Notice: NI - 33-105 - Underwriting Conflicts

Notice: NI - 33-105 - Underwriting Conflicts

Multilateral Instrument




Substance and Purpose of Proposed Multi-Jurisdictional Instrument and Companion Policy

The substance and purpose of the proposed Multi-Jurisdictional Instrument (the "Instrument") is to impose appropriate regulatory requirements on distributionsof securities in which the relationship between the issuer or selling securityholder of the securities and the registrant acting as underwriter raises the possibilitythat the registrant will be in an actual or perceived position of conflict between its own interests or those of the issuer or selling securityholder, and those ofinvestors. The proposed Instrument imposes certain disclosure requirements to these transactions and, in some cases, the requirement that an independent dealerparticipate in the distribution.

The purpose of the proposed Companion Policy is to state the views of the Canadian securities regulatory authorities on various matters relating to the proposedInstrument, and to provide market participants with guidance in understanding the operation of the proposed Instrument and the policy concerns that lie behindsome of its provisions.

The proposed Instrument and Companion Policy are initiatives of the Canadian Securities Administrators (the "CSA"), and the proposed Instrument is expectedto be adopted as a rule in each of British Columbia, Alberta, Ontario and Nova Scotia, as a Commission regulation in Saskatchewan and as a policy in theremaining jurisdictions of the CSA other than Quebec. The proposed Companion Policy is expected to be implemented as a policy in all of the jurisdictionsrepresented by the CSA other than Quebec.

The proposed Instrument and Companion Policy are not being proposed for adoption at this time by the Commission des valeurs mobilières du Québec (the"Quebec Commission").

Because this Instrument is not, at this time, proposed for adoption in all of the jurisdictions of the CSA, it is called a Multi-Jurisdictional Instrument rather than aNational Instrument. However, as this Instrument is being adopted in a number of jurisdictions, it is numbered as a national instrument. National Instrument14-101 Definitions will be amended to apply to both national instruments and multi-jurisdictional instruments.


Existing Legislation and Blanket Orders

In 1987, the barriers to non-industry ownership and foreign participation in the Ontario securities markets were removed. The Government of Ontario anticipatedthat this would result in some registrants being controlled by foreign or domestic financial institutions ("FIs") or by other companies not wholly-owned byindustry participants. To address the potential new conflicts that were anticipated to flow from non-industry ownership, the Government introduced Part XIII("Part XIII") of the Regulation (the "Ontario Regulation") made under the Securities Act (Ontario) (the "Ontario Act"). Since 1987, each of Alberta, BritishColumbia, Newfoundland and Nova Scotia have adopted similar conflict of interest regimes based on the provisions of Part XIII, although the particular rules insome of these provinces vary materially from Part XIII. In this Notice, Part XIII and these other conflict of interest regimes are generally referred to as "theexisting conflict regime".

The general scheme of the existing conflict regime

(1) establishes tests to determine which persons or companies are non-arm's length parties in relation to a registrant, both for purposes of distributions and inconnection with general trading and advising activities,

(2) sets out general duties of registrants to their clients,

(3) requires registrants to disclose policies regarding transactions with non-arm's length parties, and

(4) prohibits securities transactions, whether underwriting, advising or trading, with or for clients involving securities of non-arm's length parties of the registrantunless specified conditions are met.

The specified conditions referred to in paragraph (d) above, contained in Ontario in section 224 of the Regulation, are the disclosure requirements andindependent dealer requirements that are the predecessors to the corresponding provisions contained in the proposed Instrument.

In 1992, the Ontario Securities Commission (the "Ontario Commission") published a blanket ruling (the "Section 224 Blanket Ruling") In the Matter ofLimitations on a Registrant Underwriting Securities of a Related or Connected Issuer(1) to clarify the various interpretations being given to section 224 of theOntario Regulation. The Section 224 Blanket Ruling was intended to address the concern that section 224 of the Ontario Regulation went beyond what isnecessary to achieve its purpose and that the same purpose could be accomplished with less intrusion into the manner in which registrants participate inunderwriting. The Section 224 Blanket Ruling has been replaced by a rule in Ontario, identical in form to the Section 224 Blanket Ruling, that will expire whenthe proposed Instrument comes into force or on December 31, 1998, whichever is earlier.

