Comments on the revised consultation draft of the provincial/territorial Capital Markets Act (CMA) and the draft initial regulations (Initial Regulations and, together with the CMA, the Consultation Drafts) for the proposed Cooperative Capital Markets Regulatory System (Cooperative System), to be administered by the new Capital Markets Authority (Authority), indicate that capital markets stakeholders continue to have major concerns about the adequacy of the consultation process, the interface between the jurisdictions that will be part of the Cooperative System and those that will not, and other provisions of the Consultation Drafts.
The CMA is intended to replace existing provincial and territorial securities legislation in Ontario, British Columbia, New Brunswick, Saskatchewan, Prince Edward Island and Yukon (Participating Jurisdictions). The initial consultation draft of the CMA was published for comment in September 2014 along with the initial consultation draft of the complementary federal Capital Markets Stability Act (CMSA). Blakes has published a series of Bulletins regarding various aspects of the Cooperative System and summarizing comments received on the initial drafts of the CMA and CMSA (please see our various Blakes Bulletins posted on our website). A revised draft federal CMSA has not yet been released.
While the 50 comment letters on the Consultation Drafts in large part expressed support for the goal of harmonizing securities regulation in Canada and moving toward a single national regulator, many commenters expressed concern about the inadequacy of the consultation process given the proposed substantive changes to securities law in certain Participating Jurisdictions, notably Ontario. Other areas on which many commenters focused included the following:
- Lack of clarity regarding the interface between the Participating Jurisdictions and the other jurisdictions in Canada and the costs of the new Authority
- The expansion of the types of actors caught by the CMA’s definition of “market participant”
- The imposition of personal liability on directors for misrepresentations in offering memoranda
- Changes to the availability of the due diligence defence for directors, officers and underwriters for prospectuses
- The proposed new regulation of extra-territorial distributions
- The elimination of the exemption from the registration requirement that banks and financial institutions currently enjoy under Ontario law
- The discretion afforded to the Chief Regulator in a range of areas
- The potential for a move to a best interests standard for advisers
- The treatment of self-regulatory organizations (SROs)
- The approach taken to the regulation of derivatives transactions and participants in those markets
- Expanded powers provided to the Authority to make freeze orders
After the release of the Consultation Drafts, the Participating Jurisdictions released guidance on certain aspects of the transition from the current regulatory system to the Cooperative System, which are described below.
CONSULTATION PROCESS STILL INSUFFICIENT
A large number of commenters repeated their objections to what they viewed as insufficient consultation on certain elements of the Consultation Drafts. In particular, these commenters were concerned that the Consultation Drafts contain a number of provisions that introduce substantive changes to securities law without providing a rationale for such changes. Examples of such provisions include the regulation of extra-provincial distributions, personal liability of directors for misrepresentations in offering memoranda and the broad discretionary power of the Chief Regulator of the Authority to, among other things, compel disclosure of information and withhold a receipt for a prospectus (all of which are discussed in greater detail below).
A number of commenters reiterated concerns initially raised in comments on the initial draft of the CMA and criticized the responses to such concerns. In particular, such commenters maintained that it was an insufficient response simply to note that the approaches of the Participating Jurisdictions differed on a given question, and proposed that an appropriate response would, in contrast, discuss the substantive differences between the approaches and provide a rationale for choosing one over the other(s). Some commenters noted that such a process was proposed for future changes to the CMA and questioned why it was not followed in the adoption of the CMA.
INTERFACE AND FEES STILL UNCLEAR
The second round of comments on the CMA saw renewed requests for further information and greater detail about the interface between the Participating Jurisdictions and the non-participating jurisdictions. Given that not all provinces and territories are planning to join the Cooperative System (including regulators for significant capital markets such as Alberta and Quebec), the interface between the Participating Jurisdictions and other Canadian jurisdictions was viewed as critical to minimizing the disruption in the transition to the Cooperative System and ensuring a streamlined system of regulation. The interface would address issues such as whether the Authority would place substantial reliance on the determinations of the securities regulators of non-participating jurisdictions, such as prospectus receipts, or undertake its own full review and approval process.
Some commenters suggested that the current Passport System could provide a basis for the interface between the Participating Jurisdictions and non-participating jurisdictions but expressed concern that the CMA and Initial Regulations did not contain provisions outlining such an interface.
As well, the proposed costs of the new Authority, which will be entirely financed by market participants, have not been disclosed and accordingly, draft regulations showing the fees to be paid by market participants have not been released for comment.
EXTENDED DEFINITION OF “MARKET PARTICIPANT”
The CMA contains a definition of “market participant” that includes certain categories of persons who are not considered market participants in the current securities legislation of all Participating Jurisdictions, and a number of commenters criticized the expansion of regulatory powers that would flow from the adoption of the proposed expanded definition.
