Prospectus/Distribution Process – Securities Regulation

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    1. Prospectus/ Distribution Process (After making the decision to go public)
    2. Have to create the prospectus ^ hire a lawyer, accountant, and registrant underwriter to sell securities on your behalf (underwriter also hires lawyer), management team, and start the process

• Is not just up to the client what goes in the prospectus, it’s for public/investor to decide what needs to be in there ^ you as the UW can’t just say you followed client’s instructions if they don’t allow you to read a k, do due diligence, etc. ^ Integrity of capital markets dictates that this must be highly regulated.

  1. Put all of the correct things in the prospectus (NI 41-101 and Rule 45-501)
  2. Ensure it contains full, true and plain disclosure of all material facts related to the securities issued or proposed to be distributed, and comply with requirements of Ontario Securities Law (Section 56(1)) (FTPD is a judgment call)
  3. Vet the Preliminary Prospectus (forward looking information, underwriter does due diligence, etc.)
  4. Certify the prospectus (issuer certificate under Section 58 and underwriter certificate under Section 59)
  5. File Preliminary Prospectus and get a receipt, then deliver it.
  6. Waiting Period
  7. Comment Letter and Clearing Period
  8. Respond to deficiencies/file final prospectus (administrator can refuse receipt on broader grounds than for the prelim)
  9. Distribution
  10. If there is a misrepresentation in the prospectus, there is liability for it

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Prospectus General Rule – Securities Regulation

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*Governed by NI 41-101 general requirements and 44-101 for short-form prospectus.

Two principle requirements of a prospectus under OSA:

  1. Prospectus must provide full, true and plain disclosure of all material facts (s. 56(1))
  • Not just a question of covering what is on a list, securities lawyers must decide what else needs to be included in order to meet this requirement, technical fulfillment of the statue is not sufficient – must not be misleading

A prospectus is a document that must be given to persons to whom securities are distributed. It is the document that is intended to provide information relevant to assessing the value of the securities.

2) Must comply with the requirements of the Securities Act (including 56, 58, 59) -Includes OSA, OSA regulation, OSC rules and the OSC director.

Section 56: (1) Full, true and plain disclosure and complying with all requirements of Ontario securities law; (2) Must also include any financial reports, statements or other docs required by the Act or regulations

Section 58(1) Issuer Certificate (signed by CEO, CFO and two directors that aren’t CFO/CEO, and any promoter of the issuer) – certifies prospectus is true

Section 59(1) Underwriter certificate (signed by any/all UWs in a contractual relationship with the issuer or selling securityholder distributing securities through the prospectus) – UW also certifies prospectus is true

• Note: can have 2 days to change your mind in securities law

  1. Misrepresentation

Misrepresentation- s.1(1): means (a) untrue statement of material fact, or (b) an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in the light of the circumstances in which it was made.

If there is a misrepresentation, you can sue everyone involved (corp, directors, officers, underwriters). Very high bar – very diff to know if you’ve missed something.

Policy: Should tell everyone everything they need to know to make informed investment decisions

Recall when a prospectus is required

  1. Does the transaction involve a “security”?
  2. Does the transaction involve a “trade”?
  3. Does the “trade” in the “security” constitute a “distribution”?

Rule (s. 53 of the OSA): “No person or company shall trade in a security on his, her or its own account or on behalf of any other person or company where such a trade would be a distribution of such security, unless a preliminary prospectus and a prospectus have been _ filed and receipts therefore obtained _ from the Director”,

  1. Dual Functions of a Prospectus: Selling + Liability Document
  2. Selling Document: Sec Act ensures regulator’s mandate of investor protection by saying only doc you can use to sell sec is the prospectus, can’t advertise in any meaningful way, can’t have fancy brochures, billboards, etc.
  3. Liability Document: Will need a lot of $, so client will want to be successful/shed the company in its most favourable light. Thus, regulator makes sure there is sig liability associated with a misrep (misstatement of a material fact/ omission)

Tension between 2 purposes (reckless selling v being too careful): You as a lawyer cannot allow client to recklessly sell in light of the prospectus (they’ll get sued), but you also can’t go so far to protect yourself/your client that you have a document that no one will buy securities with.

