NIN 98/06 - Proposed Multi-Jurisdictional Instrument 33-105 and Companion Policy 33-105CP Underwriting Conflicts [NIN - Rescinded]

The Commission, together with the other members of the Canadian Securities Administrators ("CSA") other than Quebec, is publishing for comment the text of proposed Multi-Jurisdictional Instrument 33-105 and Companion Policy 33-105CP. The Multi-Jurisdictional Instrument and Companion Policy contain footnotes that are not part of the proposed Multi-Jurisdictional Instrument or Companion Policy, as applicable, but which have been included to provide background and explanation.

The proposed Multi-Jurisdictional Instrument and Companion Policy are initiatives of the CSA. The proposed Multi-Jurisdictional Instrument is expected to be adopted as a rule in each of British Columbia, Alberta, Ontario and Nova Scotia, as a Commission regulation in Saskatchewan and as a policy in the remaining jurisdictions of the CSA, other than Quebec. The proposed Companion Policy is expected to be implemented as a policy in all of the jurisdictions represented by the CSA, other than Quebec.

The proposed Multi-Jurisdictional Instrument and Companion Policy are not being proposed for adoption at this time by the Commission des valeurs mobilières du Québec (the "Quebec Commission").

Because this Instrument is not, at this time, being proposed for adoption in all of the jurisdictions of the CSA, it is called a Multi-Jurisdictional Instrument rather than a National Instrument. However, as this Instrument is being adopted in a number of jurisdictions, it is numbered as a National Instrument. National Instrument 14-101 Definitions will be amended to apply to both National Instruments and Multi-Jurisdictional Instruments.

Background

Existing Legislation and Blanket Orders

In 1987, the barriers to non-industry ownership and foreign participation in Canadian securities markets were removed. A number of the provincial governments anticipated that this would result in some registrants being controlled by foreign or domestic financial institutions or by other companies not wholly-owned by industry participants. Since 1987, each of Alberta, British Columbia, Ontario, Newfoundland and Nova Scotia have adopted conflict of interest regimes. The applicable conflict of interest regime in British Columbia is set out in Division 11 of Part 5 of the Securities Rules (B.C.) (the "B.C. conflicts regime"). In this Notice, the B.C. conflicts regime and the other provincial conflict of interest regimes are generally referred to as "the existing conflict regime".

The existing conflict regime

(a) establishes tests to determine which persons or companies are non-arm's length parties in relation to a registrant, both for purposes of distributions and in connection with general trading and advising activities,

(b) sets out general duties of registrants to their clients,

(c) requires registrants to disclose policies regarding transactions with non-arm's length parties, and

(d) prohibits securities transactions, whether underwriting, advising or trading, with or for clients involving securities of non-arm's length parties of the registrant unless specified conditions are met.

The specified conditions referred to in paragraph (d) above, contained in the B.C. conflicts regime (particularly, section 78 of the Securities Rules (B.C.)), include the disclosure requirements and independent underwriter requirements that are the predecessors to the proposed Multi-Jurisdictional Instrument.

In 1992 the Commission, as well as the Ontario Securities Commission and certain other provincial commissions, published blanket orders (in B.C., BOR#92/9) that liberalized the requirements relating to the portion of the distribution that had to be purchased by an independent underwriter.

CSA Review of Conflict Issues

In 1994, the CSA established a committee (the "CSA Underwriting Committee") to assist in the formulation of recommendations regarding underwriting conflicts of interest. The Committee was made up of CSA appointees and senior representatives from various market participant groups, namely dealers, issuers and institutional investors.

In June 1995, the CSA Underwriting Committee delivered two reports to the CSA Chairs. One report contained the recommendations made by the majority for changes to the underwriting conflict regime (the "Committee Report"). The second report contained the dissenting views of the member representing the Canadian non-bank owned dealers (the "Dissent Report").

The Reports were published in Ontario on July 7, 1995 and made available for pick-up at the Commission (see NIN#95/26). The public was invited to make comments on the recommendations made by the CSA Underwriting Committee members. The CSA then asked the CSA Underwriting Committee to review its recommendations in light of the comments received. Except for two substantive changes suggested by the Commission, the balance of the CSA Underwriting Committee's recommendations to the CSA remained unchanged in its Supplementary Report (see NIN#96/6).

