:LPE:

About 15 years ago, the OSC commissioned a report, if memory serves in which trading patterns were tracked in relation to 35 major transactions involving issuers on the TSX, and, if memory serves, they found unusual run-ups in prices and volumes in all 35 cases prior to the disclosure of the deal to the public. They know statistically that this stuff is going on. Bloomie says so as well, in a new report, although this time they could only find unusual patterns in 60% of deals, so perhaps things are getting better up here. Link.

The article speaks for itself.

Buried in the budget documents was a set of recommendations about the future of Canadian capital markets. Link.

I suppose it had to happen. Canada’s New Government (which is a year old now, so perhaps we could make it Canada’s toddler government, or Canada’s pre-verbal government) has once again called for a single securities regulator, and several other measures to enhance the competitiveness of Canadian capital markets. Those other measaures reflect the discussion in the UK and US about “principle-based” regulation, which no-one has really defined well, and which is proposed, one assumes, in contrast to “rules based” regulation. In fact the Advanatge Canada document reads like a mash-up, as they say now, of the Bloomberg report and the report of the Capital Markets Commission, both released recently.

It makes the same claim as the NYSE - that market share is declining, and small to begin with. It adopts the UK AIM exchange’s regulatory model as the preferred model. From its blurb:

Canada can look to the experience of the United Kingdom’s Financial Services Authority (FSA), which has committed itself to moving regulation gradually away from detailed rules toward a more principles-based approach. Founding principles are simple and clearly laid out. For example, the Authority has adopted 11 simple principles to govern the behaviour of the firms it regulates. The FSA is also working to pare down its rulebook to make it less detailed and prescriptive. This approach is widely credited for having contributed to the recent success of the City of London in its competition with New York and other centres for global financial business.

The idea is, I think, issuers become responsible for meeting these substantive standards, these principles, and, I assume, make judgments about when they are met and when they are not. If they are not in the view of the investor or the regulator, they enforce the…what? Principle? That supposes a lot of uncertainty and litigation, and greater role for private litigation. What I expect issuers are looking for is the best of all worlds: fewer rules, use of principles or best practices, limits on private causes of action and an underfunded regulator who will not litigate prinicples-based cases because they are so expensive.

To be honest, I find the idea of principles-based regulation a bit surprising. We already have principles in the securities laws — full, open disclosure, for example — and the rules are, largely, efforts at providing clear or bright-line guidance to issuers. So what principles-based will mean is unclear. My experience is that issuers like rules - they like certainty, bright lines, and so-on. Financial innovators don’t mind either, they dream up lots of products to get around the rules.

I also expect there are important structural and institutional differences in London’s markets that are not easily compared across jurisdictions. More on these issues in future posts.

The Danier Leather case was argued at the SCC yesterday, the first case to reach the SCC on the statutory cause of action for failure to disclose in a prospectus (if you can believe it). It’s a wonky case. I provided a quick overview of the issues and facts to The Court and accompanied some of its editors to the hearing to see what we could SCC.

Ther case will be important because it will be top court discussions of how some of the key provisions of the Securities Act (Ontario) will be interpreted - it could have implications for other causes of action in the Act.

The overall sense of the hearing was that the Court would take some convincing of the merits of the appeal; but you can never really tell with these things. To my mind, the clearest and most persuasive arguments came from Ms. McKinnon for the OSC, who provided reasons for not permitting the use of the business judgment rule in the context of a prospectus offering, and counsel for the respondent, Mr. Zarnett, seemed to sense this, devoting most of his time to responding to the OSC, rather than the appellant.

The big question that did not get answered, that I think was asked in two or three different ways by the Court was: why was the non-disclosure of the low earnings reports *not* a material change on May 20, but a material change on June 4? Rothstein J. seemed to be thinking about this, and asked in a couple of ways, but the appellants appeared reluctant to make this argument, and I am not sure why, for to my mind, it is the most obvious problem with the responent’s position: why was it sufficient to be worth disclosing after the prospectus distribution, but not before? Everyone seemed to think these low earnings reports were material facts and the dispute was centred upon the obligation to disclose material facts during the prospectus process. However, a week after the distribution, these materials facts were considered material changes (not merely material facts), for which there is a clear obligation to disclose. In this sense, I wonder if the trial judge and the Court of Appeal were in error in finding and confirming that the low sales, of which the management knew and did not disclose, were not material changes. There may be good reasons - I don’t know what was presented at the 45 day trial - such as the planned but unsuccessful Victoria Day sale after the 20th but before the 4th.

