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

Marketing during the waiting period

• Term Sheets -  Investment dealers will be expressly permitted to provide term sheets in conjunction with a preliminary prospectus, subject to certain conditions, including that all information concerning the securities (including any comparables) be contained in the preliminary prospectus and the term sheet be included or incorporated by reference into the final prospectus.
  
• Green sheets – Regulatory guidance will be amended to clarify that while investment dealers will continue to be able to provide traditional green sheets to their registered representatives, any green sheet that is distributed to the public will be considered a "term sheet" and will need to comply with the proposed provisions applicable to term sheets (discussed above).
  
• Road shows – Road shows will be expressly permitted to be conducted for both “permitted institutional investors” and retail clients, subject to the caveat that those conducted for retail investors do not contain comparables (in the absence of prospectus liability) and other conditions are satisfied.
  
  
  • In this respect we note that a “road show” will be defined as a presentation to potential investors regarding a distribution of securities conducted by an investment dealer on behalf of an issuer in which one or more executive officers of the issuer participate. Access for road shows will also need to be restricted such that the investment dealer must establish and follow reasonable procedures to: verify the identity and keep a written record of attendants; ensure that investors receive a copy of the preliminary prospectus; and restrict copying of any written materials.
     
• Testing of waters exemption for IPOs – The proposals include a new exemption that will permit IPO issuers to communicate with permitted institutional investors through investment dealers, provided certain conditions are satisfied. This exemption will not extend to public companies in foreign jurisdictions, notwithstanding the fact that they may be doing an IPO in Canada.

Changes Applicable to Bought Deals

• Increasing the Size of a Bought deal – A bought deal agreement will be allowed to be amended to increase the offering size provided the increase is not a culmination of a formal or informal plan to offer a larger amount devised before the execution of the original agreement and:
  
  
  • A news release is issued immediately after the agreement is amended.
     
  • The preliminary prospectus is filed and receipted within four business days of the original agreement.
  • The enlarged offering is for the same price as the original offering.

The amount by which the offering can be increased will also be limited, but that cap has not been set out in the amendments and is a matter that the regulators have specifically asked for comments on.

• Enlarging Syndicate –Additional underwriters will be allowed to join the bought deal syndicate if the addition of a particular underwriter was not the culmination of a formal or informal plan to add that underwriter devised before the execution of the original agreement.
  
• Term sheets for bought deals - Investment dealers will be allowed to provide term sheets to permitted institutional investors after the bought deal is announced but before the preliminary prospectus is filed, subject to certain conditions, including that the information concerning securities in the term sheet must be in the bought deal news release or in the issuer's continuous disclosure record, and the term sheet must be included or incorporated by reference into the prospectus. The term sheet must also be approved in writing by both the issuer and the underwriters and filed before it is used (although it will not be made public until the preliminary prospectus is receipted). In this respect, the regulators have specifically asked for comments on whether investment dealers should be allowed to also provide term sheets to retail investors.

The proposals also provide guidance on road shows for cross border IPO offerings, provision of research reports and marketing after the receipt of a final prospectus and a final base shelf prospectus, among other matters.

While the CSA believe that the policy rationale for the existing rules (including ensuring equal access to information, providing investor protection through adequate disclosure, deterring conditioning of the market and deterring insider trading) still apply, the proposed amendments are intended to ease regulatory restrictions faced by issuers and investment dealers when marketing prospectus offerings.

Comments on the proposed amendments are being accepted until February 23, 2012.

The following are some key highlights emerging from the decision, some of which are discussed in detail below:

• while “material facts” are broader than “material changes” both are based on an objective assessment to be made in a contextual basis;
   
• prior disclosure can establish a “baseline” from which future disclosure decisions may be assessed (in that the company cannot later rely on the lack of impact that an event or occurrence may have if its prior disclosure did not provide adequate information for investors to be able to judge the subsequent event);
   
• disclosure of risks to which a company is subject is not sufficient to satisfy its material change disclosure obligation, if and when the risk actually transpires;
   
• materiality is based on the effect of the information on either the market price or the value of the securities;
   
• an issuer will not be liable for making premature disclosure where an event or occurrence has actually transpired, even though its impact or significance may be uncertain; and
   
• external events or developments that have a direct effect on or consequences for an issuer’s business or operations may constitute a material change.

Preliminary Matters

As a preliminary matter, the OSC considered the difference between “material fact” and “material change”. While material facts are those facts that would reasonably be expected to have a significant effect on the market price or value of securities, a material change also requires a change in an issuer’s business, operations or capital. As such, the OSC confirmed that the definition of “material fact” is broader than that of “material change”, as the former will not necessarily arise from a change in an issuer’s business, operations or capital. The standard of materiality for both concepts, however, is the same and based on an objective standard. Importantly, the assessment of materiality also requires “a contextual determination that takes into account all of the relevant circumstances”. Assessments of materiality should not, however, be made with the benefit of hindsight. Thus, according to the OSC, Coventree’s disclosure decisions, which were made at the time events were unfolding, were not judged in light of the knowledge that a market disruption in the ABCP market actually occurred in August 2007. The OSC also confirmed that the business judgment rule does not apply to decisions regarding disclosure under the Securities Act. As such, Coventree’s disclosure decisions were not protected from scrutiny after the fact by an appeal to business judgment.

Prospectus Disclosure

OSC Staff alleged that Coventree's prospectus, filed with the Commission on November 16, 2006, failed to disclose the fact that Coventree had received a letter from the Dominion Bond Rating Service (DBRS) on November 10 stating that the rating organization would henceforth be taking a more restrictive approach to rating credit arbitrage transactions. This was considered to be particularly important in this context, as Coventree relied on the prospectus exemption for suitably rated short-term debt in order for its conduits to issue the ABCP, and DBRS was the only approved organization rating ABCP with "Canadian style liquidity". Ultimately, however, the OSC found that the DBRS letter did not constitute a material fact, as the letter was: (i) unclear as to the criteria that would be applied in reviews of structured finance asset transactions; (ii) appeared to be a continuation of DBRS's existing "measured approach" to approvals; and (iii) did not affect outstanding transactions.

