CSC Volume 1 Chapter 12 - Financing and Listing Securities PDF

Financing and Listing Securities 12 CHAPTER OVERVIEW In this chapter, you will learn about the process by which governments and corporations raise debt or equity capital and bring their securities to market. You will learn abo...

Financing and Listing Securities 12 CHAPTER OVERVIEW In this chapter, you will learn about the process by which governments and corporations raise debt or equity capital and bring their securities to market. You will learn about prospectus requirements and the process of after-market stabilization. You will also learn the means by which securities are distributed through the exchanges, as well as the methods of distributing securities other than on an exchange. Finally, you will learn about the listing process, including the advantages and disadvantages of listing and the circumstances under which trading privileges can be withdrawn. LEARNING OBJECTIVES CONTENT AREAS 1 | Describe the process governments and Government and Corporate Finance corporations use to raise capital to finance funding requirements. 2 | Describe the dealer’s advisory relationship The Dealer’s Advisory Relationship with with corporations. Corporations 3 | Summarize the prospectus system and the Bringing Securities to the Market after-market stabilization process. 4 | Identify other methods of distributing Other Methods of Distributing Securities to securities to the public through stock the Public exchanges. 5 | Describe the advantages and disadvantages of The Listing Process listing shares. 6 | Describe the circumstances under which exchanges can withdraw trading privileges. © CANADIAN SECURITIES INSTITUTE 12 2 CANADIAN SECURITIES COURSE      VOLUME 1 KEY TERMS Key terms are defined in the Glossary and appear in bold text in the chapter. after-market stabilization financing group preliminary prospectus authorized shares firm commitment primary dealers banking group government securities primary offering distributor best efforts private placement greensheet blue skyed prospectus Greenshoe option bought deal public float guaranteed bond broker of record qualifying transaction halt in trading Capital Pool Company red herring prospectus initial public offering competitive tender secondary offering issued shares continuous disclosure selling group listing agreement covenant short form prospectus market capitalization crowdfunding suspension in trading market out clause delayed opening syndicate material fact delisting transparency negotiated offering direct bond treasury shares NEX due diligence report trust deed restrictions non-competitive tender escrowed shares underwriting outstanding shares final prospectus waiting period over-allotment option financing © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 3 INTRODUCTION So far in this course we have covered the many different types of financial securities and the roles that the various financial intermediaries and markets play. You also learned about a corporation’s structure and financial statements. In this chapter, you will learn how a company has its securities listed on a stock exchange so that investors can trade them. Stocks go through a complex process before they can be listed on a stock exchange. In addition to regulatory requirements that must be met, listing companies incur significant financial expenses. The process, which is established and rigorous, has been refined over the years to protect investors and maintain the integrity of the capital markets. New and exciting issues that become available when a private company goes public are regularly discussed in the financial media. However, before a new issue reaches that stage, the issuing company faces many challenges. Financial institutions have specific departments to handle securities offerings, and to ensure that the company issues securities that investors will be interested in buying. In this chapter, we discuss the various requirements that governments and corporations must adhere to during the complex process of raising capital by listing securities in the various markets. GOVERNMENT AND CORPORATE FINANCE 1 | Describe the process governments and corporations use to raise capital to finance funding requirements. Governments and corporations often need to raise capital to finance their operations, which they do through the financing process (also known as underwriting). Government financing is often accomplished through an auction process, and occasionally through a fiscal agency. Public financing is undertaken by public companies that trade on exchanges and over-the-counter (OTC) markets. Private financing is discussed only briefly in this chapter. INVESTMENT DEALER FINANCE DEPARTMENT The finance department of an investment dealer helps corporations and governments achieve their funding targets by acting as an intermediary between investors and the issuers of the debt and equity securities. Two distinct groups typically coexist in this department: government finance and corporate finance. GOVERNMENT FINANCE The government finance department specializes in selling debt instruments to institutions and other interested parties. It also advises both clients and the issuing governments on debt issues. The persons charged with the responsibility of government finance must be in touch with the market at all times to ensure awareness of market conditions and prices. They advise the issuing government on the following concerns: The size (or dollar value), coupon (interest rate offered), and currency of denomination of the issue The timing of the issue Whether the issue should be domestic or foreign What effect the issue may have on the market Whether the issue should be a new maturity, or whether a previous issue should be reopened © CANADIAN SECURITIES INSTITUTE 12 4 CANADIAN SECURITIES COURSE      VOLUME 1 CORPORATE FINANCE Corporate financing is a careful balancing act in which the dealer must balance the needs of the corporate client seeking funds with those of the investing public who provide the funds. The dealer must also balance current market conditions in both the debt and equity markets with the limitations of the company’s statement of financial position and future prospects. The job requires skill in market timing, technical knowledge of legal and financial matters, and a thorough understanding of financial analysis and promotion. The dealer must consider the following factors regarding a new issue: Types of securities Timing to market Private or public offering Proportion directed to institutional and retail investors Pricing Coupon rate or valuation multiple (such as price-to-earnings ratio) Underwriting fee (charged to the corporation) CANADIAN GOVERNMENT ISSUES The Canadian Government issues new fixed-coupon marketable bonds and Treasury bills to the market regularly through the competitive tender system. The securities are issued by way of an auction, whereby the amount won at the auction is based on the bids submitted. Only institutions recognized as government securities distributors are permitted to submit bids to the Bank of Canada. Government securities distributors may submit bids for their own accounts and on behalf of their customers. These institutions include the Schedule I and Schedule II banks, investment dealers, and foreign dealers active in the distribution of government securities. Government securities distributors that maintain a certain threshold of activity are known as primary dealers. Bids can also be submitted on a non-competitive tender basis, whereby the bid is accepted in full by the Bank of Canada and bonds are awarded at the auction average yield. To maintain regularity and transparency in its debt operations, the Government holds regularly scheduled quarterly auctions for benchmark bonds of two, five, and 10 years, as well as semi-annual auctions for the benchmark 30-year bond. The bonds can be purchased in multiples of $1,000 (face value). DID YOU KNOW? To learn how the tender system works, as illustrated in the following example, visit the Bank of Canada website and download the document Standard Terms for Auctions of Government of Canada Securities. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 5 EXAMPLE Consider an auction of $2.5 billion Government of Canada 10-year bonds, for which ten government securities distributors submit bids in the following manner: Bidder Competitive Bid Yield* Size 1 5.041% $500 million 2 5.043% $500 million 3 5.043% $500 million 4 5.044% $500 million 5 5.047% $500 million 6 5.048% $500 million 7 5.048% $500 million Non-Competitive Tenders – $25 million * Bond yields are discussed in detail in Chapter 7. In this situation, bonds are allocated to the first five competitive bidders only, awarded from lowest yield to highest. Because of the inverse relationship between bond yield and price, the bidder who submits the lowest yield is offering to pay the highest price for the bonds. Conversely, the bidder who submits the highest yield is offering to pay the lowest price. For that reason, the government awards bonds first to the lowest yield submitted and then, in rising order, to the next four bidders. The first four bidders each receive $500 million of bonds, which represents their total bid amounts. The fifth bidder receives $475 million of bonds, which is equal to its bid amount of $500 million minus the $25 million amount of non-competitive bids. Each of the five successful competitive bidders pays a price based on its competitive bid yield. The non-competitive bidders receive $25 million of bonds, paying a price based on the average yield of the bonds awarded (i.e., the average yield of the five accepted bids, or 5.0436%). No bonds are allocated to bidders 6 and 7 because their bids are too high. PROVINCIAL AND MUNICIPAL ISSUES New issues of provincial direct bonds and guaranteed bonds offered in Canada are usually sold at a negotiated price through a fiscal agent. Direct bonds are issued in the government’s name (e.g., Province of Manitoba bonds). Guaranteed bonds are issued in the name of a crown corporation, with repayment guaranteed by the provincial government. For example, the Province of Ontario guarantees the bonds issued by the Ontario Electricity Financial Corporation. Under the provincial method, a provincial government appoints a group of investment dealers and banks, called a syndicate, to underwrite issues, offer advice, and manage the process of issuing securities. The syndicate usually includes many major dealers, whose combined financial responsibility and distribution powers are more than adequate to underwrite and sell the large issues required by these parties. Municipal bond and debenture issues are more likely to be placed in institutional portfolios and pension accounts. These issues require in-depth knowledge of the tax-generating potential of the local municipal area. The dealer must also understand the industrial base and other demographic information. © CANADIAN SECURITIES INSTITUTE 12 6 CANADIAN SECURITIES COURSE      VOLUME 1 CORPORATE FINANCING Very few companies generate enough cash internally to satisfy their operational needs, hence the need for corporate financing. Canadian corporate financing usually occurs through a negotiated offering. With this method, a corporation’s management negotiates with a dealer to determine the type of security, price, interest, or valuation multiple, as well as any special features and protective provisions that may be needed to ensure the success of the new issue. Corporations raise capital by selling shares (equity financing) or by issuing debt or fixed-income securities (debt financing). EQUITY FINANCING Equity financing refers to raising capital by selling common shares to investors. In many cases, charters also authorize the use of preferred or special shares. These shares may be non-voting, but they have a special status compared to common shares in terms of dividends, distribution of assets in liquidation, and other preferential treatment. Both common shares and preferred shares form the company’s share capital. SHARE CAPITAL Authorized shares are the maximum number of shares (either common or preferred) that a corporation may issue under the terms of its charter. A company may have more shares authorized than it has issued to shareholders. This withholding of authorized shares allows the corporation to raise additional funds in the future by issuing more shares. A corporation may also amend its charter to increase or decrease the number of authorized shares. EXAMPLE The charter of ABC Inc. indicates that it has 10,000,000 common shares authorized. The company’s statement of changes in equity has the following entry: Common Shares − Authorized 10,000,000 shares of no par value Issued shares consist of the portion of authorized shares that the corporation has issued, either to the investing public, to company insiders, or to large institutional investors such as a mutual fund. Collectively, these shares owned by all shareholders are called outstanding shares. The capital stock section of the statement of changes in equity indicates the number of shares that a company currently has issued and that are outstanding (i.e., owned by shareholders). From time to time, a corporation may repurchase some of its issued shares from various classes to hold in its treasury. Under normal circumstances, this activity reduces the number of shares outstanding. If the corporation chooses not to repurchase issued shares, the total number of issued shares remains the same as the total number of shares outstanding. A company’s outstanding shares determine its market capitalization. Therefore, the total dollar value of the company is based on the current market price of its issued shares that are currently outstanding. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 7 EXAMPLES Example 1 ABC Inc. has 10,000,000 shares authorized, and issued 6,000,000 shares to investors. The company recently bought back 150,000 shares, so its statement of changes in equity shows the following information: Common Shares − Authorized 10,000,000 shares of no par value − Issued 6,000,000 shares and 5,850,000 shares outstanding. Shares are currently trading at a price of $10 per share. Therefore, ABC Inc.’s market capitalization is $58,500,000 (calculated as 5,850,000 × 10). Example 2 DEF Inc. has 1,500,000 shares authorized. The company issued 1,000,000 shares to investors. DEF Inc.’s statement of changes in equity shows the following information: Common Shares − Authorized 1,500,000 shares of no par value − Issued and outstanding 1,000,000 shares If DEF Inc.’s shares are currently trading at $10 per share, its market capitalization is $10,000,000. Not all of a company’s outstanding shares are available for trading by the investing public. For example, shares held by insiders or by a mutual fund are generally held over the long term and therefore tied up. The public float refers to that portion of outstanding shares that are freely available for public trading. It excludes shares held by company officers and directors and by institutions with a controlling interest in the company. The public float can provide insight into a company’s stock. When fewer of a company’s shares are available in the market, any large buy or sell orders on the stock will have a