Securities Final

Question 1

What is the purpose of securities regulation (2)?

Answer 1

• 1. Investor Protection (against both other investors and investment sellers, but also yourself)
     o Disclosure is key, as opposed to a merit-based system. Allows investors to determine their risk threshold through the disclosures being met. The Ontario Securities Act (OSA) does not speak to the needs of the merits of a security and regulation of its substance.
• 2. Capital Market Efficiency (proper resource allocation is central to the market working well; without confidence in the marketplace, you cannot achieve proper resource allocation)
     o Proper regulation provides investor confidence
• The history of various stock market bubbles/crashes indicates the need for regulation
  o Tulip Mania
  o 1929 crash
  o 2001 tech crash
  o 2008 global financial crisis

Question 2

Who is regulated by securities regulation?

Answer 2

• People who buy, sell, issue, and hold securities (not the securities themselves)

Question 3

How does the law regulate trading in securities?

Answer 3

• Governs the issue of securities, mainly through registration and disclosure
• Regulates trade in securities in the capital markets: through stock exchanges with their own rules; rules relate to periodic and continuous disclosure
• Regulates market intermediaries, such as stockbrokers, advisors and mutual fund salespersons
• Places insiders under additional conditions, such as prohibitions and disclosure
• Regulates change of corporate control such as through takeovers
• Establishes a securities regulator for overseeing the market (OSC in Ontario)
• Creates a civil liability regime (private enforcement) and criminal (state) enforcement regime

Question 4

Who issues and trades in securities?

Answer 4

• Mainly corporations issue securities
• General public invests, through investment vehicles such as pension plans, mutual funds, so capital markets are a key societal institution
• Different kinds of investors: retail (including day traders), and institutions such as banks and variety of funds
• Regulatory needs of investors vary depending upon knowledge, net worth etc., and the regulations recognize this (notion of accredited investors, where presumption of investment expertise  not subject to the same scrutiny/rules as others; presumption that more expertise means less need for protection via regulation)

Question 5

Compare full, true, and plain disclosure to the merit-based system, and explain which one is superior (3).

Answer 5

• Originally, regulators believed in a merit-based system, whereby it was assumed that regulators were better at judging the merits of securities and transactions over the investors making said transactions
• These merit-based rules were disposed of with the enactment of the 1945 Securities Act, and were replaced with the concept of full, true and plain disclosure
• Full, true and plain disclosure states that issuers of securities must disclose various types of information about their securities, the underlying business, directors, insiders, etc., but that as long as these disclosures are full (not incomplete), true (not inaccurate), and plain (understandable and in ordinary language), investors can make their own choices based on their personal risk profiles
• FTP disclosure is better than a merit-based system for several reasons:
  o (1) It prevents corruption
  o (2) It gives investors more freedom of choice
  o (3) It potentially sacrifices a small amount of investor protection for a large amount of capital market efficiency (and in many cases, investor protection is not sacrificed)

Question 6

Describe the Canadian regulatory framework.

Answer 6

• Unlike in the US with the federal SEC (and most other countries), Canada does not have a national regulator because these powers fall under the provinces (which have their own securities commissions)
• Commissions have regulatory oversight over other regulatory bodies, such as stock exchanges and SROs

Question 7

What are SROs, and which 2 are the primary ones?

Answer 7

• Definition: organizations to which the commissions have delegated rule making and enforcement authority
• The primary SROs are IIROC and MFDA

Question 8

What is IIROC?

Answer 8

• Definition: National SRO that oversees all investment dealers and trading activity of equity and debt marketplaces in Canada.
  o Most brokers and dealers are members of IIROC, and members must comply by its rules.
  o Brokers and dealers that are not members are governed by provincial securities commissions
  o Most stock exchanges are also governed by IIROC

Question 9

Describe the different types of securities legislation and regulation in Canada (5).

Answer 9

• Each province has its own securities act, and these also give power to the provincial regulators to make rules and regulate
• Instead of traditional regulations, securities acts have instruments (much longer)
• Instruments are created under the CSA (Canadian Securities Administrators):
  o (1) National Instrument: adopted by all jurisdictions
  o (2) Multi-lateral Instrument: adopted in more than one, but not all jurisdictions
  o (3) Policy: instruments adopted by only one jurisdiction
  o (4) Companion Policy: non-binding publication to published by securities commissions to help interpret an instrument
  o (5) Staff Notice: non-binding administrative announcements (about emerging issues) by securities commissions

Question 10

What is a security according to OSA (10)?

Answer 10

o (1) Anything commonly known as a security
o (2) Equity: stock
o (3) Debt: bond, debenture, note
o (4) Derivatives: options, warrants, futures, forwards, swaps
o (5) Royalties
o (6) Interest in a trust
o (7) Profit-sharing agreement
o (8) Income or annuity contract not issued by an insurance company
o (9) Investment contract
o (10) Interest in a scholarship or educational plan

Question 11

What is a debt security?

Answer 11

• Definition: Right of calling in payment of interest and repayment of principal

Question 12

What is a bond?

Answer 12

• Definition: Debt security backed by assets

Question 13

What is a debenture?

Answer 13

• Definition: Debt security not backed by assets

Question 14

What are the rights of an equity security (3)?

Answer 14

• (1) Right to vote
• (2) Right of ownership of corp (right to pro-rated share of surplus)
• (3) Entitlement to dividends

Question 15

What is an option?

Answer 15

• Definition: The right (but not the obligation) to buy or sell a specific number of securities at a specific price on or before a specific date
  o Calls: right to buy a stock at a specific price before a specific day
  o Puts: right to sell a stock at a specific price before a specific day
   Note: buying puts or calls requires you to pay a premium to the option seller, so your downside is limited to your premium, but selling options can potentially lead to significant losses

Question 16

What is a warrant?

Answer 16

• Definition: Options issued by corps (gives shareholders the option to buy additional shares in the corp at a specific price and time)

Question 17

What is a futures contract?

Answer 17

• Definition: Agreement (obligation) to buy or sell (and sometimes deliver) a commodity at a future date at a fixed price
• Purpose: Stabilizes the agricultural industry by protecting against price fluctuations due to changing supply/demand
• Details: Traded on futures exchanges (so prices are settled at the end of each day, and contracts are standardized)

Question 18

What is a forward contract?

Answer 18

• Definition: Like futures contracts, they are agreements to buy or sell an asset (usually currency) at some future date, but they are neither standardized nor traded on exchanges (instead, they are custom agreements between private parties, and settle at end of the agreement)
• Purpose: Usually used to hedge against currency fluctuations

Question 19

What is a swap?

Answer 19

• Definition: Agreement between parties to exchange securities, cashflows, or payments for a certain amount of time
• Purpose: Often used as hedging strategy; for example, buying CDS allows you to pay a small premium at regular installments (called the spread) to the seller in exchange for the right to a much larger payout in case the underlying security/corp defaults)

Question 20

What is the difference between a security and an investment contract?

Answer 20

• Investment contracts are a broad type of security
• While securities include investment contracts, securities often refer to financial instruments that are traded on public exchanges (such as stocks and bonds), while investment contracts tend to represent investments in a business venture with the expectation of profit (and are usually private agreements between parties)
• Requirements are defined by jurisprudence, but examples include:
  o Stock purchase agreement
  o GIC
  o Convertible debt agreement

Question 21

What is the definition of an investment contract in the US (Howey Test)?

Answer 21

• Howey Test: An investment contract is a security if an investor purchases with
  o (1) an expectation of profit arising from
  o (2) a common enterprise that
  o (3) depends upon the efforts of others.
  o Note: the Hawaii case altered the Howey test by adding an element of risk to the investment, and by clarifying that the investor has no control over the decisions of the enterprise (but this case was not at the SCC, like Howey)

Question 22

What case defines common enterprise?

Answer 22

• Brigadoon Scotch, 1973 (US)
  o Held: court found that it was a security because there were considerable promotional efforts (common enterprise) put into the entire scheme of the business, and not just a purchase and sale of goods

Question 23

What jurisprudence defines investment contracts in Ontario?

Answer 23

• Pacific Coast Exchange v. OSC, 1977 (SCC)
  o Facts:
   Account holders (investors) bought bags of silver coins at spot prices on margin (35%).
   Investors could demand delivery within 48 hours by paying balance and other admin charges.
   Transaction clearly speculative – gain if silver prices went up; lost if went down.
   OSC treated transaction as a security, and issued a prohibitory order declaring the appellant to cease trading on grounds that they were selling securities without a prospectus and without registration. The ONCA deemed these to be investment contracts.
• Held: The sales of silver margin contracts were investment contracts.
• Rule:
  o SCC Howey and Hawaii and found that both cases would conclude this was an investment contract, and endorsed the definition of “common enterprise” as “one in which fortunes of the investor are interwoven with and dependent upon the efforts and success of themselves and those promoting/seeking the investment.”
   Reference to common enterprise was necessary as the account holders would decide when they wished to make payment and take delivery (account holders made the effort)
   So both efforts of investor and those seeking the investment involved/interwoven
   This offered a broad and flexible view of investor protection

Question 24

Are cryptocurrencies securities?

Answer 24

• Whether or not a cryptocurrency is a security depends on how it is being used and what rights it confers on its holders.
• If we look at the Howey test, an investor purchases an investment with
  o (1) an expectation of profit arising from
  o (2) a common enterprise that
  o (3) depends upon the efforts of others.
• Therefore, despite not being regulated (and according to SEC chair Gary Gensler), most forms of crypto are probably securities, because all steps of the Howey test are satisfied.
• However, things start to get a little confusing when we try to understand whether the crypto has any intrinsic value, or derives its value from something else (such as an asset)
  o In the case of stablecoins that are pegged to fiat currencies like the USD, this is clearly a security
  o However, some cryptos resemble Ponzi schemes, whereby their entire value is determined by market demand without representing any underlying asset
  o Furthermore, a crypto may change its status depending on what it is being used for:
   If used to raise capital for a venture, this may be a security
   If marketed as an investment vehicle, this may be a security
   If used merely as a currency between two parties to purchase goods and services, or as a currency hedge, this is probably not a security

Question 25

What is a viatical settlement?

Answer 25

* When someone with a terminal illness holding a life insurance policy sells this policy to an investor at a discount (usually 20-40%); the investor then makes their ROI when the patient dies.

Question 26

Are viatical settlements investment contracts?

Answer 26

* US: Life Partners (NO, because failed Howey test) * Canada: Universal Settlements International (YES, because passed Howey test via Pacific Coast) * Note: viatical settlements are illegal in Canada

Question 27

What is a trade under OSA?

Answer 27

* OSA s.1(1): o (1) Transactions by security holders, o (2) Transactions by intermediaries, o (3) Transactions (transfer/pledge) by control persons, and o (4) Promotional efforts related to trade transactions (advertisement and solicitations before or after trade), but does not include those not involved in decision-making, such as admin/clerical roles (more about promotional efforts regarding prospectus) o Note: gifts are excluded

Question 28

Kilimanjaro Capital Ltd, 2021 (Alberta)

Answer 28

* Rule: Canadian regulators can pursue non-Canadian companies for illegal behaviour (regardless of the communication methods used); in this case, it was a pump-and-dump scheme targeting Alberta investors

Question 29

What is the difference between primary and secondary markets?

