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SECURITIES LAW EXAM SUMMARY

Introduction......................................................................................................................................2 Historical and Constitutional Issues, Objectives/Strategies of Regulation......................................4 The Structure of the Canadian Capital Markets...............................................................................4 Each province and territory has the constitutional ability to regulate capital markets within its own jurisdiction............................................................................................................................... 4 Overview of Regulators and Markets.............................................................................................. 6 Definitions........................................................................................................................................9 What is a reporting issuer?.............................................................................................................23 Ensures that companies with publicly traded shares (especially companies that have completed public offerings in other Canadian jurisdictions) may acquire the benefits and be subject to the obligations of reporting issuers in ON........................................................................................... 24 The Prospectus............................................................................................................................... 25 The Prospectus: Alternatives......................................................................................................... 32 The Prospectus: Civil Liability...................................................................................................... 33 Continuous Disclosure: Periodic Disclosure................................................................................. 36 Continuous Disclosure: Certification.............................................................................................38 Continuous Disclosure: Timely and Effective Disclosure Material Changes............................40 Continuous Disclosure: Civil Liability.......................................................................................... 43 Insider Reporting and Insider Trading I.........................................................................................46 Insider Reporting and Insider Trading II: Defences...................................................................... 50 Prospectus Exemptions.................................................................................................................. 52 Resale Rules and Control Distributions.........................................................................................57 Takeover Bids................................................................................................................................ 60 Takeover Bids: Defensive Tactics................................................................................................. 66 Enforcement and Public Interest Considerations...........................................................................70

Introduction
What are Securities? They are a vehicle for companies to raise capital. Two key features: o Business not under obligation to pay back the loan o The investor receiving an ownership stake in the company Both of these features deal specifically with shares. This does not apply to bonds or income trust units (which are still securities). What is Securities Law? Securities law is the law relating to the issuing of various types of financial instruments or claims, known as securities, by business or financial organizations to purchasers, with a view to raising capital for enterprises. Securities law sets out the legal requirements (and exceptions) placed on issuers in order to validly sell to purchasers, and the ongoing responsibilities of issuers. Purposes Codified in 1.1 of the OSA: 1.1 The purposes of this Act are, (a) to provide protection to investors from unfair, improper or fraudulent practices; and (b) to foster fair and efficient capital markets and confidence in capital markets o Fraud is reasonable, but is it reasonable to protect against unfair practices like excessive commissions or improper information disclosure? o New rules always cite this purpose as their justification, and this also provides guidelines for regulators when interpreting rules. Three main strategies of regulation: o Disclosure of information o Registration requirements o After-the-fact enforcement by regulators and investors themselves. Rules change constantly based on the policy objectives of the regulators. Securities law balances efficient capital-raising and the operation of efficient markets with comfort for investors that capital markets are a good place to make investments (section 2 of OSA) o Ontario Ministry of Finance Review of the Securities Act (2003) recommended that more principles be added, including promoting informed investors and facilitating innovation and competition. Regulators are a real force for change, which is different than corporate law. Securities Issues: While capital allocation makes up most of the market (97%), most rules and securities law arises from the context of capital generation. o Issuers are still involved in capital allocation, because issuers have ongoing disclosure obligations. Securities law must balance the expertise and knowledge of professional investors and the private inexperienced investors: o Securities law creates some exemptions to disclosure requirements when dealing with so-called accredited investors. o Pension reform has pushed individual investors to take a more active role in their pension investments (defined contribution pension employer wont guarantee a fixed amount for the rest of ones life provokes more interest in securities market) National scope of trading and multiple jurisdictions: o Most issuers in Canada report in multiple jurisdictions. All issuers are intraprovincial, if only because investors can come from any jurisdiction. 1/3 of issuers report in every Canadian jurisdiction. o Note that with the principal regulator instrument now in place, most issuers are reporting issuers since they now only have to comply with the rules of their principal regulator plus the Ontario regulator. Three Perspectives for Studying Securities Markets Page 4 Neoclassical Economic Analysis Basic building block of analysis: the individual acting rationally to maximize his own utility/preference and that it is rational for individuals to be driven for their own self-interest.

3 Two types of neoclassical economic analysis (from Trebilcock): o Positive Economics: (descriptive or predictive analysis) predicting the possible outcomes of policies on the assumption that individuals are motivated by rational self-interest to maximize individual utilities. o Normative Economics: (prescriptive or judgmental analysis) (welfare economics) asks whether a policy will make individuals affected by it better off in terms of how they perceive their own welfare (Pareto Efficiency and Kaldore Hicks Efficiency)

Behavioural Finance Page 8 Empirically, people do not always behave rationally. Behavioural approach is a more recent framework to reflect that people make decisions based on many criteria, not all rational. o Loss Aversion: Disposition Effect: Endowment Effect: Option Paralysis: HouseMoney Effect: Risk-Aversion Effect: Cognitive Dissonance: Mental Accounting: Socio-Legal Approach for Making Securities Laws CONDON WRITES ON THIS Socio-legal perspective on securities embraces a diverse set of normative and empirical approaches (consider markets as embedded in a set of social and cultural relations). For example, what is the difference between a securities market where a few wealthy individuals control the market or where there is a large dynamic market full of institutional investors? How do powerful groups in the system shape the overall system?

Historical and Constitutional Issues, Objectives/Strategies of Regulation

History Objectives of regulation are now to protect investors and foster fair and efficient capital markets, however earlier law was concerned only with protecting investors. The first comprehensive modern legislation came in Ontario in 1945. Influences: o First an English trajectory of full disclosure and private remedies. The American evolution went beyond disclosure and introduced a comprehensive licensing requirement blue sky legislation o We have seen a SHIFT from English influence to US influence (blue sky) and back o 1928 Ontario punished securities violations by fines or imprisonment, not civil remedies. Disclosure came back into prominence with 1944 changes o Next major change came in 1966 legislation, which was influenced heavily by the Kimber Report. This change heavily favoured disclosure requirements, both as a way to protect investors and to encourage efficiency. Constitutional Powers to Regulate Security Page 32 [in textbook] Case Name Mayland v. Lymburn Year 1932 Court Privy Council Holding Provincial securities legislation did not encroach on the federal legislative power with respect to criminal law; federally incorporated companies can be subject to provincial law Criminal powers are OK in a provincial securities act even if it covers the same ground as the criminal code, as long as this does not lead to an irreconcilable conflict (laws can operate concurrently) Push to provincial regulation (Mayland was sited with approval) Brokers were operating in Manitoba (by selling to a Manitoban resident from Ontario), and therefore were liable under Manitoba law for trading securities in Manitoba without being registered. A person can be liable even though he is not a resident of the province or does not physically enter the province to solicit trade. Action of accused was not intra-provincial trading (therefore not federal) Highwater mark for provinces : federal government has the power to regulate insider trading, but it is also valid for provincial securities to regulate insider trading concurrently (both sets of laws are intra vires). If both laws can be followed, paramountcy cannot be invoked. Double Aspect theory (affirmed in Global Case) When Quebec (or any other province) enters the capital markets of another province, it must abide by the rules of that province. Assisting foreign agencies properly falls under the 92(13) property and civil rights power of the province. Reciprocal cooperation with other agencies is appropriate because it will assist with provincial securities regulation, therefore the BCSCs actions were intra vires. Pith and substance of provision of BC is within BCSA authority and therefore intra vires. It is aimed and furthering the effective enforcement of domestic securities laws and as such falls within the provinces powers under s. 92(13) of Constitutional Act.

R. v. Smith

1966

SCC

R. v. McKenzie Securities

1966

Man CA

Multiple 1982 Access v. McCutcheon

SCC

Quebec v. OSC Global Securities v. BCSC

1992

ON CA

2000

SCC

The Structure of the Canadian Capital Markets Each province and territory has the constitutional ability to regulate capital markets within its own jurisdiction o The end result is that Canada has a disparate and fragmented system of regulation

5 Calls for National Regulator o White paper by Douglas Harris o Committee headed by Harold MacKay Wise Persons Committee to examine the structure of securities regulation in Canada Single regulator New Canadian Securities Act capital market regulation for Canada Takes into account the CSA USL project Regulations must be passed by majority of provinces Mandate of the Commission reflects the needs to foster fair and efficient capital markets, the importance of regulatory innovation, and the unique characteristics of Canadian capital markets o Constitutionality of a National Regulator L. Yves Fortier constitutional opinion Parliament has the constitutional power to enact the proposed act o General branch of federal trade and commerce power under s. 91(2) provides parliament with the strongest basis Provinces have the power to incorporate the Act and dissolves existing regulator bodies Parliament is not prevented from including a paramountcy clause that precludes provincial securities law in their entirety. o No caselaw to support this, however o MacIntosh and Choudry present the view that the WPC take on the constitutionality of a Natioanl Regulator is extremely liberal in that, provincial jurisdiction must be conceded or that the federal government must get the consensus from the main principal provinces to adopt a national regulatory framework. Both suggest that the provinces will be accommodated by the courts in typical Canadian comprise likely through overlapping jurisdictions with provincial laws governing in areas with high uniformity with fed law, and paramountcy of fed law in conflicting areas of securities law

Overview of Regulators and Markets

How Securities Markets are Structured: Primary Markets Primary market transactions, also called distributions, occur when an issuer sells its own securities or sells them through an underwriter. The securities must be previously unissued. o Private Placement is a sale of securities by the issuer directly to investors Securities in this scenario are not listed on the public market but still require a prospectus or a prospectus exemption. o IPO occurs when an issuer is first offering securities to the public. Even if the company is established with lots of public securities, if new securities are issued this still goes to the primary market as a distribution. Secondary Markets After an issuer issues securities through a prospectus offering, it becomes a reporting issuer and must comply with ongoing reporting obligations. o If shares came from a private placement, the value of the securities is determined by the buyer and seller in accordance with the restrictions of the exempt market. o Where shares came from an IPO, shares are normally traded on stock exchanges. Marketplace Operation A marketplace is either an exchange, a quotation and trade reporting system (QTRS) or an alternative trading system (ATS). Regulated by two national instruments: o NI 21-101 Marketplace Operation: NI exists to address the needs of ATS (3.1, 3.3) as well as the more traditional QTRS (3.2). o NI 23-101 Trading Rules: deals with specific trading practices by setting standards for best execution by dealers, establishment of trading hours, regulatory halts, prohibition of manipulation and fraud, audit trails. National Exchanges and Self-Regulatory Organizations Exchanges are key securities market participants and are considered self-regulatory organizations (SROs) and are recognized under NI 21-101 o The extent of an SROs sanctions is to de-list an issuer, while the OSC has much broader authority o An example of an SRO is the Regulation Services company that regulates the TSX. Canadas markets were consolidated in 1999. o The TSX assumed the role of the exchange for senior equities Now a for-profit publicly-traded company Market regulation is now delegated to Regulation Services (RS) operates at arms length. RS regulates actual trading (see below) While TSX formerly had governance requirements, these are now passed down from the CSA o Alberta and Vancouver exchanges merged to form the Canadian Venture Exchange (CDNX/TSX Venture) controlling junior equities (bought by TSX in 2001) o Montreal became the centre for derivatives trading in Canada (Bourse de Montreal) Derivatives are contracts (underlying issues like bonds, bankers acceptances, dollar, stocks indices, and commodities). Used for hedging. Derivatives have no tangible worth of their own, but derive value form the claim they give their owners to some other financial asset or security. The most common derivative contracts are options and futures contracts. All transactions are guaranteed by the Canadian Derivatives Clearing Corporation o Winnipeg Commodity Exchange is the national commodities futures and option exchange. o Other exchanges: the Canadian Trading and Quotation System (CNQ), Nasdaq Canada, and the Canadian Unlisted Board (not a trading system)

7 Quotation and Trade Reporting System (QTRS) A QTRS is an operating facility that permits the dissemination of price quotations for the purchase and sale of securities and reports of completed transactions in the securities for use of registered dealers. A QTRS can monitor and enforce their own requirements governing its members Alternative Trading Systems (ATS) An ATS is a computer-based system that automates the process of trading in securities. Systems can be continuous auction books, dealer markets, call markets, or anonymous matching networks using prices determined in the principal marketplace. o An ATS is an alternative to an exchange, and matches orders from buyers and sellers of listed securities using predetermined, established methods or rules. An ATS must enter into an agreement with a regulation services provider and its subscribers must also enter agreements that form the basis upon which a regulation services provider will monitor the trading activities of the ATS. NI 23-101 sets out the rules for an ATS: ATSs raise questions about market fragmentation and illiquidity, as well as long-term implications for the survival of independent capital markets in Canada. o Resistance to ATSs may be more about major Canadian financial players protecting their own interests than foreign control. The Current Canadian Regulatory Structure Provincial Statute (last major overhaul in 1978) (most mirror Ontario) o Canadas securities regulation are generally characterized as a closed system (distributions of securities are subject to regulation) but some provinces have open aspects under their legislative framework. Provincial Rules and Regulations (delegated authority from legislators under section 143 60 areas with power to regulate 1994 update created this power) o Regulators create draft rules, and interested parties have 90 days to comment on any rule changes (similar to US model) Transparency problem: most commentators are law firms / TSX commenting on behalf of clients. o Some critics recommend moving to a basket approach (no list needed) Policy Statements Canadian Securities Administrators (CSA) and National Instruments and Multilateral Instruments o CSA has developed 25 national instruments. Established the Mutual Reliance Review System (MRRS) NP 43-201 o MRRS allows the issuer to ask that one regulator act as principal regulator, which then provides comments and a decision on behalf of all the other regulators. o CSA also developed the System for Electronic Document Analysis and Retrieval (SEDAR) system, a national web-based filing system NI 13-101 and the System for Electronic Disclosure by Insiders (SEDI) o Uniform Securities Legislation: The USL is advocated by the CSA in its harmonization efforts. Key aspects of the USL: Ability to delegate decision-making to another securities regulator Streamlined system for inter-jurisdictional registration of firms and individuals Civil liability regime for secondary market participants. Streamlined securities act to allow for future flexibility and efficiency. Staff notices from OSC and CSA Self-Regulatory Organizations (SROs) o Investment Dealers Association (IDA), the Mutual Fund Dealers Association (MFDA), Canadian Depository for Securities (CDS), Canadian Investor Protection Fund, Canadian Public Accountability Board (for auditors) o Market Regulation Services Inc (RS) has the mandate to self-regulate the securities markets themselves by applying universal market integrity rules (UMIRS): Deals with prohibitions on deceptive or manipulative trading, short selling, and the requirement of best execution of a customers trade. RS owned in part by TSX, which may create conflict of interest though it is in the best interest of the market to operate with integrity and RS has rules to

8 preserve some independence. Appellate court decisions: Prominent cases include Pacific Coast v. OSC (1978), Pezim v. BC (1994), Asbestos v. OSC (2001), Cartaway (2004), and Global Securities v. BC (2000). Regulatory Decisions, Orders, and Rulings Internationally: International Organization of Securities Commissions (IOSCO) o Technology, new financial products, and fewer trade barriers have increased the complexity and pace of capital market transactions and have facilitated global securities trading o Competition is fierce: investors will only invest in markets with sufficient protection, and issuers who can sell in multiple jurisdictions will look for markets with efficient and low cost rules and regulations.

Administrative Law Issues: The level of review undertaken by the appellate courts of securities regulatory decisions. o The standards that court look to is a reasonableness standard (see Iacobucci) Is it problematic that the commission both investigates and prosecutes in an enforcement context, and also adjudicates on the issues (issue generally in administrative law)? o The SCC has repeatedly held that multi-functional administrative agencies are permitted if authorized by statute. However at issue is not whether the agencies are permissible, but whether it still gives rise to perceptions of unfairness. o OSC has tried to enhance the independence of adjudication. Commissioners are not allowed to adjudicate if they have had any role in the proceedings. o OSC established a fairness committee (chaired by Coulter Osbourne) in 2004 which overwhelmingly found need for bifurcation. However recommendation was wrapped up with the nationalization of securities law in Canada, meaning that bifurcation would only occur if nationalization failed. Case Name BC Securities Commission v. BDS Committee for Asbestos v. OSC Year Court Holding 2003 BC Deference of courts to regulators: there is no constitutionally-protected right to cross-examine a securities regulator (no violation of principles of natural justice) 2001 SCC Endorses broad powers that securities regulators have to intervene in the market in the public interest and court will only review commission decisions on the standard of reasonableness. 2004 SCC Deterrence is a reasonable objective and a justification of sanction by regulators. Reinforces deference to regulators

Re Cartaway Resources

Definitions
Three-Stage Test for Securities Regulation Is the item being bought or sold a security? If yes, law applies. Is the security being traded? If no, there are no registration or disclosure requirements. Does the trade amount to a distribution or offering of securities? If no, there is no need for a prospectus. Stage 1- is it a Security? Section 1(1) of the OSA definition (broad and open ended) security includes, (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, (c) any document constituting evidence of an interest in an association of legatees or heirs (Historic, no longer relevant) (d) Any document constituting evidence of an option, subscription or other interest in or to a security, (The option is a security itself, not just the asset that it derives from) (e) any bond, debenture, note or other evidence of indebtedness, share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription other than a contract of insurance evidence of deposit issued by a bank (banks have own rules) (f) any agreement under which the interest of the purchaser is valued for purposes of conversion or surrender by reference to the value of a proportionate interest in a specified portfolio of assets (g) any agreement providing that money received will be repaid or treated as a subscription to shares, stock, units or interests at the option of the recipient or of any person or company, (h) any certificate of share or interest in a trust, estate or association, (i) any profit-sharing agreement or certificate, (j) any certificate of interest in an oil, natural gas or mining lease, claim or royalty voting trust certificate, (k) any oil or natural gas royalties or leases or fractional or other interest therein, (l) any collateral trust certificate, (m) any income or annuity contract not issued by an insurance company, (n) any investment contract, (Definition that gives rise to most litigation. Courts take a purposive approach to look at the substance of a transaction) See Caselaw below (o) any document constituting evidence of an interest in a scholarship or educational plan or trust, and (such as RESPs) (p) any commodity futures contract or any commodity futures option that is not traded on a commodity futures exchange registered with or recognized by the Commission under the Commodity Futures Act Derivatives are not specifically mentioned in this definition, but all derivatives are either options, futures, or combination of the two.

Case Law on the Definition of Investment Contract OSA Section 1(1)(n) Note the court has the ultimate goal of getting people back their money and that the publics money was used in this case to finance the opening of the store (capital). Courts are moving more and more towards a policy and results-oriented application of the legal definition of securities. On Pacific Coast: reasoning runs the risk of being over-extended. Could any contract between 2 people could be a securities exchange? Laskins dissent does not think that test should be broadened based solely on some idea of policy, and prefers a narrower definition. Case Name SEC v. Howey Year Court 1946 US Supreme Court Holding Non-identified land in an orange grove is a security. Test for securities is Case defines an investment contract as (4part test): (1) investing money in a (2) common enterprise to (3) expect profits (4) solely from the efforts of the promoter or a third party.

10 Hawaii v. Hawaii Market Center 1971 Hawaii Supreme Court Pyramid Scheme. Broadens the Howie test for investment contracts. Now, the test is an investment in a common enterprise which is subject to the risks of the enterprise but is expected to generate profit. Most importantly, the investor does not receive the right to exercise practical control over the enterprise (risk capital test) Sale of silver. Case is more policy-driven and loose in its analysis (like Hawaii): If policy objectives of security act are triggered by a transaction, the law will apply. It is not whether the commodity futures contracts are securities (it is agreed they are not) but the nature of the relationship between PC and its margin customers. Investors were dependent on PC to properly hedge silver. On phantom stock options: OSC did not agree on whether PSOs where securities, but still regulated the transactions under its broad discretionary power to uphold the integrity of the markets

Pacific Coast Coin Exchange v. OSC

1978

SCC

Albino

1991

OSC

The current test in determing if it is investment property is by applying Howie as modified by Pacific Coast Coin

7) Interests in Property Section 1(1)(b) includes any document constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company. Title to or interest in ... property ... of any person or company the possible reach of this part of the definition is clear. If all that is required is a document constituting evidence of an interest in property, then a bill of sale is a security, a deed evidencing an interest in land, a mechanic's lien registered against a property, a mortgage, a vendor's interest in a vacuum cleaner bought on credit, and many other common types of interests in property. R. ex rel. Swain v. Boughner nothing more than a simple property interest must be required to create a security Barbe purchased a half interest in a pair of royal chinchillas from Boughner. A bill of sale recorded the sale of the interest to Barbe, which transferred a property interest and one-half the natural increase of said Chinchillas. A certificate was issued to Barbe that certified his ownership in the chinchillas and provided for the care of the animals and the disposition of the young. The Crown contended that the certificate constituted a security under what is now s. 1(1)(b) but at the trial level, the magistrate held that no security existed because the words "of any person or company" of (b) required Barbe to hold an interest in property belonging to another person, rather than actually owning the property (i.e., the chinchillas or a half interest in them) himself. Ontario High Court of Justice reversed this decision, holding that the "property" in question need not remain in another person or company, because the statute does not use the words "of 'another' person." Therefore any document evidencing an interest in property is a security (the Ontario High Court of Justice erred on this specific point the definition of security becomes far wider than is necessary or desirable to carry out the purpose of the statute). Reading the statute as if it says "another person" better comports with the fundamental concept underlying the meaning of the term "security," which is the furnishing of risk capital by one person to another. The final outcome in Boughner is correct b/c the interest (as evidenced by both documents furnished to Barbe) could have been characterized as a security under the "investment contract" part of the definition of security. Although Barbe nominally purchased only chinchillas, the agreement obligated Boughner to care for, and ultimately dispose of, the animals in a manner that both parties hoped would generate a profit to be split between them. Thus, Barbe was clearly purchasing more than a simple property interest. He was led to expect that a profit over and above his initial stake would arise from his investment. The purchase of the chinchillas plus an interest in the profits bore little difference in substance from a purchase of shares in the chinchilla ranch. R. v. Dalley same wide reading by ON CA [under this interpretation] almost any agreement becomes a security since nearly every such document affords evidence of title to, or interest in, some property. But where the meaning of the statute is plain, as it appears to be here, the Court must give effect to it

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Ontario (Securities Commission) v. Brigadoon Scotch Distributor (Can.) Ltd. preferable interpretation Warehouse receipts were sold to a variety of purchasers. The receipts nominally evidenced only the passing of title in casks of whiskey. However, each cask remained in the possession of the vendor for the purpose of aging and eventual sale on behalf of the owner to a whisky blender. This was anticipated to make a profit that would be distributed to the owners. Alleged that the warehouse receipts constituted securities within the meaning of part (b) of the definition. Court stated: The definition would not include documents of title which are bought and sold for purposes other than investment, for example, bills of lading and receipts for goods purchased for inventory or consumption purposes. Such an intention on the part of the Legislature can be inferred from the basic aim or purpose of the Securities Act, 1966, which is the protection of the investing public through full, true and plain disclosure of all material facts relating to securities being issued and without further explanation, the court held that the warehouse receipts were securities under part (b). Therefore properly interpreted, part (b) of the definition of security adds nothing to the meaning of "investment contract" The warehouse receipts were securities b/c the purchasers were led to believe that a profit would accrue over and above their initial investments. It is this element of investing for profit, and not merely an interest in property, that results in a characterization of the interest as a security. Because of the potential for an overly ambitious interpretation by securities regulators and courts, it would perhaps be best if part (b) were removed from the definition of security.

8) Profit-sharing Agreements Section 1(1)(i) includes any profit-sharing agreement or certificate. Few cases have been litigated under this part of the definition. In virtually every case in which it is alleged that there is a profit-sharing agreement, it is also alleged that the interest is a security by virtue of its being an investment contract b/c (1) profit sharing is at the heart of the test for an investment contract and (2) the case law dealing with investment contracts is much more detailed than that dealing with profit-sharing agreements Therefore little harm would be done by eliminating this part of the definition from the statute.

9) Investment Contracts a) Introduction Section 1(1)(n) includes any investment contract Considered to be the broadest part of the definition of security Most litigated part of the definition. The courts' guidance under this part of the definition is transposable to other parts of the definition of security. The Canadian tests for determining when an investment contract exists are the same as those adopted in the United States.

b) SEC v. C.M. Joiner Leasing Corp. The first U.S. Supreme Court case interpreting "investment contract".

SEC v. C.M. Joiner Leasing Corp. Facts: D, C.M. Joiner Leasing (Joiner), purchased a number of eases of potentia ! oi "bearing propert! in #e$as. #hese eases %ere conditiona on Joiner dri ing test %e s. #o raise the mone! to conduct the dri ing program, Joiner reso d some of its ease rights. &ift! purchasers bought parce s ranging in si'e from (.) to ) acres, at prices ranging from *) to *+) per acre %ith most purchases tota ing no more than *(). #he sa es so icitation contained the underta,ing that Joiner %ou d dri test %e s to determine the va ue of the properties. Issue: -hether the interests constituted securities.

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Ratio: i) The Importance of the Element of Economic Inducement, or the Creation of an Expectation of Profit The court recognized that Joiner was not merely selling leasehold interests. It was selling a hope of profit it is clear that an economic interest in the well-drilling undertaking was what brought into being the instruments that defendants were selling and gave to the instruments most of their value and all of their lure

ii) The Statutory Policy of Investor Protection The court in Joiner held that courts will construe the details of an act in conformity with its dominating general purpose, will read text in the light of context and will interpret the text so far as the meaning of the words fairly permits so as to carry out in particular cases the general expressed legislative policy. In this case, the legislative policy is one of investor protection. Thus, the Act must be interpreted to further that policy But circular to define an interest as a security, one must look to see if the person acquiring that interest is an investor. But must then ask who is an investor and an investor is a person who buys a security. References to the investor protection mandate emphasize that the interest in question must have an "investment" element to it and the investor must be led to expect that a return will accrue over and above her initial stake (the courts are not timid in interpreting the statute)

iii) Substance Governs, Not orm The defendant in Joiner argued that the interests could not be securities because, under Texas law, the lease assignments conveyed interests in real estate. It was argued, in other words, that something is either an interest in real estate or a security, but not both. The court rejected this reasoning, holding that the formal nature of the interest alleged to be a security is essentially irrelevant. The courts will be guided by substance, rather than form.