Despite this conclusion, the OSC did make a number of observations regarding the prospectus that were ultimately relevant in the Commission’s consideration of subsequent disclosure decisions. Of particular interest was the OSC’s pronouncement that the disclosure respecting the proportion of Coventree’s revenues deriving from credit arbitrage transactions (about 80%) was less than full, true and plain. According to the OSC, “full” disclosure is provided when disclosure is made of facts sufficient to permit investors to make an informed investment decision; “true” disclosure occurs if the disclosure is accurate, not misleading and does not omit a fact that is material or necessary to understand the facts as disclosed; and “plain” is disclosure that is understandable to investors in a plain language. The OSC also found that the prospectus failed to communicate that Coventree considered the credit arbitrage business to be “dead or dying”. The OSC’s observations in this respect were relevant insofar as the Commission concluded that the disclosure deficiencies it identified made it much more difficult for public shareholders and potential investors to fully understand the significance of subsequent developments.

DBRS release regarding credit rating methodology

OSC Staff also alleged that Coventree failed to disclose DBRS’s decision in January 2007 to change its credit rating methodology. According to Staff, the DBRS release was a material change and ought to have been immediately disclosed by Coventree.

While Coventree argued that the DBRS release did not change its business or operations in any way, the OSC found that the release imposed a requirement for global style liquidity that had not previously been required. Ultimately, the DBRS release was found to be an escalation of DBRS’s previous concerns regarding the credit arbitrage market and, given Coventree’s reliance on “Canadian style liquidity”, the DBRS release did in fact result in a material change to Coventree’s business.

Of particular interest is the OSC’s response to Coventree’s argument that the DBRS release could not have constituted a material change since there was no change in the market price of Coventree’s shares after the information was ultimately disclosed in Coventree’s second quarter MD&A. The OSC rejected this argument, stating that the fact that Coventree’s share price was not affected by the eventual disclosure did not mean that no material change had occurred. Rather, the OSC framed the issue as whether particular information would reasonably be expected to have had a significant effect on the value of securities, despite the lack of effect on the market price of the securities. According to the OSC, “one cannot assume…that the lack of impact on market price means that the information disclosed was not material.” In the immediate case, therefore, the OSC found that the DBRS release would reasonably be expected to have had a significant effect on the value of Coventree’s shares. Also, as described earlier, Coventree’s prospectus disclosure ultimately acted as a form of baseline from which to draw inferences regarding investors’ knowledge. Specifically, the OSC stated that investors did not appreciate how important credit arbitrage and CDO related SFA transactions were to Coventree’s business. Hence, the lack of a change in the market price did not necessarily imply that there had been no material change.

Material change prior to August 13, 2007

OSC Staff also alleged that Coventree failed to disclose liquidity related events in the days leading up to the disruption in the ABCP market that occurred on August 13, 2007, and that these events constituted a material change. In response, it was argued, among other things, that the events in question were external and widely known, and that specific disclosure by Coventree would have been premature. These arguments were, however, rejected by the OSC.

According to the OSC, it would not have been premature to disclose actual events and developments and their consequences to Coventree’s business, even if there was uncertainty as to their causes, future effects, financial impact or duration. As the OSC stated, “[a]n issuer does not subject itself to any liability…for premature disclosure where the disclosure made relates to events and their consequences that have occurred and is accurate, balanced and appropriately qualified.” According to the OSC, the possibility that ABCP market issues could be resolved as part of a negotiated “soft landing”, as believed by Coventree, was contingent, uncertain and highly speculative and did not insulate Coventree from its disclosure obligations.

The OSC also rejected Coventree’s argument that the events in question were external and did not require disclosure as per section 4.4 of NP 51-201 Disclosure Standards. According to the OSC, that provision is premised “on the assumption that investors will be aware of external economic developments and their general effects on reporting issuers.” In this context, the OSC was of the view that public shareholders and potential investors had very limited knowledge of the ABCP market and of events and developments affecting that market (again, looking back in part to the baseline of the prospectus). 

Even if the exemption did apply, the OSC stated that the developments affecting Coventree were uncharacteristic of the effect generally experienced by other issuers in the same industry, due to Coventree’s size and its conduits’ exposure to ABCP and, as such, Coventree would be unable to rely on the provision regardless. According to the OSC, Coventree made a “critical error to the extent that it assumed that these external events or developments could not and did not have direct effects on, and consequences for, its business and operations that constituted changes in that business for purposes of the definition of ‘material change’ in the Act.”

In light of the OSC’s findings, on November 8, the Commission ordered Coventree to pay an administrative penalty of $1 million and costs of $250,000.

Governance and Continuous Disclosure

With respect to governance and continuous disclosure, the proposals introduce an annual report requirement, which would combine business, governance and executive compensation disclosure, audited financial statements, MD&A and CEO/CFO certifications into one document, to be filed within 120 days of the financial year-end. A mid-year report requirement is also introduced, which would include an interim financial report, associated MD&A and CEO/CFO certifications.

The filing of three and nine month interim financial reports would be voluntary, but any such report would have to be filed on or before 60 days after the end of the interim period and be approved by the board or audit committee. In the event an issuer voluntarily elects to provide three and nine month interim reports, it would have to report on this basis for at least two financial years.

The current information circular requirements would also be streamlined and the governance and executive compensation disclosure moved to the annual report. Additionally, an optional significance test would be introduced to permit significance to be calculated using market capitalization on the acquisition date rather than the on the date of announcement for significant transactions. Director and executive compensation disclosure would be tailored to venture issuers, who would also be required to disclose whether their directors and officers are subject to any statutory or contractual obligations requiring them to act honestly and in good faith and to exercise the care, skill and diligence of a reasonably prudent person.