  • Obviously natural tension b/w the prospectus as a selling doc and prospectus as a liability document

o *Practice Note: Lawyers often spend too much time protecting themselves: You can’t legislate every eventuality, if you try, you won’t have a deal or you’ll have an unworkable document, or both

o What makes it challenging is not rules/what has to go in it, but how you properly strike that balance b/w assisting your client in prepping a document that is sufficiently comfortable to sell the securities and sufficiently comfortable to protect your client against liability (Judgment call)

  • Biggest ex of this tension (and of liability for both sides) is financial forecasts (see below)
  1. National Instrument 51-102 – Policy on future oriented financial statements in the prospectus

Per NI 51-102: no prospectus ever has to put future oriented financial info in it. The choice is always the business’ BUT (1) if you don’t put it in, you cannot talk about the future anywhere else; and (2) if you do put it in your prospectus you have to comply with national instrument 51-102 for disclosure Steps per NI 51-102:

  1. Company should not be disclosing forward-looking information unless it has a reasonable basis for that information
  2. A company must disclose in its prospectus that the information is forward-looking (this is a forecast), must caution users that actual results may vary, and identify material risks that could cause it to vary
  3. Forecast in prospectus has to state material facts/assumptions that were used in making the forecast
  4. Has to identify the method the company will use to update that forward looking information

a. As time passes, that forward looking info comes to be, if it’s off, has to be updated ^ must review it regularly for changes.

  1. A prospectus forecast must be updated between preliminary prospectus and final prospectus History:
  • Prior to 1982, OSC said none of us can predict the future and it’s too dangerous to let companies try, and investors will be hurt (outlawed) ^ Example of regulator “being a bad lawyer” (overly cautious)
  • Investors were unhappy ^ Protecting so much that you’re making us vulnerable, we want to know what the company thinks about the future since that’s the purpose of us buying the securities (taking away an important fact that we need to make an educated investment decision, so let us at least see what company thinks)
  • Come out with provisions in National Instrument 51-102 for financial forecasts

Financial Forecasts:

Two types of data forming financial forecasts: (1) Forecast (written estimate of most probable result of operations of a company for some pt in the future); (2) Projection (estimate of results that follow any set of reasonable assumptions)

  1. Forecast: Written estimate of the most probable result of operations of a company for some point in the future
  • e.g. four seasons hotel – how it’s going to do in 2013 (making assumptions) ^ if you assume that interest rates next year could be anywhere between 2 and 4%, but most probably, they’ll be 3%, use 3.
  1. Projection: Estimate of results that follow any set of reasonable assumptions -the assumptions always have to be reasonable but unlike a forecast they have to be the most probable, they just have to be reasonable. Reasonableness is left up to reader. (e.g. int rates could be b/w 1-3%, I use 3)
  • The only time you can use a projection vs. forecast is if it’s unreasonable to require you to do a forecast

Only where issuer is engaged in business w/ less than 24 months relevant operating history and must be accompanied by cautionary note about potential variance.

Difference is in assumptions:

  • In a forecast, company is bound to use what it believes to be the MOST PROBABLE assumptions
  • With Projection, always has to be REASONABLE, but the reasonableness of those assumptions are left to reasonableness/probability
  • Policy: Recognize tension between prospectus as selling document and prospectus as liability document -do not err on EITHER side -don’t be too hard and don’t be too soft, just be right

Policy Notes:

  • Tension: Need to include some information about future (make it attractive to investors), but not share too much to reduce likelihood of liab for misrepresentation (including omissions)

o The Form does not tell you that you need to put in financial forecasts, it’s optional. But if you put in forecasts, you have to comply with the law (National Policy 48). (and will probably want one, makes it more likely to sell if you can forecast good results)

  • Practice note: Just have to be right , but hard to do this -hard to harness your client because client can legitimately believe that the future for the business is great but you need to educate client that the marketplace understands the liability attached and understands that people are going to be more cautious in their predictions of the future then they would be if wasn’t projection process. They also understand what this is, and that there ought to be some discipline on the sale process.
  • Credibility: Companies shouldn’t spend their whole lives worried about being sued, but even so, credibility in the market place is extremely important

o You don’t get a second chance to make a first impression – so don’t be cavalier (even if you’re bullet proofed against being sued) – people are investing, they remember what it says, if it’s accurate = increases your credibility. If it’s wrong, hurts you. You won’t recover if you miss every quarter and keep updating your forecast ^ BE CAUTIOUS ABOUT PREPARATION

  • Find a happy medium: It’s better to under-reach future financial performance then to oversell and perform short of the future numbers.

o But also don’t want to be too negative, or no one will buy securities.

Note on FOFI (from text)

  • The information in a prospectus generally consists of verifiable existing facts.
  • Although future-oriented information may be quite valuable to investors attempting to assess potential future cash flows from a security, predictions about the future may be prone to abuse (and therefore, this is regulated ^ protecting investors)
  • It include information about prospective results of operations, financial position, or changes in financial position based on assumptions about future economic conditions and courses of action taken by the issuer
  • Note on proving unreasonableness: hard to prove that the information constituted misrepresentation later, since it would require showing that assumptions on which it was based were unreasonable at the time they were made ^ there is scope for overly optimistic projections)
  1. Full, True and Plain Disclosure of All Material Facts

Requirement for Full, true and plain disclosure: Section 56(1): A prospectus shall provide full, true and plain disclosure of all material facts relating to the securities issued or proposed to be distributed and shall comply with the requirements of Ontario securities law.

