Canadian Securities Law : Canadian Securities Lawyer & Attorney : Stikeman Elliott Law Firm : Montreal, Ottawa, Calgary, Vancouver, Montreal, Toronto

The Multilateral Instrument also sets out to introduce greater consistency with the reporting requirements under U.S. securities law in relation to equity monetizations, i.e. equity monetizations that are reportable under U.S. insider reporting requirements will also generally be covered by Canadian insider reporting requirements, unless subject to an exemption.

The Multilateral Instrument does not address control block issues or early warning reports, which the CSA indicated may be considered in the context of the proposed Uniform Securities Legislation initiative.

Reporting Obligations under the Multilateral Instrument
The Multilateral Instrument does not prohibit insiders from entering into equity monetization and similar derivatives transactions. Rather it requires insiders to report the existence, material terms, material amendments and terminations of such transactions. However, other requirements of Canadian securities laws, such as (i) insider trading laws that generally prohibit insiders (and certain others) from trading in securities of a reporting issuer while in possession of material undisclosed information about the issuer; and (ii) the escrow requirements of National Policy 46-201 - Escrow for Initial Public Offering, may prohibit an insider from entering into equity monetization and similar derivatives transactions either while in possession of material undisclosed information or generally.

Under the Multilateral Instrument, unless exempted, an insider is required to file an insider report in a circumstance where the insider enters into, materially amends, or terminates an agreement, arrangement or understanding of any nature or kind, the effect of which is to alter, directly or indirectly:

(a) the insider's economic interest in a security of the reporting issuer; or
(b) the insider's economic exposure to the reporting issuer.

What is "Economic Interest" in a Security?
The term "economic interest" in a security is defined (the definition being considerably simplified from the prior draft) as:

(a) a right to receive, or an opportunity to participate in, a reward, benefit or return from the security, or
(b) exposure to a loss or a risk of loss in respect to the security.

This term is meant to have broad application, and is intended to refer to the economic attributes ordinarily associated with beneficial ownership of a security, such as the potential for capital gains, capital losses and interest dividends, or other distributions. Similarly, a "security of the reporting issuer" is broadly defined in the Multilateral Instrument and is deemed to include:

(a) a put, call, option or other right or obligation to purchase or sell securities of the reporting issuer; and
(b) a security, the value or market price of which are derived from, referenced to or based on the value, market price or payment obligations of a security of the reporting issuer.

What is "Economic Exposure" to the Reporting Issuer?
"Economic exposure" in relation to a reporting issuer is defined as the extent to which the economic or financial interests of a person or company are aligned with the trading price of the securities of the reporting issuer or the economic or financial interests of the reporting issuer. The term "economic exposure" is also intended to have broad application, and is meant to catch a situation where an insider changes his or her ownership interest in securities of a reporting issuer, either directly through the purchase or sale of securities of the reporting issuer or indirectly through derivative transactions involving those securities.

What is the Difference between "Economic Interest" and "Economic Exposure"?
The CSA indicate that in many cases, an arrangement caught by the "economic exposure" test will also be caught by the "economic interest" in a security test. However, the tests are not identical.

For example, if an insider holds no shares of the reporting issuer, but enters into an actual or synthetic "short position" in the expectation that the share price will fall, the CSA indicate that the "economic interest" test may not apply since the insider will not be altering his or her economic interest in any securities of the reporting issuer (note that Section 130(1) of the Canada Business Corporations Act prohibits an insider from knowingly selling, directly or indirectly, a security of a reporting issuer or any of its affiliates, if the insider does not own the security to be sold). However, the "short position" would be caught by the "economic exposure" test and would be reportable.

Not Restricted to Equity Monetizations
The Multilateral Instrument applies not only to equity monetizations but generally to derivatives transactions with insiders involving "securities" of a reporting issuer, whether equity or debt securities. Accordingly, all other forms of derivatives transactions, such as total return swaps and credit default swaps, involving insiders and securities of reporting issuers will need to be considered carefully to determine whether they trigger reporting obligations (see the exemptions described below).

Application of the Multilateral Instrument to Pre-Existing Monetizations
The Multilateral Instrument will apply to both new derivative-based transactions caught by the Multilateral Instrument, as well as those previously entered into by insiders (or entered into before they became insiders) and remaining in effect after the effective date of the Multilateral Instrument, currently scheduled for February 28, 2004, subject to ministerial approvals.

