governance
- Sec regs with respect to corp gov are investor confidence and investor
participation measures
- Four areas of importance: proxy solicitation, corp gov disclosure, officer
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certification reqs, and audit committee independence
- Goals: increase transparency of issuer decisions and enhancing participation
rights of securityholders
- Investors signal dissatisfaction w/ goverance by existing (selling) or by voicing
(using proxy process). Participation rights give direct communication to directors.
Proxy solicitation reqs:
- Corp law seeks to enable corporation to operate – setting out respective rights of
directors and shareholders – securities law aims to protect integrity of the markets
and to ensure exercise of voting not compromised.
- Sec regs with respect to corp governance aren’t just there for disclosure: they seek
to balance power between sharheolders and management and other shareholders.
- Shareholders express their preferences and exercise limited control rights over
direction of corp using proxy provisions.
- Mgmt proxy solicitation tempers mgmt. conduct by requiring disclosures of
conflicts, req for communication and some transparency.
- In ON, compliance with OBCA satisfies OSA proxy reqs.
- NI 51-102 (Continuous Disclosure) covers proxies.
- NI 54-101 facilitates delivery of proxy materials to beneficial shareholders – can
vote but has to obtain proxy. Reporting issuers required to send form to beneficial
owners to ask if they want proxy materials.
Corp governance reqs
- Copr governance standards are voluntary bit sec regs require disclosure of
governance practices
- “comply-or-explain” approach to corp governance
- NI 58-101 applies, Disclosure of Corporate Governance Practices
- Reporting issuers have to disclose independent and non-independent directors and
the basis for that determination.
- Have to describe what board does to facilitate exercise of independent judgment if
majority are not independent and to facilitate discussion among independent
directors. Must disclose if ethical conduct code in firm.
- Describe process by which board determines director and officer compensations –
whether independent directors on compensation committee.
Certification of disclosure:
- NI 52-109: requires issuer’s CEO and CFO or similar persons to personally
certify that issuer’s annual filings and interim filings do not contain any misreps
and are fair presentations of financial info.
- Requirement for Disclosure Controls and Procedures and Internal Control Over
Financial Reporting. To create reasonable assurance about disclosures and
financial reporting.
- A certifying offier could be liable for misrep for quasi-criminal, admin or civil
proceedings under securities law. Also, may be liable at common law or under
civil law in QC.
Audit Committees:
- Auditor “capture” by corporate officers is a real problem: see Enron
- NI 52-110 requires external audits are conducted independently by assigning
oversight to independent audit committee.
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Every member of audit committee has to be independent
Independence: no material relationship with reporting issuer
It is not yet clear how securities law initiatives will interact with potential liability of
directors and officers for their governance activities and, if they do, what remedies may
be available to investors and other stakeholders for any failure to engage in effective
oversight.
Insider Trading
Chapter Eight: Insider Trading
- There is legal and illegal insider trading
- Concerns about fairness among all traders in securities fuel insider trading rules
- It is improper for insider to use confidential info by trading in securities
- “Insider”: director or officer of reporting issuer, or of company that is insider, or
of company that is subsidiary of reporting issuer. Beneficial ownership of %10 of
voting shares, except underwriters. The reporting issuer itself.
- System for Electronic Disclosure by Insiders (SEDI)
- Insiders must file Insider Trading Report within 10 days of becoming insider (but
not if they have no ownership of securities). When holdings of securities change,
ITR must be filed within 10 days of change.
- Exemptions: in NI 55-101: for when change affects all securiyholders, such as
dividends or amalgamations. Directors of subsidiary may be exempted, unless
they have info about material facts or change in ordinary course of things.
Institutional investors also enjoy exemptions if they use early warning system.
Illegal insider trading and tipping
- It is illegal for someone in special relationship with issuer to trade if they have
knowledge of a material fact or change that has not generally been disclosed. See
Donnini for full discussion.
Generally disclosed defence
- Two factors to be analyzed: whether disseminated to the trading public and
whether public given sufficient time to digest such info given its nature and
complexity
- Adopted in Pezim v British Columbia.
- There is a duty to inquire into existence of material change before engaging in
securities transaction, Pezim. A Chinese wall won’t save you from failure to find
out if material change before engaging in transaction.
Tipping:
- Must be in special relationship, must inform of material fact/change other than in
course of biz, info not been generally disclosed.