Definition of Material Fact: Section 1(1): Material Fact: When used in relation to securities issued or proposed to be issued, means a fact that would reasonably be expected to have a significant effect on the market price or value of the securities.

*note that a Material Fact and Material Change are different!!!!!

If a Material Change Occurs, Amendment Required – 57(1): If there is a MATERIAL CHANGE after receipt is obtained for preliminary prospectus, and before receipt for final OR after receipt for final is obtained but prior to completion of distribution, amendment must be filed as soon as is practicable, and IN ANY EVENT, within TEN days of the change

Danier Leather SCC

Implications: Example of how to deal with forward-looking info. A forecast DOES have an implied representation of reasonableness, but that’s all -just has to be reasonable.

A change in a material fact does NOT have to be disclosed following the filing of the prospectus (only a material change)

Facts: lawsuit to SCC as to reasonableness of a forecast in a prospectus, but does not happen very often under prospectuses b/c (a) class action lawsuits are new here, (b) we’re less litigious than US, and (c) in order to sue under prospectus, have to know that you have one, find misrep, find lawyer, etc.


• If a material FACT occurs following the filing of the final prospectus that is NOT a material CHANGE, there is no obligation to update purchasers (only have to update if there’s a MATERIAL CHANGE in business, operations or capital of the issuer. Underwriters

Have to do due diligence, and can still be found liable under s. 130(1) for misrepresentation (see more on underwriters below), and also have a due diligence defence available to them.

• Case: BarChris (US)

Will often have distributions assisted by underwriters:

  1. Underwriting Agreement: issuer enters into an agreement with the underwriter, which sets out the terms of their arrangement (obligations of underwriter, various covenants/representations of the issuer, conditions pertaining to the underwriter’s obligations/rights, and rights of termination (including a market out clause)
  2. Syndicated Underwriting: for larger issues, because there may be substantial risk associated with the issue, underwriters may choose to reduce risk by syndicating it with other underwriters wiling to join the underwriting of the issue (other firms might become obligated to buy some portion of the issue, for example)

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Prospectus Preparation – Securities Regulation

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  • Prospectus Preparation

In general, prospectus gives investors full and plain disclosure of all material facts – what the investors want to know. This may include:

  • What will the investment be used for?
  • What is the underwriter agreement?
  • How much are you paying senior executives?
  • 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? What does your company DO? How does it make its money? (e.g. Cineplex makes it money on popcorn, not movies)

2) Must comply with the requirements of the Securities Act (including 56, 58, 59) -Includes OSA, OSA regulation, OSC rules and the OSC director.

Section 56: (1) Full, true and plain disclosure and complying with all requirements of Ontario securities law; (2) Must also include any financial reports, statements or other docs required by the Act or regulations

Section 58(1) Issuer Certificate (signed by CEO, CFO and two directors that aren’t CFO/CEO, and any promoter of the issuer) – certifies prospectus is true

Section 59(1) Underwriter certificate (signed by any/all UWs in a contractual relationship with the issuer or selling securityholder distributing securities through the prospectus) – UW also certifies prospectus is true

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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”)


• 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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What is a trade? – Securities Regulation

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      1. What is a trade? ^ Statutory Definition

In order for general rule (Section 53(1) and 25 about being registered) to apply for a prospectus, there has to be a trade in a security, so what is a trade?

OSA, section 1(1): A “trade” includes “any sale or disposition (NOT A PURCHASE) of a security for valuable consideration”AND includes “any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of” any of the activities described in the definition.

Policy: Overall, trade is broadly interpreted to promote the “greater good” -prevent ppl from contracting/opting-out of securities regulation

“trade” or “trading” includes (NOT EXHAUSTIVE):

(a) any sale or disposition of a security for valuable consideration, whether the terms of payment be on margin, instalment or otherwise, but does not include a purchase of a security or, except as provided in clause (d) a transfer, pledge or


  • A trade is a sale of a security for a consideration

o E.g. orange tracts – sold security for money, it’s a trade. PC – silver – Sold investment contracts for money.

  • Incl margin trading & covers primary and secondary markets. (Note that gifts would probably not be trades, because there is no valuable consideration)

EXCLUDED is the PURCHASE of a security.

encumbrance of securities for the purpose of giving collateral for a debt made in good faith,
  • Why? Again, doing all this to see if you have to issue prospectus. Not doing it so that purchaser files prospectus before giving you the cash. So of course purchase can’t be a trade, only determining if it’s a trade is to find out if seller has to prep prospectus, purchaser is being protected/giving cash.
  • At least with respect to the distributions of securities, it is the vendor that is the object of regulation and it is the purchaser that the legislation is intended to protect.
  • Using securities as collateral is excluded because the SA was never meant to restrict the ability of security holders to use their equity as loan collateral
(b) any participation as a trader in any transaction in a security through the facilities of any exchange or quotation and trade reporting system TRADES ON BEHALF OF OTHERS

