News & Events
Remarks to The Conference Board of Canada Conference – “M&A in 2010: Finding
Opportunity in a Changing Environment”
James Turner, OSC Vice-Chair
December 1, 2009
Good morning, everyone. I’m pleased to be here with you this morning to talk about mergers and acquisitions and to kick off the second day of this conference. It’s certainly good to see the increasing activity in the M&A market given the recent disruptions to financial markets we have all suffered through.
Over the last year, there have been a number of decisions of the Ontario Securities Commission (and other securities regulators) relating to M&A matters. What I would like to do this morning is to comment on a number of the policy issues raised by those decisions.
I should say at the outset that the views I will express are my personal views and not necessarily those of the Commission or staff of the Commission. To the extent that I will be commenting on particular decisions, I note that the lawyers in this room are in as good a position as I am to come to a view, or multiple views, of what the decisions mean from a policy perspective.
I should also say that, as an adjudicator, I am generally reluctant to comment on Commission decisions, particularly where I was a member of the particular Panel. In the M&A area, however, the Commission has an important policy-making function and I believe members of the Commission and staff should contribute to the discourse on policy issues.
I would add that the Commission’s Guidelines for Members Engaging in Adjudication recognise that principle and permit Commissioners to comment on adjudicative matters that have been finally disposed of, and in respect of which there is no appeal outstanding.
I certainly encourage you to advance your own views on the decisions I will discuss and on the policy issues they raise.
Preliminary Matters
As a preliminary matter, I should emphasize that there are ethical and confidentiality walls between the Commissioners, as adjudicators, and Commission staff involved in M&A matters. Accordingly, as a Commissioner, the first that I ever hear about an M&A matter that is going to a hearing is a request from the Secretary of the Commission whether I’m available to be on a Panel on specific dates. The Secretary rarely knows what the issues are. And the only contact or communication I have with staff is through the public hearing process itself. Our Guidelines for Adjudicators prohibit me from having any conversation with any party to a hearing, including, in particular, staff, except in the presence of all parties. That is as it should be.
Staff knows that I will disqualify myself from sitting on a Panel if I have had any prior involvement in the particular matter (other than, of course, in an adjudicative role).
Apart from my adjudicative role, I do, however, participate with staff in the Commission’s formal policy development function in the M&A context.
There are a few other important principles that I should mention.
First, while there have been examples of intervention by the Commission in M&A transactions this last year, the Commission intervenes rarely and only where we believe there are clear grounds for doing so. That generally means that we intervene where our rules are being breached or where there is significant potential for shareholders or investors being harmed.
As you know, there are two overriding principles underlying our take-over bid regime:
- Protection of and fairness to shareholders, and
- Providing a regulatory framework within which bids may proceed in an open and even-handed environment
The parties to a transaction, their boards and shareholders should determine the outcome of M&A matters, not regulators. Securities regulators should become involved only when that becomes necessary.
Second, you should recognize that the Commission is composed of members with quite diverse and different capital market experience, and many of them are not lawyers. Those Commissioners bring an important and valuable perspective to the adjudicative process. Accordingly, in appearing before the Commission, you should recognize that broader perspective will be brought to bear on the matters before the Commission.
Third, Commissioners are sensitive about making new policy through adjudicative decisions of the Commission. If there is a significant shift in the Commission’s policy approach, that shift should generally be effected through the formal policy development process. That is important in ensuring the predictability and fairness of our regulatory regime.
That is not to say, however, that there are no policy implications from our decisions. There are, and necessarily will be, and the Commissioners are well aware of that in making their decisions.
Fourth, there has been some debate recently about the extent to which the Commission should be involved in assessing the question of whether directors are complying with their fiduciary duties under corporate law and the relevance of our decisions to corporate law matters.
If you are bringing a matter before the Commission, you should be advancing a securities regulatory issue. If you are addressing such an issue, the Commission may, in resolving the securities issue, also have to consider issues such as corporate governance, board process and compliance by directors with their fiduciary duties. But that will be secondary to the securities regulatory issue to be addressed. Securities law issues include compliance with our regulatory regime as well as public interest issues that have a broader impact on our capital markets.
In my view, if the basic complaint is that directors are failing to comply with their fiduciary duties, or that oppression has occurred, those are corporate law matters for the Courts, not securities regulators.
I will come back to this issue in a few moments when I comment on the Commission’s decision in the Pala/Neo matter.
I would also point out something else you already know: decisions of the Commission turn on the specific facts and circumstances of the particular case. It is unusual for an applicable legal principle to drive us to a specific conclusion on the key issues involved in a matter. Perhaps that is because of our overarching public interest jurisdiction.
