Proposed Changes to Early Warning Reporting System Address Market Transparency and Shareholder Activism in Canada
March 15, 2013
Under Canada’s early warning reporting (EWR) system, investors holding 10% or more of a public company’s voting securities must publicly report their ownership levels, the purpose of the transaction and any future intention to accumulate more securities. Eligible institutional investors can report more slowly than EWR filers and provide less information by making use of the alternative monthly reporting system (AMR).
Proposals just published by Canadian securities administrators would lower the reporting threshold, thereby increasing the transparency to the market of significant investments. The proposals would also increase EWR disclosure obligations for investors who acquire derivatives or public company securities through securities lending arrangements and make the AMR system unavailable to institutional investors who engage in certain forms of shareholder activism.
Summary of Proposed Changes
- The early warning reporting threshold would be decreased from 10% to 5%,1 which would be consistent with the standard in several major foreign jurisdictions, including the United States and Australia.
- EWR reports would be required for increases or decreases in ownership of 2% or more. Decreases in ownership are explicitly covered for the first time. The proposals also specifically invite comment on whether the 2% threshold should be reduced to 1%.
- EWR reports would also be required if ownership falls below the 5% threshold.
Increased Disclosure of Investor Intentions
- To reverse a perceived tendency on the part of filers to use boilerplate in statements of intentions, more detailed EWR disclosure requirements and an officer certification are proposed.
Derivatives and Related Financial Instruments
- Equity derivative positions that are substantially equivalent in economic terms to conventional equity holdings (equity equivalent derivatives) must be included for the purpose of calculating an investor’s early warning reporting threshold and must be described in the reports.
- Equity equivalent derivatives include:
- total return swaps;
- contracts for difference; and
- other derivatives that provide the party with the notional "long" position with an economic interest that is substantially equivalent to the economic interest the party would have had if the party held the securities directly.
- An investor with early warning reporting obligations in respect of a class of securities must disclose the existence and material terms of any related financial instruments involving that class of securities.
Securities Lending Arrangements
- Many institutional investors borrow and sell securities to offset the risk of substantial holdings (long positions) in stock. It is proposed that securities lending arrangements in effect at the time of a reportable transaction be disclosed even if that transaction did not involve a securities lending arrangement.
- The proposals envisage early warning reporting of securities borrowings even though the borrowed securities might have been held very briefly. This proposal may be perceived as controversial by some market participants.
- If a person who is subject to early warning reporting obligations lends securities, which represent a decrease in ownership of 2% or more, pursuant to securities lending arrangements, then the lender would be required to file an early warning report in respect of the securities so lent.
- Certain "specified securities lending arrangements,"2 would be exempt from the early warning disclosure requirements.
Alternative Monthly Reporting Unavailable to Activists
- The less burdensome AMR regime is currently available to activist investors, such as hedge funds, provided they do not propose change of control transactions. Canadian securities regulators assert that expanding the early warning reporting system to cover shareholder activists instead of letting them continue to rely on the AMR regime is a response to market realities. This approach may be perceived by some to favour management in disputes with activists.
- Under the current proposal, the eligibility for the AMR regime would be meaningfully narrowed and would cease to be available to eligible institutional investors who solicit, or intend to solicit, proxies from security holders of a reporting issuer on matters relating to the election of directors of the reporting issuer or a reorganization, amalgamation, merger, arrangement or similar corporate action involving the securities of the reporting issuer.
What the Proposed Changes Mean for Market Participants
We expect the proposed changes to the early warning reporting system to impact issuers and other market participants in several important ways:
- By requiring earlier and enhanced levels of disclosure, the proposed changes should improve market transparency and efficiency.
- The proposed changes will inhibit pre-bid purchase and accumulation transactions and may encourage increased reliance on modes of communication protected from proxy solicitation requirements by statute.
- The new minimum disclosure threshold may help target companies to enhance their take-over preparedness by taking steps earlier in a possible change of control process.
- Institutional shareholders, including activists, and other investors who use derivatives or borrow and sell securities to control risk associated with a large holding in the stock of a single issuer would be required to publicly disclose those holdings once the proposed lower reporting threshold has been reached.
- The proposed requirement to disclose securities lending arrangements where the borrowed securities have only been held briefly may be perceived as controversial by some market participants.
Comments on the proposals may be submitted until June 12, 2013.
1 Despite being passive investors, public mutual funds will not qualify for the AMR system and will be subject to the EWR requirements when they cross the 5% threshold. Some market participants may believe that mutual funds that are otherwise passive should qualify for the AMR system. The proposals specifically invite comment on whether requiring mutual funds to comply with early warning requirements at the proposed threshold of 5% is justified.
2 The proposals define a "specified securities lending arrangement" as a securities lending arrangement to which all of the following apply:
- the material terms of the securities lending arrangement are set out in a written agreement, a copy of which is retained by each party to the agreement;
- the securities lending arrangement requires the borrower to pay to the lender amounts equal to all dividends or interest payments, if any, paid on the security that would have been received by the borrower if the borrower had held the security throughout the period beginning at the date of the transfer or loan and ending at the time the security or an identical security is transferred or returned to the lender;
- the lender has established policies and procedures that require the lender to maintain a record of all securities that it has transferred or lent under securities lending arrangements; and
- the written agreement provides for either or both of the following:
- the lender has an unrestricted right to recall all securities or identical securities that it has transferred or lent under the securities lending arrangement prior to the record date for any meeting of security holders at which the securities may be voted; and
- the lender requires the borrower to vote the securities transferred or lent in accordance with the lender’s instructions.