Answer 29

* Primary: securities issued to public for first time (either brand new securities through IPO or new issue of pre-existing class) * Secondary: traded between investors (exchanges, OTC)

Question 30

What is a distribution?

Answer 30

* Distribution is a trade: o (1) where a security is issued (by issuer) on the primary market for the first time, or o (2) where a control person sells a previously issued security on the secondary market  Rationale: control person has informational advantage * Note: Distributions require a prospectus or a prospectus exemption (and once prospectus issued, corp becomes a reporting issuer)

Question 31

What is a control person?

Answer 31

* Definition: Person holding enough shares to affect materially the control of the issuer (20% or more of voting shares) o Can be individual or group of people acting in concert acting pursuant to an “agreement, arrangement, commitment or understanding” * Rationale: 20% is the threshold (even though 50% + 1 gives you actual control of corp and elect BoD) because with 20% you can exert a lot of power (influence other shareholders, call shareholder meetings) * Note: For widely dispersed corps, someone with less than 20% can be deemed to be a de facto control person

Question 32

What is a reporting issuer?

Answer 32

* Definition: public company (or private company deemed a reporting issuer by OSC) that has filed a prospectus and obtained a receipt

Question 33

What is a non-reporting issuer?

Answer 33

* Definition: Private company (not listed)

Question 34

How can market efficiency be broken down (3)?

Answer 34

* Market efficiency can be broken down into: o allocable efficiency: money going where best utilized o operational efficiency: carry out transactions at low cost o informational efficiency: source of Efficient Market Hypothesis

Question 35

What is Efficient Market Hypothesis (3-subtheories), and is this theory accurate?

Answer 35

* Definition: EMH states that share prices reflect all available information; stocks trade at their fair market value on exchanges. EMH can be divided into three types of theory: o Weak EMH theory: stock prices reflect all past historical data (so technical analysis is pointless because past prices are not indicative of future prices; aka random walk theory), but stocks do not always immediately reflect all releases of public information (so fundamental analysis can be used to determine which stocks or undervalued or overvalued)  Accuracy: This was likely the most accurate form of EMH up until the internet age, as value investors (like Warren Buffet) could make large profits on figuring out what stocks were undervalued o Semi-strong EMH theory: stock prices reflect all past historical data AND all publicly available data immediately, so both technical and fundamental analysis are pointless  Accuracy: This is probably the most accurate form of EMH today because of the incredible speed of data transmission through the internet (but EMH is still flawed because many people do not act rationally) o Strong EMH theory: stock prices reflect all past historical data, all publicly available data immediately AND all privately held data (meaning that people who trade on insider information will not profit in the long-term)  Accuracy: This theory is clearly wrong in practice, as there are many examples of hedge fund managers making enormous profits based on insider information * EMH accuracy: Generally speaking, EMH relies on rational market behaviour. However, people often act irrationally, much insider trading goes undiscovered/unpunished, markets do not reflect all information, and all available information is not always understood (markets often run on fear and greed [or envy according to Munger]); meme stock craze is a good example of this.

Question 36

Are markets efficient or not at determining value?

Answer 36

* Answer: Sometimes yes, sometimes no * Explanation: o Price is what the market determines something is worth (value) o While EMH and securities regulation believes that value = price, these can often be disconnected due to speculation, panic, irrationality, insider trading, and failing to properly value underlying assets o Corps are often valued by looking at P/E ratio, P/D ratio, or market capitalization o The more information is quickly available and understandable, the more likely the market is efficiently determining value (but this is not always the case)

Question 37

What is ESG, and what problems does it currently face?

Answer 37

* Definition: ESG stands for Environmental, Social, and Governance, and represents a way to rank investment opportunities by their positive or negative impact in those categories * Rationale: to encourage companies to act responsibly for not just shareholders but all stakeholders * Problems: o According to SEC, no real regulation, standards, and disclosure for ESG  Example: Tesla has lower ESG rating than oil companies, so obviously some politics o Repeat of ratings for payment reminiscent of credit rating agency fiasco leading up to 2008 financial crisis? o Several recent cases of ESG litigation involving banks accused of greenwashing (lying about a product being environmentally friendly)

Question 38

Should securities be regulated at the federal or provincial level? (Mention Crafword Pannel Report + two relevant references)

Answer 38

* The 2006 Crawford Panel Report suggested a single federal regulator via 5 executive calls: o (1) Market efficiency and competition o (2) Preserve provincial uniqueness o (3) Capital access for SMEs o (4) Single organization provides a practical structural solution o (5) Promote global competitiveness * The panel’s recommendations were not adopted in light of the 2011 Reference Re Securities Act o Reference Re Securities Act, 2011 (SCC)  Held: Bill for single federal securities regulator rejected, because day-to-day securities regulation doesn’t fall under the federal power to regulate trade and commerce, and instead deals with issues of contracts and property, which fall under provincial jurisdiction o Reference Re Pan Canadian Securities Regulation, 2018 (SCC)  Held: Despite the 2011 reference, SCC found that a federal-provincial cooperative scheme to regulate securities was not unconstitutional (perhaps paving the way for a single federal regulator one day) * Personal opinion: having a single federal regulator might very well increase market efficiency and reduce regulatory barriers, but a hybrid approach might be best, considering the fact that Toronto is the capital for securities transactions, and other provinces view regulation in different ways than Ontario (especially Quebec)

Question 39

Who does registration apply to?

Answer 39

* Anyone involved in the buying and selling of securities (dealer, advisor, investment fund manager, underwriter)

Question 40

What are the objectives of registration?

Answer 40

* Investor protection and market efficiency (same as securities regulation objectives)

Question 41

What are the firm registration categories?

Answer 41

* Dealer * Advisor * Investment fund manager

Question 42

What is the definition and business trigger of a dealer firm?

Answer 42

* Definition: Person is engaged in trading of securities (transfer, or solicitation/conduct in furtherance of a trade) o Types: any kind of “dealers” * Business trigger: Person is engaged in the business of trading securities

Question 43

What is the definition and business trigger of an advisor firm?

Answer 43

* Definition: Person gives advice (including opinions) on the wisdom, value or desirability of investing in specific securities o Types: any kind of “portfolio manager” * Business trigger: Person is engaged in the business of advising (easily fulfilled if advisor receives commission/payment, or profits indirectly from sale; can also be fulfilled through gifts, like an expensive meal, but this is a grey area) o Note: there is an exemption for advice that is not tailored to a specific person or group of persons (through media for example), but you must still disclose any positions you have in the investment you are pushing

Question 44

What is the definition and business trigger of an investment fund manager firm?

Answer 44

* Definition: Person who manages an investment fund * Business trigger: none; simply managing a fund requires registration

Question 45

What is the definition of a business trigger, and what factors trigger it (5)?

Answer 45

* Definition: Business triggers refer to trading or advising securities for a business purpose. This looks at the type of activities and whether it is carried out for a business purpose. Factors include: o (1) Engaging in activities similar to a registrant (such as promoting securities or stating that you will buy or sell securities) o (2) Intermediating trades or acting as a market maker (such as acting as a broker) o (3) Directly or indirectly carrying on the activity with repetition regulatory or continuity o (4) Being, or expecting to be, remunerated or compensated o (5) Directly or indirectly Soliciting

Question 46

What are examples where business triggers don’t apply (4)?

Answer 46

* (1) Security issuers with active non-security businesses who issue or trade in their own securities who: o (a) do not present themselves as being in the business of trading securities o (b) trade securities infrequently o (c) are not, or do not expect to be compensated for trading securities o (d) do not act as intermediaries o (e) do not produce a profit from trading in securities * (2) VP and PE firms (because while investment funds manage pooled money of investors, VCs raise capital for risky acquisitions (for purpose of control/management) * (3) One-time trading or advising activities (usually involves trustees and/or sale of business) * (4) Activity incidental to a firm’s primary business (such as professionals who primarily advise on other issues but occasionally provide advice on securities, such as lawyers, M&A specialists, accountants, engineers, etc.)

Question 47

What are the duties of dealers, advisors, and investment fund managers?

Answer 47

* Dealers + Advisors: must deal fairly, honestly and good faith with clients (high standard of care, but does not rise to fiduciary duty standard) * Investment fund managers: must perform duties honestly and in best interests of investment fund (fiduciary duty), and degree of care diligence and skill that a reasonable person would exercise in comparable circumstances (duty of care, and an objective standard) o Fiduciary duty: you put your client’s interest above your own (highest standard of care) o Standard of care: you can be sued if you fail to uphold either duty of care or fiduciary duty

Question 48

Should dealers/advisors have a fiduciary duty to clients, and if not, why not (4)?

Answer 48

* No, because this would place an unfair burden on dealers/advisors, and would likely force some of the smaller players out of the industry altogether * Why not (4)? o (1) Many of the defences available under a simple duty of care breach are not available under a breach of fiduciary duty (for example, using the defence of suitability when dealing with client losses would no longer be sufficient for fiduciary responsibility) o (2) Damages for breach of fiduciary duty can be much higher o (3) Opens the door to punitive damages o (4) 1-3 leads to lower incentives for dealers/advisors to enter the market, meaning lower market efficiency

Question 49

What are the conduct standards that registrants must comply with under NI 31-103?

Answer 49

o (1) Fit and Proper Requirements  (a) Proficiency standards  (b) Solvency requirements  (c) Financial records o (2) Conduct rules  (a) Know your client (KYC) rules  (b) Suitability rules  (c) Relationship disclosure document o (3) Record-keeping rules

Question 50

What are the registrant fit and proper requirements? (1/3 conduct standards)

Answer 50

* (1) Fit and Proper Requirements o (a) Proficiency standards: licensing, education, training, experience o (b) Solvency requirements: minimum capital requirements, maintenance of insurance o (c) Financial records: appointment of auditor, and send financial records to OSC

Question 51

What are the registrant conduct standards? (2/3 conduct standards)

Answer 51

* (2) Conduct rules (31-103CP) o (a) Know your client (KYC) rules (13.2): Requires registrants “act as gatekeepers of the integrity of the capital markets” and they cannot bring the market into disrepute. Requires registrant to look into client’s:  (i) Identity (age, net worth, etc.)  (ii) Reputation (this puts advisors in sensitive position)  (iii) Insider or majority shareholder status  (iv) Enough other info to make recommendations o (b) Suitability rules (13.3): Registrants must also ensure a trade is suitable for a client by fulfilling:  (i) KYP obligations (know risks, features, and fees of security)  (ii) Matching the security to the client’s * Financial circumstances * Risk tolerance * Investment knowledge * Investment objectives  Note: you need to make sure the client expectations are in line with their risk profile * If a client had a low risk profile but wanted to execute a high-risk trade, a note would be added to the file (or even an affidavit is signed by the client) to show that the advisor advised against it * If the advisor/broker doesn’t mention that the risky request goes against the client’s KYC, they will have breached the DoC, and can be sued * Defence: If the client bought a risky investment that clearly fell outside their KYC, and you didn’t advise against it, and it went to court because client lost everything, a good defence may be to show a past pattern of client’s risky trades o (c) Relationship disclosure document: before providing advice or acting on client’s instructions, registrant must get client to fill out client disclosure document, which outlines:  Type of account opened  How registrant will address KYC + suitability rules  Risk factors  Conflicts of interest * Fees * Client reporting

Question 52

What are the registrant record-keeping requirements? (3/3 conduct standards)

Answer 52

* (3) Record-keeping: firm must maintain records with respect to business activities, financial affairs, client transactions, and regulatory compliance

Question 53

What are the registration exemptions for dealers, advisors, and financial institutions?

