NI 41-101 proposes changes to over-allotment options, restrictions on backdoor underwritings and prospectus certification requirements for substantial beneficiaries

Proposed National Instrument 41-101 - General Prospectus Requirements and Related Amendments (NI 44-101 or the Instrument) was published by the Canadian Securities Administrators on December 21, 2006 for comment. It proposes significant amendments which would affect, among others, the long form prospectus rules, short form prospectus rules, continuous disclosure requirements and investment fund rules.

The substance and purpose of the Instrument is expressed primarily to be the harmonization and consolidation of existing prospectus requirements and policy across Canada. The proposal, however, goes much further than that, with the introduction of new restrictions for linked notes and other derivatives, expanded prospectus certification requirements, broader disclosure requirements for material contracts with tighter limits on self-redaction, as well as additional certification, undertaking and personal information form (PIF) requirements. And while the Instrument would primarily affect issuers offering and investors purchasing securities under a long form prospectus, it also impacts upon underwriters, with proposed changes to over-allotment options, limits on compensation warrants, and restrictions on backdoor underwritings.

Over-allotment positions

The securities regulators recognize that underwriters would not generally engage in market stabilization activities without the protections offered by over-allotment options. Codifying what is essentially existing regulatory practice, the Instrument permits over-allotment options, provided they:

  • are granted solely for the purpose of covering over-allocation positions;
  • do not exceed the lesser of the over-allocation position determined as at the closing of the distribution and 15% of the base offering; and
  • expire within 60 days after closing of the distribution.

The "over-allocation position" is the amount by which the aggregate number of securities sold by underwriters as at the closing of a distribution exceeds the base offering. The "base offering" means the number or principal amount of securities distributed under a prospectus. It does not include:

  • over-allotment options granted in connection with the distribution, or the securities issuable on the exercise of any such over-allotment options; or
  • securities issued or paid as compensation for acting as an underwriter, together with any underlying securities issuable or transferable on the exercise of such compensation securities if they are convertible or exchangeable securities.

The companion policy states that securities will only be considered part of the over-allocation position if they are sold to a bona fide purchaser as of the closing of the offering. This is a change from the existing guidelines, under which the timing for this determination is the close of trading on the 2nd trading day after the closing of the offering. Securities held by an underwriter for sale at a future date will therefore not be considered part of the over-allocation position. Further, securities forming part of the underwriters' over-allocation position must be distributed under the prospectus so that all purchasers in the distribution receive the benefit of prospectus rights, irrespective of whether the underwriters have over-sold the offering.

Distribution of securities to an underwriter

In an effort to curb so-called "back door underwriting" practices, the Instrument prohibits the distribution of securities under a prospectus to a person acting as an underwriter for the distribution, except in respect of:

  • over-allotment options, or the securities issuable or transferable on the exercise of over-allotment options (subject to the limits described above); and
  • certain compensation securities.

Compensation options or warrants permitted to be distributed by underwriters for the distribution must not exceed, in the aggregate, 5% of the base offering. The 5% limit is calculated using as the numerator the number of securities granted as compensation, assuming the conversion or exchange of these securities, if applicable.

Certification and substantial beneficiaries

The Instrument consolidates (and in some instances expands on) existing certification requirements found in applicable securities legislation. A significant addition is the proposed requirement (except in Ontario) that each "substantial beneficiary" of an offering as well as, in the CSA's discretion, a "control person" of the substantial beneficiary, provide a certificate (thereby exposing them to prospectus liability).

A "substantial beneficiary" is defined very broadly to include a person or company that, within the year preceding the date of the prospectus, or following the completion of any transaction or series of transactions disclosed in the prospectus, individually or in conjunction with one or more other persons or companies, is reasonably expected to acquire:

  • control of the issuer or a significant business of the issuer, or
  • 20% of the voting securities of the issuer or a significant business of the issuer,
  • and is reasonably expected to receive (directly or indirectly) 20% or more of the proceeds from the offering (whether as consideration for services, repayment of debt or otherwise), other than by virtue of its ownership of voting securities of the issuer.

The CSA's rationale for this proposed amendment is that a person or company that controls the issuer or a significant business has the best information about the issuer or significant business, and that if they also stand to receive proceeds from the distribution, they should be liable for any misrepresentations in the prospectus relating to the issuer or significant business.

Many commentators have, however, expressed concern that imposing prospectus liability on a party that is receiving proceeds as consideration for the sale of assets or repayment of debt may discourage parties who may be caught by this requirement from entering into bona fide sale or debt transactions and impair the ability of Canadian public companies to compete for acquisitions of targets (notably Canadian issuers who need to access Canadian capital markets to fund the acquisition). In particular, given that the proposed amendments require certification of the prospectus as a whole and not just the portions relating to the significant business acquired or to be acquired by the issuer, a vendor would be forced into the very difficult and burdensome position of having to do a complete due diligence on the issuer and its business and operations in order to avail itself of a due diligence defence. The economic cost of the increased liability of a vendor who is willing to sign a prospectus under these conditions will most likely be reflected in the purchase price, potentially placing Canadian companies needing to publicly finance at a substantial disadvantage to other prospective purchasers.

Legends and advertising

The Instrument includes provisions relating to advertising and marketing in connection with a prospectus, including legends for advertising material during the waiting period and after the receipt for the final prospectus is obtained. Further, the companion policy gives specific guidance on what is permitted for prospectus distributions (including contents of green sheets), stating that, at a minimum, participants in all prospectus distributions should consider the following practices to avoid contravening securities legislation:

  • directors or officers of an issuer should not give interviews to the media immediately prior to or during the waiting period and should limit themselves to responding to unsolicited inquiries of a factual nature;
  • no director or officer of an issuer should make any statement during the period of distribution of securities (which includes the pre-marketing and solicitation of expressions of interest period in the context of a bought deal) which constitutes a forecast, projection or prediction with respect to future financial performance, unless that statement relates to and is consistent with a forecast contained in the prospectus;
  • underwriters and legal counsel have the responsibility of ensuring that the issuer and all directors and officers of the issuer who may come in contact with the media are fully aware of the restrictions applicable during the period of distribution of securities. It is not sufficient to make those restrictions known only to the officers comprising the work group; and
  • issuers, dealers and other market participants should develop, implement, maintain and enforce procedures to ensure that advertising or marketing activities that are contrary to securities legislation are not undertaken, whether intentionally or through inadvertence.

Restrictions on resale

In addition to disclosure of securities subject to regulatory escrow requirements, the Instrument requires disclosure of securities subject to contractual restrictions on transfer (with certain consequential amendments proposed to NI 51-102 - Continuous Disclosure Obligations).


As mentioned above, the Instrument was published by the CSA on December 21, 2006. The comment period closed on March 31, 2007, and comments are currently under review by the CSA. Implementation of the final instrument is anticipated around December 2007.