Canadian Securities Law

CSA adopt proposals to regulate credit rating organizations

Stikeman Elliott LLP — Fri, 27 Jan 2012 14:50:11 -0500

Earlier today, the Canadian Securities Administrators announced the adoption of a new national instrument, related policies and consequential amendments to impose regulatory oversight for designated credit rating agencies and organizations. The new NI 25-101, first proposed in draft form in July 2010 and amended in March 2011 requires designated rating organizations to establish, maintain and comply with a code of conduct substantially based on the IOSCO Code of Conduct Fundamentals for Credit Rating Agencies unless exemptive relief is obtained. The instrument also sets out requirements with respect to compliance, filing, and the maintenance of books and records.

Meanwhile, all jurisdictions except Ontario are adopting amendments to Multilateral Instrument 11-102 Passport System to permit the passport system to be used for applications for designations by credit rating organizations and exemptive relief applications by designated rating organizations. NP 11-205, which was also published and to which Ontario is a party, is the equivalent policy that sets out how the process would work for filing and the review of an application to become a designated rating organization in Ontario and the passport jurisdictions.

While the draft instrument was amended in response to comments received during the consultation process, the changes are not considered material. As such, assuming Ministerial approvals are received, the new instrument and related policies and consequential amendments will come into force on April 20, 2012.

Final CPSS/IOSCO report on OTC derivatives data reporting released

Stikeman Elliott LLP — Thu, 26 Jan 2012 10:14:25 -0500

Last week, the Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions published a final report regarding OTC derivatives data reporting and aggregation requirements. Among other things, the report sets out recommendations with respect to such things as minimum data reporting requirements, access to data by authorities, and the development of an international product classification system for OTC derivatives. As we discussed in a post last year, the CPSS and IOSCO released a draft of the report in August 2011, and the final version reflects public comments received during the consultation process.

Quebec's Complaint Reporting System - Reminder of semi-annual filings for registrants in Quebec

Stikeman Elliott LLP — Wed, 25 Jan 2012 10:55:00 -0500

Alix d’Anglejan-Chatillon

Québec’s financial services regulator, the Autorité des marchés financiers (AMF), has issued a reminder that firms registered or otherwise licensed by the AMF in Québec, including as securities dealers or advisers, must file their semi-annual report of client complaints on the AMF’s Complaint Reporting System (CRS) by January 30 covering the period of July 1 to December 31. The next semi-annual filing must be completed no later than July 30 for the January 1-June 30 period.

These semi-annual filings must be completed electronically on the AMF’s CRS. For information on obtaining a CRS user code to access the system and other information on applicable requirements governing the fair and equitable handling of complaints under the Quebec rules, please refer to the CRS link above.

TSX amends rules relating to market making

Stikeman Elliott LLP — Fri, 20 Jan 2012 16:25:24 -0500

The OSC has announced that it has approved amendments to TSX rules and policies to repeal rules relating to "anti-scooping" and those setting out minimum capital and stabilization requirements for market makers. The amendments also allow market makers to fill booked odd-lot orders at the order's limit price rather than the prevailing bid and ask, and codify TSX requirements for the minimum guaranteed fill and odd lot facilities. As we discussed in a post last year, the amendments were first published for comment in September 2011. No changes were made to the proposed rule.

ASC outlines compliance review of EMDs

Stikeman Elliott LLP — Fri, 20 Jan 2012 16:20:34 -0500

Last week, the Alberta Securities Commission released a staff notice providing a summary of staff's initial compliance reviews of firms registered as exempt market dealers (EMDs). The notice highlights issues identified in staff's review and provides guidance with respect to suggested practices. Common issues identified include: (i) policies and procedures not reflecting EMDs' actual business practices; (ii) inconsistencies between clients' tolerance for risk and the types of securities that EMDs sell; (iii) an inability by some EMDs to demonstrate having conducted an appropriate level of due diligence to satisfy the suitability requirement; and (iv) EMDs not always adequately disclosing relationships to clients with respect to issuers, ownership of securities, outside business activities, and risks related to borrowing money for the purposes of making financial investments.

The notice also provides information regarding the compliance activities to be performed by ASC staff in the future. For more information, see ASC Staff Notice 33-704 Review of Exempt Market Dealers.

Continuous Disclosure Guide - 2012

Stikeman Elliott LLP — Tue, 17 Jan 2012 14:55:24 -0500

Over the past year, regulators have issued a number of notices providing guidance and suggested best practices relevant to continuous disclosure, most notably relating to amendments to executive compensation disclosure. Meanwhile, groups such as the Canadian Coalition for Good Governance and ISS have also released model policies and guidance on such topics as proxy circular disclosure and majority voting. We have created this 2012 Canadian Public Company Disclosure Reference Guide to assist you in preparing your 2011 annual disclosure, including financial statements, MD&A, AIFs and information circulars. This guide sets out the main sources of the disclosure requirements along with relevant guidance, best practices and policies, as applicable.

