If you have a Canadian place of business, safeguard client assets, and perform one or more of the following functions, be sure you’re in full compliance:

• Foreign exchange dealing
• Remitting or transmitting funds
• Issuing or redeeming money orders, traveler’s checks, or anything similar
• Dealing with cryptocurrency exchange or transfer services 
• Crowdfunding platform services

The Growth of Canadian MSBs

Several types of MSBs are growing exponentially in Canada.

For instance, Canada’s number of new immigrants has doubled yearly since 2000, and the growth of its foreign currency exchange and remittance markets are directly correlated. Its foreign currency exchange services industry is expected to increase by 29.2% in 2022, while its digital remittance transaction value is expected to grow at a 5.71% CAGR between 2022-2027 and exceed $2.33 billion.

Additionally, Canada’s digital payments are projected to grow at a 15.20% CAGR between 2022-2027 and reach a market volume of $243.1 billion.

The Role of Crypto as an MSB 

One aspect of MSBs gaining significant traction globally and within Canada, is crypto.

Canada began regulating cryptocurrency activity in August 2017 after the CSA passed the CSA Staff Notice 46-307 Cryptocurrency Offerings Act.

Canada further cracked down in March 2021 and is again looking to reign in the industry following crypto’s multiple collapses and inefficiencies in 2022, most notably the unwinding FTX bankruptcy. 

“This is an area that is still small, but it’s growing really rapidly. And it is largely unregulated,” Bank of Canada Senior Deputy Governor Carolyn Rogers told Reuters. “We don’t want to wait until it gets a lot larger before we bring regulatory controls in place.”

If you are a crypto entrepreneur or business owner attempting to handle or safeguard client assets, you must register with FINTRAC. 

Furthermore, securities legislation must also apply to cryptocurrency transactions. Some cryptocurrencies can be considered a security under securities law depending on how they are structured, marketed and designed.

Additionally, crypto is not considered legal tender in Canada. Transactions with crypto are allowed, but you cannot use it to pay state fees, taxes and charges. Crypto is also defined as a commodity (e.g., tokens are considered “utility” or non security tokens), which acts as a barter transaction in exchange for other goods.

Operating in a country without regulations may seem more appealing to an entrepreneur. After all, the world’s largest and most liquid crypto exchange, Binance, recently left Ontario because of the OSC (Ontario Securities Commission) regulatory regime.

However, history tends to repeat itself in business. Outcomes rarely end favorably without a sound and credible regulatory framework cultivating strong controls and accountability.  

Conclusion: Do I Need to Get Registered?

Crypto custodians, fintech companies, and payment processors like PayPal are conduits in the payment cycle and hold or safeguard client assets- even for a short  period.

All else being equal, if a financial conduit does not safekeep client assets or money, the business is not required to be registered with FINTRAC as an MSB. However, this does not imply that KYC (Know-Your-Customer) rules can be ignored, but simply that formal registration is not needed.

The financial conduit has regulatory compliance obligations for which other third parties (e.g., custodians, payment processors that hold client assets for any given period) that it deals with is relying upon to ensure their risk exposures are mitigated.  

If you think your firm is safekeeping client assets and fall into one of Canada’s categories as an MSB, speak to us at Black Swan Diagnostics. We can guide you in the right direction.

Failing to register with FINTRAC if your business model triggers the MSB requirements violates the PCMLTFA regime and can result in fines of up to $2,000,000 and/or up to five years of imprisonment.

Reputations take years to develop but seconds to destroy.

Black Swan can help you navigate the regulatory compliance requirements, first and foremost, with compliance manuals. As an MSB, you will need all compliance manuals specific to your business model.

Additionally, MSBs also need an Independent Risk Assessment to identify and evaluate their key risk exposures and how to best mitigate them.

Lastly, the registration process includes other specific tasks like setting up a legitimate Canadian bank account and completing several KYC forms, risk acknowledgment disclaimers, terms of use, privacy policy, policies and procedures. 

Our experience at Black Swan comes with a unique understanding that different responsibilities and obligations come once you’re a regulated entity. We can help guide you every step of the way and help you complete the registration process with all Manuals within three months.

We welcome the opportunity to speak with you and answer any inquiries.   

The post Registering Your Money Services Business (MSB) in Canada appeared first on Black Swan Diagnostics.

