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.

However, it not only meant the dawn of a new Middle East. It completely opened up this lucrative region for U.S. asset managers.

Further Context

The Abraham Accords provided more than a bridge for Middle Eastern countries to conduct business with Israel. They represented a new “mindset” shared by Israel, its Arab neighbors, and America’s leadership. 

The potential for unbridled economic opportunity and prosperity for all participating countries is now the priority. Not long-standing political and religious tensions.

With the U.S. brokering the treaty, this new “mindset” makes the UAE more accessible and open for U.S. asset managers to expand and secure licensing.

The cloud of uncertainty has been lifted, and the next 6-12 months could pose significant opportunities for U.S. asset managers to increase their AUM. 

Why Should U.S. Asset Managers Care?

The Abraham Accords changed how business is conducted in the Middle East. Particularly, if U.S. asset managers have dealings with Israeli companies.

Israel and the UAE are America’s two largest Middle Eastern trading partners. However, until now, U.S. asset managers doing business with both countries had to walk on eggshells and tolerate long bureaucratic delays. 

Regional operations have always been bifurcated between Israel and the rest of the Middle East. With the Abraham Accords, the UAE abolished its Israel boycott law. In return, the U.S. Treasury Department removed the UAE from its “boycotting countries” list.

That means substantially friendlier ties between the UAE and the U.S. and reduced barriers to entry. Especially for U.S. asset managers and UAE institutions, including capital-rich Dubai SFOs (Single Family Offices) and MFOs (Multi-family Offices), wanting to invest with them. 

Private equity or VC shops from the U.S. establishing a presence in Dubai can now invest in Israeli tech companies from Dubai.

It’s also more accessible for U.S. asset managers to simultaneously invest in Israel and the UAE’s flourishing energy, tourism and travel, and health and pharma sectors. 

Moreover, the Abraham Accords show how quickly warmer relations can benefit everyone economically. 

• According to the Rand Foundation, the Abraham Accords could create as much as $1 trillion in new economic activity when fully realized over the next decade.
• The $3 billion Abraham Fund jointly formed between the U.S., Israel, and the UAE could reduce barriers in conducting business and lead to major investment initiatives.

Many of the largest U.S. asset managers saw opportunities from the Abraham Accords from the start.

With the Abraham Accords in motion for two years now, it’s not only easier for U.S. asset managers to get licensed now and conduct business in the UAE. It’s clarified how to get licensed and conduct business. Citibank, for instance, called the Abraham Accords a “perfect fit,” opening up exciting investment opportunities in the Middle East that were previously “unavailable.”  

Consistency eliminates risk. The Accords reduced the veil of uncertainty and formalized the regulatory process rather than ad hoc.  

Plus, consider the potential longer-term implications. Today it’s Dubai. Tomorrow it could be Saudi Arabia. 

Furthermore, asset managers looking to enter the Middle East may not only have a more accessible inroad to Dubai with reduced barriers. They may also now have a more accessible entrance into East and Southeast Asia.

Black Swan’s Role 

The UAE has long been an attractive destination for American asset managers. However, the Abraham Accords changed the business and regulatory landscape in the Middle East. Regulations eased, and openness increased with economic cooperation as the priority. 

Black Swan can serve as your quarterback for navigating this new era.  

At Black Swan, we have unique insights into the region and the interplay among regulatory agencies. While much of the focus of the Accords involves the Israel-UAE economic relationship, it also opens up opportunities for American asset managers. 

As a U.S. asset manager, Black Swan can help you leverage these warming ties and introduce you to the proper regulators and connections. We are a central repository firm focused on regulatory compliance and can assist you with your expansion needs to grow your AUM. We can help you with the licensing application and associated Compliance Manuals, referrals to placement agencies and tax counsel, and more. 

With doing business in the Middle East further codified, it’s never been clearer how and why to expand to the UAE as an asset manager to increase your AUM. We can help you every step of the way. 

The post The Abraham Accords in the UAE: Implications for Foreign Asset Managers appeared first on Black Swan Diagnostics.

Blockchain is easing the burden of simple repetitive tasks, how we interact and verify data, and improvements to the capital lifecycle. These improvements require us to understand what Blockchain technology accomplishes and some of its limitations. Industry knowledge among boards of the implications of blockchain in corporate governance is lacking. A 2016 Gartner report found that 91 percent of board directors have at least heard of blockchain technology, while only 36 percent see blockchain as an opportunity and 21 percent as a threat. We will discuss and address such knowledge gaps and how blockchain can improve governance effectiveness for boards. 

One of the newest improvements is through Security Token Offerings, or STO’s, otherwise referred to as Smart Security Offerings (SSOs). These are becoming increasingly popular for companies to issue as an alternative means to raise either debt or equity capital. Security Token Offerings (STOs) or Smart Security Offerings (SSOs) are security tokens that are not utility tokens. A utility token is a token that is not considered a security token and fails to satisfy all four components of the SEC Howey test. The Howey test is a long-established test used in securities law by the SEC based on the precedent of SEC v. Howey. The test helps to determine whether a digital currency is considered a utility or security token under US securities statutes. The Canadian equivalent of the Howey test is the Pacific Coast Coin test.

STOs  are considered securities by securities regulators and are regulated and treated as such. They are often accompanied with exemption filings with the SEC before public distribution, trading, and liquidity events. STOs are also referred to as Digital Asset Security Issuances (DASIs) by the SEC (Securities & Exchange Commission).  DASIs are digital securities based on the blockchain using DLT. Blockchain powers all digital currencies.

Companies vary regarding the capital structure of their security issuance and raise capital at different stages of development. STO’s can be used as a bridge funding source instead of pursuing the traditional IPO (Initial Public Offering) method. Also, there are companies that issue security tokens to represent assets that have historically been linked to bonds. STOs are regulated offerings that must comply with existing regulatory frameworks including SEC Regulation D, Regulation A, Regulation S, Regulation CF, and the usual KYC/AML Accreditation that applies.

DASIs carry many advantages and their ascent has seen a steady uptick in popularity. Recent data from Pitchbook suggests that 2018 was likely the biggest year on record in total value for Venture Capital fundraising. While this includes all Venture Capital deals, more than 20 percent of all capital raised went to digital asset issuers including both ICO’s and STO’s. Initial Coin Offerings (ICOs) are a low-cost and efficient means of raising capital for mainly privately-owned technology companies that offer an amount of their company’s digital currency instead of a given number of shares. The secondary market for trading ICOs is usually on decentralised digital asset exchanges (e.g., Binance, Huobi, Kraken, Coinbase), while the market for trading these digital currencies on centralised exchanges is limited to non-existent. We will discuss the emergence of Smart Contracts, DLT, and Digital Asset Enhancements.

Smart Contracts

A smart contract is programmable computer code that automates functions but is not immutable. Smart contracts can be transferred automatically from one party to another provided certain conditions are met. A smart contract is just a program that is based on an agreement from multiple parties. The smart contract is created to ensure automated compliance to the agreement by the parties by hardcoding compliance. They can be based on any number of variables just as a traditional paper contract can. They are a  simple concept and are gradually working their way into mainstream business governance as an improvement to any formal agreement. This reduces the effort of staff, legal assistance and executives to ensure contractual obligations are met by outside parties, and for managers to ensure internal compliance. 

Distributed Ledger Technology (DLT)

Another very simple concept Blockchain technology has created is Distributed Ledger Technology, or DLT. This improves the process of verifying large amounts of data and their transactional value quickly and efficiently. It also can use a decentralized and encrypted system to ensure greater privacy and security. Decentralized exchanges are mainly unregulated exchanges that provide for trading of key functional digital currencies that involve utility tokens (e.g., BTC, BCH, ETH, LTC, XRP). Information is the most valued asset for corporations. DLT allows that information to be sent and managed more efficiently and with greater security, thereby improving another area of corporate governance.

Digital Asset Enhancements

Digital assets are electronic currency powered by the blockchain that are backed by an asset (e.g., real-estate, bonds, intellectual property, revenue or royalty income streams, etc.). Digital assets are significantly more versatile for managing the capital lifecycle. Digital Assets allow companies to issue fractional shares in their company, automatically payout dividends, ensure reporting to investors, manage multiple jurisdictions and their regulations automatically, verify ownership without the need for a transfer agent, and improve consensus mechanisms for shareholder voting. Digital assets are greatly improving the process of managing all those levels of corporate governance. 

Digital assets are also improving the way directors of boards interact with a company in a similar way. Boards are often scrutinized for their lack of transparency to shareholders. The use of digital assets can manage the entire process of transparency more efficiently. This reduces the cost of capital, friction costs, informational asymmetry, and the cost of management while improving profitability.

Governance relates to voting rights in this context. Voting rights are typically accorded on a share basis and are like tokens. An investor owning an equity token would have a vote in key corporate decisions made by the issuer. Security tokens allow an investor to participate in company decisions with more efficiency and greater transparency. 

Like voting shareholders in publicly traded companies or preferred shareholders in VC-backed companies, security token holders would be given rights to participate in certain governance decisions related to their assets. Some of the guiding questions that drive governance decision-making are centred around the following inquiries: How will rules be established? Will the founders set the rules, or will there be an independent board of directors? Do contributors get voting rights? If yes, what are the limits of such voting rights? Can contributors elect the board? What structures and processes exist to oversee the direction of the company to ensure it stays on course?

Institutional Imperatives in Digital Currency

Digital currency is electronic currency used for commercial transactions powered by blockchain technology. The relevance of these underlying currents is that institutional investors such as venture capital is starting to affix itself to these digital issuers and increasing the capital output. Institutional investors see a greater opportunity for liquidity on multiple channels through an STO. There is a defined process for the transfer of ownership and custody. The ability to hardcode and define governance for token holders also enables a more efficient process in terms of managing and codifying “shareholder” rights. The efficient and effective execution of shareholder rights and more broadly, stakeholders including customers, governments, regulators, suppliers, vendors and the like, are cornerstones of sound corporate governance

STO’s are enabling a more efficient and effective implementation of governance protocols. Security Tokens can accelerate investor liquidity while maintaining compliance with securities statutes. The STO achieves that without changing the current capitalization table to account for the transfer of ownership. Liquidity can be materialized in some jurisdictions within just a few months to a year. This is an attractive proposition for new age venture capitalists. Most companies don’t succeed and typically have a two-year runway. This serves as a hedge for institutional and sophisticated investors.

Digital currency is not only favorable for VC firms and Family Offices. The benefits extend to founders, and key team members – indeed, even the company itself can benefit from additional liquidity through digital issuance. These parties take some comfort in knowing that they can continue their innovation without having to compromise everything immediately. This may include the cost of capital, share dilution, divesting assets, or reallocating resources towards suboptimal use.  They can also generate partial liquidity to utilize for their own financial needs to continue their work. The universe of viable options is broadened.

Even if an STO includes an equity component, it can be spread over multiple investors. This can be a more collaborative approach without stifling decision-making. This is favorable for founders because while they still have investors to account to, they can imbue potential innovation at a greater pace. Liquidity is king in the new age of digital issuers, but governance will also play a key role in the accessibility, efficiency, and portability of new age security offerings.

What Role Will DAOs (Decentralized Autonomous Organizations) Serve In Corporate Governance?

A DAO is an organization of people who communicate with each other via a “network protocol,” communicating with one another through an online set of rules but reaching governance consensus with offline diplomacy. DAOs are the end-points of the ‘gig economy’, which so far has been championed by platforms like Uber and Airbnb, for example. However, they are likely to be truly global cooperatives and their value distributed to stakeholders – not just shareholders and executives.

Decentralized Autonomous Organizations (DAOs) will be superior to that of today’s corporate firm structure. For investors, DAOs will eventually become a less risky investment class compared to shares in a regular company that is centralized by control. This will be achieved by offering more predictable and stable ROI (Return-on-Investment) and favorable passive returns than most stock dividends – while also minimizing two of the greatest risks in corporate operations – human error and executive self-interest. According to the World Economic Forum, “The potential for blockchain lies in its architectural ability to shift, and potentially upend, traditional economic systems – potentially transferring value from shareholders to stakeholders as distributed solutions increasingly take hold.”

The nature and origins of ‘the firm’ is rapidly changing in the digital age where intangible assets such as intellectual property and the corporate brand are now regarded as the most important driver of corporate value compared to tangibles accumulated in the industrial model. This poses challenges for firms still operating in the ‘old model’ including:

• Difficulty in valuing intangible assets in digitally native organizations;
• A gradual and continuing decline in corporate accounting and auditing standards; 
• New forms of fundraising, such as Security Token Offerings (STOs) – less costly than traditional and often overpriced and expensive IPOs;
• STOs which can blend equity rights and debt with governance; 
• Growing social responsibility for corporations to account for ‘external costs’, such as ESG and CSR;
• Mounting social costs for corporations such as climate change value-at-risk; and
• The concentration of share value and corporate earnings in growth and tech stocks invested through passive strategies, thereby increasing systemic risk in the capital markets.

Facebook’s Proposed Libra Coin: The DAO in Practice

In June 2019, Facebook announced their intention to launch their own proprietary stablecoin, Libra coin, to serve as a payment gateway on their platform of 2.4 billion monthly active users. The Libra coin would be operated under the umbrella of Calibra, a Swiss registered non-profit organization consisting of a consortium of one-hundred private organizations that have equal voting rights. Libra is mainly targeting the over $600 USD billion annual market for cross-border remittances. This space has been mainly dominated by major banks and may pose a threat to the existing competitive landscape. The US Federal Reserve and major US banks have expressed concerns over Facebook’s initiative and view it as a threat to the US dollar and its functional stability in FX markets.

The goal of Libra coin is to send money instantaneously across borders securely and at low-cost. Libra would be presumably asset-backed by financial assets to include bank deposits in various currencies and short-term government securities (e.g., US Treasuries) which will likely reduce the coins’ short-term volatility while engendering trust and stability. Facebook intends to turn its crypto project ‘Libra’, into a DAO utilizing a native governance token (the Libra Investment Token). This is a significant development for a company notorious for its centralized control. Facebook’s fundamental business model is to harvest and monetize data – reams of data with over 2.4 billion users and targeting the over 1 billion unbanked in Africa. In China and India respectively, for example, there are nearly 200 million and 100 million people with a mobile phone but without a bank account. This represents a significant opportunity for a digital currency to serve as a payment gateway at costs much lower than traditional money service businesses such as Western Union. 

The Libra coin could serve as a leading payment gateway among its 90 million small business customers spanning not just consumer products and brands already advertising on Facebook, but potentially including financial services. This includes banking, savings and deposits, investments, insurance, and other financial products. In effect, the Facebook payment gateway would require registration and license as a de facto shadow bank, a regulated CFTC (Commodity and Futures Trading Commission) entity, or money transmitter license.  Going into the details of the cost-benefit analysis of the Libra coin is beyond the scope of this chapter. However, in the final analysis, instead of Libra usurping the central banks authority or undermining sovereign currency legitimacy, Libra is likely to be a vehicle for Facebook to achieve its wider goal of becoming the industry benchmark for digital identity. If Facebook can achieve this milestone, it would have access to all personal data. In a digital age of data monetization and artificial intelligence, data is the currency that begets power and sustainable competitive advantage. 

The implications of Facebook becoming the industry proxy for digital identity through its Libra stablecoin for the governance of boards are numerous. First, with nearly unfettered access to sensitive personal data of users, this gives Facebook the ability to better optimize and monetize personal financial data that may have otherwise been protected or limited. Second, although it is initially a “permissioned” blockchain with the goal of converging towards a “permissionless” blockchain, the decentralized nature will make it like Bitcoin and Ethereum in which anyone with technical capabilities can operate.  This will expose the coin to certain risks. Although permissionless blockchains can reduce infrastructure costs, they are also slow, open, and are constrained by scalability and privacy issues. This especially applies to financial services organizations, a space Facebook is clearly aiming towards penetrating on a large scale. The recent exit in October 2019 of key members of the Libra Association, including Visa, PayPal, Mastercard and Stripe, indicate that the strength of increased government regulatory scrutiny may present material obstacles to Facebook’s initial coalition of 28 corporate backers. The spate of exits by large players, including the absence of a major US payment processor, is evidence that without regulatory clarity in this emerging space, more companies are likely to exit. The recent congressional testimony of Facebook’s CEO, Mark Zuckerberg, in testifying before various members of Congress further demonstrates the delayed pace of this significant initiative and its potential impact on the US dollar. This will also likely delay Facebook’s strategic program implementation in its quest to compete directly against banks. Third, Calibra has developed specific governance protocols for its association members. Although in theory each corporate member has equal voting rights, this has yet to be demonstrated given Facebook’s dominant market power and ownership of the Libra coin. In summary, Facebook’s proposed launch of Libra through the Calibra entity is fraught with challenges and risks, let alone Facebook’s checkered history of extensive privacy violations. 

What Role Does Board Governance Serve in a Digital Currency Environment?

Governance has more to do with voting rights in this context. Voting rights are typically imparted on a share basis similar with tokens. An investor that owns an equity token would have a vote in key company decisions. Currently, most publicly traded companies or reporting issuers send out a quarterly newsletter or “alert” to investors. That alert announces upcoming meetings at which investors could exercise their votes. With security tokens, an investor could be part of company decisions with more efficiency and greater transparency. Governance is not discussed much when it comes to digital issuance, but it plays a key role in the benefits for both the digital currency issuing organization and the investor.

The definition of a security can be broad and unnecessarily overreaching. It can mean an equity position in a company, or a dividend payout/revenue sharing, convertible debt, an asset-backed security like a REIT (Real Estate Investment Trust), intellectual property rights, and even royalty components. Security tokens make it viable to have a multi-layered security that has hardcoded protocols that ensure both the investor payouts and the issuing organization remain compliant down to the individual investor digital wallet. That makes jurisdictional compliance far less costly for the issuer. Smart contracts have enabled this. 

For example, Canadian Tire fiat currency is the equivalent of a digital currency that has the functionality of a utility token. Canadian Tire fiat currency is issued only to users within its existing ecosystem, allowing users to redeem its value for equivalent goods and services without paying – nor promising – dividends. The currency offered by Canadian Tire has an intrinsic value within its respective ecosystem, and value is not derived outside of this system. It is effectively a closed system providing a means of payment while being engaged in loyalty and other programs to incentivize users. Each of the four prongs of the US SEC Howey test are not satisfied in claiming Canadian Tire fiat currency operating as an equivalent security token under the dictates of the SEC regime. 

Canadian case-law further supports this position as illustrated in Pacific Coast Coin, where the Supreme Court of Canada (SCC) elucidated “a common enterprise” as a scenario where investors’ fortunes are interwoven with and depend upon the efforts and successes of those seeking the investment of third parties. The Pacific Coast Coin test is the Canadian equivalent of the US Howey test. The only difference between Canadian Tire fiat currency and a digital currency via a utility token is that Canadian Tire fiat currency is paper-based; digital currency, in contrast, is electronically built and powered on the blockchain.

By comparison, an established US company, Ripple, has its own native digital currency with ticker symbol, XRP. XRP is widely classified as a utility token and is considered one of five functional currencies. XRP is broadly traded and is liquid on major digital asset exchanges. Ripple is aiming to replace and compete with the archaic and slow SWIFT banking network for international, cross-border fiat currency remittances.   

Smart contracts are really “dumb” programs that act as a written script of agreement between two or more parties. These contracts can be affixed to a security token. Security token compliance platforms like Polymath, Harbour Capital, Securrency, or Securitize, for example, have designed the technical pieces using these smart contracts to issue various types of tokens easily and to manage the process effortlessly. These firms have a series of “off-chain” processes including anti-money laundering and “know-your-customer” checks to identify customers, match investors to blockchain wallet addresses, and confirm an investor’s eligibility to participate in trading. Blockchain wallet addresses allow funds from a wallet, a user requires the recipient’s “receive” address or QR code. To receive funds from a wallet, a user can share his or her address or QR code with the sender.  Interestingly, and for technical reasons, a Bitcoin (“BTC”) or Bitcoin Cash (“BCH”) address will change each time a user requires it, but an Ether (“ETH”) address will always stay the same.  

The Role of DASIs and Their Potential Impact in Corporate Governance

DASIs will revolutionize the way we invest in organizations at any stage. Each party, including regulators, will benefit broadly. The digital age is moving with incredible speed and ferocity throughout the world. Digital currency can solve some issues, but it is not as ground-breaking as the possibility of hybrid security offerings that can eventually be linked to these digital currencies. For anyone doubting how a security can eventually become an openly traded currency, just look to the case of Ethereum – an open-sourced platform. Ethereum had components of a security offering during its ICO but has become so useful as a digital currency and so decentralized, that it is no longer considered a security by the SEC and other leading securities regulators around the world. It has been widely viewed as a commodity that is open-sourced where its value is not derived by any of the four properties of the Howey test.

Jurisdictional Considerations for STO Launch

When launching an STO, a global strategy and framework must be developed. Blockchain is global and borderless, and the same applies to your STO. Domestic biases will likely impair your ability to complete the STO funding cycle. The reality is that, for now, digital currency trading activity is heavily concentrated in Asia. For example, reports show as of 2018, that 60 percent of all digital currency buyers and sellers are in Japan, while nearly 8 percent are in the US and less than half of a percent in Canada. When marketing an STO, demographics matter and should form part of your strategy to determine which countries to focus on and which ones to outright avoid.

Generally, companies conducting STOs should block countries that are, at a minimum, considered high-risk STO jurisdictions. These are countries that are not friendly to digital currencies and/or hostile to digital assets in any form via regulation or other punitive measures. High-risk countries that STOSs should avoid include Indonesia, Bangladesh, and Nepal. Lower-risk countries that STOs should avoid include Macedonia, Algeria, Bolivia, Ecuador, and Libya. Recent FATF (Financial Action Task Force) reports in June 2019 have demonstrated these countries are considered high-risk from a KYC/AML perspective. 

Incidentally and not surprisingly, none of these countries form part of the G-20, which is where the majority of STO buyers are likely to be identified with serious interest. It’s the G-20 countries in combination with FATF guidance and recommendations that are material. The G-20 countries have had delayed digital currency regulation recommendations since mid 2018.. The biggest challenge to succeeding with this initiative will be regulatory coordination among the G-20 due to countries varying capital market structures, maturity, political risks, and liquidity preferences. Luckily, blocking the jurisdictions above shouldn’t materially affect the universe of token solicitations nor the efficacy of the STO funding campaign.

The post Blockchain Enhancements In Corporate Governance 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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1. Smart contracts are unstable: The law on the enforceability of smart contracts is still uncertain due to the nascency of the blockchain and lack of regulatory structures and formal enforcement mechanisms to accommodate programmable smart contracts. It will need to be determined whether legal contracts that are implemented in whole or in part on a blockchain, renders them enforceable under existing law. For example, the Uniform Electronic Signatures Act (“UETA”) and Electronic Signatures in Global and National Commerce Act (“ESIGN”) already recognize, enable, and validate the use of electronic signatures and electronic records when using a blockchain. We will need more such statutes to provide additional recognition and validation.

2. STOs are unregulated and lack liquidity: The market for STOs is mainly unregulated, other than two national and regulated digital asset exchanges such as the JSE and BSE that are onboarding STO issuers. The technological capability and regulatory approvals required for licensed securities dealers to list and integrate blockchain-native tokens into their offerings are non-existent. This demonstrates there is a limited active secondary market for trading, and thereby a lack of liquidity. Although the JSE and BSE have migrated from a traditional stock exchange to a digital asset exchange (retaining all traditional stock exchange capabilities), boards will need to carefully evaluate their secondary market needs and determine which jurisdiction(s) and the extent of regulation are required to best list their STO. Boards need to consider the absence of investor protections or insurance to mitigate against potential frauds, scams, or other malfeasance concerns.  

3. Director liability revisited: If issuers decide to raise capital via an STO, ICO, or IEO, and list on decentralised and mainly unregulated exchanges, such exchanges do not provide investor protections nor deposit insurance for neither issuers nor investors. If issuers are sued for any type of fraud, scam, misrepresentation, or other malfeasance, existing D&O (Directors & Officers) liability insurance may be insufficient or void altogether. SEC enforcement actions listed above with various ICO issuers is evidence that the SEC enforcement climate is alive and well and directors need the required protections.

4. Higher leakage costs: Blockchain powers digital currency. Issuers that raise capital via an STO, ICO, or IEO must realize that shareholder dissemination of information is now instantaneous, giving rise to the efficacy of the efficient market hypothesis. Any internal leakage of material, non-public information of corporate events or transactions are likely to significantly increase the speed and ferocity of leakage or slippage costs. This carries reputational, business, and director liability risks if certain shareholder groups are advantaged at the expense of others.

5. Adoption rates are slower than expected:  Although the market for ICOs peaked in late 2017 and early 2018, the market for STOs hasn’t been as torrid as adoption has been much slower than expected. Adoption has been mainly dependent on the state of SEC regulation to ensure investor protection and market integrity, which has delayed legislation or formal regulation of STOs. Not only has the SEC been slow to enact rules for digital currency issuers, it has denied various applications to secure regulatory approval for ATS (Alternative Trading Systems), BTC Exchange Traded Funds (ETFs), and other registered entities with a digital currency component. The pace of STO financings will depend on the wider adoption of digital currency, such as BTC, while adoption has been slow and concentrated. For example, BTC currently represents nearly 70% of the total global market cap of digital currency. This poses concentration risk among the core five functional digital currencies. 

 With the gradual and tactical evolution of STOs becoming actively listed and traded, the need for voting and programmable corporate governance dynamics will likely increase in prominence. Voting rights allow token holders to participate in important decisions related to the underlying asset of a digital currency- whether it is considered a utility or security token. Security tokens bring a unique flavor to voting rights as governance decisions are not only relevant to the lifecycle of the underlying asset, but also to the digital asset itself.  

The post The Impact Of Digital Currency: Key Lessons Learned appeared first on Black Swan Diagnostics.

1. Cybersecurity Risks: Blockchain code is still in its infancy stage and might be liable to presently obscure security vulnerabilities. For example, the Ethereum (ETH) contract language is relatively new and there may be zero-day attacks that programmers could misuse. Blockchain also imposes the real risk for a double-spending attack whereby an attacker effectively generates more than one transaction while utilizing only one token and bringing about the discrediting of the “fair” exchange. Private key holders of each account are the ones on which the reliability of each entry rests. The partial reestablishment of the agent is done through private blockchains. A private blockchain is a permissioned blockchain. Establishing rules that are maintained by either the starter of the system or by the starter of the network enables nodes in a private blockchain network to be validated and thereby require invitations. The board should ensure proper and regular oversight for the management of this recurring obligation. 

2.   Insider Trading Surveillance: Smart contracts such as Ethereum can be written so that rules and regulations are enforced at the token (asset) and protocol (technology) level. This is a significant benefit for both companies wanting to interact with digital assets and regulators seeking compliance. Smart contracts can not only remove the need for continuous compliance surveillance but are able to eliminate the need for regulatory compliance monitoring to start. For example, assume a company raises capital with ‘Company Security Token’ (CST). Your legal and regulatory counsel has advised that you utilize Rule 504 of Regulation D, which provides an exemption to the normal securities registration requirements assuming certain conditions are satisfied. One of those conditions is that CST qualify as a restricted security. This means it cannot be resold for at least six months to a year without going through the traditional securities registration process with the SEC. In the current state of the digital asset market, preventing all participants of the CST offering from violating this 6 to 12-month restricted lockup rule is a difficult and labor-intensive process. Smart contracts can solve this problem. Instead of issuing CST directly to users’ personal digital asset wallets, which gives way to track or prevent assets from being transferred or sold unlawfully, CST can be distributed directly into a smart contract that locks the asset’s movement for a specified period. This ensures that your company and its employees comply with Rule 504 of Regulation D. This can prevent the excess sale or dumping of security tokens on a digital asset exchange, thereby minimizing downward pressure on token price and liquidity. 

3.   Proxy Voting: Blockchain will provide for secure and accurate proxy voting. Proxy voting is a complicated process for corporations and often result in flaws, incomplete ballot distributions, imprecise voter lists, and problematic voter tabulation. With blockchain, this cumbersome and unsecured process of proxy voting can be completely revamped. Using the issuer’s digital currency or tokens, shareholders will have tokens representing their voting power. Votes are cast and secured on the secure blockchain network and voters can observe the ongoing voting process. Blockchain will enable corporate voting to become more accurate, and strategies such as ‘empty voting’ that are designed to separate voting rights from other aspects of share ownership, may become more difficult to execute secretly. This minimizes voting fraud or corruption and adds an important layer of integrity to the voting process. The greater speed, transparency, and accuracy of blockchain voting could also motivate shareholders to participate more directly in corporate governance and demand votes on more topics and with greater frequency. This may enable wider shareholder engagement, especially among special interest groups (e.g., Socially Responsible Investing (SRI), Corporate Social Responsibility (CSR), or Environmental & Social Governance (ESG)), voting at AGMs and other meetings. 

1. Transparency: Through disintermediating transactions via the DLT, blockchain ensures a more transparent and effective audit trail. This will help to reduce or eliminate corporate corruption. The use of DLT could provide unprecedented transparency in allowing investors to identify the ownership positions of debt and equity investors and overcome corruption by insiders, boards, regulators, broker-dealers, market makers, exchanges, and listed issuers. Authenticating a shareholder’s digital identity allows the blockchain to use an embedded trust component. This means that a shareholder doesn’t need to be physically present to prove their identity. By extension, by ensuring the democratization in corporate governance, blockchain provides opportunities for companies to manage their assets directly. In a KPMG study (2016-2017) of selected blockchain projects, it was estimated that a 20-40 percent increased efficiency of data and digitisation from single source of truth was realized from the blockchain. Digitization of data can unlock efficiencies, and consequently, incremental shareholder value.  

2. Enhanced access to documents: The existence and immutability of the DLT means that access to documents by directors is quick and efficient. Directors can easily manage insider stock ownership data to guard against trading anomalies (e.g., insider trading profits evidenced through trade surveillance tools) and the real-time and equal transmission of public information to all shareholders.  

3. Smart contracts will improve transparency: Smart contracts help to mitigate the risk of fraud for organisations by providing an immutable audit trail. They will dramatically reduce the costs of identity verification and contract enforcement. 

4. AGMs will empower shareholders: Voting can be slow and fraught with human error at an AGM. Blockchain technology can deliver faster and more reliable voting results that give shareholders a higher level of trust and confidence in voting outcomes. This should empower rather than embolden shareholders to contribute to decision-making that is in the best long-term best interests of the corporation.

5. Real-time financial reporting streamlined: Consumers of financial statement information would not need to rely on the judgment of independent third-party external auditors and the integrity of managers. Instead, users of financial statements can trust with certainty the data on the blockchain and impose their own accounting judgment to make their own non-cash adjustments such as depreciation or inventory revaluation. 

6. Board dependency is reduced via permissioned access: A permissioned blockchain a network that requires permission to gain access. Only authorized users can join and start verifying. The blockchain can offer lower costs of trading and more transparent ownership records, while permitting visible real-time observation of share transfers between owners. DLT bolsters the audit trail/record keeping function by using blockchains to record stock ownership. This could solve many challenges related to issuers’ inability to keep accurate and timely records of shareholder ownership.

Board Inquiries of Management About Blockchain

Given the nascency of blockchain technology, boards must understand the risks and opportunities associated in using blockchain as part of their corporate strategy. The following are questions that boards should be asking management in using blockchain.

1. Competition: What are our direct and indirect competitors using as it relates to blockchain for their business? 

2. Cost-Benefit Analysis: Has management considered the advantages and disadvantages of using blockchain?

3. Risk Management: What are the cybersecurity and privacy risks and other mitigating factors, in using blockchain? Do we have a Business Continuity Plan (BCP) or Disaster Recovery Plan (DRP) if the blockchain goes down or is temporarily disrupted? 

4. Protocols: Would the company deploy a permissioned or permissionless blockchain protocol? Which vendor (if any) would be used and its cost?

5.  Infrastructure: Do we have the systems and technology to support the blockchain technology? What internal controls are there to manage and mitigate such infrastructure risks?

6. Strategic Integration: How does blockchain fit into our data protection strategy?

7. Auditing: How can we independently audit the technology to ensure it can be trusted? This is especially pervasive in the financial services sector and supply chain management, two leading use cases of blockchain. 

8. Regulatory Compliance: What are the regulatory compliance issues to satisfy if blockchain was deployed? 

9. Accounting: What accounting issues should we consider in using blockchain?

10. Taxation: Where a digital currency applies, what tax issues should we consider in using blockchain?

1. KPMG, “Blockchain for technology, media, and telecom (TMT) companies: What COOs, CFOS, CIOs, CISOs, and other executives should understand about blockchain”, 2019, p.1.
2. If the organization is storing transactions, that is an expense.  The method by which it stores such transactions, however, will determine the cost. PoW (Proof-of-Work) requires that the entire blockchain and history be contained on each node (server) that is responsible for transaction processing.  This means an infinite amount of storage space is required to store its history over time for each node.  PoW is expensive to store the data because the full history must reside on each node. The continual tension for companies using the blockchain is choosing between speed versus storage.  A blockchain running at 50,000 tps (transactions per second), for example, would consume 385 TB (TeraBytes) of storage annually. The solution is to have an archive node which would cost nearly $180K.  If a company is running a permissioned blockchain, then it is more advantageous and cost-effective to archive transactions off-chain to avoid the infinite growth of PoS (Proof-of-Stake). PoS can be configured so that it can be archived and the full blockchain does not have to reside on every node.  The implication for companies and management is that it is a more efficient way to operate.

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Smart contracts may be viewed as part of an evolution to automate processes with machines and self-executing code. A smart contract is a set of coded functions that incorporate the elements of a binding contract (e.g., offer, acceptance, and consideration) that execute certain terms of a contract. The smart contract allows self-executing computer code to take actions at specified times and/or based on reference to the occurrence or non-occurrence of an action or event (e.g., delivery of an asset, weather conditions, or change in reference rate).

Smart contracts can be stored and executed on a distributed ledger, an electronic record that is updated in real-time and intended to be maintained in geographically dispersed servers or nodes. Through decentralization, evidence of the smart contract is deployed to all nodes on a network, which effectively prevents modifications that are unauthorized nor agreed to by the parties. The use of blockchain technology is a continuously growing database of permanent records, “blocks”, which are linked and secured using cryptography.

What Role Will ‘Smart Contracts’ Serve in Corporate Governance?

Smart Contracts are computer programmable code that automate functions but are not immutable. They can be transferred automatically from one party to another provided certain conditions are met. Aaron Wright, associate clinical professor at Cardazo Law School and director of The Cardazo Blockchain Project, recently stated that: “The internet forced attorneys to better understand copyright law [and] similarly, blockchain will require a better understanding of securities law and an understanding of the underlying technology of smart contracts.” For reporting issuers, it is crucial that directors have at least a cursory understanding of fundamental securities law principles relating to the fiduciary obligations of directors. The automation and enforcement of smart contracts will be significant    to boards as they grapple with shareholder rights, activism, and other oversight functions such as insider trading, quarterly reporting, and proxy voting. 

Given that blockchain is both anonymous and decentralized, it is highly secure. This is critical for legal transactions since every single transaction on the blockchain is sent to and verified by every node on a very large peer-to-peer (P2P) network. P2P (Peer-to-Peer) Transactions are electronic money transfers made from one person to another through an intermediary. This is usually referred to as a P2P payment application. Each node on that network validates each blockchain event via a challenge-response system, which it then resends to all other “verifiers” on the node. In the end, independent nodes arrive at a consensus, and “declare” the transactions as valid; notably, any attempts to corrupt this data are then, in turn, made unsuccessful by being ignored.  This concept comprises the core systematic differentiator between traditional legal processes and – now with the aid of blockchain technology – are termed “decentralized” (i.e., P2P) transactions.

How Smart are ‘Smart Contracts’?

Against this background, a “smart contract” is not necessarily “smart” in   that the operation is only as ‘smart’ as the information feed it receives and the machine code that directs it. One implication of many is that a “smart contract” may not necessarily be a legally binding contract. For example, it may be a gift or some other non-contractual transfer; it may be part of a broader contract. The result of this is that to the extent that a smart contract violates the law, it may be neither binding nor enforceable.

They use digital signatures through private cryptographic keys held by each party to verify participation and assent to agreed terms. Private cryptographic keys are a sophisticated and encrypted form of cryptography that allows a user to access his or her cryptocurrency or digital currency. Smart contracts also allow access to refer to external information data to trigger action(s). In this sense, smart contracts use oracles – a mutually agreed upon, network-authenticated reference data provider which may be an independent third-party. This is a source of information to determine actions and/or contractual outcomes, such as commodity prices, interest rates, or the probability of an event occurring. In addition, smart contracts can automate execution processes through self-execution whereby a smart contract will take actions without further actions by the counterparties (e.g., disburse payments).  

What are the Main Benefits of ‘Smart Contracts’?

There are various benefits associated with smart contracts below:

1. Standardization – standardized code and execution may reduce costs for negotiations and agreements. 
2. Security – transactions are encrypted and stored on a distributed ledger that is immutable
3. Economy and Speed – automation reduces transaction times and unnecessary manual processes.
4. Certainty – Well-designed smart contracts execute automatically, thereby reducing counterparty risk and settlement risk.
5. Business innovation – automating the flow of digital assets and payments may foster new products and business models. 

The above use cases become particularly attractive for financial markets and participants. For example, in the buying and selling of derivative instruments, firms can streamline post-trade processes, real-time valuations and margin calls. For firms that have securities outstanding with shareholders, they can simplify capitalization table maintenance by automating dividends, recalibrate share issuances, and stock splits. This provides for a more seamless experience for shareholders and reduces the margin of error for board and regulatory reporting. 

What are Some Legal Limitations of Smart Contracts?

Current law and regulations apply equally regardless of what form a contract takes. Contracts or constituent parts of contracts that are written in code are subject to otherwise applicable law and regulation. Legal frameworks apply to smart contracts and may be subject to multiple legal frameworks depending on their application or product characterization. This may span various regulatory statutes, spanning federal and state securities laws and regulations, such as The Bank Secrecy Act (BSA), The USA Patriot Act, and Anti-Money Laundering (AML) rules and regulations. Smart contracts are by no means perfect and contain structural and legal limitations, some of which are outlined below.

Extending Security Token Protocols with Voting Rights While Shoring Up Efficiencies 

STOs via the DLT for voting provide a necessary level of transparency. The chief benefit of switching traditional voting systems to the blockchain is the enhanced level of transparency the blockchain provides. The blockchain would — definitively — preclude bad actors from cheating the system. It would ensure participants do not double-vote since there would be an immutable record of both their vote and identity. Deleting votes would be impossible since the blockchain is immutable. Those charged with counting votes would have a final record of every vote counted that could be verified by regulators or auditors at any time. On the blockchain, everything is both immutable and verifiable. Results can also be encrypted, which would encourage transparency while at the same time maintaining a crucial sense of privacy.

Reporting speed is essential for efficient capital markets. Results entered and stored on the blockchain are not just immutable and transparent, however — they’re also immediately available. That means conducting shareholder proxies on the blockchain is not only safer but also more efficient. Compared to the way current shareholder voting is conducted for reporting issuers, for example, the differences are stark. It currently takes hours to count votes for board elections to fill the slate — and sometimes results are muddled on account of human or machine error, which extends the process even longer. The blockchain, however, offers a reality in which that human error is stripped from the equation and results are counted immediately. Blockchain enables voting results to be available to shareholders immediately after completion of the voting process. 

Private issuers can benefit significantly from these more efficient voting processes. What becomes clear is the more you investigate the blockchain as a mechanism for governing voting processes, the more you find its application extends further than general voting mechanisms. Individual companies and organizations could reap the same benefits by utilizing the blockchain internally. For example, companies could use tokens to grant employees and stakeholders voting rights. The more tokens or STs (security tokens) an employee or voter is granted, the more weight their potential vote may carry. Granting tokens is also a way to incentivize favorable behavior, such as consistent accuracy.

In contrast, the AGM (Annual General Meeting) voting process for public companies consists of intermediaries and inefficiencies that can result in a lack of shareholder engagement. Proposals are often voted by proxies instead of by shareholders, often weeks before the meeting. Few or a limited number of shareholders attend AGMs in person. Large institutional shareholders may be granted engagement opportunities with management of the issuer that are not otherwise afforded to individual shareholders. This may give rise to preferential treatment, asymmetrical voting opportunities, and benefits select shareholders. These factors can result in a lack of transparency in the voting process and disproportionate voting power amongst shareholders. Blockchain technology has several potential applications that can remedy these inefficiencies and restore shareholder trust, confidence, and engagement. This provides more equitable distribution of voting while also democratizing shareholder voting. 

The immutable nature of a blockchain and the ability to create a specified set of rules for its use make blockchain technology an appealing option as an automated, secure method of counting shareholder votes at an AGM. For example, Broadridge Financial Solutions Inc., a corporate services company that provides a variety services for annual meetings, was recently granted a patent for proxy voting using blockchain technology. In 2018, Broadridge tested a pilot blockchain-based voting system at the annual meeting of Banco Santander, S.A. The technology was successfully used to create a digital register of the proxy voting at the meeting and was used by more than 20-percent of voting shareholders.

Voting Systems as a Blockchain Use Case

Stock exchanges around the world have been exploring the use of blockchain-based voting systems for years. Foreign stock exchanges, such as the Abu Dhabi Securities Exchange, use blockchain-based voting systems for shareholders of issuers. In 2016, Nasdaq and the Nasdaq-operated Estonia central securities depository, developed a web-based user interface for shareholders of listed companies on Nasdaq Tallin. The interface allowed shareholders to vote before or during annual meetings, transfer their rights to a voting proxy, monitor how the proxy voted, and review previous meetings and transactions. The system relied on blockchain technology to record ownership, issue voting rights, and allow shareholders to vote. This application is particularly acute as the blockchain was not only used to register votes, but also to provide a credible and immutable audit trail of previous meetings and transactions for shareholders to view. Similar applications of blockchain technology could help resolve information asymmetries in shareholder votes.

U.S. State legislation has started to address similar uses of blockchain in corporate governance. In 2017, the state of Delaware passed legislation allowing Delaware-registered corporations to use blockchain technology in order to keep any corporate records, including stock ledgers, books of account and minute books. In 2018, the state of Vermont passed legislation allowing the creation of blockchain-based limited liability companies that can legally use blockchain and smart contracts to provide their governance, including voting procedures. In addition, the SEC continues to study the “proxy plumbing” problem and scheduled a public roundtable on the issue in 2018. As blockchain technology continues to develop, so will its practical uses for issuers in both AGMs and corporate governance.

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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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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 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.

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