Conclusion: #hese interests constituted securities %ithin the meaning of the ..S. Securities /ct of +011. c) #he 2o%e! #est The test for "investment contract" was further elaborated

SEC v. W.J. Howey Co.

Facts: 2o%e! Co. raised mone! for the cu tivation of citrus crops b! se ing some of its acreage. 2o%ever, it %as not 3ust a sa e of a piece of rea estate b4c 2o%e! Co. urged potentia bu!ers to enter into a service 5 %ith 2o%e!" in"the"2i s, a subsidiar! compan! that cu tivated, harvested, and mar,eted the citrus crop (the! to d them that it %as not feasib e to invest in citrus groves %ithout a service 5). Most of the purchasers entered into these 5s. #he 5s gave 2o%e!"in"the"2i s a easeho d interest %ith possession. 2o%e!"in"the"2i s poo ed the fruit, so d it, and a ocated profits based on the output of each tract. #he purchasers %ere most ! out"of"state residents %ho ,ne% nothing about the citrus business. Issue: -hether the sa e of an investment contract %as invo ved in the transaction. Ratio: #he most %ide ! used test for the e$istence of an investment contract6 7/n investment contract for the purposes of the Securities /ct means a contract, transaction or scheme, %hereb! a person invests his mone! in a common enterprise and is ed to e$pect profits so e ! from the efforts of the promoter or a third part!8 (!oiner). 9rob ems6 %hat does it means to have a 7common enterprise8: the use of the %ord 7so e !8 i.e. %hat if the investor a so engages in efforts, ho%ever minima , to produce a profit; Four part test for the purchase of security (vs. commodity) for unusual forms of investments 1. Payment of money by investor 2. Expectation of profit 3. From common enterprise 4. Profit made solely through efforts of others Other relevant points:

i) The Character of the "uyers The buyers' inability to protect themselves was an important element. The court stressed that most of the buyers were out-of-state residents who knew nothing about the citrus business and these buyers were in need of the full and fair disclosure that would be furnished by compliance with the Securities Act.

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ii) #e$ree of %is& Howey argued that no security existed because the investment was not speculative or promotional in character (i.e. it was not high risk) but the court held that only some risk is needed to create an investment contract.

iii) Irrelevance of the Existence of 'alue Independent of the Success of the Enterprise Howey argued that the land sales were not securities because the land had value independent of the success of the enterprise as a whole but the court held that substance triumphs over form, and an interest may be a security even though it has value independent of the enterprise as a whole.

Analysis: #he test %as met6 the bu!ers %ere 7attracted so e ! b! the prospects of a return on their investment8 (interested in simp ! profits) b4c the! did not have access to the and e$cept %hen permitted and the! had no desire to occup! or deve op it themse ves. #here %as an e$pectation of profit < the investors provide the capita and share in the earnings. #here %as a common enterprise in that the! a bought fractions of an orange grove managed, contro ed and operated b! third parties. #he sa e of an investment contract %as invo ved in the transaction, triggering the registration re=uirement of the Securities /ct of +011. Conclusion: #he combination of the and sa es contract, the deed giving tit e to and, and the service contract %as a securit!. d) #he 2a%aii #est Other commonly used test of what interests constitute investment contracts.

Hawaii v. Hawaii Market Center Inc. (Supreme Court of 2a%aii) Facts: #he 2a%aii Mar,et Center (2MC) operated a retai store. #o raise mone! to carr! on business, 2MC recruited founder members, %ho %ere either founder distributors or founder supervisors. / distributor purchased *>? %orth of merchandise for *1(?. / supervisor purchased *+@? %orth of merchandise for *A(?. Both distributors and supervisors received purchase authori'ation cards that %ere distributed to potentia shoppers. Cn ! those %ith such cards %ere a o%ed to purchase merchandise at the store. &ounder members cou d ma,e mone! in t%o %a!s6 (+) if peop e to %hom the! had distributed purchase authori'ation cards bought merchandise, the members received a commission and (() b! signing up others as founder members. 2MC argued that the 2o%e! test re=uired purchasers to be 7 ed to e$pect profits so e ! from the efforts of the promoter or a third part!8. 2o%ever, founder members cou d generate profits through their o%n efforts, and therefore did not re ! so e ! on the efforts of a third part!. Issue: -hether the interests %ere investment 5 and therefore securities. Ratio: Different four part test (ris capital test < put at ris, and re ! on others to minimi'e and remove that ris,) for the e$istence of an investment 56 Payment of funds by investor an offeree furnishes initial value to an offeror Risk of loss a portion of this initial value is subjected to the risks of the enterprise (flipside of expectation of profits and broader) people here at risk b/c depending on competence of others so wouldnt lose money therefore narrows risk element (results-oriented process) if security, there is redress for investor Investment not subject to investors control the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise even though some effort was still shared b/w them and owners (watering down even a partial effort) Expectation of a benefit when invest money 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

Analysis: #he 2a%aii test ma,es states that not a of the 7initia va ue8 needs to be sub3ected to the ris,s of the enterprise (but sti consistent %ith 2o%e!). It a so sidesteps the prob em created b! 2o%e!Ds re=uirement that the purchaser be ed to e$pect profits 7so e !8 from the efforts of a third part!, b! re=uiring on ! that the purchaser have no 7practica and actua contro 8 over management decisions (focuses on the po ic! of affording broad protection to investors even if the! on ! participate to a imited degree in the operation of the business). Conclusion: #he interests %ere securities.

14
e) Canadian Cases Pacific Coast Coin Exchange of Canada v. Ontario (Sec rities Co!!ission" Facts: 9acific Coast Coin E$change (9C) so d si ver on margin (i.e., on credit < put up E and 9C %ou d give oan for rest). 9C did not intend to actua ! de iver the si ver (the! ,ept ess than %as necessar! to ma,e de iver! to a bu!ers). I.e. 9C so d a contractua right to receive si ver. #he bu!er ac=uired the option to demand actua de iver! of the si ver on giving 9C fort!"eight hoursD notice or the bu!er cou d demand a notiona sa e of her si ver (most customers did this), in %hich case the bu!er %ou d receive (or pa!) the difference bet%een the price of si ver %hen the contract %as entered into and the price of si ver %hen the contract %as i=uidated. -hen a contract %as c osed out, 9C %ou d co ect interest on the oaned portion of the purchase price, commissions, and storage charges. 9C %as e$posed to ris, b4c if the price of si ver rose, the! %ou d be iab e to pa! an! bu!er %ho chose to i=uidate the contract the difference bet%een the contract price and the price of si ver at the time of i=uidation, or to enter the mar,et, purchase the re=uired =uantit! of si ver, and de iver it to the bu!er. If the price of si ver rose dramatica !, 9C might be unab e to meet a of its bu!ersD c aims and, therefore, become inso vent. #herefore 9C purchased si ver futures (in a futures contract, the bu!er agrees to pa! a fi$ed price for a stated =uantit! of a good for de iver! on a stated date in the future), %hich protected 9C against a rise in the price of si ver. If the price of si ver rose, 9C %ou d sti be ab e to ta,e de iver! of the specified =uantit! of si ver at the fi$ed futures contract price. / futures contract ma! t!pica ! be reso d to a third part!, %ho then assumes the ob igation to pa! the price and receive the goods on the stated date. #hus, if the mar,et price of si ver rose, 9C cou d at an! time i=uidate the futures contract b! se ing it at a premium to a third part! (the premium ref ecting the rise in the price of si ver). 9CDs e$posure to the ris, of changes in si ver prices %as therefore hedged (i.e. the! he d offsetting ris,s) < if the price of si ver rose, 9C %ou d ose mone! on the contracts it had made to se si ver to its purchasers, but it %ou d ma,e mone! on its futures contracts. 9C distributed promotiona brochures that emphasi'ed the va ue of si ver not on ! as an investment, but a so as a protection against inf ation, %hich the! predicted a ong %ith the possib e return of a ma3or depression. 9C said %ere not ob igated to repurchase but 7never fai ed to8 rese in the past (5). 9C did not compi e and distribute a prospectus to its bu!ers. /s a conse=uence, the CF regu ators issued a cease trade order, banning further trading activit! b! 9C unti such time as a prospectus %as fi ed and distributed. 9C argued that the contracts it so d did not constitute securities %ithin the meaning of the CF egis ation (and therefore the prospectus re=uirement did not app ! because it attaches on ! to interests that are securities). Issue: -hether the interests so d b! 9C constituted investment contracts (and therefore securities). Ratio: #he SCC purported to adopt the 2o%e! test but app !ing the 2o%e! test itera ! %ou d i,e ! have resu ted in the finding that there %as no securit!. #he bu!ers %ere not ed to e$pect profits so e ! from the efforts of 9C b4c the price of si ver in internationa mar,ets, over %hich 9C had no contro , %as the ,e! factor in the bu!erDs return. #herefore the SCC accepted a modification of the %ord so e ! in the 2o%e! test, stating that to give a strict interpretation to the %ord so e ! %ou d not serve the purpose of the egis ation. !"olely#: $hether the efforts ma%e &y those other than the investor are the un%enia&ly significant ones' those essential managerial efforts $hich affect the failure or success of the enterprise( #he SCC a so refined the meaning of 7common enterprise86 an enterprise in %hich the fortunes of the investor are inter%oven %ith and dependent upon the efforts and success of those see,ing the investment or of third parties: the commona it! necessar! for an investment contract is that bet%een the investor and the promoter (there is no need for the enterprise to be common to the investors bet%een themse ves). The SCC made a number of other rulings re what constitutes an investment contract: In determining whether an interest is a security, U.S. cases on point are relevant because the policy behind the legislation in the two countries is exactly the same The definitions in the OSA are not mutually exclusive, but rather are catchalls to be given their widest meaning Securities legislation is remedial legislation to be construed broadly in the context of the economic realities to which it is addressed (purposive approach): if the particular set of legal rights and obligations under review was found to be a security, the investing public would be protected through full, true and plain disclosure of all material facts in a prospectus. Investors would also enjoy statutory rights to claim for rescission or damages if the prospectus contained a misrepresentation, and the offering could be made only through persons duly registered as dealers or salespersons under the relevant statute Substance, not form, governs the interpretation of what is a security The policy of securities legislation is full and fair disclosure wrt those instruments commonly known as securities

Analysis: #here %as investment of mone! here. #here %as a so a common re ationship4interest in deriving profit in coins < the! %ere investing co ective ! in a sing e enterprise ( o% test)6 7such an enterprise e$ists %hen it is underta,en for the benefit of the supp ier of capita (the investor) and of those %ho so icit the capita (the promoter). In this re ationship, the investorDs ro e is imited to the advancement of mone!, the manageria contro over the success of the enterprise being that of the promoter: therein ies the communit!8. #here %as a so ris,iness and contro b4c investors %ere dependant on 9C to ma,e an! mone! in ( %a!s (+) e$pertise in administering funds < must dea %ith funds appropriate ! in order to be ab e to pa! out in end G broad dependence b4c a %a!s one is a %a!s dependant in 5 for the 5 to be performed and (() de iver the si ver and act proper in si ver mar,et genera ! so there is something in the end therefore maintenance of so venc! and e$pertise in si ver mar,et < the! need to decide %hat futures 5s it needs to enter into %hich is ris,! and there is dependence to maintain contro i.e. the court

15
he d that the essentia manageria efforts %ere made b! 9C6 the resu t of the investment %as dependent upon the =ua it! of the e$pertise brought to the administration of the funds obtained b! appe ant from its customers i.e. if 9C did not proper ! invest the poo ed deposit, the purchaser %ou d obtain no return on his investment regard ess of the prevai ing va ue of si ver (the ,e! to the success of the venture is the efforts of the promoter a one). But 9C %erenHt setting price of si ver (no greater than retai stores) and no%here in their iterature to induce to bu! coins do the! sa! the! %i advise4give e$pertise to investors (donHt suggest the! are acting in trustee4fiduciar!). But individua assumed and re ied on fact that 9C %ere e$perts (e ement of reasonab eness). 9C said never promised e$pertise but bragged about their activities in si ver mar,et in the past and made c ear to investors that no other e$change %ou d purchase4ma,e good (no a ternative if didnHt se bac, to 9C < dependenc!) therefore se ing them a commodit! (9C argues). Conclusion: #he 2o%e! test app ied and the interests %ere investment contracts (the 2a%aii ris, capita test %ou d ead to the same resu t). Commentary: Dissent (Chief Justice Laskin) the interests were not securities. The source of the buyers' risk was not the quality of the management brought to the project by PC, but the market risk inherent in the price of silver. The only difference between buying from PC and buying silver in the spot market was a concern over PC's solvency. Laskin C.J. would have held that a concern over the solvency of the enterprise is not enough to render the interests securities. All that distinguished the scheme in question from a purchase of silver in the spot market was solvency risk. And, if solvency risk is enough to render an interest a security, it is difficult to know when to stop finding that particular interests are securities (every commercial K to buy and sell involves a dependence that the other side will be solvent and able to fulfill their side). The degree of risk in these interests that would be deemed securities would likely be small, and requiring a prospectus/exemption would be too costly relative to the benefit to be obtained. In the Pacific Coast case, the sums of money involved and the risk taken by the purchasers were highly significant and therefore there is a greater need for the application of the securities legislation. Also, PC attempted to induce investors to part with their money by making exaggerated and inflammatory, if not simply irresponsible, claims about the future of the financial markets. Policy underlying the legislation: investor protection. The more a court or administrator perceives that capital contributors need protection, the more likely it is to find the interest to be a security. The amount of money involved, the degree of risk taken, and the likelihood that contributors of capital will be taken advantage of by promoters of the scheme all play a role in this regard. The net benefit to be achieved by applying the regulatory apparatus (i.e., the benefit less the cost) will also likely be a factor. While a court will rarely, if ever, make explicit reference to all, or indeed any, of these factors, it is beyond doubt that they will operate sub rosa, whether consciously or unconsciously. Predicting whether an interest will be considered a security thus involves two levels of analysis. One is an avowedly legal analysis, which will be played out in the context of the tests that the courts have enunciated for the meaning of the term security. The other analysis takes place within the legal subtext, which includes those things that influence a judge to make a particular finding, but which are not explicitly referred to in the judgment. A last word. At the invitation of the parties, I have examined the facts in the sole light of the Howey and Hawaii tests. Like the Divisional Court, however, I would be inclined to take a broader approach. It is clearly legislative policy to replace the harshness of caveat emptor in security related transactions and Courts should seek to attain that goal even if tests carefully formulated in prior cases prove ineffective and must continually be broadened in scope. It is the policy and not the subsequently formulated judicial test that is decisive

))) *hat if +here Is ,o -"ecurity:- .oes the /"A Apply0 The application of various provisions of the OSA turn on whether there is a security. In our view, this is entirely appropriate. The OSA was meant to deal with securities, not with consumer protection. Securities regulation covers five major areas: primary market offerings, secondary market trading, activities of market professionals, insider trading, and take-over bids. It is implicit that a condition precedent to the operation of the OSA is the presence of a security. This is clearly true in relation to primary market offerings (e.g. Sunfour). If what is being offered for sale is not a security, the prospectus requirement has no application. The presence of a security is also a condition precedent for the regulation of secondary trading. E.g. only reporting issuers are subject to the continuous disclosure requirements of the OSA and reporting issuers are those companies

16
that have issued securities to the public. The class of persons who must register under the OSA is limited to those who are engaged in trading (s. 25(1)), which involves the trading of a security. The application of the take-over bid (s. 89(1)) and insider-trading provisions (ss. 76(1, 2), 134) depends on the presence of a security. The securities regulators also have jurisdiction even in cases that do not involve a security arises from one of eight "public interest" powers empowers the OSC to make a variety of orders "if in its opinion it is in the public interest to make the order or orders." (s. 127(1)) A case in which one of the public interest powers was applied despite the absence of a security is

Re Albino
Facts: Iio / gom set up an incentive p an for its CEC, / bino, under %hich / bino %as notiona ! issued a certain number of shares (units of phantom stoc,) of I/. / bino he d an option to designate a date upon %hich the actua price of the compan!Ds stoc, %ou d be compared to the price of the stoc, %hen the phantom stoc, units %ere issued. #he difference %as to be a%arded to / bino in cash. / bino a eged ! possessed confidentia information that %ou d, %hen made pub ic, impact negative ! on the compan!Ds stoc, price (materia change to the detriment of I/). / bino de a!ed pub ic disc osure of this information unti after he %as ab e to e$ercise his phantom stoc, options, a eged ! in order to enhance the va ue of the phantom stoc, units. CSC staff as,ed the CSC to find that / bino had engaged in insider trading. Issue: -hether 7phantom stoc, units8 constitute securities (not bu!ing4se ing securit!, 3ust getting a price difference). Ratio: Commissioner Blain concluded that the insider-trading provisions had no application because the phantom stock units did not constitute securities. Commissioner Salter would have found that the units were securities because they were derivatives. Commissioner Hansen declined to decide the issue of whether the phantom stock units were securities, although her reasons suggest that had she decided the issue, she would have sided with Commissioner Blain. Thus, only one of three commissioners was prepared to find that the interest in question was a security. Hansen and Salter took the view that the OSC had the jurisdiction to make an order under s. 127 denying Albino trading exemptions in Ontario (denies the benefit of the registration (s. 34), prospectus (ss. 71, 72) and take-over bid (s. 92) exemptions). They held that the jurisdictional test for the issuance of a public interest order is not whether there is a security, but whether the transaction exhibits a significant connection to the capital markets of Ontario.

Analysis: -hether the phantom stoc,s constituted securities6 1lain: Phantom stock plans, such as the Incentive Plan, cannot be said to be a document, instrument or writing commonly known as a security They are not documents constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company b/c under the Incentive Plan, while the amount to be paid by Rio Algom is not known until encashment, it does nevertheless represent a debt in the sense of being an obligation of Rio Algom to pay an amount ascertainable upon encashment. The fact that the amount to be paid is determined from the market price does not provide, a sufficient nexus with the capital market to say that the situation is different from the other type of compensation arrangement referred to above. This is simply the yard stick to determine Rio Algom's money obligation under the Incentive Plan and is basically no percentage of profits or sales The Incentive Plan is not a security under the general section itself (the non-exhaustive "security includes") b/c if the Legislature, in an area as managed and controlled as security trading, has deliberately chosen not to define a term which, admittedly, embraces different kinds of transactions, of which some are innocent, and prefers to rest on generality, I see no reason of policy why Courts should be oversolicitous in resolving doubt in enlargement of the scope of the statutory control (Pacific Coast). However, Blain did hold that Albinos conduct was reprehensible: the conduct of Albino cannot be condoned. It seems clearthat he manipulated the time of the disclosureto his own advantage so that this news was not made public until the window had opened for encashment of award units under the Incentive Plan

"alter: Jiven the c ear and c ose re ationship bet%een Iio / gom common shares and Iio / gom a%ard units, the atter is proper ! seen as a derivative of the former, shou d be c assified as a securit! and so regu ated. Conclusion: #he phantom stoc, units did not constitute securities. Commentary: Broad vie% of CSCHs 3urisdiction but supported < the regu ators and courts ta,e the vie% that the pub ic interest po%ers ma! be invo,ed in the absence of a breach of an! feature of the CS/, ru es, regu ations,

17
po ic! statements, notices, documents, or e$pressed vie%s of the CSC. # e$ec (Sa Ma%este d Chef" v. Ontario Sec rities Co!!ission (CF C/) Ratio: Constitutiona issue of %hen the pub ic interest po%ers ma! be invo,ed < not even a transactiona ne$us to Cntario is re=uired to trigger CntarioDs constitutiona 3urisdiction. / that is re=uired to invo,e the pub ic interest po%ers, as a matter of constitutiona a%, is that the transaction have an effect on Cntario shareho ders sufficient to pre3udice the pub ic interest. #his reasoning %as subse=uent ! endorsed b! the Supreme Court of Canada in a subse=uent case arising from the same set of facts. Although the correctness of this decision may be questioned, it nonetheless represents the current state of the law. Combining Albino and Asbestos, it appears that the public interest sanctions in the OSA may be invoked even where there is no security, and even where the transaction in question takes place outside the jurisdiction, so long as the transaction has a prejudicial impact on Ontario security holders.

)2) .erivative "ecurities Derivative securities usually consist of some combination of options and futures contracts. An option contract is a contract that gives the holder a right to buy or to sell an underlying asset or interest that typically can be exercised either on or before a certain future date. E.g. a "put" option allows the holder to insist that another person purchase the optioned securities from the holder at a certain price (the "strike" or "exercise" price) on or before a certain date. Another commonly used option is a "right," which gives the holder the option of purchasing the securities of a particular corporation (directly from that corporation) on or before a certain date. A futures contract obligates one party to the contract to sell and the other party to buy a stated quantity of a good on a future date for a stated price. The name "derivative" security originates from the fact that the value of the instrument is derivative of the value of something else, which is generally called the "underlying interest." E.g. in the case of a silver futures contract, the underlying interest is silver. The value of the futures contract at any point in time depends on the price of silver when the time comes for delivery. Those who trade in silver futures contracts make forecasts of the future price of silver and adjust what they are willing to pay for the futures contract accordingly. Some derivative instruments are clearly securities within the meaning of the securities legislation put options and rights are both instruments commonly known as securities (s. 1(1)(a)); a right also confers an option to purchase other securities, which again qualifies it as a security under the OSA (s. 1(1)(d)); a call option is also clearly a security (s. 1(1)(a, d)). Put and call options constitute "exchange traded" derivative securities typically traded over the Canadian Derivatives Clearing Corporation and are subject to regulation by both the securities regulators (ss. 76, 134) and the exchange over which they trade (no controversy b/c clearly securities and those who buy and sell them are unsophisticated retail traders) Controversy "over-the-counter" (OTC) derivative securities privately negotiated contracts that are typically entered into between sophisticated parties such as financial institutions (banks, trust companies, insurance companies, pension funds, and mutual funds), securities dealers, large corporations, utilities, and governments (although for the sake of convenience, the International Swaps and Derivatives Association (ISDA) has formulated standardized documentation for trades in OTC derivatives, the terms of OTC derivative transactions remain subject to individual negotiation). Derivative contracts are most frequently entered into to hedge risk. E.g. a corporation situated in Canada, but selling most of its product in the U.S., is subject to exchange rate risk. If all its sales contracts require payment in U.S. dollars, the value of these contracts falls if the U.S. dollar falls relative to the Canadian dollar. The company may wish to hedge this risk by buying derivative products whose underlying interest is the value of the Canadian dollar vis-a-vis the U.S. dollar, so that if the value of the U.S. dollar falls relative to the Canadian dollar, the value of the derivatives contract rises. A swap contract is the most common form of OTC derivative (but questions about whether such interests constitute securities) e.g. (in practice, swaps are commonly entered into with financial intermediaries, rather than between two end-users) Company A has outstanding debt obligations with fixed interest payments. Company B has outstanding debt obligations with interest payments that float with the prime rate. Each contractually "swaps" its interest obligation with the other. Under this arrangement, each company will continue to pay the interest due on its own debt obligations; however, each is obliged to pay to the other any difference between its own interest obligation and the other's. E.g. company A and company B are both obliged to pay their creditors $1,000 in interest per period when they enter the swap. Interest rates then fall such that in the next period, company B must pay its creditors only $500 in interest while company A, with fixed interest payments, remains obliged to pay $1,000. Company A pays its own creditors the $1,000 that it owes them, but is

18
contractually entitled to collect $500 from company B. This is because, in the swap, company A agreed that it would notionally pay company B's creditors, and company B agreed that it would notionally pay company A's creditors. In each period, a "netting" or settling-up occurs between the two companies that puts each company in the same position it would have been in had the two companies actually paid the interest on each other's debt. Is there a security in this transaction? When the definition was formulated, few derivatives existed, and many derivatives, such as swaps, were unknown. Policy of the statute - the protection of investors often impossible to determine who is the vendor of the "security," and who is the "investor," in order to determine who needs the protection of the OSA. As noted above, the parties to a swap arrangement are typically financial institutions, corporations, and governments. All of these are sophisticated parties that generally do not require the protections furnished by securities legislation. OSC proposals for regulating OTC derivatives seek to regulate transactions in derivatives on the basis of whether the parties to such transactions are in fact sophisticated traders capable of protecting their own interests or whether parties are in need of protection (e.g. where both parties to the transaction are "qualified parties," neither the prospectus, registration requirements, nor any other part of the legislation apply under the draft proposal) reflect a purposive approach to securities regulation (begin with the purpose of securities regulation - the protection of investors - and attempt to construct a regulatory structure that serves that overriding purpose). But the proposal does not clearly resolve the issue of whether derivative instruments, such as swaps, are securities. The introduction to the proposal notes that amendments made to the OSA in 1994 (which gave the OSC the power to make rules) conferred upon the OSC the power to make rules: Regulating or varying this Act in respect of derivatives, including, i. providing exemptions from any requirement of this Act ii. prescribing disclosure requirements and requiring or prohibiting the use of particular forms or types of offering documents or other documents iii. prescribing requirements that apply to mutual funds, non-redeemable investment funds, commodity pools or other issuers (s. 146(1)35) The OSCs proposal suggests: The passing of [the above provision] permits the Commission to implement a regulatory regime for OTC derivatives that it considers appropriate, without regard for artificial distinctions as to whether particular derivatives transactions constitute trades in securities The provision in question is drafted very broadly and appears to give the OSC carte blanche in regulating instruments that may be regarded "derivatives." The drafting is defective in at least two ways, however. First, the OSA does not define "derivatives." It is left to the OSC to determine what it shall regulate as derivative instruments. This cedes an overly broad discretion to the OSC. Second, and perhaps more serious, as noted earlier in this chapter, all the key provisions in the legislation apply only to instruments that are "securities." Thus, the application of existing securities law requirements to derivatives is left in doubt. Given the ever-increasing importance of derivative transactions to the economy, this uncertainty should be clarified by further legislative amendment.