Exemptions from the Insider Reporting Requirements
The Multilateral Instrument provides a number of exemptions from the reporting requirement (the main area where changes were made to the prior draft). These exemptions include:

(a) arrangements that do not involve, directly or indirectly, an interest in (i) a security of the reporting issuer; or (ii) a derivative in respect of which the underlying security, interest, benchmark or formula is or includes as a material component[4] a security of the reporting issuer;

(b) a compensation arrangement established by a reporting issuer or affiliate if: (i) the existence and material terms are, or are required to be, described in certain public filings; or (ii) the terms are set out in writing and the alteration to economic exposure or economic interest occurs as a result of the satisfaction of certain previously established criteria and does not involve a discrete investment decision by the insider. The CSA note that the disclosure contemplated by this exemption is general disclosure about the material terms of the compensation arrangement applicable to all participants in the compensation arrangement and they do not intend that there be individualized disclosure about a specific insider's individual circumstances;

(c) to the extent that a person or company is exempt from the insider reporting requirements by virtue of an exemption contained in Canadian securities laws, or has obtained exemptive relief in a jurisdiction from the insider reporting requirements of that jurisdiction;

(d) a transfer, pledge or encumbrance of securities by an insider for the purpose of giving collateral for a debt made in good faith, so long as there is no limitation on the recourse (legally or structurally) available against the insider for any amount payable under such debt;

(e) the receipt by an insider of a transfer, pledge or encumbrance of securities of an issuer if the securities are transferred, pledged or encumbered as collateral for a debt under a written agreement and in the ordinary course of business of the insider (this will assist, among others, financial institutions, and was introduced in response to a comment of Stikeman Elliott);

(f) an insider, other than an insider that is an individual, that enters into, materially amends or terminates an agreement, arrangement or understanding which is in the nature of a credit derivative;

(g) a person or company who did not know and, in the exercise of reasonable diligence, could not have known of the alteration to the economic exposure or economic interest;

(h) the acquisition or disposition of a security, or an interest in a security, of an investment fund, provided that securities of the reporting issuer do not form a material component of the investment fund's market value; and

(i) the acquisition or disposition of a security, or an interest in a security of, an issuer which holds directly or indirectly securities of the reporting issuer if (i) the insider is not a control person of the issuer; and (ii) the insider does not have or share investment control over the securities of the reporting issuer.

Moreover, the Multilateral Instrument does not apply to require reports in respect of securities of a publicly offered mutual fund, as the definition of "reporting issuer" for the purposes of the Multilateral Instrument excludes a mutual fund that is a reporting issuer.

Form and Timing of Insider Reports
Reporting of the existence, material amendment or termination of a transaction under the Multilateral Instrument is done generally on-line through the System for Electronic Disclosure for Insiders (SEDI), with the same rules and 10-day deadline as for all other insider reporting for ordinary purchases and sales of securities. See Multilateral Instrument 55-102 - System for Electronic Disclosure by Insiders and www.sedi.ca. Existing derivative-based transactions caught by the Multilateral Instrument would need to be reported by March 9, 2004 (assuming the Multilateral Instrument comes into force on February 28, 2004).

In an effort to provide some guidance, the CSA has undertaken to publish a CSA staff notice containing examples of various types of monetization arrangements, together with examples of completed forms for reporting such arrangements, on or before the Multilateral Instrument takes effect.

Conclusion
Insiders entering into certain derivative-based transactions will have to carefully review the "economic exposure" and "economic interest" tests established by the Multilateral Instrument to determine whether the reporting obligations are triggered.

Of particular note is the application of the Multilateral Instrument to derivative-based arrangements previously entered into by insiders and remaining in effect after the effective date of the Multilateral Instrument, currently scheduled for February 28, 2004.

FOOTNOTE

^[1] Excerpts and examples from Companion Policy 55-103 to the Multilateral Instrument have been used in this update.

^[2] Canadian securities legislation requires "insiders" of public companies (generally, (i) directors and senior officers of public companies; (ii) directors and senior officers of companies that are insiders or subsidiaries of public companies; and (iii) 10% shareholders of public companies) to file insider reports disclosing their ownership of, and trading in, securities of such public companies.

^[3] For the purposes of the Multilateral Instrument, a "derivative" means an instrument, agreement or security, the market price, value or payment obligations of which is derived from, referenced to, or based on an underlying security, interest, bench mark or formula.

^[4] The reference to "material component" is intended to insure that if an insider entered into a derivative arrangement which satisfies one of the tests triggering reporting obligations and in respect of which the underlying interest was a basket of securities or an index which included securities of the reporting issuer, such arrangement would trigger a reporting requirement only if the derivative involved securities of the reporting issuer "as a material component". In determining materiality, similar considerations to those in the concepts of "material fact" and "material change" apply.