As a lead statutory securities regulator, the SEC yields tremendous authority, policy influence, power, and enforcement in which the agency’s ferocity should never be underestimated. The SEC has been known to exercise its extra-territorial reach far outside its borders as far as Australia in the case of SEC v. National Australian Bank, for example. Unlike other, smaller securities regulators (e.g., Ontario Securities Commission (OSC) in Canada), the SEC has a $1.6B USD budget (compared to $100M USD for the OSC, where over 80 percent of all capital market activity is in Canada). Such a budget allows the SEC to investigate, enforce, and prosecute securities breaches both at home and around the world — the long arm of US securities laws. The SEC can and will prosecute non-resident companies that breach US securities laws. However, the SEC only has jurisdiction over breaches of its own rules under the Securities Act (1933) and Securities & Exchange Act (1934).

If a non-resident, foreign company breaches US securities laws, it doesn’t necessarily escape US securities regulatory scrutiny; US securities laws are the most stringent in the world and carry the greatest fines, penalties, reputational damage, and prison sentences for breaches. This is no different than in the digital currency space where many security tokens are often being sold and marketed as unregistered utility tokens, often violating US securities laws. 

SEC Howey as a Litmus Test

The well-referenced and established SEC Howey test is used to determine whether a token issued is either a security token or a utility token. For example, the best example of a true functional utility token is Canadian Tire fiat currency distributed by Canadian Tire Corp, a reporting issuer on the TSX (Toronto Stock Exchange). This currency nullifies each of the four prongs of the Howey test. In practice, however, very few utility tokens have satisfied this litmus test.

We’re also seeing a coordinated approach among securities regulators to fend bad actors in the digital currency space. In 2018, for example, there was a regulatory sweep between the OSC and SEC in cracking down on several ICOs that were considered shady and suspect. This coordination should give comfort to token investors and purchasers in Canada and the US, especially given how quickly both regulators reacted and investigated.

In fairness, although the SEC has taken a hardline approach to token issuers generally, actual enforcement has not nearly been as harsh as the regulatory environment would predict. We’ve seen the start of a few class-action lawsuits filed against Paragon Coin on behalf of the investor class, and SEC enforcement action against Tezos and Munchee, for example. The SEC’s enforcement case against Canadian-based Kik Interactive for various alleged material misrepresentations made to US investors in their $100M USD ICO, is an example of the expansive extraterritorial reach of the SEC and US securities laws. Similarly, the SEC’s recent enforcement action against the Telegram Group Inc. $1.7B ICO in January 2018 to build its blockchain platform while failing to register its ongoing digital currency offering with the agency as a security, is further evidence of the SEC extending its extraterritorial reach. The SEC alleges that Telegram and its subsidiary company, TON Issuer Inc., failed to provide investors with information concerning its business operations, financial condition, risk factors, and management, for which securities rules require. Of the 171 investors world-wide that participated in the Telegram ICO, just over 20% (or 39 purchasers) were sold to US investors, with most large investors residing outside the US. Between the SEC enforcement actions against both Kik Interactive and Telegram, this may create a chill in the market, thereby preventing companies from raising capital in the US through a digital currency offering. We should expect these actions, with the US being the largest and most powerful capital market globally.

Regulatory Arbitrage with STOs

Regulatory arbitrage is a practice whereby digital currency issuers capitalize on loopholes in regulatory systems to circumvent unfavorable regulation. Arbitrage opportunities may exist through a variety of tactics, including restructuring transactions, financial engineering and geographic relocation. The most STO-friendly jurisdictions are Singapore, Malta, Switzerland, Japan, and various Caribbean islands (e.g., Jamaica, Grand Cayman, Barbados, Gibraltar). These countries are digital-currency-friendly and receptive to STO marketing for the sale and distribution of tokens. We will continue to see more regulatory arbitrage, where STOs are marketed in jurisdictions that have the least path of regulatory resistance. 

Regulatory arbitrage is likely to be more nuanced and multifaceted. For example, a token issuer has both digital currency securities regulation and tax regulation as major risks and concerns. It’s perfectly conceivable, for example, for an STO issuer to select Switzerland for its banking jurisdiction, Panama for taxes, Malta for its exchange (e.g., Binance, the largest digital currency exchange in the world processing $5.6B USD in digital currency transactions, formerly based in Hong Kong, recently moved its operations to Malta), and Isle of Man for its gaming. In effect, this creates a form of “virtual jurisdiction” that catapults regulatory arbitrage to new heights. 

