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THREE POLICY OBJECTIVES OF SECURITIES REGULATION: Always challenge the provisions to say which one of these 3 objectives they fall under 1. Protecting the investing public Essential function of the regulators to protect those who invest in the market to ensure continued investment which will create confidence in the market If people dont invest in companies because theres no confidence in the process, companies wont be able to raise money and the economy will fail Dont allow people to make investments unless theyre informed 2. Ensuring the efficient operation of the Capital Markets All investing companies must be able to compete on a global basis, cannot survive as a country if people do not invest in the capital markets. Important to country and economy that there be a capital market that works. Important that there will be investors to give companies money to help them grow and compete in the global market. National Interest: Need markets to be efficient to attract investors to Canada. Inherent tension between rules designed to protect the public (1) and rules to make sure the capital market system works (2). But we must strike a balance in order to prevail. 3. Increase & Maintaining Public Confidence in the Capital Markets Capital markets must maintain a level of integrity if there is to be continued investment retain capital flow. If you dont have confidence in the capital markets, you wont play in the game THREE METHODS USED TO ACHIEVE THESE OBJECTIVES: note that there are exceptions 1. Registration requirements (cannot trade in securities unless registered) Performance of registrant is carefully regulated by the Ontario Securities Commission. The OSC monitors and ensures that brokers have minimum education, integrity, and discipline them if they dont behave (rule 3). Policy - Regulating market participants ensures public confidence in the system. Exemptions: OSA recognizes that protection is not always required and provides an exemption from the registration requirement for certain trades and/or securities. o Ex: Canada Savings Bonds guaranteed by the government of Canada, so those who sell them do not have to be licensedthe Canada Savings Bond is a security, without the exemption anyone selling a bond will need to be registered, but this is not what the government wants. Policy - This is the tension in the 3 objectives, in this example its between protecting the public (registration) and efficiency in the markets (not requiring everyone to be registered) 2. Disclosure Requirements(initial prospectus must be filed and OSA requires continuous disclosure once securities are registered give people sufficient information BEFORE they purchase securities to make an INFORMED decision) Prospectus is designed to provide investors with full, true and plain disclosure of all material facts about the company and the securities being offered. o Policy - Promote investor protection by ensuring that the information in the market place is accurate. Problem: prospectus is accurate at a moment in time, but companies change every minute. There must be a system that keeps the prospectus current.


Solution: the company becomes a reporting issuer, and it is therefore subject to the continuous disclosure requirements (annual financial statements, press releases). Exemptions: Prospectus requirements are expensive and time consuming, so the OSA private placement exemptions (PPEs) that allow for the sale of securities without a prospectus. The normally stringent protection provided in the OSA is unnecessary where: o the purchaser is sufficiently sophisticated that he/she doesnt need the prospectus (these people are called accredited investors) o the information is readily available o the securities are safe (e.g. Canada Savings Bond). PROBLEM: Some investors are sophisticated, so they can buy without a prospectus. But what happens when they want to sell the shares to 200 other people? They can circumvent the prospectus requirements by selling it to the rich person then having them sell it to 200 of us. There has to be a system that stops that (closed system). Closed System and Resale Restrictions o When securities are acquired pursuant to one of the PPEs and not pursuant to a prospectus, the resale by the initial investors to other investors is restricted and conditions must be satisfied prior to their resale. OSA closes in on the second trade of these securities to be in the public domain for a certain period of time before new investors can acquire them o The policy to allow the sophisticated investor to buy the securities without a prospectus was that that investor had enough resources to protect themselves, if that sophisticated investor sells to others then it circumvents the policy that was addressed in the first place. o Therefore, if you purchase securities pursuant to one of the private placement exemptions, you cannot resell them unless: You issue a prospectus You sell pursuant to another private placement exemption (another sophisticated investor) You comply with the resale rules You receive an exempting order from the OSC Remedies - Civil and criminal remedies for breaches of the above requirements to protect persons who are damaged by persons who fail to comply with the legislation o

Materiality Concept Material Facts A fact that significantly affects, or would reasonably be expected to have a significant effect on, the market price or value of the securities Material Change Securities Act- Section 1(1) a change in the business, operations, or capital in the company that would reasonably be expected to have a material effect on market price so it must be disclosed.

Section 1 - GOING PUBLIC

Markets: Primary Markets - company raises money from the public; sale of shares from the company to all of us and the company gets the money (from company to investors directly). Secondary Markets Investors sell securities between themselves. This is how investors realize value on their investment. This sense of liquidity allows continued marketability of those shares (between investors, company plays no role) There are 3 ways for a company to raise money: 1) Borrow money 2) Sell securities by means of prospectus 3) Sell securities by means of a Private placement exemption without a prospectus Advantages of going public: Raise Capital Easily o Gives ability to raise cost-efficient funds for capital requirements o Facilitate growth, o Reduce debt etc. o Have money to do what is needed to get done increase working capital cash. Facilitates future growth o Allows a company to restructure its financial condition, permitting it to borrow additional capital on more favourable terms. o The more equity means the more cash means the more able you are to borrow in the future so opens up other avenues of generating cash o Allow investors to have a liquid investment when public. Menu of Incentives o Provides incentives that private companies dont have attract really good people with options or securities in company. Tangible value o Attract and retain better personnel, share purchase plans, etc. o Corporate image can be enhanced o Improves competitive position, customers become shareholders Acquisitions o May enable company to undertake successful mergers or acquisitions to diversify its product line, economies of scale o Easier to buy things - two forms of currency in form of cash and securities o Can acquire using shares without depleting its cash/credit facilities Tax advantages - turning regular income tax at higher rate into capital gains income which is taxed at a lower rate Shareholder Liquidity - Most significant advantage is you have liquidity. Shareholders will (subject to escrow and control block resale restrictions) hold shares that can be more easily sold in market or used as collateral o Right and ability to divest themselves of the interest in your company and move from opportunity to opportunity which they dont have as a private company

Disadvantages of going public: Loss of Confidentiality Everyone gets to see your performance, must continually update public and can loose competitive advantage. o Your competitors know what you do. 3

Can see profitability and can see contracts and assets and concerns and risks etc. see where you are vulnerable. o Obligation to disclose your top executives compensation huge invasion of ones privacy and invitation to charities Reduced Flexibility can do everything want as a private company but not as public. Thousands of bosses o Opportunities must be for company first over self. Managing Share Price Instead of Company report card in newspaper everyday how am I doing today o based on stock price rather than on company. o managers consider how will market react to this development as opposed to what is the best long term decision for my company (shortsightedness) Reduced Control o two competing considerations of the dilution of owners control and the underwriters desire to assure a sufficiently large float after offering. o Future offerings may further dilute present owners control. Expensive prospectus prepared with lawyers is a lot of money - very expensive Subject to continuous disclosure obligations Loss of Tax Advantages CCPCs will not be entitled to the small business deduction and certain other tax advantages.


General Rule No person shall engage in or hold themselves out as engaging in the business of trading a security, without being registered, and if a trade is a distribution, without preparing a prospectus (s. 25 & s. 53)
S.25. (1) Registration for trading: No person shall, (a) trade in a security or act as an underwriter unless the person or company is registered as a dealer and the registration has been made in accordance with Ontario securities law S.53. (1)Prospectus required: No person or company shall trade in a security on his, her or its own account or on behalf of any other person or company if the trade would be a distribution of a security, unless a preliminary prospectus and a prospectus have been filed and receipts have been issued for them by the Director .

Questions to ask:
1. Does the transaction involve a security? If the transaction DOES NOT involve a security, then the transaction is outside the scope of Ontario Securities Act. However, if the transaction DOES involve a security, then determine whether transaction involves a trade in a security 2. Does the transaction involve a trade? If the transaction DOES NOT involves a trade, then the requirements of the Act do not apply However if the transaction DOES involve a trade in a security, then determine whether trade constitutes a distribution of securities 3. Does the trade amount to a distribution? If the transaction of a security in the form of a trade DOES NOT amount to a distribution, then the prospectus requirement of the Act DOES NOT apply However, if the transaction of a security in the form of a trade DOES constitute distribution, then the issuer MUST prepare a preliminary (and final) prospectus UNLESS an exemption can be found

THEREFORE, YOU MUST ONLY PREPARE A PROSPECTUS WHEN YOU HAVE A TRADE IN A SECURITY THAT CONSTITUTES A DISTRIBUTION, AND NO EXEMPTION CAN BE FOUND. WHAT CONSTITUTES A SECURITY? Courts have gone to great lengths to ensure that the OSA is broadly applicable Courts have tended to use s. 10 of the Interpretation Act - every act is deemed to be remedial; large and liberal interpretation in order to achieve the objectives of the Act. The courts have taken broad provisions and given them broad interpretations. s. 1(1):Security includes (16 sub-definitions and not an exhaustive list): o (a) a document / instrument / writing commonly known as a security (note: this means commonly known by the most sophisticated securities lawyer) the US court interpreted this to mean known to the legal or financial community in sub (a), a layperson would not know the instrument as a security commonly known means known to the most sophisticated legal expert o (b) any document evidencing title to or interest in capital assets, property, profits, earnings, royalties of any person or company Courts have said this definition is too broad a definition- courts have limited to only apply to instruments intended for investment are securities and not instruments bought and sold for other commercial purposes Thus, the added element of investing for profit, and not merely an interest in property results in a characterization of the interest as a security (OSC v. Brigadoon Scotch Distributor) Look to the instrument that the person is purchasing, and try to determine whether the person is expecting an increase in value; if yes, then it is likely a security e.g. if someone invests in paper, hoping that it will increase in value, that it can be found to be a security; whereas purchasing paper as a commodity is not purchasing a security the paper is only a security if the underlying commodity is not received E.g. If you buy scotch and ask vendor to resell it on your behalf in 5 years in the hopes that it has appreciated, then the receipt you get for the scotch is a security, BUT if you purchase scotch for consumption purposes only, then the receipt you get for it is not a security. o (c) Any document constituting evidence of an interest in an association of legatees or heirs, o (d) any document constituting evidence of an option, subscription or other interest in or to a security o (e) any bond, debenture, note or other evidence of indebtedness, share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription other than a contract of insurance issued by an insurance company licensed under the Insurance Act and an evidence of deposit issued by a bank listed in Schedule I or II to the Bank Act (Canada), by a credit union or league to which the Credit Unions and Caisses Populaires Act, 1994 applies or by a loan corporation or trust corporation registered under the Loan and Trust Corporations Act, o (f) any agreement under which the interest of the purchaser is valued for purposes of conversion or surrender by reference to the value of a proportionate interest in a specified portfolio of assets, except a contract issued by an insurance company licensed under the Insurance Act which provides for payment at maturity of an amount not less than three quarters of the premiums paid by the purchaser for a benefit payable at maturity, o (g) any agreement providing that money received will be repaid or treated as a subscription to shares, stock, units or interests at the option of the recipient or of any person or company, o (h) any certificate of share or interest in a trust, estate or association, o (i) any profit-sharing agreement or certificate, o (j) any certificate of interest in an oil, natural gas or mining lease, claim or royalty voting trust certificate, 5

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(k) any oil or natural gas royalties or leases or fractional or other interest therein, (l) any collateral trust certificate, (m) any income or annuity contract not issued by an insurance company, (n) any investment contract: (See, Pacific Coast, Howey, Hawaii Market Centres ) Definition is extremely ambiguous and requires interpretation of the court Ask: We determine if a particular instrument is a security by asking whether the person invested on the premise that another persons expertise will create profit in these situations, investors need full disclosure of all relevant information (o) any document constituting evidence of an interest in a scholarship or educational plan or trust, and (p) any commodity futures contract or any commodity futures option that is not traded on a commodity futures exchange registered with or recognized by the Commission under the Commodity Futures Act or the form of which is not accepted by the Director under that Act.

Pacific Coast Coin Exchange (1977- SCC) - Investment contract branch of definition Policy is important in interpreting what constitutes a security Facts: Pacific Coast sold bags of silver coins. There were 2 ways to buy bags: walk in and buy it, or pay on margin (pay 35% today, 65% later for a bag of coins and PC holds the purchase as security until you pay the balance). Investors were thus entering into current account commodity contracts w/ PC. PC didnt put coins aside, they hedged their exposure. If the price of silver rose drastically, PCCE would become insolvent, thus it hedged against price escalation by buying silver future contracts. In the event of a price increase, PCCE would lose money on its contacts with customers but gain money on its futures contracts and visa versa. Investors who lost money claimed that these interests were a security, and that the actions of PC constituted a trade in a security and since a prospectus was not filed, the transaction was void. A cease trade order was issued, which PCCE appealed arguing it was not selling securities o Majority of purchasers were margin purchasers. o Majority of margin purchasers never actually had possession of the commodity (the silver); took cash instead when price of silver went up Held: Contracts WERE securities under investment contract branch (s.1(1)(n)) of the definition and because there was no prospectus everyone should get their money back (but there was no money because the company was bankrupt, but thats beside the point) Rationale: Court relied on two US tests: Hawaii and Howey. Both the Common Enterprise and Risk Capital Tests were accepted Comment on Howey -- A strict interpretation of the word solely would not serve the purpose of the legislation here, a strict interpretation would result in a finding that they were not securities because the buyers did not expect profits SOLELY from the efforts of PCCE, rather the profits would come from the international silver markets which PCCE had no control over. as such this would not be a security b/c they were not solely responsible for the success or failure. The court also said regarding Common Enterprise: there is no need for the enterprise to be common to the investors between themselves. A common enterprise will be found where an investor advances money while the success of the enterprise depends on the promoter. The key to the success of the venture will be the efforts of the promoter alone, for a benefit that will accrue to both the investor and promoter. Comment on Hawaii if you use the test set out in Hawaii this was definitely a securityso in essence the SCC here says that whether you follow the Howey or Hawaii test it should be considered a securityThe court says that a broader approach is needed, it is the policy and not the judicial tests that are decisive. The SCC indicated a wide scope of investment contract and security, lets courts decide based on policy that something is a security and that the tests dont need to be closely followed.

Howey (1946 - US) Common Enterprise Test Facts: Investors could buy a tract of land in an orange grove in Florida investors advised that lands needed to be serviced and recommended Howey to service lands. Told they could expect average returns of 10% per annum. Investment went bad only way to get their money back was to claim it to be a security without a prospectus thus get money back. Ratio: Common Enterprise Test to determine if something is an investment contract:

1) A contract, transaction or scheme whereby a person invests 2) investment is made in a common enterprise 3) that person is led to expect profit a. (Note: in subsequent US case United Housing Foundation, profit interpreted to mean either capital appreciation or earnings) 4) profits to be derived solely from the efforts of promoter or third party a. (Note: Solely was modified in US case Glen T. Turner Enterprises to the efforts made by those other than the investor are the undeniably significant ones, those essential managerial efforts which affect the failure or success of the enterprise.)
Hawaii Market Centers (1971 - US) Response to Howey test become too mechanical; Risk Capital Test Facts: Pyramid sales operation in selling memberships, Security Commission of Hawaii sought injunction against sale of memberships on basis they constituted investment contracts and thus securities. HMC argues that they have some control over potential return by selling new memberships, therefore did NOT depend solely on others as required by Howey test Issue: Were memberships in a store an investment contract? Ratio: Court criticized Howey test, says too mechanical and focuses on solely aspect while losing sight of need to interpret investment contract as intended by the Act.came up with own test. Risk Capital Test Something is a security if: 1. An offeree furnishes initial value to an offeror (sounds like part 1 of Howey) 2. A portion of that value is subjected to the risks of the enterprise (sounds like part 2 of Howey) 3. The furnishing of the initial value is induced by promises or representations leading to a reasonable expectation or understanding that a benefit above initial value will accrue (sounds like part 3 of Howey) 4. The offeree (investor) does NOT have the right to exercise practical and actual control over the managerial decisions of the enterprise (this is new). SEC v. C.M. Joiner Leasing Corp. 320 U.S. 344 (1943) The definition of a security should be interpreted broadly to meet purposes of the Act Court: The definition of security in the Act should not be interpreted to subvert new security interests designed to avoid application of Act or frustrate purposes of Act. A court will interpret an instrument in whichever way leads it to promote policy objectives of investor protection. Important Notes to Decipher the Cases when it comes to section 1(1)(n): We determine if a particular instrument is a security by asking whether: o The person invested on the premise that anothers expertise will create profit o Whether there is a reliance on someone elses management expertise to make an investment In order to protect the investing public when they are putting their money in the hands of others to act for them, the public needs to know information about the people that are making decisions on behalf of them to make an informed decision Deciding factor mentioned by Lastman: The Securities Act is saying that if an investor is going to give other people their money with the expectation (i.e. the investor is relying on the other party) 7

that they are going to manage the investors money to create more value for us then the only way that an investor should do that is if the investor asks a thousand questions about the manager to make an informed decisionthe primary goal of the Securities Act is to protect investors so that investors will continue to invest to keep the economy runningso the deciding factor is sufficient management control over the investment OSC will find there is a security when there is an investment made on the premise that someone elses expertise will create a profit and those who invest require information in order to make an informed decision. If labeling an investment contract a security will achieve the policy objectives of the Act, a contract will be classified as a security. (policy is what matters) o Whenever an investor should reasonably have certain questions about the expertise of the entity managing their investment, then the OSA will intervene to make sure the investor is fully informed of the expertise (and other factors) by requiring full disclosure in the form of a prospectus. The courts have huge amounts of discretion On exam mention the questions that you would tell the client they should have asked, i.e. they should have known before investing their money. You need a prospectus to get this information. NO straight line answer; courts are results oriented it is policy, and not the formal judicial test, that decides (Pacific Coast) the investing public needs protection when they do not have managerial control A security will be considered a security if: o (1) It falls clearly under one of the definitions of the OSA o (2) If can fit under one of the broad definitions and policy considerations demand coverage Note: Some instruments are expressly excluded b/c they are covered by other pieces of legislation

WHAT CONSTITUTES A TRADE? s. 1(1) non-exhaustive; not only a sale but any act or advertisement in furtherance of a trade (a) any sale or disposition of a security for valuable consideration, whether the terms of payment be on margin, installment or otherwise, but does not include a purchase of a security or, except as provided in clause (d), a transfer, pledge or encumbrance of securities for the purpose of giving collateral for a debt made in good faith (b) any participation as a trader in any transaction in a security through the facilities of any stock exchange or quotation and trade reporting system. (c) any receipt by a registrant of an order to buy or sell a security, (d) any transfer, pledge or encumbrancing of securities of an issuer from the holdings of any person or company or combination of persons or companies described in clause (c) of the definition of "distribution" for the purpose of giving collateral for a debt made in good faith, and (e) any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the foregoing; Policy: Investor Protection - It is not necessary to sell a security in order for it to be considered a trade simply trying to sell is enough. Tries to stop a misrepresentation before it happens. Securities legislation is proactive. One of the main objectives of the Act is to protect the integrity of the Capital Markets and this objective must be balanced w/ the protection of the investing public, which requires a proactive approach. Tries to stop bad transactions before they occur. As such, the Act can regulate a trade before the sale of a security. 8

Gift NOT considered trades no consideration Example: X offers to sell Y shares and sells Z shares of a company of which X owns? Three trades: Offer to Y, Offer to Z, Sale to Z Policy: Why is a purchase NOT considered a trade? o A purchase of a security is not considered a trade b/c the OSA will not impose on a buyer the obligation of providing a prospectus (dont want to impose duty on purchaser, its the purchaser were trying to protect). Investor Protection Objective o We are trying to discern whether we need to issue a prospectus to protect investors (i.e. the purchasers) - So a purchase cannot be a trade because the person who is purchasing the security should not and is not expected to file a prospectus, only the company issuing/selling the security is the target of the prospectus requirement Excludes Most Pledges (a) (d) - A pledge involves the transfer of the securities to a lender as collateral - OSA was not meant to restrict the ability of security holders to use their equity as loan collateral Two Conditions: 1) Debt must be incurred in good faith cant hide a sale as a lone 2) A Pledge constitutes a trade if the grantor is a control person (so as to insure the proper governance of non-disclosed information) Participation as a Trader (c) Must be a registrant (securities market professional) in order to buy or sell a security The actions of registrants are defined as trades, b/c the activities of professionals are key to capital markets and in order to adequately protect investors the actions of these persons must be regulated