Similarly, in 1992, the British Columbia Securities Commission (the "British Columbia Commission") published its blanket ruling (the "Section 167.4 BlanketRuling") In the Matter of the Limitations on a Registrant Underwriting Securities of a Related Party or Connected Party of a Registrant.(2) The Section 167.4Blanket Ruling was intended to address the same concern in section 167.4 of the Securities Act (British Columbia) as that in section 224 of the OntarioRegulation.

Also, in Ontario, subsection 230(2) of the Regulation provided an exemption to mutual fund dealers from some of the provisions of Part XIII. In 1991, theOntario Securities Commission issued a blanket order (the "Mutual Fund Securities Blanket Order") In the Matter of Mutual Fund Securities(3) which exemptedbrokers, investment dealers and securities dealers from the applicable provisions of Part XIII in relation to trading in mutual fund securities in the same manner asmutual fund dealers are exempted by subsection 230(2) of the Ontario Regulation, provided the issuer of the mutual fund securities is managed by an affiliate ofthe dealer. The Mutual Fund Securities Blanket Order also exempted mutual fund dealers from the independent underwriter requirements of subsection 224(1)(b)of the Ontario Regulation. That part of the Mutual Fund Securities Blanket Order will not be carried forward in Ontario into proposed Rule 33-502 Exceptionsto Conflict Rules in the Sale of Certain Mutual Fund Securities (the Ontario rule that will replace most of the Mutual Fund Securities Blanket Order), as theproposed Instrument provides a complete exemption from its requirements for distributions of mutual fund securities. Through the Instrument, Ontario will bebrought into harmony with the regime existing in the other provinces.

CSA Review of Conflict Issues

In 1994, the CSA undertook a reassessment of the manner and extent to which the existing conflict regime regulates conflicts of interest in the securitiesindustry. Following discussions among CSA members, the CSA published a discussion paper(4) setting out a summary of the issues and possible alternativeregulatory responses available. The CSA invited comments from the public on the ambit of the conflicts of interest that should be addressed by the conflictsregime and the appropriate regulatory mechanisms to control these conflicts.

The CSA established a committee (the "CSA Underwriting Committee") to assist in the formulation of recommendations regarding underwriting conflicts ofinterest. The Committee was chaired by a Vice-Chair of the Ontario Commission and was made up of CSA appointees from Alberta, Ontario and Quebec andsenior representatives from various market participant groups, namely dealers, issuers and institutional investors.

In June 1995, the CSA Underwriting Committee delivered two reports to the CSA Chairs. One report contained the recommendations made by the majority forchanges to the underwriting conflict regime (the "Committee Report"). The second report contained the dissenting views of the member representing theCanadian non-bank owned dealers (the "Dissent Report").

The Reports(5) were published and the public was invited to make comments on the recommendations made by the CSA Underwriting Committee members. TheQuebec Commission concurrently asked the public to respond to five questions that focused on whether the CSA Underwriting Committee recommendationswould adversely effect investors by reducing competition or by lessening the duties owed by underwriters to investors or the ability of investors to sue dealersarising out of their participation in a distribution.

Summary of Committee Report Recommendations

The CSA Underwriting Committee concluded that the relationships of concern between issuers and dealers were those arising from cross-ownership andindebtedness. In unusual circumstances, other relationships might give rise to concern, but this could be adequately dealt with by giving regulatory staff thepower to designate any person or company to be a related issuer or connected issuer.

In addition, the CSA Underwriting Committee made the following recommendations.

Definition of Related Issuer Status. The existing definition of related issuer should be rewritten to provide two tests for related issuer status. The first test wouldturn on straight ownership. A person or company would be a related issuer of a second person or company, if, on aggregating all voting or equity securitiesbeneficially owned, directly or indirectly, the first person or company owned more than 20 percent of the voting or equity securities of the other.