However, there are limits to regulatory arbitrage as utility tokens are often viewed as security tokens by US, Canadian and many other leading securities regulators around the world. The state of Wyoming, for example, is viewed as the most crypto-friendly state in the US. Caitlin Long is the former chair and president of Symbiont, a developer of blockchain products for capital markets, and most recently led the Wyoming Blockchain Coalition – which passed a slate of blockchain and cryptocurrency-friendly legislation in the state in 2018. Long spent 22 years in traditional finance at Morgan Stanley and Credit Suisse and echoes this sentiment: 

“Utility tokens trade, clear, settle and custody on blockchains, and the trading, clearing, settlement and custody infrastructure of Wall Street is not set up to integrate with blockchains. So, if every utility token is always a security, that effectively means that you can’t trade a utility token.” 

Cryptocurrency, otherwise referred to as “digital currency”, is based on cryptography, an advanced and arcane branch of mathematics that is powered by blockchain technology. Long’s comment is supported by the SEC’s position that 99-percent of all utility tokens are considered securities and should be regulated accordingly. This imposes a higher regulatory burden on issuers to comply with STOs.

Implications of Regulatory Arbitrage for Digital Currency Issuers 

Regulatory arbitrage has been exploited in the digital currency space as issuers seek to raise capital in jurisdictions that have the least amount of regulatory resistance and scrutiny. Jurisdictions such as Malta, Singapore, Switzerland, Cayman Islands, and Estonia, have developed hospitable environments to digital currency issuers. The absence of formal digital currency legislation in these countries is being developed, while still in its infancy stages. The following are a series of implications that may result from regulatory arbitrage in impacting corporate governance outcomes:

1. By issuers shopping for loopholes in certain jurisdictions that have either lax securities or other weak regulatory enforcement mechanisms for utility tokens (or non-registered securities with a local securities regulator), directors of issuers are cautioned to conduct enhanced due diligence on the principles and management of the issuer before assuming such roles. The director role and potential fiduciary liability from getting involved with questionable or suspicious characters who have nefarious business objectives can cause irreparable reputational risk to directors. 

2. The choice of jurisdiction where the issuer is domiciled is likely to impact the decision to issue either a utility token (non-registered with any securities regulatory authority) or a security token (which requires registration with a local securities regulator), or hybrid of both. The sale, distribution, and solicitation of a utility token in a jurisdiction such as the US, for example, is likely to carry significant enforcement fines, penalties, litigation risk, and potential criminal breaches under federal statutes. This has significant financial and reputational risk exposures for directors. 

3. The jurisdiction of choice of where the issuer is domiciled is also likely to influence the countries in which investors are solicited to buy and sell the token during the distribution of the offering. This can include both an STO Offering or an IEO on a given digital asset exchange. Although the issuer may be domiciled in the US, distribute its token in Estonia to non-US investors through an IEO, it still may be captured under US SEC rules and regulations due its domicile status. Directors of issuers must have competent and expert counsel in understanding the various forms of digital currency structures and their regulatory implications.

4. Depending on where the issuer is domiciled and conducting business, will determine the scope and type of regulatory licenses required. For example, a digital asset exchange registered in Malta, domiciled in Canada, looking to attract US customers or investors on its platform, may have to secure an ATS (Alternative Trading System) license and file registration statements with the SEC if it wishes to trade as an STO. Similarly, if the digital currency platform involves the movement or transfer of fiat and/or digital currency, it may be required to register as an MSB (Money Service Business) with the local AML regulator. This has separate and distinct regulatory compliance implications for directors. 
5. The principle of issuing a digital currency in a borderless world implies that capital is perfectly mobile across borders. The transmission of capital across borders is not without costs and regulatory burden as issuers need to ensure compliance with local securities rules and regulations of where their token is sold, issued, and distributed. Directors need to ensure the extent of regulatory capture and how regulatory arbitrage costs can be effectively mitigated.

1.  Aaron Stanley, Forbes, “Security Token Blues: Key Secondary Market Trading, Custody Questions Still Linger”, April 30, 2018, internet article

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The Canadian takeover bid (TOB) regime under MI 62-104 (“62-104”) regulates the bidder while the U.S. TOB regime mainly oversees board conduct. The Canadian and U.S. takeover systems differ mainly with the primacy of shareholders and boards, respectively. Canadian securities law statutes emphasize shareholder democracy. Delaware jurisprudence shows a board-centric model in takeovers at the expense of short-term shareholder profits. The Canadian TOB system has more shareholder protections than its U.S. counterpart. This gives shareholders voting ability on takeover bids, thereby enhancing value.