Type of Filing	Principal Form / Source of Disclosure Requirement	Current Issues / Guidance
Financial Statements	NI 51-102 Continuous Disclosure Obligations for financial years beginning before January 1, 2011 (pre-IFRS) NI 51-102 Continuous Disclosure Obligations for financial years beginning on or after January 1, 2011 (IFRS) NI 52-107 Acceptable Accounting Principles and Auditing Standards(Part 3 – IFRS, Part 4 – pre-IFRS)	Transition to IFRS OSC Corporate Finance - IFRS Releases and Tips (2011) OSC Staff Notice 51-718 Key Considerations Relating to an Auditor's Involvement with Financial Reports (May 2011) CSA Staff Notice 52-328 Disclosures About Accounting Policies in the Year of Changeover to IFRS (April 2011) CSA Staff Notice 52-306 (Revised) Non-GAAP Financial Measures and Additional GAAP Measures (November 9, 2010) OSC Issuer Guide - Top 10 Tips for Public Companies Filing Their First IFRS Interim Financial Report (November 2010) CSA Staff Notice 52-326 IFRS Transition Disclosure Review (July 23, 2010) OSC Staff Notice 52-718 IFRS Transition Disclosure Review (February 5, 2010) CSA Staff Notice 52-320 Disclosure of Expected Changes in Accounting Policies Relating to Changeover to IFRS (May 9, 2008) Other subject-specific guidance OSC Notice 52-719 Going Concern Disclosure Review (December 14, 2010) CSA Staff Notice 51-333 Environmental Reporting Guidance (October 27, 2010) CSA Staff Notice 51-330 Guidance Regarding the Application of Forward-Looking Information Requirements Under NI 51-102 (November 20, 2009) OSC Staff Notice 51-716 Environmental Reporting (February 29, 2008) General guidance and best practices CSA Staff Notice 51-328 Continuous Disclosure Considerations Related to Current Economic Conditions (January 8, 2009) CICA Guidance – MD&A and Performance Reporting (including Improved Strategy and Outlook Disclosures (November 2010)) CSA Staff Notice 52-318 Audit Committee Follow-up Compliance Review (June 2007) CSA Staff Notice 52-312 Audit Committee Compliance Review (January 2006) Upcoming proposals and amendments Proposed NI 51-103 Ongoing Governance and Disclosure Requirements for Venture Issuers (July 29, 2011) Also, see "CSA's proposed venture regime seeks to tailor regulation" via www.canadiansecuritieslaw.com Proposed MI 51-105 Issuers Quoted in the U.S. Over-The-Counter Markets (June 10, 2011) Proposed amendments to NI 52-110 (December 19, 2008), on hold as per Staff Notice 58-305 (November 13, 2009)
MD&A	51-102F1 (pre-IFRS) \| 51-102F1 (IFRS) include disclosure required by, NI 52-109 (pre-IFRS) \| NI 52-109 (IFRS) see NP 41-201 discussion of MD&A at s. 6.5
AIF	51-102F2 (pre-IFRS) \| 51-102F2 (IFRS) include disclosure required by NI 52-110 Audit Committees
CEO and CFO Certifications	NI 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings (pre-IFRS) NI 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings (IFRS)	CSA Staff Notice 52-327 Certification Compliance Update (October 15, 2010) Upcoming proposals and amendments Proposed amendments to NI 52-109 regarding securitized products
Information / Proxy Circular	51-102F5 (pre-IFRS) \| 51-102F5 (IFRS) include disclosure required by NI 58-101 include cross-reference to issuer’s AIF as per NI 52-110 in cases of management information circular to elect directors NI 54-101 Communications with Beneficial Owners of Securities of a Reporting Issuer	ISS Canadian Corporate Governance Policy (2012 Updates) ISS U.S. Corporate Governance Policy (2012 Updates) Also see, "A summary of ISS' white paper on evaluating pay-for-performance alignment" via www.canadiansecuritieslaw.com (January 10, 2012) ISS 2012 Draft Policies for Comment (October 2011) ISS 2011-2012 Policy Survey Summary of Results (September 2011) ISS Policy - Canadian Corporate Governance Policy (2011 Updates) ISS 2011 Canadian Proxy Voting Guidelines Summary (TSX-Listed Companies) ISS 2011 Canadian Proxy Voting Guidelines Summary (Venture Companies) CCGG - 2011 Best Practices for Proxy Circular Disclosure (November 2011) CCGG Shareholder Democracy Study (June 2011) CCGG Majority Voting Policy (March 2011) CCGG Annual Report - Improving Corporate Governance in Canada (September 2010) CCGG Policy - “Say on Pay” (September 2010) CCGG Policy - Board Engagement with Shareholders (September 2010) CCGG Guidelines - Building High Performance Boards (March 2010) CCGG Best Practices - 2010 Proxy Circular Disclosure Best Practices CCGG Best Practices - Disclosure of Director Related Information 2009 CPP Investment Board – Proxy Voting Principles and Guidelines (February, 2011) Ontario Teachers’ Pension Plan – Corporate Governance Policies and Proxy Voting Guidelines (2012) Upcoming proposals and amendments Revised proposed Amendments to NI 54-101 Communication with Beneficial Owners of Securities of a Reporting Issuer (June 17, 2011) OSC Staff Notice 54-701 Regulatory Developments Regarding Shareholder Democracy Issues (January 10, 2011)
Statement of Executive Compensation	51-102F6 (pre-IFRS) \| 51-102F6 (IFRS)	CSA Staff Notice 51-331 Report on Staff’s Review of Executive Compensation Disclosure (November 20, 2009) CCGG - 2011 Best Practices for Proxy Circular Disclosure (November 2011) CCGG Policy – Director Compensation (February 2011) CCGG Policy - “Say on Pay” Policy for Boards (September 2010) CCGG Best Practices - Executive Compensation Related Information (December 2009) CCGG Executive Compensation Principles (2009) Upcoming proposals and amendments OSC Staff Notice 54-701 Regulatory Developments Regarding Shareholder Democracy Issues (January 10, 2011)
Corporate Governance Disclosure	NI 58-101 Disclosure of Corporate Governance Practices NP 58-201 Corporate Governance Guidelines	ISS Canadian Corporate Governance Policy(2012 Updates) ISS U.S. Corporate Governance Policy (2012 Updates) ISS 2012 Draft Policies for Comment (October 2011) ISS 2011-2012 Policy Survey Summary of Results (September 2011) CCGG - 2011 Best Practices for Proxy Circular Disclosure (November 2011) CCGG - Governance Differences of Equity Controlled Corporations (October 2011) CCGG Shareholder Democracy Study (June 2011) CCGG Majority Voting Policy (March 2011) CSA Staff Notice 58-306 2010 Corporate Governance Disclosure Compliance Review (December 2, 2010) CCGG Principles – Governance Monitoring, Voting and Shareholder Engagement (December 2010) CCGG 2011 Board Engagement Strategy (November 2010) CCGG Policy – Board Engagement With Shareholders (September 2010) CCGG Guidelines - Building High Performance Boards (March 2010) CCGG Policy – Model Shareholder Engagement and Say-on-Pay Policy (January 2010) Globe and Mail - Board Games 2011 (November 2011) Upcoming proposals and amendments TSX proposed amendments to Part IV of the TSX Company Manual (election of directors, slate voting, etc.) (September 9, 2011) Proposed NI 51-103 Ongoing Governance and Disclosure Requirements for Venture Issuers (July 29, 2011) Also, see "CSA's proposed venture regime seeks to tailor regulation" via www.canadiansecuritieslaw.com OSC Staff Notice 54-701 Regulatory Developments Regarding Shareholder Democracy Issues (January 10, 2011) Proposed repeal and replacement of NI 58-101 (December 19, 2008), on hold as per Staff Notice 58-305 (November 13, 2009)
Oil and Gas and Resource Issuers	National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities NI 43-101 Standards of Disclosure for Mineral Projects	*CSA Staff Notice 51-327 Guidance on Oil and Gas Disclosure* (Revised)** (December 29, 2011) OSC Staff Notice 43-704 Mineral Brine Projects and National Instrument 43-101 Standards of Disclosure for Mineral Projects (July 22, 2011) ASC Oil and Gas Review - 2010 Report (June 2011) New Version of NI 43-101 effective today (via www.canadiansecuritieslaw.com, June 30, 2011) CSA Staff Notice 51-327 (Revised) Oil and Gas Disclosure: Resources other than Reserves Data (December 24, 2010) CSA Staff Notice 51-324 (Revised) Glossary to NI 51-101 (December 24, 2010) From guidance to law – amendments to NI 51-101 to codify prior guidance and supplement existing requirements (via www.canadiansecuritieslaw.com, October 22, 2010) ASC Oil and Gas Review – 2009 Report (July 2010) Rocks don’t change but rules do (re: proposals to amend NI 54-101 via www.canadiansecuritieslaw.com, May 7, 2010) Also consider exemptive relief from NI 51-101 requirements where issuer satisfies equivalent U.S. disclosure requirements
Continuous Disclosure Reviews		ASC Corporate Finance Disclosure Report 2011 (December 2011) CSA Notice 51-334 Continuous Disclosure Review Program Activities for the fiscal year ended March 31, 2011 (July 15, 2011) ASC Corporate Finance Disclosure Report 2010 (December 2010) AMF Activity Report Continuous Disclosure Review Program (December 2010) OSC Staff Notice 51-706 Corporate Finance Branch Report (October 20, 2010) CSA Staff Notice 51-332 Continuous Disclosure Review Program Activities for the fiscal year ended March 31, 2010 (July 9, 2010)

Quebec adopts material housekeeping amendments to derivatives legislation

Stikeman Elliott LLP — Fri, 13 Jan 2012 15:40:28 -0500

Alix d’Anglejan-Chatillon

On November 30, 2011, the Quebec Government passed omnibus amendments to financial services legislation under Bill 7, An Act to amend various legislative provisions mainly concerning the financial sector. Bill 7 amends various Quebec statutes regulating the provision of financial services across a broad range of areas such as whistleblower immunity, electronic communications with regulatory authorities, the receivership process for regulated firms, insider trading rules, fraudulent trading and the disclosure of false information to the Autorité des marchés financiers (AMF), Quebec’s financial services regulator.

