Introduction to Perspective on Security Law
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Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 INTRODUCTION TO PERSPECTIVE ON SECURITY LAW........................................................................................................... 4 WHAT IS SECURITIES REGULATION [2]: .....................................................................................................................................................................4 FUNCTIONS OF SECURITIES LAW ..................................................................................................................................................................................4 PURPOSE OF SECURITIES REGULATION: ......................................................................................................................................................................4 TWIN AIMS OF SECURITY REGULATIONS(EVERY QUESTION CAN BE ANSWERED IN LIGHT OF THESE AIMS): .................................................4 INTELLECTUAL PERSPECTIVES ON SECURITIES LAW [4]........................................................................................................................ 5 NEOCLASSICAL ECONOMIC ANALYSIS [4] ...................................................................................................................................................................5 TRUST BEHAVIOUR (HANDOUT) ...................................................................................................................................................................................5 BEHAVIOURAL FINANCE .................................................................................................................................................................................................5 SOURCES OF SECURITY LAW [19] ................................................................................................................................................................................6 CMN – Lynn Stoutt, Trust Behaviour – the essential foundation of securities markets. (>2008) handout – Two to three word overview .............................................................................................................................................................................................................6 SCOPE OF SECURITIES REGULATION [29] ................................................................................................................................... 7 THREE POINT REGULATORY FRAMEWORK.................................................................................................................................................................7 WHAT IS A SECURITY? [29] ..................................................................................................................................................................... 7 EQUITY FINANCE .............................................................................................................................................................................................................7 COMMONLY KNOWN AS A SECURITY ............................................................................................................................................................................8 ANY INVESTMENT CONTRACT .......................................................................................................................................................................................8 SEC v Howey (1946) [39] ........................................................................................................................................................................................8 State of Hawaii v Hawaii Market Center (1971) [p. 43] .............................................................................................................................8 Pacific Coast Coin Exchange, SCC, 1978, p. 48; Investment Contract defined in Cdn ......................................................................8 REGULATORY CONSIDERATIONS OF THE DEFINITION OF A SECURITY [56] .........................................................................................................9 Re Albino [56] ..............................................................................................................................................................................................................9 Universal Settlements [58] .................................................................................................................................................................................. 10 WHAT IS A TRADE? [61]................................................................................................................................................................... 10 WHAT IS DISTRIBUTION? [65] ...................................................................................................................................................... 11 REPORTING ISSUER [68] ........................................................................................................................................................................ 12 EFFICIENCY [70]: ......................................................................................................................................................................................................... 12 MATERIALITY [73] ................................................................................................................................................................................. 13 VALUE [74] .............................................................................................................................................................................................. 13 HISTORICAL AND CONSTITUTIONAL ISSUES [79] .................................................................................................................. 13 FULL DISCLOSURE [79]............................................................................................................................................................................................... 13 CONSTITUTIONAL ISSUES [85] .................................................................................................................................................................................. 14 Smith [90] ................................................................................................................................................................................................................... 14 McKenzie Securities Limited [95] ..................................................................................................................................................................... 14 Multiple Access Ltd. v. McCutcheon [100]..................................................................................................................................................... 14 Quebec (Sa Majeste du Chef) v. OSC [104] .................................................................................................................................................... 14 THE STRUCTURE OF THE CANADIAN CAPITAL MARKETS [118] ......................................................................................................... 14 CALLS FOR A NATIONAL REGULATOR [119] ........................................................................................................................................................... 14 WISE PERSONS COMMITTEE REPORT [127] .......................................................................................................................................................... 15 PASSPORT SYSTEM [128] ........................................................................................................................................................................................... 16 CONSTITUTIONALITY OF A NATIONAL REGULATOR [128] ................................................................................................................................... 16 OTTAWA SETS OFF CONSTITUTIONAL BATTLE OVER REGULATOR [G&M ARTICLE] ...................................................................................... 16 OVERVIEW OF REGULATORS AND MARKETS [142] ............................................................................................................... 16 1 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 HOW SECURITIES MARKETS ARE STRUCTURED .................................................................................................................................... 16 Copper Mesa Suit ..................................................................................................................................................................................................... 17 THE CURRENT CANADIAN REGULATORY STRUCTURE (163).............................................................................................................. 17 THE PASSPORT SYSTEM [181] .................................................................................................................................................................................. 17 CMN – Pearson v. Boliden, 2002, BCJ, p. 165; jurisdiction where security is distributed is the law that applies ............. 18 REFORM INITIATIVES [189] .................................................................................................................................................................. 19 THE PROSPECTUS [219]................................................................................................................................................................... 21 PROCESS OF GOING PUBLIC ........................................................................................................................................................................................ 21 THE PROSPECTIVE PROCESS [225]: ...................................................................................................................................................... 22 CMN – YBM Magnex International, 2003, OSCB - p.231 – Underwriters’ responsibilities......................................................... 23 CMN – Kerr v Danier Leather, 2001, On SC p.234 – Agency v Bought deal; no right of recission against the issuer in bought deal................................................................................................................................................................................................................. 23 CMN – Retrieve Resources v Canaccord capital, 1994, p.235 – Market-out clause refers to the market for the security ......................................................................................................................................................................................................................................... 23 PRELIMINARY PROSPECTUS [239] ........................................................................................................................................................ 23 WAITING PERIOD AND REVIEW PROCESS [242] .................................................................................................................................................... 24 ADVERTISING DURING WAITING PERIOD ................................................................................................................................................................ 24 FINAL PROSPECTUS [252] ......................................................................................................................................................................................... 24 ALTERNATIVES ............................................................................................................................................................................................................. 24 SPECIAL FORMS OF PROSPECTUS [253] .................................................................................................................................................................. 24 SHELF PROSPECTUS [261] ......................................................................................................................................................................................... 24 POST RECEIPT PRICING PROSPECTUS (PREP) [262] ........................................................................................................................................... 24 WELL KNOWN SEASONED ISSUERS (US ONLY) ...................................................................................................................................................... 25 MULTIJURISDICTIONAL DISCLOSURE SYSTEM (MJDS) ......................................................................................................................................... 25 SECURITY AS TO ACCURACY OF PROSPECTUS [270] .............................................................................................................................................. 25 MATERIAL FACT [271] ............................................................................................................................................................................................... 25 MATERIAL CHANGE [277] ......................................................................................................................................................................................... 25 MARKET IMPACT TEST V REASONABLE INVESTOR TEST ...................................................................................................................................... 25 HOW MATERIALITY IS DETERMINED (YBM MAGNEX) [284] ............................................................................................................................. 26 MATERIAL FACTS V. MATERIAL CHANGES (PEZIM) [287] ................................................................................................................................... 26 Kerr v. Danier Leather [287] ............................................................................................................................................................................... 26 MATERIALITY STANDARD NP 51-201 .................................................................................................................................................................... 26 MATERIALITY DETERMINATIONS .............................................................................................................................................................................. 26 EXAMPLES OF POTENTIALLY MATERIAL INFORMATION ....................................................................................................................................... 26 TIPS ON MATERIALITY ................................................................................................................................................................................................ 27 LESSON 9 – MATERIALITY [HANDOUT] ................................................................................................................................................. 27 CONSTRAINTS ON DISCLOSING INFORMATION ........................................................................................................................................................ 27 FORWARD LOOKING INFORMATION .......................................................................................................................................................................... 27 HISTORICAL FACTS....................................................................................................................................................................................................... 28 THE TOTAL MIX (TEST FOR ‘MATERIALITY’) ......................................................................................................................................................... 28 Food Lion .................................................................................................................................................................................................................... 28 MANAGEMENT INTEGRITY .......................................................................................................................................................................................... 28 Franchard Corp......................................................................................................................................................................................................... 28 DISCLOSURE OF MANAGEMENT’S INTEGRITY AND COMPETENCE ....................................................................................................................... 28 FUTURE-ORIENTED FINANCIAL INFORMATION (FOFI)[288] ............................................................................................. 28 CMN – Kerr v Danier Leather, Year, SCC, p. 288– Material Change; Implied representation of reasonable objectiveness ......................................................................................................................................................................................................................................... 29 PROSPECTUS REQUIREMENTS IN SECONDARY OFFERING [294] ......................................................................................................................... 30 REFUSAL TO ISSUE A RECEIPT FOR A PROSPECTUS [296] .................................................................................................................................... 30 RIGHT TO WITHDRAW OR RECISSION [300] .......................................................................................................................................................... 30 LAPSE DATES AND REFILING OF PROSPECTUS [307]............................................................................................................................................ 30 2 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 PUBLIC POLICY CONSIDERATIONS ............................................................................................................................................................................. 30 CIVIL LIABILITY [597] ...................................................................................................................................................................... 30 AN OVERVIEW: ............................................................................................................................................................................................................. 30 WHY WE HAVE STATUTORY REMEDIES FOR CIVIL LIABILITY FOR SECURITIES ................................................................................................... 31 LIABILITY FOR MISREPRESENTATION – OSA S. 130(1)........................................................................................................................................ 31 REMEDIES FOR BREACH .............................................................................................................................................................................................. 31 DAMAGES ....................................................................................................................................................................................................................... 31 DEFENCES [600] .......................................................................................................................................................................................................... 31 CMN – Escott v BarChris Construction, USA 1968, p. 605– Due Diligence defence requirements .......................................... 32 CMN – YBM Magnex Internation, 2003, OSC p. 608 – Due Diligence Defences; different from Bar Chris ........................... 32 Danier Leather; p. 619, Entire history of Litigation explained; Significance ................................................................................... 33 CMN – Danier Leather, 2004, ON Sup Crt, p. 619 – Civil Liability ........................................................................................................ 33 Danier Leather – Supreme Court of Canada; p. 629................................................................................................................................... 34 CONTINUOUS DISCLOSURE [355] ................................................................................................................................................. 34 UNDERLYING RATIONALE FOR CONTINUOUS DISCLOSURE [355]....................................................................................................................... 34 BENEFITS OF CONTINUOUS DISCLOSURE ................................................................................................................................................................. 34 INITIATIVES TO INCREASE INVESTOR CONFIDENCE AND ALIGN US AND CDN SEG REG ................................................................................... 34 MATERIALITY AND CONTINUOUS DISCLOSURE [360]........................................................................................................................................... 34 NI 51-102 .................................................................................................................................................................................................................... 35 TSX & MATERIALITY ................................................................................................................................................................................................... 35 TSX & MATERIAL INFORMATION .............................................................................................................................................................................. 35 TIMELY AND PERIODIC DISCLOSURE REQUIREMENTS [365]............................................................................................................................... 35 WHO MUST DISCLOSE [366] ...................................................................................................................................................................................... 35 WHAT MUST BE DISCLOSED [366] ............................................................................................................................................................................ 35 GENERAL REQUIREMENTS FOR FINANCIAL STATEMENTS [367] ........................................................................................................................ 35 REPORTING ISSUERS MUST ALSO DISCLOSE [373] ................................................................................................................................................ 36 DO CURRENT FINANCIAL STATEMENTS PROVIDE ADEQUATE DISCLOSURE? [380] ....................................................................................... 36 MANAGEMENT DISCUSSION AND ANALYSIS [385] ................................................................................................................................................ 36 TIMELY AND SELECTIVE DISCLOSURE ........................................................................................................................................ 37 PROXIES [395] ............................................................................................................................................................................................................. 37 MATERIAL CHANGE REPORTING [399] ................................................................................................................................................ 38 Pezim SCC 1994 (Pre-Danier Leather) [403] ................................................................................................................................................ 38 AiT [410]...................................................................................................................................................................................................................... 39 PROBABILITY / MAGNITUDE TEST (REJECTED IN AIT, BUT STILL HOLDS FOR MATERIALITY OF FACT) [414] .............................. 39 YMB Magnex [414] .................................................................................................................................................................................................. 39 CIVIL LIABILITY FOR BREACH OF CONTINUOUS DISCLOSURE OBLIGATIONS.............................................................. 40 STATUTORY CIVIL LIABILITY ...................................................................................................................................................................................... 40 WHO CAN BE LIABLE FOR A MISREPRESENTATION (OSA 138.3(1)) ................................................................................................................. 41 DEFENCES [340] .......................................................................................................................................................................................................... 41 DAMAGES [340] ........................................................................................................................................................................................................... 42 IMAX Case (ON SC) s. 138.8 OSA ........................................................................................................................................................................ 42 EXEMPTIONS FROM A PROSPECTUS............................................................................................................................................ 42 THE CLOSED SYSTEM [223] ....................................................................................................................................................................................... 43 CATEGORIES OF EXEMPTIONS [229] ........................................................................................................................................................................ 43 SPECIFIC EXEMPTIONS [231] .................................................................................................................................................................................... 43 CAPITAL RAISING EXEMPTIONS [232]..................................................................................................................................................................... 43 TRANSACTION EXEMPTIONS [240] .......................................................................................................................................................................... 44 3 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 INSIDER TRADING .............................................................................................................................................................................. 45 THE LEGISLATIVE SCHEME [481 - 482] ................................................................................................................................................................. 45 INSIDER TRADING REPORTS [482 – 483] .............................................................................................................................................................. 46 ILLEGAL INSIDER TRADING [485] ......................................................................................................................................................... 46 1 – SPECIAL RELATIONSHIP – OSA S. 76(5) [485] .............................................................................................................................................. 