CSA 92/03 - Bought Deal Financings [CSA Notice - Rescinded]

Introduction

Over the past decade a financing technique known as the "bought deal" has emerged and has become the principal means by which issuers eligible to use the prompt offering qualification system (the "POP System") have raised capital in the Canadian capital markets. A bought deal may be characterized as a public offering of securities in Canada where the issuer and underwriter enter into an underwriting agreement prior to, or contemporaneously with, the filing of a preliminary prospectus. Bought deals have become increasingly common over the past number of years and are said to currently account for the majority of debt and equity offerings of issuers eligible to use the POP System. However, certain concerns have been expressed in respect of bought deals and the Canadian Securities Administrators (the "CSA") have resolved to examine these concerns in order to determine whether: (i) regulatory changes should be made to eliminate bought deals, (ii) changes should be made to the regulatory regime in respect of bought deals, or (iii) no changes to the current regulatory regime should be made. Consequently, the CSA are issuing this Request for Comments.

Background

Prior to the emergence of bought deals in the early 1980s, an underwriter would not enter into a firm commitment to purchase securities from an issuer until it had "pre-marketed" the issue after the filing of a preliminary prospectus. In contrast to a bought deal, the prospective issue was disclosed to the market prior to the time when the underwriter entered into an underwriting agreement with the issuer. The underwriter determined the appropriate size and price of a prospective offering at the conclusion of a pre-marketing period, which occurred after the filing of a preliminary prospectus, and based its underwriting commitment on that information.

With the advent of the bought deal, the underwriter committed its capital prior to, or contemporaneously with, the filing of a preliminary prospectus. It has been expressed to the CSA that while this financing technique enables issuers to obtain a firm price and satisfaction of its financing needs with a minimum of risk and delay, it also increases an underwriter's risk, relative to traditional underwritings, due to the lack of a pre-marketing period prior to the entering into an underwriting agreement.

In 1986, blanket rulings (the "Blanket Rulings") were issued by several provincial securities regulatory authorities. Generally, the Blanket Rulings permit the solicitation of expressions of interest from investors two business days prior to the filing of a preliminary short form prospectus provided that an underwriting agreement has been entered into which requires, among other things, that a preliminary short form prospectus be filed with a securities regulatory authority within two business days of the entering into of such underwriting agreement.

Request for Comments

Various concerns have been expressed by the CSA with respect to certain aspects of bought deals, which include, but are not limited to, retail participation, underwriting risks and pre-marketing practices. The Corporate Finance Committee of the Investment Dealers Association of Canada has, over the past number of months, reviewed the practices relating to bought deals and has now provided the CSA with specific proposals to modify the bought deal financing technique (the "IDA Proposals"), in order to address some of these same concerns. The IDA Proposals are being published along with this Request for Comments in order to facilitate and generate comment from interested parties concerning bought deals in general, and the IDA Proposals in particular.

The CSA have neither accepted nor rejected the IDA Proposals and the publication of such proposals should not be viewed as an endorsement of them, but merely as publication for the purpose of soliciting comments. In addition, the fact that the CSA have determined that it is appropriate to examine concerns expressed by various parties regarding bought deals should not be taken as indicating that the CSA have in any respect determined that bought deals, as they currently exist, are prejudicial to investor protection or the effective operation of the Canadian capital markets.

It would be helpful to the CSA in conducting their examination of bought deals to have the benefit of the views of issuers,
dealers, retail, mutual fund and institutional investors and other interested parties. Where appropriate, interested parties are strongly encouraged to provide, if at all possible, statistical information which addresses various issues related to bought deals and, in particular, statistical information relating to the impact that bought deals have had on the retail investor and the cost of capital to issuers.

It has been expressed to the CSA that a number of the concerns relating to bought deals stem from the desire of underwriters to reduce their underwriting risk in such transactions. Comment is requested on the concerns set out below and, in addition, the CSA seek comment on the relationship between these concerns and the underwriting risk associated with bought deals. The following is not intended to set out all of the concerns related to bought deals, but rather to highlight certain concerns which have been expressed for the purpose of eliciting public comment. Comment need not be restricted to the matters set out below.

The issue of greatest interest to the CSA is the impact of bought deals on the overall structure of the capital markets in Canada and the way that such markets are perceived. The CSA seek comment as to whether bought deals have "institutionalized" capital formation in Canada and, if this has occurred, whether this change may be negatively impacting certain investors and the integrity and efficiency of the capital markets.

It has been suggested that the perception that there exists a lack of retail participation in bought deals, whether accurate or not, erodes retail investor confidence. In addition, concern has been expressed to the CSA that retail investors do not have an opportunity to purchase securities in certain bought deals at an offering price which reflects a discount from the then current market price in the same manner as institutional investors and that this further erodes retail investor confidence. With respect to existing individual shareholders, it has been stated that such investors should have the opportunity to participate in new offerings of the issuers in which they already own securities, so that their ownership interests are not diluted without them having the opportunity to preserve those interests, and that such shareholders would have that opportunity were retail participation in bought deals increased. It has also been stated that the apparent exclusion of smaller institutional investors from greater participation in bought deals results in a two-tier institutional investor structure that negatively impacts the marketplace. Comment is requested regarding the impact on primary and secondary markets of perceived or actual reduced retail, existing individual shareholder and smaller institutional participation in bought deals.