II    DIFFERENCES IN SHAREHOLDER TAKEOVER PROTECTIONS

Canadian securities regulators have relied on a modified version of the Revlon duty. The Revlon principle was established by the Delaware courts and suggests that target boards have a duty to seek the best price available for shareholders. The goal of NP 62-202 (“62-202”) is to protect the interests of target shareholders by creating shareholder equality, identical consideration, and continuous disclosure. In its simple form, 62-202 requires regulators to intervene when defensive tactics prevent shareholders from responding to TOBs. This protects shareholders through a vote, fairness hearing, or board determination. 

First, the conflict in 62-202 is finding a balance between the board’s fiduciary duties to maximize shareholder value while protecting the ability of shareholders to tender to the bid. Limiting the role of the board creates a “responsibility vacuum” where shareholders can affect a control change while owing no duties in connection with that result. Unlike Canadian boards, U.S. boards can choose a suitable framework under s. 102(b)(7) of Delaware General Corporation Law (“DGCL”). The 1985 Delaware Supreme court decision in Van Gorkom showed the depletion of director duties as director judgment trumps short-term shareholder profits. This can prevent shareholders from voting on takeover bids, affecting their ability to tender to an attractive bid. This does not protect investors and may reduce shareholder value.

Second, there are major differences in the treatment of poison pills among the two TOB regimes. Poison pills make it prohibitively expensive for acquirers through dilution in voting power and economic position in the target company. While poison pills do not change the value of the company, wealth is redistributed from the acquiring company to shareholders. A poison pill gives the target time to find competing offers to maximize selling price and increase the negotiating power of the target. In Canada, poison pills give directors limited discretion since they expire after 45-75 days from bid inception. Under s. 157 of DGCL, poison pills do not require shareholder approval, nor do they expire. This allows U.S. target directors to deny a takeover bid with a “just say no” defense under DGCL. It also allows the bidder to negotiate with the board, thereby bypassing shareholders. The Circon case illustrated the speed of U.S. board approval without a shareholder vote. This fails to protect shareholders in voting on a TOB.

The 2011 Delaware Chancery Court decision in Airgas upheld the right of the Airgas board to maintain a pill during a hostile takeover bid. In Airgas, Chancellor Chandler III concluded that “the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors.” The Airgas decision is inconsistent under DGCL which allows shareholders to limit a board’s authority on poison pill issues. As Delaware courts defer to boards on the use of poison pills, investors may accept takeovers at lower prices. This can harm shareholders by failing to capture more value through competitive bidding.

Third, there are concerns with bidders making cash offers and avoiding disclosure, diluting transparency for target shareholders. Under DGCL, boards are not required to accept all cash bids despite shareholder support. Under DGCL, U.S. boards can adopt the “just say no” defence despite a premium offered to shareholders. The 2010 OSC decision in Magna required enhanced disclosures and showed the risks of insufficient investor disclosures during a hostile TOB. Additional disclosures allow target shareholders more time to review the merits of a transaction, thereby safeguarding shareholders.

Fourth, although the U.S. takeover regime gives discretionary powers to boards, Canadian minority shareholders are protected against the oppressive actions of controlling shareholders under MI 61-101 (“61-101”). 61-101 was designed to safeguard against the undue capturing of the private benefits of control at the expense of minority shareholders. The 2008 Supreme Court of Canada (SCC) decision in BCE showed the protections under the CBCA oppression remedy given to bondholders whose values would significantly decline by the leveraged takeover. The takeover was an opportunity for BCE shareholders to capture over $10.3B of lost enterprise value from weak board governance by neglecting to pursue various strategic options. The decision in BCE showed that where the interests of the corporation conflict with shareholders, under s. 122(i) of the CBCA the duty of directors is to the corporation.  

Finally, there are concerns over unequal consideration paid to target shareholders tendering to a bid at a low premium above the pre-bid price. Other discriminatory measures include controlling shareholders offered a premium, while neglecting to offer minority shareholders the same premium. This is unjust for shareholders for which no offer was previously made. The U.S. shareholder profile is more dispersed with a higher volume of large-cap issuers on NYSE/NASDAQ than any other capital market. Over 25% of all TSX companies have controlling shareholders, the highest of any developed exchange. The Canadian takeover regime aims to minimize inequities and offers takeover protections for minority shareholders.