Stage 2 is it a Trade? Page 211 If there is a trade, the trader typically has to be registered (OSA s.25) A trade has five main components (from definition in OSA section 1(1)): o (a) Sale for valuable consideration: Issues: why sale is included and not purchase (what does this mean for takeover bids?), and why there must be valuable consideration (what about gifts or corporations that issue stock dividends)? Starting assumption is that there is an asymmetry of information between buyer and seller. Protecting investors means regulating sellers. What about insider trading? What if you purchased securities based on insider information? Insider trading rules (see section 76) govern these. Important to note that using a security as collateral for a debt is not a trade. o (b, c) Trades by professionals: consistent with policy objective of controlling access to the activity of professional trading. o (d) Trades by Control Persons (for the purposes of giving collateral for a debt made in good faith note how this doesnt apply to non-control holders) Note that pledging by non-control holders is specifically excluded based on the assumption that control persons have superior access to information Control persons are defined under distribution o (e) Acts in Furtherance of a Sale: greatly extends the scope of the definition of trade: includes providing a list of names of prospective securities purchasers, or advertising an IPO. Regulation of pre-sale activities helps regulate the markets.

19 Jurisdictional Issues in relation to Trading deals with issues of whether solicitations of all kinds, including via the Internet, fall under the definition of trades. o There are some exceptions to the definition applying when the Internet site makes clear a disclaimer that the local jurisdiction of the investor is not involved in regulation of the trader. These disclaimers are contentious.

Step 3 is there a Distribution? Once it is determined that there is a security and a trade, the next question is whether there is a distribution (or offering in BC). o A prospectus is necessary if shares are being distributed (OSA, s.53) Section 1(1) of the OSA: distribution, where used in relation to trading in securities, means, o (a) Securities Not Previously Issued a person or company offering a security for sale that has not previously been offered for sale constitutes a distribution in Ontario o (b) Reissue of Securities If the issuer reissues securities this is also a distribution. Somewhat of a moot point in Ontario, since corporate law requires that a corporation that buys back shares cannot hold tem for resale and must cancel. o (c) Sales of Securities by Control Persons sales by control persons are considered distributions (even though securities have been previously issued by the issuer): (1) a control person may control management and have better access to information than the average investor, (2) a large sale could alter the share price of the securities, and (3) the control person could be part of the success of the enterprise, and this change should be made known to all investors. A control block of shares is an amount that enables the holder to materially affect the enterprise, and does not have to be actual control. A holding of more than 20% of the voting securities is deemed to represent a control block unless there is evidence to the contrary Less than 20% can still be a control block if there is qualitative evidence that this controlling person affects materially the enterprise. A control block holding does not need to sell its entire stake to trigger a distribution: they need only sell a portion of their holding. o (d and e) are of historical interest, and not really relevant to our purposes. o (f) Resale of Securities Awkward provision, where a resale is deemed a distribution when the original issuance was under a prospectus exemption. What is a Reporting Issuer? A reporting issuer is responsible for continuous disclosure after a security is issued to the public. Section 1(1) of the OSA: reporting issuer means an issuer, o (a) Securities Issued Under a Predecessor Act corporations that issued voting securities prior to the current act coming into force and obtained a prospectus receipt o (b) Obtaining a Receipt for a Prospectus the most common definition of a reporting issuer. Note that it is only a requirement for a prospectus receipt to be given, not for the actual securities to be distributed. A distribution is only allowed once the OSC issues a receipt. o (b.1) Exchange Takeover Bid: closes a loophole where a company would buy an inactive company that was an RI to avoid being a reporting issuer itself. o (c) Listing on a Recognized Stock Exchange note that only the TSX is recognized by the OSC for the purposes of this definition. Famous example: Bre-X qualified as a reporting issuer in Ontario without ever qualifying a prospectus in the province (loose standard) o (f) Regulatory Power to Deem Issuers to be Reporting Issuers newly acquired OSC discretionary power. Used to deem reporting issuers in other Canadian jurisdictions to be reporting issuers in Ontario where Ontario residents access their securities (or when issuers securities trade on exchanges not recognized by (c) in the Ontario definition) even though the issuer has never issued a prospectus in Ontario. That the commissioner as deemed to be a reporting issuer under section 83.1 Key Concepts behind Securities Regulation Efficiency

20 Often linked with cost-benefit analysis, it is efficient to engage in activities where the benefits outweigh the costs. Many securities laws and policy (like disclosure) are justified by efficiency arguments. Efficiency is used to justify reduced government interference and also strict disclosure requirements. o Efficient Market Theory (EMT) explains why it is difficult to beat the market. Relevant new information is inherently unpredictable (otherwise it wouldnt be new), therefore stock prices fluctuate randomly (though not arbitrarily) based on the information (which is absorbed into the stock price almost instantaneously). o Behavioural finance theorists and even EMT theorists have recently begun to challenge some of the presumptions of EMT. o Modern financial theorists referring to EMT, they generally have in informational efficiency

Materiality Sets the threshold that distinguishes information that is legally disclosable from that which isnt. If information is material, it must be disclosed. The current statutory standard for materiality in Canada is the market impact test that is, information that should be disclosed is information that would affect the price of value of the issuers securities, while in the US it is what the reasonable investor would consider relevant in making an investment decision.

Value Commonly the price at which a security is trading is not the same as its value. Financial experts use several techniques to value shares: o Dividends: the value of shares of common stock is best thought of as a function of the dividends that the corporation can be expected to pay out over its life. o Earnings: To the extent that earnings are retained and invested by the company, the value of the firms assets and earnings and capacity to pay dividends should increase.
*3A+ I" A +RA.40 Securities law is primarily transaction based i.e. it focuses on specific commercial transactions (the most fundamental being a trade in sec Section 1(1) trade: (a) any sale or disposition of a sec for valuable consideration, whether the terms of payment be on margin, installment or otherwise, but does not include a purchase of a sec or, except as provided in clause (d), a transfer, pledge or encumbrance of sec for the purpose of giving collateral for a debt made in good faith, (b) any participation as a trader in any transaction in a sec 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 sec, (d) any transfer, pledge or encumbrancing of sec 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

5a) !Any "ale or .isposition for 6alua&le Consi%eration# Definition is not exhaustive (includes) Indicates that the OSA regulates sellers of sec, not purchasers Exempts gifts or other gratuitous dispositions this is b/c of the investor protection rationale of the legislation (if the sec are given rather than sold, there is little or no danger that the donor will take advantage of the donee) Valuable consideration can take many forms therefore an issue or transfer of sec could constitute a trade even in cases where the recipient does not appear to be paying for the sec at the time of the transaction

21
5a an% %) .efinition of +ra%e 47clu%es 8ost "hare Ple%ges Sec such as shares are assets that can be used by owners as collateral for debt obligations a common method of granting a security interest in a share or other corporate sec is a pledge A pledge involves the transfer of the sec to the lender and when the loan is repaid the sec are returned to the borrower. If the loan is not repaid, the lender is entitled to realize on its security The OSA did not want to restrict the ability of sec holders to use the equity in their sec as loan collateral therefore pledges are excluded from the definition of a trade (s. 1(1) trade (a)) 2 exceptions: 1. The debt owed by the borrower to the lender must have been incurred in good faith i.e. people cannot attempt to avoid the application of the OSA by disguising a sale transaction as a secured-lending transaction 2. A pledge constitutes a trade if the grantor is a control person (s. 1(1) trade (d)) Control person is not defined in the Act Control person distribution (Rule 14-501) Control person (s. 1(1) distribution (c)) Generally speaking holder of a significant block of voting shares of an issuer The OSA treats control persons as though they were the issuers of the sec b/c it is assumed generally that the people who control corporations or who have the power to materially influence control have special access to corporate information that is not available to smaller, public investors OSA is not intended to make it impossible or unduly burdensome for control persons to pledge or otherwise encumber their sec but they are kept within the definition of trade to ensure that they are subject to the Acts rules governing the use of material nondisclosed information

5& an% c) Participation as a +ra%er: Receipt of an /r%er &y a Registrant Trading includes more than simply selling sec: (b) any participation as a trader in any transaction in a sec 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 sec Registrant sec market professional who must register with the sec regulators before they may ply their trade (generally only play a facilitative role in consummating a purchase or sale of sec) A registrants activities are defined as trades b/c of the policy rationale of the legislation in order to adequately protect buyers of sec, it is insufficient to regulate only the actual sellers market professionals who advise sellers participate in negotiating and structuring the terms of the sale and the activities of professional traders can have a critical impact on the functioning of the capital markets protection of buyers, and of the markets generally, requires that market professionals be regulated

5e) Acts in Furtherance of a +ra%e Most important part of the definition (e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the other activities constituting a trade Soliciting a purchase prior to an actual sale is a trade (ss. 25(1)(c), 65(2), 68) e.g. as soon as a prospective seller phones another person with a view to selling sec, the prospective seller engages in trading, whether or not the phone call results in a sale Policy rationale of the legislation the legislation is not merely reactive but it also allows the regulators to step in to prevent harm before it occurs

+ra%es +hat Are ,ot .istri&utions The regulation of primary market activity attaches only to a trade that constitutes a distribution of sec but a trade that is not a distribution is still subject to regulation any person engaged in trading must register with the sec regulators, either as a dealer or an advisor unless an exemption from registration applies Registration requirements ensure that professionals engaged in sec market activities attain minimum standards of integrity, competence, and financial soundness

22

*3A+ I" A .I"+RI19+I/,0

Section 1(1) distribution: (a) a trade in sec of an issuer that have not been previously issued, (b) a trade by or on behalf of an issuer in previously issued sec of that issuer that have been redeemed or purchased by or donated to that issuer, (c) a trade in previously issued sec of an issuer from the holdings of any person, company or combination of persons or companies holding a sufficient number of any sec of that issuer to affect materially the control of that issuer, but any holding of any person, company or combination of persons or companies holding more than 20% of the outstanding voting sec of an issuer shall, in the absence of evidence to the contrary, be deemed to affect materially the control of that issuer, (d) a trade, by or on behalf of an underwriter in sec which were acquired by that underwriter, acting as underwriter, prior to the 15th day of September, 1979 if those sec continued on that date to be owned by or for that underwriter, so acting, (e) a trade by or on behalf of an underwriter in sec which were acquired by that underwriter, acting as underwriter, within 18 months after the 15th day of September, 1979 if the trade took place during that 18 months, and (f) any trade that is a distribution under the regulations, and on and after the 15th day of March 1981, includes a distribution as referred to in ss. 72(4,5,6,7) and also includes any transaction or series of transactions involving a purchase and sale or a repurchase and resale in the course of or incidental to a distribution Policy of OSA underlies the meaning of distribution protecting members of the investing public by ensuring that buyers receive full disclosure of all material facts relating to a given sec before purchasing that sec Distributions are trades in sec in which the information asymmetry b/w buyer and seller is likely to be at its greatest, with buyers having the greatest risk of being taken advantage of If a trade is a distribution, the issuer is required to assemble, publicly file and distribute to all buyers a prospectus (s. 53) A prospectus is highly detailed and expensive to prepare and its purpose is to ensure that those who are asked to contribute capital to the corporation have sufficient information with which to make an informed investment decision

!.istri&ution# Inclu%es +ra%es 4ffecte% in : Circumstances: )( 5a an% &) +ra%es &y Issuers Any sale by an issuer is a distribution to which the prospectus requirement applies (ss. 1(1), 53) b/c issuers almost always have better information about the true value of the sec they sell than do the buyers

2( 5c) +ra%es &y Control Persons Anyone who holds a sufficient number of sec to affect materially the control of that issuer (i.e. a control person) is assumed potentially to have privileged access to information concerning the issuer of the sec Therefore a sale by a control person is deemed to be a distribution to which the prospectus requirement attaches Who is in a position to materially affect the control of the issuer? Does not require legal/de jure control when a person or group of persons acting together hold or exercise voting control over shares entitled to elect a majority of directors (i.e. 50.1% of shares of a corporation) Does not require practical/de facto control may arise with holdings of less than 50% of the shares b/c an ordinary resolution is one that is passed by the majority of the shareholders who actually vote rather than all shareholders (CBCA s. 2(1) ordinary resolution) not all shareholders exercise their right to vote and therefore a shareholder/group of shareholders can be confident of securing the passage of an ordinary resolution (and therefore elect all the directors) by holding shares with only 15-20% of the total votes (the number of shares required for any single blockholder to attain practical control will therefore depend on how many shareholders typically vote as well as whether there are

23
any other shareholders holding large share positions who might use their votes in opposition to that blockholder) One might materially affect the control of an issuer without being able to exercise either legal or practical control a blockholder with 5% of the common shares but lacking legal or practical control may have sufficient power to exert influence over management on important issues There are exemptions from the prospectus requirement for certain control-block distributions

:( "ales of Restricte% "ec 3el% &y 47empt Purchasers Preventing a backdoor underwriting Regulating primary market issuances of sec requires protection against the danger of a backdoor underwriting through the use of a prospectus exemption The closed system In a closed system any trade in sec that qualifies as a distribution requires a prospectus The system is closed b/c there are a limited number of ways of escaping the prospectus requirement The OSA and related rules prescribe specific exemptions from the prospectus requirement and issuances of sec under these exemptions are exempt market transactions and the buyers of these sec are exempt purchasers (exempt purchasers only where the protection afforded by a prospectus is not needed e.g. when the buyer is sufficiently sophisticated to be able to protect her own interests when buying sec) Exempt purchasers are subject to the prospectus requirement when they seek to resell the sec to others unless (1) they are selling to another exempt purchaser or (2) they hold the sec for a statutorily defined length of time (the restricted or hold period) before attempting to resell

What is a reporting issuer?

Only reporting issuers are subject to the OSAs continuous disclosure rules Section 1(1) reporting issuer means an issuer: (a) that has issued voting sec on or after the 1st day of May, 1967 in respect of which a prospectus was filed and a receipt therefore obtained under a predecessor of this Act or in respect of which a sec exchange take-over bid circular was filed under a predecessor of this Act, (b) that has filed a prospectus and has obtained a receipt for it under this Act, (b.1) that has filed a sec exchange take-over bid circular under this Act before December 14, 1999, (c) any of whose sec have been at any time since the 15th day of September, 1979 listed and posted for trading on any stock exchange in ON recognized by the Commission, regardless of when such listing and posting for trading commenced, (d) to which the BCA applies and which, for the purposes of that Act, is offering its sec to the public, (e) that is the company whose existence continues following the exchange of sec of a company by or for the account of such company with another company or the holders of the sec of that other company in connection with, (i) a statutory amalgamation or arrangement, or (ii) a statutory procedure under which one company takes title to the assets of the other company that in turn loses its existence by operation of law, or under which the existing companies merge into a new company, where one of the amalgamating or merged companies or the continuing company has been a reporting issuer for at least 12 months, or (f) that the Commission has deemed to be a reporting issuer under s. 83.1 The most common way in which an issuer of sec becomes a reporting issuer is through (b) the filing of a prospectus and obtaining of a receipt for it Once an issuer is a reporting issuer, it is subject to all of the periodic and timely disclosure obligations until the issuer applies to the OSC and is granted an order deeming that it has ceased to be a reporting issuer (s. 83) but if the reporting issuer has 15 or more sec holders the order must not be prejudicial to the public interest The concept of the reporting issuer is fundamental to a closed system those issuers that choose to access ONs public markets oblige themselves to ensure that current information about their businesses is readily available to the investing public (so that investors buying or selling sec of such issuers in the

24
secondary markets are better able to make informed trading decisions); also the fact that a body of information about issuers exists, and is regularly updated, facilitates the development of more streamlined procedures for additional public financings such as the short form, shelf, and PREP procedures Section 83.1 Provides the OSC with the authority to deem an issuer to be a reporting issuer where it would not be prejudicial to the public interest to do so

Ensures that companies with publicly traded shares (especially companies that have completed public offerings in other Canadian jurisdictions) may acquire the benefits and be subject to the obligations of reporting issuers in ON

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The Prospectus
The Prospectus Definition: a detailed circular setting out information underpinning the issuers distribution of the securities to the public. o Section 53 of the OSA requires a prospectus filing (both preliminary and full) with the OSC before distribution of a security. Prospectus is required for an IPO, a primary offering, and a secondary offering by a control block holder. o Goal for rules for the prospectus: (1) investor protection (2) capital market efficiency (3) enhance public confidence in capital markets Fundamental Aspects: o Issuer must prepare a preliminary and final prospectus. Content of prospectus include- business forecast, financial statements most recent three years, description of factors that could make the security risky Overriding principle is that there be full, true, and plain disclosure of all material facts OSA s. 56(1) o Regulatory oversight of the process o Right of withdrawal and rescission for investors o Statutory liability for misrepresentation and omissions, or failure to deliver a prospects Underwriting an Offering Page 235 Section 1(1) Definition: underwriter means a person or company who, as principal, agrees to purchase securities with a view to distribution or who, as agent, offers for sale or sells securities in connection with a distribution and includes a person or company who has a direct or indirect participation in any such distribution, but does not include (certain exceptions) Most underwriters are investment banking firms o Note that there is no requirement to use an underwriter (Google) Roles of Underwriters: o Underwriters offer credibility to issuers, bolstering their claims to future profits. o Underwriters usually set the price and terms of the offering o Underwriters give governance advice, etc. o Underwriters have public obligations to make sure the integrity of the market is maintained (gatekeepers) o Underwriters must sign the prospectus of the issuer that to the best of their knowledge, information, and belief, the prospectus constitutes full, true, and plain disclosure of all material facts OSA s.59(1) Slightly different than the issuers certificate, in that the standard is higher for issuers than underwriters (due to better access to the information). Types of underwriter agreements: o Direct Offering: no underwriter used, issuer goes directly to the market (ie Google) o Agency: underwriter agree to use its best efforts to sell the securities as agent of the issuer. The underwriter takes a commission on the sale (up to 7% of offering price). Risk-free arrangement for underwriter, but less commissions usually. o Firm Commitment: underwriter agrees to purchase all securities and resell them. Profit between issue price and sale price is also known as the underwriters spread. Usually there will be a group of underwriters, and different investment bankers will jockey to be the lead underwriter. Firm commitments affect remedies, since investor is not buying from issuer directly (Kerr v. Danier). However rescission against underwriter still possible under 130(1)(e) Even with a firm commitment, underwriting agreement usually contains: A Market-out clause underwriter can terminate the agreement if it determines (reasonably) that securities cannot be marketed profitably. A Disaster-out clause underwriter can terminate the agreement if a significant event affects the issuers business or the capital markets. The prevalence and wording of these agreements depend on how hot the markets are (if hot, likely there wont be a market-out clause) o Bought Deal (more intense version of a firm commitment, due to timing): used when

26 a short form prospectus is contemplated, the underwriter makes a firm commitment to purchase a large block of securities within 2 days before the preliminary prospectus is filed at the securities commission, accompanied with a media release announcing the transaction. The underwriter then has two days to solicit expression of interest prior to filing the preliminary prospectus (NI 44-101) Used to facilitate securities distribution and canvas potential purchasers. Conflicts of Interest in Underwriting Page 240 Classic conflicts: In Toronto, all big investment banking firms are subsidiaries of banks: issuer may engage IB to raise money to pay down a bank loan; When shareholder is a shareholder of the issuer and the underwriter. National instrument addressing conflicts in underwriting: (31-105CP to NI 33-105) o Policy instrument sets out three levels of conflict (from highest to lowest) 2.1(2) The Underwriter as issuer or selling securityholder: prohibits the underwriter from acting for the issuer or security holder in this case. Related issuer (cross-ownership): either the issuer or selling securityholder and the underwriter is an influential securityholder of the other: underwriter cant act as the direct underwriter for the issuer. Connected issuer issuer or selling securityholder has relationship with registrant (underwriter) which casts doubt on independence of transaction. o 2.1(3) provides exceptions to the strict requirements in 2.1(2). Year Court Holding 2003 OSC Role of underwriter for disclosure and certification (less onus than issuer): Underwriters certificate under s.59(1) of the OSA must certify that the prospectus contains full, true, and plain disclosure of all material facts, but only to the best of our knowledge, information, and belief. Underwriters cant accept issuer statements as true: they must probe, question, verify (adversarial) 2001 ON Effect of bought deal on 130 damages: A bought deal means GD that the purchaser has no remedy of rescission against the issuer for misrepresentations, although a claim for damages is allowed 1994 BCSC Considered the market out clause and whether an underwriter can terminate its agency agreement using a market-out clause: that the agreement can be determined due to the the state of the financial markets applies specifically to the market in the specific shares to be placed

Case Name YBM Magnex

Kerr v. Danier

Retrieve Resources v. Canaccord Capital and CLD Financial

The Prospectus Process (note sanctions under 127 for failure to comply with this process)
Period Pre-Filing Period Activities of the Period Secure services of underwriter, gather documents needed for prospectus, develop PP, file PP, obtain receipt from Regulator Documents Included Preliminary Prospectus (PP) Contents of Documents Assumed by regulator that documents are near completion (except security price, class): resolution of board authorizing filing, UW agreement, financial statements, certification note by officers, caution that PP is not final Notes Regulator can refuse to issue a receipt if not in the public interest (unconscionable) (OSA s.61(2)) (rarely used) (Tricorp) Due process protection for issuer 61(4) Regulator can prohibit PP distribution if there is a PP defect (OSA s.68)

Waiting Period (time between PP receipt and FP receipt)

Once receipt is issued for PP, issuer can get interest from investors (not before). Also revisions to PP occur.

Waiting period minimum 10 days for long form prospectus (OSA 65(1)). Distribution of PP can be solicited or unsolicited, but advertising can only alert to availability of PP (re Cambior)

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Filing of Final Prospects Filing of final prospectus and issuance of a receipt Final Prospectus (FP) Business Plan, Financial Statements of last 3 years (balance sheet, cash flow, income) (OSC 41-501), Capital Structure, Estimated proceeds of dist., purpose for capital, underwriter agreement, List of factors making security risky No shares can be distributed to public unless final prosp filed and receipt OSA s. 65 Overriding Principle: Certification required by CEO, CFO, and 2 directors that prospectus contains full, true, and plain disclosure of all material facts. Note Lapse Date: distribution cant continue 12 months after FP receipt (OSA 62) but according to s. 62(2) a pro forma prospectus must be filed not less than 30 days prior to the lapse date + a prospectus is filed not later than ten dats following the lapse date of previous prospectus + a receipt for the prospectus is obtained from the director within twenty days following the lapse date of previous prospectus Investors cannot actually buy securities until after receipt for FP is received OSA 53(1) Deals with interaction with Material Change reporting (s.57) See Cooling off Period Examples below. Underwriters advise issuers that securities are out of distribution

PreClosing Stage Coolingoff Period

PostClosing Stage

Commercial copies of FP are delivered to investors Investors have 2 days to opt out of promise to buy after delivery of FP or amended FP OSA 71 [2] Distribution of securities (note receipt from regulator for FP needed)

Cooling Off Period Examples

Example 1 Day 1: final prospectus received Day 2: agreement to buy Day 5: prospectus amendment filed Day 6: investor wants out. Can they? No, they made a binding agreement, and the cooling off period ended on day 3. Investor wouldnt receive amendment that would trigger a new cooling off period. Example 2 Day 1: agree to buy Day 4: receive final prospectus Day 5: prospectus amendment filed Day 8: amendment delivered Day 9: want out. Can they? You are entitled to get an amendment if it is filed during your cooling off period, and receipt on Day 8 triggers a new cooling off period (otherwise there wouldnt be full information for the purchaser) Example 3 Day 1: receive prospectus Day 4: agree to buy Day 5: prospectus amendment filed. Entitled to receive? No. If you are beyond your cooling off period when you agree to buy, the cooling off period does not run.

