BCN 2004/11 - Insider reporting requirements for equity monetization transactions [BCN - Rescinded]

The government has, by regulation, brought into force effective February 28, 2004, amendments to the insider reporting requirements and insider trading prohibition in the Securities Act and to related provisions of the Securities Rules.

We developed these amendments to respond to concerns that some insider reports filed under current requirements might not accurately disclose the insiders’ economic interests in the securities reported. Specifically, we understand that some insiders have interpreted the existing insider reporting requirements not to require disclosure of some types of derivative-based transactions (including “equity monetization transactions”) through which the insiders can effectively dispose of their economic interest in and exposure to securities that they legally own. If this interpretation is correct, these transactions could undermine the effectiveness of our insider reporting requirements and prohibitions on insider trading.

The amendments to the Act and Rules will now clearly require the reporting of these transactions. Other jurisdictions in Canada will be adopting Multilateral Instrument 55-103 Insider Reporting for Certain Derivative Transactions (Equity Monetization) (MI 55-103) to address these same transactions. You can find this instrument at http://www.osc.gov.on.ca/en/Regulation/Rulemaking/Rules/rule_20031128_55-103_pro-rule.htm (link no longer operational).

What are equity monetization transactions?
Equity monetization transactions allow an investor to receive a cash amount similar to the proceeds they could get from disposition of a security, and to transfer part or all of the economic risk or return associated with the securities, without actually transferring the legal and beneficial ownership of the securities. We understand that these transactions are often used to reduce tax liability or for other legitimate purposes, but they can threaten the integrity of the market and regulatory system in two ways:

• If an insider has reported a legal interest in securities and does not disclose that he or she has disposed of the economic interest, the insider reporting record would fail to disclose that trading activity by the insider and could mislead investors about the insider’s real interest in the securities.
• A person in a special relationship with a reporting issuer who has material undisclosed information might be able to improperly profit from the information by entering into derivative-based transactions to acquire or dispose of an economic interest in the issuer’s securities while avoiding liability for illegal insider trading.

Effect of Act amendments
The Act amendments require that an insider who enters into a transaction involving a “related financial instrument” (a newly defined term) is subject to insider reporting requirements and that a person in a special relationship with a reporting issuer must not enter into a transaction involving a related financial instrument with knowledge of undisclosed material facts or material changes.

A transitional requirement in section 87.1 of the Act requires insiders to report by March 9, 2004 any existing monetization transactions that have not already been reported. (MI 55-103 includes a similar requirement.)

The definition of related financial instrument is quite broad and would catch instruments and agreements that, for policy reasons, should not give rise to insider reporting requirements. To exclude these things, the Commission is adopting BC Instrument 55-506 Exemption from insider reporting requirements for certain derivative transactions, which provides a number of exemptions. The exemptions include:

• an agreement that does not involve an interest in a security of the reporting issuer or a derivative based on a security of the reporting issuer
• a compensation agreement, provided certain conditions are met
• a pledge of securities as collateral for an unlimited recourse loan
• securities received by an insider if they were pledged as collateral for a debt to the insider in the ordinary course of business of the insider
• credit derivatives
• mutual fund or non-redeemable investment fund securities, subject to certain conditions
• indirect acquisitions or dispositions, if certain conditions are met.

These exemptions are similar to the exemptions set out in section 2.2 of MI 55-103. We expect that insiders will report their equity monetization transactions the same way in all CSA jurisdictions.

Sections of the Act affected
Sections 5, 7, 8, 9 and 13(c) of the Securities Amendment Act, 2003 will come into force by regulation on February 28, 2004. These amendments affect the following sections:

Section Heading Change
84.1  Definition added
86(1)  Trading or informing where undisclosed change  amended
87 Insider reports  amended
87.1 Temporary insider filing requirement  added
155 Offences generally  amended

Consequential amendments
Consequential amendments have also been made to sections 155 Interpretation and 155.1 Prescribed time periods for filing insider reports of the Securities Rules to correct section references and to specify the date for filing the transitional report required under section 87.1 of the Act.

Related CSA Staff Notice
We are publishing with this notice a CSA staff notice containing examples of various types of monetization arrangements, together with staff recommendations about how to report these arrangements under the System for Electronic Disclosure by Insiders (SEDI).

Questions
You may refer questions to:

Denise Duifhuis
Senior Legal Counsel
Legal and Market Initiatives
British Columbia Securities Commission
(604) 899-6792
(800) 373-6393 (in B.C. and Alberta)
dduifhuis@bcsc.bc.ca

February 25, 2004

Douglas M. Hyndman
Chair

Ref:  BC Instrument 55-506
CSA Staff Notice 55-312

This Notice may refer to other documents. These documents can be found at the B.C. Securities Commission public website at www.bcsc.bc.ca in the Commission Documents database or the Historical Documents database.