The Canadian Securities Administrators Propose Amendments to the Early Warning Reporting Regime
Davis LLP Securities & Corporate Finance Bulletin
March 27, 2013
The Canadian Securities Administrators (the “CSA”) have published for comment proposed amendments to Multilateral Instrument 62-104 Take-Over Bids and Issuer Bids (“MI 62-104”), National Policy 62-203 Take-Over Bids and Issuer Bids (“NP 62-203”) and National Instrument 62-103 Early Warning System and Related Take-Over Bid and Insider Reporting Issues (“NI 62-103”) (collectively, the “Proposed Amendments”). The public comment period will expire on June 12, 2013.
The Proposed Amendments include:
In light of the recent trend towards increased shareholder activism, the objective of the Proposed Amendments is to provide greater transparency about significant holdings of reporting issuers’ securities and to enhance consistency with several foreign jurisdictions, including the United States and the United Kingdom. However, the Proposed Amendments are not without drawbacks, particularly for those shareholders who have kept their shareholdings just below the 10% level.
The early warning reporting regime currently requires certain large shareholders to disclose their holdings in order to advise the market of an accumulation of a significant block of securities that may influence control of a reporting issuer. Under the current regime, every acquiror who acquires beneficial ownership of, or control or direction over, voting or equity securities of any class of a reporting issuer that, together with the securities of that class held by the acquiror, would constitute 10% or more of the outstanding securities of that class, must promptly issue and file a news release and within two business days from the day of the acquisition file a so-called “early warning report.”
Lowered Threshold for Acquisitions
In the CSA’s view, the reality of increasing shareholder activism and the ability of a shareholder holding 5% of the outstanding shares of a public company to requisition a shareholders’ meeting necessitates a need to lower the early warning reporting threshold from the current 10% to 5%. The CSA may have been influenced by the fact that the equivalent reporting threshold in the United States has been 5% for many years.
New Reporting Trigger for Decreased Ownership
Currently, the early warning regime does not explicitly require a person to file a further early warning report where there is a decrease in share ownership and a person must determine whether the decrease in ownership is a change of material fact and file a further report on the basis of that assessment. In the CSA’s view, decreases in ownership of an issuer are as relevant to the market as increases in ownership. Therefore, the CSA proposes to explicitly require disclosure of a 2% decrease in ownership.
Ownership Percentage Decreasing to less than 5%
The CSA proposes to require the issuance and filing of a news release and early warning report when an ownership percentage decreases to less than 5%.
Enhanced Disclosure in Early Warning News Releases and Reports
The CSA’s view is that the disclosure currently contained in many early warning reports filed in Canada, particularly with respect to the purposes of the transaction, is often inadequate, “boilerplate” in nature and does not sufficiently inform investors. As a result, the CSA is proposing an amendment to require more detailed disclosure in an early warning news release and an early warning report about the intentions of the person acquiring securities and the purpose of the acquisition.
Hidden Ownership and Empty Voting
Derivatives and Related Financial Instruments
In the CSA’s view, changes in the disclosure rules are required in order to ensure proper transparency of securities ownership in light of the increased use of derivatives by investors. Specifically, the CSA expressed concern regarding “hidden ownership," whereby a sophisticated investor may be able, through the use of equity swaps or similar derivative arrangements, to accumulate a substantial economic interest in an issuer without public disclosure and then potentially convert this interest into voting securities in time to exercise a vote. The CSA also expressed concern about “empty voting,” which may occur where an investor, through derivatives or securities lending arrangements, holds voting rights in an issuer and may possibly influence the outcome of a shareholder vote, even though the investor may not have an equivalent economic stake in the issuer. These types of arrangements may not be disclosable under current securities law requirements because the current requirements are primarily based on the concept of beneficial ownership of, or control or direction over, voting or equity securities. As a result, the CSA is proposing amendments that would require disclosure of an investor’s economic interest in an issuer as well as its voting interest in the case of securities lending arrangements. An investor would also have to disclose that it has entered into related financial instruments and other arrangements with respect to the securities of the issuer. The CSA has indicated that it is considering providing an exemption for lenders from the early warning reporting trigger for securities transferred or lent pursuant to “specified securities lending arrangements” that include an unrestricted ability to recall the securities before a meeting of security holders.
Inclusion of Equity Derivatives
The CSA is also proposing to amend the early warning reporting trigger in MI 62-104 and section 102.1 of the Ontario Securities Act so that an investor would be required to include, within the early warning threshold calculation, certain equity derivative positions that are substantially equivalent in economic terms to conventional equity holdings. In the CSA’s view, hidden ownership strategies can significantly undermine the early warning regime, since an investor may have practical access to securities held by the derivative counterparty but avoid a disclosure obligation which has traditionally been premised on legal ownership or control. The intention is to ensure that, for purposes of the early warning reporting threshold only, an investor would be deemed to have control or direction over voting or equity securities referenced in an “equity equivalent derivative.” Examples of instruments that the CSA intends to fall under this definition include total return swaps, contracts for difference and other derivatives that provide the party holding the notional “long” position with an economic interest that is substantially equivalent to the economic interest the party would have if it held the securities directly.
Securities Lending Arrangements
Under the current early warning disclosure form, a person that is required to file an early warning report (or alternative monthly report) is generally not required to disclose the general nature and material terms of securities lending arrangements. The CSA is of the view that greater transparency about and appropriate disclosure of securities lending arrangements are necessary, and therefore the CSA is proposing to remove the current carve-out for lending arrangements in early warning reports. The Proposed Amendments include requirements to disclose securities lending arrangements in effect at the time of a reportable transaction, even if that transaction did not involve a securities lending arrangement.
The Proposed Amendments would further require a lender of securities, who holds more than 5% of a public company’s outstanding shares, to report any loan that has the effect of decreasing the lender’s ownership of the applicable securities by 2% or more.
Changes to Alternative Monthly Reporting (“AMR”) Regime
The policy rationale behind the relaxed timing requirements for reporting under the AMR regime is that the regime is only available to eligible institutional investors with a passive intent concerning their ownership or control of the securities of a reporting issuer. The CSA is of the view that the current practice of allowing an eligible institutional investor who solicits, or intends to solicit, proxies from the security holders of a reporting issuer to use the AMR regime, even though the intent of the eligible institutional investor may be to actively engage with the security holders of the reporting issuer, is not consistent with the policy intent of the regime. To address this concern, the CSA is proposing to make the AMR regime unavailable for eligible institutional investors who solicit, or intend to solicit, proxies from security holders of a reporting issuer on matters relating to the election of directors or a reorganization, amalgamation, merger, arrangement or similar corporate action involving securities of the reporting issuer.
Anticipated Cost and Benefit of Proposed Amendments
The CSA anticipates that an enhanced scope of disclosure obligations will provide greater transparency about significant holdings of an issuer’s securities, which will serve to reinforce the quality and integrity of the early warning reporting regime and improve market efficiency.
On the other hand, the Proposed Amendments will result in increased compliance costs and other costs, including potential dissemination of investment strategies. Many market participants in Canada have, for many years, kept large shareholdings just below the 10% level specifically to avoid early warning disclosure requirements. Obviously, those participants will need to decide whether to reduce their holdings below the proposed 5% level or to comply with the new requirements. The Proposed Amendments may result in making take-over bids more expensive and a successful outcome more uncertain, since an offeror’s ability to obtain a “toe-hold” in the target’s shares without disclosure would be substantially reduced. Further, the Proposed Amendments will eliminate some of the perceived shareholder activist-friendly features of the early warning reporting regime. It, therefore, remains to be seen what impact these changes will have on the level and nature of shareholder activism in Canada.
Please note that this is only a summary of the issues highlighted in the Proposed Amendments. If you have any questions concerning this bulletin, the Proposed Amendments or how to contribute to the comment process, please contact any of the authors at Davis LLP.
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