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This chapter focuses on the steps involved in bringing investment products to market. Theprocess of listing a security on an exchange is discussed, along with the procedures,requirements and general regulations governing listed companies. A brief examination ofregulations governing investment advisors and other participants in the investment industry fol-lows. Financial industry professionals, as well as investors, need to understand this process inorder to make informed decisions about investments.

A. FINANCINGFinancing, or underwriting as it is sometimes called, is the process by which an issuer (govern-ment or company) raises debt or equity capital either publicly or privately. For governments, thisfinancing is often accomplished through an auction process and occasionally through a fiscalagency. For companies, financing takes the form of a private offering, an initial public offeringor IPO, or a secondary offering. Public financings are undertaken by public companies thattrade on the exchanges and the over-the-counter markets. Private financings are discussed onlybriefly in this chapter.

The finance department of an investment dealer helps corporations and governments achievetheir funding targets. This provides new investment opportunities for investors. There are usual-ly two distinct groups in the finance department of an investment dealer: Government Financeand Corporate Finance.

1. Government Financing

The government finance department specializes in selling debt instruments to institutions andother interested parties, and advises both clients and the issuing governments on debt issues. Thepersons charged with the responsibility of government finance need to be in touch with the mar-ket at all times to ensure awareness of market conditions and prices. Their advice to issuing gov-ernments includes:

The size (or dollar value), coupon (interest rate offered) and currency of denomination ofthe issue;

The timing of the issue;

Whether the issue should be domestic or foreign;

What effect the issue may have on the market; and

Whether the issue should be a new maturity, or whether a previous issue should be re-opened.

Governments issue debt securities because:

Revenues sometimes cannot support the current level of spending;

Funding is required for infrastructure projects (e.g., roads and bridges); and

Funding is required for services (e.g., operating expenses for schools and hospitals).

Chapter 3

Financing, Listing and Regulation

CSI Global Education Inc. (2005)

PRE-TEST

While most investors are familiar with the debt issues of the Canadian Government,both provincial and municipal governments borrow as well. Government financedepartments act as intermediaries between investors and the issuers of debt securities(i.e., the various levels of government), trying to negotiate deals that satisfy both parties.

a) Canadian Government Issues

In preparing for a new debt issue, the Bank of Canada, which acts on behalf of theDepartment of Finance, supplements its own views of market conditions and investorpreferences with informal advice from investment dealers, banks, and other market par-ticipants. This is a pre-marketing phase, prior to the actual issue period, when potentialinvestors are approached and asked whether they would be interested in a security simi-lar to the issue being contemplated. This is commonly referred to as obtaining indica-tions of interest in the contemplated issue. This informal survey helps the investmentdealers and banks acting as advisors to the Government and the Bank of Canada toactually gauge how the market would react to a new issue.

The Canadian Government brings new issues of fixed-coupon marketable bonds andtreasury bills to market on a regularly scheduled basis by using the competitive tendersystem. The securities are issued by way of an auction, whereby the amount won at theauction is based on the bids submitted. Only those institutions recognized as govern-ment securities distributors are permitted to submit bids to the Bank of Canada. Theseinstitutions include the Schedule I and Schedule II banks, investment dealers, and for-eign dealers active in the distribution of government securities. Government securitiesdistributors that maintain a certain threshold of activity are known as primary dealers.

Bids can also be submitted on a non-competitive tender basis, whereby the bid isaccepted in full by the Bank of Canada and bonds are awarded at the auction average.

The process generally works as described below.

Bids are submitted to the Bank of Canada, usually electronically, by 12:30 p.m. onthe date of the auction.

Competitive tenders may consist of up to seven bids stated in multiples of $1,000and subject to minimum size per individual bid of $100,000. Bids do not state aprice for the bond, but instead, the yield on the bond that each bidder hopes toearn.

All parties involved in bidding on an issue have bidding limits that cannot exceed acertain percentage of the total issue. For example, the total amount of bids submit-ted by any primary dealer may not exceed 40% of the total amount of the bondsbeing offered and a bidder may not act in collusion with another bidder.

Each government securities distributor may also submit one non-competitive ten-der, in addition to any competitive bids. The ceiling on non-competitive bids foreach participant is $3 million. Non-competitive tenders are allotted by the Bank ofCanada at the average price of the accepted competitive tenders. A non-competitivetender is in multiples of $1,000, subject to a minimum of $1,000.

The competitive tenders are carefully constructed by the government securities distribu-tors, based on the information received from interested parties during the pre-marketingphase of the issue. The distributor wants to ensure that an adequate number of bondsare received to fill demand, but does not want to submit too low of a yield for fear ofwinning too many bonds in the tender process. The non-competitive tender is less riskyas it is filled at an average price.

The submitted bids are accepted in rising order of yield until the full amount of the auc-tion has been allocated. A detailed list of accepted and rejected bids is not released, but


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the total amount of the bids, as well as the high, low, and average bid, are published. Atabout 2:00 p.m. on the day of the tender, the Bank of Canada sends out complete infor-mation on the results of the tender. Based on this information, each participant candetermine the number and cost of the bonds and/or bills specifically awarded.

Consider an auction of $2.5-billion Government of Canada 10-year bonds, for which10 government securities distributors submit bids in the following manner:

Bidder Competitive Bid Yield* Size

1 5.041% $500 million

2 5.043% $500 million

3 5.043% $500 million

4 5.044% $500 million

5 5.047% $500 million

6 5.048% $500 million

7 5.048% $500 million

8 5.049% $500 million

9 5.049% $500 million

10 5.053% $500 million

Non-Competitive Tenders - $50 million

*Bond yields are discussed in detail in Chapter 5.

In this situation, bonds would be allocated to the first five competitive bidders only,whose bids total $2.5 billion. The first four bidders would receive their total bidamounts, while the fifth bidder would receive $450 million, equal to its bid amountminus the amount of non-competitive bids. Each of the successful competitive bidderspays a price based on its bid. The non-competitive bidders would receive $50 million ofbonds, paying a price based on the average yield of the bonds awarded (i.e., based onthe average yield of the five accepted bids, or 5.0436%).

Generally, the total bids received from the banks and investment dealers, excluding theBank of Canada, are for a greater amount of bonds than the amount being offered, soall bids will not be successful. In addition to bidding for its own requirements, the Bankof Canada stands ready to absorb the entire tender, if required. This implies that theBank could theoretically set the yield at each tender.

To maintain regularity and openness, or clarity (called transparency), in its debt opera-tions, the Canadian Government now holds regularly scheduled quarterly auctions ofbenchmark 2-, 5- and 10-year bonds, and semi-annual auctions for the benchmark 30-year bond. Denominations available are $1,000, $5,000, $100,000 and $1 million.

No commissions are paid to the dealers who purchase the bonds from the CanadianGovernment and there are no selling price restrictions for the successful buyer. TheBank of Canada distributes bonds to primary distributors using the New IssueDistribution Service for Canada Bonds (NIDS), a service provided by the CanadianDepository for Securities.

Other popular Government issues are sold directly to the public by Canada Investmentand Savings (a Crown agency) beginning in October every year, through investmentdealers, banks, and trusts on an agency basis. These debt issues include the CanadaSavings Bond (CSB) and the Canada Premium Bond. These issues are distributed verydifferently than other Federal Government debt issues. The rates paid on these securitiesare set when the issue comes to market and are set to be competitive with bank and

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trust company guaranteed investment products, and to reflect the cashability optionsembedded in these instruments. The government can, if it so chooses, sell as manybonds as is necessary to meet demand.

b) Provincial Issues

Although government bonds are guaranteed and backed by the tax-generating powers ofthe government in question, the size of a government issue is important. There must beenough bonds outstanding (i.e., market depth) to ensure sufficient marketability in thesecondary markets to facilitate large bond trades. New issues of provincial direct bondsand guaranteed bonds offered in Canada are usually sold at a negotiated price througha fiscal agent. Under this method, a provincial government appoints a group (syndicate)of investment dealers and banks to underwrite issues as well as advise and manage theprocess of issuing securities. The syndicate usually includes many major dealers, whosecombined financial responsibility and distribution powers are more than adequate tounderwrite and sell the large issues required by these parties.