Bill 7 also includes various housekeeping amendments to the Derivatives Act (Quebec) (QDA), as well as the following:

Incorporating contracts for difference in the definition of a “derivative” regulated under the QDA.
Additional requirements (not yet in force) governing the initial and ongoing business conduct of “qualified persons” as described in our other post dated today.
Amendments in respect of the use of set-off related to cash posted as credit support, as more fully described in our Structured Finance blog post of November 18, 2011.
Provisions governing the regulation of “trade repositories” as “regulated entities” subject to recognition by the AMF, consistent with the high level recommendations of the Canadian Securities Administrators in their CSA Consultation Paper 91-402 Derivatives: Trade Repositories.
Changes to the exemption for over-the-counter (OTC) derivatives transactions. While activities or transactions in OTC derivatives involving “accredited counterparties” only will continue to be exempted from the derivatives registration and qualification requirements under the QDA, those transactions are no longer generally exempt from the application of various market supervision, enforcement and other procedural remedies available to the AMF and the Québec Bureau de décision et de révision.
Specifying that a derivative cannot be invalidated for the sole reason that a counterparty is not an “accredited counterparty” or the derivative “otherwise departs from the Act”, unless the cause of the invalidity is set out in the terms of the derivative.
Additional provisions governing the ability of the AMF to inspect market participants or compel the production of documents.
Provisions governing liability for misrepresentation “about the offering or trading of a derivative”.

AMF tables proposed rules on the derivatives qualification requirement in Quebec

Stikeman Elliott LLP — Fri, 13 Jan 2012 15:25:27 -0500

Alix d’Anglejan-Chatillon

On December 16, 2011, Quebec’s financial services regulator, the Autorité des marchés financiers (AMF), tabled proposed amendments to the Derivatives Regulation (Quebec) (QDA) which are intended to implement the provisions of the Derivatives Act (Quebec) governing “qualified persons” (the Proposals) In addition to the derivatives dealer and adviser registration requirements applicable to dealers and advisers in derivatives (the “derivatives registration requirement”), the QDA requires that a person, other than a regulated entity¹ who “creates or markets a derivative” must be qualified by the AMF, as prescribed by regulation, before the derivative is offered to the public (the "qualification requirement"). Under an amendment not yet in force, the qualified person must also have the marketing of the derivative authorized by the AMF, as prescribed by regulation (the “authorization requirement”).

As outlined below, the Proposals would, among other changes, significantly increase the disclosure, compliance and reporting requirements applicable to Canadian and foreign intermediaries offering listed derivatives products in the Quebec market to any person, or OTC derivatives to persons other than “accredited counterparties”, unless a discretionary exemption can be obtained. The Proposals are published for a period of 30 days after which the AMF may submit the Proposals to the Minister of Finance for approval, with or without amendments. The AMF is accepting written comments on the Proposals until February 1, 2012.

Market participants conducting derivatives-related activities in the Quebec market should carefully review their product lines, and seek detailed advice as to whether the new qualification/authorization requirements will impact this business and what actions should be taken in contemplation of these new rules.

Impact of the Proposals

The Proposals are significant for several reasons.

First, the Proposals, if adopted, would round out the basic framework governing the regulation of both OTC and standardized derivatives first introduced in Quebec in 2009. They follow on the enactment of more detailed amendments to the “qualified persons” provisions of the QDA effective November 30, 2011, as described in our other post dated today.

Second, the Proposals represent an innovative means of regulating the offering of derivatives to persons other than eligible counterparties outside of the conventional prospectus-based framework of securities regulation which has generally been employed by regulators in other Canadian jurisdictions to regulate trades in all or certain categories of derivatives. The basic mechanics of this new qualification requirement are outlined below.

Third, and more importantly, upon the adoption of these rules, material transitional relief issued by the AMF in conjunction with the implementation of the QDA would lapse.² The effect of this change is that:

OTC derivative transactions involving eligible “accredited counterparties” in Quebec would continue to be exempt from the derivatives registration and the qualification/authorization requirements.
Market participants offering OTC derivatives to Quebec-resident persons other than qualified “accredited counterparties” would now be subject to the derivatives registration and the qualification/authorization requirements.
Market participants offering standardized (listed) derivatives to any Quebec-resident person (including to “accredited counterparties”) could no longer rely on blanket and other transitional or discretionary relief previously issued by the AMF. These market participants would have to apply to the AMF for qualification/authorization within 30 days of the coming into force of the new rules and, as the case may be, comply with the derivatives registration requirement (unless an exemption is available)³, or obtain separate discretionary relief from the AMF.

The Proposals do not specify how much time, if any, will be given to the market to transition to the new “qualified persons” regime. The QDA came into force in 2009 with a six-month transition period. It is to be hoped that, in this period of intense regulatory change (particularly in the major derivatives markets outside Canada), the final rules will include a transition period at least that long.

Key Features of the Qualification Process

As noted above, the Proposals build on recent amendments to the QDA made under Bill 7, An Act to amend various legislative provisions mainly concerning the financial sector which further flesh out the cornerstones of the qualification/authorization requirements (the “qualified persons amendments”).

The qualified persons amendments, once in force, would introduce general provisions governing the initial and ongoing business conduct of “qualified persons”, including requirements that a qualified person have an effective corporate and organizational structure with adequate personnel, financial and technological resources and appropriate business policies and procedures and governance practices; that it take the necessary measures to ensure the security and reliability of its transactions and activities; that it offer derivatives to the public through a registered dealer or register as a dealer; that it comply with initial and periodic reporting requirements; and that it comply with safekeeping and segregation requirements.

The Proposals would further provide that:

A qualified person must participate in a contingency fund that protects the assets entrusted to it by its counterparties, or comply with minimum working capital requirements as calculated on Form 31-103F1 Calculation of Excess Working Capital⁴ or under the Joint Regulatory Financial Questionnaire and Report of the Investment Industry Regulatory Organization of Canada (IIROC). The minimum required capital would be C$20 million plus 5% of amounts due to counterparties to a derivative that a qualified person is marketing which exceed C$10 million.
A qualified person must maintain proper books and records to ensure efficient operations and demonstrate compliance with the QDA.
A qualified person must have an emergency and contingency plan in place to ensure business continuity.
An applicant for qualification must provide documents in support of its compliance with specified requirements of the qualified persons amendments, a completed Schedule B Application for Qualification (including background organizational, business and regulatory compliance information on the applicant, and information on distribution methods, client disclosure, electronic systems and operations and audited financial information). The Schedule B application must be accompanied by a completed Form 33-109F4 Registration of Individuals and Review of Permitted Individuals for each of its “permitted individuals”(e.g., directors, the chief executive officer, the chief financial officer, the chief operating officer and individuals having beneficial ownership of, or direct or indirect control or direction over, 10% of the voting securities of the applicant) unless the Form 33-109F4 information is already on file with the AMF (e.g., as in the case of applicants which are already Quebec-registered firms).
An applicant for authorization must provide a completed Schedule C Application for Authorization to Market a Derivative, including a detailed description of the derivative, and associated trading methods, prospective clients, risks and costs and fees. The AMF must make any objection to an application for authorization within 21 days after submission of the application.
Designated information set out in the Schedule B and Schedule C applications must be included in the risk information document that a derivatives dealer must provide to its clients before the first trade in a derivative.
A qualified person must notify the AMF “without delay” if its excess working capital or risk adjusted capital calculated as described above is less than zero or in the case of “any failure, malfunction or material delay of [its] systems or equipment”.⁵
A qualified person must notify the AMF of any material change to the information provided in its applications for qualification or authorization, within 7 days of the change. The rules provide definitions of what constitutes a “material change” in respect of a qualified person or a derivative. Other changes to such information would have to be notified within 30 days following the end of the quarter in which the change occurred.
A qualified person must also notify both the AMF and “the counterparties to a derivative that [it is] marketing, including counterparties waiting to trade such a derivative” of “any change that could affect the trading of such a derivative or the transactions under way in respect of such a derivative at least 10 days prior to the change”. This 10-day prior notice requirement raises a number of conceptual and practical issues, including the absence of any materiality threshold, the absence of any guidance as to the type of change that would trigger the notice requirement and the issue of changes that may arise over which a qualified person has no reasonable ability to give a 10-day prior notice, particularly in the case of a qualified person that is part of a global financial services group and in a dynamic financial markets environment. Hopefully, this requirement will be modified or further clarified through additional guidance.
A qualified person must, within 90 days after the end of its financial year provide to the AMF:
1. audited financial statements prepared in accordance with Canadian GAAP applicable to publicly accountable enterprises (there would appear to be no provision for the delivery of financial statements prepared in accordance with IFRS, U.S. GAAP or other accounting principles as contemplated in Regulation 52-107 respecting Accounting Principles and Auditing Standards), an adjustment to the Proposals which should be contemplated given the number of foreign stakeholders potentially affected by these rules;
2. the number of contracts entered into in Quebec and their notional value for all derivatives offered to the public during the latest fiscal year; and
3. the percentage of contracts, for each of the latest four quarters, that were profitable for counterparties.

