Fundamental Securities Law Concepts

• Author: Christopher C. Nicholls, Jeffrey G. Macintosh
• Pages: 23-62

CHAPTER

2

FUNDAMENTAL

SECURITIES

LAW

CONCEPTS

A.

INTRODUCTION

In

this chapter,

we

introduce some essential securities

law

terms

and

concepts. These include

the

three perhaps most foundational

defini-

tions

in

Canadian securities law:

security,

trade,

and

distribution.

B.

WHAT

IS A

"SECURITY"?

1)

Introduction

Thus far,

we

have considered,

in

conceptual

terms, what constitutes

a

security

and the

basic characteristics

of

some common examples

of

securities. Now,

we

turn

to a

more detailed examination

of the

legal

meaning

of the

term "security."

The

question

of

what

constitutes

a

"security"

is

central

to the

application

of

securities legislation.

The

application

of

securities legislation depends

on a

finding

that

the

trans-

action

in

question

involves

a

security (although,

as we

shall

see

below,

the

securities regulators sometimes assume jurisdiction even when

there

is no

security1).

Many

requirements

of

securities legislation

are

triggered when "securities"

are

involved, including

the

following:

1 See the

discussion

of

derivatives

in

section

B(12)

below.

23

24

SECURITIES

LAW

1.

The

requirement that

an

issuer prepare

and

distribute

a

prospectus

depends

on

whether there

is a

distribution

of

"securities."2

2.

The

requirement that

an

issuer

publicly

disclose

material changes

in the

life

of the

company (i.e., comply with continuous disclosure

obligations)

depends

on

whether

it has

issued securities (and

whether these securities

are

publicly held, such that

the

company

qualifies

as a

"reporting

issuer").3

3. The

criminal

and

civil prohibitions against insider trading

are

trig-

gered

only when someone with material non-public information

trades

in

securities.4

4. The

application

of the

take-over

bid

rules depends

on

whether

there

is a

take-over

bid to

acquire

the

securities

of an

issuer.5

5.

The

registration requirements

of the

legislation come into play only

when there

is

activity involving

securities.6

What

then

is a

security? Consider

the

following

transactions:

You

buy

shares

or

bonds

of IBM

through

a

broker.

You

buy

shares

or

bonds

in a

small, private

software

company direct-

ly

from

the

company.

You

buy a

unit

in a

real estate limited partnership.

You

buy

units

in a

mutual

fund.

You

lend money

to

your aunt

for the

purpose

of

opening

a

commer-

cial

design studio.

You

buy an

interest

in a

number

of

chinchillas,

in

return

for a

prom-

ise

that

you

will share

in any

profits

generated

by the

sale

of the

chinchillas.

You

open

a

bank account.

You

buy a

life

insurance policy.

You

buy an

interest

in a

time-share condominium unit.

Which

of

these transactions involves

a

security? Most people

would recognize that shares

of a

public company

are

securities. Most

2

Securities

Act

(Ontario),

R.S.O.

1990,

c. S.5

[OSA],

ss.

1(1) (definition

of

"distribution")

& 53.

3

Ibid.

ss.

1(1) (definition

of

"reporting issuer," defined exclusively

in

terms

of the

trading

status

of the

issuer's securities)

& 75.

4

Ibid.

ss. 76 &

130.

5

Ibid.

s.

89(1)

(definition

of

"take-over

bid").

6

Ibid.

ss.

1(1) (definitions

of

"underwriter"

and

"adviser")

& 25

(when

registra-

tion

required).

people would likely recognize that bonds,

or

debentures,7

or

other sim-

ilar

debt instruments issued

by a

public company

are

also securities.

It

is

likely that most people would

similarly

expect that

shares

or

bonds

in a

private company

are

also securities. However, many would

fail

to

recognize that every other transaction

on

this list

may

conceivably

be

characterized

as a

security,

or

could

be so

characterized,

but for

specif-

ic

exclusions

from

the

definition

of

security

found

in the

securities leg-

islation. This shows just

how

wide

the

legal definition

of

security cuts.

2) The

Securities

Act

Definition

How

is it

possible that

so

many things

can be

classified

as

securities?

The

first

place

to

look

for an

answer

is the

definitions section

of the

Act.

In

Ontario,

"security"

is

defined

as

follows:

"security" includes,

(a)

any

document,

instrument

or

writing commonly

known

as a

security,

(b) any

document constituting evidence

of

title

to or

interest

in the

capital, assets, property, profits, earnings

or

royalties

of any

per-

son or

company,

(c)

any

document constituting evidence

of an

interest

in an

associa-

tion

of

legatees

or

heirs,

(d) any

document constituting evidence

of an

option, subscription

or

other interest

in or to a

security,

(e)

any

bond, debenture, note

or

other evidence

of

indebtedness, share,

stock,

unit, unit

certificate,

participation

certificate,

certificate

of

share

or

interest, preorganization

certificate

or

subscription other

than

a

contract

of

insurance issued

by an

insurance company

licensed under

the

Insurance

Act and an

evidence

of

deposit issued

by a

bank listed

in

Schedule

I or II to the

Bank

Act

(Canada),

by a

credit

union

or

league

to

which

the

Credit

Unions

and

Caisses

Populaires

Act,

1994

applies

or by a

loan corporation

or

trust corpo-

ration

registered under

the

Loan

and

Trust

Corporations

Act,

At

one

time,

a

bond

represented secured debt, while

a

debenture represented

unsecured debt

— a

distinction,

as

mentioned

in

chapter

1,

that

is

still

found

in

some

finance

texts.

Today,

however,

the

terms "bond"

and

"debenture"

are

often

used interchangeably, although

it

would

be

unusual

to use the

term "debenture"

to

describe

a

debt instrument secured solely

by a

charge

on a

particular

fixed

asset.

Fundamental Securities

Law

Concepts

25

7