Securities Regulation by chenshu


									S ec ur i t i e s     R e gul at i o n     i n   C a n ad a

September 15, 2000:


Corporation = creature of law, created by statute ie Canada Business Corporations
Act or provincial statute. We only look at those corporations with share capital.
Principle reason for existence of corporations is limited liability ie Salomon. Some
corporations are created by special acts of the legislature ie Toronto Stock
Exchange, insurance and trust companies, etc…

Corporations have all the powers of a natural person, in theory. Corporations are
the most significant issuers of securities. Other issuers: limited partnerships (also
created by statute): all the features of a partnership from a tax perspective BUT
limited liability for limited partners. General partnerships do NOT issue
securities ie law firms.

Other vehicle for issuing securities: a commercial trust. They have been formed
by K (b/w trustees and beneficiaries), can issue interests/securities; their
securities can be traded ie mutual funds. The form of organization through
which mutual funds are created is often a trust, sometimes a corporation, never a

Each of these entities can subdivide its ownership into unlimited number of units
ex: share of Microsoft. Every corporation, to the extent that it issues shares,
subdivides its ownership.         Most significant feature of corporations,
partnerships, trusts for this course ie the way in which ownership interests are
created, marketed, sold and traded. There are other ways to create securities
apart from subdividing security interests, but won't look at them much.

Virtually everyone who carries on a business wants to raise capital, beginning
with need for basic operating expenses, etc… One way to do this is getting a
business partner. Most small businesses are run by single entrepreneurs - first
thing entrepreneurs want to do is borrow money from other people instead of
having to give up some ownership of the business. Can g o to the bank (in basic
commercial transaction, your debt is not sold to someone else, but in other
commercial transactions, your debt could be sold).

Can also get cheaper ways to borrow money the bigger you get, the more
attractive is your business - ie you borrow money from a whole bunch of people
and you give them a promise to pay them back (either promises to pay, bonds or
debentures). So you will have Ks with hundreds of people; people will then
trade their promises with others (this is the secondary market) - based on
expectation of how much they will get paid and when.

If you decide to sell part of the ownership: sell shares in corporation ie creating a
security. Most companies can issue unlimited numbers of shares. These shares
may be called units in limited partnerships and trusts.
Ie capital market = creation and issue of debt instruments & equity interests
(ownership interests) = securities. Securities in the Act is defined very

[Governments also issue debt instruments ie Canada Savings Bond]

In "Securities Regulation": article by Henning describing the different types of
capital markets. Primary and secondary markets. Primary market = when new
securities (new capital) are created for the first time and sold. Secondary
markets = trading of instruments that have already been issued (resale of
outstanding securities).

Both debt markets (for bonds, promissory notes, debentures) and equity
markets (ie stock exchanges).
Also derivative markets: people can buy more sophisticated securities ex: if you
sell options to buy promissory notes, share (in exchange for an option premium,
can buy a security at given price at given time; don't always end up exercising
your right to buy). Put options (right to sell) and call options (righ t to buy).
[Calls and puts are economical and highly effective tools for speculating on the
increase or decrease in the value of securities. Future contracts are Ks under
which a buyer agrees to take possession of a certain quantity of product at a
predetermined time and price - used for resource products and financial
Montreal Exchange is now the principal market for derivatives/options/futures . Toronto
deals with equity market. Derivatives are very popular right now.

[Much more money is traded in debt markets that in equity markets]

[Rare to have futures on equity securities, but can have futures on debt securities
& commodities. Futures: a promise to K in the future, to buy something in the
[Indexes: anyone can create this for a bundle of shares, futures, etc…]

If you own a share and worried that will go down, you buy a put option
measured against an index -so as to protect against risk of volatile change.
Pension fund managers often do this, as do commodity companies (ex oil and gas
company that are exploiting fuel).

There are markets for everything; the prices are becoming more and more global
ie stable around the globe.

Money markets (vs capital markets): buying and selling of very short term debt
interests: promises to pay, issued by either corporations or governments.
Currencies trade in the money markets: may want to protect yourself against the
risk of the Cdn dollar fluctuating through hedging. Can buy right to sell Cdn
dollars for US dollars next year at a given price, etc… Banks typically do this or
other types of intermediaries (ie people who find others who want to sell or buy,
etc…). Over the counter market - cluster of intermediaries around the world who
manage risk: for put/call options, commodities, foreign exchange, etc…

Difference between money market and debt markets? Money markets are short

Purpose of existence of capital markets is to make sure that people's accrued
savings is investible into something of value - ex: Canada Savings Bond (the most
conservative investment you can make is buying a government bond).
Corporations are riskier investments (ie corporate debt). Even riskier: owning
shares of a corporation. Even riskier: owning an option on a share.
So level of risk (lowest to highest)
1) government debt 2) corporate debt 3) corporate shares 4) options on shares.

Moody, Standard and Poor's: assess credit-worthiness of corporations and
government. Makes a huge difference since a AAA rating means that the
government has to pay less interest to borrow money than if AA rating.

Equities: brokerage firms will assign a research analyst to look at your firm and
determine whether it's worth investing.


-   Point: The Securities Act has a section (1.1, p. 12) which points to purpose of
    the act: "provide protection to investors from unfair, improper or fraudulent
    practices, and foster fair and efficient capital markets and confidence in capital
    markets." Task Force Report for Securities Act: goal of securities regulation is
    to prevent fraud, promote efficiency of capital markets. Efficiency = giving
    info you need to choose what you will invest in.
-   Tension between the 2 purposes of the Act: most efficient capital markets are
    the ones with no regulation, where money flows freely. However, need to
    protect unsophisticated people against fraud.
-   Business needs capital to thrive: ultimately, want to have people competing
    for the right to give you money, so that can reinvest this money, etc… To the
    extent that have to deal with regulation, that is a cost of capital. But if capital
    markets were fraught with fraud, no one would participate in capital markets
    - so in everyone's collective interest. Need for investors to have confidence in
    the market.
-   Nations have an interest in making sure that have regulatory schemes that
    inspire confidence ex: since Canadians want to have access to the US capital
-   Capital markets have HUGE power to influence governments to establish
    sophisticated, stable, confidence-inspiring regulation. Ex: Hearing re BPM (oil
    company): Russian company told shareholders (namely BPM Co.) after that
    they were not to get dividends or any information or anything! BPM lost their
    first go through Russian legal system. So Russia should really try to regulate
    its capital markets since confidence very low now!
-   Ie Handout (OSC Alert dated September 12, 2000); also McKenzie Securities in
    Securities Regulation. Classic fraud ("pump-and-dump"): selling securities over
    the phone saying that X company will be booming, that should buy X
    company. Can be very sophisticated. The intrinsic value of the stock almost
    has nothing to do with the value of the stock ie the value is what people want
    to pay - law of supply and demand.
-   Mutual funds: most do not trade (you can redeem your units); some mutual
    funds trade: they trade at whatever a buyer is prepared to pay. Sometimes
    they trade above the theoretical value, or below theoretical, intrinsic value.

-   First step to regulating: register yourself with OSC or other commission.
    Companies have to divulge certain info to client. Quasi-penal provisions, civil
    liability provisions in the Securities Act. These are the ways that government
    tries to combat fraud.

-   Every province has its own securities commission (some provinces only have
    a public servant that does it on the side! - ie Maritimes). These commissions
    make millions since have to pay for your offering memoranda, etc..

-   Self-regulating organizations (SROs) (private organizations): ex: Investment
    Dealer's Association of Canada: regulatory body that promotes interests of
    investments dealers + it carries out a number of regulatory functions
    nationally that the 10 provinces did not want to pay for. It makes sure all its
    members are regulated, that punishments are carried out, etc… - this is paid
    by those that are regulated. Same for Car Dealer's Association, etc…
-   Stock exchanges: also regulating; see handouts re: changes in stock markets
    globally. There are mergers going on wrt stock exchanges around the wor ld.
    Stock exchanges are going from not-for-profit, regulatory, semi-public bodies
    to for-profit, going public, etc…
-   Stock exchanges can discipline their members, have a code of rules.
-   Other self-regulatory organizations: Canadian Mutual Funds Association -
    OSC wanted mutual funds to self-regulate since mutual funds are different.
-   So you have direct government regulation (Securities Commission) and
    indirect government regulatory agencies (TSE, IDA, etc …).

- Kimber report in 1966: very foundation of modern securities act for Canada to
  prevent fraud. All provinces have adopted almost same model.

-   Since 1978, mild changes, same principles of requiring info to be shared, filed
    with commission, companies should be registered, etc…
-   See constitutional background to securities regulation in Canada in Securities
    Regulation: federal laws in CBCA have laws similar to those in Securities Acts.
    First province to pass Securities law was Manitoba: said that Manitoba had to
    approve of the company before it could issue securities in Manitoba. Went to
    Privy Council that said that this was ultra vires of the provinces.

    So Manitoba said that would require company to prepare a prospectus that
    contains information and that Manitoba could approve this - Privy Council
    allowed this. So provinces have ability to review prospectuses and approve or
    reject them.

-   Case that argued that Securities Act cannot impose jail provisions since
    criminal law power (federal): SCC said that was constitutional to have quasi-
    penal provisions in provincial securities law.

R v. MacKenzie Securities Ltd. (1966) (Man CA) the securities legislation of one
province governs trading which is initiated in another province
Facts      Pump-and-dump scheme from Toronto, victim was in Manitoba
           (scheme whereby told that should buy stock in a company, and then
           encouraged to buy more, that stock would soon rise, discouraged
           from selling until victim finds out shares are worthless and company
           does not exist.) Manitoba Securities Commission filed a charge
           against company in Toronto (that was registered with the OSC but
           not with the Man SC).

Argument     Ds said that Manitoba had no jurisdiction.

Held         The law that applies to a transaction for securities is the law of the
             jurisdiction in which seller is situate AND the law of the jurisdiction
             in which the buyer is situate. There is no conflict b/w jurisdiction
             when it comes to cross-provincial trading (same with international

-   Multiple Access [1982] (SCC) argument that a federally incorporated company
    cannot be charged under a provincial law, had to be charged under a federal
    law (ie CBCA).
    SCC: No, the same provisions can exist at the federal level and at the
    provincial level (Securities Act): both can exist together, not ultra vires the

-   Securities Regulation mentions that in Securities Act, residual jurisdiction on
    the securities commission to exercise powers in the public interest. Was
    thought at one time that in order to exercise public interest jurisdiction,
    securities commission first had to find that had breached the statute in some
    Canadian Tire (1987) stands for the proposition that this is not true
    Facts     2 types of shares in a company (some with votes, some with no
              votes; 5% of the shares had votes). Provisions were put in the
              articles of incorporation that were supposed to insure that if
              someone wanted to make a takeover bid, would have to convince

             both those shareholders having shares with votes and those without
             votes (they promised this to investors).
             But lawyers for Canadian Tire did not draft the articles of
             incorporation very well since did not protect the non-voting
             shareholders in all circumstances.       A few years later, someone
             wanted to buy only the voting shares so that could have control over
             the company.
             It was those with the voting shares that wanted to buy out the family
             that had the rest of the voting shares - so the group figured out
             loophole, that could make 2 different bids.
             Securities Commission was asked to intervene and stop transaction,
             so as not to undermine confidence in capital markets.

    Issues   Perfectly legal transaction - can the Securities Commission stop it
             anyway, using s. 127 (cease-trade order)?

    Held     Yes, in public interest.

-   Securities Act provides that governor-in-council may make regulations wrt
    certain matters. No sooner was act and regulations passed in 1970s that
    changes were projected ie there were no provisions dealing with derivatives,
    etc… There is a power for the Securities Commission to grant certain
    exemptions from the Act on a discretionary basis: Securities Commission
    wanted a blanket ruling so that would not have to deal with each case. Then
    started passing policy statements - b/c Securities Commission could not pass
    regulations, legislation was not being updated, commission passed more and
    more policy statements and more blanket rulings (from 1980 - 1994). These
    were treated as if they were law. Finally, Securities Commission passed a law
    to put out of business penny stock dealers, fraud agents (since the governor
    wasn't taking care of it) - this was finally done this year.
-   Finally, one of these fraud agents went to court on this to challenge
    jurisdiction of administrative bodies. This was the Ainsley case. Courts
    finally said to Securities Commission that could not just put out laws: need
    a constitutional basis for doing so, either the law-maker or delegated
    powers. Courts struck down the policy statements of the Securities
    Commission. Legislature then passed amendment to the Securities Act that
    created a rule-making power for the Securities Commission, made all these
    policy statements law.

-   Level of regulation: Top of hierarchy is act; then regulations by governor-in-
    council; rules of the OSC that are the force of law; then policy statements
    (which now do not have the force of law); then notices and communiques.
    Some of the other provinces also gave their securities commissions rule-
    making powers EXCEPT Quebec, which made sure that when the law was
    changed, was done through an act of the legislature and not just rules (these
    rules are called instruments). Securities Commission still have policy
    statements, that accompany certain rules. Also local and national policy
    statements, but these are gradually being eliminated, turned into proper rules.

September 22, 2000:


Two theories for why there is securities regulation: 1) anti-fraud and 2) efficient
capital markets.

All provinces have Securities Acts and Commissions, except Nfld., NB, and PEI.
These three provinces have other statutes.

Each Securities Commission is a body corporate under the Securities Acts of the
various provinces and is an agent of the crown. As a result, the commissions
enjoy crown immunity from liability.

Members of the commission are experts in the field, and the commission serves
as an investigative and enforcement functions. Section 11 of the Securities Act
gives an investigative power.

Commission also serves a policy making function

Beneath the commissioners we have the full time civil servants which are
governed by the "executive director" who is also the CEO of the Securities

Therefore, Securities Commission is an administrative body which regulates the
Securities Act.

Securities Commission also has power to regulate certain portions of the CBCA
(i.e. for M 'n' A etc). In other words, the government delegates certain powers to
Securities Commission because they are experts.

Constitutionally, securities regulation is under a provincial head of power.
However, for corporations incorporated under the CBCA, the Federal
Government has the power to regulate those corporations. As such, the solution
has been to cooperate and hence create the Canadian Securities Administrators
which is in charge of cooperation and all provinces, territories and the Federal
Government are included in this group.

Each province has its own Securities Commission and for a stock broker to deal
with people of a province, he must be approved by the Securities Commission of
a province. He must be approved by the Securities Commission of that province.
As a result, an American broker wanting to deal in Canadian provinces, he must
be approved in all Canadian jurisdictions in which he wishes to deal.

However, there is widespread non-compliance with this law because US on-line
brokerage firms are usually not registered in Canada and Canadian citizens want
US discount brokerage services which are rapid. But many of these brokerage
firms do not comply with Canadian Securities Regulation Law (i.e. they deal with
Canadian citizens in Canada while not being registered in Canadian provinces)

Enforcement Powers of Securities Commission

Once an investigation is completed, Securities Commission may issue a "notice of
hearing" and therefore summons people to appear before the Commission and
decide whether a person's security license should be revoked or whether other
measures should be taken.

The Securities Commission can also take away an individual's right to trade
securities (for trade violations). But this is only effective for individuals living in
that province, but now Section 20 allows for Securities Commissions of various
provinces to sit together and revoke an individual's right in one or more
provinces (i.e. this occurs when issues cross provincial boundaries). Securities
Commission is an investigator, adjudicator, enforcer and sentencing body of the
Securities Act.

Problem: You could be banned from trading in Ontario or other provinces and
continue to trade in other provinces. This is the problem that arises from having
a provincially based securities regulation system according to McReynolds.
Thus, although other provinces cannot revoke a "registrant's" license due to a
Securities Commission finding in another province for registration based on

disciplinary findings of another Securities Commission in another province or
even another country.

The provinces also have other regulatory bodies in financial services area.
Ontario is merging its Financial Services Commission (which deals with things
like Insurance) with its Securities Commission. This is occurring because of the
convergence that has occurred in the financial sector, because everyone in the
financial is selling mutual funds, stocks, Insurance and, as a result, the thinking
that one body should govern all of them.

Note: The Federal Government can prosecute you criminally but you can still
trade. Thus, only a provincial securities commission can revoke your t rading
license or right to trade as a private individual.

Recently, the Securities Commissions in each of the provinces have decided to
delegate routine paperwork and the enforcement function with respect to minor
violations to Self Regulating Organizations (a.k.a. SRO's). When joining a SRO,
members agree to follow the rules of the SRO and subject themselves to review
by the SRO. Moreover, the Securities Commission allows the SRO to take over its
regulatory function over certain minor matters.

Thus, registrants in Ontario will have to join the Ontario SRO (known as the I.
Dealers Association) by next year and it will regulate and police certain aspects of
Securities Exchange. In other words, the IDA will police all Ontario stock brokers
etc. by next year.

The development of the SRO is important according to McReynolds because they
are the frontline regulatory body.

The Toronto Stock Exchange (TSE) is another SRO. There is a global trend to
consolidate and merge Stock Exchanges. An example of this trend would be the
merger of the Vancouver Stock Exchange and the Alberta Stock Exchange into the
CDNX (known as the Venture Stock Exchange)

Trades are settled in Canada by ??? Settlement, which is absolutely vital to the
operation of markets. These clearing houses add security to system by requiring
minimum capital levels by brokerage firms, etc.

Securities Commission can be appealed all the way to the Supreme Court of

Pezim Case (Supreme Court of Canada)

Alleged disclosure scam, and Securities Commission levied sanctions against
            him. He
appealed up to the SCC. Iacobucci assessed role of the Securities Commission
            and the
courts. He said "we have a highly specialized tribunal deciding on a highly
area." He said that courts should show considerable deference to Securities
decisions and that courts should avoid intervening.

Manning Decision: Courts can also hear appeals on SRO decisions.

The U.S. Securities Exchange Commission deals with stocks. Derivatives are
           dealt with
by another body. It is important for Canadian lawyers to know U.S. rules
because of importance of U.S. securities markets to Canadian investors and

U.S. Securities Regulation System

Two principal statutes: 1) Securities Act of 1933 and 2) Securities Act of 1934.
Both of these statutes are federal.

The 1933 Act deals with distribution of securities to the public (issuing). The 1934
Act deals with the trading of stocks after their issuance (i.e. M 'n' A, takeovers,

The Securities Exchange Commission can even pass rules regulating the way
stocks are issued and traded and therefore it is more powerful than Canadian
Securities Commissions.

The individual states also have Securities Commissions but are weaker than their
Canadian counterparts.

September 29, 2000:

The casebook categorizes securities law into four different variants:

1)   rules on registration
2)   prospectus rules
3)   disclosure rules
4)   rules regulating take-over bids

There are 5 basic propositions that are one needs to understand:

1) You must register in order to trade securities
2) You must prepare and file a prospectus in order to "distribute" securities
3) People who are registered, registrants, must satisfy minimum standards of
4) Issuers must make timely disclosure and insiders of issuers must report
   publicly their trades of securities of the issuers
5) There are penalty provisions in the Act designed to discourage fraud.

Pretty much the entire Securities Act fits into one of those propositions.


Some of the basic concepts:

Registration: Sec. 25 of the Act. "No person or company shall trade a security, or
act as an underwriter, unless the person or company is registered as a dealer…."

Prospectus: Sec. 53 of the Act. "No person or company shall trade in a
security….where such a trade would be a distribution unless a preliminary
prospectus and a prospectus have been filed…."

These are the 2 most important provisions of the Securities Act. Everything turns
of them. These rules exist in all 10 provinces. There is a similar approach in U.S.
Securities law.

If you want to deal with the public and want to recommend what securities they
should buy or take their order and purchase securities on their behalf or
represent a company and sell securities to the public on their behalf, you have to
be registered to so.

Similarly, if you are a company, partnership or a trust and you want to issue
securities that have never been issued before and sell them to the public, you
have to file a prospectus with the Securities Regulators and get a receipt for it in
order to so.

Thus, the focus is two-fold: 1) first, the focus on the people who trade securities
with the public and 2) second, the focus is on the initial distribution of securities.

Security: Sec. 1 of the Act. First thing to notice is that the definition is not
exhaustive, but rather inclusive.

A key characteristic of what a security is a right to participate in the profit of an

An option to buy a security is also in and of itself a security.         Every debt
instrument that is tradable is also a security.

It also includes "any investment contract" which is caused a lot of litigation.
"Investment contract" was not defined in the Ontario Securities Act, but it is
defined in the Quebec Securities Act. An "investment contract" occurs where one
party enters into a contract with another party and invest in their enterprise,
invest in the other party's ability to create a profit for you.

PACIFIC COAST COIN EXCHANGE (SCC, 1970s): The commodity here was a
bag of silver coins. SCC decides it is an "investment contract" and, therefore a
security. The SCC said that the buyers never intended to take possession of silver
coins, but rather the buyers were buying a speculative instrument that would
allow you to profit from the rise and fall of the price of silver. In addition, the
buyers were buying the silver on margin. This was key to the determination that
the investment contract, in this case, was a security.

The case is most important, however, Mr. Justice De Grandpre came up with:
"The Securities Act is remedial legislation and must be construed broadly. It
must be read in the context of the economic realities to which it is addressed.
Substance, not form, is the governing factor."        These two sentences are
emblematic of the approach that courts have taken in this area and in many other
areas of securities regulation.

Thus, the court in this case looked at the substance of what was happening. By
doing this, they saw that people were making speculative investments in the

silver mine. Thus, the little piece of paper that got sent out to people which said
that they owned X bags of silver coins each weighing Y lbs was a security in the
eyes of the court. This decision has stood the test of the time.

De Grandpre also said in this case that because there is a dearth of case law in
Canada in this area, it is quite appropriate that when cases come up to the courts
in Canada that are novel to look to United States jurisprudence.