Of particular interest to mining issuers, the CSA clarified that the requirement to file a technical report under NI 43-101 would only be triggered if the venture issuer files a short form prospectus or, in the case of the annual report, if it contains first time disclosure of mineral resources, mineral reserves or a preliminary economic assessment, or a change to that disclosure, if that change is material to the venture issuer.

Prospectus and exempt offerings

In the case of prospectus offerings, the proposals would introduce a new Form 41-101F1 to conform to the disclosure required by the annual report and remove the requirement for business acquisition report (BARs) in connection with an offering, although financial statements would still be required for reverse take-overs and acquisitions that are 100% significant. Additionally, the proposals would require only two years of historical financial statements for IPOs.  Disclosure of three and nine month interim financial statements and related MD&A would also be eliminated.  Corresponding changes are also being proposed to the qualifying issuer offering memorandum and the TSXV short form offering document contemplated under NI 45-106.

Definition of “Venture issuer”

Finally, the amendments propose a new definition of “venture issuer” which would, unlike the current definition, exclude debt-only issuers, preferred share-only issuers and those issuing securitized products. This group of issuers that meet the current definition of “venture issuer” in NI 51-102, to be referred to as “senior unlisted issuers”, will continue to be subject to the NI 51-102 venture issuer requirements.

In proposing the changes, the CSA recognized the unique characteristics of the venture market in Canada and specifically outlined some of these attributes in their notice. For example, the CSA noted, among other characteristics, that venture issuers typically (i) have limited financial resources, which can make it more difficult to hire staff dedicated to securities regulatory compliance, (ii) may lack the foreseeable prospects of generating significant revenue and (iii) may be more likely to rely on financing to fund development for a prolonged period.

They further note that venture investors are more likely to be retail investors with smaller positions than investors in more senior issuers, while limited institutional involvement and analyst coverage may result in investors having to conduct their own research in the absence of broker generated reports. Investors in venture issuers may expect more dramatic growth and are more likely influenced by material news than historical financial statements. They are also typically interested in the amount that officers and directors have invested and may be particularly concerned about the issuer’s burn-rate.

The CSA’s proposals recognize the fact that venture issues play an important role in our capital markets and require a set of rules that better reflect the needs of venture investors and resources of venture issuers. The proposals are a step towards a more streamlined reporting regime. The proposals remain open for comments until October 29, 2011.

• Whether the IPO price "significantly exceeds" the average price paid by the founders. The CSA is particularly concerned with structures where the founders of the company have paid a nominal amount for a large block of shares.
   
• Whether the amount of capital proposed to be contributed by the IPO purchasers will be "significantly disproportionate" to their equity interest on completion of the offering.
   
• Whether the average capital contributed per share for all issued and outstanding shares on completion of the offering is "significantly" lower than the IPO price due to the quantity and nominal price of the founders' shares.
   
• Whether founders have spent time, effort or resources developing a business, which may justify a structure containing significant founders' shares. The CSA may request an explanation of the size of a founders' position and the discount relative to the IPO price.
   
• The CSA may only have concern with some of the founders' shares but not others, due to the fact that some founders may receive shares at a significantly lower average price than other founders.
   
• The more cash a founder has invested and the longer it has been invested, the more likely the share structure at issue will be acceptable.
   
• The presence of convertible securities at exercise prices lower than the IPO price may lead to the rejection of a share structure where "the number is large enough or the exercise is low enough".

The notice stems from concerns that IPO investors may ultimately receive an "unconscionably low percentage of ownership" in cases where existing nominally priced shares cause a dilution of invested capital. Further, according to the CSA, such share structures could provide a platform for future market manipulation.

The notice, however, remains vague as to the thresholds that will lead to a regulator rejecting a particular share structure. For example, it is unclear how a regulator will assess whether an IPO price "significantly" exceeds the price paid by founders, whether the amount of capital contributed by IPO investors would be "significantly disproportionate" to the equity interest or whether dilution caused by founders' existing nominal shares will reduce the average capital contributed per share "significantly" in comparison to the IPO price. The CSA did, however, state that the notice is not meant to provide certainty for every possible scenario but, rather, is intended to provide insight into the factors considered when staff evaluate proposed structures. Further the CSA stated that they will continue to monitor the issue and consider further guidance or policy changes.

For more information, see Staff Notice 41-305 Share Structure Issues - Initial Public Offerings

In addition to changes relating to registration reform, the CSA have also taken the opportunity to reflect other changes in the Revised NI 45-106, mainly to clarify certain provisions, reflect policy decisions that were made in the course of granting exemptive relief and to harmonize certain previously issued local exemptions.  

Finally, the Revised NI 45-106 also results in certain consequential amendments, including amendments relating to National Instrument 45-102 Resale of Securities, OSC Rule 45-501 Ontario Prospectus and Registration Exemptions, National Instrument 33-105 Underwriting Conflicts, National Instrument 51-102 Continuous Disclosure Obligations and related forms and companion policies.

These amendments are scheduled to come into force, subject to Ministerial approval, on the later of September 28, 2009 and the day on which sections 5 and 11, subsection 12(1) and section 13 of Schedule 26 of the Budget Measures Act, 2009 (Ontario) are proclaimed into force.

The amendments to the OSA proposed under Schedule 26 to Bill 162 amend statutory provisions in the following areas:

• registration requirements for dealers, advisers and others,
   
• exemptions from the registration requirements,
   
• exemptions from the prospectus requirement, and
   
• resale of securities previously distributed under an exemption from the prospectus requirement.

Proposed amendments to the Prospectus and Registration Rules were originally published for comment on February 29, 2008 in connection with proposals to reform and harmonize registration requirements across the country under Proposed NI 31-103 Registration Requirements (Registration Reform). As a consequence of Registration Reform, NI 45-106 was proposed to be repealed and replaced (largely to reflect to new approach to registration being required on a business-based trigger as opposed to a trade-based trigger) and OSC Rule 45-501 and NI 45-102 were proposed to be amended to, among other things, reflect corresponding changes.

Under Bill 162, the Government of Ontario has taken the approach of retaining or including certain prospectus and registration exemptions in the OSA, thereby requiring corresponding amendments to the Prospectus and Registration Rules as previously proposed.