Contents of a Prospectus OSA Section 56(1) 2-part test for creating a prospectus: A prospectus shall provide full, true and plain disclosure of all material facts relating to the securities issued or proposed to be distributed and shall comply with the requirements of Ontario securities law (see OSC rule 41-501) o Failure to comply with section 56, the OSC Rule, or section 57 can lead to sanction under section 130 of the OSA (see YBM Magnex - YBM should have disclosed the material fact that it was being investigated by the FBI for money laundering)

28 OSC Rule 41-501 General Prospectus Requirements In the consolidation, this rule covers 80 pages and contains 33 separate items (onerous). Contents of a Prospectus: there is a huge amount of time and detail that goes into producing a prospectus (often 100+ pages). Types of things to be disclosed: o Description of offering (characteristics of securities offered for sale) (items 10 & 19) o Financial Statements (Part IV of the Rule). Three years of historical financial statements must be provided, as well as interim financial statements (4.6) for the most recently completed interim statement (released more than 60 days before the prospectus release). Kinds of financial statements (4.1): Assets and Liabilities (balance sheet); Cash flow statements; Income Statements (provides richest detail about revenues, expenses, and net income). http://www.osc.gov.on.ca/Regulation/Rulemaking/Current/Other/rule_200012 15_general.pdf [Not more than 90days before the date of the prospectus] Description of business and business history (3 year history) (items 5 & 6) Includes market trends, significant acquisitions, etc. Note that material information could also have an impact on the market (very qualitative) Section 6 is a narrative of main business events, milestones, principle products and services, markets, etc. Rule 41-501 (14.1) final receipt must be gotten within 90 days of your preliminary prospectus OSC, solve the problem of stale financial statements o In a prospectus, the issuer must disclose risk factors (Item 20). Risk can be an internal business risk, but can also relate to the general economy, the political environment, etc. Sub 2 of item 20 requires the issuers to disclose any risk to the security holder for the issuers liability (remember unit holders in a trust have a different exposure to risk than shareholders). Shows a tension between disclosure of risk to meet legal requirements and also the motivation to use the prospectus as a sales tool for investors. o Principle shareholders must also be disclosed (Item 15) Contentious issue, and many investors complain about inflated compensation. o Executive compensation disclosure (Item 17). Material Fact As noted above, the requirement for full, true, and plain disclosure of all material facts is an essential requirement of the prospectus process Section 1(1) defines a material fact as a fact that would reasonably be expected to have a significant effect on the market price or value of the securities. o This definition is quite forward-looking. Other provinces have definitions that are both retrospective and forward-looking. o Includes Internal and External facts that impact an issuer. In Canada, the materiality of a fact or change is based on a market impact test while in the US the risk factors must be material to reasonable investors (which has been adopted in section 20.1 OSC Rule 41-501) o The Ontario Ministry of Finance 5-year committee recommended adopting the US reasonable investor test in the interests of harmonization, while acknowledging that the test may have different effects on disclosure (possibly making it more subjective and possibly less inclusive to overall market conditions) Material Change Material change is defined in section 1(1) of the OSA: o (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 New National Instrument: harmonization of what a material change means across Canada with the introduction of NI 51-102 (definition essentially the same as in Ontario) Section 57 describes an issuers reporting obligations if a material change occurs during the waiting or distribution period:

29 o Subject to subsection (2), where a material adverse change occurs after a receipt is obtained for a preliminary prospectus filed in accordance with subsection 53 (1) and before the receipt for the prospectus is obtained or, where a material change occurs after the receipt for the prospectus is obtained but prior to the completion of the distribution under such prospectus, an amendment to such preliminary prospectus or prospectus, as the case may be, shall be filed as soon as practicable and in any event within ten days after the change occurs. o (2) Where an amendment to a prospectus is filed under subsection (1) additional distribution shall not be proceeded for a period of ten days after the amendment is filed or, if the Commission objects to the further distribution, until such time as a receipt for the amended prospectus is obtained from the Director. o (3) An amendment to a preliminary prospectus shall be forwarded to each recipient of the preliminary prospectus according to the record maintained under section 67. If a material change occurs, section 75 of the OSA requires the issuer to issue a news release and also to file with the Commission a report of the change

Key Difference between material fact and material change: (from Pezim v. BC, 1994 SCC): Material fact includes all risk (including external) that could reasonably be expected to significantly affect the securitys value, while a material change only deals with changes in the business, operation, assets, or ownership of the issuer o In Kerr v. Danier: the obligation too revise the prospectus only extends to material changes, not material facts. The courts have distinguished between material facts and material change in terms of statutory reporting obligations Pezim, Iacobucci stated that material fact is much broader than material change remember, prospectus must disclose all material facts, but is only require to amend prospectus where there is material change Future-Oriented Financial Information Page 275 One aspect of disclosure in a prospectus is forecasting future revenues and profits. If the information is positive, this can induce more sales. There is considerable risk in forecasting if the information turns out to be inaccurate. For many years, regulators prohibited any future forecasts in a prospectus. Now, NP 48 gives guidance to issuers about including FOFI. NP 48 (Information to be included in a FOFI) there is a proposed rescission of NP 48, and to consolidate all forward looking information into NI 51-102 Defines forecast: FOFI reflecting a companys judgment based on the most probable set of economic conditions applicable to the forecast. o Clearly, this judgment could be wrong. Issuers need to have rock solid evidence to support their forecasts usually accompanied with auditors reports Forecast should include a cautionary note that actual results may vary widely from forecast Information cannot forecast into the future more than 2 years. A business must be in operation for more than 2 years to issue a forecast. A business with less than 2 years of history can only make projections (similar to forecast, but with a hypothesis about plausible circumstances rather than most probable economic conditions). o In limited circumstances, a business more than 2 years old can apply to the OSC to make a projection instead of a forecast. Forecasts must be material to the circumstances of the issuer: it is material if its omission or inclusion would probably change an investment decision. Section 7.1(1) of NP 48 requires an issuer to update FOFI if there is a change in the events or assumptions used to prepare FOFI that has a material effect on such FOFI NP 48 requires the issuer to compare the FOFI with the actual results as they come due Currently there is a proposal to rescind NP48 and replace with an amended NI 51-102 o Streamlining regulation that will simplify and clarify our expectations for issuers who prepare forward-looking information o Will also include earnings guidance procedure for FOFI Sanctions for Misrepresentation see also Civil Liability Chapter below Kerr v. Danier Material Change Reporting and FOFI

30 Facts: Issuer was making a public offering (IPO), but the sale was mostly a sale of the founding shareholders shares, not shares from the company treasury. Issuer made a forecast in a prospectus. Timeline (1998): o May 6 receipt obtained for final prospectus o May 16-19 Information assembled re: financial info for first half of Q4 Information shows sales are seriously down, which deviated from forecast o May 20 Distribution closed o June 4 management revealed that it may have difficulty meeting the projected fourth quarter results. Danier issues revised forecast and material change report. o June 27 Q4 ends, and major sales before the end of the quarter and substantially meets its forecast. Investors still sued under section 130, based on a misrepresentation in a prospectus because the material change was not disclosed. Issue: Having received results that showed a change in the forecasted 4th quarter results before distribution closed, should the issuers have disclosed the information and updated the forecast (section 57) based on it being a material change? If it was not a material change, could the investors still sue for a misrepresentation under section 130?
Key Holdings Key Differences Danier Management liable for statutory misrepresentation. Under section 130, the issuer has a continuing obligation to disclose material facts until end of the distribution period. The change in sales was not a material change (warm weather external to business) A forecast is a fact A forecast is not an untrue statement of material fact if the results are not achieved: a forecast is an untrue statement of material fact if the factual assertions implied are untrue. Factors: forecast not prepared using reasonable skill and care, management does not believe forecast, managements belief in the forecast is unreasonable, or management is aware of facts that undermine forecast (italics were found to exist in this case) Disclosure of material facts is only required up until CA disagreed that Ontario the receipt for the final prospectus (section 57(1)), not follows US jurisprudence end of distribution period. making a forecast actionable if not reasonably based. (para Change in sales was a material fact, not a material 138) change (since cause was external factor) (agrees with CA admonished trial judge for trial) failing to defer to the business A forecast is a fact, since inferences can be drawn judgement of management from it. Cautionary language in forecast does not even if there was an implied negate the forecasts status as a material fact (agrees representation of with trial) reasonableness (para 157 and Unlike the trial decision, there is NOT an implied 164) representation that managements subjective belief Appeal a shift away from the that it would achieve its forecast is objectively trial judges interventionist reasonable. approach to protect investors. Even if it is assumed that the forecast contained an implied representation of objective reasonableness, the trial judge failed to consider that (1) the forecast was ultimately achieved, and (2) should have deferred to the business judgement of the management s. 56(1) and 57(1) constitute a complete code of prospectus disclosure, both for statutory compliance and for statutory civil liability. While NP 48 may have required Danier to disclose that it would not meet its sales targets, this is not law and cannot be used by the investors to find liability.

Court Superior Court (2004)

Court of Appeal (2005)

31 Sanction for failure to deliver a Prospectus The requirement to deliver is found in s. 71(1): A dealer not acting as agent of the purchaser who receives an order or subscription for a security offered in a distribution to which subsection 53 (1) or section 62 is applicable shall, unless the dealer has previously done so, send by prepaid mail or deliver to the purchaser the latest prospectus and any amendment to the prospectus filed either before entering into an agreement of purchase and sale resulting from the order or subscription Penal sanction; s. 122(1)(c): If you attempt to distribute securities without a prospectus or by incorrectly relying on an exemption you will be found to liable under s. 122 and you will be prevented from continuing to distribute the securities. Administrative order for compliance s. 127(5): If the Commission is satisfied that Ontario securities law has not been complied with, an order that a release, report, preliminary prospectus, prospectus, return, financial statement, information circular, take-over bid circular, issuer bid circular, offering memorandum, proxy solicitation or any other document described in the order[shall be made] Civil sanction under OSA s 133: A purchaser of a security to whom a prospectus was required to be sent or delivered but was not sent or delivered in compliance with subsection 71(1) or a security holder to whom a take-over bid and take-over bid circular or an issuer bid and an issuer bid circular, or any notice of change or variation to any such bid or circular, were required to be delivered but were not delivered in compliance with section 95 or section 98 has a right of action for rescission or damages against the dealer or offeror who failed to comply with the applicable requirement. o Jones and Deacon Hodgson (p. 339): Any contract that you entered into to purchase securities is void if there was failure to meet prospectus requirements.

32

The Prospectus: Alternatives

Alternative Short Form Prospectus (SFP) Governing Instrument NI 44-101 (all other rules that govern a prospectus also apply to SFP) MRRS rules under NP 43201 govern the review timelines. Description Allows large, repeat issuers to make timely and costefficient public offerings. Due to recently-enhanced eligibility, long form prospectus will now only be used for IPOs Eligibility Issuer must be listed on TSX, TSX Venture or CNX; Debt securities must be rated by rating agency; SEDAR filing required, Issuer must be RI in at least one CDN jurisdiction. Quick review (3 days after issuance of receipt) under MRRS. Contents Initial and current AIF, SFP requirements on form 44-101F: distribution plan, intended market, use of proceeds, rights attaching to securities, include any CD filed during year (means misreps now actionable under 130). Summary Statement can also be filed that can be used to sell instead of a prospectus. Section 5.6 itemizes info that can be omitted from a base shelf prospectus (information about the securities, their price, information about the underwriter, etc). This info is provided when the security is issued. Basically same contents as an SFP.

Shelf Prospectus

NI 44-102

Post-Receipt Pricing Prospectus (PREP)

NI 44-103

MJDS Prospectus

NI 71-101

Capital Pool Companies

OSC 41-601

A shelf prospectus allows an issuer to file a prospectus (an SFP) and then leave it on the shelf for up to 25 months. Securities can be distributed at any time during that period. Main difference now between a PREP and an SFP is that the postreceipt period is much shorter (90 days on the shelf instead of 2 years). Also it is used for a specific transaction and a single type of security. To add, it can not be used for a rights offering Enables prospectus offerings for distributions in CAN and US or distributions by US issuers in Canada where they comply with NI 71-101. Similar requirement characteristics to those of SFP and Shelf prospectus special arrangement for companies that have no assets other than cash and have not commenced business activity

Available to any issuer that qualifies for an SFP. When it is time to distribute, only a [pricing] supplement, which updates info, is required. PREP is available to all issuers, not just those who qualify for an SFP

Issuer must have a sufficient reporting history or be of a sufficient market size, etc based on the type of securities.

Major benefit to CDN issuers who want access to US capital markets (and vice versa). Facilitates the extension to Canadian investors in US issuers of take-over bids, issuer bids, etc.

CPC will submit PP and FP, and after the distribution closes the CPC has 18 months to complete a qualifying transaction

Highly scrutinized by regulators due to increased risks. Popular by small mining companies needing funds for exploration.

Also note Part 7 of Rule 44-101 underwriters do not need an preliminary prospectus to solicit expressions of interest although, there needs to be disclosure of the expected price of the issuer etc.

33

The Prospectus: Civil Liability

Civil Liability under Section 130 Section 130 allows investors to sue for a misrepresentation = misstatements and omissions (failure to make full, true, and plain disclosure of material facts OSA 1(1)) in a prospectus o Note that this is in addition to CL remedies (though reliance must be proved in CL) A claim of misrepresentation to prove misstatement, reliance on that misstatement, and causation between the reliance and the damages suffered 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, Damages or Rescission (election in (e)) (cant choose both) 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 required by section 59; Damages only 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 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 (ie experts) 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) (ie CFO) Other statutory misrepresentation provisions: o For misrepresentation in an offering memoranda and takeover bid circulars (including directors circulars and issuer bid circulars) o For anyone in a special relationship with a reporting issuer, who purchases or sells securities of that issuer with knowledge of a material fact or material change that has not been generally disclosed, can be liable for misrepresentation Plaintiffs Onus The statutory test: o Purchase of securities offered under the prospectus o Purchase made during the period of distribution o That there was a misrepresentation in the prospectus Deemed reliance: Section 131(1) of the OSA does provide that purchasers have a remedy without regard to actual reliance on the representation. o Like US CL position that inaccurate information is a fraud on the market Limitations on Recovery Section 130(6) (9) sets limits on how much can be recovered o (6) Underwriters can only be liable for the portion that they underwrote o (7) If you can show other causes for depreciation in stock price other than misrepresentation then this can lower the damages amount. o (8) Joint and several liability o (9) In no case shall the amount recoverable under this section exceed the price at which the securities were offered to the public. This means that opportunity costs cannot be claimed. In Kerr v. Danier, trial court said that you dont need to have sold your securities for a loss (ie crystallized loss) to be eligible to receive the damages. o Court said that loss would be calculated on the date that the market totally absorbed the effect of the misrepresentation (which becomes very unpredictable) o The US does not agree: in the US investors have to have sold the securities. Limitation periods are set out in section 138: Action cannot be commenced o (a) in the case of an action for rescission, 180 days after the date of the transaction that gave rise to the cause of action; or o (b) in the case of damages, the earlier of, (i) 180 days after the plaintiff first had

34 knowledge of the facts giving rise to the cause of action, (ii) three years after the date of the transaction that gave rise to the cause of action. Statutory Defences Statutory defences are a key difference between CL actions for misrepresentation and statutory actions. Defences balance investor protection with allowing good-faith transactions. On reasonableness: section 132: In determining what constitutes reasonable investigation or reasonable grounds for belief for the purposes of sections 130 and 131, the standard of reasonableness shall be that required of a prudent person in the circumstances of the particular case (Mixed objective/subjective standard)
Name of Defence Purchasers Knowledge of the Misrepresentation Section OSA 130(2) Description Complete defence if purchaser had knowledge of the misrepresentation when the securities were purchased. Also available for OM and Takeover bid misrepresentations. Defendant did not know about/consent to filing of prospectus. Note: Pleading ignorance is not very compelling (shows lack of attention to the business by the defendant)(also applies to takeover circulars (131(5)(a)) Valid defence if the defendant withdraws consent previously given to the prospectus or takeover bid circular. Withdrawal must occur after the issue of a prospectus receipt and before a purchase of securities, must occur as soon as the defendant becomes aware of the misrepresentation, and the defendant must provide reasonable general (ie public) notice of the withdrawal. Defendant can avoid liability for an expert statement not made by them and no reasonable grounds to believe and did not believe it was wrong or that did not fairly represent report/opinion of expert (objective and subjective). Also available for takeover circulars. Expert report was not represented fairly and properly by the issuer when it was included in the issuers prospectus. Expert can also rely on the withdrawal of consent defence, under the same conditions as a defendant. Conducted reasonable investigation to provide reasonable grounds for belief that no misrepresentation or did not believe there was a misrepresentation Onus Defence

No Knowledge

OSA 130(3) (a)

Defence

Withdrawal of Consent

OSA 130(3) (b)

Defence

Reliance on Expert

OSA 130(3) (c)

Defence

Experts Defence

OSA 130(3) (d)

Defence (Expert)

Due Diligence Defence Experts

OSA 130(4)

Due Diligence Defence Non-experts (ie Directors does not apply to issuer or

OSA 130(5), also s. 122 (quasicriminal

Conducted reasonable investigation to provide reasonable grounds for belief that no misrepresentation or did not believe there was a misrepresentation

Plaintiff can show that defendant knew there was a misrep or had no reasonable grounds to believe there was not a misrep. - some would suggest that the onus should be on defendants as they have more evidence to draw upon Plaintiff can show that defendant knew there was a misrep

35
underwriter) provisions) or had no reasonable grounds to believe there was not a misrep.

Case Law
Case Name Escott v. BarChris Year 1968 Court U.S. Holding Leading case on reasonableness in the case of statutory defences. Note difference in US law: in US, onus of due diligence defence on defendant. Key Point: The court made a detailed individual-byindividual assessment to determine whether directors (insider and outside outside lawyer held to higher standard) and officers exercised due diligence in a reasonable manner. Outside directors and underwriters need to attempt to verify data. The cause puts forward a tough objective standard, which is relaxed somewhat in YBM. One of the few Canadian cases to discuss what it takes to make a due diligence defence (though this falls under 127, not 130). OSC mixes an objective and subjective standard, but follows BarChris by considering the diligence of each director (inside, outside, and special committee), underwriter, and lawyer. Degree of conflict and experience considered. On the issue of due diligence, the court takes a deferential approach to the business judgment rule linking business judgment to section 132 of the OSA (reasonableness)

YBM Magnex

2003

OSC s.127 decision

Kerr v. Danier

2004

ON SC

36

Continuous Disclosure: Periodic Disclosure

Continuous Disclosure Overview Once one issues securities in a distribution, and become a reporting issuer, there are continuous disclosure obligations to the secondary market. o Definition of RI: has securities trading in the public domain through a previous prospectus, merger, amalgamation, or arrangement, or when deemed so by a regulator (OSA section 83.1) Two fundamental components of CD in Canada: o (1) Periodic disclosure of interim and annual financial statements and reports, MD&A, AIF, Proxy circulars and o (2) Timely disclosure of material changes under OSA section 75 National Instruments and Multilateral Instruments for Reporting Issuer CD Page 353 NI 51-102: General CD requirements across Canada. o OSC Rule 51-801 implements NI 51-102 and indicates that certain statutory provisions do not apply too issuers complying with NI 51-102 NI 71-101: Multi-jurisdictional Disclosure System NI 51-101 and NI 53-101: Sector-specific CD requirements for Oil and Gas, and Mineral Projects, respectively MI 55-103: Insider Reporting for Certain Derivative Transactions has CD requirements Continuous Disclosure Obligations on Other Parties Insider reporting - OSA s.107 o There is a new System for Electronic Disclosure by Insiders (SEDI) Early Warning System (takeover context) - OSA s.101 o Comes into play in the case of a take-over. If you are planning on a take-over, you must give disclosure of security purchasing in advance. Periodic Disclosure - Financial Statements: NI 51-102, Part 4 Page 355 Each reporting issuer must prepare and file quarterly and annual financial statements. Statements include: o Income statement, statement of retained earnings, cash flow statement, balance sheet Statements to be comparative to the previous years filings (s.4.1) o Certification by board and officers (s.4.5) o Auditor committee review report (s.4.1(2) and s.4.3) 4.3 contains provisions for disclosure of the auditors review of annual statements (required) and also interim statements (optional but if engaged ad then unable to complete or there were reservations, must be disclosed). Goals: Enhancing investor confidence and reducing risk of auditor capture Filing Deadlines for Interim Statements (s.4.4) and Annual Statements (s.4.2) o Venture vs. non-venture issuers (more time if you are a venture issuer) A venture issuer is one that does not have securities listed or quotes on the TSX, a US market, or an international market. o For interim statements, non-venture issuer, they must be filed within 45 days before end of quarter o For annual financial statements, they must be filed within 90 days of the year end Delivery requirements (51-102 s.4.6) o We are moving to an access equals delivery rule: now, issuers must only send a form to shareholders enabling them to request a copy if desired. Continuous Disclosure for SEC Issuers (s.4.3(4)) o Reconciliation requirements for converting between US and Canadian GAAP Change of Auditor (s.4.11) o If a reporting issuer changes auditors for any one of several reasons, the issuer must disclose this change, including the previous auditors reviews in certain cases. A reporting issuer can apply for an exemption if it is not in the public interest to grant it

37 Management Discussion and Analysis (MD&A) - NI 51-102 Part 5 Page 362 Definition of MD&A: narrative interpretation of issuers current financial position and future prospects. Financial statements describe what happened; MD&A describe why it happened (and also predict what will happen going forward). In Canada, all reporting issuers are required to provide an MD&A. o Particularly important for junior companies without a history of profitable operations o Discloses nature of changes in issuer performance and managers opinion as reason for change, discuss positive and negative developments, reconcile plans with results, disclose whether milestones or projections were achieved, disclose pending liabilities, related party transactions, disclose regulatory approval needed for transactions Content of MD&A prescribed by NI-51-102 FI o Material Information. Definition of materiality to be used (NI 51-102 Part 1): would a reasonable investors 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? If so, the information is likely material (not market impact). o Capital structure of the issuer (designation and number of shares and share classes) NI 51-102 s.5.4. o Forward looking information (Part 1) o Off-balance sheet arrangements (51-102F1 Item 1.8 (at p.1605) o Approval requirements by the board or audit committee (for interim MD&A) (s.5.5) o Filing requirements for MD&A (s.5.1(2)) o Delivery requirements for MD&A (s.5.6) Enforcement: regulators are increasingly scrutinizing the MD&A and requiring refiling. Annual Information Form (AIF) - NI 51-102 Part 6 Page 364 AIF is similar to a prospectus, because it requires detailed information about history, operations, and financial affairs of the reporting issuer. AIF originally (and still) used by large issuers to communicate extensive information in order to qualify for SFP process. Now required for all non-venture reporting issuers (s.6.1) Content of AIF: prescribed by NI 51-102F2 o Definition of materiality same as the MD&A o 51-102F2 Items 5.1(4), 5.2 (risk factors): A new explicit requirement is social and environmental policy information for policies fundamental to operations. Filing Requirement (NI 51-102 s.6.2) o Must be filed within 90 days after the end of the issuers financial year o Note there is no delivery requirement only SEDAR filing

38

Continuous Disclosure: Certification

All of this is about strengthening the role and responsibilities of gatekeepers. Will they make a difference in terms of corporate performance or improve the behaviour of corporate issuers? Its not entirely clear. The rules also provide major challenges to some issuers, especially small-cap. Certification requirements hold corporate officers accountable for the quality and accuracy of an issuers disclosures. There are new certification requirements based on the U.S. SOX Act. o Canadian Issuers listed in the US must comply with SOX.
Name Certification of Disclosure in Issuers Annual and Interim filings Rule MI 52109 (not adopted by BC) Purpose Meet a standard of overall material accuracy and completeness that is broader than financial reporting requirements under GAAP (applies to all non-foreign, non-investment fund issuers) Liability: Subject to quasi-criminal, administrative, or civil proceedings. Subject to private actions for damages either at common law, civil law (Quebec), or statute (OSA). Fair Presentation MI 52109 CP Broader than GAAP: fairly present means a materially accurate and complete picture of the issuers financial condition. Financial condition includes qualitative and quantitative factors (CICA). There is deference to GAAP, but not if the standard fails to meet an obvious and reasonable standard of fair presentation readily apparent to the trier of fact (Kripps v. Touche, 1997 BCCA) Enhanced audit control rules are a direct transplant of SOX rule 404 (delayed due to issuer concerns), however reporting issuers say that this is too costly, since controls themselves are time-consuming and need to be audited. Note: applies to non-venture issuers An audit committee is a board committee responsible for oversight of financial reporting process. Rules in place to prevent auditor capture, to enhance independence and financial literacy of committee, and improve transparency (disclosure). Responsibilities include (MI 52-110 2.3): Helping directors meet their responsibilities; Enhancing communication between directors and external auditors; Enhancing independence of external auditor; Increasing the credibility and objectivity of financial reports; Strengthening the role of the directors; Must have Charter, 2.3(7); must establish procedures for dealing with complaints (whistleblower function); Pre-Approval of non-audit services provided by the external auditor Market-based approach: the best practices in NP 58-201, but the market should know if they are not followed Requirements CEO and CFO must personally certify that there is nothing misleading and that there is no misrepresentation in issuers annual and interim financial statements. Must certify the establishment of disclosure controls for auditing. Each certificate filed in SEDAR separately Fair presentation includes disclosure of accounting policies, proper application of those policies, informative financial info, and additional disclosure to provide material accurate picture of issuer.

Internal control over financial reporting

MI 52111

Similar to 52-109, except that not only have audit control procedures been put in place, but that they are evaluated annually in comparison to a suitable control framework Must contain at least 3 directors of issuer (3.1(1)) F. Literacy, education, and experience of members disclosed in AIF Whether audit committee exemptions utilized Must be independent (1.4, 1.5) cannot have material relationship with issuer (past officer, partner of firm providing legal or accounting, cannot have received more than $75K annual pay from issuer) Must have ability to read broad and complex financial statements (GAAP knowledge optional, unlike US)

Audit Committees

MI 52110 (not adopted by BC)

Disclosure of Corporate Governance

NI 58-

Disclosure of governance practices and the extent to which with these meet best

39
Practices and be able to decide how to invest accordingly. practice guidelines (Form 58101F). If they are not followed, the directors are to explain why governance rules are not followed. Best Practices: Majority of board independent (3.1) Chair independent (3.2) Independent members should occasionally meet separately (3.3) Board should have business mandate, code (3.4, 3.8-9) Other: orientation, education, compensation

Disclosure of Corporate Governance Practices

NP 58-

Adopts a disclose and explain approach to corporate governance. Describes best practices.

Canadian Public Accountability Board (CPAB)

NI 52-

Sets out standards for accountants and auditors.