The test for what is a security according to McReynolds:

1) Are you making an investment in somebody else's business and does the
outcome of the investment depend on the skill, expertise or actions of a third
2) Are you taking of physical possession of what you bought or are you getting a
piece of paper that evidences an ownership interest?
3) Does the outcome of you investment depend on a change in value of a
commodity or an index?

If, at the root of what you are doing, is investing or speculating in the change in
value of something, then chances are it is a security because the goal of the
Securities Act is to protect investors. Thus, if you are being induced to invest in
something, then chances are what you are buying is a security.

In PACIFIC COAST COIN EXCHANGE, the reason that the bags of coins that
people bought were securities was because the people would buy the bags of
silver coins on margin. Thus, it was the margining issue that turned what would
have been a simple purchase of a commodity into an "investment contract."

"Trade": Section 1(1) of the Securities Act: "any sale or other disposition of a
security for valuable consideration…any act, advertisement, solicitation, conduct
or negotiation directly or indirectly in furtherance of any of the foregoing."

Valuable Consideration doesn't appear in Quebec Securities Act because you
don't need consideration for the transaction to be considered a trade. Moreover,
the Ontario Securities Act only mentions sale and not purchase. Thus, in
common-law jurisdictions, a gift is not a trade. Second, you don't have to be
registered to buy a security because the act of purchasing is not a trade.
However, the act of selling for valuable consideration is a trade.

The reason that all of us are not registered under the Securities Act is because
when we go to sell a security we call a stock broker and get him to sell on our
behalf. The stock br oker is registered so as to be able to effect a sale of our
securities on our behalf. Moreover, the stock broker also has to be registered
because he or she may well have recommended that one buy that security.

An underwriter is a registrant or dealer who participates in the distribution of
securities. Section 1(1) of the Securities Act defines underwriter as the following:
"means a person or company who, as principal, agrees to purchase securities with
a view to distribution or who, as agent, offers for sale or sells securities in
connection with a distribution …"

Prominent Canadian underwriters are: Royal Bank of Canada Dominion
Securities, Canadian Imperial Bank of Commerce World Markets, Bank of
Montreal Nesbitt Burns.

They will approach a company like BCE and ask if they want to raise more
capital by selling shares. If BCE does want to raise capital by selling shares, the
underwriters will say that they will buy the shares and turnaround and resell
them to our clients. This function of acting as an financial intermediary is what
an underwriters are. Moreover, if one is not BCE and is, in fact, a company
whose shares are not easy to sell, the company can go to one of these investment
firms and hire them to act as my agent which will entail them to find people who
will buy the company's shares.       This function too is one that belongs to an

Sales of securities, in and of themselves, are largely unregulated unless they
constitute a distribution. "Distribution" Section 1(1)(a) of the Securities Act: "a
trade in securities of an issuer that have not been previously issued." The only
time a secondary market sale is a distribution is stated in Section 1(1)(c) of the
Securities Act: "a trade in previously issued securities from the holdings from a
person, company or a combination of persons or companies who hold a sufficient
number of securities of that issuer to affect materially the control of that issuer."
Whenever you hear the expression "control block", that is referring to Sec tion
1(1)(c) is from the Securities Act. There is a rebuttable presumption in the
Securities Act that at the 20% percent level, one is in control. Thus, whether or
not my shares constitute a control block is a question of fact. But, there is a
rebuttable statutory presumption that at 20% percent level, my shares constitute a
"control block." If my holdings do constitute a "control block," any sale by me of
even one share will be considered a distribution.

Why regulate "control block" sales? Th e answer boils down to information. The
presumption is that the issuer of securities and the people who have controlling
interests of companies, have better and more current information about the issuer
and the securities that are being sold.

Section 1(1) of the Securities Act: "Adviser" is "any person or company engaging
in or holding him, her or itself out as engaging in the business of advising others
as to the investing in, or buying or selling of securities"

Section 1(1) of the Securities Act: "Issuer" is "a person or company who has
outstanding issues or proposes to issue a security."

Section 1(1) of the Securities Act: "Reporting Issuer" is "a person or company that
has filed a prospectus and obtained a receipt." If you file a final prospectus with
a securities commission and obtain a receipt for it, you are now a reporting issuer
and that subjects you to a bunch of rules requiring continuous disclosure about
information about yourself. These rules do not apply to mere issuers.

There are companies that are reporting issuers that have not filed a prospectus.
However, if their securities are listed on a stock exchange, you are a reporting
issuer in the province of that stock exchange. Given that the company has its
securities trading in a particular province, the Securities Act will make the
company subject to the disclosure rules even though the company in question
may never have filed a final prospectus with the securities commission of that

You can also become a reporting issuer through mergers and acquisitions. If a
private company that has never issued securities to the public and amalgamates
with a public corporation and all the shareholders get shares in the new
amalgamated corporation, that new amalgamated corporation will be a reporting
issuer. It will be the product of an amalgamation or, in some cases, a statutory
arrangement and it will, as a result of that legal process, be a reporting issuer.

You can become a reporting issuer voluntarily by filing a non-offering
prospectus. The non-offering prospectus is very similar to a regular prospectus,
but the company in question files the prospectus for the sole purpose of
becoming a reporting issuer. There are some advantages in terms of the ability to
have one's securities traded on a free basis if you have been reporting issuer for at
least a prescribed period of time.

Section 1(2) of the Securities Act: "affiliate" is defined as the following: "a
company is deemed to be an affiliate of another if one is the subsidiary of the
other, or if both companies are subsidiaries of the same company or if each of
them is controlled by the same person or company."

Control is where one person has more than 50% of the votes for election of the
board of directors of another person (section 1(3) of the Securities Act). This is a
de jure test.

Company A owns 51% of Company C. Company A owns 100% of Company B
and 49% of Company D. Company C owns Company E. Company B owns 10%
of Company F and company E also owns 10% of Company F and the public owns
the remaining 80% of Company F.

Thus, A controls B because it owns B 100% and controls C because it owns 51% of
C. However, since A only has 49% of D, A does not control D. C controls E with
100% ownership. A controls indir ectly through its 51% ownership of C. Thus, A
and B are affiliates because B is a subsidiary of A. C and A are also affiliates
because C is a subsidiary of A. E and C are affiliates because E is a subsidiary of
C. E and A are affiliates because E is a subsidiary of C which is a subsidiary of A.
D is not an affiliate of any of the other companies herein mentioned. B and E are
affiliates given that they are both subsidiaries of A. B and C are affiliates given
that they are both subsidiaries of A. A is deemed to beneficially own the
securities of E that C owns because C is a subsidiary of A (section 1(5) of the
Securities Act). B is deemed to beneficially own the shares of E that C owns
because B and C are affiliates (section 1(6) of the Securities Act)

The Securities Act defines take-over bid as where an offeror seeks to own more
than 20% of shares of a company. When you try to figure out what an offeror
owns you have to look at what is deemed to own beneficially as well. Thus, the
rules in Section 1(5) and Section 1(6) are there so as to avoid the possibility of A
defeating the 20% limit stated in the definition of take-over bid.
Section 1(5) of the Securities Act: "a person will be deemed to own beneficially
securities beneficially owned by a company controlled by that person or by an
affiliate of such a company"

Section 1(6) of the Securities Act: "a company shall be deemed to own
beneficially securities beneficially owned by its affiliates."


One can either register as a dealer or as an adviser. If you register as a dealer,
you are automatically allowed to give advice. However, if you register as an
adviser, it only entitles to you give advice, but not deal with securities.

Everyone who is registered is subject a variety of conditions of registration that
are in the Regulations in the Securities Act. These conditions start at Section 102
of the Regulations in the Securities Act. You don't need to memorize this stuff,
but you should know generally that if you are registered under the Securities Act,
you are subject to a number of conditions and regulations, such as maintaining a
certain amount of regulatory capital, in some cases subject to insurance bonding,
required to keep records, specific rules about setting up new acc ounts with
clients, specific rules about the segregation of clients' funds and securities.

There are also conditions of registration such as proficiency requirements that
demonstrate to the regulator that you got a base level of competency. Finally,
there are reporting requirements.       The onus is put upon registrants to
periodically report to the regulator what they are doing in certain areas, such as
monthly capital reports.

The provincial securities commissions have just come out with uniform forms for
registration and one will only have to apply with one securities commission and
if your application is successful, you are registered in all 10 provinces.

Ontario Securities Commission published a notice of hearing this week in the
OSC bulletin where they have proposed sanctions on a company called
Southwest Securities. It is an American company based in Texas and has no
offices in Canada and carries on no business in Canada other than it is the
correspondent firm for a Canadian-based day trading firm called Swift Trade.
Swift Trade out-sourced all the functions that the registrant has with the public to
Southwest Communications.


Part XXII of the Securities Act, especially Sections 122 to 129(1).

The goals of securities regulation are to promote efficient capital markets and to
deter fraud.

There are four different techniques that the government has used to deter and
punish fraud and operate to promote efficient capital markets.

Supreme Court of Canada has determined that it is within the power of the
provinces to put in with their Securities Acts, civil and penal provisions. At the
same time, the Federal government can put civil and penal provisions into the
Criminal Code or the CBCA.

Procedural Remedies available to the Commi ssion: Section 126 allows the
Securities Commission to issue orders freezing order. This is called interim
preservation of property. This is done on a ex parte basis, without notice to the
person who owns the property for a seven day period. Within the 7 days, the
Securities Commission must apply to a court for a judicial review of the order.

Section 129 allows the OSC to apply for the appointment a receiver, trustee or a
liquidator. The OSC applies to the Court for this appointment.

The limitation period in the Ontario Securities Act has now been extended 6 years
from the last event that could be the subject of an action.

Administrative Processes that the Commission can follow under Section 127 :

The Commission, when it considers that it is in the public interest to do so, can
have a hearing and can issue orders having a wide-ranging effect. The
commission can make a temporary order, but it must have a hearing no later than
15 days after the order. After 15 days, they have to have a hearing a t the
Securities Commission before a panel of Commissioners and make a decision as
to whether or not to issue any permanent orders.

The commission can suspend one's registration or attach terms and conditions to
one's registration.

The commission can order that trading in any given class of securities be halted.
This is known as the cease-trading power.

The commission can order to remove the ability of the insiders to trade by taking
away the exemptions that are available to the insiders to trade.

The commission can order a registrant submit to a review of its practices and
order changes in its practices.

With respect to disclosure documents that are filed with the commission, the
commission may issue orders stating that those documents be amen ded.

The commission can reprimand you.

The commission can order a director or an officer of an corporation to resign.

The commission can issue an order preventing someone to be an officer or
director of a corporation if they think that person is unfit .

The commission can fine you.

Civil Remedies that the Commission can pursue through the Courts under
Section 128:

The OSC can apply to the court. The Court has more powers: failure to observe a
court order is contempt of court and thus one can be threatened with penal
sanctions, the court can order rescission of a transaction, court can order a
cancellation of securities, court can order a refund, court can order compensation
and restitution, court can order punitive damages, court can order disgorgement
of amount obtained in the breach of law.

Penal Sanctions are prescribed under Section 122:

Three categories of penal offences:

1) general offences: 122(1)(a) lying to the OSC when you are the subject of an
   investigation, when giving evidence to the OSC, when being interviewed or
   even when talking to the OSC. Documents filed with OSC that contain
   misrepresentations: 122(1)(b). These documents, would be prospectuses,
   press releases, financial statements, take-over bids circulars, proxy circulars,
   offering memoranda. Finally, every other breach of Ontario Securities Law,
   not just the Act, is a contravention of the Act and therefore you can be charged
   under 122(1)(c). The maximum penalty for this is 2 years and a million dollar
2) Offences committed by directors and officers of an issuer: 122(3). Every
   director or officer who authorizes, permits or acquiesces in the commission of
   an offence by a company or person under 122(1) is him or herself guilty of an
   offence. There is due diligence defense for these directors and officers and it

   appears in 122(2). It provides that no person is guilty of the general offence if
   that person did not know and in exercise of reasonable diligence could not
   have known that a statement was misleading or untrue or that there was a
   material omission.
3) Insider Trading and Tipping: Section 122(4) provides a special category for
   fines on this crime. The fine for this crime will be at least the profit you made
   or loss avoided via the insider trading and not more than the greater of a
   million dollars or 3 times the profit made or the loss avoided. Only OSC can
   commence a prosecution.

October 6, 2000:

Subjects to be discussed in this lecture:
1) Process of issuer going public: relationship between issuers and underwrit ers,
   types of distributions that an issuer can carry on, the legal regime that requires
   that a prospectus be prepared and delivered to the buyer.
2) Types of Prospectuses
3) Preparation of a Prospectus

A distribution is the sale of previously unissued securitie s. This distribution can
be a sale from a control block. In certain circumstances, if one purchases
securities on an exempt basis (i.e. not pursuant to a prospectus), the resale of
those securities can within a certain time period can also be a distribut ion.

The overwhelming majority of public offering of shares are treasury issues.
Generally speaking, a sale of shares in the secondary market (unless the sale is
from a control block) is not going to be a distribution and therefore will not
require the preparation of a prospectus.

The first time one goes to the public to invites them to buy shares in one's
company is called the Initial Public Offering (IPO).

The whole point of prospectuses is to give investors the material facts to make an
informed decision. A material fact is defined in Section 1 of the Securities Act as
"any fact that could reasonably be expected to have a significant effect on the
market price or the value of the securities of the issuer." The requirement in the
Securities Act for an issuer preparing a prospectus is that they make full, true and
plain disclosure of all material facts.

Once you file a prospectus and receive a receipt for it, you become a reporting
issuer. As a reporting issuer, you then have an obligation to ma ke a variety of
continuous disclosure filings. These continuous disclosure filings include:

1) filing annual audited financial statements for the company
2) every quarter the issuer has to file interim financial statements
3) annually, the issuer will have to file a proxy circular that discloses to the
   public who the significant shareholders of the issuer are, who is nominated for
   election to the board of directors of the issuer, how much the executives of the
   issuer have been paid in the last 5years, how many stock options have been
   granted to the executives of the issuer and how many of those stock options
   they exercised, whether the issuer lent the executive any money, information
   about the management and direction of the issuer.
4) The issuer also to file an Annual Information Form (AIF) (aka form 10-k in
   the USA). This form is prescribed for most issuers in National Policy
   Statement 47. It is precondition to filing a short form prospectus. The AIF sets
   out a bunch of information about the company: when it was incorporated,
   where it has business, who the directors and officers are, etc.
5) Reporting issuers are also compelled to make unscheduled, timely disclosure
   of material facts and material changes in their business.

This body of information in the Quebec Securities Act is called the Permanent
Information Record.

The casebook has a reasonably decent passage about deciding to go public.


     If you are a public company, you can use your shares as currency to make
     other acquisitions. (e.g. AOL-Time Warner)
     If you are a public company, you can increase the liquidity of the shares for
     your shareholders.
     If you are a public company, you can measure what value of every minute of
     every trading day.
     If you are a public company, your shares can be used as collateral.
     If you are a pubic company, you get prestige and awareness that comes with
     being a public company.


1) It costs a lot of money: have to hire an investment dealer, a lawyer, an
2) Subject to all of the regime of disclosure
3) If you stay private, you can run your whole lifestyle through it. (i.e. tax
4) If you are a public company, you have to have outside directors, have to have
   an audit committee. Thus, if you are a public company in Canada, you ne ed
   to have at least 2 outside directors by law. As a result, there will be more
   bureaucracy that will have to be followed by the company.

The casebook refers to two other ways of going public:

1) One of the ways, called EXCHANGE-OFFERING PROSPECTUSES, is,
   according to McReynolds, entirely theoretical and no one ever does that.

2) The other way of going public is called a REVERSE TAKEOVER. The reverse
   takeover is where you have an existing public company that has remained
   public even though the company di d not succeed in its line of business. Some
   private companies will look at such failed companies as being attractive
   because the failed company has a stock exchange listing and, consequently, a
   history of being a reporting issuer, and thus will allow the private company to
   avoid having to hire and pay for investment dealers, lawyers, and
   accountants. The mechanics of the reverse takeover involve the private
   company selling itself to the public company and the private company taking
   back a majority of the shares of the public company. It is called a reverse
   takeover because the public company issues more shares than those that are
   currently outstanding so that person in charge of the private company has
   close to 80 or 90% control of the public company.

In Alberta, the law allows you to raise money without you having any idea what
to do with it. This is called a junior capital pools. The junior capital pools
become the seed capital to make further acquisitions and are used as vehicles for
what are effectively reverse takeovers.


There are three types of prospectuses:

1) long-form prospectus

2) short-form prospectus
3) shelf prospectus

Companies that make initial public offerings all use the long-form prospectus. It
must contain the information set out in Form 12 to the Securities Act. Form 12 is
the prospectus form for an industrial company. Form 12 sets out all of the
information that has to be put in a prospectus. There are variety of items t hat are
prescribed content for prospectuses.

There are some content provisions that are in the Regulations themselves. This is
the case for financial statements, for example. Section 37 until Section 66 of
Regulations of the Securities Act prescribe a variety of other rules with respect to
what has to be in the prospectus.

The face page of the prospectus usually look the same way because item 1 of the
Form requires to put your distribution spread in. In fact, virtually everything
one sees on the face page of the prospectus is prescribed by the Form.

Item 5 of the Form is use of proceeds which sets out what the money raised will
be used on.

Another thing that is important in a prospectus are the risk factors which are the
risks associated with buying the securities. The risk factors state why the plans of
management may not work out.

In addition to all of the form items in Form 12, there are also financial statement
content requirements which are found in the Regulations to the Securities Act,
starting at Section 53. The Act and the Regulations to the Act mandate that the
financial statements of the company for the previous 5 years be shown. Most
times, however, you can get a waiver from the Securities Commission to reduce
the period for which financial statements of the company down to 3 years.

If you file the preliminary prospectus within 120 days of audited financial
statements, you meet your obligations. However, if your audited financial
statements are older than that, then you have to prepare new financial statements
which don't have to be audited but have to be filed within 90 days of filing the
preliminary prospectus.

If you are going to use the money raised to buy another business, then you have
to prepare what are called pro-forma financial statements, which show what
your business is going to look like after the acquisition.

You also have to prepare something called Management's Discussion and
Analysis of the Results of the Financial Performance of the Company (MDNA).
It is designed to take you through the financial statements through the eyes of

Moreover, you have to provide an outlook section which predicts what is going
to happen to the company in the future. This is called Future Oriented Financial
Information (FOFI) and is referred to in National Policy 48. NP 48 says that if
you are going to provide Future Oriented Financial Information, then you have
an obligation to have your assumptions checked by your auditors and explain to
people what your assumptions are.

Up until 1983, all prospectuses were long form prospectuses. In the early 80s, the
SEC in the United States was overwhelmed with these long form prospectuses.
The SEC then started to understand that the some of the companies were more
high risk than others. Thus, they came up with a selective review policy. Thus,
there is a section in most short-form prospectuses that is entitled in Documents
that are Incorporated by reference.

How does one become a short-form flier? You must have been a reporting issuer
for at least 12 months and have filed an AIF that has been reviewed by the
Securities Commission and in Canada, you have to have a market capitalization
of $75 million dollars. This is known as the Prompt Offering Prospectus
Qualification System. (POP)

National Policy 47 is the mechanism through which the POP Qualification
System was adopted in every province other than Quebec. In Quebec, the POP
Qualification System appears right in the Quebec Securities Act.

Whether you use a short form or a long form prospectus, the process is the

1) First, you file a preliminary prospectus
2) The Securities Commission will then issue a receipt for the prospectus

3) In the case of long-form prospectuses, the Securities Commissions have 10
   business days to make comments, which may or may not be extensive. (this
   period is 3 business days if you are filing a short-form prospectus.)
4) If Securities Commissions think that you have omitted something or if they
   are not clear about something, they will write you a letter asking you to
   clarify. You have to clarify before you are allowed to file the final prospectus.

The preliminary prospectus allows you to market the securities and solicit
expressions of interest. You are not allowed to sell securities until there is a final

Generally, one province will take the lead in reviewing the prospectuses and
issue the first comment letter. Once the lead jurisdiction has done this, the other
provinces will then generally look at what the lead jurisdiction's comments were
and then look at the prospectus and add any comments they may have in the
form of a second comment letter which is supposed to be provided within 5 days
of the first letter being provided.       When all of the comments have been
responded to satisfactorily, the lead jurisdiction will then tell the issuer make the
changes that you have said that you will make and then you can file your final
prospectus and then the Securities Commission issue a receipt for it and then you
are allowed to contract with potential buyers for the securities in question.

The Securities Act then requires that you send a final prospectus to each buyer
together with a confirmation slip that is evidence of the contract of purchase and
sale of securities.

The Securities Act also has consumer protection feature to it that provides for a 48
hour cooling off period. Thus, everyone who buys securities pursuant to a
prospectus has the right under the Securities Act to rescind the transaction within
48 hours of receiving the prospectus.

There are a couple of different types of underwriting that you find in short -form

Usually, during the period in which the Securities Commission is reviewing a
prospectus, the issuer and the underwriter will go across the country and have
marketing shows in every city and stock brokers are invited to a hotel ballroom
and meet with the company and hear the story of the company.

However, other times, underwriters will buy the securities straight from the
issuer and then issuer will file a preliminary prospectus within the next 48 hours
and the underwriter assumes that the prospectus will clear within the next 3 to 5
days and then the issuer will file its final prospectus and at that time the issuer
will get his money from the underwriter. This is known as a bought deal.

