Category: Law School Notes

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• Sources, History & Constitutional Division of Powers of Securities Regulation
• Division of power
• Provinces have enacted securities acts under their power to legislate wrt “property and civil rights”- includes dealings in prop, contracts, and reg of business, trades and professions

o Provincial laws upheld even where there is some overlapping, but not conflicting, federal law

o sometimes prov securities laws do not apply to federal companies

• Federal government could justify regulating securities under the trade and commerce power (may be necessary due to globalization)
• History of securities regulation
• Securities reg (regulating brokers, requiring prospectus disclosures, etc.) is a rel recent phenomenon, beginning in mid 19^th century (ON first jurisdiction to adopt English Directors Liability Act in 1891; 1920 fraud protection acts, prospectus disclosures in 1947)

o Modern Can securities reg = derived from Kimber Report, 1965 (addressed insider trading, takeover bids and ongoing disclosure requirements) and Merger Report, 1970 (led to “closed system” statute with emphasis on ongoing disclosure for the purposes of secondary market trading)

o Interprovincial cooperation has also been an important part of securities reg, although there is no national regulator yet

• Sources of Provincial Securities Regulation

1) Securities Law & Related Sources

1. Provincial and Territorial Securities Acts
2. Provincial regulations and rules: originally security acts give extensive powers to Lieutenant Governor in Council to make regs. Now, securities commissions also have power to make rules and regs, subject to procedural requirements
3. Procedural requirements include: commission must publicize proposed rule and accept comments for 90 days; if commission makes material changes to rule must publish amended rule and give further period for comment; when finalized, rule goes to Minister who can accept/ reject/ return rule to commission for further consideration
4. National and multi-lateral instruments: developed cooperatively and agreed to by all securities administrators across country (no binding legal effect, but can be adopted in each jurisdiction).
5. when some but not all of Can Securities Administrators is sue an instrument, it is a multilaterial instrument
6. Policy statements: issued by securities administrators in Can and indicate how they interpret the legislation, regs or rules and provide guidance to market participants in complying with legislation, regs and rules
7. National policy statements: issued jointly by Can Securities Administrators
8. Notices and Accounting Communiques: released by securities commission and contain info of interest to those who deal with regs on a regular basis
9. Memoranda of Understanding: between diff securities administrators in Can or abroad
10. Decisions & rulings
11. Blanket orders: securities commissions can issue orders (usually sought and provided on a case- by-case basis)- in ON this is no longer allowed (must instead pass a rule)
12. Bulletins, Websites and Canadian Securities Administrators Communiques
13. International Organization of Securities Commissions: review major reg issues, promote development and improvement of efficiency of emerging securities markets by establishing principles and min standards, prepare training and facilitate exchange of info/ expertise

• Self-regulatory bodies

1. Stock exchanges: pass by-laws and rules to govern qualifications and continued fitness of members for membership in exchange, set out requirements for listing of securities of issuers and conditions to be met by listed issuers to maintain their listing, and govern manner in which trading is conducted
2. Will also issue policy statements
3. Other self-regulatory orgs: Investment Dealers Association of Canada, Canadian Securities Institute, Institute of Chartered Financial Analysts (have tests etc.)
4. Securities Commission Review: have power to review and make decisions wrt a by-law, rule or other reg instrument made by a self-regulatory org or stock exchange

• Commission and Administrators: Commissions are 2 tiered structures

1. Panel of commissioners: makes orders and rulings and acts as an appeal tribunal from decisions of administrator; also formulates policies and makes recommendations to govt for changes in legislation/regs
2. Admin agency headed by chief admin officer: exercises admin functions assigned to administrator under applicable act and implements decisions/directives of commission

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• Securities Trading
• Open Market in Capital

Primary market (sale of securities to investors) and secondary market (investors exchange sec in return for payment from another invested) together permits continued marketability / liquidity of shares

• Crucial term, two parts together constituting “open market in capital”

o Primary market: sale of securities to investors. The money flows through from investors to the company (have benefit of liquidity)

o Secondary market: investors exchange securities in return for payment from another invested (issuer not generally involved)