46 2 - MATERIAL FACT AND MATERIAL CHANGE [486] ............................................................................................................................................ 46 Re Donnini [487 – 496] .......................................................................................................................................................................................... 47 3 – GENERALLY DISCLOSED [497] ........................................................................................................................................................................... 47 INSIDER TRADING II – TIPPING [499] ......................................................................................................................................... 48 THREE BASIC ELEMENTS OF TIPPING [499] .......................................................................................................................................................... 48 R v. Rankin [500] ..................................................................................................................................................................................................... 48 DEFENCES FOR ILLEGAL INSIDER TRADING [501] ............................................................................................................................... 49 1. REASONABLE BELIEF THAT INFORMATION HAS BEEN GENERALLY DISCLOSED. [501] ............................................................................ 49 DEFENCES FOR PROFESSIONALS [505].................................................................................................................................................................... 49 2. REASONABLE MISTAKE OF FACT [506]................................................................................................................................................................ 49 Fingold (An issue of insider trading and not tipping) .............................................................................................................................. 49 Harper [508] Defence that information was not Material, and if it was he reasonably believed that it was not. ........... 49 3. “NECESSARY COURSE OF BUSINESS” [512] ........................................................................................................................................................ 49 Royal Trustco [514] ................................................................................................................................................................................................ 49 Introduction to Perspective on Security Law What is Securities Regulation [2]: Securities law: the law relating to the issuing of securities to purchasers in order to raise capital Role of securities law: Governance of the capital raising process because efficiency equals a healthy economy Efficiency is reliant on a set of rules which enhances investor confidence Securities regulation is the attempt to draw a balance between efficient securities markets and an acceptable comfort level for investors to invest in business The nature of securities markets is what drives the need for securities regulation: Investors pay enormous amounts of money to strangers for completely intangible rights, whose value depends entirely on the quality of the information that the investors receive and on the sellers’ honesty Functions of Securities Law Securities law: Defines what a security is Establishes the legal requirements to be fulfilled by issuers of securities before they can sell to purchasers Clarifies ongoing responsibilities of issuers to purchasers and repurchasers of securities in secondary trading markets Provides civil and criminal remedies for breaches of substantive requirements of the law (i.e. Insider trading) Regulates intermediaries in the markets (i.e. Brokers, advisers, mutual fund sales personnel) Purpose of Securities Regulation: Based on several underlying assumptions Regulation should not impose excessive cost or intervention Investors and issuers cannot escape some level of risk There is a correlation between risk and return – the higher the risk, the greater the return (and the loss) As a result, securities regulation is disclosure based – investors need to make informed decisions Twin Aims of Security Regulations(every question can be answered in light of these aims): 1. 2. Protecting investors and Efficiency of capital markets. 4 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Intellectual Perspectives on Securities Law [4] Neoclassical Economic Analysis [4] Underlying premise: individuals should be free to make their own choices based on their ability to act rationally and maximize their own welfare Markets are the best organizing device for facilitating the making of individual bargains Securities laws: replace or frame private bargaining markets Fill in gaps Legal rules lower transaction costs that would otherwise be incurred in the making of individual bargains Easterbrook & Fischel [8] Benefits of disclosure: If disclosure is worthwhile to investors, the firm can profit by providing it. o Managers who omit cost-justified steps for the protection of investors will receive less money for the securities the firm issues; the entrepreneurs and managers, not the investors, pay the price o Disclosure for the purpose of stilling investors’ doubts also reduces investors’ incentives to search too much for trading information. A firm can increase the return on a stock by reducing the costs of information of the stock Firms that promise to make disclosures for this purpose will prosper relative to others, because their investors incur relatively lower costs and can be more passive with safety. The more convincing the promise, the more investors will pay for the stock. Trust Behaviour (handout) Rational expectations, which provides the foundation for economic analysis, assumes that investors (and other people) are cool, calculating, and purely self-interested actors Vast majority of individuals who invest in public securities markets are not rational investors Most are “trusting investors” who are willing to believe that at least some people, and possibly some institutions, are “trustworthy” Characteristics of Trust Behaviour trust means knowingly making yourself vulnerable to another. trust requires that you know that the person to whom you make yourself vulnerable could gain from exploiting your vulnerability. trust requires that you make yourself vulnerable because you believe that the person to whom you make yourself vulnerable will not actually take advantage of you even though he could Trust and Securities When trust is reciprocated by trustworthiness, both sides profit This observation has some important implications for the investment process. In particular, it implies that trust may be an essential ingredient for a successful public securities market Lessons Most people are willing to trust not only other people whom they’ve actually met, but also strangers, computers, corporations or “the market.” The willingness to trust a particular person or institution seems to depend in significant part on past experience Applying the Lessons of trust to the security markets securities markets are based more on trust-based investing than rational expectations explain market phenomena like price bubbles If trust is influenced by history, investor trust can only be expected to decline Trust is therefore integral to understanding how securities markets work Behavioural Finance Disposition Effect 1. You wish to invest in Google, but you have no cash and must sell a position in another stock in order to have the cash for the new purchase. You can sell either of two stocks you hold. Stock A has earned a 20 percent return since you purchased it, and stock B has lost 20 percent. Which stock do you sell? Fearing regret and seeking pride causes investors to be sell winners too early and ride losers too long Considering the Past People use past outcome as a factor in evaluating a current risky decision. In short, people are willing to take more risk after earning gains and less risk after losses o House money effect – after gain/profit, people are more willing to take risk. o Snake-bit e effect – after experiencing a financial loss, people become less willing to take a risk o Endowment Effects – People often demand much more to sell an object than they would be willing to pay to buy it o status quo bias - people have a tendency to keep what they have been given instead of exchanging it Cognitive Dissonance and Investing 5 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Investors seek to reduce psychological pain by adjusting their beliefs about the success of past investment choices. Investors tend to view themselves as good investors so the memory of past investment performance adapts to be consistent with the self image Mental Accounting Decision makers tend to place each investment into a separate mental account. Each investment is treated separately and interactions are overlooked Sources of Security Law [19] Provincial Securities Statutes Provincial securities regulators’ rules National and Multilateral Instruments o NI – national instrument agreed to by all provinces and territories o MI – multilateral instrument agreed to by some but not all of the provinces National and Local Policies o NP – national policy statements are joint policy statements agreed to by the CSA o companion policy (CP) elaborates on the meaning of the accompanying rule or instrument or provides examples of its application Staff Notices Federal Legislation Self-Regulatory Organization Rules or Policies i.e. IIROC Stock exchanges Universal market integrity rules (UMIRs) Appellate Court Decisions Regulatory Decisions, Orders and Rulings International Organization of Securities Commissions Common Types of Securities Securities are sold primarily to raise funds for investments Two general types: o debt finance Bank loans Commercial paper Bonds Debentures o equity finance o Restricted Shares o Rights o Options Call option Put option o Derivatives o Grants rights to share in the distribution of profits net of interest payments on debt and the proceeds of a sale of the assets of the business net of payment of debts o Share capital –usually entitle owners : to share in the distribution of profits of the company net of interest payments on borrowed funds (dividends) To share in the proceeds, net of the payment of debts, on a sale of the assets of the company when the company is being wound up or dissolved Common Shares most frequently used bundle of share rights carries three essential rights: o The right to vote at shareholder meetings o The right to share in any dividends available for distribution on the common shares o The right to share in a distribution of the proceeds from a liquidation of the company’s assets on dissolution Preferred Shares given preference wrt distribution of dividends and often also wrt distribution of the proceeds on liquidation Features include: Cumulative v. Non-cumulative dividend rights Participating v. Non-participating Redemption/Call Provision Retraction Rights CMN – Lynn Stoutt, Trust Behaviour – the essential foundation of securities markets. (>2008) handout – Two to three word overview Overview – Trust is essential to a well developed securities market Discredits the rational expectation theory – vast majority in investors could not be rational expectation investors Trust Behaviour has 3 basic characteristics: 6 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 o Knowing making yourself vulnerable to another person o Know that the other person could gain by exploiting your vulnerability o Requires the trustor to make himself vulnerable knowing the other person will not take advantage of you Trustor must know the trustee isn’t being driven by self-interest. Real people are willing to trust, even strangers and companies. – based on the rational calculation that most people are trustworthy Bubbles in the market occur b/c people are looking to the past and not paying attention to economic fundamentals If we want sustainable trust, we must first have trustworthiness. Trust may provide the foundation for securities markets, but trustworthiness provides the foundation for trust. Remove the foundation of trustworthiness and the market will collapse Twin Aims (every question can be answered in light of these aims): 1. 2. Protecting investors and Efficiency of capital markets. Scope of Securities Regulation [29] Based on three fundamental concepts: What is a security; When is there a trade; and Is there a distribution Does securities law apply? Only if the item being brought or sold is a security Yes, if a security is being traded. Then there are registration or disclosure requirements Yes, if the trade amounts to a distribution or an offering of securities. If so, there are prospectus requirements Three Point Regulatory Framework 1. Registration of Persons – everyone who trades in a security must register 2. Registration of Securities – an issuer must register a prospectus for all securities being distributed for the first time 3. Anti-fraud -everyone in the securities field must honour the anti-fraud rules found in companies, securities and criminal legislation What is a Security? [29] s. 1(1) Ont. Securities Act (a) any document, instrument or writing commonly known as a security, (b) any document constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company... (e) a bond, debenture, note or other evidence of indebtedness or a share, stock, unit, unit certificat (i) any profit-sharing agreement or certificate, (m) any income or annuity contract not issued by an insurance company, (n) any investment contract... [34] Quebec Securities Act (more broadly based wording that OSA) - does not define security although it states that the Act applies to the following forms of investment: (1) any security recognized as such in the trade, more particularly, a share, bond, capital stock of an entity constituted as a legal person, or a subscription right or warrant; (2) an instrument, other than a bond, evidencing a loan of money; (3) a deposit of money, whether or not evidenced by a certificate except a deposit received by the government; (7) an investment contract; (8.1) an option or other non-traded derivative whose value is derived from, referenced to or based on the value or market price of a security, granted as compensation or as payment for a good or service; (9) any other form of investment determined by regulation of the Government. Interpretive principles in determining whether securities regulation is applicable. 1.Securities regulation is remedial not punitive so a broad, flexible interpretation is appropriate. 2.Choose substance over form in interpreting the definition. 3.Examine the whole of the transaction to determine if it has the substance of an investment Equity Finance Grants rights to share in the distribution of profits net of interest payments on debt and the proceeds of a sale of the assets of the business net of payment of debts Share capital –usually entitle owners : to share in the distribution of profits of the company net of interest payments on borrowed funds (dividends) 7 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 To share in the proceeds, net of the payment of debts, on a sale of the assets of the company when the company is being wound up or dissolved Commonly known as a Security i.e. OSA s. 1(1)(a) not commonly known by the man in the street, but known as one in financial and legal circles the test is what character the instrument is given in commerce by the terms of the offer, the plan of distribution and the economic inducements held out to the prospect paying for a promise and expectation of a return on their investment is a security (SEC v. Glenn W. Turner Enterprises, Inc.) ...evidence of title to or interest in capital, assets, property, profits, earnings or royalties... i.e. OSA s. 1(1)(b) Often the key issue is whether the person acquiring the interest was making an investment as opposed to buying a commodity. Motive for investment makes it a security The basic test is whether the document shows some form of investment or speculation Any Investment Contract i.e. OSA s. 1.1(n) Intended to cover the variety of investment vehicles that have been and may be devised to obtain funds from investors (SCC in Pacific Coast) Defined by s. 1 of the QSA: a contract whereby a person, having been led to expect profits, undertakes to participate in the risk of a venture by a contribution of capital or loan, without having the required knowledge to carry on the venture or without obtaining the right to participate directly in decisions concerning the carrying on of the venture SEC v Howey (1946) [39] Purchasers bought land containing orange groves. Is this an Investment K which must be registered? [YES] p. 39: Test for Investment Contracts: Focused on the individual motivation of the purchasers. Finding an “investment K” meant the requirement for registration under s. 5(a) of the Securities Act. Cf p. 58 – Universal Settlements An investment contract is [41]: 1. a contract, transaction or scheme whereby a person invests money, 2. in a common enterprise, 3. and is led to expect profits 4. solely from the efforts of the promoter or a third party State of Hawaii v Hawaii Market Center (1971) [p. 43] Purchasers bought some elaborate scheme to raise money for a store. Is the agreement an Investment K? [YES] Approach for “Investment Contracts” Focused on risk capital by emphasizing the risk of loss to the investor and the lack of control of the investor over the success of her investment. (Risk Capital Approach) Errs towards the side of protecting investors. o The more you protect investors the more it costs to the detriment of efficiency. Found here to be “investment Contracts” and must be registered with the Securities Commission. An investment contract is created whenever: 1. An offeree furnishes initial value to an offeror; 2. a portion of this initial value is subjected to the risks of the enterprise; 3. the furnishing of the initial value is induced by the offeror's promises or representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the initial value, will accrue to the offeree as a result of the operation of the enterprise, and 4. the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise. Howey v Hawaii Howey focused on the individual motivation of the purchasers Hawaii focused on risk capital by emphasizing the risk of loss to the investor and the lack of control of the investor over the success of her investment Which approach is better? Pacific Coast Coin Exchange, SCC, 1978, p. 48; Investment Contract defined in Cdn (Sort of Howie-ish with a bit of Hawaii-ian thrown in); Definitive Test for “Investment Contracts” in Canada Facts: Investors buy silver coins either for cash or on margin. Coins are only delivered once account is paid in full. 85% of accounts are on margin. At withdraw, investors receive (or pay) the difference b/w purchase price and prevailing market rates for silver, net of fees, commission, and storage charge. Is this an investment contract under On Securities Act. Issue: Is this an investment Contract (requiring the issuance of a perspective)? [YES] 8 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Reasoning: (De Grandpre J.) Investment K is defined in a two-part test: 1. If there is a common enterprise; a. (looking for vertical commonality b/w the promoter and the investor. The intermingling of money b/w promoter and the company satisfies the co-mingling. [55] 2. If those efforts made by those other than the investors are the undeniably significant ones – those essential managerial efforts which effect the failure or success of the enterprise. Money is made through the fluctuations in the price of silver. SCC is truly focused on who is making decisions. Such an enterprise exists when it is undertaking for the benefit of the supplier of capital (the investor) and of those who solicit the capital (the promoter). In this relationship, the investor’s role is limited to the advancement of money, the managerial control over the success of the enterprise being that of the promoter; therein lies the community. In other words the “commonality” necessary for an investment contract is that between the investor and the promoter. There is no need for the enterprise to be common to the investors between themselves. The end result of the investment made by each customer is dependent upon the quality of the expertise brought to the administration of the funds obtained by appellant from its customers If Pacific does not properly invest the pooled deposit, the purchaser will obtain no return on his investment regardless of the prevailing value of silver Dissent: Laskin C.J. Did not find a common enterprise b/c: o Did not find that the enterprise depended solely or substantially on Pacific b/c: o Need to include in the prospectus that there is the possibility of a loss. Did not find a common enterprise because: Pacific did not control the market price of bags but was itself subject to the price set in the market. Pacific’s hedging was solely of concern to itself, if it did not hedge, it faced a risk of a higher profit or higher loss. The hedging did not affect the market value of the bags so it did not affect the customer’s investment Did not find that the enterprise depended solely or substantially on Pacific because: The market not the promoter determined profitability. Disagreed with the majority’s conclusion that a risk of insolvency made the transaction into an investment contract Ratio: Comments: Most courts tend to protect investors over efficiency Regulatory Considerations of the Definition of a Security [56] Re Albino [56] Executive had “award units” that were cashable for stock. He cashed in on the day the coy was set to announce good earnings report. Can only sanction him if the “AU”s are stock options. 1. Is the phantom stock plan a security such that the OSC has jurisdiction over it? a. Blain: Not a security i. No, because the plan is not an instrument of debt linked to the market ii. The plan was like any other employment contract with an interest in the profits or earnings of the company iii. There was insufficient nexus with the capital market to make the plan different from the debt obligations represented by other employment contracts b. Salter: Yes a Security i. Yes, given the close relationship between Rio Algom common shares and award units, the latter is properly seen as a derivative of the former ii. The objectives sought to be achieved by prohibiting insider trading justify the finding of a security c. Bennett – Did not decide the Issue Even if the phantom stock units are not a security, can the OSC issue a decision in the public interest? s. 127 OSA states: The Commission may make one or more of the following orders if in its opinion it is in the public interest to make the order Held: the officer's conduct warranted trading sanctions against him Looking at the economic reality of the transaction, sanctions should be applied (Salter) There was a sufficient nexus with the capital markets for the OSC to exercise its discretionary power to sanction in the public interest (Bennett) Principle Protected Notes & Income Trust - Both are Securities [57] Principal Protected Note (PPN) offers an investor potential returns based on the performance of an underlying investment and a guarantee that the investor will receive, on maturity of the PPN, no less than the principal amount invested Income trusts (defined in NP 41-201) 9 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 a trust or other entity, including corporate and non-corporate entities, that issues securities which entitle the holder to net cash flows generated by : (i) an underlying business owned by the trust or other entity, or (ii) the income-producing properties owned by the trust or other entity. I ncome trusts are securities – see OSA s. 1(1)(e) Viatical Settlement - Security the sale, at a discount, by the terminally ill of their life insurance policies The viator (patient) receives money now and the investor receives the full value of the policy when the viator dies viatical settlements are securities if: o they take the form of a fractional interest in a pool of benefit payments. o an investor is matched with a particular policy holder, o the investor relies on the intermediary to select and evaluate the policy, to monitor the health of the insured and to collect the benefits. Universal Settlements [58] Are USI’s viatical products securities? Yes because: o Investors in the USI viatical offering cannot exercise any managerial control over their investment (Hawaii) o USI engages in significant managerial activities which insure the success of the investment making USI’s viatical products investment contracts o The viatical products’ success is entirely dependent on the promoter’s entrepreneurial and managerial skills as in Siporin What is a Trade? [61] Jurisdiction Issues in Relation to Trading It is necessary to know where a trade is taking place in order to know which regulator has jurisdiction over that trade. ¡ A key term in determining the application of the securities act ¡Determines whether there is a requirement to produce a prospectus ¡Is essential to determining the requirement to be registered to trade in a security s. 1(1) of the OSA defines it as: ¡(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 stock exchange or quotation and trade reporting system, ¡(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; Sale for Valuable Consideration [62] involves the contemplation of the soliciting for or making of purchases of securities by a person (i.e. a sale, not a purchase of securities) the vendor of securities is the object of the regulation and the legislation is intended to protect the purchaser a transaction characterized as a purchase of securities does not fall within the definition of trade Trades by Professionals: Clauses (b) and (c) of the Ontario definition of trade are directed toward the regulation of persons involved in carrying out trades on behalf of others Gives legal authority to the regulatory strategy of registering professional traders and is consistent with the policy objective of controlling access to the activity of professional trading Trades by Control Persons: Various transactions from the holdings of control persons for the purpose of giving collateral for a debt made in good faith are considered trades by virtue of clause (d) of the trade definition under the OSA Control person is a person holding more than 20 percent of an issuer’s outstanding voting securities. (OSA s. 1(1) “distribution” (c)) Acts in Furtherance of a Sale: 10 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 S. 1 OSA (e) includes various kinds of presale activities or sales pitches Excludes entities not involved in the investment decision-making process But includes administrative tasks that precede the completion of trades Prevents “gun jumping” by prohibiting issuers and their directors and officers from engaging in promotional activities or making public statements in the period immediately prior to the filing of a preliminary prospectus or during the waiting period thereafter ¡Whether a particular act is in furtherance of a trade is fact-dependant. One useful guide is whether the activity in question had a sufficiently proximate connection to an actual trade. Also captures: o An offer to sell o Supplying a list of names of prospective clients to a broker o Advertising before and after incorporation, and o Sending letters to potential investors the week before the preliminary prospectus saying that there were opportunities to invests in its IPO Jurisdictional Issues in Relation to trading [63] It may be necessary to determine where a trade is taking place in order to assess which regulator has jurisdiction over that trade Registration requirements of securities legislation apply in connection with the posting of a prospectus or other offering document on the Internet for use in connection with a distribution in a local jurisdiction unless disclaimer added(World Stock Exchange) What is Distribution? [65] s.1(1) of the Ontario SA defines distribution as: ¡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... s. 5 of the Quebec SA states that distribution” means (1) the endeavour to obtain, or the obtaining, by an issuer, of subscribers or acquirers of his securities; (2) the endeavour to obtain, or the obtaining, by a firm underwriter, of purchasers for securities he has underwritten; (3) the endeavour to obtain, or the obtaining, by a subscriber or purchaser of securities which he acquired under an exemption under section 43 ...; (4) the endeavour to obtain, or the obtaining, by a subscriber or purchaser of securities which he acquired through a transaction for which no prospectus was prepared as required by law and no exemption was granted, of purchasers for such securities; ¡... (5) the endeavour to obtain, or the obtaining, by a subscriber or purchaser of securities which he acquired outside Québec, of purchasers for such securities in Québec, except on a stock exchange ... (9) the disposal, by a control person of an issuer or a person holding more than a determined portion of an issuer's securities, of the securities held by that control person or that person or a determined portion of them according to the portion and in the manner prescribed by regulation; Scope of the Definition of Distribution Securities not previously issued o “Issue” means offer of securities for sale o “issuer” means a person or company who has outstanding, issues or proposes to issue, a security o Covers only new issues o Means that a prospectus is required unless an exemption is available Reissue of Securities [66] Covers trades by the issuer (or on its behalf) in securities that the issuer previously issued (due to possible possession of non-public info) Includes: o securities which the issuer has redeemed; o securities the issuer has purchased on the market or those donated to the issuer by the holder Note: this point may be moot since many securities regs prohibit shares that are redeemed from resale Sales of Securities by Control Persons [66] If any person, alone or in combination can “affect materially the control” of the issuer, that person is a control person or control block person What is control block of shares? 