Ontario’s securities laws strictly regulate the purchase and sale of securities held by persons who alone, or in combination with others, hold a significant security holding in an issuer - such persons being more commonly referred to as members of a "control block." These laws impose certain trading restrictions and reporting obligations on such holders and have the effect of reducing the liquidity of securities that are part of the control block. The rationale for these restrictions and obligations is: (i) to alert the marketplace to changes in ownership of persons with access to inside information and potential to exert substantial influence over the business and affairs of the issuer by virtue of their significant shareholdings; and (ii) to allow for an orderly market in trading of securities of such persons.
This article is a general discussion of these restrictions and obligations, as well as legal developments of concern to holders of a control block of securities in the Province of Ontario. Ontario is known substantially as the leading capital markets jurisdiction in Canada. The other Canadian jurisdictions often follow the regulatory regime and policies set by Ontario. Accordingly, a review of the issues relating to control blocks in Ontario will provide the reader with a reasonable guide to the topic throughout all of Canada. As the application of these rules is fact-specific, readers should seek professional legal advice on the particular issues that concern them.
What is a "Control Block"?
In Ontario, a person is said to be a member of a control block if that person is, or is a member of a combination of persons holding a sufficient number of any securities of that issuer to affect materially the control of that issuer.1 There are two elements to this test:
Defining the Group
One must determine who is in the "group" of persons holding the securities in question. The phrase "combination of persons" is not a defined term and the determination will be a question of fact. Social and business connections are a few of the factors that must be considered. For example, if there is a voting arrangement among two or more shareholders, these shareholders would clearly be considered to be a "combination of persons" and the holdings of the group as a whole would be the appropriate holding to consider. Family members who hold securities of an issuer may also be considered to be a "combination of persons" for purposes of the test.
The other part of the test is whether the person or combination of persons holds a sufficient number of any securities of an issuer to "affect materially the control of that issuer."
The Securities Act (Ontario) (the "Securities Act") provides that a person or group of persons holding more than 20 per cent of an issuer’s securities are deemed to affect materially the control of the issuer, absent evidence to the contrary.2 A holder of 15 per cent of the voting shares of an issuer may affect materially the control of the issuer in certain situations.3 In other situations, a holder of 22 per cent of the voting shares of an issuer may not affect materially the control of the issuer. It is a question of fact that must be considered in the context of the issuer involved and its shareholder base. A few of the many factors to be considered when determining if a person affects materially the control of an issuer will include historical ties and associations, representatives on the board of directors, whether the shareholder is also an officer of the issuer or has close ties with management and the extent to which the person involved controls the proxy machinery of the issuer.
If it is determined that a person holds (or is a member of a combination of persons which holds) a control block position, the following rules apply to purchases and sales of such securities by such persons.
Methods of Selling from a Control Block
Securities that form part of a control block (other than securities held by an "eligible institutional investor"4) can only be sold in one of four ways:
The securities that are to be sold can be qualified by preparing and filing a prospectus. This method is both expensive and time-consuming. Realistically, this route is only used in situations where an issuer is offering to sell its securities by way of prospectus and the securities from the control block form part of the larger offering (commonly known as a "secondary offering"). In such circumstances, the control block party must pay a proportionate percentage of the costs involved, including the fees of the registered dealer who is engaged to sell the securities.
A trade from a control block can be made pursuant to an exemption order of the Ontario
Securities Commission ("OSC").5 This route is often impractical as an order is unlikely to be granted absent exceptional circumstances. However, if the proper fact situation exists, an application order may be the appropriate route to proceed.
