Not an empty seat in the province
30 April 2013
The Canadian Securities Administrators’s proposed amendments to securities lending tackle the issue of empty voting. SLT takes a look
Image: Shutterstock
The Canadian Securities Administrators, a firm responsible for securities regulations in all of the country’s provinces, is attempting to tackle the thorny issues of insider reporting and empty voting, by appealing for comment on proposed amendments and changes to their current usage.
The objective of the amendments, stated the CSA, is to provide: “Greater transparency about significant holdings of issuers’ securities by proposing an early warning reporting threshold of five percent, requiring disclosure of both increases and decreases in ownership of two percent or more of securities, and enhancing the content of the disclosure in the early warning news releases and reports required to be filed.”
The CSA also proposed changes so that certain “hidden ownership” and “empty voting” arrangements are disclosed.
The shifting rulebook includes amendments to the early warning reporting requirements, which applies in all provinces and territories of Canada except Ontario. The province does not get off scot-free, however, with the CSA anticipating that amendments to its Securities Act will be proposed so that the substance of the changes can apply fully in Ontario.
A history of warning
The early warning system was introduced in Canada in 1987 as a result of proposals made by the Securities Industry Committee on Take-over Bids. The industry committee believed that a 20 percent threshold was appropriate for regulating take-over bids in Canada, but at the same time recognised that the accumulation of a holding of 10 percent should be disclosed as it could be a signal of a potential acquisition of control.
In June 1990, the CSA published for comment a proposal to reduce the take-over bid threshold to 10 percent.
“We indicated … that we were reviewing reform proposals to address hidden ownership concerns in other jurisdictions and were considering developing similar proposals for Canada,” said a statement from the CSA.
It added that it had received a number of comments in support of developing comparable proposals for Canada, including comments from issuers, investors, law firms and investor protection organisations, and that no commenters opposed the initiative.
The basic requirements of the early warning regime are that, if a person acquires beneficial ownership of, or control or direction over, voting or equity securities of any class of a reporting issuer that would constitute 10 percent or more of the outstanding securities of that class, the person must issue and file a news release promptly and file a report within two business days. A person must also issue a news release and file a report for additional acquisitions of 2 percent or more of the outstanding securities.
Amanda Linett, partner in the Toronto office of Stikeman Elliott, and Ruth Elnekave, a member of the corporate department in Stikeman Elliott’s Toronto office, remarked in an online report that the amendments could affect the conduct of certain equity derivative transactions and related hedging activities.
“Currently, under the Early Warning Reporting (EWR) regime, prescribed disclosure is required by any investor that acquires beneficial ownership of or the power to exercise control or direction over 10 percent or more of any class of a public company’s voting or equity securities,” they wrote. Additional reporting is required on each incremental acquisition of two percent as well as a change in a material fact contained in an earlier report. However, there is leeway for certain eligible institutional investors, who can take advantage of relaxed timing requirements for early warning reporting under the alternative monthly reporting regime.
“In our view, our current threshold of 10 percent, introduced in 1987, does not respond to the reality of increasing shareholder activism and to the ability of a shareholder holding five percent to requisition a shareholders’ meeting,” said the CSA. “The objective of early warning disclosure is not only to predict possible take-over bids but also to anticipate proxy-related matters where a threshold of five percent may be critical.
It added that its own early warning disclosure requirements should recognise the realities of current markets where a significant accumulation of securities is relevant for purposes beyond signalling potential take-over-bids.
“We believe that changes to the scope of the early warning framework are required in order to ensure proper transparency of securities ownership in light of the increased use of derivatives by investors,” the CSA added. “A sophisticated investor may be able, through the use of equity swaps or similar derivative arrangements, to accumulate a substantial economic interest in an issuer without public disclosure and then potentially convert this interest into voting securities in time to exercise a vote (this is referred to as hidden ownership).”
How to make friends and
influence votes
As well as hidden ownership concerns, the CSA also started to grow uneasy with the practice of investors using derivatives or securities lending arrangements to hold voting rights without an equivalent economic stake and influence the outcome of a shareholder vote—a practice known as empty voting.
Though these types of arrangements may not be disclosed under current securities law, disclosure of them would be helpful in maintaining transparency and market integrity, said the CSA.
As a result, it proposed amendments that were intended to include certain types of derivatives that affect an investor’s total economic interest in an issuer for the purposes of determining the early warning reporting threshold trigger. The changes would require disclosure of an investor’s economic interest in an issuer, as well as its voting interest in the case of securities lending arrangements. An investor would also have to disclose that it has entered into related financial instruments and other arrangements with respect to the securities of the issuer, if this is the case.