In any event, Commission decisions are fact-specific and must be interpreted within that context. One can only speculate what a particular decision such as HudBay or Pala/Neo might have been, if the facts were significantly different.
The HudBay Decision
Let me then turn first to the Commission’s decision in HudBay/ Lundin. Most of you are aware of the facts, so I won’t review them here.
HudBay has attracted some significant attention partly because it is the first decision since Canada Malting in which the Commission has dealt with the review of a TSX decision in the M&A context and because, in the circumstances, the Commission overruled a portion of that decision.
In HudBay, one of the issues for determination by the Panel was whether the Commission had a reasonable basis to rely on the decision of the TSX with respect to the effect of the transaction on the quality of the marketplace. The Panel ultimately concluded that it did not.
The Panel did defer to the TSX on the question of whether there was a material effect on control of HudBay as a result of the transaction.
While the reliance issue was an important element of the decision, particularly from the perspective of the TSX, in my view, it did not drive the ultimate conclusions. The decision states that the Commission would have intervened in the TSX decision on the quality of the marketplace in any event, based on either new or compelling evidence that was presented to the Commission that was not before the TSX (as to HudBay’s governance practices) or on our different perception of the public interest. Accordingly, the decision should be viewed in a broader context.
There are two general issues from HudBay that are perhaps relevant for consideration by practitioners in structuring M&A transactions.
One of the important issues for the Panel was the question of whether the transaction was, in effect, a merger of equals that resulted in a fundamental change in the board of directors and a transformation of the business of HudBay. All without a HudBay shareholder vote.
The dilution as a result of the transaction in HudBay was 100% because, at the end of the day, the shareholders of each company were to own 50% of the continuing entity. Yet, only the shareholders of Lundin were voting on the transaction.
The Panel was also concerned about the governance practices of HudBay related to the holding of the relevant shareholders meetings (the shareholders meeting of Lundin to vote on the transaction and a requisitioned HudBay shareholders meeting to remove the HudBay board).
I should note in this respect that the relevant provision of the TSX rules require the TSX to consider an issuer’s governance practices as one of the factors in deciding whether to require shareholder approval.
In this case, Lundin significantly accelerated its shareholders’ meeting to vote on the transaction. The accelerated meeting date was announced just before Christmas and the shareholders’ meeting was to be held on January 26, 2009.
At the same time, HudBay called a requisitioned shareholders’ meeting to remove the board (after having rejected an earlier requisition) for a date well after the holding of the Lundin shareholders’ meeting.
The Panel concluded that HudBay was actively frustrating or interfering with the ability of shareholders to exercise their rights as shareholders to, in effect, vote on the transaction. It was not a circumstance in which Lundin had established the date for a shareholders’ meeting and a requisitioned HudBay shareholders’ meeting to replace the board could not be held before the Lundin shareholders’ meeting.
In any event, the decision in HudBay was made based on a consideration of all of the relevant circumstances including the two matters I have mentioned.
Fairness Opinions
The comments in HudBay with respect to fairness opinions have also generated some, shall I say, interest.
I believe that the HudBay reasons are clear that the Panel felt that, in the particular circumstances, if the fairness opinion obtained by HudBay had been relevant to its decision, the Panel would not have accepted that opinion as assisting the HudBay board of directors in demonstrating due care. By relevant, I mean had the fairness opinion been a consideration affecting the outcome of the securities law issues that the Panel had to determine. In the circumstances, it was not relevant.
In my view, the decision was careful not to comment on whether a board should obtain a fairness opinion or whether it should pay a success fee to the person giving that opinion.
Those are decisions for the board.
I believe that what the Panel said was, where the financial incentive to a person giving a fairness opinion is to complete a particular transaction, that incentive may be inconsistent with the interests of the shareholders for whose benefit the fairness opinion is being given. That is to say that the financial incentives to the opinion giver can give rise to a potential conflict of interest. The Panel in HudBay felt that they did give rise to such a conflict in the circumstances of the HudBay-Lundin transaction.
The Panel also felt that, where it saw an issue that raised significant concern, it was fairer to market participants to identify that issue so that they are at least aware of it and can give it some consideration.
I would note that one of the key facts in HudBay was that the fairness opinion was being given in respect of the interests of the shareholders of the acquiror, not of the target of the acquisition. My personal view is that, where a company is looking to maximize value by being acquired by any purchaser on the most beneficial financial terms, a success fee would not likely give rise to any conflict of interest of the nature identified in HudBay.
