Canada: U.S. And Canadian Securities: Regulatory Reform In 2006 And The Implications For 2007

Securities Trends in Canada

Impact of Changes re Taxation of Income Trusts

The announcement of the Canadian Government on October 31, 2006 rocked not only the tax world but the Canadian public markets and the Canadian corporate finance world as well. While it seems relatively clear what the immediate impact on conversion of businesses into income trusts will be, the medium to long-term impact on Canadian corporate finance and M&A activity remains to be seen.

What is known at this stage is that real estate investment trusts are not negatively impacted in the same manner as "business trusts" and that REITs are expected to continue to be a significant investment vehicle in Canada. The Canadian Government has been lobbied by the energy trust sector for differential treatment and there are calls for a 10-year as opposed to a 4-year phase-in of the new taxation rules.

The announcement and clarification in mid-December of the so-called "undue expansion" rules will have an impact on M&A activity among income trusts themselves. What is not evident is what impact the new rules will have on Canadian M&A activity in general. There may be a significant impact with respect to the approach of strategic/industry players. The developments could also have an impact on private equity M&A activity.

If one believed the media reports, the announcements were expected to create a "cheap pool" of Canadian assets held by business trusts that were ready for the taking by foreign buyers. The Canadian market was told to prepare itself for an influx of acquisitions by foreign acquirors. However, the potential for re-conversion back to a conventional corporate structure may play against that anticipated phenomenon. Private equity buyers have traditionally viewed income trust conversions as one of the principal ways to create value and as a primary avenue in their exit strategies in that regard, it is not clear what impact, if any, the announcements could have on private equity M&A activity in the near term but acquisitions by private equity buyers is expected to be a continuing phenomenon.

Civil Liability

On December 31, 2005, a new regime of civil liability for secondary market disclosure came into force in the province of Ontario. Other Canadian provinces, including Québec, have now announced or begun the process of introducing similar regimes. While there has yet to be any real meaningful use of the Ontario provisions, the measure constituted a significant legislative development for participants in the Canadian public markets.

In implementing the regime, the Ontario legislator had the benefit of decades of judicial application and analysis of Rule 10b-5 under the U.S. Securities Exchange Act of 1934 (or "10b-5" as it is generally known) and made a conscious choice not to import the rule into Canada in its U.S. form. It remains to be seen whether the Ontario regime will be more effective than 10b-5 in policing and deterring misrepresentations and omissions or whether it will lead to a rash of abusive and speculative litigation, including class actions, despite the regime's built-in protective mechanisms. While they share certain similarities, the Ontario regime is not quite "10b-5 North". The provisions do share the same basic purpose, to establish a basis for statutory civil liability for misrepresentations or omissions. However, in their scope and application, the regimes are much more cousins than they are siblings.

The expected flood of securities class actions in Canada has not yet taken place as predicted when Ontario introduced its regime and the jury is still out on the merits of the new system. It is possible that 2007 will bring with it increased use of the provisions and shed some light on the utility and benefits, or harm, of a Canadian regime for civil liability for secondary market disclosure as other provinces usher in their regimes and litigants seek to make use of the new avenues for actions.

Regulatory Enforcement

If the last few years following the corporate scandals in the United States have been about rule implementation, it is expected that 2007 will continue the trend evidenced and announced by the securities regulators of a focus on enforcement. It is becoming clear that securities regulators have come to the realization that a complex regime of specific rules tailored to prevent scandal and fraud without a functioning enforcement regime is not worth much more than the paper on which such elaborate rules are written.

It is expected that, while securities regulators will continue their mission of implementing rules to deal with potential corporate wrongdoing, there will be increased focus on enforcement. In this regard and by way of example, both the Toronto Stock Exchange and the Canadian Securities Administrators have issued staff notices to deal with the granting of options at a time when there is material, undisclosed information and the phenomenon of "option backdating" that has received much media and regulatory attention, particularly in the United States, in the latter half of 2006. (See discussion below.) It is expected that regulatory scrutiny will continue and intensify in this area in 2007.

Securities Trends in the U.S.

In the United States, the trends that we will be following include developments in the options backdating "scandal", changes to the securities offering processes in the light of the securities offering reform adopted by the Securities and Exchange Commission just over a year ago, potential relief from some of the perceived burdens of the Sarbanes-Oxley Act, especially for smaller companies, and, possibly, increased use of tender offers in reaction to the recent amendments to the "best-price rule" under the United States' tender offer regulations.

