Changes to the Canadian early warning reporting system adopted by securities regulators
On March 13, 2013, the Canadian Securities Administrators (CSA) published for comment proposed changes to the Canadian early warning reporting system and received extensive comments from market participants and industry groups, including a comment letter from Dentons Canada LLP.
On February 25, 2016, the CSA announced final amendments (the Amendments) to key provisions forming part of the early warning reporting system, including reporting thresholds and triggers, alternative monthly reporting (AMR) eligibility, treatment of derivatives, and enhanced disclosure obligations with respect to the content of early warning reports. The CSA have stated that the Amendments are intended to “provide a greater transparency about significant holdings of reporting issuers’ securities” in order to “enhance the quality and integrity of the early warning system”. The Amendments are largely consistent with the update released by the CSA on October 10, 2014 (the October Proposal) and, upon receipt of required approvals, are expected to come into force on May 9, 2016.
Summary of the amendments
- Reporting threshold remains at 10 percent. As announced in the October Proposal, the CSA will not reduce the early warning reporting threshold from 10 percent to 5 percent, which would have been consistent with the Rule 13d reporting threshold applicable in the United States. The CSA have indicated that the adoption of the lower threshold was not effected in light of “the unique features of the Canadian public capital markets, including the large number of smaller issuers, as well as limited liquidity.”
- New requirement to report certain decreases in ownership. The Amendments introduce new requirements to report decreases in ownership, control or direction of 2 percent or more of the outstanding securities of the applicable class, as well as the reduction in the security holder’s ownership, control or direction below 10 percent (sometimes referred to as an “exit report”).
- Eligibility for AMR by institutional investors. Under the current system, eligible institutional investors are generally able to rely on the AMR system and to report ownership positions in reporting issuers on a monthly basis, within 10 days of the end of the month. Further, eligible institutional investors are currently disqualified from utilizing the AMR system in the event 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 their having effective control of the reporting issuer. Upon implementation of the Amendments, eligible institutional investors will be excluded from relying on the AMR system if they solicit proxies from security holders on matters relating to the election of directors other than those proposed by the issuer’s management, or a reorganization, amalgamation, merger, arrangement or similar corporate action that is not supported by, or is contrary to, management’s proposal.
- Derivatives treatment. Initially, the proposed changes included the concept of “equity equivalent derivatives” for the purpose of determining whether an early warning reporting obligation was triggered, which was intended to capture derivatives that substantially replicate the economic consequences of ownership of equity securities. In light of concerns raised by certain commentators about this approach, the CSA have elected to move in a different direction by providing new policy guidance regarding certain derivative arrangements that may be captured under the early warning system. Specifically, the new guidance states that an investor may have to include in the early warning reporting threshold calculation an equity swap or similar derivative arrangement, if the investor has the ability, formally or informally, to obtain the voting or equity securities or to direct the voting of securities held by any counterparties to the transaction. Cash-settled derivatives, for example, will generally not be included for purposes of determining whether the early warning reporting threshold has been reached.
- Separate exemptions for securities lenders and borrowers. The Amendments include a specific exemption for lenders from the early warning reporting trigger for securities transferred or lent pursuant to a “specified securities lending arrangement” (an arrangement that includes an unrestricted ability to recall the securities before a meeting of security holders). A similar exemption for borrowers from the early warning reporting trigger has not been provided, due to concerns about “empty voting” situations. Instead, a narrower exemption will be available for borrowers in the context of short selling, provided certain conditions are met, including that the borrowed securities are disposed of by the borrower within three business days, and that the borrower does not intend to vote and does not vote the securities.
- Enhanced disclosure in early warning reports. The CSA have noted that the goal of the additional disclosure obligations included in the Amendments is to enhance the “substance and quality” of the early warning reporting system that will “result in more comprehensive disclosure about the acquiror’s economic and voting interests.” The Amendments 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. In addition, the Amendments also require disclosure in the early warning report of an interest in a “related financial instrument” (as defined in securities legislation), a securities lending arrangement and other agreement, arrangement or understanding in respect of a security of the class of securities for which disclosure is required. The CSA have clarified that disclosure requirements with respect to material terms of such agreements, arrangements or understandings are not intended to capture proprietary or commercially-sensitive information; rather, the focus of the disclosure should be on information that is relevant to the ownership of, control or direction over voting or equity securities.
- Timing and certifications. The Amendments clarify the timelines to issue and file both a news release and an early warning report. Prior to the Amendments, a news release was required to be filed “promptly.” The Amendments provide that a news release must be filed no later than the opening of trading on the business day following the acquisition of securities or other event that triggered the obligation to file an early warning report, and the early warning report must be filed no later than two business days following the event. In addition, the Amendments provide for some streamlining of the news release content by permitting the news release to make reference to the early warning report for specified further details. There is also a new requirement for the early warning report to be certified and signed either by the acquiror or its agent.
The Amendments are contained in Multilateral Instrument 62-104 – Take-Over Bids and Issuer Bids, National Instrument 62-103 – The Early Warning System and Related Take-Over Bid and Insider Reporting Issues, National Policy 62-203 – Take-Over Bids and Issuer Bids, as well as in certain related Ontario legislation.
Navigate with care
In light of the recent volatility of the Canadian markets, there has been substantial speculation that there are currently numerous opportunities for merger and acquisition activity in the Canadian markets. With this in mind, holders of significant interests in Canadian reporting issuers should be cautious to ensure that: (i) they are in full compliance with the amended early warning requirements in order to avoid sanctions and/or monetary penalties imposed by a Canadian securities regulator; and (ii) failure to comply does not provide a target company or opposing shareholder group with ammunition to challenge, and potentially derail, further investment or acquisition mandates.