The Multi-Jurisdictional Instrument reflects the ultimate recommendations set out in the Committee Report as revised by the Supplementary Report.

Joint Securities Industry Committee Review of Conflict Issues

The five Canadian self-regulatory organizations in Canada, the Investment Dealers Association of Canada, and the Montreal, Toronto, Alberta and Vancouver Stock Exchanges, announced in October 1996 the formation of the Joint Securities Industry Committee on Conflicts of Interest (the "Joint Committee").

The Joint Committee delivered its interim report in February 1997 (see NIN#97/12) and its final report in September 1997 (see NR#97/29). In addition to dealing with a substantial number of issues relating to conflicts that are outside the scope of the proposed Multi-Jurisdictional Instrument, the final report recommended that the conflict of interest rules relating to underwritings be applicable to holdings by a "professional group" of 20 percent or more of an issuer. This recommendation has been accepted and is included in the proposed Multi-Jurisdictional Instrument.

Substance and Purpose of Proposed Multi-Jurisdictional Instrument

The proposed Multi-Jurisdictional Instrument imposes appropriate regulatory requirements on distributions of securities in which the relationship between the issuer or selling securityholder of the securities and the registrant acting as underwriter raises the possibility that the registrant will be in an actual or perceived position of conflict between its own interests or those of the issuer or selling securityholder, and those of investors. The proposed Multi-Jurisdictional Instrument imposes certain disclosure requirements on these transactions and, in some cases, the requirement that an independent underwriter participate in the distribution.

The proposed Companion Policy, which includes four flow charts as appendices, provides guidance in interpreting the proposed Multi-Jurisdictional Instrument and in determining its applicability to a distribution.

Terms used in the proposed Companion Policy that are defined or interpreted in the proposed Multi-Jurisdictional Instrument or a definition instrument in force in the jurisdiction should be read in accordance with the proposed Multi-Jurisdictional Instrument or definition instrument, unless the context otherwise requires.

Summary of Proposed Multi-Jurisdictional Instrument

The proposed Multi-Jurisdictional Instrument applies to a direct underwriter that is distributing securities of an issuer that is a related issuer or connected issuer of the underwriter, except where the securities are exempt securities under section 46 of the Securities Act (B.C.) or mutual fund securities.

Some of the key aspects of the proposed Multi-Jurisdictional Instrument are as follows:

• "connected issuer". The definition of "connected issuer" is based on the current definition of connected party set out in the present B.C. conflicts regime. The test is whether in the circumstances the relationship between the issuer and the registrant, or any of their respective related issuers, might in the view of a reasonable prospective purchaser affect their independence from one another. In this regard it should be noted that not only debtor/creditor relationships may form the basis of a connected issuer relationship. Other forms of business relationships, described in the Companion Policy, may also give rise to a connected issuer relationship. The definition of "connected issuer" includes a "related issuer".

• "influential securityholder". A person or, in some cases, a professional group, is an influential securityholder of an issuer if the person owns more than 20 percent of the voting or equity securities of the issuer, or if there is cross-ownership of 10 percent of the voting or equity securities combined with 20 percent cross-directorships or the right to nominate 20 percent of the other's directors.

• "related issuer". A person is a related issuer of another person if one is an influential securityholder of the other, or if each is a related issuer of a third person.

• Where an underwriter of a securities offering and the issuer are related or connected, the proposed Multi-Jurisdictional Instrument, like the existing rule, requires disclosure in the prospectus or other offering document as to the nature of the relationship between the issuer and the underwriter and how they are connected or related. The required disclosure is set out more explicitly in the proposed rule (see Appendix C to the proposed rule in this regard) than under the current Securities Rules (B.C.).

• The proposed Multi-Jurisdictional Instrument, like the existing rule, requires an independent underwriter to participate in the distribution of securities under a prospectus whenever the issuer and the underwriter are related.