Acts in Furtherance of a Trade (e) A trade occurs even if nothing is bought or sold, the legislation not just curative, it is also prophylactic. It seeks to allow the regulators to step in to prevent harm before it occurs

Trades that are not Distributions - are still considered trades and are restricted

WHAT CONSTITUTES A DISTRIBUTION? there are three branches; the one of importance is an exhaustive definition s.1(1) where used in relation to trading securities means: o (a) a trade in securities of an issuer that have not been previously issued Policy: allowed to trade = issued and outstanding, not yet issued = treasury o A prospectus is only required where a security is issued for the first time by the company. o Prospectus is required for primary market o Secondary market is protected by continuous disclosure and previous prospectus on record. o Prospectuses do not need to be filed every time an already issued "share" is distributed In General, Four things will amount to a distribution 1) Trades by issuers; issuers almost always have better information than the info that is available for buyers; thus it is a distribution to which a prospectus is attached 2) Resale of Securities Returned to Issuer Must provide prospectus when issuer reissues securities which have been repurchased or returned to it 3) Trades by control persons; anyone who holds a sufficient number of securities to materially affect the control of the issuer is assumed to have privileged access to information and is considered a control person May mean that control person is no longer controlling issuer Control person is defined as having sufficient control over voting rights to materially affect control of issuer (20% is deemed, in absence of evidence to contrary, to be sufficient) 4) Deemed distributions on resale Sometimes, exemptions exist for prospectus requirement when purchaser does not need such protection. However, if this purchaser then resells the securities, subsequent purchase may REQUIRE this protection.. Consequently, resale is deemed distribution, triggers prospectus requirement (b) a trade by or on behalf of an issuer in previously issued securities of that issuer that have been redeemed or purchased by or donated to that issuer, (c) a trade in previously issued securities of an issuer from the holdings of any control person, (d) a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, prior to the 15th day of September, 1979 if those securities continued on that date to be owned by or for that underwriter, so acting, (e) a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, within eighteen months after the 15th day of September, 1979, if the trade took place during that eighteen months, and (f) any trade that is a distribution under the regulations


Need to first meet with lawyers, accountants, and underwriters o The first thing to do if I want a public company and I want people to invest in it is I call my lawyer and accountant, hire an investment banker who will be the underwriter and sell the securities for me. The underwriter hires its own lawyers. We get together and decide to form a prospectus to tell the world everything they must know for this company. o You cant take your clients word for it that the facts are the facts, and you must independently verify the facts, and if you dont, youre liable for a misrepresentation of the prospectus. Your client will pay you to verify that what theyre telling you is correct, as will the underwriters. o It takes a LOT of TIME and MONEY to prepare this story. Policy:a prospectus is required to allow investors knowledge of what they need to know before they invest in the company (b/c they do not have control) What goes into a prospectus (anticipate what investors needs to know)?Form 45-501 F1 General Prospectus Requirements and Forms o A prospectus is supposed to answer all of these questions: before you get into a business, better know what that business does. Its not that difficult to prepare a prospectus: youre telling a story. - What does the company do? - What experience does the company have? - What are the companys assets? - What are the uses of the proceeds? (what does the company need your money for?) - What debt does the company have? - Historical financial performance, and future forecasts? - Who are the competitors? - Who is the management of the company? - Who are the directors/officers? - How much does the management own/what are they paid? - Any lawsuits pending against the company? - How can I re-sell the securities? - Does company pay dividends? - Who are major shareholders? - What material contracts exist? - What is the future of the company? - What is the upside potential for the company?

DUAL NATURE OF THE PROSPECTUS: Tension exists between the prospectus as a selling document (company's desire to raise money) and as a liability document (OSC regulation) o Tension is most apparent with Future Oriented Financial Information (FOFI) - prior to 1982, the solution to the problem with future predictions was that FOFI was not permitted to be included in a prospectus because it is unreliable. Now they are (see below) There are also very circumscribed rules as to what is permissible advertising during the course of a public offering - The only sales document allowed is the prospectus Therefore, it must be attractive enough to engage people but careful enough to protect investors Lawyer has an obligation to the public, to legal bar, and to client o Lawyers need to balance b/w these two roles; too much liability will make the shares not sellable; if you go either way to appease your client/underwriter then you/they can be sued


o o

If all the lawyer does is protect the client to the fullest the securities will not be sellable, and on the other hand if you let your client write whatever they want to sell the securities then the client is going to get sued for misrepresentation The real challenge of a lawyer is to strike the correct balance.

FUTURE ORIENTED FINANCIAL INFORMATION (FOFI): NI 51-102 Future Oriented Financial Information (hardest area to strike the balance) o Prior to 1982, OSC did not allow forward looking financials; this changed. Securities industry wanted to know what company thought of future o You don't have to include FOFI in a prospectus (optional) o If you dont you cant talk about the future at all o If you do you have to comply with NI 51-102 o Forecast written estimate about the most probable result of a future state of a company, e.g. assume that interest rates are 3% (best guess) next year, you would have to use your 3% best guess scenario....Projection estimate that follows any set of reasonable assumptions, e.g. we can pick 2% or 4% for interest rates, both reasonable. The only time you cant use a projection is if its unreasonable for the company to do a forecast (because if it cant estimate most probable, it cant make reasonable assumptions) o A company cannot disclose FOFI unless it has a reasonable basis to do so If you're uncomfortable with your assumptions you cannot include FOFI in your prospectus o CONDITIONS TO SATISFY If you want to use FOFI: 1. Identify the information in the prospectus as forward looking 2. Caution the readers that actual results may vary and there are material risks that actual results might be different than the forecasted results 3. Explicitly set out what material facts and assumptions you used so that the reader can assess for themselves this forward looking information 4. Review that forward information regularly and update it if there are changes, and then tell the reader that you will do this and along with the method of doing this 5. If any changes occur between the time you filed preliminary prospectus and when you filed final, you must include that new information in the final prospectus o Lastman: Be smart. Dont be so conservative in the projections as to make the prospectus unattractive, but dont make it too exuberant so as to be suedstrike the balance!!!! You are better to under-promise and not deliver, then to do the opposite.. But dont be too negative that no one buys.

STAGE 1 CREATE PRELIMINARY PROSPECTUS GENERAL PROSPECTUS REQUIREMENTS: s.56: (1) A prospectus shall provide full, true and plain disclosure of all material facts relating to the securities issued or proposed to be distributed and shall comply with the requirements of Ontario securities law. (2) the prospectus must comply with the act. o A material fact as defined in s. 1(1) of the securities act is any piece of information that would reasonably be expected to have a significant effect of the market price or value of the securities of the company. o Must tell your story the way the OSC tells you to otherwise you will face civil liability in the form of misrepresentation, defined in s. 1(1) as: (a) An untrue statement of a material fact OR (b) An omission of a material fact 12

S. 56: mere technical compliance with the Act is not sufficient (cant just follow the form) you have an obligation to anticipate other questions not provided in the act. It doesnt matter that the OSC missed something, if at any time in the future an omission is found the company will be liable.

PRELIMINARY PROSPECTUS (PP) REQUIREMENTS: S. 53(2) - A preliminary prospectus must be filed in order to become an issuer S. 54 (1) Preliminary Prospectus form - PP shall substantially comply w/ the requirements respecting the form and content of a prospectusexcept that the reports or reports of the auditor or accountant required by the regulation need not be required S. 54 (2)PP is the same as a [final] prospectus, but can OMIT o price of securities o underwriters compensation, and o any matters relating to price to the underwriters Can only get indications of expression of interest and not binding agreements of final sales (no legal right to buy) at this time. Allows the underwriters to assess the market and determine the demand for the securities. This enables them to set a price after they see the demand cant anticipate in advance Things to INCLUDE in the PP: S. 60 prospectus must tell purchasers what their rights are in section 71 and 130 (if there is a misrepresentation you can sue) S. 71says that you not only have to give someone a prospectus if they request one in 48 hours but they can change their mind in 48 hours after seeing the prospectus. Legal right to get out of deal. S.71 must tell purchasers they can sue you due to misrepresentation S. 130 must contain provision that says if there is a misrepresentation in that document then the buyer can sue. NI 41-101 F1 PP must have a statement printed in RED INK and italics on the top of front cover [regulation 50] known as a Red Herring, it must: o Identify the document as a preliminary prospectus o State it is not complete o State that securities may not be sold until a receipt for final prospectus is obtained Prospectu s can only include graphic displays/pictures of the product you are selling. OSC told Four Seasons to take picture of a chef out of their prospectus. After weeks of debate, they let it go through. o Old exam: Toronto Maple Leafs are going public, there was a picture of the Stanley Cup, IS THE STANLEY CUP PART OF WHAT THE LEAFS SELL? OSC COULD TAKE ISSUE WITH THIS NI 41-101 F1 -every PP and final P must contain a statement on the outside front cover stating that "no securities commission or regulatory authority has expressed an opinion about these securities o BUT, this is not true! OSC vets the document and offers opinion on the merits in the form of a receipt. o Policy: They have a genius at the OSC giving all kinds of opinions. Essentially the regulators are saying no one should rely on them. Public must know OSC is not there as a safeguard for them; public must protect themselves. OSC cant possibly scrutinize every prospectus they receive with that much detail cant possibly do more than a cursory review Preliminary prospectus is NOT a draft document --there are still liabilities attached for misrepresentation o From a business perspective, if that document requires significant amendment, credibility will be diminished


STAGE 2 SUBMIT PRELIMINARY PROSPECTUS s.58(1) of NI 41-101 F1 Certificate by issuer: CFO, CEO and two other directors of the company must certify that the PP constitutes full, true, and plain disclosure of all material facts o If there is a misrepresentation in this document, the company will be sued successfully s.59: of NI 41-101 F1Certificate of underwriters: Underwriters must certify that to the best of their knowledge the foregoing constitutes full, true and plain disclosure o Company is held to a slightly higher standard because they know more about the business and its actual prospects o Since just to the underwriters knowledge means that the underwriter can escape liability if they prove a certain degree of due diligence, there are defenses available to exculpate their liability (these defenses are not available to the CEO, CFO and directors). s.55 of NI 41-101 F1Issuance of receipt for PP: Director shall issue a receipt for preliminary prospectus IF it complies with the Act o Note: little room for OSC discretion at this stage o Policy: discretion not yet needed b/c you cannot yet offer securities until final P STAGE 3 WAITING PERIOD s.65(1): of NI 41-101 F1 Waiting period: there has to be a period of at least 10 days between the issuance of receipt of the preliminary prospectus and the issuance of a receipt for the final prospectus, o Purpose: (1) gives the OSC and accountants time to review/discuss (2) gives investors opportunity to read information before there is a legal obligation to buy (3) gives the underwriter time to supply the preliminary as to identify demand REASONS for waiting period: s.65(2)(c)Underwriters make copies of PP and circulate to potential investors so they have time to read it o Underwriters get a sense for the appetite of the offering, assess the market, and determine the price for which securities should be sold at s.66Distribution of PP: During the waiting period, the underwriters can only deliver copies of the PP and solicit expressions of interest o Expression of interest = an indication by a prospective purchaser that they might want to buy the securities - but they are by no means bound to anything by stating this s.67:Distribution list: Underwriter must keep record of names and addresses of anyone who received the preliminary prospectus o so that they can send any necessary amendments s.57(3), 71: Obligation to deliver any amendment and revised final prospectus to all potential purchasers Gives time to get a lawyer and accountant at the OSC to look it over before they are willing to issue a final P ADVERTISING BAN during waiting period NI 41-101: During the waiting period the type of materials that can be distributed to the public is extremely limited All that can be advertised is o (1) company is going to sell securities o (2) where potential investors can find the prospectus and o (3) if known, the price; Corporate image advertising: is allowed BUT will need to satisfy the following test o TEST: Is advertising in furtherance of trading of securities? If so, the OSC will disallow such activities


Recall s. 1(1)(e) of OSA trading includes any act, advertisement, solicitation, conduct or negotiation directly or indirectly in the furtherance of any of the foregoing o Since trading is not allowed during the waiting period, advertising is not allowed Exam Q: The Leafs advertised in the newspaper here are upcoming tickets available and you should buy our prospectus. Can you do this? Nope, not allowed to talk about the prospectus, only about where to find it. Policy Lastman disagrees with advertising ban for the following reasons: o Lastman comments that investors should be dissatisfied with the rules regarding advertising because they handicap the public o e.g. when Air Canada went public because of advertising restrictions, only a certain number of persons were able to access these securities o He says this creates a special club for institutional investors and that although the rules are designed to protect the common public, they also hold the public back because we are prevented from finding out info until it is too late it prevents public from making ANY decision not just BAD decisions

MATERIALCHANGE during waiting period: S. 1(1)Material change: (a) when used in relation to an issuer other than an investment fund, means, i. 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 any of the securities of the issuer, or ii. a decision to implement a change referred to in (i) made by the board of directors or other persons acting in a similar capacity or by senior management of the issuer who believe that confirmation of the decision by the board of directors or such other persons acting in a similar capacity is probable, and (b) when used in relation to an issuer that is an investment fund, means, (i) a change in the business, operations or affairs of the issuer that would be considered important by a reasonable investor in determining whether to purchase or continue to hold securities of the issuer, or (ii) a decision to implement a change referred to in subclause (i) made, (a) by the board of directors of the issuer or the board of directors of the investment fund manager of the issuer or other persons acting in a similar capacity, (b) by senior management of the issuer who believe that confirmation of the decision by the board of directors or such other persons acting in a similar capacity is probable, or (c) by senior management of the investment fund manager of the issuer who believe that confirmation of the decision by the board of directors of the investment fund manager of the issuer or such other persons acting in a similar capacity is probable; (changement important) S. 57(1) Amendment to PP on material change if a material change occurs that is adverse to the company it must prepare & file an amendment reflecting this as soon as practicable but in any event within 10 days of the event o Must go to every single person who has a preliminary prospectus o If change is not adverse then amendment is optional b/c they will get the info in the final prospectus and deal is not final until 2 days after receipt, therefore investor already protected


STAGE 4 RECEIPT FOR FINAL PROSPECTUS S.61(1) - The Director shall issue a receipt for a prospectus filed under this Part UNLESS it appears to the Director that it is not in the public interest to do so (super broad discretion) o Broad discretion under S. 61 - OSC reserves the right to refuse receipt, the OSC has a mandate to review not only that the disclosure requirements have been met, but also the merits of the securities being offered Note its more than ensuring that the disclosure requirements are met, the OSC commonly reviews the merits of the security if deemed too risky they wont issue a receipt. Only a limited number of subscribed securities issued for sale, and every time you want to issue more you need to issue another prospectus OSC using its s.61(1) Discretionary Powers o Rivalda: OSC refused to grant final receipt to a junior mining company b/c it felt the directors were too inexperienced. It did not matter that the prospectus disclosed that directors had no experience o Lake Forest Fund: OSC did not grant a final receipt b/c it did not like the fee structure set out in the prospectus. o Deprenyl Facts: Dr. Shulman suffered from Parkinsons; went to US and used drug E. E worked for him. E was not approved in Canada under FDA so Dr. Schulman came back to Canada, incorporated a company and filed a P for the sole purpose of seeking FDA approval for E so Canadians could access it and so that the shareholders of Deprenyl could make a lot of money. The prospectus repeatedly disclosed that: E is not permitted in Canada, there is no assurance that it will ever be approved, and if the drug is never approved in Canada, the investors will lose their money OSC issues comment letter with suggestions, changes made, but OSC still refused to issue receipt for final prospectus Even despite all the disclosure that the company was making the OSC believed that the investment was simply too risky Held: OSC agreed, after a lot of pressure, to let D go public and a year later, E approved by FDA. o Lastman: What could be seen to be wrong with Depernol the OSC is making the call to not let the drug into Canada by denying its public offering because it is risky. In essence this is a lawyer at the OSC making the call whether to not let a drug into Canada, not leaving it about to potential investors to make their own decision on whether its a good investment. Policy: Why should lawyers and accountants decide what we invest in they dont have any particular industry expertise o Protecting the economy at large > individual peoples interest who think they knowSomeone has to look after the greater good commission wants to maintain the integrity of the capital markets and if the listed securities on the exchange are too risky it will erode companys ability to raise capital particularly through international investment. o In the opinion of the OSC, not allowing unnecessary risk into the capital market is a small price to pay in order to protect the investing public and maintain the integrity of the capital markets In Depernol the OSC is showing that the integrity of the capital markets reigns supreme over individual business interests. o In the Depernol case the facts support that the OSC maybe should have allowed it because it involved a drug that could potentially help people, but the OSC really considers the integrity of the capital markets as the trump card. Lastman agrees with this because he thinks the OSC is reasonable and some governing structure needs to be in place to ensure the system works.


S.61(2)Other reasons to not be issued a final prospectus: a) Did not substantially comply with the Act ; statements, promises, estimates or forecast that are misleading, false or deceptive ; Contains a misrepresentation (pure disclosure) b) Unconscionable consideration paid to the promoter (review of the merits), even if you disclosed such consideration c) Insufficient Proceeds for purpose set out in prospectus (recall, you have to say what the money the company trying to raise is for. This comprises money that is being raised by way of a prospectus as well as money already on hand). (The company needs to be able to acquire the full amount of money needed to complete whatever the project is that the money is being raised for) d) Financial condition of company or those running seems too risky or irresponsible financial responsibility e) Past conduct of issuer/Os/Ds/promoters/anyone holding significant interest in company suggest lack of integrity and will put markets in disrepute - bad faith, fraud (not concerned about murder, this is criminal, the OSC is protecting the capital markets). This is way beyond disclosure, the OSC can search on the background of the directors and other senior managers of the company Policy: conduct by someone that would lead to disrupt in mkt if shares were issued; bad faith/ fraud f) A person or company that has prepared or certified any part of the prospectus, or that is named as having prepared or certified a report or valuation used in connection with the prospectus, is not acceptable; If someone involved in process is an unacceptable professional (certification) (e.g. lawyer is a crook) g) If escrow arrangements are not satisfactory (the economic risks of going public must be shared by the founders and the investors alike) (NP 46-201) Escrow is way of ensuring by contract that I am not going to sell you securities in my company and sell them out at the same moment. Investors are comforted by the fact that founders have economic risks. If you go public for the first time, you have to agree with the OSC that you wont sell more than a third of your shares per year over the next three years; so new investors know you arent bailing. h) Adequate arrangements have not been made for the holding in trust of the proceeds payable to the issuer from the sale of the securities pending the distribution of the securities STAGE 5 CLOSING THE TRANSACTION After receipt for final prospectus is received - remove the Red Herring, set price, setup deal with Underwriting Agreement (obtaining binding agreements for purchase and sale), go to OSC, final prospectus in hand and certify it Note - there is typically a 3 week lapse between issuance of receipt and closing of transaction. S. 60: Statement of Rights in Prospectus - Every Prospectus shall contain a statement of the rights provided by S. 71- Cooling off period,&S.130- Misrepresentation MATERIAL CHANGE between receipt for final prospectus and closing: S.57(1) - If there are any material changes(good or bad) after the final receipt and before closing an amendment must be filed as soon as practical and no later than 10 DAYS after and deliver a copy to all those who received a final prospectus, except those whose 2 day cooling off period has expired o Why positive OR negative? Final Prospectus is the only document that will pick this info up Unlike waiting period after PP where only negative info is required because any positive changes will be reflected later in the FP at that pointwhereas after final receipt and before closing, there is no document going into the public domain that can clarify the situation, so to 17

o o

make sure final document is complete, ANY change must be made to ensure the record is complete The marketplace needs to know everything in order to make an informed decision, and there is no other forum for that to occur. In the waiting period, if there is a positive change it will be included in the final prospectus, but we want to make sure people know about negative changes so they are not buried in the final prospectus. Note: the decision as to what is adverse and material is unknown it is a subjective answer; this is where business judgment plays a role Exam question: why is it that in the waiting period after PP you only need to do an amendment for an adverse change but after final receipt before closing an amendment is needed for both positive and negative ones?...Answer: Between PP and final there will be another document that reflects that change i.e. the final, if its positive and you dont want to put it in it will be there but if its negative its sooo important you will learn it so they dont want to assume you will notice it in the finalafter the final is issued there is no later document to be issued t o clear the record so you have to do a positive or negative amendment because theres going to be all this trading in the secondary market that is not subject to this continual disclosure.

