Securities Regulation 2005
Table of Contents
Introduction
Regulation
Provincial Regulation
National v. Provincial Regulator
Foundational Concepts:
Prospectus Process
Exempt Market Transactions
Continuous Disclosure
Corporate Governance
Insider Trading
Takeover Bids
Civil Liability
Enforcement
Introduction
Prospectus (stages)
- Preliminary (red herring)
- Get receipt from regulator
- Waiting period
- Register securities
- Start doing advertising
- Do “road shows” to get interest in offering
- Make revisions
- Haven’t decided on price at this point
- Final prospectus
- Distribute
Then becomes a public company:
- Reporting issuer
- Obligation to file reports and documents
- Need an auditor, lawyer
- Must hold annual meetings
- Deal w/ shareholders
- May want to issue dividends
- Need board of directors
- Corporate governance
- Management is now an insider risk b/c must not disclose or sell shares based on info
- Civil liability to public/ shareholders
If need more money can do secondary offering (Secondary Market)
-initial offering is Primary Market
-Secondary Market is b/n public
-Want deep secondary market and liquid
Registrants
-“gatekeepers”
-accountants, lawyers, broker dealers, sales people
Regulation
Pros and Cons of national regulation:
Con to decentralized reg
-if bad actor in one prov can move to another prov
Pro
-more tuned to specific market in prov (eg. tech, mining)
-“multiple laboratories” to run experiments to see what works best
Provincial Regulation
R v. W. McKenzie
does not matter where you are located, must register where you want to trade
F: securities broker out of Ont, investor from Man – buys securities – Ont charged w/ unlawfully trading in Man b/c not registered in Man – accused argued Man act didn’t apply b/c fed jurisdiction (interprov trade)
H:
-Man sec Act not designed to regulate interprov trade
-P&S (intent test) is not to regulate outside prov
-Can’t trade in securities in Man unless registered in Man (prov/prov tension)
A:
-increases power of provs to regulate what goes on in prov
-doesn’t matter where business is, must register everywhere want to sell securities
Quebec v. OSC (Asbestos)
regulator can reach outside its province to enforce a law that affects investors in their jurisdiction
-flip side of McKenzie case
F:
-const valid Act
-has effects outside region
I:
-can regulator reach outside jurisdiction
H:
-only law of Ont is the question in Ont
-it would be wrong if Ont had to figure out these other effects when enacting law
-Ont can enforce Act generally in its own prov
-Ontario can regulate Quebec co in Ont jurisdiction if co acting in Ont capital markets
National v. Provincial Regulator
Wise Persons’ Committee Report
-most ambitious proposal
-no longer opt-in
-invites constitutional clash
-components
- new securities legislation at national level
- new CSC (administration) run federally
- find common threads b/n provs regulations
- regulated by single CSC w/ nine representatives from different regions
- amendments to leg done through majority of provs representatives
- in Ottawa as opposed to Toronto
- new policy committee
- designed to address various concerns
- accountability
- more responsive to regional concerns and fed gov’t representation concerns
- various offices
-concerns
- whether it will happen
- passport system
WPC
-6 reasons why better than passport system (p. 73-74)
- policy development
- fees for jurisdictions centralized
- accountability b/c all regions components of system
- passport system not a significant improvement in regulation
Passport System
-described by Harris to have all advantages of WPC report
- single regulator contact
- local presence
- ease of implementation
-criticism
- doesn’t protect investors in place of trading (eg. case from last day)
Fortier (p. 75)
WPC
-whether Parliament has power to enact
- yes, fed trade and commerce
- must be of national concern
-want provs to agree
-if one or more provs don’t go along, do feds have power to use paramountcy
- Fortier says yes
-Multiple Access v. McCutcheon case is important
-Argument that feds and provs have joint jurisdiction
-McIntosh says will have another fed layer
How Securities Markets Structured
3 levels:
-Global
- Global capital markets have generated competition for capital
- Countries compete for global capital
- Canada is currently only 3% global
- Must be protected
- Must have efficient procedures in place
- William Hess
- Technology has provided cheaper access to capital markets
- Erasing boundaries of regional and national capital markets
- Permitted 24/7 trading
-National Scope
- P89-91 WPC benefits of national v. prov regulator
- Foreign investment – possibly should be national regulator
- Bond market mostly in cdn gov’t bonds
- Capital in Canada is very concentrated
- Small number of companies contain most capital
-Regional Markets
- Poonam Puri
- LICR’s (local infrastructures for capital raising)
- Alta for oil and gas, BC for micro-cap issuers, Ont for financial services
- Localized markets but not good enough reason for prov regulations b/c stocks trade nationally
- National v. centralized 84% of entrepreneurs and raising capital reside in same prov argument for centralized?