III    VARIANCES IN SHAREHOLDER VALUE-ADDED FROM PROTECTIONS  

The Canadian and U.S. takeover regimes yield differences in shareholder value from various protections given to shareholders. Under DGCL, directors may use a variety of defensive mechanisms to prevent an inadequate takeover bid before reaching a shareholder vote. The Delaware approach is at odds with the Canadian approach where boards may not deny shareholders the ability to vote on a takeover bid. Canadian issuers have limited takeover defences as shareholder primacy prevails.  Shareholders ultimately decide whether to accept or reject a bid. Airgas reaffirmed the director primacy of U.S. boards. This gives U.S. target boards more negotiating power and control in takeovers, increasing premiums for shareholders.

Under s. 122(1)(b) of the CBCA, the duty of care obligates Canadian boards in a takeover bid to get the best price for shareholders through acting as auctioneers. This is consistent with the Revlon duty under DGCL. BCE illustrated that the fiduciary duty analysis of maximizing shareholder value applies during TOBs. BCE showed that Canadian boards have limited options to prevent a TOB. This allows shareholders to vote on TOBs that provide opportunities to unlock shareholder value.

In addition, in Canada unlike the U.S., poison pills are regulated by securities regulators who rely on their public interest jurisdiction to intervene in contested takeovers. In the 2007 decision in Pulse Data, the ASC prevented the poison pill from expiring and emphasized the duty of the target board owed to the corporation and not only to shareholders. The 2010 BCSC decision in Lions Gate showed the challenges for a target board to keep a poison pill during a hostile bid. Pulse Data and Lions Gate show shareholder approval is not a conclusive factor in allowing a poison pill to expire. Canadian boards cannot use a “just say no” defence by unilaterally denying shareholders the ability to vote on TOBs. This protects shareholders by allowing them to vote on bona fide TOBs.

Canadian securities regulators can prohibit target boards from taking inappropriate defensive measures to prevent a takeover. 62-202 gives regulators takeover protections that encourage unrestricted auctions for shareholders. The 2006 OSC decisions in Sears and the 2010 OSC decision in Magna showed regulatory interference when transactions are perceived to be abusive or coercive towards minority shareholders. The practice of U.S. issuers using staggered boards makes it difficult to gain board control by limiting the number of directors elected in any year. Empirical evidence shows that neither poison pills nor staggered boards increase shareholder value. The excessive entrenchment of U.S. boards having wide discretionary powers has prevented shareholders from voting on TOBs, thereby compromising value. U.S. shareholder protections are limited as director primacy dominates board decisions in takeovers.

IV    CONCLUSION 

Canadian takeover regulations under securities law gives shareholders more statutory protections compared to its U.S. counterpart under Delaware corporate law. The director primacy of U.S. boards can enhance value through premiums for shareholders. Canadian courts and regulators have a clear bias towards shareholder primacy in TOBs. The U.S. Dodd-Frank Act may shift the governing power from boards to shareholders through greater voting rights, transparency, and disclosure. This may strengthen U.S. investor protections in takeovers, thereby increasing value.

1. Harvard Business School (HBS) Case Study, “Circon (A) (Abridged)”, at 6.
2. Airgas, supra note 2, at 5.
3. INSEAD Case Study, The Bid for Bell Canada Enterprises (BCE), at 15.
4. Bebchuk, Cohen, and Ferrell, “What Matters in Corporate Governance?” 22 Review of Financial Studies (2009), at 792.

The post What Are Some Differences In Shareholder Protections Between The Canadian And U.S. Take-Over Bid (TOB) Regime? appeared first on Black Swan Diagnostics.

The empirical evidence suggests that the current TOB regime may favour the target shareholders over the bidder (if one defines favour that the economic benefits accrue primarily to the target shareholders).  This depends on various factors, including the demonstrated value in a control position and the regulatory and legal regime that favours the interests of the target shareholders, leading to auctions which increase value.  While on its face, this transfer of value appears to be recognition of the value of the control premium, is there more to consider?  Is the creation of circumstances that so boldly favour auctions actually decreasing the vitality of the market for corporate control (as TOBs become pricey), thereby losing the benefits of TOBs? 

