Fundamental Securities Law Concepts

• Author: Christopher C. Nicholls
• Profession: Faculty of Law, Western University
• Pages: 47-108

47

CHAPTER 3

FUNDAMENTAL

SECURITIES LAW

CONCEPTS

A. INTRODUCTION

This chapter provides an overv iew of some essential securities law ter ms

and concepts. These include three of the most foundational def‌initions

in Canadian securities law: security, trade, and distribution.

B. WHAT IS A “SECURITY”?

1) Introduction

Thus far, we have referred to securities in an imprecise, non-technical

way, as we reviewed some of the basic characteristics of some of the

most common examples of securities, such as shares or debentures

issued by a corporation. Now, we turn to a more detailed examination

of thelegal meaning of the term “security.” As we will see, the mean-

ing of “security,” for purposes of Canadian securities legislation and

regulation, is exceedingly broad and extends to far more instruments,

investments, and devices than are conventionally associated with

the “securities” industry. The question of what constitutes a “secur-

ity” is pivotal because the application of securities legislation typically

depends on a f‌inding that a particular transaction involves a security

(although, as we shall see below, the securities regulators sometimes

have regulatory authority over matters even when there is no security

SECU RITIES LAW48

involved1). Many requirements of securities legislation are triggered

when “securities” are involved, including the following:

1) The requirement that an issuer (such as a corporation) 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 business, capital, or operations of that issuer (i.e., comply

with continuous disclosure obligations) depends on whether it has

issued securit ies in certain circumsta nces or f‌iled a prospectus such

that the company qualif‌ies as a “reporting issuer.”3

3) The quasi-crim inal and civil prohibitions against in sider trading are

trig gered only when someon e with mater ial non-public infor mation

purchases or sells (or “tips” or recommends others to purchase or

sell) securities.4

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

is a take-over bid to acquire the outstanding voting or equity secur-

ities of an issuer.5

5) The registration (essentially, professional licensing) requ irements 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 Microsoft through a broker.

• You buy shares or bonds in a small, private software company d irectly

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 commercial

design studio.

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

2 See, for example, O ntario Securitie s Act, RSO 1990, c S.5 [OSA], ss 1(1) (def‌inition

of “distribution”) and 53.

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

4 Ibid, ss 76 and 134. The def‌inition of “secu rity” in s76 does include, among

other thing s a “related derivative.” Ibid,s 76 (6)(c).

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

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

tration requi red). Although the def‌i nition of “‘trade or ‘trading ’” does include

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

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

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

to s 25 a new s1.1, which anticipates t he possibility of a regist ration category

based on tra ding in derivatives, SO 2010, c 26, Sched 18, s 19.

Fundamenta l Securities Law Concept s49

• 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 tran sactions involves a security? Most people would

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

would likely recognize th at bonds, or debentures,7 or other similar 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 pri-

vate company are also securit ies. However, many would fail to recognize

that every other transaction on this list may conceivably be character-

ized as a transaction involving a security, or could be so characterized,

but for specif‌ic exclusions from the def‌inition of security found in the

securities legislation. This shows just how broadly the legal def‌inition

of security is drafted.

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 secur-

ities legislation. In Ontar io, for example, “security” is def‌ined a s 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 associ-

ation of legatee s or heirs,

(d) any document constituti ng evidence of an option, subscription or

other interest in or to a sec urity,

7 At one time, “bond” was a term u sed to refer to secured debt, whi le the term

debenture refer red to unsecured debt — a distinction, as m entioned in Chapter1,

that is sti ll found in some f‌inance texts. Today, however, the ter ms “bond” and

“debenture” are often us ed interchangeably, although it would be unusu al to use

the term “debentur e” to describe a debt instr ument secured solely by a charge on

a particul ar f‌ixed asset.