The terms direct and guaranteed refer to the structure of the debt issued by the government.A direct obligation is one that is issued in the governments name e.g. Province of Manitoba bonds.A guaranteed debt is an obligation that is issued in the name of a crown corporation, but is guaran-teed by the provincial government as to payment.An example of a guaranteed obligation would be abond issued by Ontario Electric Financial Corporation but guaranteed by the Province of Ontario.

Each fiscal agency agreement lasts at least a year and sets out the participation, the under-writing fee, the types of issues covered and other pertinent matters. There are someexceptions for short-term issue (e.g., private placements arranged by one or two dealersor banks). It is the responsibility of the syndicate manager or lead underwriter of the fis-cal agency to provide continuous advice to the province on market conditions, the char-acteristics of issues most acceptable to investors (innovations are important), the timingof offerings (avoiding simultaneous offerings of other borrowers) and pricing of issues.

As with the Canadian Government issues, there is a pre-marketing phase that essentiallytakes the temperature of the market. After this phase, the terms of the deal are struckbetween the provincial government and the syndicate, and each member of the group isallotted a portion of the issue up to their stated liability.

c) Municipal Issues

Municipal bond and debenture issues are more likely to be placed in institutional port-folios and pension accounts. Municipal bonds and debentures require in-depth knowl-edge of the tax-generating potential of the local municipal area as well as the industrialbase and other demographic information.

Federal, provincial and municipal pension plans are important purchasers of municipaldebt issues. Also, the Federal Government often loans municipalities money directly forspecific projects.

2. Corporate Finance

Corporations seek new financing for a variety of reasons, including the need to:

Increase working capital;

Repay debts; and

Purchase fixed assets, other companies or repurchase the firms own shares.

Very few companies generate enough cash internally to satisfy all their cash needs.Companies often need to borrow to fund activities such as additional research, expan-sion and growth. Even a profitable company must seek external funds to expand andcompete in an increasingly competitive global marketplace. This new funding is provid-



POST-TEST

PRE-TEST

ed by the market if the company can prove that its plans are viable, and that such aninvestment sufficiently compensates the investor for the risk borne from making theinvestment.

Financing is a careful balancing act in which the dealer must balance the needs of thecorporate client who requires funding with the requirements of the investing public whoprovide the money necessary for corporate purposes. The dealer must also balance cur-rent market conditions in both the debt and equity markets with the limitations of thecompanys balance sheet and future prospects. This requires skill in market timing, tech-nical knowledge with regard to legal and financial matters and a thorough understand-ing of financial analysis and promotion. Some of the decisions involved with a new issueinclude:

What types of securities are to be issued;

Whether the issue should be a private or public offering;

What the issue price will be;

What the coupon rate or valuation multiple (such as the price/earnings ratio) will be;

What the underwriting fee charged to the corporation will be;

When the issue will come to market; and

What proportion of the issue will be bought by institutional and by retail investors.

Canadian financings sometimes occur by competitive tender. This is an auction by anumber of dealers to buy an issuers new securities. A negotiated offering is more com-monplace for corporate issues. Under a negotiated offering, a firms management negoti-ates with a dealer on the type of security, price, interest or valuation multiple, specialfeatures and protective provisions needed to market a new issue successfully.

3. The Financing Process

When deciding on who will be the corporations inaugural lead dealer or its new leaddealer, a corporate issuer considers the dealers reputation for providing various services.These include advisory services on timing, amount and pricing of an issue, issue distri-bution, after-issue market support, and after-issue market informational support.Corporate issuers attempt to engage a lead dealer with a better reputation, since thisusually results in both better market acceptance of the issue and a cheaper financing forthe issuing corporation. Frequently used measures of a dealers reputation are the num-ber and the dollar value of new issues for which the dealer was the lead.

The dealers corporate finance team regularly advises corporations and governments ofmarket conditions and factors affecting their outstanding or proposed securities. Theyprovide advice on re-organization of companies, privatization of government companies(i.e., sale to the private sector), taking companies public, buying public shares back, aswell as mergers and takeovers.

When negotiations for a new issue of securities begin between the dealer and corporateissuer, the dealer normally prepares a thorough study of the corporation and the industrywithin which the corporation operates. This includes the position of the corporationwithin that industry, the financial record and financial structure of the corporation, itsfuture prospects, and all risk factors associated with the industry and company. Thisreport is sometimes referred to as the due diligence report. If the dealer has an estab-lished advisory position with the corporation for which the dealer would receive a fee most of this information is already possessed by the dealer. If the dealer has had no previ-ous connection with the corporation, as is often the case for an initial public offering(IPO), the investigation begins from the ground up. Often the assistance of outside con-

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sultants or experts in the appropriate field such as engineering, geology, management, orchartered accountancy, is required. After the study is conducted, the dealer decideswhether it wants to continue to negotiate to be the lead in the proposed offering.

a) The Dealers Advisory Relationship with Corporations

Whether the dealer subsequently acts as principal or agent, the issuing corporation relieson the dealers advice and guidance in security design, including establishing theamount of the issue, its attributes and the final issue price. Corporations that frequentlyraise capital develop a close advisory relationship with the lead dealer similar to the pro-fessional relationship between a lawyer and client. The dealer often is represented on thecorporations board of directors, especially for smaller companies.

From the corporations point of view, continuous access to professional financial adviceis valuable, as is the continuing interest of the dealer in the secondary market of the cor-porations securities. Once the relationship is solidified, the dealer may become the bro-ker of record and may have the right of first refusal on new financings planned by thecorporation.

Dealers also aggressively seek out new corporate clients by suggesting, on an unsolicitedbasis, new financings or creative financing designs to the corporation. This more aggres-sive approach has led to the introduction of numerous innovative financing techniquesand vehicles.

b) The Method of Offering

The dealer helps decide how the issue is to be distributed or sold, either as a privateplacement or as a public offering.

The Private Placement

In a private placement, one or a few large institutional investors, such as banks, mutualfund companies, insurance companies and pension funds, are solicited and the entireissue is sold to one or more of them. Given that private placements are generally offeredto sophisticated investors and institutional clients, the requirements for detailed disclo-sure and public notice are typically waived, thus no formal prospectus need be pre-pared. This dramatically reduces the cost of distribution for the issuing company. Inmany cases, private placements are announced after they have occurred, usually viaadvertisements in the financial press.

Public Offerings

Where the decision is to offer securities to the public in Canada, the corporation andthe dealer come to a preliminary agreement only on whether the dealer is to act as agentor is to underwrite the securities as a principal. Agreement on the dealers commission(when acting as agent) or on the spread between the possible offering price and thedealers cost price (when acting as principal) is arranged at an early stage in the negotia-tions. The final offering price and certain other details are usually finalized just beforethe public offering date. The pricing of the issue and the actual volume of securitiesissued is dependent upon the market environment at the issue date.

Prior to issue, steps are taken to comply with the provisions of the provincial securitiesacts that regulate the manner in which securities may be sold. Whenever a new issue ofsecurities is offered to the public in the province, a prospectus must be prepared inaccordance with the requirements of the particular provincial act, and must be acceptedfor filing by the provincial securities commission.

In addition, the Canada Business Corporations Act requires federal companies issuingsecurities to file a prospectus as specified under the Act.



A primary offering of securities refers to a new issue of securities by an issuer and gen-erally takes place in the initial public offering (IPO) market. The IPO requires a greatdeal of finesse by the underwriter, especially in terms of the pricing and marketing ofthe issue. The company seeking financing is relying on the expertise and advice of theinvestment dealer in providing funding. How the issue is handled can affect the finan-cial well being of the company for years to come.

A secondary offering refers to the public sale of a companys previously issued securitiesmade after its IPO. As with an IPO, a secondary offering (or distribution) is usuallyhandled by an investment dealer or syndicate. The dealer purchases the shares from thecompany at an agreed upon price and then re-sells them at a higher price to institutionsand the public, making a profit on the spread.

