A Basic Overview of Securities Regulation in British Columbia

Transcription

1 SECURITIES FOR JUNIOR LAWYERS AND LEGAL SUPPORT STAFF PAPER 1.1 A Basic Overview of Securities Regulation in British Columbia These materials were prepared by Dwight D. Dee of Miller Thomson LLP, Vancouver, BC, for the Continuing Legal Education Society of British Columbia, February Dwight D. Dee

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3 1.1.1 A BASIC OVERVIEW OF SECURITIES REGULATION IN BRITISH COLUMBIA I. Introduction...1 II. Sources of Law...2 III. What is a Security?...2 IV. Objectives of Securities Legislation and Principal Requirements...3 V. Registration...3 A. What is a Trade?... 4 B. Requirements for Registrants... 4 C. Exemptions from Registration... 4 D. Advising... 4 VI. The Prospectus Requirement...4 A. What is a Distribution?...5 B. Going Public and Becoming a Reporting Issuer... 5 C. Prospectus... 5 D. Exemptions from Prospectus Requirements... 5 E. Resale Restrictions and the Closed System... 6 VII. The Continuous Disclosure Requirements...6 A. Insider Trading and Tipping... 7 B. Insider Reporting Obligations... 7 C. Corporate Governance... 8 VIII. The Take-Over Bid Requirements...8 IX. Rules of Stock Exchanges...8 X. Conclusion...9 I. Introduction The purpose of this paper is to provide an overview of securities regulation in British Columbia. This paper will provide an outline of the general framework of securities legislation and discuss some of the principal areas of regulation.

4 II Sources of Law The principal statute governing the securities industry and the trading of securities in BC is the Securities Act, R.S.B.C. 1996, c The Securities Rules, BC Reg 194/97 as am., set out more detailed regulatory requirements. Several other regulations promulgated under the Securities Act (e.g., BC Reg 196/97) deal with matters involving the BC Securities Commission (the BCSC ), the provincial agency responsible for administering the Securities Act. The Securities Act grants rule making authority to the BCSC 1 and under its rule making powers, the BCSC has adopted a significant number of rules. Most significantly, in an effort to harmonize securities regulation across the country, the BCSC, in co-operation with other provincial securities regulators, has brought into force a large number of national and multilateral instruments which have also been adopted in some or all of the other Canadian jurisdictions. The BCSC also issues policy statements to provide guidance as to how it intends to interpret regulations and use its discretion. Exemption orders, enforcement orders and decisions of the BCSC (as well as other commissions across the country), along with case law, also provide guidance as to the interpretation of legislation and rules. III. What is a Security? The principal objective of securities legislation is to protect the interests of investors when they choose to invest in securities. So, a good place to start a discussion on securities regulation is to consider what securities are. The Securities Act uses the term security broadly and defines it to not only include things we would normally think of as a security, such as a bond, debenture, note share, stock, unit, unit certificate but also includes, among others, items such as a document, instrument, or writing commonly known as a security ; a document evidencing an option, subscription or other interest in or to a security ; a profit sharing agreement or certificate ; and an investment contract. 2 With this broad and non-exclusive definition in the statute, one has to turn to case law for further guidance. The Supreme Court of Canada in Pacific Coast Coin Exchange of Canada et al. v. Ontario (Securities Commission), [1978] 2 S.C.R. 112 adopted two important tests in consideration of whether something was a security : the common enterprise test and the risk capital test. The common enterprise test, which was based on the American decision of the Securities and Exchange Commission v. W.J. Howey Co. (1946), 328 U.S. 293 found that an investment contract (and therefore a security ) exists when three factors are present: (1) a person invests money; (2) in a common enterprise; and (3) the investor is lead to expect profits solely from the efforts of the promoter or a third party. The risk capital test which was developed in State of Hawaii v. Hawaii Market Center, Inc. (1971), 485 P. 2d 105, expands on the common enterprise test and sets out that an investment contract exists when: (1) the offeree (i.e., investor) furnishes initial value (i.e., an investment) to an offeror (i.e., an issuer); (2) a portion of the initial value is subjected to risks of the enterprise; 1 Securities Act, R.S. B.C c. 418, s See definition of security in Securities Act, s. 1(1).