more dramatic effect on its price. Conversely, a larger float means the stock price is likely to be more stable because it is less affected by large trades. Thus, the smaller the public float, the more volatile the stock price is likely to be. EXAMPLE GHI Inc. has 6,000,000 common shares outstanding. Large institutions and the company’s officers and directors own 2,200,000 common shares. GHI Inc.’s public float is therefore 3,800,000 shares. DEBT FINANCING AND OTHER ALTERNATIVES A corporation with a need for a large amount of new capital may also undertake debt financing. Unlike equity financing, funds raised by issuing debt securities represent a loan from investors that must be repaid. The two main types of securities used in long-term debt financing are mortgage bonds and debentures. Mortgage bonds are backed by a specific pledge of assets, such as land or properties, much like a mortgage loan on a house is secured by the house itself to protect the lender’s investment. Debentures are backed only by the general creditworthiness of the corporation. The corporation’s ability to repay its obligations is considered sufficient, without a specific pledge of its assets. In practice, a corporation has many other financing options, including bank loans, money market borrowing, commercial paper, leasing, government grants, and export financing assistance. © CANADIAN SECURITIES INSTITUTE 12 8 CANADIAN SECURITIES COURSE      VOLUME 1 THE DEALER’S ADVISORY RELATIONSHIP WITH CORPORATIONS 2 | Describe the dealer’s advisory relationship with corporations. When a corporation decides to undertake financing, it secures the services of a dealer. Selecting a lead dealer involves various considerations about the dealer’s reputation for providing advisory services on timing, amount, and pricing of an issue. As well, the lead dealer provides advice on issue distribution, after-issue market support, and after-issue market informational support. Obtaining a reputable dealer also tends to result in better market acceptance of the issue and cheaper financing for the issuing corporation. When negotiations for a new issue of securities begin between the dealer and corporate issuer, the dealer normally prepares a thorough assessment of the corporation and its industry. The study includes the corporation’s position within the industry, financial record, financial structure, and future prospects. As well, all risk factors associated with the industry and the company are closely observed. The resulting assessment is sometimes referred to as a due diligence report. Various experts in the appropriate field may be consulted, such as engineers, geologists, management professionals, or chartered accountants. After the study is completed, the dealer determines whether or not to continue negotiations as the lead dealer in the proposed offering. The dealer may not necessarily choose to act as principal or agent for the corporate financing. Regardless, the issuing corporation relies on the dealer’s advice and guidance to design the various features of the securities. The corporation may develop a close advisory relationship with the lead dealer, similar to the professional relationship between a lawyer and client. Once the relationship is solidified, the dealer may become the broker of record with the right of first refusal on new financings planned by the corporation. ADVICE ON THE SECURITY TO BE ISSUED The lead dealer’s corporate finance team plays an important role in designing the new issue and advising the corporation on the best approach to pursue in the market. The corporation wants to ensure that the new securities are consistent with the firm’s capitalization (i.e., the way the firm is financed with debt and equity), and also that the restrictive provisions included in the new securities do not limit the corporation’s future decision-making flexibility. Based on the dealer’s assessment of current market conditions, investor preferences, the impact of various financing options on the corporation’s existing capitalization, future earnings stability, and prospects, the dealer recommends an appropriate financing vehicle. When considering the merits of recommending a debt issue, rather than an equity issue, the dealer considers the advantages and disadvantages of each type of financing. Table 12.1 summarizes these considerations. Table 12.1 | Issuing Securities Type of Security Advantages Disadvantages Bonds Bonds have a lower interest rate than They are less flexible because the comparable debentures. assets are pledged to a trustee. They are marketable to institutions that They can be problematic in mergers require debt issues secured by assets. and amalgamations because of pledges against specific assets. They require regular interest payments, the omission of which can lead to default. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 9 Table 12.1 | Issuing Securities Type of Security Advantages Disadvantages Debentures Debentures are flexible because there are The coupon rate can be higher than no specific pledges or liens. that of a comparable bond because of the lack of pledge on specific assets. The cost at issue is lower because there is no registration of assets. They require regular interest payments, the omission of which can lead to default. Preferred Shares Technically, preferred shares are The cost of issuing preferred shares is considered equity. Therefore, the company high because the dividends are paid can increase debt outstanding and still with after-tax income. The high cost maintain a stable debt-to-equity ratio, if can increase risk to the corporation. the issue is successful. Occasionally, non-payment of Omission of a dividend payment does dividends on preferred issues can not trigger default, as non-payment of trigger the implementation of voting interest on the bond or debenture would. privileges for preferred shareholders. They provide greater flexibility in financing A purchase fund can be a drain on because of the lack of pledge of assets. company assets during recessionary times. They have a limited lifespan because they can be redeemed through the open market, lottery, or purchase fund. Common Shares There is no obligation to pay dividends. Equity is diluted for existing shareholders upon the issuance of No repayment of capital is required. additional shares. The larger equity base can support more debt. Dividends, if paid, are more expensive than interest because they are paid The market value of the company can be with after-tax dollars. established for estate purposes, mergers, or takeovers. A higher underwriting discount than on a debt issue is charged. ADVICE ON PROTECTIVE PROVISIONS The dealer provides advice to the corporation about the security’s specific attributes. For bonds, the dealer may offer advice on the interest rate, the redemption process, and refunding provisions. The dealer may also provide advice on various protective clauses of bonds called protective provisions, trust deed restrictions, or covenants. These clauses appear in the trust deed. In the case of a mortgage bond secured by assets, these clauses are known as a deed of trust and mortgage; in the case of a corporate debenture, they are known as a trust indenture. These clauses are essentially safeguards placed in the issue’s contract with the purchaser to guard against any further weakening in the position of the security holder, in case that the issuer’s financial position weakens. Protective provisions may make an issue more appealing to investors. A company in a weak financial condition may need to raise the number of provisions or make them more stringent and restrictive to float a new issue, unlike