The IDA Proposals would introduce a "delay period" commencing after the earlier of the filing of a preliminary prospectus and the issuance of a press release. Prior to the delay period, no pre-marketing activities (as defined) may be conducted by dealers. The stated objective of the delay period is to provide dealers with the opportunity to make an informed decision about the size and price of the offering prior to entering into an underwriting agreement. Retail demand is to be canvassed through contact with the dealers' retail distribution networks. The IDA Proposals indicate that the delay period is intended to provide an improved opportunity for retail investors to participate in bought deals. Comment is specifically requested as to whether the proposed delay period would achieve this purpose and/or whether it may lead to other problems.

Comment is also sought on a number of other issues relating to the delay period contemplated in the IDA Proposals. Many of the securities which are the subject of bought deals are of issuers whose securities are inter-listed on foreign exchanges. Since the delay period contained within the IDA Proposals is based upon domestic stock exchange trading hours, comment is requested as to the impact on domestic markets and the bought deals of such issuers of trading which may occur on foreign markets during the delay period. Comment is requested as to whether the filing of a preliminary prospectus is an acceptable alternative to the filing of a press release for the purpose of determining the commencement of the delay period. In addition, comment is requested as to whether the required contents of a press release contemplated under the IDA Proposals are appropriate.

Concern has been expressed to the CSA about the potential systemic risk that bought deals represent for the Canadian capital markets as a result of the capital risk faced by individual underwriters that participate in such deals. It has been suggested to the CSA that the reduced use of "market out" clauses in underwriting agreements used in bought deals compounds the risks associated with the early commitment of capital by dealers in such financings.

The IDA Proposals indicate that the ability to assess market demand during the delay period will improve the likelihood that an offering will be sold successfully at an attractive price to the issuer; thereby reducing the risk that an underwriter will be forced to absorb losses by selling the offered securities at prices below the initial offering price. Comment is specifically requested on whether bought deals have created undue risk to Canadian underwriters and whether this risk is destabilizing to the Canadian capital markets and/or adversely effects competition. In addition comment is specifically requested as to whether, and to what degree, the IDA Proposals will reallocate market risks between underwriters and issuers and what the effect on the Canadian capital markets might be of any such reallocation of risk.

It has been suggested to the CSA that underwriters are unable to perform adequate due diligence within the time-frame of a bought deal. Comment is specifically requested on this issue.

Having regard to the efficiency of raising capital in the Canadian marketplace and the concerns expressed regarding retail participation, systemic risk to the Canadian capital markets and due diligence, comment is requested as to whether the suggested delay period in the IDA Proposals is appropriate, and if not, whether it should be shorter or longer. In addition, comment is requested as to whether there should be a maximum length of time for any delay period.

Concerns have been expressed to the CSA that pre-marketing activities, contrary to the Blanket Rulings, are being carried on prior to the entering into of an underwriting agreement. A related issue is that insider information may be being divulged unintentionally or otherwise. The IDA Proposals restrict marketing activities to the period after the earlier of the issuance of a press release and the filing of a preliminary prospectus. The stated intent of these proposals is that there be no pre-marketing activities conducted prior to information about the offering being made public.

The restrictions on pre-marketing activities contained within the IDA Proposals hinge upon the definition proposed for the term "pre-marketing". The term "pre-marketing" is defined in the IDA Proposals as "the imparting of information on an issuer's ... intentions in relation to an issue ... of [e]quity [s]ecurities ..." to a prospective investor. Comment is requested as to whether this definition is appropriate. Comment is specifically sought as to whether the focus on the "imparting" of an issuer's intention contained within the proposed definition creates problems for the general application of the pre-marketing restrictions. Comment is further sought as to whether the focus on an issuer's "intention" contained within the proposed definition creates similar problems. Comment is also requested on whether the definition should be expanded to include the imparting of information on the dealer's intention so as to restrict a dealer advising others that it is contemplating making a specific financing proposal to a particular issuer. In addition, the pre-marketing restrictions contained in the IDA Proposals do not appear to relate to general discussions that dealers may have with their clients in order to broaden their understanding of market developments and client needs. Comment is generally sought on the implications of the proposed pre-marketing restrictions and the exceptions outlined in the IDA Proposals.

There are two ways in which bought deals may be initiated. Either the offerings are initiated by the issuer (solicited bought deals) or they are initiated by the dealer (unsolicited bought deals). Comment is requested on the differing impact, if any, of the IDA Proposals on unsolicited bought deals in general, and the pre-marketing of such deals in particular.

It has been suggested to CSA that innovative terms and financing techniques in securities financings are encouraged by bought deals because underwriters are able to enter into underwriting agreements prior to information relating to the financing entering the public domain. Comment is requested on the impact of bought deals, generally, and the IDA Proposals, in particular, on innovation in the Canadian capital markets and on competition among underwriters.
Comment is also requested on the impact that bought deals have had on Canadian issuers in terms of cost of capital, access to capital, financing risk and the competitiveness of Canadian capital markets to satisfy the needs of such issuers. Comment is further requested on the probable impact that the IDA Proposals would have on these factors.

Market stabilization rules set out restrictions on secondary market trading by issuers, underwriters and certain other distribution participants during a prospectus distribution of exchange listed securities. Connected and related issuer rules restrict the portion of a distribution that may be underwritten by dealers that are "connected" or "related" to an issuer. Comment is sought as to the effect that these rules have had on bought deals and whether implementation of the IDA Proposals would require changes to the foregoing rules.

Comment is sought as to the extent to which any of the foregoing concerns relate to bought deals for debt securities or preferred shares and, since the IDA Proposals deal only with equity securities and securities convertible into such securities, whether any regulatory response is necessary with respect to bought deals for debt securities or preferred shares.

