In a notable ruling for sophisticated market participants in Canada’s capital markets, including investment dealers and their clients, the Ontario Capital Markets Tribunal (the “CMT”) rejected all allegations of wrongdoing brought by the Ontario Securities Commission (the “OSC”) against Cormark Securities Inc. (“Cormark”) and the other respondents under the Ontario Securities Act (the “OSA”). In particular, the CMT’s ruling in Cormark Securities (Re)[1] provides new and detailed guidance for market participants considering hedging transactions related to private placements as well as regarding the scope of the CMT’s public interest jurisdiction.
Our key practical takeaways include:
- While “distribution” is defined broadly by the OSA, it has limits. In this case, the CMT expressly confirmed the “extended” definition of a “distribution” does not capture a private placement investor using restricted shares as collateral to borrow freely trading shares in the same issuer to sell short. Or, put more generally, the CMT’s ruling instructs that the “extended” definition of a “distribution” does not function to equate or make interchangeable two distinct sets of securities.
- Absent some form of improper behaviour, “using their knowledge and skills, and benefitting from their efforts, is what is expected of market participants and registrants.” In rejecting all the grounds upon which the OSC argued the CMT’s public interest jurisdiction was engaged by the respondents’ conduct, the CMT characterized the OSC’s allegations as an “overreach” that had the “unfortunate” consequence of adverse financial and reputational consequences for the respondents. The CMT also made several other assertions favorable for sophisticated capital markets participants, including that hedging or managing risk is a “normal and accepted” practice and that “reducing or eliminating risk” does not make a structure contrary to securities law.
- An investment dealer will not be deemed an underwriter or otherwise the advisor of a public issuer in the absence of meaningful evidence of a client relationship. The CMT’s ruling indicates a complicated transaction structure will not erode the lines between sophisticated market participants with their own counsel or make an issuer vulnerable to or reliant on an investment dealer.
Our more detailed comments and analysis follow. For more of Fasken’s capital markets thought leadership, visit our Capital Markets and M&A Knowledge Centre.
The Related Transactions
At issue were a series of related transactions (the “related transactions”) developed by Cormark and occurring around March 17, 2017, the day Canopy Growth Corporation (“Canopy”) joined the S&P TSX Composite Index. These were:
- Canopy sold 2.5 million common shares (the “restricted shares”) to Cormark’s client, Saline Investments Ltd. (“Saline”), by private placement under a prospectus exemption and whereby a four-month hold period was attached to the shares.
- Saline used the restricted shares as collateral to borrow 2.5 million previously issued and freely-trading Canopy common shares under a securities loan agreement.
- Saline sold short 2.5 million Canopy common shares on the TSX, later using the borrowed freely-trading shares to settle the short sales.
- Once their four-month hold period expired, the restricted shares were released to the lender under the securities loan agreement in satisfaction of Saline’s obligation to return the borrowed freely-trading shares.
The OSC’s Allegations
The OSC made three main allegations against Cormark and the other respondents in its proceeding before the CMT:
- First, the aggregate result of the related transactions was a distribution of 2.5 million Canopy common shares to the public that was unlawful for having occurred without a prospectus.
- Second, that Cormark’s conduct in developing the related transactions for its client (Saline) engaged the CMT’s public interest jurisdiction, including for (1) not disclosing the full scope of the related transactions to Canopy, (2) undermining investor protections, (3) avoiding continuous disclosure, and (4) threatening the efficiency of, and confidence in, public markets.
- Third, that Canopy was effectively a client of Cormark such that Cormark owed Canopy a duty to deal with Canopy fairly, honestly, and in good faith.
Canopy was not accused of any wrongdoing by the OSC.
While Defined Widely, a “Distribution” Has Limits
The OSA’s definition of “distribution” includes two components. First, a list of six specific types of trades, including a “trade in securities that have not been previously issued.” Second, what is commonly called the “extended” definition, which includes “any transaction or series of transactions involving a purchase and sale or a repurchase and resale in the course of or incidental to a distribution”. The OSC’s position was that, taken together, the related transactions fell within this “extended” definition of a “distribution”.
The CMT rejected the OSC’s arguments. The fundamental problem was the “premise” at the “heart” of the OSC’s position that the related transactions “effectively converted” the restricted shares into the free-trading shares. The CMT held this notion was “ill-conceived” for being inconsistent with the facts. Key here was that the restricted shares and free-trading shares were “distinct sets of securities” with different CUSIP numbers and with only the restricted shares bearing a restriction legend. Also key was that the hold period applicable to the restricted shares had been honoured. That the related transactions were “designed to work together” did not impact either of these realities nor make the two separate sets of securities “interchangeable”. Stated differently, the CMT did not “consider it appropriate to extend the definition of distribution to include transactions involving different shares.”
