Canada: ABCP Revisited

Last Updated: October 26 2011
Article by Caitlin Sainsbury and A. Nicole Westlake

Edited by David Di Paolo

On September 28, 2011, the Ontario Securities Commission (the "Commission") released its long awaited decision In the Matter of Coventree Inc., Geoffrey Cornish and Dean Tai. The Commission concluded that Coventree Inc. (Coventree), its President, Geoffrey Cornish, and former CEO, Dean Tai, failed to disclose material facts about the underlying weakness of the asset-backed commercial paper (ABCP) market. Specifically, the Commission found that Coventree breached subsection 75(1) (disclosure of material changes) and 75(2) (report of material changes) of the Ontario Securities Act (the Act) in respect of material changes that occurred on January 22, 2007 and by the close of business on August 1, 2007. With respect to Cornish and Tai, the Commission found that, as senior officers and directors of Coventree, they authorized, permitted or acquiesced in Coventree's contraventions of the Act and were thereby deemed also to have not complied with section 129.2 of the Act. The Commission further found that the conduct of Coventree, Tai, and Cornish was contrary to the public interest.

Staff also alleged that Coventree had failed to make full, true and plain disclosure in its prospectus in contravention of section 56 of the Act, and that Coventree made a misleading statement on April 25 and 26, 2007 by telling the market that the total U.S. subprime mortgage exposure of its sponsored conduits was 7.4% and failing to provide investors with a breakdown of that exposure by conduit and ABCP note series, in contravention of section 126.2(1) of the Act. Staff's allegations in this regard were dismissed.


In January 2007, Dominion Bond Rating Service Limited (DBRS) published a release (the DBRS January Release) which stated, in effect, that future collateralized debt obligation (CDO) related structured finance asset (SFA) transactions would not be rated by DBRS unless they had the benefit of global style liquidity. Global style liquidity facilities provided liquidity if the ABCP covered by the facility failed to roll for any reason. Until that time, DBRS had been prepared to rate ABCP issued in CDO related SFA transactions that had the benefit of Canadian style liquidity, which imposed two conditions on the obligations of a liquidity provider to provide liquidity in support of ABCP, the first being that a general disruption of the ABCP market had occurred and the second being that DBRS had confirmed the credit rating of the relevant ABCP.

The Commission found that Coventree knew it could not obtain global style liquidity for its sponsored conduits. As a result of the DBRS January Release, Coventree could not carry out any new CDO related SFA transactions through its conduits. Accordingly, in the Commission's view, it was clear that the DBRS January Release resulted in a direct change to Coventree's business within the meaning of the term "material change" in the Act.

The Commission went on to consider whether the DBRS January Release and its effect

on Coventree's business was material. The Commission cited evidence which indicated that 40% of the sponsored conduit assets of Conventree and its subsidiary Nereus were CDO related SFA transactions. In the Commission's view, a reasonable shareholder or investor would have considered Coventree's inability to carry out any future CDO related SFA transaction important information in making an investment decision and, as a result, the DBRS January Release constituted a change in Coventree's business that would reasonably be expected to have a significant effect on the market price or value of Coventree shares within the meaning of the term "material change" in the Act. As a result, Coventree was obligated to disclose that material change in a news release and to file a material change report, and its failure to do so constituted a breach of sections 75(1) and (2) the Act.


Of particular interest are the findings of the Commission with respect to Coventree's failure to disclose material facts about the weakness of the ABCP market. Staff alleged that Coventree failed to comply with its continuous disclosure obligations under the Act by failing to publically disclose the liquidity and liquidity-related events and the increasing risk of a market disruption in the days leading up to the disruption in the ABCP market that occurred on August 13, 2007.

The Commission found that Coventree experienced the following changes in business by close of business on August 1, 2007:

(i) an inability to issue new ABCP due to lack of liquidity in the market;

(ii) difficulty rolling outstanding ADCP due to lack of liquidity in the market;

(iii) a widening in the ABCP interest rate spread;

(iv) a widening in the credit default swap spread; and

(v) sale of conduit assets to generate cash.

According to the Commission, the inability to issue new ABCP constituted a change in Coventree's business or operations that would reasonably be expected to have had a significant effect on the market price or value of Coventree shares. Those events and developments therefore constituted a "material change" with respect to Coventree, within the meaning of s. 75 of the Act, that occurred by the close of business on August 1, 2007.

The Commission further found that, in any event, the items listed as (i) to (v) above, when taken together, constituted changes in Coventree's business or operations that would reasonably be expected to have had a significant effect on the market price or value of Coventree shares.

While Coventree argued that the events and developments affecting its business during the period from late July to August 13, 2007 were external events beyond its control, and that pursuant to section 4.4 of NP 51-201 it was not required to issue a news release in respect of these events, the Commission made it clear in its reasons that the cause of the liquidity related problems experienced by Conventree's conduits was not important in reaching its conclusions that the liquidity related problems constituted a material change. The Commission held that Coventree made a critical error to the extent that it assumed the external events and developments taking place in the period leading up to August 13, 2007 could not and did not have direct effects on and consequences for its business and operations that constituted changes in that business for the purposes of the definition of "material change" in the Act.

Going forward, reporting issuers will have to consider carefully whether external events which are already in the public realm nevertheless have affected their business and operations in such a way that a material change has occurred requiring public disclosure.

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