The CSA understand that persons submitting responses may be concerned from a confidentiality perspective as a result of competitive, commercial or economic considerations. Accordingly, responses will, upon request, be treated as confidential and will not be placed on the public files of the securities regulatory authorities. Public access to such responses will not be permitted except as may be required by law. However, copies of all responses will be circulated among and reviewed and considered by the CSA in connection with this initiative.

Comments should be in writing and should be delivered to the address indicated below on or before October 30, 1992.

Canadian Securities Administrators
Corporate Finance Committee
c/o Secretary, Ontario Securities Commission
Ontario Securities Commission
Suite 800, Box 55
20 Queen Street West
Toronto, Ontario
M5H 3S8

Questions may be referred to:

Susan I. McCallum
Director, Corporate Finance
Ontario Securities Commission
(416) 593-8248

Arnold Hochman
Deputy Director, Policy
Corporate Finance
Ontario Securities Commission
(416) 593-8247

August 7, 1992

Corporate Finance Committee

Investment Dealers Association of Canada

Submission on Proposals to Modify the Bought Deal Financing Technique

July 1992

Corporate Finance Committee

Thomas L.A. Allen, Q.C. Chairman Gordon Capital Corporation

Daniel F. Sullivan ScotiaMcLeod Inc.

Bryce W. Douglas / Douglas G. Hall RBC Dominion Securities Inc.

David Bird Burns Fry Limited

George Ratner Richardson Greenshields of Canada Limited

Kenneth G. Copland / Richard Lint Nesbitt Thomson Inc.

Anthony R. Graham Levesque Beaubien Geoffrion Inc.

John A. Plaxton / Peter McKenzie Deacon Barclays de Zoete Wedd Limited

Terry C.W. Reid / Jim Hinds Wood Gundy Inc.

Brent McCredey-Williams Loewen Ondaatje McCutcheon & Company Limted

Peter L. Jones Salomon Brothers Canada Inc.

Thomas R. Spencer / Harry Malcolmson TD Securities Inc.


J. Charles Caty President Investment Dealers Association of Canada

Ian C.W. Russell Vice-President Investment Dealers Association of Canada

Introduction

Through the late 1970s and 1980s, the removal of capital controls in international markets, growing international trade and widespread financial deregulation cnotributed to the increased volatility of North American capital markets. Greater volatility in markets tended to impact on the capital raising process for corporations as volatility increased the risk of significant deviation in the price of capital during the financing period.

Regulators in Canada and the United States introduced several initiatives to shorten the prospectus clearance process for public offerings and thereby provide greater certainty of priced capital for corporations. In the early 1980s, the U.S. Securities and Exchange Commission developed the Shelf Prospectus System which allowed large corporations to file prospectuses for a predetermined amount of capital well in advance of actual requirements. This regulatory framework enabled U.S. companies to obtain rapid access to priced capital when the need arose. The experience in the United States, however, has been that issuers have not used the Shelf Prospectus System for equity financings because of a reluctance to disclose equity requirements well in advance of coming to market.

In Canada, provincial securities commissions introduced the Prompt Offering Qualification System, or the POP Sytem, for large corporate issuers, with eligibility determined on the basis of equity market float. Large issuers qualifying under this System were permitted to file a short form prospectus which limited information mainly to a description of the securities offered. Since these issuers are subject to continuous disclosure requirements, it was not deemed necessary to provide information on corporate operations or financial condition in the short form prospectus. There are approximately 180 Canadian corporations which now qualify under the POP System.

The POP System dramatically shortened the time period between the filing of the preliminary and the final prospectus. The three to six weeks clearance period for a traditional long form prospectus was reduced to seven to ten days. Underwriters took further steps to reduce the delay period by offering an earlier commitment to an offering price. In effect, dealers began to sign underwriting agreements sometime before the filing of the final prospectus. Competitive pressures tended to move the timing of the commitment earlier and earlier. This process raeched its limited when the pricing commitment or signing of the underwriting agreement coincided with the filing of prelimiarny prospectus. In order for the earlier underwriting commitment to be meaningful to the issuer, underwriters also offered early commitments without the traditional industry "market out" clause. The removal of this clause prevented underwriters from revoking commitments in the event of a general market decline. The financing technique which combines an underwriting agreement in advance of, or contemporaneous with, the preliminary prospectus and absence of a "market out" clause, is commonly referred to as the "bought deal".

The selling efforts in bought deal transactions are similar to those utilized in a traditonal underwriting. Traditionally, solicitations of expressions of interest typically began once the preliminary prospectus was filed and actual purchase orders were processed after the receipt of the final prospectus. In 1986, provincial securities commissions in major jurisdictions approved a Blanket Ruling which permitted solicitations to start two days prior to the filing of the preliminary prospectus, on condition a firm underwriting commitment had been entered into. This refinement to the regulations gave underwriters the comfort that if they were to enter into an underwriting commitment before the filing of a preliminary prospectus, underwriters could, for a two day period prior to filing a preliminary prospectus, solicit expressions of interest and "get off their long positions".

The bought deal provides the corporate issuer with a firm price for equity capital at the time the capital is required. Moreover, a firm commitment to an offering price for capital can be made even before the information on the forthcoming offering is conveyed to the marketplace. This added flexibility means that the market settle, i.e. the market impact of the financing on existing share values, is not absorbed by the issuer, but rather is absorbed in an agreed-upon manner between the underwriter and the issuer, based on negotiation between these parties. Even greater certainty of capital is obtained due to the fact that a "market out" clause is not included in most bought deal transactions, thereby ensuring the issuer obtains capital even in the event of a general market decline. Correspondingly, the absence of this clause places greater risk on the underwriter.

