Report Early, Report Often: CSA Adopts Final Amendments to Early Warning System
March 15, 2016
On February 25, 2016, the Canadian Securities Administrators (CSA) published final amendments to the rules governing early warning reporting in Canada (Final Amendments). The Final Amendments were released concurrently with the final amendments to Canada’s take-over bid rules, which are discussed in our February 2016 Blakes Bulletin: Finish Line in Sight: New Take-Over Bid Rules are Coming. The Final Amendments are designed to provide greater transparency with respect to significant holdings of the securities of reporting issuers in a manner that is suitable for the Canadian capital markets.
The Final Amendments are not materially different from the CSA’s proposed amendments previously published for comment in March 2013 and updated in October 2014. Except in Ontario, the Final Amendments will come into force on May 9, 2016. In Ontario, the Final Amendments will come into force on the later of May 9, 2016 and the day on which the relevant legislation is proclaimed into force.
The CSA first published for comment proposed amendments to the framework for early warning reporting in March of 2013 (Proposed Amendments) (see our March 2013 Blakes Bulletin: CSA Move to Enhance Transparency of Significant Voting Positions and Economic Interests for more information). In October 2014, the CSA published an update of the Proposed Amendments in which the CSA indicated that it did not intend to proceed with certain of its key proposals, including reducing the reporting ownership threshold from 10 per cent to five per cent and including “equity equivalent derivatives” for the purposes of calculating an investor’s ownership level. See our November 2014 Blakes Bulletin: CSA Revises Approach to Amending Early Warning Report Regime for more information.
As discussed in our March 2013 Blakes Bulletin: CSA Move to Enhance Transparency of Significant Voting Positions and Economic Interests, the CSA originally proposed a reduction of the early warning reporting threshold from 10 per cent to five per cent, to match the threshold applicable in the U.S. and several other major foreign jurisdictions. While the CSA determined not to proceed with this proposal, the Final Amendments will require disclosure by a person who is required to report under the early warning regime where their ownership of, or control or direction over securities decreases (in addition to increases) by two per cent or more or falls below the 10 per cent reporting threshold.
Alternative Monthly Reporting Regime
The Final Amendments will disqualify institutional investors who solicit proxies from security holders in order to contest director elections or a reorganization, amalgamation, merger, arrangement or similar corporate action involving the securities of the reporting issuer from relying on the alternative monthly reporting (AMR) regime that is available to eligible institutional investors. The Proposed Amendments would have made the AMR regime unavailable for an institutional investor who “solicits or intends to solicit” proxies for such purposes. In response to comments requesting clarification of the scope of the new disqualification, the Final Amendments have removed the concept of “intends to solicit.” The Final Amendments also specify that the term “solicit” has the meaning given to it in National Instrument 51-102 Continuous Disclosure Obligations, and will therefore not include certain activities, such as a public announcement of how a securityholder intends to vote and communications to other securityholders regarding the business and affairs of a reporting issuer that are not accompanied by a proxy solicitation.
The CSA has moved away from explicitly recognizing that certain equity derivatives must be included in applying the early warning reporting triggers. In its place, the CSA has provided general guidance to the effect that an equity derivative arrangement may, under certain circumstances, result in deemed beneficial ownership, or control or direction, over the referenced voting or equity securities. Specifically, the guidance suggests that an equity derivative arrangement will need to be reflected in the early warning threshold calculation if the arrangement gives an investor the ability, formally or informally, to obtain the referenced securities or to direct the voting of referenced securities held by any counterparties to the derivative arrangement.
Nevertheless, the prescribed early warning disclosure forms will require an investor who otherwise becomes subject to early warning disclosure in respect of a security to describe the material terms of any agreement, arrangement or understanding (excluding the identity of the counterparty or proprietary or commercially sensitive information) that has the effect of altering, directly or indirectly, its “economic exposure” to such security. The definition of economic exposure for this purpose is taken from National Instrument 55-104 Insider Reporting Requirements and Exemptions; namely, the extent to which the economic or financial interests of a person or company are aligned with the trading price of securities of the issuer or the economic or financial interests of the issuer. The CSA concluded that such enhanced disclosure was appropriate to ensure that the reports provide complete disclosure about the investor’s interest in an underlying issuer.
As we described in our March 2013 Blakes Bulletin: CSA Move to Enhance Transparency of Significant Voting Positions and Economic Interests, the Proposed Amendments included changes to require early warning disclosure of certain “hidden ownership” arrangements, under which an investor could use equity derivatives to accumulate an economic position in an underlying issuer without public disclosure and then convert its position into voting securities in time to exercise a vote. To address this scenario, the Proposed Amendments contemplated that “equity equivalent derivatives” would be taken into account in applying the early warning triggers and making early warning disclosures. The CSA’s focus was on equity derivatives that would substantially replicate the economic consequences of ownership of underlying securities, providing an investor with a notional “long position” and an economic interest substantially equivalent to holding the securities directly. If the counterparty who took the “short position” under the derivative was a market participant who could substantially hedge itself by holding 90 per cent or more of the underlying securities, the arrangement would generally be considered to be an “equity equivalent derivative” on the basis that the market participant would have a strong economic incentive to hedge and might well decide to vote in accordance with the investor’s wishes or to make the securities available to the investor on request.
