3
Securities Regulations – Fall 2006
Instructor: Maryse Bertrand
Notes: Laurence Bich-Carrière
Up to a point, the better regulated the market, the more attracted the investors.
The better regulated the market, the more rules to learn.
The more rules to learn…
Table of Contents.
A. The Basics 3
I. Introduction: Basic Concepts 3
1. Participating in the Economy: Types of business associations 3
2. The market as a meeting of the minds 4
2.1. How can one raise money? 4
2.2. Where can one raise money? 4
2.2.1. The market 4
2.2.2. Specialised markets 5
2.2.2. Liquidity of a market. 5
3. The Actors 5
3.1. Market participants. 5
3.2. The Ontario Securities Commission 5
3.3. The Québec Securities Commission 6
4. Market regulations 6
4.1. The point of having regulations. 6
4.2. The regulators: should they be market or State players? 6
4.2.1. The States 6
4.2.2. Self-regulatory organisms (SROs) 7
5. The rule-making and the policy instruments. 7
6. Judicial Review 8
II. Fundamental concepts and key definitions 8
1. Objectives of the Act 8
2. Definitions (s. 1 SAO) 9
2.1. Security (valeurs mobilières) 9
2.2. Trade (opérations), dealers (courtiers) and distribution (placements) 9
2.3. Material changes and material facts (fait/changement important) (see p. 12 and 14). 9
2.4. Misrepresentation 9
2.5. Issuer, reporting issuer and underwriter. 10
2.6. Insiders (see also p. 23) 10
3. Relation between companies 10
III. Enforcement (part XXII, ss. 122-129 SAO) 10
1. Types of remedies 10
1.1. Administrative remedies (s. 127 SAO) 11
1.2. Civil remedies (through application to Court, s. 128 SAO) 11
1.3. Penal proceedings (s. 122). 11
B. Trade and distribution of securities 12
I. The Infamous Prospectus. 12
1. Registration Requirements: the three commandments 12
1.1. Thou shall not trade securities if you are not registered (s. 25(1)). 12
1.2. Thou shall not distribute securities without a prospectus (part XV, s. 53 et s.). 12
1.3. Thou shall disclose "full, true and plain" information (s. 56(1)) 12
2. The Process of Going public: how does an Initial Public Offering (IPO) work? 12
2.2. The Pros and Cons of Going Public 12
3. Preparation of Prospectus 13
3.1. Overview 13
3.2. The Prelim(inary prospectus) aka the Reds. 13
3.2.1. From the Commission's Comments to the Road Show 13
3.2.2. The Underwriter's Risks 14
3.2.3. The Buyers. 14
3.2.4. Material changes. 14
3.2.5. And voilà! 15
3.3. Short-form prospectus (SFP) 15
3.3.1. The benefits of SFP 15
3.4. Shelf registration (enregistrement en attente). 15
4. Prospectus liability (s. 130 SAO) 16
4.1. What remedies, for who, against whom? 16
4.2. Accusations and defences (including due diligence) 16
5. Material change: Wesley Voorheis's speech on Danier. 16
5.1. His position. 16
5.2. The forecast 17
5.3. Difference between material fact and material change. 17
II. Prospectus Exemptions: The Closed System 18
1. Introduction (s. 53) 18
1.1. who is exempted 18
1.2. Getting out of the system (see closed system sheet) 19
Seasoning Period 19
Control Block Distribution 20
C. Do's and don't's 21
I. Continuous and timely disclosure 21
1. The duties of the reporting issuer. 21
1.1. Periodic obligation. 21
1.1.1. The financial statements (s. 4 CP 51-102) 21
1.1.2. Annual information form (AIF) (s. 6.1.2. CP 51-102) 22
1.1.3. Annual meeting. 22
1.2. Events reporting. 22
Case Study: Agnico-Eagle – Material Change or Not? 23
2. Statutory Civil Liability for Misleading Disclosure (ss. 138.1 et s. SAO) 23
2.1. Overview. 23
2.2. Who made the misreprenstation? 23
2.3. What document did it appear in? 23
2.4. Condition to leave. 24
2.5. Whom Can Sued? 24
2.6. Defences. 24
2.7. Damages 25
II. Insiders Trading and Self-Dealing. 26
1. Insider reporting (s. 106 et s.) 26
1.1. Who is an insider? 26
1.2. The reporting duty (s. 107 SAO) 26
2. Insider Trading (s. 76) 27
2.1. What is insider trading (and tipping) 27
2.2. Who is subject to these rules 27
2.3. Liability 28
2.4. Suing. 28
2.5. Defences 28
D. Mergers and Acquisitions 29
1. Introduction 29
1.1. Types of M&A 29
1.2. What is a take-over bid (TOB) 29
2. The TOB Regime 30
2.1. Circular and Circular Exemptions (s. 93) 30
2.2. General rules (ss. 95 to 97 SAO). 30
3. The Offer 31
3.1. Ways of making an offer 31
3.2. Collateral benefit: seeking an exemption (s. 104) 31
3.3. Anti-avoidance rules around the bid. 31
3.3.1. Pre-bid integration rules (s. 94(5) SAO). 31
3.3.2. During the bid (s. 94(2)-(3)SAO). 31