The bought deal has evolved into an important and progressive financing vehicle for corporate Canada. This financing technique has given Canadian issuers even faster access to priced capital than issuers in the domestic United States market. This provides an important advantage to Canadian financial markets to counterbalance the fact they are much smaller and less liquid than U.S. capital markets.

Concerns have been raised in some quarters that retail investors are not always given a fair opportunity to participate in bought deal underwritings. The common explanation for neglect of the small investor is that selling efforts in bought deal transactions concentrate primarily on large institutional clients capable of making rapid decisions on large block purchases of new issue stock. This institutional focus arises because the early commitment to price in a bought deal and the additional risk resulting from the absence of a "market out" clause forces dealers to eliminate the underwriting liability as quickly as possible. Moreover the early commitment also provides limited time to establish large banking group syndicates, thereby requiring the underwriting syndicate to assume larger liability positions than in traditional underwritings. This development adds pressure on underwriters to move off the liability position as soon as possible. Finally, the early commitment the bought deal sometimes impairs the formation of selling groups which can result in a narrower retail distribution of new securities.

Retail distribution in bought deal financings is handicapped by the short notice of forthcoming deals, the compressed time to solicit investors before committing to a deal and pressures to move off the liability in the shortest possible time. An expansion in the time period to market the new issue before entering into a commitment would increase the time during which retail interest can be determined to ensure appropriate share of the financing is "circled" or set aside for retail investors. There is a general agreement among underwriting firms that the time period should be sufficient to enable a comprehensive survey of retail interest through the sales infrastructure of investment dealers, in particular extensive contact with regional sales managers, branch managers and registered representatives to ascertain retail interest in the underwriting. Sales managers and registered representatives can provide a good assessment of client interest in new securities based on recent client investment activity, the overall tone of the markets, competing investment opportunities and detailed knowledge of the client's investment profile. Direct contact with retail investors, while helpful, is not essential to develop a good sounding of the retail marketplace for bought deal financings.

The bought deal transaction is considered by some to have disadvantaged existing shareholders. The short timeframe to solicit retail investors has meant that shareholders have rarely been given the opportunity to participate in new offerings, thereby resulting in the dilution of their ownership interest. While corporate law does not accord pre-emptive rights to shareholders, some corporations nonetheless do wish to respect shareholder rights by providing shareholders with the widest possible access to new financings.

The debate about the efficacy of retail solicitation in bought deal transctions, combined with several well-publicized underwritings which could not meet strong retail demand has left the perception that retail investors and smaller institutions are disadvantaged in bought deal underwritings vis-a-vis large institutions. This perception of inequitable treatment among investors is not positive for Canada's capital markets to the extent it may lead to reduced retail participation in equity underwritings and secondary market transactions. It is critical to remove this perception. Individual participation in both primary and secondary equity markets is a central component of market efficiency. The participation of large numbers of investors in equity markets, and concomitant large bid-offer order flows, contributes to more efficient pricing of equity shares. Large order flows also contribute importantly to market liquidity.

A concern has also been raised that bought deals increase underwriting risks for investment dealers. The risk in question is not so much a question of dealer solvency in that underwriters are subject to adequate capital rules and dealer clients are fully protected through the Canadian Investor Protection Fund. It is more the risks associated with possible loss of profitability and capital in a bought deal transaction which in turn may unduly constrain dealers from carrying out their normal business activities in the marketplace.

The critical task for the underwriter in a bought deal transaction is to ensure that it is committed to an offering price which accurately reflects underlying market conditions. In particular, the offered price should be the highest possible price which is acceptable to investors. The risk is that the offering price will be too high relative to prevailing market prices, limiting demand for new shares and ultimately forcing underwriters to lower the offering price below the issue bid and absorbing the loss. This loss represents an eventual charge against dealer's capital.

The task to set the right offering price and to assume the risk of being wrong and ending up "long" is no different than in a traditional underwriting. What is different in a bought deal transaction is that the risk is assumed earlier, without the benefit of as much market information, and the risk is taken on without the insulation of a "market out" clause.

The ability to offer an effective price to the corporate issuer requires a good assessment of market demand for the offered shares. There is some concern that a pricing commitment made early in the underwriting process in bought deal transactions limits investor solicitation and fails to allow for a proper assessment of the marketplace. The limited opportunity to solicit investors in bought deals, however, must be considered in conjunction with the effectiveness of the dealer to obtain general market intelligence on potential investor interest. Good market intelligence can to some extent compensate for the limited solicitation period in bought deals.

Continual discussions between investors and underwriters are essential to build good market intelligence and reduce underwriting risk. There is considerable uncertainty about securities regulations which govern discussions between investors and dealers in connection with proposed underwriting transactions which have not yet been made public. The conventional legal interpretation is that discussions which divulge any material information on the issuer's intentions before any public disclosure constitutes the misuse of inside information. There still can exist some uncertainty or "shades of gray" in terms of what constitutes material information. Clearly, a definite decision on the part of the issuer to offer securities is material whereas an inquiry about the possibility of issuing new shares may not be material.