In a related tactic, a company may find it advantageous to repurchase some of its out-standing shares currently trading in the market. These repurchased shares are calledtreasury shares. Treasury shares do not have voting rights or dividend entitlements,however the company does have the option of reselling them back to the market at alater date through a secondary offering (or treasury offering). Accordingly, a secondarycommon share offering increases the number of shares outstanding.

c) Advice on the Security to be Issued

The lead dealers corporate finance team plays an important role in designing the newissue and advising the corporation on the best approach in the market. The corporationwants to ensure that the new securities are both consistent with its capitalization (i.e.,the way the firm is financed with debt and equity) and that the restrictive covenants orprovisions included in these new securities do not limit the corporations future deci-sion-making flexibility. Based on the dealers assessment of current market conditions,investor preferences, the impact of various financing options on the corporations exist-ing capitalization, future earnings stability and prospects, the dealer recommends anappropriate financing vehicle.

When considering the merits of recommending a debt issue instead of an equity issue,the dealer considers the advantages and disadvantages of each type of financing.

Factors to consider when choosing between a debt and an equity issue include:

Debt may be the lowest after-tax cost source of financing since interest chargespayable on money borrowed to purchase income-producing assets is tax deductible;

Debt issues do not dilute equity ownership;

Debt increases the rate of return earned by the owners of the corporation if the rateof return earned on the use of the borrowed money exceeds the cost of the bor-rowed money. The opposite holds if the return earned on the borrowed money isless than the cost of the borrowed money.

Assets are not burdened nor is management restricted with the issuance of equity;and

An equity issue improves a companys credit rating by providing a greater cushionagainst insolvency and by enhancing the stability of a corporations operatingincome stream.

Once the decision to issue debt and/or equity is made, the corporation in conjunctionwith the dealer, decides on the exact security to be issued. Table 3.1 summarizes some ofthe advantages and disadvantages in issuing different debt and equity securities.

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TABLE 3.1

Issuing Securities

Advantages Type of Security Disadvantages

B O N D S

Lower interest rate than a comparable Less flexible because of pledgedebenture. of assets to trustee.

Marketable to institutions that require Difficult in mergers and amalgamationsdebt issues secured by assets. because of pledges against specific assets.

D E B E N T U R E S

Flexible: there are no specific pledges or liens. Possibly a higher coupon than acomparable bond because of lack of

Reduction in cost at issue because there pledge on specific assets.is no registration of assets.

P R E F E R R E D S H A R E S

Because preferreds are technically equity, Cost of issuing preferred shares is the company can increase debt outstanding expensive as the dividends are paidand still maintain a stable debt equity ratio with after-tax income.This can increase riskif the issue of preferreds is successful. and cost to the corporation.

Omission of a dividend payment does not Occasionally, non-payment of dividends trigger default as non-payment of interest on preferred issues can trigger the on the bond or debenture would. implementation of voting privileges

Greater flexibility in financing because of for preferred shareholders.

non pledge of assets.

Limited lifespan through redemption of A purchase fund could be drain on shares through open market, lottery or company assets during recessionary times.purchase fund.

C O M M O N

No obligation to pay dividends. Dilution of equity for existing shareholdersNo repayment of capital required. on issuance of additional shares.

Larger equity base can support more debt. Dividends if paid are more expensive(Pre-planning of additional financing) than interest because they are paid

with after-tax dollars.

Market value of the company can be The underwriting discount is usuallyestablished for estate purposes, greater than that which would havemergers or takeovers. been charged on debt issue.

d) Advice on Protective Provisions

The dealer also offers advice about the securitys specific attributes, which may includefor bonds the rate of interest, redemption and refunding provisions, and protectiveclauses called Protective Provisions, Trust Deed Restrictions, or Covenants. Theseclauses appear in a legal document called a Trust Deed. They are called a Deed of Trustand Mortgage in the case of a mortgage bond secured by assets, or a Trust Indenture inthe case of a corporate debenture. These clauses are essentially safeguards placed in theissues contract with the purchaser to guard against any further weakening in the posi-tion of the security holder if the issuers financial position weakens. Protective provisionsmay make an issue more appealing to an investor. A company in weak financial condi-tion may need to include more, or more stringent restrictive protective provisions inorder to float a new issue than a company with greater financial strength.



e) The Prospectus

A prospectus provides a detailed description of the securities offered and of the issuingcorporation, including its history, operations, management, risk and audited financialstatements. The basic principle governing prospectus requirements is full, true andplain disclosure of all material facts relating to the securities offered. A material fact isany information that significantly affects, or would reasonably be expected to have a sig-nificant effect on, the market price of the securities being offered. In no way does theprospectus imply that any government body has approved the issue as being a suitableor attractive investment. The prospectus is designed to enable prospective investors tomake intelligent investment decisions.

The acts of most provinces require that a prospectus accepted for filing by the adminis-trator be mailed or delivered to all purchasers of the securities being offered. This mail-ing or delivery must be made to the purchaser or the purchasers agent by not later thanmidnight on the second business day after the trade.

Prospectuses contain a great amount of important and valuable information concerningboth financial and non-financial matters of the issuer. The information must be present-ed in narrative form to make it more meaningful to prospective investors. Examples ofsome of the more important items required for a prospectus of an industrial companyinclude:

Details of the offering (e.g., offering price to the public, plan of distribution, char-acteristics of the security);

What the company plans to do with the proceeds from the issue;

Information on the business and affairs of the issuer (e.g., history, operation details,directors and their history, legal proceedings);

Factors affecting an investment decision (e.g., risk factors, income tax considera-tions);

Information on promoters, principal security holders, and interest of managementin material transactions; and

Financial information, including the companys share and loan capital structure,operating results, debt, etc.

The issuing company may decide to list their shares in the unlisted market. In this case,a prospectus or a similar disclosure document would still be required for filing with theprovincial administrators.

Most provinces require that issuers file both a preliminary prospectus and a finalprospectus. Additionally, companies that have previously made public distributions andwho are subject to continuous disclosure requirements may also make use of a simpli-fied or short-form prospectus.

Preliminary or Red Herring Prospectus

When the issuer and the underwriters have agreed to the basic terms and methods ofissuing the new securities, they submit the preliminary prospectus to the respectiveprovincial securities commissions for review. The applicable securities commission willthen issue a receipt and the issuing company will have 75 days to prepare, submit andreceive approval for the final prospectus. This period of 75 days is referred to as thewaiting period.

Since the preliminary prospectus is not in its final form, it is required to display in redink on its front cover a statement, in approved form, stating that it is preliminary. Itshould say something to the effect that the preliminary prospectus has been filed but is

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not final, is subject to completion or amendment, and that commitments for the pur-chase or sale of the securities cannot be made until a receipt for the final prospectus hasbeen issued. This prominent warning led to the term Red Herring prospectus.

A preliminary prospectus serves two key purposes. It is a disclosure document requiredunder provincial securities laws. Secondly, underwriters use the preliminary prospectusto solicit expressions of interest from potential buyers of the security.

The dealers may also prepare an information circular, for in-house use only, called agreensheet. For sales representatives, the greensheet highlights the salient features of thenew issue, both pro and con in order to successfully solicit interest to the general public.

The form and content of a preliminary prospectus must comply substantially with therequirements of the acts covering the form and content of a final prospectus. However,the preliminary prospectus often does not include information that is quite importantto potential investors. The price and size of an issue are usually not stated in the prelim-inary prospectus because that information is not finalized until after the issue has beenmarketed to the investment community.

The interval between issuing the preliminary and final prospectus is a mandatory periodduring which only limited communication with potential investors is permitted. Thesales staff is allowed to identify the security, its features, and price (if determined), and isobligated to record names and addresses of individuals and corporations who haverequested and received a preliminary prospectus. If any amendments to the preliminaryprospectus are to be made, a copy of the amended prospectus must be forwarded to allprospective purchasers that had received the original copy. Most other activities in fur-therance of an issue (e.g., entering into agreements of purchase and sale of the newsecurities) are strictly prohibited. Additionally, information not contained in the prelim-inary prospectus, such as market commentary, research and investment reports, projec-tions and other matters relating to the issuer in question, may not be distributed tointerested investors during this time.

Once all of the issues in the preliminary prospectus have been resolved, a receipt isissued by the securities commission and a copy of the final prospectus must be deliveredto all security purchasers on record.