There was considerable opposition to this proposal. Commenters emphasized that equity derivatives are commonly used for risk management purposes and to implement trading strategies, and are not necessarily entered into for the purpose of influencing underlying issuers or voting outcomes. There was also recognition that the proposals could add undue complexity, while not providing relevant information to the market.
On this basis, the CSA removed the concept of “equity equivalent derivatives.” Instead, the CSA chose to elaborate on the circumstances in which the existing early warning threshold would apply to derivative arrangements, by providing guidance in National Policy 62-203 Take-Over Bids and Issuer Bids to the effect that an equity swap or similar derivative arrangement may have to be included in the early warning threshold calculation (and indeed more broadly with respect to early warning and take-over bid requirements) if an investor has the ability, formally or informally, to obtain the voting or equity securities or to direct the voting of voting securities held by any counterparties to the transaction.
The CSA’s shift away from economic equivalence to focus on voting rights more clearly aligns with the underlying focus on voting control in the early warning requirements. That said, the guidance provided by the CSA is directed at the substance of an equity derivative arrangement, to uncover the real consequences of the arrangement. As a result, it will be necessary to take account of any tacit or informal voting arrangements beyond the written words of the derivatives contract itself in determining whether the early warning ownership threshold is reached.
As noted above, once an investor is required to provide an early warning report in respect of a security, an equity derivative transaction that impacts on its “economic exposure” to such security will need to be described in the prescribed form of early warning reports. Accordingly, an equity derivative arrangement that does not affect voting rights or control or direction over an underlying security may not be relevant for the purposes of applying the early warning ownership threshold calculation, but may well be disclosable if and to the extent that the investor is otherwise required to provide early warning disclosure in respect of the underlying security.
As previously indicated, the Final Amendments will not subject lenders of securities transferred or lent pursuant to a “specified securities lending arrangement” to the early warning requirements. For a loan or transfer of securities to qualify as a “specified securities lending arrangement”, the lender must have established policies and procedures pursuant to which it maintains a written record of all securities transferred or lent and the securities must be transferred or lent under the terms of a written agreement. The terms of the agreement must require the borrower to pay to the lender the amount of any dividends or interest payments paid on the securities during the term of the loan and must grant the lender the unrestricted right to recall the securities loaned prior to the record date for voting at any meeting of securities holders at which the borrowed securities may be voted or, alternately, require the borrower to vote the borrowed securities in accordance with the lender’s instructions.
Although not included in the Proposed Amendments, the Final Amendments also include an exemption for borrowers of securities under certain lending arrangements. In response to comments it received on the Proposed Amendments, the CSA acknowledged that those who borrow securities in the course of short selling activities generally engage in borrowing for commercial or investment purposes and not with the intent of voting the borrowed securities or influencing voting. Such short selling activities do not, therefore, give rise to the concern that the derivatives or securities lending arrangements are being used by investors to influence the outcome of a shareholder vote without the investor having a significant economic interest in the issuer. To qualify for the exemption, the borrower must dispose of the borrowed securities within three business days of the date of the loan or transfer; have an arrangement whereby the borrower will, at a later date, acquire the securities or identical securities and return or transfer them to the lender; and not vote nor intend to vote the borrowed securities or identical securities during the term of the loan.
However, while these exemptions will exclude qualified securities lending arrangements from the early warning ownership threshold calculation, all securities lending arrangements involving securities of the class of securities in respect of which early warning disclosure is otherwise required will be required to be disclosed in the related early warning report.
Enhanced Disclosure and Other Changes
The Final Amendments will introduce enhanced disclosure of an acquiror’s economic and voting interests with respect to the class of securities in respect of which an early warning report is required to be filed. As noted above, the Final Amendments will require detailed disclosure of the material terms of related financial instruments, securities lending arrangements and other agreements, arrangements or understandings involving the securities that are the subject of an early warning report (but excluding proprietary or commercially sensitive information). The Final Amendments will also require more detailed disclosure regarding investors’ intentions in acquiring securities and the purpose of the transactions.
The Final Amendments will require that early warning news releases be issued and filed by no later than the opening of trading on the next business day following the date of the transaction giving rise to the reporting requirement. In addition, the acquiror will be required to certify that the information disclosed in the early warning report is true and complete in every respect. In the case of an early warning report filed by an agent on behalf of an acquiror, the agent must certify that, to the best of his or her knowledge, information and belief, the information provided is true and complete in every respect and the acquiror will remain responsible for ensuring that the information disclosed is true and complete.
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