Primary Markets
-primary market transaction, called a distribution , takes effect where the issuer sells its own securities or sells them through the services of an underwriter
-eg. IPO
-Prospectus – document containing comprehensive disclosure
-Follow-on – raising additional capital
Secondary Markets
-in which shares and other securities are traded after being issued by the issuer for the first time
Marketplace Operation
-an exchange, a quotation and trade reporting system (QTRS), or an alternative trading system (ATS)
-refer back to p19-21 Numbering System for Policy Reformulation Project
- so many have a numbering system for these national instruments
Marketplace
ExchangesQTRSATS (National Instrument 21-101)
National Instrument 21 – 101 talks about exchanges, QTRS and ATS
Exchanges
-provides a listing function
-must enter into agreement w/ exchange
-guarantees a two sided market
-“market makers” ensure always a buyer for a seller
-make money on the spread (what they buy at and what they sell at)
-can impose fines, pull you from market, etc
QTRS (quotation and trade reporting systems)
-provides price quotations and reports
-can set own rules
ATS (alternative trading system)
-can’t provide quotations
-can’t set own rules
SRO (self-regulating organizations)
-required to maintain records
-can make rules and regulations
-eg. exchanges
National instrument 23-101
-sets trading rules
-eg. closing times (hard closes)
-“double jeopardy”
- if being regulated by prov and exchange, must follow exchange
To monitor people following rules (Exchange or QTRS):
-do it yourself
-farm it out to a regulation services provider
-ATS must farm it out to a regulation services provider (the rules set out in 23-101 – ie. not their own rules)
Market regulation services inc.
-regulation service provider
-“RS”
Regulation Service Provider (RS)
-regulatory outsourcing
-not independent actors
-enforcing rules exchanges and QTRS’s are giving them
-owned by TSX and IDA
Securities Regulators
-regulating the whole marketplace
-delegate to exchanges, QTRS and ATS
Other SRO’s:
-IDA (investment dealers association)
-MFDA (mutual fund dealers association)
IOSCO (international order of securities commissions)
-like the united nations of securities regulators
CSA (Canadian Securities Administrators)
-forum for different regulators to meet to talk about things like national regulation
-coordinative
-deal w/ securities regulators
-don’t have any powers
TSX (main exchange in Canada)
-senior equities (big companies)
-went public in 2002 (spun off its RS)
TSX Venture
-until 2001 was the Canadian Venture Exchange
-microcap and small cap issuers
-head office in Calgary now (was in Vancouver)
Bourse (Quebec)
-canada’s oldest exchange
-deals in derivatives
-derivatives
- futures, options
- Options
- Deal that you will buy or sell a stock at a particular date and price
- Futures
- Binds person to a price
- Used to hedge investments (balancing risk)
CNQ (canadian trading a quotation system)
-became an exchange in 2004
-aimed at early stage companies
-have market makers
-all automatic based on limit orders
NASDAQ Canada
QTRS
-there are no QTRS’s now
-there was one but now an exchange (CNQ)
ATS
-tons of them in the US
-eg. E-trade, Ameritrade
-in Canada Instinet
p. 112-122
Securities Regulators
Pearson v. Boliden
-securities laws like consumer protection laws
-if you are BC resident you can sue under BC law and bring action in BC
-means nothing for harmonization and passport system (MI 11-101)
-prov regulator has ability to protect their own
Chart (p. 117)
Key to note:
-Commission on top and then staff
Commission
-appointed
-make policy decisions
-ultimately responsible for all decisions regulators make
-does registration for companies, brokers, dealers
-can investigate (can supine documents, etc)
-strong public interest power (ie. can wade in if public interest concern)
-enforcement
-rule-making power
Staff
-lots of sections: enforcement, risk analysis, etc
-do the work of the commission
Mutual Reliance Review System (MRRS)
-as of today (sept 19, 2005) augmented by MI 11-101
-different securities regulators have reached agreement to have principal regulator system
-similar to passport system
-biggest problem: multilateral, not national (ie. Ont is not participating b/c don’t want momentum for passport system)
Distinction b/n regulation and punitive
-public interest power is regulatory and not penal
