On August 25, 2015, a revised consultation draft of the uniform provincial and territorial Capital Markets Act (CMA) and draft initial regulations under the CMA (together with the CMA, the Consultation Drafts) for the proposed Cooperative Capital Markets Regulatory System (Cooperative System) were published for comment. The Consultation Drafts are open for comment until December 23, 2015.
The CMA is intended to replace existing provincial and territorial securities legislation in Ontario, British Columbia, New Brunswick, Saskatchewan, Prince Edward Island and the Yukon (CMR Jurisdictions).
Blakes is publishing a series of Bulletins regarding various aspects of the Consultation Drafts, which you can read on our website. This Bulletin concerns the approach proposed to be taken towards issuers distributing their securities out of the CMR Jurisdictions. It does so through provisions split between Capital Markets Regulatory Authority (CMRA) Regulation 71-501 International Issuers and Securities Transactions with Persons Outside the CMR Jurisdictions (Reg 71-501) and CMRA Policy 71-601 Distribution of Securities to Persons Outside CMR Jurisdictions (Policy 71-601 and, together with Reg 71-501, the Proposals). The approach taken follows that of the British Columbia Securities Commission in BC Interpretation Note 72-702 Distribution of Securities to Persons Outside British Columbia, which applies where securities are offered by British Columbia issuers to investors in other jurisdictions, rather than the safe harbour approach of the Ontario Securities Commission in its Interpretation Note Distributions of Securities Outside Ontario or that of the U.S. Securities and Exchange Commission (SEC) in Regulation S made under the U.S. Securities Act of 1933 (1933 Act). As proposed, Reg 71-501 and Policy 71-601 would act as an obstacle to cross-border capital flows. A broad range of Canadian issuers seeking to raise capital outside Canada would be handicapped by the proposed provisions even though the provisions fail to further the purposes of the CMA. In addition, they would restrict the access of Canadian institutional investors to investment opportunities where the issuer has a connection to a CMR Jurisdiction.
Unfortunately, the Proposals restate British Columbia's existing approach modelled on U.S. requirements of the 1960s that imposed an extraterritorial application of the registration requirement under section 5 of the 1933 Act. The Proposals do not take into account subsequent changes in international capital market practice and regulation, including greater integration of Canadian and U.S. capital markets following implementation of the multijurisdictional disclosure system (MJDS) in 1991, the growing importance of continental European and Asian capital markets, and the sophistication of the regulation of markets outside Canada, the United States and the United Kingdom.
Policy 71-601 sets out two primary circumstances in which an issuer is subject to compliance with the CMA's prospectus requirement. The first is a distribution of securities from a CMR Jurisdiction to an investor outside a CMR Jurisdiction. The second is an indirect distribution into a CMR Jurisdiction where an issuer outside the CMR Jurisdictions distributes securities outside the CMR Jurisdiction, but instead of the securities coming to rest outside the CMR Jurisdictions, they are resold into a CMR Jurisdiction. Reg 71-501 then makes prospectus exemptions available for distributions that are not made to any purchaser resident in a CMR Jurisdiction.
DUPLICATIVE REGULATION OF DISTRIBUTIONS OUTSIDE A CMR JURISDICTION
Policy 71-601 would require an issuer with sufficient connection to a CMR Jurisdiction wishing to distribute its securities to investors outside a CMR Jurisdiction without filing a prospectus in the CMR Jurisdictions to ascertain that, not only is the private placement made in accordance with the requirements of the investor's jurisdiction, but also pursuant to an exemption from the prospectus requirement of the CMA. Thus, an underwriter of a Rule 144A offering by an issuer in a CMR Jurisdiction would have to ascertain both that the U.S. investor is a qualified institutional buyer (QIB) as defined in the SEC's Rule 144A and an accredited investor under the CMA. These requirements would constitute not just duplicative regulation because rules to protect investors already exist in the U.S., but inappropriate extraterritorial application of the CMA. Issuers in CMR Jurisdictions accessing the U.S. exempt market would incur the additional cost not imposed on issuers in the United States or elsewhere of filing post-trade reports under the CMA in respect of sales of securities to U.S. investors.
Dealing with the accredited investor exemption and imposition of hold periods on U.S. investors would be even more problematic in the context of a public offering made into the U.S. by an issuer in a CMR Jurisdiction. An issuer using the MJDS for a U.S.-only offering could avoid this problem by filing a non-offering prospectus in the CMR Jurisdictions. However, what is the benefit of filing a prospectus that will not be delivered to investors? For a U.S.-only at the market offering of equity inter-listed in the United States, imposing effective restrictions on resale over the Toronto Stock Exchange (TSX) to prevent flowback into the CMR Jurisdictions is unworkable. Further, it would not be possible to determine the status of the U.S. purchasers as accredited investors because their identities are unknown.