Answer 53

* Dealers (firm or individual): o Who trade debt securities issued or guaranteed by federal, provincial, or municipal governments in Canada o Any registered advisor who trades (aka a dealer) for an investment fund for which they act as the advisor and investment fund manager * Advisors (firm or individual): o Who provide advice in the media (publications, TV, or online) about buying or selling securities, but the advice is not tailored to the needs of anyone specific  Additional requirement: the advisor must disclose any financial interest they have related to the securities they are advising about * Financial institutions (as dealer, advisor, or investment fund manager): o (1) A bank listed in Schedule I, II or III to the Bank Act (Canada). o (2) Credit Union, loan corporation, trust corporation, insurance company o (3) Business Development Bank of Canada

Question 54

Re Costello (Ontario)

Answer 54

* Fact: o Unregistered radio host offered investment advice during speaking engagements o Told listeners to consult with dealers who were registered, but did not disclose that he had a financial interest in those dealers * Rule: o (1) Cannot use teacher exemption for advisors because if your main occupation is not education, but instead financial advice o (2) You are not considered a dealer if your activities are not sufficiently proximate to your audience placing trades o (3) You cannot be found guilty of failure to disclose certain conflicts of interest because if you are unregistered, because that OSA section only applies to registered persons  However, your failure to disclose can be contrary to the public interest under OSA

Question 55

Re Donas (BC)

Answer 55

* Facts: o Unregistered Donas printed newsletters regarding a food company and distributed them to registered dealers and friends. o The newsletters said to “buy now”, that the stock would explode, and that the company would soon be listed. * Held: o (1) Donas should have been registered as an advisor. o (2) Donas made representations in the flyer about upcoming stock listing without proper approval.

Question 56

Re Momentas (Ontario)

Answer 56

* Facts: Momentas issued convertible debentures without registration and without a valid registration exemption. Two directors took money from proceeds of sale of debentures (neither was registered). * Held: Both directors were found to have violated the OSA by selling debentures without being registered

Question 57

Re Canadian Shareholders Association

Answer 57

* Rule: Providing financial information about securities is not advice, but providing opinions about investing in specific securities is.

Question 58

What is a prospectus?

Answer 58

* Prospectus is a filing at the beginning of the disclosure process * All public offerings need a prospectus * Once you file a prospectus, you become a reporting issuer (and must subsequently comply with continuous disclosure obligations)

Question 59

What is the purpose of a prospectus (2)?

Answer 59

* (1) Provides info to investors to make investing decisions * (2) Allows regulator to screen the document before it is made public (but regulator does not provide opinion, just ensures that prospectus conditions are met) * Note: There are different forms of prospectus for different types of issuers

Question 60

What are the different types of issuers (3)?

Answer 60

* (1) Seasoned issuer (established companies) * (2) Junior issuer (under $10m assets, annual revenue, and shareholder equity [for each]) o Require additional disclosures (concerning funding, cashflow, and expenditures) * (3) Venture issuer (unproven company with no significant operations, often listed on TSXV) o Require additional disclosures for issuers with no significant operations in last two years

Question 61

What is the timeline for an issuance (for IPO) (7)?

Answer 61

* Step 1: appoint underwriter for issue * Step 2: develop and file preliminary prospectus (with help of underwriter) and obtain receipt * Step 3: mandatory waiting period (no marketing allowed) * Step 4: OSC sends issuer a comment letter (explaining changes to be made for final prospectus) * Step 5: underwriter meets with institutional investors to determine pricing and subscription * Step 6: respond to regulator’s comments on preliminary prospectus, carry out revisions, file final prospectus, and obtain final receipt o Note: issuer must file amendment to prospectus (and receive another receipt) if there are any material changes between the preliminary prospectus and final prospectus * Step 7: issue securities via IPO

Question 62

What is the function of underwriters (2)?

Answer 62

* (1) Determine price of issue and advise issuer in marketing security * (2) Carry out obligations to the public (obtain required assurances and covenants from issuer)

Question 63

What are different types of underwriting agreements?

Answer 63

* (1) Agency agreement: “best efforts” to sell securities, minimal involvement from underwriter (not very common; underwriter not sure about how many of the securities can be sold, but best effort will be made) * (2) Firm commitment: shows confidence to the market; considerable effort from underwriter and higher commission as underwriter is now accepting risk; issuer assured that the issue will be sold (multiple types) o (a) Bought deal: underwriter buys from issuer and then resells to market, so actual seller is the underwriter (more common) o (b) Marketed deal offering: underwriter first markets deal to potential investors and assesses market demand before underwriter agreement finalized (gives underwriter a bit more flexibility) (more common) o (c) Stand-by underwriting: Sell at pre-determined price and then underwriter will buy unsold securities

Question 64

What are some underwriter conflicts of interest (2), and what is the rule when a conflict occurs?

Answer 64

* Conflicts can occur (2): o (1) When the underwriter is the investment bank arm of a bigger institution that wants to issue its shares (such as TD); this also applies to related parties o (2) When the underwriter will own and hold some of the shares to then sell later (they might make the shares appear to be better than they actually are by other certifying a prospectus that should not be certified, or fail to notice issues) * Rule: Where there is a conflict of interest, a second underwriter must be appointed (and this underwriter must underwriter at least 20% of the distribution)

Question 65

What is a syndicate of underwriters?

Answer 65

* With large issuances, several underwriters will team up to spread the risk * However, there will always be a lead underwriter

Question 66

What is the standard underwriting fee?

Answer 66

* 5% of money raised in the offering

Question 67

Describe the preliminary prospectus, and what it doesn’t include (5)

Answer 67

* First version of prospectus * Will be near final form, but will not include (5): o (1) auditor’s report, o (2) financial statements, o (3) size of offering, o (4) price of shares, o (5) percentage paid to underwriters

Question 68

Describe the general prospectus requirements (long form)

Answer 68

* Business description * Use of proceeds * Forward-looking information * Management Discussion and Analysis (MD&A) * Description of securities (size of offering, price of shares, percentage paid to underwriters) * Capitalization of company * Prior sales * Principal shareholders * Directors and executive officers * Executive compensation * Risk factors (to itself or its business operations) * Legal proceedings and regulatory action * Relationship between issuer and underwriter * Material contracts * Certificate page * Market out and disaster clause (not obligatory, but common)

Question 69

Prospectus requirements: What is included on the prospectus certification page (2)?

Answer 69

* Includes certification signatures of o two directors (CEO and CFO) of issuer, o two directors who are not the CEO or CFO of issuer, and o each underwriter * Signatures are preceded by statement saying that prospectus contains “to the best of knowledge, information and belief…full, true and plain disclosure of all material facts” relating to the securities being distributed under the prospectus * This forces underwriter to challenge issuer on disclosures as they take on liability

Question 70

Prospectus requirements: What is a market out disaster clause?

Answer 70

* Enables underwriter to avoid purchasing shares from issuer where there are significant changes in market conditions between time of contract and issuance

Question 71

What does it mean when there is a requirement that disclosure is “full, true and plain”?

Answer 71

* Full: facts are sufficient to permit investors to make an informed investment decision * True: disclosure is accurate and not misleading (and does not omit facts that are material or necessary to understand other facts) * Plain: understandable to investors and in plain language

Question 72

What is the passport prospectus system?

Answer 72

* If you file with the regulator in one province (and receive a receipt), you can issue your securities in any other province (except Ontario; if you want to issue in Ontario, you must file prospectus with OSC) * Note: underwriters who certify prospectuses must be registered with the regulator of the jurisdiction where the shares are issued

Question 73

What is a dual prospectus?

Answer 73

* When you file in a passport jurisdiction and Ontario at the same time, you receive a coordinated review * If the principal regulator and the OSC make the same decision, the receipt of the principal regulator generates a deemed receipt in Ontario (and any other passport jurisdiction where the prospectus is filed)

Question 74

What is the power of regulator if problem with prospectus?

Answer 74

* OSC has the right to reject a prospectus and refuse to issue a receipt * If any problem is found with either the preliminary or final prospectus after issuance of a receipt, the OSC can issue a cease trading order

Question 75

What are reasons for prospectus rejection and refusal to issue receipt (8)?

Answer 75

* OSC Director can refuse to issue receipt if prospectus: o (1) does not comply with OSA o (2) contains misleading statements o (3) contains misrepresentations o (4) reasons of unconscionability o (5) the proceeds of the sale of the securities are insufficient to accomplish the purpose(s) outline in the prospectus o (6) past conduct of issuer, directors, or control persons o (7) financial condition of issuer o (8) reasons of public interest (macroeconomic reasons, risks offending rule of law)

Question 76

How broad should powers of Director of OSC be to refuse to issue receipt for prospectus? Compare full, plain and true to merit-based system.

Answer 76

* The current OSC regime allows the Director to refuse issuing a receipt for reasons that seem to go beyond the bounds of mere full, plain and true disclosure, and begin to look like some merit is involved. * Ensuring that the prospectus complies with the OSA, contains no misleading information or misrepresentations, and that proceeds of sale are sufficient to accomplish the purposes outlined within the prospectus are all objective standards that fit well within the FPT standard. * However, looking at issues of unconscionability, the past conduct of issuer/directors/control persons, the financial condition of the issuer, and reasons of public interest all seem to be subjective standards that veer into the domain of merit (which is not good, because it is overly paternalistic, gives the regulator way too much power, and increases the possibility of corruption)

Question 77

What does undersubscription and oversubscription mean?

Answer 77

* Between the preliminary prospectus and final prospectus, underwriters will meet with prospective institutional investors to gauge interest in the shares * Investor interest will be recorded * Oversubscription: when demand is higher than supply * Undersubscription: when demand is lower than supply

Question 78

What is a short form prospectus (purpose and rationale)?

Answer 78

* Purpose: shorter prospectus for issuances of a corp that is already a reporting issuer * Rationale: much shorter and less expensive; no need to disclose info that was already disclosed before

Question 79

What are the requirements of a short form prospectus (8)?

Answer 79

o (1) Must already be a reporting issuer in at least one jurisdiction o (2) Be a filer with SEDAR o (3) Must file periodically and timely disclosures o (4) Not in breach of any regulatory order o (5) Have financial statements and annual information form in at least one jurisdiction o (6) Have listed equity securities o (7) Have a continuous and substantial business (capital requirements) o (8) Short form prospectus must also be approved by regulator

Question 80

What are the essential features of a short form prospectus (3)?

Answer 80

* Essential features: o (1) Price o (2) Date of issuance o (3) Critical information for investor, such as updated business plan explaining what corp will do with the money raised, risk factors

Question 81

What is a shelf prospectus (purpose and rationale)?

