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

Mr. Kanji noted that there is a need for a more transparent and predictable regime and that many things have changed since the defensive tactics policy (NP 62-202) was first adopted. According to the OSC panel members, a better framework would be to remove the regulation of pills from the defensive tactics policy and create a separate rule for pills that would allow pills to remain unchallenged if they are approved by shareholders. The shareholders would be able to remove the pill on a vote, which essentially means the bidder would have to launch a proxy battle (as opposed to coming before the Commission to have the pill cease traded). There would otherwise be very minimal regulation of the content of the pill itself, with the Commission leaving it up to shareholders and the board to determine the scope and latitude.

Mr. Kanji continued that this approach may in fact represent “walking away” from Jorex. In his view, it is time to set aside the framework that was put in place by Jorex and start the process from first principles. These proposals (to re-visit defensive tactics and create a standalone shareholder rights plan policy) are currently before the CSA at a very preliminary level.

At a preliminary level (without having more details), it is fair to say that people would like to see the Commission get out of the regulation of pills and this approach seems to achieve that. While I find it difficult to comment on this approach without knowing the details, assuming institutional shareholders keep their current positions on what they want to see in a shareholder rights plan, we would likely see more “permitted bids” under this approach. Since an unsolicited bidder would not be able to mount a challenge before the Commission its only option would be to come in as a permitted bid. In this situation you would have a traditional pill that gets approved on an annual basis and could layer a tactical pill on top of it.

Admittedly, not everyone believes that regulators should continue regulating conduct by boards in relation to shareholder rights plans. As my partners Ed Waitzer and Sean Vanderpol argue, such battles would be better left to the courts.

This approach suffers from a number of disadvantages. One critical flaw is that it does not require regulators to analyze the conduct of the board of directors, who are charged at law with the statutory duties of managing the business and acting in the best interests of the corporation. At a practical level, securities regulators lack the evidentiary discipline in their process (compared with court adjudication) that would allow for a detailed and meaningful inquiry into director conduct and the question of the best interests of the corporation. This is compounded by the fragmented structure of Canadian securities regulation, which lends itself to static policy and inconsistent adjudication. The broad and ambiguous "public interest" jurisdiction of the Canadian securities regulators is rooted in the objectives of securities regulation, investor protection and market efficiency. These goals are less clear and differ from the jurisdiction of the courts, which interpret the duties imposed by corporate law on directors.

These inherent limitations faced by the Canadian securities regulators in adjudicating contested control transactions have manifested themselves in many of their recent decisions that are either difficult to reconcile (Ontario and Alberta in the case of Neo Materials and Pulse Data, and British Columbia in the case of Lions Gate), or that demonstrated no reticence (Ontario in Baffinland) in overriding the business judgment of directors, ostensibly in the interests of "shareholder choice."

The securities regulators' approach to hostile takeovers is set out in a document called the Defensive Tactics Policy. The challenges in following this policy have been magnified by the evolution of corporate law and of the competence of our courts in addressing commercial law issues.

In BCE, the Supreme Court of Canada expressly stated that a board's duties are owed to the corporation, which can involve a consideration of the interests of more than just shareholders and requires a long-term view of the corporation. This is difficult to reconcile with the shareholder-centric approach to take-over bids reflected in the Defensive Tactics Policy, and leads to a pernicious result. The securities regulators, in stressing the importance of the right of individual shareholders to sell their individual shares, neglect the role of the board in a control transaction.

As a consequence, the shareholders, as a body but without acting collectively, are able to effect a change in control of the corporation, but owe no duties (to the corporation or to each other) in connection with that result, while the board, which has better information and is subject to statutory duties, is unable to effectively act on them.

All of this has arguably contributed to making Canadian companies attractive targets to bidders, who have demonstrated an ability to plan their tactics in order to take the best advantage of the Defensive Tactics Policy.

