In a notable ruling, the Capital Markets Tribunal (the Tribunal) dismissed enforcement proceedings against parties involved in complex capital-raising transactions, which included a private placement, securities loan agreement and short sales, deeming the allegations were an overreach. In Cormark Securities Inc (Re),[1] the staff of the Ontario Securities Commission (OSC) alleged that the transactions resulted in an illegal distribution of securities and the parties’ conduct contravened Ontario securities legislation. Ultimately, the Tribunal rejected all allegations of wrongdoing brought by the OSC,concluding that it failed to prove its allegations, and dismissing the proceedings.
The Tribunal’s decision offers comfort to sophisticated industry professionals who seek to raise capital using creative transaction structures that such practices are “normal and accepted” and that “reducing or eliminating risk” in these transactions is not contrary to securities law.
Background
On March 17, 2017, Canopy Growth Corporation (Canopy) was added to the Toronto Stock Exchange’s (TSX) composite index. Prior to this, William Jeffrey Kennedy (Kennedy), a Managing Director and Head of Equity Capital Markets Operations at Cormark Securities Inc. (Cormark), approached Canopy regarding capital-raising transactions that would capitalize on the anticipated increased demand for Canopy’s shares. The transactions also involved Cormark’s clients Marc Judah Bistricer and his company Saline Investments Ltd. (Saline).
The transactions were structured as follows: Canopy sold 2.5 million common shares at a 9% discount to Saline in a private placement (the Restricted Shares) which were subject to a four-month hold period. Simultaneously, Saline borrowed 2.5 million freely-trading Canopy common shares (the Free-Trading Shares)from Goldman Holdings (Goldman) under a securities loan agreement. The Restricted Shares were pledged as collateral for the loan, and Saline then sold short 2.5 million Canopy common shares on the TSX, settling the short sales using the Free-Trading Shares. Once the hold period on the Restricted Shares expired, Goldman retained them to satisfy Saline’s obligations under the loan.
Decision
The OSC’s allegations primarily focused on whether the parties involved in the transactions (the Respondents) engaged in an illegal distribution of securities. The OSC argued that the transactions constituted an indirect offering of securities to the public, bypassing the prospectus requirement or an applicable exemption. Further, the OSC alleged the transactions fell within the extended definition of a “distribution” since the private placement was a trade in securities that had not been previously issued and the securities loan agreement and short sales were part of or incident to the distribution.
The Tribunal disagreed, holding that the extended definition of distribution did not apply. The heart of the OSC’s submissions were that the transactions converted the Restricted Shares issued under the private placement into the Free-Trading Shares borrowed under the securities loan agreement. However, the Tribunal rejected the OSC’s argument on the basis that the Restricted Shares and Free-Trading Shares were distinct. The Restricted Shares remained in the closed system until the end of the hold period, and Saline was entitled to pledge them as collateral for the loan. The Free-Trading Shares, on the other hand, were previously issued and outstanding shares that were used to settle the short sales in the secondary market.
The OSC also cited Companion Policy 41-101CP to support its argument that the transactions constituted a single distribution. The Tribunal rejected this view, noting that the OSC’s position would only be valid if the Restricted Shares were converted into Free-Trading Shares. Since the Restricted Shares were subject to the hold period, and Saline did not act akin to an underwriter of the Free-Trading Shares, the Tribunal found no grounds for the OSC’s claims. Similarly, the Tribunal rejected the OSC’s argument based on the anti-avoidance guidance in Companion Policy 45-106CP and Companion Policy 45-501CP.
Another key issue was whether Cormark and Kennedy breached OSC Rule 31-505 Conditions of Registration by failing to deal fairly, honestly and in good faith with Canopy as a client. The Tribunal first considered whether Canopy was a client and concluded that Canopy was neither Cormark nor Kennedy’s client. Therefore OSC Rule 31-505 was not engaged. Canopy was not a vulnerable individual investor and did not rely on Cormark or Kennedy since it had an experienced team of management and counsel. Any alleged benefits that Canopy conveyed to Cormark or Kennedy were indirect, hypothetical and/or insignificant and there was no formal documentation or belief (on the part of Canopy) establishing a client relationship. Rather, the evidence established a client relationship with Saline, not Canopy.
The OSC additionally made numerous public interest allegations. The Tribunal rejected each of the claims, finding that the OSC failed to establish any sort of misconduct warranting the exercise of its public interest jurisdiction. The OSC first alleged that Cormark and Kennedy misled Canopy about the ordinary course nature of the transactions, lied to Canopy about short-selling in the transactions, concealed Saline’s risk-reward ratio and failed to disclose the risk to Canopy’s net proceeds from the transactions. The second set of allegations asserted that the Respondents undermined investor protection in relation to the hold periods, avoided disclosure by sizing the private placement to be immaterial and making misleading statements in a draft press release Cormark provided to Canopy, threatened capital markets efficiency and confidence through the short sales and failed to meet the high standards of fitness and business conduct expected of market participants and registrants.
The OSC’s public interest arguments failed largely because the Tribunal did not accept that the Restricted Shares were converted into the Free-Trading Shares. Further, the fact that Cormark and Kennedy were alive to regulatory compliance and structured the transaction to be immaterial so as to comply with the regulatory framework was not inconsistent with the principles underlying the rules. In the Tribunal’s view, the application of accumulated knowledge and skill for financial benefit was expected of market participants and registrants. The Tribunal concluded that none of the allegations of misleading, dishonest or wrongful conduct were proven and that the OSC overreached in its allegations against the Respondents.
Key takeaways
The decision highlights the importance of establishing a robust evidentiary record to support legal arguments. The OSC attempted to rely on a US securities law decision involving a similar triangular transaction structure between restricted and free-trading shares. The SEC has treated these transactions as part of a single larger transaction, subjecting the entire transaction to US registration requirements. The Tribunal declined to consider the case because the OSC failed to file evidence detailing the similarities or differences between the Ontario and US securities regulatory frameworks.
This case represented a rare opportunity for the Tribunal to address triangular or swap transaction structures involving restricted and free-trading securities, and it did so decisively in favour of Cormark and the other respondents. It will be interesting to observe whether this decision will spark any change in Ontario securities law in light of the Tribunal’s detailed guidance in this decision that hedging or managing risk in a transaction is a normal and accepted part of participating in the capital markets and is not contrary to the animating principles of securities law.
For more information on this topic, please reach out to the authors, Brandon Barnes Trickett and Samantha Chang.
The authors wish to thank Janson Fu, articling student, for his assistance with this article.
[1] 2024 ONCMT 26.