I would add that the principle here is not a new one. The same concept is reflected in Multilateral Instrument 61-101 where a valuator is preparing an independent formal valuation. A valuator is not independent for that purpose where its financial compensation depends in whole or in part on an arrangement that gives it a financial incentive in the outcome of the transaction.
I hasten to add that I am not suggesting that MI 61-101 applies to fairness opinions or that the Commission has any intention of regulating the use of such opinions. I am simply noting that MI 61-101 addresses a similar conflict of interest issue in the context of the preparation of an independent formal valuation.
Similar concerns about financial incentives to the givers of fairness opinions have been expressed by U.S. courts.
I would reiterate my view that the HudBay reasons do not say to directors:
- don’t get a fairness opinion, or
- don’t pay a success fee to the person giving a fairness opinion.
And the decision does not suggest that a board cannot by other means demonstrate due care in exercising its responsibilities. In my view, there is nothing inappropriate per se from a securities law perspective in obtaining a fairness opinion where a success fee is paid to the provider of that fairness opinion.
My personal conclusion from this is that any issue of the alignment or misalignment of the financial incentives to an opinion giver, relative to the interests of shareholders, is one for consideration by the board of directors in the particular circumstances of the relevant transaction.
The InterRent Decision
As I mentioned, in HudBay, the Commission decided that it could not defer to the TSX decision with respect to the effect of the transaction on the quality of the marketplace. I would note that in the subsequent Commission decision in InterRent, the Commission reiterated that it is not going to second-guess decisions of the TSX that are made on reasonable grounds.
If you are applying to the Commission for a hearing and review of a TSX decision, you will have a heavy onus to demonstrate one of the accepted grounds for intervention by the Commission.
The InterRent decision also notes that parties to an application to the Commission for review of a TSX decision should generally not expect the same level of discovery and examination of relevant persons as may be available in a Court proceeding.
That is an issue that applicants should consider in deciding whether to bring an application before the Commission.
The ARC Equity Management Decision
In HudBay, the Panel also expressed a view on whether shares acquired in a private placement in connection with a linked business combination should be able to be voted in favour of that transaction.
The Alberta Securities Commission subsequently addressed that issue in its decision in ARC Equity Management.
In my view, there were a number of important factors that the ASC considered in concluding not to interfere with the voting of the privately-placed shares on the particular transaction:
- The private placement responded to the target’s difficult financial circumstances;
- The private placement was effected at a premium to the then market price of the shares;
- The private placement was not conditional on or linked to the success of the simultaneous bid;
- If there was a superior competing bid made, the bidder subscribing for the shares could be required in certain circumstances to tender those shares to that bid.
In my view, the decision of the Alberta Securities Commission was eminently reasonable based on those considerations.
There are two additional learnings I would take from the ARC decision.
First, any regulatory concern there may be about a private placement in connection with a linked M&A transaction does not constitute or suggest that there is any per se restriction or prohibition on such private placements or the voting of the shares that are issued.
As I mentioned above, any securities regulatory issue can be understood and addressed only in the context of the specific circumstances.
I would have thought that conclusion is obvious, but the contrary position was argued, and rejected by the Panel, in ARC.
Second, the fact that the TSX had approved a private placement and that decision was not appealed, did not prevent the Alberta Securities Commission from reviewing the transaction from a public interest perspective.
I should note that in HudBay and ARC this issue was not being addressed under the provisions of Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions.
The Patheon Decision
Let me now briefly turn to the Commission’s decision in Patheon.
In that matter, a significant shareholder was given the opportunity to either tender to a bid or to remain a shareholder by exchanging its shares for shares of the acquisition vehicle. In the latter event, the shareholder would have the benefit of a shareholders’ agreement with certain liquidity rights.
Public shareholders were not given this second alternative. Their choice was simply whether to tender to the bid.
There were two key issues that were addressed in the decision.
First, the Commission suggested, but did not ultimately decide, that a shareholder does not have to tender to a bid in order for there to be a collateral benefit to that shareholder that engages the prohibition against such benefits.
In this respect, the wording of subsection 97(1) of the Act prohibits an agreement or arrangement that provides a security holder a consideration of greater value than that offered to other shareholders.
The argument that was made in Patheon was that if a shareholder doesn’t tender to a bid, that shareholder cannot receive a higher consideration for its shares than other shareholders. The shareholder who is not tendering is receiving no consideration under the bid.
Therefore, there can be no prohibited collateral benefit.
That argument was not accepted by the Panel in Patheon.