The second test would be a combination of ownership and overlapping directors. A person or company would be a related issuer of a second person or companyif there is cross-ownership of more than 10 percent of the voting or equity securities and the nominees of either person or company and its related issuers occupymore than 20 percent of the board seats of the other person or company.

Determination of Connected Issuer Status. An issuer would be a connected issuer of an underwriter if the proceeds of a distribution were being used to repaymore than 20 percent of the amount owing by the issuer, selling securityholder or any of their respective related issuers to the underwriter or any of its relatedissuers. If this relationship exists, then disclosure would be required. The proposed rules would also clarify that "amount owing" only includes those liabilitiesthat appear on the balance sheet of the borrower in accordance with generally accepted accounting principles.

Independent Underwriter Requirement. An independent underwriter would be required to participate in all distributions by related issuers and in distributions byconnected issuers unless the issuer or selling securityholder was not in financial difficulty or the indebtedness represents less than 10 percent of the issuer's orselling securityholder's total equity (a de minimus exemption). These exemptions were based on the conclusion that if the issuer or selling securityholder was notin financial difficulty, it would have alternative means of raising the funds to repay the lender and would not likely be amenable to inappropriate influence by thelender. The lender would also have no incentive to attempt to cause its related registrant to act improperly in respect of the distribution. Also, if the debt were deminimus, the benefits to a lender or a related registrant of inappropriately affecting the distribution would be offset by the comparatively large risk of acting insuch a manner.

The CSA Underwriting Committee proposed that in cases in which there was a requirement for an independent underwriter to be involved in the transaction,then the minimum required participation of the independent underwriter should be the lesser of 20 percent of the dollar value of the distribution, and the largestposition underwritten by a non-independent underwriter. The CSA Underwriting Committee strongly believed that the independent underwriter must be an activeparticipant in the pricing, due diligence and disclosure activities undertaken by the lead underwriter as it is these activities that are assumed to be affected by theconflict of interest.

Disclosure Requirement. In all distributions in which there was a related issuer or connected issuer relationship, the relationships between the issuer or sellingsecurityholder and the underwriter would have to be disclosed so that the market may make its own assessment about the importance of significant relationshipsand their effect on the transaction. The independent underwriter should be identified as such in the prospectus, and the required prospectus disclosure shouldinclude the role played by the independent underwriter in the structuring and pricing of the distribution and in the due diligence activities carried out by theunderwriters. The disclosure requirements were assumed to have the effect of ensuring that the independent underwriter would actually participate adequately inthese activities.

Harmonization. The final recommendation of the CSA Underwriting Committee was that the conflict regime be harmonized across the country.

Summary of Dissent Report & Alternative Proposed

The CSA Underwriting Committee member representing the Canadian non-bank owned dealers dissented from the Committee Report. In his view, theCommittee had no justification or empirical evidence to support the substantial amendments that the Committee proposed for the conflict regime. The CSAUnderwriting Committee member argued that the proposed changes would reduce the involvement of the independent dealer in the underwriting syndicate tovery few circumstances and have a profound impact on investor protection.

The Dissent Report referred to the alternative proposal submitted to the CSA Underwriting Committee by the dissenting entities. This alternative proposal wouldhave maintained the current Ontario and Quebec definition of connected issuer. A connected issuer relationship would lead to one of two results in the context ofa distribution, depending upon the financial health of the issuer and, in the case of an initial public offering of securities by an issuer, its parent or the sellingsecurityholder. If there was financial difficulty, an independent co-lead underwriter at a level of participation at least equal to the conflicted lead underwriterwould be required. If there was no financial difficulty, there would be no requirement for independent underwriter participation if the Chief Executive Officer ofthe "conflicted" underwriter certified that the relationship that gave rise to the conflicts of interest concern did not affect its judgment and a senior officer of thecontrolling shareholder of the underwriter certified that it did not influence the offering. Full disclosure of the relationships that give rise to the conflict would berequired.

