by Brian Koscak and Greg Hogan
Cassels Brock & Blackwell LLP
On May 22, 2009, the Investment Industry Regulatory Organization of Canada, otherwise known as IIROC (the equivalent of the Financial Industry Regulatory Authority in the United States) published a notice titled “Trading in Securities of U.S. OTC Issuers – Proposed Amendments to Dealer Member Rule 1300.1” (the Proposed Amended Rule) that will make it more difficult for Canadian investment dealers from trading in securities of United States issuers that have a class of securities (other than American Deposit Receipts) that have been assigned a ticker symbol on the OTC Bulletin Board or the Pink Sheets (U.S. OTC Issuers).
Identification
IIROC is proposing, among other things, to prohibit an investment dealer from accepting an order to sell securities of U.S. OTC Issuers until the investment dealer has formed a reasonable belief (see below) as to the true identity of the beneficial owner of those securities, including the identity of every natural person who controls the beneficial owner where the beneficial owner is not a natural person. So, for example, if the seller of securities of a U.S. OTC Issuer is a corporation, the investment dealer will have to ascertain the identity of every shareholder of the corporation until it has identified all upstream shareholders that are natural persons.
There will be no exemption where the account holder is a bank, securities dealer or similar financial institution, whether foreign or domestic, as presently is the case for non U.S. OTC Issuers under the existing IIROC rule. In fact, if the securities of a U.S. OTC Issuer are for the account of a foreign institution subject to bank secrecy laws, the investment dealer cannot accept an order to sell those securities if it cannot obtain the required information. Simply, it will get tougher for Canadian investment dealers to sell securities of U.S. OTC Issuers and for some investment dealers, it may not be worth the time, money and effort.
Reasonable Belief
The Proposed Amended Rule requires investment dealers to undertake good faith inquiries to form a “reasonable belief” as to the identity of the beneficial owner(s) of the securities of a U.S. OTC Issuer that they are being requested to sell. This may involve direct contact with those individuals or making inquiries with third parties. If there is any doubt, an investment dealer cannot complete the trade.
Another Reason to list on the CSE
The Proposed Amended Rule, however, does not apply to a U.S. OTC Issuer that has a class of securities listed or quoted on certain prescribed stock exchanges, such as the Canadian Securities Exchange (“CSE”). Therefore, for those U.S. OTC Issuers seeking to avoid the burdensome requirements to be imposed on investment dealers (and indirectly on shareholders of U.S. OTC Issuers) under the Proposed Amended Rule, they will have to first become a reporting issuer in one or more Canadian jurisdictions as well have a class of their securities listed on certain prescribed stock exchanges such as CSE.
According to Robert Cook, President of CSE, “It is cheaper and faster for any issuer, let alone a U.S. OTC Issuer, to list its shares on CSE than any other Canadian stock exchange, and the Proposed Amended Rule is just another reason to list. If the U.S. OTC Issuer is already a reporting issuer it’s even easier and the listing fee is only $12,500.”
Arguably, the Proposed Amended Rule will distinguish the reputable U.S. OTC Issuers from those less reputable by providing more information about these issuers and by holding investment dealers across Canada more accountable for their trading activities in securities of U.S. OTC Issuers.
The Harm the Proposed Amended Rule is Trying to Avoid
The Proposed Amended Rule states that U.S. OTC Issuers have often been a source of scandal with links to Canada, especially British Columbia. As a result of the actual harm and reputational damage to British Columbia’s capital markets, in 2008 the British Columbia Securities Commission implemented BC Instrument 51-509 – Issuers Quoted in the U.S. Over-the-Counter Markets) (the BC Rule) whose purpose is to prevent further abusive practices involving U.S. OTC Issuers and which impose certain reporting requirements on U.S. OTC Issuers. The BC Rule requires, among other things, that investment dealers determine the identity of every individual who is a beneficial owner of the securities of a U.S. OTC Issuer. This requirement targets high risk transactions, such as abusive or illegal trading where identities are hidden behind offshore intermediaries.
IIROC has based the Proposed Amended Rule in part on the BC Rule, to discourage and prevent any illegal market activity in securities of U.S. OTC Issuers from migrating to other parts of Canada by imposing similar restrictions on all investment dealers in Canada. BC investment dealers operating from BC will still be required to adhere to the BC Rule in addition to the Proposed Amended Rule, once implemented.
Exemption
The Proposed Amended Rule also provides for an exemption from the identification requirements. However, the exemption is very narrow and is not expected to be relied upon to any great extent by investment dealer members.
So How Does a U.S. OTC Issuer Get Listed on CSE?
For information on how to get listed on CSE, one can contact the authors or Jeffrey Stanger of ITB Solutions by telephone at (647) 500-0492 or by e-mail at jeffrey@itbsolutions.ca.
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This article is not intended to provide legal advice as individual situations will differ and should be discussed with a lawyer. For more information contact Brian Koscak or Greg Hogan at Cassels Brock & Blackwell LLP. Brian and Greg are partners specializing in corporate finance and securities law at Cassels Brock & Blackwell LLP, a full-service law firm located in Toronto, Ontario. Brian can be reached at 416.860.2955 or bkoscak@casselsbrock.com; Greg can be reached at 416.860.6554 or ghogan@casselsbrock.com.
Since 2005 ITB Solutions has provided listings development services to stock Exchanges in Canada such as the Canadian Securities Exchange. ITB Solutions currently provides New Listing Services to the NEO Exchange. We assist companies with the listing application and managing the process to become publicly tradable in Canada, as well as offering advice on how to make the most of your public listing. You can reach Jeffrey Stanger at 647-500-0492 or by email at jeffrey@itbsolutions.ca