a company with greater financial strength. © CANADIAN SECURITIES INSTITUTE 12 10 CANADIAN SECURITIES COURSE      VOLUME 1 THE METHOD OF OFFERING Another service that the dealer provides is help in deciding how the issue is to be distributed or sold. Corporate financing can take the form of a private placement, a primary offering, or a secondary offering. A primary offering is commonly known as an initial public offering (IPO) if a corporation issues shares to the public for the very first time. PRIVATE PLACEMENT In a private placement, the entire issue is sold to one or several large institutional investors. The issuer solicits one or more large investors such as banks, mutual fund companies, insurance companies, or pension funds. Placements are generally offered to sophisticated investors and institutional clients. Therefore, the requirements for detailed disclosure and public notice are typically waived and a formal prospectus is not prepared. This waiver dramatically reduces the cost of distribution for the issuing company. In many cases, private placements are announced after they have occurred, usually through advertisements in the financial press. PUBLIC OFFERINGS In a public offering, the corporation and the dealer come to a preliminary agreement to determine if the dealer will act as an agent or as a principal. In a best efforts underwriting agreement, the dealer acts as an agent and make its best efforts to sell the securities to the public. If the securities do not sell, the issuer does not receive the proceeds of the sale of the securities, and the unsold securities are returned to the issuer. The issuer faces the risk of not raising the capital that it had intended. In a firm commitment underwriting agreement, also known as a bought deal, the underwriter acts as a principal and commits to buy a specified number of securities at a set price, which it then resells to the public. The firm commitment can be initiated either by the issuing corporation or by the dealer member syndicate. In a firm commitment, the underwriter pays the full proceeds to the issuer, regardless of whether it has been able to resell the securities to the public. The underwriter assumes the risk of selling the security. Presumably, on the basis of having performed due diligence, the underwriter perceives the risk to be low. In the early stages of negotiation, the two parties establish the dealer’s commission (if acting as agent) or the spread between the proposed offering price and the dealer’s cost price (if acting as principal). The offering price and various other details are not normally finalized until just before the public offering date. The pricing of the issue and the actual volume of securities issued are dependent on the market environment at the issue date. A primary offering of securities requires a great deal of expertise and finesse by the underwriter, especially in terms of the pricing and marketing of the issue. The way the issue is handled can affect the financial well-being of the company for years to come. In a related tactic, a company may repurchase some of its outstanding shares currently trading in the market. These repurchased shares, called treasury shares, do not have voting rights or dividend entitlements. However, the company does have the option of selling them again back to the market at a later date, when the voting rights and dividend entitlements of those shares are restored. Like the primary offering, a secondary offering is usually also handled by an investment dealer or syndicate. A secondary offering refers to previously issued stock being sold by shareholders, who are usually in a control position. A firm commitment agreement to issue bonds often involves various different groups. The issuing company sells bonds to a financing group. The financing group is the lead underwriter, also known as the managing underwriter or syndicate manager. The bonds are then offered for public resale at the par value price of 100. The financing group is in continuous contact with the issuing company. Its members make recommendations on the type, size, and timing of the issue. They also advise regarding covenants or protective clauses, the currency of payment, and pricing. Financing group members also arrange for such items as the preparation of the prospectus © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 11 and the trust deed, the clearing of the issue with securities commissions, and the provision of selling documents. The financing group accepts the liability of the issue on behalf of all its members. In addition to the financing group, the banking group consists of additional dealers, all of whom have previously agreed to participate on set terms and to accept a liability up to their individual participation. The initial designation of bonds set up by the financing group may be altered as the sale of the issue progresses. However, various different groups may be allotted responsibility for different components of the bond issue, as follows: The banking group consists of additional dealers with liability for their participation, as noted above. The selling group consists of other dealers who are not members of the banking group. Casual dealers are non-members of the banking or selling group. They may include broker dealers, foreign dealers, or banks. Special group orders may occur under various circumstances. For example, the issuer may demand special consideration for a dealer or its banker, or for its parent’s banker, if it is a subsidiary of a foreign parent. A portion may be allotted for sale to the exempt list. This list usually includes only large professional buyers, mostly financial institutions, that are exempt from prospectus requirements. DEBT AND EQUITY FINANCING Can you explain the differences between debt financing and equity financing? Complete the online learning activity to assess your knowledge. BRINGING SECURITIES TO THE MARKET 3 | Summarize the prospectus system and the after-market stabilization process. Securities administrators have long been concerned that funds should not be raised from the public through the issuance of securities without a number of safeguards and disclosure requirements being satisfied. These safeguards are in place to ensure the integrity of the capital markets, but also to permit the orderly flow of capital into the economy to support those companies that are seeking capital. The desire is to balance these two competing demands so that clients wishing to invest can do so on an informed basis. These concerns have led to the development of various procedures and disclosure rules pertaining to the preparation of detailed prospectuses and the subsequent sales of previously issued securities. WHEN A PROSPECTUS IS REQUIRED Unless an exemption has been granted, all provincial securities acts require that a prospectus be filed and delivered if the offering or sale of securities is deemed to be a distribution to the public. In simplified terms, a prospectus is the investment contract between the investor and the corporation that is offering its securities for sale. It is designed to provide full, true, and plain disclosure regarding the material facts about the security in question. On this basis, investors considering purchasing the security are able to evaluate it and make an informed decision. The prospectus requirement generally applies to three types of trades in securities: Trades by or on behalf of an issuer (e.g., a new issue from treasury) Except in Quebec, trades from a control position, unless the trade is made under a prospectus exemption Trades in securities previously acquired by way of a prospectus exemption, unless