3.3.3. After the Bid (s. 94(4) SAO) 32
4. The Director's Duties and Rights. 32
4.1. Responding to the circular 32
4.2. Defensive tactics (esp. for hostile takeovers). 32
4.3. Deal-protection measures: the Offeror Strikes Back (or was well-prepared) 33
5. Special requirements for special people 33
5.1. Reporting requirements: the Early Warning System (s. 101 SAO). 33
5.2. Special Situations 34
5.2.1. What are they? 34
5.2.2. What do they entail? 34
6. Enforcement and Liability 34
Appendices 37
I. Instruments 37
II. The Ontario Securities Act Is My Friend Too! 39
III. Readings 43
A. The Basics
I. Introduction: Basic Concepts
1. Participating in the Economy: Types of business associations
There are numerous ways of organising work. It is up to the entrepreneur to choose the form of business association to meet his needs. Factors to consider include the need to raise capital, one’s desire to retain control, issues of liability and taxation concerns (we will not be dealing with these latter issues). Note as well that a business may change its form of association throughout the life of the business. A company that begins as a sole proprietorship may become a partnership (whether the regular form or the stranger lawyer-related LLP), or a corporation, and a corporation may become a business trust, depending upon the needs of the investors and those responsible for the management of the business. You might also get tax advantages.
Assets – liabilities = equity (worth of the business).
2. The market as a meeting of the minds
2.1. How can one raise money?
The securities business is a right to participate in market economy. So you have your economic entity that wants to make money. In order to get started, you need some capital to buy tools, hire employees, whatever is needed.
There are two main ways to do that:
· debt capital (you borrow the money, that's on the liability side)
o Debt is good, but not too much, of course (or you'll be overleveraged).
o The lender has a right to get his money back, and this money is rarely lent for free (interest, it's an economy activity for the lender).
o It generally generates a direct rate of return.
o From a technical treatment, tax-wise, the interest is a deductible business expense.
o It can be secured or not. But even if it is unsecured, it ranks in front of shareholders. It can take different forms (bank loan, note, bond, debentures).
· Share capital (get it from the shareholders, on the equity side).
o Share (or units of partnership/trust) capital seems safer but financial theorists say that some loans make it more efficient.
o The shareholder has no guarantee (about their investment or in case of bankruptcy) – though sometimes the shares can be redeemable.
o The shares are retractable (they can be sold back to the company)
o There is generally no direct rate of return (no right to get dividends).
o There's also a very important voting issue: shareholder are the only one who get to vote (as they are the owners).
o The price of a share is function of the demand: when people want shares, they go up. And vice-versa, of course[1].
o Capital market is the place where financing meet opportunities, voilà.
2.2. Where can one raise money?
2.2.1. The market
The trade market includes two submarkets:
· the primary market, where the shares are first issued[2], worth only about 10% of the whole market. This is the heavily regulated prospectus market (see p. 12, s. 25, 53 SAO).
· the secondary market (or after-market), where the shares are later traded, re-sold of the shares, whatever happens after the initial sale.
o This is where the analysts are. They are assigned to watch a particular stock and comment to the public on it (and have heavy influence).
o You also have intermediaries (brokers, see below). They know the market and can play it easier than individuals. Because they play with individual’s money, they are heavily regulated;
o Advisors are the people or company giving advice, telling you what to do on the market. They have to register.
· The liability is more about the free flow of information (you only have to prove misrepresentation, the statute presumes you relied).
2.2.2. Specialised markets
Most big companies have many means of financing. Aside from the regular share markets, there are other makets: the bond market (obligations d'épargnes), the money market (less then 365 days, short-term paper program) or the derivatives markets.