Including new classes of persons in the definition of market participant would impose significant additional requirements on those persons newly considered market participants. Subject to certain prescribed exceptions, the CMA would impose record-keeping obligations on market participants, mandate the authority of the Authority’s tribunal (Tribunal) over market participants, and require that market participants comply with an order of the Chief Regulator to provide information, records or other things. It would potentially also subject such new market participants to future new requirements under the Authority’s regulation-making authority.
Examples of new categories of persons included in the definition of market participant are control persons and non-reporting issuers that have distributed securities in reliance on exemptions from the prospectus requirement, both of which are included in the CMA definition but not in the definition of market participant in theSecurities Act (Ontario) (Ontario Act).
NEW PERSONAL LIABILITY OF DIRECTORS FOR MISREPRESENTATIONS IN AN OFFERING MEMORANDUM
The Consultation Drafts propose a number of changes to the regime governing civil liability for a misrepresentation. One proposed change that attracted widespread criticism was the creation of a new statutory right of action for damages against the directors of an issuer for a misrepresentation in a “prescribed offering document” such as an offering memorandum used in a prospectus-exempt private placement.
The private placement regime, with its various tailored exemptions, has been developed over time in order to respond to the needs and areas of concern specific to the exempt market. Commenters cautioned that the CMA’s imposition of civil liability on directors of an issuer for a misrepresentation in an issuer’s offering memorandum was a major change to the allocation of risk in the private placement regime that would be disruptive to the functioning of the exempt market that should be reconsidered.
CHANGE TO DUE DILIGENCE DEFENCE
Another change to the civil liability regime in the CMA that was widely criticized by commenters was the reversal of the onus of proving due diligence.
Currently, the Ontario Act, by providing that a director, officer, underwriter, or expert is not liable for a misrepresentation in a prospectus unless he, she or it has failed to undertake a reasonable investigation, requires the claimant to prove that such an investigation was not undertaken. In contrast, the CMA would impose liability for a misrepresentation in a prospectus or offering memorandum unless the person proved that they had undertaken a reasonable investigation, requiring the defendant to establish that such an investigation had been undertaken.
REGULATION OF EXTRA-TERRITORIAL DISTRIBUTIONS
The comment letters indicated widespread opposition to the Initial Regulations’ approach to the regulation of extra-territorial, or “outbound,” distributions of securities. Institutional investors, industry associations, self-regulatory organizations and others all expressed opposition to the idea that distributions from a jurisdiction should be subject to the securities regulation regime of that jurisdiction.
Currently, under Ontario Securities Commission’s Interpretation Note 1, distributions of securities by Ontario-based issuers to purchasers outside of Ontario are generally not required to be made under a prospectus or an exemption from the prospectus requirement. In contrast, the British Columbia Securities Commission requires an issuer distributing securities from British Columbia to comply with the registration and prospectus requirements or rely on exemptions therefrom.
The Initial Regulations adopt an approach substantially similar to the British Columbia regime, and this attracted considerable opposition from commenters, who warned that such an approach may impede issuers in the Participating Jurisdictions from accessing foreign, especially U.S., capital markets.
A broad array of commenters argued that, to preserve and promote Canadian issuers’ access to foreign capital markets, the B.C. model should be discarded in favour of the Ontario model, since the Ontario regime is the Canadian securities regulation regime with which the majority of Canadian and foreign capital markets participants are most familiar.
ELIMINATION OF EXEMPTION FROM REGISTRATION REQUIREMENT FOR BANKS
Industry associations and law firms identified the decision not to carry forward the Ontario Act’s exemption from the registration requirement for banks and financial institutions as an area for concern in the Consultation Drafts. In addition to the long-standing exemption from the registration requirement, the regulation of banks’ trading activities by the Office of the Superintendent of Financial Institutions was put forward as evidence that the registration requirement was not needed and would create unnecessary regulatory overlap and confusion.
One industry association commenter described the change as “fundamental” and warned of the “material negative impact on how banks, and their affiliated trust companies, conduct their business.” Another commenter argued that, without providing a policy rationale for the change, it was inappropriate to remove the exemption and require banks and other financial institutions to undertake the “time consuming and costly endeavour” of determining whether another exemption under the CMA would be available to them.
BROAD DISCRETIONARY POWERS OF THE CHIEF REGULATOR
Many commenters flagged the broad discretion granted to the Chief Regulator under the CMA as worrying. Specific areas of concern that commenters focused on were the discretionary powers of the Chief Regulator to refuse a receipt for a prospectus beyond the current narrowly prescribed grounds for doing so, and to compel the disclosure of information from directors and officers of an issuer.
