BCN2007/33 Notice and Request for Comment Proposed British Columbia Instrument 51-509 Issuers Quoted in the U.S. Over-the-Counter Markets Propsed Conditions of Registration for Investment Dealers that Trade in the U.S. Over-the-Counter Markets [BCN - Lapsed]
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We are publishing for comment:
- a proposed rule, British Columbia Instrument 51-509 Issuers Quoted in the U.S. Over-the-Counter Markets, and
- proposed new conditions of registration for investment dealers that trade in the U.S. over-the-counter markets.
The proposed rule and conditions of registration are important parts of the commission's response to abusive practices in British Columbia involving the over-the-counter markets in the United States. You can find background on the problem and the commission's proposed response in BC Notice 2007/24.
We invite comment on these materials and will consider all comments received by December 31, 2007. Instructions for providing your comments are at the end of this notice.
II THE PROPOSED RULE
The proposed rule would give the commission better legal tools to:
- improve disclosure by issuers with significant connections to British Columbia that are quoted in the U.S. over-the-counter markets, and
- discourage the manufacture and sale in British Columbia of U.S. over-the-counter quoted shell companies that can be used for abusive purposes.
The proposed rule would apply to any OTC issuer that has a significant connection to British Columbia.
Under the proposed rule, an OTC issuer is an issuer that is quoted on the OTC Bulletin Board or the Pink Sheets, unless the issuer is also listed on the TSX Venture Exchange, The Toronto Stock Exchange, the New York Stock Exchange, the American Stock Exchange, or the NASDAQ Stock Market. Those exchanges impose requirements on issuers that make it unnecessary for them to be subject to the proposed rule.
An OTC issuer has a significant connection to British Columbia if
- it is directed or administered, or investor relations activities are conducted on its behalf, from British Columbia (or from British Columbia and other jurisdictions), or
- its ownership structure makes it vulnerable to being used for manipulative purposes.
The proposed rule would apply to an OTC issuer when it becomes a public issuer. That happens when it is assigned a ticker symbol for the OTC Bulletin Board or the Pink Sheets. The proposed rule would apply for at least one year after the issuer becomes a public issuer. After that, the proposed rule would apply only if the issuer is directed or administered from, carries out investor relations activities from, or has a control person resident in, British Columbia.
The proposed rule applies to OTC issuers that are reporting issuers in British Columbia or another jurisdiction in Canada at the time the rule comes into force. We considered excluding the application of the rule to this class of OTC issuers but concluded, given the objectives of the rule, that there is no persuasive policy reason to exclude its application to this class of OTC issuers.
C. Disclosure requirements
We intend that the proposed rule's disclosure requirements will improve continuous disclosure for OTC issuers. Commission staff will monitor and enforce compliance with the new requirements through continuous disclosure reviews and the use of compliance and enforcement tools when appropriate.
Under the proposed rule, OTC issuers must
- meet the same periodic disclosure requirements imposed on other domestic reporting issuers under National Instrument 51-102 Continuous Disclosure Obligations, including an annual information form, management's discussion and analysis, and audited financial statements,
- comply with Canadian timely disclosure requirements, and
- file their public disclosure on SEDAR.
Apart from the requirement to file an annual information form, OTC issuers would be treated as venture issuers under NI 51-102.
OTC issuers that are SEC filers - issuers that file disclosure with the United States Securities and Exchange Commission - could comply with the proposed rule's requirements to file financial statements, MD&A and AIFs using documents they file with the SEC.
The proposed rule would require an OTC issuer to report a material change by issuing a news release and filing it, along with a material change report.
The proposed rule would also require an OTC issuer to file
- the most recent registration statement it filed with the SEC, and
- information about persons it retains for investor relations activities, the nature and scope of the engagement, compensation, and other material terms of the agreement.
The proposed rule would also require OTC issuers in the oil and gas business to comply with National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities. The proposed rule does not mention National Instrument 43-101 Standards of Disclosure for Mineral Projects because that instrument currently applies to OTC issuers.
The proposed rule would require insiders of OTC issuers to file insider reports on SEDI.
Personal information forms
In connection with the proposed rule, the Executive Director proposes to require, under section 90 of the Act, each director, officer, promoter or control person of an OTC issuer to file a personal information form (PIF) with the commission. This form would include the person's consent to a criminal record search. Directors and officers of issuers listed on the TSX Venture Exchange must file a similar form with the Exchange.
Disclosure exemptions for foreign issuers not available
Some OTC issuers are "SEC foreign issuers" under National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers. That Instrument exempts SEC foreign issuers from Canadian continuous disclosure requirements as long as they comply with SEC disclosure rules, file in Canada the documents they file with the SEC, and send to Canadian security holders the documents they send to security holders under SEC rules. In essence, they comply with Canadian rules by complying with SEC rules.