Such discussions raise two legal issues: (a) do such discussions constitute trading in securities without a prospectus or without an exemption from the prospectus requirements of relevant law and (b) do such discussions constitute improper "tipping" of non-public material information? On the first of these issues, although legal opinion may be divided the view of provincial securities commissions is implicit from the aforementioned Blanket Ruling. On the second of these issues, even if the conversations between dealer and institutions can be excused as being in the necessary course of business, we are concerned by the practical dilemma imposed on institutions whose trading activities thereafter come into serious question.

The Association proposes to prohibit premarketing of new issue equity securities distributed through either a short form or long form prospectus offering to remove the uncertainties among underwriters as to the legality of client discussions and, more importantly, to remove the perception among the public at large that large institutions are favoured over individual investors. In the event that premarketing of new issues were deemed legal, large institutional investors would be favoured over small investors to the extent most discussions would take place with large institutions and many individual investors and small institutions would be ignored.

Premarketing is defined as the imparting of informtion on the issuer's intentions in respect of the issue (or sale) of equity securities through a short form or long form prospectus which has not been publicly disclosed, for the purposes of obtaining an indication of interest in purchasing the securities. This definition has been framed in such a way to deal with securities related to a specific offering and not preclude dealers from carrying out general discussions with clients to broaden their understanding of market developments and client needs. These general discussions are important in order that markets work efficiently. The premarketing definition would not apply to private placement financing.

The Proposal

The Corporate Finance Committee of the lnvestment Dealers Association of Canada reached a majority decision that bought deal financing procedures should be amended to address concerns in respect of retail participation, underwriting risks and premarketing practices in bought deal transactions. The Committee's task was to address alleged problems and, if those allegations were considered justified, to modify the bought deal financing technique to provide a better balance between the competing interests involved in the underwriting transaction. The perception, if not in some cases the reality, is that the pendulum has swung too far in favor of corporate issues and large institutions at the expense of individual investors and small institutions. The popularity of bought deal financing, accounting for nearly two-thirds of common equity financings last year, has therefore encouraged greater concentration in primary and secondary equity markets and may ultimately contribute to less efficient and liquid markets.

At the same time, it is recognized that the bought deal provides a timely and cost-effective financing instrument for raising new equity capital. The financing technique enables Canadian corporations to place large amounts of new shares more quickly in the market than U.S. corporations. The challenge for the Committee was to preserve the integrity of the bought deal and yet provide better opportunity for individual investors to participate in these equity underwritings. The Committee believes that it has developed a proposal, "The Proposal", to modify the bought deal financing technique so that both objectives can be effectively met.

Regulations would be put in place to permit underwriters to buy, or enter into a commitment to buy, for resale other than through a private placement, any public offering of participating equity securities, or securities convertible into participating equity securities, on condition that a prescribed delay period of six hours has elapsed after either the filing of the preliminary prospectus or the issuance of a press release announcing a proposed issue of securities. In this delay period, securities firms would be permitted to solicit expressions of interest from investors, particularly individual investors, to make an informed decision on the size and price of the offering of these securities. A delay period would in the most likely circumstance, but not necessarily, fall between 4 o'clock p.m. EST on one business day, i.e. after the close of the Canadian stock exchanges (other than the Vancouver Stock Exchange), and 8:30 o'clock a.m. EST on the next business day, i.e. before the reopening of the stock exchanges. This provision would enable underwriters to canvass the marketplace in the overnight period when markets are closed and then commit a price to the issuer before markets have reopened and are able to react to the forthcoming offering.

Once the commitment is made by the dealer, and the underwriting agreement signed, the offering would then proceed in the normal manner. The preliminary prospectus would be filed within two days, followed in due course by the filing and clearance of the final prospectus and the closing of the deal. The actual timing of the underwriting commitment need not occur at the end of the six hour delay period and, indeed, prolonged negotiations between the underwriter and issuer may preclude such a development. The commitment can in fact occur at any time prior to the filing of the final prospectus.

Benefits of the Proposal

Investors

The mandated six hour delay between the announcement of the forthcoming underwriting and the commitment or agreement to terms, provides an improved opportunity for retail investors to participate in the bought deal underwriting. The prospect of greater retail investor participation is very much in the interests of efficient and liquid markets.

The delay period would in practice occur after the four stock exchanges close. The period would commence at the nearest one-half hour after the market closing i.e. at 4:30 o'clock p.m. EST (other than the Vancouver Stock Exchange). One business hour would elapse between 4:30 o'clock p.m. and 5:30 o'clock p.m. EST, followed by the overnight period between 5:30 o'clock p.m. and 8:30 o'clock a.m. EST the folowing morning. The overnight period is deemed to represent five business hours.

One minor complication is the extra one-half hour of trading on the Vancouver Stock Exchange. As the Exchange closes at 4:30 o'clock p.m. EST, the issuer would have an obligation to inform the Exchange of a planned public announcement of a forthcoming offering between 4:00 o'clock p.m. and 4:30 o'clock p.m. EST. The Exchange would then halt trading in the particular securities, if they are interlisted on the VSE. The delay period would still encompass the period between 4:30 o'clock p.m. EST and 8:30 o'clock a.m. EST the following morning.

The delay period would provide underwriters with more opportunity to canvass retail interest and enable an effective assessment of retail demand for the underwriting. The six hour gap between the announcement and commitment to the underwriting would give adequate time to make extensive contact with regional sales managers, branch managers and registered representatives of investment dealers. The time period would even provide some opportunity for direct contact with individual investors. The delay period would begin at 1:30 o'clock p.m. PST on the west coast, enabling an opportunity to solicit individual investors throughout the afternoon and early evening. -Similar solicitations can get underway in the early evening in central Canada and on the east coast. These solicitations can continue into the early morning hours of the following day. European and far east interests in the securities can be canvassed in the evening and early morning hours.

