What is a distribution? – Securities Regulation

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What is a distribution?

Unless exemption is available… if trade is a distribution, need to issue prospectus

Distribution (per s.1(1) definition: means (EXHAUSTIVE def) (a) trade in sec of an issuer that have not been previously issued, (b) a trade by or on behalf of an issuer in previously issued securities of that issuer that have been redeemed or purchased by or donated to that issuer, (c) a trade in previously issued securities of an issuer from the holdings of any control person, (d +e) a trade by or on behalf of an underwriter in securities (see full def below)

Purpose: def determines whether or not there’s a requirement to prep prospectus^Thus, purpose is to ensure those who are potentially going to invest in the corp have suff info with which to make an informed investment decision

If a trade in a security constitutes a distribution, the issuer is required to assemble, publicly file and distribute to all buyers and informational document known as a prospectus (both a preliminary and final prospectus), unless the transaction complies with one of the 4 valid Private Placement Exemptions for a sale of securities without a prospectus.

s.1(1) of the Securities Act: “distribution”, where used in relation to trading in securities, means (EXHAUSTIVE def):

(a) a trade in securities of an issuer that have not been previously issued, A prospectus is required where the security is issued for the first time

by the company

^ Covers Treasury Shares owned by the company that have not been issued to the public

^ Does not cover secondary trades, b/c when those securities were issued initially they were subject to the prospectus requirement.

^ POLICY: issuers have greater access to information than

buyers, so this is a distribution to which a prospectus is attached

(b) a trade by or on behalf of an issuer in previously issued securities of that issuer that have been redeemed or purchased by or donated to that issuer, ^ Prospectus is required for the primary market, and the secondary market is protected by the continuous disclosure obligations and previous prospectus on record

^ This covers treasury shares (shares that are not outstanding = held onto by the board to be issued at a future time if the Directors decide to) that are owned by the company that have not yet been issued to the public.

^ In Canada, these distributions are rare because other corporate statutes prohibit corporations from reselling these types of securities.

(c) a trade in previously issued securities of an issuer from the holdings of any control person, TRADES BY CONTROL PERSON

^ Any person, company or combination of persons or companies holding a sufficient number of any securities of that issuer to affect materially the control of that issuer

^ Trade by a control person will often require a prospectus

regarding 1) the amount of securities sold and 2) the effect of the sale on the control of the issuer.

^ A person or combination of persons holding more than 20

percent of the issuer’s outstanding voting securities is deemed to materially affect the control of that issuer

(d) a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, prior to the 15 th day of September, 1979 if those securities continued on that date to be owned by or for that underwriter, so acting,
(e) a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, within eighteen months after the 15th day of September, 1979, if the trade took place during that eighteen months, and
(f) any trade that is a distribution under the regulations, and on and after the 15th day of March, 1981, includes a distribution as referred to in subsections 72 (4), (5), (6) and (7), and also includes any transaction or series of transactions involving a purchase and sale or a repurchase and resale in the course of or incidental to a distribution and “distribute”, “distributed” and “distributing” have a corresponding meaning; (“placement”, “placer”, “place”)

POLICY:

• The meaning of distribution follows from the policy of the OSA: protecting members of the investing public by ensuring that buyers receive full disclosure of all material facts relating to a given security before purchasing that security. The definition is exhaustive, but includes protection for where there are trades in securities in which the asymmetry between the buyer and the seller is likely to be at its greatest, with the buyers having the greatest risk of being taken advantage of.

  1. Lastman’s 3 Main Branches of Distributions
  2. Securities that have not been previously issued (s.1(1)(a)), 2) Trades by Control persons (s.1(1)(c)), 3) Sales of restricted sec held by exempt purchasers
  3. Securities that have not been previously issued
  • Section 1(1) of OSA, under Distribution – subsection (a). Prospectus needed for the primary market.
  • Policy: Focus on primary market (i.e. corporate issuer and not investors) because issuer will always have better info than the purchasers ^thus, should have to issue a prospectus.

o Don’t want you to file prospectus when you’re selling amongst yourselves.