SHELF PROSPECTUS: National Policy 44 deals with shelf prospectuses. This
was another mechanism that created to try to facilitate easier access to capital by
seasoned companies. Thus, you are only eligible to file a shelf prospectus if you
are an issuer that has had a reporting history for, at least, a year and have a
minimum market capitalization of 75 million dollars. It is largely used for debt
securities, rather than equity. However, it can be used for both.

You file a prospectus and you qualify for distribution a large quantity of
unspecified debt securities. And then when you actually figure out what it is that
you do want to sell, you file a supplement to your prospectus with the specific
terms of the specific securities that you want to sell.

                        THAN MCREYNOLDS:

The Shelf Prospectus allows the issuer to qualify a prospectus that will apply to
a series of distributions of securities under the prospectus over the ensuing
two years. To do this the issuer files the short-form prospectus that would be
filed under the POP system. However, the short-form prospectus can omit
information that would normally be included. The omitted information is
information that relates to a specific tranche of securities to be distributed and
which will vary from one trance of securities to another. When a tranche of the
securities cleared under the short-form prospectus is issued, the issuer must
provide a prospectus supplement which contains the omitted information. The
prospectus supplement will not normally be vetted by the Securities
Commission, but must be filed within 2 days of the date on which the offering
price of the securities is determined or within 2 days of the first use of the
supplement. The distribution of a particular tranche can start whenever the
issuer and its underwriters decide it is an appropriate time to issue the securities.

The short-form prospectus filed under the shelf procedures must set out the
aggregate amount of securities to be offered under the prospectus and all
information that will not vary from the offering of one tranche of securities under

the prospectus to another. To the extent that information is not known at the date
of the filing of the shelf offering of the short-form prospectus, there may be
omitted from the short-form prospectus filed under the shelf procedures such
information as:

1) the amount of securities to be distributed under each separate tranche of
   securities distributed under the prospectus;
2) maturities, denominations, interest, or dividend provisions, purchase,
   redemption, retraction, conversion, exchange, or sinking fund provisions, or
   any other special covenants or terms applicable to a partic ular tranche of
   securities to be distributed;
3) which of any alternative methods of distribution will be applicable to each
   tranche of securities offered;
4) names of any underwriters, conflicts of interest or prospectus certificates of
   unnamed underwriters, the distribution spread, underwriting fees, discounts
   and commissions
5) the public offering price, delivery dates, legal opinions concerning the
   eligibility of for investment of the securities, statements regarding of the
   securities, actual amount of proceeds or more specific information about the
   use of proceeds.

The above enumerated information is known as "shelf information." The
short-form prospectus filed under the shelf procedures must indicate that all
such information will be provided in one or more prospectus supplements that
will be delivered to purchasers together with the prospectus .

The shelf prospectus must incorporate by reference the latest AIF. It must also
incorporate by reference continuous disclosure documents filed since the
beginning of the latest financial year in which the latest AIF was filed. It is
deemed to incorporate by reference the latest AIF and all continuous disclosure
documents filed by the issuer after the date of the prospectus and before the
completion, or withdrawal, of the offering.


Section 1of the Securities Act defines misrepresentation: "an untrue statement of
material fact or 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"

Section 130 of the Securities Act, "Civil Liability for Misrepresentations in
Persons who purchased the securities under the prospectus are deemed to have
relied by Section 130 on the misrepresentation. This is important because at
common law if you just sued somebody for a misrepresentation in a prospectus,
you had to establish detrimental reliance. In essence, you had to prove, as a
plaintiff, that you relied on the misrepresentation. Under Section 130, you are
presumed to have relied on a misrepresentation.

You have a right for damages against the issuer or if you bought from a selling
security holder under a prospectus, you have a right for damages against the
selling security holder. Second, you have a right for damages against each
underwriter who signed the certificate page of the prospectus. Moreover, every
director of the issuer that sign a certificate that says that there are no
misrepresentations in the prospectus can be sued for damages if indeed there is a
misrepresentation. Finally, every person or company who has expertized the
prospectus can be sued for damages. For example, there is section usually
entitled "Eligibility for Investment" and a law firm will usually sign off on that
part that the securities being offered will qualify as investments under the
Income Tax Act. If that law firm is wrong about that, the law firm can be sued on
the matter. Moreover, every other person wh o has signed the certificate page of
prospectus, like the CEO and CFO, can also be sued for damages.

In the case of the issuer or the underwriters, the purchaser of such securities has
in addition to the cause of action for damages but can also exercise a right of
rescission. However, if you exercise your right of rescission, you obviously
cannot then claim damages.

Section 130(2) of the Securities Act: Nobody is liable if the purchaser knew of the

Section 130(4) and 130(5) of the Securities Act: Due Diligence Defense does not
apply to the selling security holder or the issuer. However, it is available to
underwriters and to the other signatories of the certificate page of the prospectus.
If these people can establish that they took reasonable action and made a
reasonable investigation to make sure that there was no misrepresentation and,
as such, believed that there was no misrepresentation, then such people are

unlikely to be held liable. In essence, if you have made it your business to satisfy
yourself to a standard that a reasonable person would consider appropriate and
reasonable in the circumstances that the content of the prospectus is true and that
there are no material omissions, then you are unlikely to be held liable.

The leading case on this matter is ESCOTT v. BARCHRIS CONSTRUCTION
CORP. It can be found on page 176 and 177 of the casebook and should be read
according to McReynolds. This case dealt with a company that would build
bowling alleys. They would finance the cost of building the bowling alleys by
accepting promissory notes from the people who would own the bowling alley in
question. However, many of the people were defaulting on the promissory notes.
The company, however, was showing an asset all of the se accounts receivable
which consisted of the promissory notes as good assets when they were not good
assets because people were not paying their promissory notes. The company
does a public offering and did not tell anybody that their clients were default ing
on their promissory notes. The company went bankrupt a year later and someone
sued. Some of the outside directors claimed that they did not know that the
promissory notes were being defaulted upon when they had signed the certificate
page of the prospectus and that they had asked the CEO if everything is OK and
the CEO had said yes. The court, however, finds that this is not acting reasonably
for the outside directors and consequently does not shield them from liability.

There are some limitations of liability. Obviously, an underwriter cannot be sued
for more than the portion of the offering that they distributed. The public at large
cannot recover more than they paid.

If you are a director of a company and you objected to the filing of the
prospectus, you can exculpate yourself from liability in this fashion.

Moreover, the rights of action in Section 130 are in addition and without
derogation of any other right you may have at common law (see 130(10)).

October 13, 2000:

Exempt distributions

You may have seen references in the casebook to the expression "the closed
system." The expression means the following: until such time the distribution of
securities is qualified by a prospectus or otherwise released by the passage of
time, securities that are issued on an exempt basis, i.e. without a prospectus

qualification, will not be freely tradable. These securities are, therefore, caught in
the "closed system." In other words, it means that if you bought such securities
you purchased them with legal restrictions on your ability to resell them.
Remember, this only catches securities that are the subject of a distribution.

A distribution is the issuance from treasury of securities that have not been
previously issued or a sale from a control block. The general idea is that
whenever there is a distribution of securities, the presumptive informational
imbalance between the issuer or the control block person who is the seller of the
securities and the public purchaser of the securities must be corrected through
the provision of disclosure of all material facts related to the issuer and the
securities being sold. The mechanism for this disclosure is a prospectus. If there
is no prospectus, the presumption is that the informational imbalance has not
been rectified. While the legislatures of the various provinces understood that in
certain circumstances buyers don't necessarily need prospectuses (i.e. that there
are certain categories of purchasers and certain types of securities where as a
matter of public policy the legislatures were prepared to concede that even if
there is an informational imbalance, a prospectus would not be needed), the
legislatures have discouraged people from taking advantage of those exemptions
by fettering the ability of the purchasers of securities on an exempt basis from
turning around and selling them.

The selling of securities on an exempt basis is known as a private placement.

The whole "closed system" has been called into question for the last 15 years and
have suggested that it is "Byzantine, complex, illogical and not cost effective."

Securities that are distributed without the benefit of a prospectus, go into the
"closed system." That is to say, by virtue of Section 72(4) or (5) or, in some cases
(7) of Securities Act, any resale of these securities that were distributed on an
exempt basis is itself a distribution. Thus, a distribution will also be the first
trade in securities that were previously issued on an exempt basis. In addition, a
distribution will also include additional trades in securities that were distributed
on an exempt basis if there were certain resales of those securities that were
distributed on an exempt basis prior to the expiry of a prescribed time period.

Thus, when securities are issued on an exempt basis, there are 2 ways to get out
of the "closed system:"

1) The first way is to qualify the distribution (i.e. the resale of those securities)
   with a prospectus
2) The second way is to allow for the passage of a certain amount of prescribed
   time. In most cases, with the passage of time, the securities will become freely
   tradable and will be freely sold and will out of the "closed system." The time
   period is generally either 6, 12 or 18 months. Moreover, the issuer must have
   been a reporting issuer for at least a year.

The critical legislative passages that one should read: Section 72 of the Act,
Section 72(7) of the Act, Section 73, Rule 45-501, CP 45-501, Rule 45-502, National
Instrument 62-101 (which deals with control block sale s by certain eligible
institutions) and Section 35 (which deals with the registration requirement.)

All issuers are not subject to prospectus regulation when they issue securities.

The first category of exemptions apply to what are known as private issuers.
There is a definition in Section 1 that tells you what a private company is. Section
73(1)(a) contains a prospectus exemption for all securities that are described in
Section 35(2) of the Act, except for paragraphs 14 and 15 of Section 35(2). Section
73(1)(a) imports into the prospectus exemptions provisions all of the securities
for which registration is not required under Section 35(2) of the Securities Act.
One of the sections for which registration to trade is not required for securities of
a private company (Sec. 35(2)(10)).

Thus, the first question you have in trying to figure out whether you can avail
yourself of that exemption is: am I dealing with securities of a private company.
Rule 45-501 has expanded the notion of what constitutes a private company to
include non-corporate issuers.

A private company is defined in the Securities Act as a company whose articles of
incorporation, by-laws, memorandum of association contains a restriction on the
transfer of securities of the corporation. Thus, the first thing you need to have in
order avail yourself of this exemption is to have a passage in the constituting documents
of the corporation that says "the right to transfer the shares of the corporation is restricted
in that no share shall be transferred without the express approval of the majority of board
of directors." By law, in most Canadian jurisdictions, you cannot have such
restrictions if you are a public company.

The second thing you need to have in the constituting documents in order to be
considered a private company as defined in the Securities Act is a limit on the number of
shareholders. The limit is that there be not more than 50 shareholders, exclusive of
employees or former employees.

The third thing you need to have is that any invitation to the public to subscribe for the
securities of your company is prohibited.

The fourth thing is that you can issue securities of a private company where they are
not offered for sale to the public. This element has been the subject of a substantial
amount of litigation because it brings into question what constitutes "the public"?
The case law in this area largely stems from enforcement actions, charges that
have been laid under provincial securities laws against individuals who have
offered to sell securities or sold securities to people who subsequently did not
like the way it turned out and complained about that.


There are two lines of cases that have been adopted by the Canadian cour ts when
these sorts of issues come up.

The first line of cases is represented in your casebook by the SEC v. RALSTON
PURINA. It is a Supreme Court of the United States case from the 1950's. The
Purina Corporation would encourage their employees to purchase shares in the
company. Thus, they established an employee share purchase program where
employees could check off a box on a form and every pay day, a couple of dollars
would be taken off their pay check and applied it to the purchase of shares. The
Securities Exchange Commission said that the share purchase program was
inappropriate because the mere fact that employees are employees does not cure
the informational imbalance and thus they considered it necessary for the
employees to be provided with a prospectus. The Court of First Instance said
that the SEC was wrong. The Court of Appeals says there is no informational
imbalance because they are employees. The Supreme Court of the United States
said that the SEC was right because what really matters here is do these people
have sufficient information about the company that a prospectus is not
warranted? On that test, the Supreme Court held that there ought to have been a

Therefore, the case stands for a need to know approach to analyzing whether a
particular person or a group of persons falls within the rubric of "the public" for
securities laws purposes.

Canadian legislatures have passed a rule that says that you can issue shares to an
employee. There is a specific exemption in Canada to allow you to issue
securities to employees. The RALSTON PURINA case is still important in a
sense because there may be situations where a group of persons don't meet the
legal test of whether there is an employer-employee relationship. Moreover, it is
still important because one of the things you look at is whether or not the people
have a need to know to some of the information they would otherwise get from a

The other stream of case law developed in Canada is illustrated by R. v.
PIEPGRASS. There was a fellow in the 1950s in Alberta in his company and
went to some friends and acquaintances and went to a complete stranger and
offered them some shares. The court in this case took different approach. The
court said that it does not matter what people know, what really matters is how
well do you know the people. The court said the difference between private and
public should be measured based on the personal relationship between the
person who is buying the security and the person who is selling the security.

There are variety a number of phrases in this case that people have brought
forward as being relevant factors for your consideration:

1) am I dealing with people who have common bonds of interest or association
   when I am offering these shares up?

There is a case called R. v. BUCK RIVER RESOURCES (1984 25 Business Law
Reports 209). Have a look at this case. It tried to expand what it means to have
"common bonds of interest or association." In that case, the individual def endant
was trying persuade people that were co-operators of a Minor Hockey
Association somewhere out west to purchase shares from him. The defendant
tried to claim that he and the people he was trying to convince to buy the shares
shared common bonds of interest and association because they were all on the
board of directors of the Red Deer Minor Hockey Association. The judge,
however, said that the common bonds that they shared were purely social when
convicting the defendant. The judge reasoned that the bonds of association have
to be the kinds of bonds that allow the purchaser to really know whether they are
dealing with someone of character and integrity. The judge went on to say that

the common bonds ought to relate to the particular company or venture
involved. The judge did not really apply the Ralston Purina case.

Canadian courts now apply both lines of cases:
See, for example, a case that came out in 1996, a Manitoba case, (1996 11 CCLS
1999) called R. v. ZITZERMAN. You don't have to read this case, but it applies
both the Ralston Purina and the Piepgrass and Buck River line of thinking. In this
particular case, there was a lawyer in Winnipeg who was also selling securities to
some of his clients. The lawyer pleaded that he and his clients had common
bonds of interest. The judge said that doesn't work. The judge also said that
Ralston Purina makes sense because it is about correcting an informational
imbalance and so the mere fact that the lawyer sells to his clients does not mean
they get the necessary information about the issuer.

Ask yourself the following questions through a fact pattern on the exam:

1) were the purchasers sophisticated?
2) Was there a broad solicitation?
3) Ask yourself would virtually any subscription be accepted?
4) Ask yourself were the investors friends or associates of the person? If they
   were under the Piepgrass theory, they are not going to be members of the
   public. What common bonds of interest or association exist? If there are any
   common bonds, are they the sort that give the investors an opportunity to
   truly know the seller's character and integrity?
5) Was there any selling pressure?
6) How did the buyers come to know about the opportunity?
7) Were they given anything that resembles a prospectus or a selling document?

A second group of exemptions that are predicated on the presumed
sophistication of the purchasers. There are a number of circumstances where the
legislatures have said that some people can look out for themselves and thus they
do not need the classic protection of the Securities Act.

Section 72(1)(a): prescribes types of financial institutions that are presumed to be
able to take care of themselves. These types of financial institutions so presumed
include: credit unions, loan and trust corporations, chart ered banks, caisses
populaires, insurance companies, registered investment dealers, the Federal and
Provincial Governments, Public Boards, Municipal Corporations.

Section 72(1)(c): sets out a way to go to the Securities Commission to prove that
you are sophisticated and get yourself on a list of exempt purchasers.

Section 72(1)(d): "the purchaser purchases as principal, if the trade is in a security
which has an aggregate acquisition cost to such purchaser of not less than
$150,000 or such other amount as is prescribed." In 72(1)(a) and (c) there is no
minimum amount of the securities that one would have to purchase.

Rule 45-501 adds some new wrinkles to Sec. 72(1)(d):

1)   you can now buy more than one issue as long as the total is at least $150,000.
     Before, you pay for each separate issuer you had to pay $150,000
2)   You can pay by assuming liabilities or by giving a promissory note. If you
     are paying by a promissory note, there has to be an interest component to
     make sure that the present value is $150,000.
3)   The $150,000 has to come from one person. Thus, two friends cannot each
     chip $75,000 or create a corporation to simply defeat the rule.
4)   Investment clubs: each member of the club has to put up $150,000.
5)   If you advertise securities that you propose to sell under this exemption,
     then you must prepare and deliver to the purchasers an offering
     memorandum. Offering memorandum is any document that purports to
     describe the business and affairs of the issuer. There are no prescribed
     content provisions for offering memoranda in Ontario. First, whatever goes
     into the offering memorandum has to be true and there can be no
     misrepresentation.      Second, you have to include in the offering
     memorandum a contractual right of action. In other words, you have to give
     people, by virtue of your contract of sale and purchase of securities, the same
     rights of rescission and damages that they would have had had they bought
     under a prospectus that are contained in Section 130 of the Act.

These above subsections of section 72 are known as the private placement

Another group of exemptions has to do with seed capital. It is the principal
exemption available for young companies accessing capital for the first time.
This is found in Section 72(1)(p)

The number of solicitations is limited up to 50 and you can only sell to 25. The
people who can buy under this exemption are: 1) family members who have
knowledge about the business or 2) other people who by virtue of their net worth

or their investment experience can be presumed to be sophisticated enough to
take care of themselves and who also have access to sufficient information about
the business to make an informed decision. This exemption can only be used

All purchasers under this exemption have to be purchasing as principal for their
own account.

The next exemption is an exemption for "government incentive securities." These
are tax shelter securities. You cannot advertise these securities. You were limited
to 75 solicitations and 50 purchasers.

Another group of exemptions that exist where the securities themselves are
presumptively safe. Section 73(1)(a) will refer to Section 35(2)(1) (for government

Finally, there are some other exemptions because the way in which the security is
distributed (Section 72(1)(f)(1)). These are known as issuer trade exemptions.
These are exemptions are predicated on the way in which the securities are
received by the buyer. (Company declaring a stock dividend) If you look at Rule
45-502, there are variety of rules in this rule that deal with dividend re-
investment plans. This can be done on an exempt basis.

Section 72(1)(f)(2): is another exemption and it occurs where securities are issued
are incidental to a good-faith reorganization or winding up or a distribution for
the purpose of winding up.            Does that mean if you do a good-faith
reorganization of the capital of the company that has nothing to do with winding
it up, do you still qualify for that exemption. The answer is probably yes. The
question is what is a reorganization in this context? Does it mean a situation
where you are reorganizing the capital because it is insolvent or because it is
going insolvent under the Corporate Creditors Arrangement Act? That situation
probably applies. What if it is a perfectly solvent corporation that is reorganizing
its capital? The exemption would probably apply.

Section 72(1)(f)(3)(i): this is an exemption for securities issued pursuant to the
exercise the right of a purchase, convert, or exchange previously granted by the
issuer. There are some qualifications to using this exemption: there can be no
commissions or payments other than for professional services rendered by a
registered dealer. When a company issued a convertible debenture, a conv ertible
preferred share, or any other kind of convertible share or security, a warrant, a

right, a stock option (anything that has the right to buy yet another security) that
other security is generally not issued under a prospectus as long as it is issued by
the same company. It is generally delivered to the person who exercised that
conversion or purchase right under this exemption

October 20, 2000:

[Note: the $150,000 exemption will be done away with very soon, and a "net
worth" rule will come into force.]


Exemption for rights offering: 72(1)(h)
72(1) Prospectus not required – ―Subject to the regulations, s. 53 and 62 do not
apply to a distribution where,
h) the trade is made by an issuer,
(i)    in a right, transferable or otherwise granted by the issuer to holder of its
       securities to purchase additional securities of its own issue and the issue of
       securities pursuant to the exercise of the right, or
(ii)   in securities of a reporting issuer held by it transferred or issued through
       the exercise of a right to purchase, convert or exchange previously granted
       by the issuer
if the issuer has given the Commission written notice stating the date, amount,
nature and conditions of the proposed trade, including the approxima te net
proceeds to be derived by the issuer on the basis of such additional securities
being fully taken up and either,
(iii) the Commission has not informed the issuer in writing within 10 days of
       the giving of the notice that it objects to the proposed trade, or
(iv) the issuer has not delivered to the Commission information relating to the
       securities that is satisfactory to and accepted by the Commission.‖

This facilitates a ―rights offering‖ ie a method of raising share capital from
existing shareholders rather than the public at large. Members are given a right
to acquire future shares, usually in proportion to their existing holding and at a
price below the market value of existing shares. This is so that existing
shareholders can maintain their % share. The shares that have not been
purchased by shareholders can be transferred to underwriters so that they can
seek outside buyers.

Sometimes, the only way for some junior companies to get financing is by doing a
rights offering since only their existing shareholders will buy additional shares
(the company is not doing well and existing shareholders figure the only way to
save the company is to put more money in!).

Thus, the Securities Act provides this exemption for the distribution of the rights
out to security holders. However, OSC Policy 6.2 adds some gloss to this
exemption by saying that they are a little bit uncomfortable with this going on in
a couple of areas. This policy statement will become a rule probably by the end
of this year.

The first area that the Securities Commission feels uncomfortable with this
exemption is with respect to issuers that are reporting issuers for less than one
year. Thus, if you have not been a reporting issuer for a year, the Commission
will reject any use of that exemption.