11 o o o o Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Where the person is in a position to exercise rights with respect to securities A combination of persons or companies – i.e. some sort of relationship between the persons such as family or intercorporate ties Concerns the ability to block significant transactions A holding of more than 20 percent of the voting securities is deemed to represent a control block unless there is evidence to the contrary Resale of Previously exempt securities covers securities which were previously exempt from the distribution requirements When a security is exempted, no prospectus is required. A security may be exempted the next time it is traded, if it fits within one of the exemptions. However, if no further exemption is available, the security must be qualified with a prospectus before it can be traded Reporting Issuer [68] An important concept as reporting issuers are subject to continuous disclosure requirements and subject to insider trading restrictions Primary way for an issuer to become a reporting issuer is to file a prospectus under the securities laws of a jurisdiction. It then becomes a reporting issuer in that jurisdiction. Defined in s. 1(1) of the OSA. An issuer becomes a “reporting issuer” once they file a prospectus in the jurisdiction and become subject to periodic reporting requirements. Taking apart the Branches of the Ontario Definition of “Reporting Issuer” [68] Securities Issued under a Predecessor Act (section a) Pertains only to corporations that have issued “voting” securities prior to the coming into force of the current act Obtaining a Receipt for a prospectus (section b) requires only that a receipt was obtained for the prospectus not that securities were ultimately distributed Listing on a Recognized Stock Exchange (section c) Only the TSE is recognized by the OSC for the purposes of this definition Regulatory Power to Deem Issuers to be reporting issuers in the public interest (s. 1(11) OSA) intended to allow the OSC to deem reporting issuers in other Canadian jurisdictions to be reporting issuers in Ontario where Ontario residents might access their securities. Why require controlling SH sales to trigger the creation of a prospectus issue? Seller may have special knowledge Will reduce the share price This is a ridiculous requirements Typically this is bypassed by informing the regulator who can grant a waiver to the prospectus requirement. Efficiency [70]: Efficient markets are those that absorb information about issuers as quickly as possible and adjust prices accordingly Efficiency market theory arose from early attempts to answer the question: is it possible at any given moment to predict how the price of a share will move EMT posits that stocks prices appear to move randomly because relevant information is absorbed by the markets so quickly that at any given moment a stock’s price impounds the market’s collective assessment of all available information The implication is that shares are fairly priced at any given moment and so it is impossible for the amateur investor to find a bargain and beat the market with any consistency Empirical Tests to Gauge Efficiency [71] Weak-form efficiency – a market is weak form efficient if current prices reflect all historical price information Semi-strong form efficiency – a market is semi-strong form efficient if current prices reflect not only all historical price information, but also all publicly-available information Strong-form efficiency – a market is strong form efficient if current prices reflect all relevant information about a stock -whether or not publicly disclosed; Postulates that all information is fully reflected in the price. o Courts in Canada and the US maintain skepticism about the efficient market hypothesis, while securities regulators take it seriously. [73] Efficient Market Hypothesis and Securities Legislation Does efficient market theory support our current mandatory disclosure regime or is it a theory that buttresses the case for dismantling that regime? Does EMT strengthen the case for mandatory disclosure? 12 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Or is all information relevant to the pricing of securities being disclosed in the absence of statutory requirements such that securities regulations impose needless costs? Note that courts are reluctant to rely on EMT to value shares Materiality [73] the threshold that distinguishes information that is legally disclosable and that which is not Materiality under Cdn law - market impact test Materiality under US law - reasonable investor test Generally issuers are required to make an assessment of the “effects” of information on the market generally Value [74] Is the market price at which a particular security is trading the same as its value? The value of shares of common stock is a function of the dividends that the corporation can be expected to pay out over its life Earnings are relevant in determining the value of the firm’s shares because they provide information about future capacity to pay dividends Historical and Constitutional Issues [79] History of Securities Regulations Original purpose was investor protection Today purpose is to protect investors and to foster fair and efficient capital markets Two philosophies that have historically underlay securities regulations: o principle of full disclosure o standards of conduct imposed on securities issuers that go beyond disclosure Full Disclosure [79] The principle of full disclosure, conceding freedom to sell anything provided the truth, and the whole truth, is told about it. The English Origin o English Joint Stock Companies Act of 1844 o Companies Act, 1867 o the Directors Liability Act, 1890 o Companies Act, 1900 The Canadian Companies Acts – Developments to 1912 o Canada Joint Stock Companies Letters Patent Act, 1869. o Canada Joint Stock Companies Act, 1877 o English Director’s Liability Act, 1891 (Ontario) o Ontario Companies Act, 1907 Blue Sky Laws: The Sale of Securities Act 1912 – 1926 Involves the imposition of standards on security issuers, goes beyond full disclosure, and frequently involves issuer licensing. Blue Sky Legislation – Kansas, 1911 Within two years, two provinces and seventeen states had adopted acts copying the Kansas statute o i.e. Manitoba copied the Kansas statute but added application to secondary as well as primary offerings An Act respecting the issue and sale of shares, bonds and other securities, 1924 (Quebec) The Security Frauds Prevention Acts 1928 – 1945 Ontario adopted the first of the new security frauds prevention acts Security Frauds Prevention Act, 1928 aimed at controlling traders in securities rather than the issuing of securities became the model for the uniform statute adopted by 1930 in almost every province combined anti-fraud provisions with a requirement that brokers and salesmen be registered The Securities Act, 1945 First modern Canadian securities act was the Ontario Securities Act of 1945 Aimed at tightening control of broker-dealers and assuring full disclosure in securities offerings, but without any direct restraint on issuers Significant changes to disclosure requirements: 13 o Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 The Act forbade any broker from trading in any security until a “statement” had been filed with the Commission and a receipt obtained and until the broker had notified the Commission of his intention to participate in the distribution The Securities Act, 1966 formed the basis of securities legislation across Canada The basis for the 1966 Act in Ontario was the recommendations in the Report of the Attorney General’s Committee on Securities Legislation in Ontario, 1965 (the Kimber Report) The Kimber Report: o Mandate of the AG’s Committee on Securities Legislation in Ontario: insider trading, takeover bids, and addressing the degree of disclosure to shareholders. o Recommendations included requirements for ongoing disclosure including the distribution of periodic financial statements, mandatory proxy solicitation and reporting of insider trading. Constitutional Issues [85] Over time, provincial securities regulation came to be challenged on the basis that it infringed federal powers. Manitoba v. Canada (AG) - provincial securities legislation was ultra vires the province insofar as it applied to Dominion companies Mayland [86] Ratio: Provincial securities legislation does not encroach on the federal legislative power with respect to criminal law. o ”if a dominion company is formed to trade in securities there appears no reason why it should not be subject to the competent laws of the province” o Under s. 9 of the act, the definition of fraudulent act appears to be very wide, in some cases having no relation to securities or dealing in securities and it is possible that if the question becomes relevant, a limited construction would be put upon the very general terms used Potential Conflicts with Securities Laws Smith [90] no conflict between s.63 of the Securities Act and s. 343 of the Criminal Code in the sense that compliance with one law involves breach of the other. they can operate concurrently McKenzie Securities Limited [95] Provincial securities act is not designed for the regulation of interprovincial trading, so it does not invade the domain of trade and commerce securities legislation of one province governs trading initiated elsewhere and pursued in the province Multiple Access Ltd. v. McCutcheon [100] Conflict between federal corporate laws and provincial securities regulations The provincial legislation duplicated the federal; but does not contradict it Mere duplication without actual conflict or contradiction is not sufficient to invoke the doctrine of paramountcy and render otherwise valid provincial legislation inoperative **Provincial laws will be declared ultra virus if their pith and substance is in relation to extra-territorial rights [104] **If the pith and substance of the of the legislation is within the province’s competence, then incidental effects on extraprovincial rights will not render the legislation ultra virus. Quebec (Sa Majeste du Chef) v. OSC [104] where the pith and substance of the provincial enactment is in relation to matters which fall within the field of provincial legislative competence, incidental or consequential effects on extra-provincial rights will not render the enactment ultra vires Global Securities Corp v BCSC [107] The pith and substance of the provision in question was the enforcement of BC’s securities laws. This fell within provincial domain under property and civil rights in s. 92(13) of the Constitution while it does involve relations with a foreign authority, s. 141(1)(b) does not attempt to extend the reach of provincial legislation outside its borders S. 141(1)(b)’s dominant purpose is the effective regulation of domestic securities, which falls within provincial authority. The Structure of the Canadian Capital Markets [118] Canada has a disparate and fragmented system of regulation national and international character of the Cdn securities market and its importance to the economic welfare of the country, in addition to the market being national in scope suggests the need for a national regulator Calls for a National Regulator [119] Porter Report (1964) 14 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Impetus - recommendation of the Royal Commission on Banking and Finance was that government securities regulation should be strengthened and a federal regulatory agency established to give leadership in this field and to work in cooperation with provincial authorities Elements – create a federal registry and then have provincial regulators delegate some functions to it and then have provincial regulators focus on local matters like licensing securities dealers and their salesmen CANSEC Proposal [120] impetus – OSC argued the Porter report had emphasized the need for a much improved securities regulation but that many provinces didn’t have the level of securities activity that would justify the expense involved in creating one Elements - single national regulatory body, likely federal, would administer the provincial securities legislation of each participating province under delegated authority from the province Proposals for a Securities Market Law for Canada (1979) Impetus - developments in the securities market itself emphasized the need for coordination of and federal involvement in its regulation Elements - creation of federal securities legislation and a federal securities commission, to be called the Canadian Securities Commission 1994 Proposal Impetus - premiers of the Atlantic provinces asked the federal government to establish a federal securities regulator with the goals of promoting the efficiency of Canadian capital markets by establishing a uniform national securities regulatory structure Elements o the federal government would develop and enact federal securities legislation and the provinces would develop and enact implementing legislation o “opt-in” regime – only those provinces that chose to participate would relinquish jurisdiction to the federal government 1996 Revival of 1994 Proposal Impetus - part of a package of centralization initiatives that would represent the quid pro quo for a package of decentralization initiatives in the areas of labour training, forestry, mining and recreation Elements - A memorandum of understanding conforming essentially to the 1994 MOU was circulated among the provinces and formed the basis for the 1996 discussions See also p. 308 – Proposed National Securities Legislation Wise Persons Committee Report [127] Recommendations for a single regulator: 15 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 the government enacts a new Cdn Securities Act (CSA )that provides comprehensive scheme of capital markets regulation for Cnd amendments to the legislation would not be implemented if a majority of the provinces representing a majority of the population of Cda objected The CSA is administered by a single Cdn securities commission consisting of 9 regionally representative commissioners 2 commissioners from each of Ont. and Quebec; one from BC and AB and two commissioners from the remaining jurisdictions the mandate of the commission reflects the need to foster fair and efficient capital markets, the importance of regulatory innovation & the unique characteristics of Cdn capital markets (NO INVESTOR PROTECTION!!) adjudication is the responsibility of a separate body independent of the commission Passport System [128] the province of incorporation would be the determinant of jurisdiction Any approval granted by the regulator with jurisdiction would then function as a “passport” into the other jurisdictions, subject only to disclosure by the issuer (or possibly intermediary) of the identity of its regulating jurisdiction proposed “passport” system in which an issuer could choose the jurisdiction that would be the principal regulator of an interprovincial offering and compliance with the requirements of the chosen jurisdiction would be recognized by all other participating jurisdictions. Strengths: single regulator contact, local presence, ease of implementation. Weaknesses: Does not constitute a significant improvement of enforcement, still need to forge concensus among all regulators, does not enhance Cdn’s international capital market credibility, creates needless duplication, users must pay fees in multiple jurisdictions, and does not improve accountability or governance. Constitutionality of a National Regulator [128] 1. 2. 3. Does Parliament have the constitutional authority to enact the Act? a. General Trade and Commerce Power (Criteria from GM v City National Leasing) i. The Act contains a general scheme regulating Canadian securities markets ii. The CSC would be a regulatory agency with continuing oversight of the scheme iii. The Act would not regulate a “particular industry”, but rather it would regulate a broad range of market participants and a broad range of economic activities iv. the Act would exceed the scope of any collective scheme the provinces are capable of implementing v. If one or more provinces opted out of the federal CSC model, the failure of any province to effectively regulate its securities market would jeopardize the efficiency and integrity of the Canadian securities markets and the protection of the investing public. b. Interprovincial and International Trade and Commerce Power c. Criminal Law Power d. National Concern Branch of POGG e. Federal Works and Undertakings Do the provinces have constitutional authority to enact legislation: a. incorporating the Act by reference – YES b. delegating administrative powers to the CSC – YES, so long as it is not abdication and can revoke the grant. c. dissolving their existing securities regulators? - YES If one or more provinces decides not to enact such legislation, and if the federal government concludes that this would jeopardize the successful operation of the scheme in other parts of the country, would Parliament have the constitutional authority to include an express paramountcy clause in the Act? a. the enactment of an express paramountcy clause could create an irreconcilable conflict that precludes provincial laws. b. but an express paramountcy provision should be valid so long as it is contained in an otherwise valid federal law c. in our view the Act falls within Parliament’s constitutional power and so the express paramountcy clause would be contained in an otherwise valid federal law Ottawa Sets off Constitutional Battle over Regulator [G&M Article] The federal government is drafting legislation to create a single commission that could replace Canada's patchwork of 13 provincial and territorial securities regulators. At least two provinces, including Quebec, oppose these plans, calling them an overstepping of Ottawa's bounds. Provinces are not obliged to join this national regulator, but Quebec fears a countrywide body would render any provincial holdouts obsolete Reference sent to SCC to determine the constitutionality of this move Overview of Regulators and Markets [142] How Securities Markets are structured Global, national or regional: issuers access different markets depending on the types of securities they sell, the amount of capital they seek and the regulatory framework in which they wish to operate 16 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Global capital markets have generated competition for capital and a need for a regulatory regime that provides investors with sufficient confidence in the markets to make investing in its issuers’ securities attractive Canadian regulators are under pressure from the range of regulatory regimes available to issuers to be competitive in providing both confidence to investors and efficient procedures for approval to issuers ¨The challenge to regulators is to find an appropriate balance between the two goals The National Scope of Securities Trading [144] Most reporting issuers are reporting issuers in more than one jurisdiction, almost one-third are national issuers Cross border transactions represent almost 40% of GDP Almost half of all Canadians own publicly traded equities Capital in Canada is still relatively concentrated The Internet is a means for investors to access information about issuers and to undertake investment transactions The vast majority of Cdn based issuers access capital markets nationally. There are some regional markets, particularly in the resource sector National Exchanges and SROs [151] SRO - defined as a person or company that represents registrants and is organized for the purpose of regulating the operations and the standards of practice and business conduct of its members and their representatives with a view to promoting the protection of investors and the public interest. TMX Group Inc. o TSX o TSX Venture Exchange o NGX o Montreal Exchange Key SRO – 1. Investment Industry Regulators of Canada – they monitor the TSX, and yet TSX has a financial interest in IIROC. Question as to how they can be independent monitors when they are part owners. Copper Mesa Suit Claim: TSX Inc. and TSX Group Inc., by listing Copper Mesa Mining Corporation on the Toronto Stock Exchange and thereby providing access to substantial amounts of capital to Copper Mesa Mining Corporation, caused or materially contributed to the assaults issued against the Plaintiffs by agents of Copper Mesa. TSX Inc. and TSX Group Inc. are liable in negligence and otherwise for the harms caused to the Plaintiffs that were materially contributed to or caused by their acts and omissions TSX Inc. is under a legal duty to “take reasonable care to avoid conduct that entails an unreasonable risk of harm to others” In particular, TSX Inc. is under a legal duty not to list a corporation when there is a reasonably foreseeable and serious risk that funds raised on the Exchange will be used in such a way as to harm individuals In the alternative, TSX Inc. is under a legal duty not to list a corporation on the Exchange without instituting precautionary measures to prevent a serious risk that funds raised through the Exchange will be used to harm individuals such as the Plaintiffs The Current Canadian Regulatory Structure (163) International Organization of Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation Provincial and Territorial Securities Regulation o Securities regulators derive their authority from the provincial or territorial securities statute in their jurisdiction which sets out their authority to regulate trading in securities. Ontario Securities Commission has authority to examine the financial affairs of a market participant for the due administration of Ontario securities law or the regulation of the capital markets can review the books, transaction records, and documents that are required to be kept by market participants and stock exchanges for the purposes of determining whether securities law is being complied with. empowered to conduct hearings both within Ontario and outside the jurisdiction on matters arising under the statute can hold hearings in conjunction with other regulatory authorities and jurisdictions Ontario is a conduit to enter in to the passport system. Once you are registered with your principal regulator you can use Ontario as a conduit for the rest of the country. Ie. Corporations will likely register in their home province and Ontario. The Passport System [181] Under the passport system, all Canadian regulators, except Ontario, have agreed that one securities regulatory authority acts as the principal regulator for all materials relating to a filer 17 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 NI 41-101 expressly recognizes the passport system, creating a “passport prospectus” and a “dual prospectus,” where issuers are seeking to distribute in more than one Canadian jurisdiction The purpose of the passport system is to implement a system that gives a market participant access to the capital markets in multiple jurisdictions by dealing only with its principal regulator and meeting the requirements of one set of harmonized laws. Although the OSC did not adopt MI 11-102, it can be a principal regulator under the instrument, thereby giving market participants in Ontario access to the capital markets in passport jurisdictions by dealing only with th Advantages: the process of negotiation among different regulators has allowed for considerable public policy debate on the impact of proposed standards Disadvantages: time and cost of building consensus on regulatory changes that may be required and different regulators interpreting and enforcing national standards differently CMN – Pearson v. Boliden, 2002, BCJ, p. 165; jurisdiction where security is distributed is the law that applies Maj (Judge Name): Judges most important reas. only right here. Closed system of securities trading in Canada regulates: initial distribution, takeover bids, insider trading and the disclosure of information related to publicly traded shares. Dealer or broker may not trade in a province unless he is registered. Each province protects the investors in their jurisdiction Once the act of a province applies to regulate the “distribution” of a security, the statute must be looked to for statutory causes of action for misrepresentation claimed in the document The creation of a right in civil damages for infringing the act must also be found in the act. o The province in whose territory the security is distributed has the jurisdiction to regulate the manner in which the distribution is carried out and to attach civil consequences for non-compliance SEDAR – the number one place to find most documents electronically. facilitates the electronic filing of securities information allows for the public dissemination of Canadian securities information collected in the securities filing process provides electronic communication between electronic filers, agents and the Canadian securities regulatory agencies Investment Industry Regulatory Organization of Canada (IIROC) [182] Established in 2008 through the merger of the Investment Dealers Association of Canada (IDA) and Market Regulation Services Inc. (RS) Sets regulatory and investment industry standards, protects investors and strengthens market integrity responsible for monitoring the financial, business, sales practice and trading of firms and their employees monitors the trading activity on Canadian equity markets for compliance with market integrity rules IIROC surveillance functions o Real-time monitoring of trading activity on the Canadian equity markets, including the TSX o Ensuring compliance with timely disclosure of information by publicly traded companies o Ensuring trade desk compliance with the Universal Market Integrity Rules (UMIR) Universal Universal