Request for Comments: OSC Rule - 48-501 - Trading during Distributions, Formal Bids and Share Exchange Transactions

General Comments

1.

Consistency between rules

One commenter stated that there should be absolute consistency between the rule and the UMIR amendments both in terms of their substantive application and in the use of terminology. There should also be the utmost uniformity between these rules and Reg. M.

The Commission and RS are attempting to achieve the greatest degree of harmonisation between the rule and the UMIR amendments. However, there are several reasons for differences between the rules: while RS has jurisdiction over dealers that trade in marketplaces to which RS provides regulation services, the Commission's jurisdiction extends to all market participants including issuers and selling securityholders and their associates and affiliates. The Commission also has jurisdiction over all securities, whereas, RS's jurisdiction is restricted to listed and quoted securities. There are also differences that arise as a result of differences in defined terms and drafting conventions for provisions of UMIR and Commission rules. Further, there are certain exemptions contained in the UMIR amendments, such as those relating to basket trades and rebalancing of portfolios which are only intended for use by dealers subject to UMIR and hence are not included in the rule.

The Commission and RS are cognizant of the benefits of ensuring as much harmonisation with Reg. M as possible. Differences may exist as a result of feedback from participants, as for example, the decision not to adopt the three tiered approach to the commencement of the restricted period.

Definitions

2.

"acting jointly or in concert"

Two commenters suggested that it would be useful to have further clarification of what is meant by "acting jointly and in concert".

Commentary has been included in the proposed Companion Policy 48-501 CP (CP) as to what is meant by "acting jointly and in concert".

definitions of "dealer-restricted person" and "issuer-restricted person" 48-501 s.1.1 UMIR s.1.1

3.

"basket trade"

Two commenters suggested that the proposed definition of "basket trade" is too restrictive and that the requirements for a "basket trade" include fewer securities, baskets with a greater proportion of one security, and baskets of securities which substantially represent a recognized index.

The UMIR amendment definition of "basket trade" will be amended to indicate that such a trade will include the simultaneous purchase of at least 10 listed or quoted securities provided that the restricted security comprises not more than 20% of the total value of the transaction or the simultaneous purchase of a basket of securities which represent a recognized index.

UMIR s.1.1

4.

"connected security"

One comment made in respect of clause (a) of the definition of "connected security" was that the wording should refer to "a listed or quoted security which is immediately convertible, exchangeable or exercisable into the offered security...".

Clause (a) is intended to capture securities into which the offered security can be converted and not securities that can be converted into the offered security. It is unlikely that a change in the price of a convertible security will have any impact on the offered security and has therefore not been included in the definition.

48-501 s.1.1 UMIR s.1.1

A comment was also made that the phrase "may significantly determine the value of the offered security" in clause (b) of the definition is vague. Another commenter recommended that an exclusion be built into paragraph (b) when the price at which the security is being offered was greater than 110% of the best ask price of the underlying listed or quoted security at the commencement of the restricted period.

Clarification has been included in the CP regarding the meaning of what may significantly determine the value of the offered security. Due to the variety of circumstances in which paragraph (b) may be applicable, it would not be practical to set out the terms of a price exception that would be appropriate in all cases. Where warranted, exemptive relief tailored to the specific fact situation may be sought.

5.

"dealer-restricted period" -- commencement -- public distribution

The rule and UMIR amendments would not impose trading restrictions on the largest issuers -- those whose securities would qualify as highly-liquid securities -- and for all other issuers the restricted period would commence two days prior to pricing. The Commission had requested specific comment on whether the commencement of the restricted period should adopt a three-tiered approach similar that that used in Reg. M. Three commenters responded to this request and concurred that there was no apparent benefit to adopting the more complicated approach used in Reg. M and that they preferred the method as presented in the rule and UMIR amendments.

The method of determining the commencement of the restricted period as originally proposed in the rule and UMIR amendments will be retained.

48-501 s.1.1 UMIR s.1.1

6.