How would the hearing have been different if, instead of re-arguing the trial judge’s reasoning that s. 130 contained an obligation to disclose material facts during a prospectus process, the appellants had made the more obvious case that the low sales figures that management knew about but did not disclose, was a material change, and that the trial judge had the right result for the wrong reasons and the Court of Appeal judgment was substantially incorrect? Probably a riskier strategy than re-arguing the trial judge’s reasons, which would require overcoming the trial judge’s findings of fact (a high threshold), but closer to the equities of the situation. It would have also forced the respondent to pick and choose between the elements of the two lower judgments - a more complicated defence.

Finally, the respondents and the Court made a lot of hay with the fact that the prospectus forecast (the original one) was actually almost met, in the end. I’m really not sure whether this should be important to consider, but it was, as Zarnett said, the elephant in the room. The question is, or should be, when you don’t know what the future holds, hope for the best, but your best information at the time of purchase says you have a material change, should you disclose it? Sadly, it is this hindsight that will help drive this decision, and it obfuscates the real issue somewhat. As I said, it’s wonky and not the best example with which to test these provisions.

For the anecdotal record, here is a list of the question asked by the Court:

Appellant’s submissions:

CJ: Where is the breach of s. 130 if the prospectus was substantially correct?

Abella J: If s. 56 and 7 were complied with, can there be a further breach of s. 130? If there is no on-going liability for s. 56-7, what else can there be? Isn’t all liability related to material facts?

Bastarache J: What is the definition of misrepresentation? What is the fact that is alleged that was untrue at the time it was stated? Is it not that nothing was untrue at the time stated?

Rothstein J: Isn’t what changed a “material change”?

Abella J: Isn’t it true that there is only an obliogation to disclose material changes not material facts?

CJ: How was the prospectus untrue? It was more or less likely to become true or untrue, but was not true or untrue. It is transitory information.

Bastarache J: What fact was misrepresented? Nothing in the prospectusd was untrue, the projections and forecasts were not untrue, they were not facts. There is no representation that the projections are facts. There is a warning in the propsectus that the projections are just opinions.

Binnie J: Did they issue new financial statements?

Bastarache J: What was the fact that was not true at the time of purchase?

Rothstein J: Do you concede that there was a material change?

Fish J: What would be the effect of eliminting the following words from the statute: “in light of the circumstances in which it was made”. Can you remove those words?

Intervenor’s submissions:

Abella J: Is thewre always an element of subjective judgment in the CICA rules and other standards applied to business decisions?

CJ: What are forecasts, how common are they and why are they made?

Respondent’s submissions:

Charron J: What is a material change (using hypothetical examples of a patent).

Deschamps J: When would a material change occur?

Binnie J: If the company didn’t know what was causing lower sales at the time it knew there were lower sales, it only knew there were lower sales, can it therefore say that there was only a change in a material fact, and not a material change?

Deschamps J: What is the difference betweeb penal and civil liability regimes in the code?

Charron J: Would you have to disclose a change in a material fact after the prospectus is issued?

Rothstein J: Do you have to disclose changes, events past the issue of a prospectus?

Charron J: How are we to read the words “at the time of purchase” in the statute?

Deschamps J: Is there a business judgment defence to a decision to disclose? Or only to the manner in which the forecast was prepared?

Abella J: HOw can the business judgment rule fit into s. 130 when s. 56-7 contain the entire code for propsectus disclosure?

Rothstein J: Why should there be a defence when we discuss disclosure?

Binnie J: Does the business judgment rule require objective factors?

A little off my beaten path, but indicative of some developing projects on corporate and lender accountability in “emerging markets”, this article on Barclays bank in Zimbabwe. Apparently, the rest of the financial world is not content to lend Mugabe’s government money, but Barclays has, secured by large land grants in Zimbabwe. Link.

This is the fellow who had the official opposition mauled by paramilitaries last week. The Mugabe governmet is widely regarded as brutal and undemocratic.