Answer 81

* Purpose: o For longer time frame available for distribution of securities o You have 25 months from date of receipt of shelf prospectus to file your securities * Rationale: o Tend to be used because there is no ready market (when market is uncertain), and corp may wish to distribute over the 25 months

Question 82

What are the requirements of a shelf prospectus?

Answer 82

* Requirements: same as short form prospectus o Before every distribution, supplement (summary update) must be filed, although not reviewed by regulator

Question 83

What is the multijurisdictional disclosure system (purpose and rationale)?

Answer 83

* Purpose: Enable issuers in the US and Canada to use the same disclosure forms for operating in each other’s markets * Rationale: Allows time and cost benefit (on the same basis as short form prospectus, because information is already available in the market) * Note: Does not deal with original offerings, just offerings already in the market

Question 84

Who is liable for misrepresentation on prospectus (4)?

Answer 84

* Purchaser can sue: o (1) the issuer o (2) each underwriter o (3) every director of the issuer (who were directors at time of issue) o (4) every other person/corp who signed the certificate of accuracy * Note: to sue, no need to show reliance on the misrepresentation o However, if proven that plaintiff knowingly purchased the securities despite the misrepresentation, liability is waived

Question 85

What’s the difference between material change and (change in) material fact? Give examples.

Answer 85

* Material fact: a fact that would reasonably be expected (forward-looking) to have a significant effect on the market price/value of issuer securities o Example of material fact: political, social, or economic issues that impact business (such as COVID-19) o Note: Facts are deemed material (and must be disclosed) if they give rise to material risk (the risk can be uncertain, but the facts are not; the test for materiality looks at market impact) * Material change: a change (or decision of the BOD/senior management to implement 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/value of issuer securities o Example of material change: decision by BOD to sell a significant asset, the loss of a large class-action lawsuit against the corp * Note: Material fact is broader than material change (includes more than just developments that affect the business, operations or capital of a business); therefore, every material change is a change in a material fact, but every material fact is not a material change

Question 86

What are material change and material fact requirements during the prospectus process?

Answer 86

* Material facts: Certification signature page includes statement saying that prospectus contains “full, true and plain disclosure of all material facts” relating to the securities (for both preliminary prospectus and final prospectus) * Material changes: If any material changes take place (or there is intent to implement a material change by BOD or management) after a receipt is received during the prospectus process, issuer must file amendment to prospectus (and receive another receipt) o Note: this duty only applies to material changes that are negative, not positive (since investors don’t need to be protected from good news, and the market will take care of this naturally)

Question 87

Why is there a difference in requirement for changes in material fact, and material changes vis-à-vis amending a preliminary prospectus or prospectus?

Answer 87

* Future information/forecasting is difficult (especially relating to political or economic factors), and material changes are usually within the control of the corp * Therefore, forcing corps to amend based on every change in material fact would be too onerous and time-consuming for both the issuer and the regulator

Question 88

Prospectus requirements: What is disclosure of risk factors?

Answer 88

* Issuer has duty to disclose risk factors relating to its business * Risk factors include: o cash flow and liquidity problems; o risks re management experience; o general risks as to issuer’s business; o reliance on key personnel; o regulatory constraints, o economic and political conditions; o any other material risk

Question 89

Prospectus requirements: What is forward looking information (FLI)?

Answer 89

* Disclosure about: o Possible events o Possible financial performance * Based on: o Future economic conditions o Future courses of action * Includes other info such as: o Key performance indicators o Future Oriented Financial Information (FOFI)  FLI financial info presented in format of historical financial statements o Financial outlook  FLI financial info not presented in format of historical financial statements  Examples: projected EPS, projected EBITDA, revenue targets, R&D spending, earnings guidance

Question 90

Is FLI disclosure mandatory for reporting issuers?

Answer 90

* No

Question 91

Where is FLI usually found?

Answer 91

* Reporting issuers usually provide FLI in news releases, MD&As, annual information forms, marketing materials, or websites

Question 92

What are the requirements of FLI (if reporting issuer decides to provide it) (4)?

Answer 92

* If a reporting issuer discloses FLI, it must: o (1) identify FLI as FLI (to be clearly distinguished from historical information) o (2) cautions users of FLI about using it o (3) explain how assumptions of FLI were used (if you sue on FLI, you must prove assumptions were not reasonable) o (4) describes the reporting issuer's policy for updating FLI

Question 93

Why is FLI less reliable than historical information?

Answer 93

* FLI is less reliable than historical information because it is based on management’s best judgement and assumptions of how future trends will impact their business

Question 94

Why must control persons file a prospectus when selling shares (definition and rationale)?

Answer 94

* Definition: o 20% voting rights are deemed control, but can be less if broad investor base o Can be individual or group of people acting in concert acting pursuant to an “agreement, arrangement, commitment or understanding” (no written agreement needed) * Rationale: Control persons must file a prospectus because: o (1) they may be insiders, o (2) can hold influence over issuer and disclosures, and o (3) sale can have a significant influence on price of shares

Question 95

What does acting in concert mean?

Answer 95

* Acting in concert involves sharing information on common interests

Question 96

Who reads a prospectus (7)?

Answer 96

* (1) Lawyers (before it’s issued for sure, but maybe after if they want to invest) * (2) Underwriters (they must also sign it), * (3) Auditors, * (4) Institutional investors, * (5) Regulators (in order to issue a receipt), * (6) Advisors (as a tool to provide advice), * (7) Some investors (since prospectuses must be sent to all investors, even retail ones)

Question 97

What would your general advice be to an issuer, as their lawyer, in terms of setting out plans in a prospectus? Especially one who wants to maximize investor interest (6)?

Answer 97

* To maximize investor interest, I would advise my client to ensure that: o (1) All the material facts are correct o (2) All relevant parties have signed the certification form o (3) The chosen auditor is reputable and has a good track record o (4) FLI is accurate, is clearly distinguished from historical information, and includes a clear warning statement that says that investors should not “place undue reliance on FLI statements within, especially those relating to expectations of future growth, revenue, cashflow, etc.) o (5) Risk factors are accurate, and include a statement that says that investors “may lose all or part” of their investment o (6) Any material changes that take place during the prospectus process are followed by amendments refiled with regulator for new receipt

Question 98

Re YBM Magnex, 2003 (OSC)

Answer 98

* Facts: o YBM was formed to commit securities fraud o They eventually raised nearly $900m before the company declared bankruptcy o But case is not about crime, but instead about disclosure of risk * Held: o YBM's key disclosure documents did not contain full, true and plain disclosure of all material facts, and YBM also failed to disclose a material change * Rule: o Disclosure is the main principle for protecting investors, ensuring fairness in the markets, and enhancing investor trust. o Materiality is the standard for such disclosure in securities markets  Determining materiality involves exercise of judgment and reasonable due diligence

Question 99

What is the due diligence defense regarding disclosure (and how does it relate to the case of YBM Magnex)?

Answer 99

* DDD: When charged with failure to disclose material facts, a defence of due diligence is available when there was an honest and mistaken belief that material facts were properly disclosed (but the accused has the onus of demonstrating that due diligence was undertaken) * Relevance to case: interesting because one of the directors, being young and inexperienced, was permitted to use the due diligence defense. The others were not permitted to, as they were experienced underwriters.

Question 100

What are the two types of ongoing disclosure for issuers and insiders?

Answer 100

* Periodic disclosure * Timely disclosure

Question 101

What is periodic disclosure?

Answer 101

* Requirement that reporting issuer files disclosure documents on SEDAR on a periodic basis (quarterly and annually)

Question 102

What is timely disclosure?

Answer 102

* When reporting issuers must immediately disclose a material change (separate from periodic disclosure)

Question 103

What are the five elements of continuous disclosures (5)?

Answer 103

* (1) Interim Financial Reports (Quarterly) * (2) Annual Financial Reports * (3) Annual Information Form (AIF) * (4) Management Discussion and Analysis (MD&A) * (5) Other Documents

Question 104

Continuous disclosure: What is the purpose of financial reports, and what is the role of the third-party auditor?

Answer 104

* To provide financial information to investors that has been checked by auditor * Auditor checks if reports fairly represent corp, and whether they abide by IFRS/GAAP accounting principles

Question 105

Continuous disclosure: What are some types of financial reports (3)?

Answer 105

* Income statement * Balance sheet * Cash flow statement

Question 106

Continuous disclosure: What type of financial reports require auditor review?

Answer 106

* Annual financial statements (not quarterly)

Question 107

What is the corp’s audit committee, what is its purpose, what are its duties, and what are its requirements?

Answer 107

* Definition: a committee made up of independent members of the BOD * Purpose: o to act as the intermediary between the corp’s officers and the third-party auditor o to recommend appointment of third-party auditor o to recommend fees paid to auditor o to decide whether auditor has other responsibilities outside of auditing FS * Requirements: o committee must have a written charter o members must be independent directors (no relationship with issuer) o members must be financially literate

Question 108

Continuous disclosure: What is the management discussion and analysis (MD&A)?

Answer 108

* Allows management to explain how the company performed (by looking to financial statements), and looks to future prospects * MD&A complements but is not part of financial statements

Question 109

Continuous disclosure: What are the requirements of the MD&A (annual or interim)?

Answer 109

* Annual and interim: o Must be approved by BOD o Must be certified by management * Annual: o Must be reviewed by audit committee (if any issues arise, audit committee communicates with auditor)

Question 110

Continuous disclosure: What is an annual information form (AIF)?

Answer 110

* Document that must be filed by reporting issuer to OSC (SEDAR) * AIF discloses business and financial information about the year, and some information from past years * Similar to a prospectus (shows more than financial statements)

Question 111

Continuous disclosure: What is an information/proxy circular?

Answer 111

* Document sent to shareholders outlining matters being raised at shareholder meeting\ * Also includes proxy vote form

Question 112

Continuous disclosure: What is an executive compensation disclosure?

Answer 112

* Document that outlines compensation for CEO, CFO, and 3 highest-paid executives * Also describes how compensation policy was used to determine compensation * Not required as separate document if already disclosed in AIF or information circular

Question 113

RIM, 2009 (OSC)

Answer 113

* Top executives were charged by OSC and fined $75m for improperly backdating stock options * They were supposed to grant options based on the previous day’s price, but instead used days in quarter with the lowest price (at a benefit of $66m) * Punishment was severe, as directors also had to step down for a while

Question 114

Continuous disclosure: What are the requirements of timely disclosure?

Answer 114

* If there is a material change, issuer must file news release immediately and file report via SEDAR within 10 days (unless information is confidential)

Question 115

Continuous disclosure: What is the confidential change exemption to timely disclosure?

Answer 115

* If the issuer thinks that timely reporting of a material change involving confidential information would be “unduly detrimental to the issuer’s interests,” the issuer can file the material change with the OSC (but not via news release or SEDAR)

Question 116

Continuous disclosure: What happens once OSC receives notice of a confidential material change?

