NIN 96/06 - Supplementary Report of the Committee on Underwriting Conflicts of Interest to the CSA Chairs [NIN - Rescinded]
| Published Date: | 1996-01-26 |
|---|---|
| Effective Date: | 1996-01-24 |
The Committee Report and Dissent Report were published by the Ontario Securities Commission [(1995) 18 OSCB 3157 and 3195] and a limited number of copies were made available for pick up, upon request, at the British Columbia Securities Commission (the "Commission"). The public was invited to make comments on the recommendations made by the Committee members. The CSA received several comment letters from the public and two responses containing alternative regulatory models from the Commission and the Commission des valeurs mobilières du Québec. The CSA asked the Committee to review its recommendations in light of these responses.
The report of the Committee discussions containing some amended recommendations (the "Supplementary Report") is attached to this Notice. The Supplementary Report has the support of all Committee members, save one. The Committee member representing the Canadian non-bank-owned dealers maintains his dissent. The Committee Report, Dissent Report and Supplementary Report also have been forwarded to the individual securities regulatory authorities comprising the CSA for review, with the aim of developing a nationally-harmonized regulatory regime that would then be published for comment.
Questions may be directed to:
| Tanis MacLaren Ontario Securities Commission Phone: (416) 593-8259 Fax: (416) 593-8283 | Joëlle Saint-Arnault Commission des valeurs mobilières du Québec Phone: (514) 873-5009 ext.237 Fax: (514) 873-4130 |
DATED at Vancouver, British Columbia, on January 24, 1996.
Douglas M. Hyndman
Chair
REFERENCE: NIN#94/24
NIN#95/26
NIN#95/34
Attachment
SUPPLEMENTARY REPORT OF THE CSA COMMITTEE ON UNDERWRITING CONFLICTS OF INTEREST
TO THE CSA CHAIRS
The Committee was established by the Canadian Securities Administrators to review and advise on the regulatory provisions in place in Alberta, British Columbia, Nova Scotia, Ontario and Quebec governing certain conflicts of interest in the underwriting process. In June, 1995, the Committee delivered two reports to the CSA Chairs. One report contained the recommendations made by the majority of the Committee for changes to the underwriting conflict regime (the "Committee Report"). The second report contained the dissenting views of the Committee member representing the Canadian non-bank-owned dealers (the "Dissent Report").
The Reports were published and the public was invited to make comments on the recommendations made by the Committee members. The Quebec Securities Commission ("QSC") concurrently asked the public to respond to five questions which focused on whether the Committee recommendations would adversely effect investors by reducing competition or by lessening the duties owed by underwriters to investors or the ability of investors to sue dealers arising out of their participation in a distribution.
The CSA received several comment letters from the public. All of these responses, except the one delivered to the QSC by the Canadian non-bank-owned dealers, generally were supportive of the Committee's recommendations. Three of the letters made specific suggestions for additional exemptions that the respondents thought the Committee should have incorporated in its proposed regime. If these suggestions were adopted, the ambit of the amended conflict regime would be reduced substantially. Those respondents who commented on the questions asked by the QSC were of the view that the Committee recommendations would not negatively affect the investing public.
At the last CSA meeting, the British Columbia Securities Commission ("BCSC") delivered a draft paper commenting on the Committee and Dissent Reports and making alternative recommendations for changes to the conflict of interest regime. The QSC also indicated that it wanted more time to review the Reports and might want to propose an alternate structure. As a result of the discussions at the CSA, the Committee was asked to review its recommendations in light of the public comments received, the alternative model proposed by the BCSC and any structure that might be proposed by the QSC.
The Committee met on December 20, 1995. The members reviewed the suggestions made by the public for changes to the regime proposed in the Committee Report. Douglas Hyndman reviewed the BCSC recommendations with the Committee. Guy Lemoine presented a summary of a paper prepared by the QSC.