"dealer-restricted period" -- commencement -- formal bids

Three commenters noted that the proposed commencement of the restricted period for take-over bids, issuer bids and capital reorganizations from the date of the first public announcement of the transaction could result in an unnecessarily long restricted period. It is also different from the requirements of Reg. M where the restrictions commence when the proxy and solicitation materials are first disseminated to shareholders. One of the commenters suggested that the restriction on trading should only be for the period of solicitation which is effectively the seven day period prior to the shareholder vote.

The rule and UMIR amendments have been amended to provide that the commencement of the restricted period begins on the date of the information circular, take-over bid circular, issuer bid circular or similar document (circular). The date of the circular is a more precise date and more easily determined; it is expected that in most cases, the date of the circular will be very close to Reg. M's date of dissemination of materials.

48-501 s.1.1 UMIR s.1.1

7.

"dealer-restricted period" -- commencement -- wide distributions

A commenter has indicated that the notice requirement is inconsistent with industry practices and that the time horizon for such trades is often less than two days.

Wide distributions are currently contemplated only under UMIR and not securities legislation. The references to "wide distributions" in the rule and UMIR amendments have been removed.

48-501 s.1.1 UMIR s.1.1

8.

"dealer-restricted period" -- termination -- public distribution

The Commission had requested specific comment on whether the determination of the end of the restricted period was sufficiently clear as proposed in the rule or whether further clarification such as that proposed in the amendments to the UMIR provisions would be helpful. Commenters sought clarity with respect to when the restricted period ended in the rule and some thought that the language proposed in the interpretation section of the UMIR amendments would be helpful in providing clarification.

The rule has been amended to make the definition consistent with the proposed interpretation provision of the UMIR amendments.

48-501 s.1.1 UMIR s.1.1 and 1.2(6)

A couple of commenters suggested that reference to the end of the selling process should require only a final receipt to be issued and not also a final prospectus delivered to each subscriber. Another commenter noted that it may be problematic in cross-border public offerings of securities of inter-listed issuers if the proposed amendment was inconsistent with Reg. M where the restricted period ends solely on a dealer by dealer basis.

The Commission takes the view that it is appropriate that stabilization arrangements terminate for all dealers on the termination of the syndicatation agreement. Cross-border public offerings will not be prejudiced by the requirements in the rule as these securities, if subject to Reg. M and considered to be an "actively-traded security", are exempt from the restrictions in the rule. As such, the Commission has decided to make no amendments to the rule.

9.

"dealer-restricted period" -- termination -- formal bids

One commenter wrote that paragraph (c) of the definitions of "dealer-restricted period" and "issuer-restricted period" in the rule and UMIR amendments should be amended to clarify that the relevant securityholder vote or votes is by the securityholders who will receive the offered security. Another commenter noted that the length of the restricted- period from the date of the announcement to the date of approval/deposit of securities was unnecessarily broad and recommended that the period should only be the solicitation period, the seven day period before the scheduled shareholder vote.

The suggested amendment clarifying that the vote is by the securityholders who will receive the offered security has been made to the rule and UMIR amendments. Paragraph (c) has been amended so that the restricted period will commence on the date of the circular. The restricted period will continue to the date of approval.

48-501 s.1.1 UMIR s.1.1

10.

"dealer-restricted person" -- scope -- related parties

The Commission received considerable comment regarding the breadth of the previous proposed definitions of "dealer-restricted person". These commenters expressed concern that the inclusion of "related entities" of a dealer-restricted person was too sweeping. One commenter noted that every employee of a major Canadian bank would be considered to be a "dealer-restricted person" even though, in reality, only a small fraction of that group would have any involvement in the activities of the bank's affiliated dealer. Another commenter wrote that the proposed definition would capture portfolio management companies that are related to the participating dealer and any of the investment funds or accounts managed by them. A number of commenters also reported that the costs of monitoring and ensuring that appropriate compliance systems are in place as would be required by the previously proposed rule would be substantial.

The Commission and RS agree that the scope of this provision should include only those persons or companies with a direct interest in the outcome of a distribution or transaction.