the subsequent trade is made under a further prospectus exemption © CANADIAN SECURITIES INSTITUTE 12 12 CANADIAN SECURITIES COURSE      VOLUME 1 NEW ISSUES When a company raises equity capital in the marketplace, it issues securities from its own treasury. These issues are new securities, as compared to those being already publicly traded in what is known as the secondary market. New securities are issued from the company and then sold to the public. The proceeds are received by the company that issues the securities. If the company is issuing securities for the first time, it is considered an IPO, and a prospectus must first be filed with the regulators. Newly issued securities are often referred to as new issues. However, a new issue isn’t necessarily an IPO; it may be an additional raising of capital from a reporting issuer (an already public company). A prospectus is normally still required in such cases, unless a prospectus exemption is available. The prospectus of a reporting issuer may be less detailed than the one associated with an IPO because information about the reporting issuer is already available to the public. PRELIMINARY PROSPECTUS Most provinces require the filing of both a preliminary prospectus (also called a red herring prospectus) and a final prospectus. The preliminary prospectus must have on its front cover, in red ink, a statement to the effect that the prospectus has been filed, is not in final form, and is subject to completion or amendment. This prominent warning states that the securities cannot be sold, and offers to buy cannot be accepted, until a receipt for the final prospectus has been obtained from the provincial securities commission that leads the review of the prospectus. That regulator is typically the securities commission located in the principal jurisdiction or head office of the issuing company. All provinces other than Quebec require a preliminary prospectus to be filed; in Quebec a preliminary prospectus may be filed. When an offering is made in more than one province, or where it is intended to solicit expressions of interest, a preliminary prospectus is to be filed. One purpose of the preliminary prospectus is to allow the distributor of a new issue to determine the extent of public interest in the issue while it is being reviewed by the securities commission acting as principal regulator and prior to its actual pricing and distribution. The form and content of the preliminary prospectus must comply substantially with the requirements of provincial securities legislation, which are now essentially harmonized in many respects. It must cover the form and content of a final prospectus, but may exclude information on the price paid to the underwriter and the price at which the securities will be offered to investors. The auditor’s report may also be excluded from the preliminary prospectus. The dealers may also prepare an information circular, for in-house use only, called a greensheet. The greensheet highlights the salient features of the new issue, both pro and con, to help sales representatives solicit interest from the general public. PASSPORT SYSTEM All jurisdictions of the Canadian Securities Administrators, except Ontario, adopted Multilateral Instrument (MI) 11-102 Passport System. MI 11-102 gives issuers streamlined access to the capital markets in multiple jurisdictions. Under this system, the issuer files a prospectus in its principal jurisdiction with its principal regulator, thus meeting the requirements of one set of harmonized laws. The principal regulator issues a receipt, and the issuer gives notice to the local jurisdictions in which it otherwise would also have filed the prospectus. Upon receiving notice, the other jurisdictions automatically issue a deemed receipt. The Passport System can be used only in specified jurisdictions, including British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, Quebec, New Brunswick, and Nova Scotia. Approval automatically applies in all other passport provinces and territories. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 13 Even though Ontario did not adopt MI 11-102, the province is still considered a principal regulator under the instrument. This status gives issuers in Ontario access to the capital markets in other passport jurisdictions by dealing only with the Ontario Securities Commission for purposes of filing a prospectus or applying for a deemed exemption. The underwriter, agent, or company distributing securities to the public must maintain a record of all persons and companies to whom a preliminary prospectus has been sent. A revised prospectus must be provided if the preliminary prospectus is determined by the securities commission to be defective, or if an amendment or change is made. The revised preliminary prospectus (or the final prospectus) must be sent as soon as it is available to each recipient of the first preliminary prospectus. PERMITTED ACTIVITIES DURING THE WAITING PERIOD The period between the issuance of a receipt for a preliminary prospectus and receipt for a final prospectus is called the waiting period. During this period, the underwriters may solicit expressions of interest from potential purchasers of the security. A copy of the preliminary prospectus must be provided to anyone who expresses interest, whether solicited or unsolicited. Activities that are considered to be encouraging a trade are prohibited (e.g., the execution of an agreement to purchase the security in question). However, advertising the proposed issue to inform the public that the preliminary prospectus is available can be done during the waiting period. Other permitted information includes the price (if determined) and the name and address of the dealer member or registrant from whom the security may be purchased. No other material may be distributed to interested investors during the waiting period. FINAL PROSPECTUS A final prospectus must contain complete details of the securities being offered for sale. In other words, it must provide the required full, true, and plain disclosure of all material facts relating to the securities to be distributed. It is in this context that an investor evaluating the potential purchase of securities assesses whether he or she wishes to complete the transaction. This decision is based solely on the information contained in the prospectus. Any information that can significantly affect the market price or value of the securities is considered a material fact. This includes the offering price to the public, the proceeds to the issuer or selling security holders (or both), the underwriting discount, and any other required information that may have been omitted in the preliminary prospectus. As evidence of compliance with regulatory requirements, the final prospectus must be accompanied by the written consent of experts whose reports or opinions are referred to in the prospectus and other documents. Such experts might include appraisers, auditors, and lawyers. The regulators review the documents carefully and may require changes before final approval. Once approval of the final prospectus is granted, the issue is then said to be blue skyed and may be distributed to the investing public. A copy of the final prospectus must be mailed or otherwise delivered to all purchasers of securities offered in a distribution. Delivery must be made to the purchaser, or the purchaser’s agent, by no later than midnight on the second business day after entering into an agreement of purchase and sale. Therefore, maintaining a list of recipients of the preliminary prospectus will ensure that the purchaser’s final decision is based on the final, not