British Columbia Securities Commission Alternative Model
The BCSC proposed that the underwriting conflict of interest regime be amended as follows:
a. the related party/issuer definition recommended in the Committee Report would be adopted;
b. the connected party definition currently included in the BC conflict regime would be left unamended and the disclosure requirements resulting from this relationship would stay the same;
c. certain complete exemptions from the requirement to have an independent underwriter involved in a distribution of the securities of a connected issuer (or selling securityholder) would be added to the legislation;
d. an exemption would apply where the issuer (or selling securityholder) is not a related issuer of the dealer and:
1. the issuer (or selling securityholder) is not in financial difficulty; or
2. the connected issuer relationship arises because there is a debt relationship between the registrant (or one of its related issuers) and the issuer (or selling securityholder), but the total amount of the debt owed represents a de minimus amount compared to the total capital of the issuer; or
3. the relationship arises out of cross-ownership of preferred shares, but the preferred share position represents a de minimus portion of the total capital of the issuer;
e. alternatively, the registrant could apply for and be granted an exemption order from the Executive Director of the Commission;
f. the "financial difficulty" test proposed by the Committee would be adopted, subject to some modifications; the term used for the test should be a more neutral one.
Three alternative ways to deal with the minimum participation of the independent underwriter(s) were suggested.
i. No change would be made to the existing requirement; the aggregate positions underwritten by the non-independent underwriters would have to be matched by the aggregate position of the independents and the largest position of a non-independent must be matched by that of a single independent (the "50/50 rule").
ii. A dollar value cap could be placed on the minimum participation of the independents in large distributions; for example, the independents would have to underwrite the lesser of:
the minimum dictated by the 50/50 rule; and
the aggregate underwritten by all independents must be at least $50 million with one independent underwriting at least $25 million.
iii. The portion underwritten by the independent could be reduced and new rules could be introduced regarding the obligations of the independent and non-independent underwriters.
Quebec Securities Commission Alternative Model
The QSC proposed that the underwriting conflict of interest regime be amended as follows:
a. the related issuer definition recommended in the Committee Report would be adopted;
b. the connected issuer definition currently included in the Quebec conflict regime would be left unamended;
c. the required disclosure in the prospectus of a connected issuer would be increased to include:
1. specific identification of the non-independent underwriter;
2. the nature of the relevant relationship between the issuer and registrant;
3. the percentage of the debt to be repaid to the non-independent underwriter and its related issuers; and
4. the related or connected underwriter would have to certify that the relationship giving rise to the potential conflict of interest did not, in fact, affect the dealer's judgement regarding the structure and pricing of the transaction;
d. the Regulation to the Securities Act (Quebec) be amended to adopt the 50/50 rule for most transactions; and
e. where an issuer qualified under the POP system and was in good financial condition, the minimum participation of the independent underwriters could be reduced to one dealer underwriting the lesser of the largest position underwritten by a non-independent dealer and 20% of the distribution; this reduction would be included in the regulation and not require separate case-by-case applications.
Mr. Lemoine also suggested that there may be situations where a relaxation of the 50/50 rule might be justified for an issuer which had borrowing relationships with a large syndicate of financial institutions.
Summary of Committee Conclusions
The Committee discussed the alternatives proposed in some detail and reviewed a number of points that had been discussed during the course of the previous Committee deliberations.
The Committee rejected the suggestions for modifications to its recommendations made by the various public commentators on the basis that most of the amendments proposed by these commentators would have narrowed the application of the conflict of interest regime to a degree that the Committee found to be unacceptable.
The Committee members repeated their belief that it was crucial that any amendments to the conflict regime be made on a uniform basis across the country. In the interests of achieving that unanimity, the Committee members were willing to modify the recommendations contained in the Committee Report.
The Committee agreed with the observation of the BCSC that it would be better if the concept of "financial difficulty" could be described by a less negative term. The determination of an acceptable alternative term and the details of the test should be determined by discussions at the CSA involving the appropriate accounting and other personnel. The test should not consist of several pages of criteria.
In order to enhance the possibility of achieving a national consensus, the Committee was willing to agree with continuing to use the existing form of definition of "connected issuer". However, this support was subject to the caveat that the reformulated regime must include significant exemptions from the requirement to involve an independent underwriter in transactions where there were few concerns, such as where the issuer was not in financial difficulty or the relationship was not material compared to the size of the issuer. Merely reducing the requisite percentage participation of the independent in these circumstances was viewed as not being sufficient.