48-501 s.1.1 UMIR s.1.1

Several commenters recommended that, in certain circumstances, related entities should be excluded from the definition by using the same factors as in Policy 5.1 or Reg. M. Reg. M has the following conditions: (i) the dealer maintains, enforces and obtains an annual assessment of written policies which are reasonably designed to prevent the flow of information that might result in a violation of Reg. M; (ii) the affiliate has no officers (or persons performing similar functions) or employees (other than clerical, ministerial, or support staff) in common with the dealer that direct, effect or recommend transactions in securities; and (iii) the affiliate does not, during the applicable restricted period, act as a market maker (other than as a specialist in compliance with the rules of a national securities exchange), or act as a broker in solicited transactions or proprietary trading of restricted securities. Another commenter submitted a proposal to create information walls around related entities.

The definition in the previously proposed rule would not capture employees of a bank but would capture all related entities (i.e. those affiliates of the dealer registered under the Securities Act). The definition of "dealer-restricted person" has been amended in the rule and the UMIR amendments to exclude related entities of a dealer provided the dealer has in place policies and procedures that restrict the flow of information between the dealer and its related entities. The conditions in the rule are substantially similar to those in Reg. M.

11.

"dealer-restricted person" -- managed accounts

In the rule the definitions of a "dealer-restricted person" and an "issuer-restricted person" included an investment fund or account managed by a dealer- or issuer-restricted person. The comment was made that incorporating the concept of "direction or control" over an account, similar to the equivalent UMIR provision, would be clearer.

The Commission has adopted similar wording to the UMIR amendments.

48-501 s.1.1 UMIR s.1.1

12.

"dealer-restricted person" -- scope - agents

One commenter submits that imposing trading restrictions on dealers acting as agents on a best efforts basis in private placements and public offerings is not necessary and could inhibit smaller companies in their efforts to raise capital. Financings that are structured on a best efforts basis would not give rise to any incentive to manipulate the market as the dealer could extricate itself from the financing if it is not acceptable to the dealer. Another commenter agreed with the proposal to extend the trading restrictions to public offerings but suggested that further study should be undertaken before also extending the restrictions to private placements.

The Commission and RS are of the view that, although dealers/participants involved in a financing on a best efforts basis are not subject to the same degree of economic risk that accompanies a committed financing, there is, nonetheless, sufficient interest to make manipulation a concern. A failed agency offering would not only result in no compensation for time and effort committed by the dealer/participant to the effort but also entails significant reputational risk to the entity. The Commission has decided to include in the definition of "dealer-restricted person" agents in significant public offerings and private placements. The threshold for significant offerings in the rule is where the number of securities being offered pursuant to the public distribution is more than 10% of the number of issued and outstanding offered securities.

48-501 s.1.1 UMIR s.1.1

13.

"highly-liquid security"

The Commission received considerable response on its request for specific comment on whether the definition of highly-liquid security should include criteria based on the size of public float, similar to Reg. M, and whether this information or that in the proposed definition would be difficult to obtain or calculate on a consistent basis. Some felt that the average number of trades per day test was a less accurate reflection of truly highly-liquid securities because some securities may experience an unusual trading volume due to public disclosure of unanticipated information by an issuer, or inappropriate market conduct. The public float test was preferred by most commenters over the average number of trades test. It was suggested that a threshold of $150 million would be appropriate. Clarification was also sought on how average daily trading volume would be calculated, and in particular, whether trading volume is to be measured on a world wide basis.

A security will be considered a highly-liquid security provided that has traded, in total, on one or more marketplaces as reported on a consolidated market display during a 60-day period ending not earlier than 10 days prior to the commencement of the restricted period, with an average daily trading value of $1 million and a minimum average over of 100 trades a day on Canadian marketplaces. The Commission and RS are of the view that this test is most reflective of liquidity.

48-501 s.1.1 UMIR s.1.1

One commenter suggested a principle based approach to the definition and submitted that the tests for determination of a highly-liquid security should be applied only as guidelines. However, most of the commenters suggested that one entity should develop and maintain the list of highly-liquid securities citing that it was important to have certainty as to what would qualify as a highly-liquid security and to avoid inconsistent application of the exemption from one dealer to the next.