  • Such persons are required to register. A “trade” is defined to include participation as a trader in a transaction in a securities.. .on the floor or through the facilities of an exchange

*Exam Example:

  • X offers to sell to Y and Z, but only Z buys. There are 3 trades! The offer to Y, the offer to Z, and the sale to Z
  • “Trade” is a key term in determining the application of the securities act. Remember: prospectus requirement is activated when there is a trade in a security which constitutes a distribution.
(e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the foregoing; (“operation”) PRE-SALE ACTIVITIES: TRADE INCLUDES ANY ACT, ADVERTISEMENT OR SOLICITATION IN FURTHERANCE OF THE FOREGOING (OF A “TRADE”)

  • Isn’t only when you sell it, but when you TRY to sell securities
  • May involve pre-sale activities, which can involve pressure tactics/subtle misrepresentations. Risk that this will influence buyers who rely on pre-sale activities/pressure.
  • POLICY: Securities Act Is PROACTIVE legislation, NOT REACTIVE

o SA is proactive, is saying we want to stop bad things from happening before they happen b/c protection of investing public/maintaining confidence in the markets is so fundamental to our system that we want to avoid it happening at all costs

o If you try to sell securities you must create a prospectus, you can’t wait until you actually sell them. This is consistent with the purposive approach of the courts.

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The Prospectus Requirement: Does the Securities Act Apply

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    1. The Prospectus Requirement: Does the Securities Act Apply?

Prospectus ONLY IF there is a TRADE in a SECURITY which constitutes a DISTRIBUTION.

Recall General Rule: ss. 25, 53 of the SA: No person shall engage in or hold themselves out as engaging in the business of trading in a security without being registered and if a trade is a distribution, without preparing a prospectus

Analysis for Whether You Need to Issue Prospectus:
  1. Does transaction involve a security? ^ If NO, SA does not apply. If so…
  2. Is it a trade in a security? ^ If NO, SA does not apply. If so.
  3. Does that trade in a security constitute a distribution? ^If NO, no Prospectus. But if yes. then you must prepare a prospectus [1]unless one of private placement exemptions are available
  • The definitions are key to this analysis!
  • Remember why you care: b/c fundamental question is… I want to do something, do I need to prep a prospectus to do that? (to engage in activity I’m proposing)
      1. What is a security?
        1. Statutory Definitions

LEGISLATION ACT 2006 – Interpretation

Section 64(1): an act shall be interpreted as being remedial and shall be given such large and liberal interpretation and best ensures the attainment of the object

  • POLICY: To understand a statute, have to understand what it’s trying to do because we’re going to give it a broad enough interpretation to have it achieve what we wanted it to do
  • The courts have gone to incredible lengths to make sure that happens.

ONTARIO SECURITIES ACT – Interpretation & Definitions

S.1(1): “security” includes (NOT EXHAUSTIVE= broad def): (a) any document, instrument or writing commonly known as a security, (b) any document constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company,(n) any investment contract

  • Very broad definition^ Covers common types of securities, as well as other less common items – thus, contains items capable on taking a broad meaning and is non-exclusive.

s.1(1): “security” includes (NOT EXHAUSTIVE)

(a) any document, instrument or writing commonly known as a



  • A “security” includes “any bond, debenture, note or other evidence of indebtedness, share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription (OSA s. 1(1) “security” (e)).
  • Also, “any document constituting evidence of an option, subscription, or other interest in or to a security”.
  • Also includes “any instrument or writing commonly known as a security”.

^ Both US and Canadian case law have made it clear that “commonly known” refers to known in the legal/financial community – a sophisticated legal expert (not common to lay person)

(b) any document constituting evidence of title to or interest in the capital, assets, LESS COMMON SECURITIES

• Definition sets out a number of specific items all of which would normally involve an initial payment that would be used to produce some future returns (e.g. investment contract)

property, profits, earnings or royalties of any person or company, ^ Too broad a definition (so a receipt for the purchase of a hockey stick could theoretically constitute a security, because it is evidence of an interest in property)

^ Courts have had to narrow this definition, so only instruments intended as investments are securities and not instruments bought and sold for other commercial purposes (ex: title to a car is property, not security) (test: is the individual investing in the piece of paper OR are they investing through the piece of paper in a product)

^ Look to see whether the person is expecting an increase in value – if yes, security

(n) any

investment CATCH ALL PROVISIONS (Pacific Coast)
  • Definition is case in open-ended terms

o Included items listed—thus non-exhaustive.

o Includes “a document evidencing title to or an interest in the capital, assets, property profits, earnings or royalties of a person”. o “a profit sharing agreement or certificate” and o “an investment contract”.