Interested stakeholders should consider submitting comments on these proposals by February 1, 2012.

¹ The term “regulated entity” includes exchanges, alternative trading systems, clearing houses, trade repositories and self-regulatory organizations that are subject to the requirement to be recognized by the AMF.

² In connection with the adoption of the QDA on February 1, 2009, the AMF issued a discretionary blanket decision on January 22, 2009 (the “AMF Blanket Decision”) by way of broad transitional relief (AMF decision No. 2009-PDG-0007 (January 22, 2009), as supplemented and extended by AMF notices of October 2, 2009 and September 24 2010). The AMF Blanket Decision sets out a temporary exemption from the derivatives registration requirement and the derivatives qualification requirement for specified derivatives activities carried out solely with “accredited investors” as defined under Regulation 45-106 respecting Prospectus and Registration Exemptions (45-106).

³ The Derivatives Regulation (Québec) (the “QDR”) provides an exemption (the “standardized derivatives exemption”) from the derivatives registration requirement under the QDA for a person authorized to act as a dealer or an adviser or authorized to exercise similar functions under legislation applicable in a jurisdiction outside Quebec where its head office or principal place of business is located to the extent it carries on business solely for an “accredited counterparty” and its activity involves a standardized derivative that is offered primarily outside Quebec. The standardized derivatives exemption does not, however, provide an exemption from the derivatives qualification or authorization requirements.

⁴ Regulation 31-103 respecting Registration Requirements, Exemptions and Ongoing Registrant Obligations.

⁵ The term “material” would appear to qualify the terms “failure”, “malfunction” or “delay” in the governing French language version. We would hope that this technical translation error will be rectified in the final provision.

IIROC updates compliance and supervision guidance

Stikeman Elliott LLP — Fri, 13 Jan 2012 13:53:59 -0500

On December 15, the Investment Industry Regulatory Organization of Canada (IIROC) released a draft guidance note regarding the role of compliance and supervision at member firms. The draft guidance is intended to update IDA Member Regulation Notice MR-0435, released in 2006, in light of recent amendments to registration requirements contained in NI 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations in order to ensure consistency between the registration reform related amendments and IIROC's guidance. The draft guidance considers such issues as the responsibility for compliance, the distinction between supervisory and compliance roles, and the role of dealers, board of directors, management and the compliance officer. The notice also includes guidance on creating an effective compliance program, and provides information on the circumstances under which IIROC may initiate enforcement proceedings relating to compliance or supervisory matters.

Comments on the draft guidance are being accepted for 60 days from the date of the notice. For more information, see IIROC Notice 11-0361.

Canadian companies easier targets for activist investors than U.S. companies

Stikeman Elliott LLP — Thu, 12 Jan 2012 15:45:56 -0500

Many features of the Canadian regulatory framework are friendly to shareholders and make it easier for activist investors to take action against management. Specifically, it is easier in Canada for shareholders to requisition meetings and nominate directors, the threshold for share disclosure is 10% in Canada as opposed to 5% in the U.S., and it is easier to dismiss directors with a single resolution. Watch Stikeman Elliott partner Mihkel Voore discuss the Canadian regulatory regime generally, and specifically with respect to the recently announced plans by a stakeholder in Canadian Pacific Railway to propose a minority slate of alternative directors, in this interview on BNN.

CSA revise guidance on oil and gas disclosure

Stikeman Elliott LLP — Thu, 12 Jan 2012 14:15:06 -0500

On December 29, 2011, the Canadian Securities Administrators published a revised version of CSA Staff Notice 51-327, which provides guidance on compliance with oil and gas disclosure requirements. The recent revisions to the notice include: (i) new guidance on the general responsibilities regarding the formulation of oil and gas disclosure information; (ii) new guidance regarding the disclosure of after-tax net present value of future net revenue, well-flow test results, and the use of Barrels of Oil Equivalents; and (iii) expanded guidance on the evaluation, classification and disclosure of unconventional hydrocarbons. The revisions were made in light of recent amendments to NI 51-101 Standards of Disclosure for Oil and Gas Activities and are intended to re-emphasize or expand guidance on some of the issues discussed in previous versions of the notice.

SEC limits policy regarding non-public submissions from foreign private issuers

Stikeman Elliott LLP — Thu, 12 Jan 2012 13:15:46 -0500

On December 8, the U.S. SEC released a statement regarding non-public submissions of initial registration statements by foreign private issuers. Historically, the SEC has allowed foreign private issuers (FPIs) to submit initial registration statements on a non-public basis for staff review prior to a public filing since the majority of FPIs were traded on foreign exchanges where there were no requirements to publicly disclose such statements before the completion of a regulatory review.

According to the SEC, however, most FPIs now making use of the non-public review process do not have securities listed outside the U.S. Consequently, the SEC has decided to generally limit its policy respecting the non-public submission of such initial registration statements to circumstances where the registrant is: (i) a foreign government registering its debt securities; (ii) a foreign private issuer that is listed or is concurrently listing its securities on a non-U.S. securities exchange; (iii) an FPI that is being privatized by a foreign government; or (iv) an FPI that can demonstrate that the public filing of an initial registration statement would conflict with the law of an applicable foreign jurisdiction. The change in policy took effect on December 8.

IIROC proposes more generic marketplace disclosure on trade confirmations

Stikeman Elliott LLP — Thu, 12 Jan 2012 13:02:19 -0500

Earlier this week, IIROC released draft guidance regarding the language it considers acceptable for marketplace disclosure on trade confirmations. Currently, IIROC's Dealer Member Rules require that trade confirmations disclose the stock exchange or commodity futures exchange on which a trade takes place. In cases where an order is executed on more than one marketplace existing guidance permits dealers to disclose that the order has been executed on multiple marketplaces. The confirmation, however, must also disclose that details of each trade are available upon request.

In light of the move towards a multiple marketplace environment, IIROC's proposals would revise current guidance to allow for more generic disclosure on trade confirmations. Specifically, trade confirmations for securities subject to UMIR could include the following disclosure language: "Traded on one or more marketplaces or markets, details available upon request."

The proposed language would be acceptable in circumstances where an order was executed on a single marketplace in Canada, multiple marketplaces in Canada, a foreign organized regulated market or any combination of one or more marketplace and foreign organized regulated markets.

Comments on the proposals are being accepted until March 9, 2012.

