The current Baffinland Iron Mines Corp. control contest, in which the Ontario Securities Commission (OSC) has intervened several times, raises yet again questions about the fundamental differences between securities regulation and corporate law. It also casts more doubt on the utility of National Policy 62-202, known as the Defensive Tactics Policy, under which securities regulators deal with unsolicited corporate takeover bids and hostile control contests.
Criticisms of the Defensive Tactics Policy have been heard before. In June 2008, the report of the Competition Policy Review Panel, Compete to Win, said Canadian securities regulators should repeal the Defensive Tactics Policy and cease to regulate conduct by boards in relation to shareholder rights plans (poison pills). That conclusion was reached after broad consultations and input from the legal and investment banking community on both sides of the border. To replace the policy, the panel recommended that the regulation of substantive decision-making by directors in respect of change-of-control proposals should be left to the courts, as is the case in the U.S.
This recommendation, although recent, echoed views expressed as long ago as 1983 — before the OSC first published for comment a position paper indicating that it was considering regulating defensive tactics. A committee of senior lawyers commissioned by the OSC said it was particularly concerned that “the determination of questions of law is the proper function of the courts and not the Commission.”
Capital markets, ownership demographics and corporate governance standards have evolved dramatically since the Defensive Tactics Policy was implemented a quarter century ago. At that time, there were no hedge funds and institutional investors were generally passive, longer-term investors. Turnover, both of stock portfolios and CEOs, was less tied to short-term stock price fluctuations. Courts were largely deferential to the conduct of directors and management.
But times changed. Until recently the manner in which the Defensive Tactics Policy has been applied reflected a 1988 decision of the Delaware Chancery Court, which found that: “In the setting of a non-coercive offer, absent unusual facts, there may come a time when a board’s fiduciary duty will require it to redeem the rights and to permit the shareholders to choose.” This endorsement of “shareholder choice” was echoed shortly thereafter in an OSC decision that stated: “The time has come when the pill has got to go.” As a result, a generation of market participants has acted on the understanding that Canadian securities regulators are generally willing to terminate rights plans within some fixed period after the commencement of a hostile bid. This approach has conditioned board responses to hostile bids and, in the global mergers and acquisition context, has made Canadian issuers particularly attractive targets.
In contrast to the relatively static application of the Defensive Tactics Policy, the law in both Delaware and Canada has evolved considerably, and continues to do so. In Canada, our courts have become better equipped to address the nuanced duties of directors in control transactions. Moreover, in its BCE decision, the Supreme Court of Canada rejected the notion that directors’ duties in such situations are solely to maximize value for shareholders. Instead, the court reiterated its view that directors’ duties are owed to the corporation, and may include a consideration of the impact of a transaction on a range of other stakeholders.
Two procedural disadvantages faced by securities regulators in adjudicating directors’ behaviour in control contests are the lack of evidentiary discipline in their process (compared to court adjudication) and the reality that the fragmented structure of Canadian securities regulation lends itself to static policy and inconsistent application thereof. The latter concern has recently surfaced in decisions by different securities commissions (Ontario and Alberta in the case of Neo Materials and Pulse Data, and British Columbia in the case of Lions Gate) that are difficult to reconcile.
This, coupled with the tension between the Defensive Tactics Policy and the role assigned to the board of directors under corporate law, including the principles articulated by the Supreme Court of Canada in BCE, can only serve to create uncertainty and undermine public confidence.
A more substantive issue is that the jurisdiction of securities regulators is only through the exercise of broad and ambiguous “public interest” powers (unlike courts, whose jurisdiction derives from the interpretation of duties imposed by corporate law on directors). The law is clear that the exercise of such powers should only be protective and preventative and firmly rooted in the objectives of securities regulation (investor protection and market efficiency). Unfortunately, as noted in Compete to Win, it hasn’t been clear for some time that the application of the Defensive Tactics Policy satisfies any of these criteria.
In reviewing mainstream economic literature, a recent academic study by Slavisa Tasic of the University of Kiev noted the near-complete absence of concern that regulatory design might suffer from the same lack of competence ascribed to market participants. The author noted a number of mistakes that government regulators often share with the rest of us. One is the illusion of competence — overestimating how much we understand about the causes and mechanisms of things. Given developments over the past quarter century in both law and the capital markets, perhaps “the time has come” for securities regulators to heed their own advice and exercise restraint by withdrawing (or, at least, being more circumspect in their application of) the Defensive Tactics Policy.