Issuers

The six hour delay, which can be timed to occur overnight, retains virtually all the benefits of the bought deal for the issuer. Under the Proposal, the issuer can obtain a binding commitment on priced equity capital within six business hours (or overnight) following the announcement of the deal - only a few hours after the issuer would be given a firm commitment under the existing bought deal framework. Given that the delay period can be arranged overnight, a period when domestic equity markets are closed, the issuer is not forced to absorb the full market settle, as would be the case in a traditional short form or long form prospectus offering. As is the case in existing bought deals, the settle can be the subject of negotiation between the issuer and underwriter. Further, the opportunity for more effective solicitation of retail investor interest improves the prospects for a more broadly based and stable market for the placement of new shares.

There is one drawback to the proposed arrangements. The public announcement by an issuer in advance of a firm commitment to price and quantity clearly risks potential embarrassment to the issuer if, after overnight solicitation of interest, demand is insufficient or uncertain for underwriters either to commit to the offering or the bid for the new shares is unacceptable. The likelihood of this outcome, however, is small and will occur only in exceptional circumstances. Once the public announcement is made, underwriters are under pressure to proceed with the financing, given the overnight delay period while markets are closed. The opportunity to preserve an existing business relationship with the issuer provides a practical incentive for underwriters to follow through with an offering acceptable to the issuer, except in unusual market circumstances. Moreover, at the time of annnouncement, underwriters would likely propose offering prices within a range to accomodate normal market conditions. Unless investor interest is adversely affected by unforeseen market or economic developments overnight, an acceptable bid should be forthcoming.

On the other hand, it makes good sense to give the underwriter an option through the mandated delay period to decline to commit to an offering in the event of a sudden and dramatic deterioration in capital market conditions. An obligation to follow through in this case could result in serious losses to the underwriter with possible claims on the Canadian Investor Protection Fund, market losses to investors and weak market support for the issuer's securities.

Underwriting Risk

The six hour delay period provides dealers with better opportunity to assess market demand for the underwriting thoroughly before making a firm commitment to the deal. This comprehensive market solicitation improves the likelihood that the offering may be sold successfully at a price attractive to the issuer and thereby reduces the risk that the underwriter will be forced to absorb losses by selling the new shares at prices below the offering price.

Premarketing

The rigorous definition of premarketing adopted in the Proposal, i.e. prohibiting the conveyance of information on yields several important benefits. First, the elimination of premarketing, de jure, removes the perception that large institutions are favoured over smaller institutions and individual investors in bought deal transactions, thereby bolstering confidence in the underwriting process and the marketplace. Second, the public announcement of the deal prior to soliciting expressions of interest, together with the premarketing definition, gives a clearer understanding of the rules in respect to solicitation and thereby enables underwriters to canvass investor interest in a more open, forthright and effective manner.

The delay period in the Proposal is particularly important in the context of the strict definition of premarketing. In the existing bought deal framework, the solicitation period can be quite short before a firm price commitment is made, reflecting the inability to solicit until 48 hours before filing a preliminary prospectus (Blanket Ruling). Indeed, the existing rules make it possible for underwriters to commit to a deal without any solicitation of investor interest. This early commitment could increase underwriting risk to the extent dealers bid "blind", relying only on general market intelligence to assess market demand for the specific deal. The Proposal would defray risk by mandating at least six business hours of solicitation before a commitment to terms. Existing law relating to disclosure of non-public information by persons in a special relationship would continue to apply.

Due Diligence

The six hour delay mandated in the proposal would provide underwriters with additional time to prepare for and conduct due diligence. The improvement in due diligence standards, however, will be marginal as due diligence is carried out effectively within the existing bought deal timetable. Due diligence can be conducted effectively within a relatively short time period, given that issuers are subject to continuous disclosure requirements providing a public record of material matters and, as well, the availability of skilled bankers and lawyers trained in due diligence procedures.

Specific Comments

The Mandatory Delay Period

The definition of business hours raises practical considerations with respect to determining the six hour delay period when financings occur in different regions of the country with different time zones. Business hours are based on the hours that the four Canadian stock exchanges, Vancouver Stock Exchange, the Alberta Stock Exchange, the Toronto Stock Exchange, and the Montreal Exchange are open. Since these stock exchanges are open concurrently across the country at different local times (except for the extra one-half of trading on the Vancouver Stock Exchange), this provision would ease enforcement as the delay period would expire simultaneously in all jurisdictions. For example, business hours are defined as 3:30 o'clock a.m. to 5:30 o'clock p.m. EST in Toronto and 5:30 o'clock a.m. EST to 2:30 o'clock p.m. PST in Vancouver.

Corporate issuers which select Ontario as the principal jurisdiction for the equity offering would issue a press release between 4.00 and 4:30 o'clock p.m. EST. The six hour delay period would then expire at 8:30 a.m. the following morning, enabling the underwriter to commit a firm price to the issuer and release the second press statement before the opening of domestic equity markets. Since the delay period occurs overnight while domestic markets are closed, the commitment can be made before the announcement of the pending deal has influenced market prices. In the event the firm commitment is made just prior to the opening of the exchanges, or sometime after the exchanges have opened, it is expected stock exchanges would halt trading so that the terms and conditions of the underwriting can be made fully available to the market. The exchanges are unlikely to halt trading simply based on a public announcement that a forthcoming deal has been made, and negotiations between underwriters and the issuer on the specific terms and conditions are underway.