SEC excludes primary residence from "accredited investor" net worth standard

Stikeman Elliott LLP — Wed, 11 Jan 2012 13:58:25 -0500

The U.S. Securities and Exchange Commission has adopted an amended "accredited investor" net worth standard that, in accordance with the Dodd-Frank Act, excludes the value of an individual's primary residence. The definition of accredited investor, used to determine the availability of certain exemptions from the Securities Act of 1933 for private and other limited offerings, currently includes individuals exceeding $1 million in net worth. The recently-adopted changes would maintain the $1 million threshold, but no longer allow for a primary residence to be included in calculating net worth. As we described in a blog post last year, the SEC first proposed the change in January 2011. The amended standard will become effective on February 27, 2012.

The accredited investor exemption has also garnered attention north of the border. Specifically, the OSC expressed concern last year that issuers and dealers were improperly relying on the accredited investor exemption to ineligible investors. As we discussed in a November 2011 post, Canadian regulators have now also launched a review of the domestic accredited investor and minimum investment amount exemptions. Under Canadian rules, the accredited investor standard for individual investors includes both a $1,000,000 financial asset test and a $5,000,000 net asset test, with only the latter including an investor’s personal residence (minus liabilities). Depending on the feedback (the consultation period ends on February 29th), possible options include keeping the status quo, retaining the exemptions with adjusted thresholds, limiting the use to certain investors (such as institutional investors), using alternative qualification criteria or imposing other investment limitations.

BCSC extends conditions for registration of investment dealers trading in U.S. OTC markets

Stikeman Elliott LLP — Wed, 11 Jan 2012 10:28:11 -0500

On January 3, the British Columbia Securities Commission published a revised version of BC Interpretation Note 33-705. The revised note, which describes how the BCSC interprets and applies its conditions of registration for investment dealers with a BC office that trade in the U.S. OTC markets, reflects the fact that the conditions have now been extended to December 31, 2014.

IIROC releases guidance allowing dealers to guarantee trade prices

Stikeman Elliott LLP — Wed, 11 Jan 2012 09:56:45 -0500

On January 9, the Investment Industry Regulatory Organization of Canada (IIROC) published guidance regarding the procedures to be followed by a Participant (dealer) wishing to guarantee a trade price for a client order that outperforms a benchmark price. As we discussed last year, IIROC released a draft version of the guidance on July 4 that would allow a certain amount of "outperformance" to be guaranteed under certain circumstances if a dealer agreed to take the trade as principal. Under the initial proposal, dealers would only be able to guarantee outperformance up to a maximum of the lesser of 50% of the Participant's historical realized outperformance of the same benchmark over the prior calendar quarter and 30 basis points.

The final version of the guidance released yesterday, however, has been revised to address public comments received. Of particular interest, the guidance now provides that a dealer may guarantee outperformance up to a maximum of the greater of 50% of the Participant's historical realized outperformance of the same benchmark over the prior calendar quarter and 25 basis points. Thus, dealers will be able to guarantee outperformance of 25 basis points, even in the absence of a demonstrated ability to outperform the benchmark.

For more information, see IIROC Notice 12-0010.

A summary of ISS' white paper on evaluating pay-for-performance alignment

Stikeman Elliott LLP — Tue, 10 Jan 2012 09:43:18 -0500

Jonathan Moncrieff -

On December 20, 2011, Institutional Shareholder Services (ISS) released a white paper entitled “Evaluating Pay-for-Performance Alignment: ISS’ Quantitative and Qualitative Approach”. As we discussed in a post of December 21, the Paper introduces ISS’ new approach to evaluating pay-for-performance and is thus the most current and thorough description of the approach ISS’ will now use to evaluate pay-for-performance.

The new approach comprises an initial quantitative assessment and, as appropriate, an in-depth qualitative review to determine either the likely cause of a perceived long-term disconnect between pay and performance or factors that mitigate the initial quantitative assessment. ISS has introduced this new approach because investor feedback received regarding pay-for-performance indicated a preference for a focus on long-term alignment, board decision-making, and pay relative both to market peers and to absolute shareholder returns.

While the Paper is primarily focussed on pay practices of companies in the United States, ISS has indicated that the new methodology is being considered for Canada. Further, given the influence ISS can have on Canadian capital market participants, the content of the Paper may be of interest to Canadian readers.

Background

The Paper explains that ISS regularly polls both clients and other market participants on the issue of executive pay and in response develops evolving methodologies to detect potential pay-performance disconnects of concern to shareholders. ISS’ historic approach utilized a quantitative methodology to identify underperforming companies. In particular, the historic methodology was designed to identify companies with both one and three-year total shareholder return (TSR) below the median of peers in their 4-digit Global Industry Classification Standard (GICS) group. ISS then historically performed an in-depth qualitative review, focused primarily on factors such as the year-over-year change in the CEO's total pay, the five-year trend in CEO pay versus company TSR, and the strength of performance-based pay elements, on companies that it perceived to be underperforming.

In the Paper, ISS states that a substantial majority of institutional respondents to its 2011-12 policy survey (the Survey) confirmed two factors as being particularly relevant to evaluating pay-for-performance alignment: (i) pay relative to peers, and (ii) pay increases that are inconsistent with the company's performance trend. Most issuer respondents to the Survey also indicated that pay versus peers is an appropriate factor and that pay increases in light of company performance should be considered. Further, institutions and issuers have contended that pay−performance alignment should be viewed in a long-term context. These results from the Survey prompted ISS to refine its approach to pay-for-performance evaluations and develop a more sophisticated methodology to drive the quantitative component of the analysis. The Paper strives to articulate, in detail, ISS’ new approach to measuring pay-for-performance alignment.

What ISS Measures

As described in considerable detail in the Paper, ISS measures the following elements as part of its new methodology:

CEO Pay. ISS focuses on the CEO's pay because the CEO’s pay package sets the "compensation pace" at most companies, and the compensation committee and board of directors are most directly involved in and accountable for the decisions that generate the CEO's pay.
In evaluating pay−performance alignment, ISS focuses on “total compensation” as reflected in the summary compensation table in the applicable issuer’s continuous disclosure documents, by utilizing a standard set of assumptions to value equity-based grants.
Performance: While there are several ways to measure corporate performance, ISS believes that the key measure for investors in the context of long-term pay-for-performance evaluation is TSR. ISS indicates that, from their perspective, if a company’s business strategy is sound and well executed, the expectation is that it will create value for shareowners over time, as reflected in long-term total shareholder returns. Therefore, TSR, which ISS highlights as being objective and transparent, is the primary metric utilized in evaluating pay and performance alignment. Nevertheless, ISS is careful to note that it does not advocate that companies use TSR as a metric underlying their compensation program.
Relative and Absolute Alignment Over Time. A substantial majority of institutional respondents to the Survey confirmed two factors as important in determining pay-for-performance alignment: (i) pay relative to peers and (ii) pay increases that are disproportionate to the company's performance trend.

In light of this information, ISS incorporated these factors into the quantitative component of its revised pay-for-performance analysis, as ISS believes that this ensures a balanced evaluation from both relative and absolute pay-for-performance perspectives. In the event that the quantitative assessment indicates significant pay-for-performance misalignment, ISS then completes an in-depth qualitative analysis to determine either the probable cause or any applicable mitigating factors.

Goals of ISS' Quantitative Evaluation of Pay-for-Performance Alignment

The first step in ISS’ evaluation of pay-for-performance has historically been a quantitative assessment of how well a company’s CEO pay has been aligned with its financial performance. This step was designed to identify a potential misalignment of pay and performance, thereby prompting a further qualitative assessment of the company in question.

ISS’ new quantitative pay-for-performance model maintains this approach but is intended to introduce new factors. The three main goals of the new pay-for-performance methodology are:

Measure alignment over multiple time horizons. As business cycles and compensation plans’ performance cycles span multiple years, the assessment of alignment between shareholders and executives should accordingly see pay across timeframes that approach the length of performance and business cycles.
Use multiple measures to assess alignment. Since no single quantitative measure can conclusively indicate that pay and performance are aligned, the revised approach seeks to identify multiple measures to assess a company’s pay for performance alignment from a distinct perspective.
Provide more information about pay-for-performance concerns to investors and issuers. ISS’ current pay-for-performance evaluation is a binary pass/fail performance-oriented test. Its new approach is designed to provide more robust information about pay-for-performance alignment by evaluating and reporting the degree of alignment found.

