Trades in securities and the governance of reporting issuers (ie, persons that have issued securities to the public pursuant to a prospectus or similar disclosure document or whose securities are listed on a stock exchange) in Canada are regulated by:
Securities regulation in Canada is the responsibility of the provinces and territories. Each of Canada’s ten provinces and three territories has its own legislation and securities regulatory authority that regulate, among other things, public offerings, disclosure, corporate governance and takeover bids. The provinces of Ontario and Québec have additional securities rules (including approval by a majority of the minority shareholders and independent valuation of the subject matter of the transaction) designed to ensure fair treatment of minority shareholders in connection with certain types of transactions involving related parties (which include the holders of ten per cent or more of the voting securities of a company).
The provincial and territorial securities regulatory authorities coordinate their activities through the Canadian Securities Administrators (CSA), a forum for developing a harmonised approach to securities regulation across the country. The CSA has developed a system of mutual reliance pursuant to which one securities regulatory authority acts as the lead authority for reviewing prospectuses and other regulatory filings of reporting issuers.
The Ontario Securities Commission (OSC) is generally regarded as the lead securities regulatory authority in Canada.
There are two principal stock exchanges in Canada: the Toronto Stock Exchange (TSX), the senior market, and the TSX Venture Exchange (TSX.V), the junior market. The exchanges prescribe minimum listing standards for issuers seeking an initial listing and ongoing rules for listed issuers, including prior notification and approval of additional issuances of securities.
The Investment Dealers Association of Canada (IDA), Market Regulation Services Inc (MRS) and Mutual Fund Dealers Association of Canada (MFDA) prescribe rules for investment dealers involved in the distribution of securities, including capital adequacy and business and trading conduct.
The Canadian Depository for Securities Limited (CDS) handles equity clearing and settlement functions.
Eligible Canadian issuers may take advantage of the Canada-US Multi-jurisdictional Disclosure System (MJDS), a unique regime that allows them to access the US public markets using Canadian disclosure documents (which are subject to review by Canadian securities regulatory authorities only) without becoming subject to US domestic registration and reporting requirements. Also, in many cases, Canadian continuous reporting documents can be used to satisfy US continuous reporting obligations.
Canadian companies may be incorporated under the federal Canada Business Corporations Act or one of the similar provincial or territorial business corporation acts. These statutes regulate ordinary and extraordinary corporate transactions. Extraordinary corporate transactions (which include statutory amalgamations and plans of arrangement) must be approved by a special resolution of shareholders (typically two-thirds of the votes cast). Shareholders generally have the right to dissent from extraordinary corporate transactions and demand payment of the ‘fair value’ of their shares (as determined by a court, if necessary). Canadian courts have broad remedial powers under Canadian corporate statutes to intervene in respect of transactions that are oppressive or unfairly prejudicial to, or that unfairly disregard the interests of, shareholders.
Transactions involving the acquisition by a non-Canadian of ‘control’ of a Canadian business with assets which exceed prescribed monetary thresholds are reviewable under the Investment Canada Act and subject to approval by the federal Minister of Industry or, in the case of a cultural business, the federal Minister of Canadian Heritage. As part of the review process, the non-Canadian acquiror is expected to present a business plan for the Canadian business that demonstrates that the transaction is likely to be of ‘net benefit to Canada’. It is customary for non-Canadian acquirors to provide binding undertakings to fulfill their business plans. Transactions that are not reviewable are subject to a ‘tick-the-box’ notification process that may be made post-closing.
Certain other Canadian statutes limit foreign ownership in specified industries (eg, financial services, broadcasting and telecommunications).
Transactions involving mergers and acquisitions that meet each of the following thresholds are notifiable transactions under the Competition Act:
Other thresholds apply in connection with amalgamations, business combinations and acquisitions of interests in combinations.
If a transaction is notifiable, both parties must prepare and file pre-merger notification filings with or request an advance ruling certificate (ARC) from the Commissioner of Competition. Normally, a notifiable transaction may not close until the expiry of a waiting period of either 14 or 42 days following notification. The length of the waiting period depends on whether the acquiror files a short or long-form filing. In hostile notifiable transactions, the Commissioner may require the target to submit a filing. In all cases, there is a filing fee of C$50,000.
Whether or not a transaction is notifiable, the Commissioner of Competition may review the transaction to determine whether it raises any potential substantive competition concerns in Canada. The timing of the Commissioner’s review in both notifiable and non-notifiable transactions may or may not coincide with the applicable waiting periods.