-protection of investors and efficiency of markets
-preventive in perspective and not punitive forward looking
Asbestos v. OSC
-prior jurisprudence
-s. 127
- seriousness and severity of the sanction
- effect of that sanction on efficiency and public confidence
- reluctance to use open-ended powers
- powers were preventative and not remedial
-found it was not justified
-if connection to your jurisdiction is not so strong then shouldn’t use broad, sweeping powers
-what does it say about harmonization?
- Anti-harmonization
- If reason to not use sweeping powers is b/c somebody else might say something different
-What does it say about investors? For minority shareholders?
- Not a good decision for them b/c they are not being protected by their own Act
- Said they were mislead
-OSC – it is an attempt to put the brake on things
Re Cartaway
-insider trading fraud case
-Cartaway was a mining co – announced a huge fined in Boisy Bay – share price soared overnight – insiders traded Cartaway shares made $5 million – find wasn’t real – share price went down to $1 from in the $20’s – securities commission hit them w/ the biggest fine
-Reason: general deterrence, protecting securities market (general interest power)
-Issue: can court use general deterrence to impose fine?
-S. 162 Securities Act
- Power to impose penalties up to $100,000
- Now it is $250,000
-R: endorse Asbestos case
- Find general deterrence is appropriate and maybe even necessary for prevention
RS (Market Regulation Services Inc)
-owned jointly by TSX and IDA
-rules UMIR (Universal Market Integrity Rules)
- developed primarily by TSX
- apply to exchanges and ATS’s
-follow insider trading, how the shares are trading, etc
-note: the securities commissions of the provs still look after prospectuses, etc
Clearing houses
-work w/ exchanges
-process trades
-validation – buyer has money in bank, etc
Financial professionals
- IDA, MFDA
CPAB
-regulate financial market professionals that make things run smoothly
-gatekeepers
Critiques
-4 initiatives
- Uniform legislation
- WPC
- Passport system
- BC Securities Act
Uniform Legislation project
-run by Canadian securities regulators (CSA)
-goal: a model Act or set of rules that provs can implement themselves
-talking about harmonization and not substantial change (not from ground up)
-platform piece of legislation b/c then can change as fast as capital markets change
- also, platform leg’n lets off steam b/n different prov rules
- different provs can then act w/ their own prov rules but still agree w/ platform leg’n
-similar to Uniform Commercial Code (UCC) in the US
-like to see
- ability to delegate to another regulator
- streamline registration system
- civil liability for secondary market participants
WPC
-will talk more about later
Passport System
-Sept 30, 2004 memorandum of understanding b/n provs except Ontario
-Newfoundland dropped out and new Brunswick joined
-MI 11-101
-Territories and PEI are participating but not signed on
-One stop shop for regulators only file prospectuses w/ one prov regulator
-Still have to pay fees to every prov and follow each prov’s rules
-The host prov regulator is still responsible for enforcement
-Host
- Where may be doing business other than in primary jurisdiction
- Still pay fees to all host regulators (provs)
-Primary
- Use indicators (head office location, where incorporated, where primary business centered) to determine who is primary regulator
-Requires some harmonization of prov laws
Note: (differ from passport system)
MRRU system worked for exemption for requirements
-could apply for exemptions
-narrower than Passport System (memorandum)
-Passport system is a mandatory reliance system (ie. once agreed, not supposed to opt out)
BC approach to securities law reform
-outcome based approach
-getting rid of detailed rules that have plugged up system
-streamlined back to first principles
-idea: rolling rules to see what works
-substantive overhaul of securities regulation
-based on same fundamental principles
-reduce cost of compliance and increase investor protection
-five major changes
- continuous market access
- when you issue securities for the first time must file prospectus but then not again
- creating code of conduct for advisors to replace detailed rules of procedure
- firm only registration (brokers, dealers, advisors)
- cost savings for firm
- as of Aug, decided not to do this! (the book is not up to date)
- ???
