Fundamental securities law concepts

• Author: Christopher Nicholls
• Pages: 23-74

23

CHA PTER 2

FUNDAMENTAL

SECURITIES LAW

CONCEPTS

A. INTRODUC TION

This chapter provides an overv iew of some essential secur ities law

terms and concepts. These include the th ree perhaps most foundational

def‌initions in Canad ian securities law: secur ity, trade, and distribution.

B. WHAT IS A “SECURIT Y”?

1) Introduction

Thus far, we have considered, in conceptual terms, what constitutes a

security and the basic characteristic s of some common examples of

securities. Now, we turn to a more detailed exam ination of the legal

meaning of the term “security.” The question of what constitutes a “sec-

urity” is pivotal because the application of securities legisl ation typ-

ically depends on a f‌inding that the transaction in question involves

a security (although, as we shall see below, the securities regulators

sometimes assume jur isdiction even when there is no security1). Many

requirements of securities legislation are triggered when “securities”

are involved, including the following:

1 See the dis cussion of derivatives in Se ction B(12), below in this chapter.

SECU RITIE S LAW24

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 materi al changes

in the life of the company (i.e., comply with continuous disclosure

obligations) depends on whether it has issued securitie s in certain

circumstances or f‌iled a prospectus such that the company qual i-

f‌ies as a “reporting is suer.”3

3) The quasi-crim inal and civil prohibitions against insider trading

are triggered only when someone with m aterial non-public infor-

mation purchases or sell s securities.4

4) The application of the take-over bid rules depends on whether

there is a take-over bid to acquire the outst anding voting or equity

securities of an issuer.5

5) The registration requirements of the legisl ation 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 dir-

ectly from the company.

• You buy a unit in a real estate limited par tnership.

• 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 chinchill as, in return for a promise

that you will share in a ny prof‌its generated by the sale of the chinch illas.

• You open a bank account.

• You buy a life insurance policy.

• You buy an interest in a time-share condominium unit.

Which of these tran sactions involves a security? Most people would

recognize that shares of a public company are securities. Most people

2 See, for example, Ont ario Securities Act, R SO 1990, c S.5 [OSA], ss 1(1) (def‌in-

ition of “distribut ion”) and 53.

3 Ibid, s 1(1) (def‌inition of “reporti ng issuer”).

4 Ibid, ss 76 and 134.

5 NI 62-104, s 1.1 (def‌inition of “take-over bid”).

6 OSA, ss 1(1) (def‌initions of “underw riter” and “adviser”) and 25 (when regis-

tration requi red). Although the def‌i nitions of “‘trade or ‘tradi ng’” does include

activitie s in relation to the tradin g of derivatives (see clauses ( b.1) and (b.2)),

the OSA’s s 25 regist ration requirement itsel f refers to “trading in securitie s.” A

proposed amendm ent to s 25, not yet in force at the date of writing, would add

to s 25 a new subsection , 1.1, which anticipates the p ossibility of a regist ration

category bas ed on trading in derivati ves.

Fundamenta l Securities Law Concept s 25

would likely recognize that bonds, or debentures,7 or other similar

debt instruments i ssued by a public company are also securities. It is

likely that most people would similarly ex pect that shares or bonds

in a private company are also secur ities. However, many would fail to

recognize that ever y other transaction on this list may conceivably be

characterized as a transaction involving a security, or could be so char-

acterized, but for specif‌ic exclusions from the def‌inition of security

found in the securities legi slation. This shows just how broadly the

legal def‌inition of security is drafted.

2) The Securities Act Def‌inition

How is it possible that so many th ings can be classif‌ied as sec urities? The

f‌irst place to look for an answer is the def‌initions section of securities

legislation. In Ontario, for example, “security” is def‌ined as follows:

“security” includes,

(a) any document, in strument or writ ing commonly known as a

se cu ri ty,

(b) any document constituting ev idence of title to or interest in t he

capital, asset s, property, prof‌its, earnin gs or royalties of any per-

son or company,

(c) any document constituting ev idence of an interest in an as soci-

ation of legatee s or heirs,

(d) any document constit uting evidence of an option, subsc ription

or other interest in or to a sec urity,

(e) a bond, debe nture, note or other evidence of indebtedne ss or a

share, stock, unit, un it certif‌icate, par ticipation certif‌icate, ce rtif‌i-

cate of share or interest, pre organization cert if‌icate or subscrip-

tion other than,

(i) a contract of insurance i ssued by an insur ance company

licensed under the In surance Act, and

(ii) evidence of a deposit issued by a b ank listed in Schedu le I, II

or III to the Bank Act (Canada), by a credit union or league to

which the Cred it Un ions and Caisses Populaires Act, 1994 applies,

by a loan cor poration or trus t corporation regi stered under the

Loan and Trust Corporations Act or by an a ssociation to which

the Cooperative Credit Associations Act (Canada) applies,

7 At one time, bond wa s a term to refer to secured debt, wh ile the term debenture

referred to un secured debt — a distinction, as mentioned in C hapter 1, that is still

found in some f‌inance t exts. Today, however, the terms “bond” and “debenture” are

often used inter changeably, although it would be unusual to u se the term “debenture”

to describ e a debt instrument secur ed solely by a charge on a particu lar f‌ixed asset.