Final Prospectus

A final prospectus must contain sufficient details on the securities being offered for sale,so as to provide full, true and plain disclosure of all material facts about the securitiesproposed to be distributed. The final prospectus must contain all the information thatmay have been omitted in the preliminary prospectus, such as the offering price to thepublic, the proceeds to the issuer (and/or selling security holders), the underwriting dis-count and any other required information that may have been omitted in the prelimi-nary prospectus. The final prospectus must include the consent of experts such asappraisers, engineers, auditors and lawyers whose reports or opinions are referred to inthe prospectus, the certificates and undertakings relating to financing and distributionarrangements, and other documents evidencing compliance with regulatory require-ments.

The regulators review the documents carefully and may require changes before finalapproval. Once approval of the final prospectus is granted, the issue is then said to beblue skyed and may be distributed to the investing public.



Simplified or Short Form Prospectus

Certain issuers may access capital markets without the necessity of preparing a full pre-liminary and final prospectus prior to a distribution. The Short Form ProspectusDistribution (SFPD) system may be used only by certain senior reporting issuers.These are issuers who have made public distributions and who are subject to continu-ous disclosure requirements of annual financial and other required information. Theshort form prospectus works on the theory that much of the information that would beincluded in a full prospectus is already available and widely known because of this con-tinuous disclosure. The SFPD system shortens the time period and streamlines the pro-cedures by which qualified issuers can access Canadian securities markets throughprospectus offerings.

Access to the SFPD system is usually restricted to issuers who:

Have filed an Annual Information Form (AIF);

Have been reporting issues for 12 months prior to the date of the filing of its AIF;

Were not in default of any requirement of the appropriate act or regulations at thetime of the filing of the preliminary short form prospectus or at the time of issuanceof the receipt for the short form prospectus;

Have a large public float (i.e., equity shares listed on a stock exchange held by non-insiders) with a market value of at least $75 million.

Issuers that satisfy the first three conditions may also use the short form system for theissue of high quality non-convertible debt and/or non-convertible preferred shares.

A short form prospectus does not include a large portion of the information found in afull prospectus. It focuses on matters relating primarily to the securities being distrib-uted, such as price, distribution spread, use of proceeds and the securities attributes.The short form prospectus incorporates by reference certain information contained inthe most recent AIF and continuous disclosure documents of the issuer and alsodescribes how members of the public may obtain copies of such documents. The SFPDsystem is one of the reasons why the bought deal has become a frequently used methodof raising corporate capital.

In bought deals, an investment dealer negotiates with the issuer directly and bids for aspecific new issue of securities. Under a bought deal the dealer assumes the risk of theposition; that is, acts as principal. The details of price and the type of issue is decidedeither simultaneously with filing the short form prospectus or shortly thereafter. Undera bought deal arrangement, the spread between the dealers cost and the final sellingprice may be as low as one percent of the issue price, well below traditional financingspreads. Once final regulatory approval is received, the bought issue is sold by theinvestment dealer, either as a private placement to a select group of investors or as apublic issue under a short form prospectus. Distribution probably is not as wide, sinceonly one, or possibly a few, dealers are involved with the bought deal as opposed to themany dealers involved in other types of public offerings. Exhibit 3.1 explains the boughtdeal in more detail.

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EXHIBIT 3.1

The Bought Deal

The process of financing and issuing new securities has changed a great deal over the last twentyyears. Financing a new issue used to be a more time consuming and tedious process. For every newissue, the company, and underwriter as advisor and facilitator, would prepare a long form prospectusthat would in detail address the companys business.This process could take months to complete andthe type and price of the issue, which while not specifically set, could have evolved substantially by thetime approval from the appropriate securities commission was obtained.

During this process, the issue was shopped to potential investors as part of the pre-marketing of theissue. It was commonplace for such issues to include a market-out clause that would allow the deal-er to cancel the issue if market conditions changed to the point where the issue became unsaleable.The risk was assumed by the issuer and not the dealer. Most long form prospectus offerings could beconsidered agency deals or best efforts underwritings.The dealer, in other words, expected tosell the issue but did not guarantee it.

Market participants realized several years ago that issuers of public securities already filed with thecommissions substantial amounts of information regarding their companys affairs. Providing such infor-mation in the long form prospectus was deemed to be unnecessary, as the commissions had alreadyreviewed financial information that the law required public companies to file. In addition, the volume ofnew issue business and the volatility in the market place increased to the point that it was necessary toshorten the elapsed time of the approval process. Consequently, the short form prospectus was intro-duced.This document contained some of the information previously contained in the long formprospectus and excluded some previously disclosed information. Only issuers whose public statusmeant that they had already filed with the securities commission were allowed to use the short formprospectus.This reduced the time necessary to prepare the new issue documents and obtain the neces-sary regulatory approvals.This shortened approval process, in conjunction with a far more competitivemarketplace, meant that dealers had more impetus to act as principals. Dealers purchased entire newissues from corporations (hence the term bought deal), reselling these issues to the investing public.

Internet Prospectus

The first Canadian Internet prospectus offering was an offering by E-MineralsExploration Corp., to Ontario residents, in early 1999. Purchasers could subscribe tothe offer 24 hours a day using an online web connection, and make payment by creditcard. Interested potential purchasers could view the Companys prospectus on line at theissuers website. Since the offering involved no dealer, the know your client rule and thesuitability principle were imposed on the issuer itself who had to obtain dealer registra-tion as a securities issuer.

Offerings over the Internet present jurisdictional issues. For instance, if an issuer resi-dent in British Columbia distributes securities to a purchaser that resides in California,the issuer must comply with the laws of all applicable jurisdictions - in this case, thelaws of British Columbia, the state laws of California and the federal laws of the U.S.Disclaimers should be included at the beginning of the communication, stating thejurisdiction to whose residents the securities are being offered, or, alternatively, statingjurisdictions in which the securities are not available.

f) Other Documents and Sale of the Issue

While the preliminary prospectus is with the securities commissions, work proceeds onthe preparation of other documents for the issue along with the appropriate marketingmaterials. These include:

(i) The Trust Deed or Trust Indenture in the case of a debt issue.

(ii) The underwriting agreement or the agency agreement between the dealer and thecorporation, providing for the purchase of the issue by the dealer for resale or defin-ing the dealers agency position in the offering. This agreement specifies the price tothe public and the price to the dealer.



(iii) The Banking Group Agreement the lead dealer may invite a limited number ofother dealers to join in the offering to the public on the basis of sharing ownership,liability and profits of the issue.

(iv) The Selling Group Agreement an extensive additional group of dealers (frequentlyincluding all members of the IDA and of specified Canadian stock exchanges) maybe offered the opportunity to purchase the new issue for re-sale to their clients.

(v) Final agreement on the public and dealer issue prices. The price to the public isbased on a careful appraisal by the dealer of investor indications of interest. Properpricing of the issue is vital to its success, as an unsuccessful issue results in a loss tothe dealer distributing the issue as principal. It also has an immediate and potential-ly future adverse impact on the ability of the issuing corporation to raise funds pub-licly. An unsuccessful issue from the issuers perspective is one where the corpora-tion does not raise the funds required, or the issue was overly underpriced. Both sit-uations may mean that subsequent issues will be necessary, leading to substantialadditional issuance costs.

g) Example of the Financing Process

The following is a step-by-step description of the financing process in a simplified form.Table 3.2 illustrates this process.

TABLE 3.2

The Financing Process

Issuing Companysells $100 million of bonds

at 98

Financing Group(Dealers A and B) which sells$100 million of bonds at 98

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Step 1

The Issuing Company sells a $100 million bond issue at a discounted price of 98 tothe Financing Group (also known as managing underwriters and syndicate managers orlead underwriters) consisting of Dealer A and Dealer B for public resale at the par valueprice of 100. In this case, the bond issue is sold for a total cost of $98.25 million to theFinancing Group, while the sale to the public is made at $100 million.

Dealers A and B have been in continuous contact with the Issuing Company, providingrecommendations on type, size and timing of the issue, any covenants, protective claus-es, as well as currency of payment, pricing, etc. They also arranged for the preparationof the prospectus and the trust deed, the clearing with securities commissions, and theprovision of selling documents, etc.

The Financing Group accepts the liability of the issue on behalf of Banking Groupmembers, which includes themselves.