The control block securities can be sold pursuant to an available prospectus and registration exemption. For example, Ontario’s securities laws currently permit sales of securities where the sale price is in excess of $150,000 and will soon permit the sale to certain "accredited investors."6 Sales from the holder of a control block to another holder of a control block and sales from the holder of a control block to the issuer itself are also permitted. There are many additional exemptions which may be available. A practical limit on the ability to rely on this method is that the securities acquired by the buyer are not then freely tradable, as the buyer will acquire the securities subject to the applicable resale restrictions (currently six, 12 or 18 months). As a result, even if an exempt trade is permitted, there may not be a buyer willing to accept these resale restrictions, or such buyer may offer a price for the securities that is less than what would have been paid for non-restricted, freely tradable securities.
Pre-Trade Public Notification and Reporting Issuer Eligibility
Unlike issuers of securities that are limited to the three alternatives described above when distributing securities, control block holders have a fourth alternative available to them if certain conditions are met. Ontario’s securities laws currently permit, in certain circumstances, trades to take place from a control block on the open market if: (i) the issuer of the securities is at the time of the trade a reporting issuer and has held that status for the prior 18-month period; (ii) no unusual effort is made to prepare the market or to create a demand for the securities (e.g., taking steps to promote the stock prior to the proposed sale) and no extraordinary commission or other consideration is paid in respect of such sale; and (iii) the seller files certain forms with the OSC and the applicable stock exchange at least seven days and not more than 14 days before the date of the first sale.7
The forms required to be filed disclose certain information about the proposed sale and the seller, including the number of securities held, the number being sold and how they are to be sold.8 The forms also require the seller to confirm that it is not aware of a material change involving the issuer that has not generally disclosed and does not have any other material adverse information about the issuer that is not generally disclosed.
These filings must be renewed 60 days after the initial filing and every 28 days thereafter so long as any of the securities specified under the original notice have not been sold or until notice has been filed that the securities are no longer for sale. This procedure provides notice to the OSC who is given time to object to a proposed trade if deemed appropriate. This information is also made available to the public by the OSC. If the issuer’s shares are listed on The Toronto Stock Exchange (TSE), the seller will also have to comply with the orderly marketing requirements of the TSE.9 In these circumstances, the forms discussed above are also required to be filed with the TSE and the TSE will then issue a bulletin respecting the proposed sale. The TSE may impose certain price and volume restrictions to ensure that the market is not adversely affected by the proposed sale.
This method of selling ("filing out"), is usually the most attractive way for persons who hold a control block position to sell their securities. Unfortunately, filing out is not available unless certain conditions, in addition to those set out above, are met.10 These conditions essentially require that the seller has held its securities for a certain period of time.
The rules are highly technical in nature; however, a few generalizations can be made. Generally speaking, the securities have to be held by the seller for a period of six, 12 or 18 months from the date that the seller last acquired any securities of that class. Each time that a seller, who is part of the control block, acquires shares of the class that is part of the control block or securities convertible into securities of that class, this acquisition will usually "taint" the entire class and start the time period running from zero once again. The determination of whether the six, 12 or 18-month category applies will depend on such factors as how the seller originally acquired its securities, the stock exchange that the securities are listed on and the type of securities involved.
Given the restrictions discussed above, holders of a control block need to consider what effect the acquisition of additional securities of the issuer will have on their ability to sell such securities. For example, currently a grant of stock options to a director or officer who is a member of a control block will taint the pool of securities and cause the trading restrictions to start afresh. Accordingly, holders of a control block should consider if the acceptance of the grant of options or the participation in a private placement financing have any negative impact on their ability to sell securities that they currently hold.
The OSC and certain other members of the Canadian Securities Administrators have published a proposed Multilateral Instrument and Companion Policy that will soon have the effect of modifying the filing out rules under the Securities Act set out above.11 Under the proposed Multilateral Instrument, trades by control persons in securities of an issuer that is a "qualifying issuer"12 at the date of the trade will be exempt from the prospectus requirements of the Securities Act if: (i) the issuer is and has been a reporting issuer (or the equivalent) in a recognized jurisdiction13 for the four months immediately preceding the trade; (ii) the seller has held the securities for at least four months; (iii) no unusual effort is made to prepare the market or to create a demand for the securities; (iv) no extraordinary commission or other consideration is paid in respect of such sale; and (v) the seller has no reasonable grounds to believe that the issuer is in default of any requirement of securities legislation.