“Under securities lending arrangements, the lender disposes of its securities and the borrower acquires the securities, generally along with the right to vote the securities for the duration of the loan,” wrote Linett and Elnekave. The CSA stated that the current regime requires the lender and borrower to consider the securities disposed of and acquired, respectively, in determining whether the reporting requirement has been triggered, notwithstanding the duration of the loan.
In light of the proposed requirement to report 2 percent decreases in ownership, the reporting requirement would specifically apply to lenders under securities lending arrangements, absent available exemptions. However, wrote Linett and Elnekave, the proposals would excuse the lender (but not the borrower) from reporting securities lent out as a disposition under a “specified securities lending arrangement”. This provides an unrestricted ability for the lender to recall the securities (or identical securities) before a meeting of securityholders and/or requires the borrower to vote the securities in accordance with the lender’s instructions.
“Further, in order to provide the market increased transparency about the use of these arrangements, it is also proposed that securities lending arrangements in effect at the time of a reportable transaction be disclosed, even if such transaction did not involve the securities lending arrangement.”
Sorting out the possibilities
As for what the proposed changes will mean for the Candian sector, Linett and Elnekave wrote that reducing the reporting threshold from 10 to 5 percent could benefit potential borrowers by identifying more broadly, and earlier in the process, lenders that hold 5 percent of the target securities, and allow issuers more time to defend against a potential borrower or activist shareholder.
“On the other hand,” they wrote, “pre-bid accumulation transactions may be hindered, and potential acquirors would need to consider, in some cases, the earlier disclosure to the market of their intentions.”
The proposed changes may result in increased compliance costs, largely to investment managers, mutual funds and other institutional investors, and Linett and Elnekave predict the volume of reporting under the EWR regime to increase significantly, particularly among public mutual funds that are subject to a higher portfolio concentration limit of 10 percent.
Also, investors who use derivatives and securities lending as a risk management tool in connection with short and/or long positions in an issuer’s stock—and who may not have previously been caught—may have to publicly disclose holdings, and at the lower five percent threshold.
Ultimately, investors have three things to check off of their to-do list, wrote Linett and Elnekave. “They will need to plan early in connection with stock accumulations, consider carefully whether a particular proposed transaction is caught by the EWR regime—and generally assess possible implications in connection with reportable transactions such as the potential dissemination of investment strategies.”
The CSA’s request for comments is open until 12 June.
The objective of the amendments, stated the CSA, is to provide: “Greater transparency about significant holdings of issuers’ securities by proposing an early warning reporting threshold of five percent, requiring disclosure of both increases and decreases in ownership of two percent or more of securities, and enhancing the content of the disclosure in the early warning news releases and reports required to be filed.”
The CSA also proposed changes so that certain “hidden ownership” and “empty voting” arrangements are disclosed.
The shifting rulebook includes amendments to the early warning reporting requirements, which applies in all provinces and territories of Canada except Ontario. The province does not get off scot-free, however, with the CSA anticipating that amendments to its Securities Act will be proposed so that the substance of the changes can apply fully in Ontario.
A history of warning
The early warning system was introduced in Canada in 1987 as a result of proposals made by the Securities Industry Committee on Take-over Bids. The industry committee believed that a 20 percent threshold was appropriate for regulating take-over bids in Canada, but at the same time recognised that the accumulation of a holding of 10 percent should be disclosed as it could be a signal of a potential acquisition of control.
In June 1990, the CSA published for comment a proposal to reduce the take-over bid threshold to 10 percent.
“We indicated … that we were reviewing reform proposals to address hidden ownership concerns in other jurisdictions and were considering developing similar proposals for Canada,” said a statement from the CSA.
It added that it had received a number of comments in support of developing comparable proposals for Canada, including comments from issuers, investors, law firms and investor protection organisations, and that no commenters opposed the initiative.
The basic requirements of the early warning regime are that, if a person acquires beneficial ownership of, or control or direction over, voting or equity securities of any class of a reporting issuer that would constitute 10 percent or more of the outstanding securities of that class, the person must issue and file a news release promptly and file a report within two business days. A person must also issue a news release and file a report for additional acquisitions of 2 percent or more of the outstanding securities.
Amanda Linett, partner in the Toronto office of Stikeman Elliott, and Ruth Elnekave, a member of the corporate department in Stikeman Elliott’s Toronto office, remarked in an online report that the amendments could affect the conduct of certain equity derivative transactions and related hedging activities.