The second area that the Securities Commission feels uncomfortable with this
exemption is when then magnitude of the new financing that is being created by
these rights is more than 25% of the company's capitalization. Thus, if the
company has a million shares outstanding and it issues rights to its shareholders
that basically say "for every 4 shares that you currently have, you can buy one
new one," it would be ok to do that on an exempt basis and you just do a little
circular and you send it out to your shareholders explaining what the deal is and
how to exercise the right, but you don't have to do a prospectus. However, if you
go beyond the 25% threshold by saying that the issuer, for example, will double
the company's capitalization ("for every share your currently own, you can buy
one new share"), the Securities Commission will reject the use of the exemption in
this case because the magnitude of the new financing that it should really not be
done on an exempt basis.

The third area that the Securities Commission feels uncomfortable with this
exemption is with respect to these "junior" companies that have been "dormant,"
even though they have been reporting issuers for 12 months. The Securities
Commission does not allow the use of this exemption if the company has been
dormant (not carrying on much in the way of business), even if it has been
current in its continuous disclosure or even if the company has not been dormant
but will take the money raised by the issuance of this new capital and go into a
whole line of business.

Thus, you have this regime with this exemption. However, layered onto this
exemption, the Securities Commission has come along and said that there are
certain circumstances where we are going to object to the use of this exemption
and they have the power built right in that exemption to so object.

Section 72(1)(h)(ii) Exchangeable Securities: this talks about where the issuer is
distributing to its securities holders securities of a different reporting issuer and
not of its own. Thus, if the reporting issuer issues to its securities holders a
debenture, for example, that is exchangeable for shares of another company that
the reporting issuer owns.

A convertible debenture is where I give you a debenture (a debt o bligation of the
issuer) and you can exercise a right to convert into shares that I issue (securities
of the same issuer)

An exchangeable debenture, however, is, classically, where you take a debt
instrument of one issuer and that issuer has attached to that instrument a right
that the holder has to exchange it for securities of yet a different issuer provided
that that issuer is a reporting issuer those other securities (they are pre-existing)
can be delivered out to you on an exempt basis under Section 7 2(1)(h)(ii).

Now, the way Section 72(1)(h)(ii) and 72(1)(f)(iii), for that matter, contemplates a
situation where the security holder exercises a right to convert or to purchase or
to exchange. A lot of these instruments have been drafted in a way that t he
conversion or exchange of the instrument is not necessarily dictated by the action
of the holder. The conversion or exchange can happen automatically in certain
circumstances or, in fact, the issuer of the securities can reserve the right to cause
the conversion or exchange of the instrument in certain prescribed circumstances.
Where this is the case, Rule 45-501 has layered on to Sections 72(1)(f)(iii) and
72(1)(h)(ii) , a prospectus exemption that deals with both automatic and issuer -
triggered exchanges as opposed to holder-initiated exchanges (found in Section
2(10) of Rule 45-501). Read Rule 45-501.

Section 72(1)(i) is designed to deal with corporate mergers. "the trade is made in
a security of a company that is exchanged by or for the account of such company
with another company or the holders of the securities of that other company in
with, (i) a statutory amalgamation or arrangement, or (ii) a statutory procedure
under which one company takes title to the assets of the other company which in
turn loses its existence by operation of law, or under which the existing
companies merge into a new company;

The classic example of this: Two companies amalgamate: Company A and
Company B amalgamate and Company C comes into existence. Company A
shareholders and Company B will exchange their securities for securities of
Company C. All of those securities of Company C that are issued on that
exchange will be exempt under Section 72(1)(i).         Rule 45 -501 goes on and
expands Sec. 72(1)(i) to make it clear that it is intended to apply in any sort of
arrangement, amalgamation or merger transaction that gets you to the same
substantive result. You should read Companion Policy 45-501 because it tries to
explain some of these things.

Section 72(1)(j): exemptions for takeover bids. A takeover bid is a specific way
for one company to takeover another company. It is highly regulated way
because it is the only way that allows one company to deal directly with the
shareholders of the target company. As a result, it is mandated in Part XX of the
Securities Act, that anyone who wants to make a takeover bid must prepare a
takeover bid circular that contains a wide variety of prescribed information. If
the acquirer wants to offer its own securities as consideration instead of just cash,
then the Act and its Regulations go on to say that the takeover bid circular must
contain the same information that a prospectus for the acquirer would contain. In
Section 2.2 of Companion Policy 45-501, you will see some discussion by the
Securities Commission about their concern for abuse when shell companies try to
become reporting issuers using sub-standard disclosure documents. The reason
for that comment in the Companion Policy is that Securities Commission does
have discretion and reserves the right to say: "the mere fact that you are doing a
securities and exchange takeover bid circular, does not necessarily mean we are
going to give reporting issuer status and we are going to check those circulars
when shell companies are being used as acquirers to make sure that there truly is
appropriate prospectus level disclosure made or otherwise we will deny the
prospectus exemption."

Section 72(1)(k): If an offer is made to you that is a takeover bid and you accept
it and sell your securities to a bidder, that is a trade. This is not a big deal if you
have freely tradable securities. If, however, you had securities that were
themselves not freely tradable because they were in the "closed" system or
because they were part of a control block (and, therefore, any trade is a
distribution) you need an exemption in order to accept the takeover bid offer.
Section 72(1)(k) is that exemption.

Section 72(1)(n): has been the traditional exemption for sales to employees.
There is a whole new rule that has replaced Section 72(1)(n) and that is Rule 45 -
503 and so you should read it. Historically, 72(1)(n) has been the exemption to
issue stock option to employees. This exemption in the Act has been removed by
Rule 45-503 and is there now a more comprehensive scheme that has broadened
the universe of people to whom a company may grant and issue securities (in
particular, granting options) on an exempt basis. Thus, employees can receive
securities under this exemptions and so can employees of affiliates. Consultants
can receive securities. Note there is a definition of what consultant is in Rule 45 -

Historically, the TSE imposed rules on the issuance of stock options relating to
the price, to whom stock options could be granted, etc… The OSC imposed no
real restrictions on the issuance of stock options. 45-503 has imported the TSE
requirements into the Securities Act. These requirements seek to limit the
amount of dilution that shareholders can suffer as a result of the granting of stock
options; forbid granting options below market price, granting options that are
transferable, as well as options that last more than 10 years. As well, these
requirements restrict the issuance of stock options to insiders. Within these
constraints, the issuance of stock options can be done in any way.

One requirements is that in the case of the issue of a security as an incentive, the
incentive or incentive plan must specify a maximum number of securities that
can be issued as options. This is also a rule that 45-503 applies where the number
of shares reserved for issuance under stock options exceeds 10% of the
outstanding issue.


There are certain trades in outstanding shares that are defined as distributions by
virtue of 72(4), (5), (6); and various provisions in Rule 45-501, 45-503, etc…

1(1): Definition of distribution: One type of distribution that is treated
analogously to an issue by a company is a trade by a control block.

A control person is a person who is the holder of control block shares.

There is a (rebuttable) presumption that someone holding more than 20% of the
shares if a control person. The question of “control” is a matter of fact. The
presumption will be rebutted is someone else holds 35% of shares a nd the 20%

shareholder has no one on the Board of Directors. Below 20%, there is no
presumption of control, but control may still exist: a 19% shareholder is the
largest shareholder, has some people on the board of directors, etc… [The lowest
number accepted so far in the case law is 12%.]

The test for whether you are making a distribution is whether you are a control
person, and not just an insider (you are an insider if you own more than 10% of

A bunch of shareholders who get together and agree to all vote in the same
manner may be considered to be making a distribution [Part XX mentions that
even oral Ks to vote in the same manner may be used to deem persons to be part
of a control block]. There are a variety of other tests (apart from all v oting
together) for when people are considered to be part of a control block.

 There is no black-and-white test for whether someone or a group of persons is
  considered a control block. The key is whether, as a matter of fact, someone
  or group a group of persons controls the company, materially affects the
  control of an issuer.
 If a shareholder is within a control block, a sale of his shares will be deemed to
  be a distribution, no matter how much say the shareholder has in the group.
  Thus, a prospectus will be required unless you can find a prospectus

"Dribble Out" Exemption in 72(7) – deals specifically with control block sales.
The section says that a control block person can use an exemption in Section
72(1)(so that the stock stays within the "closed system") or if the company has
been a reporting issuer for at least 18 months you can file a notice with the
Securities Commission of your intention to dispose of a defined number of
securities provided that you certify that you have no knowle dge of any material
change or any material adverse information that is not generally disclosed and
then starting 7 days later for a period of X days after that you can sell your
securities in the marketplace. Thus, there is a way for control person without
doing a prospectus and without selling on an exempt basis to get securities out of
the "closed system" using the exemption in 72(7).

Prospectus not required – ―s. 53 and 62 do not apply to a distribution with in the
meaning of (c) of the definition of ―distribution‖ in 1(1) or by a lender, pledgee,
mortgagee or other encumbrance for the purpose of liquidating a debt made in
good faith by selling or offering for sale a security pledged, mortgaged, or

otherwise encumbrance in good faith as collateral for the debt in accordance with
(1)(e) if
    (a) the distribution is exempted by Ontario securities law, OR
    (b) the issuer of the security is a reporting issuer and has been a reporting
        issuer for at least 18 months and is not in default of any requirement of this
        Act or the regulations and the seller, unless exempted by the regulations,
        (i)    files with the OSC and any stock exchange on which the securities
               are listed…
               (a) a notice of intention to sell in the form prescribed by the
                   regulations disclosing particulars of the control position known to
                   the seller, the number of securities to be sold and the method of
               (b) a declaration that no knowledge of material change….
        (ii)   files within 3 days after the completion of any trade, a report of the
               trade in the form prescribed under Part XXI, and
    (c) no unusual effort is made to prepare the market or to create a demand file
        for the securities and no extraordinary commission or other consideration
        is paid in respect of such trade."

People who want to use this exemption cannot have acquired any shares of the
class that they are selling in the previous 6 months, no matter how the acquisition
was done, as per Section 3.11 of Rule 45-501.


The two principal regimes that apply to securities that have been distributed on
an exempt basis are found in Sections 72(4) and (5).

Sections 72(4) and (5) are other ways to get securities out of the closed system.
Both these provisions say that "the first trade in securities previously acquired
pursuant to an exemption contained in clause …. other than a further trade
exempted by law (i.e. other than a trade that is made in reliance on one of the
exemptions in Section 72(1), in other words, a trade where it stays in the "closed
system") is a distribution unless…‖. Thus, if you keep it on a n exempt trade and
thus keep it in "closed system" it is not a distribution. However, the first trade
that the holder who takes on an exempt basis wants to affect will be caught by
these words as a distribution. If you bought shares subject to a prospect us
exemption, 72(4) and (5) will deem a further sale to be a distribution unless you
comply with the requirements of (4) and (5).

Requirements for Section 72(4):
   1) (a): The company that initially distributed the shares has to be a reporting
      issuer that has not defaulted of its reporting issuer requirements. The
      shares will remain in the closed system forever as long as the initial
      company who issued them is not a reporting issuer. AND
   2) (b): the securities have been held for a specified amount of time (―hold
      period‖). The hold period starts running from the later of the following
      two events: the date that that I bought the shares or the date that issuer
      started becoming a reporting issuer.

Hold periods are 6, 12 or 18 months. This varies across provinces. The length of
this period is predicated on the quality of the securities owned, namely:

Are the shares listed on a stock exchange? Listing is presumed to be good.
Do the shares comply with the requirements of 433(1)(m)(n) of the Insurance

Section 72(4)(b)(i): ―The securities comply with the requirements of either clause
433(1)(m) or (n) of the Insurance Act and have been held at least 6 months…‖
(ii) ―The securities are bonds, debentures, or other evidences of indebtedness
issued or guaranteed by an issuer or are preferred shares of an issuer and comply
with the requirements of 433(1)(k) or (m) of the Insurance Act and have been held
for at least 6 months…‖

―Legal-for-life‖ test: historically, life insurance companies, trust companies,
banks, pension funds and other regulated financials who have large pools of
capital that are regulated have had rules about what they can and cannot invest
in. Most of these rules are now abandoned and most of these entities are allowed
to invest in pretty much what they want to invest in. Figuring out what these
companies could or could not invest in was done under the rubric of "are these
securities legal-for-life?" which was short form for "are they eligible investments
that a life insurance company can make?" And the test for whether a life
insurance company could buy shares in Section 433(1)(m) or (n) was did the
company have earnings available for the payment of dividends in 4 of the last 5
years in excess of 4% of the amount at which its shares were carried on the books
of the company stock record. The second test was whether had the company, in
fact, paid dividends in 4 of the last 5 years in excess of 4% of the amount at which
its shares were carried on the books of the company stock record, regardless of
whether it had the earnings. The bottom line was that there was earnings test
and a dividends paid test and the theory was that companies that had a history of

earning at least 4% of their book or having paid dividends in that amount in at
least 4 of the last of the 5 years were good companies. These securities are
considered to be the safest investments, as the issuers are considered very
mature, and thus the market does not need a long time to become informed.

For securities that are listed and that comply with the legal-for-life test and that
were initially issued by a reporting issuer, the hold period is 6 months. This hold
period also applies to unlisted preferred shares & (unlisted) debt instruments –
So it applies to:
          1) listed & legal-for-life
          2) unlisted preferred & legal-for-life
          3) unlisted debt and legal-for-life

Section 72(4)(b)(iii): ―The securities are listed and posted for trading on a stock
exchange or are bonds, debentures or other evidences of indebtedness issued or
guaranteed by the reporting issuer whose securities are so listed, and have been
held at least one year from the date of the initial exempt trade or the date the
issuer became a reporting issuer, whichever is later‖

Provided that the initial issuer is a reporting issuer, applies to:
   1) listed but not legal-for-life
   2) (Unlisted) debt of reporting issuer whose other securities are listed
   3) (Unlisted) debt guaranteed by reporting issuer whose securities are listed

Section 72(4)(b)(iv): ―The securities have been held at least 18 months from the
date of the initial exempt trade or the date the issuer became a reporting issuer,
whichever is later‖
   Provided the initial issuer is a reporting issuer, applies
   1) Reporting issuers whose securities do not fit into the 6 or 12 month
   2) Securities that are not listed, but instead are traded over-the-counter, or
      have been placed and are traded privately.

READ 45-501 for other resale restrictions placed on sales made under 72(4).

Section 72(5)

Note that this applies only to some of the exemptions ie those where purchasers
are presumed to be sufficiently informed about the issuer by reason of their
position as security holders of the issuer or of another issuer

No hold period: the primary restriction is that must have been a reporting issuer
for at least 12 months and not be in default under any reporting issuer
requirement in the Act. The company has to make periodic disclosure.

There will be a hold period for shareholders who bought shares in a company
when it was private. Those shareholders will have to wait until the company has
been a reporting issuer for 12 months.

 Almost all exempt distributions will fit into 72(4) or 72(5). See handout

Convertible securities

[―Convertible security‖ means a security of an issuer that is convertible into or
carries the right of the holder to purchase or of the issuer to cause the purchaser
of, a security of the same issuer.]
Ex: If you bought convertible debentures under 72(1)(d). 72(4) stipulates there is
a hold period before they can be out of the ―closed system‖: what happens if
instead you convert your debentures into common shares? You will receive those
shares on an exempt basis. However, you will not be obliged to restart the hold
period by virtue of the fact that you acquired (converted) common shares. When
you convert a convertible security, the hold period does not restart.

October 27, 2000:


Continuous Disclosure is the generic statement that applies to the regularly
scheduled disclosure events in the life of a public company. Reporting issuers are
the only category of issuers that have these obligations. Thus, continuous
disclosure refers to statutorily mandated disclosure documents that every
reporting issuer must file on a prescribed schedule

Timely disclosure are the disclosure obligations that reporting issuers have that
are unscheduled; that arise by virtue of the happening of events or the coming
into existence of facts that require immediate disclosure by the corporation and

not simply disclosure at the next, regularly scheduled and statutorily mandated
disclosure event.

By becoming a reporting issuer, you subject yourself to both of these regimes. If
you are not a reporting issuer, you don't worry about this stuff.

An issuer becomes a reporting issuer either because it files a final prospectus and
gets a receipt for it or it makes a takeover bid in respect of which it offers its
securities (and thus prepares and files a takeover bid circular that has prospectus
level disclosure called a Securities Exchange Takeover Bid Circular) or it applies
to the Stock Exchange and gets its securities listed there. If the issuer attempts to
list on the Stock Exchange, it has to file an application and an initial listing
statement with the Stock Exchange, which itself will contain prospectus level
disclosure. The final way to become a reporting issuer is where a company is
created through some sort of amalgamation or plan of arrangement or merger
transaction where one of the predecessor corporations was itself a reporting
issuer. In every one of these instances, the common theme is that there is a
disclosure document (a prospectus or a disclosure document that is the functional
equivalent of a prospectus that is placed on the public record via filing with the
Securities Commission).

Continuous Disclosure

Every prospectus is going to contain a panoply of information about an issuer.

In the documents that an issuer files in order to become a reporting issuer, one
will definitely find the issuer's financial statements. In the context of a
prospectus, you will find audited financial statements that are current to a date
which is at least within 4 months of the date of the document.

The Financial statement content of a prospectus generally consists of three

1) A balance sheet: it is a snapshot, a picture of the company at a moment in
   time. It will set out what the company's assets and liabilities are. Assets
   minus liability equals shareholder's equity. Shareholder's eq uity is the book
   value of the company.
2) The income statement or sometimes known as the Statement of Profit and
   Loss: it is not a snapshot. It shows you what the issuer did over a certain
   period of time. It will reflect a sum of all of the revenue that the issuer took in

   during that period and will subtract all of the expenses of the issuer during
   that period. The difference between the two is the profit or loss. There are
   categories of expenses that are intangible in the sense that they don't actuall y
   reflect the spending of cash money. Thus, an issuer is required to do a third
   financial statement: A statement of Cash Flows.
3) A statement of Cash Flows: it is designed to give investors yet another picture
   of how the issuer spends its money.

In the bedrock disclosure document pursuant to which an issuer acquires its
status as a reporting issuer, you will have presentation of a balance sheet as at, for
example, December 31 and you will have an Income Statement and a Statement
of Cash Flows for the year ending December 31. The legislature also requires
interim financial sheets for every three months. These interim financial sheets do
not have to be audited.

Section 77 of the Securities Act: is the section that requires that every reporting
issuer do these quarterly interim financial statements and the reporting issuer has
to do it within 60 days of the end of the quarter.

Section 78 of the Securities Act contains the requirement to file audited financial
statements annually and the reporting issuer has 140 days after the end of the

The reporting issuer is required to send the quarterly and year-end financial
statements have to be mailed to shareholders. Under paragraph 13 of Rule 51 -5a,
reporting issuers can do press releases of the data and can then send them to the
shareholders. In the past, the mailing to the shareholders had to be done
concurrently with the filing.

Rule 54-1a goes further and allows the reporting issuer to ask its shareholders
whether they want to receive these interim financial statements.

Section 11 of the Regulations to the Act requires that annual financial statements
be approved by the Board of Directors and that that approval is evidenced by the
signature of two directors. There is nothing in Securities law that requires that
interim financial statements, in fact, be approved by the Board of Directors.

In Rules 51-5a and 51-5b, you will see that the Ontario Securities Commission has
tried to harmonize Ontario rules with those of the other Canadian prov inces and
those of the United States by effectively deferring to those jurisdictions where

they have reasonably similar reporting obligations. You should read OSC policy
7.1 given that it explains these rules.

Shareholders, generally speaking, get their audited financial statements in a
document called the Annual Report. With the audited financial statements, there
is a mandated section called Management's Discussion and Analysis (MDNA).
MDNA is placed with the financial statements and it is a document that is
required to be disseminated to the shareholders because it is designed to be an
explanation of what really happened to the company and what management
thinks is going to happen going forward. The outlook section of the MDNA is a
section in which the issuer is supposed to say to investors what they think is
going to happen in the future.

The next document that the issuer has to file is an Annual Information Form. The
initial obligation to file an AIF came into existence at the same time as the Short
form Prospectus system (a.k.a. Prompt Offering Prospectus Qualification
System). One of the bedrock documents that you do in order qualify for the
Short Form Prospectus system is the AIF(10-k in the United States). The premise
was that these senior companies would do this once-a-year prospectus style
document that addressed a bunch of form items and contained pretty standard
stuff about the business of the company and then when they actually went to do
a prospectus, they could simply incorporate that stuff by reference.

OSC policy 5.10 (which is about to be changed into Rule 51 -501) requires all
reporting issuers to do an AIF whether or not you are in the short -form system.
The only exception being made is for very small companies. In the AI F, the
following items are stated:     the name of the corporation, when it was
incorporated, what changes have been made to its articles, describe its business,
properties, and its management.

The last document that every reporting issuer has to do once a year is called the
Information Circular (a.k.a. Proxy Circular). Once a year, in the context of having
its annual meeting of shareholders (which all companies must do at least once a
year), the company will prepare and send to shareholders and file on the public
record, something called the Management Information Circular (or Management
Proxy Circular). It will tell you who the principal shareholders of the corporation
are, current information on the number of shares outstanding (so you can figure
out who has voting control over the corporation), who is being nominated for
election to the Board of Directors, it will give you a bunch of information about
the manner in which the corporation compensates its senior executive officers,

some information about whether the corporation complies with the Toronto
Stock Exchange guidelines on corporate governance if it is a TSE listed company,
tells you who the auditors are, and to the extent that there is any special business
to be conducted at the meeting, it will tell you about that as well.

So, proxy circular, AIF, audited Annual Financial statements with MDNA and
quarterly interim financial statements represent the regularly scheduled
communication events between a reporting issuer and its security holders that
are statutorily mandated.