The certification approach referred to in the alternative proposal was based on the Investment Dealers Association of Canada ("IDA") approach topre-marketing(6), a self-policing mechanism that depends upon the underwriters involved in a transaction satisfying themselves that their conduct is appropriateand documenting that conclusion in a certificate filed with the Director of Compliance of the IDA.

Summary of Public Comments

The CSA received several comment letters from the public concerning the CSA Underwriting Committee's proposals. All of these responses, except the onedelivered to the Quebec Commission by the Canadian non-bank owned dealers, generally were supportive of the CSA Underwriting Committee'srecommendations. Three of the letters made specific suggestions for additional exemptions that the respondents thought the CSA Underwriting Committeeshould have incorporated in its proposed regime. If these suggestions were adopted, the ambit of the amended conflict regime would be reduced substantially.Those respondents who commented on the questions asked by the Quebec Commission were of the view that the CSA Underwriting Committeerecommendations would not negatively affect the investing public.

Both the British Columbia Commission and the Quebec Commission made alternative recommendations for changes to the existing conflict of interest regime.Both Commissions accepted the recommendations of the CSA Underwriting Committee regarding the amendments to the definition of related issuer. Both wouldhave also retained their respective current definitions of connected issuer or connected party. The British Columbia Commission would have retained the existingprospectus requirements for disclosure of relationships, while the Quebec Commission would have increased the disclosure obligations and added a requirementfor the non-independent underwriter to certify that the relationship with the issuer did not in fact affect the dealer's judgment regarding the structure or pricing ofthe transaction.

The British Columbia proposal would have provided automatic exemptions from the participation of an independent underwriter in circumstances in which theissuer was not in financial difficulty or if a de minimus debt relationship was involved. The CSA Underwriting Committee's financial difficulty test, with somemodifications, was supported by British Columbia. If an independent dealer were required, the minimum participation of that dealer might follow one of threemodels: the current rule; a dollar value cap; or the proportion would be less than under the current rules and new rules would be introduced regarding theobligations of underwriters on these distributions.

The Quebec Commission model would have required independent underwriters to take 50 percent of a distribution by a connected issuer that was not POPsystem eligible. For POP eligible issuers, only one independent underwriter would be required to distribute the lesser of 20 percent of the distribution or theproportion distributed by the largest non-independent dealer.

Summary of Supplementary Report

The CSA asked the CSA Underwriting Committee to review its recommendations in light of the comments received. Except for two substantive changessuggested by the British Columbia Commission, the remainder of the CSA Underwriting Committee's recommendations to the CSA were unchanged.(7) The firstchange was to adopt the British Columbia definition of connected party. The second change was undertaken to reflect the inclination of the Canadian Institute ofChartered Accountants with respect to defining a person or company's liabilities, by adding the parties' cross-ownership of preferred shares to the de minimusrelationship calculation.

The Committee reaffirmed its previous recommendations regarding the definition of related issuer, the importance of disclosure of all material facts relating tothe relationship between the dealer and the issuer, the required minimum participation of the independent underwriter and its role in the due diligence, pricing anddisclosure process and the need for exemptions from the requirements to have an independent underwriter where the issuer is not in financial difficulty or therelationship was de minimus.

Joint Securities Industry Committee Review of Conflict Issues

The five Canadian self-regulatory organizations in Canada, the Investment Dealers Association of Canada, and the Montreal, Toronto, Calgary and VancouverStock Exchanges, announced in October 1996 the formation of the Joint Securities Industry Committee on Conflicts of Interest (the "Joint Committee"). TheJoint Committee was established in the wake of several controversial incidents that occurred in emerging company markets. The self-regulating organizationsasked the Joint Committee to examine the potential conflicts of interest that occur when brokers and member firms participate in emerging company investmentsand ascertain if the existing self-regulatory rules and the provincial regulations adequately protect investors. The priority of the Joint Committee was todetermine whether market confidence was being harmed by current practices and to make whatever recommendations it considered appropriate to ensure that theintegrity of the capital-raising process for emerging companies is maintained.