- Defences
- Reasonable belief info has been generally disclosed: for disclosure, not enough to
say there is disclosure – need to disclose the info itself (Green Charterhouse
Group).
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It’s not enough for press release to have general disclosure. Have to wait for
market to absorb info (Re Harold P Connor). A safe rule is to wait a whole full
day after press release before trading.
Reasonable mistake of fact: a case law, not statutory defence. In strict liability
offences, onus on defendant to prove on balance of probs that he took all
reasonable steps to avoid committing the offence. In Lewis v Fingold, def argued
that he did not know bad 4th quarter results were a material fact. Determining if
something is a material fact depends on objective test. While objectively bad 4th
quarter results were material fact, def believed they were not. Court of Appeal
held trial judge finding that def did not believe it was a material fact.
Necessary course of business: NI 51-201 sets standard for necessary course of biz.
A mixed question of law and fact. Applies to: vendors, suppliers,
employees/officers/directors, lenders, legal counsel, auditors, underwriters,
financial advisors, parties to negotiations, labour unions and industry associations,
govt agencies, credit rating agencies.
Re Donnini [2002] OSCB
Facts: D worked as trader for Yorkton, which was arranging financing for KCA. After
conversation with boss, D started shorting KCA shares. D says he was mitigating risk as
underwriter holding long position in KCA stock. He shorted the first round of financing,
but continued to short upon learning of second financing prior to public announcement.
Issue: Whether D had knowledge of a material fact that not been generally disclosed
when he purchased and sold shares?
Holding: D is liable for insider trading.
Ratio: Court will conduct objective and subjective analysis of the knowledge of insider
traders.
Reasoning:
- Court agrees that, up to a certain point, D was conducting valid hedging.
- It is important to note that D and Yorkton held on to 650,000 units from second
round of financing even though client demand existed. This indicates that it didn’t
necessarily need to hedge.
- D’s activities deprived hedge funds and other investors the opportunity to short
shares and to buy second round special warrants but weren’t able to.
Can a contingent event be a fact?
- Facts may be material facts without being material change. Here, we’re concerned
with whether it is a material fact, not whether it matured into a material change
(pursuant to s. 75).
- The question, simply, is whether info D got from constituted a material fact?
- The probability/magnitude test: balance prob of event occurring with anticipated
magnitude of the event.
- Here, though lower probability of KCA second special warrants, high potential
magnitude for value of KCA shares.
- It would have been reasonable at the time to conclude that secon financing would
add intrinsic value of KCA shares.
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D’s knowledge
- He was head institutional trader at Yorkton, lieutenant to boss.
- Managed risk exposure to KCA
- Had three min meeting in hallway w/ boss about KCA: but knew far more
- D had knowledge of material facts in question.
- D continued to short – naked – after learning of second financing round. You
don’t go naked if you’re mitigating risk.
- D knew of size and price of transaction ($6.75).
- Paterson mused aloud about how avg price of short position was $7.00. And how
a 25 cent+ difference could be shared with KCA. (Basically, was selling shares
for $7 (naked) in the market, with knowledge that offering price would be $6.75).
- The transaction could not have been a reasonable mistake.
- Where a trader had no knowledge of material fact/change but director or officer of
issuer did, then corporation would be guilty of infraction of s. 76(1). S. 175(1) of
Securities Regulations.
- Firms may use “grey list” to identify issuers it has insider info on; restricted list
for which registrant may have insider info.
- It is advisable to set up Chinese walls and take precautions to avoid potential
material transactions. Required by Ontario Policy 33-601.
Civil Liability
Chapter Ten: Civil Liability
- Civil liability applies to not only prospectuses and takeover bids, but also CD
documents now.
- Remedies available under Act are also available at CML (really??)
- Misrep in securities laws includes misstatements and ommissions, unlike CML
- No need to show reliance, as at CML
- Act contains a number of defences.
- According to some, securities laws matter because they facilitate private
contracting, rather than public regulatory enforcement.
- Burden of proof: plaintiff must prove breach of relevant Act provision; defendant
can rely on defences but must prove them. Onus of proof with respect to defences
is not always clear: sometimes, It is clear defendant must prove but in others it is
ambiguous. Must read statutory provisions closely!
- S. 130: right of action for damages lies with issuer, underwriters and others; right
of action for recission lies with issuer and udnerwriters only (makes sense!).