Timely Disclosure

One of the principal ways that investors get their information is through
brokerage and the analyst community. Major brokerage firms have research
analysts working for them. Research analysts, as part of their job, are required to
study certain companies usually within a particular industry to become experts
and thus to create models of their own that would have a predictive effect on the
future stock price of the company. In order to that, the analyst must be
intimately familiar with what makes the company tick, what drives its profits,
how the marketplace assesses the company, whether there is particular value
given to the company's strategic role in the marketplace and its growth prospects.

National Policy 40 and the TSE rules require timely disclosure of all material
information. The United States does not have a timely disclosure requirement.
The Americans have passed a rule called Regulation Fair Disclosure that
essentially says that if you are goin g to say something that is material, tell
everybody at the same time and do not disclose selectively. And if you
accidentally disclose selectively, then within 24hrs issue a press release and tell

Thus, it is the rule in Canada for all TSE listed companies that timely disclosure
(i.e. immediate disclosure by way of press release) must be made of all material
facts. There is a policy statement of all 10 Securities Commission, NP 40, which
says the same thing. Because it is a policy statement, it does not have the force of
law: Under Section 122 of the Securities Act you cannot be charged with a breach
of a policy statement.

However, you can be charged under the Securities Act for failing to disclose a
material change in the business, operations, or capital of the company. Under
Section 75 of the Securities Act, all reporting issuers are required where a

material change occurs in their affairs to issue a press release and disclose the
nature and substance of the change.

A material change is defined in Section 1 of the Securities Act as being "a change
in the business, operations or capital of the issuer that would reasonably be
expected to have a significant effect on the market price or value of the securities
of the issuer." The definition goes on to say that material change includes "a
decision to implement such a change."

This disclosure obligation satisfied by virtue of issuing a press release
immediately and filing a material change Report (which is a prescribed form in
the Regulations of the Securities Act). In Quebec, you don't have to file a material
change report; you simply file the press release with the Quebec Securities

The material change Report and the press release are required to disclose the
nature and substance of the change. This means that you are supposed to tell
people with a reasonable degree of specificity what it is you have done and why
that could reasonably be expected to affect the market price of your securities.
Companies can be disciplined if they fail to comply with this legal obligation.

A material fact, on the other hand, is what the market really wants to know.
National Policy 40 is observed by virtually all public companies even though it is
not law. NP 40 says that you have to make timely disclosure of any fact that
could reasonably be expected to have a significant effect on the market price or
value of your securities.

Material changes, generally speaking, are matters that are internal to the
company. Material facts, on the other hand, could be some external happening.

The disclosure obligation occurs when the change or fact is material and likely.
There is an exception to the rule is that you don't have to make immediate
disclosure of a material fact where it would harm your shareholders' interests.

National Policy 40 has a useful list of the sorts of things that can constitute
material facts under the caption entitled "Developments to be disclosed." NP 40
says quite clearly that the reporting issuer is not required to interpret the impact
of external political, social, economic development on the reporting issuer's
affairs. However, things like changes in your stated capital, change in share
ownership that might affect control, takeover bids or issuer bids, developments

of new products, significant discovery by resource companies, significant
litigation, major labor disputes or major disputes with suppliers and events of
default under a loan agreement should be mentioned. There is also catch-all in
NP 40 that says that "any other developments related to the business and affairs
of the issuer that would reasonably be expected to significantly effect the market
price or value of any of the issuer's securities or that would reasonably be
expected a significant influence on a reasonable investor's investment decision."

PEZIM CASE (leading decision in Canada in this area of what constitutes
material change and material fact and timely disclosure)

FACTS: Murray Pezim was a promoter behind a couple of companies, one was
called Prime and the other was called Calpine. Prime owned 23% of Calpine.
Pezim was the chairman of the board and there was another guy who was the
President and the CEO. Prime and Calpine had staked out some properties in
Northwest British Columbia as potential gold mines.

On June 20, 1989: drilling began on properties in Northwest British Columbia
On July 11, 1989: the head geologist went out and toured the property
On July 12, 1989: the head geologist returns to Vancouver and said that he was
highly optimistic that there might actually find some mineralization on this
On July 12, 1989: Mr. Pezim has the company grant a bunch of stock options to a
bunch of insiders of the company at a price of $1.50. At the end of the very same
day, he certifies to the Vancouver Stock Exchange that there were no material,
undisclosed changes in respect of the company.
On July 13, 1989: The company issues a press release that basically said that they
were doing some drilling and that they were optimistic. The company had some
assay results in had that showed mineralization but they did not include them in
the press release.
On July 14, 1989: They did a private placement of stock out of Calpine. They did
not tell anybody who the buyer was. It turned out that the buyer was Prime, the
insider who is controlled by Pezim and his friends and associates.
On July 19, 1989: They actually disclose the assay results that were promising.
On July 26, 1989: They were drilling and struck real gold.
On July 28, 1989: The geologist and the team that was working on the minesite
called Vancouver and told the president that they had struck gold.
On July 31, 1989: They grant some stock options to one of Mr. Pezim's cronies.
Pezim again certifies to the VSE that there were no material, undisclosed changes
with respect to the company.

On August 2, 1989: They issue a press release with the assay results. The stock
price goes up $6/share.
On Aug. 14, 1989: They find even more gold than what they thought they had.
On Aug. 15, 1989: The company took some stock options that were held by the
Pezim and his cronies and changed the exercise price to lower the exercise price.
On Aug. 17, 1989: They grant another round of stock options. Once again they
certify to VSE that there were no material, undisclosed changes with respect to
the company.
On Aug. 22, 1989: They issue a press release announcing what they discovered
on                                  Aug.                                        14.

The B.C. Securities Commission, after many complaints, commences an
enforcement action against Mr. Pezim and the President and some of the other
people in charge of the company alleging that they were in breach of the British
Columbia Securities Act for failure to make timely disclosure of a material
change. The British Columbia Securities Commission hearing the enforcement
action finds Mr. Pezim guilty and imposes sanctions on him. He appeals to the
B.C. Court of Appeals. In a stunning reversal of a decision of a Securities
Commission, Mr. Justice Lambert of the B.C. Court of Appeals comes to a
different view of things. Lambert J. holds that there was no material change
because the gold was always there. His view is that gold had been there since
time in memorial and somebody just found it and this did not constitute a
material change in the business, operations, or the capital of the company. The
Supreme Court of Canada grants leave to appeal and Iacobucci J. writes the
judgment. He holds that the discovery that you have an asset that you did not
you know you had can be a material change in yo ur business. Mr. Pezim is
therefore held liable for failure to make timely disclosure.

There is no statutory civil liability for misrepresentation in continuous disclosure
documents or for these sorts of omissions to disclose material changes. Unlike
the statutory civil liability in Section 130 and Section 131 for misrepresentations
in documents that are filed, there is no statutory civil right of action for investors
that includes such valuable things as "deemed reliance" for continuous disclosure
documents or timely disclosure documents for that matter. So, investors in the
marketplace could only try to assert some action at common law but, according
to McReynolds, it is impossible to all intents and purposes.

November 3, 2000:

There are certain fundamental events in a corporation's life that have to approved
by the shareholders by law and by the TSE rules. If neither the law nor the TSE
rules require that the events be approved by shareholder approval, then all that is
needed is board of director approval.

Thus, where shareholders are not given a say on a particular issue, their only
recourse is to vote the directors out and put in a different set of directors that
would handle the issue in a way that they want.

However, this can be difficult to do when certain people in a company have
shares that have more than one vote attached to them (multiple voting shares).
Some companies, for example, split their common shares into 2 classes that are
identical in every respect except voting rights.

The Securities Commission allowed this is to happen because some entrepreneurs
had founded companies and brought them from a concept to being substantial
public companies largely through their effort, judgment, capacity to manage,
capacity to raise capital and their vision and these entrepreneurs did not want
lose control of the company.

If you look at the top 100 companies on the TSE, probably 1/3 of them this
multiple voting shares structure.

Leaving those companies aside where there isn't really a great deal of corporate
democracy, in those companies where it is one share, one vote, the company is
required to have this annual shareholder's meeting within at least 6 months from
the end of its fiscal year.

The Securities Act in Section 85 states that when management of a reporting
issuer gives notice to shareholders that it is going to have a shareholder's
meeting, it must solicit proxies from the shareholders.

A proxy is a piece of paper where one shareholder confers power on another
person to represent the shareholder at the meeting and to vote their shares
owned by the shareholder in accordance with the shareholder's instructions. If
you are shareholder of a public company, you are perfectly entitled to attend the
shareholders meeting and you do not have to give a proxy to anyone. However,
because the meeting can be held anywhere and at a time that management
chooses, it is practically impossible and sometimes beyond their means, to attend
the shareholders meeting. Thus, in recognition of that fact, this mandatory

solicitation of proxies was implemented to make sure that shareholders would
not be disenfranchised simply because they could not afford or could not get to
the shareholders meeting to vote.

Thus, the company itself must prepare a circular (called a Management Proxy
Circular or sometimes it is called a Management Information Circular) to send to
shareholders that basically says that they there is going to be a meeting on such
date and at such place and also says that the shareholder is welcome to attend
and vote at the meeting.

Moreover, it says this is the following business that is going be transacted at the

A. we are going to elect directors to serve for the next year
B. we are going to appoint auditors to be auditors for the corporation for the next
C. whatever other business that comes up that has to be transacted at the

There are two things that are for certain at every shareholder meeting: the
election of the directors and the auditors appointed b ecause under the Business
Corporations Act, public companies are required to have auditors and the
shareholders can elect the auditors. Other than these two items of business, any
other business that is transacted at the shareholder meeting is referred to as
special business.

Under the Business Corporations Act, to the extent that special business is to be
transacted at a shareholder meeting, there is a positive obligation on the
management of the corporation to provide information in the management proxy
circular that is sufficient to enable shareholders to make informed judgments
about how to vote their shares at the meeting. Thus, you have to tell people, for
example, it is proposed that we amalgamate with this company and we are going
to vote on it on at this meeting and in order for it to be approved, the vote must
be carried by a 2/3 vote of the shareholders who choose to vote their shares.

The Management Information Circular is required to say that there are X number
of shares outstanding of the corporation and Mr. X and Mr. Y each own 15% of
the shares. There is a positive obligation on management to disclose if
anybody owns more than 10% of the shares of the company. Thus, you get

information regarding the number of shares outstanding and you get
information about who the significant shareholders are.

You, as a shareholder, get information about who the nominees for election to
the Board of Directors are. The names and principal occupations of the
nominees are given. Moreover, you get information regarding in which
municipalities the nominees reside, how long the nominees have been directors
of the corporation, and what securities of the corporation they own. You get
information with respect to how the corporation pays its executives. You are
told what the company pays its senior executives, what stock options have been
granted to the senior executives, and you are also given a chart of how the
company's stock price has done over the last 5 years in relation to some basic
indices (e.g. TSE-300 index). All the disclosure requirements that require you
disclose how the corporation compensates its executives mirror, virtually word
for word, the American rules.

In the circular, the auditors have to be identified.

The TSE has corporate governance guidelines. Under the TSE rules, the circular
has to state how independent the directors are of management. Public companies
that are listed on the TSE are required to address these guidelines in their proxy
circulars and to describe for sharehol ders whether they comply with these
guidelines or not.

When management solicit proxies, there are whole set of rules that apply and
states what has to go in the proxy circular (such as the above information
regarding the number of shares outstanding, the shareholder with more than 10%
stakes, the personal information of the nominees), the form the proxy must take,
the fact that shareholders must be advised that their proxy can be revoked and
changed by them at any time up until the time of the meeting.

The management proxy usually states that you, the shareholder, hereby appoint
the Chairman of the Board of the Corporation, or failing him, the Vice-Chairman
of the Board of the Corporation, or failing both of them, and then there will be a
blank on the form where you, the shareholder, can write in the name of whoever
you want to appoint as your proxy holder. Under the law, you can appoint
anyone as your proxy holder. The proxy holder has the same rights as a
shareholder by virtue of holding a valid proxy from you (i.e. they are entitled to
attend the meeting, to speak at the meeting, and they are entitled to vote as the
shareholder has instructed them)

The regulations with respect to what has to go in the proxy circular is in s. 176 of
the Regulations to the Securities Act. S. 176 states that the content of every
management proxy circular must contain all of the items that are set out in Form
30. The Canada Business Corporations Act has similar provisions.

S. 86 of the Securities Act states that anybody who wants to solicit proxies must
also provide a circular. In other words, although the management of the
corporation is obliged to solicit proxies for use at the meeting, they are not the
only ones who can do it. If you, the shareholder, don't like what is going to go on
at the meeting and want to nominate someone else for election to the board or
nominate a different firm to be the auditors of the company, you, too, can select
proxies. Again, the process is as regulated as it is if management chooses to do
select proxies. You, the shareholder, as well have to describe what it is you are
proposing and give people adequate information to decide whether or not to give
you their proxy and you have to say to people how you are going to vote their
proxy if they give it to you.

If you solicit proxies (the definition of solicit is in s. 84 of the Act and is quite
broad; virtually everything that you could do that remotely sounds like it might
be a solicitation, probably is), you must prepare a circula r and a form of proxy
that complies with the regulations and you must act in accordance with the
proxies that are given to you.

If you comply with the rules in the Ontario Securities Act with respect to proxy
solicitation, most other provinces recognize that compliance with those rules as
being adequate to have complied with their rules. Ontario does the same thing in
s. 88 by saying that if you have complied with the laws of a jurisdiction that
provide for substantially the same level of disclosure, than you don't need to
comply with the rules of Ontario. OSC Policy 7.1 states which jurisdictions are
the same.

It is very important to comply with the proxy solicitation rules. If you breach a
rule, it is breach of the Securities Act and you can get into trouble for that.
Moreover, the courts have held that if you have not provided shareholders with
sufficient information to form a reasoned judgment with respect to the business
that is going to be transacted at a meeting, than the actions at the meeting that
purported to approve a particular business will be held invalid. This is enough to
scare most corporations into providing more than adequate disclosure.

Moreover, to the extent that by virtue of your conduct people have been
damaged, those people will have actions against you.

In terms of communicating with shareholders, the Canadian Securities
Administrators have published a policy called National Policy 41. NP 41
prescribes a bunch of rules that makes sure or are intended to make sure, that
corporations communicate properly with their shareholders. Nowadays, in
corporations' list of shareholders, most shares are registered in the name of
depositary (a simple nominee that has no beneficial interest in the securities, the
nominee simply holds them on behalf of the shareholders or on behalf of yet
another intermediary, such as a brokerage firm, which, in turn, holds on behalf of
the true owner of the shares. As a result, a corporation's ability to communicate
with its real shareholders is somewhat limited. Thus, NP 41 sets out a timetable,
a regime and a bunch of rules that require companies to prepare their circulars
sufficiently in advance of a meeting date so that they can be given to the
brokerage firms so that they in turn can mail to them the shareholders
themselves. As a matter of corporate law, you are required to give 21 days
advance notice of a shareholders meeting. However, if the corporation gave the
circular to the brokerage firm 21 days before the meeting, most of the real
shareholders would not have enough time to get the circular or even read them
or get advice about the business to be transacted. Thus, the rule now is that
brokerage firms have to have the materials 25 days before the meeting and you
have to advertise that you are going to have a meeting 60 days before the

The Business Corporations Acts provides that any holder(s) of at least 5% of the
issued shares of the corporation are entitled to requisition a meeting. There is a
requirement to meet once a year. If a company wants to meet more than once a
year, it can. A board of directors can always call a meeting any time they want.
However, a person or a group that has 5% can go to the board of directors and
say call a meeting and the board will then be required to have a meeting.


Section 75 of the Securities Act embodies the requirement that a company issue a
press release and file a material change report whenever there has been a material
change in their business, operations or capital.

Section 76 of the Securities Act provides the prohibition against insider trading.
It is broader than Section 75 in terms of what can triggered it. "No person or

company in a special relationship with a reporting issuer shall purchase or sell
securities of the reporting issuer with knowledge of a material fact or material
change with respect to a reporting issuer that has not been generally disclosed."

Thus, if you are in a special relationship with a reporting issuer you cannot
purchase or sell securities of the reporting issuer with knowledge of a material
fact (i.e. not just material changes) with respect to the reporting issuer that have
not been generally disclosed.

Section 76(5) of the Securities Act tells you who is in a special relationship with
the reporting issuer.

The first category of persons in a special relationship: "any person that is an
insider, affiliate or associate of the reporting issuer." (Section 76(5)(a)(i))

The definition of 'insider' is in Section 1 and it states that 'insider or insider of a
reporting issuer' means the following:

(a) "every director or senior officer of a reporting issuer,
(b) every director or senior officer of a company that is itself an insider or
    subsidiary of a reporting issuer,
(c) any person or company who beneficially owns, directly or indirectly, voting
    securities of a reporting issuer or who exercises control or direction over
    voting securities of a reporting issuer or a combination of both carrying more
    than 10 percent of the voting rights attached to all voting securities of the
    reporting issuer for the time being outstanding other than voting securities
    held by the person or company as underwriter in the course of a distribution,
(d) a reporting issuer where it has purchased, redeemed, or otherwise acquired
    any of its securities, for so long as it holds any of its securities"

Thus, an insider is, in plain English, the following:

1)   directors and senior officers of the issuer itself
2)   directors and senior officers of the subsidiaries
3)   directors and senior officers of any company that owns 10% of the issuer
4)   the issuer itself when its buying back its own shares

The definition of 'affiliate" is stated in Section 1(2) of the Securities Act:

"A company shall be deemed to be an affiliate of another company if one of them
is the subsidiary of the other or if both are subsidiaries of the same company or if
each of them is controlled by the same person or company." This definition
picks up sister companies.

The definition of 'associate' is stated in Section 1 of the Securities Act. The
important thing here is that you are caught if you are an associate of the reporting
issuer you will be in a special relationship.

The second category of persons in a special relationship: "a person or company
that is an insider, affiliate or associate of a person or company that is proposing to
make a take-over bid, as defined in Part XX, for the securities of the reporting
issuer" (Section 76(5)(a)(ii) of the Securities Act)

Thus, in the context of a takeover bid, if you are an insider, affiliate or associate of
a person that is proposing to make a takeover bid, you are in a special
relationship. However, it does not catch the person that is itself making the
takeover bid. The rule in Quebec is different in that in Quebec the person or
company that is itself proposing to make the takeover bid also gets caught.

The third category of persons in a special relationship : "a person or company
that is an insider, affiliate, or associate of a person company that is proposi ng to
become a party to a reorganization, amalgamation, merger or arrangement or
similar business combination with the reporting issuer or to acquire a substantial
portion of its property" (Section 76(5)(a)(iii) of the Securities Act)

Whether someone has engaged in insider trading, you first have to see whether
they are someone who is in a special relationship.

People in such a special relationship are prohibited from selling or purchasing
securities of the reporting issuer if they have knowledge of a material fact or
change in the reporting issuer that is not generally disclosed. For the purposes of
Section 76(1) of the Act, security includes, as per Section 76(6) of the Act, "(a) a
put, call option or other right or obligation to purchase or sell securities of the
reporting issuer; or (b) a security, the market price of which varies materially
with the market price of the securities of the issuer."

Among academics, there are two schools of thought on insider trading. Some
scholars, legal and economic, suggest that insider trading promotes efficient
capital markets. Yes, Mr. X who has material undisclosed information went on

the stock exchange and bought the shares, the person who he bought them from
was selling anyway and, therefore, the question i s who is harmed?

McReynolds does not really like this school of thought.

In addition, to not being able to purchase or sell securities in such circumstances
you are also not allowed to tell other people the material facts that you know that
have not yet been disclosed unless you are required to do so in the necessary
course of business. (See Section 76(2) of the Act). Moreover, any person who is
told these facts that have not been disclosed, is not allowed to purchase or sell
securities of the reporting issuer. The person who is told these facts that have not
been disclosed is the last category of person in a special relationship because he is
a person who learns of a material fact from a person in a special relationship.

A couple of cases in Ontario:


FACTS: Mr. Fingold was a director of Cineplex Odeon Corporation in the 1980s
and a director of a holding corporation that he owned 50/50 with his brother and
he was a director of a public corporation called Slater Steel, which is family had
historically controlled through a minority shareholding. Mr. Fingold's father had
been in the movie-theatre business and had sold the company to Cineplex Odeon
Corporation and taken back a substantial number of shares in Cineplex Odeon
Corporation. Mr. Fingold was very supportive of the management of the
company through the 1980s. Mr. Fingold also had his personal shares of
Cineplex and his wife had her personal shares of Cineplex. Matters at Cineplex
became a little bit fractious at the end of the 80s. Business started to unravel.
There was a board of directors meeting scheduled for Feb. 25, 1989 at which the
board was going to be presented with the financial results of the corporation
from the 4 th quarter. On Feb. 23 and Feb. 24, Mr. Fingold's holding company
started selling shares of Cineplex. This was unusual because Mr. Fingold had
insisted strongly in the past that the holding company not sell shares. On Feb. 25,
the board of directors was presented with the financial results of the 4 th quarter
for the core business of the corporation which were horrible. There was a huge
fight at the board meeting between some of the significant investors in the
company with the managers of the company at the time over the future direction
of the company. The managers of the company were put on a short leash in
terms of what they could do without the getting the approval of the directors.
Mr. Fingold said that he first heard of the bad information was the meeting on

Feb. 25. On Feb. 26, the holding corporation and Slater Steel started to dump all
of their shares of Cineplex Odeon. There had been no announcement of the
financial results on the part of Cineplex Odeon. On Feb. 27, Mr. Fingold sends a
letter of resignation into the corporate secretary purporting to resign as of Feb. 21.
The corporate secretary writes back on March 1 saying that Mr. Fingold cannot
back date your designation and you have material undisclosed information and
thus you better not have been trading.