“Currently, under the Early Warning Reporting (EWR) regime, prescribed disclosure is required by any investor that acquires beneficial ownership of or the power to exercise control or direction over 10 percent or more of any class of a public company’s voting or equity securities,” they wrote. Additional reporting is required on each incremental acquisition of two percent as well as a change in a material fact contained in an earlier report. However, there is leeway for certain eligible institutional investors, who can take advantage of relaxed timing requirements for early warning reporting under the alternative monthly reporting regime.
“In our view, our current threshold of 10 percent, introduced in 1987, does not respond to the reality of increasing shareholder activism and to the ability of a shareholder holding five percent to requisition a shareholders’ meeting,” said the CSA. “The objective of early warning disclosure is not only to predict possible take-over bids but also to anticipate proxy-related matters where a threshold of five percent may be critical.
It added that its own early warning disclosure requirements should recognise the realities of current markets where a significant accumulation of securities is relevant for purposes beyond signalling potential take-over-bids.
“We believe that changes to the scope of the early warning framework are required in order to ensure proper transparency of securities ownership in light of the increased use of derivatives by investors,” the CSA added. “A sophisticated investor may be able, through the use of equity swaps or similar derivative arrangements, to accumulate a substantial economic interest in an issuer without public disclosure and then potentially convert this interest into voting securities in time to exercise a vote (this is referred to as hidden ownership).”
How to make friends and
influence votes
As well as hidden ownership concerns, the CSA also started to grow uneasy with the practice of investors using derivatives or securities lending arrangements to hold voting rights without an equivalent economic stake and influence the outcome of a shareholder vote—a practice known as empty voting.
Though these types of arrangements may not be disclosed under current securities law, disclosure of them would be helpful in maintaining transparency and market integrity, said the CSA.
As a result, it proposed amendments that were intended to include certain types of derivatives that affect an investor’s total economic interest in an issuer for the purposes of determining the early warning reporting threshold trigger. The changes would require disclosure of an investor’s economic interest in an issuer, as well as its voting interest in the case of securities lending arrangements. An investor would also have to disclose that it has entered into related financial instruments and other arrangements with respect to the securities of the issuer, if this is the case.
“Under securities lending arrangements, the lender disposes of its securities and the borrower acquires the securities, generally along with the right to vote the securities for the duration of the loan,” wrote Linett and Elnekave. The CSA stated that the current regime requires the lender and borrower to consider the securities disposed of and acquired, respectively, in determining whether the reporting requirement has been triggered, notwithstanding the duration of the loan.
In light of the proposed requirement to report 2 percent decreases in ownership, the reporting requirement would specifically apply to lenders under securities lending arrangements, absent available exemptions. However, wrote Linett and Elnekave, the proposals would excuse the lender (but not the borrower) from reporting securities lent out as a disposition under a “specified securities lending arrangement”. This provides an unrestricted ability for the lender to recall the securities (or identical securities) before a meeting of securityholders and/or requires the borrower to vote the securities in accordance with the lender’s instructions.
“Further, in order to provide the market increased transparency about the use of these arrangements, it is also proposed that securities lending arrangements in effect at the time of a reportable transaction be disclosed, even if such transaction did not involve the securities lending arrangement.”
Sorting out the possibilities
As for what the proposed changes will mean for the Candian sector, Linett and Elnekave wrote that reducing the reporting threshold from 10 to 5 percent could benefit potential borrowers by identifying more broadly, and earlier in the process, lenders that hold 5 percent of the target securities, and allow issuers more time to defend against a potential borrower or activist shareholder.
“On the other hand,” they wrote, “pre-bid accumulation transactions may be hindered, and potential acquirors would need to consider, in some cases, the earlier disclosure to the market of their intentions.”
The proposed changes may result in increased compliance costs, largely to investment managers, mutual funds and other institutional investors, and Linett and Elnekave predict the volume of reporting under the EWR regime to increase significantly, particularly among public mutual funds that are subject to a higher portfolio concentration limit of 10 percent.
Also, investors who use derivatives and securities lending as a risk management tool in connection with short and/or long positions in an issuer’s stock—and who may not have previously been caught—may have to publicly disclose holdings, and at the lower five percent threshold.
Ultimately, investors have three things to check off of their to-do list, wrote Linett and Elnekave. “They will need to plan early in connection with stock accumulations, consider carefully whether a particular proposed transaction is caught by the EWR regime—and generally assess possible implications in connection with reportable transactions such as the potential dissemination of investment strategies.”
The CSA’s request for comments is open until 12 June.
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