Market Integrity Rules common set of equities trading rules designed to ensure fairness and maintain investor confidence rules essentially create the framework for the integrity of trading activity on marketplaces seeks to foster trading of securities in a fair and transparent manner Applies to trading on any Canadian marketplaces that retain IIROC as their market regulation services provider Cannot be circumvented by directing trading activity to another marketplace Applies to trading of all forms of listed or quoted securities Other Intermediaries in the Regulatory Structure SROs make rules about the requirements for participation in the markets or professions to which they control access. The Mutual Fund Dealers Association of Canada (MFDA) regulates the operations, standards of practice, and business conduct the mutual fund industry The Canadian Depository for Securities undertakes the clearing, settlement, and payment for trades The Canadian Investor Protection Fund protects investors from insolvencies of member firms The Canadian Public Accountability Board (CPAB) is responsible for developing and implementing an oversight program that includes regular inspections of the auditors of Canada’s public companies Critique of regulatory systems in Canada [186] There continue to be inconsistencies in standards and enforcement For issuers, there are unequal investment opportunities across Canada because of the need to pay fees and seek regulatory approval in different jurisdictions Insufficient resources directed toward monitoring and enforcement of securities laws Wise Person’s Commission Critiques [186] securities regulators are not uniform in either structure or function 18 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Investigations and enforcement proceedings may also be impeded if jurisdictions do not cooperate Provincial regulators also lack the ability to compel the attendance of a witness from another jurisdiction. Capital market participants can exploit these inter-jurisdictional limitations to avoid or delay investigations On occasion, businesses with national scope hide behind the fragmented regulatory system as an excuse not to cooperate with commission investigations. When an offender is banned from participating in the capital markets in a jurisdiction, it may move to another jurisdiction and attempt to carry on business there. potential for multiple investigations and enforcement proceedings by different regulators in respect of the same respondent Questions p. 189 1. In what sense can Canadian capital markets be understood to be inefficient? multiple regulators, legislative environment. Disclosure is viewed as inefficient, and yet the retail investor does not even understand it. 2. The above excerpts indicate that securities regulators have considered increased enforcement a priority in recent years. Why is public enforcement needed if capital markets involve primarily private actors Reform Initiatives [189] Uniform Securities Legislation o The goal of the USL Project is to develop a uniform securities act and rules for adoption by each jurisdiction of Canada on a fast-tracked basis. The Uniform Act and Uniform Rules would be word-for-word uniform in each jurisdiction. Since the USL Project is a harmonization initiative, the resulting Uniform Act and Uniform Rules would contain few substantive differences from current securities laws Draft Securities Act [192 and handout] o include core, fundamental provisions in the statute while allowing for more detailed and technical requirements to be implemented through rules. o In a principles-based system less detail is provided in the statute and more is left to be filled in through the regulator’s rule-making powers. US Securities Laws [198] federal-state system structure aimed at creating uniform standards where possible Securities Act of 1933 o focuses primarily on registration and initial distribution of securities ¨Securities Exchange Act of 1934 o created the Securities and Exchange Commission (SEC) o aimed primarily at secondary trading o governs the mandatory disclosure system for market participants The Private Securities Litigation Reform Act of 1995 and the Securities Litigation Uniform Standards Act of 1998 limits private class actions for securities violations, imposes sanctions for frivolous complaints as a deterrence measure and compensation for victims of such litigation. Under securities laws, the commission can bring enforcement actions either in the federal courts or before an administrative law judge. The US system has encouraged convergence of standards with a view to as much uniformity as possible in federal and state regulatory standards. State statutes were retained after enactment of federal laws, in part because they were rewritten to reduce compliance obligations for federally registered issuers and because the states have performed a significant enforcement role. The United States has faced problems of inadequate incentives to compliance, including inadequate monitoring and enforcement. This problem was a contributing factor to the scandals at Enron, WorldCom, and other large US corporations. Since 2002, various rules have been adopted by the SEC to implement the Sarbanes-Oxley Act (SOA), Pub. L 107-204, 116 Stat. 745 (2002). The Sarbanes-Oxley Act of 2002 mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud. It also resulted in the creation of the Public Company Accounting Oversight Board to oversee the activities of the auditing profession. In 2002, a revised Uniform Securities Act was adopted to further harmonize federal and state securities legislation. o There are also recent developments at the state level aimed at improving investor confidence, i.e.: o initiatives relating to corporate fraud and accountability, including whistle-blower protection o Credit Rating Agency Reform Act, which gives the SEC authority to supervise rating agencies o ¨Other changes: o SEC’s rules now require intermediaries acting for customers to trade at the very best prices and permit securities prices to be quoted in pennies o regulatory regime now focuses on competition—one that does not pick winners and losers but instead, one that removes barriers to new entrants o adopted a new antifraud rule specifically aimed at abusive short selling when it is part of a scheme to manipulate the price of a stock. US Securities Laws Canadian Securities Laws 19 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 generally governed by federal statutes except for intrastate securities markets Province by province registration and initial distribution of securities governed by Securities Act of 1933 Provincial statutes govern requirements for prospectuses Registration statements are subject to examination for compliance with disclosure requirements in terms of their accuracy and completeness Same requirement for prospectuses Investor information available on EDGAR Investor information available on SEDAR (and SEDI) Governing authority SEC Governing authority – provincial regulator (i.e. OSC) SROs include NYSE SROs include TSX Sarbanes-Oxley Act 2002 enacted to mandate a number of reforms to enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud Created the Public Company Accounting Oversight Board to oversee the activities of the auditing profession Congress was determined to ensure that "corporate executives certify that their books are not cooked and their numbers are truthful“ and enacted SOX accordingly. As a result, the law no longer tolerates corporate executives who "bury [their] heads in the sand” (statement of Joe Biden) Role of the Securities and Exchange Commission (SEC) [201] protect investors and maintain the integrity of the securities markets oversees other key participants in the securities world, including stock exchanges, broker dealers, investment advisors, mutual funds, and public utility holding companies Brings civil enforcement actions against individuals and companies uses no-action letters as guidance interprets federal securities laws; responds requests for exemptive relief; reviews investment company and investment adviser filings investigates possible violations of securities laws, recommends Commission action when appropriate establishes and maintains standards for fair, orderly, and efficient markets by regulating the major securities market participants European Union Regulations [206] concerted efforts in recent years to become less dependent on bank lending and to foster liquid capital markets. EU initiatives have made progress toward greater integration of capital markets. gradual shift to an increasingly integrated and harmonized set of EU securities law Opted eventually for a mutual recognition system EU Financial Services Action Plan (FSAP) is the overarching plan for an EU single market in financial services European Financial Services Action Plan a mutual recognition system aimed at harmonizing principles and minimum technical standards at the EU level Member states are responsible for transposing EU law into national law and for supervising compliance with standard The Lamfalussy Process [207] Level 1 o EU legislation that deals with framework principles and defining implementing powers for the Commission. o Commission engages in extensive consultation with member states and market participants before adopting legislation Level 2 o community legislation adopted by the Commission which sets out the technical implementing measures for the principles set out in the Level 1 legislation 20 o Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Decision making is at the EU level under “comitology procedures” whereby member states reps assist the commission in developing legislation Level 3 o involves the Committee of European Securities Regulators facilitating implementation of Community law including issuing guidelines and common non-binding standards. Level 4 o Commission’s monitoring of compliance of Member States with the EU legislation Markets in Financial Instruments Directive (MFID) Became effective Nov. 2007 Designed to accelerate the adopting of legislation based on the four-level Lamfalussy approach Objectives: o to protect investors and safeguard market integrity by establishing harmonised requirements governing the activities of authorised intermediaries; o to promote fair, transparent, efficient and integrated financial markets. Key Elements of MFID Authorization conditions and procedures o Directive must allow investment firms, banks and stock exchanges to offer their services across borders on the basis of the authorization issued by the competent authority of their home Member State Prudential assessment o Establish the harmonization of the assessment rules of procedure and criteria for the acquisition of a qualifying holding Investor Protection o set minimum standards for the mandate and powers that national competent authorities must have and establish effective mechanisms for cooperation in investigating and prosecuting breaches of the rules Transparency and market integrity o safeguard market integrity, report transactions and keep records Operator protection o also establishes a fair market for retail investors. It prevents financial institutions from discriminating between such investors Recent EU Securities Directives [214] Directives: principal instruments in the move toward a single capital market are directives The Transparency Directive o aimed at imposing continuous disclosure obligations, enhancing material change reporting, and improving communication to securities holders in order to encourage greater participation at shareholder general meetings. Financial Instruments Markets Directive o gives investment firms, banks, and exchanges a “single passport” to operate and provide their services throughout the EU on the basis of their home country authorization Market Abuse Directive o Sets out broad principles covering both insider trading and market manipulation on regulated markets Prospectus Directive o is intended to provide a single passport for issuers of securities that is based on approval from the issuer’s “home” authority, allowing distribution across the EU once the issuer meets the home authority’s prospectus requirements The Prospectus [219] Process of Going Public No distribution of a security can be effected without a prospectus (or an exemption) i.e. s.53(1) OSA The purpose for the rule requiring a “prospectus” is to give investors “full true and plain disclosure” of all material facts required to make an enlightened investment decision (S.56 OSA) All the prospectus rules and the continuous disclosure rules which apply after one has filed a prospectus are based on that basic principle The Prospectus a detailed circular setting out information underpinning the issuer’s distribution of the securities to the public. Statutory requirements for preparation and filing of prospectuses compel disclosure of information provided to potential purchasers of the securities. provides investors with detailed information regarding the issuer in order that they can make informed valuation and investment decisions designed as an instrument to increase public confidence in public offerings Securities law requires a preliminary prospectus and a prospectus to be filed 21 1. 2. 3. Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Compilations of all the information required by law to disclose publicly the inner workings of the company, so investors can make informed decisions to buy, hold, or sell securities. The Prospectus is the most important document – gives “full, true, and plain disclosre” (materiality test) Gives valuation information, so investors to make informed decision about the valuation of a security. The Law Prior to trading, must qualify securities for sale by filing a preliminary, then a final prospectus and getting receipts (S.53 (1)) The prospectus must be based on full true and plain disclosure so investors can make informed decisions (S.56(1) Receipt will be issued unless not in public interest to do so – S.61(1) ie. It is missing full, true, and fair disclosure. The Prospective Process [225]: 1. 2. 3. 4. Required for: a. IPO (very first issuers issue), primary offering(different class from a current issuer), in limited instances a secondary offer. i. Description of Risks: material information: pending lawsuits, perhaps leaders health, ii. Statement of purchasers rights b. The Process: a. Underwriter (the process of selling securities in the market) i. Provides credibility – plays devil’s advocate ii. Types of Underwriting agreements: 1. Agency agreement – agree to sell on a best effort basis. 2. Bought Deal – underwriter makes a firm commitment – agree to make a firm purchase of a large block of shares – even before the shares are issued. iii. Can face similar liability as issuers for misrepresentation iv. They must be registered and if they fail to uphold their public interest status they can lose their registration b. Preliminary prospectus and issuing of receipt i. Due Diligence 1. Ensures accuracy, verifies each material fact in the prospectus, identifies potential problems, tests the validity of the business model. c. Waiting period d. Comments and revision e. Final prospectus and issuance of receipt f. Distribution of securities The Market Out Clause [235] a. Can cancel the bought deal if the underwriter determines the securities cannot be marketed profitably – based on the market for the share to be placed and not the markets in general. The Disaster Out clause a. Underwriter can terminate the deal is a significant deal affects the issuer’s business of the capital markets. Prospectus and the Passport System All jurisdictions, except Ontario implemented MI 11-101 Principal Regulator System as part of the passport system. The goal is that parties will have to deal with only one principal regulator which will assess matters using its own securities laws. The other jurisdictions will then accept the principal regulator’s decision. One important area in which the principal regulator system operates is prospectus filings. Process for Prospectus Reviews in Multiple Jurisdictions (NP 11-202) Passport Prospectus (1) If the principal regulator is a passport regulator and the prospectus is not filed in Ontario, only the principal regulator will review the prospectus. Under MI 11-102, the issuance of a receipt by the principal regulator will trigger a deemed receipt in each other passport jurisdiction where the prospectus is filed. (2) If the principal regulator is the OSC and the prospectus is also filed in a passport jurisdiction, only the OSC will review the prospectus. Under MI 11-102, the issuance of the OSC receipt will trigger a deemed receipt in each passport jurisdiction where the prospectus is filed. Dual Prospectus If the principal regulator is a passport regulator and the prospectus is also filed in Ontario, the principal regulator will review the prospectus, and the OSC, as a non-principal regulator, will coordinate its review with the principal regulator. The receipt of the principal regulator will trigger a deemed receipt in each other passport jurisdiction where the prospectus is filed and will evidence the receipt of the OSC, if the OSC has made the same decision as the principal regulator. Contents of the Prospectus – NI 41-101 business plan and current and expected activities financial statements for last 3 years capital structure of the issuer 22 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 estimated proceeds of the issue planned purpose for utilization of the capital underwriting agreement description of risks statement of the purchaser’s rights (OSA s. 60) The Role of the Underwriter [230] The underwriter is a gatekeeper of the public interest with professional expertise in the capital markets An underwriter must: o avoid automatic reliance o seek out and question all relevant and material facts concerning the issuer o exercise a high degree of care in investigation and independent verification of the company’s representations o challenge the disclosure the issuer proposes to make to the investing public o play devil’s advocate Bought Deal Underwriting Agreements [232] Where the underwriter makes a firm commitment at the preliminary prospectus stage Advantage is that the underwriter provides a firm commitment to purchase a large block of securities signed before the preliminary prospectus is filed has implications for purchaser remedies under securities legislation CMN – YBM Magnex International, 2003, OSCB - p.231 – Underwriters’ responsibilities. Issuer’s Certificate signed under OSA s. 58(1) requires CEO, CFO, 2 directors to confirm the prospectus contains full, true, and plain disclosure of all material facts. The Underwriters’ Certificate signed under OSA s. 59(1) requires confirm the prospectus contains full, true, and plain disclosure of all material facts, but only “to the best of our knowledge, information, and belief”. This requires underwriters to obtain information before they can make that assertion. Underwriter is the gatekeeper of the public interest with professional expertise of the capital markets. Underwriters are independent experts: they are joint venturers with the issuer, but also must play the role of adversary to seek out and question all relevant and material facts concerning the issuer. Comment: the more the underwriter acts as a gatekeeper, the more costs is involved and the less money they make, which is ultimately their real goal. Not necessarily a conflict of interest, if the things in the public interest are also in the underwriter’s interest. CMN – Kerr v Danier Leather, 2001, On SC p.234 – Agency v Bought deal; no right of recission against the issuer in bought deal Issuer’s Certificate signed under OSA s. 58(1) requires CEO, CFO, 2 directors to confirm the prospectus contains full, true, and plain disclosure of all material facts. Issuer’s Certificate signed under OSA s. 59(1) requires confirm the prospectus contains full, true, and plain disclosure of all material facts, but only “to the best of our knowledge, information, and belief”. This requires underwriters to obtain information before they can make that assertion. Underwriter is the gatekeeper of the public interest with professional expertise of the capital markets. Underwriters are independent experts: they are joint venturers with the issuer, but also must play the role of adversary to seek out and question all relevant and material facts concerning the issuer. CMN – Retrieve Resources v Canaccord capital, 1994, p.235 – Market-out clause refers to the market for the security The Market-out clause refers to the state of the market in general, but also refers specifically to the market in which the specific shares are to be placed. The market in general could be good, but for the securities poor, and therefore the market-out clause would offer an escape. Preliminary Prospectus [239] First version of the final document that will accompany a public offering of securities Preliminary prospectus contains all the same requirements as the final prospectus except: o the report or reports of the auditor or accountant o information with respect to the price to the underwriter and offering price of any securities and other matters dependent upon or relating to such price (s. 54 OSA) o See also Form 41-101F1 Purpose: to allow securities regulators to ensure that the issuance complies with securities laws before investors are approached Aka the red herring prospectus Due Diligence Ensures accuracy of statements since liability attaches for misstatements 23 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Verifies each material fact in the prospectus before final receipt Identifies potential problems and discloses them to protect against future litigation Tests the validity of the business model Waiting Period and review Process [242] Waiting period (around 10 days) during which the activities of the issuer are restricted Securities cannot be sold during this process A filer that receives a receipt for a preliminary prospectus or prospectus from the principal regulator will be deemed to have a receipt for the preliminary prospectus or prospectus in a passport jurisdiction if certain conditions are met, Waiting period allows regulators the opportunity to consider the filed preliminary prospectus and to determine whether it complies with all the statutory and regulatory requirements Review process: basic review, full review, issue-oriented review -- risk based approach Advertising During Waiting Period Advertising is for the most part restricted during the waiting period, except in accordance with OSA s. 65(2) Re Cambior: [249] ›Advertising is confined to alerting the public of the existence of the preliminary prospectus; allowed to: advice as to where to find the prospectus information and the ability to solicit expressions of interest. “Gun jumping” if you sell or promote securities before there is a sufficient amount of information in the mkt place. Prospectus may not be approved, or may be substantially changed. Not insider trading. Final Prospectus [252] Once the receipt for the final prospectus is issued actual sales can begin For a dual prospectus, the principal regulator’s receipt for a final prospectus will also evidence that the OSC has issued a receipt, if the OSC has indicated on SEDAR that is it “clear for final” (NI 41-101, s. 7.1(1)). Must be filed NLT 90 days after the Short form Prospectus [252] Distribution of Securities must cease 90 days after receipt for Final Prospectus is issued. It is an offence: o to distribute securities without a final receipt being issued (unless exempt) o to fail to deliver a final prospectus Sanctions can include: o Cease trading orders o Cancellation or restriction of the party’s registration; o Person in violation can be ordered to resign or be prohibited from acting as director or officer[253] Alternatives 4 types commonly used Alternatives to the Long Form Prospectus: short-form prospectus, shelf prospectus, PREP prospectus, and MJDS Prospectus Special Forms of Prospectus [253] Short form prospectus/simplified prospectus (NI 44-101) Substantive requirements of SFP [253-257] ›allows larger issuers who are repeat issuers to make public offerings in a more timely way. ›The policy rationale is that there is already considerable information regarding the issuer in the public domain and so the issuer can build on previously filed and reviewed documents. Can expedite the raising of capital and lower the costs of the offering. Investing public is protected by: prior vetting, & specific requirements of the short form Prospectus Most issuers use the short form prospectus – results in a heightened responsibility to ensure accurate and complete continuous disclosure that fairly and comprehensively discloses the material aspects of their business and operation. [259] Shelf Prospectus [261] can be used to qualify securities in advance for multiple subsequent distributions to the public over a specified future period (25 months) (NI 44-102). Any time during that period the issuer can take the securities off the shelf and issue them. Only available to issuers with considerable information in the Mkt place. Advantage: iot issue security only required to issue a supplement updating information, which does not need to be reviewed by the regulator. Post Receipt Pricing Prospectus (PREP) [262] Available to all Investors. Can file a base PREP prospectus without price and other information and then file a supplemented prospectus with the omitted information within 90 days, (with amendments made every 20 days) [262] Allows for a reduction in risk if the price of the security varies between the final prospectus and the giving of the receipt and reduces the pressure on securities administrators from expending the issuance of the receipt for the final prospectus 24 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Well Known Seasoned Issuers (US only) In the US, they get favoured treatment based on the SEC’s conclusion that these issuers are most closely followed by analysts and institutional investors. a company is eligible for “automatic shelf registration. So no delays in going to market. can add securities to its registration statement as it goes). excused from the “gun-jumping” restrictions that would otherwise limit public statements No delays in going to mkt, can simply grab a shelf prospectus, input relevant data and submit then immediately being issuing securities. But, how do you become “well-known”? Multijurisdictional Disclosure System (MJDS) Allows issuers in the United States and Canada to use the same disclosure forms when selling securities in each other’s markets. Prospectuses must comply with both US requirements and the requirements of NI 71-101, The MJDS is of significant benefit to Canadian issuers in terms of having timely and cost-effective access to the US capital markets. The MJDS prospectus is similar to a shelf prospectus and based on the same policy considerations as a short form prospectus—specifically, that considerable information about the issuer is already available in the market. Security as to Accuracy of Prospectus [270] Prospectus must contain the signature: of the CEO, CFO, and 2 directors [class 8 March: underwriters, experts (lawyers, auditors, coy. Specific experts like engineers), Issuer] that the issued Prospectus contains full, true, and plain disclosure of all material facts relating to the security. Encourages director oversight, due diligence, and care in the prospectus process. Selling securities holders are liable for misrepresentation in a prospectus whether or not they sign a prospectus certificate [270]. Material Fact [271] The requirement for full, true and plain disclosure of all material facts is an essential requirement of the prospectus process. However, there is no uniform definition of material fact in securities statutes across Canada. What is a material fact? › a fact that would reasonably be expected to have a significant effect on the market price or value of the securities. ›S. 1(1) OSA/s. 5 QSA. Material Change [277] The issuer generally has an obligation to disclose any material changes during the prospectus and distribution process ›S. 57(1) OSA - Where a material adverse change occurs … an amendment to the prospectus shall be filed as soon as practicable and in any event within ten days after the change occurs [278] Material change means: ›(i) 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, or ›(ii) a decision to implement a change referred to in subclause (i) made by the board of directors or other persons acting in a similar capacity or by senior management of the issuer who believe that confirmation of the decision by the board of directors or such other persons acting in a similar capacity is probable (s. 1(1) OSA) S. 5.3 of the QSA defines it 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, or a decision to implement such a change made by the directors or by senior management of the issuer who believe that confirmation of the decision by the directors is probable. Material facts - include facts external to the business of the issuer that nonetheless might have a significant impact on that issuer Issuers have an obligation to disclose any material change during the prospectus and distribution process. Risk factors that must be disclosed which are material to reasonable investors (ie Form 41-101F1) [281] ›cash flow and liquidity problems ›the general risks inherent in the business carried on by the Issuer ›environmental and health risks ›reliance on key personnel, ›regulatory constraints ›economic or political conditions ›any other matter that in the opinion of the Issuer would be most likely to influence the investor's decision to purchase, hold or sell the Issuer's securities. Market Impact Test v Reasonable Investor Test Market Impact Test (Canadian Test) there is an interest in moving towards a reasonable investor test. 25 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 ›whether the change or fact would reasonably be expected to have a significant effect on the market price or value of a security Reasonable Investor Test (US Test) ›information is material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision ›there must be a substantial likelihood that a fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available How Materiality is Determined (YBM Magnex) [284] Assessments of materiality are not to be judged against the standard of perfection or with the benefit of hindsight. It is not a science and involves the exercise of judgment and common sense [284] The investor is an economic being and materiality must be viewed from the perspective of the trading markets, that is, the buying, selling or holding of securities. Test for materiality is an objective one, and further that “when one or more facts do not appear to be material on their own, materiality must also be considered in light of all the facts available to the person responsible for the assessment” [Text p. 523, case para 94] Material facts v. Material Changes (Pezim) [287] material fact broader than "material change"; encompasses any fact that can "reasonably be expected to significantly affect" the market price or value of the securities of an issuer and not only changes in the business, operations, assets, or ownership of the issuer” material change the change must be (a) "in relation to the affairs of an issuer", (b) "in the business, operations, assets, or ownership of the issuer" and (c) material, i.e., would reasonably be expected to have a significant effect on the market price or value of the securities of the issuer. [this seems to be an expansion/explanation/interpretation of s. 1 of the Act]. Kerr v. Danier Leather [287] The Act supplants the “buyer beware” mind set of the common law with compelled disclosure of relevant information. At the same time, in compelling disclosure, the Act recognizes the burden it places on issuers and in Part XV sets the limits on what is required to be disclosed. 