On March 22, Cineplex Odeon finally announced its 4 th quarter results and the
stock price plummeted dramatically. On the same day, Mr. Fingold sold the
balance of his personal holdings and those of his wife. However, by the time the
announcement was made, the Holding Company and Slater Steel had sold all of
their holdings in Cineplex at substantially higher prices than were available in
the marketplace immediately after the press release. Two years later, the former
CEO of Cineplex accused Mr. Fingold of insider trading in an examination with
an Ontario Securities Commission investigator and charges were laid against Mr.
Fingold some year and a half later after that.

HOLDING: The charges were thrown out that on the basis that the OSC had
missed the limitation period for missing the charge (which at the time was a 1
year period). The judge went on to say that even if he was wrong on the
limitation issue, he would still find Mr. Fingold innocent because he did not
believe, and the judge found it reasonable for him not to have believed, that the
4 th quarter financial statements constituted a material fact. The OSC appealed
and the OSC again lost on the limitation period issue. The judge on appeal said
that the role of the Appeal Court is not to substitute its judgment for a t rial judge
unless the trial judge so manifestly erred that there is just no way that the judge
could possibly have reasonably come to that conclusion on the evidence before

The case stands for the proposition that there is some room for the advanci ng
of a defense to this offense on the basis that you reasonably concluded that the
facts in your possession were not material at the time you traded.


Harper was the founder, director and president of Golden Rule Resources Inc.
Golden Rule Resources Inc. was a company that was exploring for gold in Ghana.
Throughout the fall of 1996, the company, under Mr. Harper's direction, was
putting out a variety of press releases about how encouraging its drilling results

were. It was getting assay results back from the laboratory that were suggesting
that there was gold in the soil sample it was taking. On 2 nd or 3 rd of January, Mr.
Harper received 800 soil assay reports from the exploration site that suggested
that there was little or no gold on the property. No press release was issued. In
February and March, Teck Corporation did some sampling on the property
because Mr. Harper was trying to induce them to buy a portion of his company.
Teck Corp. took 30 samples of soil and had it tested by their own people. Thus,
on March 12, Teck Corp told Mr. Harper that there was no gold. The stock had
gone $2.15 on October 1 to $13.10 on January 27.         No press release issued.
However, on 3  rd of January, Mr. Harper sold stock and continued selling virtually

every day until May 6 th . He sold an aggregate of $4 million worth of stock,
including exercising some stock options and selling those shares as well.

Finally on 15 th of May, Mr. Harper puts out press release stating that they had
some disappointing results from some of their samples. The stock immediately
fell to $3.00/share. Then, in July, he had another press release stating that there
were some more results and that he was unable to reconcile these results with the
results from the previous fall which had been positive and that he was going to
get another independent exploration company to reconcile these differences that
he could not explain. The stock dropped to $1.000. Mr. Harper was charged with
insider trading. The OSC said that the assay results that Mr. Harper received on
January 2 or 3 constituted material facts that were not disclosed and that Mr.
Harper was in a special relationship by virtue of being a president and a director
of the company and he clearly traded in securities of the reporting issuer.

Mr. Harper's defense was that the facts were not material or, in the alternative,
that he reasonably believed that they were not material at the time that they
traded. Mr. Harper's assertion was that he relied upon the advice of the chief
geologist of the company that because there was a discrepancy between the
earlier good results and the later bad results, the bad results were immaterial.
The court concluded that the geologist was not a credible witness. The court held
that Mr. Harper having had 30 years of experience in the mining industry and
particularly in the financing of mining company and who had interacted many
time with investment firms, knew clearly that bad drilling reports were as
material to the price and value in which a mining company's shares would trade
as good drilling reports. Mr. Harper was convicted in July and sentenced to a
year of prison and fined $4 million.

November 10, 2000:

There are a number of ways that one business can acquire another business:

1) The simplest way is to buy the shares of the other business

2) One business can buy the assets of the other business

3) You can merge the two corporate enterprises, usually by amalgamation. There
   are provisions in the Business Corporations Act that state that two companies
   incorporated under the same Business Corporations Law may amalgamate
   and form yet a third company with the corporate existence of the two
   amalgamating companies disappearing. By operation of law, the third
   company will own all of the assets of the two amalgamating companies' assets
   and is responsible for all of the assets and the liabilities of the two
   amalgamating companies. Thus, there is a fusion of the two corporations to
   create a new one. In some jurisdictions, outside of Canada, instead of fusing 2
   companies to create a third, you will have one company absorbed by the other
   and notionally the corporate existence of one of the companies is extinguished
   and the corporate existence of the other carries on.

4) Statutory plan of arrangement (OSC Rule 61-501, formerly OSC Rule 9.1) These
   are rules passed by the Securities Commission that regulate merger
   transactions that are not takeover bids by definition. A Plan of Arrangement
   allows companies to effectively restructure them selves or combine themselves
   with other companies or exchange securities for other securities or exchange
   securities for assets. You can virtually do anything you want within the
   rubric of a plan of Arrangement, provided that it is a approved by Court. It is
   a broad and flexible method that allows for business combinations and
   business restructurings without providing for a whole lot of formality with
   respect to the structure of these business combinations provided that a Court
   approves it. An amalgamation, however, is more structured given that both
   of the companies amalgamating must be incorporated under the same
   Incorporation Statute. With a plan of arrangement, that requirement is not
   necessary. A plan of arrangement does not exist in the Quebec Companies

5) The distinguishing feature of a takeover bid from the other four ways of
   combining business corporations is that a takeover bid allows the purchaser,
   or the offeror, to make an offer to all of the shareholders of a company
   regardless of whether the board of directors of a company supports or
   opposes the combination of the two companies. In the takeover bid, the

     offeror can go over the heads of the board of directors and just go directly to
     the shareholders of a company. There is piece in the casebook on page 282 by
     Phil Anesman that McReynolds to us that summarizes what takeover bid
     regulation is all about and some of the arguments both for and against
     allowing takeover bids to exist.

     National Policy 62-202 (formerly National Policy 38) essentially says that
     defensive tactics against takeover bids by boards of directors will be
     considered by Securities Regulators if the defensive tactics go so far as to
     prevent shareholders from ultimately exercising their judgments in deciding
     whether to accept or reject the takeover bid. The stated policy of the
     Canadian Securities Regulators in this area is to have a level playing field and
     to ensure that directors are given sufficient leeway to promote auctions for
     companies because it has been proven that the shareholders of a company are
     most likely to receive the highest possible price for their shares if the company
     is auctioned off. Thus, directors are given leeway to promote auctions and
     that may involve some short term impairment of the ability of an offeror to
     simply take up shares within the minimum statutory time period.

     In Canada, takeover bids were largely unregulated until the current statute
     that was put in force in the late 1970s and early 1980s which created a fairly
     comprehensive scheme of regulation of takeover bids that was premised on
     the notion that with very few exceptions when a takeover bid occurs, all
     shareholders should be treated equally. If there is going to a premium paid
     for control of the company, all shareholders should share in that premium
     equally. This philosophy winds its way through most sections of the
     Securities Act.

Takeover bids apply regardless of whether the target is a reporting issuer or not.
What does matter, is where do the offerees live. A takeover bid is an offer to
acquire voting or equity shares of a class or series made to any person in Ontario
or to any security holder whose address appears on the target's book as being in
Ontario where the securities subject to the offer to acquire when combin ed with
the offeror's securities will result in the offeror holding 20% or more of the class.

Section 89 of the Securities Act defines the components of a takeover bid:

3) First, the offer has to be an offer to acquire either a voting or equity security.
   A non-voting share that is an equity share can still be the subject of a takeover
   bid. An equity security is a share that ultimately participates in the earnings

     of the issuer and the assets in liquidation or winding up of the issuer. In 99%
     of the circumstances, an equity security means a common share. If you have
     voting and non-voting shares that participate equally in the earnings and the
     liquidation and winding up of the company, then those non-voting shares are
     equity securities and thus an offer to acquire of those shares could be a
     takeover bid.     If you have a preferred share and in the articles of
     incorporation, you find that upon the liquidation of the corporation the holder
     of a preferred share is entitled to $25, then it is not an equity sec urity because
     the holder of such a share is not allowed to participate in the residual of the
     company upon its winding up. A preferred share that has a limit to what the
     holder is entitled to receive upon liquidation is not enough to cause the
     preferred share to be considered an equity share. Thus, equity shares are
     those shares that have unlimited right to participate in the residual assets of
     the company upon liquidation. You can have participating preferred shares.
     You really have to look at the terms of the shares to satisfy yourself whether
     the shares are equity shares in the circumstances and therefore susceptible to
     being the kind of class or series of shares that can be the subject of a takeover

4) Second, there has to be an offer to acquire these shares. An offer to acquire
   means an offer to purchase these shares but it can also include the solicitation
   of an offer to sell securities. The acceptance of an offer to sell securities,
   whether solicited or unsolicited is also included.

In order to figure out whether one will trigger the 20% threshold limit, one must
start by asking what are the offeror's securities? The offeror's securities are not
only what he owns directly (what he beneficially owns) it is also what you
exercise control or direction over. Moreover, it is not only securities beneficially
owned by the offeror or securities over which the offeror exercises control or
direction, but also includes securities which act jointly or in concert with the
offeror. Thus, you cannot sneak up on a company by having 5 friends each buy
19.9% of the company. If those 5 friends are acting jointly or in concert, the
holdings of the 5 friends will be aggregated for the purposes of determining what
the offeror's securities are.

"Acting jointly or in concert" is a question of fact. However, there are some
presumptions in Section 91 of the Securities Act as to who "acts jointly or in

You are presumed to "act jointly or in concert" with someone else where you have
any agreement, understanding, commitment, formal or informal to act jointly
with respect to the acquisition of shares or with respect to the voting of shares.

You are presumed to "act jointly or in concert" with your associate. An associate
is any company where you control more than 10% of the shares. It includes your
partners, if you are a partnership. It includes trusts, where you are a beneficiary
or a trustee. It includes your relatives.

You are presumed to "act jointly or in concert" with your affiliates.

Moreover, "offeror's securities" it also includes convertible securities, in other
words, a right to acquire securities. Thus, if someone has 19.9% of a public
company and that person goes out buys convertible preferred shares that upon
conversion would result in that person's ownership interest increasing to 20%,
the purchase of those preferred shares is a takeover bid. Furthermore, if someone
owns convertible preferred shares that upon conversion would entitle that person
19.9% of the shares of the company and then that person goes and buys more
shares such that is holding is 20% or more, the purchase of the common shares
would be a takeover bid given that the person is presumed to already own 19.9%
because of the convertible preferred shares.

The same is true of options or warrants to buy shares. Provided that a person has
a right to acquire the shares within 60 days, the person will be deemed to
beneficially own the shares that the person has a right to acquire. (Section 90(1) of
the Securities Act)

Company A issues to a person a debenture that entitles that person on exchange
to receive common shares of Company B. That person, provided he has the right
to effect the exchange within 60 days, will be deemed to own those common
shares of Company B that the debenture would entitle that person to receive if
the exchange is actually executed. Thus, the person will be deemed to own the
shares of Company B even though that person only really owns a debenture of
company A. Thus, if the person turns around and buys more shares of Company
B, to find out what the "offeror's securities" are, you have to add up the number
of shares of Company B that the person is offering to buy, plus the number of
shares that the person is deemed to beneficially own through his ownership of
Company A's debenture.

Exchangeable Debenture: gives the right to buy shares that were previously

Convertible Debenture: gives the right to buy shares that were previously
unissued from the treasury of a corporation. By definition, the issuance of a
treasury share is not an offer to acquire a share from a person in Ontario. Buying
unissued shares from the company itself is not a takeover bid. A share is only
counted in "offeror's securities" if it is share that is already outstanding, not a
share that is previously unissued.

Thus, the key to determining "offeror's securities" is:

what do I already own? Ownership includes, by virtue of Section 90(1), what I
am deemed to own. Section 90 only applies to Part XX of the act. Moreover, you
are deemed to own shares that you have the right to acquire within 60 days. If
you have the right to acquire the shares within 61 days, you are NOT deemed to
own them. This is done for the purpose of determining whether any other
purchases you make are takeover bids.

Whether or not you are making a takeover bid is predicated on the following:

Firstly, there must be an offer to acquire as defined in Section 89 of the Securities
Act. Second, the offer must be made to a person in Ontario. Third, the shares
that are the subject of the offer when combined with the offeror's securities would
result in the offeror having 20% or more of the class or series of voting or equity

The question of whether you have made an offer to someone in Ontario is easy to
answer if you are mailing the offer to someone who lives in Ontario. However, it
is harder to answer if you are making purchases through the New York Stock
Exchange because you don't know who you're vendor is. However, it is
nonetheless fair to say that if you are making purchases through the Toronto
Stock Exchange you are making an offer to acquire in the Province of Ontario.
The important thing is that there is a lack of clarity as to whether or not these
rules would apply if you limited yourself strictly to purchases through facilities
of a non-Canadian stock exchange.

Happily, however, purchases through the facilities of a Stock exchange that is
recognized by the Ontario Securities Commission to the extent that they are small
in number, are exempt from these rules. Section 93(1)(a) says, for example, that

someone who is at 20% can buy an additional 5% every 12 months through stock
exchange purchases.


1) Section 93(1)(a): exemption made for purchases made through the facility of a
   stock exchange. The Toronto Stock Exchange rules mirror the rules in Section
   93(1)(a)(i). Section 93(1)(a) also allows for the purchases of 5% of the class in
   any 12 month period.
2) Section 93(1)(b): this allows you make the same sort of small purchases that
   are made in Section 93(1)(a), but not necessarily through the facilities of a
   stock exchange. You can do them off the floor of a stock exchange provided
   that you are not paying more than market price and you do not buy more than
   5% in 12 months.
3) Section 93(1)(c): This is called the private agreement exemption. This section
   is the compromise that allows some shareholders to dispose of their property
   and some purchases to be made from those shareholders without full blown
   takeover bid regulation. The section allows the offeror to purchase from not
   more than 5 persons any amount of stock provided that the offeror does not
   pay a premium over market in excess of 15%. There is some debate as to
   whether this can be done more than once. McReynolds thinks that you can do
   it more than once. The calculation of market price is the weighted average of
   the closing price of the last 20 days. The formula for market price is in Sect ion
   183 of the Regulations to the Securities Act.
4) Section 93(1)(d): private issuer exemption. In the same way that shares of
   private issuers are exempt from prospectus and registration rules, they are
   also exempt from the takeover bid rules and the issuer bid rules.
5) De Minimis exemption: Section 93(1)(e) states where there are fewer than 50
   holders in the province holding in the aggregate less than 2% of the class of
   securities, you can get exemption from the takeover bid rules.

Suppose you are at 19.9%, but you do not want to go through takeover
regulation. Thus, you can do a private agreement and buy 10%, 12 months will
have to pass before doing anything pursuant to the exception in 93(1)(b) or (a).
However, if I started by buying 5% pursuant to 93(1)(a) or (b), I can still buy the
10% through a private agreement the very next day because past purchases
through the stock exchange in no way, shape, or form affect you ability to do 5
private agreements.

Section 92 of the Securities Act: This is intended to catch indirect offers as well
as direct offers.

Example: Company A is a private company, owned 100% by me. Company A's
sole asset is a 25% interest in a public company, B. If Section 92 did not exist, the
sale by me of my shares of Company A would not be a takeover bid. However,
Section 92 operates to say that an offer to acquire the shares of Company A also is
an indirect offer to buy the 25% in Company B.

The Rules Governing a Takeover Bid:

The rules are designed to make sure that shareholders get sufficient information
to make a reasonably informed judgment to accept your offer or not. So, you are
obliged to do a takeover bid circular with a variety of prescribed form items
which are designed to elicit information that the regulators believe that a
shareholder of the target company ought to have in order to make an informed
decision to accept your offer or not. The takeover bid circular is Form 32 of the
Securities Act.

The offer has to be made every shareholder within the province of Ontario. If
you have 50 holders holding less than 2% of the stock in a province, you do not
have to make the offer in that in province and you can buy on an exempt basis.

The offer has to be delivered to a target company.

The offer has to be filed with the Securities Commission.

The offer has to be mailed to the shareholders of a company.

The offer has to be open for at least 21 calendar days. The first day is the day
after the offeror mails.  There is no maximum period: you can have an offer
open for as long as you want.

You have to set out the conditions of your offer. The only restriction on the
conditions of your offer is that if you are making an offer with cash as
consideration you cannot make your offer conditional on getting the cash
together. You must have already made adequate arrangements prior to making
your bid for the cash that you require. This is different from the United States of
America, where no such rule exists. (Section 96 of the Securities Act)

If you change your mind, and you want to change a condition of the offer, you
have to send out an amendment to my circular and extend it for another 10 days.
(Section 9? of the Securities Act)

Section 95 of the Securities Act says that where you make an offer for less than all
of the shares and more shares are tendered than you have sought to purchase,
you must treat all shares equally and purchase a pro-rata amount from each
shareholder who deposited his shares.

For the first 21 days, shareholders who have deposited shares, can withdraw
those shares. However, if the offer is for 25 days, shareholders cannot withdraw
their shares after the 21 st day unless the offer is amended given that an
amendment to an offer opens up withdrawal rights. If the offer is for 45 days,
shareholder can withdraw their shares after 45 days.

If you take up shares under an offer, you have 10 days to pay for the shares.

Section 97 of the Securities Act says that all vendors shall be offered identical
consideration. Section 97(2) prohibits an offeror from entering into a collateral
commitment, understanding, agreement with any shareholder of the offeree that
has the effect of providing to the holder a consideration of greater value than that
offered to other holders (The Rule Against Collateral Benefits)

Section 104(2)(a): "The commission may, if it is satisfied that it would not be
prejudicial to the public interest, decide for the purposes of Section 97(2) that an
agreement, understanding, or commitment with a selling security holder is made
for reasons other than to increase the value of the consideration paid to the
selling security holder for the securities of the selling security holder and that the
agreement, understanding or commitment may be entered into despite that

November 17, 2000:

Answer to questions relating to last class and a general review of main topics
from last class:

If I were to buy a convertible debenture that entitles me on conversion to buy
shares, most people are of the view that under s. 92 that ac quisition of the
convertible debenture can be an indirect takeover bid even though the shares on

the exercise of the conversion are themselves unissued because you are buying an
issued security.

Imagine a scenario where someone has 19.9% of the common s hares of the
company and wants to sneak up and acquire control and imagine that there are
convertible debentures outstanding that if converted might allow you to buy 10%
of the common shares of the company on a fully diluted basis. (fully diluted basis
means that you add to your denominator the number of shares that the issuer has
after conversion and add to your numerator the number of shares that the
acquirer has after conversion). Thus, assume that if the person bought the
convertible debentures and that person converted them would end up at 29%
instead of 19%.

If it was case that section 92 did not apply to that acquisition of a convertible
debenture than the person would be able to go from 19% to 29% without making
takeover bid and that person might well be in a position to lock up control of the
company. Thus, the orthodox view of Section 92 is that it would apply to the
purchase of that convertible debenture and that the purchase of the convertible
debenture would be an indirect takeover bid because it allows you to through the
purchase of that security to get more securities upon conversion.

The other view points to the fact that if one were simply to go and buy 10%
percent from the company directly and thus move from 19% to 29%, this would
not be a takeover bid because the person has not made an offer to acquire to any
security holder.

However, the orthodox view of Section 92 is that if you buy an issued security,
even if it is not a security of a particular class that you are seeking to acq uire, you
will be caught by Section 92 making an indirect takeover bid if the convertible
debenture will take the person from 19% to 29% after conversion.

A takeover bid is an offer to acquire voting or equity securities where the shares
that are the subject of the offer to acquire when combined with the offeror's
securities would result in the offeror owning 20% or more of a class or series of

Offeror's securities is what the offeror's owns and what the offeror's cronies own
and it is what the offeror is capable of buying within the next 60 days through the
exercise of rights of purchase or conversion.

Indirect takeover offers can be both the purchase of another company that owns
shares and it can be the purchase of a convertible security.


S. 94 of the Securities Act contains a number of restrictions on what an offeror can
do in the context of making a bid.

The first thing that you have to notice about S. 94 is that it has an expanded
definition of offeror. The offeror in S. 94 is not the just person making the offer
but it includes people who are acting jointly or in concert with the offeror and
persons who are control persons of the offeror. Control person is someone who
has sufficient number of securities of the offeror such that they would fall within
the definition of "control person" in Section 1 of the Act is going to be considered
an offeror himself.

S. 94 offer states that once the offeror has announced that it is going to make an
offer, the offeror cannot buy shares other than through the offer unless offeror's
say so in its takeover bid circular and the offeror does not buy shares until 3 rd
business day after the offer has been made formally and the offeror limits itself to
5% of the class of shares and if the offeror does purchase under these
circumstances, the offeror has to announce every day that it has made purchases.

In the United States, an offeror cannot buy shares on the marketplace once the
offeror announced a takeover bid. In Canada, the offeror can buy but only in the
limited and restricted basis described above.

PRE-BID INTEGRATION RULE: This rule integrates the purchases the offeror
has made within 90 calendar days of the making of the bid with the bid itself.

Thus, this rule says that if the offeror buys any shares, other than open stock
exchange market purchases that are unsolicited, during the 90 day period
preceding the offeror's bid, those purchases will be integrated with the bid.

The rule says that when the offer or makes the formal bid, the offeror will have to
pay, at least equal consideration, under the formal bid as the highest price the
offeror paid in the preceding 90 days in the offeror's pre-bid acquisition. This is
the equal consideration rule and notice that the rule does not say "exactly the
same." This means consideration of equal value.