The Joint Cmmittee delivered its interim report in February 1997 and its final report in September 1997. In addition to dealing with a substantial number of issuesrelating to conflicts that are outside the scope of the proposed Instrument, the final report recommended that the concept of a "professional group" be introducedinto the rules governing underwritings by related or connected issuers. The concept of "professional group" was recommended to deal with the perception that,even though the amount of stock of an issuer held by a registrant firm may be small, the combined holding of that issuer's shares by individuals within that firm,including directors, officers, brokers and corporate finance personnel, may be significant. The final report recommended that the conflict of interest rules relatingto underwritings be applicable to holdings by a professional group of 20 percent or more of an issuer.

Summary of Proposed Instrument

Part 1. Section 1.1 sets out the definitions used in the proposed Instrument. The three key definitions are those of "connected issuer", "related issuer" and"influential securityholder", which collectively define the relationships to which the proposed Instrument applies.

"connected issuer". The definition of "connected issuer" is based on the current definition of connected party set out in the present conflict provisions in BritishColumbia. It represents a simplification of the current definition of connected issuer in use in Newfoundland, Nova Scotia, Ontario and Quebec, in that the testonly turns on whether there is a direct or indirect relationship between the issuer and the registrant so that a reasonable prospective purchaser of the securitiesmight question the independence of the two. The second part of the present test in use in Newfoundland, Nova Scotia, Ontario and Quebec (a relationship that areasonable prospective purchaser might consider important in making the investment decision) has been deleted.

The definition of "connected issuer" includes a "related issuer".

"direct underwriter". The proposed Instrument applies only to registrants that are acting as a "direct underwriter" in certain distributions. A "direct underwriter"is defined as an underwriter that is in a contractual relationship with the issuer or selling securityholder to distribute the securities that are being offered in thedistribution, or a dealer manager, if the distribution is a rights offering.

"related issuer" and "influential securityholder". The definition of "related issuer", along with the definition of "influential securityholder", makes substantivechanges to the current definition of related issuer/party in the existing conflict regime. A person or company or, in some cases, a professional group, is aninfluential securityholder of an issuer if the person or company owns more than 20 percent of the voting or equity securities of the issuer, or if there iscross-ownership of 10 percent of the voting or equity securities combined with 20 percent cross-directorships or the right to nominate 20 percent of the other'sdirectors.

"specified party". In essence, a specified party is an issuer for which there are indicia of a decline in financial health. These indicia are set out in the definition andinclude a default on payments due under debt obligations, a downgrade by a rating agency to below investment grade, a breach of a financial covenant or amaterial adverse financial condition as shown in the issuer's most recent financial statements. The definition of "specified party" is used to determine whether ornot an independent underwriter is required to be involved in a distribution by a connected issuer of the underwriter. The CSA specifically invite comment on thisdefinition.

Section 1.2. Section 1.2 contains several interpretation provisions. Subsection 1.2(1) contains a number of provisions relating to the calculation of shareholdingsrequired to be made under the proposed Instrument. Subsection 1.2(2) provides that a person or company is a related issuer of another person or company if oneis an influential securityholder of the other, or if each is a related issuer of a third person or company. Subsection 1.2(3) provides an interpretation of the timingrequirements of the proposed Instrument in relation to distributions.

Section 1.3. Section 1.3 provides that the proposed Instrument does not apply to distributions of exempt securities (being securities listed in the provisions ofsecurities legislation contained in Appendix A of the proposed Instrument) or mutual fund securities.

Part 2. Part 2 sets out the general scope of the rule regarding the participation of a registrant acting as an underwriter in a distribution in which it is the issuer orselling securityholder or as a direct underwriter of securities of or by a connected issuer.