COOLING OFF PERIOD: S.71(1) Obligation to deliver Prospectus must deliver to the purchaser the latest prospectus and any amendments either before they entered into an agreement and sale or not later than midnight on the second day after running into such an agreement o Basically, every dealer of securities must send a copy of the prospectus and any amendment prior to the second business day following the entering into an agreement (i.e. a broker selling you securities over the phone) o If you never get a prospectus, you are never bound to buy at any point down the road S.71(2): Withdrawal from purchase an agreement of purchase and sale is not binding if the purchaser withdraws not later than midnight on the second day after receipt by the purchaser of the latest prospectus and any amendment o Purchaser has right of rescission o Investors must have 48 hours with ALL the information before they are bound to buy o Policy -Act wants to make sure the purchaser has made an informed decision and that the purchaser has had the opportunity to re-think and re-consider the agreement to purchase the securities o NOTE - you do not need to have a good reason to change your mind; this rule presents great potential to purchasers b/c securities fluctuate in price during this interval S.71(8) Onus of proof is on the dealer to show that cooling-off period has expired Once the cooling off period is over, the purchaser is bound to buy the securities








DAY 11










**It does not matter what information is in the companys mind if the fire occurred w/in your 48hr cooling off period it will still reset you period asover to 2 days after the time YOU Cooling off = bound to buy receive the amendment**

By policy, you had more than 48 hours with all the information, so no cooling off period. However evidentiary burden [via s.71(8)] will be on issuer to show company

MISREPRESENTATION LIABILITY Common law: Persons liable for inaccurate statements in Prospectus if theyve been fraudulent/ to show that they had it @ da y 6 easier for purchaser to argue that they did not recklessly disregarded truth have it until day of buying the shares hence fire occurred during cooling off period o Not entirely clear under CL if youre liable if you have been reckless in reviewing document (Hedley Byrne) S.130(1) Liability for misrepresentation in a Prospectus - where there is a misrepresentation each purchaser is deemed to have relied on the misrepresentation o Strict Liability = reverse onus on company to prove they did NOT rely on misrepresentation o What about a secondary market transaction during the period of distribution?? S. 130 (1) Action against: Public deemed to have relied on misrepresentation and has an action against: A)Issuer / selling security holder (company & secondary offerers) B)Each underwriter who signed Note: In underwriter agreements there are usually indemnity clauses; courts have found them unenforceable as contrary to the public interest C)Every directors at the time of prospectus/amendment issuance Policy: may discourage people to sit on the BOD, but you can issue an IPO w/ no name directors but if so, you cannot mention the names of potential future members if BOD is limiting their liability by not being included in Prospectus then company cannot benefit from their involvement during the IPO Policy: Lastman if we make our directors so liable they will just stop being directors and we wont have societys brightest minds running our companies anymore. There needs to be a balance. D)Every person/company whose consent to disclosure of information (experts) Note: but only w/ respect to their reports, opinions and statements E)Every person/company who signed the prospectus/amendment (officer) 19

S. 130(8) Liability is joint and several, but can seek contribution from the other parties, unless the court finds that contribution is not warranted o Policy: Act is pro-activewant to limit opportunity for misrepresentation by holding as many people liable as possible more people that can be held liable the less likely a mistake will be made. Everyone will be careful in preparing the prospectus; not just those Ps are likely to go after b/c of deep pockets. S. 130 (10):No derogation of rights: Rights of rescission or damages are in addition to and without derogation from rights under common law. o Common Law liable for a fraudulent and reckless disregard for the truth o Negligent misrepresentation (Hedley Byrne) Purchasers Election of Rescission the purchaser may elect to exercise the right of rescission against such person, company or underwriter, in which case the purchaser will have no right of damages S.133- Liability of Dealer or Offeror provides for a right of rescission or damages if the dealer or offeror failed to comply w/ the applicable requirements particularly w/ reference to s.71 - they did not mail amendments

Kerr v. Danier Leather Material fact vs. Material Change; not the courts place to question a companys subjectively reasonable and genuine business judgment Facts: After seeing a drop in sales due to unseasonably hot weather, the company filed a revised forecast with the OSC. This resulted in a material temporary drop in share price. However, weather cooled and before the amendment was officially made, Danier had substantially achieved its original forecast. The directors genuinely believed that it would be OK, which in the end it was. SHs sued claiming original forecast was a misrepresentation. Issue: whether Danier Leather and two of its senior officers were liable under section 130 of the Act for failing to disclose material facts that became known to them after the filing of the prospectus at issue but before the closing of the offering Held: At trial, the directors of Danier held liable, this overturned by Appeal Court and upheld by the SCC Reasons Ont. Trial Div: Danier and senior officers liable for P misrepresentation relating to earnings forecast in their prospectus: 1. Poor 4th quarter revenue and earnings were material adverse facts that Danier had to disclose. 2. Prospectus provided that forecast was true and accurate at time it was written and at time of closing 3. Because they knew before closing that they were unlikely to meet the forecast and didnt disclose it, this amounted to a misrepresentation CA: Trial judge erred in three ways: Danier wins! 1. S.51 only requires an amendment if there is a material change (not a material fact). There may have been facts but there was no change in the business, the managers still genuinely believed that they would meet the forecasts therefore no obligation to file an amendment. 2. Not a question of being objectively reasonable. When it was written the people believe it was right. The test is subjective, not objective. 3. Failed to give enough credence to business judgment rule. If directors and senior management genuinely believed they would meet their forecast, judges cant exercise their own business judgment to override judgment of senior management. No continuing obligation to disclose material facts occurring between date of P and date of closing when no material change has occurred. Ds made what they believed to be a reasonable decision, not a perfect decision as long as Ds have selected one of several reasonable alternatives, deference is accorded to the boards decision. Ratio: Not the courts place to question a companys subjectively reasonable and genuine business judgment Note: The SCC said that you need to give directors sufficient latitude to run their businesses reasonably.


DAMAGES If the plaintiff elects damages over rescission, the plaintiff can claim the diminution in value of the securities resulting from the misrepresentation of the prospectus S.130(7):Defendant is not liable for all/a portion of the damages that it can prove was not the result of the depreciation of the security value. Not liable for diminution in value that did not result from the misrepresentation o Reverse onus on the defendant to prove this, which is almost impossible to prove, so basically if a representation is shown there are going to be lots of damages S.130(6):Underwriter is only liable for the total public offering price represented by the portion of the distribution underwritten by him S. 130(1)(d):Experts are only responsible for expertized portion of the prospectus S.130(9)Limit on the damages is whatever the plaintiff paid for the securities. In no case shall the amount recoverable exceed the price at which the securities were offered o Note: Theres no opportunity cost available, i.e. you cant say if you didnt buy RIM because of the misrepresentation you would have bought Apple and that went up in value a lot and you would have capitalized on that. S. 130(8): All the defendants who are liable are jointly and severally liable to the whole, subject to the right to recover from other defendants unless the court denies that right. o Seems inconsistent with s.130(6)&(1)(d), but isnt since you can go after all the other parties for their amounts. DEFENCES S.130(2) Purchaser Knowledge of misrepresentation - No person or company is liable if its proven that the purchaser purchased the securities with knowledge of the misrepresentation o Strict liability for company or selling security holderonus is on the company to prove, obviously this is very hard for the company to do. o Only defence for issuing company or selling security holder Policy: If everyone involved had the same liability as the company, no one would issue prospectuses because liability was too harsh and can't reasonably know everything . As a result, there is only strict liability for issuing company and selling security holder. The theory is that if you are the company or the selling security holder, you should know everything, so if theres any question between you and the innocent buyer, youll be held liable. Everyone else has certain defences available S.130(3)No person or company, other than the issuer or selling security holder, is liable under subsection (1), if she proves, o (a) Signed without knowledge or consent that the prospectus or the amendment to the prospectus
was filed without his, her or its knowledge or consent, and that, on becoming aware of its filing, he, she or it forthwith gave reasonable general notice that it was so filed;

Applies to underwriters, directors, and officers who signed and the experts (b) Withdrawal prior to purchase that, after the issue of a receipt for the prospectus and before the
purchase of the securities by the purchaser, on becoming aware of any misrepresentation in the prospectus or an amendment to the prospectus he, she or it withdrew the consent thereto and gave reasonable general notice of such withdrawal and the reason therefore;

Not liable if you withdraw consent and give general notice to OSC prior to a purchase (c) Liability for Non-Experts for the Expert portion had no reasonable grounds to believe that there was a misrepresentation or that such part did not fairly constitute a report or was not a fair copy of said report, statement or opinion Non-experts are not liable for misrepresentation in expert portion of prospectus if they had no reasonable grounds to believe there was a misrepresentation and that they in fact did not believe a misrepresentation existed. This tells you that you cant just rely on the information in a prospectus. You have to actually believe that there wasnt a 21

misrepresentation (subjective) and also there shouldnt be grounds for a misrepresentation (objective) The defendants have the burden of proving such a belief and reasonable grounds, there is no additional requirement (as there is in the case of the non-expertised portion of the prospectus) for the defendants to prove that a reasonable investigation was undertaken to verify the accuracy of the experts opinion o (d)Liability of Experts for the Expert Portion misrepresentation attributable to failure to represent fairly their report, opinion or statement not liable IF (i) after reasonable investigation they had a reasonable ground to believe and did believe that prospectus fairly represented AND (ii) on becoming aware that it did not they advised the Commissionthat they would not be responsible - Wilful blindness is not acceptable - Defendants have the burden of proving such a belief and reasonable grounds - No additional requirement for Ds to prove a reasonable investigation was undertaken to verify the accuracy of the experts opinion 130(4) Expert Due Diligence Defence No person or company, other than the issuer or selling security holder, is liable under subsection (1) with respect to any part of the prospectus or the amendment to the prospectus purporting to be made on his, her or its own authority as an expert or purporting to be a copy of or an extract from his, her or its own report, opinion or statement as an expert unless he, she or it, o (a) they failed to conduct reasonable investigations as to provide reasonable grounds for belief that there had been no misrepresentation; OR o (b) believed there had been a misrepresentation S.130(5)Due Diligence Defence No person or company, other than the issuer or selling security holder, is liable under subsection (1) with respect to any part of the prospectus or the amendment to the prospectus not purporting to be made on the authority of an expert and not purporting to be a copy of or an extract from a report, opinion or statement of an expert unless he, she or it, o (a) they failed to conduct reasonable investigations as to provide reasonable grounds for belief that there had been no misrepresentation; OR o (b) believed there had been a misrepresentation

DUE DILIGENCE TEST: Available to all, EXCEPT issuer and selling security holder. Not responsible if they can show: 1. Actual Belief that there was no misrepresentation (subjective), AND 2. Reasonable grounds for that belief (objective), AND 3. Conducted reasonable investigation to support that belief S.132 Standard of Reasonableness = what is required of a prudent person in the circumstances of that particular case o Policy for vague standard -- We want to maintain confidence in the capital market system. Securities legislation is proactive, which is the only way to ensure balance between 3 objectives. The OSC cant set a standard because every company is different, but if they set a standard to objectively determine whether directors are careful, then everyone is comfortable. The only way to encourage brightest people on boards is to make the standard reasonable, b/c imposing layers of investor-protection and liabilities wont protect investors since well end up with bad directors. We must find a balance between investor protection and efficient capital markets, and we wont find it with a Code. o Lastman: no one knows what this means USELESS clarification but it is better than creating a code for situations which are so varied that would be insufficient in some situations or too much 22

in others; if it is b/w you and an innocent investor you will be the one liable if you did not take reasonable steps to ensure access to accurate informationbasically what is going on here is the legislative requirement for these people to be careful, which will be judged in hindsight. The OSC is saying that investor protection trumps requiring all the front line parties having to take reasonable steps to be careful. Escott v. Barchris Construction (1968, US)Leading US case; attempted to define the level of Due Diligence required by various parties in the prospectus; Reasonable due diligence seems to indicate an obligation on each and every party to conduct independent investigation to verify statements made by the issuer to ensure the prospectus constitutes FULL, TRUE and PLAIN disclosure Facts: B constructed and equipped bowling alleys. Needed money so did a public offering. The P was found to be misleading so the only issue is whether there is a due diligence offence available. Company went bankrupt the next year. Shareholders sued for a misrepresentation in the prospectus. Court: The prospectus was misleading and there were misrepresentations in it. The only question left was regarding ALL of the defendants, and which were liable (jointly and severally) / had a due diligence defense available. o Company: Strict liability (statute). No due diligence defence available. o CFO: did not reasonably investigate and was in a position to know and must have known of the misrepresentation did not conduct reasonable investigation cannot blame lawyer o CEO: Signed prospectus, aware of relevant facts no DDD available. (liable as an officer who signed the prospectus) o President & VP (founders): despite limited expertise & education. Court held that whether or not you understood was irrelevant - they knew or OUGHT TO HAVE KNOWN all the relevant facts, and they signed it. o Accountant: relied on others should have known and cannot rely on other experts, also need to do your own DD o Outside Directors: obliged to do independent investigation = no DD Defenseit doesnt matter if youre new to the company, you cannot rely on management. o Underwriters: One underwriter did all the investigations, all others relied on him. He claimed that it was the companys responsibility to get it right. Court said cannot just rely on the company. The court cited the purpose of the statute to protect investors and therefore underwriters are part of the system and they cannot simply rely on other underwriters or the company, they each need to take more action and take reasonable efforts to verify the information given to them. The question of the effort needed to verify is a question of degree but in this case they did basically nothing. o Young in-house Lawyer: became a director after PP but before the FP (when he signed an amendment) but he wasnt an executive officer and did not participate in management of the company. Court said he made no reasonable investigation and he relied on others and he should have known his reasonable legal obligations. No DD defence liable There is no code for how much effort you need to put in. It becomes a question of degree. You need to make sure that your investigations are reasonable under the circumstances. It is difficult to say how much effort is needed when the judgment comes in hindsight of how much effort you put in. Reasonable due diligence seems to indicate an obligation to conduct independent investigation to verify statements made by the issuer to ensure the prospectus constitutes FULL, FAIR and PLAIN disclosure.


Feit v. Leasco A reasonable investigation and reasonable grounds will vary with the degree of involvement of the party in question Ratio - A completely independent and duplicate investigation is not required, however defendants are expected to examine those documents which are readily available. A reasonable investigation and reasonable ground to believe will vary with the degree of involvement of the individual, his expertise, and his access to the pertinent information and data Reasons - What may be reasonable for one director may not be reasonable for another by virtue of their differing positions Inside directors with intimate knowledge of corporate affairs and of the particular transactions will be expected to make a more complete investigation and have more extensive knowledge of facts supporting or contradicting inclusions in the registration statements than outside directors Policy for Due Diligence Defense: Protect the investors - if allowed to rely on management then no extra protection for the public by inclusion of underwriters. THE POLICY OF THE STATUTE IS TO MAKE AS MANY PEOPLE CAREFUL AS POSSIBLE ON THE FRONT END E.G. COMPANY AND UNDERWRITERS. If it comes down to the innocent investor and someone who has been involved w/ preparing the P if you have NOT done due diligence you will carry the cost Securities legislation is proactive- trying to avoid people making misrepresentations in advance and by holding as many people liable as possible (joint & several), in order to make them more careful.



Continuous Disclosure: That disclosure required of a company which has distributed its securities to the public.
Policy Must ensure info is kept current to facilitate the secondary market. Recall that the prospectus tells everything you need to know at one moment in time, so we need to have a mechanism to keep info current: starts with prospectus and continues as events and time pass Policy Protect integrity of capital markets; ensure fairness, disclosure, equality of treatment and information upon which investment decisions are made This all applies to companies that are reporting issuers, and as described in the Act you become a reporting issuer by filing a prospectus.

Five Types of Continuous Disclosure: 1) Regular Financial Disclosure: at predictable and fixed intervals. This is info. that is useful to the market to assess how the co. is doing. Very clear and certain, e.g. quarterly and annual reports. 2) Timely Disclosure: at irregular and unpredictable intervals. This disclosure is created as a result of some material event that changes the nature of the co. such that the marketplace has to be informed. This change could be something that is planned (closing a building), OR it could be unplanned (lawsuit, fire). This is the most difficult area of the disclosure requirement. The company must report events even if the public already knows through a newspaper etc. 3) Early Warning: This is designed to give advance notice to the marketplace that someone is accumulating a block of stock indication of a potential takeover bid. 4) Insider Reporting: when insiders of a company buy or sell public securities, they have an obligation to disclose. This is important to let investors know what insiders think of their company and to stop insider trading. The fact that insiders are buying and selling is useful information in the marketplace. 5) Insider Trading: Prohibits the use of information that is not in the public domain in the buying and selling of securities. If you buy or sell securities with inside information, you will go to jail. Who is subject to Continuous Disclosure Regime? Continuous Disclosure regime only applies to reporting issuers as defined by S. 1(1) essentially you are a reporting issuer if you have filed a prospectus


REGULAR FINANCIAL DISCLOSURE NI 51-102 says if you are a reporting issuer in Ontario you must file audited financial statements within 90 days of your year end. And you must prepare interim quarterly statements (unaudited) within 45 days of the end of each quarter. Annual Financial statements: Within 90 days of financial year end, reporting issuer must file with OSC (Item 4.2) and deliver to any investor who requests it, annual audited comparative financial statements (Item 4.6) Interim Financial statements: In addition to the annual audited comparative FS, within 45 days of the end of each quarter, companies must file with Commission and any investor who request is, cumulative quarterly unaudited FS o At end of every quarter, provide unaudited financial statements o At end of every year, provide audited financial statements

S. 75: There is a duty to disclose if you are a reporting issuer (a company thats filed a prospectus) upon the occurrence of a material change (not material fact) in the affairs of the reporting issuer o s. 75 must be read in conjunction with NI 51-201 o s. 75(1)Publication of material change: Subject to (3), where a material change occurs in the affairs of a reporting issuer, it shall issue and file a news release authorized by a senior officer disclosing the nature and substance of the change o s. 75(2)Report of Material change: subject to subsection (3), the reporting issuer shall file a report of such material change in accordance with the regulations as soon as practicable, and in any even within 10- days of the date on which the change occurs. o S.75(3) Except for where, (a) in the opinion of the reporting issuer, and if that opinion is arrived at in a reasonable manner, the disclosure required by subsections (1) and (2) would be unduly detrimental to the interests of the reporting issuer; or (b) the material change consists of a decision to implement a change made by senior management of the issuer who believe that confirmation of the decision by the board of directors is probable and senior management of the issuer has no reason to believe that persons with knowledge of the material change have made use of that knowledge in purchasing or selling securities of the issuer, the reporting issuer may, in lieu of compliance with subsection (1), forthwith file with the Commission the report required under subsection (2) marked so as to indicate that it is confidential, together with written reasons for nondisclosure o s. 75(4) Report every 10 days Where a report has been filed with the Commission under (3), the reporting issuer shall advise the Commission in writing where it believes the report should continue to remain confidential within 10 days of the date of filing of the initial report and every 10 days thereafter until the material change is generally disclosed in the manner referred to in subsection (1) or, if the material change consists of a decision of the type referred to in clause (3)(b), until that decision has been rejected by the board of directors of the issuer. o s. 74(5) Need to report right away - Although a report has been filed with the Commission under (3), the reporting issuer shall promptly generally disclose the material change in the manner referred to in subsection (1) upon the reporting issuer becoming aware, or having reasonable grounds to believe, that persons or companies are purchasing or selling securities of the reporting issuer with knowledge of the material change that has not been generally disclosed. Policy reason for timely disclosure - to give the marketplace information on a timely basis so they know what theyre doing when theyre buying and selling shares. Theres confidence in the markets because you as a shareholder know that information gets put into the market immediately.