Defences
- Act’s defences work to balance investor protection with good faith transactions in
violation of statute
- Purchaser’s knowledge of misrep: only defence available to issuer
- No Knowledge: defendant can prove that doc containing misrep was filed without
his knowledge.
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See excel table of provisions for more info.
Secondary Market Liability
- Until recently, issuers bore no liability for misrep in CD
- Amendments now allow right of action against issuers, officers, directiors and
experts for material misreps for CD reqs.
- Rules distinguish between core and non-core docs
Escott v BarChris Construction Corp
A US case but leading authority on due diligence defence.
Facts: Involved incorporators of construction company whose founders did not speak
English. Founders signed prospectus and were held liable b/c of omissions and misreps.
Court emphasizes objective standard.
Company constructed bowling alleys. Automatic pin machines led to booming business.
P and V, initial founders, were unsophisticated. Method of biz was to get small
downpayment and then get rest upon completion (credit risk!). Plaintiffs claim many
falsities in prospectus.
Issue: Whether the founders are liable for misrep?
Holding: Yes
Reasoning:
- Nine directors signed prospectus
- Five were officers of corp (P, V, R, K, B); Grant (an attorney for firm
representing company); Coleman, a partner at Drexel. Auslander and Rose, not
otherwise connected w/ company.
- P and V, initial founders, were unsophisticated. R was accountant. K was CPA. B
was house counsel.
Court considers each defendant separately to see if due diligence defence available:
- R: for all purposes was CEO of company and was aware of financial conditions.
- P and V: Men of limited education. Could not read prospectus. But not as naïve as
they seem: must have known of inadqueacy of cash. Moreover, nothing to show
they made investigation of anything they may not have known or understood. Not
proved due diligence.
- K: A CPA, CFO, intelligent. Claims he relied wholly on counsel b/c he didn’t
understand prospectus process. K had, however, reason to believe exertised
portion of prospectus was in part incorrect (numbers, he knew).
- T: Signed registration statement as controller, not director. May well have known
about inaccuracies. He made no reasonable investigation that afforded him
reasonable ground to believe it was true. Couldn’t just sign registration and leave
DD up to others.
Notes: Compare to YMB
YBM Magnex International Inc
Facts: YBM made public offering in 1997; In 1996, board set up special committee to
investigate allegations, concluding that no disclosure was required due to lack of clarity
in the allegations. After US authorities, in 1998, ordered cease trade, OSC staff sought
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orders in public interest alleging YBM did not state full, true and plan disclosre and failed
to make timely material change disclosure.
Issue: Whether YBM directors liable for not disclosing full material facts? Whether
YBM failed to disclose material change?
Reasoning:
- YBM claimed it was subject to normal risks of doing biz in Eastern Europe; that
was not true – investors have right to know specific risks.
- Sections with respect to Eastern Europe were vague and opaque versus other
sections of prospectus.
- Disclosure encourages investing and therefore growth. It protects investors, aids
in ensuring free and open manner of securities markets. But only need material
facts.
- The question is, would disclosure of special committee and its findings translate
into market gains or losses? OSCB holds disclosure of facts would reasonably be
expected to have a significant effect on YBM’s securities.
- The broader factual context must be examined.
- There was no evidence any officer or director of YBM was a target; no charges
laid. However, rumoured involvement of YBm founders with organized crime
provided potential reason for USG’s investigation.
- Interim report of Special Committee stated management made aware of pending
investigation of the Company and its activities through US AG’s office in Philly.
- In the OSCB’s view, when omissions that are material on their own and omissions
which in isolation may not appear to be material are considered together, the
evidence indicates that YBM was subject to a set of risks specific to itself. These
were never disclosed – AIF said Special Committee only connected to general
concerns in the media and govt authorities related to all companies in Eastern
Europe.
- Yes, it was hard to decide whether to disclose but obscure disclosure in AIF was
unsatisfactory – did not provide investors with the opportunity to adequately
inform themselves regarding specific risks facing YBM.
- OSCB discusses how public interest may sometimes require cease-trade orders
even if directors meet the defences. Recognizes that high standards of fitness and
business conduct must not overly constrain the ability of directors/officers to
make rational business decisions and take measured risks.
Due diligence discussion
- Mitchell, co-lead underwriter, chaired the Special Committee. Board is entitled to
rely on special committees, but M’s independence and non-participation of other
two members was questionable.
- Info of Special Committee should have resulted in halting public financing and
acquisition of another company. More than a one short briefing from M was
required.