2. CANADIAN CAPITAL MARKETS
The Canadian capital markets are small compared with the US capital markets. At 31 December 2005, 1,537 issuers were listed on the TSX with an aggregate market capitalisation of C$1.8 trillion and 2,221 issuers were listed on the TSX.V or the NEX (a trading board established by the TSX.V for issuers that have fallen below the TSX.V’s ongoing rules) with an aggregate market capitalisation of C$34 billion.
Other significant features of the Canadian capital markets include:
An increasingly important vehicle in the Canadian public markets is the income trust, the popularity of which has been driven by the demand for steady returns at a higher yield. Since 2001, income trusts have accounted for a significant portion of new equity offerings in Canada. In addition, many Canadian public companies have restructured themselves into income trusts. At 31 December 2005, there were 232 income trusts listed on the TSX with an aggregate market capitalisation of over C$178 billion.
An income trust is a trust that indirectly acquires and holds operating assets that produce a stable stream of income. Like the shares of a public company, the units of an income trust are publicly traded on a stock exchange. Unlike many public companies, however, income trusts pay out most of their cash flow to unitholders on a regular basis, usually through monthly distributions. The typical income trust structure involves a trust that holds units and subordinated debt of a second trust, which in turn holds the outstanding equity of a partnership or other entity that owns the operating assets. The income trust structure generally allows pre-tax operating income to be distributed to unitholders in a manner that substantially reduces or eliminates company or asset level tax. As a result, pre-tax earnings are generally subject to only one level of tax in the hands of the income trust unitholders.
3. SECURITIES OFFERINGS
Unless a statutory exemption is available or a discretionary exemption has been granted, an issuer may not distribute securities (ie, issue previously unissued securities, sell previously issued securities from a holding that materially affects control of the issuer [generally, a holding of more than 20 per cent of the outstanding voting securities of the issuer] or resell securities acquired pursuant to an exemption) unless the issuer has first filed and cleared a prospectus with the securities regulatory authorities in the provinces and territories where the distribution takes place.
In order to distribute securities pursuant to a prospectus, an issuer must prepare and file with the applicable securities regulatory authorities a preliminary prospectus, and a final prospectus that addresses any deficiencies identified by the securities regulatory authorities during their review of the preliminary prospectus. The issuer will select a designated securities regulatory authority to act as the lead agency to clear the preliminary prospectus. After reviewing the preliminary prospectus, the designated authority will send a comment letter to the issuer specifying the amendments that must be made to the preliminary prospectus before a receipt for a final prospectus will be issued. The other securities regulatory authorities may provide additional comments within a prescribed period after the comment letter of the designated authority is sent. Although an offering may commence with the filing of a preliminary prospectus, it is common to delay the marketing ‘roadshow’ until after the comment letters of the security regulatory authorities have been received and any identified deficiencies resolved.
Canadian securities laws prescribe the type of information that must be included in the final prospectus. A preliminary prospectus includes all the information that must be included in the final prospectus except the price of the security being offered and related information.
Generally, an issuer is required to provide a complete, accurate and plain description of all information, positive and negative, that prospective purchasers might reasonably require to make an informed investment decision, including:
Financial statements of the issuer must also be provided, including an income statement, a statement of surplus, a statement of changes in financial position and a balance sheet for specified periods and at specified dates. In addition, separate financial statements for acquired businesses or pro forma financial information may be required if an issuer has made significant acquisitions or significant dispositions during any of its three most recently completed financial years.
The long-form prospectus review process typically takes between three and four weeks to complete.
(i) Short-form prospectus offerings
Canadian securities laws permit eligible issuers to sell securities more quickly using a short-form prospectus. Generally, an eligible issuer is a reporting issuer that has prepared and filed with the applicable securities regulatory authorities current annual financial statements and a current annual information form (AIF): a disclosure document that contains the same information that the issuer would provide in a long-form prospectus. The securities regulatory authorities usually review an issuer’s initial AIF, and may periodically review subsequent AIFs.
Generally, a short-form prospectus contains information about the securities being offered. It also incorporates by reference all of the information about the business and assets of the issuer contained in the issuer’s current AIF, financial statements, MD&A and management proxy circular as well as all subsequent material change reports from the issuer’s public file with the securities regulatory authorities.
The short-form prospectus review process typically takes five working days to complete.
(ii) Bought deal financings
Issuers that are eligible to use a short-form prospectus often use a technique called a ‘bought deal’ financing to issue securities.
Under a bought deal financing, the underwriters commit to purchase securities from the issuer at an agreed price before or contemporaneously with the filing of a short-form preliminary prospectus (ie, without the usual marketing period). Although the underwriters assume more risk than under a traditional marketed offering, the short time frame for reviewing the preliminary short-form prospectus reduces the chances of a significant fall in the market price of the purchased securities between the time the underwriters agree to buy the securities and the time that the securities can be distributed under the final short-form prospectus.