40

Continuous Disclosure: Timely and Effective Disclosure Material Changes

Statutes and Regulations OSA section 1: Definition of material change: o 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 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 OSA s. 73: Material Change o 73. Where a material change occurs that is likely to have a significant influence on the value or the market price of the securities of a reporting issuer and is not generally known, the reporting issuer shall immediately prepare and distribute a press release disclosing the substance of the change OSA s.75: Material Change Reporting o 75. (1) Subject to subsection (3), 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. o (2) Report of Material Change Subject to subsection (3), 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. o (3) Confidential Disclosure - If it would be unduly detrimental or a decision is pending approval of the board, a reporting issuer may file with the OSC the report marked confidential and the reasons for non-disclosure to the public. The issuer has to advise the commission in writing every 10 days that it wishes the material change to remain confidential (4) If it becomes apparent that people are trading based on the unreleased information, the commission will release it (5) o Note that the OSA and the NI requirements are the same but the form to be completed is found in the NI (Form 51-102F3) Material change rule in Ontario under section 75 continue to apply, but only if a reporting issuer does not comply with the National Instrument. NI 51-102, Part 7: Greater, harmonized requirements for Material Change Reporting o The introduction of NI 51-102 harmonizes the definition of material change: 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 and a decision to implement a change made by the board or senior management that significantly impacts results of operations and financial position. o Reporting 7.1 If material change occurs, news release must be filed, and material change report must be filed as soon as practicable or within 10 days (same as Ontario) Change reports are generally short (1-2 pages), but regulators still tell firms how to put the report together. Disclosure must reveal the significance of the change without having to refer to other material. NP 51-201: (Page 387) (Best Disclosure Practices) 2.2 confidentiality, 2.3 maintaining it o Elements of best practices: Establish corporate disclosure policy Review by board/audit committee Designate authorized spokespersons Establish policy re analyst conference calls and reports Establish policy re quiet periods and insider trading monitoring Establish policy re electronic communication o Section 2.2: Issuers may withhold public disclosure if it unduly detrimental, but must still make a confidential filing with the regulator o Section 2.3: If rumours leak or impact stock price then must make full disclosure. o Part 3 Selective Disclosure see below o Section @.(6 e$amp es of materia information6 changes of structure financia K corporation, changes of financia operations.

41 So regu ators have made distinction bet%een operations and structure. Materia facts and changes are both inc uded in this po ic!. o Section 6.14: guidance re handling rumours: should adopt a no-comment policy. Confidential Disclosure Section 75(3) and NP 51-201 7.1(2) Disclosure to regulators but not disclosure to investors (doesnt exist in US). Allows reporting issuers where their opinion has been arrived at in a reasonable manner, that the disclosure required in earlier parts of section would be unduly detrimental, RI may material change report to SC saying its confidential along with written reasons. o Example: sensitive stage of negotiating merger/takeover bid and public disclosure will cause bidder to get cold feet. Selective Disclosure NP 51-201 Part III Example: issuers have an interest in communicating with number of classes, including institutional and retail investors. Concern about whether retail investors get same info as institutions. Issuers also talk to analysts in brokerage houses who follow their stock. Legal issue is possibility of insider trading: Selective disclosure could amount to tipping. o Defence: gave info in the necessary course of business. NP says giving info to analysts isnt in the necessary course of business, though information to credit rating agencies is allowed (see page 1669) Enforcement: if there is mitigating factors (ie if unintentional) in selective disclosure enforcement: 3.7 of NP (page 1675) Disclosure of Significant Acquisition NI 51-102 section 8.3 If a RI completes a significant acquisition of a business or related business it must file a BAR (business acquisition report includes balance sheet of RI) within 75 days of acquisition. Significance tests under section 8.2: o Asset test, investment test, or income test: if any exceeds 20% of buyers assets, assets or income (respectively), then BAR must be filed. Venture issuers have different tests. 9ub ic Enforcement of Continuous Disc osure Cb igations6 Enforcement is possible under section 122 and 127 of the OSA. o OSC conducts CD compliance reviews in conjunction with insider trading. CSA Staff notice 57-301 (2002): management cease-trade order issued when RI cant file financial statements on time. OSC Policy 57-603: management CTO (cease trade order) when default in filing requirement (p2162) but regulators require material change report to be issued immediately. Case Law: Principle: if unclear as to whether something is a material change, then err on side of disclosure. If news is negative, issuers dont want to hear this
Case Name Pezim Year 1994 Court SCC Holding Failure to disclose mineral find. SCC holds that change in the value of assets is a material change (no difference between change in assets and change in value of assets economic reality) Note that assets is not found in OSA or NI definition of material change. Three elements of material change definition: (1) Change must be in relation to the affairs of an issuer; (2) In the business, operations, assets or ownership of the issuer; and (3) Material (ie would reasonably be expected to have a significant effect on the market price or value of the securities) Meaning of as soon as practicable when revealing material change to public s. 67 creates duty to inquire on the part of directors wrt material change The standard of review of decisions of securities regulators is reasonableness great deference. Financial results do not form part of business operations or capital, and under

Kerr v.

2005

ON

42
Danier CA normal circumstances are not a material change (differs from economic reality principle in Pezim) (para 88) Unseasonably warm weather is not a material change: it was a factor external to a companys operations (66). The example of all of the companys stores burning down is a material change, however. Supports the Probability/Magnitude test to determine whether future events are material changes. 2 prong test (qualitative): (1) assessment of probability event will occur, and (2) assessment of magnitude of change on reasonable investors. Here, auditor concerns of organized crime was a material change not adequately reported under 75(1). Auditor delay could have lead to a CTO. Likely this falls under a change in capital (policy-oriented) Uses Probability/Magnitude Test to conclude that the accused was liable for insider trading

YBM Magnex

2003

OSC

Donnini

2002

OSC

43

Continuous Disclosure: Civil Liability

9rivate enforcement6 Common La% Iemedies6 9re"stat remed! the on ! option for investors pre (1.+ %as a tort c aim for fraudu ent or neg igent misrepresentation. 9rob ems for 9s6 o +) Courts have said that 9s have to sho% re iance on the misrepresentation in ma,ing their decision to trade. #his ma,es c ass action difficu t to mount because it is ver! difficu t to sho% re iance across a c ass. o () In order to ground such c aims, have to sho% that D o%ed 9 dut! of care6 see (ercules )ana$ement. 7 raud on mar&et theory8 iabi it! in Canada6 o #his assumes that securities mar,ets are efficient. Because the! are efficient the! inc ude a info about the sec being traded. #he price changes to ref ect the information. If there is a misrepresentation, this becomes a fraud on the mar,et. o &raud on mar,et is ega p atform in .S for suing %ithout demonstrating individua re iance on misrepresentation. &raud on mar,et means a investors re ied on the misrepresentation (deemed re iance, part of the hurd e to find iabi it!) o In Canada, no 3udge has accepted &raud on the mar,et. (istory of efforts to le$islate* 9rimar! Mar,ets* S.+1? a o%s investors to sue re misrepresentations in prospectus. Fot ots of itigation unti +err v, #anier. Secondar! Mar,et6 efforts to egis ate remed! for () !ears. #he! esca ated in ate 0?s %hen #SL issued a report (/ en Ieport) that securities egis ation in Cntario shou d inc ude a civi right of action in the secondar! mar,et. (??? report recommended same thing. o Draft egis ation %as produced (??? (??(, but not passed unti (??). o Lots of obb!ing6 regu ators pushed initiative to enab e investors to sue in courts, but issuers strong ! resisted due to the increased iabi it! that the! %ou d face. Part XXIII of the OSA New Section 138 Potential #efendants - #efinitions . /S0 Section &'(.& The Issuer, #irectors, /fficers Influential person G / contro person, promoter, insider (not director or senior officer), or an investment fund manager. (Legis ation introduces concept that there are additiona parties that can be Ds in action for damages). o Control person G Securities ho der or ho ders acting in concert %ho can materia ! affect the contro of the issuer. 2o der(s) %ho ho ds (?E M of securities is deemed a contro person. o Promoter G a person4compan! responsib e for founding4reorgani'ing an issuer o Insiders G Securities ho ders %ho ho d +?E or more of securities of an issuer. NN Securit! 2o der can be a D to an action. Legis ation ifting the vei NN Expert6 9erson or compan! %hose profession gives authorit! to a statement made in a professiona capacit! b! the person or compan! inc uding an accountant, actuar!, appraiser, auditor, engineer, financia ana !st, geo ogist or a%!er Sources of 1iability and Parties 1iable . /S0 Section &'(.' Documents that contain a misrepresentation ():8(: 5)) and 5:)) < re eased b! issuer or docs re eased about issuer b! a person or compan! %ith actua , imp ied or apparent authorit! to act on beha f of a responsib e issuer: o Parties possibly liable6 responsib e issuers, directors, officers, inf uentia persons (if ,no%ing ! inf uenced issuer), e$perts (%here misrep contained in materia the! provided to issuer). 9ub ic Cra Statements containing misrepresentation6 ):8(: 52) and ):85:) if made b! person %ith 7actua , imp ied or apparent authorit! to spea, on beha f of a responsib e issuer8: o Parties possibly liable6 responsib e issuers, directors, officers, inf uentia persons (if ,no%ing ! inf uenced issuer), e$perts (%here misrep contained in materia the! provided to issuer), and person 2ho made the public statement Documents4Statements made b! Inf uentia 9erson6 ):8(:5:) < if inf uentia person ma,es a statement or produces a document %ith a misrepresentation, the same peop e as above can be

44 iab e, but the inf uentia person can be iab e %ithout have to sho% that that person ,no%ing ! inf uenced the issuer. &ai ure to ma,e time ! disc osure6 ):8(:5;)( o Parties possibly liable6 responsib e issuer, directors4officers, and inf uentia persons

Who has a Cause of Action? &or docs containing misrepresentations6 persons4companies ac=uiring4disposing of securit! bet%een time %hen document %as re eased and time %hen misrepresentation corrected: &or pub ic ora statements6 containing misrepresentations, same as above: -here fai ure to ma,e time ! disc osure6 person4compan! ac=uiring4disposing of securit! bet%een time materia change %as re=uired to be disc osed and subse=uent disc osure of materia change. Procedural Issues Leave of court re=uired under ):8(8 b! 9 aintiffs before aunching action o Merit"based assessment (court as gate,eeper) < must be satisfied brought in good faith and satisfied that there is a reasonab e possibi it! that the action %i be reso ved in favour of 9 aintiff O tria . 1iti$ation chill cou d arise. o 9urpose of eave re=uirement; #his ,eeps unmeritorious c aims out of the court, %hich o%ers the ris, e$posure to issuers (this change %as introduced after issuers strong ! protested about the introduction of CD statutor! iabi it!). Deemed Ie iance6 Fo need an!more to sho% re iance on misrepresentation or to sho% re iance on issuer having comp ied %ith disc osure re=uirements Sec ):8(2 < ist of transactions that donHt come %ithin mandate of 9art LIII. Court approva of sett ements re=uired: ):8()< Cost ru es ):8()) o 9ossibi it! that this creates liti$ation chill if Ds %in6 prevai ing part! is entit ed to cost determined in accordance %4ru es of civi procedure. Disincentive for 9s; o PLoser 9a!sH cost ru es are a so an attempt to screen out unmeritorious c aims, and %ere pushed for b! issuers. /nus on Plaintiff to Prove
+ype of 8isrepresentation Misrepresentation in Core Document .ocs Inclu%e% For .irector = Influential Persons 9rospectus, ta,eover bid circu ars, MD/, /I&, annua financia statements, interim financia statements Materia Change Ieports .ocs Inclu%e% For Issuers = /fficers 9rospectus, ta,eover bid circu ars, MD/, /I&, annua financia statements, interim financia statements an% material change reports 4lements of Proof 9 aintiff must prove (+) ac=uisition or disposition of securit! at re evant time and (() e$istence of misrepresentation (standard definition app ies) In addition to core document test, (+) Defendant ,ne% there %as a misrepresentation: or (() Defendant de iberate ! avoided ac=uiring such ,no% edge: or (1) Defendant %as gui t! of gross misconduct in connection %ith doc4statement: 9 aintiff must prove (+) Defendant ,ne% of materia change: or (() Defendant de iberate ! avoided ac=uiring ,no% edge of materia change: or (1) Defendant %as gui t! of gross misconduct in connection %ith fai ure to ma,e time ! disc osure.

Misrepresentation in Fon"Core Documents or Cra 49ub ic Statements

&ai ure to Ma,e #ime ! Disc osure < CS/ ):8(;5:)

45 Defences for Misrepresentation in Continuous Disc osure < Section ):8(; 5>): 9 ac=uired4disposed %ith ,no% edge of misrepresentation or %ith ,no% edge of the materia change. Burden of proof on D. 5?): Defendant made reasonab e investigation and had no reasonab e grounds to be ieve o (a) #here %as a misrepresentation. o (b) #hat the fai ure to ma,e time ! disc osure %ou d occur. o Note that onus is still on the defence, unli&e &') 2here onus s2itches to plaintiff on the issue of due dili$ence. 57): &actors to be considered b! ct %ith respect to reasonab e investigations (due di igence) o / re evant circumstances inc uding nature of issuer, ,no% edge, office he d, e$istence of an! s!stem designed to ensure responsib e issuer meets its continuous disc osure ob igations 58): In defence of failure to ma&e timely disclosure, a defendant a so has the defence of 9rior confidentia disc osure* (Iemember time ! confidentia disc osure a o%ed under 7>5:)) o Must sho% reasonab e basis for ma,ing disc osure on confidentia basis (must sho% that undu ! detrimenta to ma,e fu disc osure at that time). Limits on iabi it!6 /ctions for dama$es only < no rescission Proportionate liability under ):8(? o (+) 9roportionate re e$tent of breach of each D " o (() Fot proportionate (ie fu amount can be assessed against one defendant) %here defendants other than issuers ,no%ing ! authori'ed or permitted misrepresentation or fai ure to disc ose materia change. o 3nder section &') there is 4oint and several liability, 0ssessment of dama$es under ):8(> < depending on %hen 9 investor so d securities. o Issuer imit6 greater of )E mar,et cap and *+ mi ion do ars: o Individua s imit6 greater of *(),??? and )?E of aggregate annua compensation. So individua Ds arenHt going to be ban,rupted.Statutory limits on liability . ):8(7 o (+) D on ! pa!s the esser of the aggregate damages assessed and iabi it! imits o (() Limit does not app ! to a defendant other than the responsib e issuer if the p aintiff proves that the defendant authori'ed, permitted or ac=uiesced in the ma,ing of the misrepresentation or the fai ure to ma,e time ! disc osure %hi e ,no%ing that it %as a misrepresentation or a fai ure to ma,e time ! disc osure, or inf uenced the ma,ing of the misrepresentation or the fai ure to ma,e time ! disc osure %hi e ,no%ing that it %as a misrepresentation or a fai ure to ma,e time ! disc osure. Basica ! no imit if fraud Implications for leave application: %i 9s have to c aim fraud at the beginning of app ication because of possibi it! of imits.

46

Insider Reporting and Insider Trading I

Overview /s ong as insiders disc ose their trades, and the trade does not resu t from materia undisc osed information, trading b! insiders is permissib e. o 1e$al insider trading is sti regu ated, in that is must be reported. 9o ic! Iationa e6 -h! do %e prohibit i ega insider trading; Shou d %e prohibit insider trading; -h! do %e regu ate insider trading; o &airness to other investors (not fairness to the actua insiders) %ho do not have access to the same information overa mar,et confidence o La% and economics sa! it is not necessari ! c ear that the benefits of preventing insider trading out%eigh the costs. Insider trading cou d be a o%ed as a form of e$ecutive compensation, and can more accurate ! price securities. But there is a need to regu ate %hen there is bad ne%s, other%ise insiders are insu ated from ris,. -h! do %e ma,e insiders report their trades; Deterrence, but not that compe ing. / so acts as a data point for other investors. #efinition of Insider Section )5)): 7insider8 or 7insider of a reporting issuer8 means, o (a) ever! director or senior officer of a reporting issuer, o (b) ever! director or senior officer of a compan! that is itse f an insider or subsidiar! of a reporting issuer, o (c) an! person or compan! %ho beneficia ! o%ns, direct ! or indirect !, voting securities of a reporting issuer or %ho e$ercises contro or direction over voting securities of a reporting issuer or a combination of both carr!ing more than &) per cent of the voting rights attached to a voting securities of the reporting issuer for the time being outstanding other than voting securities he d b! the person or compan! as under%riter in the course of a distribution, and o (d) a reporting issuer %here it has purchased, redeemed or other%ise ac=uired an! of its securities, for so ong as it ho ds an! of its securities: Fote that there is a retrospective aspect to this < section )58) and )59) o (A) -here an issuer becomes an insider of a reporting issuer, ever! director or senior officer of the issuer sha be deemed to have been an insider of the reporting issuer for the previous six months or for such shorter period that he or she %as a director or senior officer of the issuer. If !ou %ere a senior officer in a compan! p anning to bu! another compan!, !ou cou d bu! stoc, in the other compan! and ma,e a arge %indfa . o (0) -here a reporting issuer becomes an insider of an! other reporting issuer, ever! director or senior officer of the second"mentioned reporting issuer sha be deemed to have been an insider of the first"mentioned reporting issuer for the previous six months or for such shorter period that he or she %as a director or senior officer of the second"mentioned reporting issuer. Senior officers of the target are a so considered senior officers of the bidder. Legal Insider Trading Reporting Requirements OSA section 107 Jenera !, the ru e is that insiders must report %ithin +? da!s that the! o (+) 2ave become insiders (creates a reporting profi e) Fote that an insider %ith no o%nership, direction, or contro over an! of the issuerHs securities need not fi e an I#I. o (() 2as their o%nership, direction, or contro change (ma&es a trade) in the issuer as an insider, or o (1) 2as become an insider under 567) or 568) < note one must fi e the I#I %ithin +? da!s after merger of the t%o issuers being comp eted (retrospective report) 2o% serious are the ob3ectives of insider reporting re=uirements %hen there is a +?"da! period a o%ed for fi ing the report; o /uthors recommend a 1"da! period in ine %ith c earance and sett ement ru es. Reporting 8echanism - ,I >>-)<2 @ "ystem for 4lectronic .isclosure &y Insi%ers 5"4.I) SEDI6 re=uires insiders to create an Insider profile ())"+?(&+) and reports ())"+?(&() on the internet < from section )<7

47 o .nder SEDI, I#I reports are avai ab e through SED/I instead of on ! through commission and business pub ications. Exemptions from Insider %eportin$ %e9uirements . Pa$e :;< 47emption Issuer change to a securities E$emption for Directors4Cfficers or Subsidiaries E$emption for Directors4Cfficers of 0ffiliates of Issuer E$emption at discretion of the CS/ Rule FI ))"+?+ FI ))"+?+ ReAuirements=,otes /rises if there is a dividend or ama gamation that affects e=ua ! or is avai ab e to a shareho ders. Issuer must fi e %ithin one business da!. D4C of Subs ma! not have an! ,no% edge of the parent issuer, but are norma ! caught b! (b) of the Insider definition under s.+. Note* CS/ proposes to e$pand e$emption for peop e %ith e$ecutive tit es mar,eting purposes. Same as e$emption above (affi iate comes from special relationship definition in CS/ >Q())). Must not have ,no% edge of materia facts or changes about the issuer. Issuer must notif! regu ators that it is using the e$emption and provide the regu ators %ith a ist of those inc uded. Interested person ma! app ! for an e$emption, or commission ma! grant e$emptions on its o%n motion %here P3ust and convenientH (cost doesnHt 3ustif! e$emption). #he test on %hether to grant re ief is %hether the person has access to specific undisc osed confidentia information. E$emptions for eli$ible institutional investors if the! have fi ed an ear ! %arning report and do not have ,no% edge of an! materia fact or change. Important6 an investment manager cou d represent severa retai investors, %ho in sum contro R+?E of a compan!, %hich other%ise %ou d re=uire an insider trading report.

FI ))"+?+

CS/ +(((()(a) and (b)

E igib e Institutiona Investors

FI Q("+?1 9art 0

I ega Insider #rading < 9age @10 Trading o Trading 76(1): 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. Elements of Proof #he accused %as in a specia re ationship %ith the II #he accused purchased4so d securities of II #he accused made the purchase4sa e %ith ,no% edge of materia info (facts4change) concerning the affairs of the II, and the materia info is not genera ! disc osed. Tipping o Tipping - 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. Elements of Proof: #he accused %as in a specia re ationship %ith the reporting issuer #he accused informed another person of materia information (facts and changes) %ith respect to the reporting issuer other than in the necessar! course of business #he accused informed another person of the materia information before it %as genera ! disc osed o Notes* (a so see the %an&in decision) #here does not have to be trading b! the tippee in order for there to be tipping #he tippee does not have to ,no% that tipper is in a specia re ationship in order for there to be tipping (on ! the activit! of informing is important) 2o%ever the tippee %ou d on ! be gui t! of trading or tipping if he ,ne% the tipper %as in a specia re ationship %ith the issuer.

48 Can a tippee a so be a tipper; If the tippee knows (or reasonably ought to know) that the tipper is in a special relationship with the issuer, the tippee can also be a tipper since they will have a special relationship with the issuer (76(5)(e)). Therefore a chain of tippers can form.

Criminal Code insider Trading and Tipping- CB 595-597 Section :82()5)) ma,es it an indictab e offence to direct ! or indirect ! bu! or se a securit! &no2in$ly using insider information8 b! virtue of various re ationships to the issuer. Section :8)()52) ma,es it an indictab e offence to &no2in$ly engage in tipping. o Fote that these crimina offences re=uire that the accused &no2in$ly committed the offence, %hich is a much higher onus to prove. o / so, the provisions app ! to a issuers, not 3ust reporting issuers. o #he provisions seem to app ! to individua s %ho possess insider information b! virtue of being a shareho der, but not to investors %ho ho d bonds or units in a trust. What is the nature of a Special Relationship? Page 440 o S.7?5>): person or company in a special relationship with a reporting issuer means, o (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 of issuer (iii) a person or company that is proposing to become a party to a reorganization, amalgamation, merger, major asset purchase, etc. with the RI o (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), ie Lawyers, accountants, underwriters o (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), o (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), o (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. . Anyone who learns of a material fact or change from anyone described in the definition as a whole and who should have known that the person was in a special relationship with the issuer can come within the definition This provision is based on a reasonableness standard but nevertheless potentially implicates those who learn of the information, not simply those who convey it 9otentia ! e$tensive chain of peop e %ho can be gui t! of insider trading. Broader than definition of insider for reporting purposes under section )<7 or .S Definition
Case Name Re Donnini Year Court 2002 OSC Holding D, financier of KCA, shorted KCA stocks to hedge against risk based on information not yet public. D had special relationship, sold securities, based on material information (court applies probability/magnitude test that info, while not confirmed, was a material fact), and material info not yet public. Court considers OSA Reg. 175 defence (grey lists) and find it doesnt apply. General disclosure is a two-prong test: means that the information was disclosed to the market and the market must have sufficient time to digest the information. One full trading day deemed the appropriate time to wait after info disclosed before insiders can trade. Test is now codified in NP 51201 3.5(2) (adopted in Pezim) Insiders have a dut! to in=uire about materia changes and materia facts at the issuer before ma,ing an insider trading transaction (even if the issuer uses Chinese %a s to ,eep info confidentia < prob ematic in arge,

Re Harold P Connor

1976

OSC

Pezim v. BC

1994

SCC

49
mu tinationa issuers) First prosecution for tipping under section 76 (2) (brought under s.122): Rankin an I-banker at RBC. There was circumstantial evidence that Rankin was tipping his friend Duic, but this was not persuasive (info could have come from anyone at RBC, not just Rankin). However Duic testified against Rankin, which was the grounds of the conviction. Judge convicted Rankin despite him not knowing the extent to which Duic was trading.

R. v. Rankin

2005

ON

Sanctions for Insider #rading Criminal6 the ma$imum term for indictab e offences is +@ !ears (s( :8<52) <&raud /ffecting the 9ub ic Mar,ets). /ggravating circumstances (page )0Q) can increase the harshness of the pena t!. =uasi-Criminal6 s. )22 (especia ! +(((@))6 If an accused ma,es a profit of *( mi ion from insider trading, a person cou d pa! a fine of up to *Q mi ion (1L the amount) as sanction Civil section +1@(+), (@), and +1) 0dministrative6 ss. +(>4+(A6 E$amp e is the #onnini decision. /ssessment of I ega Insider #rading < 9age @>? In (??1, the CS/ estab ished an independent tas, force to assess enforcement of i ega insider trading in Canada. o Due to data imitations, it is current ! ver! difficu t to estab ish accurate ! the e$tent of i ega insider trading in Canada. )cNally and Smith did a stud! that suggests that insiders do not avoid trading prior to announcements of materia information, and that vio ations are infre=uent ! enforced. Iecommendations6 o &o o% .S strateg! %here peop e %ho snitch on insider traders get to ,eep a portion of the fine evied. o 2armoni'e #SL and CSC Iu es o Ie=uire insider trades to be reported much sooner than the +? da! period o Insiders shou d be restricted from trading in a period 3ust prior to pre"p anned announcements such as earnings re eases (man! companies a read! vo untari ! have such a procedure in p ace)

50

Insider Reporting and Insider Trading II: Defences

Type of Defence Reasonable belief that information has been generally disclosed Statutory Provision OSA 76(4) Onus Accused Case Name Green v. Charterhouse Group Year Court 1976 ON CA Holding / Description 2inting at the e$istence of materia information in a etter is not significant enough to count as a disc osure of materia information. Only when the disclosure is completely honest and forthright, and that the public would have had sufficient time to digest the information (deemed 1 day), is defence allowed. Exemption from section 76 for the corporation if the person making the trade did not have knowledge of the material information held by someone else in the corp. See notes Includes education of employees (Insider rules, ethical standards, etc) and containment of insider info (codenames for files, grey lists, restricted lists, Fingold in special relationship, info was material, info would reasonably be expected to affect market, and F traded on info. Mistake of fact defence allowed: his experience made it reasonable to think that the poor results would not affect market (not

Re Harold Connor

1976

OSC

Defence for companies when some people know of material info and others dont

OSA Regulations 175

Accused

Considered in Donnini there must be reasonable policies and procedures in place to prevent info sharing (Chinese Walls, Grey Lists) Donnini supports Chinese Walls, but in Rankin, the court is highly skeptical of info containment procedures (thinks info is informally shared)

Guidelines for Prevention of Information Dissemination

OSC Policy 33601

Reasonable Mistake of Fact

CL: because insider trading is strict liability if this defence was not available, threshold for defence would be too high.