Ian Brown noted in last weekend’s Globe that Black and his trusty defender Greenspan have shut up, after pursuing a strategy of trying the case in the papers prior to the opening statements. Lots of people wondered how smart it would be to make inflammatory comments about the judge and US legal system prior to trial, and to deliver some of Black’s famous polysyllabic insults.

It appears they have been reined in by cautious counsel. The trial judge censored Greenspan, who said that he was only “expressing a sense of humour” by implying the US judicial system was foolish or stupid for calling him stupid, and mocking elements of their due process laws.

Maybe it was more considered than it appears. The stance this implies — Fast Eddie and his client are the little guys against the Goliath system. I can’t think of a more inapt characterization of Black and his lawyer, but I suppose the Chicago 12 might not have a clue who they are.

I’ll need some time to go through this report, but the push to “modernize” the SEC and the rules for US capital markets is on in the US. The major recommendations are:

+”modernize” the approach to markets and participants (i.e., reduce compliance and inspection functions)
+ incoprorate Sar-Ox into the Secutities Act
+ end quartlerly earnings guidance (it was dropped in the UK recently)
+limit auditor liability
+”connect” employers with more than 21 employees to financial institutions to offer savings plans
+ enhance portability of retirement accounts, simplify 401k

Among other things, including litigation reform and harmonization of international accounting standards. Broadly, speaking, this is an issuer agenda. I’ll blog more on this report soon, especially the pension aspects.

In perhaps an unintentional irony, the report states “without US capital markets, the Microsoft of 1978 might not have bencome the Miscrosoft we know today”. As good a case for regulation as there ever was.

The past month or two has seen an interesting development in the U.S., as an issuer-prompted campaign has pushed for greater de-regulation of capital markets. Yesterday a group of the richest people in the world gathered in Washington to have a chit chat about how hard done by they are, and how excessive regulation is hurting the bottom line.

The main targets are Sar-Ox and securities litigation, both of which, they say, are driving capital markets business overseas. This is broadly in line with the Bloomberg report’s story and various editorial boards’ positions. To be fair, some of the folks there reminded the group of the wide-spread accounting frauds of five years ago, still happening (Nortel indicted on fraud counts by the SEC *again* yesterday, stock option scandal steaming right ahead) and Greenspan stated that Sar-Ox works, because it makes the CEO responsible for what happens under him or her. The mood, though, was of the contrary opinion. There was not a lot of talk about the high costs of labour in US capital markets (read: record bonuses) or the high prices generally there, and of course little or no recognition that de-regulation is tantamount to a trade subsidry. The days of ‘free’ trade are over, if they were ever here for services.

The timing is about right to get something out of the Bush II government before it stalls in 600 days, and the challenge will be getting it past Congress. On that side, yesterday saw the Commerce Department release a report on capital markets modernization released: link.

More comment on this soon.

An article in the WSJ (via Globe last week March 7, B1) found that September 12, 2001 and the following week was a very popular date upon which to locate the grant of back-dated options. It was the worst week on the stock markets in 60 years, and during that period, the DOW lost about 20% of its value, but was back to 100% by late October. Apparently, one explanation for this choice was that it was to “help motivate executives through this difficult period”.

That ought to sit well with the judge and jury.

We’ve been following it in this space for two years, and others have been there before us, the “innovations in credit” in the retail mortgage market, and the implications for the overall health of that market, home purchases, equity being used for current consumption, and the whole kaboodle. Herewith, one of the signs of correction coming: Link. I imagine there have been others as well, I have not followed the recent trends in lenders of this sort, or more generally, overall trends in commercial paper values, which last I looked were headed south. By now there will be a lot more discussion of the implications of the deflation of the housing asset bubble, and really, here we have Greenspan’s final legacy to the capital markets: yet another bubble caused by him, he didn’t see coming, and left to burst.

A high-risk strategy for a foreigner running a trial in the U.S., I’d have thought, going public and accusing your prosecutors and judicial system of incompetence or bias. Link. Good theatre though. And “Fast Eddie” appears to play the part as well, the blustery individualist who fights for the little guy. It’s a bit much from the richest criminal lawyer in Canada and his client, who once told Prime Ministers what to do. Well, let’s watch the events unfold and hope justice creeps in.