E-issuing and Trading of Securities In Canada

Transcription

1 E-issuing and Trading of Securities In Canada John S. M. Turner Fasken Martineau DuMoulin LLP Toronto IBA: Business Law International 2001 Cancun, Mexico Monday, October 29, :30 12:30

2 E-issuing and Trading of Securities In Canada Where We Are While the Internet has increased potential opportunities for retail investor involvement in public offerings and other public and private financings, the failure by Canadian regulators to adapt to the potential of the Internet has negated much of the potential benefit to date. While the Internet has, to some degree, expanded the Canadian securities offering community to a variety of discount brokers and Internet-based investment banks, it has primarily been utilised in Canada as an add-on to traditional offerings by major issuers to institutional and high net-worth clients. Therefore, though the Internet has diversified the way securities are offered in Canada it is not yet clear whether these changes will ultimately level the playing field for retail investors and allow the Internet to drive lasting change to the securities industry, through, for example, direct public offerings ( DPOs ) by issuers. However, the reality is that the majority of Canadian on-line brokers continue to be affiliates of the bank-owned fullservice securities firms with little impetus to fully take advantage of the power of the Internet. While on-line retail brokerage was introduced in Canada in 1997, Internet securities offerings did not become a reality in Canada until January 2000 after the adoption by the Canadian Securities Administrators (the CSA ) of National Policy Delivery of Documents by Electronic Means ( NP ) and National Policy Trading in Securities Using the Internet and Other Electronic Means ( NP ). Today, while the non-bank-owned on-line brokers have led much of the innovation, they have been largely under-funded and, as a result, have not been able to broadly penetrate the market. Many thought the power of the Internet offering would be to open the qualified offering capital markets to smaller issuers, who would be able to readily access large numbers of small investors. However, in large part, the small online-brokers who were attempting to focus in this sector have not been able to reach a critical mass of on-line accounts. Attempts to jump start this process by establishing relationships with smaller financial institutions, like credit unions and cooperatives, who each have a loyal customer base, have been largely unsuccessful. The recent easing of the online know-your-client rules, appear to have achieved little in expanding the number of online customers or the number of trades per customer. These

3 -3- rules required online brokers, as is the case with traditional brokers, to determine that a particular trade fits within an individual investor s investment profile. While DPOs seemed appeared destined to become a fixture of the Internet, the reality is that very few have occurred to date in Canada. In fact, some of the few regular users of DPO are established very large motor credit issuers. Investors comfort from the due diligence and independent pricing of traditional underwritings seem to outweigh the advantage of cutting out the middleman. The Canadian Regulators Approach to Internet Securities Offerings General prospectus and registration requirements in Canadian provincial securities legislation govern the offering of securities on the Internet. As a result, unless made pursuant to an exemption, a prospectus must be filed and a receipt issued by securities regulators in each of the provinces of Canada where the offering is made. In addition, persons acting in furtherance of a trade must be registered as a dealer or exempt from registration. Issuers wishing to undertake a DPO must be specially registered as a dealer under the category securities issuer, unless the offering fits within one of the classes of exempt transactions. These requirements are supplemented by NP and NP as well as the Electronic Communications Disclosure Guidelines of The Toronto Stock Exchange 2, and National Instrument Communications With Beneficial Owners of Securities of a Reporting Issuer. NP and reflect the CSA s view that Internet offerings could be successfully incorporated into the existing securities legislation framework. Their approach was that statutory requirements relating to trading and offering securities should not change as a result of the involvement of the Internet. In other words, in the absence of specific policies, the Internet could still be utilised for a trade or offering, provided that general securities legislation was complied with. NP and NP only represent guidelines - not a mandatory change of any substantive requirements. Market participants were left free to determine how best to comply with the substantive requirements of securities legislation. The CSA decided to enact NP and NP as policies rather than mandatory rules primarily because of the continual change of the use of the Internet by market participants (at the time). 1 The text of the policies in available on the Ontario Securities Commission s web-site: 2 The text of the guidelines is available at: and includes recommendations that listed companies maintain Web sites for investor relations, notes that disclosure by Internet alone does not meet companies' disclosure obligations, prohibits misleading electronic communications, provides a duty to correct and update electronic communications, prohibits use of electronic communications to tip or leak material information, and prohibits distribution of news release via Internet before it has been distributed via newswire service in accordance with TSE Policy Statement on Timely Disclosure and Related Guidelines.