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,” which the Act defines in s. 1 in relevant part 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 … . 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 is where the legislature has drawn the line. Materiality Standard NP 51-201 A fact is material when it (i) significantly affects the market price or value of a security; or (ii) would reasonably be expected to have a significant effect on the market price or value of a security. NP 51-201 conflates the distinction between material facts and material change Materiality Determinations In making materiality judgments, consider: the nature of the information itself the volatility of the company’s securities prevailing market conditions The materiality of a particular event or piece of information may vary between companies according to their size, the nature of their operations and many other factors Examples of Potentially Material Information Changes in Corporate Structure ›major reorganizations, amalgamations, or mergers Changes in Capital Structure ›the public or private sale of additional securities Changes in Financial Results ›unexpected changes in the financial results for any periods Changes in Business and Operations ›any development that affects the company’s resources, technology, products or markets Acquisitions and Dispositions ›significant acquisitions or dispositions of assets, property or joint venture interests Changes in Credit Arrangements 26 ›the borrowing or lending of a significant amount of money Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Tips on Materiality External developments with an effect on a business that are material and uncharacteristic of the effect generally experienced by other companies engaged in the same business should, where practical, be explained Proposed actions need not be disclosed until the decision is essentially final Issuers do not have to disclose financial forecasts unless they anticipate a significant change in earnings in the near future In general, commissions refer issuers to err on the cautious or inclusionary side, and release information if there is any doubt regarding its materiality Problem Assume that a significant portion of the issuer’s business is the development of oil wells in an emerging African nation, and this fact is disclosed in a prospectus. Also disclosed was the grant of an exploration licence by the ruling government. There is a coup d’état and the new government of the African nation announces that it intends to cancel all existing oil exploration licences. a)Does the announcement require the issuer to amend the prospectus? Not yet, this is only an announcement, and is not yet a material change (a) "in relation to the affairs of an issuer", (b) "in the business, operations, assets or ownership of the issuer" and (c) material, i.e., would reasonably be expected to have a significant effect on the market price or value of the securities of the issuer the business, operations, assets, or ownership. There must be probability of change before something becomes a “material change”. b)What if the issuer’s licence is officially cancelled? Yes, this amounts to a Material Change c)What if the licence is not cancelled but renewed on the same terms and conditions? No Material Change, no need to disclose d)Would there be any difference if the reasonable investor test were the test for such disclosure instead of the market impact test? Lesson 9 – Materiality [Handout] ¨Six Feet inc. is in the funeral business. It owns a chain of funeral homes in the U.S. and Canada and its shares are listed on the NYSE. David is the chairman of the Board and CEO; his younger brother Nate is the President. ¨You are an investor of Six Feet Inc. You hold only a small number of shares but are considering buying more if the company continues to be a good investment. What kind of information would you want Six Feet to disclose to consider whether it is a good investment. ¤Information on Nate’s lunch habits. [Unlikely, but depends on what he is eating] ¤The fact that David is an avid fly-fisher [Unlikely] ¤The structure of David’s compensation package [yes, want to understand where the money is going, performance of business] ¤Information on how long it takes to inject embalming fluid into clients [unlikely] ¤Information on David’s family predilection toward heart attacks [Maybe, if there is a high risk he may die soon] ¤Information on the company’s new secret product that will help shift Six Feet into the expanding backyard mausoleum market before its competitors [Do not want to disclose this, as it would destroy their secret, and could only serve to profit the investors, so they would never be concerned about making more money than they expected][Corp may want to disclose this iot get more investors, and get more money in an IPO] Reason for questions above: most investors would want to know all these things, but the corp does not want to disclose some of these personal things. There is a fine line between what is material and should be disclosed and what should not. Constraints on Disclosing Information ¨Disclosure: ¤requires extra costs to put information together and disseminate it ¤ Expands scope of liability ¤ too much of it – can confuse investors with unnecessary or speculative information ¤ Can result in competitors gaining a competitive advantage over your business o Corp can also reveal this information to the Regulator and have them keep it private. Forward Looking Information ¨pertains to disclosures regarding events that may or may not come to pass ¨A brighter future for a company translates into higher expected earnings and a higher return ¨Basic v. Levinson [Leading US case on materiality] o Materiality is fact specific based on a weighing of the significance of the information (probability of the event x the magnitude) o An event may be contingent and probabilistic and still be material o Corp denied the merger despite repeatedly being asked. Corp gave a misstatement and Investors are angry when they sold their share pre-merger and watched the share price rise dramatically after the merger. o The history of this US case would likely be considered by Canadian Courts. o There is no “Business Judgement” in Securities Law, and securities law is separate from Corporate law. 27 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Historical Facts Most companies are willing to reveal past/historical data. historical facts such as accounting data on revenues and profits may shed important light on a company’s future course only information that is so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance can be dismissed (Ganino v. Citizens Utilities Co.) Materiality can be determined by the effect on stock prices from the first public disclosure of information (In re Merck & Co) o Revealed the information on small scale and there was only minimal impact on share price o When the story broke on the Wall Street Journal, the stock price tanked. o Judged ruled the first released counts as disclosure. o Efficient market theory says the first time the news hit the market it absorbed the information, and by the time the WSJ broke the story the price had already adjusted on the market. o Merck says they didn’t reveal this information b/c it was not material. The Total Mix (Test for ‘Materiality’) Materiality requires a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available Information is required only if an investor does not already possess the information How does information get into the total mix? o Investors read and digest the information directly o Investors depend on their brokers for information o Investors obtain information indirectly through the stock market price for a company whose stock trades in an efficient market Food Lion If information is well known to the market, it is not material o Can be gauged by whether stock price moved at time of announcement of information. Information was already publicly known and stock prices did not move, so the later move of stock price after ABC TV show demonstrates that it is not material. statements that are mere puffery and generalizations that reasonable investors would not rely upon when deciding whether to buy stock are not material. Management Integrity Disclosure on a manger’s biography, compensation package, related transactions with the company and the financial performance of the company can be used by investors to discern whether they have good managers or not Without this disclosure, it is more difficult to have investors look over the shoulders of directors Disclosure can help limit agency costs – The costs that agent will act in his own interest and not the interest of the principal. Franchard Corp. Principle investor is engaging in side deals, and personal deals with corporate money. information about management is of cardinal importance to investors Management quality is particularly important where shares are sold largely based on the personal reputation of the company’s controlling person Information about the actions of the controlling shareholder are material b/c investors are investing b/c of the shareholder’s reputation Disclosure of Management’s Integrity and Competence ¨These include: Past business experience Management’s past performance as shown by comprehensive financial and other disclosures concerning the issuer’s operations The business interest of insiders that may conflict with their duties to the corporation Remuneration and other benefits paid to them Material transactions between the corporation and management Future-Oriented Financial Information (FOFI)[288] Financial forecasting can be included in the prospectus, but can be problematic in terms of both the content and the appropriate cautions provided Future-oriented financial information (FOFI) should: include a cautionary note of the risk that actual performance may vary from the forecast be updated where there is a change in the underlying assumptions or the external events such as market changes that cause the issuer to revise its forecast Financial outlook 28 “FOFI” Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 ›forward-looking information about prospective results of operations, financial position or cash flows that is based on assumptions about future economic conditions and courses of action and that is not presented in the format of a historical balance sheet, income statement or cash flow statement (NI 51-102) ›“future-oriented financial information”, means forward-looking information about prospective results of operations, financial position or cash flows, based on assumptions about future economic conditions and courses of action, and presented in the format of a historical balance sheet, income statement or cash flow statement (NI 51-102) Forward-looking information” ›disclosure regarding possible events, conditions or results of operations that is based on assumptions about future economic conditions and courses of action and includes future oriented financial information with respect to prospective results of operations, financial position or cash flows that is presented either as a forecast or a projection (OSA s. 1(1)) CMN – Kerr v Danier Leather, Year, SCC, p. 288– Material Change; Implied representation of reasonable objectiveness Facts: Change to sales forecast b/w prospectus receipt and security issue. About two weeks after closing, Danier issued a revised forecast. Danier’s share price dropped by about 22 percent. A number of purchasers had sold their new shares soon after the announcement and lost money and started a class action arguing that the prospectus contained a misrepresentation on the closing date (May 20), because even though the year-end sales forecast was reasonable on the filing date (May 6), lagging sales thereafter rendered it misleading to management’s knowledge at the date of closing Issue: Did the revised Intra-Quarterly Results Amount to a Material Change? [NO] Danier wins Maj (Judge Name): Plaintiff: If Danier knew about the change in weather forecast b/w filing the prospectus and issuing shares, this is a material change which should have been disclosed. The Securities Act is remedial legislation and is to be given a broad interpretation It protects investors from the risks of an unregulated market, and by its assurance of fair dealing and by the promotion of the integrity and efficiency of capital markets it enhances the pool of capital available to entrepreneurs The Act supplants the “buyer beware” mind set of the common law with compelled disclosure of relevant information At the same time, in compelling disclosure, the Act recognizes the burden it places on issuers and sets the limits on what is required to be disclosed 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 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” Business – What is the function of the business – nature of commercial enterprise Operations – activities of commercial enterprise Capital – financing structure of the business 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. 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. Did the revised Intra-Quarterly Results Amount to a Material Change? The shortfall in sales noted on May 16, 1998 is properly characterized as “results of operations” not in the operations themselves 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). Did the Forecast Contain an Implied Representation of Objective Reasonableness? 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 receipted on May 6. the forecast represents management’s best judgment based on facts and assumptions that reasonable business people in possession of the same information as Danier’s management would reasonably regard as reliable for the purpose of a forecast, but only as of May 6. The prospectus did not promise that the forecast would be updated if and as soon as conditions changed Potential investors should therefore have recognized that the forecast was just a snapshot of the company’s prospects as of May 6 Ratio: First point Second if needed. Comments: The SCC found that the poor intra-quarterly results could not be characterized as a "material change" because the cause of the depressed results was unseasonably warm weather, which was an event external to the issuer. It is unclear why the court focused on the "cause" of the results rather than the results themselves. The definitions of "material fact, and "material change" do not advert to the idea of the "cause" of the material fact or change, but to the existence of the fact or change itself. If the intra-quarterly results themselves are good or bad enough to have a material impact on the price or value of the issuer's securities, then how they were caused is 'somewhat beside the point. Thus, the commentators conclude the intra-quarterly results should have been disclosed 29 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Prospectus Requirements in Secondary Offering [294] A prospectus is required where there is a sale of previously issued securities by a person distributing within the meaning of securities legislation, where the person has not received an exemption or the seller is a controlling shareholder When a prospectus is required in a trade of previously issued securities, the issuer and its directors and officers must supply the information and certificates that allow the holder to sell the securities. Alternatively, in appropriate circumstances, regulators can waive this requirement Refusal to Issue a Receipt for a Prospectus [296] When a prospectus is filed, the director must issue a receipt if the prospectus complies with the statutory requirements, unless: it is not in the public interest to do so the proceeds from the sale of the securities to which the prospectus relates, together with other resources of the issuer, are insufficient to accomplish the purpose of the issue stated in the prospectus, the issuer cannot reasonably be expected to be financially responsible in the conduct of its business where the past conduct of the issuer affords reasonable grounds for belief that the issuer’s business will not be conducted with integrity and in the best interests of its security holders (OSA s. 61) p. 296 Instances where a receipt was refused where an issuer has neither assets to appraise nor business activities to evaluate (Re Loki Resources Inc.) where there was evidence that the issuer had previously been controlled by a convicted felon and only circumstantial evidence that the convicted individual continued to control the company (Tricor Holdings) Where the issuer did not have its income statement confirmed by a reputable accounting firm (YBM Magnex) But where a receipt is denied, the issuer must be given as much information as possible (including confidential information) without disclosing the precise information or sources in order to balance the requirement of fairness to the company an protecting the objective of the Securities Act – investor protection (YBM Magnex) Right to Withdraw or Recission [300] QSA s. 30 A person who subscribes for or purchases from a dealer securities offered in a distribution may unilaterally rescind the subscription or the contract merely by transmitting a notice of rescission to the dealer within two days after receipt of the prospectus or any amendment thereto Time for withdrawal is usually 2 weeks, although not applicable if purchase has already resold its securities (Pearson v. Boliden) Lapse Dates and Refiling of Prospectus [307] To ensure information is current, there is a “lapse date” of 12 months after the date of the most recent prospectus relating to the security (OSA s. 62(1); NI 41-101, s. 17.2(2)) Under specific conditions, a distribution can continue for another 12 months post lapse date (OSA s. 62(2)) All trades completed in reliance on the prospectus after the lapse date may be cancelled at the option of the purchaser within 90 days of the purchaser’s first knowledge of the failure to comply Public Policy Considerations Three important considerations for disclosure: What are the most appropriate policy instruments to achieve the concurrent goals of investor protection, efficiency in capital markets, and public confidence in the system? When did this get expanded? Are the requirements for prospectuses too complex and too expensive? Are they of real assistance to less sophisticated investors, in terms of these investors being able to make informed decisions regarding their investment choices? Civil Liability [597] An Overview: Failure to meet full, true, and plain standard of disclosure supports the claim that the prospectus contains a misrepresentation in its disclosure Civil liability applies to the disclosure made in prospectuses, offering memoranda, and takeover bid circulars and most recently, continuous disclosure docs Civil liability provisions in securities legislation: o apply to “misrepresentations,” which include omissions as well as misstatements. o do not require an investor to prove each of the elements of a negligence claim and o contain a number of defences to the statutory civil liability provisions 30 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Why we have statutory remedies for civil liability for securities Contributes to investor confidence and the integrity of the market Helps develop financial markets which do not prosper when left to market forces alone Facilitates private contracting: o Securities law can structure contracting and litigation by explicitly describing the obligations of various parties and burdens of proof, thereby reducing the costs to them and to the court of establishing liability Other legal avenues available but rejected: o Why not criminal law? State has burned of funding prosecution, victims don’t get damages. o Negligent misrepresentation in Tort: requires DoC, fault, reliance…which could be hard to demonstrate b/c unlikely a retail investor actually “relied” on the document given to them. Therefore the benefit of a statutory regime, which eliminates the need to prove reliance. Gaps in current law is tailoring the law to our specific situation. Eliminates the need for reliance, and adds “omission” to the definition of “misrepresentation”. Failure to put relevant information into disclosure docs, can be as harmful as putting in misrepresentation. Liability for misrepresentation – OSA s. 130(1) Where a prospectus, together with any amendment to the prospectus, contains a misrepresentation, a purchaser who purchases a security offered by the prospectus during the period of distribution or during distribution to the public has, without regard to whether the purchaser relied on the misrepresentation, a right of action for damages against, o (a) the issuer or a selling security holder on whose behalf the distribution is made; o (b) each underwriter of the securities who is required to sign the certificate ... o (c) every director of the issuer at the time the prospectus or the amendment to the prospectus was filed; o (d) every person or company whose consent to disclosure of information in the prospectus has been filed pursuant to a requirement of the regulations but only with respect to reports, opinions or statements that have been made by them; and o (e) every person or company who signed the prospectus or the amendment to the prospectus other than the persons or companies included in clauses (a) to (d), o or, where the purchaser purchased the security from a person or company referred to in clause (a) or (b) or from another underwriter of the securities, the purchaser may elect to exercise a right of rescission against such person, company or underwriter, in which case the purchaser shall have no right of action for damages against such person, company or underwriter. Remedies for Breach If a breach is found, the investor can seek rescission or damages Both these remedies are available against the issuer or underwriter in the case of a firm commitment underwriting. However, only damages are available against directors, persons who consented to any part of the prospectus or any other person who signed the prospectus or amendment Only those who sign the Prospectus can be held liable: CEO, CFO, and 2 directors [class 8 March: underwriters, experts (lawyers, auditors, coy. Specific experts like engineers), Issuer]. Why is the remedy of recession only available against some people? Only make sense to give back the share to the person who sold the share: issuer or underwriter. Damages Limited to the price at which they were offered to the public (OSA s. 130(9)). Calculated based on the difference between the price paid for the shares and their value once the misrepresentation is disclosed as such or the omission is rectified OSA s. 130(7) states that the defendant will not be liable for damages that “do not represent the depreciation in value of the security as a result of the misrepresentation relied on.” Defences [600] Purchaser’s Knowledge of the Misrepresentation [601] only defence available for the issuer other than the defence that the depreciation in the price of the securities was not caused by the misrepresentation OSA s. 130(2) o Normally requires confirmed information that the investor knew for sure the information was misleading, b/c they were privy No Knowledge [601] OSA s. 130(3)(a) - document containing the misrepresentation was filed without knowledge or consent of the individual (defendant). Issuer is expected to be all knowing, so this is not a defence for issuers. Withdrawal of Consent [602] OSA s. 130(3)(b)) 31 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Some assents to the prospectus, but later withdraws consent after receipt is issued, must be after the issue of receipt, and before the purchase of the security. Reliance on an Expert [602] Misrepresentations in expertise portion of prospectus (ie. The audit Defendant can be relieved of liability if he proves that he had no reasonable grounds to believe and did not believe that there had been a misrepresentation or an inaccurate representation of the expert’s report (OSA s.130(3)(c) o Objective or subjective test? Defendant would have to show some form of due diligence either internal or external – must be reasonable to understand the accuracy of the expert’s work. Expert’s Defence [603] Experts can be relieved of liability for the