Accused established on balance of probability

Lewis v. Fingold note a 122 decision (quasicriminal), that may not fly under s.127 (administrative)

1999

ON GD

51
material) H mistaken belief that negative result was not material is not reasonable given his experience, and H cant rely on expert advice. Securities sanctions stiffer than criminal. Disclosing information to a shareholder (that dividend would be paid) as part of an attempt to defend against a takeover bid is not in the necessary course of business, and is tipping.

R. v. Harper

2000

ON

Necessary Course of Business

NP 51-201 for defence to tipping: necessary course of business would not permit selective disclosure of material info to an analyst, institutional investor, or other market professional.

Accused 76(4) of OSA

Royal Trustco v. OSC

1983

ON

52

Prospectus Exemptions
Cvervie% E$emptions a o% issuers to issue securities %ithout the accompan!ing mandated disc osure. (prospectus and register as issuer etc) o E$emption ru es app ! to reportin$ issuers and non-reportin$ issuers, Policy reasons for Exemptions* o E$amp e of regu ators favouring efficienc!4cost reduction over protection4 iabi it! o Concern for start"ups4sma issuers < reducing the regu ator! burden and cost. Iu es have e$panded the e$empt mar,et and made it easier for sma issuers to get mone!. o 9rospectus unnecessar! for %ea th!4sophisticated investors (capab e of ma,ing investment decisions %ithout the information provided in a prospectus) o 9rospectus unnecessar! %hen there is a pre"e$isting re ationship bet%een the issuer and the bu!er of securities (for e$amp e %hen investor a read! a securit! ho der < rights offering < or %hen investor is an emp o!ee, friend, fami ! of issuer) o Some securities, i,e government bonds, are e$treme ! safe investments. Cntario has a c osed s!stem of regu ation. #his means that a ega %a!s of distributing securities are considered under e$isting a%s. /ptions available to issuers include6 o Provide a prospectus o =ualify for explicit exemption %ith resa e of those securities i,e%ise being considered a distribution un ess the rese ers =ua if! for the re evant resa e ru es. C oses off bac, door under%riting. o 0pply for a discretionary exemption (in Cntario, under section 7;). Securities practitioners can advise their c ient that if the financing the! %ant raise cannot be structured so as to fit the terms of the various prospectus e$empting ru es, it is possib e to app ! to securities regu ators to obtain a transaction"specific e$emptions from the prospectus re=uirement Exempt mar&et consists of three levels of transactions*
+ype of +ransaction Bet%een Issuers and Investors "tatutory Provisions for 47emption ,I ;>-)<? (September (??)) (attempt at harmoni'ation) /"C Rule ;>-><)6 Covers some e$emptions, most ! rep aced b! ne% FI /"A Part B6II no% most ! inoperative b! FI ,I ;>-)<2 app ies to c osed 3urisdictions (Man., FB, S5 are open, sections donHt app !) Companion 9o icies for ,I ;>-)<? and ,I ;>-)<2 give guidance. .escription Can be grouped into categories of e$emptions for SMEs, accredited investor e$emptions, minimum investment e$emptions, e$emptions for pre" e$isting re ationships, and residua discretion for e$emptions b! regu ators.

Bet%een Investors and Subse=uent Investors (%esale %ules) Securities from Contro 9erson4B oc,

9urpose6 protection of investors and prevention of bac& door under2ritin$ See next section of the course

SME and Startup E$emptions

,ame Jovernment Incentive Securit! (JIS) E$emption Rule /"C Rule ;>><) s(2(): .escription &aci itates the setting up of business entities for beneficia ta$ purposes (deductions to promote the activities of 3unior e$p oration issuers in the resource Rules on "ecurities Max 75 investors solicited, max 50 may purchase (anti-avoidance rules apply) Investor must receive substantially same info as a prospectus Issuer cannot advertise or promote offering, and GIS can only be used once *ho can 1uy Investor must be able to valuate security (unique requirement), or must be officer/director or child of such

53
sector) annually Investor must receive Offering Memorandum and the report of trading (to OSC) Report must be filed within 10 days of trade (Form 45-501F s.7.1, 7.2) Securities must not be bonds or debentures Securities must have restrictions on transfer in artic es of inc, (or trust agreement) Securities cannot be o%ned b! more than )? peop e Fo cap on amount of * that can be raised under e$emption (different than o d 8I ;>-)<:) Distributions do not need to be reported to regu ators M no registration or prospectus re=uirement %hen se ing to the group mentioned in ne$t bo$ Feeds to be ana !sis %hether purchaser is 7the pub ic8

9rivate Issuer E$emption (a so can be grouped under an accredited investor e$emption) ,I ;>)<?' s( 2(; /pp ies to 9rivate Issuers not Ieporting Issuers

&ounder, Contro 9erson, and &ami ! E$emption

,I ;>)<? s(2(7

CFLS /U/IL/BLE IF CF#/IIC, targets first" generation financing C2IHs are imited to raising capita up to *1,???,??? and to 1) investors (outside of the noted members). #his is to ,eep the purpose of the e$empt consistent %ith the ob3ective of the po ic!. #here is re=uirement that an information statement be provided to purchaser b! se er < has a arge disc aimer %rt to

#here is no imit on the financing avai ab e, and there are no reporting re=uirements (regu ators on ! intervene if there is a comp aint) Shares are sub3ect to restrictions on transfer (re=uire approva of directors, or shareho ders) through a constating document or agreements M outstanding shares are o%ned b! not more than 1) persons or companies, e$c usive of ,e! o%ners, emp o!ees, directors (p1?))

C ose ! 2e d Issuer E$emption

s( 2()5)) of /"C Rule ;>><)

Set out in 2(;52)6 (a) Director, officer, founder, emp o!ee, contro person (b"f) Spouse, 9arents, grandparents, chi dren, c ose persona friend, c ose business associate of directors, officers, founders, or contro persons (or their spouse) (g) Cther peop e in e$empt c ass (resa e ru e) (h) /ccredited investors Tdoes not appear that the! are e$c uded from the )? pp cei ing (un i,e C2I e$emption) (,) 9erson %ho are Pnot the pub icH (%alston Purina6 emp o!ees G pub ic, issue test6 did the emp o!ees need a prospectus;) I v. 9iepgrass 7need to ,no% test8 and 7common bond8 test (a) &ounders (b) /ffi iate &ounder (subs < +.() (c) Spouse, parent, sib ing, grandparent, or chi d of officer, director, or founder (d) Contro 9erson - accredited investors - emp o!ees, directors, former directors, etc

54
investing / e$emption for trading in securities of an issuer if the purchaser is fami !, etc #he issuer is re=uired to fi e a report in the oca 3urisdiction in %hich the distribution ta,es p ace on or before the +?th da! after the distribution (s. >.+)

&ami !, &riends, and Business /ssociates E$emption

8I ;>)<: s( :() @ replace% $ith ;>)<?

" there is no restriction as to ho% man! pp it can be so d to " there is no prohibition on 7the use of registrants, finders, te emar,eting or advertising in an! form to so icit or find purchasers under an! of the e$emptions (MI @)"+?1C9 s.+.>) ho%ever an adverse imp ication %i be dra%n if fees are paid to find purchasers "further, there is =ua itative assessment in determining c ose friend or associate %hich is based on the indiv ,no%ing the director ,officer etc ong enough to be in a position to assess the capabi ities and trust%orthiness (MI @)" +?1C9 s. (.()

securities can be so d to fami !, friends, business associates, fami ! of directors, a founder of issuer and fami ! etc but it e$c udes emp o!ees from %hom the! can be so d to %ith e$emption

/ccredited Investor E$emptions (,I ;>-)<? s(2(:) ()ost >idely 3sed in Securities) %ational underpinnin$ that came from Cntario (/"C ;>-><)). Most accredited investors are financia institutions %ho bu! securities through private p acements. Is it rationa ; o Do these factors mean that you no longer required the protections? Does that make good sense? Maybe if youre in the IB industry but otherwise o The rules seem to suggest income and/or assets are a proxy for being able to access investment advice (be able to hire an investment advisor). 0nti-avoidance rule (s(2(:5?))6 Cant set up corporation and transfer individual shareholders assets to meet 5m threshold under branch (l) of accredited investor definition Seller to accredited investor does not have to be an issuer6 wording of 2.3 says nothing about who the seller is, which makes it possible for one accredited investors to sell to another #here is no minimum purchase re9uirement in this ru e. %eportin$ re9uirement in s.?() (&rom ;>-)<?FI)6 reporting ob igation on the issuer to report %ithin 5? days after the distribution occurs. o "ut see *I +,-&). s.../* Issuers dont have to file reports where theyre selling to certain Canadian financial institutions (defined in the rule covers credit unions, banks, loan corps, insurance companies) #efinition of accredited investor 6section &.&) 6Pa$e 5@8@) (a) Canadian financia institution (b) Business deve opment ban, of Canada (f) Jovernment of Canada, provincia 4territoria 4municipa governments (i) 9ension funds, (=) mutua funds, (p) trust companies, etc. (3" ) app ies to individua s and covers different possibi ities for investment savv! based on an asset test Tfinancia and netV or income test under section :(>. o Financial asset test [branch (j) of definition]: Liquid Financial assets of investor (or with spouse) exceeding $1 million net of any related liabilities Fote that there is no proportionate re=uirement of oneHs assets to the si'e of the investment Factors indicative of beneficial ownership (NI 45-106 CP s.3.5): (1) physical or a constructive possession of evidence of ownership, entitlement to receipt of any income generated by the financial asset, risk of loss of the value of the financial asset, and ability to dispose of the asset or otherwise deal with it as the individual sees fit. o Income test [branch (k) of definition]: Net income before taxes exceeded 200,000 or

55 with spouse 300,000 for past two years and expects to qualify in the current year (reasonable expectation of exceeding the same net income level in the current year) o Net asset test [branch (l) of definition]: Not necessarily financial assets just assets generally over $5m (includes properties, etc) business investor Minimum Investment exemption - NI 45-106 s.2.10 E$emption from prospectus if +)?,??? paid in cash at time of the trade in a sing e issuer for a sing e transaction (previous ! discarded b! CF to encourage SME financing and get ride of artificia f oor for financing, but brought bac, in FI for harmoni'ation) Section (3) contains an anti-avoidance rule and the reporting requirements (6.1) are same as the accredited investor exemption (see above) Exemptions based on Pre-existing Relationships .nder !ing rationa e6 issuer has pre"e$iting re ationship %ith entit! to %hich it is distributing securities, and therefore a prospectus is not re=uired. ,ame
Dividends < Securit! as 9a!ment

Rule
,I ;>)<? s(2(:)

.escription
/pp ies %hen ne% securities are used to pa! dividends to securit! ho ders (former ! CSC Iu e @)" )?()

Rules
Must be (+) in respect of a trade by an issuer in a security of its own issue to a security holder of the issuer as a dividend, or (2) In respect of a trade by an issuer in a security of a reporting issuer as a dividend Fote imitations in section6 must not exceed @A of the issued and outstandin$ shares of a class " constrain operation of e$emption < not se ing too man! securities through e$emption to avoid disc osure See a so FI @)"+?Q C9 s.@.(

Dividends < Interest or cash pa!ments app ied to ac=uire additiona securities (dividend reinvestment plan) Ieorgani'ations (good or bad)

,I ;>)<? s(2(2

,I ;>)<? s(2())

Dividends4interest4cash pa!ments app ied to ac=uire additiona securities. Instead of giving stoc, as dividends, !ou give cash and the option to ro the cash into stoc, < dividend reinvestment p an (ne% distribution of securities) Jood6 ama gamation4merger %ith another business, %hich invo ves a share e$change for securities in ne% entit!, Bad6 reorgani'ation of issuer due to inso venc! (CC//), %here debt is e$changed for e=uit! /pp ies %hen securities that have %ith them a previous right granted of conversion, e$change, or purchase. -hen this right is e$ercised, technica ! ne% securities are issued, but an e$emption is granted. Cffer of right to e$isting securit! ho ders to ac=uire additiona securities. E$emption covers both granting of right and issuing of securities pursuant to the right. Constrained use of this e$emption so that it doesnHt end up being norma course a ternative to the prospectus.

Conversion, E$change or E$ercise

,I ;>)<? s(2(;2

E$amp es6 -arrants (options to ac=uire additiona shares for cash), options, convertib e debt, convertib e preferred shares

Iights Cfferings

,I ;>)<? 2(), and ,I ;>-2<2 s(2(2 and ;>><)CP s(2()

Distribution to Emp o!ees

,I ;>)<? s(2(2:-2>

/ o%s for distribution of securities to emp o!ees %ithout triggering a prospectus.

FI @)"+?+ s.(.( and @)"+?+ C9 +.(6 grounds on %hich rights offering e$emption not avai ab e6 increase of R()E of outstanding securities of c ass, to finance reactivation of dormant issuer, to finance a ma3or ne% underta,ing, %here securities issued can be e$ercised into an ne% c ass. Disc osure re=uirements6 advance notice to regu ators via ri$hts offerin$ circular, regu ator has +? da!s to ob3ect (.(1(()6 acceptab e consideration has to be past services, not inducement of future emp o!ment, (.(@6 9articipation in trade b! emp o!ee must be vo untar!

56
(.()6 &or un isted issuers, there is a imit to the W4E of securities that can distributed un ess securit! ho der approva

Cones v( F3 .eacon 3o%gson 5)98? /, 3C) @ Page ::9: If an issuer relies on an exemption inappropriately, and should have actually provided a prospectus, those 2ho purchased the securities are not time-limited in see&in$ a remedy under section ,', 2hich can include rescission, If issuers are unsure about an e$emption, consu t %ith regu ators. Note on Offering Memoranda (OM) Definition of CM6 CS/ s.+ and CSC Iu e @)")?+6 a document that provides info about securities being sold used in conjunction with an exemption from the prospectus requirement Distinction bet%een CM e$emption in non"Cntario 3urisdictions (,I ;>-)<? s(2(9) and use of CM in Cntario (/"C Rule ;>-><)). /pp icab e Cntario ru es6 o You may give an OM if using exemption generally, but must provide it with the government incentive exemption o With accredited investor exemption (s.2.3) you can voluntarily give OM (likely that they will request it anyway) not a legal requirement for the exemption but as a matter of business practice it is expected. Voluntary OM still subjects issuer to liability for misrepresentation (See OSC Rule 45-501 CP Part 5 - page 1402) 130.1 OSA Notes6 / though a cop! of an CM has to be fi ed %ith the CSC under s. Q.( of Iu e @)")?+ T%ithin +? da!s of purchaseV, the regu ators do not revie% the CM and the! do not put it on SED/I Contents of OM OSC Rule 45-501 JIS (government incentive securit!)6 Iu e @)")?+ s.(.+(+) o Info about officers directors and promoters of business entity Cther%ise itt e prescribed content (see CSC Iu e @)")?+ 9art Q) o The only requirement is description of rights available to buyer under s.130.1 (equivalent of s.130 for prospectuses right of action for misrepresentation) OM: Statutory Right of Action (OSA s.130.1)(45-501 s.6.2) " Section 130.1(1): Where an offering memorandum contains a misrepresentation, a purchaser who purchases a security offered by the offering memorandum during the period of distribution has, without regard to whether the purchaser relied on the misrepresentation [deemed reliance], the following rights: [Damages] or [Rescission] (same as 130) " Defences: Purchaser knowledge when they purchased; Depreciation not due to misrepresentation; Not receiving proceeds issuer was not receiving the proceeds (sale of securities is by a control person) " Remedies: Statutory right of action under s.130.1 is NOT granted to CDN financial institution accredited investors

57

Resale Rules and Control Distributions

Cvervie% < 9o ic! Cb3ectives Uer! technica ru es, no rea consensus about %hat these ru es are tr!ing to achieve. Cntario statutor! resa e ru es are no% out, and resa e ru es are no% governed b! ,I ;>-)<2 Policy /b4ectives of ,I ;>-)<2 o #isclosure < if e$emptions pu s bac, on the goa of disc osure, the resa e ru es tr! to bring the ro e of disc osure bac, into p a! (b! regu ating do%nstream purchases) o Preventin$ Bbac&doorC under2ritin$ < %hich is an initia distribution to an e$empt purchaser, %ho then rese s to the broader mar,et (avoiding regu ation) o Pricin$ < resa e ru es provide an order ! mechanism for e$empt securities to find their %a! into the genera mar,et (assists %ith pricing the securities) o Control distributions < providing a mechanism for contro persons to rese their securities (section 2(8) Fote6 once a resa e ru e is satisfied %hich moves the securit! from the e$emption s!stem to the genera mar,et, resa e ru es no onger attach to that securit! or investor. Substantive Ie=uirements " ,I ;>-)<2 Securities issued under various e$emptions attract either 0ppendix # (2(> resa e ru es) or 0ppendix E (2(? resa e ru es) of ,I ;>-)<2 o FI @)"+?( (.) (restricted period ru e < more strin$ent) Conditions on both the rese er and the issuer, imposed %here regu ators thin, that there is more potentia for bac,door under%riting to ta,e p ace. o FI @)"+?( (.Q (seasoning period ru e) Conditions are on ! p aced on the issuer. 47emption un%er ,I ;>-)<? Applica&le ,I ;>-)<2 Resale Rule Jovernment Incentive Securit! (JIS) E$emption < (.) /"C Rule ;>-><) s(2(): 9rivate Issuer E$emption < s(2(; (.Q &ounder, Contro 9erson and &ami ! E$emption < (.) s(2(7 /ccredited Investor E$emption < s(2(: (.) Minimum Investment E$emption < s(2()< (.) Stoc, Dividend E$emption < s(2(:) and 2(2 (.Q Ie"organi'ation E$emption < s(2()) (.Q Conversion. E$change, E$ercise E$emption < s(2(;2 (.) or (.Q (depending on ho% previous !"issued securit! %as ac=uired) Iights Cffering E$emption < s(2() (.Q Emp o!ees 4 Cfficers 4 Directors 4 Consu tants (.Q E$emptions < s(2(2; Iesa e Iu es for Contro 9ersons " ,I ;>-)<2 s(2(8 If the contro person se s through an e$emption under ,I ;>-)<? instead, the respective ,I ;>-)<2 resa e ru es app ! Iesa e Iu es for Contro 9ersons %ho are Eli$ible n4a Inst, Investors " ,I ?2-)<: and ,I ;>-)<? 5p;) Iestricted 9eriod Iu e < "ection 2(>52) (more stringent < conditions on issuers and rese ers) if these re=uirements are not met, the! are deemed to be a distribution Condition 5 - Seasonin$ re9uirement6 o Issuer is and has been a reporting issuer in Canada for the @ months preceding the Trese ingV trade (seasoning perio%) @"month re=uirement means that there %ou d be information on the mar,et (ie a =uarter ! report). #he @"month period is a re a$ation of o der ru es, and %as i,e ! a resu t of stricter continuous disc osure ru es under ,I >)-)<2. Note effect of section /.06 as ong as issuer became a reporting issuer (b! fi ing prospectus) b! the time of the rese ing trade, seasoning period is satisfied Fote, ho%ever, that if the issuer does not become a reporting issuer, the @ month period remains unfulfilled and the securit! ho der cannot rese the securities, un ess he finds another e$empt investor. Condition @ . %estrictedD(old Period %e9uirement*

58 o #he initia purchaser cannot rese %ithin four months of the securit! first being issued ( i,e a Pho d periodH re=uirement) o )())CP6 @ month Seasoning period (condition +) does not need to be commensurate for the @ month ho d period (condition (). (old period must be met, even if : month seasonin$ period is already met by filin$ a prospectus o )(8CP Ca cu ation of restricted periods %here more than one e$empt purchaser6 ho d period runs on ! once even if purchaser rese s (doesnHt restart) o ,I ;>-)<2 2(>5:) and )()<CP6 time period ca cu ated from distribution date of origina convertib e securit!, not date of the conversion to ne% t!pe of securit!. Condition ; . 1e$endin$ %e9uirement o Issuers and rese ers must disc ose to other purchasers of their ob igations to comp ! %ith the resa e re=uirements under the e$emption (%arning) (enhances transparency) Legending re=uirement does not app ! to the trade of under !ing securit! if four months has passed since the origina convertib e securit! %as issued. o .sefu ; #he ne$t accredited investor must a so =ua if! for e$emption (sophisticated) Condition : . Trade is not a Control #istribution o Contro b oc, distributions have a different set of ru es under section 2(8 Condition E . No 3nusual Effort o Inc udes activities such as dissemination of so iciting materia , formation of se ing grounds, sa es to non"armHs ength purchases Condition F . No BextraordinaryC commissions o Compensation cannont more than can be e$pected for other rese ing of the si'e in =uestion. 1DE looseleaf (C" ;;;-;:)6 the egis ation itse f does not e aborate on Punusua effortH or Pe$traordinar! commissionsH, but the /SC Iu es give a number of e$amp es to describe these points. Condition < . Sellin$ Security (older is an Insider or /fficer o #his app ies to se ing in a non"contro conte$t. #he se er must verif! that the! have no reasonab e be ief that the issuer is in defau t of securities ru es. o Dea s %ith as!mmetries of information bet%een insiders and possib e investors.

Seasoning 9eriod Iu e < "ection 2(? Main re=uirement is seasoning period for issuer (@ months) o Note6 seasonin$ period can be compressed b! fi ing a prospectus < 2(752) o Cther conditions simi ar to 2(>, e$cept that there is no egending re=uirement, and no restricted4ho d period for purchaser -hat if the issuer is a read! a reporting issuer for severa !ears %hen the securities are first issued; /s ong as other re=uirements4conditions are met (see (.)), then the securit! can be so d immediate ! (no @ month term) Xuestions Pa$e ;;E 6=;)* Jiven that the seasoning period is reduced if the issuer becomes a reporting issuer after distribution, does the seasoning period add an!thing of va ue to ru es re ating to %hen purchasers can rese under s.(.); o &or reporting issuers6 the seasoning period is a non"issue due to s.(.> o &or non"reporting issuers6 the seasoning period is a crucia hurd e. Investor needs the issuer to become a reporting issuer, other%ise securities cannot genera ! be reso d. o %ule therefore could be drafted differently for reportin$ and non-reportin$ issuers, Pa$e ;;F 6=@)* %hen do the resa e ru es app ! to private issuers; o E$amp e6 Issuer LSY =ua ifies to be private issuer according to definition in FI @)" +?Q s.(.@. LSY has (? securities ho ders, /, B, and C are directors of LSY. D is a c ose persona friend of / (being c ose friend of issuer is characteristic for bu!ing private securities from issuer). E is a c ose persona friend of B o LSY corp. issues securities to &, a c ose friend of C &ine6 & =ua ifies as a c ose friend, and there are sti ess than )? tota securit! ho ders in LSY. Se=uentia transactions b! issuers can sti =ua if! for a 9I e$emption, so ong as 9I retains the status of a private issuer. o D (LSY securit! ho der) %ishes to se to E. Is this C5; Ses. Disc osure re=uirements are not engaged, since the resa e is to another

59 accredited investor. (Iemember 9I must sti be a 9I T ess than )? securit! ho dersV after transactions) o LSY does an I9C in March, (??Q. /pri +, (??Q, E %ants to se her securities. Iesa e ru e (.Q app ies (since 9I is a (.Q resa e ru e) Seasoning period %as met since a prospectus %as fi ed, therefore E can se . Iesa e Iu es for Contro 9ersons < ,I ;>-)<2 s(2(8 #here are separate resa e ru es for contro b oc, persons, since contro persons are he d to a higher standard than average securit! ho ders. Security sales by a control persona are still counted as a distribution < s() of /"A (ypothetical* Control Persons %esale B becomes contro b oc, ho der of LSY, a private issuer, in &eb. (??Q LSY does an I9C in March (??Q B %ishes to se securities in /pri , (??Q o B cannot se , because the @ month ho d period is not met (2(8) o Note6 if B %as not a contro b oc, ho der, B cou d have so d right a%a! in March, since the (.Q seasoning period %ou d have been met for the private issuer e$emption. )anner in 2hich a control bloc& holder can sell securities from their bloc&
"trategy Issue a 9rospectus .escription Fot norma ! feasib e due to cost, but sometimes done as a Ptag onH %hen an issuer is a so fi ing a prospectus Cbtain an e$emption from regu ators to se securities on the secondar! mar,et. .se an! other prospectus e$emption, i,e one isted under ,I ;>)<?. Benefit6 the @" month ho d period under 2(8 cou d be avoided. Con%itions to 9se Rules to Follo$ Standard 9rospectus Ie=uirements

Discretionar! E$emption < /"A s(7; .se another prospectus e$emption

Fot norma ! a o%ed due to purposes of securities a% po ic! #he se er (contro b oc, ho der) needs to find a bu!er %ho =ua ifies for an e$emption ( i,e an accredited investor) #his on ! %or,s for e$emptions that donHt set out %ho the se er can be (se ing to accredited investor most i,e !) E conditions for a control person to be able to sell6 (+) Seasoning period (though 2(7 app ies %hich can erase this), (() 2o d 9eriod (2(95:) sets out time for convertib e securities < combine under !ing and convertib e securit! time), (1) Fo unusua effort to mar,et, (@) Fo e$traordinar! commission, ()) Se er has no reasonab e grounds to be ieve issuer in defau t of securities a% #he bu!er %ou d face restrictions based on the corresponding resa e ru e ((.) or (.Q)

.se SpecificContro 9erson4B oc, E$emption < ,I ;>-)<2 2(8

Specia e$emption for contro b oc, persons 4 b oc, %hich does not trigger the resa e ru es. /dvantage6 bu!er does not need to be an accredited investor, and faces no further restriction in rese ing.