- increased enforcement powers
- fines are higher – want to be able to fine $1,000,000
- broader powers to ban people from being directors, etc
-people are worried that this may lead to less investor protection and not more
-may create less certainty for investors
- don’t know what you can and can’t do
- this system has a lot of vague wording (eg. “inappropriate”, “inadequate”)
Foundational Concepts:
-security
-trade
-distribution
-investment K
***Note: refer to “Essentials” notes
Subject to disclosure requirements:
-Must be a security, must be a trade, must be a distribution and must be a reporting issuer
SEC v. Howey
-SEC wanted to stop Howey from selling land and marketing product to public
-Howey – owns land
-Howey-Hills – services
-Investor could buy piece of land and can also get second K to service land and sell fruit for profit although did not have to get service K
-People invested in this in expectation of profit
-Co found customers through resort next door and through the mail
-Get under Fed umbrella by doing cross state activities like using the mail
-Issue: whether this whole sale and service K is considered an “investment K” which falls under securities regulation, s. 2(1)
-Analysis:
- Use broad “purposive” approach to protect investor
- Look at blue sky laws in the states
- Def’n (p. 193): K, transaction or scheme whereby person invests money in common enterprise and is led to expect profits solely from efforts of promoter or 3rd party
- Court: doesn’t matter if shares are evidenced by formal certificates or not
- Court: it is more than just buying fee simple in land
- Court: relative that investors were out of state, not farmers and expecting profit
- Court: does not matter that not everybody bought whole package, co cannot offer the package (security)
-Important: flexible way to interpret regulations to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits
-If you are going to solicit money from people you have obligations
-test for existence of investment K:
- a K, transaction or scheme, whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a 3rd party
State of Hawaii v. Hawaii Market Center
-“risk capital” case
-state law case
-not bound by Howey case b/c not interpreting fed law (Howey was a state decision)
-combination b/n co-op and “pyramid” scheme
-retail store catering to members needed to raise money so recruited founder members (distributors and supervisors)
-distributors must put in $320 for a sewing machine ($70 wholesale value)
-supervisors pay $820 for sewing machine and cookware set
-founder members get commissions and payments when others join
-Issue: is this an investment K?
-Court: Broaden def’n from Howey so that “solely” is not read so narrowly
-Court: Advocate a more purposive approach
-Look at:
- Statute – broad protection to investors
- Remedial purposes of Act – meant to be interpreted broadly b/c meant to fix a problem (if read narrowly then undermine purposes)
- Economic realities of transactions – more creative people get the more important it is to have broad def’n to catch them
-“investment K” the placing of capital or laying out of money in a way intended to secure income or profit from its employment in an enterprise
-K created whenever:
- Offeree furnishes intial value to offeror
- Portion of initial value is subject to risks of enterprise
- Initial value is induced by offeror’s promises of benefit
- Offeree does not receive right to exercise practical managerial control of enterprise
-How much involvement can you have before you fall outside of def’n?
- P. 199 no power to influence the utilization of the accumulated capital nor any authority over decisions which affect operation of enterprise
-Fixed returns on money – doesn’t matter whether fixed
Pacific Coast Coin Exchange v. OSC
-offer bags of silver coins
-buy on margin or not
-pamphlet comes w/ investment saying how risky it is and that it is an “investment” saying price of silver will go up and good hedge against inflation
-to get out of K must sell to co offering coins and they take a commission on both ends