Section 1 of the CMA states that its purposes are to:
- Provide protection to investors from unfair, improper or fraudulent practices
- Foster fair, efficient and competitive capital markets in which the public has confidence
- Contribute to the stability and integrity of the Canadian financial system
It is appropriate that the CMRA, the body that will regulate markets under the CMA, exercise its jurisdiction to take action against an issuer in a CMR Jurisdiction that acts fraudulently or otherwise in an improper manner in a distribution of its securities solely outside the CMR Jurisdictions that may bring the capital markets of the CMR Jurisdictions into disrepute. In so doing it would further the purposes of the CMA. However, why does the CMRA need to know which category of accredited investor a U.S. purchaser is in, or why should the U.S. purchaser that is a QIB even need to be an accredited investor? This would not protect investors from unfair, improper or fraudulent practices, but only serve to make capital markets less efficient by imposing duplicative regulatory requirements. The principal purpose of the CMA is to protect investors in the CMR Jurisdictions, not foreign investors otherwise protected by their own regulators. Further, capital markets would become less competitive because this duplication of regulation would apply to the distribution of securities outside the CMR Jurisdictions, but not within the CMR Jurisdictions. Capital markets would not be fairer nor would the stability and integrity of the Canadian financial system be enhanced.
REG 71-501 EXEMPTIONS UNNECESSARILY RESTRICT MARKET ACTIVITY
Reg 71-501 provides two alternative prospectus exemptions that remove the need to verify that foreign investors are accredited investors as defined in Canadian securities legislation, though retaining the requirement to file a post-trade report. For more information, please see our August 2015 Blakes Bulletin: Yet More Enhancements Proposed for Private Placement Reporting. It also provides for registration exemptions that parallel the prospectus exemptions (the parallel registration exemptions were necessary under the prior dealer registration regime of Canadian securities legislation, which was based on doing a trade in a security rather than being in the business of trading securities). Both Reg 71-501 alternative prospectus exemptions are based primarily on the distribution not being made to any purchaser resident in a CMR Jurisdiction and set out specific requirements for ensuring that the securities come to rest outside a CMR Jurisdiction. These exemptions raise the question: If there are legitimate regulatory concerns for ensuring that investors in a Rule 144A offering made by an issuer in a CMR Jurisdiction are accredited investors how would those concerns be addressed through the alternative exemptions set out in Reg 71-501?
The answer is that restricting a distribution only to investors outside the CMR Jurisdictions does not address these concerns because the exemptions bear no relation to them. The burden of ensuring the accredited investor status of non-Canadian purchasers is removed, but at the cost to the issuer of having to structure a second concurrent offering to investors in the CMR Jurisdictions using the accredited investor exemption or another exemption. Absent that Canadian offering, the issuer may lose a significant market for the securities being distributed, while institutional investors in the CMR Jurisdictions would not have access to the securities at the offering price and be required to purchase in the secondary market. In contrast, Regulation S under the 1933 Act enables simultaneous offerings of securities both within and outside the U.S.
The additional requirements imposed by the exemption available for any securities are:
- The purchaser must either certify in a subscription agreement or other document, or be given notice that by purchasing securities it will be deemed to have represented, that the purchaser is not resident in a CMR Jurisdiction, purchasing the securities for the benefit of a person resident in a CMR Jurisdiction (other than as manager of fully discretionary accounts) or purchasing the securities with a view to resale to a person in a CMR Jurisdiction
- The purchaser must either provide specified acknowledgements in a subscription agreement or other document, or be given notice that by purchasing securities it will be deemed to have provided those acknowledgements
- The purchaser's ability to resell the securities in Canada must be subject to restrictions and the purchaser is responsible for finding out and complying with those restrictions (the restrictions under the CMA would apply to the resale by foreign investors of securities sold under the exemption)
- The issuer must have equity securities listed or quoted on a specified market (currently limited to exchanges in North America and the United Kingdom)
The specific additional requirements imposed by an exemption available only for Eurobond offerings are:
- The securities must be accepted for listing on a specified market outside Canada, which currently is only the Eurobond market as regulated by the International Securities Market Association
- The offering circular must contain a specified legend in respect of the restriction on sale in a CMR Jurisdiction and the underwriters must contractually agree to observe this restriction
- The securities must be initially issued in temporary form exchangeable for definitive securities 40 days after completion of the distribution on certification by the holder that the definitive securities are not beneficially owned by residents of a CMR Jurisdiction
This exemption specifically for Eurobond offerings may have been appropriate in the 1980s, when Canadian issuers were active in the Eurobond market, securities were represented initially by a temporary global certificate and typically listed on the Luxembourg Stock Exchange. The Proposals need to be amended to reflect capital market practice in 2016 and beyond.