preliminary, prospectus. Some important final prospectus details are described below. These items must be presented in narrative or tabular form to ensure that they are useful to prospective investors. It is crucial that purchasers make informed decision based on the material presented. © CANADIAN SECURITIES INSTITUTE 12 14 CANADIAN SECURITIES COURSE      VOLUME 1 DETAILS OF AN OFFERING The prospectus for an offering of securities contains the information described below. Cover page disclosure The cover page includes relevant information for investors such as the value of the offering, how stakeholders will be paid, market out clauses, and whether the prospectus is preliminary or final. Summary The summary highlights information likely to influence the investor’s decision to purchase the securities, which appears elsewhere in the prospectus. Information relating Issuer information includes the issuer’s name and business, selected financial to the issuer information, capital structure, recent facts, and trends that could have a material impact on the business. Information relating Securities information includes the type of product, use of proceeds, distribution method to the securities and eligibility of investment, as well as a description of the securities. Information relating Officers and shareholders information includes names and addresses of directors and to the officers and officers with five-year histories of principal occupations and shares owned. It also shareholders includes the following specific information: Disclosure of specified information with respect to executive compensation and indebtedness of directors and senior officers to the issuer or its subsidiaries Information regarding any bankruptcies, cease-trade orders, or securities regulatory violations Details of any outstanding options, rights, or warrants to purchase securities of the issuer, of shares held in escrow Details of any prior sales of the securities being offered Information relating The prospectus also contains a number of representations, declarations, and certificates to the parties from the parties who are involved in the issuance of a security. These documents include involved the following two certificates: A certificate stating that the information in the prospectus constitutes full, true, and plain disclosure of all material facts relating to the securities offered, signed by the issuer’s chief executive officer, the chief financial officer, two board directors, and any promoters A certificate stating that the information in the prospectus constitutes full, true, and plain disclosure of all material facts relating to the securities offered by the prospectus, signed by the underwriters and made to the best of their knowledge, information, and belief MARKET OUT CLAUSES A market out clause permits the underwriter to cancel an offering without penalty under certain conditions. For example, one condition might be the issue becoming unsaleable due to changes in market conditions or the affairs of the issuer. The underwriter must fully disclose whether any or all market out clauses might result in the cancelling or cessation of an offering. A reference to the conditional aspects of the underwriting is required on the cover page of the prospectus, along with a cross reference to the location of further details under the Plan for Distribution in the prospectus. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 15 THE SHORT FORM PROSPECTUS SYSTEM All Canadian provinces have adopted compatible legislation, policies, and practices that allow certain securities issuers quicker access to capital markets by using a short form prospectus. This system shortens and streamlines the procedures for qualified issuers to access Canadian securities markets through prospectus offerings. The short form prospectus may be used by certain issuers on the basis that much of the information in the long form prospectus is already available and widely distributed elsewhere. A short form prospectus omits information that can be found in the issuer’s annual information form (AIF) and other continuous disclosure documents. Accordingly, the short form prospectus focuses on matters relating primarily to the securities being distributed, such as price, distribution spread, use of proceeds, and the securities’ attributes. An issuer is permitted to use a short form prospectus under the following conditions: It electronically files using the System for Electronic Document Analysis and Retrieval + (SEDAR+). It is a reporting issuer in at least one Canadian jurisdiction (and relies on the Passport System, if it files in other jurisdictions). It has filed current annual financial statements and a current AIF in at least one Canadian jurisdiction in which it is a reporting issuer. It is not an issuer whose operations are ceased or whose principal asset is cash, cash equivalents, or exchange listing. It has equity securities listed and posted for trading or quoted on a short form eligible exchange. A long form prospectus is always required for certain offerings, including an IPO, an offering by an inactive or dormant issuer, and an offering for the purpose of financing a material change in the issuer’s business. AFTER-MARKET STABILIZATION After an issue is brought to market, one of the duties of the lead dealer may be to provide after-market stabilization of that security’s offering. Under this arrangement, the dealer is required to support the offer price of the stock once it begins trading in the secondary market (also called the after-market). Typically, the issuing company and the dealer negotiate the terms of any after-market stabilization as part of the underwriting contract. The dealer’s role is stated on the front page of the prospectus, and additional information must be provided inside the prospectus. The three types of after-market stabilization activities are described below: Greenshoe option The Greenshoe option (or over-allotment option) allows the dealer to issue 15% (or over-allotment more shares than originally planned. If demand is high, the dealer exercises this option, option) allowing the dealer to leave additional shares in the market. In effect, the issuer raises more capital. If demand is low, and the price of the stock drops, the dealer buys back the additional shares to cancel them, and the purchase of the shares puts upward pressure on the stock price. Penalty bid The lead underwriter penalizes other dealers if their customers flip shares in weak issues. Flipping means selling the shares during, or shortly after, the distribution period. Penalties may include paying back commissions to the underwriter or reducing the number of shares that the investment advisor can receive in future IPOs. Stabilizing bid The dealer posts a bid to purchase shares at a price not exceeding the offer price if the distribution of shares is not complete. © CANADIAN SECURITIES INSTITUTE 12 16 CANADIAN SECURITIES COURSE      VOLUME 1 SECURITIES DISTRIBUTIONS THROUGH THE EXCHANGES A different form of prospectus, or similar document, may be used when shares are distributed through the facilities of the TSX Venture Exchange. Rather than a provincial securities commission, the exchange reviews the prospectus and approves or disapproves it. The prospectus must meet all requirements of both the exchange and applicable national instruments. This prospectus exemption can be used by issuers who meet the following requirements: The issuer has filed an AIF, is a reporting issuer, and is a SEDAR+ filer. The securities are listed securities or units of securities and warrants. The issuer has filed with the TSX Venture Exchange an exchange