Control Blocks

Ontario's securities laws strictly regulate the purchase and sale of securities held by persons who alone, or in combination with others, hold a significant security holding in an issuer - such persons being more commonly referred to as members of a "control block." These laws impose certain trading restrictions and reporting obligations on such holders and have the effect of reducing the liquidity of securities that are part of the control block. The rationale for these restrictions and obligations is: (i) to alert the marketplace to changes in ownership of persons with access to inside information and potential to exert substantial influence over the business and affairs of the issuer by virtue of their significant shareholdings; and (ii) to allow for an orderly market in trading of securities of such persons.

This article is a general discussion of these restrictions and obligations, as well as legal developments of concern to holders of a control block of securities in the Province of Ontario. Ontario is known substantially as the leading capital markets jurisdiction in Canada. The other Canadian jurisdictions often follow the regulatory regime and policies set by Ontario. Accordingly, a review of the issues relating to control blocks in Ontario will provide the reader with a reasonable guide to the topic throughout all of Canada. As the application of these rules is fact-specific, readers should seek professional legal advice on the particular issues that concern them.

What is a "Control Block"?

In Ontario, a person is said to be a member of a control block if that person is, or is a member of a combination of persons holding a sufficient number of any securities of that issuer to affect materially the control of that issuer.1 There are two elements to this test:

Defining the Group

One must determine who is in the "group" of persons holding the securities in question. The phrase "combination of persons" is not a defined term and the determination will be a question of fact. Social and business connections are a few of the factors that must be considered. For example, if there is a voting arrangement among two or more shareholders, these shareholders would clearly be considered to be a "combination of persons" and the holdings of the group as a whole would be the appropriate holding to consider. Family members who hold securities of an issuer may also be considered to be a "combination of persons" for purposes of the test.

Material Control

The other part of the test is whether the person or combination of persons holds a sufficient number of any securities of an issuer to "affect materially the control of that issuer."

The Securities Act (Ontario) (the "Securities Act") provides that a person or group of persons holding more than 20 per cent of an issuer's securities are deemed to affect materially the control of the issuer, absent evidence to the contrary.2 A holder of 15 per cent of the voting shares of an issuer may affect materially the control of the issuer in certain situations.3 In other situations, a holder of 22 per cent of the voting shares of an issuer may not affect materially the control of the issuer. It is a question of fact that must be considered in the context of the issuer involved and its shareholder base. A few of the many factors to be considered when determining if a person affects materially the control of an issuer will include historical ties and associations, representatives on the board of directors, whether the shareholder is also an officer of the issuer or has close ties with management and the extent to which the person involved controls the proxy machinery of the issuer.

If it is determined that a person holds (or is a member of a combination of persons which holds) a control block position, the following rules apply to purchases and sales of such securities by such persons.

Methods of Selling from a Control Block

Securities that form part of a control block (other than securities held by an "eligible institutional investor"4) can only be sold in one of four ways:

Prospectus

The securities that are to be sold can be qualified by preparing and filing a prospectus. This method is both expensive and time-consuming. Realistically, this route is only used in situations where an issuer is offering to sell its securities by way of prospectus and the securities from the control block form part of the larger offering (commonly known as a "secondary offering"). In such circumstances, the control block party must pay...

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