What is a Material Change? S. 1(1) Material change: a change in the business, operations, or capital of a company that would reasonably be expected to have a significant effect on the market price or value of a security of the issuer; includes a decision to implement such change made by the Board or senior management who believed that confirmation of the decision by the Board is probable. o So proposed changes only become material when The BOD decides to do something, or Senior management decides to do something and believe BOD confirmation is probable Internal v. External Change o Internal a fire, contract, lawsuit. For these changes, there is an obligation to disclose o External if the government in Canada raises the prime rate that has material effect on your business, that is not internalized to your business and theres no obligation to disclose. NP 51-102 if that external change has a greater impact on your business than on the rest of the world, you DO have an obligation to disclose Example Shoppers used to sell cigarettes. It was a destination stop that resulted in other purchases beyond the cigarettes. When the government banned cigarettes from drug stores, that external event had a huge impact on shoppers. So there would be an obligation on shoppers to disclose. Today, when the government continues to tax cigarettes at higher rates, its hard to tell if that has a significant impact on Macs Milk, that they must disclose. Actual v. Proposed Change o Actual A strike, a fire, a lockout, a sale of a major asset, all result in an obligation to disclose. If theyre all material, there must be timely disclosure. o Proposed The obligation to disclose arises when youve decided to do something even when youre not going to implement it for a while. In that context, material change provides 2 situations where a decision to do something in the future triggers timely disclosure: 1. When the board of directors has decided to do something (i.e. close an Oshawa plant in 3 months), the decision triggers the disclosure obligation, not the actual closing of the plant. Consistent with the objectives of timely disclosure get the information in the marketplace at the most appropriate time so people are trading with the most recent information. 2. When senior management has decided to do something and they believe that board of director approval is probable. For example, when management wants to close the Oshawa plant, and they believe that the board will ultimately support that decision (recall that the board will make the decision), that triggers timely disclosure. o NOTE: that your mere intention to do something that you lack the control or power to do is inappropriate disclosure Material change v. Material Fact - Timely disclosure is triggered upon the material change in the affairs, as opposed to a material fact.


Royal Trust Co. v. Campo material change v. material fact was at issue; here there was only a material fact Facts: Directors of RT knew that 60% of the shareholders were not going to tender (agree with) Cs takeover bid. The bid was unsuccessful and C sued, because if they had known that the bid was going to fail, they would not have wasted money doing it (trying). Court: Directors NOT liable, as there was no material change, only a material fact (knowledge that the bid would fail). Reasons: Timely disclosure is only required when theres a material change in the affairs of the company. The FACT that 60% of the shares were not going to tender to the bid is a material fact, but nothing has changed in the business of RT, and theres no obligation under the OSA to make timely disclosure of material facts. Similarly, recall Danier - SCC: Danier did not have an obligation to disclose the poor revenue and earnings for the first half of the 4th quarter unless it amounted to a material change. The fact that the weather was bad was a material fact, and if it had an impact on the company it would have been a material change. So there was no obligation to discloseCourt said they would not interfere with genuine business judgment. Definition from s.1(1) Material Change: 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 any of the securities of the issuer (think internally of the business) Material Fact: a fact that would reasonably be expected to have a significant effect on the market price or value of the securities (think externally from the business) Policy Balance timely information vs. confidentiality and market manipulation (markets cant function properly if there is too much speculation - premature disclosure) Premature disclosure is a problem because can screw around with market doesnt create confidence in capital market You are in a gigantic disadvantage if you had to disclose every time you are about to make a deal only want to announce a deal when you know the deal is final. Tension between investor protection and efficient capital markets Premature Disclosure: OSC said premature disclosure can be equally destabilizing as late disclosure Cant disclose late and cant disclose early. Have to disclose at just the right time. NI 51-102 3 types of reports when there IS a MATERIAL CHANGE: 1. Complete public disclosure The most common circumstance. When there is a material change in the affairs of a reporting issuer, the reporting issuer is subject to 2 obligations: o (a) Press Release: Immediately issue press release discussing the nature & substance of change Press releases are to be factual and balanced with complete and promote disclosure with unfavourable / favourable news. Not to contain unnecessary details, exaggerations, and promotional commentary. o (b) Material change report: Report disclosing in detail the nature and substance of the material change. Supposed to be more detailed describing what happened and the consequence to the business Must be filed as soon as practicable, but in any event within 10 days of the date of the change. 28

2. Incomplete public disclosure Lastman has never seen this happen The same as (1) except there is some fact that you can show the OSC that is unduly detrimental to include. o So you ask the OSC to grant permission for you not to include this information. If they grant it, you still file the press release and the material change report, but you dont have to file this unduly detrimental fact. 3. Confidential report Effectively youre saying that something is material but you are asking the OSC for permission to not include it See S. 75(3) below
S.75(3): Confidential Report
S.75(3) Where,

(a) in the opinion of the reporting issuer, and if that opinion is arrived at in a reasonable manner, the disclosure required by subsections (1) and (2) would be unduly detrimental to the interests of the reporting issuer; or (b) the material change consists of a decision to implement a change made by senior management of the issuer who believe that confirmation of the decision by the board of directors is probable and senior management of the issuer has no reason to believe that persons with knowledge of the material change have made use of that knowledge in purchasing or selling securities of the issuer, the reporting issuer may, in lieu of compliance with subsection (1), forthwith file with the Commission the report required under subsection (2) marked so as to indicate that it is confidential, together with written reasons for non-disclosure (4) Where a report has been filed with the Commission under subsection (3), the reporting issuer shall advise the Commission in writing where it believes the report should continue to remain confidential within ten days of the date of filing of the initial report and every ten days thereafter until the material change is generally disclosed in the manner referred to in subsection (1) or, if the material change consists of a decision of the type referred to in clause (3) (b), until that decision has been rejected by the board of directors of the issuer. (5) Although a report has been filed with the Commission under subsection (3), the reporting issuer shall promptly generally disclose the material change in the manner referred to in subsection (1) upon the reporting issuer becoming aware, or having reasonable grounds to believe, that persons or companies are purchasing or selling securities of the reporting issuer with knowledge of the material change that has not been generally disclosed.


There is no press release / material change report. NI 51-102 - Every 10 days you must advise the OSC why it should remain confidential, and if you cant prove this, you must disclose the information. You cant assume something is confidential just because you want it to be. You must also include in your letter to the OSC that to the best of your knowledge there is no insider trading going on. o Note: If it leaks to the press or if rumours start circulating, the information is no longer considered confidential and you must disclose it You can file this report in 2 circumstances: o (1) Unduly Detrimental: Must prove to the OSC that to disclose this information to the marketplace would be unduly detrimental to the company. Courts take strict interpretation to unduly detrimental There is a HUGE bias towards disclosure, and regulators are unlikely to be persuaded in a simple circumstance that you should be entitled to keep this information confidential. Courts have taken a strict interpretation of the words unduly detrimental Niagara Wire Weaving : unduly detrimental = undue economic harm to the corporation that is not outweighed by the benefit realized to the market and its goals Cant use just kidding defence: Lastman has never seen a material change that has been deemed to be unduly detrimental and therefore has resulted in confidential disclosure. By seeking confidential disclosure, you have made the decision that the change is material, and 29

therefore if youre denied confidentiality, disclosure is mandatoryBE CAREFUL, BIG RISK o (2) As of right: Also acknowledging there is a material change, youre asking for confidential disclosure until the board approves a certain move that management has put forward. You get confidential disclosure as of right until the board has decided to implement the decision (or when senior management thinks the decision is probable), at which point you must fully disclose. Purpose: Youre putting management in an impossible position if they decided to do something and have to go to their bosses if they must disclose this before they go to their bosses. You want to put the OSC on notice that somethings happening so they can watch the stock. When management makes this request the OSC wants to make sure that no one will trade on this information thats being kept confidential. The OSC needs to be able to monitor these companies. Once the board approves it, then it becomes full public disclosure Consequences of failure to make timely disclosure in accordance with the Act: To prove failure by a public issuer to make timely disclosure, a plaintiff must prove o A reporting issuer failed to make timely disclosure o Plaintiff acquired or disposed of the security of the issuer o The acquisition or disposal of the security occurred between the time when the material change was required to be disclosed, and the subsequent disclosure of the material change Where D is not the issuer / an officer of the issuer, P must also prove that at the time that the failure occurred, D: o Knew of the change and that it was a material change o Deliberately avoided acquiring knowledge of the change or that it was a material change, or o Was guilty of gross misconduct, through action/failure to act, in connection w/ the failure to make timely disclosure Failure to comply with the continuous disclosure requirements can lead to o Penal sanction (as can a misrepresentation in the required disclosure) o Compliance orders can be obtained o OSC could make a cease trade order or remove an issuers right to use the various exemptions provided in the Act People responsible for failure of the issuer to make timely disclosure are o The issuer o Directors and officers who authorized the failure o Influential persons each influential person and each D & O of the influential person, who knowingly influenced the issuer or any person / company acting on behalf of the issuer in the failure, or who knowingly influenced the D or O of the issuer to authorize in the failure P does not have to prove that he relied on the a


EARLY WARNING SYSTEM Subjected to this when you own 10% of a class of shares! Used to show possible change in control Takeover bids are very expensive in Canada. Must be able to prove the ability to meet the financial obligation. To do so, usually need to hire a bank to approve financing, and pay a high fee to the bank to do so! Policy: The investing public should know when somebody is taking a run at acquiring a company. It might influence their decisions to buy, sell or hold shares as takeovers usually put stocks at a premium. Obligation on a shareholder if they own 10% of a public company or more of the outstanding voting securities of an issuer - they have to disclose their intentions going forward S. 102.1(1): Early Warning Obligations: Once an entity acquires 10% or more of the voting or equity securities of a public company, that entity has an obligation to (a) immediately file a press release containing the information prescribed by the regulations, and (b) must file within 2 business days a report with the OSC containing same information as press release. o S. 102.1Acquiror = you, or others acting jointly or in concert with you, cant beat the system by joining with another party who has 9.99% later on. o Policy: Early warning that someone is accumulating a significant block of stock, and therefore they may be making a takeover bid at a premium, and current shareholders should be cognisant of that fact as they may want to hold on to stock o Note: You cant do anything indirectly that you are not permitted to do directly s.92

Contents of Press Release: NI 62-103, Appendix E

S. 1(f): Must disclose intention tell why you are buying stock In practice, they all say we have no present intention, but everyone knows intuitively that stock will go up and what their true intentions are s. 102.1(2)Further 2% Rule: Every time you acquire an additional 2% of the outstanding securities of the class to which disclosure required under (1) relates, you must go through the same process (file a press release and report), including securities that are convertible into an additional 2% of the outstanding securities referred to above o Purpose: This can give the target corporation an early warning of a potential takeover bid, and can signal to the others the potential gain from acquiring the target. This will increase the potential for competing bids and will allow target management more time to engage in defensive tactics s. 102.1(3):Period when Acquisitions are Prohibited - you cannot buy anymore securities of the company until one business day after you have filed your report freeze periodThis means there needs to be 1 whole business day of no trading, so if you buy 23rd, cant buy again till 25th. o Purpose: This rule enables the market to digest the information of a potential takeover bid and encourages acquirers to file their reports quickly. It is only the trade that puts you over 10% that has to be disclosed. Will make you file early warning report as soon as possible (<2 day maximum). Gives time for market to adjust to new information NOTE: Early warning continues up until the time of the takeover bid, but after 20% the freeze period stops happening, only the reporting needs to continue. o o

The theory of takeover bids is to acquire as much as you can as fast as you can. Once you put out your press release, the stock price skyrockets. So the strategy is to get to 9.99% and save the largest transaction to the end. The goal is to get the largest amount over 10% before the company has to follow the early warning disclosure rules (get to 20% faster). You will want to buy the small shareholders up first so that you can get to 9.99%. Once you are at 9.99% then you want to make the large buy to put you the furthest over 10%. Should buy strategically to maximize the number of shares you can buy before early warning rules come into effect.


EXAMPLE Whats your purchase order? A) 4%, B) 5%, C) 6% Answer: you will want to buy A then B then C, so that you get to 9% and then the bell doesnt go off until you hit 15%. EXAMPLE: Whats your purchase order? A) 4%, B) 1%, C) 9%, D) 3% Answer: A, B, D then C: First purchase you make that puts you over 10% triggers the early warning system. EXAMPLE: A, B, C are shareholders in a public company. Which would you buy if you owned 9.99% already? A = 3% B = 4% C = 2% Answer: If you have 9.9%, there is still no need for disclosure. You would want to buy as much as possible first, so you would buy B. You want to reach 20%, so you would get there faster this way. Policy: Why allow even 9.99%? There is an exception to insider trading about trading on your own information. Legislatures have decided that takeover bids are a good thing for society. Efficient and effective means of economic growth. If they didnt allow up to 10%, then takeover bids would be too expensive in Canada.

s.102.2(1): Outstanding Takeover Bid; 5% Rule Acquisitions during a bid, 5% rule: If there is a takeover bid already outstanding, then anyone else that acquires 5% of the stock has to put out a press release before the opening of trading on the next business day saying that they have acquired 5% (added to previously acquired securities = 5%) No report required and no freeze on the stock (this information is prescribed by the regulations) There is a different set of rules dealing w/ early warning during an outstanding takeover bid. o Theres no obligation to file a report, no press release requirement, no freeze, they just want you to give advance notice to the marketplace. o That obligation continues every 2% until you hit 10%- then regular early warning regime Policy: No report or waiting time required; simply to allow the market to know that a bidding war may ensue. This happens every 2% until the company reaches 20% (at which point takeover bid rules apply - a press release and report are still required but the freeze period no longer exists NI 62-103 When someone has already announced a takeover this will create an auction for the shares. During the course of the takeover bid, the 5% early warning rule applies. Note: It is beneficial to buy stock before you announce a bid so you have less to buy, and if you lose to another bidder, you can tender your shares to defray your costs from what will be an inflated share price.

INSIDER REPORTING Subjected to this when you own 10% of a class of shares!
Used to show how insiders feel about company S. 107(1) Insider Reporting: As soon as you become an insider of a public company, you must file an electronic report (Form 51-501F) explaining that youre an insider and how you became one within 10 days of becoming an insider S. 107(2) Once you are an insider EVERY TIME you buy or sell securities of the reporting issuer you must report this change within 10 days of the event saying you bought and sold (with the same requirements as above) o Must disclose any direct/indirect beneficial ownership of, or control over, securities of the reporting issuer). o There is nothing wrong with insiders of a public company buying or selling securities in their OWN company


Policy why insider reporting is a good idea: Obligation on the insiders of a company to report when they buy / sell shares. This is very important information to shareholders (want to know what insiders think of the company). o Nothing wrong with insiders buying or selling shares so long as they are not doing it based on insider info., i.e. information that is not in the public domain (in fact, trades should be encouraged) o Reporting is used as a deterrent to insider trading (if OSC knows about trades, they can investigate). Deterring insider trading keeps confidence in the public markets o Therefore, it is a useful information tool for investors and it discourages insider trading S. 1(1)Insider of a public company: - (narrower than special relationship) o Every director or officer of a reporting issuer, o Every D or senior O of a company that is itself an insider or subsidiary of a reporting issuer, subsidiary defined under s.1(1) as a company with 50% or more of its shares owned by another company o Person or company who beneficially owns, directly/indirectly, or exercises control/direction, or both, over voting securities of a reporting issuer carrying more than 10% of the voting rights attached to all the issuers outstanding voting securities Often youll see shareholders who hold 9.5% because they dont want to deal with the complications o A reporting issuer where it has purchased/ redeemed / otherwise acquired any of its own securities For so long as it holds any of its securities; Therefore, when you own 10%, 1. You become an insider 2. You are subject to early warning **Once you acquire 10% of shares in a public company bells should be going off because you now have to file initial insider trading materials and early warning disclosure documents.


1) Special Relationship - Guilty of Insider Trading (unless there is a defence) 1. Is the person in a special relationship with the reporting issuer? If YES 2. Is there a material fact or change that has not been generally disclosed? If YES 3. Did the person buy or sell on the basis of this information? If YES 2) Tipping - Guilty of tipping 1. Is the person in a special relationship with the reporting issuer? If YES 2. Did the person pass on or tip other people with respect to undisclosed material fact or change? If YES 3. Was it in the necessary course of business? (If YES, not guilty of tipping). Note: There will likely be a question on insider trading on the exam. Go through the analysis and the policy. Prepare an answer ahead of time. Policy: we need a level playing field so people are making informed decisions based on the same information. Ensure that there isnt an informational advantage with relation to the buying or selling of securities (Kimber Report, 1965 report in favour of establishing a Canadian securities regulator). This maintains confidence in the system.

1) SPECIAL RELATIONSHIP s.76(1): Prohibition against trading where undisclosed change: Offence for someone in a special relationship with the reporting issuer to buy or sell securities having knowledge of a material fact or material change that has not been generally disclosed s. 76(5):Special relationship with a reporting issuer means, o a) a person or company that is an insider, affiliate or associate of (i) the reporting issuer, (ii) a person or company that is proposing to make a take-overbid, as defined in Part XX, for the securities of the reporting issuer, or this says that an insider of the company proposing to make a take-over bid cant buy shares in the company, but it doesnt say that the company cant buy shares in the company they are going to make a take-over bid forthis is because if this was done it would completely prevent a take-over bid from starting (iii) a person or company that is proposing to become a party to a reorganization, amalgamation, merger or arrangement or similar business combination w/ the reporting issuer or to acquire a substantial portion of its property, o b) a person or company that is engaging in or proposes to engage in any business or professional activity with or on behalf of the reporting issuer or with or on behalf of a person or company described in (a) (ii) or (iii), [e.g: reporting issuers lawyer] o c) a person who is a director, officer or employee of the reporting issuer or of a person or company described in (a) (ii) or (iii) [i.e. company making a takeover bid] or clause (b), o d) a person or company that learned of the material fact or material change with respect to the reporting issuer while the person or company was a person or company described in clause (a), (b) or (c), i.e. if you were formerly in a special relationship and learned information, you are still in a special relationship; (e.g. if you obtained information as a lawyer, but are no longer the lawyer) o e) Tippee = a person or company that learns of a material fact or material change with respect to the issuer from any other person or company described in this subsection, including a person or company described in this clause, and knows or ought reasonably to have known that the other person or company is a person or company in such a relationship The potential chain of tippees is infinite. This is unique to Canadian law different in US 34

Tippees of tippees are also included as part of the special relationship if they know or ought reasonably to know that the tippor is in a special relationship (depends on facts) Note about takeover bids: Nothing wrong with the company buying shares of another reporting issuer, as takeover bids are a good thing. However, there is a disclosure requirement if more than 10% of the shares are purchased. There is a policy in place to allow takeover bids, but no policy to allow directors of the company taking over to get rich! The company making the takeover bid is not in a special relationship because there is a policy consideration that allows the company to buy shares of the company, which it intends to takeover (however, if that company learns other confidential information through a friendly bid, it cannot trade those shares; lawyers make sure that nothing is disclosed that is not in the public domain or that it is immediately disclose or the takeover company would be prevented from trading o If the take-over company learns of a material fact/change from the target company they themselves are then considered to be in a special relationship as a tippee and could subsequently not buy the company, so gotta be careful there). You can trade on your own information.