RS will maintain and distribute a list of securities which will be considered to be "highly-liquid securities". Market participants may rely on the list but market participants would be entitled to rely on information contained in a consolidated market display of trades executed on Canadian marketplaces. (In part, RS prefers the "trade" test to the "public float" used in Reg. M. as RS is considering proposing an amendment to the short sale rules to provide an exemption for "highly-liquid securities" from the requirement that short sales be done at a price not less than the last trade. A liquidity test based on trades rather than float is most appropriate in those circumstances.)

Inter-listed securities which meet the "float" test under Reg. M. will be considered "highly-liquid securities".

14.

"issuer-restricted period"

One commenter requested clarification on the definition of issuer-restricted period, and in particular, whether the restricted period begins on the earlier of the days described in sub-paragraphs (i), (ii) or (iii).

Clause (a) of the definition of "issuer-restricted period" has been amended to start two trading days prior to the day the offering price is determined.

48-501 s.1.1 UMIR s.1.1

15.

"marketplace" and "marketplace rules"

One commenter requested clarification of the term "marketplace" and "marketplace rules" as used in the rule.

Commentary has been included in the CP as to what is meant by "marketplace" and "marketplace rules". The reference to "marketplace rules" has been removed from the definition of "public distribution".

48-501 s.1.1 UMIR s.1.1

16.

"offered security"

One commenter felt that the definition of "offered security" should be subject to a test of materiality of the merger or acquisition to the offeror. Clarification was also requested to specify that the proxies were those of the shareholders that would acquire the offered security.

A materiality test from the perspective of the offeror is not appropriate. The transaction will always be material to the shareholders that will acquire the offered security. The definition has been revised to clarify that the proxies refer to those solicited from securityholders that will receive the offered security.

48-501 s.1.1 UMIR s.1.1

A comment was also made that as paragraphs (b) and (c) would extend the application of trading restrictions to take-over bids and issuer bids that would otherwise be exempt from applicable securities law requirements, consideration should be given to further exempting these transactions from the rule.

Paragraphs (b) and (c) of the rule and UMIR amendments have been amended so that paragraph (b) refers to a security which is offered by an offeror in a securities exchange take-over bid in respect of which a take-over bid circular or similar document is required to be filed under securities legislation and paragraph (c) refers to a security which is offered by an issuer in an issuer bid in respect of which an issuer bid circular or similar document is required to be filed under securities legislation. These materials are not required to be filed, under securities legislation, for exempt bids.

17.

"public distribution"

The suggestion was made by one commenter that listed or quoted securities being distributed by way of a private placement should also be subject to a restricted period, and accordingly the definitions of "offered security", "connected security" and "restricted security" be amended to included private placement transactions.

Private placements are subject to trading restrictions as the definition of "public distribution" includes offerings by way of prospectus, or private placements.

48-501 s.1.1 UMIR s.1.1

18.

"dealer-restricted period"/"restricted period"

One commenter noted the different definitions of "dealer-restricted period" and "restricted period" in the rule and the UMIR amendments but acknowledged the need for the rule to accommodate both dealer-restricted persons and issuer-restricted persons. Another commenter expressed concern that the different definitions in the two rules might result in situations where a dealer-restricted person might be subject to trading restrictions but that an issuer-restricted person might not be similarly restricted.

The restricted period for dealers and issuers in the rule and UMIR amendments are intended to be identical in substance. Changes have now been made to conform the respective provisions.

48-501 s.1.1 UMIR s.1.1

As presently proposed, the issuer-restricted period will commence at or before, but never later than, a dealer-restricted period will commence (although it is possible for a dealer's restricted period to commence later than that the issuer-restricted period.) Therefore it is not possible for a dealer to be subject to trading restrictions while an issuer-restricted person is not so restricted.

19.

"restricted security"

One commenter suggested that the definition of "restricted security" to be included in UMIR be consistent with the definition of "restricted security" in the rule. The commenter believes that securities which comprise the public distribution be exempt from being a "restricted security" in the definition rather than within the exemptions from the restrictions in UMIR s.7.7(4).

The definition of restricted security in the rule as originally proposed would have excluded those securities comprising the public distribution with the effect that subsequent trades in those securities would not have been subject to the prohibitions in the rule. The equivalent UMIR provisions would include all offered securities as restricted securities but would provide an exemption for the primary distribution of securities pursuant to the public distribution. It was not the intention of the Commission to exempt the subsequent secondary market trades of the securities under the public distribution. The definition in the rule has been amended to adopt the same approach as that taken in the UMIR amendments.