Measures of Pay-for-Performance Alignment

At the heart of ISS’ new methodology are what the ISS considers to be three measures of alignment between executive pay and company performance. Two such measures are relative measures, designed to evaluate a company’s pay-for-performance alignment in reference to a group of comparable companies and one element is an absolute measure, which evaluates alignment independently of other companies’ performance.

The three measures, which are each discussed in further detail in the Paper, are summarized below.

Relative Measure 1: Relative Degree of Alignment

This measure compares the percentile ranks of a company’s CEO pay and TSR performance, relative to an industry-and-size derived comparison group, over one and three year periods.

This measure is designed to address the question: Is the pay opportunity delivered to the CEO commensurate with the performance achieved by shareholders, relative to a comparable group of companies?

This measure also compares the percentile ranks of a company’s CEO pay and TSR performance, relative to a comparison group of between 14 to 24 companies selected by ISS on the basis of size, industry, and market capitalization, over one and three year periods. For more information on ISS’ process for selecting peers, see Appendix I to the Paper.

Relative Measure 2: Multiple of Median

This measure expresses the prior year’s CEO pay as a multiple of the median pay of its comparison group for the same period.

This measure is intended to address the questions: (a) Is the overall level of CEO pay significantly higher than amounts typical for its comparison group? and (b) Is the company significantly more than comparable companies, even for strong performance?

This measure is calculated by dividing the company’s one-year CEO pay by the median pay for the comparison group.

Absolute Measure 1: Pay-TSR Alignment

This measure compares the trends of the CEO’s annual pay and the value of an investment in the company over the prior five-year period.

For the past two years, ISS has incorporated into its pay-for-performance analysis an appraisal of the last five years alignment of pay and performance. The results of this appraisal are presented in a chart that displays the values of a company’s pay and “indexed TSR” (i.e. the value of a $100 investment at the end of each fiscal year (assuming dividends are reinvested)). This chart is intended to provide ISS analysts and clients with the ability to assess the general alignment of pay and performance for a company over a five-year period.

This new measure of long-term absolute alignment is intended to tackle, as discussed in the Paper, certain challenges created by ISS’ previous approach and address the question: Have shareholders’ and executives’ experiences followed the same long-term trend?

ISS’ new measure is calculated as the difference between the slopes of weighted linear regressions for CEO pay and for shareholder returns over a five-year period. According to ISS, the difference demonstrates the degree to which CEO pay has changed more or less rapidly than shareholder returns over the same period. For detailed information on how the applicable regressions are calculated, see Appendix II of the Paper.

By using regressions to estimate the long-term trends for pay and TSR, ISS’ new method addresses certain pitfalls of its previous approach of evaluating pay and performance over time, including (i) performance over a fiscal year and pay granted over that period are measured in a consistent fashion, on the same scale, and are matched in time; and (ii) volatility of pay and lumpiness of performance are smoothed (but not eliminated).

Back-testing the new methodology

According to ISS it completed extensive back-testing to substantiate its new methodology. In particular, ISS analyzed pay and performance data for 2,500 companies from the years 2006-2010, constructing applicable comparison groups for each company and then calculating each of the three measures in the methodology. Results of ISS’ analysis, including descriptive charts, are presented in the Paper.

Canadian M&A trends for 2012: World's best country for business

Stikeman Elliott LLP — Mon, 09 Jan 2012 11:15:31 -0500

Richard E. Clark and Curtis A. Cusinato -

Is the glass half full or half empty? We are decidedly in favour of the glass being half full, and getting fuller, for Canadian M&A markets in 2012. While uncertainty and slow growth in the U.S. and Europe have affected the Canadian economy, the country has continued, for the most part, to post impressive economic results, thanks not only to unceasing demand for its natural resources but also to its strong regulatory system and stable majority government. Thus – as noted by Canadian Prime Minister Stephen Harper in his year-end address for 2011 – Forbes recently ranked Canada as the best country in the world in which to do business, the only country of the 134 surveyed that reached the top 20 in ten separate metrics. All things considered, therefore, we expect favourable growth in M&A activity in Canada in 2012.

The following are some of the top “trending topics” for the coming year:

1. Tax Trends (and a New Twist on Income Trusts?)

Rumours of the demise of the income trust may have been exaggerated, which is positive news for M&A participants looking for “made in Canada” liquidity alternatives. By way of background, in 2006 (on Halloween night), the Department of Finance unexpectedly announced proposed changes to Canadian tax rules under which tax would be imposed on publicly-traded trusts and partnerships, just as it is imposed on Canadian corporations. While these “SIFT Rules” did not become fully effective until January 1, 2011 (and do not affect REITs), the 2006 announcement largely signaled the end of business and resource income trusts, entities that had effectively been treated for tax purposes as flow-through vehicles not subject to taxation.¹ However, the SIFT rules do not apply to foreign source income, and in 2011 we began to see a few income trust offerings in Canada in which investors were given exposure to U.S. resource-based assets and foreign real estate assets through the income trust structure. Look for this trend to continue in 2012, with offerings providing Canadian yield-seeking investors with exposure to other foreign-based asset classes, such as real estate.

U.S. buyers in cross-border M&A transactions into Canada will continue to utilize creative acquisition structures, including the continued use of Luxcos and ULCs, although proposed changes to the Canada-Barbados treaty will likely make structures using Barbados entities to invest in Canadian real estate companies less effective, with the result that they may need to be unwound or restructured before January 1, 2013.

2. Competition and Foreign Investment Regulation

Canada’s antitrust regulator, the Competition Bureau, continues to aggressively assert itself on a number of important fronts. High-profile, ongoing M&A matters include an application to block Air Canada’s proposed joint venture with United Continental, the investigation of the Maple/TMX transaction, and an application to dissolve a completed transaction that was not large enough to trigger a pre-closing notification requirement. Many observers trace the more vigorous enforcement of Canada’s competition laws to 2009 amendments giving the Bureau enhanced information-gathering powers and longer periods of time to investigate mergers, and greater penalties for anti-competitive conduct. We expect this trend to continue in 2012. The Bureau also released new Merger Enforcement Guidelines in 2011 (following a similar update to the U.S. guidelines in 2010) in an attempt to preclude bidders in hostile bid transactions from using disclosures as a tactical weapon.

From a foreign investment law perspective, 2011 proved surprisingly uneventful for a year born in the shadow of the Minister of Industry’s rejection, in late 2010, of BHP Billiton’s hostile bid for Potash Corporation of Saskatchewan. Greater guidance on the scope and meaning of the “net benefit to Canada” test contained in the Investment Canada Act (ICA) had been anticipated in the wake of the Potash decision, but ultimately no such guidance was forthcoming. It appears, instead, that the federal government is adopting a “case-by-case” approach to high-profile matters under the ICA. Had it proceeded, the proposed acquisition by London Stock Exchange plc of TMX Group Inc. may have proved another challenge under the ICA. We do not expect any material legislative changes to occur in 2012 in relation to the ICA, but there may be important developments in terms of potential changes to foreign investment restrictions in the telecom sector - a very hot topic in recent years.

The annual change (based on cost-of-living) to the review threshold under the ICA for direct acquisitions by WTO investors in non-cultural businesses is anticipated to be $330 million for 2012 (book value of target assets). Regulations first proposed in 2009 that would have amended the calculation of thresholds under the ICA based on an “enterprise value” concept have not yet been implemented and the current thinking is that they may be discarded altogether.

