Proposed Rescission: Rescission of OSC Policy Statement No. 5.2 - Notice and Request for Comments

ONTARIO SECURITIES COMMISSION POLICY STATEMENT NO. 5.2

JUNIOR NATURAL RESOURCE ISSUERS

DISCUSSION PAPER

OSC Policy Statement No. 5.2 - Junior Natural Resource Issuers, which was remade into a rule entitled In the Matter of Certain Trades in Securities of Junior Resource Issuers (1997), 20 OSCB 1220, effective March 1, 1997, (the "Policy") is scheduled to expire on the earlier of the date on which a new rule intended to replace it comes into force and July 1, 2001. The preliminary view of the Commission, subject to considering comments which may be received during a 90 day comment period, is that a new rule not be developed to replace the Policy and, accordingly, that the Policy be permitted to expire on July 1, 2001. The Policy regulates the financing and, to some extent, the operations of non-TSE listed junior natural resource reporting issuers in Ontario. A 90 day comment period is being provided given the pivotal role of the Policy in the regulation of junior natural resource issuers.

Background

Development of Policy

Since the late 1960's, the Commission has had policies in place that are specific to the junior natural resource sector. Policies relating to maximum offering price, escrow, and vendor consideration for resource properties date back to 1966.

In 1986, an advisory committee chaired by E.G. Thompson (the "Thompson Committee") was invited by the Ministry of Northern Development and Mines to review and make recommendations on the effectiveness and efficiency of Ontario’s capital markets in providing capital for the junior natural resource sector and to propose changes to make Ontario competitive with other jurisdictions.

The Thompson Committee conducted an exhaustive review of the junior natural resource sector, focussing mainly on the competitive position of Ontario as compared to the other provinces. Input was sought from a wide range of experts. The Committee observed that the policies of the OSC and the TSE since 1967 were too structured and rigid and did not provide the flexibility required by the junior natural resource sector. In particular, the Committee was of the view that former Policy 3-02 (which related to junior natural resource financing) had resulted in a rigid financing structure that did not sufficiently reward vendor-prospectors, encouraged broker-dealers to sell paper to the public at the maximum mark-up without proper screening, and resulted in limited amounts of invested capital actually being spent on projects in the field. Policy 3-02 and Policy 3-03 (which related to escrow of shares of junior natural resource issuers) were repealed in 1982, leaving a regulatory vacuum and thereby causing staff of the Commission to review certain attributes of junior natural resource financings on a case-by-case basis.

The proposals of the Thompson Committee led to the adoption of the Policy in 1988 which has remained unchanged since then. The Policy incorporated many of the recommendations of the Thompson Committee and brought together elements of a number of separate existing policies and policy positions relating to junior natural resource issuers.

The provisions of the Policy may be broken down into four general categories: (i) those which were adopted to curb specific abuses which had been occurring in the junior natural resource capital markets, such as unconscionable commissions being charged by broker-dealers and junior natural resource financings in which only a small percentage of invested capital was actually being used for exploration; (ii) those which regulate both arm’s-length and non arm’s-length transactions such as private placements and vendor consideration in connection with resource property acquisitions; (iii) those which provide exemptive relief for share-for-debt issuances and financial assistance from insiders; and (iv) those which regulate disclosure such as the requirement that a prospectus be accompanied by a Risk Disclosure Statement.

Factors Underlying Determination to Rescind the Policy

CDNX Application

Following the exchange restructuring which occurred at the beginning of 2000, CDNX made application on March 18, 2000 seeking an amendment to the Policy to provide an exemption for CDNX issuers from the application of the Policyin its entirety or, alternatively, an exemption from the majority of its provisions. The application also sought an amendment to the Blanket Ruling entitled In the Matter of Certain Trades in Securities of Junior Resource Issuers to permit CDNX issuers that comply with CDNX policies to avail themselves of the prospectus and registration exemptions provided by the Blanket Ruling.