The prospectus and registration exemptions that the Government of Ontario intends to retain or include in the OSA relate to:

• securities subject to other provincial or federal regulatory regimes such as mortgages, securities evidencing indebtedness secured by or under a security agreement provided under personal property security legislation, and financial intermediaries and Schedule III banks,
   
• securities that Ontario Ministry of Finance staff have advised are subject to securities regulatory considerations as well as broader public policy considerations such as specified debt, including government debt, and
   
• securities that the staff of the Ministry of Finance have advised relate to key government policy priorities such as school board debt, tax incentive securities and venture capital raising.

Specifically, the proposed amendments to the OSA under Bill 162 would supersede the following exemptions contained in NI 45-106, as previously proposed to be amended: specified debt (proposed sections 2.34 and 3.34), mortgages (proposed sections 2.36 and 3.36), securities evidencing indebtedness secured by or under a security agreement provided under personal property security legislation (proposed sections 2.37 and 3.37), and evidences of deposit issued by a Schedule III bank or an association governed by the Cooperative Credit Associations Act (Canada) (proposed sections 2.41 and 3.41). References to resale provisions in section 72 of the OSA found in Appendix C to proposed NI 45-102 would be modified to reflect proposed amendments to section 72 and a new section 73.7 found in sections 11 and 13 of Schedule 26 to Bill 162. Certain provisions of OSC Rule 45-501 would be modified or deleted in favour of the application of corresponding provisions in the OSA.

If the proposed amendments to the OSA under Bill 162 are passed, implementation is expected to take place in two stages; the first, reflecting transitional provisions corresponding to the implementation of Registration Reform; and the second, at a later time intended to replace the prospectus exemptions enacted in stage one. If the second stage of amendments to the OSA are enacted, the OSC intends to publish new versions of NI 45-106 and OSC Rule 45-501 for comment. These stage two amendments are found at subsection 12(2) of Schedule 26 to Bill 162 and related regulation-making powers are found at subsection 20(17) of that Schedule.

These proposals have been published for a 30-day comment period expiring on June 22, 2009.

Court Authorization

Similar to the Ontario requirement for leave, an action in Quebec may not be brought without prior authorization of the court. In order to determine whether to grant authorization, the court must find that the action "is in good faith" and that there is a reasonable possibility it will be resolved in favour of the plaintiff. Unlike Ontario, however, which prescribes specific limitation periods for the commencement of proceedings of three years from the date of the statement of misrepresentation (or non-disclosure) or six months after the issuance of the news release announcing that leave has been granted, Quebec's Bill 19 allows any interested party to request the court to perempt the authorization if an action is not commenced within three months of the authorization being awarded. 

Cause of Action

Bill 19 identifies four situations that may lead to a cause of action. These consist of situations where:

• the issuer or a representative of the issuer releases a document containing a misrepresentation;
• a representative of the issuer makes a public oral statement relating to the issuer's business or affairs, which contains a misrepresentation;
• an influential person or representative of the influential person releases a document or makes a public oral statement relating to the issuer, which contains a misrepresentation; or
• the issuer fails to make timely disclosure of a material change.

Persons Potentially Liable

Also similar to Ontario, Quebec's Bill 19 provides for a number of potential defendants.  These include:

• the issuer, its directors and officers who authorized, permitted or acquiesced in the release of the document or the making of the public statement containing the misrepresentation, or in the failure to make timely disclosure of a material change;
• an "influential person", which includes a control person, promoter, an insider who is not a director or officer of the issuer, or an investment fund manager if the issuer is an investment fund, who knowingly influenced the misrepresentation or failure to make timely disclosure, or who authorized, permitted or acquiesced in the misrepresentation if it was made by the influential person or representative;
• an expert, which includes, inter alia, accountants, engineers, financial analysts and geologists whose report, statement or opinion contained the misrepresentation, who was quoted in the offending document or statement and who consented in writing to the use of the report, statement or opinion;
• in the case of a public oral statement, the person who made the statement.

Burden of Proof

The plaintiff is not required to prove that there was reliance on the document or statement containing the misrepresentation or on the issuer having complied with its timely disclosure obligations. Unless the defendant is an expert or the misrepresentation was contained in a core document (prospectus, take-over bid circular, etc.), the plaintiff must prove that the defendant knew of the misrepresentation or deliberately avoided such knowledge, or was guilty of gross fault in connection with the release of the document or of the public oral statement. With respect to a failure to disclose, unless the defendant is the issuer, its officers, an investment fund manager or its officers, the plaintiff must prove that the defendant knew that a material change report should have been filed or deliberately avoided such knowledge, or was guilty of gross fault in the failure to make timely disclosure. In determining "gross fault", the court will consider a number of factors that are substantially similar to those to be considered in Ontario for determining "gross misconduct". They include, inter alia: the nature of the issuer, the knowledge, experience and function of the defendant, and the reasonableness of reliance on the disclosure compliance system.

Defences

Bill 19 contains a number of defences to an action for civil liability similar to those found in Ontario's Bill 198.  These include:

• that the plaintiff knew of the misrepresentation or material change;
• that the defendant conducted a reasonable investigation and had no reasonable grounds to believe that a misrepresentation or failure to make timely disclosure would occur;
• that the misrepresentation was also contained in a document filed by, or on behalf of, a third person, other than the issuer, with the Autorité des marchés financiers or the securities commission of another province, providing that the misrepresentation was not corrected in another filed document, the document or statement contained the reference to the source of the misrepresentation and the defendant did not know and had no reasonable grounds to believe there was a misrepresentation;
• that a misrepresentation or failure to disclose a material change that was made without the defendant's knowledge or consent was followed by corrective action in the form of notification to the board of directors of the issuer and possibly notification to the Autorité des marchés financiers. This defence is not available to an issuer;
• in the case of a public oral statement, that a defendant other than the person who made the statement did not become, or should not reasonably have become aware of the misrepresentation before the plaintiff acquired or disposed of the issuer's security and that the person who made the public oral statement had no authority other than apparent authority to do so;
• with respect to a forward-looking document or statement, that reasonable cautionary language was included in the statement along with a statement of the material factors or assumptions applied. The statement or document must contain certain qualifiers in order for the defendant to rely on this defence.  Futher, this defence is not available with respect to a statement or information required to be filed under the Securities Act or regulations;
• non-experts who rely on expert reports, statements or opinions may rely on a lack of knowledge or reasonable grounds to believe there was a misrepresentation in the relied report and that the report of the expert was fairly represented in the document or statement;
• an expert may rely on having withdrawn his or her report, statement or opinion in writing before the document containing the misrepresentation was released or the statement made;
• that a defendant was unaware and had no reasonable grounds to believe that a document containing a misrepresentation would be released; and
• that the issuer filed a material change report on a confidential basis, made the material change known when the basis for confidentiality ceased to exist, did not release a document or statement containing a misrepresentation and, if the material change became publicly known in some other way, promptly disclosed it.

Damages and Liability Cap

Damages under Bill 19 are assessed based on calculations that rely on the price of the securities bought or sold, and the average price of the security once the material change has been disclosed. Damages do not include changes in the value of the security due to market forces unrelated to misrepresentations or the failure to make timely disclosure.  Much like Ontario, Bill 19 also includes liability limits. They are:

• in the case of the issuer or an influential person that is not a natural person, the greater of 5% of its market capitalization and $1,000,000;
• in the case of a natural person other than an expert, the greater of 50% of the aggregate of that person's compensation from the issuer and its affiliates and $25,000 or, if the person is a director or officer of an influential person, the greater of 50% of the aggregate of that person's compensation from the influential person and its affiliates and $25,000;
• in the case of an expert, the greater of the revenue that the expert and affiliates of the expert earned from the issuer and its affiliates in the year preceding the misrepresentation and $1,000,000.

The liability limits are available unless the plaintiff proves that the defendant, other than the issuer, authorized, permitted or acquiesced in the release of the document or making of the public oral statement containing the misrepresentation, or failed to make timely disclosure, while knowing it to be a misrepresentation or a failure to make timely disclosure.

Implementation and transition

As stated above, Bill 19 came into force on November 9, 2007.

Key features of Phase II of the Passport System

The proposed National Instrument 11-102 Passport System (NI 11-102) and related policies would build on the steps taken in Phase I, while moving further towards the uniformity of requirements across jurisdictions. Further, each issuer would essentially be exempted from: non–harmonized continuous disclosure requirements, prospectus form and content requirements outside of its Principal Jurisdiction and registration requirements, through a general discretionary exemption system.

While the Ontario Securities Commission (OSC) has not signed onto the Passport System, Phase II has been designed for adoption by all Canadian securities regulatory authorities. 

Proposed Interface Rules with the OSC

Despite Ontario’s reservations, the design of the Passport System allows for Ontario market participants to access Passport System jurisdictions. Further, National Policy 11-202 Process for prospectus review in multiple jurisdictions (“NP 11-202”) and National Policy 11-203 Process for exemptive relief applications in multiple jurisdictions (“NP 11-203”) have been proposed to provide an interface between the OSC and the Passport System regulators. These proposals are designed to protect the efficiencies currently available under the Mutual Reliance Review System by allowing issuers to deal with only one regulator in most circumstances for prospectus review and exemptive relief applications. 

Generally speaking, the proposed interfaces of NP 11-202 and NP 11-203 would work as follows:

Prospectus Review (NP 11-202)

• The market participant would file its prospectus with the Principal Regulator and with the non-principal regulator in each other jurisdiction in which it wishes to offer securities;
• If the OSC was the Principal Regulator, the filer would deal with the OSC, and the decision of the OSC would be the decision of all Passport System regulators. The receipt of the OSC would result in a deemed receipt from each jurisdiction in which the prospectus was filed;
• A market participant for which Ontario was not the Principal Regulator would deal with its Principal Regulator (under the Passport System), which would then coordinate its review with the OSC, and obtain the OSC’s comments. The receipt of the Principal Regulator would result in a deemed receipt from all Passport System regulators and, if the OSC cleared the prospectus, of the OSC.

Exemptive Relief Applications (NP-203)

• If the OSC was the Principal Regulator, the filer would pay fees to the OSC only, which would then deal with the application. The decision of the OSC would result in an automatic exemption in all Passport System jurisdictions;
• If the OSC was not the Principal Regulator, the filer would file the application and pay fees with its Principal Regulator and the OSC. The Principal Regulator would then coordinate its review with the OSC. The decision of the Principal Regulator would result in an automatic exemption in all other Passport System jurisdictions and would evidence the decision of the OSC, if the OSC agreed with the decision;
• If the application was outside the scope of NP 11-102, it would be dealt with as a “coordinated review application” and filings and fees would be submitted in each jurisdiction in which the exemption was required.

Registration

The proposed interface for registration, which has not yet been released for comment, is expected to work in much the same way as described above.

Implementation and transition

Phase I of the Passport System came into force on September 19, 2005.  The CSA is targeting March 2008 for the implementation of all but the registration portion of the Passport System, with the registration portion planned for adopted in July, 2008.

Summary of facts

Danier filed its prospectus on May 6, 1998, with the offering to conclude on May 20. There was no dispute as to the accuracy of the prospectus as of May 6, but, toward the end of the offering period, management learned of figures showing that unusually hot weather was seriously affecting the outlook for the current quarter as forecast in the prospectus. This was not publicly disclosed until two weeks after the offering had concluded. At that point a material change report was filed and the stock price slumped. However, a combination of cooler weather and a successful nationwide half-price sale resulted in the prospectus forecast being substantially achieved after all.