Section 2.1. Section 2.1 states that, unless two conditions are satisfied, a registrant may not act as an underwriter in a distribution in which it is the issuer orselling securityholder or as a direct underwriter of securities of or by a connected issuer. The first of these two conditions is full disclosure of the relationship, incompliance with the required information contained in Appendix C of the proposed Instrument, which must be given in writing for all distributions, whether ornot the distribution is effected by way of a prospectus. The second condition requires the participation of an independent underwriter if the distribution is doneunder a prospectus. The independent underwriter must distribute a percentage of the distribution equal to the largest percentage underwritten by anon-independent underwriter or 20 percent of the distribution, whichever is less. The independent underwriter's name and role played in the due diligence,disclosure and pricing process must be disclosed in the prospectus.

Section 2.1 also applies to a distribution in which a registrant is acting as an agent, rather than as a principal. In those circumstances, an independent underwritermust receive 20 percent of the total management fees for the distribution or the largest portion of the management fees paid or payable to the non-independentunderwriter, whichever is less.

Part 3. Part 3 sets out the non-discretionary exemptions to the general rule.

Section 3.1. Section 3.1 provides that the disclosure requirements of the general rule do not apply if the distribution is effected under a prospectus exemption andeach of the purchasers is a related issuer of the registrant or the transaction is a control block distribution made under provisions of Canadian securitieslegislation specified in Appendix B of the proposed Instrument.

Section 3.2. Section 3.2 contains the most significant practical exemption from the requirement to involve an independent underwriter in a distribution. Aregistrant may act as a direct underwriter of a distribution of securities by a connected issuer if the issuer or selling security holder is not a specified party or theonly relationship between the issuer or selling security holder and the registrant is a "minor debt relationship". A relationship is a minor debt relationship if theaggregate debt owed to the registrant and its related issuers by the issuer or selling securityholder and their related issuers, plus the preferred shares of the issueror selling securityholder and their related issuers, owned by the registrant and its related issuers is less than 10 percent of the book value of the issuer's or sellingsecurityholder's equity. The exemption provided by this section is not available if the issuer of the securities or the selling securityholder is the registrant or arelated issuer of the registrant.

Part 4. Section 4.1 permits the regulator or, except in the case of Ontario, the securities regulatory authority to provide exemptions from the proposedInstrument. Section 4.2 provides that, in certain circumstances, the granting of such an exemption is evidenced by the issuance of a receipt for the prospectus.

Appendices. Appendix A lists, for the purpose of section 1.3 of the proposed Instrument, the provisions in securities legislation that describe "exempt securities".Appendix B lists, for the purpose of section 3.1 of the proposed Instrument, the provisions of securities legislation that describe a control block distribution.Appendix C sets forth the disclosure requirements imposed by paragraph 2.1(a) of the proposed Instrument.

Summary of Proposed Companion Policy

Part 1. Part 1 states that the purpose of the Policy is to allow the Canadian securities regulatory authorities to state their views on various matters relating to theproposed Instrument and to provide market participants with guidance in understanding the policy concerns and operation of the proposed Instrument.

Part 1 also states that the general policy rationale for the proposed Instrument is to protect the integrity of the underwriting process in circumstances in whichthere is a direct or indirect relationship between the issuer or selling securityholder and the underwriter that might give rise to a perception of a conflict ofinterest in connection with the distribution.

Part 2. Part 2 summarizes the general structure of the proposed Instrument, the relationships between the underwriter and issuer or selling securityholder towhich the proposed Instrument applies, and the basic disclosure obligations and the independent underwriter obligation required by the proposed Instrument ifthe registrant is a non-independent underwriter.

Part 3. Part 3 summarizes the exemptions from the independent underwriter requirements of the proposed Instrument contained in Part 3 of the proposedInstrument.

Part 4. Part 4 provides commentary to assist in determining what constitutes a "related issuer" relationship or a "connected issuer" relationship.