In addition to Dealers A and B, the Banking Group consists of Dealers C to T, all ofwhom have previously agreed to participate on set terms and to accept a liability up totheir individual participation. For example:

Dealers A and B might typically have participation (hence ultimate liability) rang-ing from perhaps $7 million to $25 million for an issue size of $100 million.

Dealers C to T agree in advance to their individual participations (i.e., potential lia-bilities) in the Banking Group. Dealers C to T undertake to comply with terms andconditions concerning underwriting and distribution set out in the Banking Groupagreement. Dealers A and B offer various amounts to Banking Group Members Cto T based on estimated distribution ability, geographical locations, etc. However,the Issuing Company may request or require that special consideration be given tocertain dealers. For example, on its global bond issues, the federal government mayrequest that a certain minimum percentage be reserved for Canadian dealers.

Step 2

The Financing Group sells the $100 million bond issue to the Banking Group (DealersA to T) at 98. In practice, a draw down price somewhat higher than 98 is estab-lished. The differential provides a fund which is applied against expenses incurred bythe Financing Group on behalf of the Banking Group in connection with preparing andclearing the prospectus, legal fees, accountant fees, IDA levy, etc. Any residue in thefund is ultimately distributed to Banking Group Members proportionately.

The Financing Group (Dealers A and B) also obtains an override, which is an addition-al payment over and above their original entitlement on the entire issue in payment fortheir services as financial advisors and syndicate managers or leads. Each Banking GroupMember (Dealers A to T) has a preset maximum liability.

Dealers A to T are the dealers whose names appear in so called tombstone advertise-ments which appear in the financial press as a matter of record once the deal has beencompleted.

Step 3

The initial designation of bonds set by the Financing Group may be altered as the saleof the issue progresses.

$60 million of the issue may be allotted to the Banking Group (Dealers A to T) fordistribution to their clients at a price of 100 or par. This means that each dealer has60% of its participation to sell although the liability of each dealer is still 100% ofthe agreed-upon participation.



$30 million may be designated for sales to the exempt list at 100. This list usuallyincludes only large professional buyers, mostly financial institutions, who areexempt from prospectus requirements. They may receive a selling document insteadof the prospectus, which would include the salient features of the issue. Each ofthese buyers is offered bonds by the Financing Group (Dealers A and B) on behalfof the entire Banking Group. Resultant sales are applied to reduce each BankingGroup Members liability proportionately.

If exempt list sales are less than $30 million, the remainder may be returned pro-portionately to the Banking Group (Dealers A to T) or, if considered desirable, allo-cated to other dealers.

$10 million may be provided to (i) the Selling Group, (ii) Casual Dealers, or (iii)Special Group. Bonds allotted to these three groups proportionately reduce eachBanking Group (Dealers A to T) Members liability. However, any shortfall isreturned to the Banking Group.

(i) The Selling Group consists of other dealers, normally members of the IDA,who are not members of the Banking Group (Dealers A to T). They are invitedin writing by the Financing Group to buy bonds at 99 to offer at 100 to theirclients (excluding the exempt list). The Selling Group orders are subject toallotment and each member of the Selling Group has liability for the ordersplaced with the Financing Group.

(ii) Casual Dealers are non-members of the Banking or Selling Groups. They maybe brokers, broker dealers, foreign dealers, banks, etc. They are not offeredbonds directly or indirectly, but may receive orders for bonds from clients andapply to the Financing Group for an allocation. They may, at the discretion ofthe Financing Group, be allotted bonds at say 99 1/2 for resale at 100. Sincethey have firm orders, they incur no liability.

(iii) Special Group orders occur under various circumstances. For example, theIssuing Company may demand special consideration for a dealer or its bankeror, its parents banker, if it is a subsidiary of a foreign parent. The terms andconditions of the allotment are not standardized.

h) After-market Stabilization

Once an issue is brought to market, one of the duties of the lead dealer may involveproviding after-market stabilization of that securitys offering. Under this arrangement,the dealer is required to support the offer price of the stock once it begins trading in thesecondary market (also called the after-market). Typically, the issuing company and thedealer will negotiate the terms of any after-market stabilization as part of the underwrit-ing contract. The dealers role is stated on the front page of the prospectus, and addi-tional information must be provided inside the prospectus.

Three types of after-market stabilization activities are possible.

The most common type of activity is for the dealer syndicate to initially sell securities inexcess of the original amount offered by the issuer for sale to the public. In this way, thedealer oversells the offering, setting up what is called a short position in the stock priorto the close of the offering. Once the offering begins to trade in the after-market, twopossible scenarios could develop: the share price falls below the IPO offer price, or theshare price rises above the offer price on strong demand for the issue.

For example, ABC Co. goes public with an IPO of 10 million shares at $10 a share.The offering includes an over-allotment option (also referred to as a green shoe option)whereby a total of 11 million shares are actually sold to the public. This creates a short

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position of 1 million shares for the dealer once the offering begins to trade. If the priceof the ABC shares drops below the $10 IPO offer price, the dealer will cover the shortposition by buying shares offered for sale by public investors in the after-market. Thebuying activity on the part of the dealer is intended to bring the share price back to itsoffer price. If the price of the ABC shares rise above the $10 offer price, the dealer canexercise the over-allotment option and cover the short position by buying shares fromABC at the original IPO price.

These activities help to stabilize the after-market price of the recently issued security byeither increasing demand in the case of covering a short position or increasing supply inthe case of over-allotment option exercise.

The second most common activity is to penalize members of the selling group if theircustomers flip (sell) shares in weak issues in the after-market shortly after the offercloses. For example, the lead underwriter may reduce the allocation of shares in futureofferings that the offending selling group members are allocated to sell to the public.Since lower future allocations of shares reduce the offending members potential rev-enues, this practice is referred to as a penalty bid. In turn, dealers discipline their IAsby restricting the allocation of future issues to IAs whose customers do not flip shares inthe after-market. In turn, IAs discipline clients who quickly flip shares by not offeringto sell them subsequent new issues that are believed to be underpriced (so-called hotissues). These activities help to support the after-market price of the offered shares byrestricting supply.

The least common stabilization activity is one where the dealer posts a stabilizing bid topurchase shares at a price not exceeding the offer price if the distribution of shares is notcomplete. These activities help to stabilize the after-market price of the recently issuedsecurity by maintaining demand while the dealer attempts to complete the distributionof securities.

4. Other Methods of Distribution

A different form of prospectus may be used when shares are distributed through thefacilities of Canadian stock exchanges. The exchange, rather than the Administrator,reviews the prospectus and approves or disapproves it. Companies already listed may usea less detailed exchange offering prospectus or a statement of material facts with theapplicable exchanges and securities administrators. Currently, only the TSX VentureExchange maintains an Exchange Offering Prospectus (EOP) system.

Distribution to the public through stock exchange facilities is essentially a Canadianinnovation and does not occur on the stock exchanges of most other countries.

a) Junior Company Distributions

When a listed junior company decides it must raise new capital through a distribution oftreasury shares to the public, it must find a member firm to act either as an underwriterfor the offering or to act as the issuing companys agent with respect to the offering.

Treasury share underwritings or distributions through the facilities of a stock exchangeare usually priced below the stocks prevailing market price, but the discount from themarket can be no greater than a stated schedule of percentages (10% to 25% dependingon the market price of the shares).

The exchanges require that each underwriting or distribution must provide a companywith a stated minimum of new capital. This minimum ranges from $100,000 to$350,000.

Historically, listed junior mining and oil companies are frequent users of such distribu-tions, raising millions of dollars. Such companies usually have no record of earnings and



few assets that would qualify as collateral for conventional credit sources (i.e., bankloans, mortgage or funded debt, government assistance). The funds these companiesneed is known as risk capital because it is usually earmarked for exploration and devel-opment with a high risk of failure.

b) Options of Treasury Shares

As an incentive to an underwriter to provide risk capital as a principal rather than mere-ly acting as agent for an offering, junior companies often grant the underwriter specifiedtreasury share options. Such options can prove valuable should the company becomesuccessful. These treasury shares may be given to people or companies who have previ-ously invested in the non-public form of the company, or promoters for services ren-dered in managing the public issue, or management of the company.