4 -4- Electronic Delivery - NP Delivery Components NP sets out the CSA s views relating to the use of electronic means to satisfy the delivery requirements of Canadian securities legislation. Canadian provincial securities legislation requires that a prospectus be sent by prepaid mail or delivered to purchasers of securities pursuant to a distribution. The word deliver is not defined in such legislation. NP , generally provides that the delivery requirements of securities legislation may be satisfied by electronic means. According to the policy there are four components to electronic delivery that should be satisfied in order to show good delivery: i) notice of delivery is made to the recipient; ii) easy access of the recipient to the document; iii) the deliverer has evidence of delivery; and iv) non-corruption or alteration of the document in the delivery process. The effect of satisfying the above components is that the deliverer is entitled to infer that the recipient actually received the document. The first three components can be satisfied through the use of a consent to electronic delivery delivered to a proposed recipient of documents. The requirement to obtain a recipient's prior consent was viewed by the CSA as necessary to prevent a disenfranchisement of securityholders. The consent required is quite burdensome on deliverer, including a listing of the documents electronically deliverable and a detailed explanation of the delivery process. Notice of delivery can be effected by electronically delivering the document to an address in respect of which consent has been obtained or by ing a notice to such address that the document can be viewed at a particular website. Easy access includes ensuring that the server of a website where a document is posted is sufficiently powerful having regard to the volume of recipients of the notice. Absent satisfaction with all four components, delivery is uncertain and NP does not include a deemed delivery provision 3 as, for example, the Securities Act (Ontario) does. The significance of this is that Canadian provincial securities legislation creates rights of withdrawal for two days after receipt of the prospectus. Where delivery does not take place purchasers are entitled to a 180 day rescission period or to a right of action for damages for up to three years. 3 The Securities Act (Ontario) deems delivery to have been made in the ordinary course of mail by the person or company to whom it is addressed.

5 -5- This appears to create a higher burden on issuers to effect delivery than was the case prior to the Internet. Securities legislation does not generally require re-delivery of documents if there is a failure in delivery. Under NP arguably, for example, delivery could fail because a recipient has not updated the deliverer with respect to their current address. In addition, the CSA recommend (but do not require) that the deliverer make available a paper version of every document delivered by electronic means. Timing NP confirmed that electronic documentation, like traditional paper documentation, must not be used to condition the market before the filing of a preliminary prospectus. Specifically, this would include the posting of information on an issuer s or market participant s website or sending s to advise of a forthcoming offering prior to the filing of a preliminary prospectus. "Paperless" Market Participants Some investment dealers contemplated communicating with investors entirely through electronic communications. The CSA therefore made certain changes to the draft version of NP to permit brokers and dealers to operate entirely on an electronic basis. However, it was thought that refusal to deliver a paper version of documents where requested might constitute a breach of their obligations under securities legislation. It was therefore recommended that market participants continue to make available, at no cost, paper versions of documents delivered electronically where requested by investors to do so. Of interest, the CSA also took the view that, in spite of the fact that electronic versions of documents may be available sooner than the printed versions, electronic delivery of materials to investors should be made contemporaneously with the mailing of the paper version of such materials. The CSA also note that delivery requirements under securities legislation contemplate that delivery will be made at the same time to all securityholders. The CSA did clarify that referring a recipient to a third party website will generally not constitute valid delivery - unless the recipient has previously consented to this form of delivery. Hyperlinked Information The CSA warned that information hyperlinked from a prospectus or other document would risk incorporating the hyperlinked information into the document. However, simply referencing a corporate website or referencing the SEDAR website was not considered to create incorporation issues provided care was taken not to hyperlink these sites. The question of who bears responsibility for information contained in hyperlinks was not neatly settled in the policy. Some observers believe that only the original information