Appendix A. Appendix A contains four flow charts designed to illustrate the analysis that would be followed in order to determine the applicability of theproposed Instrument to a distribution. The first two flow charts assist in determining whether parties are related issuers. The third flow chart assists indetermining whether parties are connected issuers to registrants. The final flow chart provides a general analysis of whether, or how, the proposed Instrumentapplies to a given distribution.

Terms used in the proposed Companion Policy that are defined or interpreted in the proposed Instrument or a definition instrument in force in the jurisdictionshould be read in accordance with the proposed Instrument or definition instrument, unless the context otherwise requires.

Authority for Proposed Instrument

In those jurisdictions in which the Instrument is to be adopted or made as a rule or regulation, the securities legislation in each of those jurisdictions provides thesecurities regulatory authority with rule-making or regulation-making authority in respect to the subject matter of the proposed Instrument.

In Ontario, the following provisions of the Ontario Act provide the Ontario Commission with the authority to make the proposed Instrument. Paragraph 143(1)2of the Ontario Act authorizes the Ontario Commission to make rules prescribing the conditions of registration or other requirements for registrants or anycategory or sub-category of registrant, including requirements that are advisable for the prevention or regulation of conflicts of interest. Paragraph 143(1)3 of theOntario Act authorizes the Ontario Commission to make rules that extend any requirements prescribed as conditions of registration or other requirements forregistrants to unregistered directors, partners, salespersons and officers of registrants. Paragraph 143(1)7 of the Ontario Act provides authority to the OntarioCommission to make rules regarding the furnishing of information by registrants to the public. Paragraph 143(1)13 of the Ontario Act authorizes the OntarioCommission to make rules regulating trading or advising in securities to prevent trading or advising that is fraudulent, manipulative, deceptive or unfairlydetrimental to investors. Paragraphs 143(1)16 and 39 of the Ontario Act provides the Ontario Commission with authority to make rules governing prospectusesand their contents.

Alternatives Considered

The CSA considered a number of alternatives to the regime contained in the proposed Instrument. The CSA have reached the view that maintaining the currentconflict regime for underwriting is not appropriate, given the level of problems that have been experienced in interpreting and applying the current regime. TheCSA have also reached the view that repealing the current conflict regime is not appropriate because there is a need to address both actual and perceivedconflicts of interest in the context of distributions. Therefore, the CSA are of the view that some changes to the existing regime are appropriate.

The CSA considered whether it would be appropriate to eliminate the requirement for the involvement of an independent underwriter, and concurrently create astatutory liability regime whereby any investor who suffered damage as a result of a lack of independence of the issuer and an underwriter could sue theunderwriter and the issuer or selling securityholder. The CSA have determined that this would not be an acceptable alternative to the regime proposed in theInstrument.

The final alternative considered by the CSA and the CSA Underwriting Committee was the certification model put forward by the Canadian non-bank owneddealers. Under this model, no independent underwriter would be required for financially healthy issuers unless the connected underwriter and its controllingshareholder cannot certify that the relationships that gave rise to the conflicts of interest concern did not affect its judgment. This alternative was rejected asimpractical owing to the difficulty of anyone certifying that all the relationships that might exist between the issuer and the underwriter and their respectiverelated issuers did not influence their actions.

Related Instruments

The proposed Instrument and Companion Policy are related to each other and, in Ontario, to sections 219 and 224 of the Ontario Regulation.

Unpublished Materials

In proposing the Instrument and the Companion Policy, the CSA have not relied on any significant unpublished study, report, decision or other written materials.

Anticipated Costs and Benefits

Based on experience to date under the existing conflict of interest regimes of the various jurisdictions of the CSA, the CSA believe that the benefits of theproposed Instrument justify the costs.

The most significant benefit is the maintenance and improvement of investor protection provided by requiring, in certain circumstances, the presence of anindependent underwriter in distributions. In the case of distributions made under a prospectus, there exists the requirement to disclose the role that theindependent underwriter played in the structuring, pricing and due diligence activities of the distribution. This information should benefit investors as it isexpected to ensure that an independent underwriter takes an active role in those activities where the independence of the underwriter and the issuer is mostimportant to investor protection.