5 1.1.3 (3) the furnishing of the initial value is induced by promises or representations leading to a reasonable expectation or understanding that a benefit above the initial value will accrue to the offeree as a result of the operation of the enterprise; and (4) the offeree does not have the right to exercise practical and actual control over the managerial decisions of the enterprise. These two tests provide for a wide scope for the meaning of the term security and, therefore, the application of securities legislation can be very broad. IV. Objectives of Securities Legislation and Principal Requirements The stated mission of the BCSC, is to protect and promote the public interest by fostering: (1) a securities market that is fair and warrants public confidence; and (2) a dynamic and competitive securities industry that provides investment opportunities and access to capital. 3 Securities regulation is meant ensure the public can have confidence when they choose to invest in securities and that issuers who access the capital markets engage in common rules of fair play. Securities regulation can be said to have four principal objectives: (1) to ensure investors have relevant information needed to make informed investment decisions; (2) to set out standards and rules for fairness in the capital markets; (3) to establish qualifications and competency requirements for investment professionals and the investment industry; and (4) to promote investor confidence and protection through enforcement. Securities regulation attempts to achieve these objectives by four broad sets of requirements: (1) the registration provisions which require those in the investment industry to have certain qualifications and knowledge and abide by certain standards; (2) the prospectus provisions which require the preparation and provision of a document called a prospectus when a security is issued for the first time; (3) the continuous disclosure provisions which require issuers that have offered securities to the public to disclose information that will assist investors in making investment decisions; and (4) the take-over bid provisions which require uniform and fair treatment of securityholders in take-over bids. 4 This paper will briefly discuss each of these broad areas of regulation. V. Registration The principal registration requirement found in s. 34 of the Securities Act provides that a person must not trade in a security unless the person is registered in accordance with the regulations. Essentially, this requirement is a licencing requirement which provides that only persons who meet a certain level of knowledge and who are bound by certain standards and rules can trade securities. 3 BC Securities Commission, Service Plan , April Outline based on Vancouver Stock Exchange, An Introduction to Securities Law in British Columbia, July 1997.

6 A. What is a Trade? The act that triggers the registration requirement is the act of trading in securities. Section 1(1) of the Securities Act defines trade broadly and the definition includes: dispositions of a security for valuable consideration and also includes any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any activity that would constitute as a trade. B. Requirements for Registrants For those who wish to be registered, there are different categories of registration which are set out in the Securities Rules. BC Policy Registration Requirements summarizes the principal requirements for each registration category. This policy also provides guidance on how the BC Securities Commission is likely to exercise discretion under the legislation in various circumstances. The BCSC has authorized the Investment Industry Regulatory Organization of Canada ( IIROC ), the self-regulatory organization which oversees investment dealers, to register investment dealers and their trading employees. In addition to adhering to rules and regulations of self-regulatory organizations they are a member of, registrants must abide by rules and standards of conduct set out in the Securities Rules and other regulatory instruments. For example, s. 14 of the Securities Rules requires registrants to deal fairly, honestly and in good faith with the clients of the registrant. Section 48 of the Rules requires registrants to know their client and ensure that the registrant makes a reasonable effort to advise a client if the registrant considers a proposed purchase and sale of a security is not suitable for the investment needs and objectives of a client. C. Exemptions from Registration The BC Securities Commission recognizes that a registrant is not necessarily required to be involved in every trade in order to protect the investing public. For this reason, the rules and regulatory instruments set out various exemptions to the registration requirements. The exemptions set out circumstances in which the securities regulators believe that a purchaser can buy or sell a security without the assistance of a registrant. Certain exemptions are found in the Securities Act in ss. 45 and 46. Commonly used exemptions to the registration requirement are also set out in National Instrument Prospectus and Registration Exemptions. The exemptions found in National Instrument will be discussed in more detail below. D. Advising Section 34(1) also requires that a person not act as an adviser unless the person is registered. The BCSC has interpreted advising to be offering an opinion about the investment merits of, or recommending the purchase or sale of, securities. In BC Instrument , the BCSC provides guidance as to what activities who require registration as an adviser under the Securities Act. VI. The Prospectus Requirement The prospectus requirement set out in section 61 of the Securities Act provides that: a person must not distribute a security unless: (a) a preliminary prospectus and a prospectus respecting the security, have been filed with the executive director [of the BCSC] and the executive director [of the BCSC] has issued receipts for the preliminary prospectus and prospectus. The prospectus requirement is a key regulatory requirement with the objective of ensuring that an issuer seeking to receive investments from members of the public makes available relevant information about the issuer.