This technique involves the use of escrowed shares which serve as payment for proper-ties, goods or services. Escrowed shares are shares held by an independent trustee intrust for its owner that cannot be sold or transferred unless special approval is given.Shares can be released from escrow only with the permission of the appropriate authori-ties, such as by a stock exchange(s) or the securities administrators.

c) Escrowed Shares

Escrowing shares ties the value of the shares held by these shareholders to what happensto the property used to obtain these shares. In addition, it prevents their owners fromselling their shares before a proper market can develop. This ensures some stability inthe secondary market performance of the new issue after the completed offering.Escrowed shares maintain full voting and dividend privileges for these (primarily, non-dividend-paying) companies. Escrowed share release is usually determined by a formuladesigned not to disrupt the market for the companys free shares, and is usually basedon some exploration milestones being reached by the company. For example, this couldinvolve completion of exploration drilling that has provided favorable and promisingassay results.

d) TSX Venture Exchange Capital Pool Company Program

For small, emerging private companies, the costs associated with going public through atraditional IPO is not always financially viable. Accordingly, the TSX Venture Exchange,home to many emerging Canadian businesses, developed the Capital Pool Company(CPC) program as a vehicle to provide businesses with an opportunity to obtain financ-ing earlier in their development than might be possible with a regular IPO.

The CPC program permits an IPO to be conducted and a TSX Venture Exchange list-ing to be achieved by a newly created company which, other than cash, has no assetsand has no business or operations. The CPC then uses this pool of funds to identifyand evaluate assets or businesses which, when acquired, qualify the CPC for listing as aregular Tier 1 or Tier 2 issuer on the Venture Exchange (a Qualifying Transaction).

The CPC program involves a two-stage process. The first stage involves the filing andclearing of a CPC prospectus, the completion of the IPO and the listing of the CPCscommon shares on the Venture Exchange. The second stage involves:

the identification of a business or asset that can be acquired as a QualifyingTransaction (QT);

the preparation and filing with the Venture Exchange of a comprehensive CPCinformation circular containing prospectus level disclosure of the QT; and

the holding of a shareholders meeting to get approval to close the QT.

At the time of listing and until completion of the QT, the CPCs directors and seniorofficers must be either Canadian residents, or individuals who have a demonstrated pos-

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itive association with Canadian or U.S. public companies. A minimum of $100,000 inseed capital must be contributed by directors and officers of the CPC or companiescontrolled by them.

Under the CPC program, the issuer must raise between $200,000 and $1,900,000 in aninitial public offering. The IPO offering price can range from $0.15 to $0.30 per share.

The TSX Venture Exchange may suspend from trading or delist the listed shares of aCPC where the issuer has failed to complete a QT within 18 months after the date oflisting.

e) NEX

NEX is a new and separate board of the TSX Venture Exchange that provides a tradingforum for companies that have fallen below the Venture Exchanges listing standards.Companies that have low levels of business activity or who do not carry on active busi-ness will trade on the NEX board, while companies that are actively carrying on busi-ness will remain with the main TSX Venture Exchange stock list.

NEX companies benefit from the support and visibility provided by a listing and trad-ing environment that meets their needs, while the profile and reputation of TSXVenture Exchange companies is enhanced as a result of the overall improved quality ofthe main TSX Venture stock list.

NEX provides a trading forum for:

Issuers that have been listed on the TSX Venture Exchange but no longer meet theTier Maintenance Requirements (these companies are currently known as InactiveIssuers);

CPCs that have failed to complete a QT in accordance with the requirements of theexchange; and

TSX issuers that no longer meet continued listing requirements and would havebeen eligible for listing on TSX Venture as Inactive Issuers under existing policies.

B. THE LISTING PROCESSSometimes as a new share issue is brought to market, a market develops for the securityprior to actual exchange listing. This grey market is an unofficial OTC market com-prised of dealers wishing to execute customers orders as well as support the issue untilthe official listing of the stock on a recognized exchange.

1. Advantages and Disadvantages of Listing

a) Advantages of Listing

Before applying for a listing, a public company considers the advantages and disadvan-tages both to the company itself and to its shareholders of doing so. Some of the advan-tages of listing are:

Prestige and goodwill Company prestige is enhanced due to increased public visi-bility. Shareholder goodwill is increased as buying and selling become easier and vis-ibility of market performance is enhanced.

Established and visible market value The market value of a listed company isreadily visible. This may be a benefit for the company for mergers and acquisitions,the issuance of convertible debt or debt with warrants attached, and for employeestock options. This may be a benefit for shareholders because it may enhance thecollateral value of an investors share holding.



Excellent market visibility The daily financial press carries full details of listedtrading on a daily and weekly basis. Over-the-counter (unlisted) trading is reportedin less detail.

More information available Because of strict exchange disclosure regulations,investors have access to more information on a regular basis.

Facilitates valuation for tax purposes The valuation of securities for estate tax pur-poses and estate tax planning is easier.

Increased investor following Financial analyst following is likely to be higher withlisting. In turn, this can attract new shareholders, enhancing overall marketability inthe secondary market and increase the market for new issues by the company.

b) Disadvantages of Listing

Some of the disadvantages of listing are:

Additional controls on management After listing, restrictions with respect to suchmatters as stock options (those issued for internal use only), reporting of dividends,issue of shares for assets, etc., are put in place.

Additional costs to the company Various fees, including a listing fee and subse-quent annual sustaining fee, must be paid to the exchange(s) when a class of sharesis listed.

Market indifference Low trading volume and poor market performance of a listedcompany is a matter of public record.

Additional disclosure Listing imposes additional disclosure requirements on thecompany that consume management time. Specifically, management is required tomake continuous and prompt disclosure of material changes related to the company.

Need to keep market participants informed A listed companys management mustdevote considerable time to meeting with security analysts and institutionalinvestors and meeting with the press to explain company developments.

2. Listing Procedure for a Company

a) The Listing Application

Companies wishing to be listed on a recognized exchange must apply and be acceptedfor trading. The application is a lengthy questionnaire designed to obtain detailed infor-mation about the company and its operations.

The listing application must be accompanied by the following:

Copies of the companys charter;

Any current prospectus;

Financial statements including three to five consecutive years of profit and lossstatements;

Sample share certificates;

Annual reports; and

A written opinion from the companys legal counsel verifying the propriety of allmatters relating to the organization of the company and the issue of its securities.

When the listing application is completed and supporting documents are assembled, thecompany signs a formal Listing Agreement. The agreement details the specific regula-tions and reporting requirements that the company must follow to keep its listing ingood standing.

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The exchanges have listing committees (e.g., the Stock List Committee on the TSX)which consider listing applications and then rule on the acceptability of applications.After approval is given, a specific date is set for applicable securities to be called for trad-ing on an exchange. There is a formal announcement to members and public announce-ments in the financial press.

b) Regulations for Listed Companies

By signing a Listing Agreement, a company agrees to comply with specific regulations,some of which pertain to:

The submission of annual and interim financial reports and other corporate reportsto the exchange(s);

Prompt notification to the exchange(s) about dividends or other distributions; pro-posed employee stock options; sale or issue of treasury shares;

Notification to the exchange(s) of other proposed material changes in the businessor affairs of a listed company.

The listing standards of the various exchanges are not static and may become morestringent when an exchange wants to increase its prestige or is reacting to some eventthat damaged its prestige.

3. Withdrawing Trading Privileges

As a protection to investors, the exchanges are empowered to withdraw a listed securitystrading and/or listing privileges temporarily or permanently. Serious action such asdelisting occurs infrequently. Other actions occur more frequently and may be imple-mented by either the exchanges or at the request of companies with regard to their ownsecurities.

a) Temporary Interruption of Trading

There are three types of temporary withdrawals of trading privileges which exchangescan invoke:

Delayed Opening

Shortly before the opening of trading, an exchange can order trading in a security to bedelayed. The need for this action might arise if a heavy influx of buy and/or sell ordersfor a particular security materialized. The delay gives exchange traders time to sort outthe orders and match up buys with sells to allow fair and orderly trading when the delayorder is removed. A delayed opening in one security does not affect trading in otherlisted securities.