Answer 116

* OSC will keep info confidential for 10 days (extensions are possible) * If matter/negotiations related to the info fail, this is disclosed immediately * If matter/negotiations related to the info succeed, it will eventually be released to the public

Question 117

What are the two versions of material change?

Answer 117

* (1) Internal: a decision made by BOD to implement a change, or where senior management believe that it is “probable” that such change will be approved by the BOD * (2) External: exogenous to corp (such as a political disturbance, or financial crash) o Note: usually, any external factor is a change in material fact, not a material change, but courts have found that serious changes in material facts (due to external circumstances, such as COVID-19 leading to a 90% loss of revenue) is also a material change

Question 118

How do you determine materiality of information (for the purpose of disclosure) (3)?

Answer 118

* You look at: o (1) the nature of the information itself; o (2) the volatility of the reporting issuer’s securities; and o (3) prevailing market conditions.

Question 119

How does the TSX Manual go further than the OSA in material change disclosure requirements?

Answer 119

* On top of disclosing material changes, all listed companies should disclose all material information (which includes changes in material facts) * The TSX surveillance unit might also require issuers to disclose rumours

Question 120

AIT Advanced Information, 2008 (OSC)

Answer 120

* Facts: OSC staff argued that AIT was obligated to disclose a potential merger and had not * Rule: o (1) Material change includes a decision to implement a material change o (2) The probability/magnitude test should be used to determine materiality of information o In short, corps should disclose when something is likely to happen and have an impact on share price

Question 121

Pezim v BC, 1994 (SCC)

Answer 121

* Facts: Allegations that respondents had violated continuing and timely disclosure requirements and insider-trading provisions. * Held: respondents guilty (CoA overturned) * Rule: Directors of the issuer have a positive duty to inquire about material changes and to ensure that any such changes are disclosed prior to the transaction taking place

Question 122

Kerr v Danier Leather, 2007 (SCC)

Answer 122

* Facts: Danier had forecasted demand for leather would be lower than in previous years (leading to lower earnings) via business analysis which was conducted before the completion of the final prospectus. o Danier had not disclosed this information while their IPO was ongoing. o Class action for prospectus misrepresentation was started * Held: Danier wins; class loses. o Rule: Changes in intra-quarterly results (within reason) are not changes in the issuer’s business, operations or capital, and are therefore not materials changes (only changes in material facts)  Therefore, no requirement to amend prospectus due to change in material fact

Question 123

What are the different types of prospectus exemptions (7)?

Answer 123

* (1) Private issuer exemption (SMEs) * (2) Accredited investor exemption (wealthy and sophisticated investors) * (3) Minimum amount exemption (wealthy investors) * (4) Crowdfunding exemption * (5) Pre-existing relationships with issuer * (6) Offering memoranda exemption * (7) Discretionary exemptions * Note: some exemptions might overlap

Question 124

What is a private issuer exemption, what are the requirements, and who can purchase shares from a private issuer (3)?

Answer 124

* Definition: exemption for private SME * Requirements: SME shares must be held by 50 persons or less (excluding employees) * Who can purchase shares (3): o (1) Director, officer, employee, founder, control person of issuer/affiliate (or any of their family members, close personal friends, or close business associates) o (2) Accredited investor o (3) A “person that is not the public”

Question 125

What are the requirements for an accredited investor exemption (8)?

Answer 125

* Accredited investors are (8): o (1) Canadian bank + credit union o (2) Canadian government (federal, provincial, municipal) o (3) Person/organization recognized as accredited investor by OSC (such as an advisor or dealer, including those are registered as representatives of advisors or dealers, or who were formerly recognized) o (4) Pension fund o (5) Person or couple worth $1m+ of financial (liquid) assets net of liabilities o (6) Person or couple worth $5m+ of total assets net of liabilities o (7) Person with average pre-tax income of $200k+ (past 2 years + expected to increase) o (8) Couple with average pre-tax income of $300k+ (past 2 years + expected to increase)

Question 126

What is an offering memoranda exemption?

Answer 126

* Definition: substitute for a prospectus (with less detail) * Purpose: allows raising of funds where issuer can’t find enough “accredited investors” or those in a “sufficiently close relationship”

Question 127

What is a discretionary exemption, and what is its rationale?

Answer 127

* Definition: statute grants powers for regulator to exempt from almost anything * Rationale: whenever investors are no worse off by the exemption from disclosure

Question 128

What are the resale rules/restrictions, and when do they apply (2)?

Answer 128

* If securities were issued (distributed) under a prospectus, investor who bought them is free to sell them without the sale being considered a distribution * However, if investor bought securities from issuer under exemption from the prospectus requirement, the first trade (aka a sale) is a distribution (and prospectus requirements would apply) * However, there are two exemptions where the prospectus requirements would not apply, but these are subject to certain limitations before the securities become freely tradable: o (1) Restricted period: applies when securities were originally issued by a reporting issuer under certain prospectus exemptions o (2) Seasoning period: applies when securities were issued under certain prospectus exemptions and issuer subsequently became a reporting issuer

Question 129

The restricted period resale rules apply to what type of prospectus exemptions (4)?

Answer 129

* (1) Accredited investor exemption * (2) Minimum amount investment exemption * (3) Family, friends and business associates exemption * (4) Offering memorandum exemption

Question 130

The seasoning period resale rules apply to what type of prospectus exemptions (5)?

Answer 130

* (1) Private issuer exemption * (2) Stock dividend exemption * (3) Convertible or exchangeable securities exemption * (4) Business combinations or reorganization exemption * (5)Distribution to employees exemption

Question 131

Why are the seasoning period resale rules less strict than restricted rules?

Answer 131

* Because the types of prospectus exemptions listed under restricted are more likely to be abused

Question 132

To whom do certification requirements for ongoing disclosure apply to?

Answer 132

* All reporting issuers except investment funds

Question 133

Who must certify annual and interim filings?

Answer 133

* CEO + CFO (or persons fulfilling those roles) * And third-party auditor certifies attached auditor report

Question 134

What do annual and interim filling certifications certify (5)?

Answer 134

* (1) that, after due diligence, the annual/interim filings do not contain any misrepresentations, * (2) that those persons have designed or supervised the design of disclosure controls and procedures (DC&P) and internal controls over financial reporting (ICFR), * (3) that they have caused the issuer to disclose any material changes in ICFR, * (4) that they have annually evaluated the effectiveness of the issuer’s DC&P, and * (5) that they have caused the disclosure of their conclusions about the effectiveness of the DC&P

Question 135

What is an issuer’s financial condition (3)?

Answer 135

* Overall health of issuer, including o (1) liquidity o (2) capital resources o (3) solvency

Question 136

What must disclosure controls and procedures (DC&P) assure (4)?

Answer 136

* (1) information gets disclosed by issuer in its filings, * (2) information is recorded, processed, summarized and reported in a timely fashion, * (3) information flows to management and senior officers, and * (4) 1-3 are done in a manner that allows timely decisions regarding required disclosure * Note: these disclosure controls are huge and impose significant obligations

Question 137

What are internal controls over financial reporting (ICFR), and what policies/procedures do they include (3)?

Answer 137

* These are processes designed by or under the supervision of certifying officers that o Are implemented by the BOD, management, and other personnel o Provide “reasonable assurance” that financial reporting is reliable and in accordance with IFRS o Include policies and procedures (relates to corporate governance):  (1) relating to maintenance of records that reflect accurately transactions and asset dispositions,  (2) are designed to provide assurance that transactions are recorded so that financial statements can be prepared in accordance with IFRS, and expenditures are made under proper authorization, and  (3) are designed to provide reasonable assurance regarding prevention or timely detection of unauthorized use, acquisition or disposition of assets that could impact the financial statements  Note: not only the supervision of the design of the procedures, but also their implementation, must be certified

Question 138

What are the obligations of certifying officers regarding financial filings (3)?

Answer 138

* Certifying officers must certify that: o (1) financial statements fairly present the financial condition of the issuer, o (2) internal controls exist to ensure the communication to the decision makers of material information, and o (3) disclosures have been made to the auditor and to the audit committee about internal control deficiencies or instances of fraud that may affect the financial position

Question 139

What is the certification standard for certifying financial statements?

Answer 139

* Standard = “Fairly present in all material respects the financial condition, financial performance and cash flows…” of the issuer”

Question 140

Why does the certification standard for certifying financial statements omit the words “in accordance with IFRS”?

Answer 140

* Because not omitting them would impose an accounting standard instead of a legal standard (legal standards are stronger, and prevent you from sheltering under the opinion of an accounting firm)

Question 141

Kripps v Touche Ross, 1997 (BCCA)

Answer 141

* Facts: Auditor provided certification that financial statements were in accordance with GAAP * Rule: Court said that standard of care acceptable at law is independent of professional accounting standards (must use legal standard)

Question 142

Can EMH be rationalized via disclosure and timeliness?

Answer 142

* No, because no matter how fast technology gets, people will not be able to access all disclosed information instantly, and even if they could, there will always be insider trading

Question 143

Explain the difference between material fact and material change, and explain how these differences apply to securities regulation (prospectus + continuous disclosure)

Answer 143

* Prospectus: o Material facts: Certification signature page includes statement saying that prospectus contains “full, true and plain disclosure of all material facts” relating to the securities (for both preliminary prospectus and final prospectus) o Material changes: If any material changes take place (or there is intent to implement a material change by BOD or management) after a receipt is received during the prospectus process, issuer must file amendment to prospectus (and receive another receipt) * Continuous disclosure: o Timely disclosure: if there is a material change, issuer must file news release immediately and file report via SEDAR within 10 days (unless information is confidential)

Question 144

When it comes to disclosure controls under certification of financial disclosures, are these controls too rigorous? Are we imposing too much on these senior officials? Or are they not high enough?

Answer 144

* DC&P impose significant obligations on senior officials, but reducing these obligations in any way would be a bad idea. * By removing any one of the controls, or by cutting the link between senior executives and others that may come up with the controls, you are opening the issuer up to risks of negligence, and even intentional harm. * Reducing these controls would severely limit executive liability and reduce the power of regulators to uphold standards. Since the purpose of securities regulation is to protect investors and increase market efficiency and trust, reducing these controls would almost certainly make securities regulation less effective, leading to less trust, more corruption, less market efficiency, and must less investor protection

Question 145

What are the (3) requirements of insider trading under OSA s 76(1)?

Answer 145

* (1) Insider (person, as defined in OSA) in a special relationship who * (2) purchases or sells securities with knowledge of a material fact or change, and * (3) the material fact or change has not been disclosed to the public

Question 146

What is the definition of an insider according to the OSA (6)?

Answer 146

* (1) Director or officer of a reporting issuer * (2) Director or officer of a company that is a subsidiary of a reporting issuer * (3) Person who owns and/or controls securities that have 10%+ of voting rights of reporting issuer (excluding an underwriter in the course of a distribution) * (4) Reporting issuer that has purchased/redeemed its own issued security (as long as it holds it) * (5) Person designated as an insider of a reporting issuer by OSC under OSA * (6) Person designated an insider who would reasonably be expected to have access to material information about the business, operations, assets or revenue of the issuer

Question 147

What are the (3) requirements of tipping under OSA s 76(2)?