7 A. What is a Distribution? The trigger for the prospectus requirement is a distribution of securities. The term distribution is defined in s. 1(1) of the Securities Act. Most commonly, a distribution is a trade in a security of an issuer that has not been previously issued. For example, the sale of common shares by a company from its treasury to raise capital would be a distribution. The definition of distribution also includes, however, a trade in a previously issued security of an issuer from the holdings of a control person. A control person is generally a person that holds sufficient voting rights to affect materially the control of the issuer and is deemed to be anyone who holds more than 20% of the voting securities of an issuer. 5 B. Going Public and Becoming a Reporting Issuer Generally, a prospectus is first filed by an issuer when it needs to raise capital from members of the public (i.e., persons that are not personally known to the directors/officers/founders of the issuer) and the issuer is no longer able, or does not wish to rely on an exemption to the prospectus requirement. In connection with the filing of a prospectus, an issuer usually seeks a listing of its securities on a stock exchange in order that its securities (usually its common shares) have a ready market where people can conveniently buy and sell the securities. The process of filing an issuer s first prospectus and seeking a listing on an exchange is commonly referred to as going public or the initial public offering or IPO. When an issuer files a prospectus or seeks a listing of its securities on a stock exchange, it becomes a reporting issuer under the Securities Act. 6 C. Prospectus A prospectus is a disclosure document that contains a full description of the business, affairs, securities and management of an issuer. The Securities Act requires that a prospectus must contain full, true and plain disclosure of all material facts relating to the securities offered. National Instrument General Prospectus Requirements and the accompanying Form F1 set out the requirements for the contents of a prospectus. These include specific disclosure on the issuer s business, history, products, competitors, markets, management and directors, and financial condition. National Instrument also sets out requirements for financial statements that must be included with a prospectus. A prospectus must not contain any misrepresentations. A misrepresentation is defined by the Securities Act as an untrue statement of a material fact or an omission to state a material fact that is required to be stated or necessary to prevent a statement from being false or misleading in the circumstances in which it was made. 7 Section 131 of the Securities Act provides that a person who purchases a security offered by a prospectus during the period of distribution is deemed to have relied on the misrepresentation and has a right of action for damages against persons including the issuer, the directors of the issuer, and every underwriter who signed the prospectus. D. Exemptions from Prospectus Requirements As discussed above, not all trades of a security are viewed by regulators to necessarily require the advice of a registrant and similarly, not all distributions of a security are viewed to require an issuer to have to prepare and provide a prospectus. Exemptions for both the registration and prospectus requirements are available and oftentimes an exemption to the registration requirement has a corresponding exemption to the prospectus requirement. 5 See definition of control person in Securities Act, s. 1(1). 6 See definition of reporting issuer in Securities Act, s. 1(1). 7 See definition of misrepresentation in Securities Act, s. 1(1).