6 -6- provider should be held responsible for any misrepresentations or inaccuracies in the hyperlinked information. However, for example, hyperlinking to third party information like research reports creates the possibility of liability for the issuer and underwriters. Potential uses for hyperlinked information include speedy movement through the document (from e.g., the table of contents), links to experts reports or multimedia materials like virtual roadshows. The first of the above uses seems to raise no regulatory concerns but as of yet has been under utilised in Canada. Likewise a hyperlink to documents incorporated by reference in a short form prospectus or to material which otherwise must be available for inspection during the offer period seem to be wise uses of the technology available but have been rarely used in Canada. Hyperlinking to other information like online roadshows and multimedia communications, although possible under NP , raises more difficult issues for regulators in Canada. As discussed below, they raise issues such as compliance with restrictions on advertising during a distribution. Multimedia Communications NP also provided guidance as to the use of communications (e.g., videos) that cannot be reproduced in a non-electronic format in statutorily mandated disclosure documents. At issue was whether the potential for misrepresentation when information is presented other than in text format outweighed the benefits to the use of multimedia communications in such disclosure documents. The CSA took the view in NP that graphics, charts and photographs can be included in statutorily mandated disclosure documents so long as such information can be provided in both electronic and non-electronic formats. However, it is not viewed as appropriate for issuers to incorporate multimedia communications which could not be non-electronically reproduced. Issuers are left to discuss special situations with staff of the appropriate provincial securities regulatory authority where a certain proposed form of multimedia communications would materially enhance an investor's understanding of a proposed offering of securities. Electronic Trading - NP Jurisdictional Issues and "Safe Harbour" Provisions Traditionally, Canadian regulators have required certain connecting factors to a Canadian jurisdiction before attempting to take jurisdiction over activities deemed troublesome. The Canadian regulators have taken a fairly broad view of this, frequently the involvement of a resident of province or the occurrence of a meeting were deemed sufficient to assert authority. Many market participants were looking for guidance from the CSA as to whether the Canadian regulators would only assert jurisdiction where Internet communications are

7 -7- directed to persons in a Canadian jurisdiction and also provide guidelines as to when electronic communications would be considered to be directed to Canadians. The policy provides that they consider a person of company to be trading in a Canadian jurisdiction if a document offers securities that are accessible to Canadian purchasers. However, the Policy includes exceptions where the document expressly discloses the jurisdictions in which the distribution is qualified (and does not include a Canadian jurisdiction), and reasonable precautions are taken by the offeror and underwriters not to sell to a Canadian resident. The CSA did advise in NP that they would not limit their authority to communications directed at Canadians. Instead, the CSA noted that persons operating out of a local Canadian jurisdiction and perpetrating a fraud on investors outside of that local jurisdiction may still be subject to the regulatory authority of the local jurisdiction from which such person physically operates. In addition, the limits of liability for registrants for the conduct of other parties who sell over the Internet to persons resident in a jurisdiction in which securities are not qualified for sale remains unclear. Some market professionals commenting on the draft NP stated that issuers should not be required to disclose in a prospectus both the Canadian and the foreign jurisdictions in which an offering is to be made, particularly to the extent that this was not previously required under securities legislation. It was further suggested that perhaps disclosure of the jurisdictions in which an offering is to be made should be made at the Internet site at which the prospectus is posted rather than in the prospectus itself. To date, jurisdiction has been asserted by the CSA on a case by case basis. For example, the Ontario Securities Commission would continue to review the nature of parties' conduct in Ontario to determine if it should assert jurisdiction and, in appropriate circumstances, will do so even if the investors are located outside of Ontario. NP also provides that a record of the names and addresses of those persons and companies who download or view an electronic version of a preliminary prospectus should be maintained so that such persons and companies can be provided with amendments to such prospectus, if any. This in effect means that persons wishing to view or download a prospectus from a website must first provide the necessary name and address information electronically. This obligation seems odd given that persons may download a prospectus directly from SEDAR, for example, without having their name and addresses recorded. In February 2000, the Alberta Securities Commission issued an order directing the "World Stock Exchange" to shut down as a threat to Alberta investors and as a business "utterly contrary" to the public interest. The Commission found that it had jurisdiction because the "exchange's principals, for example, had conversations with between 30 and 40 people in Alberta, several of whom lost substantial sums of money." The exchange was begun by two Canadians in October 1997 and touted itself as set up so as not to be