• Permits continued marketability/ liquidity of shares: For investors to realize on their investment, they must be able to sell among themselves on various exchanges (g. TSX)
• Simplifications for trading

o Brokers: Takes orders from buyers/sellers, locates buyers/sellers for clients and executes trades on behalf of clients.

o Stock exchange: Trading involves 1) communication between buyer and seller; 2) exchange upon agreement. A stock exchange facilitates both elements, saving the client time/money and increasing the likelihood that security will be sold (for sellers). Issuers want securities to be traded on exchange b/c it increases their securities’ value and therefore, the amount of capital they can raise

1. Buyers can find sellers and sellers can find buyers (brokers meet in a specified place – either real or online)
2. When asking and bid price correspond, there would be an offer, acceptance and consideration (money to be paid in return for shares). Payment would occur and the ownership would change hands (bearer form – less used to prevent theft; or registered form with the name of the owner on the certificate and on books of company with endorsements)

o Clearing agency: created to simplify transfers between brokers by tracking obligations and notifying brokers of their net obligation

o Broker inventories: reduce amount of issuances and re-issuances (instead of performing full transfer for every transaction, brokers would record in their books who the beneficial owners of securities were)

o Nominee owners: as brokers began to hold too many securities, nominee owners name and securities registered to them – bookkeeping entries keep track of who the beneficial owners are o Securities Depository corporations: represent a single nominee owner (and sometimes perform clearing role (e.g. Canadian Depository for Securities Ltd – CDS) o Computerized stock exchanges and trading: Increases transaction speed AND further facilitates communications.

• Private Trades
• Private trade: Trades without using brokers or a stock exchange – take place directly between the buyer and the seller
• Upstairs market: involves trades by large, institutional investors buying or selling in large volumes
• Over-the-Counter Trades: when issuers are unable to meet listing requirements of a formal stock exchange they may trade over-the-counter, with the assistance of a broker

o used for bonds/debentures too b/c 1) large denominations, 2) nature of investment – longer time horizons, 3) held in large Q by institutional investors

• Other trades:

o Alternative trading systems: less restrictive listing requirements, and largely automated o Margin trading: Broker loans funds to clients to purchase securities

• Restrictions exist regarding 1) the % that the client must pay and 2) to maintain a particular % if the value of the security changes.

o Short selling: Investor sells securities that he/she doesn’t own and takes on a contractual obligation to supply the shares in return for payment by the person purchasing the securities.

• Broker can facilitate this trade by loaning the investor the securities.

NOTE: Major investors in Canadian Securities Market include banks, trust companies, credit unions/caisses populaire, life insurance companies, pension funds, investment funds (mutual funds/investment companies), and individuals (to a lesser extent).

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• Purpose of Selling Securities
• Securities are primarily sold to raise funds for investment, e.g. the launching of a business venture/ expanding existing venture (private company goes public ^becomes a reporting issuer)

o To purchase assets that will be used to produce goods/services for which there is a demand sufficient to generate profits comparable to that of other investment opportunities of similar risk.

• Types of Securities

Two main types of securities

• Debt: Funds can be borrowed, offering interest payments and principal repayment

o Includes trade credit (e.g. ST accounts payable), short-term bank loan (e.g. line of credit), long­term bank loan (e.g. with security interest – property and/or adherence to ratio tests that may indicate risk of bankruptcy), commercial paper (obligation to pay specified amount at specified date), bonds (evidence of indebtedness secured by an asset of borrower), debenture (unsecured evidence of indebtedness)

o Other characteristics of bonds/ debentures:

• Call feature: allows borrower to repurchase bond after specified date for specified price (usually prem to face amount/ par value)
• Sinking fund: indenture may provide for a fund built up each year to redeem some portion of bonds before maturity or to meet the obligations to pay at maturity
• Convertible: right to convert bonds into shares
• Warrant: right to buy securities from issuer for exercise/striking price during a specified period
• Equity: rights to share in the distribution of the profits and the proceeds remaining after the sale of the assets of the business and payment of amounts borrowed.