  • These are sufficiently broad/vague that interpretations have not gone outside the listed items.
^ Hotly litigated because it is ambiguous

^ We determine if a particular instrument is a security by asking whether or not the person invested on the premise that the other person’s expertise would create profit (in these situations, need full disclosure of relevant info) How Case Law Has Defined a Security

Main Points: Definitions in the OSA are not mutually exclusive, but are catchalls

  • Securities legislation is ‘remedial legislation; to be ‘construed broadly’ (SEC v CM Joiner Leasing & Pacific Coast Coin Exchange)
  • Substance not form governs the interpretation of what is a security -it is flexible, not static (Pacific Coast Coin Exchange)

-The policy of securities legislation is ‘full and fair disclosure’ with instruments regarded as securities

  • Something will be considered a security if:
  1. It falls clearly under one of the definitions of the OSA
  2. If can fit under one of the broad definitions and policy considerations demand coverage SEC v. Glen T. Turner Enterprises Inc. (US, 1973)

Ratio: s.1.1(a) definition that a security includes “any document, instrument or writing commonly known as a security” means if known as such by the legal/ financial community, not common person.

Implications: takes a broad def and makes it even broader!

Due to POLICY: most sec are technical in nature, not likely to be understood by anyone other than legal/ financial community

Reasons: interprets US law similar to OSA s.1(1)(a) that provides a security includes: (a) Any document, instrument or writing commonly known as a security.

o “The court doubts that Congress intended that in order to qualify under these general categories, a transaction must be commonly known to the man in the street as a security. Most securities are rather technical in nature and not likely to be understood except by the legal or financial

community. It is sufficient that an offering be considered as a legal matter to be a security, regardless of the popular perception of it”

• Supported by Can courts

Ontario (Securities Commission) v. Brigadoon Scotch Distributors (1970 Ont. H.C.)

Ratio: Provides insight into s.1(1)(b): Securities only includes instruments intended as investments and not instruments bought for other commercial purposes.

Test: Is the investor investing in the piece of paper (the security) in the hopes that it will appreciate in value? Or is the investor investing through the piece of paper in the product?

Policy: The reason you’re defining this is to figure out if you need to issue a prospectus, so had to narrow definition (otherwise, could be anything you’re selling)


  • Recall: s.1(1)(b) Any document constituting evidence of, title to, or interest in the capital, assets, property, profits, earnings or royalties of any person or company

o Case interprets section: def of security doesn’t include documents of title bought/ sold for purposes other than investment

o Basically if you’re buying something and you get a receipt for it, that receipt does not

constitute a security unless you’re planning on selling it in order to make an investment off of it

  • Test for whether or not a title document is a security:

o Is the investor investing in the piece of paper (the security) in the hopes that it will appreciate in value? Or is the investor investing through the piece of paper in the product?

■ E.g. go to store that ages scotch. Buy a bottle, age for 5 yrs, give you doc evidencing you own it. If my intention is to buy the bottle of scotch, that piece of paper is not a security. If my intention is to sell that piece of paper evidencing that I own that bottle at a higher price in the future, then that piece of paper is a security.

Policy: There’s no incentive of investor protection by covering something like the receipt for the shampoo I bought at the store as securities.

  1. If you enter into an investment contract, that’s a security

No one has any idea what an investment contract means, but some American cases, and then SCC case adopting American reasoning…

SEC v. CM Joiner Leasing Corp. (USA)

Ratio: Act will be construed broadly and in whatever way leads to it to promote the policy objective of investor protection (Purposive approach to interpreting the meaning of “security”). Specifically, interprets s.1(1)(n): an investment contract will be where people are investing in the potential for something to generate profit and are purchasing expertise of someone else.

Policy: Purposive approach to interpreting the meaning of “security” required to respond to new, novel, uncommon or irregular devices.

Facts: SEC sought injunction against CM with respect to assignment of leases. Anthony acquires leases in Texas, transferred a substantial portion to Joiner Corp., and engaged in sales campaign where they tried to assign leases in land in parcels of 5-20 acres with the promise the Joiner would drill a test well to test the oil producing potential of the land. Transaction was set up so that it was arguably only a sale in land.

Decision: the court found that it was not just a sale of an interest in property, but the sale of the prospect of gaining from the exploration exercise. The transaction “had all the evils inherent in the securities transactions which it was the aim of the Securities Act to end”


  • Although set-up to be a lease in land, the definition of a security uses very general terms and can encompass this transaction.

o Decision based on POLICY:

  • The Act must be able to respond to new, novel, uncommon or irregular devices.
  • Interpret the definition broadly to meet the purpose of the Act – it should not be subverted by new instruments designed to avoid the application of the Act or frustrate its purpose.

• Ultimately, investors likely needed more info on scheme administration etc. through a prospectus

  • If investors are investing in the potential for the item/ doc to generate profit, and are purchasing the EXPERTISE of someone else, tends to be read like an investment contract ^ means that looking at OSA objectives, the investors could have BENEFITED from OR NEEDED info that would be in a prospectus

o In this case, investors would have needed information on oil/gas potential of the land, structure of C.M. Joiner Corp., background on the individuals, their interests in the plan, how the plan would be administered, etc. For such small investments, a prospectus made sense.

