INTRODUCTION I THEORY AND ACTION: THE ONTARIO SECURITIES ACT AND ITS REGULATORY REGIME i. Ontario Securities Act 111 ii. Manifestation in Securities Regulation: National Policy 62-202 and Poison Pill Decisions II CRITICISMS OF THE CURRENT REGIME III THE PROPOSED CSA REFORM: NATIONAL INSTRUMENT 62-105 IV ALTERNATIVE PROPOSAL: THE PERMITTED BID MECHANISM CONCLUSION INTRODUCTION
Shareholder Rights Plans (commonly referred to as "poison pills"), which allow a target company to fend off a hostile take-over through issuing new shares at a discounted price, have for many years been an established but controversial aspect of Canadian corporate law. (1) However, in 2013, the Canadian Securities Administrators ("CSA") introduced a significant change to the Canadian take-over bid regime through the proposed National Instrument 62-105--Security Holder Rights Plans. (2) The proposed National Instrument 62-105 would carve out poison pills from the current non-binding national policy on defensive tactics (3) and make them subject to binding, national rules. As a result, renewed discussion regarding the respective benefits of new poison pill regulation in Canada is warranted.
This article endeavors to contribute to such discussion by analyzing the proposed National Instrument 62-105 based on its conformity with the goals of the Ontario Securities Act ("OSA") (4) and the Ontario Securities Commission's implementation of such goals. (5) In this regard, the article also explains why an alternate reform based on a permitted bid mechanism would be preferable to the proposed National Instrument 62-105.
Following this introduction, Part I discusses the goals of the OSA--efficiency, investor protection and fairness--as well as how such goals have been interpreted and implemented by the Ontario Securities Commission in Ontario securities regulation. Next, Part II discusses common criticisms regarding the Ontario Securities Commission's methods for implementing the OSA's goals during hostile take-over bids. Part III then discusses the proposed National Instrument 62-105, including concerns that weigh against its adoption. Part IV in turn explains why an alternate reform based on a permitted bid mechanism would be preferable.
I THEORY AND ACTION: THE ONTARIO SECURITIES ACT AND ITS REGULATORY REGIME
ONTARIO SECURITIES ACT
As a starting point, the Ontario Securities Commission is required to regulate in accordance with the goals of the OSA. In section 1.1 of the OSA, the OSA's goals are outlined as follows:
to provide protection to investors from unfair, improper or fraudulent practices; and
to foster fair and efficient capital markets and confidence in capital markets. (6)
As made clear by section 1.1 and supplementing Canadian jurisprudence, the OSA is predominantly investor-centric in focus. The language of section 1.1 could of course be interpreted as making investor protection instrumental to instilling confidence in capital markets and promoting efficiency. In other words, one could interpret section 1.1(a) as being important only to the extent that it reduces information asymmetries or distrust that can prevent well-functioning markets with free-flowing capital, as envisioned by section 1.1(b). However, the investor protection goal of section 1.1(a) has come to occupy a distinct position in securities law. (7) Canadian courts and the Ontario Securities Commission have generally interpreted the language of section 1.1(a) as creating a goal in itself, rather than a mechanism for facilitating more efficient markets. Relying on early American cases that adopted a strong, almost paternalistic view of investor protection, (8) the Canadian Supreme Court in Pacific Coast Coin Exchange v Ontario Securities Commission (9) adopted a similar stance as such American cases. (10) In doing so, it rejected a weaker caveat emptor model endorsed by the dissent that would arguably have allowed freer movement of capital and facilitated more efficient markets. The Ontario Securities Commission has subscribed to the same framework that was adopted by the majority in Pacific Coast Coin Exchange, and it continues to make investor protection an important consideration in the provincial securities regulatory framework. (11)
As indicated by section 1.1(b), the OSA also emphasizes the importance of
fostering efficient capital markets. While the OSA does not define the term "efficiency", it does provide some indications of what it entails. For instance, cost-benefit efficiency has been incorporated into the OSA. Section 2.1(6) of the OSA instructs the Ontario Securities Commission to consider whether the constraints and costs placed on market participants are proportionate to the significance of the regulatory objectives. In addition, law and economics theory (12) has worked its way into Ontario securities law. Although it is not explicitly mentioned in the OSA, Ontario securities regulators appear to have endorsed this aspect of efficiency, at least in the take-over bid context. (13)