Lower Courts

The trial judge held that the forecast implied certain statements of fact, notably that the forecaster reasonably believed the forecast and was unaware of anything that would undermine it. While recognizing that s. 57(1) of Ontario's Securities Act (OSA) requires disclosure of post-filing material changes but not post-filing material facts, the trial judge found Danier in breach on the basis of s. 130(1), a general section of the OSA that creates a liability in the event that there is a misrepresentation "at the time of purchase." While Danier's officers might have believed that the forecast would be achieved, and even though it was in fact substantially achieved, the trial judge found that this had not been an "objectively reasonable" belief at the critical time.

The Court of Appeal overturned the trial judge's ruling in 2005, finding that the prospective forecast did not contain any implied assertion of "objective reasonableness," that the general provision of s. 130(1) should not be interpreted so as to override the specific provision of s. 57(1) and that the forecast had in any event been objectively reasonable at all material times - a conclusion supported by the application of the business judgment rule.

Supreme Court of Canada

Harmonious interpretation of the OSA

The Supreme Court upheld the ruling of the Court of Appeal but for slightly different reasons.  The Supreme Court held that an application of the general liability provision in s. 130(1) to the case would obliterate the careful distinction in s. 57(1) between the disclosure requirements for material facts and material changes. The Court similarly rejected the appellants' contention that Danier was in breach of common law principles of misrepresentation. The Supreme Court was clearly of the view that where a representation is made pursuant to a statutory disclosure requirement, it is the statute and not the common law that decides when a breach of the requirement is actionable.

Poor results not a "material change"

The appellants argued in the alternative that the intra-quarterly result was a material change, not just a material fact as the trial judge had decided. The Supreme Court held, however, that a change in results is simply not a "change in the business, operations or capital of the issuer," as required by the relevant statutory definition. It may reflect such a change - e.g. that there has been a restructuring - but it does not in itself constitute a material change.

No implication of reasonableness after filing, but there is such an implication at the time of filing

The Court also held that there was no implication of objective reasonableness with respect to the forecast in the post-filing period. However, the Court agreed with the trial judge (and disagreed with the Court of Appeal) that such an assertion was implied up to the date of filing - a point that was of no assistance to the appellants in the circumstances.

Business judgment can't undercut disclosure

Although the question of whether the business judgment rule applied (as had been found by the Court of Appeal) was moot in the circumstances, the Supreme Court voiced disagreement with the Court of Appeal's suggestion that judicial deference to business judgment is appropriate in disputes over disclosure. As Binnie J. stated: "while forecasting is a matter of business judgment, disclosure is a matter of legal obligation" and "the disclosure requirements under the Act are not to be subordinated to the exercise of business judgment."

The Court noted that the fundamental bases of business judgment - the "relative expertise" of the board or management and the "need to support reasonable risk-taking" do not apply in the context of legislated disclosure. One can expect these criteria to be raised for and against "business judgment" arguments in the future.

Costs

Like the Court of Appeal, Binnie J. held the representative plaintiff liable for costs. The appellant "representative plaintiff" had argued that he should not be subject to costs, since novel issues were raised and/or it constituted a test case.  Both Courts rejected the argument, noting the significant financial means of the plaintiff and the fact that this "case is a piece of Bay Street litigation that was well run and well financed on both sides".
 

Background

Forward-looking information is defined under the Securities Act as "disclosure regarding possible events, conditions or results that is based on assumptions about future economic conditions and courses of action and includes future oriented financial information with respect to prospective results of operations, financial position or cash flows that is presented as either a forecast or a projection."

To rely on the forward-looking information defence, the document or public oral statement in question is required to contain, "proximate" to the forward-looking information:

• reasonable cautionary language identifying the forward-looking information and the material factors (risk factors) that could cause actual results to differ from a conclusion, forecast or projection contained in it; and

• a statement of the material factors or assumptions that were applied in drawing a conclusion or making a forecast.

For public oral statements a person is deemed to have satisfied these requirements if he or she states that (i) the oral statement contains forward-looking information, (ii) actual results could differ materially from what is expected, (iii) certain factors or assumptions were applied in arriving at the forward-looking information, and (iv) that additional information about the material factors or assumptions that were applied in arriving at the forward-looking information and the material risk factors that may affect actual results is contained in a readily-available document. This means a document that is filed with the OSC or otherwise generally disclosed must contain the required cautionary statements and be identified for further reference. As well, to satisfy the forward-looking information defence for both documents and public oral statements, the person or company must have a reasonable basis for drawing the conclusions or making the forecasts or projections contained in the forward-looking information.

What the OSC says about the Defence

Recognizing that forward-looking information is both valuable and necessary "yet by its very nature carries a level of uncertainty," the Draft Policy states that the objective behind the forward-looking information defence is to avoid a "disclosure chill" on account of the risk of liability, while facilitating balanced and responsible disclosure about future prospects. The need for the OSC to provide clarification arises from the concern and confusion caused in the market by the specter of secondary market liability together with the technical aspects of the forward-looking information defence.

These technical aspects include the requirement that the cautionary language required to satisfy the defence be presented proximate to the forward-looking information itself and include a statement of both the relevant risk factors and the underlying assumptions. Depending on how these elements of the defence are interpreted and applied, it has the potential of rendering a disclosure document confusing, unwieldy and potentially of little use in conveying what is sought to be communicated to the reader.

In the Draft Policy, the OSC explains that it does not interpret the term "proximate" to require immediate juxtaposition of the cautionary language in every instance and where a disclosure document contains various threads of forward-looking information that are subject to common assumptions and risk factors, the proximity requirement may generally be satisfied by adding the required cautionary language either before or after the disclosure containing these threads. The OSC has also clarified that where particular assumptions and risk factors apply equally to multiple instances of forward-looking information, issuers should use their judgment in making cross-references to cautionary language in a manner that supports the principle underling the forward-looking information defence (namely, that an investor reading or hearing the information should be able to identify the forward-looking information, understand that it is being provided and be informed of the material assumptions and risk factors underlying or associated with it). In the OSC's view, these principles suggest that the more closely tied a particular risk factor or assumption is to a particular conclusion, forecast or projection, the more "proximate" it should be to the forward-looking information.