- F, who was on Committee, but was not consulted wanted to carry out more
investigations, and was not expensive.
- Efforts of directors were sufficient but their processes were deficient.
- M: an underwriter who was compensated based on compensation scheme. M had
conflict of interest, since he would profit from public offering. Potential for
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divded loyalties makes ti more difficult for M to justify reasonableness of his
belief that YBM made full, true and plain disclosure.
- Davies: outside director who got personal visit from FBI. FBI told him to keep
confidential but OSCB finds he had positive duty to act when he obtains info
which might adversely affect the company. Davies failed his responsibility to ask
tough questions.
- Schmidt: Considered info, relied on other professionals with more experience and
applied his own judgment. That belief was reasonable in the circumstances. His
belief in legitimacy of biz was not unreasonable.
- Peterson: Chair of Cassels Brock and former Premier of ON. An experienced corp
director. An outside director, not on Special Committee, and signed prospectus
certificate but was not substantially involved in offering process. Knew of Special
Committee. Peterson could have done more, he acted reasonably based on his
involvement in the matter, his skill and access to info. Due diligence defence
available to him, but barely.
- Gatti: no experience in such matters, relied on Special Committee and on
underwriters and securities lawyers. Counsel advised investigation was not
disclosable. Gatti had reasonable belief that prospectus disclosure was true and no
material facts were omitted. Proves due diligence, but barely.
Notes: Decision seems to suggest that individuals in positions of responsibility do not
always need to make inquiries about mirep; they can, in certain cases, rely on what was
given to them. While BarChris appears to lay down an objective test for analyzing def
actions, YBM illustrates mix of objective and subjective tests.
An objective analysis entails looking at position and responsibility of defendat; subjective
analysis looks at knowledge and actions of each individual. It’s pretty inconsistent, says
book. I agree.
Kerr v Danier Leather [2004] ON Superior Court of Justice
Facts: CEO and CFO became aware after filing of prospectus but before end of
distribution that 4th quarter venues would fall short. They believed, however, forecast
would be met at end of year. After IPO closed, Danier issued press release revealing
lower revenues; shares dropped.
Issue: Whether financial projections relating to Danier’s fourth quarter results were
misrepresentations creating liability under s. 130?
Holding: Danier liable under s. 130 for misrep of material facts – forecast.
Reasoning:
- Plaintiffs allege mgmt. failed to disclose lower than forecast intra-quarterly
results, failing to correct untrue and misleading statements.
- S. 130(1) creates liability for misrep – untrue or omitted material fact.
- Can a forecast be a fact? Issuers cannot be liable for forecast results under s. 130.
However, a forecast would be an untrue material fact due to intra-quarterly results
if (i) mgmt. no longer believes the forecast; (ii) it is not an objectively reasonable
forecast; (iii) the results seriously undermine accuracy of forecast.
- The forecast was a material fact statement forecasts have market value impact.
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BUT: A change in financial results as a result of business, operations and assets
would be material change. Changes to the weathr – an external source – and their
impact on financial results are not a material change.
- As of May 20, 1998, given the sufficient probability that departure from Forecast
would continue until the end of the quarter mean that the Forecast was unetrue as
of that date. The prospectus thus contained a misrep, and Danier is liable under s.
130.
- CML of negligent misrep may be implied from inaccurate forecast. However,
OSA s. 130 is not codification of CML – it is a statutory creation.
- The goal of s. 130 is to award damages for difference between price paid less
post-misrep price.
Notes: SCC reversed this holding, concluding that prospectuses need not be updated with
new material facts; subsequent material facts cannot support an action under. S 130(1).
Kerr v Danier Leather SCC
Facts: Prospectus filed May 6, 1998. Distribution closed on May 20, 1998. May 16, 1998
they saw earnings fall but still thought they would pick up by year end. May 25, 1998
they realized earnings were significantly down. June 4, 1998 they released material
change report. Plainitffs claim results of May 16th should have been released. Trial judge
found May 6th filing was full, true and plain.
Issue: whether a compliant issuer can be held civilly liable for statutory
misrepresentation for failing to update its prospectus with information that comes to light
during the period of distribution (i.e., after the prospectus was filed on May 6, 1998 but
prior to closing) to correct a statement that was correct when made but which has become
misleading?