The commission proposes to amend the order adopting National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers to deny the exemptions in that Instrument to OTC issuers.
The exemptions for SEC foreign issuers were intended for an operating issuer that is an SEC filer and has a stronger connection to a foreign country than to Canada (shareholders, management and business all mostly outside Canada). An OTC issuer by definition has a significant connection to British Columbia. Allowing these issuers to use the foreign issuer exemptions would be inconsistent with the reason for those exemptions.
For similar reasons, the proposed rule would not allow an OTC issuer to use the exemptions in
- Part 5 (exemptions for foreign issuers) of National Instrument 52-107 Acceptable Accounting Principles, and
- Parts 14, 15 and 16 (material change reporting, financial reporting and proxies) of National Instrument 71-101 The Multijurisdictional Disclosure System.
Similarly, an insider of an OTC issuer would not be entitled to rely on the exemption in Part 17 (insider reporting) of National Instrument 71-101 The Multijurisdictional Disclosure System.
D. Restriction of exemptions
We intend the proposed rule to deter shell manufacturers from delivering to shell buyers the "public float" that is created from shares sold in private placements to British Columbia residents and registered in a US registration statement that an issuer files with the SEC prior to becoming a public issuer.
To do this, the proposed rule would
- deny the use of exemptions that could be used for this purpose,
- require a British Columbia resident who acquired shares from an OTC issuer before it became public to sell the shares only through a registrant, from an account in the person's own name, into the market or into a formal take over bid, and
- require the OTC issuer to place a legend on the certificates or a legend restriction notation on the ownership statements representing the shares held by British Columbia residents to that effect.
The proposed rule refers to take over bid exemptions for bids that involve purchases from less than 5 persons in total, and for bids that involve an non-reporting issuer with no published market in sections 98(1)(c) and 98(1)(d) of the Act. On April 28, 2006, the commission published for comment proposed National Instrument 62-104 Take-Over and Issuer Bids. If that instrument comes into force before the proposed rule, we will revise the rule to refer to the substantially similar take over bid exemptions in the National Instrument.
Most Pink Sheet quoted issuers are not currently subject to a continuous disclosure regime. Under the proposed rule, they would be. Therefore, the proposed rule would extend to security holders of issuers quoted on the Pink Sheets the same resale regime for securities acquired in a private placement currently available to security holders of issuers quoted on the OTC Bulletin Board.
All the usual capital raising exemptions would be available to an OTC issuer during both its private and public stages.
However, the proposed rule would deny an OTC issuer the use of these exemptions from the date it comes into force:
- the securities for debt exemption in section 2.14 of National Instrument 45-106 Prospectus and Registration Exemptions,
- the exemption for trades to employees, executive officers, directors and consultants in section 2.24 of NI 45-106 unless the conditions in section 2.25 of that instrument are met, and
- the exemptions for trades in securities of non-reporting issuers in section 2.26 of NI 45-106.
The exemptions in section 2.14 and 2.24 of National Instrument 45-106 are appropriate for issuers subject to exchange supervision. The exemptions in section 2.26 of NI 45-105 could be used to transfer control of an OTC issuer as part of a scheme to use a shell company for abusive purposes.
E. Effective date and transition provisions
Following the comment period and our review of the comments, we will decide whether to seek the Minister's approval to adopt the rule, with any revisions that we consider appropriate. We will announce then the date on which we expect the proposed rule to come into force.
If we adopt the proposed rule, an OTC issuer will have to begin making disclosure immediately. The first quarterly and annual filings would require reporting on periods prior to the effective date of the rule.
Issuers that are not current SEC filers may not have an auditor or the resources and experience to meet the rule's new disclosure requirements. To give them more time to prepare for compliance with the new rule, they will not have to comply with its requirements to file annual and interim financial statements, related MD&A, and AIFs for financial years ending before January 1, 2008. For issuers with a December 31 year end, the first financial statements required to be audited would be for the financial year ending December 31, 2008.
An insider of an OTC issuer must file an initial insider report within 60 days of the date the rule comes into force.
OTC issuers must file investor relations information within 60 days of the date the rule comes into force.
F. Proposed fees
We propose to impose the same filing fees that reporting issuers, and insiders of reporting issuers, pay to the commission. These fees are set out in Part 7 of the Securities Regulation. OTC issuers will also have to pay SEDAR fees.
G. Anticipated costs and benefits
An OTC issuer has a significant connection with British Columbia. We think it is appropriate that those issuers make disclosure to the same standard as British Columbia reporting issuers.