(iii) Special warrant financings
Issuers that are not eligible to use a short-form prospectus often use a technique called a ‘special warrant’ to issue securities.
Under a special warrant financing, the issuer issues special warrants (or other forms of convertible securities) for cash in a transaction that is exempt from the prospectus requirements (usually pursuant to the accredited investor exemption described in 3.2.1 below). The issuer then prepares and files a preliminary prospectus and, upon the issue of a receipt for the final prospectus, the special warrants are converted into the underlying securities (typically, common shares). The distribution qualified by the final prospectus is the conversion of the special warrants into common shares so that the common shares are freely tradable. In effect, the special warrant financing allows the issuer to carry out a private placement for cash and thereafter to deliver freely trading securities to the purchasers of the special warrants by way of a prospectus.
(iv) Shelf prospectus offerings
The shelf prospectus system permits issuers who are eligible to use a short-form prospectus to use a shelf prospectus that will allow them to complete a series of distributions of securities over a two-year period.
In order to use the shelf prospectus system, eligible issuers must file a short-form base shelf prospectus containing all of the information required for a short-form prospectus, other than the terms of each particular offering to be made over the two-year period. The base shelf prospectus must also set out the aggregate amount of securities to be offered over the two-year period. To complete a particular offering of securities, eligible issuers prepare and deliver to purchasers a prospectus supplement containing the terms of the offering and file the supplement with the securities regulatory authorities.
MJDS permits substantial Canadian issuers to offer securities in the US using a Canadian prospectus ‘wrapped’ with prescribed additional US disclosure. An MJDS offering may be made as part of a contemporaneous Canadian offering or solely within the US. Except in special circumstances, the US Securities and Exchange Commission (SEC) does not review prospectuses for MJDS offerings, and will generally clear such offerings immediately after the prospectuses have been cleared in Canada.
Canadian issuers wishing to use MJDS must meet certain eligibility requirements, including:
To obtain a listing on the TSX or TSX.V, an issuer must complete and file a listing application in prescribed form with the exchange. The form requires detailed disclosure of the issuer’s history, business, authorised and issued share capital, share distribution, principal shareholders and material properties, investments and subsidiaries. Much of this disclosure may be incorporated by reference from a prospectus.
The application will be considered in the context of the exchange’s listing criteria.
If accepted for listing, the issuer must agree to enter into a listing agreement with the exchange pursuant to which it agrees to comply with the rules, regulations and by-laws of the exchange. These include rules requiring the issuer to obtain the exchange’s prior approval to the issuance of new securities, to notify the exchange in advance of any declaration of dividends and to comply with the exchange’s disclosure policies.
Canadian securities laws impose strict limitations on publicity regarding the issuer during the period of a securities offering. The general rule is that securities should be marketed using only the preliminary prospectus. Accordingly, any advertising or marketing activity that could reasonably be considered to be in furtherance of the offering is prohibited until a receipt for a final prospectus is issued. Also, the publication of research reports by an investment dealer that is participating in the offering must cease at the earlier of the time the dealer is given a mandate to start work on the offering and the time that the dealer is invited to participate in the underwriting syndicate.
It is possible to use electronic ‘roadshow’ materials in connection with an offering. Access to and transmission of these materials must, however, be controlled by the issuer or the underwriters and a copy of the preliminary prospectus must be made available to each viewer of the materials before each transmission. Also, the materials should contain a statement referring the viewer to the preliminary prospectus.
Generally, except for the type of information required to be provided, there is no distinction between distributions of debt and equity securities or between primary and secondary offerings. Unless the articles of the issuer specifically so require (which is rare), holders of the issuer’s securities do not have preferential rights in connection with an offering of securities. Also, the articles of an issuer may permit the issuer to issue specified classes of securities (eg, preferred shares) on such terms as the issuer’s board of directors may determine without requiring shareholder approval.
Public offerings in Canada are typically underwritten, (ie, a syndicate of investment dealers is formed to purchase the securities for resale to the public). After the preliminary prospectus is cleared by the securities regulatory authorities, and subject to satisfactory pricing terms, the dealers will commit to purchase the securities as principal at the public offering price for their own account and will earn a commission for doing so. The terms of the agreement to purchase are set out in an underwriting agreement. Following the execution of an underwriting agreement, the final prospectus is filed with the securities regulatory authorities and the closing of the purchase typically takes place five to seven business days after the receipt for the final prospectus is issued. Purchasers have a statutory right of withdrawal exercisable within two days after they receive the final prospectus.