Furthermore, TOBs are expensive propositions for both the bidder and the target board.  TOBs include onerous transaction costs, including legal fees for investment bankers, preparation and filing costs and the delivery of mandatory information circulars required by both the bidder and the target.  When TOBs are contested, the costs escalate dramatically, driven by multiple factors, including lack of certainty of result, and the possibility of regulatory proceedings before two key decision makers—provincial securities regulators and the courts.

Do concerns over TOB regulation suggest improvements are needed?

In terms of Canadian securities regulators, Canadian Jorex was the first decision in which a commission considered the now classic Canadian takeover defence, a SRP. The Commission found that it is time to terminate a SRP after considering whether the rights plan had served its purpose by facilitating an auction for the target. In Canadian Jorex, the Commission found the continued existence of the SRP would not result in anyone else joining the auction nor would it result in any enhancement of existing bids and it was therefore cease traded.  

This conclusion was based on the Commission’s stated view of the public interest in contested takeover bids: 

For us, the public interest lies in allowing shareholders of a target company to exercise one of the fundamental rights of share ownership—the ability to dispose of shares as one wishes—without undue hindrance from, among other things, defensive tactics that may have been adopted by the target board with the best of intentions, but that are either misguided from the outset or, as here, have outlived their usefulness.

The decision in Canadian Jorex was the building block that would set the tone from 1991-2007 in determining how the OSC would interpret TOB regulation in contested transactions. The theory was that at some point, the pill would expire—there was always a time when the “pill had to go”. The issue was when it would go, not if.  This provided some certainty of process.  In the result, since Canadian Jorex, Canada has been much more ‘bidder’ friendly than the US, especially concerning defensive tactics.

In recent years, however, there have been a variety of decisions across the country suggesting that boards may, in fact, be entitled to play a more expansive role in defending against a takeover bid. For example, in Ontario in Neo Materials and in Alberta in Pulse Data, each suggest that there may be increasing deference paid to efforts to ‘just say no’, even in circumstances where there is no alternative transaction available.

There is no uniformity of analysis nor result by the provincial commissions.  In Lions Gate, the BCSC decision demonstrated that shareholder approval is a relevant but not a determinative factor in deciding whether a SRP should remain in place.  It also showed that in B.C. it really is when, and not if, a SRP will be cease traded. The BCSC Commissioners noted that they believed that Neo Materials and Pulse Data were distinguishable. They also stated that those cases would seem to depart from the Canadian securities regulators’ view of the public interest.  Finally, the recent Quebec decision in Fibrek, where the Bureau took a different view of appropriate tactics than staff of the AMF, further highlights the uncertainty that exists in Canada concerning how a deal must/can be responded to by a board, which in turn drives uncertainty by bidders, leading to higher sunk costs and a depressed bid market.  Hence, the need to reform the TOB regime.

Proposals that could be implemented which would balance the rights of the target and the bidder, and which may both foster the TOB market, while reducing transaction costs include the following:

1. SRP’s and other defensive tactics should require shareholder approval. This includes any prospects for the removal of opportunistic or purely defensive SRPs. This principle promotes shareholder democracy and certainty. This is consistent with the spirit and intent of 62-202;

2. Shorten bid timelines. A change in the legislation reducing the bid timelines from 35 days to 21 days and permitting pre-approved SRPs for only 21 days post bid-expiry, for a total of 42 days.  This would improve certainty and reduce litigation costs;

3. Accelerate the auction process. Maintaining the possibility of a SRP for which has secured advanced shareholder approval would encourage the possibility of an auction. At the same time, however, it would also encourage auctions to proceed expeditiously while balancing the reality that the first bidder may be  the ‘best’ (successful) bidder or generate the most superior bid;

4. Codify information leakage controls. Institute mandatory rules that would impose information leakage controls on all service providers to halt pre-bid price run ups that are likely to make TOBs more expensive, thereby discouraging hostile bidders. This also encourages the payment and valuation of true control premiums;