Ratio: s. 57(1) is a limitation on issuer disclosure obligations; s. 130(1) to be read in
harmony with the rest of the statute, which while stating misrep “at time of purchase”
really means reading it “in light of circumstances” in which it was made – i.e., only at
time of filing of prospectus.
Reasoning:
 Although disclosure lies at the heart of an effective securities regime, the extent of
the disclosure is a matter of legislative policy. Balancing the needs of the investor
community against the burden imposed on issuers, the Ontario legislature adopted
a policy governing the continuous disclosure requirements of an issuer that drew
the line at “material change” in the “business, operations or capital of the issuer”
(s. 1).
 The problem for the appellants is that when a prospectus is accurate at the time of
filing, s. 57(1) of the Act limits the obligation of post-filing disclosure to notice of
a “material change”
 Court cites OSC report: “The term “material change” is limited to a change in the
business, operations or capital of the issuer. This is an attempt to relieve reporting
issuers of the obligation to continually interpret external political, economic and
social developments as they affect the affairs of the issuer, unless the external
change will result in a change in the business, operations or capital of the issuer,
in which case, timely disclosure of the change must be made.”
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


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Sales fluctuate in response to external facts: but these do not constitute a material
change to the business, operations or affairs of the corporation. The Legislature
would have said “results of operations” had it meant to account for all changes.
It is not disputed that the revenue shortfall as of May 16 was caused by the
unusually hot weather, a factor external to the issuer. Consequently, Danier
experienced no material change that required disclosure and did not breach s.
57(1)
While forecasting is a matter of business judgment, disclosure is a matter of legal
obligation. The Business Judgment Rule is a concept well-developed in the
context of business decisions but should not be used to qualify or undermine the
duty of disclosure.
Investors only entitled to know whether material change after prospectus filed (s.
57)
If issuer has complied with s. 56 and 58 of Act it would be contrary to scheme of
act to find civil liability under s. 130(1) for post-filing information.
Enforcement
Chapter Eleven: Enforcement
- In light of scandals, calls for more enforcement.
- Wise Persons Committee wanted to federalize securities law for better
enforcement
- Law and economic is sceptical of enforcement: should be ambit of investors
harmed, not govt regulator
- There are crim, admin and civil enforcement powers.
- Admin powers: at first instance, OSCB
- Crim Code or crim offence provisions of Act at first instance, provincial court
- Powers range from: admin financial penalties to cease trades.
- RCMP has Intergrated Market Enforcement Teams.
- Lots of self-regulation and monitoring also: IIROC.
- S. 400 Criminal Code makes it a crime to publish, with intent to induce, a
prospectus containing false info.
- S. 380 of Crim Code prohibits defrauding for money.
Quasi-Criminal Offences
- s. 122: failing to file docs.
- S. 128 allows for broad range of remedies upon application to Superior Court
Civil Enforcement Powers
- s. 128 allows OSC to apply to Court for declaration of not compliance and to seek
various remedies – rescind transaction, reastitution, disgorgement. But these are
rarely used in Canada.
Administrative enforcement penalties
- Can be made following hearing by regulator
- If in public interest
- Do not require breach of securities laws but see Re Canadian Tire OSCB
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-
S. 127
Most frequent infraction is distribution without prospectus
R v Landen (Criminal charges) (ON Sup Ct J)
Facts: Landen and Diamond face insider trading charges. Landen charged also with
tipping under s. 76(2). Landen sold securities and Diamond bought securities in AgnicoEagle, while they were in special relationship w/ reporting issuer. Landen for VP for
Agnico-Eagle, a gold mining company. Diamond is a friend of Landen and is a CA,
Landen allegedly learned of lower forecasts before public, and these became basis for
trades (put options and sales of securities).
Issue: Whether L is in contravention of prohibitions on insider trading tipping? Whether
D is in contravention of prohibition on insider trading?
Holding: L is guilty of trading on insider info, but not tipping. D is not guilty of insider
trading.
Reasoning:
- The defendants contend non-materiality of information, and in any case, it was
generally disclosed.
- Lawyer present at meeting with senior mgmt. testified that everyone was aware
this was material fact: that stock price would fall as forecast was released.
- Landen failed to file insider trading reports for the trades.
- Diamond: received $100,000 cheque from Landen.
- For materiality, Court turns to probability/magnitude test: significant impact on
price, measured against probability that long-term production would fall.
- Court analyzes all the particulars/claims of OSC one by one.
- Oddly, Court holds that insider advice to trade is not material information; only
material fact or change about issuer is. Diamond received advice to trade but no
material information.