Another rule is that if in the pre-bid 90 day acquisition period someone sells the
offeror a certain % of their shares, than the offeror must offer to buy that %a ge of
shares from everyone that is still a shareholder. However, the offeror can always
offer in the actual bid period to buy more than the %age that it bought during
pre-bid 90 day acquisition period, but it can offer to buy a lower %age from every
shareholder in the actual bid period from the %age it bought from a shareholder
during the pre-bid 90 day acquisition period.

POST BID INTEGRATION RULE: It is also found in Section 94. It states that
when an offeror makes a bid and it expires, the offeror cannot buy any shares for
20 business days unless the offeror makes another takeover bid.

If you are offering cash, you must have made adequate arrangements for your
cash financing, before you make your bid. (s. 96)

Prohibition against collateral ben efits (s. 97) The only exception to this rule is
found in Section 104.

S T A T U T O R Y                     O B L I G A TI O NS                        O F

Director's statutory obligations to respond to a Takeover bid

The Board of Directors under the Securities Act is required to issue a Director's
Circular. The philosophy is that the role of the Board of Directors is an advisory
one; their job is to provide information and thereby assist them to make an
informed decision whether to accept or reject the offer that has been made.

Therefore, the Board of Directors are obliged to prepare and send to you, the
shareholder, a director's circular that contains all of the information that is
prescribed in Form 34 to the Securities Act.

Secondly, the Board of Directors is required to give a recommendation t o
shareholders or if they are unwilling to do so, to explain to shareholders why
they are unwilling to do so. The presumption here is that the shareholders
actually care about what the Board of Directors thinks.

S. 101 is the early warning requirement in the Securities Act and it is part of Part
XX. This section compels the disclosure by a persons who acquire 10% or more of
the shares of a class or series of a reporting issuer. In the United States, there is a

similar rule that requires disclosure at the five percent threshold (called Schedule

As soon as you hit 10% of beneficial ownership, or control or direction of 10% or
more of the shares of a class or series of a public company, you have to report it
to the Securities Commission by issuing a press release and filing a report within
2 business days.

What has to be in the press release and in the report is set out in National
Instrument 62-103 in Appendix E. The whole regime for early warning reporting
is now encapsulated in NI 62-103.

Until such time as you file the report, you cannot buy any more shares. Once you
file the report, you can buy shares 1 business day after the report was filed.

The report once filed has to be amended if the either of the following two events

1) Each time you buy an additional 2%, after the 10% threshold and, presumably,
   upto 19.999999%.
2) or there has been a change in any material fact in your report. One of the
   things that you have to say in your initial report is what your intention is with
   respect to taking over the company. Thus, if this intention were to change in
   the initial report, one would have to amend the report.


What do boards of Directors really do when they are faced with takeover bid that
they were not consulted on?

There are three things that the Boards of Directors can do if they don't like the

1) try and persuade shareholders not to accept the offer
2) try to take active steps to sell the company at the best possible price
3) to take steps to cause the bid to fail.

National Policy 62-202 (formerly called National Policy 38) discusses issues
related to No. 3 directly above.

NP 62-202 states that Boards of Directors may take action to improve shareholder
value by engaging in certain takeover defens e tactics. However, this engagement
in defense tactics against takeover bid cannot not be done to the point where the
shareholders' ability to accept the offer or a competing offer will be completely

In Canada, because of NP 62-202, you cannot get in the way of shareholders of
having the ultimate say.

The principle defensive tactic available in both US and Canada to a board of
directors that would impair a shareholder's ability to accept an offer is the
shareholder rights plan or the so-called poison pill rights plan.

A company enters into a indenture with a trustee for the benefit of all its
shareholders. Pursuant to the indenduture (which is just a contract), the
company issues to every shareholder a right. The right is inseparable fr om the
share and is attached to the shares as the they trade. The right once triggered by
a particular event allows to buy a share of the company at a price that is usually
10 times what the shares actually trade at. The right is effectively worthless an d
no one would ever exercise it. The event triggers the right's exercisability is the
announcement by a party that it intends to make a takeover bid for the company.
Initially, the rights are attached to the shares and are not exercisable (severable)
from the shares. If someone announces that they are going to make a takeover
bid, the rights become separable and separate trading instruments in theory,
subject to the board of directors power to throw this out. What makes the right
poisonous is this: if an acquirer acquires a specified amount (usually 20% in
Canada), the rights become exercisable on the part of all of the other shareholders
except that shareholder who has gone to the specified amount. At that point, it
will allow the other shareholders to buy a large amount of stock at half price. It
creates massive dilution for the acquirer

Example: Shares are trading at $20 and there is a million shares outstanding.
Each shareholder gets a right to buy one share for $200. Someone announces a
takeover bid. Then, my right is a separate instrument and is exercisable.
However, it is still involves buying one share at $200. But, if a takeover bid is
made and the acquirer buys 200,000 shares, he will trigger the pill. At that point,
there will 800,000 rights outstanding that are exercisable and 200,000 rights that
are not exercisable. The contract will then say that once the pill is triggered, the
800,000 rights that are exercisable can buy $400 dollars of worth of stock for $200.
Thus, one will be able to 20 shares for the $200. Thus, if everyone exercises their

rights (20shares x 800,000 rights), there are now 16 million new shares and the
acquirer will have 200,000 shares of 17 million shares. Thus, there is mass
dilution of the takeover bid acquirer.

In Canada, the Securities Commissions have decided that there will come a point
in time at which they are going to order the poison pill to be taken away. They
do this by issuing a cease trade order that prevents the ability of the rights being

The questions that the Securities Commission will ask in determining whether
the poison pill should be taken away are the following:

Are the board of directors in this particular situation conducting themselves in a
way in which they are acting in the shareholders' interests? Are they trying
honestly and objectively trying to get a better transaction for shareholders? If the
answer is yes, then the question is there a reasonable chance that they will get a
better deal for shareholders?

The Board of Directors of the target have to persuade the Securities Commission
that it is interests of the target's shareholders to allow you to continue to try to
sell the company. If the Board of Directors is successful in persuading the
Securities Commission, the Securities Commission will not order the Board of
Directors to throw out the poison pill.

If the Securities Commission is not persuaded, however, then they are going to
tell the Board of Directors of the target to withdraw the poison pill or we will
make a cease trade order.


In Canada, one sees far more negotiated transactions than in the United States.
The good thing about a negotiated transaction is that it is more likely to succeed
than a hostile takeover bid.

In a negotiated transaction, where there is a significant or controlling
shareholder, the first thing you, as a lawyer, want to do, is to get the support of
the significant or controlling shareholder and at the same time you also want to
get an agreement from the Board of the target that they will support the merger
of the companies.

However, the mechanism by which one gets the support of the significant or
controlling shareholder is called a lock-up agreement. A lock-up agreement is a
simple contract between the acquirer and the controlling or significant
shareholders of the target where they agree to form a transaction. If the form of a
transaction is a takeover bid, the significant or controlling shareholders of the
target will typically agree to tender over their shares to the takeover bid in the
lock-up agreement. If the form of the transaction is an amalgamation or
arrangement, the significant or controlling shareholders agree to vote in favour of
the amalgamation or arrangement in the lock-up agreement.

Sometimes, the significant shareholder says that he likes the offer of the acquirer
and that he is willing to accept but that he still is not satisfied that the offer of the
acquirer is the best offer available. Thus, this kind of a significant shareholder
will say in such a situation that he wants the right in the lock-up agreement to
withdraw from the lock-up agreement if a higher offer is made. Thus, in such
situations the compromise will be that there will be a limited ability to withdraw
from the lock-up agreement and to sell to a higher bidder but that the extra
money will be shared between the initial bidder and the controlling shareholder.
This is called a topping fee.

The acquirer will also you usually to try and get the Board of Directors of the
target and the controlling or significant shareholders to agree to a no-solicit
clause or non-shop clause. This clause says that the Board of Directors and the
significant shareholder cannot shop the company around in order to get higher
offers from other bidders after having agreed to support the acquirer's bid. The
point is that the Board can still withdraw its support if there is a higher offer but
they cannot go out into the market and shopping around for a higher offer.

Moreover, as the acquirer, you will also want to negotiate a break-up fee with the
Board of Directors if someone comes out of left field that pay more than you are
willing to pay. At the point if the Board supports the competing offer after
having agreed to have support your offer, the initial acquirer will get a fee for the
Board having switched its support from the initial offer to the competing offer.
The quantity is only limited by what is considered "reasonable." 3 -4% of the
equity value of the initial offer is reasonable. The test is whether or not the fee is
so high that it effectively precludes anyone else from reasonably being expected
to make a higher offer.

Another mechanism used to protect a transaction occurs where the acquirer
simply wants a particular part of the target company. The acquirer in such

situations will say: "I am willing to buy the whole company including the parts
that I do not want. However, if the deal to buy the whole company is somehow
frustrated, I still want to buy the particular part of the business for which I was
willing to buy the whole company." This is a so-called "crown-jewel" option.

Another mechanism used to protect a transaction is called a cross-option. It is
used in mergers of widely-held companies, such as the Canadian banks that
wanted to merge. The cross-option gives each of the companies involved in the
merger to buy from the treasury a bunch of shares from the other company at
prevailing market prices so that in the event that someone came along and made
unsolicited bid for either one of the companies, the company that was not subject
to the competing offer would get a consolation prize through the ability to
exercise stock options and sell them to a higher bid.

An example: Someone comes to you, the lawyer, and says I have no shares of
Company X. The company is incorporated under the CBCA and is listed on both
the NYSE and TSE and nobody has control over it. However, there are 3
institutional shareholders that together have 45%. One institutional sharehold er
has 18%, another has 15% and the last one has 12%. The rest is all widely held.
Moreover, there is publicly traded convertible debentures out there that if bought
and converted would lead the purchasing them to have a 10% interest in the

What are the options of the persons who has no shares of Company X but wants
to get control over Company X?

The first option is to just make a bid and go to talk with the institutional
shareholders and see whether they will sign a lock-up agreement to support your
bid. If you get them locked up, you have 45% in the bag from the beginning.

The second option occurs if the client only wants to get control over the company
and does not want to buy all the shares. If that is the case, you would
recommend that your client buy shares in the marketplace. The fact that the
company is listed on the NYSE, means that you, the lawyer, have to tell your
client that once he reaches the 5% threshold of shares of the company, he must
file a Schedule 13-d in the United States, which is the American early-warning
requirement. At the 10% threshold of shares of the company, your client will
have to file a notice under S. 101 of the Ontario Securities Act and he will have to
start filing insider trading reports. You will tell your client that he can keep
buying in the market until he get 19.9999% just as long as he is making his insider

trading reports. However, you, as the lawyer, must tell the client that he cannot
go up to 19.9999% of the common shares if he owns any of the convertible
debentures because you will have to count them as part of "offeror's securities"
any time he is looking at whether or not a purchase that he is going to make is
constitute a takeover bid. Thus, it is probably not in the interest of the clien t to
buy any of the convertible debentures. If the client wanted to buy 100% of the
company, the client would probably want to buy the convertible debentures.

Once the client gets to 19.9999%, any shares that the client buys is going to be a
takeover bid. The objective is not own the whole company but simply to get
control over it. Thus, what can our client do? The client can talk to the
institutional shareholders. If they do not agree on price, the client can wait for 12
months and then buy more shares on the marketplace. However, the client can
only buy 5% using this exemption. Therefore, this is not much help. Thus, if the
client wants to get much further, he has the following choices: making a private
agreement with the institutional shareholders only paying a 15% premium or the
client can make a partial takeover bid of the company. The problem with the
partial takeover bid is that the Board of Directors of the target is likely to go and
find someone who is willing to make a better offer than you are. Thus, at that
point, the client has to ask himself whether it is not really worth his while to
make a bid for the whole company.

November 24, 2000:

RULE 61-501 (formerly OSC policy 9.1)

This rule was only put into force by the OSC on May 1, 2000. It replaced OSC
Policy 9.1. The fact that it is a rule means that it has force of law, whereas policy
statements do not have force of law.

In Quebec, there is a local policy of the QSC called Q-27.

These rules regulate in a specific way 4 different types of transactions:
1) Insider Bids
2) Issuer Bids
3) Going Private Transactions (GPTs)
4) Related Party Transactions (RPTs)

There is virtually no difference whatsoever between Q-27 and Rule 61-501.

By virtue of the fact that virtually almost issuer in this country of any size will
have security holders resident either in Ontario or in Quebec, the other provinces
have not felt any need to enact similar legislation. This rule in Ontario and the
policy in Quebec have the de facto effect of regulating virtually every kind of the
above-mentioned transactions across the country given that most companies will
have security holders either in Ontario or in Quebec.


Thus, theoretically, every company in the universe could attract this regulation.
There are, of course, exceptions where there is a de minimis connection with the
jurisdiction. Usually, there will be an automatic exemption if there are 50
shareholders holding less than 2% of the shares.

OSC Policy 9.1 was originally passed in 1990. Up until 1990, the regulation of
takeover bids made by insiders pretty much resembled the regulation of takeover
bids generally. There were no special rules merely by virtue of the fact that the
offeror was an insider of the company.

There has been regulation of issuer bids for a long time. Everything that we have
talking about with respect to takeover bids applies to issuer bids as well. Thus,
OSC Policy 9.1 had a relatively mild effect in terms of the company buying back
its own securities.

However, OSC Policy 9.1 really got teeth with respect to GPTs. GPTs is where
one's interest in a company can be extinguished without your consent. In other
words, someone proposes a merger between their company and the company of
which you have shares with you being left with cash and them getting all the
shares. There had been virtually no regulation of those sorts of transactions other
than the basic Business Corporations Act regulation of amalgamation and merger

The most controversial part of OSC Policy 9.1 was when it started to regulate
RPTs. It was controversial because in large part because RPTs don't involve the
issuing of securities.

The Securities Commission's had a rationale for its intervention in RPTs via OSC
Policy 9.1. The rationale was this: when someone has a position of significant
influence, but not complete ownership of a public company and cause that

company to enter into a transaction with another company that they own but that
they don't control entirely, then the controlling person might have an interest in
tipping the scales of fairness in one direction or another depending on the
materiality of their financial interest in one company or the other.

Let us say that Company X has 11% of Company Y and 51% of Company B and
let us say that Company X effectively controls Company Y. Suppose further that
Company X decides that Company Y has a nice mining property and Company B
is also a mining company and thus wouldn't it be nice for Company X if
Company Y sold the mining property for Company B. Thus, the other 89% of
shareholders of Company Y are likely to suffer from the deal because it is likely
that Company X will use its control of Company Y to get the mining property f or
Company B at a good price.

Thus, the Securities Commission said that it didn't care if the subject matter of the
transfer is an asset and that its interest in regulating the transaction came from
the fact that minority shareholders' interests and the integrity of the capital
markets are at stake here and are threatened by this kind of conduct.


The definition of insider bid is in Section 1.1(3) of the Rule. "Insider bid" means
"a takeover bid made by an (a) an issuer insider of the offeree issuer, (b) an
associate or affiliated entity of the issuer insider, (c) an associate or affiliated
entity of the offeree issuer, or (d) an offeror acting jointly or in concert with a
person or company referred to in paragraphs (a), (b) or (c)"

An insider bid is defined in the Rule as a takeover bid made by an insider or
what is now called an issuer insider. Basically, it means directors and senior
officers of the issuer, directors and senior officers of the company that is itself an
insider and any person who beneficially owns, controls, or directs more than 10%
of the voting securities.

Company X is an insider of Company B and Company Y and Company D
because it owns more than 10% of the securities. Company X owns 11% of
Company D. Let us say that you are a director of Company X and thus you are
an insider of Company X. You are also an insider of Companies B, D and Y
because you are the director of a company that is itself an insider .

Company B owns for 49% of Company C and therefore Company B is an insider
of Company C. Company C is not an insider of Company B because the rule
does not go upstream. Because you are a director of X, you are an insider of
Company X. You are also an insider of Company B because Company X is
insider of Company B. You are also an insider of Company C because
Company B is insider of Company C.

Thus, if you, a director of Company X and you make a takeover bid for
Company C, it is an insider bid.

If you are an associate or an affiliate of an insider and you make a takeover bid, it
will also be called an insider bid. Associates can be a trust for one's benefit or it
can be one's spouse or a relative or any company where one owns 10% of the
shares. Thus, suppose that you are a director of X and you have your personal
holding company on the side. The holding company on the side will be an
associate of yours.

Let us suppose that Company X has a 51% interest in Company E and a 51%
interest in Company B. That would make Company E and B affiliates because
they are both subsidiaries of Company X. Therefore, if Company E makes a
takeover bid of Company B, it would be an insider bid because it is a bid made
by an affiliate of the insider and also affiliates of the Company B, by
definition, are making insider bids if they make a takeover bid.

Lastly, any person acting jointly or in concert with the insider is considered to
be making an insider bid if they make a takeover bid. Again, this is a question
of fact.

The reason there is a special level of regulation here is that when an insider
makes a bid, the insider is presumed to have a special level of knowledge that an
arms-length 3 rd party would not have. But, if one is a shareholder and get an
offer from somebody that is an insider, the law presumes that the insider has
better information than the simple shareholder. So, what Rule 61 -501 says is that
in those circumstances, we, the Securities Commission, will do something to level
the playing field between the offeror who is an insider and is presumed t o have a
better information base and the recipient of the offer so that the recipient of the
offer is not going to taken advantage of. So what does Rule 61 -501 do? It says
that if one is going to make an insider bid, one should commission and prepare
for the benefit of minority shareholders a valuation by an independent expert
valuator and the target company should set up a committee of its Board of

Directors that is composed entirely of directors that are independent of the
offeror and all of its affiliates, associates and actors acting jointly or in concert
with the offeror.      The committee of independent directors of the Board of
Directors of the target company go out and hire an independent, expert valuator
to value the shares of the target company. The valuator then prepares a valuation
of the shares of the target company. The insider has already made its offer,
however. The valuation of the independent valuator may be the same as what
the insider has offered or it come in higher; it rarely comes in lower.

Thus, as a practical matter, this rules has had the effect in the last decade to force
insiders to pay fair value and not to take advantage of an imbalance of
information by virtue of the role of the independent valuator.

After the valuation is done, the insider must still disclose any valuations made of
the target company in the last 24 months.

One can always ask for an exemption from Rule 61-501 if one is insider but one
has no representation on the board and no access to non-public information and
no role in management and no other relationship that could lead one to have
non-public information. It is referred to in Section 2.4(2) of Rule 61-501.

Section 2.4(3) of Rule 61-501 provides an exemption for the insider if there has
been a previous arm's length transaction. Here, the rule is saying that if there has
been a transaction within the prior 12 months of a substantial number of
securities and the insider is offering a price now as the price offered at the
previous arm's length transaction, then there will be a valuation exemption. This
prior arm's length deal can actually occur in the context of the insider making a
takeover bid. This occurs usually if there is a holder(s) of 20% or more of the
shares. The insider will usually attempt to get a lock up agreement with said
holder(s) of 20% or more of the shares and to do that the insider will have to
negotiate with the holder(s). Thus, if the insider can go and negotiate a fair price
with an independent holder of at least 20% or a group of holders that aggregate
to 20% provided that at least one of them has 10%, then the Securities
Commission will say that the price negotiated with the holder(s) will be a
substitute for the valuation and the insider will not have to commission an
independent valuation.

If the insider already has 80% of the shares and wishes to use this exemption so
as not to commission an independent valuation and, therefore, he negotiates with
a group of holders whose aggregate is the remaining 20% of the shares, one

member of the group of holders must have at least 5% in order for the insider to
avail himself of the exemption.

The person or group of persons having 20% or more of the shares with which the
insider can negotiate an arm's length transaction must have "full knowledge and
access to information to the offeree issuer and its securities" and cannot be
motivated by other non-financial reasons.

Section 2.4(4) of Rule 61-501: Another exemption can occur in the following
situation: Let us say that you are an 11% and are an insider and someone else
makes unsolicited takeover bid at $20, you, the insider, can bid $21 without
making a valuation.

Everything that we have talked about the last two weeks on takeover bids applies
to all takeover bids and all issuer bids. What we are talking about today applies
to certain takeover bids where the bidder is an insider or an associate or an
affiliate or joint actor of an insider. Thus, when you see a takeover bid problem,
you have to ask yourself who is the offeror here? Is the offeror an insider? If so,
Rule 61-501
applies and there may be a valuation obligation here.


Here instead of the insider being the buyer, it is the company itself that is the

The issuer bidder will have to disclose prior valuations and prepare a formal
valuation. There is one exemption here that does not apply to insider bids:
where there remains a liquid market (the test for what is a liquid market is set out
in Section 1.3 of Rule 61-501) after the bid is complete, the issuer does not have
make a formal valuation.



Here there is more than the problem of an informational imbalance. Here the
shareholders who is being bought out are losing their equity interest in the
company going forward.

Here a transaction has been put forward that if approved by a majority of your
fellow shareholders is going to result in you losing your investment and getting a
pile of money instead and you, as a shareholder, might not agree with that.

Let us say that Company B goes to Company and C and let's amalgamate.
Company B says that its 49% of shares of Company C will be replaced with 100%
shares of the amalgamated company and the other 51% shareholders of Company
C will get cash money. This is the functional equivalent of Company B going to
the 51% and offering them money for their shares except that it is not an takeover
bid. Rather it is a merger transaction through an amalgamation or arrangement.