Halt in Trading

A temporary halt in the trading of a security can be ordered or arranged at any time toallow significant news to be reported and widely disseminated (e.g. a pending merger ora substantial change in dividends or earnings).

Suspension of Trading

Trading privileges can be suspended for more than one trading session. Such suspen-sions are imposed if the companys financial condition does not meet the exchangesrequirements for continued trading or if a company fails to comply with the terms of itslisting agreement or for some other good cause. If the company rectifies the problem tothe exchanges satisfaction within the time required by the exchange, trading in the sus-pended security will resume. During the suspension, members are usually allowed toexecute orders for the suspended security in the unlisted market except for those securi-ties suspended from trading on TSX Venture Exchange.



b) Cancelling a Listing (Delisting)

A listed security can be delisted by the exchanges (or at the request of the companyitself ) which would be a permanent cancellation of listing privileges. Reasons for delist-ing could include:

The delisted security no longer exists. It has been called for redemption (e.g. a pre-ferred share) or substituted for another security as a result of a merger;

The company is without assets or bankrupt;

The public distribution of the security has dwindled to an unacceptably low level;or

The company has failed to comply with the terms of its listing agreement.

C. REGULATION AND INVESTOR PROTECTIONThe securities industry has extensive legislation and regulation to protect the investorand to ensure high ethical standards. This protection flows from both self-regulatoryorganizations (SROs), such as the IDA and stock exchanges, as well as the provincialsecurities regulators and administrators. Regulation is covered in much greater detail inthe CSIs The Conduct and Practices Handbook (CPH) course. Some of the basic con-cepts are covered here.

1. Underlying Principles of Provincial Securities Legislation

Provincial securities acts are designed to regulate the under-writing, distribution and saleof securities, and to protect buyers and sellers of securities. The term act is used here torefer to the securities act or the securities-related legislation of a province. The termadministrator is used to describe the securities regulatory authority of a province,whether it is a commission, registrar or other government official.

No federal regulatory body for the securities industry exists in Canada, in contrast tothe United States where the national Securities and Exchange Commission (SEC) hasconsiderable regulatory authority. With increasing involvement in the investment busi-ness by federally regulated financial institutions such as banks, trusts, and insurancecompanies, the number of National Policies issued by the CSA (the CanadianSecurities Administrators) has increased. These National Policies attempt to create aregulatory environment that is consistent and applicable across the country.

Formal conferences of provincial administrators are held regularly and informal consul-tation and co-operation is continuous.

The general principle underlying Canadian securities legislation is not approval or dis-approval of the investment merits of a particular issue of securities by the provincialadministrator, but rather that of full, true and plain disclosure of all pertinent facts bythose offering the securities for sale to the public. Until disclosure is made to the satis-faction of the administrator concerned, it is illegal to offer such securities for public sale.As discussed earlier, such disclosure is normally made in a prospectus issued by the com-pany and accepted for filing by the administrator concerned.

Even the most determined public official and the most exhaustive legislation cannotguarantee that the gullible or the greedy will suffer neither financial loss, nor that thoseintent on dishonest behaviour will be stopped. It is very difficult to restrict completelythe activities of unscrupulous promoters without impeding the efforts of legitimateentrepreneurs. The laws are designed to prevent, as far as possible, fraud and deceit andto protect the investor from his or her own naivet due to a lack of information or

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POST-TEST

PRE-TEST

undue selling pressure from investment service providers. Nevertheless, no legislationsupplants the rule that one must investigate before one invests or recommends aninvestment.

Generally, the acts use three basic methods to protect investors: registration of securitiesdealers and advisors, disclosure of facts necessary to make reasoned investment decisionsand enforcement of the laws and policies. The industry also relies on the SROs for theirmembers compliance to legislation.

a) Registration

Generally, every firm and all Investment Advisors (IAs) employed by such firms mustbe registered. As well as granting registrations, administrators have the power to suspendor cancel registration or otherwise discipline registrants.

All employees of members firms of a stock exchange or the IDA who deal with theinvesting public must register with the applicable stock exchange or the IDA, as well aswith the applicable administrator. Such employees must meet the SROs requirementsfor approval which include, as a minimum, completion of the Canadian SecuritiesCourse (CSC) and an examination based on the Conduct and Practices Handbook(CPH) course.

New investment advisors must also complete a 90-day training program before they arepermitted to deal with the public. After licensing, the registrant is subject to a six-month period of supervision by his or her supervisor. New registrants must also com-plete CSIs Professional Financial Planning Course (PFPC)or the Investment ManagementTechniques Course (IMT) within thirty months of becoming licensed as an IA.Participation in the industrys Continuing Education program is also a condition ofmaintaining a license.

Applicants not giving any advice to clients may choose to be registered as InvestmentRepresentatives (IRs). The proficiency requirements for IRs are similar to those for IAs,with the exception of the length of the training period (30-days) and the 30-monthrequirement.

In order to become a Sales Manager, the candidate must successfully complete theBranch Managers Course (BMC). Within 18 months they must also complete theEffective Management Seminar (EMS). Both courses are offered by CSI.

b) The National Registration Database (NRD)

The National Registration Database (NRD) is a web-based system used by investmentdealers and employees to file registration forms electronically when applying forapproval by any one or more of the stock exchanges, the CSA or the IDA. The NRD isdesigned to enable a single electronic submission to satisfy all jurisdictions in Canada.

The significance of the NRD means that instead of requiring registrants who want to belicensed in more than one province or territory to file separate registration forms in eachjurisdiction, the NRD is designed to enable a single electronic submission to satisfy alljurisdictions in Canada. The NRD also eliminates the burden of providing proof of reg-istration in other jurisdictions because the regulators can use the NRD to verify registra-tion status in other jurisdictions.

Both the IA and the member firm are required to notify the applicable SROs immedi-ately in writing of any material changes in the original answers to the questions on theNRD application. This includes a change of address. Also, each member firm isrequired to immediately report to the administrators and SROs to which it belongs, thetermination of an IA. If the IA is dismissed for cause, a statement of the reasons for thedismissal must be reported.



c) Designated Non-trading Employees

Employees of securities firms who are not primarily engaged in sales, such as tradingdesk and certain administrative personnel, may occasionally accept orders from the pub-lic. In most provinces, such employees may be designated as Non-Trading Employeesand may be exempt from registration by the administrator. If exempt status is not given,however, such employees are required to register with the applicable administrator.

d) Securities Firms

Generally, securities firms are required to register under provincial securities legislationunless their activities are limited to trades or securities where a prospectus is notrequired.

Firms may have full registration, allowing employees a fair amount of latitude in theirdealings with the public. Some firms, such as mutual fund dealers, are restricted as totheir permitted activities. IAs should be aware of any restrictions that apply to theirfirms.

Additional exemptions may be granted by provincial regulators if it is felt that the pub-lic interest is adequately protected. Such exemptions are rare.

e) Know Your Client Rule

The SROs require that member firms and their investment advisors:

Learn the essential facts relative to every client and to every order or account accept-ed the know your client rule;

Ensure that the acceptance of any order for any account is within the bounds ofgood business practice;

Ensure that recommendations made for any account are appropriate for the clientand in keeping with his or her investment objectives, personal circumstances andtolerance to bearing risk the suitability principle.

The first step in complying with this regulation is completion of a New AccountApplication Form prior to the acceptance of any order. A partner, director, officer orbranch manager of the advisors firm must approve the application prior to or promptlyafter the completion of the first transaction.

Some market participants, particularly discount brokers, have asked the SROs andadministrators to relax the know your client rule for their employees. They argue thattheir members do not provide advice and thus should not be required to meet the samestandard for this criterion. Consequently, in April 2000, the CSA ruled that discountbrokers that do not provide investment advice might submit applications for exemptionfrom the suitability requirements under certain conditions. The IDA has also submitteda proposal to the CSA recommending that full service brokers be exempt from the suit-ability requirements on a trade-by-trade basis whereby suitability considerations areonly triggered when recommendations are made. In effect, the dealers suitability obliga-tions should be based on the nature of each individual transaction.

f) Breach of Fiduciary Duty

Every director of a public corporation has a fiduciary obligation not to reveal privilegedor inside information to anyone not authorized to receive it. A director is not releasedfrom this obligation until there is a full public disclosure of such data, particularly whenthe information might have a bearing on the market price of the corporations securities.