The OSA also mentions the importance of fostering fair capital markets. In this regard, one's opinion as to whether a given situation is or is not fair is contingent on the underlying normative theory to which one subscribes. (14) The term "fair" itself does not provide an independent standard against which actions may be measured as do investor protection or efficiency, but instead describes the extent to which an action measures up to a separate, unmentioned standard or goal. (15) Interestingly, the OSA does not indicate the separate standard against which fairness should be measured, but it could be assumed that absent any other indications, the OSA's conception of fairness captures the extent to which treatment of market participants is equitable or even-handed based on the normative values within the investor protection and efficiency rationales. (16)
In addition, fairness can be further broken down into procedural and substantive components. Provisions of the OSA incorporate aspects of procedural fairness, though substantive fairness is not explicitly discussed in the OSA and is therefore a source of debate. Procedural fairness can itself be subject to different understandings, though investor protection and efficiency are often aligned in this regard. Consider, for instance, provisions in the OSA that require a hostile bidder to disclose information so that shareholders can make an informed choice whether or not to tender to the offer. (17) In such cases, the provisions are consistent with the efficiency goal as they reduce transactional costs from information asymmetries. The provisions are also consistent with the investor protection goal as they prevent a bidder from taking advantage of shareholders because it has better information than they do. (18)
However, in some situations, there is divergence between what efficiency and investor protection consider to be procedurally fair. For instance, procedural rules that require equal treatment of shareholders would tend to be disfavored from the standpoint of efficiency as they can make transactions more expensive to complete and inhibit the transfer of resources from less efficient to more efficient uses. However, securities law has generally sided with investor protection in such situations. (19) Thus, to the extent that efficiency and investor protection lead to conflicting conceptions of procedural fairness, it is likely that Ontario securities regulators will take the side of investor protection.
Provided that the prescribed structural protections are followed, procedural fairness is ambivalent to the fairness of the price offered to shareholders. Substantive fairness, however, is not. Instead, substantive fairness focuses on whether the tender offer (rather than just the tender process) is itself fair. While not directly reflected in the OSA, the OSA's conception of fairness is arguably broad enough to encompass substantive elements. (20) Like procedural fairness, substantive fairness is also generally framed based on efficiency and investor protection. When considered from the perspective of efficiency, a fair tender offer can be determined solely through the market price of the target company's shares, since this reflects the company's value based on all the information available in the market. (21) In an efficient market, bid premiums over the pre-bid share price of a target company reflect the fact that the transaction will generate increased value through more efficient management or realization of synergies. Substantive fairness would therefore require a determination of the percentage of this increased value that should be allocated to target shareholders through a bid premium, and the percentage that the bidder should retain. (22) As Professor Jeffrey MacIntosh has argued, it is difficult to come up with a convincing reason as to why target shareholders deserve to receive a premium over the market price of shares. (23) Moreover, as target shareholders extract more value from a bidder, the bidder's returns from the transaction will decrease. (24) Lower systematic returns for bidders will likely result in fewer take-over bids, which would mean that less value would be realized across the market as a whole. (25) In addition, to the extent that the threat of a hostile take-over is decreased, directors may also be less motivated to maximize value, which could result in inefficient management. This in turn would create a less valuable company, and thus lower share prices.
However, investor protection proponents have highlighted market inefficiencies that indicate that the market price of a company's shares might not always determine the fairness of a tender offer. (26) In particular, when markets are not perfectly efficient, the share price of a company may sometimes diverge from the intrinsic value of the company's shares. Thus, market price alone may not set a "fair" price as it may not always reflect the actual value...