Answer 147

* (1) Issuer or person in special relationship with issuer who * (2) informs, other than in the necessary course of business, the tippee of a material fact of change, and * (3) the material fact or change has not been disclosed to the public

Question 148

What is a person in a special relationship (5)?

Answer 148

* (1) Insider of issuer or subsidiary of issuer (including director, officer, employee) * (2) Person engaged or planning to engage in any business/TOB/restructuring with issuer * (3) Insider of company proposing to engage in any business/TOB/restructuring a of substantial assets of issuer * (4) Person who invertedly acquired (did not seek out) undisclosed material fact/change as a result of their position/status listed in 1-3 * (5) Person who invertedly acquired (did not seek out) undisclosed material fact/change from a person listed in 1-4, but who ought to know that person had a relationship with the issuer (overhearing private convo in restaurant)

Question 149

What is the necessary/ordinary course of business, and who is privy to such business communications (7)?

Answer 149

* Definition: normal and routine day-to-day operations consistent with the past practices and customs of the business. o This includes ordinary business communications between issuer and:  (1) vendors, suppliers, and partners related to R&D, sales, marketing  (2) employees, officers, and directors  (3) professionals (lawyers, underwriters, lenders)  (4) parties to negotiations  (5) labour unions  (6) government agencies and regulators  (7) credit rating agencies

Question 150

What is the ordinary course of business onus?

Answer 150

* The tipper has an onus to ensure the person receiving information knows it is confidential and should not be disclosed (this is where obligatory filling of forms comes into play)

Question 151

Royal Trustco v OSC, 1983

Answer 151

* Facts: o Royal Trustco was the target of a TOB o Two officers who knew that majority shareholders would not accept the bid had revealed to a major shareholder (TD Bank), other than in the “necessary course of business” certain material facts that had not been generally disclosed including:  (i) the bid would probably fail, and  (ii) dividend on Trustco shares would probably increase * Held: the information disclosed fell within the category of material facts and that such material facts had been made available to such shareholder not "in the necessary course of business" from Royal Trustco's perspective, but instead to influence TD Bank regarding the bid o In other words, this was tipping, and therefore illegal

Question 152

What are the defences to insider trading/tipping under the OSA (3)?

Answer 152

* (1) the insider/tipper reasonably believed the material fact or change had been disclosed, * (2) the material fact or change was known or ought to have been known to the seller or purchaser of securities, or * (3) for tipping, information was given in the necessary course of business

Question 153

What are the additional defences to insider trading/tipping under the OSA regs (5)?

Answer 153

* Reg 175 (1): if company that traded on insider info can prove that nobody who was involved in the trade o (a) had knowledge of the material fact/change, or o (b) was given advice by someone who had knowledge of the material fact/change * Reg 175 (2): if person who commits the trade is an innocent agent for another person o Example: if client instructs their broker to buy shares in a corp (even if broker has knowledge of undisclosed material fact/change), this is fine, as long as broker did not solicit the trade from client * Reg 175 (3): If person with insider knowledge has an automatic dividend reinvestment plan (as long as the DRIP was created prior to the acquisition of knowledge) * Reg 175 (4): If person with insider knowledge has a legally binding contract to buy/sell securities that was entered into prior to acquisition of knowledge (but this does not include options to buy/sell) * Reg 175 (5): if both buyer and seller are both insiders and are both privy to the same information

Question 154

How could a company bolster their defence to insider trading/tipping under Reg 175(1)?

Answer 154

* By having a “Chinese wall” within a corp (to prevent transmission of knowledge, such as locked doors, code names on files, firewalls on servers, etc.) for various deals

Question 155

How does accountability for improper gain from insider trading/tipping work?

Answer 155

* OSA S 134(4): anyone who trades on insider information or tips is liable to the issuer for any benefit or advantaged they received or will receive as a result

Question 156

How do you measure damages for insider trading/tipping (2)?

Answer 156

* (a) if plaintiff is buyer: damages = price paid by plaintiff – average market price over 20 trading days after disclosure of material fact/change o Example: if bought at $10, and price after disclosure is $7, damages = $3/share * (b) if plaintiff is seller, damages = average market price over 20 trading days after disclosure of material fact/change – price received by plaintiff o Example: If sold at $7, and price after disclosure is $10, damages = $3/share

Question 157

Who is a reporting insider (an insider with a duty to report) (7)

Answer 157

* Reporting insider is: o (1) Director and key officers of a reporting issuer o (2) Significant shareholder (ownership/control of 10% or more voting rights) of a reporting issuer o (3) Key officer of significant shareholder listed in #2 o (4) Management company providing significant services to a reporting issuer o (5) Key officer of management company listed in #4 o (6) Any other insider that receives inside information in the normal course of business, and has ability to exercise significant power or influence/control over the reporting issuer o (7) Persons designated under the look back rule, which states that:  For an amalgamation or takeover, there must be reporting for previous 6 months:  Example: if A takes over B, the insiders of A are deemed to be insiders of B; one wants to know trades with respect to insiders from B.

Question 158

What is the timeline for insider duty to report (3)?

Answer 158

* (1) On becoming a reporting insider, must file a report within 10 days (on SEDI) * (2) Every time a change in insider status, need file a report within 5 days * (3) Under look back rule, need file report on becoming insider within 10 days

Question 159

When are reporting insiders exempt from reporting (6)?

Answer 159

* (1) If securities are covered by an automatic stock purchase plan (DRIP) * (2) If securities are part of a compensation arrangement disclosed in SEDAR * (3) If specific events (such as stock splits, amalgamations, reorganizations) affect all security holders uniformly * (4) If shareholders hold shares of mutual funds * (5) If significant shareholder of reporting issuer/subsidiary of reporting issuer does not have access to material facts/changes before being disclosed to public * (6) If reporting issuer transfer/pledges securities as collateral for debt

Question 160

What is meant by information being “generally disclosed” (2)?

Answer 160

* Information has been generally disclosed when: o (1) the information has been disseminated in a manner calculated to effectively reach the marketplace; and o (2) public investors have been given a reasonable amount of time to analyze the information.

Question 161

In relation to insider disclosure requirements, does any statute outline what a “reasonable amount of time” is for public investors to analyze information being generally disclosed, and if not, does this create confusion?

Answer 161

* A reasonable amount of time means you cannot disclose and then legally commit insider trading within a few seconds/moments of making the disclosure; you must wait between 24–48h before acting * However, no specific time is given in the statute/NI * This becomes more confusing with modern tech, such as social media platforms and push notifications from brokerages and banks

Question 162

What questions should you ask yourself when trying to figure out whether insider trading took place, or tipping is illegal (5)?

Answer 162

* (1) Is there a special relationship? * (2) Is there a material fact/change? * (3) Was there disclosure? * (4) Is there a defence to disclosure? * (5) Is the answer in line with the spirit of the Act (investor protection + market integrity)?

Question 163

Why should we try to prevent insider trading?

Answer 163

* Preventing insider trading eliminates informational advantage, which upholds market integrity, investor protection, and market confidence * In short, this evens out the playing field and makes retail investors more enthusiastic about investing

Question 164

Are there any counterarguments to preventing insider trading?

Answer 164

* Some might argue that you will never be able to truly eliminate all information advantage * Strong EMH theory also states that all information (public and private) is already baked into the price of securities, so insider trading does not provide any long-term gain o However, this theory is clearly wrong in practice, as there are many examples of hedge fund managers making enormous profits based on insider information

Question 165

Paramount financial equity corporation, 2022 (OSC)

Answer 165

* Majority found fraud was committed under the OSA because investor funds were used in ways not disclosed that benefitted the accused * Former OSC chair Zordel was criticized for her dissent for being too lenient

Question 166

Majd Kitmitto, 2022 (OSC)

Answer 166

* Majority found that some of the accused tipped, and others used this info to insider trade, but found that OSC was not able to prove that all parties accused of tipping and insider trading were guilty * Former OSC chair Zordel was criticized for her dissent for being too lenient

Question 167

Re Donnini, 2002 (OSCB)

Answer 167

* Fact: Trader acted on insider information (a material fact about how the investment banking side of a firm was negotiating the financing of a company) * Held: Donnini not guilty of insider trading, but still found that he should not have traded on his information without first checking if the info was material or not, and forced him to pay the cost of the investigation and banned him from trading for 15 years * Rule: hallway discussions, and a strong expectation of something happening that hasn’t happened yet, can be deemed material facts

Question 168

Green v Charterhouse, 1976 (ONCA)

Answer 168

* Rule: o The plaintiff has the onus of showing that the insider defendant had specific confidential information, and that it was a factor in the action that the insider defendant took which resulted in the plaintiff suffering a loss o However, the insider defendant then has the onus to prove that he did not make use of the information in the transaction (that the information was not a factor in what he did)

Question 169

R v Rankin, 2007 (ONCA)

Answer 169

* Prof takeaway: OSC monitors significant trades

Question 170

Finkelstein, 2018 (ONCA) – *insider trading leading case*

Answer 170

* In this case, the ONCA considered the definition of “person in a special relationship with an issuer” for the first time * Rule: o Successive tippees further downstream the tipping chain can be held liable for insider trading/tipping o The factors considered by OSC in determining liability are:  The relationship between the tipper and tippee;  The professional qualification and standing of the tipper;  The professional qualification of the tippee;  The level of detail and specificity of the MNPI;  The length of time a tippee waits to make a trade after receiving MNPI;  The intermediate steps a tippee takes, if any, to verify the information received;  The tippee’s past ownership, or lack thereof, of the particular stock; and  The significance of the trade given the size of a tippee’s portfolio o The weight given to each factor depends on the circumstances o Based on these factors, someone who lacks subjective knowledge about the origins of Material Non-Public Information (MNPI) can still be liable if they “ought reasonably to have known” that it came from an insider. o Case also confirms the deference appellate courts will show to OSC findings

Question 171

TOB: What is the purpose of the early warning system, and what is the applicable rule (3)?

Answer 171

* Purpose: to warn the marketplace that a take-over bid could be imminent. * Rule: Every person who acquires securities (either alone or with others jointly or in concert) so they then hold 10% or more of the issued voting or equity securities (including convertible securities) of a reporting issuer must: o (1) Issue and file on SEDAR a press release immediately (by end of business day) to disclose their identity, their intention and the extent of their holding. o (2) file on SEDAR a disclosure report containing their identity, their intention and the extent of their holding within two business days. o (3) file an insider report (on SEDI) disclosing all beneficial ownership/control (since they are now officially an insider) within 10 days of SEDAR disclosure o (4) face a 1-day freeze on all trading of those specific securities (to allow the market to digest the information)

Question 172

TOB: What does acting jointly mean?

Answer 172

* legally acting as one entity

Question 173

TOB: What does acting in concert mean?

Answer 173

* 2 or more parties acting together separately but with a common interest

Question 174

TOB: What does deemed mean, and when is it deemed that parties are acting jointly or in concert (2)?

Answer 174

* Meaning: Finding cannot be rebutted in court (conclusive finding) * Applies to: o (1) a person who, as a result of an agreement with the offeror/acquirer acquires or offers to acquire securities currently being offered o (2) an affiliate of the offeror or acquirer (you control 50%+ of voting shares)

Question 175

TOB: what is the threshold for being an affiliate of the offeror or acquirer?