8 1.1.6 As indicated above, National Instrument Prospectus and Registration Requirements contains most of the commonly used exemptions. Certain of the exemptions are based on the assumption that there are certain purchasers of securities who are sophisticated enough to not require the protection of a registrant or prospectus. For example, the accredited investor exemption permits certain classes of persons (e.g., certain institutions, wealthy individuals) to purchase under an exemption. Other exemptions are provided based on the close relationship between the issuer and its directors and officers with the purchaser of the securities (e.g., family, friends and business associations exemption, private issuer) or the nature of the transaction of which the trade or distribution is a part. It is a common misconception that securities laws only apply to public companies (i.e., companies whose securities are listed for trading on a stock exchange). In actuality, securities laws apply to all entities that distribute/trade securities, whether the company or issuer is a listed entity or not. Private companies should ensure that when distributing securities, they comply with an available exemption to the prospectus requirement. The most common exemption used by private companies is the private issuer exemption found in National Instrument The private issuer exemption allows an issuer to sell securities without any disclosure provided that it has a limited number of securityholders, has only distributed to a certain listed class of persons, and the issuer s constating documents contain restrictions on the ability of securityholders to transfer their securities. Certain of the prospectus exemptions require the filing of a report of exempt distribution with the BCSC within 10 days of the date of the distribution. When using a prospectus/registration exemption, issuers should be careful to ensure that all the conditions of the exemption are met. E. Resale Restrictions and the Closed System When a purchaser acquires a security in a distribution in which the issuer of the security has relied on an exemption from the prospectus requirements, the first trade of the security by the purchaser (in other words, the first sale of the security) may be subject to resale restrictions. This is the result of what is referred to as the closed system. If securities are not originally qualified by a prospectus, the securities are said to be caught within the closed system and securities regulations do not permit the person who originally purchased the securities to sell to other persons unless they can comply with another prospectus exemption or they meet certain conditions, often referred to as the resale rules. The resale rules are generally found in National Instrument Resale Restrictions. The rules are specific and can be quite complex. Generally, securities of a reporting issuer must be held by the original purchaser for a period of four months before they can be sold without relying on a prospectus exemption. Securities of a non-reporting issuer generally cannot be sold without a prospectus exemption until the issuer becomes a reporting issuer, usually by filing a prospectus. VII. The Continuous Disclosure Requirements Once an issuer becomes a reporting issuer, it is subject to on-going disclosure requirements. These disclosure requirements are meant to ensure that members of the public that are trading the securities of the reporting issuer have current and accurate information to make informed decisions about whether to buy or sell an issuer s securities. Generally, the continuous disclosure rules require a reporting issuer to immediately announce material changes in its affairs; file interim and annual financial statements; provide an analysis of its financial results; provide disclosure about significant acquisitions; disclose details on executive compensation; comply with certain standards for soliciting proxies; and publicly file its constating documents and material contracts. The specifics of these rules can be found in National Instrument Continuous Disclosure Obligations. Continuous disclosure 8 Refer to National Instrument Prospectus and Registration Exemptions, section 2.4.

9 1.1.7 documents of a reporting issuer are generally filed through SEDAR, the System for Electronic Document Analysis and Retrieval, the electronic filing system established by the Canadian Securities Administrators to facilitate electronic filing and public dissemination of information from reporting issuers available at Reporting issuers in certain industries have special disclosure requirements that they must adhere to. Mining companies are required to comply with National Instrument Standards for Disclosure for Mineral Projects when disclosing scientific or technical information concerning a mineral project on a property material to the issuer. Issuers in the oil and gas industry must comply with the standards set out in National Instrument Standards of Disclosure for Oil and Gas Activities. Reporting issuers must ensure its continuous disclosure record is accurate, complete and up to date. Persons who trade in a security when there is a misrepresentation in the reporting issuer s public record may commence an action against the issuer, its directors, officers, insiders and promoters (as well as others). A. Insider Trading and Tipping The Securities Act prohibits a reporting issuer or a person in a special relationship with a reporting issuer from informing anyone, other than in the necessary course of business, of a material fact or a material change before that material information has been generally disclosed to the public. This prohibited activity is commonly known as tipping. Securities legislation also prohibits anyone in a special relationship with a reporting issuer from purchasing or selling securities of the reporting issuer, with knowledge of a material fact or material change about the reporting issuer that has not been generally disclosed. This prohibited activity is known as insider trading. The prohibitions against tipping and insider trading are designed to ensure that anyone who has access to material undisclosed information does not trade or assist others in trading to the disadvantage of investors generally. In simple terms, a person is in a special relationship with a reporting issuer when a person is an insider, affiliate or associate of a reporting issuer; a person is engaging in or is proposing to engage in any business or professional activity with or on behalf of the reporting issuer; a person is a director, officer or employee of the reporting issuer; and includes anyone who learns of material information from someone that the person knows or should know is a person in a special relationship with the reporting issuer. B. Insider Reporting Obligations Section 87 of the Securities Act requires a person to file an insider report within ten days after becoming an insider of a reporting issuer. Generally, an insider is a director or senior officer of an issuer; a director or senior officer of a person that itself is an insider or a subsidiary of the issuer; and a person that has beneficial ownership of securities of the issuer that carry more than 10% of the voting rights of all the issuer s outstanding voting securities. The form of insider report is found in Form 1 of National Instrument System for Electronic Disclosure by Insiders ( SEDI ) and requires disclosure of the person s full legal name, address, telephone number, fax number (if applicable), address (if applicable), the name of the reporting issuer, the insider s relationship to the reporting issuer and the date the insider became an insider of the reporting issuer. More importantly, an insider must disclose in the insider report the amount of their direct or indirect beneficial ownership of, or control or direction over, securities of that public company, and any changes in that ownership. Thereafter, any changes to an insider s holdings of securities in the reporting issuer need to be reported within ten days of each trade. The insider report is filed electronically through the System for Electronic Disclosure by Insiders, a national electronic insider reporting system available at