**note: next two cases are only important b/c reasoning is later adopted by SCC in Pacific Coin Exchange

SEC v. W.J. Howey Co. (USSC, 1946) – reasoning used by SCC in Pacific Coin

Ratio: Common enterprise test for identification of an “investment contract” and therefore, security. Test


  1. A contract, transaction or scheme whereby a person invests;
  2. That the investment be in a common enterprise; and
  3. That the person is led to expect profits (or capital appreciation: see Forman) solely from the efforts of a promoter or third party (pol obj: since it is them who controls success/failure of enterprise)

Facts: Howey Co. and Howey-in-the-Hills Service Inc. were under common ownership. Howey Co. owned orange groves in Florida and a hotel. Groves were for sale and sold in plots of 1 acre each. Buyers advised that land needed to be serviced, recommended Howey-in-the-Hills Service Inc. Buyers would derive profit from orange groves manages by HHS Service Inc. Buyers told that 20% returns had occurred but that they could expect 10%.

Decision: Investment contract ^ this was more than just a sale of fee simple interests in land. The transfer of land was merely a convenient way of allocating the profits of the enterprise. Again, these investors would have benefitted from some information regarding their decision to buy and put the land under management.


• Common enterprise test: contract or transaction where a person invests in something that is a common enterprise that is expected to lead to a profit for the investor, and this profit will be derived solely from the efforts of a promoter or third party – key is that someone else controls success/failure of the enterprise and that’s why you would want that information

State of Hawaii v. Hawaii Market Center Inc.

Ratio: Risk Capital Test for identifying an investment contract (broader than Howey test to comply with policy objectives). Test requires:

  1. The offeree furnish initial value;
  2. A portion of the initial value is subjected to the risks of the enterprise;
  3. The furnishing of initial value is induced by promises or representations leading to a reasonable expectation or understanding that a benefit above initial value will accrue; and
  4. The offeree does not have the right to exercise practical and actual control over the managerial decision of the enterprise.

However, it is the policy and not the subsequently formed judicial test that is decisive. The primary objective is to protect the investing public. Are investors relying on expertise/management—courts have immense discretion.

Facts: A store where only members can shop. The capital for the store was raised by the sale of founding memberships. Costs was $320-$820. Earn returns by selling other memberships and by commissions. Securities Commission of Hawaii sought an injunction against the sale of these memberships on the basis that they constituted “investment contracts” and thus constituted securities. Hawaii Market Center argued that members had some control over their potential return, and did not rely “solely” on others as required by Howey.

Held: The court said the problem with the Howey test was its narrow focus on the mechanical test of “solely”.

This results in losing sight of the need to interpret investment contract broadly.

Reasons: The RISK CAPITAL TEST for identifying an investment contract should be used as it is broader than Howey test (thereby, meeting broad securities def) to comply with policy objectives

  • Here, the premium paid for sewing machine was initial value. Ability to recoup investment depended on the success of the store. Fixed fees and commissions were expected benefits. Investor did not have practical and actual control over the investment of the capital or the management of the store, and thus no way to his/her investment.

in the end, we don’t care so much about the judicial test, more about the policy of protecting the investing public who is relying on someone’s expertise/management (with both cases).

Pacific Coast Coin Exchange of Canada v OSC (SCC, 1978)

Ratio: Broad, purposive approach should be used in interpreting meaning of word “security” (even broader – s.1(1) is not exhaustive) ^it is legislative policy to replace the harshness of caveat emptor in security related transactions and courts should seek to attain that goal even if tests carefully formulated in prior cases prove ineffective and must continually be broadened in scope. It is the policy and not the subsequently formulated judicial test that is decisive.

*Accepts US definition for “investment contract” as a security

Facts: PCCE was in business of selling bags of silver coins. Two ways to buy from PC: (a) pay 100% $ in cash and receive bag of silver coins, or (b) you could buy bags of coins on margin through current account commodity agreement

  • Margin: you buy it, own it, but you don’t get it until you pay the rest of the balance you owe (e.g. if bag is $100 on Day 1, Give $35 on Day 1, and in 5 yrs, give $65, get back an investment contract on Day 1, and get the bag of silver when you pay off balance)
  • Almost everyone bought silver on margin. PC after receiving $35 did not keep silver in reserve for the person b/c they wouldn’t make $ doing that. Instead, hedged: have an obligation in 5 yrs to deliver 500 bags of silver ^ enter in futures contract w/ $35 payments, make $ b/c going to decide when the right time to buy bags in silver is 5 yrs from now ^ e.g. if worth $100 today, when it’s worth $90, buy 500 bags and make a profit on $10

• Crucial to solvency of PC was ability to properly hedge. They didn’t. All customers come forward with

$65 asking for their silver that’s increased dramatically, and they obviously don’t have it. Customers sue saying that they should have had a prospectus. D said they weren’t securities, they were selling silver.