Answer 175

* You control 50%+ of voting shares

Question 176

TOB: What does presumed mean, and when is it presumed that parties are acting jointly or in concert (2)?

Answer 176

* Meaning: Finding can be rebutted in court (not conclusive finding) * Application: o (1) a person who, as a result of an agreement with the offeror/acquirer intends to exercise any voting rights attaching to any securities of the offeree issuer o (2) an associate of the offeror or acquirer (you control 10% of voting shares)

Question 177

TOB: what is the threshold for being an associate of the offeror or acquirer?

Answer 177

* You control 10%+ of voting shares

Question 178

TOB: Other than the first time someone acquires 10% of issued securities, what are the additional/ongoing early warning system requirements (4)?

Answer 178

* The same early warning disclosure requirement applies each time: o (1) The buyer acquires (either alone or with others jointly or in concert) an additional 2% or more of the same securities (including convertible securities) o (2) There is a 2% decrease in ownership o (3) A shareholder’s ownership falls below the 10% reporting threshold o (4) There is a change in any material fact in the disclosure required in the most recent previously filed early warning report.

Question 179

TOB: When does the early warning system stop applying?

Answer 179

* When the 20% threshold is reached (and then TOB rules apply)

Question 180

TOB: What is the exception to the 10% early warning system threshold?

Answer 180

* If the issuer buys back its own shares (thus increasing the shareholder’s % interest), the 10% threshold rule does not apply

Question 181

TOB: Who does a TOB target?

Answer 181

* TOB offer is made to shareholders, not target corp

Question 182

TOB: Why is the TOB threshold 20%?

Answer 182

* Most other shareholders will not own anywhere near as much, so you have a lot of power to bring proposals, requisition meetings, exert influence over BOD

Question 183

TOB: how can a 20% threshold be reached (2)?

Answer 183

* 20% threshold can be reached by either: o (1) purchasing a control block of shares from held by one person or a combination of persons acting jointly or in concert, or o (2) purchasing a percentage of shares from each shareholder

Question 184

What is the difference between a friendly and hostile TOB?

Answer 184

* Friendly: BOD supports it * Hostile: BOD does not support it

Question 185

What are some motives for TOBs (6)?

Answer 185

* (1) Vertical integration: one company takes over different stages in production or distribution of product or service (revenue increase through economies of scale) * (2) Horizontal integration: one company takes over similar or identical company involved in same stage in production or distribution of product or service (revenue increased through lowers competition and gaining of clients) * (3) Belief by executives of acquiring company that they can run target better than current management * (4) Belief by executives of acquiring company that target is undervalued * (5) Tax reduction strategy * (6) Acquiring IP

Question 186

Who stands most to gain during a TOB (2)?

Answer 186

* (1) Shareholders of target company (short-term due to market sentiment) * (2) Shareholders of acquiring company (long-term if purchase was wise/profitable)

Question 187

Who stands most to lose during a TOB?

Answer 187

* Middle managers and junior executives + board members of target company, as many of these will often lose their jobs

Question 188

What are the reasons for TOB regulation (3)?

Answer 188

* To ensure: o (1) Disclosure of information o (2) Target and shareholders have time to respond o (3) Equal treatment of shareholders (since first-come, first-serve offers unfairly pressure shareholders)

Question 189

What is the timeline of a TOB?

Answer 189

* Step 1: bidder secures necessary financing to launch bid (if bid has cash component) * Step 2: bidder publishes ad with summary of offer, or sends bid (as TOB circular) to shareholders, target corp, and OSC (via SEDAR) * Step 3: Within 15 days of the date of the bid, directors of the target corp must issue a director’s circular to shareholders * Step 4: bid remains open for minimum deposit period of 105 days from date of TOB launch * Step 5: once minimum deposit period expires and bid conditions are met, there is a mandatory 10-day extension period to allow shareholders who haven’t deposited their shares to deposit

Question 190

What is a TOB circular?

Answer 190

* Document that include purpose of bid, source of funds, and minimum tender requirement

Question 191

What is a director’s circular?

Answer 191

* This document includes recommendations of the target board to shareholders to accept or reject the bid, or must communicate that the board is unable to make a recommendation o All recommendations (or lack thereof) must include reasons by the board

Question 192

TOB: What are the equal consideration rules (2)?

Answer 192

* (1) Offer must be made to all shareholders of the class * (2) All shareholders must be offered identical consideration per share (or if consideration is different, shareholders must be given the choice); no collateral benefits (side offers providing greater consideration) allowed

Question 193

TOB: What does it mean to “take-up” shares, and what are the take-up rules (3)?

Answer 193

* Definition: to acquire shares (but not having paid for them yet) * Take-up rules state that shares can’t be taken up until: o (1) expiry of 105-day minimum deposit period, o (2) all terms of TOB complied with or waived, and o (3) at least 50% securities subject to the bid have been deposited and not withdrawn by shareholders

Question 194

TOB: What is the share withdrawal rule, and how can shareholders withdraw (3)?

Answer 194

* Shares tendered can be withdrawn by shareholders at any time before taken up * Ways shareholders can withdraw shares: o (1) when securities have not been taken up, o (2) if offeror has not paid for them within 3 business days after take up, o (3) before expiration of 10-day extension from a notice of change or variation of the bid

Question 195

TOB: What is the purpose of a squeeze out transaction, and what are the 2 types?

Answer 195

* Purpose: o If a bidder can buy all the outstanding shares to take the company private, the offeror no longer needs to consider the rights of any shareholders (which is what the bidder wants) o But in most cases, this will not happen without a fight, because some shareholders might reject the offer, while others might not get around to tender their shares to the bidder o This is where squeeze out transactions come into play, to squeeze out the remaining minority shareholders * Types: (1) compulsory acquisition and (2) amalgamation squeeze out

Question 196

TOB: What is a compulsory acquisition, and what are the steps?

Answer 196

* Definition: If the bidder acquires at least 90% of outstanding shares, the bidder is entitled (by law) to acquire the remaining 10% * Steps: o (1) The bidder will send notices to the remaining shareholders who did not tender their shares, and will place the money (or any other consideration) for those shares in trust for those shareholders o (2) Once the TOB conditions are satisfied, the shares will be transferred to the bidder

Question 197

TOB: What right do dissenting shareholders have in a compulsory acquisition?

Answer 197

* To apply to a court to establish the fair value of their shares * However, this is unusual, because courts are unlikely to determine that the fair value of the shares is different from the price (fair market value) the other shareholders accepted under the bid

Question 198

TOB: What is the difference between fair market value and fair value of shares?

Answer 198

* Fair market value: share value based on what the market would pay for, so what the 90% of shareholders sold their shares for) * Fair value: share value based on the value of the underlying company as a whole (realizable value of sold assets minus liabilities) * Note: fair value and fair market value may be the same, but it is sometimes not

Question 199

TOB: What is an amalgamation squeeze-out, and what are the steps?

Answer 199

* Definition: If bidder acquires under 90% of outstanding shares but over 2/3 of shares and a majority of the outstanding minority shares, the bidder can use an amalgamation squeeze out o Corporate law dictates the 2/3 amalgamation rule o Securities law dictates the majority of the minority rule for amalgamations post-TOB * For example, if bidder A holds 70% of C before the bid and then acquires 16% through the bid, this 86% is not sufficient to do a compulsory acquisition (under 90%), but it is enough to do an amalgamation squeeze out (because 16% is more than 50% of the 30% remaining outstanding minority shares) * Steps (assuming the TOB was already launched and the bidder acquired enough shares): o (1) The bidder creates a subsidiary o (2) The subsidiary and the target enter into an amalgamation agreement (if TOB was hostile, bidder will have replaced old directors to ensure that target cooperates in amalgamation process) o (3) Upon the amalgamation:  (i) the shareholder of the subsidiary (the bidder) receives common shares in the amalgamated company;  (ii) the shareholders of the target (those who didn’t accept the TOB) receive redeemable preferred shares of the amalgamated company; and  (iii) the redeemable preferred shares are immediately redeemed (meaning repurchased by the amalgamated company) for cash or whatever other consideration was paid under the TOB o (4) Upon completion of the amalgamation, the bidder ends up with all of the outstanding shares, and the former shareholders of the target end up with the same consideration they would have received if they had tendered their shares under the bid

Question 200

TOB: Does your choice to do a TOB before an amalgamation squeeze out change whether the bid is friendly or hostile?

Answer 200

* Yes. If the target’s BOD supports the TOB, it is more efficient to go straight to the amalgamation squeeze out stage instead of first conducting a TOB (but this requires cooperation of the target’s BOD, meaning that in the context of a hostile bid, you must go through both steps)

Question 201

TOB: How does the early warning system change for TOBs, and what is the rationale?

Answer 201

* Where there is a TOB outstanding, the early warning reporting requirement is lowered from 10% to 5% * Rationale: Because there might be another bid forthcoming, so you want to lower the threshold and give the market additional information

Question 202

What are conflicts of interest in TOBs (3), and how do you deal with them?

Answer 202

* Conflicts may arise where (especially in hostile TOBs): o (1) director is also an officer/employee of target and might lose job if bid is successful, or be entitled to payout if bid is successful; o (2) director is also a substantial shareholder of target, so would have financial interest in the bid; o (3) director also has ties to the bidder, such as holding shares in the bidder or being an officer/director of the bidder * Solution: Set up some form of independent committee/review to determine if there is a conflict, and then to figure out how to deal with it

Question 203

TOB: What are exemptions from the TOB rules?

Answer 203

* (1) Normal course purchaser exemption * (2) Private agreement exemption * (3) Non-reporting issuer (aka private company) exemption * (4) De minimis exemption

Question 204

TOB: What is the normal course purchaser exemption?

Answer 204

* Allows control block holders (more than 20%) to buy up to 5% more shares within a year

Question 205

TOB: What is the private agreement exemption?

Answer 205

* Allows you to buy more shares without making the same offer to all shareholders, as long as you are buying from 5 shareholders or less (but the purchaser cannot pay more than 115% of the market price, meaning the premium cannot be more than 15%)

Question 206

TOB: What is the non-reporting issuer exemption?

Answer 206

* Allows acquisition of smaller private company (not more than 50 shareholders)

Question 207

TOB: What is the De minimis exemption?

Answer 207

* Allows TOB under rules from foreign jurisdiction when fewer than 50 shareholders who hold less than 2% of shares live in Ontario

Question 208

TOB: What are the defences to TOBs (4)?

Answer 208

* (1) Poison pill (shareholder rights plan) * (2) White knight (auction) * (3) Sale of crown jewels * (4) Roadblocks

Question 209

TOB: What is the poison pill defence?

Answer 209

* In case of a hostile TOB, a shareholder rights plan it put into place to disincentivize the hostile bidder from going through with the TOB * The plan (if triggered) allows all other shareholders (excluding the bidder) to buy additional shares of the company at a steep discount, thereby diluting the existing ownership of the bidder, making it much more expensive for the bidder to successfully complete the TOB (to the point where it no longer makes financial sense to pursue the TOB)

Question 210

TOB: Is the poison pill defence effective?