Canadian securities laws contain a number of exemptions from the prospectus requirements thereby permitting private placements in specified circumstances. Generally, except for a requirement to file notice of the placement and pay the required fee and as noted below, no mandatory procedures must be implemented to effect a valid private placement.
There are two groups of prospectus exemptions: securities-based exemptions and transaction-based exemptions. Of the former, the most important are debt securities of high creditworthy issuers (eg, Canadian and foreign governments, banks and trust and insurance companies). Of the latter, the two most important (in most provinces and territories) are the accredited investor exemption and the private issuer exemption.
Generally, in addition to governments, banks and trust and insurance companies, an accredited investor includes an individual who, either alone or together with his or her spouse, has net financial assets before taxes in excess of C$1 million or net income before taxes in excess of C$300,000 (C$200,000 on his or her own) in each of the two most recent calendar years and a partnership, trust or company that has net assets of at least C$5 million.
Generally, a private issuer is an entity which is not a reporting issuer and whose shares or equity interests are subject to restrictions on transfer (requiring the approval of the board of directors or shareholders of the entity or their equivalent) and whose outstanding securities are owned by not more than 50 persons excluding current and former employees of the entity or an affiliate of the entity.
If an issuer distributes securities relying on an exemption from the prospectus requirements and, in connection therewith, provides an offering memorandum (ie, a document describing the business and affairs of the issuer) to prospective purchasers (either because it is legally required to do so or for business reasons to facilitate the distribution), the purchasers have the same statutory right of action that they would have had had they purchased under a prospectus (see 3.6.2 below). The issuer is required to describe the statutory right of action in the offering memorandum. Otherwise, the securities laws generally do not prescribe what an offering memorandum should contain.
If an issuer distributes securities relying on an exemption from the prospectus requirement, the securities usually will not be freely tradable in the secondary market unless the issuer is or becomes a reporting issuer and the purchaser holds the securities for a prescribed period (typically four months). Trades in the securities before the end of the prescribed period may only be made pursuant to a further exemption from the prospectus requirement. (See also ‘Special warrant financings’ in 3.1.3 above.)
Under Canadian securities laws, there is currently no equivalent to Regulation S of the SEC that deals with the extra-territorial application of the registration requirements of US securities laws. However, the OSC has commented that a distribution outside of Canada by a Canadian issuer might, depending on the connecting factors with Ontario (eg, the existence of a trading market in Ontario, the likelihood that the securities will come to rest in Ontario and the method of distribution of the securities), be a distribution in Ontario requiring a prospectus or reliance on an exemption from the prospectus requirements. In general, if reasonable steps are taken by the issuer and other participants in the distribution to ensure that the securities come to rest outside Ontario, no prospectus or exemption from the prospectus requirements is required.
Rights offerings are less common than in jurisdictions where shareholders have preferential rights in connection with offerings of securities. Rights offerings are, however, used as part of capital reorganisations in financial distress situations or where there is a significant shareholder that wishes to maintain its percentage equity interest or where the issuer wishes to provide its shareholders with a right of first opportunity to participate in a financing transaction.
In a rights offering, shareholders receive rights to subscribe for additional securities of the issuer upon payment of a fixed subscription price. Rights holders may choose to exercise or sell their rights (which are typically listed on the stock exchange). A rights offering must be open for at least 21 days. If a third party has agreed, upon completion of a rights offering, to acquire any securities that are not subscribed for pursuant to the rights offering, rights holders must have an additional subscription privilege before the third party may exercise its rights.
There are two types of arrangements used in connection with Canadian public offerings: agency or ‘best efforts’ arrangements (where investment dealers agree to use their best efforts to sell the securities on behalf of the issuer at a specified price and pass on the proceeds, net of commission, to the issuer) and underwritten arrangements.
Generally, there are two types of underwritten arrangements:
Underwriting agreements typically contain provisions with respect to indemnity, termination rights and over-allotment options. Success fees are unusual.
Underwriters are typically indemnified for losses arising as a result of:
The enforceability of the underwriters’ indemnity has not been tested in Canada. Courts in the US have, however, held that the underwriters’ indemnity is not enforceable in circumstances of wilful misconduct or negligence on the part of the underwriters. For this reason, Canadian underwriting agreements have followed the US practice of introducing a contribution clause which attempts to apportion responsibility for losses between the underwriter and the issuer on the basis of the relative benefit received by them and, in some cases, the relative fault between them. The contribution clause applies only if the underwriters’ indemnity is determined not to be enforceable.