• When the issuer and the underwriter are connected but not related, the proposed Multi-Jurisdictional Instrument requires an independent underwriter to participate in the distribution only where the connected issuer is a "specified party". In essence, a "specified party" is an issuer for which there are indicia of a decline in financial health.

• Under the proposed Multi-Jurisdictional Instrument, even where the connected issuer falls within the "specified party" definition, an exemption from the independent underwriter requirement may still be available where the relationship between the issuer and the underwriter and their respective related entities, immediately before the distribution, is a "minor debt relationship" as defined in the proposed rule.

• Where the independent underwriter requirement applies, the independent underwriter must underwrite at least 20% of the offering or a portion of the offering equal to that underwritten by the largest connected underwriter, whichever is less and the prospectus must disclose the role the independent underwriter has played in the structuring and pricing of the distribution and in the due diligence activities carried out by the underwriters.

Alternatives Considered

The CSA considered a number of alternatives to the regime contained in the proposed Multi-Jurisdictional Instrument. The CSA have reached the view that maintaining the current conflict regime for underwriting is not appropriate, given the problems that have been experienced in interpreting and applying the current regime. The CSA have also reached the view that repealing the current conflict regime is not appropriate because there is a need to address both actual and perceived conflicts of interest in the context of distributions. Therefore, the CSA are of the view that some changes to the existing regime are appropriate.

The CSA considered whether it would be appropriate to eliminate the requirement for the involvement of an independent underwriter, and concurrently create a statutory liability regime whereby any investor who suffered damage as a result of a lack of independence of the issuer and an underwriter could sue the underwriter and the issuer or selling securityholder. The CSA have determined that this would not be an acceptable alternative to the regime proposed in the Instrument.

The final alternative considered by the CSA and the CSA Underwriting Committee was the certification model put forward by the Canadian non-bank owned dealers. Under this model, no independent underwriter would be required for financially healthy issuers unless the connected underwriter and its controlling shareholder cannot certify that the relationships that gave rise to the conflicts of interest concern did not affect the underwriter’s judgment. This alternative was rejected as impractical owing to the difficulty of anyone certifying that all the relationships that might exist between the issuer and the underwriter and their respective related issuers did not influence their actions.

Anticipated Costs and Benefits

Based on experience to date under the existing conflict of interest regimes of the various jurisdictions of the CSA, the CSA are of the view that the benefits of the proposed Multi-Jurisdictional Instrument justify the costs.

The most significant benefit is the maintenance and improvement of investor protection provided by requiring the presence of an independent underwriter in distributions where the conflicts posed by the issuer being a connected issuer are most likely to affect the pricing and disclosure. In the case of distributions made under a prospectus, there exists the requirement to disclose the role that the independent underwriter played in the structuring, pricing and due diligence activities of the distribution. This information should benefit investors as it is expected to ensure that an independent underwriter takes an active role in those activities where the independence of the underwriter and the issuer is most important to investor protection.

In addition, the CSA have attempted to clarify in the proposed Multi-Jurisdictional Instrument a number of issues that have been problematic under the existing conflict regime. For example, the test for related issuer status is less subjective in the proposed Multi-Jurisdictional Instrument than in the existing regime. Also, the application of the proposed Multi-Jurisdictional Instrument to agency distributions has been clarified, and assistance is provided in determining what participation each underwriter may have in a multi-underwriter distribution if more than one connected underwriter is involved. The CSA are of the view that this clarification will reduce the costs to the market and eliminate some sources of potential delays in underwriting currently caused by those issues.

These points of clarification should result in a reduction of time spent on the interpretation of rules, on questions brought to regulators and on applications submitted to regulators. The inclusion of the automatic exemption provisions contained in the proposed Multi-Jurisdictional Instrument will result in fewer applications for exemptions and should also save time and money for underwriters, issuers and regulators without compromising investor protection.

Finally, the reduction of the potential number of independent underwriters that must be involved in a single transaction should reduce the distortions in the formation of underwriting syndicates created by the existing conflict regime.

Given the nature of the proposed changes, the CSA do not anticipate any additional costs of compliance with the proposed Multi-Jurisdictional Instrument.