The interplay of issues raised by a contested control transaction, as well as the nuanced and rigorous analysis that can be brought to bear on director conductinthesecircumstances, was demonstrated by the recent decision of the Delaware Chancery Court in Air Products v. Airgas. In a long and carefully reasoned decision, the court reviewed the law in Delaware on this issue, and concluded by affirming the right of the Airgas board to maintain a pill in the face of a hostile bid that, in its (unanimous) view, undervalued the corporation.

While the court itself was clearly uncomfortable with this conclusion, its review of the conduct of the Airgas board revealed a rigorous and thorough decision-making process by an independent board that was capable of withstanding enhanced judicial scrutiny.

Criticisms of the Defensive Tactics Policy are not new or original. When the policy was first being considered, a panel of senior securities law practitioners urged the Ontario Securities Commission to defer on such determinations to the courts. In June 2008, the Report of the Competition Policy Review Panel, Compete to Win, recommended that Canadian securities regulators repeal the Defensive Tactics Policy and cease to regulate conduct by boards in relation to shareholder rights plans. We made a similar point in a recent paper published in the Osgoode Hall Law Journal.

The drawbacks of the procedural and substantive limitations imposed on securities regulators in the area of contested control transactions, as well as the evolution of corporate law, have led to increasing tension and uncertainty in this area.

With the benefit of 20 years experience, it can be questioned whether the Defensive Tactics Policy is still in the "public interest," or whether, to paraphrase the Ontario Securities Commission's decision in Canadian Jorex, it has come time for the Defensive Tactics Policy to go. Given relative institutional competencies, surely there are better uses to which the limited resources of Canadian securities regulators should be applied.

As published in today's Financial Post

This recommendation, although recent, echoed views expressed as long ago as 1983 — before the OSC first published for comment a position paper indicating that it was considering regulating defensive tactics. A committee of senior lawyers commissioned by the OSC said it was particularly concerned that “the determination of questions of law is the proper function of the courts and not the Commission.”

Capital markets, ownership demographics and corporate governance standards have evolved dramatically since the Defensive Tactics Policy was implemented a quarter century ago. At that time, there were no hedge funds and institutional investors were generally passive, longer-term investors. Turnover, both of stock portfolios and CEOs, was less tied to short-term stock price fluctuations. Courts were largely deferential to the conduct of directors and management.

But times changed. Until recently the manner in which the Defensive Tactics Policy has been applied reflected a 1988 decision of the Delaware Chancery Court, which found that: “In the setting of a non-coercive offer, absent unusual facts, there may come a time when a board’s fiduciary duty will require it to redeem the rights and to permit the shareholders to choose.” This endorsement of “shareholder choice” was echoed shortly thereafter in an OSC decision that stated: “The time has come when the pill has got to go.” As a result, a generation of market participants has acted on the understanding that Canadian securities regulators are generally willing to terminate rights plans within some fixed period after the commencement of a hostile bid. This approach has conditioned board responses to hostile bids and, in the global mergers and acquisition context, has made Canadian issuers particularly attractive targets.

In contrast to the relatively static application of the Defensive Tactics Policy, the law in both Delaware and Canada has evolved considerably, and continues to do so. In Canada, our courts have become better equipped to address the nuanced duties of directors in control transactions. Moreover, in its BCE decision, the Supreme Court of Canada rejected the notion that directors’ duties in such situations are solely to maximize value for shareholders. Instead, the court reiterated its view that directors’ duties are owed to the corporation, and may include a consideration of the impact of a transaction on a range of other stakeholders.

Two procedural disadvantages faced by securities regulators in adjudicating directors’ behaviour in control contests are the lack of evidentiary discipline in their process (compared to court adjudication) and the reality that the fragmented structure of Canadian securities regulation lends itself to static policy and inconsistent application thereof. The latter concern has recently surfaced in decisions by different securities commissions (Ontario and Alberta in the case of Neo Materials and Pulse Data, and British Columbia in the case of Lions Gate) that are difficult to reconcile.

This, coupled with the tension between the Defensive Tactics Policy and the role assigned to the board of directors under corporate law, including the principles articulated by the Supreme Court of Canada in BCE, can only serve to create uncertainty and undermine public confidence.