Trades by control persons in securities of an issuer that is not a "qualifying issuer" at the date of the trade will be exempt from the prospectus requirements of the Securities Act if: (i) the issuer is and has been a reporting issuer for the 12 months immediately preceding the trade (a) in a recognized jurisdiction14, if the issuer is an electronic filer under National Instrument 13-101 System for Electronic Document Analysis and Retrieval (SEDAR), or (b) in the local jurisdiction of the buyer if the issuer is not an electronic filer under National Instrument 13-101 System for Electronic Document Analysis and Retrieval (SEDAR); (ii) no unusual effort is made to prepare the market or to create a demand for the securities; (iii) no extraordinary commission or other consideration is paid in respect of such sale; (iv) the seller has no reasonable grounds to believe that the issuer is in default of any requirement of securities legislation, and (v) the seller has held the securities for at least 12 months if the seller acquired the securities under certain specific prospectus exemptions or, in all other cases, at least six months. The Multilateral Instrument also imposes an obligation on the seller to sign and file a form with the applicable securities regulatory authorities and stock exchanges, similar to the current process which is discussed above. The most significant effect of these changes as they apply to holders of a control block will be to reduce the amount of time that shares will have to be held by such persons before the filing out procedures are available to them.
Section 101 Requirements
The Securities Act requires that persons (or groups of persons) that acquire more than 10 per cent of the outstanding voting securities of an issuer file a report with the OSC and issue a press release announcing this event.15 Ontario’s securities laws also require the filing of another report and the issuance of an additional press release each time that an additional two per cent of the outstanding voting securities of that issuer are acquired, until such time as the holdings of that person exceed 20 per cent. The Securities Act further prohibits such persons from acquiring any additional securities of that class for one business day from the date that the report is filed.
Once a person or group of persons acting jointly or in concert acquires more than 20 per cent of the outstanding voting or equity securities of an issuer, the acquisition of additional securities constitutes a take-over bid.16 Unless the acquisition of these securities is an "exempt" take-over bid, the Securities Act will prohibit any acquisitions of additional securities by such persons without making an offer to all of the shareholders of the issuer by way of a take-over bid circular (a costly and time consuming procedure). Two notable "exempt" take-over bids under the Securities Act permit such persons to:
- acquire securities through a published market (i.e., a stock exchange) at the "market price" provided that such person and any persons acting jointly or in concert with such person does not acquire more than five per cent of the outstanding voting securities of the issuer during any 12-month period; and
- purchase securities privately from up to five persons at a price not more than 115 per cent of the "market price" if the offer is not made generally to security holders of the class.17
The term "market price" has a defined meaning depending on a number of factors which must be considered at the time of the proposed acquisition.
Holders of a control block will be considered to be "insiders" of the issuer by virtue of their shareholdings if they hold, directly or indirectly, or exercise voting direction or control over securities carrying more than 10 per cent of the voting rights of the issuer. Accordingly, such persons will be required to prepare and file insider reports with the OSC within 10 days of first becoming an insider.18 In addition, such persons will also be required to prepare and file insider reports with the OSC within 10 days of the date of any sale or purchase of securities of the issuer, unless the sale is made under the "filing out" provisions of the Securities Act (discussed above), in which case the filing is required within three days of the date of the sale.