The rules of most stock exchanges deal with the potential conflicts of interest that mayarise when a director of a public corporation is also a director, partner, officer or

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employee of a securities firm, and prescribe what is acceptable conduct by and for thedirector. The same obligations apply to an advisor or other employee of a member firmwho is assisting in an underwriting or acting in an advisory capacity to a corporationand as a result are discussing confidential matters. Should the matter require consulta-tion with other personnel of the member firm, adequate measures should be taken toguard the confidential nature of the information to prevent its misuse within or outsidethe member firm.

Fiduciary obligations also arise when an advisor is providing investment advice. Wherean advisor undertakes to advise a client, the advisor owes a duty to the client to advisefully, honestly and in good faith. An advisor must ensure that all conflicts are disclosedand all representations made with respect to an investment are honest. In addition, anadvisor acts as agent for the client in executing the clients investment transaction (bestexecution). In doing so, the advisor is bound to do the best for the client and to followthe clients instructions or intentions. An advisor must advise a client if instructions can-not be carried out in order to allow the client to make alternate arrangements. A breachof these obligations can result in civil liability being imposed directly upon the advisorand upon the member firm responsible for supervising the advisor.

2. Self-Regulatory Organizations (SROs)

The SROs are industry organizations that regulate their own members, whether as offi-cially recognized SROs or under the stock exchange portions of their provincial securi-ties acts. SROs are directly responsible for enforcement of their members conformitywith securities legislation. They also have the power to establish and enforce industryregulations to protect investors and to maintain fair, equitable and ethical practices inthe industry. The Canadian SROs include the IDA, the exchanges, Market RegulationServices Inc. (RS) and the MFDA.

SRO regulation is divided between member regulation and market regulation. The IDAand MFDA deal with member regulation while the exchanges and RS are the SROs thatdeal with market regulation. The four main areas of member regulation are:

Financial Compliance: Includes monitoring the minimum capital and financialrequirements of member firms.

Sales Compliance: Revolves around maintaining high industry standards of IAs andmember business conduct.

Registration: Responsibility for overseeing professional standards and educationalprograms designed to maintain the competence of industry employees.

Enforcement: This department investigates complaints received against a memberfirm or a registered employee.

Market regulation, on the other hand, focuses on three main areas:

Market Surveillance: Involves the review of real time trading, historical trading andpress releases, as well as the sales practices of IAs.

Investigation and Enforcement: These activities usually begin after a complaint hasbeen filed or when market surveillance finds that the rules have been broken. If aninfraction has been committed, prosecution proceedings may begin.

Regulatory/Market Policy: As the name implies, the SROs are also responsible fordeveloping rules and policies that promote more efficient markets.



a) Market Regulation Services Inc.

Market Regulation Services Inc. (RS) is an independent, not for profit organizationjointly owned by the TSX and the IDA. Its mandate is to promote investor confidencein the Canadian securities market and to safeguard investor protection through theadministration, interpretation and enforcement of the Universal Market Integrity Rules(UMIR) as a common set of trading rules consistently in all markets in Canada. Toensure compliance with UMIR, RS is authorized to monitor real-time trading opera-tions and market-related activities, to investigate alleged rule violations, and to adminis-ter any settlements and hearings that may arise in respect of such violations. Thus, theUMIR are designed to promote fair and orderly markets.

RS is recognized as an SRO in the provinces of Alberta, British Columbia, Ontario andQuebec and it officially started providing independent regulation services to Canadianmarketplaces (traditional exchanges, quotation and trade reporting systems or QTRSs,and alternative trading systems or ATSs) in March 2002.

RSs Investigations and Enforcement Division investigates such activities as:

manipulative or deceptive trading;

illegal insider trading;

the failure of a registrant to ensure that the best possible market price was obtainedfor a client;

the failure of a registrant to give a client order priority over all other similar princi-pal and non-client orders existing at the same time;

frontrunning, whereby a registrant trades ahead of a known client order in anattempt to take advantage of the market impact that such a pending trade mighthave;

all technical rules violations such as restrictions on short sales and order marking;and

background checks with respect to directors and officers of companies which haveapplied for listing.

b) The Exchanges

Presently, the exchange SROs in Canada are the Toronto Stock Exchange (TSX), theBourse de Montral, the TSX Venture Exchange, the Winnipeg Commodity Exchange(WCE) and Market Regulation Services (RS). The TSX and TSX Venture Exchangehave retained RS as their regulatory services provider.

Bourse de Montral is unique among the SROs in that its by-laws grant it the power toorder the restitution of funds to any person who has suffered a loss as a result of themisconduct of a person under its jurisdiction. Additionally, costs of the investigation aretypically assessed against respondents who have been found guilty of a violation.

3. Necessity for Ethical Trading and Conduct

Ethical trading is of paramount importance to both the investing public and the usersof the capital markets, the listing corporations. If trading on an exchange were consid-ered unethical it would be impossible for corporations to raise the money they requirefor expansion and growth because the investing public would simply not participate.This could cripple new financings by both initial and experienced issuers of securities.

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The exchanges and other SROs have developed extensive rules and regulations in con-junction with the securities regulators to govern trading. Infractions are punishable byfines, suspensions and expulsion. If required, criminal charges can be laid against thosefound to have violated regulations.

Unethical conduct may be defined as any omission, conduct, manner of doing businessor negotiation, which in the opinion of the disciplinary body is not in the public interestnor in the interest of the exchange. Decisions made by the SROs can be appealed to thegoverning body.

a) Examples of Unethical Practices

The following are examples of practices which are considered unethical:

Any conduct which has the effect of deceiving the public, the purchaser or the ven-dor of any security as to the nature of any transaction price or value of such security;

Creating or attempting to create a false or misleading appearance of active publictrading in a security, e.g., fictitious orders for the same security placed with a varietyof securities firms or a series of orders for one security in an attempt to create a falseimpression of market interest;

Entering or attempting to enter into any scheme or arrangement to sell and repur-chase a security in an effort to manipulate the market;

Deliberately causing the last sale for the day in a security to be higher than warrant-ed by the prevailing market conditions (window dressing);

Making a fictitious trade or giving or accepting an order which involves no changein the beneficial ownership of a security for the purposes of misleading the public;

Misleading or attempting to mislead any board of governors or any committee onany material point;

Confirming a transaction where no trade has been executed (bucketing);

Improper solicitation of orders either by telephone or otherwise;

High pressure or other selling techniques of a nature considered undesirable;

Violation of any statute applicable to the sale of securities;

Selling or attempting to sell a prospective dividend on a stock;

Leading a client to believe that there is no risk or chance of loss through opening anaccount or trading in this account or purchasing a specific security;

Making a practice, directly or indirectly, of taking the opposite side of the market toclients, or effecting a trade for the advisors own account prior to effecting a tradefor a client (frontrunning); or

Conduct that would bring the securities business, the exchanges, or the IDA intodisrepute.

A member firm is responsible for the acts or omissions of all its employees. Conduct byan advisor considered unethical may be dealt with, in matters of discipline, as though itwere the conduct of the member firm itself, as well as that of the advisor.



b) Prohibited Sales Practices

Securities legislation prohibiting certain types of selling activities exists for very goodreasons. Any competent and honest advisor may earn a substantial income while per-forming a valuable service and will not be materially impeded by these provisions.Unethical, dishonest, high-pressure operators will find that such regulations are designedto curb their style of selling.

It is extremely important that all advisors study the rules applicable in their provinceand conform carefully to all the requirements. All changes in the law should be carefullynoted, and the advisor should immediately conform to such changes.

4. Public Company Disclosure and Investor Rights

Securities legislation in each of the provinces requires the continuous disclosure of cer-tain prescribed information concerning the business and affairs of public companies.This disclosure usually consists of periodic financial statements (including managementdiscussion and analysis), insider trading reports, information circulars required in proxysolicitation, an annual information form (AIF), press releases and material changereports.

The principle of disclosure is seen also in the requirements of the acts, regulations andpolicy statements of most provinces covering a distribution of securities, discussed previ-ously in this chapter. Generally, every person or corporation that sells or offers to sell tothe public securities which have not previously been