offering document, which incorporates by reference the AIF, the most recent financial statements, and material change reports. (This document must be delivered to purchasers.) The number of securities offered does not exceed the number previously outstanding. The gross proceeds do not exceed $2 million. No more than 20% of the offering goes to one purchaser. DIVE DEEPER For more information on this topic, consult the TSX Corporate Finance Manual—Policy 4.6 Public Offering by Short Form Offering Document; see also Part 5 of National Instrument 45-106. OTHER METHODS OF DISTRIBUTING SECURITIES TO THE PUBLIC 4 | Identify other methods of distributing securities to the public through stock exchanges. Although we have discussed in detail the most common methods that corporations use to bring securities to market, securities can also be distributed to the public by the following means: As junior company distributions As options of treasury shares and escrowed shares Through a Capital Pool Company (CPC) The NEX board Through Crowdfunding JUNIOR COMPANY DISTRIBUTIONS A listed junior company may decide that it must raise new capital through a distribution of treasury shares to the public. The company must find a dealer member to act either as its underwriter or agent for the offering. Historically, listed junior mining and oil companies have raised millions of dollars through such distributions. These types of companies usually have no record of earnings and few assets that would qualify as collateral for conventional credit sources such as bank loans, mortgage or funded debt, or government assistance. The funds these companies need is known as risk capital because it is usually earmarked for exploration and development with a high risk of failure. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 17 OPTIONS OF TREASURY SHARES AND ESCROWED SHARES A company may decide to offer an incentive to an underwriter to provide risk capital as a principal, rather than having the underwriter merely act as agent for the offering. A junior company (primarily, a non-dividend-paying company) can grant the underwriter specified treasury share options. This technique involves the use of escrowed shares that serve as payment for properties, goods, or services. Escrowed shares are shares held by an independent trustee in trust for its owner. The escrowed shares cannot be sold or transferred, unless special approval is given. The shares can be released from escrow only with the permission of the appropriate authorities, such as a stock exchange or securities administrator. Escrowing shares ties the value of the shares held by these shareholders to what happens to the property used to obtain these shares. It also prevents the owners of the shares from selling them before a proper market can develop. This restriction ensures some stability in the secondary market performance of the new issue after the completed offering. Escrowed shares maintain full voting and dividend privileges for these companies. CAPITAL POOL COMPANY PROGRAM For small, emerging private companies, the costs associated with going public through a traditional IPO is not always financially viable. Accordingly, the TSX Venture Exchange, home to many emerging Canadian businesses, developed the CPC program. The CPC program is a vehicle for emerging businesses to obtain financing earlier in their development than might otherwise be possible with a regular IPO. A CPC describes a newly created company with no assets other than cash and with no established business or operations. A CPC can conduct an IPO and list the shares on the TSX Venture Exchange. The CPC’s goal is to buy an existing business or assets, called significant assets, through a qualifying transaction (QT). The CPC program involves a two-stage process: In the first stage, a CPC prospectus is filed and cleared, the IPO is completed, and the CPC’s common shares are listed on the TSX Venture Exchange. Under this program, the issuer must raise between $200,000 and $9,500,000 from the IPO. The second stage involves the following steps: 1. Within 24 months, the CPC identifies an appropriate business and issues a news release to announce the agreement to acquire the business. 2. The CPC prepares a filing statement or information circular providing prospectus-level information on the business to be acquired. 3. The TSX Venture Exchange reviews the disclosure document and evaluates the business to see that it meets initial listing requirements. Shareholder approval is typically not required to close a QT. THE NEX BOARD NEX is a separate board of the TSX Venture Exchange that provides a trading forum for companies that have fallen below the TSX Venture Exchange’s listing standards. Companies that have low levels of business activity, or who do not carry on active business at all, can trade on the NEX board. © CANADIAN SECURITIES INSTITUTE 12 18 CANADIAN SECURITIES COURSE      VOLUME 1 NEX provides a trading forum for the following types of issuers: Issuers that have been listed on the TSX Venture Exchange but no longer meet the TSX Venture Exchange Maintenance Requirements (currently known as Inactive Issuers) CPCs that have failed to complete a QT in accordance with the requirements of the exchange TSX issuers that no longer meet continued listing requirements, and would have been eligible for listing on TSX Venture as Inactive Issuers under existing policies CROWDFUNDING Crowdfunding is the process of raising start-up capital by soliciting contributions from the public at large, usually aided by online or Internet-based systems. This process is a new variation from the traditional approach that seeks funds from a limited pool of banks or venture capital firms. In a number of jurisdictions, the participating regulators have adopted harmonized registration and prospectus exemptions that allow start-ups and early stage companies to use crowdfunding to raise capital. THE LISTING PROCESS 5 | Describe the advantages and disadvantages of listing shares. 6 | Describe the circumstances under which exchanges can withdraw trading privileges. When a company wants to be listed on a recognized exchange, it must apply and be accepted for trading. The application form is a lengthy questionnaire designed to obtain detailed information about the company and its operations. When the listing application is completed, and supporting documents are assembled, the company signs a formal listing agreement. The agreement details the specific regulations and reporting requirements that the company must follow to keep its listing in good standing. By signing a listing agreement, a company agrees to comply with the following specific regulations: Submit annual and interim financial reports, as well as other corporate reports, to the exchange. Promptly notify the exchange about dividends or other distributions, proposed employee stock options, and sale or issue of treasury shares. Notify the exchange of other proposed material changes in the company’s business or affairs. After approval is given, a specific date is set for applicable securities to be called for trading on an exchange. There are formal announcements to members and public announcements in the financial press. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 19 ADVANTAGES AND DISADVANTAGES OF LISTING When applying for a listing, a public company considers the advantages and disadvantages of being listed on a major exchange, both to the company itself and to its shareholders, as shown in Table 12.2. Table 12.2 | Advantages and Disadvantages of Listing Advantages Disadvantages Prestige and goodwill Additional controls on management Company prestige is enhanced through increased After listing, certain restrictions are put in place public visibility. Shareholder goodwill increases regarding stock options (those issued for internal as buying and selling become easier and market use only), reporting of dividends, issue of shares for performance becomes more visible. assets, and other matters. Established and visible market value Need to keep market participants informed The market value of a listed company is readily A listed company’s management must devote visible. Financial analysts are more likely to considerable time to meet with security analysts follow a listed company. In turn, this can attract and institutional investors and to communicate new shareholders, enhance overall marketability with the press to explain company developments. in the secondary market, and increase the market for new issues by the company. Market indifference Low trading volume and poor market performance Excellent market visibility of a listed company become a matter of public The daily financial press carries full details of record. listed trading on a daily and weekly basis. Additional disclosure More information available Listing imposes additional disclosure requirements Because of strict exchange disclosure regulations, on the company that consume management time. investors have access to more information on a Specifically, management is required to make regular basis. continuous and prompt disclosure of material changes related to the company. Simplified valuation for tax purposes The valuation of securities for estate tax purposes Additional costs to the company and estate tax planning is easier. Various fees, including a listing fee and subsequent annual sustaining fee, must be paid to the exchange when a class of shares is listed. WITHDRAWING TRADING PRIVILEGES As a protection to investors, the exchange is empowered to withdraw a listed security’s trading and listing privileges, both temporarily and permanently. Serious action such as delisting rarely occurs. However, other actions related to protecting investors can occur more frequently. These actions may be implemented either by the exchange or at the request of the company itself, in regard to the company’s own securities. © CANADIAN SECURITIES INSTITUTE 12 20 CANADIAN SECURITIES COURSE      VOLUME 1 TEMPORARY INTERRUPTION OF TRADING The three types of temporary withdrawals of trading privileges that an exchange can invoke are described below. Delayed opening Shortly before the opening of trading, an exchange can order trading in a security to be delayed. The need for this action might arise if a heavy influx of buy or sell orders for a particular security materialize. The delay gives exchange traders time to organize the orders and to align buys with sells, to allow fair and orderly trading when the delay order is removed. A delayed opening in one security does not affect trading in other listed securities. Halt in trading A temporary halt in trading of a security can be ordered or arranged at any time to allow the reporting and communication of significant news, such as a pending merger or a substantial change in dividends or earnings. Suspension in trading Trading privileges can be suspended for more than one trading session. Such suspensions in trading are imposed for various reasons. For example, the company’s financial condition may not meet the exchange’s requirements for continued trading, or the company fails to comply with the terms of its listing agreement. If the company rectifies the problem to the exchange’s satisfaction within the time required by the exchange, trading in the suspended security resumes. During the suspension, members are usually allowed to execute orders for the suspended security in the unlisted market, except for those securities suspended from trading on the TSX Venture Exchange. CANCELLING A LISTING (DELISTING) A listed security can be cancelled, which means that the security is delisted. Delisting can be done by the exchange or at the request of the company itself. Delisting is a permanent cancellation of listing privileges. A security might be delisted for any of the following reasons: The delisted security no longer exists because it was called for redemption (in the case of a preferred share) or was substituted for another security as a result of a merger. The company is without assets or has gone bankrupt. The public distribution of the security has dwindled to an unacceptably low level. The company has failed to comply with the terms of its listing agreement. LISTING SHARES FOR TRADING Can you identify the various methods of distributing securities and explain how shares are listed on an exchange? Complete the online learning activity to assess your knowledge. CASE SCENARIO An acquaintance of yours is confused about outstanding, issued, and authorized shares. Can you help with Pavel’s understanding of these terms? Complete the online learning activity to assess your knowledge. KEY TERMS & DEFINITIONS Can you read some definitions and identify the key terms from this chapter that match? Complete the online learning activity to assess your knowledge. © CANADIAN SECURITIES INSTITUTE  CHAPTER 12      FINANCING AND LISTING SECURITIES 12 21 SUMMARY In this chapter, we discussed the following key aspects regarding the financing and listing of securities in the capital markets: Federal government financing is usually accomplished through an auction, but new issues of provincial direct and guaranteed bonds are usually sold at a negotiated price through a fiscal agent. Corporations issue common or preferred shares to raise capital, which creates the company’s capital stock. They may also raise capital by issuing bond, debentures, and other debt securities. They can also raise capital by borrowing from lending institutions. Securities legislation requires that a prospectus be filed and delivered if the offering or sale of securities is deemed to be a distribution to the public. The Passport System gives issuers streamlined access to the capital markets in multiple jurisdictions, which simplifies the regulatory approval process. An issuer is permitted to use a short form prospectus containing limited information only under certain conditions. For example, the issuer must file electronically using SEDAR+ (www.sedarplus.ca) and must be a reporting issuer in at least one Canadian jurisdiction. The requirement for continuous disclosure applies to reporting issuers and those who have issued securities under a prospectus. It also applies to a securities exchange offering or securities listed on a stock exchange. After securities have been issued, the lead dealer may be required to provide after-market stabilization by establishing a short position, by penalizing dealers that sell securities shortly after issue, or by creating an open bid to buy securities at the offer price. Advantages of listing shares for trading on an exchange include prestige and goodwill, establishment of market value, increased market visibility, wider distribution of company information, easier valuation for tax purposes, and increased investor following. Disadvantages include additional controls on management, additional costs, visibility of any market indifference, requirement for additional disclosure, and the requirement to provide information to a range of individuals and organizations on a regular basis. REVIEW QUESTIONS Now that you have completed this chapter, you should be ready to answer the Chapter 12 Review Questions. FREQUENTLY ASKED QUESTIONS If you have any questions about this chapter, you may find answers in the online Chapter 12 FAQs. © CANADIAN SECURITIES INSTITUTE