The disclosure requirements should not be onerous for OTC issuers whose securities are quoted on the OTC Bulletin Board, since they are SEC filers and can use the documents they file with the SEC in lieu of the Canadian forms of financial statements, MD&A and AIF.
The Pink Sheets do not require issuers whose securities are quoted on the Pink Sheets to file disclosure with the SEC. These issuers may incur significant new costs to comply with the rule.
H. Alternative approach
Under Bill 28, Securities Amendment Act, 2007 the commission would be authorized to designate OTC issuers as reporting issuers. If the Bill comes into force, we might modify the form of the proposed rule to impose requirements with the same substantive effect through that mechanism instead of implementing the proposed rule.
III THE PROPOSED CONDITIONS OF REGISTRATION
The proposed conditions would implement one of the initiatives described in the June notice. The conditions would increase dealers' accountability for their trading activities in the US over-the-counter markets.
The proposed conditions would apply to the British Columbia operations of all investment dealers that are registered, and have an office, in British Columbia and trade in OTC issuer securities.
We will not impose the conditions on any dealer that undertakes not to trade in OTC issuer securities.
The proposed conditions would require dealers to have a supervision and compliance system in place to effectively manage the risks of trading OTC issuer securities.
Monitoring, recordkeeping and reporting
The proposed conditions would impose recording and reporting requirements on dealers.
Some dealers may not have systems currently in place to record and report to the standard required by the conditions. The commission will accept reasonable, good faith estimates while dealers are developing the necessary systems.
Establishing beneficial ownership
Under the proposed conditions, dealers would be prohibited from trading OTC issuer securities until they are confident they know the beneficial owner of the securities. Dealers would also have to determine whether the beneficial owner was closely related to the issuer, and if so, how the owner acquired the securities to be traded.
We will expect dealers to make good faith inquiries using reasonable and effective procedures. For retail accounts existing when the conditions come into force, the dealer will be able to comply with the conditions using previously-verified information from new client account/application forms or verifications obtained under anti-money laundering procedures.
Responsibility of UDP
The conditions would prohibit a dealer from accepting the deposit of any OTC issuer securities though the physical deposit of share certificates until the dealer's UDP (Ultimate Designated Person) approves the deposit.
Dealers would not be required to re-verify further deposits by the same person for the same OTC issuer security, absent suspicion that the person depositing the securities is not the beneficial owner of the securities.
We intend that the proposed conditions would expire after three years.
D. Public hearing
Before imposing the conditions, we will give affected dealers an opportunity to be heard. This opportunity will take the form of a public hearing before a panel of commissioners. The commission will provide reasonable notice of the hearing to affected dealers.
E. Effective date and transition provisions
The commission would impose the proposed conditions after it releases its decision from the public hearing. Because the timing of implementation may well be an issue raised by dealers in the hearing, we will not know the implementation date until the panel releases its decision. The commission intends to give dealers a reasonable time to prepare for implementation.
F. Anticipated costs and benefits
Trading in OTC issuer securities has some additional risk to dealers for the reasons described in the commission's June notice. The commission believes that the conditions of registration are a reasonable way to address that additional risk so that dealers can fulfill their responsibilities as gatekeepers for the market. We expect the costs will be fairly allocated, because the anticipated costs would be borne directly by the dealers who engage in the business, and that the costs would be proportionate to the extent each dealer engages in this business.
The anticipated benefit is the less frequent use of dealers registered in British Columbia to facilitate abusive promotions of OTC issuer securities. The resulting benefit to the integrity of British Columbia's capital markets would far outweigh the burdens associated with the conditions.
IV REQUEST FOR COMMENTS
We welcome your comments on the proposed rule, conditions of registration and related proposals.
Please submit your comments in writing on or before December 31, 2007. If you are not sending in your comments by email, you should also send a diskette containing your submission (in Windows format, Word).
Please address your submission to the British Columbia Securities Commission.
Deliver your comments to:
Senior Compliance Counsel, Corporate Finance
British Columbia Securities Commission
P.O. Box 10142, Pacific Centre
701 West Georgia Street
Vancouver, British Columbia V7Y 1L2
We cannot keep submissions confidential because securities legislation requires publication of a summary of the written comments received during the comment period.
Please refer your questions regarding the proposed rule to:
Senior Compliance Counsel, Corporate Finance
British Columbia Securities Commission
Please refer your questions regarding the proposed conditions of registration to:
Senior Legal Counsel, Capital Markets Regulation
British Columbia Securities Commission
October 29, 2007
Brent W. Aitken
This Notice may refer to other documents. These documents can be found at the B.C. Securities Commission public website atwww.bcsc.bc.cain the section Securities Law & Policy: Policies & Instruments.