2) TIPPING s.76(2): Prohibition against tipping: Offence for a reporting issuer and a person or company in a special relationship with the reporting issuer to pass on information or tip other people except with respect to undisclosed material fact or changes in the necessary course of business o You can never be guilty of insider trading unless you are a person in a special relationship! o You can trade on this information once it is generally disclosed o Policy: we need a level playing field by ensuring that there isnt an informational advantage need to maintain public confidence in the market o There must be a positive action resulting to invoke insider-trading regulations EXCEPT with tipping o If you give an inside tip you are guilty of insider trading, whether or not the other party acts on the tip o Offence to convey insider information whether or not shares are purchased as a result of the tip o Objective and subjective test: you have to KNOW that the person is not in a special relationship and you OUGHT to reasonably have known that the person is not in a special relationship o Tipping in the necessary course of business is NOT an offence. This is a pure question of fact (Example: if you disclose information to your lawyer when attempting a takeover) No bright line test s.76(3):Prohibition against tipping for person or company proposing takeover bid, reorganization, amalgamation, etc: Except in the necessary course of business Necessary Course of Business: NP 51-201 Mixed question of fact and law that must be determined in light of the policy reasons for the tipping provisions. o Policy: to ensure efficient capital markets; if not allowed at all then business would be impossible Obligation on tipper to make sure tippee is aware that info is confidential and should not be acted upon or disclosed Generally does not apply to analysts, institutional investors (i.e. Dont give an information advantage to someone who might use it ) If the information starts to leak there is no safe harbour must disclose immediately.


Royal Trustco (2004, OCA) IT IS TIPPING!! Facts: Directors of Royal Trust Co knew that Campeau could not win his takeover bid and told a shareholder that there was no risk, since 60% of shareholders were not tendering to Campeaus bid. Held: The information was not given in the necessary course of business and therefore tipping occurred immediately when the information was passed to SHs. Ratio: There is no circumstance where you can give an informational advantage to a shareholder and claim it is in the necessary course of business. Takeover Bid example: If Co. A is planning a takeover bid of Co. B and Co. A buys shares knowing that they will increase, this is not insider trading. Why? o To promote takeover activity, there is nothing offensive about A buying securities of B with information about what A is going to do. But, directors of A cannot trade because they should not be allowed to profit from the information that they know (there is no public benefit here). Example 1: You are the president of a company that has a patent on a drug and a competitor comes out with a press release that they are getting a patent on that drug. The price of that company's stock increases dramatically and you short sell (knowing that price will eventually go down). o NOT INSIDER TRADING o Intuitively, you should not be able to do the transaction but, technically, you cannot be caught by the definition of "special relationship". By definition, it is not "insider trading". o Policy: How far do you want to cast the net of insider trading? Example 2: President of Coca Cola is in a meeting with Pepsi. You are in the same restaurant and he gives you a wink. You buy Coca Cola stock. Are you a tipee? o NOT CLEAR o No clear answer. He didnt really give you any material information that hadnt been disclosed. He might have just had something in his eye. Example 3: Law firm working secretly on a takeover bid. Partner trades, not knowing that firm is working on the file. o YES INSIDER TRADING o Too bad, partner is caught by the Act. o Law firms often deal with this by circulating lists of companies that you cannot trade in. Sometimes, they put up Chinese walls to prevent the flow of info. Example 4: If you are a lawyer acting for a company that is suing a public company can you be caught for short-selling your shares of the public company that your client is suing? o NOT INSIDER TRADING o Technically, you are not caught by the Act you have no special relationship with the public company whose shares you are short selling. Intuitively, you should be caught. o Different from the drug company example because lawyer is looking to profit from client info. Drug company may have just fallen onto the information. Policy Usually you are still caught if you violate the spirit of the Act but not in the case of insider trading because dealing with a criminal situation.


DEFENCES TO INSIDER TRADING Even if not convicted, a charge of insider trading is detrimental to ones career b/c they will be all over the papers, etc; when they are let go there will not be nearly as much publicity Once the case has been made against you for insider trading, i.e. offended ss. 76(1) or 76(2) 1. You were in a special relationship with a reporting issuer 2. You had knowledge of an undisclosed material fact or change 3. You purchased or sold securities of that issuer or passed the info on to another person 1. Chinese Wall Defence Reg. 175 Problem: Under agency law, if you are partner in mid to large firm, you are deemed to know what is going on in your firm. In reality, you barely know what you know! Insider trading is a very serious offence, so we need a way to protect really innocent people from bad facts. Defence: If you are found guilty of insider trading because you are deemed to have inside information, you have a defence if you can prove the following 4 things: o (1) The information was known to one of your directors, officers, partners, employees, or agents (Not known by me, I am only deemed to know, me being the person that traded) o (2) The decision to buy / sell was made by someone who did not have actual knowledge of the information (I didnt know, and Im only deemed to know b/c one of my partners knew) o (3) No advice given with respect to the trade was given by the person who had actual knowledge to the person who made the decision to trade (My partner didnt tell me to do it) o (4) An appropriate Chinese wall was in existence to prevent the flow of information from the person who had the actual knowledge to the person who made the decision to trade (obligation to be careful) Restricted List: Before anyone in a firm can buy / sell securities, they must phone a designated person/s in the law firm to say that they want to buy shares of A, and must ask if A is on the firms restricted list? Any time someone learns of a new matter that may involve insider trading concerns, they must call this designated person to put the company on the restricted list. Investment banks have physical geographic barriers between the people doing the deals and the people doing the trading, so that they can take advantage of this defence. Reg.175 (3) in determining whether the person / company sustained the burden of proof under S.175(1) the OSC will consider the extent company /person has procedures & policies to prevent contraventions of S. 76(1) o If a law firm is sloppy in guarding the info. (does not satisfy #4), the lawyer who purchases the shares will likely not go to jail but will have to repay the innocent vendor (civil suit). In such cases, with two innocent parties, the sloppy one must pay. 2. Unsolicited Order Defence Reg. 175 (2)(a) Purchase or sale was entered into as an agent of another person or company pursuant to a specific unsolicited order. E.g. I call my broker who knows Onyx is about to buy Air Canada, and you tell him to buy 5000 shares of Air Canada. Your broker doesnt tell you anything one way or another. Law can demand that your broker refuse, or demand that the broker execute (which it does) this is the better option and avoids flagging to the world that something is going on (rather than demand that your broker refuse) o A broker can execute the trade and it will not be insider trading. This happens in the case that your broker knows that Stelco is being taken over, you call and ask him to buy shares (broker has two options: execute trade or tell you he cannot do it. If he says something to you this would make you curious). 3. Automatic Dividend Investment Plan Defence Reg. 175(2)(b) Automatic dividend plans, if entered into prior to the acquisition of the knowledge of the material fact or change. 37

Most kids have a share of Walt Disney; stock pays dividends of 3 cents / quarter. This was kind of stupid, so they came up with this plan. Plan: lease dont ask us to send you 3 cents every quarter, and well keep the money and buy you another share of Disney with that money, and will send you the certificate when the money equals the cost of another share. Since this is good for them, they wont make you pay for commission. You sign up for this plan in the beginning (many companies do this) What if you signed up for this plan and then 4 days before there are enough dividend cheques to buy more shares, and you learn that Disney stock is going to triple? o Law says do nothing! You entered this plan with no information (it was automatic), so theres no reason to interrupt this cycle because you have to learn new information. Policy: this purchase was not based on undisclosed information that you now are aware of If theres an automatic decision for you to get shares, i.e. buy them, then you did not rely on the information to make any type of decision and it would not be insider trading. 4. Legally Binding Obligation Reg. 175(2)(c) If purchase or sale was made to fulfill a legally binding obligation prior to the acquisition of the knowledge of the material fact or change. o IE. when you enter into a contract to purchase the shares of Co. A in two weeks. Two days later, you find out that a takeover is happening. o Law: Do nothing. You entered into a contract knowing nothing, so there is no harm no foul if you happen to learn something in an intervening period. o This defence does not apply if you have an option to buy, and you exercise the option. So you cant exercise your option if you find out about something before. 5. Both Parties Have the Same Info If both parties to the trade have access to the same material information, it is not insider trading (they can exchange shares on a level playing field no disadvantage to either party). TEST: did they reasonably believe the other had knowledge? 6. Reasonable Belief in Disclosure Defence If you can show that you reasonably believed that the material facts had been generally disclosed. When has information been generally disclosed? (OSC does not give guidance) o Massive onus of proof (YOU must prove this) o Just because something is in a newspaper does not mean it is generally disclosed o It is YOUR obligation to disclose, not the newspapers obligation to disclose o You need to understand that a press release may not be sufficient disclosure to have the defence, as you need to give market time to digest o NP 51-201: By press release in a responsible manner. o **Texas Gulf (OSC) Facts: Company had lots of information and put out press release. Next minute, called to buy the stock. Reasonable belief in disclosure: o The Information must be disseminated to the trading public (a news report is only the first step to disseminate the information); and o The trading public must have it in its possession for long enough to digest it. o Rule of thumb: wait one full trading day. An exact timeline does not exist b/c the dissemination of info. will differ in each case depending on the industry and the size of the co. (for less significant issuers, the intervention of a calendar week would suffice). o **National Sea: No firm rule on timing, as it depends on: o The nature of the market for the stock o The place of the market for the stock o The place of dissemination of news release o Rule: An insider may not trade with the release of the news as in this case, and must let the information be disseminated and the market needs to digest the 38

information (safe working rule = 1 full trading day) after the release of the information before insider trading issues are removed. The amount of time must reflect the purpose of the Act, that is, to protect investors

Why is the term insider trading a misnomer? It doesnt apply just to insiders applies to people within a special relationship to reporting issuer It doesnt necessarily involve a trade. Under the Securities Act a trade is defined as a sale of securities. You are guilty of insider trading whether you buy or sell. Additionally, you dont have to buy or sell in order to be guilty of the offense. EXAM: How to do an insider trading question: link concepts from different segments of the course (LINK THE 3 OBJECTIVES BACK). Talk in English as if youre the lawyer and hes the client and explain it in a way that the client can understand. Dont assume that the client knows what special relationship or whatever is. Spell it out in ordinary terms. Communicate to the client in the way that they will understand. So you cite the section of the Act that says what it does. Define special relationship. Then decide whether material change or material fact. Then did you buy or sell with knowledge that hadnt been disclosed. Then you look to the possible defenses.



Three ways to sell securities to the public (3 ways to raise money): o (1) Prospectus o (2) Private Placement Exemption: allows you to sell securities without a prospectus o (3) Discretionary Ruling from the OSC: Allows you to sell securities without a prospectus and without a PPE, but its really more of an idea than a reality because therell never be a case where this is granted. General Rule: OSA requires registration and the filing of a prospectus with the OSC, unless an exemption can be found. Advantages from company perspective o (1) Speed: since there is no prior regulatory review PPs can be done quickly (no waiting period, no review by OSC). o (2) Confidentiality: transaction is not subject to full, true and plain disclosure of all material facts, or is subject to the Continuous Disclosure regime. However, PP exemptions are subject to supervisory review, since they have to meet the conditions. More than superficially regulated! Failure to meet the conditions set out in the Act carries significant consequences (e.g. transaction can be void). Policy: Advantages from system perspective o Reflects the trade-off between investor protection and efficient capital markets (allowing small companies to gain access to financing without significant expense) We cannot survive as a country if the only way for companies to access the market is through a prospectus many companies cant afford it or dont want to be public. An efficient capital market needs another way to access the market Problem is that regulators are OCD! - The rules are supposed to be in place to allow small companies access to markets, but the conditions that a company now has to meet are so restrictive that small companies cant qualify for the exemptions anymore 3 underlying policy assumptions: All exemptions are usually premised on the view that the normally stringent protections afforded by the prospectus are unnecessary, either because 1) Purchaser is sufficiently sophisticated (deemed to be a function of wealth) and therefore doesnt need protection of a prospectus will go through time and trouble of protecting themselves; or 2) Information is otherwise readily available from some other source; or 3) Securities are considered inherently safe that to require a prospectus would be ridiculous (e.g. Canada Savings Bonds)
Reflect back on the policy and always ask: why does rule exist? What are they trying to accomplish? How are they trying to accomplish it? And why is that ok?

All of the following exemptions are found in one of two places: (1) NI 45-106 OR (2) Rule 45-501

There are FOUR types of Exemptions:

1) 2) 3) 4) Exemptions based on wealth or sophistication of the purchaser Limited offering exemptions limited in their scope (Government Incentive Securities ??) Trades in securities of private issuers Isolated Trades


#1 - EXEMPTIONS BASED ON WEALTH OR SOPHISTICATION 1. Accredited investor exemption s. 2.3 of NI 45-106 - Allows a company to raise any amount of money from any number of investors as long as each of those investors is an accredited investor o No minimum purchase price o No restriction on the number of times a person can sell securities using this exemption o An accredited investor may qualify under this exemption and a closely-held issuer exemption Policy: Accredited investors are so sufficiently sophisticated and wealthy that theyll go to the time, trouble, and expense of protecting themselves, and they therefore dont need the protections of a prospectus Examples of accredited investors: (mostly large institutional investors or really rich people) o Prescribed financial institutions o Charities o Pension funds o Insurance companies o Governments o Individuals who either individually or with a spouse own financial assets with an aggregate, realizable value before taxes exceeding $1 million. o Spouse, parent, grandparent, child of a promoter, officer or director o Promoter of an issuer or affiliate of the company o A company, LP, trust, estate, or individual with net assets of at least $5 million When you sell securities and rely on this exemption, there is no requirement for you to deliver anything to the accredited investor, other than the shares. (No legal obligation to describe the business / affairs of the company). o But, practically speaking, these people dont usually give you big checks unless you provide them sufficient information in writing so they can evaluate the investment. So, although theres no obligation if business practice dictates that you do, then the OSA says that that document you delivered to investors, is an offering memorandum, and it must contain a statutory right of action referred to in s. 130. (s. 4.2) - If I misrepresented this to you, you can sue me If you have delivered an offering memorandum with this exemption, you must deliver a copy of this memorandum to the OSC within 10 days of the time of the trade.(s. 4.3) 2. Minimum amount exemptions ($150,000 exemption) s. 2.01 of NI 45-106 Exemption where the purchaser purchases as principal, if the trade is in a security of a company, which has a single acquisition cost to that purchaser of at least $150,000 paid in cash at the time of the trade. o Aggregate acquisition of the cost of the securities purchased must be at least 150K in cash on closing of trade o Lastman thinks this is a modest benefit hard to find people who have 150K to invest o No need to deliver any information to investors, but as a matter of business practice ,you may have to (same rule about OM applies here) Policy: If youre a wealthy investor youll take the time to protect yourself. The policy is defeated if youre only going to pay $5,000. o The cash requirement is so that youll have enough financial assets to pay for it now, and they dont want you paying for it over a number of years because the present value may drop. o Example: Set up a company with 30 people at $5000 each, where the company purchases as principal for $130,000. The rule would say that this company was only set up to do indirectly what you couldnt do directly, and this would not be allowed.


o Example: What if Apple wants to buy a share unit for $150,000? This is OK, because they havent been incorporated for that purpose. They didnt set up apple to buy this unit, so theres nothing wrong with it. o Its all about policy. if you set up a company in order to defeat the purposes of the statute, the OSC is not going to help you You dont need to give paper, but if you do its an offering memorandum.

#2 LIMITED OFFERING EXEMPTIONS Policy either there is some policy more important than investor protection that the government is trying to promote, like investment in gold/mining, OR theyre giving companies the ability to start up a business or rehabilitate an older one. This is also to create an opportunity for establishment of a new enterprise, or rehabilitation of an old enterprise. 1. Government-incentive securities exemption s. 2.1 of OSC Rule 45-501 Exemption if you are trading in government-incentive securities where solicitations are made to no more than 75 solicitations, and sales are not made to more than 50 purchasers. o Government-incentive securities those which from time to time the government sets out; whatever industry the government wants to promote at the moment Example: The government wants to promote the mining industry, so all mining securities are government-incentive securities, and so people can rely on this exemption. To rely on this, you must satisfy some preconditions o You cant solicit more than 75 people. o You cant sell to more than 50, each of whom must be purchasing as principal. So you better be really careful about who you show this to. To keep track of this, companies provide and number the offering memoranda - but Lastman has seen multiple numbering so people try to solicit to more than 75 Contradictory nature of the exemption, because on one hand they want to promote a certain industry, but on the other hand, as these are not accredited investors (and cannot protect themselves), they go too far and impose the following precondition. o You must provide each purchaser with substantially the same information concerning the company that a prospectus would provide, this essentially triggers the offering memorandum The whole point of this is that we dont want to get into this! But they get scared because unlike with the wealth exemptions theres no guarantee that these people can protect themselves because theyre wealthy The only way to satisfy this is to deliver a document that is an offering memorandum and includes a statutory right of action in the event of a misrepresentation. o Each of the purchasers, who are effectively naked purchasers and have no attributes to protect themselves, must either be: an executive officer or director of the company, or the spouse or child of that executive officer or director of the company, or a person who, by virtue of their net worth and investment experience, or on advice from a registered advisor, is able to properly evaluate the investment - Purpose: Basically theyre still motivated by protecting investors. This just makes the legislators feel better, but it doesnt actually protect the investors. o Cant advertise in connection with this exemption Purpose: This would be soliciting to more than 75 people, and OSC generally doesnt like advertising 42

o No promoter can use this exemption more than once in any calendar year (the promoter is the person responsible for founding, creating, and running the company) Consider: If youre going to go through the time of essentially preparing the prospectus, why not prepare a prospectus so youre not limited to 75 solicitations and 50 purchasers? o No prior regulatory review so its quicker o No continuous disclosure obligation. Once you file a prospectus, youre a public company and must do regular financial reporting, annual financial statements, etc Note on public companies using the exemptions: Every time you sell securities you must do one of the 3 things (above), so sometimes private companies do private placements, which is typically what were thinking of, and sometimes public companies do private placements. Public companies never go to this particular exemption, because theyre already public, but once youre already subject to the continuous disclosure regime, you may want to use the accredited investor exemption to avoid going through continuous disclosure. So dont assume, even though its usually the case, that private placement exemptions are exclusively in the domain of private companies. 2. Founder and Family Exemption s. 2.7 of NI 45-106- Exemption if you sell a security to a person who purchases as principal, and is a founder of the company, or the spouse/brother/parent/sister/child of an executive officer or director or founder, or a control-person of the company o Control person person who alone or in conjunction with others has the effective right to control the company o No disclosure obligation, but if you provide an offering memorandum, offering memorandum rules apply #3 - PRIVATE ISSUER EXEMPTION s. 2(4) of NI 45-106 - You must be selling securities of a private issuer to an enumerated list of purchasers who purchase as principal, or to someone who is not the public o Therefore, identity of the purchaser is very relevant o Policy: Designed to facilitate the ability of companies to raise money at a very early stage of their existence. The small entrepreneurs are what create value in jobs from nothing. So we as a country must promote the ability of those entrepreneurs to have a chance. They cant file a prospectus, they dont have rich friends, and they arent government -incentive securities exemptions Private issuer: Defined as an entity with 3 qualifications: 1. Articles of incorporation restrict the transfer of shares a. No one in this company can transfer their shares in the company without the written consent of the directors (or shareholders, etc) 2. Articles must limit the number of shareholders to 50 exclusive of current and former employees 3. Articles say any invitation to the public is prohibited Note: No restriction on the number of purchasers or number of solicitations (subject to the 50 security holder limit) Identity of the purchaser, such that they are not a member of the public? o No restriction on the number of purchasers that you can approach, as long as they qualify o Ridiculous list of people who classify as an acceptable purchaser Director, officer, employee, founder, or control-person of the company Spouse, parent, grandparent, brother, sister, or child of any of those people 43