10 C. Corporate Governance In recent years, the securities regulators have emphasized the importance of directors and management of reporting issuers adhering to certain minimum standards in relation to overseeing and managing the affairs of an issuer. These rules, generally referred to as corporate governance rules include standards relating to audit committees; certification of an issuer s annual and interim financial statements and management discussion and analysis; and disclosure with respect to board oversight and practices. VIII. The Take-Over Bid Requirements One of the objectives of securities legislation is to ensure that all security holders are treated fairly when an offer is made by a third party to acquire control of an issuer, or when the issuer itself seeks to repurchase its own shares. The take-over and issuer bid rules are largely set out in Multilateral Instrument Take-Over Bids and Issuer Bids. A take-over bid is triggered when a person makes an offer to acquire voting securities or equity securities of a class made to one or more persons where the securities subject to the offer to acquire, together with the offeror s securities, constitute in the aggregate 20% or more of the outstanding securities of that class of securities at the date of the offer to acquire. When a take-over bid is triggered, an offeror must comply with certain requirements. These include making the offer of identical consideration to all holders of the class of security that is the subject of the bid; making a public announcement of the bid in a newspaper; and sending out a bid circular to security holders which explains the terms and conditions of the bid. Directors of an issuer whose securities are the subject of a take-over bid are required to evaluate the proposed bid and circulate a directors circular indicating whether they recommend to accept or reject the bid or are not unable or are not making a recommendation regarding the bid. Strict timelines must be adhered to. The take-over bid rules also require that whenever a person acquires beneficial ownership of, or control or direction over, voting or equity securities of any class of a reporting issuer or securities convertible into voting or equity securities of any class of a reporting issuer that, together with the person s securities of that class, would constitute 10% or more of the outstanding securities of that class, the person must file a press release announcing that fact and file an early warning report with the BCSC. An additional news release and report must be filed at each instance the person acquires an additional 2% or more of the outstanding securities or securities convertible into 2% or more of the outstanding securities. An issuer bid is defined in Multilateral Instrument to be an offer to acquire or redeem securities of an issuer made by the issuer to one or more persons 9 Similar requirements to a takeover bid exist for issuer bids. Multilateral Instrument also contains a number of exemptions to the take-over bid and issuer bid requirements IX. Rules of Stock Exchanges The vast majority of reporting issuers have their securities listed on a stock exchange. When an issuer is listed on a stock exchange, the issuer executes a listing agreement with the exchange which requires the issuer to covenant to abide by the stock exchange s rules and policies. The rules and policies of a stock exchange often include standards of disclosure and corporate governance that are above and beyond what is required under securities regulation. In addition, stock exchange policies also may require approval of the exchange and adherence to exchange policies with respect to securities offerings, stock options and significant transactions, acquisitions or divestitures. 9 See definition of issuer bid in Multilateral Instrument Take-Over Bids and Issuer Bids.

11 1.1.9 X. Conclusion This paper is designed to give a broad introduction into securities law in BC. Of course, it cannot provide a comprehensive summary of all the rules. Anyone who has practiced securities law for a period of time knows how complex securities regulation can be and how quickly things change in this area of practice. As of the date of the writing of this paper, for example, there are significant proposals to revamp the requirements related to registration. In addition, new initiatives are being announced towards moving to a national securities regulator and to replace provincial legislation with a single securities act for the entire country. Having said this, no matter how specific rules change, the basic objectives of promoting investor confidence and ensuring fair and orderly capital markets will remain fundamental to all securities regulation.