NIN 87/52 - Flow-Through Shares [NIN - Rescinded]

With the introduction of the "closed system" under the new Securities Act S.B.C. 1985, c.83 the Commission has received numerous inquiries as to the treatment of flow-through shares. The questions asked most frequently are

1. What is the route through the "closed system" followed by shares acquired by a limited partnership and ultimately either distributed to the limited partners or "rolled over" into a mutual fund or similar entity.

2. When does the hold period commence for flow-through shares.

3. When, and how many times, should a Form 20 be filed by an issuer of flow-through shares.

4. What is the Commission's position with respect to issuers of flow-through shares who are not reporting issuers under the Securities Act.

1. Limited Partnerships

It is accepted that in most every case limited partnerships acquire flow-through shares from issuers pursuant to the "$97,000 exemption" section contained in Section 55(2)(4) of the Act. With respect to securities acquired from non-exchange issuers these flow-through shares may then be transferred to a mutual fund, again pursuant to the exemption under Section 55(2)(4) of the Act, thus avoiding the resale restrictions otherwise applicable under Section 125(3) of the Securities Regulation, including the 12 month hold period.

However, in respect of securities acquired from exchange issuers, it is proposed to amend the Securities Regulation to require purchasers to sign an undertaking agreeing to hold securities acquired pursuant to the "private placement" exemptions, including Section 55(2)(4) of the Act, unconditionally for 12 months. The Commission takes the position that it is appropriate in these circumstances for the limited partnership to undertake to hold the securities for the period up to the date of transfer to the mutual fund or other similar entity, as disclosed in the limited partnership's offering material, and for the mutual fund to undertake to hold the securities for the remainder of the twelve month hold period. This will enable the transfer to take place without the limited partnership requiring an order or waiver of its undertaking.

In either case, whether the securities are those of an exchange issuer or a non-exchange issuer, they may then be traded by the mutual fund at the end of the applicable hold period in accordance with the appropriate resale rules.

On the other side of the transaction, the securities of the mutual fund which are exchanged for the flow-through shares are issued to the limited partnership pursuant to the "shares for assets" exemption contained in Section 55(2)(5) of the Act. These shares may then be distributed to the limited partners pursuant to the "winding up" exemption contained in Section 55(2)(11)(ii) of the Act.

Similarly, this last exemption may be used where there is no mutual fund or similar entity involved. In such cases, the limited partnership simply dissolves and distributes the flow-through shares directly to its limited partners.

2. The Hold Period

For the purpose of dealing with flow-through shares only, the Commission, like several other securities commissions across Canada, is treating the agreement to subscribe for flow-through shares as a security. This agreement is considered to be a right entitling the holder to acquire flow-through securities as the qualifying resource expenditures are incurred. Accordingly, the single hold period for these flow-through securities commences from the date the funds for same are irrevocably committed. When this occurs is a question of fact. A commitment letter would not be sufficient to trigger commencement of the hold period, but an agreement in writing committing the purchaser to pay for flow-through shares subject to regulatory approval of the agreement would suffice. In situations where the agreement is subject to the ability of a limited partnership to raise public money in an amount sufficient to fully fund its commitment, the closing of the partnership's public offering would normally be required in order to trigger the commencement of hold periods in respect of flow-through shares subscribed for under agreements entered into prior to the partnership having funds available. In the event that this interpretation conflicts with that of other jurisdictions in cases of national limited partnership offerings, the Commission will entertain submissions as to the appropriate date for the commencement of the hold period.

As discussed in NIN#87/21 dated March 13, 1987 proposed amendments to the Securities Regulation and the Exchange Issuer First Trades Regulation will clarify matters by setting out that the resale restrictions attaching to securities acquired upon the exercise of a right will be identical to those imposed upon the right itself. Further the amendments will provide that hold periods applicable to these "converted securities" will run from the date the right was acquired. Thus it is intended that there be only one hold period in respect of flow-through shares, regardless of when the shares are actually issued.

In the interim, should concerns arise on the issue of hold periods as a result of the above position and the effect of Section 124(3) and (4) of the Securities Regulation, which deal with the first trade of "converted" securities, discretionary orders pursuant to Section 59 of the Act may be granted where appropriate.

3. Form 20

As set out above, the Commission will treat the agreement to subscribe for flow-through shares as a security. It is in respect of this security that the Form 20 must be filed pursuant to Section 55(2)(4) of the Act. The form should be filed within 10 days of the occurrence of the event which triggered the hold period, as discussed in the previous section. Further, in completing the form the "amount or number of securities purchased" should be an "up to" number indicating the maximum number of securities which could be acquired from the issuer pursuant to the subscription agreement.

In some instances, the price at which flow-through shares are issued is not a fixed amount but is determined by reference to a formula. In those cases, the formula should be appended and the appropriate reference to this fact made in that part of Form 20 which refers to the issue price of the security.

4. Non-Reporting Issuers

Another issue which has arisen in dealing with flow-through shares is the problem of the first trade of securities acquired by a person in British Columbia from an issuer which is not a reporting issuer in British Columbia. This problem is not unique to the flow-through share situation and the position set out herein is of general application.

Where an issuer is a reporting issuer in another jurisdiction and has its securities listed and posted for trading on an exchange outside of British Columbia, an order may issue pursuant to Section 59 allowing the first trade of those securities. This order would require that the securities be traded on the appropriate exchange and that the shareholders resident in British Columbia be provided with all information provided to shareholders in the jurisdiction where the issuer is reporting. In exercising his discretion in this regard the Superintendent will need to be satisfied that it is not appropriate to require the issuer to become a reporting issuer in British Columbia. In reaching this conclusion the Superintendent will consider the nature of the transaction, particularly whether this is an isolated issuance of securities in British Columbia or is, or can reasonably expected to become, an ongoing practice of the issuer.

The above sets out the position of the Commission on the most frequently raised concerns respecting flow-through shares. It is accepted that other concerns may exist and that schemes involving flow-through shares may not fit exactly into the transactions described in above. In these circumstances it is requested that questions be directed in writing to the Superintendent setting out the nature of the transaction, the perceived problems and the recommendation as to how the matter can be properly dealt with, both in the specific instance and as a matter of general application.

As a result of this notice it is anticipated that most transactions involving flow-through shares will be covered by exemptions available under the Securities Act. As indicated above, where appropriate the Superintendent will issue orders pursuant to Sections 33 and/or 59 of the Act. These orders will only be given where necessary and will not be given solely to provide comfort to the issuer. It is therefor suggested that prior to making application to the Superintendent, the applicant be satisfied that no applicable exemption exists.

DATED at Vancouver, British Columbia, this 24th day of July, 1987.