Scope of the Securities Act
In order for the Securities Act to apply to a trade to or from a control block, there must first be some nexus with the Province of Ontario. If the seller or buyer in a trade are resident in the province, the Securities Act will almost certainly apply. However, where the issuer of the securities being traded is a reporting issuer in Ontario, the OSC may take the position that these rules will apply to the trade, even if the trade is between two "off-shore" parties. While the Securities Act does not explicitly set out its jurisdictional scope, there is case law to support the OSC’s position that their jurisdiction extends to activities outside of Ontario where such activities have an effect on the capital markets within Ontario.19 In September 2000, a number of securities commissions in Canada, including the OSC, published a notice with a view to providing some guidance to issuers and control block sellers in determining whether a trade outside of a province would fall under the jurisdiction of the relevant provincial securities legislation even if none of the parties involved in the trade was resident in such province.19 The notice indicated that the Canadian securities regulatory authorities are of the view that a trade in securities may fall within the securities legislation of the local jurisdiction if one or more connecting factors to the local jurisdiction exist, such as: (i) the issuer’s mind and management is primarily located in the local jurisdiction (e.g., head office and residence of the directors and senior officers of the issuer); (ii) a significant percentage of the outstanding securities of the class being traded are held of record by residents in the local jurisdiction; (iii) the principal register of the equity securities of the issuer is located in the local jurisdiction; or (iv) the operations of the issuer are principally conducted in the local jurisdiction. While this legislation is not yet in force, it sends a clear message that the OSC and a number of the other Canadian securities regulatory authorities take the view that offshore trades in control blocks by non-resident persons may still be subject to Canada’s securities laws.
- See paragraph (c) of the definition of "distribution" contained in subsection 1(1) of the Securities Act (Ontario).
- See e.g., Deer Horn Mines Ltd., January, 1968 OSCB 12 where the Ontario Securities Commission found that the acquisition of 14.6 per cent of the voting shares of a corporation constituted the acquisition of a controlling interest.
- For the rules relating to sales from a control block by an eligible institutional investor (e.g., financial institutions, pension funds, mutual funds that are not reporting issuers) see National Instrument 62-101 - Control Block Distribution Issues.
- See Sections 72(7)(a) and 74 of the Securities Act.
- See proposed OSC Rule 45-501 Exempt Distributions which is scheduled to replace existing OSC Rule 45-501 effective November 30, 2001.
- Section 72(7) of the Securities Act.
- Form 23 under the Securities Act - Notice of Intention to Distribute Securities and Accompanying Declaration Pursuant to Section 72(7) of the Act.
- Appendix D to The Toronto Stock Exchange Company Manual - 4-305. Sales from Control Block Through the Facilities of the Exchange.
- Section 3.11 of OSC Rule 45-501 - Exempt Distributions.
- Proposed Multilateral Instrument 45-102 -Resale of Securities, with Companion Policy 45-102CP, Forms 45-102F1, 45-102F2 and 45-102F3, (2001) 24 OSCB 5511 (expected to come into force November 30, 2001).
- Qualifying Issuers are defined in Multilateral Instrument 45-102. Generally, the key requirements for an issuer to be a qualifying issuer are: (i) the issuer is a reporting issuer (or the equivalent) in Ontario or one of six other recognized provinces, (ii) the issuer is an electronic filer under National Instrument 13-101 System for Electronic Document Analysis and Retrieval (SEDAR), (iii) the issuer has a current Annual Information Form, and (iv) a class of the issuer’s securities are either listed on a recognized market or have received an approved rating.
- In addition to Ontario, the other recognized jurisdictions for this purpose are: Alberta, British Columbia, Manitoba, Nova Scotia, Quebec and Saskatchewan.
- Section 101 of the Securities Act.
- Section 89 of the Securities Act.
- Section 93 of the Securities Act.
- Section 107 of the Securities Act and proposed National Instrument 55-102 System for Electronic Disclosure by Insiders (SEDI).
- See e.g., Libman v. Queen,  2 S.C.R. 178 and Quebec (Sa Majesté du Chef) v. Ontario Securities Commission,  10 O.R. (3d) 577 at 595 (C.A.).
- See Proposed Multilateral Instrument 72-101, Companion Policy 72-101CP, Form 72-101F1, (2000) 23 OSCB 6260 (not yet in force).
The content of this article is intended to provide a general to the subject matter. Specialist advice should be sought about your specific circumstances.