A close, personal friend of any of those people An individual who knows the person well enough and for a sufficient period of time to assess their capabilities and trustworthiness. The relationships must be direct. Its not enough to be related, client, former client, customer or former customer, or a member of a religious group A close business associate of any of those people Sufficient business dealings to assess capabilities and trustworthiness. The relationship must be direct. Not sufficient to be a client, former client, customer, or former customer. Spouse, parent, grandparent, brother, sister, child of the close, personal friend / business associate Person that is not the public (cannot solicit shares in the public) Accredited investor Canadian courts have relied on 2 US cases with different tests: Pipegrass (1959, Alta. CA) o Facts: Company solicited the purchase of shares from a large group, 5 of whom eventually purchased. Of those 5, the company had previous dealings with 4 of them. The investment went bad, and the investor demanded money back, arguing that the company sold him securities without a prospectus and without proper reliance on a PPE. Company argued that it wasnt the public. o Held: These were sales to the public since the 4 purchasers with previous dealings were not in any sense friends or associates of the D, or persons having common bonds of interest or association. The fifth was a complete stranger. Thus, P was required to be registered. Common bonds test: If an individual has common bonds of interest or association with an insider (friends or associates of the seller), then that individual will not be construed as a member of the public. An insider includes a director, officer or shareholder of the issuer. Ralston Purina (1953, US) o Facts: Company established a stock purchase plan, under which any employee could purchase shares. No solicitation by the company was permitted or conducted. Among those that purchased were several low-level employees. When investment went bad, they argued the company did not comply with the PPE, as they were members of the public. o Held: This was an offering to the public. Employees are just as much members of the investing public as any of their neighbours in the community. Some employee offerings could be exempt, such as those made to executive personnel who have access to the same kind of information that the Act would make available. But, absent special circumstances, employees are in need of protection through full disclosure of pertinent information. Offers to employees will be exempt from the prospectus requirement only where it can be proven that those employees would already have access to the pertinent information that the prospectus would contain (i.e. they would not need to know the information b/c they already have access to it) ***Need to know test: Persons who, because of their sophistication or relation to the company, do not need the information a prospectus would provide, are not members of the public. The focus on the inquiry should be on the need of the offerees of the OSA protections. Those who are able to fend for themselves for a transaction are those who are not the public (clarify)The design of the act is to protect those investors that need protection. Lastman: WTF are they talking about?! Nobody knows how to rely on this exemption, and lawyers dont know how to give advice about it. Unless you are desperate, or extremely confident


that your kid wont sue you, you have no basis to rely on this exemption. Its a really important exemption for the country, and its nearly impossible to rely on it.

Lastman: The legislation is so annoying because you want to take advantage of these exemptions, but they make it so hard and come up with these ridiculous concepts. Its all really unclear whats going on here.

Note about Multiple Exemptions There is nothing wrong in law and policy with combining exemptions, as long as youre not trying to be smart o Example - If I have to raise $10 million dollars, I can raise $5 million from 80 accredited investors, and $5 million from 50 purchasers under the government-incentive exemption. o Example: It would be wrong if I went to the 75 people in this room under the government-incentive securities exemption, and 10 of them said theyd like to write checks for $200,000. If I then told them to walk over to the other room, and then I invite 10 more people into this room, that would violate the rule of the law because I would be soliciting 85 people for the government-incentive exemption. As soon as I find out that people will spend $200,000, you cant then say I dont want to waste a solicitation on you and invite in 10 more people. Must be explicit about who you are soliciting, and for what. o Example: If you cant prove that you never solicited for the government -incentive exemption and only spoke to them about the $150,000 exemption, youre FUCKED!

#4 - ISOLATED TRADE s. 2(3) of NI 45-106: You dont need a prospectus for an isolated trade If a trade is an isolated trade and is NOT in the course of continued / successive transactions, or by a person whose usual business is trading in securities o Lastman: no clue what an isolated trade is. This is never used. DONT USE THIS ON THE EXAM! Discretionary Rulings s. 74(1) - Allow you to sell securities without a prospectus / private placement exemption, if it would not be detrimental to the public interest to do so. Lastman it is impossible to do so. There is such a bias towards disclosure that its hard to think of a situation where the OSC would say that its in the public interest to do this (forget it!).


OFFERING MEMORANDUM Introduction Many of the exemptions dont require an offering memorandum, but business practice dictated that a document that fits the definition may have to have been provided to satisfy the buyer of securities, and therefore you may have voluntarily delivered an offering memorandum. In either case, once you have delivered this OM, you must file a copy with the OSC within 10 days of the date of the trade. Definition s. 1.1(2) of Rule 14-501: A document purporting to describe the business affairs, for delivery to and review by a prospective purchaser, to assist investors in making an informed decision o includes a statutory right of action if theres a misrepresentation in this document, you can sue me. o Misrepresentation constitutes an untrue statement of fact or an omission of a statement of fact Thus, an OM carries the same implications as a prospectus, without regulatory review o Level of required disclosure is unknowndoes not explicitly say it must not contain a material misrepresentation of fact o Policy: This reflects the fact that once you give the highlights, you must give the lowlights, and theyre very concerned about people giving a modest amount of information and not being able to deal with it. Tell them everything or tell them nothing Government-incentive securities exemption is the only one that weve discussed that requires you to deliver an offering memorandum. But all of the other exemptions weve covered basically say that you dont have to deliver one. However, if you deliver a document that describes the business and affairs of the company as part and parcel of what you must do to convince a buyer to buy, whether you call it an offering memorandum or not, the rule says that that document you have delivered IS an offering memorandum Rule 45-501: If all you deliver is a term sheet that sets out the terms of the deal, or current financial information, that is not an offering memorandum. But once you go beyond that and describe your business and affairs, then you have delivered an offering memorandum and youre subject to the statutory right of action.

Requirements Can be as long or short as the company wants Cant contain untrue information Cant be ambiguous Document must describe contractual right of action Document must in some way deal with the business and affairs of the company Two types of Offering Memorandum 1. Obligation: like in government incentive securities exemption (requires an OM) 2. Voluntary: for business practices, even though you are not required to provide it. Doesnt matter what you call it, if the document includes a description of the business then it meets the definition of an OM, and the statutory right of action attaches


Statutory Right of Action S. 130.1 of OSA: If there is a misrepresentation: o The purchaser has a right of action for damages against the company and the selling securities holder, OR o The purchaser can elect to rescind the purchase, the damages are limited to the price of the securities so there is no opportunity cost, and all of the Ds are jointly and severally liable for the damages against the contributions of each other Until now, weve talked about three ways to issue securities to the public 1. Do a prospectus 2. Satisfy a private placement exemption 3. Discretionary Rule (which youll never get) We havent considered what happens if you sell securities to the public without a prospectus and without proper compliance with the private-placement exemptions. Until Jones v. Deacon Hodgson, no one really knew. Jones v. Deacon Hodgeson (1986, ON) - a sale in contravention of the prospectus of PPE requirements is voidable at the instance of the purchaser (always, never statute-barred, statute of limitations does NOT apply) Facts: DH was an investment bank in Canada. In December 1980 they set up a private company to invest in an oil expiration and sold shares to J in 1982. A year later J is in Australia, and gets charged with fraud on an unrelated matter. Deacon, chairman of DH, is called to Australia to testify in that matter (he knew him). J goes to prison. Meanwhile, this investment he made a year before in this oil expiration company goes bad, and in 1986 Js still in prison, and realizes that Deacon sold him securities 4 years ago with no prospectus and no proper reliance on a PPE. From prison in Australia he sues Deacon to get his money back. Deacon relies on s. 138 of OSA which says that theres a 3-year statute of limitations, so J cant sue. Court: DH did sell these securities without a prospectus or proper reliance on a private placement exemption. The requirement that people sell securities this way is so fundamental to the integrity of our capital markets that if you dont comply, the transaction is NEVER statute-barred, and is always voidable at the instance of the purchaser. Lastman: This case says it is NEVER put to bed, as there is no limitation period on the sale of securities without a prospectus/PPE. Every securities lawyer wanted DH to appeal that decision, but they also didnt want a CA to affirm this. So its never been challenged, and as far as anybody knows this is the law! Registration Recall that no person shall trade in a security unless they are registered (s.25), and if such a trade is a distribution, without proper reliance on a prospectus or on a private placement exemption Everything we have done played off of this NI 31-103: Business Trigger Test TEST: If for a living you buy/sell or assist/advise people on whether or not they should trade in securities, you have triggered this test, and are therefore in the business of trading securities, and must register in the OSA. o Policy: The purpose of this is so youre registered under the Act (to maintain and increase public confidence in the capital markets), and if they license you they can police you. So when you do a private placement, theres an exemption for the company, but anybody else involved in the process would be caught by this test, and therefore theyd be registered under the OSA. So you must ensure that whoever youre using to sell the securities (i.e. agent), is registered = would enter into an agency agreement as opposed to an underwriting agreement


RESALE RULES FOCUS ON THE POLICY BEHIND THE RULES Recall First Principles Open market in capital serves 2 purposes o Sale of securities from the company to investors o Sale of securities among investors When you issue a prospectus re securities, you become a reporting issuer in Ontario, which subjects you to the continuous disclosure regime so the sale of shares in this case are freely tradeable in the open market But recall that you can sell securities without a prospectus and without being a reporting issuer, because it reflected this trade off between investor-protection and efficient capital markets o E.g. under a PPE - if somebody will spend $150,000 buying securities, theyll go to the time, trouble, and expense of protecting themselves, and they dont need a prospectus. o But now we have a problem I buy $150,000 worth of securities pursuant to the $150,000 exemption. Now I want to resell them. I go to 30 people and offer to sell them $5,000 worth of securities each. o Whats the problem? The whole rationale which allowed me to buy the securities

without a prospectus was that I was spending the $150,000 to protect myself. If the OSA allows me to sell these to you, weve just run around the whole OSA, and the 30 people wouldnt, for $5000, go to the time, trouble, and expense of protecting themselves. o With securities sold pursuant to a prospectus there is no problem with those securities being resold because the company has an obligation of continuous disclosure so all the information is readily available to the public, so theres no need to prevent resale.
How do you solve this? 1. Limit who the people with exemptions can sell to 2. Find someone else that will buy pursuant to a PPE (i.e. if a Bank buys pursuant to the exemption, another Bank will do the same) 3. If I cant find someone who will buy it for $150,000, the company must file a prospectus o So before you buy securities, you will insist on having some mechanism to resell them you will only buy them if the company agrees that within a reasonable period of time the company will file a prospectus so eventually I can resell the securities make them put a CONTRACTUAL obligation in the agreement to issue prospectus within certain time period, otherwise big penalties Technically, how do you stop someone from reselling securities? Recall the rule that no trade in a security that amounts to a distribution without a prospectus Definition of Distribution: o A sale of securities that had not been previously issued o It is a distribution to resell securities that you acquired pursuant to a PPE unless you satisfy the resale rules So the way you stop the sale of securities is always through the definition of distribution Resale rules are broken down into 2 categories (A) Every PPE covered but the private issuer exemption (B) Private issuer exemption


GENERAL RULES 1. If the company WAS a reporting issuer at the time you bought through the PPE you can resell those securities 4 months after you bought them. o Policy: You have to take a leap of faith theres no good rationale for making you wait 4 months, but the securities regulators have decided that the price you pay for buying securities through a PPE even if the company is a public company, (b/c they want the public to have time to digest the information), is making you wait 4 months. 2. If the company was NOT a reporting issuer at the time you bought through the PPE you cant resell the securities until the later of 4 months from the date of the trade and the date the company becomes a reporting issuer o If the company never becomes a reporting issuer, you can never resell them (unless pursuant to another PPE because a prospectus wouldnt have been issued yet to give investors the info) 3. Additional Conditions: o The share certificate you get must have a legend that says there is a holding period. o The trade cannot be from a control person o Theres no extraordinary commission o Theres no reason to believe that the company is in default of its obligations

Example: If I buy shares pursuant to a PPE and the company is already a reporting issuer I have 4 months to hold these securities. If I resell them to someone else for $150,000 2 months in, the OSA says that that next purchaser only has to hold them for 2 months. Its not a new 4-month period in the hands of the next purchaser. In this case (when youve resold to someone through a PPE), it begins counting the 4 months from when YOU purchased the securities.

ANALYSIS: Any time you look to an issue regarding the resale of securities, you must ask 2 questions: (1) WHO are you? a. Non-control person move on to Q2 b. Control person no need to ask Q2, and can only resell them under these 5 conditions to ensure that the marketplace is aware of the fact that the person, for whatever reason, is selling their shares. (2) HOW did you acquire the securities? a. By way of prospectus the securities are freely tradeable (can immediately resell them) b. By way of PPE must satisfy the resale rules or resell by way of another PPE


#1) RESALE RULES FOR NON-CONTROL PERSONS (1) Securities acquired pursuant to a prospectus are freely tradable unless the seller is a control person o Rationale - Information is available in the marketplace to allow investors to make an informed investment decision and ongoing continuous disclosure obligations ensure that the information remains current. Other policy considerations prevent control persons from selling securities even if acquired pursuant to a prospectus. (2) If securities are acquired pursuant to a PPE, the seller cannot resell them unless 1 of 4 conditions are met: o 1) Get the issuing company to file a prospectus and include the specific securities that want to be resold in that prospectus. However, most people cant get a company to sell its securities pursuant to a prospectus, as the selling security holder has strict liability for a misrepresentation in a prospectus This would happen only if there was a contract when securities were first sold that the company would file the prospectus with respect to my securities (ensure when you buy that there is a mechanism for you to resell your securities) Selling security holder (the owner of the specific shares who acquired those shares pursuant to a PPE) will be subject to strict liability with respect to a misrepresentation only defence is that the Purchaser knew of the misrepresentation when they purchased o 2) Seller relies on another PPE or, for the GIS exemption, the sale is to a member of the original 50 purchasers o 3) An exemption order is obtained from the OSC (wont get this!); or o 4) The resale rules referred to below are satisfied (NI 45-102) PPEs permit the issuance of securities without the accompanying obligation to provide complete disclosure to investors and without the continuous disclosure obligations. The Act permits these transactions because either: - The sophistication of the purchaser or his or her knowledge of the business and affairs of the issuer reduces the need for prospectus-like disclosure; or - The legislators are trying to address some more important policy objective. However, to ensure that there are not subsequent sales of securities to persons who need the protection offered by a prospectus, the Act has to regulate the second trade in such securities until such time as the protections afforded by a prospectus are available. Resale Rules for All Exemptions EXCEPT the Private Issuer Exemption (NI 45-102) (a) The issuer is and has been a reporting issuer in a jurisdiction of Canada (Ontario) for the 4 months immediately preceding the date of the resale (Seasoning Period = date of the trade). This condition does not apply if a. The issuer became a reporting issuer after the date of the original private placement (distribution date) by filing a prospectus in Alberta, BC, Manitoba, Nova Scotia, Ontario, Quebec or Saskatchewan, and b. is a reporting issuer in a jurisdiction of Canada at the time of the trade c. Policy: Dont want to have the resale take place in a private company context, so the public has all the needed information to make an informed decision my making the seller be a reporting issuer. (b) At least 4monthshave elapsed from the distribution date (Restricted Period); a. Policy: Want time for market to digest the information before they can re-dump securities into the market (c) The share certificate of the resale securities must include the prescribed legend setting out the restriction on transfer; (d) The trade is not a control distribution 50

(e) No market manipulation; (i.e. nobody prepared the market for this event) (f) No extraordinary commission or consideration is paid in respect of the trade (g) No grounds to believe issuer is in default. What this says is you can resell securities on the LATER of 4 months have passed since you purchased the securities through a PPE AND the issuer has become a reporting issuer Note: If the issuing company (the company you initially got the securities from) never files a prospectus (i.e. becomes a reporting issuer) you can never resell the securities! Resale Rules for the Private Issuer Exemption (a) The issuer is and has been a reporting issuer in a jurisdiction of Canada for the 4 months immediately preceding the date of the resale (Seasoning Period = date of the trade). This condition does not apply if The issuer became a reporting issuer after the date of the original private placement (distribution date) by filing a prospectus in Alberta, BC, Manitoba, Nova Scotia, Ontario, Quebec or Saskatchewan, and is a reporting issuer in a jurisdiction of Canada at the time of the trade i. Policy: Dont want to have the resale take place in a private company context. (b) The issuer became a reporting issuer after the distribution date by filing a prospectus in Alberta, BC, Manitoba, Nova Scotia, Ontario, Quebec or Saskatchewan and is a reporting issuer in a jurisdiction of Canada at the time of the trade; AND (c) The trade is not a control distribution; AND (d) No market manipulation; AND (e) No extraordinary commission or consideration is paid in respect of the trade; AND (f) No grounds to believe issuer is in default. As long as the issuer has now become a reporting issuer, theres no need for at least 4 months to have elapsed. But for all other PPEs, you need that condition. No Matter How a Control Person Acquires Securities, They Cannot Be Resold Unless These Rules Are Met


#2) RESALE RULES FOR CONTROL PERSONS A completely different set of rules apply if you are a control person, in which case, for very different reasons, they want to control your ability to resell securities. If you want to stop the sale by a control person, you deem the transaction a distribution unless certain conditions are met Third branch of distribution says a control person cannot resell securities unless he satisfies the resale rules. o S.1(1)Control person: Person who alone or in combination w/ others holds sufficient shares to effect materially the control of the company; deemed to control a public company In absence of evidence to the contrary, there is a rebuttable presumption that you are a control person if you hold more than 20% of the shares. Pure question of fact, but there is a rebuttable presumption at 20%. o Policy: The policy behind regulating trading by control persons is to prevent abuses by such persons of their access to material information concerning the affairs of an issuer where that information has not been generally disclosed. Regulators are worried about these people in control of public companies having better access to information, and may thus take advantage of the market. The public must know that the person theyre buying securities from is the control person. This has nothing to do with HOW they bought their securities, but WHO they are. RULE: No matter how a control person acquires securities, they cannot be resold UNLESS: (a) The control person qualifies a prospectus for the sale of the subject securities (as a selling security holder) o Get the company to prepare a prospectus to sell my securities, so I now have liability as a selling security-holder. (b) An exemption order is obtained from the OSC (Lastman: this will not happen!) (c) The control person sells pursuant to another PPE (which gives rise to the resale rules) o i.e. find an accredited investor or a $150,000 purchaser o Problem with relying on the PPE is that it gives rise to the resale rules, so the person Im selling to is going to have a hold period of 4 months, so she wont pay me the same price as if I could sell her freely tradeable shares, because shell be at risk for 4 months. So this isnt very attractive. (d) The control person sells to another control person (which gives rise to the resale rules); o Problem with this is the same, because this is subject to the resale rules, not freely tradeable and thus there is a discount and is therefore less attractive. (e) The control person sells pursuant to the advance notice route discussed below. o If you give advance notice to the market that youre a control person, law will let you sell shares within a 30-day period which is renewable, to any purchaser in any denomination you want. o You should be allowed to do this because the goal is to get the buyers to know youre a control person who wants to sell your securities. o The advantage is I can sell them to anyone I want in the open market, and I wont take the discount because theres no hold period on those shares in the hands of the buyer. ADVANCE NOTICE ROUTE o o Advantage: Control persons can sell securities in any denominations to any persons without subjecting the purchaser to resale rules (i.e., the purchaser receives freely tradable shares). If you give notice to the market that you are a control person then you will be allowed to sell shares within a 30 day period (which is renewable) to any person in any denomination.