expertise portion of the prospectus o If after reasonable investigation, he had reasonable grounds to believe and did believe that such part of the prospectus or the amendment to the prospectus fairly represented his report, opinion or statement, or o on becoming aware of the misrepresentation in the expertise portion of the prospectus forthwith advised the Commission and gave reasonable general notice that such use had been made and that he, would not be responsible for that part of the prospectus OSA s. 130(3)(d) Due Diligence Defence [603] Available to all potential defendants except for the issuer or selling security holder OSA, s. 130(4) As long as the defendant conducts a reasonable investigation or (debatable whether this should be ‘and’ or ‘or’) does not believe there had been a misrepresentation, he can avoid liability – but commentators argue this requirement is conjunctive Onus is on the plaintiff to prove that the defendant did not act diligently: Danier CMN – Escott v BarChris Construction, USA 1968, p. 605– Due Diligence defence requirements Facts: Action concerning bond issued by BarChris. Plaintiffs allege the registration certificate (prospectus) contained material false statements and material financial omissions. The signers of the certificate in addition to BarChris itself: nine directors of BarChris, (including 5 officers – Vitolo, president; Russo, executive vice president; Pugliese, vice president; Kircher, treasurer; and Birnbaum, secretary), plus its controller, defendant Trilling, who was not a director. Issue: Is the defence of Due Diligence available to the signers? [NO] Maj (J. McLean): Vitolo and Pugliese: Due Diligence NOT PROVEN They were the founders of the business who stuck with it to the end. Vitolo and Pugliese are each men of limited education. It is not hard to believe that for them the prospectus was difficult reading, if indeed they read it at all. But whether it was or not is irrelevant. The liability of a director who signs a registration statement does not depend upon whether or not he read it or, if he did, whether or not he understood what he was reading. Objective standard imposed on Directors: must do what a “reasonable director” would do. Trilling Did not prove DUE DILIGENCE As a financial officer, he was familiar with BarChris’s finances and with its books of account. … In the light of these facts, I cannot find that Trilling believed the entire prospectus to be true. But even if he did, he still did not establish his due diligence defenses. He did not prove that as to the parts of the prospectus expertised by Peat, Marwick he had no reasonable ground to believe that it was untrue. He also failed to prove, as to the parts of the prospectus not expertised by Peat, Marwick, that he made a reasonable investigation which afforded him a reasonable ground to believe that it was true. As far as appears, he made no investigation. He did what was asked of him and assumed that others would properly take care of supplying accurate data as to the other aspects of the company’s business. This would have been well enough but for the fact that he signed the registration statement. As a signer, he could not avoid responsibility by leaving it up to others to make it accurate. Ratio: The signer of a prospectus must take reasonable precautions to ensure the accuracy of the document, and inability to read or make investigation does not satisfy the due diligence requirement. Additional comments: Heatway Problem: CMN – YBM Magnex Internation, 2003, OSC p. 608 – Due Diligence Defences; different from Bar Chris Facts: YBM had operations in Eastern Europe, that were the subject of US Attorney’s Office investigations for money laundering in Eastern Europe. They filed a final prospectus in November 1997 which failed to contain full, true, and plain disclosure of all material facts relating to the securities offered. Issue: Do the defendants have the defence of Due Diligence? Maj (PER CURIAM): Investigation is Material b/c of the potential financial repercussions on the corporation Consider the reasonableness of the respondents’ diligence and their belief from the perspective of a prudent person in the circumstances. This entails both objective and subjective considerations including the defendants’ degree of participation, access to the information and skill. o BarChris was fully objective and found vitolo could not advance a due diligence, here an objective/subjective test, and could consider the defendant’s skill. Mitchell – the underwriter – DUE DILIGENCE IS NOT AVAILABLE 32 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 took a number of positive steps towards uncovering facts, but the risks at issue left little margin for error – b/c of his experience, he ought to have known better. Davies –outside director – Due Diligence is not available o having regard to his skill and business experience, he failed to act prudently A director has a positive duty to act when he or she obtains information, or becomes aware of facts, which might lead one to conclude that there may be an issue that may adversely affect the company A director’s belief cannot be considered reasonable when he is aware of circumstances of such a character, so plain, so manifest, that a person with any degree of prudence would not have acted in this manner Schmidt – director – Due Diligence is available o reasonable for him to rely on experienced counsel and financial advisors given his low level of experience o He also did not have any information that other directors did not have Peterson - outside director – DUE DILIGENCE DEFENCE IS AVAILABLE o experienced corporate director who serves on many boards, not on the Special Committee. Not substantially involved in the offering process, attended only one meeting with staff o based on his involvement in the matter, his skill and his access to information in the circumstances, due diligence defence available to him, but just barely Antes and Greenwald- directors - due diligence defence available o did not have public company or business experience of other YBM directors; had no material role in the financing; members of members of Audit Committee, but not involved in selecting auditor Gatti – CFO - due diligence defence available, but just barely o Inexperienced; knew less than the Special Committee; relied on the experience of underwriters and securities lawyers o Although an engaged CFO should communicate directly with the board of directors of the company, at the relevant time, Gatti had a reasonable belief that the prospectus disclosure was true. First Marathon – underwriter - defence of due diligence unavailable o unaware of all the facts; due diligence process not complete at the time preliminary prospectus filed o given its knowledge, access to information, involvement and skill, GMP – underwriter - defence of due diligence unavailable o relied on First Marathon’s flawed investigation; should have taken certain steps that would have been consistent with its role as a co-lead underwriter. Ratio: First point Second if needed. Additional comments: o Danier Leather; p. 619, Entire history of Litigation explained; Significance Significance 1. First action under s. 130 to go to trial in Ontario 2. First Cdn Securities Class Action to go to trial 3. Addresses FOFI, including obligation to disclose change in such information 4. Establishes the parameters to update a prospectus and the distinction b/w material fact and material change. History 1. TJ agreed with Danier that the poor results were the result of warm weather and not a “material change” requiring amendment to the prospectus under s. 57(1). 2. TJ found an obligation under s. 130(1) to disclose material facts. 3. TJ awarded SH who sold their shares after 10 June the difference b/w the IPO price and the price of the security on 10 June. 4. CoA reversed and allowed the appeal of liability. 5. CoA found no material change during the period of distribution which required disclosure. 6. CoA found TJ had erredin not giving sufficient defference to the business judgement of Danier leather’s snr management. 7. Plaintiff’s appeal to SCC, which dismissed the appeal. 8. SCC held the prospectus need not be updated where new material facts come to light after the prospectus has been filed. 9. Subsequent material facts cannot support action pursuant to s. 130(1). CMN – Danier Leather, 2004, ON Sup Crt, p. 619 – Civil Liability Facts: Issue: Bold Maj (J. Lederman): Judges most important reas. only right here. Liability for a Prospectus: o Civil liability can arise where a prospectus together with any amendments to the prospectus: o (i) contains an untrue statement of a material fact, o (ii) omits to state a material fact required to be stated, or o (iii) omits 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. In this case, the statement is the Forecast and the omitted facts are the intraquarterly results to May 20, 1998. Disclosure is necessary in order to make the Forecast not misleading when intra-quarter results represent a marked departure from Forecast expectations, and there is a sufficient probability that this departure will continue to the end of the quarter. Defences for a Misrepresentation in the Prospectus: OSA, s. 130(5): o One must conduct a reasonable investigation so as to provide reasonable grounds for a belief that there had been no misrepresentation; or/and o believe that there had not been a misrepresentation. The belief must be based on a reasonable person standard, but keeping in mind the individual’s degree of participation, access to 33 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 information and skill o The burden of proof is on the plaintiff (different from BarChris) Application to case o Wortsman and Tatoff’s failure to make any kind of adequate analysis of the poor financial results experienced and what was causing them is not a reasonable investigation required of a prudent person in the circumstances of this case. o This failure cannot support any reasonable belief that the Forecast remained achievable. o Their failure to consult with any of the professional advisors regarding the impact of this information on the Forecast and its potential impact on the price of the shares does not reflect a standard of conduct expected of senior management Ratio: Failure to disclose the intra-quarterly results prior to closing rendered the prospectus forecast “misleading” at the “time of purchase” to the knowledge of the respondents, and therefore actionable under s. 130(1). Second if needed. Additional comments: Danier Leather – Supreme Court of Canada; p. 629 o An issuer’s duty to disclose material facts does not continue until the closing date of the IPO. The duty is only to disclose material changes. o When (as here) a prospectus (or an amendment) contains no misrepresentation on the date the document is filed, information amounting to material facts (but not material changes) that arises subsequently cannot support an action under s. 130(1). (Of course, if a material change arises during the period of distribution, failure to disclose this change as required by s. 57(1) could support an action under s. 130(1).) In the case at bar, however, the intra-quarterly results were not a material change) Continuous Disclosure [355] Every reporting issuer must constantly disclose certain information Continuous Disclosure is used: o By investors to decide whether to buy or sell the issuer’s securities and at what price; and o As an accountability technique Two components: o periodic disclosure of financial statements and accompanying reports, and o timely and accurate disclosure of material changes Underlying Rationale for Continuous Disclosure [355] Theoretically creates a level playing field where all investors have access to the same information. Increases investors’ protection by ensuring that all investors have the information to make rational investment decisions Increases capital market efficiency by helping investors target the most deserving securities An integral part of the ability of the issuer to effectively and cost efficiently raise capital Benefits of Continuous Disclosure Can facilitate issuance of new securities, through use of publicly available information via short form, shelf, or post-receipt pricing (PREP), Can also increase financial analyst coverage, ensure an appropriate risk premium, and encourage better capital allocation decisions. Has a corporate governance role o Can be used by board as a monitoring tool in its oversight of corporate managers. o Can be a signalling device for corporate directors, as it allows the board to assess both upside and downside changes and adjust its strategic planning o Can act as a signalling device for investors in respect of the quality of director oversight, officer managerial skills, and operational efficiency. Initiatives to Increase Investor confidence and align US and Cdn Seg Reg National Policy [NP] 51-201 and National Instrument [NI] 51-102 Advocating: o written disclosure policies o senior officer or committee oversight of the policy o The disclosure of material information including changes to accounting policies, changes in rating agency decisions, and any exceptions to corporate ethics or practices that are put in place for key employees. o Caution for issuers circulating analysts’ reports to investors Materiality and Continuous Disclosure [360] Governed in all jurisdictions except QC by NI 51-102 Continuous Disclosure Obligations (2002). In QC, reporting issuers are exempted from the local continuous disclosure requirements if they comply with the requirements of NI 51-102 o see http://www.lautorite.qc.ca/userfiles/File/intervenant-secteurfinancier/emetteurs/vm_emetteur_modif/51_102_fr.pdf 34 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 NI 51-102 defines material change as a change in the business, operations, or capital of the reporting issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the reporting issuer (s. 1.1) requires the reporting issuer to describe any plans or proposals for material changes in its business affairs or the affairs of an acquired business that may have a significant effect on the results of operations and financial position TSX & Materiality Issuers listed on the Toronto Stock Exchange (TSX) and the TSX Venture Exchange (TSXV) must comply with a disclosure standard of material information Material information is any information relating to the business and affairs of a company that results in or would reasonably be expected to result in a significant change in the market price or value of any of the company’s listed securities. Material information consists of both material facts and material changes TSX & Material Information A listed company is required to disclose material information concerning its business and affairs forthwith upon the information becoming known to management, or in the case of information previously known, forthwith upon it becoming apparent that the information is material Companies are not required to interpret the impact of external political, economic and social developments on their affairs, but if the external development will have or has had a direct effect on their business and affairs that is both material and uncharacteristic of the effect generally experienced as a result of such development by other companies engaged in the same business or industry, companies are urged, where practical, to explain the particular impact on them. Section 410 – examples of actual or potential developments that should be disclosed Forecasts of earnings and other financial forecasts need not be disclosed, but where a significant increase or decrease in earnings is indicated in the near future, such as in the next fiscal quarter, this fact must be disclosed Timely and Periodic Disclosure Requirements [365] Timely disclosure - material changes Periodic disclosure: quarterly and annual financial statements management discussion and analysis (MD&A) of financial condition and results document annual information form (AIF), and information circulars in connection with proxy solicitation This allows TXS to compete/consistency with other international exchanges. Who must disclose [366] reporting issuers (OSA S. 1.1) (filing prospectus, deemed, trading in the secondary market) o In exchange for the benefits of distributing and having their securities trading publicly, reporting issuers must provide timely and accurate information o can apply to be deemed a reporting issuer (i.e. OSA s. 83.1) What must be disclosed [366] 1. 2. 3. Financial statements a. Reporting issuers must file annual, audited, comparative financial statements within 90 days of its year end; a venture issuer must file within 120 days b. A reporting issuer must also file interim financial statements for periods ending nine, six and three months before the end of the financial year (i.e. OSA s. 77(1)) Management Discussion and Analysis Annual Information Forms General Requirements for Financial Statements [367] International Financial Reporting Standards Auditor’s Report require an auditor’s report with no reservation Significant or Material Information Financial statements need contain only significant matters. Delivery of Financial Statements holders and owners can request copies of annual (filed within 90 days) or interim (filed within 45 days) financial statements or both. (NI 51-102 s. 4.6) Board Approval Board must approve financial statements before they are filed (NI 51-102 s. 4.5) 35 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Reporting Issuers must Also Disclose [373] A copy of any disclosure material that it sends to its security holders, or that it files with or furnishes to the SEC, including material filed as exhibits to other documents, if the material contains information that has not been included in disclosure already filed in a jurisdiction by the SEC issuer. Those with a significant equity investee must disclose in its MD&A, the assets, liabilities, and results of operations of the equity investee, and the reporting issuer’s proportionate interest in the equity investee and any contingent issuance of securities by the equity investee that might significantly affect the reporting issuer’s share of earnings. a copy of any news release issued by it that discloses information regarding its historical or prospective results of operations or financial condition for a financial year or interim period (NI 51-102 s. 11.4). any contract that it or any of its subsidiaries is a party to, other than a contract entered into in the ordinary course of business, that is material to the issuer and was entered into within the last financial year, or before the last financial year but is still in effect (NI 51-102 s. 12.2). But Securities regulators can provide relief against filing requirements if, in their opinion, the relief and any terms and conditions that they impose would not be prejudicial to the public interest Do Current Financial Statements Provide Adequate Disclosure? [380] Securities regulators continue to be concerned about the accuracy of disclosure in financial statements As a consequence of these challenges, supplementary documents to financial statements are increasingly common. A significant factor is the existence of any system designed to ensure that the responsible issuer meets its continuous disclosure obligations Issuers frequently establish written disclosure policies to ensure adequate controls and monitoring of continuous disclosure and for determinations as to when a change is material For eg., regulators have taken steps to ensure that the disclosure of executive compensation complies with regulatory requirements o RIM [383] – engaged in option backdating/repricing but reported in its disclosure documents that options were priced at FMV Repercussions: repayment of benefits from incorrect option pricing, fines, duties of directors and officers course, prohibitions on becoming a director for a limited time Management Discussion and Analysis [385] Contains reflective and prospective analysis of the issuer’s business Disclosed by filing Form 51-102F1 MD&A with annual and interim financial statements Allows investors and potential investors to assess underlying value in making their decisions about continued or new investments in securities of the issuer Particularly important for retail investors, especially those who may not be able to readily understand the financial statements alone, without the context provided by the MD&A. Requires the disclosure of only material information (i.e. 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?) Disclosure in the MD & A: the nature of changes in the issuer’s performance and management’s opinion as to the reasons for the change positive and negative developments and any material changes whether or not the issuer achieved significant milestones and its projections for achieving them in the future any outstanding commitments and obligations not reflected in the financial statements any current or pending legal proceedings and contingent liabilities; the nature and purpose of related party transactions, any management changes; any regulatory approval required for a particular transaction future financial and operating plans any risks to solvency the capital structure of the issuer Annual Information Forms (AIF) [387] Provides a basis for ongoing disclosure because of the extensive nature of the information provided, which can then be updated annually. Also used to qualify for the short form prospectus process Must be filed within 90 days after the end of the issuer’s most recently completed financial year (NI 51-102 s. 6.2) AIF Contents [388] The text of the audit committee’s charter, the name of each audit committee member, and whether or not each is independent and financially literate Oversight issues in relation to auditors Any specific policies and procedures for the engagement of non-audit services. by category, all external auditor services fees in each of the last two fiscal years (form 52- 110F1 s. 9). 36 1. 2. Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 disclosure of social and environmental policies, as well as risk factors such as environmental and health risks and political considerations. The required standard of disclosure of social or environmental policies is that the policies are fundamental to operations. These are called Therapeutic disclosure. Leads to “enlightened shareholders”, who may be investing for socially responsible reasons. Significance of disclosing environmental protection and social policies: explains companies exposure to risk. Identifying risk seeks to minimize the risks in advance, and is cheaper to investors in the long run. Business Acquisition Report When a reporting issuer completes a significant acquisition it must file a BAR within 75 days, which describes both the acquisition and its effect on the reporting issuer (NI 51-102 s. 8.2) May also require a material change report Form 51-102F4 specifies that the disclosed information is to be relevant to an investor, analyst or other reader and that material may be incorporated by reference Timely and Selective Disclosure Proxies [395] Issuers must communicate with investors and provide them with information and a means of expressing their preferences through proxy voting. What is a proxy? o evolved to allow geographically dispersed investors to participate without attending meetings o involve an interactive element and the process implicates both corporate and securities laws for a reporting issuer that is a company Why we have Proxies The Kimber report recommended that proxy solicitation be mandatory Kimber felt that there was a benefit in drawing absentee security holders into some form of participating in the issuer’s affairs even if only indirectly or remotely The Proxy Process management of a reporting issuer must mail a form of proxy to each security holder either before or at the same time as the notice of the meeting to which the proxy applies National Instrument 51-102, Continuous Disclosure Obligations - Part 9 Proxy Solicitation and Information Circulars If proxies are solicited, must be accompanied by information circulars unless there is an exception (NI 51-102 s. 9.2; see also OSA s. 86(2)(a); QSA s. 83). Registered v Beneficial Owners [397] NI 54-101 Communication with Beneficial Owners of Securities of a Reporting Issuer ensures that beneficial owners receive their proxy related materials NI 54-101’s fundamental policies are: o (a) all securityholders of a reporting issuer, whether registered holders or beneficial owners, should have the opportunity to be treated alike as far as is practicable; o (b) efficiency should be encouraged; and o (c) the obligations of each party in the securityholder communication process should be equitable and clearly defined Information Circulars [395] Are mandatory when there is solicitation (s. 9.1(2) NI 51-102) Should contain all the information needed by security holders to make informed decisions on proxy votes Must be prepared in the prescribed form – see. NI 51-102F5 Solicit is defined: “Solicit”, in connection with a proxy, includes (a) requesting a proxy; (b) requesting a securityholder to execute or revoke a proxy; (c) sending a form of proxy or other which will likely result in the giving, withholding or revocation of a proxy; or (d) sending a form of proxy to a securityholder by management of a reporting issuer; but does not include (e) sending a form of proxy in response to a unsolicited request for one; or (f) performing ministerial acts or professional services on behalf of a person or company soliciting a proxy Content of the Form of Proxy [396] 37 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 defined as a document containing the required information that on completion and execution by or on behalf of a securityholder becomes a proxy. (NI 51-102 s. 1.1 “form of proxy” and s. 9.4) proxy form must: o state in bold type whether or not it is solicited by or on behalf of management o state in bold that the securityholder may select any person as nominee (and explain how to do so) o allow the securityholder to vote for or against each matter or group of related matters o state that the securities will be voted according to the instructions on the proxy Beneficial Owners of Securities NI 54-101 places obligations on reporting issuers to allow for the participation of non-registered beneficial owners in the proxy process reporting issuer must send a notification of meeting and record date, requesting beneficial ownership information from proximate intermediaries within a specified period prior to an annual or special general shareholder meeting. (NI 54-101 s. 4.1) Costs of Proxy Solicitation reasonable expenditures are allowable Expenses are not permitted if the solicitation is solely intended to maintain directors in office expenses must still meet the test of bona fide concern for the best interests of the company as a whole proxies must be used for a meeting which addresses a genuine issue of company policy Reimbursement of Proxy Expenses (US Law) No reimbursement unless the dispute concerns questions of corporate policy Reimbursement of only reasonable and proper expenses. Reimbursement for incumbents whether they win or lose (different from Canadian Law) Reimbursement for insurgents with a win and with shareholder ratification. (different from Canadian Law) Material Change Reporting [399] Issuers must make timely disclosure of material changes OSA 75. (1) ... where a material change occurs in the affairs of a reporting issuer, it shall forthwith issue and file a news release authorized by a senior officer disclosing the nature and substance of the change (2) ... the reporting issuer shall file a report of such material change in accordance with the regulations as soon as practicable and in any event within ten days of the date on which the change occurs. Note however: (3) Where, (a) in the opinion of the reporting issuer, and if that opinion is arrived at in a reasonable manner, the disclosure required by subsections (1) and (2) would be unduly detrimental to the interests of the reporting issuer; or (b) the