In addition, the CSA have attempted to clarify in the proposed Instrument a number of issues that have been problematic under the existing conflicts regime. Forexample, the test for related issuer status is less subjective in the proposed Instrument than in the existing regime, and the test for connected issuer status is nowclearer. Also, the application of the proposed Instrument to agency distributions has been clarified, and assistance is provided in determining what participationeach underwriter may have in a multi-underwriter distribution if more than one connected underwriter is involved. The CSA believe that this clarification willreduce the costs to the market and eliminate some sources of potential delays in underwriting currently caused by those issues.

These points of clarification should result in a reduction of time spent on the interpretation of rules, of questions brought to regulators and of applicationssubmitted to regulators. The inclusion of the automatic exemption provisions contained in the proposed Instrument will result in fewer applications forexemptions and should also save time and money for underwriters, issuers and regulators without compromising investor protection.

Finally, the reduction of the potential number of independent underwriters that must be involved in a single transaction should reduce the distortions in theformation of underwriting syndicates created by the existing conflict regime.

Given the nature of the proposed changes, the CSA do not anticipate any additional costs of compliance with the proposed Instrument.

Regulation to be Revoked

In Ontario, the Ontario Commission proposes to delete the definition of "influence" contained in subsection 219(1) of the Ontario Regulation, and to replace thedefinitions of "connected issuer" and "related issuer" with definitions that refer to the definitions contained in the proposed Instrument. The Ontario Commissionalso proposes to delete subsections 219(2), (3) and (4) and section 224 of the Ontario Regulation. Finally, the Ontario Commission proposes to amendsubsections 230(2) and 230(3) of the Ontario Regulation to delete the reference to section 224 of the Ontario Regulation.


Interested parties are invited to make written submissions with respect to the proposed Instrument and Companion Policy. Submissions received by May 8, 1998will be considered.

Submissions should be sent to all of the Canadian securities regulatory authorities listed below in care of the Ontario Commission, in duplicate, as indicatedbelow:

British Columbia Securities Commission
Alberta Securities Commission
Saskatchewan Securities Commission
The Manitoba Securities Commission
Ontario Securities Commission
Office of the Administrator, New Brunswick
Registrar of Securities, Prince Edward Island
Nova Scotia Securities Commission
Securities Commission of Newfoundland
Registrar of Securities, Northwest Territories
Registrar of Securities, Government of the Yukon Territory

c/o Daniel P. Iggers, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As securities legislation in certainprovinces requires that a summary of written comments received during the comment period be published, confidentiality of submissions cannot be maintained.

Questions may be referred to any of:

Derek Patterson
Legal Counsel
British Columbia Securities Commission
(604) 899-6645

David Sheridan
Legal Counsel
Alberta Securities Commission
(403) 297-2630

Barbara Shourounis
Saskatchewan Securities Commission
(306) 787-5645

Tanis J. MacLaren
Associate General Counsel
Ontario Securities Commission
(416) 593-8259
Proposed Instrument and Companion Policy
The text of the proposed Instrument and Companion Policy follow, together with footnotes that are not part of the Instrument or Companion Policy, but havebeen included to provide background and explanation.

DATED: February 6, 1998


1. (1992), 15 OSCB 3645.

2. BOR#92/9 Weekly Summary, Edition 92:31, pg. 2.

3. (1991), 14 OSCB 3763.

4. In Ontario, published in November, 1994 at (1994), 17 OSCB 5255.

5. The Committee Report and the Dissent Report were published in Ontario on July 7, 1995 at (1995), 18 OSCB 3157 and (1995), 18 OSCB 3195,respectively.

6. IDA By-law 29.13 enacted August 31, 1993.

7. The Supplementary Report of the CSA Committee on Underwriting Conflicts of Interest to the CSA was published on March 1, 1996, in Ontario, at (1996),19 OSCB 1129.