Answer 210

* Such plans are so effective that no poison pill defence has ever been triggered once put in place by the target BOD (meaning that no bidder has ever gone through with a TOB after facing a poison pill defence)

Question 211

TOB: Is the poison pill defence still used in Canada and US, and why/why not?

Answer 211

* Today, poison pills are still used very often in the US, but they are quite rare in Canada * Why? Because our new TOB rules (increasing the minimum deposit period from 35 to 105 days) allows BOD to solicit other interest, while 35 days often wasn’t enough, so a poison pill would be used to get additional time * When would a poison pill still be useful today? Perhaps during a recession when shares are worth less (and the company is undervalued), or during a creeping takeover (where shares are slowly acquired via exemptions to the TOB regime)

Question 212

TOB: What is the white knight (auction) defence?

Answer 212

* If the BOD of the target is not satisfied with the terms of a TOB, the BOD may try to find another bidder offering better terms (the white knight) * The BOD may set up an auction whereby the white knight will offer a higher price than the original bidder, leading the original bidder to increase their offer price * The white knight might also be a preferable option for the BOD because of what they will do with the company post acquisition * White knights will often be reluctant to get involved in a bidding war over the target because of the associated costs and effort (especially due to the risk of the bid being unsuccessful), so the target will incentivize the white knight by entering into a “support agreement” with the white knight * The agreement states that the white knight will make a TOB, and in exchange, if the TOB is unsuccessful, the target will pay the white knight a break fee (anywhere between 3-5% of the value of the target, which can sometimes be substantial)

Question 213

TOB: What is a defence to the white knight defence?

Answer 213

* Lock-up agreement between bidder and target (where the bid was originally friendly but turned hostile)

Question 214

TOB: What is the sale of crown jewels defence?

Answer 214

* For this defence, the target will sell one or some of the most attractive parts of the company to a friendly third party (such as a property, some IP, etc.) to disincentivize a hostile bidder from launching a TOB * Generally, only used in certain industries (such as mining)

Question 215

TOB: What is the roadblocks defence?

Answer 215

* When a target tries to disincentivize an bidder by slowing them down via instigating (frivolous) litigation, conflicting out counsel, etc.

Question 216

Maple Leaf Foods v Schneider Corporation, 1998 (ONCA)

Answer 216

* Facts: o Maple Leaf made a TOB for Schneiders o Schneiders created a Special Committee consisting of independent non-family directors to review the Maple Leaf offers o Schneider rejected ever-increasing bids for non-financial criteria (such as to keeping the business in the family) o Schneiders was only willing to accept the bid from Smithfield (but entered into a lock up agreement) o When Maple Leaf offered more than Smithfield and was rejected because of the lock-up agreement, they sued * Held: Maple Leaf loses * Rule: If Special Committee directors are independent, act in good faith, and use their business judgment, they are entitled to deference

Question 217

TOB: What is a lock-up agreement?

Answer 217

* Agreement to bidder and target where target agrees to tender their shares to the bidder’s bid even if a superior bid comes along later * Can be used to defend against possible future white knight offers

Question 218

Sears Canada, 2006 (OSC)

Answer 218

* Facts: o Three large Sears Canada shareholders opposed the attempt by Sears Holding Company to buy out minority shareholders since Sears Holding had offered special consideration to some shareholders * Held: o Sears Holding loses * Recap: this case showed that the OSC is willing to act harshly when necessary to protect the interests of minority shareholders in cases where they find coercive or abusive behaviour

Question 219

What are special transactions?

Answer 219

* Transactions that might be abusive in the absence of regulation * As a result, they have additional regulations imposed

Question 220

What are the 4 types of special transactions?

Answer 220

* (1) Insider bids * (2) Issuer bids (buybacks) * (3) Business combinations * (4) Related party transactions

Question 221

Special transactions: What are insider bids, what concerns arise from them, and what’s the rationale for regulation?

Answer 221

* Definition: TOB made by an insider (director, officer, 10%+ shareholder) * Concerns: bidder could have information about the company that shareholders are unaware of, and could use that info to gain an unfair advantage over the shareholders by offering a price that is less than what the shareholders think was the true value of the company if they had access to the same information as the bidder * Rationale: level the informational playing field

Question 222

Special transactions: What are issuer bids, what concerns arise from them, and what’s the rationale for regulation?

Answer 222

* Definition: share buybacks * Concerns: disparity of information; buybacks done for nefarious purposes * Rationale: level the informational playing field

Question 223

Special transactions: What are some rationales for companies performing issuer bids/buybacks?

Answer 223

* (a) Reducing cash (to make it less attractive to TOBs) * (b) Increasing majority shareholder holdings (via dilution) * (c) Boost share price (if officers think shares are undervalued)

Question 224

Special transactions: What are business combinations, what concerns arise from them, and what’s the rationale for regulation?

Answer 224

* Definition: also known as a squeeze-out transaction (compulsory or amalgamation) * Concerns: o Unfair that dissenting shareholders who dissent for reasons other than financial ones are forced out in squeeze outs, but securities law only sees securities as a financial interest o Therefore, regulation is concerned with ensuring that dissenting shareholders are fairly compensated for their shares * Rationale: o Without squeeze-out rules, any 2/3 shareholder could force an amalgamation without fairly compensating minority shareholders o If squeeze-out rules didn’t exist, many bidders would be dissuaded from ever making a bid (meaning that the majority of shareholders would be deprived of the opportunity to sell their shares at the higher bidder price)

Question 225

Special transactions: What are related party transactions, and what concerns arise from them?

Answer 225

* Definition: a transaction involving two companies (or a company and an individual) in which one person has a material interest in both sides of the transaction * Concerns: o In a transaction only involving arm’s length parties (independent parties looking out for their own interests), it is assumed that a fair bargain is struck (otherwise the parties would not enter into the transaction) o However, if the transaction involves related parties, the influence that may be exerted by the related party may result in unequal bargaining  Example: a person may try to force a company they control to buy assets from that person at a price that is higher than if it had been negotiated between two arm’s length parties * Rationale: related party rules exist to level the playing field (to ensure the transaction is fair)

Question 226

Special transactions: What are the securities law requirements for special transactions (3)?

Answer 226

* (1) Disclosure requirements * (2) Formal valuation requirements * (3) Minority approval requirements

Question 227

What is the objective of corporate governance?

Answer 227

* Objective of CG: to align interests of the company (directors and officers) with stakeholders, and clarify accountability

Question 228

What are the duties of directors to the corporation (not shareholders) (2)?

Answer 228

* (1) Fiduciary duty * (2) Duty of care

Question 229

Duties of directors: What is fiduciary duty, and what standard is used to determine breach?

Answer 229

* Definition: Directors must act honestly and in good faith, focusing on the best interests of the corporation (not owed to shareholders or creditors) * Standard: subjective; determination relies on business judgment rule

Question 230

Duties of directors: What is the business judgment rule?

Answer 230

* Courts use BJR to give deference to the business judgment of directors, because they are in the best position to take into account the interest of the corporation and its stakeholders (as long as the decision is reasonable, not pointless, and not illegal)

Question 231

Duties of directors: What is duty of care, and what standard is used to determine breach??

Answer 231

* Definition: Imposes a legal obligation upon directors and officers to be diligent in supervising and managing the corporation’s affairs o “To exercise the care, diligence and skill a reasonably prudent person would exercise in comparable circumstances” * Standard: objective

Question 232

In determining the best interests of the corporation, what stakeholder interests do directors look to (6)?

Answer 232

* (1) Shareholders * (2) Employees * (3) Creditors * (4) Consumers * (5) Governments * (6) The environment

Question 233

BCE v 1976 Debentureholders, 2008 (SCC) (leading case about fiduciary duty)

Answer 233

* Facts: Debentureholders sued BCE for issuing new debt, because this new debt reduced the value of their old bonds by 20% * Held: BCE wins * Rule: absent of fraud or other illegal acts, directors can use the business judgment rule to defend actions where they consider all stakeholder interests, but end up making a decision that ends up harming one stakeholder if the net interests of all stakeholders benefits o Also, Debentureholders were a sophisticated party, so if they wanted to avoid this scenario, they should have included a clause in their original contract with BCE

Question 234

Explain why corporate governance rules are important even though directors already have statutory duties (and explain what these duties are)

Answer 234

* Discuss fiduciary duty * Discuss duty of care * Discuss Maple Leaf case * Discuss BCE case * Discuss obligatory duties * Discuss non-obligatory principles

Question 235

What are obligatory corporate governance rules aside from statutory duties of directors (3)?

Answer 235

* (1) Certification of disclosure (annual/interim financial statements, MD&A, CD&P, ICFR) for issuers * (2) Disclosure of matters relating to structure of BOD * (3) Information regarding independent audit committee

Question 236

What are some non-obligatory corporate governance guidelines (2)?

Answer 236

* (1) Suggesting (but not mandating) structure of BODs (but mandates disclosure of practices relating to composition of BOD) * (2) Suggesting (but not mandating) that BOD have a written mandate stating what BOD is responsible for, such as culture of integrity, identifying risks, internal control, succession planning, corporate governance, etc.

Question 237

Do you think company directors should be held to additional standards/regulations (other than fiduciary duty and duty of care)?

Answer 237

* Enron and Worldcom are examples where directors didn’t follow these rules (so they were clearly insufficient) * Whether there are formal conspiracies and active criminal activity, or just negligence, additional regulations will help reduce the severity and frequency of market harms and failures (we only need to look at the lack of regulation in crypto and the dozen or so of crypto firms that recently collapsed in the wake of the FTX fraud and collapse) * Moving forward, regulators may want to impose additional and specific regulations dealing with security and firewalls * However, we must also be worried about imposing too much personal liability on directors (because this would likely reduce market efficiency and overall wealth creation, since directors/officers would be less willing to take risks)

Question 238

Discuss the role of activist shareholders, and the disclosure of additional factors (such as compositions of board of directors)

Answer 238

* Bring forward proposals * Push for more ESG * Push for more diverse BOD and senior management positions * Get more involved in executive compensation (say on pay votes) * Can demand stricter executive compensation claw-back policies for inaccurate disclosure, fraud, negligence

Question 239

What is a say on pay vote?

Answer 239

* Where executive compensation is voted on by shareholders (but is non-binding in Canada, often binding in US); but can have significant influence on board; if board ignores, even if non-binding, they may be voted out later as a result, so definitely important

Question 240

Control persons are treated differently under the OSA (when compared to ordinary investors). Explain how they are treated differently (3) and offer a rationale for this (3).

Answer 240

* Definition: Control persons control 20% or more of voting shares * Additional obligations/Impact: o (1) Can influence whether regulator issues receipt for prospectus to another issuer o (2) Have a duty to file a prospectus upon share trades o (3) Cannot be investors in restricted or seasoning period exemptions * Rationale: To level the playing field, because they o (1) have additional information that the public does not o (2) can hold influence over issuer and disclosures o (3) there sales can influence share price

Question 241

What is a direct listing?

Answer 241

* Where employees and investors sell their existing stocks to the public without using an IPO