material change consists of a decision to implement a change made by senior management of the issuer who believe that confirmation of the decision by the board of directors is probable and senior management of the issuer has no reason to believe that persons with knowledge of the material change have made use of that knowledge in purchasing or selling securities of the issuer, the reporting issuer may, in lieu of compliance with subsection (1), forthwith file with the Commission the report required under subsection (2) marked so as to indicate that it is confidential, together with written reasons for non-disclosure. Idem (4) Where a report has been filed with the Commission under subsection (3), the reporting issuer shall advise the Commission in writing where it believes the report should continue to remain confidential within ten days of the date of filing of the initial report and every ten days thereafter until the material change is generally disclosed in the manner referred to in subsection (1) or, if the material change consists of a decision of the type referred to in clause (3) (b), until that decision has been rejected by the board of directors of the issuer. (5) Although a report has been filed with the Commission under subsection (3), the reporting issuer shall promptly generally disclose the material change in the manner referred to in subsection (1) upon the reporting issuer becoming aware, or having reasonable grounds to believe, that persons or companies are purchasing or selling securities of the reporting issuer with knowledge of the material change that has not been generally disclosed. Exceptions to Filing a Material Change Report Disclosure would be unduly detrimental to the interests of the reporting issuer The material change is a probable decision of the board; the information is not being traded on and the report is filed and marked as confidential In Québec, if disclosure would be seriously prejudicial to the interests of the reporting issuer; there is no trading on the information; and the report is filed and marked confidential However, the issuer must report to the regulator every 10 days as to whether the information is still confidential and must disclose the material change if insiders begin to trade on it Pezim SCC 1994 (Pre-Danier Leather) [403] 38 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Material change requirements: o the change must be (a) “in relation to the affairs of an issuer,” (b) “in the business, operations, assets or ownership of the issuer” and (c) material, i.e., would reasonably be expected to have a significant effect on the market price or value of the securities of the issuer The assay results are a material change because there is a change in a company’s assets when a discovery is made on a portion of company property that had been previously categorized as having no known mineralization The private placement was a material change because the company’s control over the subsidiary was being increased o Private Placement becomes material depending on the number of shares sold, as it has the potential to dilute the ownership for shares outstanding. Non-disclosure of the contractual dispute was also a material change because an Accounts Receivable became a contractual dispute, b/c it could change the assets of the corporation. Under current tests, pending litigation is less likely to become a material change. o The K’ual dispute was a 4.5 millions dollar dispute. AiT [410] A board resolution, in the context of an arm’s length negotiation of a merger transaction before a definitive agreement has been reached, is a material change (and must be disclosed) only if: o there is sufficient evidence by which the board could have concluded that there was a sufficient commitment from the parties to proceed; and o there is a substantial likelihood that the transaction would be completed Material Change and Merger Negotiations – AiT No bright line test – depends on circumstances But a material change can occur in advance of the execution of a definitive binding agreement In the context of a merger and acquisition transaction, it is necessary to establish whether there is sufficient commitment from both parties of the transaction to determine whether a “decision to implement” the transaction has taken place Must consider the nature of the parties - i.e. negotiations from a smaller, less process-driven acquirer more likely to be a material change than that of a large, complex organization Timing of Disclosure [414] Material changes must be disclosed as soon as practicable And when an issuer is about to engage in a securities transaction, the 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 The duty to inquire as part of the general obligation to disclose material changes helps guarantee the fairness of the market Probability / Magnitude Test (Rejected in AiT, but still holds for materiality of fact) [414] Requires an assessment of the probability that an event will occur, having regard to all the known or ascertainable facts and an assessment of the magnitude or significance of the change, in terms of whether the information would be viewed by reasonable investors as important information YBM Magnex holds that the test encompasses an assessment of the current value of the information as it affects the price of securities, discounted by the chances of it occurring Note: however that AiT specifically rejects the use of this test in the context of determining what a “material change” is, but not in assessing materiality YMB Magnex [414] Was the audit suspension a change in the business, operations or capital of YBM that would reasonably be expected to have a significant effect on the market price or value of its securities? Using the probability/magnitude test, what was the probability of not obtaining an audit opinion by May 20 based upon the audit suspension on April 20, given that it would lead to a cease-trading order? o Held: High probability of this, therefore a material change o Audit suspension was suspicious and could amount to a material change. Rumours [418] Test to determine if we should file a “confidential material change report with regulator”: If the harm to a company’s business from disclosing outweighs the general benefit to the market of immediate disclosure, withholding disclosure is justified. The regulator is the gatekeeper to ensure this information is truly worthy of condifentiality, and to ensure it is released immediately publicly as soon as the reason for confidentiality ends. During the period before a material change is disclosed, market activity in the company’s securities should be carefully monitored If the confidential material change, or rumours about it, have leaked or appear to be impacting the share price, a company should take immediate steps to ensure that a full public announcement is made 39 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Confidentiality in Filing [419] Confidentiality is also permitted in situations where the material change consists of a decision to implement a change made by the company’s senior management, who believe that confirmation of the decision by the company’s board of directors is probable Note, the Québec Securities Act does not require a confidential filing, but it does relieve a company from the obligation to disclose a material change if senior management reasonably believes that disclosure would be seriously prejudicial to it; and no one has purchased or sold, or will purchase and sell its securities based on the undisclosed information (NP 51-201, Disclosure Standards, s. 2.2) A company must issue and file a press release once the reasons for not disclosing no longer exist (NP 51-201). Civil Liability for Breach of Continuous Disclosure Obligations (Handout) Development of Statutory Civil Liability for Continuous Disclosure Problems with common law remedies Remedies for Plaintiffs available in Tort and Contracts. Problem is that plaintiff in tort must show: misstatement, reliance, negligence, and causal link. Contract is more difficult as there is usually no direct contractual relationship b/w person making the misstatement and the investor. Also the fear that loser will have to pay the winners costs. Allen Report – 1997 Recommended Statutory Civil Liability (SCL) regime for continuous disclosure obligations It’s very simple. If you choose to trade in my securities, here’s the deal. I’ll tell you the truth. I’ll tell you promptly, and if I don’t and you are damaged, then within reasonable limits I’ll make you whole Recommendations: Hold a wide range of responsible parties liable for misrepresentations in all filed material The test for imposing liability = o if such misrepresentations would reasonably be foreseen as likely to affect the market price of the security Liability to be proportionate Deemed reliance Defences possible Limited liability for forward-looking information Limited damages Sanctions wrt Continuous Disclosure Requirement Statutory Sanctions o Penal sanctions - See OSA s. 122; QSA Chapters II and III o Compliance orders - See OSA s. 128; QSA s. 272.1 o Impose cease trade order - See OSA s. 127(1)2; QSA s. 265 o remove an issuer’s right to use the various exemptions provided in the Act – See OSA s. 127(1)3; QSA s. 264 Statutory Civil Liability The provisions set out private actions for a misrepresentation by an issuer in a document, for a misrepresentation by an issuer in a public oral statement and for a failure to make timely disclosure ›See, e.g.., PART XXIII.1, OSA Misrepresentation in a Document The plaintiff must show that: o i. the issuer is either: a. a reporting issuer or b. any other issuer with a real and substantial connection to Ontario, any securities of which are publicly traded o ii. The disclosure document contains a misrepresentation; and o iii. The plaintiff acquired or disposed of a security of the issuer during the period between the time the document was released and the time when the misrepresentation contained in the document was publicly corrected See OSA 138.3, 138.1 Core Documents (OSA s. 138.1) 40 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Include: a prospectus, a take-over bid circular, an issuer bid circular, a directors’ circular, a notice of change or variation in respect of a take-over bid circular, issuer bid circular or directors’ circular, a rights offering circular, management’s discussion and analysis, an annual information form, an information circular, annual financial statements and interim financial statements of the responsible issue Misrepresentation in a non-core document Plaintiff must prove that the defendant: ›knew that the document or public oral statement contained the misrepresentation; ›deliberately avoided acquiring knowledge that the document or public oral statement contained the misrepresentation; or ›was, through action or failure to act, guilty of gross misconduct in connection with the release of the document or the making of the public oral statement that contained the misrepresentation See OSA 138.4(1) Higher standard: must show deliberate avoidance or gross misconduct. Misrepresentation in a Public Oral Statement (OSA 138.3(2)) A public oral statement defined as an oral statement made in circumstances in which a reasonable person would believe that information contained in the statement will become generally disclosed: OSA s. 138.1 Requirements same as for misrepresentation in a non-core document Failure by a Public Issuer to make a timely disclosure The plaintiff must show that: o A reporting issuer failed to make a timely disclosure; o The plaintiff acquired or disposed of a security of the issuer; o The acquisition or disposal of the security occurred between the time when the material change was required to be disclosed and the subsequent disclosure of the material change. Who can be liable for a misrepresentation (OSA 138.3(1)) The responsible issuer; Directors of the responsible issuer; Officers of the responsible issuer who authorized, permitted or acquiesced in the release of the document; Influential persons who knowingly influenced the responsible issuer to release the document, or a director or officer of the responsible issuer in the release of the document; and Experts Persons who can be Liable [338] “Influential person” includes control persons, promoters insiders other than directors or senior officers and investment fund managers. For misrepresentations in public statements, defendants include the person who made the statement if she had “actual, implied or apparent authority” to speak on behalf of the issuer. o But directors only liable if they “authorized, permitted or acquiesced” in the making of the public oral statement For failures to make timely disclosures, experts not among potential defendants Actual Authority – The authority of someone who truly holds the authority delegated to another person. Buying pens example. Implied Authority – customary things that are coupled with Apparent Authority – must be reasonable reliance on the representation between principle and agent. Influential Person – OSA s. 128.3(3) Who can be liable for misrepresentations by influential persons: o the responsible issuer, if a director or officer of the responsible issuer, authorized, permitted or acquiesced in the release of the document or the making of the public oral statement; o the person who made the public oral statement; o each director and officer of the responsible issuer who authorized the release of the document or the making of the public oral statement; o the influential person; o each director and officer of the influential person who authorized the release of the document or the making of the public oral statement; and o experts Defences [340] Plaintiff’s Knowledge - OSA s. 138.4(5) Due diligence - OSA s. 138.4(6) 41 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 (New) Presence of a system to ensure continuous disclosure compliance- OSA s. 138.4(7)(e)&(f) – o Internal compliance program in place, can help to demonstrate due diligence. Reliance on Expert’s report – OSA s. 138.4(11) – Relying on advice provided by experts Non-consent and corrective action – OSA s. 138.4(15) – took action to correct mistake, and upon failure to correct, reported the mistake to the securities commission. Protection for Forward Looking Information – OSA s. 138.4(9), 138.4(9.1), 138.4(9.2) – must demonstrate what the assumptions you relied upon to make forward looking information. Reliance on Disclosure by other issuer or public official - OSA s. 138.4(14) – If information is submitted to other regulators and they don’t catch the mistake, then you can rely in their assessment….ish. Confidential Disclosure – OSA s. 138.4(8) – did not file publicly, b/c you filed confidentially with the regulators. Damages [340] Calculation of damages - OSA s. 138.5 – Delta b/w Purchase price and price of security when misrepresentation disclosed. Limits on damages – See OSA s. 138.7 and the definition of “liability limit” in s. 138.1. = 5% of mkt cap of issure and $1 million. Damages unrelated to misrepresentation or failure to disclose – OSA s.138.5(3) Proportionate Liability - OSA s. 138.6 – can divide up liability by pointing fingers, to divide up the whole millions bucks. Other way to reduce liability is to pin reduced stock price on something other than misrepresentation, like an earthquake, but must happen on the same day as the misrepresentation becomes public. Procedure (how do you initiate a claim?) [342] Limitation period of three years from the misrepresentation and six months from notice of leave being granted - OSA s. 138.14 Requires leave of court to proceed o Test for granting leave: based on good faith and a reasonable chance of success –OSA s. 138.8 IMAX Case (ON SC) s. 138.8 OSA Test to sue an issuer under security law: Para 16 – XX, 225 – 273, Statutory Leave 274 Facts: recognizing revenue before it was earned. Premature recognition. This inflated stock price The standard to be used in determining whether to grant leave is relatively low Test to bring a leave application for a breach of continuous disclosure obligation: 1. First consideration: the action is being brought in good faith [para 295] "there is no reason to read in a 'high' or 'substantial' onus requirement for good faith in this type of proceeding" The plaintiffs need only show that they are bringing their action in the honest belief that they have an arguable claim and for reasons that are consistent with the purpose of the statutory cause of action Good faith involves a consideration of the subjective intentions of the plaintiffs in bringing their action which is determined by considering the objective evidence 2. Second consideration: reasonable possibility that the action will be resolved in favour of the plaintiff [para 310] Reasonable means more than a de minimis possibility of success “a threshold that is too difficult may have little deterrent value" and an onerous threshold "may unduly lengthen and complicate the leave procedure” 3. Proposed part 3 – para 340 The Future of SCL Is IMAX a signal of the times ahead? Will cases alleging liability for continuous disclosure obligations arise? Or will the cap on liability for damages prevent Canada from becoming like the US in terms of class actions? o For the most part a 1 million dollar limit will limit litigation. Exemptions from a Prospectus Handout Exemptions Exemptions avoid the prospectus requirement, so they avoid the time, effort and expense associated with preparing a prospectus and complying with continuous disclosure obligations But further trading is subject to certain restrictions Referred to as “private placements” or “exempt distributions” Two types: o mandatory exemptions o discretionary exemptions 42 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 The closed System [223] The closed system ensures that all securities are traded only with a prospectus or with an exemption The system is closed in the sense that: o there are no openings for unregulated distributions of securities o when distributions do occur without a prospectus, pursuant to an exemption, any subsequent secondary market trading is confined to a narrow group of persons who do not need to know the information contained in a prospectus If an issuer distributes securities using an exemption, further trading is limited to one of three options: 1.File a prospectus to qualify the securities already distributed 2.Hold the exempted securities until a specified "hold period" expires. Once the hold period is over, the securities may be freely traded 3.Rely on a further exemption, although not all exemptions are available for subsequent trades Hold Periods [224] Keep securities distributed pursuant to an exemption from being freely traded for a period of time Two types- "restricted periods" and "seasoning periods". do not apply if another exemption is used or if a prospectus is used Duration of four months (NI 45-102 Resale of Securities) This is intended to allow sufficient information to build up in the public sphere. if the issuer is not a reporting issuer in Canada, the securities may be subject to an indefinite hold period Reasons for Using Exemptions [226] Time and effort to prepare a prospectus Cost of a prospectus Offering securities to a narrow range of investors Inability to fulfill prospectus disclosure requirements Inability to find a registered dealer willing to sell the securities through a prospectus Issuer prefers not to become a "reporting issuer” Rationale for Exemptions [227] Exemptions are granted when the present and future costs of complying with prospectus requirements outweigh the benefits That is an exemption is granted when it would not be contrary to the public interest (twin aims of sec law) to do so. Categories of Exemptions [229] Policy reasons behind granting an exemption No "Need to Know“ o Public Investors do not need to know, as investors already know intimately the details of the issuers business. (ie. Directors or officers of the corporation). Sophistication o For example an “accredited investors”, rich investors who already know what’s going on. Redundancy o Same information available through an information circular or a take-over bid circular. The info must be so detailed that it rivals a prospectus. Could be posted in SEDAR. Must be given to investor. Also could be found in Annual Information Form Dual Regulation o Issuer has already filed in another jurisdiction. Specific Exemptions [231] Found in NI 45-106 Prospectus and Registration Exemptions Ontario's Rule 45-501 outlines exemptions different from the rest of the jurisdictions Capital Raising Exemptions [232] 1. Rights Offering [233] a. issuer issues rights to purchase more of its own securities to holders of its own securities b. Requires notice to regulators and compliance with NI 45-101 Rights Offerings c. resale rule applicable to a rights offering does not include the restricted period d. No hold period prior to resale. 2. Reinvestment Plan [233] a. intended to cover plans where current security holders receive more securities, typically in lieu of a cash dividend from the issuer 3. Accredited Investor [233] (definition: banks and other institutions, pensions, investment funds, certain charities, indiv fin assets > $1,000,000 or net income > $200,000, or net assets > $5,000,000). a. S. 2.3 NI 45-106 b. Covers both corporate entities and individuals c. A common exemption although requires report to authorities 43 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Idea is that you’re so wealthy you do not require additional disclosure information, or can buy it, or can afford to lose money invested. You cannot create an entity to become an accredited investor. Private Issuer Exemption [234] a. "private issuer“ defined as an issuer: i. that is not a reporting issuer or an investment fund; ii. whose non-debt securities are subject to transfer restrictions ... and are directly or indirectly beneficially owned by a maximum of 50 persons ; and iii. that has distributed designated securities only to persons described in the private issuer section Family, Friends and Business Associates Exemption (ie Facebook example) [235] a. Is there concern that family members and friends are not adequately protected by virtue of their relationships? b. There could be situations where the relationship itself does not disclose enough information. Affiliate Exemption [237]– If you sell security to subsidiary you can get an exemption. Offering Memorandum Exemption [237] a. Requires an issuer to disclose, in writing, details about its business and the securities being offered b. Form 45-106F2 and F3 Minimum Amount Investment [239] a. Available if the purchaser buys as principal; the purchaser's acquisition cost is not less than $150,000, paid in cash upon closing; and the securities are issued from a single issuer d. 4. 5. 6. 7. 8. Transaction Exemptions [240] 1. Business Combination and Reorganization [240] a. available for a trade of a security in connection with amalgamations, mergers, reorganizations or arrangements, when new securities are issued to the existing SH of the previous corporations. 2. Asset Acquisition [241] a. A trade by an issuer in its own securities, where the securities are consideration for a person's assets. Creditors can be paid off with securities rather than cash. 3. Take-over Bid and Issuer Bid [241]– One bigger corporation taking control of a smaller corporation, and absorbes into the bigger. Done by purchasing the outstanding securities of the smaller corp. a. exemption for trades made in connection with a take-over bid or issuer bid Other Exemptions 4. Investment Fund Exemptions[241] 5. Employee, Executive Officer, Director and Consultant Exemptions. [242] a. A trade by an issuer in its own securities (or by a control person in securities of the issuer) to an employee, executive officer, director or consultants b. “the benefit of employee ownership is more important than the employees' need to know” Miscellaneous Exemptions [243] 6. Isolated Issue a. exempt if (i) the trade is not part of a series of similar continued and successive transactions, and (ii) the trade is not by a person whose usual business is trading in securities 7. Dividends and Distributions – given to existing SH, as they already have all the information they need. 8. Acting as Underwriter – sophisticated and do not require additional information. 9. Conversion, Exchange or Exercise Discretionary Exemptions [244] Can be requested where unique or novel facts or circumstances justify some variation of the applicable requirements The Commission has the ultimate discretion to decide if an exemption should be granted, if it is not "prejudicial to the public interest” The Commission also has the power to declare an investor an "accredited investor” Resale of Securities securities distributed under a prospectus exemption may be subject to restrictions on their resale The particular resale, or “first trade”, restrictions depend on the parties to the distribution and the particular exemption that was relied upon to distribute the securities Resale restrictions are imposed under National Instrument 45-102 Resale of Securities National Instrument 45-102, 2. 2.5 (1) Unless the conditions in subsection (2) are satisfied, a trade that is specified by section 2.3 or other securities legislation to be subject to this section is a distribution. (2)... the conditions are: o the issuer must be a reporting issuer in a jurisdiction in Canada for the four months immediately preceding the trade; o a period of four months has elapsed since the date of the distribution of the securities under the exemption; o the security certificate or ownership statement bears a legend, setting out the period for which the securities can not be traded; o the distribution is not a control distribution; . o no unusual effort has been made to prepare the market or create a demand for the securities; o nor has any extraordinary commission or consideration been paid in respect of the trade; and 44 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 if the selling security holder is an insider or officer of the Issuer, the selling security holder has no reasonable grounds to believe that the issuer is in default of securities legislation. Restricted and Seasoning Period o The "seasoning period" is similar to the restricted period except that it also applies to "private companies" and "private issuers” Both require a reporting issuer; not a control distribution; no unusual effort to prepare the market; no extraordinary commissions or consideration; and no reasonable grounds to believe the issuer is in default The hold period is 4 months Insider Trading An Introduction to Insider Trading [479 – 480] —Not illegal in all circumstances —As long as “insiders” disclose their trades, and the trades do not result from material undisclosed information, trading by insiders is permissible. —Insider trading laws —Are built on concerns relating to fairness —Assume risk in trading and therefore prohibit risk free trades —Seek to build confidence in the capital markets —Try to create a level playing field Background: The Kimber Report [480] —The ideal securities market should be a free and open market with the prices thereon based upon the fullest possible knowledge of all relevant facts among traders —The law should provide that the use by insiders, for their own profit or advantage, of particular information known to them but not available to the general public is wrong and that the law should give appropriate remedies to those aggravated by such misuse —The legislation should provide for full and public disclosure of all transactions effected by insiders in the securities of their companies —Also, the law should provide an effective procedure to recover any benefits derived by those who engage in improper insider trading The Legislative Scheme [481 - 482] —If insiders report trades within a certain time period, such trades are permissible providing they are not based on undisclosed material information No insider, or any other person in a “special relationship” with the issuer, can trade on material undisclosed information Who is an Insider S.1.