5. Consistency among provincial regulators. Regulators should examine 62-202 to determine if further policy guidance is required and ensure, at the CSA level, a consistent policy to generate greater certainty.  The re-examination of 62-202 would include an analysis of reconciling the decisions of both Neo Materials and Pulse Data with Lions Gate.  Finally, the length of time for the SRP to expire is not clear under 62-202. Where there is no legislative change, a policy suggestion would be of assistance; 
6. Remain within the purview of securities law statutes. Regulators should restrict their action to consideration of matters authorized by the OSA and not purely governance issues.  The decisions in Magna, HudBay, Neo Materials, Pala Investments, and Sears show that the OSC is increasingly providing commentary in corporate governance. These decisions also show that the OSC is considering issues which remain outside the jurisdiction of the OSA. Where such issues are considered, it adds to the uncertainty surrounding the TOB regimes at the Commission. This increases costs and reduces the likelihood of such bids being launched.
7. The OSC tribunal should confine adjudication to its statutory jurisdiction. The OSC should not cross the lexicon of corporate law statutes. The decisions in Magna, HudBay, Neo, Pala, and Sears show that the OSC is increasingly providing commentary in corporate governance. At the same time, however, these decisions also show that the OSC may be crossing the lexicon of corporate law statutes which lie outside its statutory authority. This is problematic as there is a continual tension between the intersection of securities law and corporate law statutes, a tension which is known to securities regulators across Canada. 

In deciding on contested transactions, 62-202 requires the OSC to satisfy its policy objective of shareholder primacy. At the same time, however, courts have vigorously protected the business judgment rule in deciding on corporate governance cases. Corporate governance cases do not have a clear connection to securities legislation. Where a securities regulator rules on a corporate governance matter that offends the business judgment rule, this brings into question the merits of whether a securities regulator has a right to err on a principle for which the courts have closely protected. In such cases, courts should not provide deference to OSC tribunal decisions. There is increasing interplay between securities law and corporate law statutes combined with the concurrent jurisdiction in contested takeovers. This has and will continue to pose a future challenge for the OSC tribunal.

8. The OSC tribunal should provide shareholders with enhanced disclosures. The Magna decision demonstrated the perils of failing to provide sufficient disclosures to investors when a takeover bid is in play and contested. The ordering of the OSC of Magna to provide enhanced disclosures for investors to make reasoned and informed decisions is consistent with the policy basis of 62-202 and 62-104. During takeover bids, Special Committees have a fiduciary duty and owe a duty of care to investors to ensure information transparency is provided while the board considers other competing alternatives. Securities regulators should ensure that shareholders are provided with enhanced disclosures to make informed decisions. 

9. Shareholder democracy should not trump director primacy. Under the rubric of 62-202, shareholder democracy is a pervasive theme throughout by allowing shareholders to have the final say on takeover bids. There is a strong myopia in 62-202 in favour of a bias towards supporting shareholder interests at the expense of serving the long-term interests of the corporation. Corporate law statutes such as the OBCA or CBCA emphasize the role of the board in acting as stewards of the corporation to satisfy the long-term best interests of the corporation. This does not necessarily coincide with the long-term interests of shareholders, which are one set of stakeholder interests. In Air Products & Chemicals v. Airgas (“Airgas”), the Delaware court held that boards should be able to “just say no” to hostile takeover bids. In the Airgas decision, Chancellor William B. Chandler III wrote the following:

I conclude that, as Delaware law currently stands, the answer must be that the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors. (Emphasis added)

The decision in Airgas provides some guidance as to how boards should respond to hostile takeover bids. The Delaware court recognized the potential conflict between boards and shareholders and has provisionally resolved it in favour of boards. The Airgas decision should prompt the OSC tribunal to reconsider its adjudicative approach towards defensive tactics in takeover bids by respecting the statutory obligations of boards under corporate law statutes.

10. Public policy interests should balance the interests of shareholders and issuers. Recent securities commission decisions in Neo, HudBay, Pala Investments, and Magna highlight the dominance of shareholder democracy over the interests of issuers under board primacy. The sweeping public interest powers of the OSC under s. 127 of the Act was intended to promote capital market integrity, efficiency, and investor protection. In reconciling such objectives, the OSC has failed to provide a semblance of procedural fairness and balance in ruling on contested M&A transactions.  The OSC’s public interest powers have been criticised for being overly expansive at the expense of considering non-shareholder interests.