o Common Shares: most frequent bundle of rights in a company that includes the following rights

1. Right to vote (on important matters – e.g. election of directors, how company will be managed etc.)
2. Right to dividends (not obligation – corp can decide to declare dividends to which each common share has a right a share in $ or in stocks where there is a stock dividend)

• Liquidation right: entitled to share pro rata in any proceeds of liquidation (to the extent proceeds remain after satisfaction of other claims)

o Preferred Shares: given preference wrt distrib of dividends and proceeds of liquidation (usually non-voting). May carry the following special features:

1. Cumulative: if div are not declared or are not suff to pay full amount of annual preferred div on preferred shares, amount unpaid carries over to the next year (usually preferred shares are cumulative)
2. Participating: participate in div beyond the specified preferred amount (preferred amount + included in common share amount left over)

• Redemption/Call provision: if shares are redeemable by the company (to facilitate financing of company at specified price)

1. Retraction rights: permits shareholder to tender share to co and co has to buy it back at specified price

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For the exam:
1) Know what the rules are;
2) Look at why they exist (why does the law regulate these activities? What objectives is the rule trying to establish?);
3) THEN Challenge the rules

• Always keep in mind that he wants you to answer WHY it is that you’re doing what you’re doing
• WHY does the law regulate this particular activity? (will mostly have to do with achieving the three above goals/dealing with tensions among those goals)
• Securities reg is nothing more than sophisticated consumer protection legislation with the consumer being investors.
  o The Securities Act is really a policy document where intention is the most important thing.
  o The rules that the SA sets out are intended to be appropriate in the circumstances in which they are employed.

3 types of policy statements
o OSC Policy –> info about how the Ontario Securities Commission will decide
o Uniform Act –> provinces of BC, Alberta, Saskatchewan, Manitioba and Ontario
o National –> all of the Securities Commission get together and say how they’re going to use their discretion

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1) Registration Requirement, 2) Disclosure Requirement, 3) Remedies for Breach of 1 and 2

1.2.1 Registration requirement

• Licence people in the business
• you cannot trade in securities unless you’re licensed (underwriters)
  
• There are exceptions, e.g. can sell Canada Savings Bonds without registering (b/c it wouldn’t make sense  in the context to register; b/c they are so safe – unlikely Govt of Can will default)
  

POLICY: This helps ensure accountability, makes sure you are educated and policed –> fosters confidence in the market, and the exceptions are to provide efficient markets for securities that are considered to be very low-risk to the public. People will lose confidence if some whackos are selling you securities.

• 1.2.2 Disclosure Requirement
  To protect investing public, must make sure they have full, true and plain disclosure of all material facts related to the company (adv/disadvantages, risks, contracts etc.) via a prospectus and continuous disclosure
  Note: there is an adv to being an investor in a public company –> the asset is easily liquidated but must have info to do so
  To provide info:
  1) Prospectus: comprehensive disclosure document – tells investor what they need to know to make an informed decision
  Also creates a cause of action for misrepresentations and omissions in a prospectus
   2) Continuous disclosure: once a company goes public, the company has continuing disclosure/reporting obligations which require the company must keep information current. Continuous  disclosure has 4 parts:
  a) Regular Financial Reporting
  b) Timely Disclosure (for material issues must file press release and amendment to prospectus)
  c) Insider Reporting (insiders must disclose when they buy/ sell shares to prevent insider trading)
  d) Early Warning (at a certain level of ownership in shares, need to tell the world how many you own and your intentions)

POLICY: need to protect investors, OSA is consumer protection legislation and in order to do that, we need to give you the information that you need to make an informed investment decision
1.2.2.1 Exceptions to the Disclosure Rule

(i) the purchaser is sufficiently sophisticated (wealthy/ well resourced); (Private Placement)
(ii) the information is otherwise readily available; or
(iii) the securities are “safe” (Canada Savings Bonds)
POLICY: Need to balance the objectives of the efficiency of capital markets (would be inefficient to file a prospectus every time a company needs money) with the need to protect the public.