In connection with the application made by CDNX, staff conducted an examination of CDNX policies and staff practices relative to the provisions of the Policy. Based on its findings, staff concurs with the submission made by CDNX in its application that, "The combination of CDNX Corporate Finance Policies and the requirement for Exchange acceptance for most transactions, together with the general oversight function exercised by CDNX, offers a more flexible method of providing at least equivalent regulation of CDNX issuers."

While the Policy addresses a broad cross section of market-related and corporate activity, the primary regulatory utilization of the Policy has historically been in the areas of minimum expenditures on resource properties; escrow requirements; vendor consideration for resource properties; offering structure and dealer compensation; private placements; bonuses for loans and guarantees and finder’s fees; management remuneration; and interests in adjacent resource properties and retained interests. CDNX has broadly equivalent regulation in all of these areas except for certain facets of regulation related to offering structure and dealer compensation. However, as summarized below, certain of these areas are regulated by other securities regulation, certain areas are best addressed through underwriters exercising their responsibilities and through the discipline imposed by the marketplace, and certain areas are no longer utilized or relevant.

Regulated by other Securities Regulation
- minimum size of prospectus distribution as it relates to sufficiency of proceeds to accomplish stated purpose of issue
- requirement to hold proceeds of best efforts offering in trust until minimum amount of offering is received
- parameters for extended green shoe option

Underwriters’ Responsibilities/Discipline of Marketplace
- maximum dealer compensation
- minimum size of prospectus distribution
- size and terms of secondary offerings

No longer Utilized/Irrelevant
- promoter’s option
- requirement for market maker for CDN issuer

The balance of the areas addressed by the Policy, generally speaking, relate to more peripheral areas of activity and are more marginal in terms of their regulatory importance.

The CDNX review process facilitates a more flexible approach to regulatory oversight than occurs at the securities commission level, particularly if the governing regulatory instrument is in the form of a rule. The application of CDNX Corporate Finance Policies results in issuer transactions being categorized on the basis of pre-determined criteria which are formulated based on the relative materiality and risk associated with a given transaction. The more material the transaction, or the more risk involved therein, the more thorough the review which is conducted by CDNX corporate finance analysts and the more onerous are the filing requirements. Further, there is the flexibility to apply CDNX policies more or less stringently depending upon the nature of the particular transaction, the players involved, and the financial circumstances of the issuer.

In addition, the imposition of minimum listing requirements, continued listing requirements, and ongoing market surveillance provides CDNX staff with the ability to continually monitor regulatory compliance by its listed companies. In addition to real time market surveillance functions, CDNX utilizes listed company surveillance officers who conduct post-facto reviews of transactions conducted by listed companies and the adequacy of related disclosure. These reviews facilitate a second assessment, from a broader perspective, of whether issuers are in regulatory compliance.

Developments in the Junior Natural Resource Sector and in the Securities Industry

As noted above, the Policy was developed in the late 1980s in response to concerns related to the effectiveness and efficiency of Ontario’s capital markets in providing capital for the junior natural resource sector. The Policy was designed to, amongst other matters, curb specific abuses which were occurring in the junior natural resource capital markets. These abuses stemmed from the highly speculative nature of resource exploration and the nature of the financings and transactions which were being conducted.
At the time of the development of the Policy, the financings which were being conducted in the junior natural resourcesector tended to be small in scale, usually being confined to the province of Ontario. More often than not, broker dealers were involved as underwriters, agents and/or advisors. The combination of a highly speculative industry which, at the time, was the speculation of choice; small Ontario-only financings; the unfettered practices of broker dealers; and unequal bargaining power between small promoters and broker dealers no doubt all contributed to the abuses which had come to characterize the sector.

More recently, there have been significant concerns related to the accuracy and integrity of public disclosure in the mining sector generally. It appears that systemic weakness in the reporting process for mineral exploration projects has generally underlain these concerns, although fraud has been involved in some of the more egregious cases. Recently enacted National Instrument 43-101 Standards of Disclosure for Mineral Projects, which upgrades the requirements for technical reporting and disclosure, is designed to address these concerns.