Underwriters typically retain the right to terminate an underwriting agreement in the following circumstances:
Other typical outs include a change in the rating of debt securities and a change in the expected tax treatment of the securities offered. In the case of bought deal underwriting agreements, termination rights do not typically include the market out. The inclusion or exclusion of the disaster out and the market out clauses may affect the underwriter’s margin requirements applicable to the underwriting commitment.
Underwriters may be given the right (an over-allotment option or ‘green shoe’) to purchase additional securities (generally, up to 15 per cent of the securities offered under the prospectus) to cover over-allotments (ie, sales in excess of the number of securities that the underwriters are obliged to purchase pursuant to the underwriting agreement) and for market stabilisation purposes.
The IDA, MRS and MFDA prescribe certain rules for investment dealers involved in the distribution of securities, including capital adequacy and business and trading conduct.
A person who makes a misrepresentation in a prospectus is guilty of an offence unless the person did not know and, in the exercise of reasonable diligence, could not have known that it had made a misrepresentation. The offence is punishable by a fine of not more than C$5 million and/or imprisonment for a term of not more than five years less a day. Any director or officer of the person who authorises, permits or acquiesces in the making of the misrepresentation is also guilty of an offence and is liable to the same penalties.
A purchaser of securities under a prospectus that contains a misrepresentation is deemed to have relied on the misrepresentation and has a right of action for damages against the issuer, the selling security holder (in the case of a secondary offering), the underwriters, the directors of the issuer and the officers of the issuer who signed the prospectus or a right of rescission against the issuer, the selling shareholder or the underwriters.
The right of rescission must be exercised within 180 days after the date of purchase. An action for damages must be commenced by the earlier of 180 days after the purchaser first becomes aware of the misrepresentation and three years after the date of the purchase.
The underwriters and the directors and officers of the issuer are not liable for damages for a misrepresentation in a prospectus unless they believed that there had been a misrepresentation or they failed to conduct such reasonable investigation as to provide reasonable grounds for a belief that there had been no misrepresentation (the ‘due diligence defence’). In determining what constitutes reasonable investigation, the standard is that of a prudent person in the particular circumstances.
Any liability for damages may not exceed the purchase price paid for the securities.
A purchaser of securities may also have a right of action for damages at common law against any person whose misrepresentation induced the purchase, whether the misrepresentation was made in a prospectus or otherwise. This right of action, which has rarely been used, is not subject to the limitation periods contained in the securities laws.
The main mechanisms for seeking remedies and sanctions for improper securities activities are administrative proceedings initiated by or brought before one or more securities regulatory authorities or self-regulatory organisations and civil litigation by way of class action proceedings. Criminal prosecution is rare.
4. ONGOING COMPLIANCE REQUIREMENTS
Reporting issuers are required to prepare, publicly disclose and file with the securities regulatory authorities interim quarterly unaudited and annual audited financial statements and related MD&A. Reporting issuers listed on the TSX are also required to prepare and file with the securities regulatory authorities an annual AIF setting out all material information with respect to their business, operations or capital that would reasonably be expected to have a significant effect on the market price or value of their securities.
Reporting issuers are required to make immediate public disclosure, followed by a prescribed filing with the securities regulatory authorities, of any material change.
Corporate reporting issuers are required to prepare a management information circular in connection with the solicitation of proxies for the annual meeting of shareholders. In addition to information with respect to the business to be transacted at the meeting (eg, information with respect to nominees for election as directors), the circular must include prescribed information with respect to:
Other information may also be provided, such as a summary of board and committee meetings held and a record of attendance by directors.
Insiders (ie, directors, senior officers and shareholders owning ten per cent or more of the voting securities) of a reporting issuer are required to disclose changes in their share ownership.
A person who buys or sells securities of a reporting issuer that has a real and substantial connection to Ontario at a time when the issuer’s public disclosure record is incorrect or incomplete may have, depending on the circumstances, a right of action for damages against the issuer, a person who is in a position to influence the conduct of the issuer (eg, an insider, a 20 per cent shareholder or a promoter of the issuer), the directors and officers of the issuer or the influential person, or an involved expert (eg, an accountant, actuary, engineer, geologist or lawyer).
A reporting issuer’s public disclosure record is ‘incorrect’ if the issuer or an influential person releases a public document or makes a public oral statement that relates to the business and affairs of the issuer and contains a misrepresentation. A reporting issuer’s public continuous disclosure record is ‘incomplete’ if the issuer does not make timely disclosure of a material change in its business and affairs.