Issue: whether the “current account commodity agreements” constituted an “investment contract” as defined in s.1(1)(n) of the Securities Act, i.e. whether they were a “security”

Held: SCC held 8-1 that the contracts were “investment contracts”, and since it was a trade that amounted to a distribution with no prospectus, the investors were entitled to their money back. Must fulfill the statutory purpose of compelling full and fair disclosure relative to the issuance of instruments that fall within the concept of a security

Analysis/ Implications: Majority examined tests from two US cases (Howey and Hawaii), concludes that a broader approach is required than even these tests, and goes on to adopt a more realistic test in light of underlying objectives of the Act.

It also determined the following:

  1. Appropriate for Canadian courts to consider US jurisprudence b/c i) def of security is similar, ii) both defs refer to an investment contract, ii) purpose of legislation was the same and iv) dearth of Can authority
  2. Expanded the concept behind the Howey test so that it would not be constrained by narrow interpretations of the words “common enterprise” or “solely”.
  • Under Howey test, the third part requires “that the person is led to expect profits…SOLEYfrom the from the efforts of apromoter/third-party: following this rationale would have caused case to fail. HOWEVER, SCC reasoned that the Q is whether the efforts of the third party are undeniably significant for the success/ failure of the enterprise
  • Under the 2nd requirement in Howey, require the investment to be a COMMON ENTERPRISE: Court found significant managerial efforts were made by D (promoter) and that the actions of this promoter lies in the commonality – between investor and promoter; there is no need for enterprise to be common to the investors between themselves
  1. Broad purposive approach should be used in interpreting the meaning of the word “security”: This case is a blank cheque to call anything a security as long as it satisfies the underlying policy of the Legislation.
  • Case indicates that courts will go to great lengths to ensure that the investor has the information he needs to make an informed investment.
  • Must appreciate economic realities,

o “Such remedial legislation must be construed broadly, read in context of economic realities to which it is addressed, substance not form is the focus. Any definition must permit fulfillment of statutory purpose of compelling full and fair disclosure. What will fall within the definition of a security is flexible rather than static… capable of adaptation to meet countless and variable schemes to those that seek use of $ of others on promise of profits”

Dissent: Laskin reasoned that the source of the buyers’ risk was not the quality of the management brought to the project by PCCE, but the market risk inherent in the price of silver. The only difference between buying silver from PCCE and buying on the open market was concern over the solvency of PCCE. As such, there is nodifference between this and commercial contracts where bankruptcy can lead to non-performance. This is extending the definition of security too far.

Policy Notes:

  • IF PURCHASING EXPERTISE, PURCHASING A SECURITY: Every time you invest in something where your expectation ofprofit is based on the expertise of someone else, the courts will go to whatever length they need to go to find that that’s a security

o Remember what you’re trying to do: if you’re investing in something to make a profit from it, and you’re relying on someone else’s expertise, you’re buying that expertise and therefore someone is required to give me a prospectus telling me everything that I need to know.

o The key difference between buying a product vs. buying something to profit from that someone else is managing is that in the latter cases the profit is not only risky, but the risk is largely determined by the management of others. Because of this reliance on expertise, to earn a profit there are 100 questions that need to be asked about the skill and risk before you give them the money.

o In order to protect the public and to foster confidence in capital markets these people need to have the protection of a prospectus

  • Here, PC was not selling bags of silver, were selling expertise in knowing how to hedge it for a profit. Buying MANAGEMENT EXPERTISE, which is a security.
  • This is the only way they can force prospectus/disclosure and to ensure that protection of investing public happens.
  • Policy: Basically, the court will find anything to be a security, so long as it fits into the definition – the reason for this relates back to the three objectives, but mainly investor protection

o Joiner, Howey, Hawaii, and Pacific Coast suggest courts will take a purposive approach if it is the type of transaction to which securities regulation was intended to be directed.

o We care about the investing public because we need confidence in capital markets and efficient capital markets (companies will not survive without the public’s $)

  1. “Commonly Known As” does not mean commonly known as security to ordinary people on the street. If commonly known as a security to most sophisticated security lawyer in the country, it’s commonly known as a security

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Going Public -Securities Regulation

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  • Introduction to Going Public
  • General Rule- Securities Act, 25 and 33

RULE: No person shall engage in or hold themselves out as engaging in the business of trading in a security, without being registered, and if a trade constitutes a distribution, without preparing a prospectus (Section 25 and 53, Ontario Securities Act).

s.25 deals with not being able to engage in business of trading securities unless REGISTERED s.53 deals with not being able to issue securities without a prospectus

  • How Companies Go About Raising Capital

3 Ways: 1) Borrow, 2) Go Public (IPO – segment 1), 3) Private Placement of Securities (segment 3)

  • Borrow: Can go to an FI and borrow it, but might be expensive, might not be able to get it
  • Go Public (IPO): first segment of course
  • Private Placement of Securities: third segment
  • Why Go Public?
  • If a client wants to take a private company public, if you’re worth anything as a lawyer, then you won’t just take instructions, but provide advice and guidance.
  • Lots of advantages/disadvantages of going public, have to address those with your client.