Be!ond the conditions, there are fi ing re=uirements in 2(85:). 0t least < days Pretrade, C9 must fi e form ;>)<2F) on SED/I (must be certified and signed). Posttrade, I#I must be fi ed %ithin 1 da!s. Note also separate rules for Beli$ible institutional investors 2ho are control bloc& holders (ma!be due to investments of their c ients added together) " ,I ?2-)<: and Part ;' ,I ;>)<?

60

Takeover Bids
Cvervie% #a,eovers occur (for purposes of securities a%) %hen a corporation (bidder) ma,es an offer to purchase more than (?E of the outstanding shares of another corporation (target) o #his is different than an amal$amationDmer$er or a sa e of a or substantia ! a of a businessH assets. Ta&eovers can be BhostileC or BfriendlyC o 2osti e bids are ess i,e ! in Canada because it is more i,e ! that a Canadian compan! %i have a contro b oc, ho der compared to the .S. Conse9uences of chan$in$ shareholder identity 6by ta&eover) o In change of contro , the successfu bidder a most inevitab ! puts in p ace its o%n board. #herefore =uestions are sometimes raised %hether directors of the target are acting in their o%n se f"interests %hen the! engage in defensive tactics. o Cften, the interests of other sta,eho ders in the target go unconsidered (such as emp o!ees, to%ns %here the target is ocated, etc). )otivations for ta&eovers6 business e$pansion, diversification b! the bidder, the remova of competition in ,e! mar,ets (sub3ect to competition a%), to ma,e the target more efficient and un oc, va ue, s!nergies and efficiencies in the bidderHs business, for ta$ purposes, etc. o Canadian egis ation is c ear ! structured to encourage ta,eover bids based on the assumption that the! are good for the econom!. o 2o%ever, note that ta,eovers face competition a% cha enges in Canada, %here our econom! is =uite concentrated (so man! ta,eovers are therefore anti"competitive). Types of consideration offered in ta&eovers* o Case, shares (va uation a ,e! issue), or combination of the t%o. Governance and the duty of the tar$et board o #he board of the target must comp ! %ith securities egis ation (Part BB of the /"A' and ,P ?2-2<2) and fiduciar! duties under corporate a%. Protections afforded to tar$et shareholders have deve oped b! Case a% and statute to6 o Jive shareho ders amp e opportunit! to change their mind if consider various bids and change their mind if the! decide to %ithdra% their shares after tendering. #here have been recent reforms increasing the time periods o Be treated e=ua ! in terms of the consideration that the bidder offers to them. Fote the approach in the .S, %here the price often drops ater in the bid as incentive for shareho ders to tender ear !. o Be ab e to ma,e fu ! informed decisions But is disc osure actua ! a misp aced concern; Disc osure increases the cost in a ta,eover bid and reduces the efficienc! gain. (istory and Process Issues o +imber %eport in +0Q) made recommendations %hich %ere adopted, inc uding6 Insider trading restrictions in anticipation of a ta,eover Definition of ta,eover and estab ishment of the (?E thresho d / o%ance for changes of contro b! private agreement Estab ishment of (+ da! period during %hich a ta,eover bid must remain open Imp ementation of pro rata ta,eup ru es Ie=uirement to provide shareho der ists and information regarding financing Uariations to the offer price and ta,eover bid circu ars. o .pdates and changes occurred since the 5imber Ieport6 +0>? Ieport of the Committee of the CSC +0A1 CSC Ieport prepared b! Pthe report of the three %ise menH +00Q Yimmerman report to the CSC. Ma3or changes6 Minimum deposit period e$tended from (+ to 1) da!s Bidder can begin bid b! p acing ad in financia ne%spapers (%4 circu ar mai ed %ithin ( business da!s) #a,eover egis ation is genera ! harmoni'ed across Canada. o .ni=ue e ement for Cntario and Xuebec6 conf ict of interest transactions regu ated b! /"C Rule ?>-><) (Ie evant to re ated"part! transactions, going"private transactions, issuer bids, and insider bids)

61 /re regu ator! bodies or courts the appropriate forum for hearing disputes that arise in the conte$t of a ta,eover bid; %e C> Shareholdin$s v, >IC >estern International 65887 /SC) o Bidder comp ained of targetHs defensive tactics (cro%n 3e%e sa e) to CSC. #arget argued that courts %ere appropriate p ace to revie%, not regu ator. Decision6 %hi e commission has authorit! to oversee dispute, court is proper p ace based on a pub ic interest test6 If the matter is a pub ic interest matter that concerns a shareho ders, then the securities commission, %ith its po%er to regu ated pub ic mar,ets, ma! be appropriate. If the matter is a private interest matter bet%een a shareho der and the compan!, the courts are in a better position to ad3udicate due to the 3udicia process (p eadings, e$amination for discover!, better remedies, etc.)

Definition of a #a,eover Bid "ection 89 of the CS/6 7ta,e"over bid8 means an offer to ac=uire outstandin$ votin$ or e9uity securities of a c ass made to an! person or compan! %ho is in Cntario or to an! securit! ho der of the offeree issuer %hose ast address as sho%n on the boo,s of the offeree issuer is in Cntario, %here the securities sub3ect to the offer to ac9uire, to$ether 2ith the offerorCs securities, constitute in the a$$re$ate @? per cent or more of the outstandin$ securities of that c ass of securities at the date of the offer to ac=uire.8 o PCfferH can come from the bidder (offer to bu!) or from the target (acceptance of offer to se ) (section 9)) o Fote reason %h! definition inc udes e=uit! securities6 often, e=uit! securities ( i,e preferred shares) can convert into voting shares, and this is often triggered %hen a ta,eover bid is aunched. o Fote that securities being ac=uired must be PoutstandingH6 this means that the offer is not being made to the issuer to issue more securities from the treasur!. o Fote that a bidder does not need to ho d ess than (?E %ith the p an to o%n more than (?E for there to be a ta,eover. If you start off above the @?A threshold and plan to ac9uire even 5 additional share, then ta&eover rules are tri$$ered J oba /ssessment to reach (?E6 Counting ru es dictate that securities convertib e into the re evant c ass (usua ! the voting c ass) %ithin Q? da!s, or securities that offeror ma! or must ac=uire %ithin Q? da!s b! e$ercise of option or right are deemed to count to%ards the (?E thresho d " /"A 9<5)) #here %i be a g oba assessment of the bidderHs sta,e in the target to determine %hen the (?E is met. o #%o or more parties cannot divide up the number of securities that the! are bidding for in order to avoid ta,eover bid ru es < /"A 9<52) If t%o or more parties are acting 3oint ! or in concert %ith each other to ac=uire the target, their securities %i be counted together to%ard the (?E. See "ection 9)6 o 79)(5)) &or the purposes of this 9art, it is a =uestion of fact as to %hether a person or compan! is acting 4ointly or in concert %ith an offeror and, %ithout imiting the genera it! of the foregoing, the fo o%ing sha be presumed to be acting 3oint ! or in concert %ith an offeror6 (forma or informa agreement4commitment4understanding, or an! associate or affi iate) Fote anti"avoidance ru e re Pindirect offersH in section 926 o 7a reference to an offer to ac=uire or to the ac=uisition or o%nership of securities or to contro or direction over securities sha be construed to inc ude a direct or indirect offer to ac=uire or the direct or indirect ac=uisition or o%nership of securities, or the direct or indirect contro or direction over securities, as the case ma! be.8 /, a ho ding compan!, has a ma3orit! sta,e in B. If C ma,es an offer to ac=uire /, then C ma! be considered to ma,e an indirect offer to ac=uire B. 1aunchin$ a Ta&eover "id &o o%ing Yimmerman, there are ( %a!s of aunching a ta,eover bid6 o #eliverin$ a circular to a shareho ders (CS/ )<<52)) o Publishin$ an announcement of the ta&eover bid in a ma4or daily ne2spaper. If pursued, a cop! of the bid must be de ivered to the target compan!Hs office (CS/ )<<57)) accompanied b! a ta,eover bid circu ar (CS/ 985))) -ithin ( da!s of receiving a ist of the targetHs shareho ders, bidder must a so de iver circu ar to a shareho ders of the target. &or both options, a circu ar must be de ivered6

62 o 98(5)) /n offeror sha de iver, %ith or as part of a ta,e"over bid or issuer bid, a ta,e" over bid circu ar or issuer bid circu ar, as the case ma! be. .nder 52) and 5;) there is an ob igation to send out a notice of any variation (though not e$act ! a materia change re=uirement < no mar&et impact analysis, 3ust reasonab ! e$pect to affect) o 9>5)))( #he bid sha be made to a ho ders of securities of the c ass that is sub3ect to the bid %ho are in Cntario, and de ivered b! the offeror to a ho dersZ of securities of that c ass and of securities that, before the e$pir! of the bid, are convertib e into securities of that c ass. Bidders prefer a =uic, process, %hi e targets prefer a onger bid period. 0llo2in$ commencement of a bid by advertisement is a ma4or advanta$e for bidder. o 1)"da! period begins to run the date the bid is commenced < an announcement can t!pica ! be p aced +? da!s ear ier than a bid document can be mai ed. o See e$amp e of a pub ic announcement < page @0? CB

E1 it23 4isc5os re3 6i!ing E9ual Treatment* Important for the mar,et being perceived as fair, democratic, and functioning in the best interests of investors. 2o%ever regu ators donHt %ant too man! protections, %hich can imba ance capita f o%s, ead to imperfect competition, reduced innovation, etc. ( main provisions ensuring e=ua treatment6 o Pro %ata Ta&eup in Ppartia bidH6 If more shareho ders tender than the bidder desires, the bidder %i ta,e up the shares on a pro rata basis so that the bidder %i purchase the same proportion of shares from a tendering shareho ders (/"A 9>57)) Iep aced the o d Pfirst come, first servedH s!stem. o Identical Consideration6 a ho ders of the targetHs securities sha receive identica consideration. Jroups of shareho ders ( i,e a contro b oc,) cannot receive additiona consideration, even the non"monetar! ,ind (/"A 97) If consideration is increased ater in the bid, there is a re=uirement to pa! the higher consideration to the ear ier tenderers Pre-bid consideration rule . section 9;5>)) If the bidder ma,es offers before the bid to securit! ho ders to generate momentum for the bid before the forma ta,eover, the amount offered in the forma ta,eover must be the same amount. E$ception6 / good faith reason for ma,ing a separate arrangement to a CEC to pa! them s ight ! more mone! (for instance, for stabi it!) ma! be a o%ed. #isclosure* Disc osure is the cornerstone of investor protection6 it ensures shareho ders have fu information about the bid and the bidder. / shareho ders are granted e=ua access to6 Circulars6 Circu ars are re=uired b! the bidder and the target6 o #a,eover Bid Circu ar6 must be sent to shareho ders %hen the bid is commenced, or as soon as a shareho der ist is avai ab e after the bid is commenced b! advertisement. Bidder can modif! the bid, but this re=uires a notice to be de ivered to ever! target shareho der (%hose shares %ere not ta,en up at the date of the variation) orm6 Regulations to /"A' Form :2 (9age 1?) of Conso idation)6 Item +)6 if part of offer is securities of the bidder, then prospectuslevel info about bidder is re9uired. Item +A6 disclosure of plans that 2ould e9ual material chan$es in the affairs of the tar$et (inc uding asset sa e, ama gamations, management4personne changes, etc.) o DirectorHs (of #arget) Circu ar6 /fter bid commenced, the targetHs board have an ob igation to prepare a directorHs circu ar and de iver it to target shareho ders. (/"A 995))). Circu arHs most important feature is a recommendation to target shareho ders to either accept or re3ect the bid (though egis ation permits no recommendation) Information inc uded (prescribed b! Regulations to /"A' Form :;) Item >6 Ie ationship bet%een target board4management and bidder (ie compensation to target board) Item +?6 #rading b! managers and directors

63 Item +(6 Materia changes in the target Item +@6 %ecommendin$ acceptance or re4ection of bid Directors circu ar must be de ivered %ithin +) da!s after the date of the bid. o Enforcement6 Conse=uences of not filin$ punishab e under CS/ )225)) 1iability for misrepresentation (/"A ):)5))) and for directors (/"A ):)52)) /pp ies to circu ars from both the bidder and the target. If contravention of securities a% violates the public interest there can be administrative action (/"A )27) or court action (/"A )28) Early >arnin$C System6 /"A s()<) re=uires an! person %ho ac=uires contro over +?E of voting or e=uit! securities of an issuer to issue and fi e a press re ease. o )<)5)) Ever! offeror that ac=uires beneficia o%nership of, or the po%er to e$ercise contro or direction over, or securities convertib e into, votin$ or e9uity securities of an! c ass of a reporting issuer that, to$ether 2ith such offerorCs securities of that class, %ou d constitute +? per cent or more of the outstanding securities of that c ass, Fote ho% ru e covers e=uit! and voting securities because e=uit! securities often can convert into voting securities, and often the conversion is triggered %hen a ta,eover is aunched. (a) Sha issue and fi e forth%ith a ne%s re ease containing the information prescribed b! the regu ations: and Content set out in ,I ?2-)<:' Part : an% Appen%i7 4 (page ((10) (b) -ithin t%o business da!s, sha fi e a report containing the same information as is contained in the ne%s re ease issued under (a). o Cnce +?E has been reached, every further increase of @A of outstandin$ securities re9uires a press release < /"A s()<)52) o >hy have the early 2arnin$ systemG 9revents a bidder from getting a Ptoe ho dH in an issuer in advance of a forma ta,eover, thus avoiding pa!ing premium on some shares o Note6 the .S has a )E thresho d for the ear ! %arning s!stem, and studies have found that this decreased the number of ta,eovers, %hich mar,et economists have critici'ed. Exemptions from Early >arnin$ System < ,I ?2-)<:6 E$emptions are granted for mutua funds or Pe igib e institutiona investorsH, entities that have an increase in a c ass of securities that arose so e ! due to certain actions of the issuer, and under%riters (if shares o%ned on ! for under%riting purposes). Despite the e$emption, ne%s re eases are often sti re=uired o #he e$emptions cannot be used if one of the e igib e institutiona investors intends to ma,e a forma ta,eover bid for the targetHs securities. o / so, there is the possibi it! of discretionar! e$emption under 9art ++ of FI Q("+?1

Timin$* The ;E-#ay %ule . Ta&e-up and Payment / ta,eover bid must remain open for at east 1) da!s (/"A 9>52)) Bidder is not $enerally permitted to ta&e up, or accept for purchase, an! shares deposited b! tendering shareho ders during the 1)"da! period (/"A 9>5:)). Shareho ders %ho have deposited shares are permitted to 2ithdra2 them (/"A 9>5;)) Fote that the bidder is sti ab e to ma,e mar,et purchases of the securities (these are ac=uired outside the bid, and on the mar,et)6 o 9;5:) Despite subsection ((), an offeror ma&in$ a ta&e-over bid may purchase, through the faci ities of a stoc, e$change recogni'ed b! the Commission for the purpose of c ause 01 (+) (a), securities of the class that are sub4ect to the bid and securities convertible into securities of that class commencing on the third business da! fo o%ing the date of the bid unti the e$pir! of the bid, if, (a) the intention to ma,e such purchases is stated in the ta,e"over bid circu ar: (b) the aggregate number of securities ac=uired under this subsection does not constitute in e$cess of ) per cent of the outstanding securities of that c ass as at the date of the bid: and (c) the offeror issues and fi es a ne%s re ease forth%ith after the c ose of business of the e$change on each da! on %hich securities have been purchased disc osing information prescribed b! regu ations. Tensions6 shareho ders ta,e comfort in ,no%ing that the! can %ithdra% their decision to deposit, but bidders oo, for%ard to the time %here shareho ders can no onger change their minds about the decision to tender. Cfferor has to ta,e up securities not ater than +? da!s after the e$pir! of the bid (/"A 9>59))

64 Cnce ta,en up, se ing shareho ders must be paid %ithin 1 business da!s (/"A 9>5)<)) If bidders do not get enough shares during the 1)"da! period, the! can e$tend the date on %hich the offer %i e$pire. 2o%ever, bidders are only permitted to extend the bid if the securities previously deposited are first ta&en up < /"A 9>5)2) o 2o%ever bidders do not have to ta&e up tendered shares if the shareholders still en4oy the ri$ht of 2ithdra2al < /"A 9>5)2()) o Iemember pro rata apportionment if the bidder has more shares tendered that actua ! desired 5/"A 9>57))

"id Conditions Bidders can have conditions on their ta,eover offer. Guidin$ %ule6 the fe%er the conditions the better (from the bidderHs point of vie%). 5eeping the bid simp e can ma,e it easier to persuade target shareho ders to tender. Note6 there cannot be conditions concerning financing (/"A s(9?) (same as .S approach) o Iecent decision6 "NH Capital v, +atota&is T(??) CF SCV6 sets out the test for Pade=uate arrangements for financingH means (from s.0Q)6 Means accurate, clear, and une9uivocal assurance that the financin$ is in place. / pub ic shareho der can be une=uivoca ! assured that the funds are avai ab e to comp ete the transaction. In this case, ade=uate arrangements %ere not met /"C Rule ?2-><: (came into force in Januar! (??Q) (pg.((@A of conso idation) o Ieduces the uncertaint! of +atota&is (%hich set ver! high thresho d)6 there can be conditions in financing, but there must be reasonable belief by the bidder that the financin$ conditions 2ill be met, Re Canfor Corp 5)99> /"C) @ Page ;9? #he consideration offered b! Canfor is deposit receipts, not Canfor shares. #he Canfor bid does provide for the ta&in$ up of deposited Slocan shares by the issuance of transferable #eposit %eceipts, The ta&e-up occurred 2ithin the ;-day 2indo2. #herefore va id. Commission found that Canfor inade9uately disclosed that the method of avoidin$ a chan$e of control for the purposes of the orest 0ct. Canfor shou d have done more to disc ose the ength and comp e$it! of the approva process under the orest 0ct o In vio ation of Item )9 on Form :2 (CS/ Iegu ations) -hi e the court cautions that the directorHs circu ar %i not a %a!s remed! disc osure prob ems, the court found that the directorHs circu ar remedied the disc osure prob em in the present case. Fo additiona remedies are re=uired. The bid is not so abusive to investors or capital mar&ets as to 2arrant intervention by section &/0(&" of the 0ct 62ithdra2al ri$ht) or cease trade, o Fote, ho%ever, that the commission did e$tend the bid period b! +? da!s to give S ocan shareho ders more time to consider the bid. E$emptions from the #a,eover Bid Ie=uirements < CS/ Section 01
47emption Stoc, E$change Bids "ection 9:5))5a) and 9:5;) .escription Bids made through the faci it! of stoc, e$changes are genera ! e$empt from securities ru es, but are sub3ect to simi ar stoc, e$change ru es Rules .nder #SL ru es, bids sti re=uire notice, must be fi ed, must be distributed to a CDF shareho ders, detai s must be disseminated to media, and target directors must ma,e recommendation. Fo conditions (other than ma$ shares) are a o%ed. Iu e provides that (+) purchase price does not e$ceed mar,et price, and (() on ! )E are purchased in an! one"!ear period 9remium is substantia if it is +)E above the prevai ing mar,et price (regu ation )8:), and regu ators ma,e sure bidders donHt artificia ! increase price through repeated trading ahead of

Forma Course 9urchase Contro B oc, 9urchases under 9rivate /greement

9:5))5&)

9:5))5c)

/ o%ances for a ho der of (?E or more of a c ass of shares to ma,e modest purchases if made in the norma course #ransfers of contro through the sa e of contro b oc,s for a premium are a o%ed under a private agreement as ong as the premium is not substantia and the offer is made to five or fe%er persons. Fot %ide ! used, as most

65
contro ho ders %ant substantia premium. -ide ! critici'ed %hen introduced, but needed due to many control companies in Canada. 9rovided %here the number of securit! ho ders of the c ass sought is ess than )?, the bid is not for the shares of a reporting issuer, and there is no pub ished mar,et for the securities sub3ect to the bid. E$ception %hen ta,eover does not invo ve man! Cntario residents. bid.

C ose ! 2e d Compan!

9:5))5%)

#he f ipside to the private issuer prospectus e$emption.

Limited Ie evance to Jurisdiction (de minimis)

9:5))5e)

Discretionar! E$emption /pp ication

)<;52)5c)

/ o% for an app ication to the commission for an e$emption from ta,eover bid regu ations %here an enumerated e$emption does not app ! and such an e$emption %ou d Pnot be pre4udicial to the public interestH

Less than (E of securities of c ass he d in Cntario, fe%er than )? ho ders of the securities in the province, bid is made in comp iance %ith a%s of other 3urisdiction, and securit! ho ders in province sti get materia re ated to bid. E$amp e6 bid ma! comp ! %ith de minimis, but 1E of securities are he d in Cntario. -ou d grant e$emption.

66

+a eover 1i%s: Defensive Tactics

#!pes of Defensive #actics &or various reasons, the Board of the target ma! decide that a bid is inappropriate, and ma! emp o! a variet! of defensive tactics. Due to the conf ict of interest potentia , there are ru es that govern this behaviour6 ,P ?2-2<2 Fote6 the board cannot 3ust sa! no to a ta,eover bid, but can engage in defensive tactics. o Tactics Bbuy timeC to consider the bid or see& alternatives, Fote on the Canadian Mar,et6 o .n i,e the .S, Canadian pub ic companies are genera ! not as %ide ! he d. .S companies are more i,e ! to adopt tactics that affect a broad range of target shareho ders ( i,e poison pi s or issuer bids) %hi e Canadian boards are more often respondin$ to the interests and concerns of the controllin$ shareholder, through brea, fees or sa e of the cro%n 3e%e . .sua !, %hen a target of a bid, the board %i set up a committee of independent directors to revie% the bid in order to avoid conf icts of interest. >hite +ni$ht #arget board finds a competing bidder that generates a better option for shareho ders, and hopefu ! increases the bid. Is the board rea ! acting in the best interests of shareho ders %hen finding a competing bid; #his can be an issue %hen the %hite ,nightHs bid is not financia ! superior. #he board ma! argue that it is sti preferentia b! eaving the business, its assets, and sta,eho ders in tact. Cften a %hite ,night %i a so negotiate other defensive tactics %ith the target board, inc uding brea, fees for ma,ing their bid. Poison Pills or Shareholder %i$hts Plans 6S%P) SI9 %or,s in the fo o%ing %a!6 o Characteristic is added to the c ass of the shares that are the target of the bid (before the bid occurs). Dominant feature is that if a bid is made for the shares of that c ass, the ho ders of the shares of that c ass %i be ab e to bu! additiona securities from the issuer of the securit! at a huge discount. o #his has the effect of floodin$ the mar&et. Most important !, the bidder is e$c uded from the bidder for the shares. SI9 %i a so usua ! a o% a Ppermitted bidC that does not trigger the operation of the SI9. .sua !, a permitted bid is negotiated %ith the target board over the terms of the bid. o E$istence of the SI9 is meant to deter hosti e ta,eovers o M/FS Canadian companies have poison pi s in p ace Issue6 Is an SI9 ega or appropriate %hen it e$c udes a bidder from an SI9 p an, even though the! are i,e ! a read! a shareho der; o Corporate a% sa!s that members of the same c ass cannot be treated different !. o .sua !, regu ators sa! that the SI9 is egitimate, but on ! for a set period of time (to a o% the target to find a %hite ,night) and not indefinite !. Sale of Cro2n !e2el 60sset /ption) Bid can be defended if ma3or asset (desire of bidder) is so d off to someone e se. Iaises serious fiduciar! issues6 if asset is so d off at ess than &MU to deter a bid, is this in the best interests of shareho ders; (see >estern International v, >IC) 1iti$ation 9reventing the bid through itigation, such as accusation of vio ating the competition act, ta,eover ru es (Canfor). Litigation de a!s and possib ! th%arts the bid process Bidders have a so gone to court, sa!ing that the actions of the target board are oppressive. 2o%ever the courts have been re uctant to accept this argument (%o$ers) Issuer "id Issuer ma! bid for its o%n shares, %hich %ou d be in competition %ith the hosti e bid. Enhanced disc osure re=uirements for issuer bids are governed b! ,I ?)-><).