Consequential Amendments to the Securities Rules

In British Columbia, adoption of the proposed Multi-Jurisdictional Instrument will require the repeal of section 78 of the Securities Rules (B.C.), which will be replaced by the Multi-Jurisdictional Instrument. Consequential amendments will also be necessary as a result of the proposed Multi-Jurisdictional Instrument to sections 75 (the definitions of "connected party", "related party" and "registrant" will be replaced with the corresponding definitions in the Multi-Jurisdictional Instrument), 77 and 85 of the Securities Rules (B.C.). A draft of the proposed consequential amendments to the Securities Rules (B.C.) is published concurrently with this Notice.

Comments

Interested parties are invited to make written submissions with respect to the proposed Multi-Jurisdictional Instrument and Companion Policy. Submissions received by May 8, 1998 will be considered.

In particular, the CSA invites comment on the indicia of financial stress set out in the definition of "specified party" and on that definition generally.

Submissions, in duplicate, should be addressed to all of the Canadian securities regulatory authorities listed below in care of the Ontario Securities Commission

British Columbia Securities Commission
Alberta Securities Commission
Saskatchewan Securities Commission
The Manitoba Securities Commission
Ontario Securities Commission
Office of the Administrator, New Brunswick
Registrar of Securities, Prince Edward Island
Nova Scotia Securities Commission
Securities Commission of Newfoundland
Securities Registry, Government of the Northwest Territories
Registrar of Securities, Government of the Yukon Territory

c/o Daniel P. Iggers, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As securities legislation in certain provinces requires that a summary of written comments received during the comment period be published, confidentiality of submissions received cannot be maintained.

Questions may be referred to any of the following:

Derek E. Patterson
Legal Counsel
British Columbia Securities Commission
(604) 899-6645

David Sheridan
Legal Counsel
Alberta Securities Commission
(403) 297-2630

Barbara Shourounis
Director
Saskatchewan Securities Commission
(306) 787-5645

Tanis J. MacLaren
Associate General Counsel
Ontario Securities Commission
(416) 593-8259

DATED at Vancouver, British Columbia, on February 4, 1998

Douglas M. Hyndman
Chair

Ref: BOR#92/9
NIN#95/26
NIN#96/6
NIN#97/12
NR#97/29

1. Section 75 of the Securities Rules, B.C. Reg 194/97, is amended

(a) by repealing subsections (2) - (6) inclusive,

(b) by amending subsection (1) by deleting the definitions of "connected party", "related party" and "registrant" and substituting the following definitions for those terms:

"connected party" has the meaning ascribed to the definition of "connected issuer" in Multi-Jurisdictional Instrument 33-105, Underwriting Conflicts;

"related party" has the meaning ascribed to the definition of "related issuer" in Multi-Jurisdictional Instrument 33-105, Underwriting Conflicts;

"registrant" has the meaning ascribed to that term in Multi-Jurisdictional Instrument 33-105, Underwriting Conflicts; and

(c) by renumbering subsection (1) as section 75.

2. Section 77(4) of the Securities Rules, B.C. Reg 194/97, is amended by substituting the following

(4) Despite subsection (1), a registrant that does not act as an adviser, dealer or underwriter in the circumstances set out in sections 79, 81, 82 or 83 or in Multi-Jurisdictional Instrument 33-105, Underwriting Conflicts, is not required to file or provide to its clients a conflict of interest rules statement if it files in the required form

(a) a statement that it does not engage in such activities, and

(b) an undertaking not to engage in such activities unless it complies with this Division.

3. Section 78 of the Securities Rules, B.C. Reg 194/97, is repealed.

4. Section 85 of the Securities Rules, B.C. Reg 194/97, is amended

(a) by repealing subsection (1), and

(b) by renumbering subsection (2) as section 85 and substituting the following:

85. Sections 79(1)(a), 80(1)(a) and (2)(a), 81(1)(a), 82(1)(a), 83(1)(a) and (2)(a), except as those sections apply to initial distributions of securities of related parties, do not apply to any trading in or purchasing of, or advising, exercising discretion, or making recommendations or statements in respect of, securities described in section 46 of the Act.