Also, if the current definition of connected issuer is to remain, then the existing BCSC provision regarding when a relationship is material to a prospective purchaser should be adopted across the country. The existence of a connected issuer relationship would turn only on whether the relationship would cause a reasonable prospective purchaser to question the independence of the issuer and the registrant. The current Ontario and Quebec provisions should be modified to delete the portion of the provision that refers to "a likelihood that a reasonable prospective purchaser would consider the indebtedness or other relationship important under the circumstances in determining whether to purchase the securities".
The Committee recognized that a regime that automatically exempted distributions by financially secure connected issuers from the requirement for independent underwriter participation might not be appropriate where the distribution by a related or connected issuer was the issuer's initial public offering ("IPO") of securities. None of the Reports, alternative proposals or public commentators made any recommendations regarding the conflict regime that should apply in these circumstances. The Committee members felt that the conflict rules may need to be modified to address the particular concerns that might arise on IPOs, but made no specific suggestions regarding what modifications would be appropriate. The CSA should consider this issue further.
In those distributions where an independent underwriter is involved, all but one of the Committee members rejected the continuation of the 50/50 rule. In particular, only Mr. Rahilly felt that continuing to require the aggregate of the transaction underwritten by the independent dealers to equal that of the non-independents served any regulatory purpose. The majority were of the view that the 50/50 rule produced unnecessary distortions in the formation of underwriting syndicates.
The Committee was unanimous in its view that the minimum required participation of the independent dealers on a transaction should be determined as a percentage of the transaction underwritten, not with reference to a dollar value amount. This minimum participation should be by one underwriter, rather than spread among several underwriters.
The Committee members were also unanimous in viewing a 20% participation by one independent underwriter as providing sufficient status and risk to the independent to ensure that the appropriate tasks were undertaken. Mr. Rahilly did not agree with the Committee's overall recommendations with respect to the conflict rules. But, from a personal perspective, agreed that, if the Committee structure were adopted, 20% of a transaction would be a large enough position to ensure the independent fulfilled the requisite role in the distribution.
Amended Recommendations
The Committee's recommendations to the CSA, as modified by their review of the comments received from the public, the BCSC and the QSC, are as follows.
1. The related issuer definition of the existing provisions would be modified so that an issuer would be a related issuer of another entity if there were direct or indirect cross ownership of more than 20% of the voting or equity shares of the other or cross ownership of more than 10% of the voting or equity shares and one can nominate more than 20% of the board of directors of the other.
2. An issuer would be a connected issuer of a registrant if the relationship between the issuer (or selling securityholder) and the registrant (or between any of their respective related issuers) would cause a reasonable prospective purchaser to question the independence of the registrant and the issuer (or selling securityholder). The part of the existing Quebec and Ontario provisions that deem parties to be connected where there is "a likelihood that a reasonable prospective purchaser would consider the indebtedness or other relationship important under the circumstances in determining whether to purchase the securities" should be deleted.
3. Where a related issuer or connected issuer relationship exists, the prospectus or other disclosure document must contain the appropriate disclosure of the nature and details of the relationship.
4. An independent underwriter would be required in all public distributions of securities by a related issuer where a non-independent underwriter is part of the syndicate.
5. An independent underwriter would be required in all public distributions of securities by a connected issuer (or selling securityholder) where a non-independent underwriter is part of the syndicate unless:
a. the issuer (or selling securityholder) is not in financial difficulty; or
b. the relationship between the registrant and the issuer (or selling securityholder) arises out of a debt relationship or cross ownership of preferred shares and the total amount of debt owed or value of preferred shares owned is less than 10% of the value of the issuer's equity; or
c. an exemption was granted by senior regulatory staff (Director, Executive Director or the like).
6. Where the participation of an independent underwriter is required, the independent underwriter must be identified as such in the prospectus and must disclose the role played by the independent in the structuring and pricing of the distribution and in the due diligence activities undertaken by the underwriters. The minimum participation of one independent underwriter would be the lesser of:
a. 20% of the dollar value of the distribution; and
b. the largest position underwritten by a non-independent dealer.
Mr. Rahilly continues to dissent from the Committee recommendations.