67 "rea& ee . Pa$e E5@ Board of target ma! sometimes offer an inducement to a competing bidder6 even if the competing bid fai s, the target %i sti pa! them. #his is t!pica ! in the order of (E"1E (up to )E) of bid va ue. If hostile bidder 2ins, payin$ the brea& fee increases the cost of the bid. Note6 Brea, fees do not invo ve the potentia issuance of securities. Instead the! are a corporate contract. .n i,e poison pi s, securities re$ulators do not have the 4urisdiction to stri&e do2n the contract itself. 2o%ever the! can sti regu ate the bidder6 o Securities regu ators on ! interfere if the brea, fee does not stri,e a reasonab e commercia ba ance bet%een mar,eting stimu ator and mar,et inhibitor (>IC CB )+)). Securities regu ators have never disa o%ed a brea, fee. o Cther actions avai ab e to shareho ders %ho %ish to cha enge brea, fees are oppression remedies or derivative actions. ,P ?2-2<2 @ Eui%elines for .efensive +actics #he primar! ob3ective of ta,eover bid a% in Canada is to protect to bona fide interests of target shareho ders. 2o%ever this is a po ic!, not an actua instrument. o Since the F9 itse f is not binding, securities regu ators %i intervene in a ta,eover under section )27 of the CS/ (pub ic interest) Tar$ets may adopt defensive tactics but they must not deny shareholders choice and must not frustrate the open biddin$ process. #hree t!pes of actions ma! attract regu ator scrutin!6 o SI9: sa e of Cro%n Je%e : Brea, &ees. %ole of %e$ulators versus the %ole of the Courts #here is a different focus of courts and regu ators. Courts oo, at the best interests of the compan!, %hi e the regu ators oo, more specifica ! at the interests of the shareho ders. o #hese t%o interests ma! be identica , but the! ma! a so be different. Cften, if a target erects a poison pi , the bidder %i contest it in front of regu ators. #he issue is brought to regu ators because the bidder %i %ant a cease trade order to prevent the triggering of the pi , since it invo ves securities issues (see %oyal (ost) 2o%ever if a target tries to se an asset, then the court is i,e ! a better p ace to reso ve the issue than the regu ators, since it is a corporate a% issue dea ing %ith contracts and duties. Case La% < Juide ines for #argetHs .se of Defensive #actics Re C* "harehol%ings v( *IC *estern International 5/"C an% E. )998) @ Page >): Cro2n 4e2el sales and brea& fees are appropriate defensive tactics 2hen they stri&e the balance bet2een auction inhibitin$ and stimulatin$ and are in best interests of the tar$et shareholders, Issue6 "rea& fees are appropriate %hen6 o #he! are necessar! in order to induce other bids: o #he bid represents a better va ue to shareho ders: and o Brea, fee stri,es a ba ance bet%een auction inhibitor and stimu ator. Issue6 Test for Cro2n 4e2el sale6 Does the sa e of the cro%n 3e%e operate as an option stimu ator or an option inhibitor; 9age )+Q6 Ie evant factors in assessment6 o -as process in deciding to se asset free of conf ict of interest and in good faith; o -hether the overa commercia ba ance and proportion bet%een auction inhibiting and stimu ating has been struc,; Ie is sa e i,e ! to prec ude further bidding; o -hether the price for the asset is reasonab e, and %hether it %ou d resu t in disproportionate erosion in the va ue of the corporation o -hether the competing bid induced b! asset oc,"up provides enough additiona va ue to the shareho ders to 3ustif! the granting of the option :;788: Al&erta Dt%( v( Pro%ucers Pipelines 5)99) "F CA) @ Page >)7 irst case on S7Ps, and the court developed a proportionality test, (ere, the S%P 2as set aside, &acts6 9roducers %as a pub ic ! traded compan!. / berta aunched a hosti e ta,eover for 9roducers. 9roducers board emp o!ed a number of tactics in response, inc uding an SI9 %ithout shareho der approva and an issuer bid. o / berta comp ained that it %as unfair that an issuer bid cou d be aunched and conc uded %hi e the SI9 remained in effect. Issues6 T2o competin$ vie2s on poison pills6

68 o Shareho der Interest6 pi stops shareho ders being coerced into accepting a o% bid. o Management Entrenchment6 management often oses their 3ob in a hosti e bid, and a pi ma! be used to preserve their tenure. o Cther issues6 po%er of directors to act %ithout shareho der approva in a hosti e ta,eover, duties of directors to act in best interest of corporation and shareho ders, and the right of shareho ders to choose the disposition of their shares. Decision6 /ppea a o%ed. SI9 set aside and dates of issuer bid e$tended to enab e other bids for 9roducers. #irectors must act in the best interests of the corporation, and their actions must be reasonable in relation to the threat posed. o Demands of a high, a "cash offer %ere effective ! impossib e to meet. #he terms %ere so onerous that a ta,eover bid %as effective ! prohibited. o Issuer bid %as forced on the shareho ders and the! %ere effective ! coerced into accepting it (if the! %anted to get an! va ue out of their shares the! had to accept)

Re Royal 3ost Real 4state Investment +rust 5)999 /"C) @ Page >2; 1eadin$ Case on S7Ps 6unit holder ri$hts plan here), Case sets out factors to determine 2hen a pill must be removed, but these factors must be applied to the specific facts of the case, Issues6 shou d the rights p an (for unitho ders) be removed; o Tension bet%een a o%ing the board to fu fi their dut! to act in the best interests of the corporation and the rights of a shareho der to decide to se their shares in a bid Decision6 #eterminin$ the validity of an S%P is contextual and depends on several factors6 o Fature of the bid6 %as it coercive or substantia ! unfair in some %a! (%e$al) o -hether shareho ders approved of the rights p an o -hen the p an %as adopted o -hether shareho ders broad ! support the p anHs continued operation o Si'e and comp e$it! of target compan! o Cther defensive tactics imp emented b! the target o Fumber of potentia viab e offers for the target o Steps ta,en b! target to find a ternative bidders o Li,e ihood that, if given more time, the target %i find a better bid o Length of time since the bid %as announced and made o Li,e ihood that the bid %i not be e$tended if the rights p an is not terminated. Iesponsibi ities of #arget Directors < 9age )(0 #he o d test for the actions of a target board in a hosti e ta,eover %as the Pproper purposeH test, but this test %as reformu ated to be the Pbest interests of the compan!H test (Tec& v, )ilar +0>(). In both cases, the directors %i have had to act Pproper !H Peoples v >ise6 the SCC said that directoria dut! is not o%ed to an! particu ar shareho der, but to the corporation as a %ho e. Re C* "harehol%ings v( *IC *estern International 5E. )998) @ Page >:< >hen a company is in play, boards have a duty to ta&e active and reasonable steps to maximiIe shareholder value, The actions of the tar$et board are revie2ed by the business 4ud$ement rule Forma !, the dut! of the board is to the best interests of the corporation. -hen a compan! is in p a!, boards have a dut! to act in the best interest of shareho ders as a %ho e and ta,e active and reasonab e steps to ma$imi'e shareho der va ue b! conducting an auction. o #he dut! must be underta,en %hi e a so tr!ing to reduce conf ict of interest as much as possib e. Conf ict of interest reduction is norma ! achieved b! hiring independent le$al and financial advisors and settin$ up special committees. B airHs discussion, page )1@6 Boards are sub3ect to the business 3udgment ru e, not the Penhanced scrutin!H ru e used in the .nited States. o #here is not a standard of perfection, on ! that decisions that %ere made %ere reasonab e and informed, in good faith, honest !, and prudent !. 8aple Deaf v( "chnei%er 5)998 /, CA) @ Page >:> In order to maximiIe shareholder value, an auction may or may not be appropriate, >hen a company is in play and there are many bidders, an auction is appropriate, If only one bidder, canvassin$ the mar&et may be appropriate, Case re-affirms the business 4ud$ement rule, Fote that the court in this case is inf uenced b! the contro ing shareho der, %ho made its vie%s c ear ! ,no%n, meaning that the compan! %as not rea ! Pin p a!H

69 Fote the .S position6 in %evlon, the court said that %hen a compan! is up for sa e, the directors have an ob igation to conduct an auction. Here, the court agreed that Schneider was not really in play since the controlling shareholders refused to accept a bid from any bidder except Smithfields.

70

Enforcement and Public Interest Considerations

Cvervie% Securities enforcement in Canada can be distinguished b! crimina enforcement (Crimina Code and =uasi"crimina po%ers under securities egis ation), administrative enforcement, and civi enforcement. o Cn ! administrative enforcement provides for the provincia regu ator to be the u timate decision ma,er. o #he ro e of regu ators in enforcement ma! change as the federa government devotes more resources to securities enforcement. #he federa government recent ! created the inte$rated mar&et enforcement team (IME#S) o Se f"regu ator! organi'ations a so p a! a ro e in enforcement, inc uding IS. Investigation 9o%ers under Securities La% < 9age )0? Scope of Investi$ation and Examination Po2ers Securities statute provides regu ators %ith a range of po%ers of investigation and e$amination. .nder the CS/6 o Section ))5)) (Investigation Crder)6 7#he Commission ma!, b! order, appoint one or more persons to ma,e such investigation %ith respect to a matter as it considers e$pedient, for administration of securities a% or mar,et regu ation in (a) Cntario or (b) another 3urisdiction o Section ))5:) (Scope of Crder)6 / person appointed to ma,e the investigation ma! investigate and in=uire into, (broad scope to oo, at securities transactions, assets, and re ationships of the person4compan! being investigated) o Section ))5;) (Iight to E$amine)6 Tdocuments or other thingsV %hether the! are in the possession or contro of the person or compan! in respect of %hich the investigation is ordered or of an! other person or compan!.8 o Section )2 a o%s the securities commission to order an e$amination of the financial affairs of a mar&et participant, #hese sections do not re=uire evidence of an! thresho d eve of suspicion on the part of enforcement staff in order to support the re=uest for the order. Cnce an order is granted under section )) or section )2, section ): gives the regu ator po%er to compe testimon! or document production6 (same po%er as vested in the court < refusa to cooperate can ma,e one in contempt of court) o -hi e section ): inc udes a search po%er, the po%er does not e$tend to the search of private residences (section ):59)). Safe$uards for Sub4ects of %e$ulatory Investi$ation #here are some boundaries to the reach of CS/ investigation and e$amination po%ers. #he investigation order or an! evidence that arises from it is strict ! confidentia ()?52)) Section )7 a o%s the commission to disc ose the information described in section )? on ! if it is in the pub ic interest. o s.)75>) a o%s a court hearing a prosecution b! the CSC to compe production of an! of these materia s and order their re ease to the defendant. Disc osure of testimon! to criminal la2 enforcement re=uires the %ritten consent of the person from %hom it %as obtained. Section )8 sa!s that testimon! given under section ): cannot be used against that person in a prosecution for an offense under section )22. o %e9uires the /SC to be strate$ic6 if the! are pursuing a section )22 action the! shou d not intervie% the accused under section +1, but if the! are pursuing a section )27 action the! can sti intervie% the accused. It is sti unc ear as to %hether the Charter provides (section > and A <reasonab e e$pectation of privac!) app ies %hen a securities action is primari ! pena . o -hen the offence is not pena , there is not a reasonab e e$pectation of privac! since securities are so heavi ! regu ated ("ranch, SCC +00)). .eloitte G +ouche DDP v( /"C 52<<: "CC) 9ursuant to Iu e 1.1(() of the CSC ru es of practice, CSC staff is re=uired to disc ose to a defendant a Pre evantH materia in its possession.

71 o CSC staff decided that the compe ed materia from De oitte %as re evant and therefore shou d be disc osed to 9hi ip (accused) Staff sought an order from the CSC to disc ose the information to 9hi ip under section +>(+) and De oitte opposed disc osure un ess and unti staff cou d demonstrate re evance. Issue6 -hat is the ro e of the CSC in disc osing compe ed testimon! to defendants in an CS/ section +(> proceeding; Is disc osure to a defendant in the pub ic interest; Decision6 #he decision of the CSC to order disc osure must be made on the standard of reasonableness. 2ere, the decision to order disc osure %as reasonab e and shou d be uphe d. #he CSC reached its decision b! considering the re evance of the information. &actors app ied to determine re evance inc uded6 o Fature of the a egations o #hat the evidence had been produced sub3ect to an CSC investigation o Indices provided b! De oitte in describing the fi es o Iepresentations b! CSC staff that at east ( of the defendants indicated the! p anned to cha enge the credibi it! of De oitte in the s.+(> proceeding o Some of the compe ed materia %ou d be re ied on b! Staff in presenting its case.

Crimina Code Enforcement < 9age )0) It is a federa offence to use a fa se prospectus, as %e as bu!ing and se ing to engage in the appearance of mar,et activit!, and insider trading Ie evant sections inc ude sections :8<-:8; and section ;<<. o Section :8<5)) ma,es it an indictab e offence to defraud the pub ic of more than *)???. o Section :8<52) ma,es it an offence to manipu ate the mar,et price of securities %ith the intent to defraud. o Section :82 ma,es it an offence to manipu ate stoc, e$change transactions to create fa se or mis eading appearances of active pub ic trading. o Section ;<< ma,es it an offence to ma,e a fa se prospectus %ith the intent to defraud 1ill C-): recent ! increased ma$imum sentences for some offences from +? to +@ !ears and a so inc uded Paggravating circumstancesH %hich ma! ma,e the vio ation more serious. Fe% offence for insider trading and tipping under section :82(). 2o%ever it %i be ver! difficu t to prosecute someone under this ne% offence due to P,no%ing !H standard. Iea it! is that people are hardly ever prosecuted under the criminal code, ho%ever it signa s that a%ma,ers ta,e securities a%s ver! serious ! Xuasi" Crimina Cffences < /"A "ection )22 (9age )0>) )225)) Ever! person or compan! that, o (a) ma,es a statement in an! material, evidence or information submitted to the Commission, a Director, an! person acting under the authorit! of the Commission or the E$ecutive Director or an! person appointed to ma,e an investi$ation or e$amination under this /ct that, in a materia respect and at the time and in the ight of the circumstances under %hich it is made, is mis eading or untrue or does not state a fact that is re=uired to be stated or that is necessar! to ma,e the statement not mis eading: o (b) ma,es a statement in an! application, release, report, preliminary prospectus, prospectus, return, financial statement, information circular, ta&e-over bid circular, issuer bid circular or other document re9uired to be filed or furnished under /ntario securities la2 that, in a materia respect and at the time and in the ight of the circumstances under %hich it is made, is mis eading or untrue or does not state a fact that is re=uired to be stated or that is necessar! to ma,e the statement not mis eading: o (c) contravenes Cntario securities a%, Is gui t! of an offence and on conviction is iab e to a fine of not more than *) mi ion or to imprisonment for a term of not more than five !ears ess a da!, or to both. Section )2252) gives an accused person a due dili$ence defence if the vio ation %as not ,no%n and cou d not have been ,no%n %hen committed if reasonab e efforts %ere made. Fote a so section )225:): Directors and officers can be prosecuted for ac=uiescing in an offence, even %here the compan! is not even being prosecuted. Fote section )225;) re insider trading o /dditiona sanctions for contravention of section >Q, the insider trading ru es.

72 Fote update re offences in section )2?() G )2?(2 o Fe% offences for fraud and mar,et manipu ation In genera , there has not been a lot of enforcement actions under section 5@@ due to the hi$her criminal burden of proof, ho%ever more enforcement is no% occurring.

General prosecution under section 5@@* R( v( Helitt 5A1 2<<:) @ Page >99 &acts6 Ye itt ied that his compan! %as deve oping 1D imagining techno og!. Decision6 Ye itt is iab e. In order for untrue statements or omissions to be misrepresentations %ithin the meaning of the securities act, the! must re ate to a materia fact as defined b! the /ct. 2ere, his statements %ere materia facts and %ere mis eading. o Ie must have a significant effect on the mar,et price or va ue of the securities mar,et impact Ye itt %as sentenced to @ !ears in prison, a fine of *+.A) mi ion, and prohibited in trading in securities or serving as a director or officer for () !ears. o Court considered deterrence, denunciation, and protection of the public o Contributin$ factors* behaviour, breach of trust, ma$nitude and impact of violation Insider Tradin$ Prosecutions under section 5@@6:) R( v( 3arper 52<<: /, CA) @ Page ?<) 57ankin also a )22 enforcement) Issue6 Section +(( ma,es an accused iab e 7to a minimum fine e=ua to the profit made or oss avoided b! the person or compan! b! reason of the contravention8 o Cn sanction, 2arper argued that the prosecution had to demonstrate that the oss avoided %as by reason of his contravening insider trading ru es (page Q?+) Decision6 Court of appea said that !ou donHt need to sho% that oss avoided %as by reason of vio ation. Cnce the prosecution has proven that the insider trading ru es %ere vio ated, and that a oss %as avoided, that is sufficient. o #irect causal lin&a$e bet2een nature of non-disclosure and fall or rise of stoc& price is not needed and not consistent 2ith scheme or ob4ect of 0ct Civi Enforcement 9o%ers < "ection )28 " 9age Q?@ 9rovincia commissions rare ! see, civi remedies from the court for securities a% infractions, %hich is different from the .S, %here civi pena ties are increasing ! common. Section )28 of the CS/ a o%s the CSC to app ! to the Cntario court for a dec aration that a person or compan! has not comp ied %ith or is not comp !ing %ith Cntario securities a%. If a court ma,es such a dec aration, the! can order comp iance %ith the a%, rescinding transactions, re=uiring compensation or restitution, pa!ment of damages, disgorgement, and the rectification of past non"comp iance. Iemedies are avai ab e in addition to section +(( or +(> remedies, though it is inconceivab e for the CSC to pursue them a . /dministrative Enforcement 9o%ers < "ection )27 " 9age Q?) Section +(> is %ithin the po%er of the regu ators to app !. #here is not a crimina standard of proof. %e$ulators may ma&e orders if it is in Bthe public interestC to ma&e them. o 9ub ic interest is interpreted in accordance 2ith the re$ulatorCs statutory mandate. Ma,ing an order in the pub ic interest does not re=uire a breach of securities a%, and it is a so possib e to ma,e an order %here there is =uasi"crimina action on same matter. o Ma,ing an order %here there has a so been a =uasi"crimina action does not infringe on the accused protections against doub e 3eopard!. o See In the )atter of Glen (arvey (arper ((??@) 2arper prosecuted under )22 for insider trading, and a so banned from officer or director for +) !ears under )27. 2earings b! provincia regu ators are t!pica ! governed b! ru es of civi procedure. #he sanctions of section +(> are far ess severe than sanctions under +((. o It %as on ! in the past fe% !ears that the regu ators even got the po%er to issue fines 'ariation in the Sub4ect )atter of Public Interest /rders* Condon Study . Pa$e F?E Different provinces e$ercise their section +(> po%ers different !6 o BC is focused on the sa e of unregistered securities

73 o Cntario is focused on bad behaviour of registrants Iegu ators across the countr! uniform ! define the pub ic interest that section +(> is protecting as the integrit! of the mar,ets and the protection of investors in the mar,et. o Capita mar,et efficienc!, %hi e important, has not been as much of a priorit! or factor %hen e$ercising discretion.

%ecent Examples of Circumstances in 2hich Enforcement /rders are )ade . Pa$e F?< %e #ix !r. ((??+ BCSCD) < 9age Q?>6 Distribution of securities to e der ! peop e in their homes %ithout a prospectus or an! independent third part! revie% or oversight. 1./,) )edical ((??@ BC)6 9resident of medica products compan! forced to pa! *+??5 fine and banned from trading for +? !ears for se ing *( mi ion in securities %ithout a prospectus. %e >( Stuart )utuals 6@??? 0SC)6 Stuart (a dea er) circumvented securities a%s and %as given a ifetime ban for a first offence for genera deterrence purposes Cther e$amp es6 improper e$emption use, fai ure to fi e documents in accordance %ith CD In the )atter of Nortel 6@??: /SC) . Pa$e F5?6 Cease trading order imposed on insiders unti Forte dea s %ith fai ure to fi e re=uired documents (=uarter ! reports). Enforcement 0ctions a$ainst 1a2yers . Pa$e F55 .nder section +(>, the CSC can reprimand Pa person or compan!H. >ilder found that a%!ers can be reprimanded, ho%ever this is ver! controversia . *il%er v( /"C 52<<< /, E.) @ Page ?)2 &acts6 Judicia revie% of the CSC decision, %hich sanctioned the a%!er %ho %as responsibi it! for &i ing SBM documents %ith the CSC. CSC a eges that -i der made a Pmis eading misstatement of materia factsH. Issues6 does section +(> have the po%er to reprimand a a%!er, or shou d the La% Societ! be the on ! entit! that can discip ine a%!ers; Decision6 a%!ers are sub3ect to +(> as a PpersonH. Cther%ise, the CSC %ou d be unab e to regu ate capita mar,ets appropriate ! (paragraph (?). The 3se of the Public Interest in the 0bsence of a "reach of Statute . Pa$e F5F Uer! controversia 6 can the securities regu ators ma,e pub ic interest orders absent an actua breach of securities a%; In BC, there must be actua breach of a% in order to set do%n a fine Re Cana%ian +ire Corp 5)987 /"C) @ Page ?)? Establishes the proposition that the securities commission can exercise its public interest po2ers even 2here the matter at issue does not involve a breach of the re9uirements of /ntario securities la2, &acts6 Invo ved a ta,eover transaction. #ransaction designed to prevent coat"tai provision from triggering, %hich meant most shareho ders did not get to en3o! the substantia premium of the bid. Bid, %hi e ega , privi eged group of contro b oc, above others. Issues6 Is this an abusive transaction that shou d be prevented in the pub ic interest under section +(> of the CS/ (cease trading order); Decision6 Securities commission sa!s that this is an abusive transaction. -hi e there is technica conformit! to the ru es, the commission protects the interest of non"voting shareho ders. See e$cerpts starting at page Q+0. o JThe 1e$islature deliberately has $iven the commission a broad and unfettered po2er to move 9uic&ly to intervene in the capital mar&ets to stop a trade or a transaction 2hich it deems to be contrary to the public interestK o #he decision points out that the mar,et is infinite ! comp e$ and d!namic, and that it is not feasib e to have e$p icit ru es for ever!thing. #hat is %h! the regu ator is given the po%er to ru e on activities that are not actua breaches. o 9ub ic interest, page Q((6 7If abusive transactions such as the one in issue here, and this is as gross ! abusive a transaction as the Commission has had before it in recent !ears, are a o%ed to proceed, confidence in our capital mar&ets 2ill inevitably suffer and individuals 2ill be less 2illin$ to place fund in the e9uity mar&ets8 #he #est6 for the regu ators to intervene absent an actua breach, there ! st $e c5ear a$ se of the !arkets3 not % st nfairness. #he abuse must a so raise a pub ic interest issue. o #his rigorous test is to ensure that there is not undue uncertainty of re$ulator

74 intervention, %hich cou d a so harm the mar,ets. Fote that this cou d a so be dea t %ith b! see,ing an oppression remed! under corporate a%, but securities regu ators %ere used since a remed! cou d be reached much sooner. o #he court sa!s that it does not need to consider corporate a% %hen ma,ing an order, since it is more genera ! concerned %ith mar,et operation. Evidence of breach of fiduciary duty cannot 4ustify an order, but it is evidence that can support an order.

0ttempts to Structure the #iscretion of %e$ulatory /fficials . Pa$e F@F -ith imited enforcement resources, regu ators have set out criteria about %hen to pursue investigations and fu hearings. #his is the Pris, regu ationH approach /"C "taff ,otice ))-7)9 52<<2)6 $uidelines for pursuin$ the potential breaches that appear to have caused 6or may continue to cause) the $reatest harm to the inte$rity of /ntarioCs capital mar&ets, ta,ing into account i,e ihood of successfu reso ution and resources re=uired to reach reso ution. o Categories of Cffences6 /busive trading (insider trading and mar,et manipu ation), abusive sa es, deficient disc osure, fai ure to fi e, ta,eover bid issues, registrant misconduct, and sa e of unregistered securities. o Se ection Criteria6 nature of the activities, impact, urgenc!, investigative va ue, other factors, and diminishing factors. Sanctions /vai ab e in Connection %ith 9ub ic Interest Crders < 9age Q(A As&estos v( /"C 52<<) "CC) @ Page ?29 %e$ulators are re9uired to &eep in mind both the purposes of their $overnin$ statutes and 2here they are enumerated, %e$ulators are re9uired to act in accordance 2ith the philosophy underlyin$ re$ulatory le$islation in $eneral, 2hich is to protect societal interests rather than punish individual faults 6protective and preventative rather than punitive) Court agreed that XuebecHs actions %ere abusive and manifestly unfair to minorit! shareho ders. 2o%ever shareho ders %ere not materia ! mis ed (asbestos %as a specu ative investment), that prevention %ou d not have been a factor in a ru ing, and that the transactiona connection %as insufficient to trigger section +(> sanctioning. 9aragraph @+6 it is an error to focus only on the fair treatment of investors 2hen decidin$ 2hether to exercise section 5@<, and the analysis should also focus on overall mar&et efficiency and public confidence in the capital mar&ets. Section +(> is protective and preventative rather than punitive (though deterrence not rea ! considered, even though it ma! have been re evant if app ied genera ! to mar,ets) Re Carta$ay Resources Corp 52<<; "CC) @ Page ?:? Decision6 Jenera deterrence is a basis for ma,ing an order %as in accordance %ith the Pprotective and preventativeH orientation of securities regu ator! enforcement. o Conventiona %isdom is that mar&et players are rational actors, and if the! see other p a!ers are sanctioned, this %i shape their behaviour #he ,e! is to note the distinction bet%een genera deterrence (of the pub ic) and individua deterrence (targeting the individua %rongdoer) #he court notes that unreasonab e %eight given to a particu ar factor, inc uding genera deterrence, %i render the order itse f unreasonab e. o E$amp e of unreasonab eness %ou d be a capricious or ve$atious order Conver$ence and 'ariation in Sanctionin$ /rders . Pa$e F:5 Most provinces have the po%er to order cease trading, and %hi e most provinces can ev! fines, the! ma! not a be ab e to ev! the same ma$imum amounts. &e% regu ators have the po%er to order profits disgorged (Cntario has this po%er under ):<5))5)<) Cn ! Manitoba has the po%er to order restitution to investors. C"A "taff ,otice >7-:<) %as an innovation in (??( that a o%ed for regu ators to issue management"on ! C#Cs. Before this notice, C#Cs cou d on ! be made on a securities of an issuer. See Nortel as an e$amp e. !udicial %evie2 of %e$ulatory #ecisions . Pa$e F:E

75 .onnini v( /"C 52<<: /,) @ Page ?;> Decision6 the court disagrees %ith man! of the actions of the regu ator, and the +)"!ear restriction on trading that it imposed. Court reduces pena t! to @ !ears. o #he court critici'ed the court for not ev!ing a pena t! %hich %as more in ine %ith its previous decisions. Stare #ecisis does not have to rigorous ! fo o%ed b! tribuna s, but it must not be comp ete ! ignored in order for there to be some predictabi it!. o #he court critici'ed the tribuna for not e$p aining their c aim for costs of *+AQ5 Fote that %hen a part! is sanctioned under section +(>, the! can be responsib e for CSC costs of investigations, e$pert %itness, staff, etc. #hese are evied under )27()5;) >hile courts must sho2 deference to tribunals, but this does not mean that a court must accept 2hatever a tribunal concludes,