It is important to emphasize that the Proposal gives corporate issuers the flexibility to issue a press release at any time during business hours, say, at 10:00 o'clock a.m. EST and then sign an underwriting commitment six hours later at 4:00 o'clock p.m. EST. If the press release is issued at any time after 11:30 o'clock a.m., say, 12:00 o'clock p.m., the commitment can only be made at 8:30 o'clock a.m. the following morning since the deemed overnight period (five business hours) cannot be subdivided.

New Issue Securities Subject to the Proposal

The Proposal is effective for participating equity securities and securities convertible into participating equity securities. Participating equity securities include all securities with residual right to participate in earnings and, upon liquidation, assets of an issuer. Debt securities would be exempt from the Proposal. First, the inclusion of debt securities would unfairly restrict underwriters vis-a-vis federally regulated chartered banks which would not be subject to the Proposal. Second, there is no retail concern in respect to corporate debt securities as individual investors typically hold highly rated government debt securities, with corporate debt relegated to the institutional market. Third, premarketing concerns in respect to debt securities are less serious to the extent new debt securities have much less impact on market prices and yields of outstanding securities.

The Proposal would not apply to offerings of new equity securities distributed primarily in offshore markets. For example, in the case of equity offerings where a domestic prospectus may be filed in order to accomodate residual sales into the domestic market, the mandated six hour delay between public announcement and commitment would not be required.

Compatibility with the Multijurisidictional Disclosure System

Multijurisdictional System (MJDS) issuers would be subject to the Proposal. This provision would not complicate the MJDS system. First, bought deal financings are already permissible under MJDS. The U.S. Securities and Exchange (SEC) has accepted the Commission practice of solicitation of expressions of interest two days prior to filing the preliminary prospectus as long as no solicitations are made in the United States. The MJDS registration statement would still be filed at the same time as the preliminary prospectus. Second, the filing of the press release which announces the forthcoming offering would not be in contravention of MJDS. SEC Rule 135 permits the issuer to give notice of the intent, in the form of a press release or a public statement, to make a public offering by means of a prospectus registered with the SEC.

The information able to be contained in the press release in the United States is limited to the name of the issuer, the title, the amount and basic terms of the securities to be offered, if any, to be made by selling securities holders, the anticipated time of the offering and brief statement of the matter and purpose of the offering without naming the underwriters. The information on the press release under the Proposal is not as comprehensive as that which may be included under SEC Rule 135.

The Competitive Impact of the Proposal

The Proposal enhances competition for equity underwritings. The requirement to file a press release in advance of the actual commitment to terms alerts all underwriters of a forthcoming offering following the six hour delay period. This public notice provides the opportunity for outside dealers to submit competing bids directly to the issuer or seek access to the underwriting syndicate, by offering added-value services such as specific placing power. The Proposal is also sufficiently flexible to permit the issuer to release a press statement which announces the intention to raise equity capital without making reference to a specific underwriter. The press statement functions as an invitation to underwriters to bid and thereby creates an open and competitive auction situation for the subsequent underwriting.

Solicitations of Expressions of Investor Interest

Provincial securities commission provided a Blanket Ruling in 1986 which permits underwriters to solicit
expressions of interest for a 48 hour period prior to filing the preliminary prospectus on condition that a binding underwriting agreement has been entered into. The Proposal envisions that solicitations of expressions of interest would begin once a press release on the forthcoming offering has been filed. To accomodate the Proposal, the Blanket Ruling should be amended to permit solicitations to begin once the press release is filed, even though a binding underwriting commitment has not yet been signed. Further, the Proposal envisions that solicitations of investor interest should continue throughout the period from issuance of the press release to the filing of the preliminary prospectus, even if the prospectus filing occurs after the 48 hour period has elapsed. There should be no objections to a more flexible approach to solicitations since, under the Proposal, a public announcement must precede every equity offering.

Information which one would reasonably expect to be conveyed in the solicitations could include all publicly available data, including the public disclosure record of the issuer and any relevant public market statistics, as well as information contained in the press release. Dealers would also be permitted to discuss possible prices and issue sizes based on the knowledge of the issuer, its requirements and the market tone. This practice would be no different than discussions which now take place in the context of a short form and long form prospectus offering.

Premarketing

The premarketing restrictions in the Proposal apply to proposed prospectus offerings of participating equity securities under the POP System. These restrictions would not apply in the case of private placements pursuant to the existing prospectus exemptions in provincial securities regulations.

Anti-Avoidance

Underwriters would not be permitted to circumvent the Proposal through various types of financial engineering. For example, the Proposal would permit POP issuers to offer special warrant financings for equity securities. The ability to issue a private placement of special warrants would enable the issuer to obtain immediate access to priced capital through a private placement financing, without being subject to the six hour delay period mandated for public offerings. Long form prospectus issuers would still be permitted to offer special warrant private placements. The merits of special warrant financings for small issuers are currently under review by the Corporate Finance Committee.

Regulatory Framework

The regulatory framework for the Proposal is an important consideration. The Proposal must apply to all securities firms engaged in the domestic underwriting of equity securities to ensure the benefits of the Proposal are achieved and a level playing field exists for all participants. Appropriate amendment to SRO (Self-Regulatory Organization) by-laws and regulations would not be sufficient to the extent registration categories exist outside the SRO system which permit the underwriting of public offerings of equity securities. The optimal approach would be to embody the Proposal in Provincial statutes through appropriate legislative and regulatory amendment. These regulations would be adopted by those provincial securities commissions which are principal jurisdictions for POP issuers, notably British Columbia, Alberta, Ontario and Quebec, or, alternatively, incorporated into national policy by the Canadian Securities Administrators.