The OSC has also stated that in its view the reference to "material" risk factors requires the disclosure of only "significant and reasonably foreseeable" risk factors and does not require the issuer to anticipate and discuss every risk factor that could conceivably cause actual results to differ from expectations. Similarly, the requirement to state the assumptions underlying the forward-looking information is also subject to a materiality standard and does not require an exhaustive statement of every factor or assumption applied.

To satisfy the forward-looking information defence the person or company must also have a reasonable basis for drawing the conclusion or making the forecasts or projections contained in the forward-looking information. The OSC believes that the reasonableness of assumptions applied, inquiries made and the process followed in preparing and reviewing the information are all factors to be considered in determining what is a "reasonable basis" for this purpose.

With respect to the defence for misrepresentations in forward-looking information contained in public oral statements, the OSC states that the requirement that the person making the oral statement also make certain required cautionary statements (in order to be deemed to have satisfied the forward-looking information defence) should be interpreted pragmatically and is not meant to be exhaustive. This means, for example, that in appropriate circumstances these cautionary statements may be made by one person on behalf of another person who actually makes the statement containing the forward-looking information. Finally, the OSC has also expressed its view that it does not interpret the forward-looking information defence to impose a duty to update such information beyond what is currently required under Ontario securities law or otherwise.

The Draft Policy cautions that the guidance contained in it represents the views of the OSC only, which do not have the force of law. Notwithstanding this proviso, given the historic deference that courts have shown towards the OSC as a specialized regulatory body, the OSC's interpretation would conceivably be persuasive if not compelling before a court of law.

Staff Notice 41-304 reflects the CSA's prospectus disclosure expectations in response to their concern that prospective income fund investors are not always being provided with adequate disclosure of the significant estimates and assumptions underlying the reconciling distributable cash or income adjustments. The Notice also addresses Staff's concerns about adjustments that are based on the expected economic effect of anticipated future events.

Adjusted EBITDA - A Forward-Looking Perspective

Staff Notice 41-304 makes clear Staff's view that any reconciling adjustment based on the expected economic effects of anticipated future events provides a "forward-looking perspective," and therefore raises many of the same issues that have concerned Staff with other forms of future-oriented financial information (FOFI). The Staff Notice seems to implicitly recognize a distinction, however, between a "forward-looking perspective" and FOFI; the former requiring enhanced disclosure in the prospectus from what has heretofore generally been provided, and the latter necessitating the inclusion of a forecast in accordance with National Policy 48 - Future-oriented financial information.

With Staff Notice 41-304, the CSA's aim is to provide prospective investors with sufficient disclosure to allow them to determine whether the adjustments used by management in arriving at estimated distributable cash represent a balanced and complete assessment of all factors affecting estimated distributable cash. To this end, the CSA expects the presentation of estimated distributable cash to include a discussion of (among other things):

• the work that was done by the issuer to ensure the completeness and reasonableness of the estimated distributable cash information;

• the nature of the adjustments, including a description of the underlying assumptions used in preparing each element of the forward-looking information as well as the forward-looking information as a whole, including how those assumptions are supported; and

• the specific risks and uncertainties that may affect each individual assumption and that may cause actual results to differ materially from the estimated distributable cash figure; general cautionary language accompanying the estimated distributable cash presentation, that "actual results may vary materially from the amounts presented", will be considered insufficient.

While we have noticed a trend over the past year towards requiring such enhanced disclosure, it is our expectation that in the future the CSA will require far greater disclosure of the underlying assumptions, how they are supported and the particular risks affecting them, than in most recent filings.  Staff has noted that it expects objective corroboration of the assumptions used in the distributable cash presentation. In many circumstances, providing such a level of disclosure should not be problematic; however, in other circumstances it may require specificity at a level that raises concerns over disclosure of competitively sensitive strategies, programs, contractual terms, and pricing and cost structures.

When FOFI Requires a Forecast

If (A) the estimated distributable cash information includes forward-looking adjustments that are based on "significant assumptions," and (B) those adjustments materially affect estimated distributable cash, then Staff expects that a forecast be prepared in accordance with CICA Handbook Section 4250 - Future-oriented financial information and included in the income trust's prospectus.

According to Section 4250, an assumption would usually be considered significant when:

• it reflects an expectation of economic conditions significantly different from those currently prevailing;

• there is a relatively high probability of a sizeable variation; or

• a small change in the assumption would have a significant impact on the forward-looking information.

The above definition, which is imported into the Staff Notice by reference, arguably sets a fairly high bar that, when combined with the second test (i.e., that the particular significant assumption materially affect estimated distributable cash), will likely provide most issuers with a safe harbour from the requirement to prepare a Section 4250 Forecast.

Aside from the time and expense involved in the preparation of a Section 4250 Forecast, and the attendant future disclosure obligations that result from providing one, most issuers and their professional advisors are reluctant to include a Section 4250 Forecast in a prospectus due to a general perception that it creates greater potential for liability.  Moreover, because many accounting firms have recently been interpreting the audit guidelines relating to the preparation of financial forecasts (examination of a financial forecast or projection included in a prospectus or other public offering documents) conservatively, issuers may find it difficult to engage a professional auditing firm to examine the required financial forecast.
 

Compendium

CSA Staff Notice 41-304 makes it clear that, at the very least, significantly enhanced and detailed disclosure of the adjustments used to arrive at estimated distributable cash will be required in prospectuses. Although in certain circumstances such disclosure may necessitate the preparation of a Section 4250 Forecast, even where a forecast is not required, the specificity and objective corroboration required by such enhanced disclosure may require issuers to disclose competitively sensitive strategies, programs, contractual terms, pricing and cost structures.

In situations where issuers anticipate making reconciling adjustments to estimated distributable cash that may necessitate a Section 4250 Forecast, issuers will need to work closely with their professional advisors in order to determine if such a forecast can be prepared. We would expect that issuers may find it increasingly difficult to include Section 4250 Forecasts in their prospectuses, and as a result creative alternative structures (e.g., "earn-ins" or "reverse grinds") will likely be employed to deliver to issuers and their sponsors the appropriate level of value.

