Regulators to take stricter approach in protecting minority shareholders

M&A lawyers concerned about prospect of enhanced real-time disclosure in related-party deals
The Canadian Securities Administrators issued a bulletin last month giving guidance on minority shareholder protection in related-party equity transactions. REUTERS/Kham
The Canadian Securities Administrators issued a bulletin last month giving guidance on minority shareholder protection in related-party equity transactions. REUTERS/Kham

DIRECTORS OF LISTED COMPANIES that are contemplating related-party transactions –– whether a deal between a parent company and subsidiary, between subsidiaries of the same company,  or a going-private transaction, for example –– would be wise to pay attention to a bulletin issued by the Canadian Securities Administrators (CSA) late last month.

The regulators of Ontario, Québec, Alberta, Manitoba and New Brunswick jointly served notice that they are going to be looking at a number of factors a lot more carefully in order to protect the interests of minority shareholders in so-called conflict transactions, and will no longer wait for complaints from the public.

Majority shareholders of a listed company are any persons or groups that together hold 10 per cent or more of a company’s shares, in some cases leaving up to 90 per cent of a company’s stockholders in the minority category. Still, in related-party transactions, staff is concerned that the 90 per cent may be at a disadvantage because the majority shareholder can often be a former owner or member of the current management team in possession of more information than other stockholders, and who may stand to profit if the transaction goes through.

Regulators let it be known through Multilateral Instrument 61-101 that they expect enhanced disclosure in such cases, and that they will be scrutinizing disclosure in real time “whether or not there’s a complaint,” says Philippe Tardif, regional leader of the securities and capital markets group at Borden Ladner Gervais LLP in Toronto. “So we now know the regulators are looking over our shoulder.”

As part of monitoring transactions as they are unfolding they will be trying to make sure minority shareholders have access to the reasoning and analysis of the board and the special committee about issues such as why they believe a transaction is fair, a discussion of any analysis they had amongst themselves, and why they believe the deal is desirable.

In fact, the CSA targets the role of the special committee, saying it doesn’t want the committee involved late in the game “with a review or a blessing,” says Wilson Acton, a partner in the business law group at McCarthy Tétrault LLP in Calgary. “They’ve made it clear what they want is the C-suite much less involved in negotiating the deal,” because theoretically, in a related-party transaction, management stands benefit.

In the staff notice the regulators also took aim at fairness opinion in minority transactions, making it clear they would like special committees to specifically assess the fairness to the minority shareholders.

While stopping short of saying they do not wish to see a simple “we find the transaction fair,” delivered by a financial advisor whose fee is contingent on the transaction being completed (part of a complaint in InterOil Corporation v. Mulacek that ended by blocking a $2-billion bid by ExxonMobil Corp.), the Canadian Securities Administrators said the following should be broadly disclosed: compensation arrangement with the financial advisor and how the special committee weighed that; details of any arrangement between the advisor and the issuer or an interested related party; and a clear summary of the information underlying the fairness opinion.

The regulators say they will use their “public-interest jurisdiction” where companies fall short.

Acton says that while the regulators are not forbidding anyone from using the traditional one-sentence finding, “if you choose to go that route, given the real-time monitoring, you’ll promptly get a phone call asking about it. They’re really pushing us more towards the US system where they use a more robust, analytic-based approach.”

He says that while the notice on related-party transactions affects just a small portion of deals, for now, it has the M&A community in Alberta “a little on edge. Real time disclosure exists in the US where the SEC reviews documents before they’re filed, but there’s a process for that.” Here, without a real process for compliance, “it’s creating some concern.”

Jean-Pierre Chamberland, a partner in Fasken Martineau DuMoulin LLP in Montréal, says the notice has also “raised eyebrows” in Québec. Some of what’s new in the CSA guidance “is more in the realm of corporate law and the duties of directors,” he says. “You have to ask yourself whether it is going beyond what you should be regulating in terms of securities law matters when you’re getting into what directors should be taking into account from their fiduciary duty standpoint.”

Faskens represented the company in two major going-private transactions this summer: Canam Group Inc. and Lumenpulse Inc. Chamberland says most of the guidance put out in the staff notice is already best practice among larger companies, and he suspects it is aimed more at smaller and mid-sized companies. “I would say the goal of this is to put people on notice that they’re going to be watching.”

Torys LLP told its clients in a memo last week that the staff notice sets a high standard for directors, “with the risk that even if they do follow a good process they may still fall short of staff expectations or be the subject of complaints.”

How big a piece of the overall Canadian deal market is affected by the CSA bulletin? Mindy Gilbert, a corporate practitioner at Davies Ward Phillips & Vineberg LLP in Toronto, says while it’s tough to give a percentage, “it’s not an insignificant amount. I’ve worked on two of these [cases] myself so far this year, and I’m working on a third. And some of my partners are working on them as well.”

She says there’s an important message to C-Suite executives and boards of directors in the new guidance: “It’s that staff of the security commission is watching and they are actively reviewing in real time these types of related-party transactions. I think they’re very concerned with the treatment of the minority in these transactions because there’s an imbalance of information. The insiders can have a lot of information; the minority shareholders don’t. So the whole purpose of the process is to make sure the minority is being looked after.”

Gilbert said she wasn’t aware of one single transaction that triggered the regulators’ interest, but even if there is only one, “it’s important enough for the integrity of the capital markets that the transaction and the process is run properly.”