If guilty, the defendants will be liable for any loss in value of the securities purchased or sold by the securityholder that is attributable to the incorrect or incomplete disclosure. Generally, each defendant will be liable only for its proportionate share of the loss (ie, to the extent that it has contributed to the loss) as determined by the Ontario court. The following are the limits of a defendant’s liability:
Reporting issuers incorporated or organised under the laws of Australia, France, Germany, Italy, the Netherlands, Spain, Sweden and Switzerland may use their home country disclosure documents to comply with Canadian ongoing reporting obligations if less than ten per cent of their shareholders are resident in Canada. Foreign reporting issuers registered with the SEC may use their US disclosure documents to comply with Canadian ongoing reporting obligations.
(i) Meetings
Canadian public companies must hold an annual meeting of shareholders not later than 15 months after the last annual meeting but no later than six months after the end of a financial year, to elect directors and to appoint auditors and authorise their remuneration. They are also required to hold a special meeting of shareholders to approve other ordinary and extraordinary corporate transactions.
Shareholders holding at least one per cent of the shares may convene a special meeting of shareholders for any purpose. In addition, and subject to certain procedural rules, a shareholder may request that a shareholder proposal be included in the agenda of a meeting of shareholders and voted on at the meeting. Except as may be set out in the constating documents of a company (ie, the articles and bylaws), a quorum for a meeting of shareholders is shareholders holding at least a majority of the outstanding shares present in person or by proxy. Typically, the constating documents provide for a reduced quorum, sometimes as low as two shareholders present in person or by proxy.
(ii) Voting
Generally, shareholders are entitled to one vote per share. Some Canadian public companies have a dual-class share structure, with one class having multiple voting rights that give the holders of those shares voting control. In most cases, shareholders holding the other class of shares have ‘coat-tail’ rights in the event of a takeover bid or similar transaction.
(iii) Election of directors
Management of Canadian public companies normally nominates director candidates on the recommendation of the board of directors and, where applicable, the nomination committee. Typically, directors are elected for a one-year term. Staggered, multiple-year terms of up to three years are permitted.
Shareholders holding at least five per cent of the shares may nominate director candidates before a meeting of shareholders. Any shareholder may nominate director candidates at a meeting of shareholders. Since management controls the solicitation of proxies for meetings of shareholders, and because of the concentration of share ownership in Canada, management’s nominees are usually elected.
Proxy battles are becoming more common particularly by hedge funds. Shareholders are entitled to obtain lists of shareholders in order to solicit proxies at meetings of shareholders. Shareholders who wish to solicit proxies from more than 15 shareholders must prepare and distribute a dissident proxy circular.
(iv) Shareholder approvals and protections
Canadian corporate statutes regulate ordinary and extraordinary corporate transactions. Ordinary corporate transactions require majority approval of the shareholders (a majority of the votes cast). Extraordinary corporate transactions require special approval of the shareholders (generally, at least two-thirds of the votes cast). Most corporate statutes give shareholders the right to dissent with respect to extraordinary corporate transactions and demand fair value for the shares held by them.
The provinces of Ontario and Québec have additional securities rules (including approval by a majority of the minority shareholders and independent valuation of the subject matter of the transaction) designed to ensure fair treatment of minority shareholders in connection with certain types of transactions involving related parties (which include the holders of ten per cent or more of the voting securities of a company).
Canadian courts have broad remedial powers under Canadian corporate statutes to intervene in transactions which are determined to be oppressive or unfairly prejudicial to shareholders, or which unfairly disregard the interests of shareholders. They also have broad powers to permit shareholders to begin an action on behalf of a Canadian public company or intervene in an action involving a Canadian public company for the purpose of prosecuting, defending or discontinuing the action on behalf of the company. Canadian courts additionally have broad powers with respect to the conduct and enforcement of these derivative actions.
The board of directors of a Canadian public company is responsible for supervising the management of the business and affairs of the company. The officers (ie, management) are appointed by the board and are responsible for day-to-day management.
(i) Officers
Except as may be set out in the constating documents, there are no prescribed officer positions. Typically, Canadian public companies have a CEO (usually the president), a CFO, one or more vice presidents in charge of various company businesses or functions, and a secretary (often combined with the office of general counsel). A director may be an officer, and an officer may hold more than one position.