48-501 s.1.1 UMIR s.1.1

Restrictions

20.

Restriction on Trading

The onus placed on a dealer-restricted person to ensure that they do not bid for or purchase a restricted security for an issuer-restricted person is exceedingly difficult to monitor.

The Commission and RS agree that it would be very difficult and expensive to monitor all issuer-restricted persons to ensure compliance with the rules. The requirement to not bid for or purchase on behalf of an issuer-restricted person has been amended to state that the dealer-restricted person shall not carry out such a transaction if it "knows or ought reasonably to know" that the person was an issuer-restricted person.

48-501 s.2.1 UMIR s.7.7

Permitted Activities and Exemptions

21.

Prohibited Use of Exemptions from Trading Restrictions

One commenter felt that section 3.1 of the rule was unnecessary.

Section 3.1 of the rule was intended to clarify that notwithstanding the exemptions available in Part 3, reliance upon those exemptions continues to be subject to prohibitions against manipulation and fraud. However, since anti-manipulation and anti-fraud provisions are found in Part 3 of NI 23-101 (and s.126.1 of the Securities Act, when it becomes effective) the Commission has decided to remove s. 3.1 from the rule and include clarification in the CP that anti-manipulation and anti-fraud provisions found in securities legislation continue to apply.

48-501, s.3.1

22.

Determination of Maximum Permitted Stabilization Price

One commenter requested guidance as to how the maximum stabilization price is determined and suggested that Reg. M was instructive where it refers to pricing in the principal market or the market where stabilization will be initiated.

Since there is no concept in Ontario of a "principal market" as referred to in Reg. M, there is no distinction to be drawn between a price on a consolidated display and the price on the principal market. No change, therefore, has been made.

48-501, s.3.1(a) UMIR s.7.7(4)(a)

23.

Market Stabilization 48-501

One commenter stated that if the underwriter enters a bid on a marketplace equal to the highest independent bid then entered on a marketplace and the independent bid is subsequently withdrawn, the underwriter should be permitted to keep its bid open and to complete a purchase if the underwriter's bid is accepted on the marketplace.

These provisions have been amended.

48-501 s.3.1(a) UMIR s.7.7(4)(a)

A dealer is permitted to purchase or bid for a connected security for the purpose of market stabilization at a price that is the lesser of the best independent bid price at the time of commencement of the restricted period and the highest independent bid at the time of the bid or purchase. If an independent bid is withdrawn this may be indicative of a movement in the market price of the security and the dealer should be limited to the prevailing highest independent bid.

24.

Short Sales

The Commission specifically requested comment on whether there should be an exemption allowing a dealer-restricted person to cover short sales entered into during the restricted period and, if so, whether any conditions, such as those in Reg. M, would be appropriate.

The Commission and RS decided to remove the short sale exemption from being tied to the 'market stabilization' exemption and instead, make it a separate exemption. In effect, for a short position entered into before the restricted period commenced there would be no price limit but if it was entered into during the restricted period, it can still be covered subject to certain price limitations. Covering of short positions from unsolicited client orders would be addressed by the exemption for unsolicited client orders.

48-501 s. 3.1(1)(h) UMIR s.7.7(4)(h)

The Commission received a number of comments on this issue. A couple of commenters recommended that dealer-restricted persons be able to cover short sales entered into during the restricted period. One commenter recommended adopting the Reg. M prohibition and felt that it would constitute an appropriate and sufficient restriction. Reg. M prohibits the covering of short sales during certain periods of time if the purchase of offered securities was from an underwriter, broker or dealer participating in the offering. Another commenter wrote that short covering should not be considered part of market stabilization activities.

25.

Exempted Securities

The rule and UMIR amendments differed on the inclusion of non-convertible debt, non-convertible preferred shares and asset-backed securities as exempted securities. One commenter supported their inclusion and another advocated against their inclusion.

This exemption has been removed from the rule.

48-501, s.3.2(b)(iii)

26.