It is also worth noting that U.S. Steel Corp. recently reached an out-of-court settlement with the Canadian Government with respect to allegations that the company had failed to abide by various undertakings provided under the ICA to gain approval of its acquisition of Stelco, the Canadian steelmaker. U.S. Steel’s defence basically relied on the unexpected economic downturn as justification for not honouring undertakings involving maintaining steady employment and continued steel production of two plants. In light of this settlement, watch for heightened scrutiny and enforcement by the federal government of undertakings provided under the ICA.

3. Poison Pills

For many years, the view of the Canadian securities regulators on shareholder rights plans (commonly referred to as “poison pills”) was that poison pills were strictly limited to the single purpose of helping the board “buy time” to seek out improved or alternative offers. As a result, in contrast to U.S. practice, poison pills could not be used by a board of directors in Canada as part of a “just say no” defence.

Over the past few years, a series of developments suggested that securities regulators were becoming more flexible in assessing the allowable purposes of poison pills, and that the conventional view that “eventually a pill must go” may be an overstatement, at least where securityholders had given a strong and recent endorsement to the pill or where a bid appeared to be an opportunistic attempt to wrest away control of the company during a difficult economic period.

Although rulings in 2010 and 2011 reversed this trend by reaffirming the traditional view of poison pills, the appropriate role of poison pills as a defensive measure continues to be debated by regulators and market participants. In late 2011, at a public roundtable discussion, the OSC revealed that it is currently reconsidering its historical approach to shareholder rights plans. New proposals being considered include allowing shareholder rights plans to remain outstanding if approved by shareholders, subject to the ongoing rights of shareholders to remove the plan on a “majority of the minority” vote (requiring a bidder to launch a proxy battle or proceed with a permitted bid). The purpose of the rule would be to provide more consistency and certainty in the context of defensive tactics and decrease the need for regulatory intervention. The progress of this proposal will almost certainly be among the most closely-watched developments in Canadian M&A in 2012.

4. Canadian Financial Markets in Support of M&A

2011 saw the re-emergence of a more established domestic high yield debt market in Canada with yields rising and the Canadian market re-pricing itself in the second half of the year. Cara Operations Ltd. accessed the Canadian high yield market for acquisition financing in respect of Prime Restaurants Inc., which was arguably the first time a Canadian issuer had accessed the Canadian high yield market where proceeds were earmarked solely for acquisition financing (which transaction was ultimately not completed). While this market continues to develop with several Canadian dealers adding domestic market expertise and/or U.S. sourcing capability, larger Canadian issuers continued to access the U.S. high yield market for larger amounts of capital (i.e. above $500M), a trend which we expect to continue in 2012. On the leveraged buyout side, the mid-market remained robust in Canada in 2011 and we expect to see this segment remain active in 2012. The fourth quarter of 2011 also saw some very large leveraged buyout transactions in the United States which bodes well for the higher end of the market in Canada, which transactions we have not seen domestically for several years. With the depth of the Canadian debt markets continuing to increase, we also expect to see more specialty lenders in 2012 (which we have not seen on transactions over the last few years) with several new bridge, subordinated debt, mezzanine and niche and industry-focused lenders participating in the Canadian capital markets, many of which are active in structuring hybrid transactions with both debt and equity components to both private and public issuers.

In addition, in 2011 there were an increasing number of re-leveraging transactions. These transactions involved deals primarily completed in 2006-2008 whereby the financial sponsors had tried to sell their investments and take their money off the table, but were unable to find a purchaser at an acceptable price. We expect to see more re-leveraging of portfolio companies in 2012 to permit these sponsors to effect liquidity and sell their equity. We also expect to see a refinancing bulge over the next 2-3 years as there are many 2005 – 2007 acquisitions which are becoming due for re-financing, potentially limiting the availability of funds for new deals.

5. Continued Appetite for Canadian Natural Resources

2012 will most certainly experience continuing global demand by foreign investors for Canadian natural resources, especially from India, China, Korea, Japan and other Asian-based investors. In addition to going-private transactions in the form of tender offers or plans of arrangement, this sector continues to see more creative and strategically oriented investment structures. De facto control transactions involving private investment in public entities (PIPES) for equity investments of more than 20%, together with negotiated investors’ rights or similar agreements (with board representation, veto rights over certain corporate transactions and pre-emptive rights) are expected to remain prevalent. In addition, transactions involving alternative structures in the natural resource sector in the form of non-control or “toe hold” equity investments below 20%, coupled with secured lending facilities and exclusive off-take agreements, are expected to continue to aid the demand in 2012 for certain commodities, including copper and base metals. Several examples of this occurred in the Canadian marketplace in 2011, including Korea Resources Corporation’s $400 million investment in Capstone Mining Corp. through which it acquired just under 20% of Capstone and permitted Capstone to purchase for $700 million Far West Mining Ltd., a Canadian copper exploration company with copper assets in Chile, and was coupled with a joint venture and off-take agreement which provided rights to Korea Resources to sell a minimum number of tonnes of copper.

6. Earnouts

We anticipate that the Canadian economy and M&A markets in Canada will continue to grow incrementally in 2012, with market uncertainty resulting in many real or perceived value differences between buyers and sellers of businesses, as well as continued difficulty in many circumstances to find acquisition financing – particularly for highly-leveraged transactions. To bridge gaps on valuation and/or financing we anticipate the continued use of earnouts, seller-financing (vendor-take backs or VTBs), seller rollover equity and the seller receiving buyer stock (perhaps with “puts” and/or “calls”).

The more interesting developments that we anticipate in 2012 include:

Earnouts being structured through a preferred share mechanism (instead of a pure contractual obligation). This raises additional issues including compliance with corporate solvency restrictions (which may necessitate a third party guarantee) and will potentially require a shareholders agreement. This also brings into play, in favour of the seller-shareholder, oppression and other corporate remedies.
Structured equity, whereby the seller receives common equity which provides a deferred payout tied to a hurdle rate of return - if buyer achieves such target over a period of three to five years the seller participates in an agreed portion of the upside.
Contingent value rights (“CVRs”) which are a form of transferable, earn-out security sometimes used as partial acquisition currency in the purchase of a public company. CVRs are usually tied to a specific milestone (such as the issue of a patent or receipt of regulatory approvals that allow the sale of a new product) but have been used, for example, to guarantee the value of buyer’s stock for a period after closing.

7. Reverse Break Fees

We expect that reverse break fees (paid by the purchaser in the event that it breaches or cannot complete a proposed transaction in specified circumstances) will become more prevalent in Canadian M&A transactions in 2012. Unlike the first generation of reverse break fees several years ago – which were designed primarily to compensate target companies in public M&A transactions who were being acquired by financial buyers in the event a regulatory or financing condition was not satisfied – reverse break fees are now more commonly used in public and, to a lesser extent, private change of control transactions and with both strategic and financial buyers. In addition, they now address a broader range of deal risks for target companies.

U.S. practice has had a major influence on reverse break fees in Canada. As a result, Canadian reverse break fees have ceased to be equal or symmetrical to the break fee amounts typically received by a buyer. Instead, they are often higher in value (and in many instances substantially higher) in recognition of their distinct underlying economic purpose, although reverse break fee percentages are still generally in the single digits, not approaching the 20% reported in the case of the Google-Motorola deal in the U.S. We expect to see continued use of reverse break fees in Canada, particularly where buyers are able to negotiate for the reverse break fee being the exclusive remedy available to the target company, therefore allowing a buyer to limit its liability exposure. In addition, reverse break fees are now a common feature of share-for-share acquisitions given the recent changes to the TSX rules whereby listed companies must obtain shareholder approval in order to issue more than 25% of their outstanding shares in connection with an acquisition or another public company.