The Canadian derivative market is based mostly in Montreal. Derivatives, also called "put or call options" (or "synthetics") are an instrument the value of which fluctuates in function or shares put without one having to own the share. Basically, it's a bet you place on the future value of a share: you create a contract that gives you the right to sell or buy your shares at a future date, at a fixed price. It's basically a bet that the price will go up (you'll buy) or down (you sell), and you'll make money if things unfold the way your predicted. The company issuing the shares has nothing to do with it. The "bets" can be about securities or commodities gas/gold/orange/overall, and range from the very simple to the very complex. It's often a sophisticated way of making money for the people who have a need for the underlying product. This originally started with farmers who wanted to protect the price of their crops. Or Tropicana who wanted to protect the price at which the oranges would be bought before the tornadoes.
2.2.2. Liquidity of a market.
What is the market liquid? This means how efficient and deep is that market. How easily can the market deal with the offer and demand? You don't have a liquid market if you have very very few people trading (because it will take time to find a taker), illiquid (!) market. Liquid market = taker(s) found in a second, no matter the size. Whatever you want to sell will get sold. Liquid market is good because more people = best (or more accurate) price, and whatever you want to sell will be sold. She calls it a virtuous circle: the better the market, the more people are attracted to it, the more liquidity, the better, etc.
3. The Actors
3.1. Market participants.
· Brokers and brokerage companies, whether real or electronic are the one who are authorised to put your orders on the markets. They are the professionals; they are licensed to do that. Otherwise, it'd be chaos.
· And the dealers, who buy or sell a security for its own account and at its own risk and then charges the customer a mark-up or mark-down.
· There are finally in large institutional shareholders, such as pension funds or mutual funds, who have billions of dollars to invest daily. They do a big pool for people who don't want to take decisions and make them for them.
3.2. The Ontario Securities Commission
The Ontario Securities Commission is continued as a corporation without share capital under the name Ontario Securities Commission in English and Commission des valeurs mobilières de l’Ontario in French.
– Section 3 of the OSA
Ontario is the larger, most active and best served market (partly because it has the TSX).
It first has a regulatory function (it makes rules, "legislation", policy), an enforcement function (after investigation, of course), and it's an adjudicator (a judge, or a bench, rather, usually three commissioner, at worst, seven). Of course, concerns have been raised as to the possible collusion between the commissioners making the rules and the ones interpreting them. The OSC is very sensitive to this type of criticism and tries to have the two departments as tight-proof as possible. This being said, there's a tension because the commissioners' expertise can always be a plus in the development of rules or understanding of the system as a coherent whole. This expertise explains the high level of curial deference that's given to the OSC decisions (see Pezim, Sears). If there more compartmentalisation, there'd be less expertise (and less deference).
On the staff side, the OSC has lawyers of course, but also accountants, an enforcement branch[3], an administrative branch, etc. There are various departments: capitals market (they verify the issuance), M&A, registration (real estate licence, etc.). The powers of the directors and executive directors are found in s. 6 OSA.
3.3. The Québec Securities Commission
The Commission des valeurs mobilières du Québec was revamped relatively recently. It is very different from the Ontario one. It follows more of a British model, and regulates the securities, but also the pension plans, the mutual funds, etc.
4. Market regulations
4.1. The point of having regulations.
A completely free market and communism have something in common, there’s one flaw: they involve human beings. Regulations are necessary to ensure that the market functions efficiently (to get a liquid market), to protect investors from unfair or fraudulent practises[4], i.e., to create confidence in a given market. See p. 8.
Up to a point (the very costly Sarbanes-Oxley…[5]), the most vigorous markets are the most vigorously policed (rule enforcement). There's tension between the desire for an efficient market and the fact that regulation is costly. And there's a balance between enough and too much regulation. There must be a balance between regulation and freedom. Regulations are there to prevent abuses, but too much regulation will choke the market, as compliance is quite expensive and slows transactions down.
4.2. The regulators: should they be market or State players?
4.2.1. The States
Securities being a form of property, they are of provincial jurisdiction (s. 92(13) CA67). This means there are thirteen different sets of regulation, one for each province and territory. This tends to scare investors away. Some sanctions are quasi-criminal (Wilder). This being said, there is an interaction with the federal level, mostly with the CBCA and federal statutes regarding fraud. Despite criticisms that it's inefficient and unworkable, it remains very territorial (though pretty much any link can lead to being called in that jurisdiction). The federal could take over the field because of the interprovincial nature of the trade (especially if the provinces don't agree amongst themselves). It hasn't very much done so (and it is unlikely it will[6]). Fortunately, the regulations are now more and more similar from province to province.