8 -8- subject to the securities laws of any country. The Alberta Securities Commission ordered the site shut down and the site was promptly moved to the Cayman Islands. Reportedly "[p]roblems with island police resulted in yet another move to Antigua." Cyberscam On March 29, 2001 the Ontario Securities Commission ( OSC ) revealed that it had two months previously posted a fake investment Web site 4. The site specifically attempted to lure Canadian investors, claiming that its offer of "international debentures" traded by big players in "a secret European location" were eligible for Canadian tax-free retirement savings plans. It promised "little no risk" investing with "profits of up to 30%". Visitors could invest online. More than 1,000 people visited the site and "[p]eople who made an effort to try and send [the site] money received a reply saying that the system was, for technical reasons, incapable of receiving anything". The site was discovered by state securities regulators in Washington state and by Canadian regulators in British Columbia, Manitoba and Ontario who were not told of the project. Interestingly, in spite of its Canadian targetting, the OSC found said some 60 percent of the site's visitors were from the U.S., 30 percent were from Canada, and 10 percent from other countries. Roadshows The primary requirement in Canada is that if a prospective purchaser is solicited in respect of an offering, they must be provided with a copy of the prospectus. Unlike the U.S. there was no regulatory concern that a roadshow could constitute of itself a prospectus. NP also attempts to control electronic access to roadshows transmitted over the Internet. The CSA recommends that: i) reasonable steps be taken that the information in the roadshow is not inconsistent with the prospectus; ii) a copy of the filed preliminary prospectus be made available to all viewers of the roadshow; iii) electronic access to the roadshow should be controlled (e.g., through passwords) by the issuer or underwriter so all viewers can be identified and offered a preliminary prospectus; and iv) the viewer must agree not to copy, download or further distribute the roadshow. However, the roadshow guidelines are apparently inconsistent with existing securities legislation because: 4 The site has been moved and is now available on the OSC's Web site at

9 -9- i) the requirement for password protection and controlled access effectively results in only institutional investors being able to view a roadshow since retail investors will likely find out about the offering after the deal has been priced and the final prospectus filed; ii) there is no requirement currently to identify every person at a conventional roadshow; iii) there is no requirement currently to provide a prospectus before one's attendance at a roadshow; and iv) there is no restriction on how widely an investor may circulate a printed version of a "green sheet" or a printed prospectus after a roadshow. The guidelines are an example of the failure to encourage the use the Internet to broaden audiences and democratize distributions. The guidelines may in fact effectively restrict the use of electronic roadshows to the same "favoured few" who are currently invited to conventional roadshows. Taken together with the following advertising concerns, it is evident that Canadian regulators did not want to move far from the traditional model of investors relying on a written prospectus after the filing of a preliminary prospectus. While the CSA acknowledged that issuers and underwriters could not necessarily control the ultimate use of information distributed at a roadshow, in the CSA's view, NP strikes a reasonable balance between the needs of issuers and underwriters on the one hand and investor protection on the other hand. Advertising NP provides that in some circumstances, posting information on a website during a distribution may be construed as advertising and be subject to the rules restricting advertising during a distribution. While the CSA claimed it was not intending to prohibit the posting of continuous disclosure during a distribution it was not possible to detail in NP every potential circumstance that could arise in connection with the posting of information on a website and therefore left it to market participants and their advisers consider the matter on a case by case basis and, where appropriate, develop policies regarding the use and maintenance of issuers' and underwriters' websites. As a result, difficulty issues arise where the issuer promotes its business on its website while displaying a prospectus. Appropriate disclaimers must be displayed prominently and the website sterilised to ensure the accuracy and consistency of the website and the deletion of out-of-date, inconsistent or other potentially inappropriate information.