Conditions for the Advance Notice Route (a) Issuing company was a reporting issuer at the time of the original purchase, in which case you must have held the securities for 4 months. The issuer is and has been a reporting issuer in Alberta, BC, Manitoba, Nova Scotia, Ontario, Quebec or Saskatchewan for the 4 months immediately preceding the trade (i.e., the date of the resale of the security) unless the issuer became a reporting issuer after the distribution date (i.e., the date of the original private placement) by filing a prospectus in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec or Saskatchewan and is a reporting issuer in a jurisdiction of Canada at the time of the trade, in which case the 4 month seasoning period does NOT apply; (b) If its not a reporting issuer, the holding period is the later of 4 months and the date the company became the reporting issuer. (c) No market manipulation; (d) No extraordinary commission or consideration is paid in respect of the trade; and (e) No grounds to believe issuer is in default.

Resale Rules Examples Scenario 1 Jan. 1, 2009: Private placement of securities of a reporting issuer, pursuant to the accredited investor exemption Can resell May 1, 2009 (4 months) Scenario 2 Jan. 1, 2009: Private placement of securities of a private issuer pursuant to the private issuer exemption Feb. 1, 2009: Private Issuer becomes a reporting issuer by filing a prospectus in Ontario. If you buy pursuant to a private issuer, you can sell on Feb. 2, 2009 (can sell the day after they become a reporting issuer). Scenario 3 Jan. 1, 2009: Private placement of securities of a private issuer pursuant to the accredited investor exemption Feb. 1, 2009: Private issuer becomes reporting issuer by filing a prospectus in Ontario Purchaser can sell 4 months after the private placement (as this is not the private issuer exemption) Scenario 4 Jan. 1, 2009: Private placement of securities of a reporting issuer pursuant to an accredited investor exemption to B April 1, 2009: B sells the securities to M pursuant to the accredited investor exemption. You can tag on the time can resell 4 months after the original private placement (tack on the 3 months that B held them)



Fundamental Concepts If A owns 51% of the shares of a public company, B owns 49%. Although there is only a 2% difference, A has full control over the company and its decisions. As shares are worth more than Bs shares. It is the control associated with As shares that is worth a lot of money, and people are prepared to pay a premium for control Policy: OSA says that someone who owns control can do what he wants. BUT if you are a public company, when you want to sell control, that premium you get for control doesnt belong to you alone, but it belongs to all shareholders of the company. You dont have to share control while you own it, but the premium you are going to get to sell the control belongs to all shareholders equally. Control only belongs to you when you own it. It doesnt belong to you when you sell it. All shareholders helped create the value, therefore the premium paid to control the company must be distributed amongst all the shareholders. Premium attached to sale of control belongs to all shareholders Under the Takeover Bid rules, control is defined as 20% (Bright Line Test) What is a takeover bid? Takeover bid: The acquisition of shares of a target company which, together with the shares already owned by the purchaser, will put the purchasers shareholdings in the target to/over 20% o A person owning 19.99% of the common shares of a company will, subject to certain exemptions, be making a takeover bid if he buys .01% or more shares o OSA doesnt care how you obtain shares up to 19.9%. o As soon as you buy 1 share that, together with what you already own (or anyone acting jointly in concert with you) puts you to/over 20%, OR as soon as you propose to, you cannot do that transaction without doing a takeover bid circular offering to buy the same % of shares from all shareholders on the same basis, UNLESS it is an exempt takeover bid. Relevant regulations: 182-203 Relevant Sections: 89-105. Note: If 3 people each own 7%, if they get together it is NOT a takeover bid if they are not offering to acquire any shares. Reasons for takeover bids From a policy perspective, there are perceived to be socially useful/not useful reasons for takeover bids, and we have to see the legislatures position on takeover bids Socially useful reasons for takeover bids 1. Moves assets to their most desired uses 2. When people can put assets together that make sense together, synergies are created and assets are put to their most effective use. As a result, people will put a premium towards assets because: i. Theyll be put to better use ii. Theyll be more synergistic iii. Example: Toronto Star take over Sunmedia Toronto Star and Toronto Sun are more efficient together 3. Forces management to be efficient if they arent, stock price is suppressed, vulnerable to takeover Socially non- useful reasons for takeover bids 1. The stock is under-valued someone takes undervalued asset for themselves a. Someone sees an opportunity to gain an advantage and they secure it only for themselves 54

2. Seen as Empire building people just want bigger toys, dont use them effectively a. No inherent value or utility to society, and this is simply see who has the most toys owning many assets with NO synergies! Lastman says stick to your knittings! 3. Creation of monopolies a. Monopolies are not perceived to be good, because they eliminate competition, which eliminates control on pricing, value, etc. 4. Tax reasons to do takeover bids that only benefit the person paying less tax On a balance, they are a good thing, so we are going to let them happen! Policy objectives behind takeover bid legislation Object of takeover bid legislation is to ensure, to the extent possible, that shareholders and the investing public receive sufficient information about the terms of the bid and that all shareholders are treated alike. Echoed in Kimber Report . This is to protect the bona fide interests of the target shareholders so they make informed decisions as to whether they want to tender their shares to the takeover bidder. All the rules come down to dealing with 1 of 3 things SO TIE IN THE RULES TO THESE POINTS!!! 1. INFORMATION: The legislation is designed to give the target shareholders sufficient information to make a reasoned decision as to whether or not they want to sell their shares to the bidder. Inform investment decisions! 2. TIME: No point giving shareholders information if you dont give them sufficient time to assess that information and digest it! o Time allows management of the target company to assess the bid and give their recommendation to their shareholders as to whether its good or bad. o The best result from the legislators perspective is that an outcome of a takeover bid will be that other bidders come in and keep bidding up the price in an auction, so that the shareholders of the target company will be able to get the highest price at the auction. 3. EQUALITY: Fundamental to our legislation is that all shareholders of the target company be treated equally. You cant treat big shareholders better than little shareholders. TAKEOVER BID LEGISLATION PROVISIONS S. 89(1)Takeover Bid: an offer to acquire outstanding voting or equity securities of a class, which together with the offerors securities, constitute in the aggregate 20% or more of the outstanding securities of that class o This is a bright line test and is problematic because its not always sufficient Example: If I own 60% of the shares and you own 30%, you cant sell your 30% without satisfying the takeover provisions; conversely, in a widely held company the 20% threshold makes more sense o 20% REPRESENTS CONTROL AND YOU CANT ACQUIRE CONTROL WITHOUT MAKING THE SAME OFFER TO ALL SHAREHOLDERS o Outstanding v. Treasury shares: A company has shares that they issue to others (outstanding) and those it keeps to itself to issue at some other time (treasury). These rules only apply to outstanding shares. If money is being paid to company, theres no premium for control going to any individual because all shareholders are sharing equally anyway. Therefore, treasury shares dont count as a takeover bid. So, if what you are going to buy together with what you already own is 20% or more of the outstanding voting or equity securities of that class, you cannot buy those shares without complying with takeover rules (think of the 20% as 50%). They must be


outstanding shares, so reaching above 20% because of exercising a stock option is not a takeover bid. Offer to acquire: an offer to purchase, or a solicitation of an offer to sell, securities; an acceptance of an offer to sell securities, whether or not the offer has been solicited; or any combination of the two The passage of time is not an offer to acquire Indirect Acquisition: A direct or indirect offer to acquire or the direct or indirect acquisition of securities Offerors securities: Securities controlled, beneficially owned, or deemed by s. 90(1) to be beneficially owned by an offeror or persons acting jointly or in concert with the offeror o Example: A,B,C each have 5%, and each want to buy 14% so they can each be under 20%, and then pool them together to have 60%. This is forbidden! S. 90(1)Deemed beneficial ownership: Where the person has the right to acquire those securities within 60 days, or the security is convertible within 60 days into the underlying security Youre deemed to own securities you have a right to acquire (i.e. options) within 60 Days of the date of the transaction (i.e. the transaction that puts you over 20%) Policy: Legislation is trying to say you cannot buy shares that put you over 20% without complying with the takeover bid rules, so if you have shares that are convertible into shares of a class within 60 days, then when calculating how many shares you own, you will be deemed to have those shares and when you go to buy your next shares you will be caught - it is 20% on a class by class S.90(3)Unissued securities deemed outstanding: When deemed to be the beneficial owner of unissued securities, the securities shall be deemed to be outstanding for the purpose of calculating the number of outstanding securities of that class in respect of that offerors offer to acquire s. 89(5) & s. 90(1) = youre deemed to own any shares you have a right to acquire within 60 days of any given event. Implications of Russell Holdings (tried to take over a private company to access a public company): OSC was purposive and saw through this. Since it was not in the public interest, the OSC enacted the following section: o s.92 Application to direct and indirect offers: a reference to an offer to acquire, or to the acquisition or ownership of securities or to control direction over securities, includes a direct or indirect offer to acquire or the direct or indirect acquisition of securities, or the direct or indirect control or direction over securities. Lastman: this provision is stupid! This says that you cant buy a holding company that owns e.g. 60% of a company you want control over without offering the same premium to the minority 40%


SAMPLE PROBLEMS: Question 1: Day 1: own 10% of common shares Day 2: option from company to purchase 9% of common shares exercisable at any time Day 4: consider buying 2% of common shares in open market The acquisition of 2% is a takeover bid. I own 10%, and on day 4 I have the right to purchase 9% (so I am deemed to own 19%). So on day 4 when I want to buy 2%, that will be put at 21%. Question 2: Day 1: own 10% of common shares Day 2: option from individual to purchase 9% of common shares exercisable at any time Day 4: consider buying 2% of common shares in open market The acquisition of 2% is a takeover bid. Again, the same logic applies on day 4 I am deemed to own 19%, so on day 6 I will own 21%. This is exactly the same as 1 it doesnt matter how you get to 20, it is only what puts you over 20 that matters it doesnt matter whether the option is from the individual or the company, it is what puts you over 20 because until you have the 20, you are not considered to have control. Question 3: Day 1: own 10% of common shares Day 2: option from individual to purchase 9% of common shares exercisable in 6 months Day 6: consider buying 2% of common shares in open market (A) Is the acquisition of 2% a takeover bid? (B) When exercise option for 9%, is it a takeover bid? (A) The acquisition of 2% is not a takeover bid. I am not deemed to own the 9% option on day 6, because it is not exercisable for 6 months. So 2% more would put it to 12% -- not a takeover. (B) When exercise the option for 9% it is a takeover bid because I own 12 and if have the 9 it would be more than 20, so I couldnt do it unless follow the takeover rules. Also, I would be getting the 9% from an individual who would be getting the benefit of my paying a premium for control. I would then be able to make every single decision so I would pay more than I would for just any other share and if there was not a takeover bid, the individual would get the premium so have to have the offer to every shareholder in the company, not just that person selling you the 9%. Note: if I own 12 and I have an option in 6 months to buy 9 more, why is it not automatically a takeover bid when that option is 60 days away? Because the option is not being exercised, it is only an option so I would have to actually buy the shares, just having the option doesnt make it a takeover and until I exercises the option - but in the above examples, you are deemed to have the options because you are buying the 2% - but the passage of time does not constitute an offer to acquire.


Question 4: Day 1: own 10% of common shares Day 2: option from company to purchase 9% of common shares exercisable in 6 months Day 4: consider buying 2% of common shares in open market (a) Is the acquisition of 2% a takeover bid? (b) When exercise option for 9%, is it a takeover bid? (A) The acquisition of 2% is not a takeover bid. (B) Buying shares directly from company treasury. Not a takeover bid money goes back to the company directly, so premium will be shared by all shareholders. You have 12% when the option is exercised, so the premium to push you over the 20% is going directly back to the company! This is precisely what TOB legislation is designed to do, so this is not a takeover bid. Note: If he then purchases another 1% on the open market, this would be a takeover bid. Outstanding means must be shares that have previously been issued (eg. not from treasury). TOB rules do NOT apply to the purchase of treasury shares (have not yet been issued by the company but are approved in the articles of incorporation).

The difference between 3(b) and 4(b)- The transaction that gives me control in 3(b) is from an individual, and therefore Ill pay a big premium for control. This premium cant go to me, but must go to all shareholders. But if the option is from the company, as in 4(b), the money goes to the company, and therefore all shareholders share equally, and theres no reason to call this a takeover bid. Thats why a takeover bid is an offer to acquire outstanding securities, because if youre buying treasury securities, the whole premise of the takeover legislation is irrelevantThe definition says outstanding shares, shares from inside the company are not outstanding. We want to make sure that any premium for control is shared among all shareholders. This can be done in 2 ways: 1. Give the money to the company that will by definition give it to all shareholders equally, or 2. Go through a takeover bid process which says you must make the same offer to all shareholders to treat them all the same. OVERVIEW OF LEGISLATION 1. Takeover Bid Circular: Details are communicated to shareholders by way of a takeover bid circular o Describes the offer (price, number of shares and any conditions), and is sent to all shareholders o Must contain information in Form 62-504F1 Sufficient information to make an informed decision 2. Minimum Period of Bid: Bid must be open for acceptance for at least 35 days s. 98(1) o It may be open longer o Rationale: Provides time to: Shareholders - to receive the circular, assess and review its merits, and decide whether to sell, Management - to make recommendations and attract others, and Other potential bidders - to create auctions o Bid may be commenced by delivery of a takeover bid circular to shareholders (bid is dated the date of the delivery) or by advertisement of a summary of the bid (bid is dated the date of first publication) 3. Pro Rata: Promotes equality to all shareholders - s. 97.2(1) o If offeror wants to buy a maximum number of shares and more than this number is tendered, then shares are taken up pro rata and not first come, first serve Example: I make a takeover bid and want to buy 75% of the shares, and I make the same offer to all shareholders, and all shareholders want to tender their shares. I cant say first 58





come, first serve, because that will pressure the shareholders and violate the principle of time. If I pick and choose, that will violate equity. So if more shares are tendered than I intend to by, I must make everyones shares pro-rate, i.e. take the same percentage of everyones shares that accepted. Rationale: Ensures that shareholders are not pressured to tender early (and can therefore review all pertinent information and are treated equally) o All shareholders of the same class must be offered the same consideration (or same choice of consideration) and no collateral agreements may be entered into, subject to limited exceptions Rationale: Ensures that a higher price per share is not paid for larger blocks or for shares tendered early o If, after shares have been taken up, the offer price is increased, all shareholders, including those whose shares have already been taken up, are entitled to the higher price Payment for Securities: 98.3(1)&(2) o If all terms and conditions of the bid are satisfied, securities must be taken up within 10 days after expiry of the bid, and must be paid for as soon as possible, and in any event within 3 business days after the securities have been taken up Withdrawal: s.98.1(1) Depositing security holders will be able to withdraw their securities at any time, provided that: o (a) Where the securities have not been taken up The offeror cant take up the tendered shares for 25 days, to allow shares which have been tendered to be withdrawn if the shareholder changes his mind, which usually occurs if a higher offer is made Normally everyone tenders at the end, but if someone tenders early and then someone else makes a better offer, they want the early person to be able to get the high premium o (b) Until the expiration of 10 days from the date of a notice of change or variation in the terms of the bid o (c) If the offeror has not paid for the securities within 3 business days after having taken up the securities, or Rationale: Prevent an offeror from holding on to shares for too long after taking them up. Variation of Bids: - s. 94.4(1) o If a term of the offer is changed (i.e. offer price increased), this must be communicated to all shareholders who are given an extra 10 days to tender their shares. Most changes (other than a price increase or the waiver of a condition) allow a shareholder to withdraw tendered shares for 10 days. o When there is a variation: Offeror must issue and file a news release and deliver a notice of variation to every person to whom the circular is required to be delivered and whose securities have not yet been taken up 10 day withdrawal right 10 day extension deposit period, unless the change is the waiver of a condition and any extension of the bid resulting from such waiver in an all cash bid Where a variation in the terms of a bid increases the value of the consideration offered, the offeror shall pay such increased consideration to each person whose securities were taken up whether or not such securities were taken up before the variation Change of Information: s.94.3(1) o If a change occurs in the information contained in a circular that would reasonably be expected to affect the decision of the security holders of the target company to accept or reject the bid, the offeror must issue and file a news release and send a notice of change to every person to whom the circular was required to be delivered, and whose securities have not yet been taken up o 10 day withdrawal right


8. Directors Circular s. 95(1)(2)(3) o Directors must respond to bid within 15 days of date of bid and make a recommendation to accept or reject the bid OR make no recommendation together with reasons thereof, no later than 7 days before the expiry of the deposit period Rationale: Helpful to shareholders in making their decision re whether or not to tender 9. Pre-bid Integration- s. 93.2(1) o Where a formal takeover bid is made, and within a period of 90 days prior to the bid, the offeror acquired beneficial ownership of securities of that class subject to the bid pursuant to a transaction not generally available on identical terms to the holders of that class of securities, the formal bid must provide for: (1) The consideration for the securities under the bid must be at least equal to and in the same form as the highest consideration paid on a per-security basis under any of the prior transactions within the 90 day period, AND (2) The bid is for at least as high a percentage of securities of the class as was purchased by the offeror from a seller in any other prior transaction within the period o In other words: Shares purchased before the offer is made but within the previous 90 days from the date of the offer can affect the price of and number of shares the offeror must buy. An offeror must offer to buy from the public the highest percentage of shares at the highest price acquired in the 90 day period before the formal takeover bid started. Example: If offeror buys 50% of a shareholders shares at $5/share 30 days before the offer, any takeover bid must be for at least 50% of the outstanding shares of all the shareholders, for at least $5/share o Exemption: If you buy on the open market (e.g. TSX) youre exempt buying them blind, not giving anyone a benefit. 10. Post-Bid Integration: s. 93.3(1) o An offeror may not acquire or offer to acquire beneficial ownership of securities of the class that was subject to the bid for a period of 20 business/trading days following the expiration of a bid by way of a transaction that is not generally available on identical terms to the holders of the class of securities in question An offeror cant purchase target shares for 20 business days after the termination of a bid, except pursuant to another takeover circular bid 11. Consideration: s.97(1) all shareholders must get the same consideration for their shares. o Say you offer a director future benefits for recommending acceptance, thats not the same consideration to all shareholders because that director is a shareholder. o How do you know whether you can do this or not: Whats your intention of doing this? Is it to protect a legit business interest or to get management to mislead shareholders? The OSC lets you go to them and if you can prove that doing this is designed to protect your investment then youre OK.