Appendix of Specific Terms and Conditions

As used in this Proposal, unless the context otherwise requires:

a) "Business Hours" means the hours falling between one hour before the opening of trading of the Canadian stock exchanges, i.e. 8:30 a.m. EST, and one and one-half hours after closing for trading of the exchanges (other than the Vancouver Stock Exchange), ie. 5:30 p.m. EST on a day on which any of the stock exchanges is open for trading (a "business day").

b) "Delay Period" means a period of six Business Hours and, for purposes of determining the commencement and conclusion of the Delay Period, the following rule shall apply:

(i) The time of issue of the press release as noted thereon by the news wire service which issued it, rounded forward to the nearest hour or half-hour, shall be the starting time of the Delay Period.

(ii) The period of time from the end of Business Hours on one business day to the commencement of Business Hours on the next business day (the "Overnight Period") shall be deemed to constitute a period of five Business Hours.

(iii) Any press release issued during the Overnight Period shall be deemed to have been issued at the commencement of the first Business Hour thereafter and the Delay Period shall commence at such time.

c) "Exchanges" means, collectively, the Alberta Stock Exchange, the Montreal Exchange, The Toronto Stock Exchange and the Vancouver Stock Exchange and "Exchange" means any one of them.

d) Pre-marketing" means the imparting of information on an issuer's or Selling Security Holder's intentions in relation to an issue or sale of Equity Securities or securities convertible into Equity Securities which has not been publicly disclosed for the purpose of obtaining an indication from the person to whom information is so disclosed of that person's interest (or the interest of any firm, corporation or other body whom he may represent) in purchasing such Equity Securities or securities convertible into Equity Securities pursuant to a distribution thereof.

e) "securities convertible into Equity Securities" means:

(i) a security shall be deemed to be convertible into a security of another class, if, whether or not on conditions, it is or may be convertible into or exchangeable for, or if it carries the right or obligation to acquire, a security of the other class, whether of the same or another issuer; and

(ii) a security that is convertible into a security of another class shall be deemed to be convertible into a security or securities of each class into which the second-mentioned security may be converted either directly or through securities of one or more other classes of securities that are themselves convertible.

f) Other capitalized terms used herein and not otherwise defined shall have the meanings set out in National Policy Statement 47.

2) Filing of Underwriting Agreements and Press Releases

A receipt for a preliminary short form prospectus and/or final short form prospectus in respect of an issue or sale of Equity Securities or securities convertible into Equity Securities would not be issued unless the procedures set out in Section 3 have been adhered to. For this purpose, the following document, if in existence, must be filed by the underwriter at the time of filing a preliminary short form prospectus:

(i) a copy of any underwriting agreement entered into at or prior to the time of filing and

(ii) if an agreement has been filed pursuant to subparagraph (i), a copy of any press release in respect of the issue or sale which were released pursuant to Sections 3(a) and 3(d), showing the time and date of release,

and the following documents must be filed at the time of filing short form prospectus:

(iii) the underwriting agreement, if not previously filed, and

(iv) a copy of any press release in respect of the issue or sale, if not previously filed, showing the time and date of release.

3) Defined Procedures for Underwriters

(a) No issuer, Selling Security Holder or underwriter shall enter into an underwriting agreement pursuant to which Equity Securities or convertible into Equity Securities are to be distributed pursuant to the POP System by an underwriter acting as principal until the Delay Period has expired after the earlier of the filing of the preliminary short form prospectus or the issuance of a press release announcing the transaction.

(b) The press release referred to in paragraph (a) shall iclude:

(i) the name of the issuer and, if applicable, Selling Security Holder,

(ii) the class of the securities to be issued or sold,

(iii) the name of the underwriter(s), if already determined, and

(iv) the date on which the preliminary was filed or is expected to be filed.

Additional information may, but need not, be included.

(c) After the earlier of the time of the issuance of the press release referred to in paragraph (a) and the filing of the preliminary short form prospectus, any underwriter or prospective underwriter may solicit expressions of interest from the public to purchase the securities to which the press release relates. The obligation to provide a short form preliminary prospectus shall be to have been fulfilled if each underwriter who subsequently enters into the underwriting agreement in respect of any of the securities referred to in the press release forwards a copy of the preliminary short form prospectus once a receipt therefor has been obtained to any person who has expressed an interest in acquiring any of such securities from such underwriting.

(d) Each Underwriting Agreement shall require that, forthwith after entering into an underwriting agreement following expiry of the Delay Period, the issuer or Selling Security Holder shall, unless such information has been previously disclosed, issue a press release disclosing the details as to price and number of securities to be sold and stating that the securities will be offered by way of prospectus.
4) Premarketing

Underwriters shall not engage in Premarketing in respect of Equity Securities or securities convertible into Equity Securities to be offered by way of prospectus.

5) Anti-Avoidance

Receipts for a preliminary short form prospectus or short form prosepctus could not be issued by provincial securities commissions if the comissions had grounds to believe that an underwriting agreement has been entered into in contravention of this Proposal. In particular, receipts will not be issued for prospectuses in relation to special warrant offerings of Equity Securities or securities convertible into Equity Securities of issuer within the POP System.