- Back to Landen: even though the news he learned of was only a possibility – of
reduced future production – the magnitude of its impact was enough to make it
material. Landen was the longest serving employee and understood the impact of
the discussions. Other factors: did not eomply with company’s Code of Ethics, did
not comply with OSA reporting obligations.
- Diamond: Bourse de Montréal noticed large put option purchase just around time
of announcement. Diamond exercised a naked put, a risk investment position. The
purchase of put options accounted for majority of total put options in US and
Canada on the days in question. But Diamond characterized himself as a trader;
had joint account with Landen to keep his wife from taking assets in divorce. He
had engaged in other options trading.
- But Diamond has always been risky, no criminal record and no improper activity
prior to trades. A reasonable doubt remains.
Notes:
Re Canadian Tire Corp (OSCB)
Facts: CTC Dealer made offer for 49% of outstanding common shares of Canadian Tire.
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Dealers would become control owners of Canadian Tire, already holding 17.4% of
shares. Sole registered shareholder of Dealer is Canadian Tire Dealers’ Association, nonshare corporation of 361 tire dealers. Under s. 127, OSC considered whether it was in
public interest to impose a cease trading order on the offer. Offer was contrary to public
interest because: if bid succeeds, customers of Canadian Tire will acquire control of
company by only acquiring 2% of participating shares and create fundamental conflict of
interest contrary to interests of Class A shares and public at large.
Issue: Whether a public interest cease trade order is permissible against the Offer?
Holding: Yes.
Ratio: To invoke s. 127 for in situations where Act has not been contravention requires
showing abuse of shareholders and capital markets in general
Reasoning:
- Offer structure in a way that would not trigger takeover protection provision
attaching to Class A shares – in takeover, Class A shares would be converted to
voting shares.
- Basically, Billeses (family owners of share) obtained exemption to sell their
shares from OSC. Then, entered lock-up agreement with Dealers to tender their
control block. Dealers then made general offering at 400% premium to all other
shareholders. This was an artificial transaction constructed to circumvent takeover
protection granted to Class A shareholders.
- S. 127 not restricted to contravention of the Act..
- Legislature granted broad and unfettered power to move quickly to intervene in
public interest.
- A transaction such as this is abound to have an effect on the integrity of the
capital markets and public confidence in controllers of major corporations.
- The transaction was grossly abusive to the rights of Class A shareholders.
- To invoke s. 127 for in situations where Act has not been contravention requires
showing abuse of shareholders and capital markets in general.
- The Commission operates to regulate capital markets and their fair and efficient
operation; Courts adjudicate rights between shareholders and their companies.
While an oppression remedy or derivative action could be filed by shareholders,
the Commission also has a role to protect integrity of markets.
Committee for Equal Treatment of Asbestos Minority Shareholders v OSC [2001]
SCC
Facts: QC govt announced plans to take control of Asbestos. Made offer to buy all public
outstanding shares. Govt proposed idea of expropriation of Asbestos, but preferred
negotiating with market. It set deadline for negotiated agreement, failing which shares
would be expropriated. They arrived at agreement, whereby govt would buy shares in GD
Canada (major minority shareholder0.
Issue: Whether the Court should intervene in the refusal of the OSC to grant a remedy to
the aggrieved minority shareholders through exercise of its jurisdiction to act in the
public interest under s. 127?
Holding: Court should not intervene w/ OSC’s discretion.
Ratio: S. 127 cannot be used to remedy securities misconduct having caused harm to
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private parties or individuals.
Reasoning:
- Quebec govt did not make follow-up offer to minority shareholders of Asbestos,
as required in a take-over bid.
- OSC considered evidence and conclusded that minority shareholders were aware
of speculative nature of investment in Asbestos, that Quebec never promised to
make follow-up offer.
- It is up to the Commission under s. 127 to decide to intervene.
- Public interest jurisdiction limited to: (1) provide investors protections from
unfair, improper or fraudulent practices; (2) foster fair and efficient capital
markets.
- S. 127 is also a regulatory provision – it is protective and preventative, not
remedial or punitive.
- S. 127 cannot be used to remedy securities misconduct having caused harm to
private parties or individuals.
- OSC correctly found insufficient transaction connection, and went further to find
no misleading by Quebec. It also had to respect jurisdiction of QC. OSC’s
decision was reasonable.
Notes:
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