1. Critics contend that takeovers expose employees to risks that were not negotiated and may result in the ‘hollowing out’ of Canada. This stems from the relative ease with which bids succeed in Canada – see Edward Waitzer, “Time to Re-think Poison Pills”, Financial Post, September, 2011.
2. Bebchuk  et al “What Matters in Corporate Governance” 22 Review of Financial Studies 783 (2009).
3. See generally Dyck and Zingales, “Control Premiums and the Effectiveness of Corporate Governance Systems”, Journal of Applied Corporate Finance, 2004 Vol 16.
4. The creation of an auction being the stated purpose of 62-202.
5. Re Canadian Jorex, (1992), 15 O.S.C.B. 257 [Canadian Jorex].
6.  Ibid, at 5.
7. Opportunistic SRPs are instituted by boards in the face of a bid, and generally have not secured shareholder approval.
8. There have been competing studies on this point – in particular, the conflicting findings by the BMO study cited on August 22, 2012 by Michael Amm, Partner, Torys LLP, and the Blakes’ study cited on August 15, 2012. In the study by Blake’s – the initial bidder gains control in the majority of cases.  The evidence supporting the likelihood of initial bidders gaining control is mixed.
9. Civil Action No. 5249-CC (Del. Ch. 2011) (QL)
10. Airgas, supra note 2, at 5.

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• The board of the seller is typically looking at avenues to enhance shareholder value, one of which is to solicit bids through an auction process

Issues

• How should personal relationships be managed and reconciled between the principals of the seller and that of the bidder to ensure the perception that conflicts of interests and any material non-public (insider) information exchange is avoided?
• How will the bidder lobby the seller to tender its shares to the take-over bid? What sweeteners (if any) should be offered as part of the transactions? E.G. – sizable premium to market, executive parachutes (e.g., executive(s) seeking retirement), a board seat on either the bidder or seller.
• How will the bidder lobby remaining minority shareholders to tender their share to the TOB? How will the strategy in lobbying any controlling shareholders differ from lobbying multiple minority shareholders, which in sum, may own a majority position in the shares?
• How widely dispersed is the share ownership that includes the minority shareholder base? Does it include any institutional investors, or is it retail investor dominated?
• If the bidder is looking to acquire 100% of the seller, should the bidder consider making a creeping TOB with an initial toe-hold position, and eventually accumulating an equity control position in the seller? What are the implications for securities disclosure rules? This is a more costly option due to transaction costs.
• How can the bidder position itself as the most preferred buyer despite other competing bidders in the auction process? Is there a strategic or tactical advantage for the bidder positioning itself in the market as a white knight bidder? If they lose the bid, it is likely to go to an identified ‘white knight’ bidder (this happens frequently)?
• Are there any strategic advantages for the bidder to make a hostile bid for the seller?
• How can the bidder impose contractual provisions to protect itself against the seller refusing to accept the bidder’s proposal?
• How long is the poison pill likely to take effect with the seller? How will this affect the negotiating strategy and terms and conditions for the bidder in making the bid attractive to the seller?
• Deal protection clauses (DPC) to be negotiated by the bidder have their limits. It’s important to be selective in which clauses will limit competing bidders while simultaneously remaining attractive to the seller in reducing uncertainty in closing the deal.
• Where there are few majority shareholders, there is a large minority shareholder base to consider that will require their approval above the 66 2/3% toe-hold position, to get to the 90% toe-hold before the “squeeze-out” transaction in acquiring 100% of the seller

Applicable Statutes

• Canadian – CBCA, OBCA; Ontario Securities Act (“Act”)
• US – Delaware General Corporation Law (DGCL), Williams Act

Analysis of Concerns

• Under what conditions (e.g., crown jewels) should lock-up agreements be devised as a DPC for the bidder?
• What are the limits of DPC’s for the bidder in ensuring it is the likely successful bidder without triggering a public auction for the seller?
• If the bidder entertains a solicited bid by the investment banker retained by the seller, how does this affect the perceived leverage for the bidder as it relates to the offer price and mobilizing minority shareholders to tender to the bid?
• Where two issuers are of roughly equal size (both large), how does this affect regulatory compliance with the securities disclosure regime?
• The policy basis of poison pills (or shareholders rights plans) under securities statutes have been inconsistent among provincial commissions across Canada. When is the ‘pill’ likely to expire?
• How do we ensure information leakage is minimized to prevent pre-bid price run ups, making the bid more expensive?
• Are shareholders trumping the needs of director primacy in ensuring the long-term interests of the corporation are in-tact? In other words, is shareholder democracy trumping director primacy?
• In operating within the spirit of 62-202, has the poison pill and any other defensive tactic been to a shareholder vote?

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