William E. Demers
The following article provides information of a general nature and does not constitute legal advice or the formation of a lawyer-client relationship.
Securities are regulated provincially and territorially in Canada. In addition to laws passed by parliaments, securities transactions may be subject to national instruments and decisions of regulatory authorities (commissions) as well as those of the courts.
Many businesses routinely engage in securities transactions, often unbeknownst to themselves, which must be compliant at law otherwise giving rise to potentially significant liability. It is not merely in the realms of publicly listed entities, investment funds and retailers of financial products that such rules apply.
Whether raising capital, creating revenue sharing arrangements, restructuring a business or drafting a simple investment contract (even absent any actual share or note issuance), it is critical for businesses to understand the securities attributes of said transactions and their implications at law.
Ontario’s Securities Act (the “Act”) defines a security very broadly. Note well that it includes:
- any document, instrument or writing commonly known as a security,
- any document constituting evidence of title to or interest in the capital, assets, property, profits, earnings or royalties of any person or company,
- any document constituting evidence of an interest in an association of legatees or heirs,
- any document constituting evidence of an option, subscription or other interest in or to a security,
- a bond, debenture, note or other evidence of indebtedness or a share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription other than, a contract of insurance issued by an insurance company licensed under the Insurance Act, and evidence of a deposit issued by a bank listed in Schedule I, II or III to the Bank Act (Canada), by a credit union or central to which the Credit Unions and Caisses Populaires Act, 2020 applies, by a loan corporation or trust corporation registered under the Loan and Trust Corporations Act or by an association to which the Cooperative Credit Associations Act (Canada) applies,
- any agreement under which the interest of the purchaser is valued for purposes of conversion or surrender by reference to the value of a proportionate interest in a specified portfolio of assets, except a contract issued by an insurance company licensed under the Insurance Act which provides for payment at maturity of an amount not less than three quarters of the premiums paid by the purchaser for a benefit payable at maturity,
- any agreement providing that money received will be repaid or treated as a subscription to shares, stock, units or interests at the option of the recipient or of any person or company,
- any certificate of share or interest in a trust, estate or association,
- any profit-sharing agreement or certificate,
- any certificate of interest in an oil, natural gas or mining lease, claim or royalty voting trust certificate,
- any oil or natural gas royalties or leases or fractional or other interest therein,
- any collateral trust certificate,
- any income or annuity contract not issued by an insurance company,
- any investment contract,
- any document constituting evidence of an interest in a scholarship or educational plan or trust, and
- any commodity futures contract or any commodity futures option that is not traded on a commodity futures exchange registered with or recognized by the Commission under the Commodity Futures Act or the form of which is not accepted by the Director under that Act, whether any of the foregoing relate to an issuer or proposed issuer.
Different measures have been established for determining the existence of a security, such as the common enterprise or risk capital tests applied to investment contracts. To the extent that a security does exist, there is the question of whether it has been traded, constituting a distribution.
The Act defines trade or trading to include:
- any sale or disposition of a security for valuable consideration, whether the terms of payment be on margin, instalment or otherwise, but does not include a purchase of a security or, except as provided in clause (d), a transfer, pledge or encumbrance of securities for the purpose of giving collateral for a debt made in good faith,
- any participation as a trader in any transaction in a security through the facilities of any exchange or quotation and trade reporting system, entering into a derivative or making a material amendment to, terminating, assigning, selling or otherwise acquiring or disposing of a derivative, or. a novation of a derivative, other than a novation with a clearing agency,
- any receipt by a registrant of an order to buy or sell a security,
- any transfer, pledge or encumbrancing of securities of an issuer from the holdings of any person or company or combination of persons or companies described in clause (c) of the definition of “distribution” for the purpose of giving collateral for a debt made in good faith, and
- any act, advertisement, solicitation, conduct or negotiation directly or indirectly in furtherance of any of the foregoing.
The Act defines distribution as:
- a trade in securities of an issuer that have not been previously issued,
- a trade by or on behalf of an issuer in previously issued securities of that issuer that have been redeemed or purchased by or donated to that issuer,
- a trade in previously issued securities of an issuer from the holdings of any control person,
- a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, prior to the 15th day of September, 1979 if those securities continued on that date to be owned by or for that underwriter, so acting,
- a trade by or on behalf of an underwriter in securities which were acquired by that underwriter, acting as underwriter, within eighteen months after the 15th day of September, 1979, if the trade took place during that eighteen months, and
- any trade that is a distribution under the regulations, and also includes any transaction or series of transactions involving a purchase and sale or a repurchase and resale in the course of or incidental to a distribution and “distribute”, “distributed” and “distributing” have a corresponding meaning.
Such a distribution may give rise under applicable statute, e.g. section 53(1) of the Ontario Securities Act, to a preliminary prospectus requirement unless an exemption is available.
While the existence of such requirements may be routine and not especially cumbersome for many businesses, other businesses and their owners will find it costly and impractical to undergo audits and prepare prescribed financial statements and forms (as may be required) needed to meet commission filing and review requirements. There is also the matter of continuous disclosure requirements.
It often happens that such transactions are inappropriate and should not have arisen in the first place. Rather than find themselves in this predicament, businesses should first explore whether their objectives can be met through certain exempt transactions or with the assistance of an intermediary better suited to the role of a securities issuer or dealer, or otherwise.
A number of exemptions to prospectus requirements are well established; most can be found in National Instrument 45-106. These include exemptions for certain forms of capital raising (e.g. re rights offerings; accredited investors; private issuers; family, friends and business associates; crowdfunding), transactions (e.g. re business combinations and reorganizations; asset acquisitions; securities for debt; issuer acquisitions or redemptions), and in respect of employees, executive officers, directors and consultants.
Canadian securities laws are sweeping, in cases complicated, and evolving. Non-compliance with or violation of such rules can impose significant personal scrutiny and both civil and criminal liabilities for those involved, including the possibility of imprisonment. The powers of authorities to investigate and prosecute are significant.
While many businesses will be exempt from registration and filing requirements, it is prudent to understand and take one’s obligations very seriously when engaging in securities transactions and to seek skilled securities counsel where appropriate.
For further information or advice on these topics, or for assistance raising funds privately, please contact the author.
[Future articles will explore in closer detail the various exempt forms of capital raising and transactions, as well as non-exempt situations.]