A more substantive issue is that the jurisdiction of securities regulators is only through the exercise of broad and ambiguous “public interest” powers (unlike courts, whose jurisdiction derives from the interpretation of duties imposed by corporate law on directors). The law is clear that the exercise of such powers should only be protective and preventative and firmly rooted in the objectives of securities regulation (investor protection and market efficiency). Unfortunately, as noted in Compete to Win, it hasn’t been clear for some time that the application of the Defensive Tactics Policy satisfies any of these criteria.

In reviewing mainstream economic literature, a recent academic study by Slavisa Tasic of the University of Kiev noted the near-complete absence of concern that regulatory design might suffer from the same lack of competence ascribed to market participants. The author noted a number of mistakes that government regulators often share with the rest of us. One is the illusion of competence — overestimating how much we understand about the causes and mechanisms of things. Given developments over the past quarter century in both law and the capital markets, perhaps “the time has come” for securities regulators to heed their own advice and exercise restraint by withdrawing (or, at least, being more circumspect in their application of) the Defensive Tactics Policy.

Under the terms of the pill, a permitted bid was required to include a minimum tender condition of more than 50% of the outstanding Lions Gate shares not owned at the time of the bid by the offeror (i.e., a majority of the disinterested shareholders). Subsequent to the adoption of the pill, Icahn varied its bid to increase the offer price, to make the bid for all of the outstanding shares, and to include a (waivable) 50.1% minimum tender condition. The revised bid was not a “permitted bid” under the pill, however, because the minimum tender condition was waivable and because it only required that Icahn obtain a majority of the outstanding shares, including the ones already owned by Icahn, as opposed to a majority of the shares held by shareholders other than Icahn. The revised expiry date of the bid was April 30 (i.e., four days prior to the scheduled shareholder meeting to consider the pill).

In its Majority Reasons, the BCSC emphasized the primacy of shareholder choice in a take-over bid – shareholders of a target company must ultimately have the opportunity to decide whether or not to accept or reject a bid. The BCSC also recognized the fiduciary duty of the board of a target company to act in the best interest of the corporation, and the reluctance of a regulator to interfere with the board in the discharge of that duty. In their view, however, that reluctance is premised on the practice of boards, in taking steps to act in the best interests of the corporation, of making efforts to maximize shareholder value, whether through enhancements to the bid, through competing bids, or through alternative transactions, and is ultimately subordinate to the need to ensure that shareholders have the opportunity to decide whether to tender to a bid.

With this reasoning in mind, the BCSC concluded that it was in the public interest to cease trade the Lions Gate pill. In their analysis, Icahn had already made several improvements to its initial offer, including raising the share price, and there was no evidence that Icahn would make any further improvements to its offer. Further, and perhaps most importantly, since the Lions Gate board had concluded that it was not the time to put the company in play, and, therefore, had taken no steps (and at the time of the hearing did not intend to take any steps) to seek a competing bid or an alternative transaction, in the view of the BCSC there was no reason to continue to sustain the pill. The pill had already generated all of the (shareholder) value maximizing alternatives that it was going to generate, and so its continued effectiveness would not have any usefulness and would deny to shareholders the ability to make their own decision about whether to accept or reject the bid.

Lions Gate had argued that the BCSC should not cease trade the pill until after the shareholders meeting (scheduled for May 4, two business days after the then scheduled expiry of the Icahn bid). The BCSC determined, however, that it would not defer or delay its decision on the pill until after the shareholder meeting. First, it found that there was no evidence that Icahn would extend its bid, and so it did not want to jeopardize the opportunity of shareholders to determine whether or not to tender to the bid. More fundamentally, however, the BCSC simply did not consider, in this context, shareholder support of the continuation of a poison pill to be relevant. In its view, shareholder support of a pill was relevant only in the context of the purpose of a pill (i.e., to allow the board time to take other shareholder value maximizing alternatives). Since Lions Gate was not pursuing alternative transactions, the only effect of continuing the pill (even if it had received shareholder support) would be to deny the ability of shareholders to tender to the offer.