(1) Ontario Securities Act —(a) every director or senior officer of a reporting issuer, —(b) every director or senior officer of a company that is itself an insider or subsidiary of a reporting issuer, —(c) a person or company that has, —(i) beneficial ownership of, or control or direction over, directly or indirectly, securities or a reporting issuer carrying more than 10 per cent of the voting rights attached to all the reporting issuer’s outstanding voting securities, excluding, for the purpose of the calculation of the percentage held, any securities held by the person or company as underwriter in the course of a distribution, or —(ii) a combination of beneficial ownership of, and control or direction over, directly or indirectly, securities of a reporting issuer carrying more than 10 per cent of the voting rights attached to all the reporting issuer’s outstanding voting securities, excluding, for the purpose of the calculation of the percentage held, any securities held by the person or company as underwriter in the course of a distribution, —(d) a reporting issuer that has purchased, redeemed or otherwise acquired a security of its own issue, for so long as it continues to hold that security, —(e) a person or company designated as an insider in an order Who is an Insider – s. 89 Quebec Securities Act —“Insider” means — (1) every director or officer of an issuer; — (2) every director or officer of a subsidiary of an issuer; — (3) a person that exercises control over more than 10% of the voting rights attached to all outstanding voting securities of an issuer ... — (4) an issuer that holds any of its securities; or — (5) a person prescribed by regulation or designated as an insider under section 272.2. —“Insider” also means a director or officer of an insider of an issuer. 45 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Insider Trading Reports [482 – 483] —National Instrument 55-102 (System for Electronic Disclosure by Insiders (SEDI)) requires insiders and issuers to file “insider profiles” and “issuer profiles,” respectively within 10 days of becoming an insider (OSA s. 107(1); QSA s. 96) —Issuers must file “issuer event reports” after defined events, including stock dividends and stock splits. Exemptions from filing Insider Trading reports [483 – 484] —Blanket exemptions under NI 55-101 (i.e. If issuer makes a change that affects equally all securities of a class) —The Commission can grant exemptions where “just and expedient” [OSA s. 121(2)(b)] —An interested person can apply for an exemption [OSA s. 121(2)(a)] —“eligible institutional investors” are exempt if they have filed an early warning report and do not have knowledge of any material fact or change (NI 62-103) —Query – is filing insider trading reports an effective means to disseminate information to the market? And is there adequate enforcement for failure to file insider trading reports[484]? Illegal Insider Trading [485] —No person or company in a special relationship with a reporting issuer shall purchase or sell securities of the reporting issuer with the knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed (OSA s. 76(1)) —No insider of a reporting issuer having privileged information relating to securities of the issuer may trade in such securities ... QSA s. 187 Focusing on the OSA definition, the elements of illegal insider trading are: (1) special relationship; (2) purchase or sale with knowledge of a material fact or change; and (3) not generally disclosed 1 – Special Relationship – OSA s. 76(5) [485] Definition: —(a) a person or company that is an insider, affiliate or associate of, (i) the reporting issuer, (ii) a person or company that is proposing to make a take-over bid ...or (iii) a person or company that is proposing to become a party to a reorganization, amalgamation, merger or arrangement ..with the reporting issuer or to acquire a substantial portion of its property, —(b) a person or company that is engaging in or proposes to engage in any business or professional activity with or on behalf of the reporting issuer or with or on behalf of a person or company described in subclause (a) (ii) or (iii), —(c) a person who is a director, officer or employee of the reporting issuer or of a person or company described in subclause (a) (ii) or (iii) or clause (b), —(d) a person or company that learned of the material fact or material change with respect to the reporting issuer while the person or company was a person or company described in clause (a), (b) or (c), —(e) a person or company that learns of a material fact or material change with respect to the issuer from any other person or company described in this subsection, including a person or company described in this clause, and knows or ought reasonably to have known that the other person or company is a person or company in such a relationship QSA s. 189 —189. The prohibitions set out in sections 187 and 188 also apply (in addition to insiders defined in s. 89) to the following persons: — (1) the officers and directors referred to in Chapter IV of Title III; — (2) affiliates of the reporting issuer; — (3) an investment fund manager or a person responsible for providing financial advice to an investment fund or for investing its shares or units and every person who is an insider of the investment fund manager or of that person; — (4) every person who has acquired privileged information in the course of his relations with or of working for the reporting issuer, as a result of that person's functions or of his engaging in business or professional activities; — (5) every person having privileged information that, to his knowledge, was disclosed by an insider or a person referred to in this section; — (6) every person who has acquired privileged information that he knows to be such concerning a reporting issuer; — (7) every person who is an associate of the reporting issuer, of an insider of the latter or of a person contemplated in this section 2 - Material Fact and Material Change [486] —Recall: A material fact is —a fact that would reasonably be expected to have a significant effect on the market price or value of the securities (OSA s. 1(1)) — a fact that may reasonably be expected to have a significant effect on the market price or value of securities issued or securities proposed to be issued; (QSA s. 5) —A material change is: 46 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 —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 (OSA) —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, or a decision to implement such a change made by the directors or by senior management of the issuer who believe that confirmation of the decision by the directors is probable (QSA) Short Trading —Short trading —a technique whereby a person sells securities that he does not own in an attempt to take advantage of an expectation that the price for the security will decrease. —A short seller borrows shares from a person/broker who owns them (the lender). They then sell the borrowed shares. —Once the share price has decreased, he buys back the shares to return them to the lender —The profit is the difference between the price at which the shares were originally sold and the buy-back price Re Donnini [487 – 496] —KCA and Yorkton entered an agreement under which KCA proposed to raise $5 million by issuing 4 million special warrants —Each special warrant was to entitle the holder to acquire one common share of KCA and one-half of one common share purchase warrant at an exercise price equal to $1.75 per common share. —Pursuant to the engagement agreement, Yorkton was entitled to receive an underwriter’s commission equal to 8% proceeds of the offering (or $400,000 in cash) and compensation options to acquire 400,000 units —During the pre-marketing of this first special warrants offering, Yorkton’s institutional clients expressed a greater demand than the proposed 4 million units available. —Commencing on or about February 15, 2000, with the knowledge of Paterson, who was the chairman and chief executive officer of Yorkton, Donnini began executing short sales of common shares of KCA for Yorkton’s own account. —On February 17, 2000, Donnini, on behalf of Yorkton, began to borrow KCA common shares from various registered dealers. Between February 15, 2000 and February 28, 2000, Yorkton sold short for its own account approximately 355,000 common shares of KCA. These transactions were transparent to the market as Donnini traded from Yorkton’s inventory account. —The short sales carried out prior to February 28, 2000 were effected as a part of a strategy to lock in Yorkton’s profits in relation to compensation options and special warrants from the first special warrants offering, which it had purchased from its clients —At 2:45 p.m. on February 29, Donnini knew that Paterson had just spoken to Milligan and proposed a second financing to Milligan, that Paterson believed that the second special warrant financing could be done, that Paterson was thinking of a size of $10 million and a price at a discount from market, and that $6.75 was likely the price —By the close of trading on the TSE on March 1, 2000, Donnini had sold short for Yorkton’s account approximately 1,019,600 common shares of KCA for the period February 29 and March 1, 2000. Issue: Whether Donnini had knowledge of a material fact that had not been generally disclosed when he purchased and sold shares of KCA after 2:45pm on 29 February and 1 March? Can a Contingent Event ever be a fact? [488 – 490] —The law imposes restrictions on certain persons trading with knowledge of either a material fact or material change with respect to reporting issuers before the material fact or material change has been generally disclosed —the negotiations for the second special warrants financing were sufficiently advanced at 2:45 p.m. on February 29, 2000 that the information about the proposed transaction at that time was a fact for purposes of the definition of “material fact” in the Act. —materiality in cases of contingent or speculative developments depends: at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity. —Since the potential magnitude of the second special warrants financing was highly significant for the value of KCA shares, a lower probability of occurrence than we determined was actually present would still have led us to conclude that each of the financing, the negotiations and the potential price and size of the financing was a material fact. Probability/Magnitude Test [490 – 492] Used to determine materiality Materiality is indicated when there is a high probability the event will occur and high magnitude of the event’s impact on the registrants. They are weighed separately. This US test is very useful in Canada. Questions 1.In Donnini, the material fact at issue was related to a transaction that was not sure to occur. Do you think a defendant should still be liable for insider trading if the contingent event never occurs? 2.In Donnini, the court applied the probability/magnitude test in order to determine whether the proposed second special warrants financing, the negotiation concerning it, and the proposed price and size of it, were material facts. Is this test fair to the accused insider trader? Because this test is applied with hindsight after the contingent event actually occurs, is there really any doubt that this test will result in a positive determination of materiality? 3 – Generally Disclosed [497] —Information has been generally disclosed if: 47 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 —(a) the information has been disseminated in a manner calculated to effectively reach the marketplace; and —(b) public investors have been given a reasonable amount of time to analyze the information. (National Policy 51-201 (2002), s. 3.5(2)) —Best practice is a press release, followed by an open conference call - see ss. 3.5(4) and (5), 6.6, NP 51-201 —publication of information on a website is not considered general disclosure —There is an implicit duty to inquire as to the existence of material changes before causing a reporting issuer to engage in securities transactions (Pezim) [498] - There are no rigid rules for determining if dissemination has been adequate. [499] Criminal Code — Section 380(1) makes it an indictable offence to “by deceit, falsehood or other fraudulent means” defraud the public or any person of “property, money, or valuable security or any service” where the subject matter exceeds five thousand dollars.” —Section 380(2) creates the offence of affecting the public market price of “stocks, shares, merchandise of anything that is offered for sale to the public” with intent to defraud. —Section 382 makes it an offence to fraudulently manipulate stock exchange transactions by engaging in various strategies, such as matched orders and wash trading to “create a false or misleading appearance of active public trading.” —Section 400 indicates that anyone who “makes, circulates or publishes a prospectus … that he knows is false in a material particular, with intent” to induce someone to become a shareholder or partner, or to deceive or defraud members, shareholders, or creditors of a company is guilty of an indictable offence —382.1(1) A person is guilty of an indictable offence and liable to imprisonment for a term not exceeding ten years who, directly or indirectly, buys or sells a security, knowingly using inside information that they —(a) possess by virtue of being a shareholder of the issuer of that security; —(b) possess by virtue of, or obtained in the course of, their business or professional relationship with that issuer; —(c) possess by virtue of, or obtained in the course of, a proposed takeover or reorganization of, or amalgamation, merger or similar business combination with, that issuer; —(d) possess by virtue of, or obtained in the course of, their employment, office, duties or occupation with that issuer or with a person referred to in paragraphs (a) to (c); or (e) obtained from a person who possesses or obtained the information in a manner referred to in paragraphs (a) to (d). What policy purposes are being served by the Criminal Code offence of insider trading? Are they necessary? Insider Trading II – Tipping [499] —OSA 76(2) No reporting issuer and no person or company in a special relationship with a reporting issuer shall inform, other than in the necessary course of business, another person or company of a material fact or material change with respect to the reporting issuer before the material fact or material change has been generally disclosed. Three Basic Elements of Tipping [499] 1.The tipper must be in a special relationship with the reporting issuer; o The tipper need not be in a special relationship with the tippee…could simply be a matter of someone overhearing a conversation (cf. Rankin). Person overhearing must know the tipper is privilege to material non-public information. 2.The tipper informs the tippee of a material fact or material change other than in the necessary course of business; and 3.The information has not been generally disclosed —Note: a tippee can also be a tipper if he gleans information from someone in a special relationship with the issuer and passes it along, creating a chain of tipping. Criminal Code s. 381.2(2) (2) Except when necessary in the course of business, a person who knowingly conveys inside information that they possess or obtained in a manner referred to in subsection (1) to another person, knowing that there is a risk that the person will use the information to buy or sell, directly or indirectly, a security to which the information relates, or that they may convey the information to another person who may buy or sell such a security, is guilty of (a) an indictable offence and liable to imprisonment for a term not exceeding five years; or (b) an offence punishable on summary conviction. R v. Rankin [500] The case was initially significant because it was the first Canadian case to yield a conviction of tipping. However, when the case was overturned and leave to appeal denied, the case came to stand as another example of how difficult enforcing insider trading and tipping is. Duit - Tippee turns out to be a very unreliable witness, and he changes his story several times. Tipper is found guilty, but conviction is overturned on Appeal. Rankin wasn’t giving out insider information, but was facilitating the acquisition of insider information by the Tippee. Rankin would tell him he was working on a big deal and that the office was open. 48 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 Defences for Illegal Insider Trading [501] 1. Reasonable Belief that Information Has Been Generally Disclosed. [501] (method of disclosure is less important, just needs to be made public). o i.e. OSA s. 76(4); QSA ss. 187(1), 188(1)) o Disclosure of insider information is not discharged by disclosing merely that the information exists, without saying what the information is (Green v. Charterhouse Group Can. Ltd) ON CoA: “a limited discussion of the relevant information in a letter was inadequate disclosure”. o an insider should wait a minimum of one full trading day after the release of the information before trading (Connor) Connor – AN insider is not in all cases free to trade as soon as a press release has been disseminated. Test: 1) The information must be disseminated to the public, and 2) the public must have it in its possession for enough time to digest it, given its nature and complexity. [504] Defences for Professionals [505] S. 175(1) of the OSA regulations provides, that a person or company may avoid liability by proving that no individual with actual knowledge of an undisclosed material fact or material change made, or participated in the making of, the decision to buy or sell a security to which the material fact or material change relates. [505, cf Domini para 161 – 170] in determining this, it is relevant whether and to what extent policies and procedures have been put in place to prevent insider trading o i.e. grey lists, employee education, Code names, Chinese walls (Ethical Walls) – barriers to prevent information moving from moving around the organization. o The material non-public information belongs to the client and not lawyers, insiders, and they should not be profiting from access. 2. Reasonable mistake of fact [506] Fingold (An issue of insider trading and not tipping) This is classic definition of Insider Trading. He is trying to raise the defence that he reasonably believed in a mistaken set of facts that the information is not material (Can be material fact or material change). He is not saying that he did not use the information to trade, he is saying that he reasonably believed at the time that it was not a material fact and he was therefore at liberty to sell his shares without violating s. 76. Could also be other explanations for why he sold stock on this day. He may simply have needed money on this particular day. Was the unexpected disappointing results for the fourth quarter of 1988 a material fact which would reasonably be expected to have a significant effect on the market price of the Cineplex shares o He traded the shares knowing disappointing results were coming, but tried to defend on basis that he was going to recover, and the weak results were only a temporary blip, and not material in the long-run. Seen in the context of his long involvement with the company and its predecessors, his confidence in Drabinsky joining the firm, and his belief in the viability of its ongoing projects, the accused had a reasonable basis in his belief that the facts would not affect the market price of Cineplex shares. He thought there was sufficient evidence to back up his position that the results would improve. Fingold found not guilty. He made a reasonable mistake of facts Harper [508] Defence that information was not Material, and if it was he reasonably believed that it was not. Harper found guilty. Given Harper’s decades of experience with Golden Rule, its related mining companies, prior employment and his industrial/financial involvement in general, his belief that poor assay (test) results were not material and would not have an effect on the market price of the shares was unreasonable. Industry experts would know that assay results are very definitive, and negative results are certainly going to lead to a depressed stock price. o He should have known not to trade on the results of the test. o Becomes a subjective/objective test: would a reasonable person in a similar situation with similar information have traded on the information. 3. “Necessary Course of Business” [512] NP 51-201 - Everyone should have equal access to information, and an equal opportunity to trade on that information But the “necessary course of business” exception exists so as not to unduly interfere with a company’s ordinary business activities. For example, the “necessary course of business” exception would generally cover communications with: o (a) vendors, suppliers, etc; o (b) employees, officers, and board members; o (c) lenders, legal counsel, auditors, underwriters, and financial and other professional advisors to the company; o (d) parties to negotiations; o (e) labour unions and industry associations; o (f) government agencies and non-governmental regulators; and o (g) credit rating agencies Royal Trustco [514] 49 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 To prevent a takeover, insiders told TD Bank personnel material facts about the company including how many SH would or would not tender to the bid These facts were told to encourage the officers of the bank not to sell or deposit the 10 per cent of the outstanding shares of Trustco that it had acquired after earlier representations Thus, they were facts not made in the necessary course of business o To rely on defence of “necessary course of business” cannot be an ulterior motive to garner some sort of gain, and most be solely in the course of business. Assessing Insider Trading [515] It is relatively difficult to detect and it is expensive to enforce insider trading. Since it’s so difficult to prosecute, there is a negligible risk of being caught. So likely, the restrictions do not deter individuals from engaging in illegal insider trading Recommendation on Prevention of Insider Trading [522] 1. Allow individuals who provide regulators with information on the illegal insider trading of others to a portion of the fines levied on convicted individuals. 2. Make announcements of insider trading faster by flagging insider trades at the time of each trade to prevent insiders from quietly disposing of or acquiring a position in their firm’s stock on the basis of material information. 3. Restrict insiders from trading in a period just prior to pre-planned announcements such as earnings releases Difficult to obtain a conviction under s. 122 OSA. Sample Exam Advise NORE Co. as to: (a) whether the Master Franchise Distributorships constitute a security using statutes and case law to justify your answer and 1. 2. 3. 4. Look to statutory definition of security in section 1.1 of the OSA. Unlikely unhelpful o Entitlement to royalties could be a start Look to see if this is an investment contract? Look to statute, s. 1.1(n). Look to Pacific Coast SCC decision, which draws inspiration from US cases: Howey and Hawaii. Review both decisions, and then put greatest focuse on Pacific Coast. ** Only refer to US decisions to the extent that they are cited or referred to in US decisions. Not fit NorCo into the test from Pacific. Is there a common enterprise? Independent contractor, so less likely to demonstrate a common enterprise. In orange grove you had to make an initial investment to buy a piece of land. Here, doesn’t look like any money changed hands. Some investment here, not in money, but perhaps effort to promote the sales in your region. This could be considered an investment. Was there a common enterprise. Independent contractor is a conscious effort to have franchisee not be considered a common enterprise. Is there comingling of funds? Master franchisee receive 5% of royalties paid to Norco. Co-mingling of royalities, but not of funds. This is vertical co-mingling (b/w investor and promoter), rather than horizontal between investors. is led to expect profits? solely from the efforts of the promoter or a third party. MF are doing most of the work, and money comes not solely from the promoter. The Norco guys are actively recruiting master franchisee. Less like a security, b/c they are doing something. Hawaii Test An investment contract is created whenever: 1. An offeree furnishes initial value to an offeror; o They put value in through their efforts towards their. You could argue there is no furnishing of initial value to the offerer 2. a portion of this initial value is subjected to the risks of the enterprise – o Yes, there is a risk the deal fails 3. the furnishing of the initial value is induced by the offeror's promises or representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the initial value, will accrue to the offeree as a result of the operation of the enterprise, and 4. the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise. What does Pacific Coast Test Say? To find a security: 1. If there is a common enterprise; [YES, commonality, fortunes of the MF are dependent on their own effort and the efforts of the franchisor]. a. (looking for vertical commonality b/w the promoter and the investor. The intermingling of money b/w promoter and the company satisfies the co-mingling. [55] 2. If those efforts made by those other than the investors are the undeniably significant ones – those essential managerial efforts which effect the failure or success of the enterprise. [Both parties have to contribute some effort to make the profit, and it is not exclusively the result of one party. Both had an integral role. Court found Norco had the greater role. There is always a greater issue in finding a security, as this is what protects investors. 50 Greg Koenderman – Securities Regulation – Prof Choudhury – Winter 2011 **answer is looking for logical flow through all the steps to reach the answer. (b) what the repercussions are for NORE Co. if the agreements are found to constitute a security. If this is a security, determing if they are being traded, then they have a prospectus requirement. •Discuss the potential liability for insider trading for Smart and Van Brainie. Are there any defences if liability is found? Two branches: insider trading and tipping. No insider trading, b/c Smart didn’t trade on secutiry. Issue: Can Smart be liable for tipping? Smart: Look to OSA s. 76(2) for definition of tipping. Tipper must be in a special relationship with issuer, must informer tippee of a material fact or material change, and the fact must not be generally disclosed. Now apply facts to legislation. 1. Special Relationship – There is a special relationship, as a CEO of the issuing corporation. 2. Is this information material? Yes – the information he is tipping would reasonably be likely to have a material effect on the stock price. You can always use the probability magnitude test to determine material fact v. change. 3. Has there there been general public disclosure of this information? Defence: Smart: divulged in the course of business. NP 51-201: “necessary course of businiess defence exists, to not unduly restrict the course of business”. Allowed to communicate with industry to research partners, which could cover the facts there. NP are persuasive in Ontario, but not binding. Smart is likely not liable, b/c of the necessary course of business defence would apply. Van Brainie. Find one piece of legislation and justify. He is in a special relationship, and the information is material, b/c as discussed under Smart, likely to have substantial effect on price if released publicly. Information is not generally disclosed. He is now in a special relationship b/c he now has information from an insider. Defences: Not really any defences, best bet is reasonable mistake of fact. Through objective lens. Never bother with “material change”, when you can use broader “material fact” category. 51