BEST INTEREST STANDARDS FOR ADVISERS
A number of comment letters noted that the CMA imposes a requirement that advisers deal “fairly, honestly and in good faith” with their clients and that they meet “such other standards as may be prescribed.” Commenters generally interpreted this as leaving open the possibility that a best interests or fiduciary standard would be prescribed. Many commenters, including investor advocacy groups and some industry groups, supported the possibility of prescribing such a standard by regulation, but others considered it inappropriate to contemplate imposing such a requirement when the Canadian Securities Administrators (CSA) were still considering whether imposing such a standard was desirable.
TREATMENT OF SELF-REGULATORY ORGANIZATIONS
A number of SROs weighed in on the Consultation Drafts’ treatment of SROs. The CMA contemplates that an order of an SRO disciplinary panel can be enforced as a court order provided that the Tribunal has issued an order in respect of the SRO panel’s order. The SROs argued that this unwieldy approach was an inefficient method of promoting compliance with capital markets law and suggested instead that an order of an SRO disciplinary panel should be able to be filed directly with the court.
The SROs also submitted that an SRO should enjoy statutory immunity for actions taken by the SRO in performing its regulatory function. The current draft of the CMA provides immunity to SROs only when they are exercising powers that have been delegated to them by the Authority.
REGULATION OF OTC DERIVATIVES
Many commenters, including the International Swaps and Derivatives Association, Inc., in a comprehensive comment letter whose major themes were often mirrored by other commenters, touched on aspects of the Consultation Drafts’ approach to the regulation of OTC derivatives.
Concerns were raised that the proposed prospectus and registration requirements for dealers and advisers applicable to OTC derivatives resulted in significant changes from existing practices in Ontario (including the failure to adopt the Ontario registration exemption for financial institutions and the imposition of the outbound distribution requirements discussed above). These changes were viewed unfavourably given the high proportion of Canadian OTC derivatives trading activity involving Ontario market participants and the resulting significant additional requirements for such participants.
Commenters noted that it would impose an undue burden to require registration (absent an exemption) in one of the existing securities dealer or adviser registration categories until a separate derivatives registration regime is developed. Keeping with the current approach in Ontario, it would be more appropriate to impose registration only once specific requirements relating to OTC derivatives were developed by the CSA Derivatives Committee. Similarly, commenters did not view the requirement for a prospectus (absent an exemption) as making sense in the context of OTC derivatives — especially since prospectus requirements are designed for traditional securities and the CMA contains provisions contemplating the development of specific disclosure requirements for designated classes of derivatives (expected to include derivatives sold as retail investment products).
Commenters questioned the appropriateness in the context of the Canadian OTC Derivative market of requiring registration by “large derivatives participants” and how such term would be defined in future regulations.
It was recommended that the extension of securities-based market-conduct rules to OTC derivatives be reviewed given the inherent differences between these products. As an example, the duty of registrants to deal with “clients” fairly, honestly and in good faith needs to be reconsidered in the context of OTC derivatives as the reference to “clients” is not clear where contracts are bilaterally negotiated or where two dealers may be the counterparties.
NEW FREEZE ORDER PROVISIONS
The expansion of the power to issue freeze orders also attracted comments. Commenters noted in particular concerns as to these new powers relative to derivatives and warned that the new provisions might be read in such a way as to authorize the Tribunal or Authority to interfere with the termination of, close-out netting under, or collateral enforcement powers in respect of, a derivatives transaction.
To issue a freeze order, the Tribunal would need to be satisfied that to do so would be “expedient to assist in the administration or enforcement of securities or derivatives law or the regulation of the capital markets in another jurisdiction,” and some commenters questioned whether this relatively low standard was appropriate given the potential consequences of such an order.
Subsequent to the release of the Consultation Drafts, the Participating Jurisdictions released a “Summary of Proposed Transition Approach” (Summary), outlining the proposed approach to transition from the current system to the Cooperative System. A number of comments on the Consultation Drafts had requested guidance on how the Authority would treat decisions of predecessor provincial securities commissions and emphasized the importance to capital markets participants of certainty with respect to previous regulatory decisions on which such participants currently rely.
Under the transition provisions proposed in the Summary, a reporting issuer in one Participating Jurisdiction would automatically become a reporting issuer in all the Participating Jurisdictions. This may potentially increase its exposure to liability and fees.
Under the Summary, the transition provisions will, among other things, ensure that decisions (for example, registration decisions, prospectus receipts and exemptive relief decisions) and orders (for example, recognition orders and designation orders) of a predecessor regulator would become decisions or orders, as applicable, of the Authority and would have effect in all Participating Jurisdictions. Where there are discrepancies between decisions of two or more predecessor regulators, the Authority and the Chief Regulator would have the power to vary or revoke decisions of a predecessor regulator in order to resolve such discrepancies.
No comments have been solicited in respect of the transition provisions outlined in the Summary.