The case involved a proposal to alter MFDA’s by-laws respecting the length of terms of directorship (“Proposal”). BCSC panel directed the MFDA to cease improperly soliciting proxies regarding a pending and controversial vote.

The Proposal

The Proposal was written by a four-person task force including two sitting directors whose very continuation in office was contingent upon approval of the proposal, giving rise to an inherent appearance of self-interest.

Although the task force believed that the proposal was supported by a “significant majority” of its members, they worried that they were at risk of defeat by a minority of opposed members who could prevent approval if the attendance at the meeting was low.  To mitigate this risk, the MFDA contacted members and asked them their opinions about the proposal, and offered them the opportunity, in the event they could not be present, to provide a proxy in favour of an MFDA director supportive of the Proposal.  However, no alternate or non-director proxy was offered.

The conflict of interest was refuted by the MFDA saying they acted with the “sincere intention of encouraging member participation in an important process and with absolutely no intention of pressuring any member.   However, the Commission appeared to doubt this intention, noting the MFDA’s failure to contact known opponents to the proposal.

Managing the Potential Conflict

The Commission drew a clear distinction between the proxy solicitation process among corporations and regulators. A shareholder of a corporation is entitled to vote arbitrarily, motivated only by self-interest.   However, it was held that the very relationship between the MFDA and a member creates an “inherent and foreseeable” risk that the member may feel pressure to vote in favour of management-sponsored resolutions if MFDA directors are involved in the proxy solicitation process.

In holding that this process would have led an objective observer to question the integrity and credibility of the MFDA, the Commission directed that any proxy solicitation be conducted through independent proxy solicitation service providers. Further, the Commission directed that the MFDA board’s role should be limited to ensuring that this independent process is appropriate and is being followed; and directed that MFDA members’ votes be kept confidential from its officials.

MFDA as SRO

In its judgment, the Commission panel did praise the MFDA as an effective and credible regulator of mutual fund dealers generally, and emphasized that despite this finding on a narrow internal governance issue it was “not making any adverse findings about the MFDA’s overall integrity or credibility as” a self-regulatory organization.

An investor is said to monetize the equity in securities when she or he transfers the risk and/or return of those securities for cash, without actually transferring ownership or control.  It is a way for investors to lock in a market gain without concurrently transferring ownership of the underlying security.

The guidelines consider a number of common derivative transactions giving rise to the duty to file an insider report through the System for Electronic Disclosure by Insiders (SEDI):

• Entering into a forward contract to sell the securities for a fixed amount on a specific date
• Entering into a swap transaction which has similar effect to such a  forward contract
• Buying a put option which allows, but does not obligate, the insider to sell the securities on a specific date for an amount which is either fixed or formula-based
• Simultaneously buying a put option allowing the insider to sell to another party at a certain price, and selling a call option allowing the same party to buy the same securities from the insider at a higher price.  The sale of the call option exercisable at a higher price is a way of financing the purchase of the put option.  The combination of a put option and call option is sometimes referred to as a “collar”
• Borrowing an amount close to the current fair market value of the securities under a limited-recourse secured loan for which the lender cannot look beyond the securities for repayment on its due date

Such transactions are most commonly entered into with investment banks who hedge their risk by entering into a series of short sales in the secondary market.

Step-by-step details of the recommended filing methods can be found here.

The guidelines are not mandatory but do serve to give comfort to the investor that disclosure will be acceptable; and they also serve to enhance uniformity of insider reporting requirements throughout Canada.

In the midst of a take-over battle between Russian-based Severstal Gold NV and Grand Cayman-based Endeavour Financial Corporation, Severstal asked the BC Securities Commission to compel TSX-listed Endeavour to comply with Canadian take-over bid requirements (Instrument MI-62-104 – Take-over Bids and Issuer Bids).

Pending that determination Severstal applied to the Executive Director to issue temporary order under section 161(2) of the Securities Act prohibiting Endeavour from trading Crew securities until a hearing was held to consider the issues raised by Severstal in its application.   The application was investigated quickly and 9 days later, the Executive Director issued a reply declining to intervene.

In last Thursday’s reasons,  the Securities Commission made short shrift of Severstal’s application to review that refusal, doing so both on procedural and substantive grounds.

Procedurally, the Commission applied Alberta and B.C.  law that the Executive Director’s discretion whether to issue such a temporary order is not subject to a review to the Commission under section 165(3) of the Securities Act.    It is not reviewable since the failure to make an order is not the same as a “decision” of the Executive Director which would be subject to statutory review.  Furthermore,  Severstal was held not to have standing to apply for a cease-trade order in that situation.

Although it could have simply dismissed Severstal’s application on procedural grounds, the Commission went one step further, in a move which is a caution to parties involved in a take-over battle not to use the Commission as a tool to manipulate a market battle without good reason.   The reasons underlying Severstal’s application were first, that recent Endeavour purchases in the marketplace were made with insider information; and second that having acquired more than 20% of the target company the purchases constituted a take-over triggering a regulatory process.  Severstal had itself announced a plan to make its own take-over bid at a price below what became the rising market price.

The Commission was obviously miffed with Severstal’s serious allegations of insider trading when it did not produce a shred of evidence to support it; the Commission expressed “concern” over that false allegation.    There had also been no ”take-over bid” triggering the Canadian regulatory process, since Endeavour’s purchases of Crew Gold stock were made offshore and not from sellers “any of whom is in the local jurisdiction”.

I view the Securities Commission’s willingness to expand its decision to cover substantive issues, and its rebuke over false inside trading allegations, as indicative of its disinclination to be used as a tool by which public companies may seek to use securities regulation to manipulate natural market forces.