(ii) Directors
Canadian public companies listed on the TSX must have a board composed of at least three independent directors in order to satisfy corporate and securities laws requirements for an audit committee composed of at least three directors, all of whom are independent. Some Canadian corporate statutes prescribe a minimum number of resident Canadian (ie, Canadian citizens or permanent residents) directors, ranging from 25 per cent to a majority. Except as may be set out in the constating documents, there is no prescribed upper limit on the number of directors. Directors must be at least 18 years of age, of sound mind and not bankrupt. There is no requirement that directors own shares, although this is regarded as good corporate governance practice. Generally, Canadian public companies have between five and 15 directors. Typically, the CEO is a director, but not necessarily the chair of the board of directors. The CSA Rules (see 4.2.3 below) recommend that a majority of the directors and the chair of the board be independent, but this is not required.
(iii) Powers and duties of directors
Except as may be set out in the corporate statutes or the constating documents, boards have unlimited powers with respect to the supervision of the management of the company’s business and affairs. The directors owe fiduciary duties of loyalty and care to the company: these duties require the directors to act honestly and in good faith with a view to the best interests of the company and to exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
Directors are liable to the company if they breach their fiduciary duties. They are also liable if they act unlawfully. Directors are entitled to indemnification from the company for lawful conduct. Most Canadian public companies maintain directors’ and officers’ insurance. Directors may be removed from office by majority vote of the shareholders.
(iv) Meetings of directors
Boards typically meet at least five times a year. Except as may be set out in the corporate statutes or the constating documents, boards are free to establish their own operating procedures. Typically, the agenda for a board meeting is established by the chair of the board and the CEO (if different), with input from the other directors and senior management, and is sent to the directors, together with supporting materials, in advance of the meeting. The chair of the board usually presides at board meetings. Typically, at every board meeting, the independent directors meet separately from management. Minutes of directors’ meetings are not normally provided to shareholders.
(v) Board committees
Boards are required to have an audit committee. Usually, boards have other committees to help them with their responsibilities, including a nomination committee (often with a corporate governance mandate) and a compensation committee. The board (on the recommendation of the compensation committee, if one exists) sets the compensation of the CEO and approves the compensation of the other members of management.
(vi) Conflicts of interest
Directors and officers who have conflicts of interest are required to disclose their interest and refrain from voting on any corporate transaction where they have a conflict of interest.
The CSA has established several national instruments and policies (CSA Rules) that affect the corporate governance of reporting issuers. The CSA Rules are similar to the US Sarbanes-Oxley Act and the consequential rules and guidelines established by the SEC and US stock exchanges.
The CSA Rules deal with:
• oversight of external auditors, including pre-approval of audit and non-audit services, prohibited services, audit partner and audit review partner rotation and cooling off periods for hiring employees of external auditors;
Public companies listed on the TSX.V are exempt from some of the CSA Rules.
5. PROHIBITED CONDUCT
Canadian securities laws prohibit a person who is in a special relationship with a Canadian public company from insider trading (ie, trading securities of the company with knowledge of undisclosed material information relating to the company) and from tipping (ie, disclosing undisclosed material information relating to the reporting issuer other than in the necessary course of business).
Persons in a special relationship with a company include:
6. MUTUAL FUNDS
A mutual fund is an issuer whose securities entitle the holder to receive, on demand or within a specified period after demand, an amount computed by reference to the value of a proportionate interest in all or in part of the net assets of the issuer.
Mutual funds are either trusts or corporations. Mutual fund trusts are preferred for tax purposes. Public mutual funds are usually set up as open-end funds.
The rules regulating the operation of public mutual funds include:
Public mutual funds are subject to prescribed continuous disclosure requirements, including financial statement reporting, preparation of AIFs, management reports of fund performance, material change reports and information circulars, and prescribed procedures for proxy solicitation and proxy voting disclosure.
Generally, mutual fund prospectus offerings are carried out pursuant to a simplified prospectus that is intended to be easy to understand and to facilitate comparison among different mutual funds.
A simplified prospectus is filed with and must be cleared by Canadian securities regulatory authorities once a year. If a significant change to the mutual fund occurs during the course of the year, an amendment to the prospectus must be filed and cleared.
7. TAKEOVERS
The acquisition of a Canadian public company may be structured as a takeover bid or a corporate transaction.
A takeover bid:
A takeover bid circular must contain prescribed information including: the terms of the offer, disclosure with respect to pre-offer share ownership and trading activities and whether the acquiror intends to initiate a second stage transaction (see below) and any other information that would be material to shareholders. A takeover bid may be subject to conditions (eg, minimum tender conditions, regulatory approvals, no material adverse change in the target and no material adverse change in the financial markets). A takeover bid may not be conditional upon obtaining financing (arrangements must be made before the bid is launched and must be disclosed in the bid circular).