10 -10- Small Offerings DPOs - Security Issuer Registration The popularity of Internet DPOs for smaller issuers in the United States has not been duplicated to date in Canada. The obligation to register in Canada as a "security issuer" dealer (except in limited exempt offering transactions) appears to act as a significant deterrent. There is a not insignificant financial and timing cost to registering the issuer and its directors and officers in each jurisdiction where the offering is to be made. Practically speaking the registration process adds virtually nil to the investor protection as the application forms required to be completed by direct issuers are very much related to the activities of professional investment banks, such as knowledge of the obligations of registrants. This may in part account for the fact that direct public offerings did not become a favoured tool of junior issuers. There have been few DPOs with the exception of major issuers, such as Ford Credit, offering their shelf prospectus debt programs directly. Regulatory Regime Another factor minimising the benefit of the Internet to offerings by small issuers in Canada is the private placement regime, and more particularly, the lack of an equivalent of Rule 504 under the US Securities Act of Ironically it is therefore easier for small Canadian issuers to raise money in the United States than in Canada. Such rule permits U.S. and non-u.s. issuers to raise up to US$1.0 million in 12 months from the public without mandated disclosure requirements. Canadian securities legislation does not offer an equivalent opportunity even after recent amendments to the private placement regime. Electronic Voting NP , which permits electronic delivery in many cases, does not apply where the mode of delivery was specified in legislation and those specifications do not include electronic delivery. Canadian corporate and securities legislation generally requires proxy materials to be delivered by prepaid mail. However, recent changes to the Canada Business Corporations Act ( CBCA ) will permit shareholders of Canadian companies to receive proxy materials and vote online for the first time later this year. Electronic voting is permitted unless specifically prohibited in the company s by-laws. In addition, draft National Instrument No ( NI ), will replace existing National Policy No. 41 which prohibits the electronic delivery of proxy materials to registered shareholders. Requirements in Canadian securities legislation that a proxy be

11 -11- in a form capable of execution have in the case of Ontario been satisfied through the Electronic Commerce Act, Electronic voting rules will require shareholders to enrol by using an enrolment number provided by regular mail. Once enrolled the shareholder will receive notification of the availability of proxy materials. Chat Rooms Regulators have shown signs that they are concerned about the use of chat rooms to manipulate share prices during distributions and in the secondary market. In fact it was reported 5 in November of last year that The Toronto Stock Exchange was testing an online surveillance technology that "trolls through Internet chat rooms and bulletin boards for mentions of public companies and rates conversations according to their 'mood.'" In addition, in October 2000 Bloomberg News 6 reported that the Quebec Securities Commission was studying a series of cases in which brokers may have used the Internet to influence stock prices. According to the report, the move followed accusations brought by the Quebec Securities Commission against an investment adviser accused of posting messages to a message board in an alleged attempt to manipulate the price of a stock which trades on the Nasdaq Stock Market. Conclusion With the decline of the small non-bank-owned Internet investment banks and the CSA s unwillingness to take bold steps to level the playing field, offerings, even those offered in part on the Internet, are still dominated by the traditional players. As a result, little market for small offerings, including DPOs, has developed and Canadian technology and biotechnology growth companies began heading to the U.S. to raise capital. The CSA has demonstrated that it is unwilling to move far from the model of investors relying on written prospectuses. The OSC s attempt to demonstrate the ease of perpetrating a cyperscam is evidence of their present mindset. Unfortunately, there will be little short to medium term impetus for significant further change given present market conditions. If Canada can not re-grow its junior market for growth companies by increasing opportunities for on qualified small offerings, the prospects for the Canadian capital markets look bleak indeed. 5 Wendy Stueck, TSE Tests Chat Room e-watchdog, GlobeTechnology (Nov. 6, 2000). 6 Frederic Tomesco, Securities Agency Looks at Web Abuses, Bloomberg News special to MontrealGazette.com (Oct. 4, 2000).