  1. Trades by control persons
  • Section 1(1) of OSA, under Distribution – subsection (c). A “control person” is defined as a person or group who has sufficient control over voting rights to materially affect the control of the issuer. A holding of 20% is deemed, in the absence of evidence to the contrary, to be sufficient to materially affect the control of an issuer. (A Q of Law)
  • Policy: Sales by persons in a position of control are considered to be distributions because it means the person may have better knowledge of the issuer and an ability to alter the value of the issuer/securities

o Anyone who holds a sufficient number of securities to “affect materially the control of that issuer” is assumed potentially to have privileged access to information concerning the issuer of the securities)

o People who fall within this part of the definition of distribution are “control persons”. A sale by a control person is deemed to be a distribution to which the prospectus requirement attaches (usually require control person to produce a prospectus in order to provide information about the amount of securities sold and the effect of the sale on the control of the issuer).

  1. Sales of Restricted Securities Held by Exempt Purchasers
  • Deemed distribution on resale: when someone has purchased securities by way of an exemption and then wants to resell them, have to do so with a prospectus
  • Policy: This prevents backdoor underwriting

o The subsequent sales of securities that were previously exempt from the prospectus requirement are considered to be distributions and thus trigger the prospectus requirement.

  1. Note: 3 Ways Securities can be distributed to the public
  2. Direct issue and private placement; 2) Offer to Sell (Bought Deal / Offer to Sell/ Marketed Offerings); 3) Best efforts underwriting

1) Direct issue (And Private Placement)

a. Direct Issue: Issuer sells the securities itself, without the service of an investment banker or dealer (direct contact b/w investor and company).

  1. This only works with a small number of investors, and the issuer will usually know the purchaser intimately (often through a rights offering to existing shareholders) b. Private Placement: Another form of direct issue. Securities are sold to institutional investors (e.g. bond issues)
  2. Often arranged through a broker who is NOT an agent of the issuer, usually. Once broker has put issuer in touch with Institutional investor buyers, issuer deals directly with/issues securities to the institutional investors.
  3. Offer to sell (Bought Deal/Offer to Sell/Marketed Offerings) [1] most common way to sell to public
  4. Bought Deal/Offer to Sell: the issuer sells the securities to an underwriter. The underwriter then resells the securities to investors. The underwriter thus finds buyers.

i. Risk allocation

  1. In a bought deal: underwriter makes the commitment to purchase in advance, before the prospectus. A bought deal (firm underwriting) thus avoids the risk for issuer of significant market fluctuations during the period in which the prospectus is being prepared. (Issuers tend to lack expertise re: price fluctuations) ^ this underwriting/insurance aspect is good for the issuer, because of their lack of expertise, the price might be much lower than expected, so good if the underwriter buys in advance… however…
  2. Market risk can be shared through a “market out clause”. This says that if certain events occur, such as a material change in the affairs of the issuer, cease trade order, then the underwriter may not be obliged to buy at the specified price.
  3. Note: Standby underwriting: underwriter provides a partial insurance by agreeing to stand ready to take up all or some portion of an issue that cannot be sold at a certain price
  4. Marketed Offering: underwriter will not commit to buy the securities until price is set after marketing the offering to prospective buyers. Commitment to buy is made after prospectus is cleared with securities regulators.
  5. Best Efforts Underwriting

a. Same as above, except I-banker doesn’t agree to buy securities unconditionally for re-sale.

  1. UW agrees to act as an agent in selling the shares for the best price it can get. Agree to use ‘best efforts’ to sell securities on company’s behalf – less risky, but lower commission.
  2. Agrees to pass proceeds to issuer, net of commission. UW is not an UW in strict sense of the word, by agreeing to give its best efforts, UW is not providing any insurance wrt risk of fluctuations in market price
  1. What does your company DO? How does it make its money? (e.g. Cineplex makes it money on popcorn, not movies)Who is the CEO/ BOD?What are your financial statements – assets, liabilities, any lawsuits?What interest in the company am I buying? – # of shares, rights (to vote, to receive dividends, etc.)What is the capital structure?

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