The directors of the target are required to prepare and mail to the target’s shareholders, within 15 days after the takeover bid is commenced, a directors’ circular containing prescribed information including the board’s recommendation as to whether shareholders should accept or reject the offer and their reasons and, if the board is unable to make a recommendation, their reasons). In a negotiated takeover bid, the takeover bid circular and the directors circular (containing a favourable recommendation) are often mailed together to shareholders.
If:
A corporate transaction typically takes the form of a plan of arrangement, amalgamation or other corporate reorganisation. The terms of a corporate transaction are typically negotiated with the target, as the transaction will require the approval of the target’s shareholders under applicable Canadian corporate law (the typical approval level is two-thirds of the votes cast). The target will be required to prepare and mail to its shareholders an information circular in prescribed form (the circular will describe, among other things, the material terms of the transaction and the negotiation process).
If the corporate transaction receives the requisite level of shareholder approval, the acquiror will acquire 100 per cent of the outstanding shares upon completion of the transaction. The target’s shareholders will generally have the right to dissent from the transaction and demand payment for the ‘fair value’ of their shares (as determined by a court, if necessary).
A court must also approve a plan of arrangement before it can be implemented. The court must be satisfied that all statutory requirements have been fulfilled, that the arrangement has been put forward in good faith and that the arrangement is fair and reasonable.
Factors that may influence the choice of transaction structure include:
In a negotiated transaction, the acquiror and the target will enter into a support or pre-acquisition agreement (in the case of a takeover bid) or a merger or combination agreement (in the case of a corporate transaction). These agreements typically contain representations and warranties and pre-closing covenants from the target to the acquiror, termination rights in favour of the target and deal protection measures (see 7.2.4 below).
It is also common for acquirors to enter into agreements under which significant shareholders of the target agree to tender their shares to a takeover bid or provide voting support for a corporate transaction. These agreements often provide termination rights in favour of the shareholder (eg, if a superior proposal is made by a third party in excess of a prescribed premium or the transaction terms are materially and adversely amended without the consent of the shareholder), particularly in circumstances where the shareholder owes fiduciary duties to others (eg, pension funds).
Canadian securities regulatory authorities and courts have looked to US jurisprudence for assistance in defining the duty of directors in a change of control situation. The Ontario Court of Appeal has stated that, in a change of control situation, the board is required to seek the best value reasonably available to shareholders (the ‘Paramount Communications’ duty in the US). It is not, however, required to conduct an auction (the ‘Revlon’ duty in the US).
Shareholders, including controlling shareholders, do not owe fiduciary duties to other shareholders in the context of a change of control transaction.
If the acquiror is a related party of the target and the target has a significant connection to the capital markets of Ontario or Québec, the transaction will be subject to enhanced fairness rules which (subject to certain prescribed exceptions):
The use of deal protection devices is not specifically regulated in Canada. The board of directors of a reporting issuer may agree to a variety of deal protection mechanisms in a negotiated transaction (including break fees, no-shop clauses and matching rights). In the context of ‘white knight’ transactions, Canadian courts have acknowledged that deal protection mechanisms are appropriate where:
Break fees have become common in most negotiated transactions. A break fee (sometimes referred to as a termination fee) is intended to compensate the disappointed party with a cash payment in the event that the proposed transaction is terminated, in some cases because the shareholders of the other party do not approve the transaction or because the other party accepts a superior proposal from a third party. Break fees are used primarily to attract a party to make an offer, protect the bidder from competing offers after its offer is made and compensate the bidder for the costs of making an offer and foregone opportunities. Break fees typically fall within a range of two to four per cent of the equity value of the transaction. Several institutional investors have established voting guidelines that stipulate that break fees should generally not exceed 2.5 per cent of the overall value of the transaction.
The adoption or use of a shareholder rights plan (sometimes referred to as a poison pill) to delay completion of a hostile bid is the most common defensive tool used in Canada. A target’s poison pill will usually be triggered when any person acquires or announces its intention to acquire a specified percentage (typically 20 per cent) of the securities of the target, and may cause a significant dilution of the acquiror’s voting rights and economic interest unless a permitted bid is made.
Canadian securities regulators will not permit a poison pill to be used to deny shareholders the opportunity to make their own decision with respect to a bid and will terminate a poison pill if the target is unable to demonstrate that it is actively pursuing alternative transactions or if there seem to be no prospective alternative bids. In several reported decisions, the OSC has stated that, while rights plans have a role to play in ensuring that a target has enough time to explore whether there is a value-enhancing alternative, the question is not ‘whether’ but ‘when’ the rights plan should go.
Other pre-emptive defensive tactics, such as ‘shark repellents’ are not popular and staggered boards are not common.
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