Options Backdating Scandal

In 2006, the Securities and Exchange Commission revealed its wide-ranging investigation into options backdating. In July, the SEC brought two enforcement actions, one relating to Brocade Communications Systems and another involving Comverse Technology. In both cases, parallel criminal charges were also brought against senior company executives.

While the Brocade and Comverse cases were the first to be brought in the crackdown on options backdating, they were merely the tip of the iceberg: the SEC has indicated that there are over 100 companies currently under investigation and many executives at other companies have resigned or been dismissed in the scandal.

The Brocade and Comverse cases involved fraudulent schemes of intentional backdating and, in the case of Comverse, more elaborate schemes of granting backdated options to fictitious employees. The conduct alleged against Brocade and Comverse was apparently not isolated and the SEC has indicated that, while it does not expect to bring enforcement actions against all of the companies that it has investigated (many of which may be guilty only of sloppy procedures and record keeping), it will be bringing more cases against the worst conduct. In addition, boards of directors continue to launch their own internal investigations into options backdating to determine whether there have been abuses and, if so, to take remedial action before the SEC and/or the U.S. Attorney's office takes the initiative.

Whether or not the SEC takes enforcement action, companies discovering options backdating practices will nevertheless have to grapple with significant tax and accounting consequences. Companies will have to restate their earnings to reflect compensation expense for the granting of in-the-money options which don't enjoy the favorable accounting treatment that at-the-money options once enjoyed. In addition, the Internal Revenue Service will likely seek to recover uncollected tax from offending companies and from the recipients of in-themoney options. While the SEC might not institute proceedings in every case, shareholder litigation has been widespread.

For 2007, we can expect more announcements of enforcement actions and more executive resignations. In addition, the scandal may have an impact on policy development as the scandal fuels demands for change of executive compensation practices generally.

Securities Act Reform

The SEC's new securities offering reform rules and rule amendments have now been in effect for about a year. We expect to continue to see offerors availing themselves of the reforms of the offering process afforded by the rules, including liberalized communications before and during the offering process and the streamlining of the registration process, especially for the largest issuers (well-known seasoned issuers, or "WKSIs"), and that practices will continue to be refined in light of the changes to the rules determining liability for disclosure in public offerings at the time that investors make their investment decisions.

Liberalized Communications. Under the rules, WKSIs are generally free to continuously communicate with the market, including making offers of securities, without regard to previously applicable "gun jumping" restrictions. All other issuers may now publish or otherwise communicate information without committing a "gun jumping" violation if the information is communicated at least 30 days before a registration statement is filed and does not refer to a securities offering. In addition, the rules permit the use of the "free-writing prospectus" in addition to the traditional prospectus used in connection with an offering. While the use of term sheets as free-writing prospectuses, particularly in the context of debt offerings, has become rather commonplace, as expected, the use of other, more marketing focused documents as free-writing prospectuses has not been as widespread.

Streamlining the Securities Registration Process. The most significant change to the registration process was the creation of "automatic shelf registration", which is available only to WKSIs and provides for automatic effectiveness of the registration statement immediately upon filing without any SEC review. Required information in the base prospectus is minimal, with offering-specific information to be provided by posteffective amendment, prospectus supplement or incorporation by reference to the issuer's Exchange Act reports. Automatic shelf registrations are good for three years, at which time a new registration statement must be filed. Almost 600 automatic shelf registration statements have been filed by U.S. companies since the rules became effective, and over 30 non-U.S. companies had filed automatic shelf registration statements as of the end of 2006. It is anticipated that ultimately most WSKIs will file these registration statements.

Liability for Prospectus Disclosure. Previously, under the Securities Act, liability for misstatements in or omissions from a prospectus used in a registered public offering was determined by reference to the final prospectus, which was generally not delivered to investors until several days after they had made their investment decisions. Under the new rules, prospectus liability will be determined by reference to whatever information has been "conveyed" to an investor at or prior to the time of sale (i.e., when the investor orally or otherwise confirms his purchase), and any information conveyed after that, including information in the final prospectus, will not be taken into account. As a result, the process for conveying pricing and price-related information, particularly in debt offerings, has become more formalized, primarily through the use of term sheets delivered by facsimile or email to investors which confirm their purchases. Although the new liability regime is not applicable to Rule 144A and other unregistered offerings, underwriters are increasingly using term sheets to convey pricing information in these transactions as well as part of their "best practices". There have also been changes in underwriting agreements, and the legal opinions and accountants' comfort letters required to be delivered to the underwriters, as a result of the new regulatory landscape. These changes include the introduction of the concept of a "disclosure package" or "information package" concept, which includes all of the information, including information contained in a free-writing prospectus, that is delivered to the investors at the time of purchase, and the requirement that the representations and warranties, as well as legal opinions, cover all the information contained in the disclosure package or information package, as opposed to being limited to the registration statement and related prospectus, as was the case prior to the implementation of the reform rules.