Subsequent to the decision of the BCSC, Icahn extended its offer on multiple occasions, and also waived its minimum tender condition. The Lions Gate board proceeded with its shareholder meeting to consider the pill, which was approved by approximately 54% of the shareholders present at the meeting (approximately 69%, excluding the shares owned by Icahn).

The full Reasons will be released in due course and are expected to include discussion regarding the BCSC’s reservations about the decisions of the Alberta Securities Commission in Pulse Data and the decision of the Ontario Securities Commission in Neo Materials Technologies Inc., where, in both cases, shareholder support of the continuation of a poison pill weighed heavily in favour of leaving poison pills in place. The BCSC has stated that its reservations centre around these two cases’ apparent departure from the Canadian securities regulators’ view of the public interest as it relates to shareholder rights plans prior to those decisions.

That being said, the OSC endorsed the Alberta Securities Commission’s (ASC) position in Pulse Data, stating that, “as a general matter, recent and informed shareholder ratification of a rights plan, erected in the face of the hostile take-over bid is suggestive of a finding that the continuation of the shareholder rights plan is in the bona fide interest of a target’s shareholders.” The OSC further noted that a fully informed shareholder approval of a tactical plan is not determinative where:

1. there is evidence the board process in evaluation and responding to the bid, including the decision to implement a shareholder rights plan, was not carried out in the best interest of the corporation and the target’s shareholders, as a whole; or
    
2. there is evidence to suggest that management or the board of directors coerced or unduly pressured the target’s shareholders to approve the shareholder rights plan.

In short, shareholder approval will be an influential factor if it is “informed, provided freely and fairly, and in the absence of coercion or undue pressure”. 

In the immediate case, the OSC found that Neo’s shareholders were sufficiently informed, that the decision by Neo’s board to implement the tactical plan reflected its business judgment and that there was no evidence of coercion or undue managerial pressure imposed on Neo’s shareholders to ratify the tactical plan. The OSC also found that despite the fact that the Neo board did not initiate an auction for the company in response to the Pala bid, the tactical plan (at the time of the hearing) continued to serve a purpose by providing the Neo board the ability to protect the long-term interests of Neo and the shareholders as a whole.  

On the issue of what is in the best interest of the corporation, the OSC confirmed that it must give effect to the business judgment rule in ascertaining whether the board has discharged is fiduciary obligations. The business judgment rule, the OSC states, properly permits directors to make appropriate decisions sufficient to fulfill their fiduciary obligations, the scope and content of which have been amplified by the Supreme Court of Canada in the recent decision of Re BCE Inc. The OSC then proceeded to emphasize the Supreme Court’s statement that the fiduciary duty is a broad and contextual concept that is not confined to short-term profit of share value and which looks to the long-term interests of the corporation where the corporation is a going concern. Indeed, the OSC clearly states in its Reasons that shareholder rights plans may be adopted for the broader purpose of protecting the long-term interests of the shareholders, where in the directors’ reasonable business judgment, the implementation of a rights plan would be in the best interests of the corporation. The corollary of this is that using a shareholder rights plan to provide sufficient time to run an auction or seek alternative bidders (which is generally acknowledged to be the primary purpose for a shareholder rights plan) is not the only legitimate purpose for a shareholder rights plan.

The OSC, stating its was not satisfied that it would be in the public interest to grant such relief at this time, cited the following influencing considerations:

1. the second plan was adopted in the context of, and in response to the offer;
    
2. there was no evidence that the process undertaken by the Neo board to evaluate the offer or implement the second plan was not carried out in what the Neo board determined to be the best interests of the corporation and of the Neo shareholders, as a whole;
    
3. an overwhelming majority of the Neo shareholders (excluding Pala) approved the second plan while the offer remained outstanding;
    
4. the evidence supported a finding that the Neo shareholders were sufficiently informed about the second plan prior to casting their votes; and
    
5. there was no evidence to suggest that management or the Neo board coerced or unduly pressured the Neo shareholders to approve the second plan.

The OSC intends to expand upon these consideration in its full reasons for decision, which have yet to be released.