MJDS Should Not Be Affected

The CSA have indicated that the proposed amendments should not affect the US-Canada MJDS Multi-jurisdictional Disclosure System.

Eligibility May Be Broadened

One of the most significant changes to the current short-form prospectus system being considered is the proposal, as one of two alternatives out for comment, to broaden the eligibility criteria so that all TSX and all "active" Tier 1 and Tier 2 TSX-V listed issuers would be eligible. This would replace the Cdn. $75 million public float/twelve-month reporting history requirements that exist today (in addition to other less commonly used eligibility criteria). An "inactive" issuer for such purposes means one whose operations have ceased or whose principal assets are cash equivalents and/or an exchange listing. Interestingly, the CNQ exchange would not be an approved exchange for this purpose.

The other alternative discussed is to substantially maintain the status quo in this regard and continue to require a Cdn. $75 million public float and twelve-month "seasoning" requirement.

In either case, issuers would be required to file a certificate at least ten business days prior to filing a preliminary prospectus declaring their intention to be eligible to file a short-form prospectus under the new rules.

More Time to Manoeuvre on Bought Deals

In the context of "bought deal" financings, the current requirement to file a preliminary short form prospectus within two (2) business days is proposed to be extended to four (4) business days. This would in effect extend the pre-marketing period. Underwriters would need to decide if they wish the preliminary prospectus to be filed and receipted earlier than this, and if so, make that a requirement of the underwriting commitment.

It is also proposed that there would continue to be, in the short-form context, no minimum time period between the issuance of a receipt for a preliminary and a final prospectus.

Auditors' Comfort Letters

Interestingly, no auditor's comfort letter in respect of unaudited (versus unsigned audited) financial statements would now need to be filed with regulators in connection with a final short-form prospectus. However, the requirements in section 7110 of the CICA Handbook remain in effect and underwriters are likely to continue to insist upon the usual "long-form" comfort letters.

Ongoing Continuous Disclosure by Guarantors and Others

In certain cases, credit supporters would be required to undertake on an ongoing basis and "in a form acceptable to the regulators" to file periodic and timely disclosure. This is not at present required of guarantors or other credit supporters in instances where the issuer itself complies with ongoing continuous disclosure requirements. One suspects that the requirement could lead to substantial negotiations in individual cases.

More Disclosure About Repaid Debt

Additional disclosure would be required about indebtedness in situations where more than 10% of the net proceeds will be used to retire indebtedness incurred within the past two years. This would apply both to income trusts, where it is seen as particularly important, as well as to other issuers.

Financial Disclosure of Significant Acquisitions

Consistent with the recently adopted business acquisition report (BAR), which requires filings of the financial statements of acquired businesses, the maximum number of years of historical financial statement disclosure is reduced to two from three. In cases involving "highly likely" proposed significant acquisitions, reverse takeovers, very recent acquisitions in respect of which a BAR has not yet been filed, or where otherwise necessary to satisfy "full, true and plain" requirements, additional disclosure may be necessary. The CSA indicate that the last-mentioned requirement may necessitate filing financial statements if any of the relevant "significance tests" is satisfied at the 40% level.

Other Matters of Interest

In the "interesting to note" category are the following statements:

• the CSA indicate that they believe that "the presence or absence of analyst following should not influence policy development given advances in information technology that facilitate widespread and timely dissemination of [continuous disclosure] to investors;"

• issuers are reminded of their obligations to keep their SEDAR (continuous disclosure) and SEDI (insider trade reporting) profiles up to date, and it is noted that "regulatory action" may follow to ensure such compliance;

• while noting that it is not their job to "prescribe due diligence practices," the CSA indicate that they expect that these proposals, plus the coming secondary market civil liability proposals (i.e. Bill 198 in Ontario, as well as the similar B.C. proposals), will encourage issuers to "seek the counsel of their advisors when preparing their [continuous disclosure]," and also that more issuers will "seek increased involvement by underwriters, as well as other advisors, in their [continuous disclosure] to ensure that they will be able to access the markets as quickly as possible." This appears to herald a shift towards more ongoing "designated underwriter counsel roles" and involvement for legal advisors, among other things;

• the CSA indicate that they "continue to believe that the current pre-marketing restrictions could be revisited in order to allow more flexible capital-raising by issuers with less focus placed on the preliminary prospectus," provided however that the pending offering had been publicly disclosed in order to reduce the risk of "improper use," such as insider trading and tipping. They are not at this time proposing any changes, however;

• French language documents (including documents incorporated by reference) would continue to be required in Quebec;

• transitional relief is contemplated to allow final prospectuses for offerings that are in progress when the rules come into effect to comply with the current rules; and

• the use of plain language in disclosure documents is "encouraged."

Further Changes May Mean the Death of the Prelim

In addition to these proposed amendments, the CSA have indicated that more fundamental changes are under consideration and have solicited comment on them. These would allow issuers "quicker and more certain access to capital without regulatory intervention," and would require legislative amendments in certain jurisdictions. They include:

• removing the requirement for a preliminary (but not a "final") prospectus;

• removing the requirement to obtain a receipt for the "final" prospectus, so that mere filing (and delivery to prospective purchasers) would suffice; and

• a right of withdrawal and, in addition, rights of rescission and damages if there was a misrepresentation in the prospectus.

The "final" (the only!) prospectus would still be required, through incorporation by reference or otherwise, to contain full, true and plain disclosure of all material facts. Marketing would likely be permitted after public disclosure and before the filing of a final prospectus, irrespective of whether a "bought deal" was involved. Comment is particularly requested on when the early disclosure test that applies to equity offerings under an unallocated shelf prospectus (i.e. upon the issuer "forming a reasonable intention that an offering will proceed") should apply in such cases. This has always been a worrying Canadian requirement that seems to potentially compel premature disclosure, and is probably one of the reasons that the unallocated shelf system is rarely used for equity offerings.