Engaging the CMT’s Public Interest Jurisdiction Requires More Than Market Participants Using Their Knowledge and Skills in Pursuit of Financial Benefit
The OSC argued the CMT’s public interest jurisdiction was engaged by Cormark conduct the OSC viewed as concealing the full scope of the related transactions from Canopy. In particular, the OSC argued full disclosure of all of the related transactions was necessary for Canopy to make an informed decision as to whether to participate.
However, the CMT saw no such misleading conduct or concealment. No direct evidence had been presented that Cormark had represented its proposal as being in the “ordinary course”. The CMT also found that Cormark had communicated sufficient information for Canopy to understand that short-selling of Canopy shares would occur in connection with the private placement. Nor was it improper for Cormark not to disclose the risk-reward ratio faced by Cormark’s client, Saline, as the CMT saw this issue as irrelevant to Canopy’s decision-making. Finally, Cormark had no duty to disclose any alleged risks to Canopy’s net-proceeds posed by the short sales. Canopy had all information necessary to conduct its own analysis and had done so.
The OSC also argued the CMT’s public interest jurisdiction was engaged by Cormark conduct that (1) undermined investor protections, (2) avoided continuous disclosure, and (3) threatened the efficiency of, and confidence in, public markets. Each of these submissions was also rejected.
The OSC argued the related transactions were deliberately structured to avoid the hold periods imposed by the OSA. This allegation failed because “no new shares were added into the public market until the hold period expired.”
The OSC also took issue with the private placement being deliberately sized so that it was not a material change and to comply with insider trading rules. However, the CMT saw nothing inappropriate about Cormark being (1) careful to structure the related transactions to comply with securities law, and (2) prepared to abandon the deal if its preferred approach could not be achieved. Nor did the respondents telling Canopy that the private placement was designed to be immaterial amount to the respondents discouraging Canopy from making timely public disclosure.
The CMT disagreed with the OSC’s submission the related transactions threatened the efficiency of Ontario’s capital markets and confidence in them as an efficient pricing mechanism because the short sales were unlikely to contribute to an efficient trading price. The CMT held that short sales are a common element in many trading strategies and that all trading contributes to pricing a security. The CMT also noted the OSC had not introduced expert evidence supporting its position on the point.
Finally, the CMT held the high standards of fitness and business conduct required of registrants is not breached by registrants using their knowledge and skills, and benefitting from their efforts. Indeed, the CMT held that this is “what is expected of market participants and registrants.”
An Investment Dealer-Client Relationship Requires Meaningful Evidence Toward That End
The OSC argued that Canopy was a client of Cormark, and as such, Cormark had a duty to deal with Canopy fairly, honestly and in good faith. However, as the CMT did not agree that Canopy was a Cormark client, these duties did not apply.
The CMT found that whether a client relationship exists is highly contextual, depends on the relevant circumstances, and is guided by the purposes of the OSA. Citing the non-exhaustive list of indicia established by precedent [2], the CMT based its decision on four considerations.
First was that, to the extent Cormark was conducting registerable activities in relation to the related transactions, it was doing so on behalf of Saline. Canopy was experienced in raising capital, had its own experienced securities counsel in connection with the transaction, and had an experienced board of directors. Canopy therefore was neither vulnerable to Cormark nor relied on Cormark. Nor was the fact that Canopy benefitted from the transaction sufficient to transform Canopy into a Cormark client alongside Saline.
Second was that any benefit received by Cormark from the related transactions was indirect, hypothetical, and/or insignificant. Canopy did not pay Cormark. While Cormark’s exposure to Canopy could result in future business for Cormark working for Canopy, this possibility was speculative at best. Saline, on the other hand, was already an established client of Cormark. The commission Cormark received from Saline was also minimal in the context of the transactions.
Third, there was no underwriting or agency agreement between Canopy and Cormark. Canopy had raised the possibility of such a contract, but never required one. Cormark, by contrast, had indicated it did not think one was necessary.
Fourth, while the OSC argued that weight ought to be given to the parties’ beliefs regarding the nature of their relationship, the CMT was not persuaded either that Canopy believed it was Cormark’s client or that Cormark believed Canopy was its client. Nor did the evidence given by Canopy’s two external counsel support the notion that Canopy was Cormark’s client. Communications between the parties also evidenced that Cormark viewed Saline as its client, not Canopy.
Concluding Comments