The Policy was not designed to, and does not, address the above noted reporting and fraud related concerns. However, there do not currently appear to be problems in Ontario in those areas regulated by the Policy. It would appear that the introduction of the Policy was the initial impetus for this development. However, it would also appear that other more fundamental factors have been at play: depressed commodity prices; larger financings being conducted both domestically and internationally; the arrival of high tech as the speculation of choice; the regulation of broker dealers; and the development of policies which upgrade the requirements for technical reporting and disclosure, thereby circumscribing the degree of speculation involved in junior natural resource financings eg. National Instrument 43-101.

Therefore, while the Policy appears to have been successful in meeting the objectives of its architects, it appears that other more fundamental factors are primarily responsible for curbing abuse in the junior natural resource sector today.

Recommendations of Small Business Task Force - No Industry Specific Financing Requirements or Regulatory Regimes

In 1996, the Commission Task Force on Small Business Financing recommended that financing requirements and regulatory regimes not be industry-specific for two reasons: first, because they felt that securities requirements should not be used to facilitate government policy objectives; and second, because they saw no basis for distinguishing between various industries. For example, the Task Force pointed to the fact that they saw no clear basis upon which to distinguish between a natural resource company with an unexplored property and a bio-tech company with an unproven pharmaceutical product. The Task Force was of the view that abuses should be addressed through Enforcement, not through legislation.

Staff concurs with the observation of the Task Force that there is no clear basis upon which to distinguish between industries. Accordingly, staff is of the view that any regulation which is formulated to facilitate the capital formation process and/or curb abuse should not be, and need not be, industry specific.

Consistent CSA Regulation

Concern has been expressed by many capital market participants in recent years that securities regulation at the provincial level is inefficient and excessively costly for participants, in large measure due to inconsistent regulation and staff practices across the country. To address these concerns, the CSA has attempted to establish consistent regulation and staff practices across its member jurisdictions. The Policy represents an impediment to this initiative.

The Unlisted Market

As discussed above, CDNX Corporate Finance Policies and practices address most of the functional areas regulated by the Policy, providing at least equivalent regulatory safeguards. While most junior natural resource issuers in Canada are now listed on CDNX, there remains the unlisted market. The Canadian Dealing Network was phased out of existence on October 10, 2000. Approximately 800 CDN stocks were moved to the Canadian Unlisted Board Inc. ("CUB") which is essentially a reporting system where investment dealers file information regarding their trades using internet technology. There is no public dissemination of data on this market.

Many of the 800 former CDN stocks are small, involving very illiquid domestic companies, while almost half are U.S. issuers which trade infrequently in Canada. It is estimated that there are approximately 150 unlisted mining companies which previously had trades in their securities reported to CDN by Ontario registrants and now have such trades reported to CUB. Approximately 115 of these companies are reporting issuers.

Given the low visibility of the unlisted market and the limited number of mining issuers reported thereon, staff is of the view that its existence does not warrant a separate instrument to regulate the affairs of these mining companies. In thisregard, there are no other industry-specific financing requirements or regulatory regimes that apply to the unlisted market.

While the future of automated trading systems ("ATS’s") has yet to unfold, it is unlikely that these systems will focus on stocks that trade in the unlisted market. As such, it does not appear that the evolution of ATS’s will result in a significant regulatory gap for the junior natural resource sector.

Commission’s Preliminary View

The preliminary view of the Commission, subject to considering comments which may be received during a 90 day comment period, is that a new rule not be developed to replace the Policy and, accordingly, that the Policy be permitted to expire on July 1, 2001.


Request for Comments

Interested parties are invited to make written submissions with respect to the Request for Comments. Submissions received by March 30, 2001 will be considered.

Submissions should be made, in duplicate, to:

The Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

A diskette containing the submission (in DOS or Windows format, preferably WordPerfect) should also be submitted to the Secretary. Since the Act requires that a summary of written comments received during the comment period be published, confidentiality of submissions cannot be maintained.

Questions regarding the discussion paper may be referred to:

Rick Whiler
Senior Accountant
Corporate Finance Branch
Tel: (416) 593-8127
Fax: (416) 593-8244
email: [email protected]