Ex. Four Seasons Hotels

  • Used to be a private company, decided it wanted to be a public one for very bad reasons
  • Went public and was a miserable public company. So miserable that it ultimately decided it had to go private again
  • A few years later, went public again for the right reasons, then it became what it is today – one of the finest hotel companies in the world (then went private again but only b/c paid lots of $) Advantages

Advantages: 1) Raising Capital, 2) Future Growth, 3) Employee Incentives, 4) Enhanced corporate image, 5) Acquisitions, 6) Shareholder Liquidity

  1. Raising Capital: In the primary offering the principle reason to go public is to raise capital to meet the company’s growth and operating objectives
  2. Future Growth: An equity offering allows the company to:
  3. Borrow additional capital on more favorable terms
  4. Issue additional equity on the market
  5. Raise future capital from current shareholders via rights offerings
  6. Employee Incentives: Can use stock options as compensation when your public (more attractive to employees b/c stocks become more liquid and provides independent valuation mechanism)
  7. Enhanced Corporate Image: Increased public profile (become better known to customers, suppliers and other stakeholders)
  8. Acquisitions: Cash generated by going public may enable a company to undertake successful M&A. Can expand using stock as a form of currency without depleting cash or taking on debt.
  9. Shareholder Liquidity: Instead of holding shares subject to the escrow requirements and control block sale restrictions, public investors enjoy increased liquidity allowing for easy diversification by selling parts of the company (constant indication of value due to share price)
  • Potential Disadvantages (and to how to mitigate the risk)

Disadv: 1) Loss of confidentiality, 2) Reduced flexibility, 3) Managing share prices, 4) Reduced control, 5) Loss of tax advantages, 6) High costs of going public (initial costs of IPO and ongoing cont disclosure requirements)

  1. Loss of Confidentiality: Significant disclosure (prospectus) and continuing disclosure requirements may prejudice the companies’ position as the information is available to all competitors
  2. Reduced Flexibility: Owner-manager undertakes a responsibility to the public, which imposes fiduciary duties. There is lost flexibility as approval from outside directors is needed to make certain decisions
  3. Ex. Need a shareholder meeting in order to approve a large acquisition which takes 60 days, thus, the opportunity may be lost to a faster moving private company.
  4. Managing Share Prices: Public companies are scrutinized on a quarter by quarter basis, this creates an incentive to manage share prices in a way that can compromises long term profitability.
  5. Reduced Control: A public offering may dilute the owners control to the point that they lose controlling power of the company which may open the company to unfriendly takeover bids.
  6. Loss of Tax Advantages: Public companies are not entitled to small business deduction and other tax advantages
  7. High Cost of Going Public
  8. Initial costs: underwriter’s commission (5-7% of gross offering proceeds), non-commission costs (1-3% of gross offering, which includes: prof fees of lawyers, accountants etc., listing fees, promotional expense, printing, translation in QC)
  9. Green Shoe (over-allot the issue by granting the right to buy more of the issue for a set period.
  10. Broker warrants (right to buy at a set price for a year): This rights provide the underwriters with a continued stake, but also have a dampening effect on the market.
  11. Ongoing costs: continuing disclosure requirements, manage the board, accounting and lawyers fees that make up governance, filings of material changes
  • Why do we regulate public offerings (3 objectives)
  • Protection of Investing Public, 2) Ensuring the Efficient Operation of Canadian Capital Markets, 3) Increasing/ Maintaining Confidence in Public Markets & the People who Operate in Them

Why do we think it’s so important to regulate public offerings vs. letting the market take care of itself?

  • Objectives of regulation: Everything in the Securities Act (SA) is designed to deal with one of three objectives (can be conflicting, have to balance)
  • Protection of Investing Public: Impose a lot of rules to make sure these people are protected
  • Make sure Markets Work – efficient operation: rules to ensure the system works
  1. There is no point having a market if nobody plays by the rules.
  2. Can’t just protect the investing public b/c there is nothing to protect if no one is investing (need to balance these goals)
  3. Increasing/Maintaining Confidence in Public Capital markets and People who Operate in Them:

Neither of the above two points matter if there’s no confidence in it.

Everything we talk about will come down to one of those three objectives*exam

**and remember methods used to achieve the objectives (Securities Act is just a bunch of rules that play into one or more of these three objectives).

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Sources, History & Constitutional Division of Powers of Securities Regulation

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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 19th 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 – Securities Regulation

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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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Introductory Concepts – Securities Regulation

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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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