CONSIDERATIONS FOR PREVENTING SECURITIES FROM BEING RESOLD INTO A CMR JURISDICTION
Where an issuer does not make an offering in compliance with one of the exemptions from the prospectus requirement set out in Reg 71-501, Policy 71-601 sets out steps and precautions for an issuer to consider taking where the purchasers are resident in jurisdictions that do not have comparable disclosure and hold period requirements, which would be jurisdictions outside Canada. These steps and precautions are relevant to an issuer having a significant connection with a CMR Jurisdiction or its capital market. The steps and precautions are:
- Restrictions on sales of the securities in the underwriting agreement, banking group or selling group agreement and/or subscription agreement and on resales in the subscription agreement
- Clear and prominent statements on the front page of any record concerning the distribution in respect of the applicable restrictions
- An "all sold" certificate by the underwriters that includes specified wording
- A statement in confirmations sent to purchasers with respect to the purchaser not being resident in a CMR Jurisdiction
- A provision in a transfer agency agreement to prohibit registration of the securities in the name of any resident of a CMR Jurisdiction during the applicable hold period
- A legend on the security certificate restricting transfers for the period during which a domestic purchaser of securities of a reporting issuer would be required to hold the securities
OTHER EXAMPLES OF EXTRATERRITORIAL APPLICATION OF THE CMA
Reg 71-501 provides foreign underwriters that offer securities qualified by a prospectus filed in a CMR Jurisdiction to investors solely in the U.S. and U.K. with an exemption from signing an underwriter certificate in the Canadian prospectus. This exemption is unnecessary because the underwriter certificate requirement would not apply to those foreign underwriters, which are not acting as underwriters of securities sold in Canada. Further, why limit sales by the foreign underwriters to purchasers in the U.S. and U.K.? Why preclude sales to investors in continental Europe and Asia?
One of the acknowledgements of a purchaser required as a condition to the prospectus exemption for a distribution of securities outside the CMR Jurisdictions is that the purchaser has been advised that it does not have the benefit of certain rights and remedies under the CMA because the issuer is relying on an exemption from the prospectus filing requirement of the CMA. This acknowledgement is based upon the premise of Reg 71-501 that if a prospectus had been filed under the CMA, the U. S. investor would receive a CMA prospectus and have the benefit of statutory rights of rescission and damages under the CMA. In a cross-border public offering, U.S. investors receive only a U. S. prospectus, not both a Canadian prospectus and a U. S. prospectus.
It is difficult to provide useful specific comment on Proposals based on a broad extraterritorial application of the CMA and capital markets practices in the 1980s and even earlier. The Eurobond market is no longer a primary focus for Canadian companies offering debt securities outside Canada. Global certificates are registered in the name of a nominee company of the clearing agency; definitive certificates are not registered in the names of individual purchasers. Underwriting syndicates rarely have separate banking and selling groups. U.S. trading volumes of many securities inter-listed on exchanges in both Canada and the U.S. have substantially increased.
The CMR Jurisdictions to do not constitute a capital market — the capital market is Canada, not the particular provinces that have chosen to participate in the CMA. The principal trading market for equity securities of most issuers from all Canadian provinces, whether or not they are CMR Jurisdictions, is the TSX. The dichotomy created by Reg 71-501 between provinces that are CMR Jurisdictions and those that are not is too artificial to be meaningful. If an Ontario issuer distributes its equity securities listed on the TSX only into provinces that are not CMR Jurisdictions, reasonable restrictions in the regulations under the CMA on flowback into Ontario will not realistically impact whether that flowback does or does not occur.
Rather than making cosmetic changes to existing policy that is incompatible with the purposes of the CMA and would impose an unnecessary burden on Canadian capital markets once expanded to all the CMR Jurisdictions, we recommend the CMRA analyze carefully how global offerings are made today and develop rules that reduce the extraterritorial impact of the CMA and facilitate capital raising with an appropriate level of investor protection, focused on the protection of investors in the CMR Jurisdictions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.