What is the Purpose of the National Instrument?

The National Instrument is intended to address concerns that current insider reporting requirements may not cover certain derivative-based transactions, including but not limited to equity monetization transactions.

What is a Monetization Transaction?

Broadly speaking, derivative-based financial products, sometimes referred to as monetization products, allow an investor to receive a cash amount similar to the proceeds of disposition and to transfer part or all of the economic risk associated with the securities of an issuer, without transferring legal and beneficial ownership of such securities. Investors may enter into monetization transactions for a variety of reasons, including, but not limited to: tax planning strategies, to improve liquidity, and to achieve portfolio diversification.

CSA Concerns Regarding Monetization Transactions

Among the CSA's concerns is the scenario where an insider in possession of material undisclosed information regarding an issuer and who is otherwise prohibited from trading securities in such issuer, may be able to improperly profit from such information by entering into a derivative-based transaction that provides the same "economic effect" as a disposition of the securities.

What Triggers the Reporting Obligations under the National Instrument?

Although it does not prohibit investors from entering into monetization transactions, the National Instrument would adopt a principle-based approach that requires investors to report the existence and material terms of such transactions. The National Instrument is triggered, and an insider is required to file an insider report, in a circumstance where an "insider" of a reporting issuer enters into an agreement, arrangement or understanding of any kind, which:

What is "Economic Exposure"?

Economic exposure in relation to a reporting issuer means the extent to which the economic, financial or pecuniary interests of a person or company are aligned with the trading price of the reporting issuer or the economic, financial or pecuniary interests of the reporting issuer.

In other words, the term economic exposure has broad application and is meant to catch a situation where an insider changes his or her ownership interest in securities of a reporting issuer either directly through the purchase or sale of securities of the reporting issuer, or indirectly, such as through a monetization involving those securities.

What is "Economic Interest in a Security"?

The term "economic interest in a security" is defined as the extent to which a person or company is entitled to receive, bears, or is subject to:

and includes, without limitation, the extent to which the person or company has or shares the opportunity, directly or indirectly, to profit or share in any profit derived from a transaction in such security or transaction which directly or indirectly involves such security.

The term "economic interest in a security" is meant to have broad application and is intended to refer to the economic attributes ordinarily associated with beneficial ownership of a security, such as the potential for gain in the nature of a capital gain realized on a disposition of the security, to the extent that the proceeds of disposition exceed the beneficial owner's tax cost.

What is the Difference between "Economic Exposure" in Relation to a Reporting Issuer and "Economic Interest in a Security" of the Reporting Issuer?

In many cases, an arrangement caught by the economic exposure test in the National Instrument will also be caught by the economic interest in a security test. However, the tests are not identical.

For example, if an insider holds no shares of his or her reporting issuer, and enters into a short position in the expectation that the share price will fall, the economic interest in a security test would likely not apply, since the insider will not be altering his or her economic interest in any securities of the reporting issuer. However, entering into this short position would be caught by the economic exposure test and therefore satisfy the policy rationale for insider reporting, making such an arrangement transparent to the market.

Application of the National Instrument to Pre-Existing Monetizations

It is important to note that if an insider of a reporting issuer, prior to the effective date of the National Instrument, entered into an agreement, arrangement or understanding in respect of which:  the insider would have been required to file an insider report under the National Instrument if the agreement, arrangement understanding had been entered into on or after the effective date; and  the agreement, arrangement or understanding remains in effect on or after the effective date of the National Instrument, then the insider will be required to file a report in accordance with the National Instrument.

Consistency with U.S. Reporting Requirements

It is also worth noting that one of the objectives underlying the adoption of the National Instrument is to introduce greater consistency in the reporting requirements under U.S. securities law and Canadian securities laws in relation to equity monetization arrangements. The reference to an economic, financial or pecuniary reward, benefit or return in the definition of economic interest in the National Instrument is intended to clarify the fact that equity monetization transactions which are reportable under U.S. insider reporting requirements will also generally be covered by Canadian insider reporting law requirements, unless subject to an exemption. Under U.S. securities legislation, insiders are generally required to report any transaction resulting in a change in "beneficial ownership" of equity securities of an issuer. For reporting purposes, a person is deemed to be the "beneficial owner" of securities if the person has a "pecuniary interest" in the securities. The term "pecuniary interest" in any class of equity securities is defined to mean "the opportunity, directly or indirectly, to profit or share in any profit derived from a transaction in the subject securities".

Exemptions from the Insider Reporting Requirements under the National Instrument

The National Instrument provides a number of exemptions for insider transactions that otherwise satisfy one of the tests under the National Instrument. Some of these exemptions include:

Timing of the Insider Report

A person or company who is required under the National Instrument to file a report must, within 10 days (not 10 business days) from the day on which the person enters into the agreement, arrangement, or understanding or such shorter period as may be prescribed, file a report in the form prescribed for insider reports under securities legislation disclosing the existence and material terms of such agreement, arrangement or understanding.

Contents of the Insider Report

It is proposed that an insider entering into a monetization arrangement will be required to file the same form of insider report as he or she would have filed in the case of an ordinary purchase and sale of securities. National Instrument 55-102 - System for Electronic Disclosure by Insiders (SEDI) provides that if a derivative expires or matures on a given date, an insider should specify the date of such expiry or maturity in his or her insider report. In an effort to provide some guidance, the CSA has agreed to provide a CSA staff notice containing examples of equity monetization arrangements, together with examples of completed insider trading reports in respect of such arrangements on or before the National Instrument takes effect.

Not Restricted to Equity Monetizations

Although the title of the National Instrument refers to "Equity Monetizations", it applies generally to any derivatives transactions with insiders involving "securities" of a reporting issuer, including for example, debt securities. Accordingly, other forms of derivatives transactions, such as credit default swaps, involving insiders and securities of reporting issuers will need to be considered closely to determine whether they trigger reporting obligations.

Conclusion

Insiders entering into certain derivative-based transactions will have to pay close attention to the "economic exposure" and "economic interest in a security" tests established pursuant to the National Instrument to determine whether their reporting obligations are triggered. Of particular note is the application of the National Instrument to derivative-based arrangements previously entered into by insiders and remaining in effect after the effective date of the National Instrument. It remains to be seen whether any of these existing arrangements will be unwound prior to the National Instrument coming into force and what effect, if any, the expanded reporting requirements will have on new monetization business.