1.2.2.2 Closed System & Resale Restrictions
When securities are acquired pursuant to one of the private placement exemptions and not pursuant to a prospectus, the resale by the initial investors of these securities to other investors on the secondary market
is restricted and certain conditions must be satisfied prior to their resale.
Conditions that must be satisfied prior to resale:
1. You issue a prospectus;
2. You sell pursuant to another private placement exemption;
3. You comply with the resale rules; or
4. You receive an exempting order from the Ontario Securities Commission

Policy: Transparency is key to the process

1.2.3 Remedies for Breach of Registration or Disclosure Requirements

• If you don’t satisfy the requirements, there are remedies for the investor against you for breaches of these obligations
• Remedies can be civil, criminal, or administrative (more detail below)
  Policy: investor protection and confidence in the market (fix something when it goes wrong)
  Now just a bunch of rules that play into one of these three objectives.
  Note: will also look at take-over bids
• Overall protect shareholders of target company and make sure there is a level playing field
  • Make sure they have enough info to make an investment decision
  • Give them suff time to make that decision
  • Protect against company doing bad things

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1.0 MAJOR THEMES IN THE COURSE
1.1 Three Goals of Securities Regulation
3 purposes:
1) Protection of investing public;
2) Ensuring the Efficient Operation of Canadian Capital Markets;
3) Increasing and Maintaining Public Confidence in Capital Markets / In the Persons and  Institutions Operating Them

Found in s.1.1 of the Ontario Securities Act (OSA) under the purposes of the act! The purposes of the Act are (a) to provide protection to investors from unfair, improper or fraudulent practices; and (b) to foster fair and efficient capital markets and confidence in capital markets

Danier case: The securities act is remedial legislation and is to be given a broad interpretation (Pezim). It protects investors from risks of an unregulated market, and by its assurance of fair dealing and by the promotion of the integrity and efficiency of the capital markets it enhances the pool of capital available to entrepreneurs.
The act supplants the buyer beware mindset of the common law with the compelled disclosure of relevant information… at the same time, recognizes burden it places on issuers and Part XV sets limits on what is required to be disclosed…(para 32) – Binnie J

1. Protection of investing public
a.Should not protect public against loss, but ensure that public has knowledge needed to make a decision about the company – assurance that its losses are genuine economic losses (correct pricing via prospectus)
b. Very high-level consumer protection legislation

2. Ensuring the Efficient Operation of Canadian Capital Markets
a.Ensure capital markets facilitate mobility and transferability of financial resources and provide facilities for continuing valuation of financial assets
b. Achieved through a free and open securities market with regulator correcting for market failure
i. More info prevents problem of adverse selection in the market (drive out high quality securities, leaving only low quality securities which would be a misallocation of financial resources)

3. Increasing and Maintaining Public Confidence in Capital Markets/In the Persons and Institutions Operating in Them
a.Investors will be WTP more for new issues of securities in primary market if confident they will be able to sell securities fairly on secondary market (want to know its fair, you can make money!)
b. With investors paying more for new issues, more savings would be channelled into investment, thereby improving allocation of financial resources (see goal #2)
c. Creating confidence in market, adverse selection is overcome – of assured of accuracy of info, investors WTP more, therefore, higher qual securities more likely to survive
*However, reg must not be at excessive cost (therefore, tension between protecting investing public and eff capital markets)

Another theme: NO SMART GUYS and NO CERTAINTY

• Certainty in almost every circumstance is a bad thing, takes away judgment
  
• judgment is what we need to make the right decisions
  
• The Securities Act –> don’t care what act actually says, care what it ought to say or intended to say. Don’t care about geniuses that spend lives devising schemes to get around SA (Securities Act). Securities regulators or courts say you’re  smart, but who cares… if you’ve done something you think outsmarts securities act, they’ll shut the door on you = no smart guys.
  

 

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