B is an insider and after giving effect to the transaction it will own all of C. In this
situation, if Company B and Company C agree to amalgamate, then under
corporate law, the amalgamation is submitted to a shareholder vote and under
corporate law if 2/3 of the shareholders who attend and vote at the meeting, the
amalgamation goes through.

Company B will only need 20% of the remaining 51% of the shares to make the
amalgamation go through assuming that everyone actually attends and votes the
meeting. Thus, securities regulators has said that this cannot go on because the
minority shareholder gets fucked in this situation.

Thus, the securities regulators say that it is ok where everyone gets to own shares
of the merged company going forward.               However, where the minority
shareholders gets only money and gets effectively squeezed out, the minority will
get to vote as a separate class on the transaction and a formal valuation subject to
the same exemptions that we talked about in discussing insider bids. See Section
4.7 of Rule 61-501 and Part 8 of the Rule. Those rules state that of the 51%
interest in Company B, a majority of those who show up and vote at the meeting
have to yes for the going private transaction to go forward. Thus, securities law
is saying that in addition to the 2/3 majority you are required to have from
corporate law requirements you will also need a majority of the people who are
getting squeezed out by the transaction.

The classic scenario for going private transactions occurs in two-step mergers. In
section 8.2 of the Rule, it talks about multi-step transactions. Step 1: I make a
takeover bid that is totally arm's length. If I get 90% or more of the shares under
most Business Corporations Act, I will have a right to acquire the balance at the
same price. If I exercise that right, it is not a going private transaction given that
is situation is specifically excluded from the definition. However, if you get less

than 90% of the shares, then you have decide what you are going to do? If I got
66.6% of the shares, then as a matter of corporate law I have enough votes to
cause a merger between my company and the target company. However, this
rule says that I have to have minority approval of any going private transaction i f
I propose a going private transaction (which would be step 2). The Rule in
Section 8.2 integrates your takeover bid with your second stage transaction
provided that they are reasonably proximate in time. Thus, if within the 120 days
of the expiry of my takeover bid, I then propose a so-called "second stage" merger
transaction between the bidder and the target, then for the purposes of these
rules the shares that were tendered into my first bid get counted as minority

Thus, if you are advising a client who is bound and determined to get 100%
control of the company, what will be your advice? Your client can make a
takeover bid and if he gets 90% or more of the shares, then the client has the right
to buy the rest. However, if your client gets 66.6% of the votes and a majority of
the minority and had said at the outset that if he got less than 90% he would
pursue a second stage going private transaction, then you know that after
sending out a proxy circular and soliciting proxies, your client will be allowed to
vote those shares that he got as out of step 1 as part of the minority and you will
not need a formal evaluation.



 A related party transaction has been defined in the law effectively as any
circumstance where an asset, a liability or a treasury security changes hands
between an issuer and related party of the issuer.

Related party transaction is where a reporting issuer enters into a transaction
with a related party and as a result of that transaction the related party acquires
an asset from the issuer or vice-versa or the reporting issuer assumes a liability of
the related party or issues a treasury security to the related party or enters into
any kind of a material contract with the related party.

Related party is defined in the Rule. Effectively, it is someone who alone or
acting in concert with other is in a position to affect control of the reporting
issuer. The control element is not measured through the 20% threshold and it is
not necessarily only through the ownership of securities. One can be a related

party by virtue of contractual rights. Anybody who has a 10% voting is
automatically caught. Moreover, any person or company in respect of which t he
reporting issuer can itself materially affect control is automatically caught. The
director or senior officer of the issuer or of a related party or any affiliate of the
foregoing is a related party.

Just like with GPTs, there is a formal valuation requirement and minority
approval obligation with respect to RPTs.

Some of the exemptions to RPTs rules are:

If the thing that would otherwise be subject to RPTs, is worth than less than 25%
of the market capitalization of the issuer, then it is considered small enough that
it does not warrant this extra layer of regulation.

If for example you issue a rights offering to every shareholder, it would be ok.

If the transaction is negotiated with an arm's length controlling shareholder who
him or herself who himself has no interest in the outcome, that would be ok.
An example: Company X owns 11% of Company D and you own 70% of
Company D. Let us say an agreement is entered into between X and D that has
been negotiated with you as the controlling shareholder where D is going to
purchase an asset from X. The purchase of the asset from the related party is a
related party transaction but because the terms were negotiated with an arm's
length controlling shareholder, that is exempt.

There is a limit to these protections: If a related party owns 90% of the reporting
issuer, then all this stuff falls away and none of this regulation applies.

December 1, 2000:

Securities Regulations          December 1, 2000

Remember 5 basic propositions
1-you must register to trade or have a registration exemption
2-must prepare prospectus if distribution unless exemption
3 peple who are registered under act have to satisfy certain minimum standards of
conduct and there are penalties if they don't abide by those minimum standards of

4-issuers of securities in capital markets must make timely disclosure of material facts
and insiders must report what they own s.122-129 penalty provisions of act include
remedies available to securities commission

know part 20 of act TOBS and rule 61-501 spent all last week talking about

p.100 csbk-guide to analyzing exam qs-
know what security, trade, distribution, reporting issuer, control block is (part of
definition of distribution)
sec not exhaustively defined in act-basic test- Investing or just buying a product? Pacific
case-buying on margin and relying on 3P getting close to it
chances are if it looks like might be a sec it probably is

trade: sale for valuable consideration (i.e. not a purchase) not matter if acting as
principal or agent-act in furtherance of a trade is also a trade –in order to trade you must
be registered unless have exemption

The definition of distribution is in (s.1) It is a trade in
5) previously unissued securities
6) sale from control block
7) 1st trade issued pursuant to prospectus exemption

difference between issuer and reporting issuer: a reporting issuer, either voluntarily
through filing of non-offering prospectus or by its own actions of listing on exchange or
involuntarily through the filing of a prospectus will be subject to continuous disclosure.
You need to file final Propsectus, a preliminary one is not enough to become reporting.

Certain things apply only to reporting and certain to all issuers.
Continuous disclosure rules-create burdens also make these securities more tradable -
s72(5) as long as comply with that s.

Control person arises when you exceed the 20% holding threshold. However, it is
always a question of fact whether or not someone is a control person. Just because a
person is at 19% percent does not mean that that person is not a control person.
Moreover, just because a person is at 21% does not mean that you are control person. It
is simply a statutory presumption at 20% that one is a control person. However, one has
to look at the facts and see if there is anyway to rebut the presumption.

When it comes to the public distribution of securities: the general principle is you must
prepare and file a prospectus unless you have an exemption. If you do distribute
securities on an exempt basis, then you enter the closed system and you are subject to
resale restrictions. BRING closed-system road map to exam!

Resale restrictions vary generally on how long the issuer has been a reporting issuer,
whether the securities are listed, whether they are legal for life (obscure test in insurance
act) and what exemption was used initially to distribute the securities.

Remember that if you distribute without a prospectus or an exemption or trade without
registration or an exemption or advise someone on securities without registration or an
exemption, you are in breach of the Securities Act.

S.122 of the Securities Act: any breach of the act, any misrepresentation in documents
released or any lie you may make to OSC, is an offence which subjects you to a million
dollar fine or 2 years in jail.

For insider trading or tipping the fine is even greater: the greater of $1 million or 3
times the profit made or loss avoided. Thus, there are special fines for tipping and
insider trading offenses above and beyond the fines that are otherwise applicable for
any other breach of the Act.

S.127 is the OSC's public interest jurisdiction: this is their ability to bring action against
you where they feel that you have conducted yourself in a way that is contrary to public

When you get a problem, one of threshold questions you want to ask yourself is: if I
have a company here that’s involved in this situation, ask is it a private company or a
public company.

Private companes are ones that have restrictions on transferabilty of shares and limit on
number of shareholders and a prohibition on invitation of public to subscribe built right
into their articles of incorporation. If dealing with a private company, then there is a
prospectus exemption in s.73(1)(a) and a registration exemption in s. 35(2)(10) that
allows trading in those securities without registration and filing a prospectus provided
that you have not invited public to subscribe. (this essentially refers to "securities of a
private company where they are not offered to sale to the public")

So, you may have to ask yourselves if I have a private company and the securities are
being distributed (sold or traded) have they been offered for sale to the public and that
gets you into those cases we talked about: R.v. Piepgrass, Raulston Purina case, Buck
River Resources that have 2 lines of analyses. One line of analysis is the R -Purina
doctrine: did the purchasers of securities have a need to know the kind of information
that would have gotten from a prospectus. The second line of analysis is the Piepgrass
line of thinking is which states that persons who are friends and associates or who have
some sort of common bond of interest or association do not constitute the public.

Those two lines of analyses are applied by the Buck River Resources Case. Therefore,
apply both lines of analysis to fact pattern on the exam. Professor gave us 9 questions
that you would ask yourself in those circumstances to try and get some sense of which
side of line you are likely to be on and these are in no particular order of importance:
1. were purchasers sophisticated?
2. was there a broad solicitation?
3. would virtually any subscription have been accepted?
4. were the investors friends or associates of vendor?
5. what common bonds of int or assoc exist bet buyers and sellers?
6. do these common bonds give investors opportunity to truly know the seller?
7. was there any selling pressure?
8. how did buyers come to know about opportunity?
9. were they given anything that resembles a prospectus?

Ask yourself those 9 questions and if most of answers suggest that dealing with people
to whom these securities were truly marketed and people who don’t really have
common bond of interest or association that would allow them to really know the
person who is selling the securities, then they are probably going to be the public.

At the end of other end of spectrum, you will have close friends and relatives that the
vendor has invested with numerous times before and are very sophisticated and are
unlikely to be public in those circumstances, so go back and read those cases.

While there is no clear answer (no bright line test), this is one area of secs law where is
no bright line test and the case law difficult to apply because issues always come up i n
content of widow who lost all money on some crummy stock, the test that you are going
to want to apply is a combination of Piepgrass ad Raulston Purina test

The more popular P exemptions have asterisks beside them on closed sys roadmap. The
most obvious popular prospectus exemptions are 72(1)(a)b,c,d,and p when it comes to
doing initial distributions of securities

There is the Rule 45-503 that replaced 72(1)(n). It deals with employees and stock

You should read 45-501 and 45-503 and companion policies because they are as much a
part of the closed system as the Act and Regulations are. A lot of the content is in those
rules now.

Then, there are other exemptions that apply to convertible securities and exchangeable
securities-72(1)(f)(iii) and 72(1)(h)(ii)--and you should know them both so that if you
have a fact pattern where there is a convertible security or a warrant to purchase

securities is involved, you will be able to trace what exemption is applicable when the
conversion right or the exchange right is exercised.

Or there are provisions in the rule that deal with automatic conversions (or conversions
that are at the option of the issuer) that are analogous to h(ii) and f(iii) and also want to
focus on resale provisions of s. 72 (4) and (5) and rule 45-501. Don’t just get asked what
exemption you are relying on, but your client will inevitably want to know when they
can sell the securities free and clear. That is why road map set up the way it is. Always
know was the applicable resale provision is.

Also talked about continuous and timely disclosure. The objective is to keep investors
apprised of all material information. There is the scheduled continuous disclosure
obligations that a company has where they are required to refresh and bring forward the
information that they have filed on the public record so that people trading securities
have reasonably fresh info and then there is the timely disclusre obligations that are in
NP 40 that require reporting issuers to make timely immediate disclosure of material
facts. Read NP 40 and review definition of material change and material fact.

We talked about Proxy solicitation: It is the obligation on part of public companies to
solicit proxies for use at annual and special meetings. If you don’t like way company is
being run your only real remedy is to throw out directors, so you use the proxy contest.
Remember the basic principle of corp law is that the directors manage the business and
affairs of the company not shareholders. Shareholders only get involved where the
statute gives them a say.

Remember that a shareholder or group of shareholders owning 5% of a company's
outstanding voting shares are entitled to requisition a shareholder's meeting

Insider Trading, a fundamental principle, all investors are supposed to be on an even
footing when it comes to material information. The critical definition is what is a person
in a special relationship. Thus go back and know that concept of what it means to be in
a special relationship

s.76(5) of the Act: gives you the definition of person or company in a special
relationship with a reporting issuer. Know what is in a special relationship when you
trade with knowledge of material info that is not generally disclosed. That is the
defintion of insider trading.

Furthermore, it is an offence in Canada to tip others to material information other than
in the necessary course of business. Thus, if you have material information and you tell
someone else, that is tipping and is as much an offence as insider trading.

Insiders required to report their trades. In most provinces now it must be within 10
days after the trade. So insider for those purposes is the definition section of the 1 of
Act (i.e. 10% or more… is an insider (read it)) If you are an insider, then you have to
report your trades

Directors and Senior officers are themselves insiders. You are not an insider solely by
virtue of share ownership. It can also be by virtue of your position as a director or
officer of the reporting issuer or director or officer of another issuer that is itself an
insider of the reporting issuer. Moreover, directors and officers of subsidiaries of the
reporting issuer are all insiders.

Understand rules on mergers and acquisitions and Takeover bids

For takeover bids, you need an offer to acquire voting or equity securities of a class or
series made to anyone in Ontario if the securities that are subject to the offer plus the
offeror’s securities (which is a defined term) equals 20% or more of the class or series.
Offeror's securities is defined in s. 89 It includes shares that are beneficially owned and
over which control or direction is excercised by any person acting jointly or in concert
with an offeror and it also includes shares that are deemed beneficially owned by
offeror (i.e. convertible securities, exchangable securities, rights to purchase securities
that are exercisable within 60 days. Whether or not X is acting jointly or in concert is
always a question of fact. There are presumptions in Securities Act that presume people
to be acting jointly or in concert where there is an agreement, commitment or
understanding, whether formal or informal, to acquire securities together or to vote
them together. This is a difficult presumption to rebut.

s.91 of the Act deals with indirect offers. Classic example is where x buys a private
company, the sole holding of which is shares of a public company. By virtue of this
section is X is buying shares of the public company.

Should go through rules in s.95 that generally apply to all Takeover bids.

In particular, you should know the       rules in s.97 on collateral benefits and equal

Should be aware of pre bid and post bid integration rules. Pre -bid rule says that any
purchase that you make within 90 days of the announcement of your formal bid will be
integrated with the formal bid. This means you have to pay highest price that you paid
to anyone in the pre-bid period and buy same percentage of securities in formal bid as
persons agreeing to selling to you at pre-bid acquisitions.

Post-integration means you can’t buy shares for 20 business days after the expiry of a
formal takeover bid.

Should also know s.101. There is also a rule relating to that section 101. The rule is
Rule 62-103.

You must know the exemptions from Takeover bid requirements
1. normal course purchases are permitted: can buy 5% in any 12 month period in stock
   exchange or in open market
2. But can also use the private agreement exemption in Section 93(1)(c)
   This exemption states that I can buy any # of shares from maximum of 5 vendors
   provided that price I pay is not more than 115% of market price for the shares.

Advising companies that are defending takeover bids. The principal Takeover Bid
defense available to companies in Canada is poison pill rights plan or shareholder rights
plan or shareholders protection rights plan. They will only buy you time but ultimately
the Securities Commission will require the company to drop the defense and allow
shareholders to decide if they want to accept the takeover bid or not.

Consider other defenses available to you if the facts are that you are a regulated
company. In that situation, there may be some sort of regulatory defense. If company
holds licences, etc think about lobbying gov-Air Cda last year

But principal defense is to buy some time to make sure that when shareholders finally
consider the offer, you’ve done your best as a board of directors to provide them with
the best alternatives.

Last week we talked about Rule 61-501, which used to be called OSC Policy 9.1. It
requires a special level of regulation that applies to insider bids, issuer bids, going
private transactions and related party transactions. All of these are defined terms in the

One should read that rule and know it and have some sense of what special rules are in
force when there is a going private transaction or insider bid. One should be able to
recognize those situations.

Look at treatment of multi-step transactions in that rule: A multi-step transaction is
where I make formal bid, it expires, then I go and propose a merger, a second stage
merger transaction between the bidder and the party because I was unable to get
sufficient number of shares in my formal bid to exercise the statutory 90% squeeze out
rule. There is a special set of rule that says when you can vote the shares that you
acquired under a formal bid as part of minority approval requirement on a second stage
merger transaction.

Three is a minority approval requirement which is one of the features of 61- 501 that
you should be cognizant about and the other is valuation requiment

Both minority approval and valuations requirements themselves have exemptions that
if available to you can allow you to avoid cost of getting a valuation and avoid minority
shareholder approval.

And that was the course: that was pretty much what we did for the last 12 weeks.


4 qs 3.5 hours same as last year-bring anything you want into exam
enough time to fairly comprehensively answer questions
can require material change report for a going private transaction (answer to Nat’s
question) 61-501-disclosure obligations, one of which is for filing of material change ..or
in circular..

Last Year's Exam

Question 1
company made continuous disclosure.

1st issue: selective disclosure rather than timely disclosure: if company wants to tell
street agree with consensus forecast put of press report to all

2nd issue: new fact Vp sales that sales slowed dramatically in July and she not kno w
why-prelim report from sales but VP sales can’t est why-uncertainty floating around
new devt that sales are slowing

uncertainty about verifiability of sales results but CEO causes her holding co to sell -
tippee/tipper depends on whether this is material info-prelim numbers suggest‖
ambiguously worded-maybe this is material info-not clear if insider trading or not-no
right or wrong answer-but if Lisa safe thing to do even if prelim view that something
bad may happen-

just looking for discussion re is this insider trading-bonus if raise control int issue

all rules are law-only policy-NP 40 just a policy wrt timely disclosure-TSE has exact
same rule as in NP 40

i.d. fact holding co could itself be tippee if this is material info

3rd issue-not so ambiguous anymore -VP calls CEO-now have blatant insider trading-
sales slowing confirmed-still the middle of quarter nto end of it where have to report-
but she says either way we will be disappointing peoples expectation with respect to
revs or earnings.

4th -Issued press release-timely discl issue-aug 11-knew had prob-waited 1 month to
issue press release to tell street that

5th-have to file by 10th day of month of trade-in br of its obln to file insider trading
reports in timely obln-an insider and Lisas obln to file and that late-on 11th day

6th-Lisa calls you-investigator-leasing late filing of insider trading reports this is Corell
fact pattern-notice of hearing in respect of Mr. Copeland
insider trading-timely discl
filing of insider tr reports
selective disclosure (if material info this is tipping)

Question 2
analyze whether PEAR is sec
Pacific coast type pattern
she wanted to buy ptg but instead buys a cert she can trade in for ptg but not really cuz
he reserved rt to give her cash back with int
if sec, you were right
yes if sec sec act applies
apu and quiki art not reg under act-assumption not reg they have engaged in trading
without benefit of being reg can be charged
no P thrfr engaged in distributing under act
but, no private rt of action for Krabapple except make case she never rec’d P and rescind
trade but since Apu bankrupt she is out of luck in terms of anything sec act could do for

Moose pasture a TSE co

co with 2 classes of shares-subord and multiple
4 control multiples
TSE widely held-know its reporting issuer cuz on TSE
an insider approaches your client to go private
client said nothing in response-raises issue of whether acting jointly or in concert-always
q of fact but this designed to provoke thought by virtue of this non-commital response
in a situation acting jtly or in concert

2nd-will have mtg and may be duplicitous will screw them outof deal-what hapens if 1
party is committed to arrangement but other not and sitting down having conversation-
not that obvious-

-to illicit that it is q of fact

sits down with 2 insiders to allow him to see what co with-sitting with insiders to pump
them for insider info-does this amount to his ability to buy shares by virtue of

tipping? To work out plan to make co private may be in necc course to talk about co-
3rd-will lend money with exec asst-facts lead to concl that exec asst nothing more than
nominee-acting in concert-secretary but one gets to 10% has early warning s.101
reporting oblns and disclose purpose for buying shares and can’t buy maj on market as
get to 20% it is a TOB

4th-twice value-private agrmt exemp to buy form 4 people but can’t pay twice mkt can
only pay 115% mkt-
should go to these 4 guys first cuz control lies with them but constrained by what can
offer them 91(1)(c)
obvly no market for mult only subrd on mkt-but if said as practical matter will not get
more than 115% a bonus

5th- a proposal toemrge a co he now ocntrols assuming he’s gotena way wththis schem
so have classic going priv tx-
rule 61-501 in multi stage tx will not be abel to vote those shares-minority shares for
second stage—i.d. that proposal would be going-priv tx and fact that need valuation
and minority approval but if paid same he would be able to vote the shares

distrn of secs q
co no longer priv co cuz took provisions out of arts but not become reporting issuer cuz
no final P for which receipt not given
-homer bought less than a year ago-if did math-paid $150,000 for inv (unitize it)
-now has 2,000 shares -got some common shares and then some from ex of his warrants
under fiii -look this up
-he ex’d warrants cuz Moe’s now doing another IPO attempt
filed final P
other early investors are under ins act—shares are legal for life

1st-H owns shares were in priv co that ceased to be priv co not priv co any more-query-
when ceased to be prv co did file form 22 red under s.75 to start clock running? Have to
run 12 months reporting issuer before holder can sell

H can’t sell for 12 months til later of date co becomes reporting issuer…
have to file form and be reporting issuer for 12 months
fact that legal for life not matter for H bec not buy any shares after he became reporting
under (d) and under warrants-and don’t restart hold period-meant to illicit--don’t
restart hold period on date he ex’d warrants but day he bought original shares-but at
end day legal for life 6 month thing a red herring, not matter

2nd-at 25% might be distn and be a control person-presumption that he is but no facts
about who other holders are but assume he is need P or sell under 72(7) and rule for sale
under control blocks

P exemption q
vendor has obln under 130 but issuer has to cooperate-
72(1)(7) not apply bec not issuer for 18 months-therefore not apply
set out both sides


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