8. Continuing Influence of U.S. M&A and Private Equity Practice:

The influence of U.S. M&A and Private Equity practices in Canada, through cross-border transactions, will continue unabated in 2012:

Limits or caps on indemnity claims continue to decrease, with many transactions having caps in the range of 5 to 15% of deal value (with lower levels in a robust auction context).
With such decreasing caps comes an increase in the number of exceptions to caps – “fundamental” warranties have now been extended in many transactions to employee and benefit plan matters, tax matters, environmental matters, and even related-party transactions and arrangements.
Increased use of a “materiality scrape” whereby all materiality qualifications (including MAE) to representations and warranties are removed for purposes of the closing condition and is now being applied for purposes of damage claims – thereby making the deductible the materiality threshold (better known as avoiding double materiality).
Expect further battles between buyer’s request for “sandbagging” provisions (a buyer can seek indemnification for breach of warranties notwithstanding knowledge of such breach) and seller-friendly anti-sandbagging provisions. Buyers with sandbagging provisions continue to resist warranties to the effect that they hold no knowledge of breach (which would have provided a basis for a counterclaim in appropriate circumstances).
Escrows (as opposed to holdbacks) continue to be very popular, particularly with private equity participants, as a source of payment for indemnification claims; often being the sole and exclusive source of indemnification claims in auction contexts. Often the amount and duration of such escrow fund matches the cap and general survival period for warranties.
General survival periods for warranties continue to decrease. A typical general period might be the lesser of 18 months from closing and three months following the end of the next fiscal year following closing. Common exceptions from such general survivorship periods include “fundamental warranties” (such as title to shares) and taxes (though even these exceptions are often negotiated in robust auction contexts).

9. Controlled Auctions

As the M&A market continues to improve, we anticipate that controlled auctions will remain a preferred route for many sellers. Because controlled auction transactions have been a major bright spot in the post-2008 Canadian marketplace, particularly in the mid-market, U.S. firms looking for acquisitions north of the border will generally want to remain open to such a transaction as a means of entry into Canada. In its broad outlines, a controlled auction is similar in Canada and the U.S., but as always the devil is in the detail. In advising U.S. companies and their counsel, we continue to stress a number of key points about Canadian law and practice in this area. For example, the Supreme Court of Canada’s 2008 BCE v. 1976 Debentureholders ruling established that Canada does not recognize a strict “Revlon” duty to maximize shareholder value in the context of change-of-control transactions. Instead, a director’s fiduciary duty is defined with respect to longer-term interests of the company and can include consideration of the interests of non-shareholder stakeholders (e.g. creditors or employees).

With respect to the procedural aspects of controlled auctions, there is no reason to expect any change to Canada’s tradition of judicial deference to seller-established auction rules. As technology continues to improve and gain acceptance, we expect to see continued growth in the use of electronic data rooms and a continuation of the corresponding decline in the use (and/or length) of confidential information memoranda. On the regulatory front, 2012 is anticipated to be “more of the same”: as always, there can be foreign investment review issues for foreign entrants into Canada in the context of a controlled auction, particularly in regulated industries such as transportation, communications and financial services. Regulatory risk in the antitrust area is similar to what might be experienced in the U.S. and can sometimes be alleviated in an auction context if a prospective purchaser obtains confidential pre-transaction guidance from Canada’s Competition Bureau. It also generally continues to be the case that partnering is permitted in Canadian controlled auctions only with the consent of the target, with a diminishing chance of such consent as the process progresses.

Finally, since Canada’s recent abolition of withholding tax on interest payments to foreign lenders, we are seeing more private equity and other financial buyers rely on their U.S.-relationship banks for committed financing (often without commitment fees) at early stages of auction processes when success is still uncertain. This is often advisable because Canadian acquisition financing markets are generally more limited than their U.S. counterparts.

For further information on controlled auctions in Canada, see our recent post “Controlled Auctions in Canada: Tactical and Strategic Legal Considerations”.

10. Quebec’s “Plan Nord”

In 2011, the government of Quebec announced the “Plan Nord”, a major economic development project for the vast northern region of the province. Plan Nord is expected to lead to investments of $80 billion over the next 25 years in the natural resources and infrastructure sectors. Plan Nord accordingly represents an attractive investment opportunity for foreign investors, especially from rapidly modernizing countries such as China and India, in light of an increasing demand for resources and commodities around the world. In 2012, we expect to see growth in acquisitions, joint ventures and financing activities pertaining to mining, transportation, energy and infrastructure projects in this region.

11. Distressed M&A

With the continued global recession, Canadian insolvency filings in 2012 are expected to remain relatively similar to 2011 but could spike if the economy slows and exposed businesses – in particular those dependent on exports, given the relative strength of the Canadian dollar, or discretionary consumer spending, given the current levels of Canadian household debt – seek protection under Canadian insolvency laws. Certain 2009 amendments to the Companies’ Creditors Arrangement Act (CCAA) and the Bankruptcy and Insolvency Act (BIA) have narrowed the differences between Canadian legislation and its U.S. equivalent. One important result is that sales of assets in distressed companies with strong presences in both Canada and the U.S. have become more efficient and the reorganization process speedier and more efficient. Of particular note in larger insolvency proceedings in which a sale of the debtor’s assets is contemplated, the “stalking horse” approach is becoming firmly entrenched as the method of choice for maximizing value. In addition, recent affirmation by courts of the legitimacy of credit bidding has emboldened purchasers with “loan to own” strategies and secured the favorable position held by senior lenders in the reorganization process.

* The authors gratefully acknowledge the assistance of Bill Braithwaite, Simon Romano, and Brian Pukier (M&A), Jean Farley (insolvency and restructuring), John Lorito (tax), Peter Hamilton (finance), Jay Kellerman (mining), Sophie Lamonde (Plan Nord) and Michael Kilby (regulatory).

¹ Needless to say, this characteristic made them very popular with Canadian tax-exempts, non-residents and even Canadian taxpayers who could earn business income through a public vehicle on a more tax-efficient basis than income earned through a public corporation.

IIROC releases amendments to rules respecting interpretation and standards

Stikeman Elliott LLP — Fri, 06 Jan 2012 13:45:15 -0500

The Investment Industry Regulatory Organization of Canada (IIROC) today released proposed amendments to its rules regarding interpretation and standards. The amendments, released as part of IIROC's plain language rule rewrite project, are intended to remove unnecessary rule provisions, clarify IIROC's expectations with respect to certain rules, ensure that the rules reflect actual IIROC practices and ensure consistency with other IIROC rules and applicable securities legislation. The proposed amendments are open to a 90-day comment period. For more information, see IIROC Notice 12-0005.

IIROC publishes circuit breaker levels for Q1 2012

Stikeman Elliott LLP — Wed, 04 Jan 2012 13:00:34 -0500

Yesterday, the Investment Industry Regulatory Organization of Canada (IIROC) published Notice 12-0001 relating to securities trading halts in coordination with the application of "circuit breakers" on U.S. markets for the first quarter of 2012. In the U.S., trading halts occur based on trigger levels of 10%, 20% and 30% drops of the Dow Jones Industrial Average, calculated at the beginning of each quarter using the previous month's average closing value. The NYSE thresholds for Q1 2012 are 1,200 points, 2,400 points and 3,600 points respectively.

It is IIROC's policy that it will coordinate trading halts with U.S. markets, but for days when Canadian markets are open and American markets are closed, IIROC has published related triggers based on drops in the S&P/TSX Composite Index. The TSX trigger levels are: Level 1 (10%) - 1,200 points; Level 2 (20%) - 2,350 points and Level 3 (30%) - 3,550 points, and result in trading halts ranging from 30 minutes to the balance of the trading session, depending on the time of day and magnitude of the market decline.