Specific Exemptions

Commenters have indicated their support for the exemptions in UMIR s.7.7(4)(g) and (h) but have indicated that certain additional exemptions should be provided where trading is an element of an on-going program that will have little chance of manipulating the market for a security.

The UMIR definition of "basket trade" will be amended to make it broader. In addition, general exemptions will be included in the rule. It should also be noted that RS staff will consider granting specific exemptions for transactions on a case-by-case basis.

UMIR 7.7(4)(g) and (h)

27.

Exemptions for the Exercise of conversion and purchase rights

It was submitted that the exemption for the exercise of options, rights, warrants and other similar contractual arrangements should not be restricted only to those held prior to the commencement of the restricted period.

The Commission and RS do not believe that extending the exemption would be appropriate. Generally, the exemptions from the general prohibition on any trading activity in a restricted security are designed to minimize any interference with the on-going business or pre-existing positions of the dealer. If a dealer acquires options, rights or warrants during a restricted period, they do so with the knowledge that their exercise during the restricted period is prohibited. Furthermore, if the dealer-restricted person or issuer-restricted person is prohibited from purchasing a restricted security at the time, they should not be able to do so indirectly through the purchase and exercise of an option, right or warrant during the restricted period.

48-501 s. 3.2(e) & 3.3(a) UMIR 7.7(4)(e) and (5)(a)

28.

Inter-listed arbitrage Exemption UMIR 7.7(4)(k)

One commenter suggested that inter-listed arbitrage activity should be exempted.

RS has decided to add to the UMIR amendments a limited exemption for bona fide arbitrage activity where the dealer-restricted person reasonably believes that they can immediately sell the security and intend to do so.

29.

Inadvertent Violation Exemption

One commenter wrote that the rule should contain an exemption to deal with inadvertent violations of the rule.

The Commission and RS have considered the comment and concluded that it would not be appropriate to add such an exemption. A violation, even if inadvertent, may be dealt with in the context of an investigation and/or prosecution by the Commission and RS. In such a case, the adequacy of the dealer's policies and procedures would be considered.

30.

Exemption for Dealer- Restricted Person affiliated with an issuer 48-501, s. 3.1(2) UMIR 7.7(9)

One commenter noted that under the rule a dealer-restricted person affiliated with an issuer is subject to the issuer and dealer restrictions and suggested adding a clause, similar to Reg. M, which allows a dealer-restricted person affiliated with an issuer or selling securityholder to use the exemptions available to dealer-restricted persons.

Subsection 3.1(2) has been added to the rule to clarify that the exemptions available to dealer-restricted persons continue to be available even where the dealer is an issuer-restricted person.

Research Reports

31.

Research Reports -- Compilations and Industry Research and Issuers of Exempt Securities

The Commission received considerable comment on the issues of compilations and industry research and research on issuers of exempt securities. There was a divergence of opinion. On the one hand, some commenters supported the proposal to allow publication of research for certain securities during a distribution or take-over bid. It was argued that when only a limited number of dealers are permitted to publish, clients are detrimentally affected by a reduction in the information available to these clients.

Upon considering the comments and the potential for conflict, the Commission has decided not to allow single issuer reports to be issued as previously contemplated in section 4.2 but to allow compilation reports to be issued that meet certain criteria. The Commission has removed the requirement in paragraph (d) in proposed section 4.1. Paragraph (d) provided that research could only be disseminated if in addition to meeting the first three conditions, the dealer-restricted person had made a recommendation as favourable or more favourable in the last publication of the report. Several submissions were received that "constrained ratings" would be of limited use and potentially misleading. The Commission is of the view that the three remaining conditions impose sufficient discipline on the compilation report.

48-501, s. 4.1 and 4.2 UMIR 7.7(6)

On the other hand, some commenters were concerned about the potential conflicts that may arise if any type of research is permitted during a distribution. The potential conflict, it was argued, may arise because there is a possibility that information contained in the research report may vary from that in a prospectus. Further, it was suggested that permitting research during a distribution allows a firm to act in a self-serving manner.

Similar changes have been made to UMIR 7.7(6).

Several submissions were made that paragraph (d) in section 4.1 was too restrictive and the constrained ratings would be of limited use and potentially be misleading.