In addition, the Panel indicated that, where the Commission is considering the application of the take-over bid rules, the Commission may intervene on public interest grounds if one of the animating principles of the take-over bid regime are engaged: such as where the requirement for identical consideration, equal treatment of shareholders or the adequacy of disclosure is questioned.
The Commission stated in Patheon that:
There should be no doubt in the minds of market participants that the Commission will intervene in the public interest where the take-over bid provisions have been complied with but the animating principles underlying those rules have not.
In my view, the decision is suggesting that, in such circumstances, no abuse needs to be demonstrated as required in the Canadian Tire line of public interest decisions.
Poison Pills
There have also been a few interesting poison pill cases over the last year. The Commission decision in the Neo/Pala matter, in particular, has generated some comment.
One question that has been raised is whether the Neo decision reflects a change in the basic approach of the Commission to poison pills and shifts the analysis to simply determining whether or not the board of directors of the target has complied with its fiduciary duties in the circumstances.
It has been suggested that the decision in Neo may now permit a “just say no” defence where the board has complied with its fiduciary duties.
In my personal view, the decision in Neo turned on the fact that shareholder approval of the specific poison pill was obtained.
That is: the shareholders overwhelmingly voted to keep the poison pill in place to prevent completion of the bid that was then before them.
On the basis of that shareholder approval, the Commission decided that it would not, at that time, cease trade the poison pill.
In my view, that conclusion is consistent with the Commission’s defensive tactics policy which states that shareholder approval of a defensive tactic may allay the concerns that securities regulators may have with respect to a particular defensive tactic.
Having come to that conclusion, the Commission in Neo went on to ask the legitimate question whether there were any additional considerations in the circumstances that might lead the Commission not to defer to the decision of the shareholders.
First, the Commission asked whether the board of directors of the target was acting in the best interests of the corporation in implementing the poison pill and in not soliciting competing offers.
Second, the Commission asked whether the shareholder vote had been coerced.
On my reading of the reasons, those two questions were addressed in considering whether there was any reason not to defer to the views of the shareholders represented by the shareholder vote.
While the Neo case discussed at some length whether the board of directors had complied with its fiduciary duties in implementing the poison pill, it was not, in my view, suggesting that whether or not the board has complied with its fiduciary duties should determine whether the Commission will leave a poison pill in place.
That conclusion would, in my view, be inconsistent with the provisions of our Defensive Tactics Policy.
I recognise, however, that different views have been expressed by others with respect to their reading of the decision in Neo.
Following the decision in Neo, I believe that the Commission applies three different lines of analysis in considering whether to cease trade a poison pill.
First, where a bid has been made and the board of directors of the target determines to solicit competing bids, the question is whether the time has come for the “pill to go”. Or should the poison pill remain in place for some limited period to permit further efforts by the target to solicit competing higher value transactions
That is the traditional analysis reflected, for instance, in the Royal Host decision.
The second line of analysis is reflected in the decisions in Neo and the Pulse Data decision of the Alberta Securities Commission.
In those cases, the relevant Commission has accepted that where shareholder approval is obtained for the implementation of a strategic poison pill in the face of an actual bid, the Commission should consider and defer to shareholders where they have overwhelmingly voted to maintain the poison pill in place.
Subject, of course, to any competing considerations, such as whether the board is acting appropriately and whether the vote was fair and not coerced.
Those two decisions leave open, of course, the question at what point in the future the shareholder approval given should cease to be relevant to the Commission’s analysis.
The third line of analysis is reflected in the Commission decision in Falconbridge. In that case, a poison pill was used to extend an auction by restricting creeping acquisitions that could have affected the outcome of that auction.
The decision in Falconbridge recognizes that poison pills can be used for other legitimate purposes within the framework of our take-over bid regime.
Accordingly, providing time to solicit competing bids is not the only legitimate use of a poison pill.
Conclusion
As I indicated above, I have been expressing my personal views on some of the policy issues arising from the Commission’s recent decisions. Like you, I will be interested to watch future decisions to see whether the Commission gives further guidance on these issues.
In the meantime, staff of the Commission and their colleagues in the Canadian Securities Administrators will be considering, as a policy initiative, whether there are changes that should be brought forward to our Defensive Tactics Policy as a result of these decisions and the evolution of our capital markets since that Policy was implemented in 1987.
I look forward to the discussions that these matters will generate.
I am sure that you will have an interesting and informative morning talking about the current environment for mergers and acquisitions. I hope I have contributed in a small way to your discussions.
Thank you for your attention.