Interpretive Guidance for Section 404 Implementation

In December 2006, the SEC proposed for public comment interpretive guidance for management regarding their evaluations of internal control over financial reporting required by Section 404 of the Sarbanes-Oxley Act and amendments to the rules under the Act that would make it clear that a company choosing to perform an evaluation of internal control in accordance with the interpretive guidance would satisfy the annual evaluation required by those rules. The proposals were made in response to widespread commentary that implementation of the internal control evaluations was proving to be overly burdensome for reporting issuers, especially smaller issuers, in comparison to the protection afforded investors by such requirements.

The proposed guidance is described as a "risk-based" approach that is intended to address many of the concerns that have been raised to the SEC, including: excessive testing of controls generally; excessive documentation of processes, controls, and testing; and the ability to scale the evaluation to smaller companies. According to the SEC, the proposed guidance is principles-based guidance that is organized around two important principles that it believes will permit companies of all sizes and complexities to implement the SEC's rules more effectively and efficiently.

  • First, management should evaluate the design of the controls that it has implemented to determine whether there is a reasonable possibility that a material misstatement in the financial statements would not be prevented or detected in a timely manner. This principle is designed to permit management to focus on those controls that are needed to prevent or detect material misstatement in the financial statements.
  • Second, management should gather and analyze evidence about the operation of the controls being evaluated based on its assessment of the risk associated with those controls. The purpose of this principle is to allow management to align the nature and extent of its evaluation procedures with those areas of financial reporting that pose the greatest risks to reliable financial reporting.

The proposed interpretive guidance addresses four specific areas, including:

  • Identification of risks to reliable financial reporting and the related controls that management has implemented to address those risks.
  • Evaluation of the operating effectiveness of controls.
  • Reporting the overall results of management's evaluation.
  • Documentation.

If the proposed interpretive guidance and amendments to the SEC's rules are adopted, they, together with the new auditing standard on internal control over financial reporting being proposed by the Public Company Accounting Oversight Board, should enable U.S. reporting companies, especially smaller companies, to conclude that more efficiently structured internal control evaluations will satisfy the requirements of the SEC's Section 404 rules.

Amendment to the "Best Price" Tender Offer Rule

On December 8, 2006, amendments to the U.S. tender offer best price rule (Rule 14d-10 under the U.S. Securities Exchange Act of 1934) approved by the SEC became effective. The best price rule provides that no one may make a tender offer unless the consideration paid to any security holder during the tender offer is the highest consideration paid to any other security holder. As a result of certain courts finding that the payment or grant of executive compensation by a target company in connection with a tender offer (even if agreed to and made outside the tender offer period) constitutes disparate treatment of shareholders in violation of the best price rule, business combinations over the last several years have been primarily structured as one-step mergers if the grant of additional compensation to the subject company's executives is necessary or desirable. The amendments to the best price rule are intended to clarify that the rule applies only to the consideration paid for securities tendered in a tender offer and that employment compensation, severance or other employee benefits should not be considered part of the price being paid in a tender offer.

The amendments to the best price rule, which apply to both issuer and third-party tender offers, clarify that the rule applies only with respect to the consideration offered and paid for securities tendered in a tender offer, rather than consideration paid to any security holder pursuant to and during the tender offer. The exemption in connection with employment compensation, severance or other employee benefits is not limited to directors or employees of the target company, but includes all security holders of the target company. An arrangement will satisfy the exemption if it "is not calculated based on the number of securities tendered or to be tendered" and the arrangement "is being paid or granted as compensation for" services rendered or to be rendered. The amendments also provide for a safe harbor that would allow an independent compensation committee of the subject company (and the directors of the bidder if the bidder is a party to the transaction) to approve an employment compensation, severance or other employee benefit arrangement and, in doing so, satisfy the requirements of the exemption to the best price rule. The amendments to the rule may lead to an increased use of tender offers in the context of friendly acquisitions if practitioners become convinced that the amendments have substantially reduced the likelihood of successful lawsuits based on the rule.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions