Alex Gorka, Douglas Bryce, Rob Lando, Donald Gilchrist
Mar 15, 2013
The Canadian Securities Administrators (the CSA) have proposed significant amendments to the “early warning” regime with respect to the disclosure of ownership positions in Canadian public companies.
In particular, if adopted the proposed amendments will:
Decrease the trigger for early warning reporting from 10% of the outstanding securities of a class to 5%;
Require the filing of an early warning update in the event that a reportable position is either decreased by an increment of 2% or more, or falls below the 5% reportable threshold;
Include certain equity derivative positions and securities lending positions in the calculation of what must be reported;
Disqualify eligible institutional investors (EIIs) that intend to solicit proxies on matters relating to the election of directors or to reorganizations, amalgamations, mergers, arrangements or similar business combinations from using the more permissive alternative monthly reporting system provided under National Instrument 62-103 Early Warning System and Related Take-Over Bid and Insider Reporting Issues (the AMR); and
Require more disclosure in an early warning report and an alternative monthly report, particularly with respect to the purpose and intentions of the investor.
Taken as a whole, the proposed amendments will, if enacted, provide greater transparency about significant holdings of issuers’ securities, enhance the content of the disclosure in early warning press releases and reports required to be filed with the securities regulators, and address certain disclosure issues related to “hidden ownership” and “empty voting”.
The proposed amendments will also eliminate what has been for many years a key difference between the reporting regimes in Canada and the United States, i.e. the ability in Canada of accumulating parties, including potential bidders and activist investors, to acquire up to a 10% interest in a Canadian public company without disclosure to the issuer or the marketplace – while in the United States the corresponding regime requires disclosure at the 5% level (although with a significantly longer timeframe to make the required disclosure). In fact, and as discussed in more detail below, the more restrictive Canadian reporting timelines and trading restrictions applicable to holders of 5% or more of a class of shares under the amended early warning rules will become the earliest applicable reporting obligations in the case of interlisted issuers, rather than the corresponding U.S. rules.
Canadian securities laws impose “early warning” obligations relating to the acquisition of securities of public companies. When a purchaser acquires beneficial ownership or control or direction over 10% or more of a class of voting or equity securities, the purchaser is required to promptly issue and file a press release and within two business days file an early warning report with the securities regulators. Further press releases and reports are required upon the acquisition of each additional 2% or more of the outstanding securities or a change in a material fact contained in an earlier report. The disclosure required in the press releases and reports must cover, among other things: (i) the number and percentage of securities acquired; (ii) the purpose for which the securities are acquired; and (iii) any further intention to acquire additional securities. There is also a cooling-off period that prohibits further purchases by the purchaser until the expiry of one business day after each report is filed (the Moratorium). The Moratorium ceases at the 20% ownership level, at which point the take-over bid rules are engaged.
Early Warning Reporting Threshold Decreased From 10% to 5%
If the proposed amendments are adopted, the early warning threshold will decrease from 10% to 5% and the required press release will have to be issued and filed promptly but no later than the opening of trading on the next business day. When combined with additional proposed amendments intended to include certain types of derivative instruments in the calculation of determining whether a shareholder has triggered the early warning reporting threshold, this change may lead to significant additional disclosure obligations. As a result of the Moratorium, purchasers will be prohibited from purchasing additional securities of the class for a period beginning at the time of crossing the 5% threshold and continuing until the expiry of one business day after filing an early warning report; however, the Moratorium will still not apply to EIIs who are eligible to report under the AMR system.
The CSA have advanced a number of rationales for lowering the threshold to 5%, including in particular responding to the realities of current shareholder activism (given that 5% is the threshold for a shareholder to have the ability to requisition a special meeting of shareholders under applicable corporate law) and an expressed desire to harmonize with the standards of several major foreign jurisdictions. We note in this regard that the change from a 10% to a 5% reporting threshold will bring Canada into line with reporting thresholds in the United States (as discussed further below) and other jurisdictions including the United Kingdom.
The proposed amendments do not amend the threshold for reporting additional acquisitions and other changes. Further press releases and reports will continue to be required upon the acquisition of each additional 2% or more of the outstanding securities or a change in a material fact contained in an earlier report. However, as discussed further below, reporting of decreases in ownership will now specifically be required.
Comparison with Corresponding U.S. Reporting Requirements
If the amendments are adopted as proposed, there will continue to be a number of significant differences between the Canadian regime and the corresponding U.S. beneficial ownership reporting requirements. For example, in the United States a report on Schedule 13D, which must disclose the holder’s purpose in acquiring the securities and its plans and proposals regarding the issuer, is required to be filed with the U.S. Securities and Exchange Commission, but that filing must be made within ten days of the acquisition of direct or indirect beneficial ownership of more than 5% of a class of publicly traded equity securities. There are no restrictions on further acquisitions by the acquiror during the period between when the requirement to file Schedule 13D is triggered and when the report is actually filed, which may be up to ten days later. As a result, the proposed Canadian regime will require public disclosure of acquisitions of 5% or more of a target’s securities as much as ten days sooner than under the U.S. regime, meaning that the Canadian reporting timelines and Moratorium will become the earliest applicable disclosure requirements and constraints applicable to an acquiror of shares of an interlisted company.
Generally, a simplified report on Schedule 13G (corresponding in concept to the AMR) which does not require disclosure of the reporting person’s purpose or plans may be filed instead of Schedule 13D, both by specified types of institutional holders purchasing in the ordinary course of business (for whom the ten day filing deadline is extended) and by other holders of less than 20% of the class of securities, so long as the holder has not acquired the securities “…with any purpose, or with the effect, of changing or influencing the control of the issuer, or in connection with or as a participant in any transaction having that purpose or effect…”. This exclusion from Schedule 13G eligibility is significantly broader than the new AMR exclusion proposed by the CSA relating specifically to proxy solicitation, with the result that in many cases activist investors acquiring more than 5% of a class of interlisted securities will still be able to rely on the AMR system in Canada (and thereby avoid the early warning system requirement to issue a press release no later than the market open on the next trading day, and associated Moratorium) despite being excluded from the ability to report their ownership position using Schedule 13G in the United States. If a holder that originally filed a Schedule 13G report later changes its intentions and holds the securities with the purpose or effect of changing or influencing control, it must file a report on Schedule 13D within ten days disclosing its new intentions, and is prohibited from either acquiring additional equity securities of the issuer or voting the securities of the issuer until ten days after the Schedule 13D is filed.
Reporting for Decreases in Ownership
Currently, decreases in ownership are only reportable under the early warning system if they represent a change in material fact, although decreases of 2.5% or more must be reported under the AMR system. Likewise, there is currently no specific requirement for disclosure under the early warning system when a holder’s ownership falls below the 10% early warning report threshold (although such disclosure is required under the AMR system). In both cases, disclosure would only currently be required if in the circumstances, the decrease in ownership represents a change in a previously reported material fact with the result that frequently no filings are made. The proposed amendments will result in disclosure being required for both a 2% decrease in ownership as well as when ownership falls below the 5% early warning threshold.
Disqualifications from Alternative Monthly Reporting
Under the current early warning regime, EIIs are disqualified from the AMR system if they make or intend to make a formal take-over bid, or propose or intend to propose a reorganization, amalgamation, merger, arrangement or similar business combination with respect to a reporting issuer that would result in the EII having effective control of the issuer.
Concerns have been raised that activist investors are able to make use of the AMR system to avoid the Moratorium and delay reporting share accumulations in circumstances where they intend to actively engage with the issuer to bring about change in the issuer’s strategy, thereby undermining the justification for allowing them to continue to utilize a reporting regime designed for passive investors. This was partly at issue in the recent battle between TELUS Corporation and Mason Capital, in which Mason used the AMR system to accumulate a very substantial economic interest in TELUS common shares without triggering the prompt disclosure required by the early warning regime. A key difference between the conventional early warning system and the AMR system is that while the conventional system currently requires the prompt issuance of a press release and the filing of an early warning report within two business days of a reporting trigger, the AMR system allows the reporting of ownership positions to be made only on a monthly basis, with each filing due within ten days of the end of the month, except that an initial AMR may in some cases have to be filed within ten days of acquiring more than 10% of a class of securities in order to preserve eligibility for the Canadian insider reporting (SEDI filing) exemption that is available for most filers under the AMR system.
Under the proposed amendments, an EII will be excluded from the AMR system if it either: (1) makes or intends to make a formal take-over bid, or proposes or intends to propose a reorganization, amalgamation, merger, arrangement or similar business combination with respect to a reporting issuer that would result in the EII having effective control of the issuer; or (2) solicits, or intends to solicit, proxies on matters relating to the election of directors or a reorganization, amalgamation, merger, arrangement or similar business combination.
An EII will not, however, be disqualified from the AMR system solely as a result of having the intention of changing or influencing control of the issuer in any manner that does not currently involve an actual or intended take-over bid or proxy solicitation.
In contrast, the rules in the United States governing when reporting is required to be made on the detailed Schedule 13D instead of the simplified Schedule 13G report focus on whether the shares are being acquired with the purpose or effect of changing or influencing the control of the issuer, in any manner whatsoever, including but not limited to participation in any transaction having that purpose or effect. This distinction appears to go to the heart of whether the investor is an active investor or a passive investor. While the U.S. provisions refer to changing or influencing “control” of an issuer, it is important to bear in mind that under United States securities laws the concept of control is interpreted much more broadly than meaning just majority voting control. Directors, officers and often holders of 10% or more of an issuer’s outstanding voting securities are generally considered to control an issuer because of their ability to exercise some degree of influence over its decision making.
The question of whether and when a shareholder develops the intention to change or influence the control of the issuer (triggering, in the case of Schedule 13G filers, the requirement to file a Schedule 13D report and restrictions on further acquisitions and voting for ten days thereafter) is by no means a bright line test and is often the subject of litigation. A shareholder that holds more than 5% of the outstanding voting shares of an issuer may be viewed as having an intention to change or influence control if it sends a letter to the board of directors of the issuer outlining the various actions which should be taken to improve the issuer’s performance and requesting a meeting with management and the board of the issuer to communicate these views to the issuer. If the shareholder had previously reported its ownership on Schedule 13G, it may well, depending on the content and tone of the letter, be required to file a Schedule 13D and become subject to the consequent restrictions on purchases of additional shares and voting of its shares for ten days thereafter. By contrast, an EII in a similar position in Canada might take the position that it is eligible to use the AMR on the basis that it does not presently intend to solicit proxies, and would only potentially do so in the future as a last resort if its efforts to influence the issuer through other means do not succeed.
Disclosure of Hidden Ownership and Empty Voting
Current disclosure requirements do not necessarily capture derivatives and securities lending arrangements, leading to concerns about “hidden ownership” and “empty voting”. “Hidden ownership” refers to the use of derivatives to achieve economic exposure to public companies while avoiding public disclosure and to exert influence over such companies and over shareholder votes on an undisclosed basis. “Empty voting” occurs when a holder of the voting right attached to a share has reduced or eliminated its economic interest in that share through the use of derivatives or securities lending arrangements while seeking to influence the outcome of a shareholder vote.
With respect to derivatives, the proposed amendments will require investors to include equity derivative positions that are substantially equivalent in economic terms to conventional equity holdings in calculating their ownership levels. These so-called “equity equivalent derivatives” will be considered substantially equivalent to conventional equity holdings if the market participant taking the short position on the derivative could substantially hedge 90% or more of its obligations by holding a specified number of reference shares. Total return swaps, contracts for difference, and similar derivative instruments will be captured by the definition of “designated derivatives”.
With respect to securities lending arrangements, whereby securities are temporarily transferred from one party to another in exchange for a fee, the CSA has taken the view that it is not necessary to amend the existing early warning reporting disclosure trigger because existing disclosure requirements already apply to both borrowers and lenders in such transactions. An exemption will be provided for “prescribed securities lending arrangements”, which will include an unrestricted ability by the lender to recall all securities under agreement prior to the record date for a meeting or require the borrower to vote at the direction of the lender.
Prescribed disclosure must be made in connection with the filing of an early warning report, including disclosing the purpose of the transaction and any future intention to acquire ownership or control over securities.
The proposed amendments will require additional disclosure regarding the purpose of the transaction and future intentions to acquire securities, and descriptions of any agreements with respect to securities and voting. These additional disclosure requirements are aimed in particular at requiring investors to provide more detailed and customized disclosure regarding the intentions of the person acquiring securities and the purpose of the acquisition, the CSA noting that currently this disclosure often consists of boilerplate language that in their view provides little useful information for the market.
If adopted, the proposed amendments will result in a significant increase in the transparency of the Canadian disclosure regime applicable to securities ownership positions. Reducing the reportable ownership threshold from 10% to 5% will help to harmonize the Canadian reporting requirements with those of other jurisdictions, and provide investors with an earlier “early warning” about accumulations of ownership positions by acquirors reporting under the conventional early warning system. The addition of a disqualification from the AMR system tied to an intention to solicit proxies should also result in earlier disclosure of the ownership positions and intentions of activist EIIs in some cases. Although the proposed amendments will not necessarily resolve all of the concerns that have been expressed regarding the current AMR regime, the CSA has stated that it will be considering more comprehensive changes to the AMR regime as part of a future review.