INTEGRATION / TENDER AGREEMENTS Example: I dont own any shares in a public company. I go to a 19% shareholder and offer to buy the 19% for $50. The next day, I make a bid for the company at $11. I havent crossed 20%, but this wasnt really a nice move to offer the big shareholder $50 and the rest $11. Was this wrong? Pre-Bid Integration says: if within the 90 period before the takeover bid was made youve entered into a private agreement (i.e. to purchase someones shares to a certain price), your takeover bid must be for the highest price AND percentage you bought in that 90-day period. Example: 30 days before the takeover bid private agreement to buy 50% of As shares for $5/ share 15 days before the takeover bid private agreement to buy 100% of Bs shares for $3 / share Pre-bid integration says: my takeover bid must be for at least the highest price ($5/share) and the highest percentage (100%) made during the previous 90-day period. Example: Ive offered $15 / share, and Mr. Big isnt going to sell them, in which case I wont win. So I tell Big to wait until the takeover bid is over. That way Big will be the only shareholder left besides me, and Ill buy his shares for $25 / share. This is not allowed because it will violate all of the rules Post-bid integration says: you cant enter into an agreement to buy the shares that are subject to a bid for at least 20 business days following the expiry of the bid Policy Integration rulesall are designed to protect equality of shareholders. Integration: When the bid is made, you cant buy shares that are subject to the bid while the bid is in progress- this would undermine equality. However you can enter into a tender agreement o Allows the bidder to lock up large shareholders; however, the premium offered to that shareholder must be the same as those offered to all shareholders in that class. Advantage to bidder can negotiate the terms Advantage to shareholder can negotiate the terms, also has a substantial interest in the company, knows the bidder wont pursue the target if she wont tender, ensures she can get her premium. Pre-bid Integrations. 93.2(1): When the bid is made, OSC will look back at previous 90 day period, o IF you have entered into a private agreement to buy shares that would be the subject of that bid. When you make the bid you have to offer the highest price you paid during that 90 day time period for the highest % (Example: if you bought 100% of someones shares your bid needs to be for all 100% of shares outstanding). Exemption: If you buy on the open market (e.g. TSX) youre exempt buying them blind, not giving anyone a benefit. - The consideration for the securities under the bid must be at least equal to and in the same form as the highest consideration paid on a per-security basis under any of the prior transactions within the period, and - The bid is for at least as high a percentage of securities of the class as was purchased by the offeror from a seller in any other prior transaction within the period Policy - Again, this is all designed to ensure that if theres a premium for control, its shared by all shareholders, and the takeover bid circular will provide information achieve the objectives of information, time, and equality.


Recall: Every rule has a series of exemptions. In the context of takeover bids, we discussed how you must make the same offer to all shareholders if you want to buy more than 20% of the company. There are, however, certain exemptions where takeover bid rules do not apply in the same way. EXEMPT TAKEOVER BIDS (1) Private agreement exemption s. 100.1(1) A takeover bid is exempt from the takeover bid requirements (rules) of the securities act provided that: o (1) Purchases are made in the aggregate of 5 or fewer people (including persons or companies outside of Ontario) o (2) Bid is not generally to security holder of the class of securities that is subject of the bid, so long as there are more than give security holders of the class o (3) You paid consideration not exceeding 115% of the market price at the date of take-over bid Market price = the 20 trading day closing average price (market driven test) o (4) If not published market for securities acquired, there must be reasonable basis for determining consideration paid is not greater than 115% of value of the securities Cannot get 5 people to sell to 1 in advance Policy: Theyre trying to say that any premium attached to the sale of control belongs to all shareholders, so one shareholder cant take it for himself, which is the purpose for the takeover bid rules in the first place. If one guy who wants to control the company wants to sell it at a huge premium, he cant extract it for himself. No one is getting a premium for control that doesn't belong to them - this is what all the takeover regulation is aimed at preventing in the first place. If all the shareholder is getting 115%, then the 15% is deemed to be a de minimis amount relative to the premium, and there is no real premium for control and therefore no need for the takeover regime to kick in Example: Shareholders A, B, C, D, and E each own 5% o You can buy shares from each of them but you cant combine A and B into one seller to meet the requirements of the Act.. this is called preparing the seller and you CANT do this! (2) Normal Course Purchase Exemption (de minimus exemption) s. 100 A take-over bid is exempt from the formal bid requirements if you go into the market and buy up to 5% of the shares in a 12- month period. Broken down: o (1) Bid is for not more than 5% of the outstanding securities of a class of securities of the offeree issuer. o (2) Aggregate number of securities acquired in reliance on this exemption is within any 12 month period, as long as the total within the same 12 month period does not exceed 5% of the outstanding securities of that class. o (3) There is a published market for the class of securities that are the subject of the bid. o (4) The value of the consideration paid for any of the securities acquired is not in excess of the market price at the date of acquisition as determined in accordance with the regulations, plus reasonable brokerage fees or commissions actually paid Policy: Even if the 5% puts you over 20%, you are buying from the public at large, and 5% is a de minimus amount and there is no premium paid if not paying premium then no concern Example: If you bought 19% 3 years ago, you can buy 5% more in the market without it triggering the formal takeover bid rules. Lastman: o If you own no shares of a public company, but you want to own as many as possible by giving the least disclosure and without attributing takeover bid requirements, buy 19.9% in the open


market, because it doesnt trigger takeover bid, then buy from 5 purchasers and get to the highest number. o Example: You own 19% of the shares, and you buy from 5 individuals 3% more 22%, can only buy 2% more because the 3% you bought from individuals is included. But if you bought 5% that takes you to 24% and then the 3% by private agreement you can get to 27% (more shares depending on how you structure your affairs). EXAMPLE: A 6%, B 6%, C 8%, D 10%, E10%, open public has 60% o REMEMBER YOU CAN BUY 19.9% FROM THE PUBLIC FIRST WITHOUT TRIGGERING THE TAKEOVER BID REQUIREMENTS. THEN BUY 5% FROM THE OPEN PUBLIC BECAUSE ITS A NORMAL COURSE PURCHASE EXEMPTION THEN ENTER INTO AN AGREEMENT WITH THE 5 PEOPLE TO GET ALL THEIR SHARES, AND YOURE AT 64.9% WITHOUT TRIGGERING THE TAKEOVER BID REQUIREMENTS.

(3) Non-Reporting Issuer Exemption - s. 100.2If youre not a reporting issuer, then you are not subject to the takeover bid legislation. Essentially, if you are a private company the takeover rules do not apply o Rationale: Takeover bid rules do not apply to private companies but problems arise when you buy a private company that owns other public companies! Dual Class Voting Shares - Results from desire to raise capital without giving up control issue restricted voting shares/multiple voting shares - Example: Izzy Sharp runs Four Seasons Hotels. He goes public, and invites you to participate. The concept behind dual class voting shares is that shareholders are buying part of the company for Sharps expertise and belief that he will grow the company. Sharp, in turn, needs the money to grow but DOES NOT WANT TO LOSE CONTROL. - Solutions: o Voting v. Non-Voting shares you get non-voting shares, which are economically the same in every other respect. Advantage to Sharp is that he can issue more equity to you without losing decision making control. o Restricted voting shares: Allow companies to raise money without giving up control. I will issue tons of shares to everyone and they will be exactly the same as the CEOs or founder but the only difference is that all of your shares will have 1 vote and the CEOs will have 10/share so the CEO/founder can control the votes. When the CEO leaves the business, his shares will sell and automatically convert into another class - Everything was great until a sickening thing happened in Canadian Tire. o Now, dual-voting share structure companies rarely exist anymore. - As a result of Canadian Tire, there are very few restricted voting share companies, and there are many rules dealing with this abuse. From now on, if you want to create shares with different voting structures, you cant do it UNLESS you (1) get the approval of minority shareholders and (2) you have to have what is known as a coattail provision this says if someone makes an offer for your shares for more than 115% of market, our shares automatically become the same as your shares, and then we are in the same place. What is a Coattail Provision? A provision is added to the Articles where in the event of a takeover bid the non-voting shares become voting shares so that the takeover bid will have to be offered to all of the shareholders


Canadian Tire (1986)Cannot violate the spirit of Coat Tail agreements; If an action violates the spirit of the coat tail or the statute, then the Commission will find a way to stop it if action has a tendency to bring the capital markets into disrepute; will stop it under public interest jurisdiction Facts: In 1986, Canadian Tire dealers offered to buy 49% of outstanding voting shares of CT at $160/share (shares were trading at about $18an 800% premium!). The Billis family (owned Canadian Tire) had voting and non-voting shares. The dealers already owned 17.4% of the voting shares. Billis family owned 60.9% of the voting shares. The offer revealed that the Billis family entered into a lock up agreement with dealers to irrevocably tender their shares to the bid (so theyll get paid the premium). Important: The dealers were guaranteed to be successful and gain control over the company with majority control. As protection and as part of an enticement, the dealers gave the family an irrevocable $30M deposit. o Note: This is not a collateral agreement because if there is no takeover bid, takeover bid rules do not apply. If there is a takeover bid, the $30M is just applied to the proceeds and spread evenly to the voting shareholders. This is legitimate because there is no obligation to offer the same bid price to the non-voting shares of a different class. Collateral benefit cant exist without a takeover bid. In 1983 (3 years before), the family only had one class of shares. The Billis introduced two classes of shares: voting (for themselves) and non-voting (everyone else). As a protection to the minority shareholders, the family introduced a Coattail protection (a provision is added to the Articles where in the event of a takeover bid the non-voting shares become voting shares so that the takeover bid will have to be offered to all of the shareholders.). The coattail agreement specifically said that the triggering event that turns non-voting to voting is when an offer is made for a majority of voting shares (51%) and a majority of shares are taken up (thus premium would be shared amongst voting and non-voting shareholders, reflecting the need for equality). BUT!! The dealers had a scheme they felt that they could not pay $160 for all shares so they were careful not to trigger the coat tail (ie. bidding for 49% so as to NOT trigger the coat tail provision). Non-voting shareholders were apocalyptic. Held: OSC will not allow the transaction to proceed (even though there are no reasonable grounds to support their decision!) o Even though there was nothing in the articles of the company, case law, Securities Act, precedent transactions, etc, the OSC did not allow it. o It didnt satisfy the public interest test. They caught it under the umbrella of public interest/protecting the integrity of the capital markets. o It seems stupid to go for 49% no chance that they are going to get away, Lastman wonders what it would have been if they only put up 38%. o Dealers argued certainty of contract, commission said forget it! there is no honour among thieves. o The OSC even denied the dealers from getting their $30M back and the Billis family kept the $30M. there is no honour among thieves. Why wasnt the $30M a collateral agreement? Collateral agreements only apply to takeover bids but this was NOT a takeover bid says the OSC. If the takeover bid occurred the money would have been applied to the price and they wouldnt be getting a premium over everyone else it would have been applied to the price........it was just meant as a deposit for the total amount. Lastman: This is a perfect example of the elegance of securities law, because they wont allow a transaction to occur that doesnt satisfy the smell test. Who knows if they did it because it stunk or because in 1983 when the coat-tail was entered into the minority shareholders entered a different bargain than they actually received. Very few companies have dual class voting shares today, but those that do have coat-tails have incredibly complex ones (indirect / direct acquisitions).


DEFENSIVE TACTICS Common occurrence: Directors of flashy companies do not want to lose their spot on the Board. If Air Canada gets an offer in the form of a takeover bid with big premium to shareholders, but the director knows that he is going to get thrown out, he may want to stop the bid (for selfish reasons). Even though he has a fiduciary duty to shareholders, there is an opportunity for a conflict. Problem with Boards in Canada Policy: company is run by Boards that have no economic interest in the enterprise, but may control the destiny of the decision making. There has to policy that protects companies from boards behaving badly. Before Unicorp, there were no policy protections, but Unicorp was so egregious that something had to be done. If Labatt doesnt have any leverage, they can try and find a white knight, buy time, get a higher price, etc. There is legitimate interest that the board has to protect, its a balancing act between whether board is acting in best interest of shareholders in pursuit of higher bid (appropriate) or acting in their own interest to defeat a bid and take vote away (absolutely inappropriate). o The fascinating part of securities is striking the balance take that initiative to create an opportunity for your shareholders without denying them the right to decide Lastman: If youre a director and so worried about protecting yourself that you dont go out on a limb in a fair way to create leverage to get a better deal for shareholders, then youre not worth a damn!

EXAMPLES Unicorp v. Union Enterprise Utility Co. F: Union Enterprises is a gigantic utility company. Their board is a whos who in Toronto, Unicorp (a nobody company) comes along and makes a hostile takeover bid. In response to this, Union management bought a pig farm by issuing 20% of new shares of Union Enterprises to the farm owner. The agreement stated that the farm owner was not permitted to tender to a Unicorp bid, thus ensuring that a significant number of shares were held in friendly hands to block Unicorp. Unicorp buys Union Enterprise anyway it costs them a lot more to buy and they were stuck with a pig farm. I: Is this type of action permissible to block a takeover bid? H: At the time, this action was permissible Note: OSC since has come out w/ a policy on defensive tactics as a result of the Unicorp and Union Enterprise takeover bid. Onex bid for Labatts Onex was rumoured to be making a takeover bid for Labatts for a long time. Labatts had a long time to prepare. Labatts at the time had 2 assets: beer and the TSN and Blue Jays. TSN was regulated and had to be owned by a Canadian company. Labatts created a $150MM tax liability (by changing TSN corporation into a partnership) that could only be triggered due to a change in control. It was a tax liability that could only be fixed pre-takeover thus guaranteeing a friendly takeover.


Onex makes a bid, and in the directors circular Labatts discloses that TSN was changed from a corporation into a partnership and discloses that this will trigger a $150MM tax liability upon change in control. Onex went to the OSC to complain, and asked OSC to force Labatts to reverse the change to the structure of TSN. Basically, this bought Labatts more time to find a higher bidder.

Macs Milk and Beckers. Couche Tarde in Quebec wants to make a bid for Silkcorp (Macs Milk). The day Couche Tarde makes its bid for Macs Milk, Macs merges with Beckers on the condition that they dont tender shares to Couche Tarde.

TorStar bids for Sun Media. Sun Media goes to competition bureau and says that the advertising rates in Toronto are cheaper than in Saskatchewan because of competition. They said that no local competition would result in skyrocketing ad rates and this would be anti-competitive. Sun Media shareholders are furious they want the deal, but if you go to a regulator, you cant change your mind later. Before it got resolved, Sun Media found Quebecor who paid a lot more, and TorStar went away. Bottom Line: If you are a target company you need to create an opportunity for negotiation and leverage. Need time to do this!

Defensive Tactics 1) Golden Parachutes A special employment agreement with a target officer / manager affording certain financial assurance in the event of a change of control. o Board agrees with the company that in the event of a takeover, they should be paid out millions of dollars. o Policy OSC says that golden parachutes are acceptable because if an officer has a golden parachute, then they will act in the best interest of the shareholders because they will not be concerned about saving their own jobs and thus ruin a good deal. o This way, Boards interests are being protected either way so they will have more incentive to fight for the best price for shareholders. 2) Poison Pills - If you are implementing this it is called a rights plan if you are fighting it it is called a poison pill - Creation of a large and unattractive corporate liability that the offeror would have to swallow along with the target, for example, the issuance of preferred shares as a pro rata dividend to holders of the targets common; o Typically shares are convertible into common shares of the target or any company with which the target is merged - LEVELS THE PLAYING FIELD, BUYS TIME, CREATES LEVERAGE FOR NEGOTIATION


Provision would say if someone wants to make a takeover bid without meeting conditions and without the boards consent, every single shareholder but that offeror can buy another share for a penny. This double the amount of shares and makes it impossible for the takeover to occur. No one has ever triggered a poison pill they are just threats but no idea what would happen if it was ever triggered. Gives the board an opportunity to stall for time and create an auction to try and get the best price for shareholders. Company calls these a rights plan (every company has one) o Unicorpwould not be justified in 2009 o LabbattOK because the problem can go away; it would have been different if they sold TSN and the Blue Jays, but they didnt. and the concept of tax liability is a good form of leverage. o Macs Milk merging the two can be seen as synergistic (no competition issues, more purchasing power and locations, etc). so although it was prompted by the takeover bid, it would have been done anyway o TorStar really good example of the board taking a chance and doing a great defence. o Golden ParachutesIf Im the CEO of a company and theres a hostile takeover bid, its not in the best interests of the shareholders that I worry about myself, as I should be devoted to protecting them. The best way to do this is for you to give me $10 million in the event of a hostile TB, and then I wont worry about myself anymore.

3) Scorched Earth: No-holds barred defence tactics often involving the sale of desirable assets 4) Crown Jewels: The targets most valuable or significant assets, which it sells in order to reduce its attractiveness 5) White Knight: A third company that the target persuades to merge with it or to make a competing offer that it hopes will lead to a combination more to its liking. 6) Lock-up: Any aspect of an acquisition transaction that is designed to preclude or at least inhibit / deter competition by any third party. For example, an option or agreement to buy unissued or treasury shares or the crown jewels, a merger agreement, an agreement for liquidated damages in the event of failure to consummate an acquisition, or an option or stock purchase agreement between a white knight and one or more principal shareholders. 7) Greenmail Not a defensive tactic, but an important concept to know. - Its the purchase of a substantial block of target securities by an unfriendly suitor with the primary purpose of coercing the target into repurchasing the block at a premium. - Greenmail is illegal in Canada b/c o (1) it precludes takeover bids o (2) it spends unnecessary resources, and o (3) the premium is not offered to all shareholders. Note: National Policy 62-202 sets out the view of Canadian Securities Administrators on Take-Over Bid Defensive Tactics (Print off and Bring!!!!). ****Lastman says most important provision is 1.1(5) on unrestricted auctions


THE RULES 1. (i) Takeover bids play an important role in the economy as a means of: a. Disciplining corporate management. b. Reallocating economic resources to their best uses. c. Creating synergies. (ii) The Ontario Securities Commission recognizes that in a takeover situation, the interests of management of the target company may differ from the interest of the shareholders. (iii)Where management is opposed to a proposed takeover bid, then management of the target company may take one or more of the following actions as a response: a. Attempt to persuade shareholders to reject the bid. b. Take action to maximize the return to shareholders including soliciting a higher bid from a 3rd party i.e. create an auction by finding a white knight. c. Take other defensive measures to defeat the bid. 2. The primary objective of the takeover bid provisions of Canadian Securities Legislation is the protection of the bona fide interests of the shareholders of the target company. The secondary objective of the legislation is to provide a regulatory framework within which takeover bids may proceed in an open and even handed environment. The rules of the legislation should favour neither party in a takeover bid situation. The rules are aimed at leaving the shareholders to make a fully informed decision. The Ontario Securities Commission is concerned with certain defensive measures that may have the effect of denying the shareholders the ability to make an informed decision and therefore frustrating the objective of open environment in a takeover situation. 3. It would be inappropriate to specify a code of conduct for the directors of the target company. Any fixed code of conduct runs the risk of containing rules that may be insufficient in some cases and excessive in others. However, the Ontario Securities Commission is prepared to examine the tactics employed by the directors of the target company to determine whether there has been an abuse of shareholder rights (in the case of inappropriate use of defensive tactic). Any prior shareholder approval of corporate action would, in the appropriate cases, allay such concerns (bless use of tactic).BEHAVIOUR WILL BE REVIEWED IN HINDSIGHT 4. The following list (non-exhaustive) of defense tactics, if employed during a takeover bid, immediately prior to a takeover bid or if it was believed that a takeover bid was imminent, may come under scrutiny a. Issuance or granting of an option on, or purchase of securities representing a significant percentage of outstanding shares (issuance of securities to a third party or poison pill). b. Sale of the crown jewels. c. Entering into a contract other in the normal course of business or taking corporate action other that in the normal course of business. 5. The Ontario Securities Commission considers that creation of an auction environment the most desired result. This is because auctions ensure that the shareholders receive the maximum value for their shares. However, any tactics employed by the target company that deprive the shareholders from making an informed decision will result in the Commission intervening. 6. OSC will give no advance rulings on defensive tactic. Ultimate test is was it designed to create an auction or was it designed to protect the targeting company? If your actions are designed or intended to defeat the bid and deny the SHs the right to make the decision you are in deep trouble this does not mean the result is what they look for; they look for the pig farm as the problem Lastman: make sure your intentions are right from the beginning 7. If youre a director who wants to play it safe, you will be useless and Shareholders will lose out. Must balance between respecting fiduciary duties to do the best for the SH and respecting fiduciary duties to not feather own nest (hard test to meet). 68

dont be a useless Director to protect yourself from being sued you have an obligation as a good Director to help protect the little guys (the shareholders) and not just yourself