1. The Prospectus Requirement
Under applicable Canadian securities laws (which are not federally regulated, but are largely harmonized across each province and territory within Canada), a trade (or an act in furtherance thereof) by an issuer in previously unissued (i.e., treasury) securities (which is broadly defined) is considered to be a “distribution,” generally requiring that a prospectus (i.e., a document containing robust, prescribed disclosure regarding the issuer) be provided to the proposed recipient of the shares (this being known as the “prospectus requirement”). For purposes of this section, we will focus on equity compensation of Canadian issuers; however, the prospectus requirement also applies to any trade in previously issued securities of an issuer from the holdings of any “control person” (e.g., a parent of an employer) and certain further rules may apply in relation to equity compensation provided by foreign employers in respect of Canadian employees, officers and directors. Please contact our Capital Markets group to discuss the securities law implications of any such proposed equity compensation arrangement.
1.1 Grants
Securities laws provide for a number of exemptions from the prospectus requirement, including for applicable distributions to “accredited investors”; however, for purposes of the granting of equity compensation, the most salient exemptions are the “employee, executive officer and director exemptions” and the “private issuer exemption” contained in Division 4 of National Instrument 45-106 – Prospectus Exemptions (NI 45-106) and section 2.4 of NI 45-106, respectively, which exemptions do not trigger distribution reporting requirements to securities regulatory authorities under Canadian securities laws (but may be subject to certain insider trade reporting or stock exchange reporting, if applicable).
Pursuant to the employee, executive officer and director exemptions, the prospectus requirement does not apply to a distribution by an issuer in a security of its own issue with an employee, executive officer or director of the issuer, or to a related entity of the issuer if participation in the distribution is voluntary. NI 45-106 also contains exemptions from the prospectus requirement in respect of “consultants” (as defined in NI 45-106) and limitations on the ability of an “unlisted reporting issuer” (i.e., a reporting issuer whose securities are not listed on certain prescribed stock exchanges, which include the Toronto Stock Exchange (TSX) and TSX Venture Exchange) to rely on this particular exemption from the prospectus requirement in respect of certain recipients of equity compensation in the absence of having received applicable shareholder approval.
Pursuant to the private issuer exemption, an issuer can distribute a security of its own issue to its employees, officers and directors, provided that:
(a) it is not a reporting issuer (i.e., a public company in Canada) or an investment fund;
(b) its securities, other than non-convertible debt securities:
- are subject to restrictions on transfer that are contained in the issuer's constituting documents or security holders' agreements;
- are beneficially owned by no more than 50 persons, not including employees and former employees of the issuer or its affiliates (subject to certain rules on counting security holders); and
(c) it has distributed its securities only to certain prescribed classes of persons (e.g., employees, officers, directors, founders, certain family members, accredited investors, etc., but not “the public”).
1.2 Exercise/Settlement and Resale of Shares
Canadian securities laws also provide that the prospectus requirement applies to the distribution by an issuer of a share of its own issue upon the exercise of an option or settlement of a share unit, as well as in respect of the proposed sale of any share received upon such exercise or settlement or that was otherwise received as equity compensation (e.g., restricted shares). In the case of reliance by a reporting issuer on the employee, executive officer and director exemptions for the grant, typically an exemption from the prospectus requirement will be available in each instance on account of at least four months having passed since the date of grant (subject to certain other conditions having been met). Accordingly, unlike in some other jurisdictions, public companies in Canada do not typically file a prospectus to qualify the issuance of shares pursuant to equity compensation grants. In the case of a grant by a Canadian non-reporting issuer that continues to not be a public company in Canada, any proposed sale of shares ultimately received as equity compensation will need to be made pursuant to the exemption for trades to “accredited investors” or another available exemption from the prospectus requirement. Please contact any member of our Capital Markets group to discuss the securities law implications of any proposed sale.
2. Requisite Approvals
In addition to any internal approval process at an issuer, and in line with its corporate governance practices, the issuance of shares from treasury also requires that certain approvals be received under Canadian corporate law and, generally, the rules of stock exchanges in Canada. For purposes of this guide, the discussion of stock exchange rules is limited to those of the TSX. Please contact a member of our Capital Markets group to discuss the rules and requirements of any Canadian stock exchange on which an issuer's securities may be listed.
2.1 Corporate Law
Under typical Canadian corporate statutes (e.g., the Canada Business Corporations Act), shares may generally be issued at such times and to such persons and for such consideration as the issuer’s board of directors may determine, provided that shares shall not be issued until the consideration for the shares is fully paid in money or property, or past services that are not less in value than the fair equivalent of the money that the issuer would have received if the share had been issued for money. While the board of directors may delegate certain of their powers to committees of the board or officers of the issuer, the issuance of securities, except as authorized by the directors, may not be so delegated. Accordingly, the establishment of a reserve of shares for issuance pursuant to any equity compensation arrangement must be approved by an issuer’s board of directors; however, the allocation of the reserve as so approved (e.g., by making a grant of a particular award of equity compensation) to particular employees, officers or directors may be delegated and determined by such authorized delegates of the board.
2.2 Stock Exchange Requirements
When instituted, and when required for amendments (e.g., to increase the size of a share reserve), all equity compensation arrangements (whether in the form of a plan or a standalone grant) of TSX-listed issuers must be approved by a majority of the issuer's directors and, subject to limited exceptions (e.g., grants as inducements to applicable new employees), the issuer’s shareholders. For these purposes, TSX rules provide that security-based compensation arrangements comprise only arrangements that involve the issuance from treasury or potential issuance from treasury of securities of the listed issuer, and include, among other possibilities, stock options, share units, share appreciation rights (SARs) and Employee Share Purchase Plans (ESPPs) where the issuer provides financial assistance or matches the whole or a portion of the securities being purchased. Accordingly, if an equity compensation arrangement provides only for the delivery of previously issued shares, cash or any combination of both, then the arrangement would be outside the purview of TSX rules. However, if the issuance and delivery of treasury shares was a possibility (even if such a possibility was not used in practice), then TSX rules would apply.
TSX also has extensive rules concerning, among other things, TSX review of equity compensation arrangements, the amendment provisions of equity compensation arrangements (including those requiring shareholder approval, such as the repricing of options held by certain insiders), annual disclosures in respect of the terms of equity compensation arrangements, the periodic re-approval of equity compensation arrangements whose reserve is measured as a percentage of the quantity of the issuer’s issued and outstanding shares rather than a fixed numerical cap, the ability of insiders to approve equity compensation arrangements and amendments thereto, and the treatment of target equity compensation arrangements in the context of mergers, acquisitions and other business combination transactions. TSX also prescribes ongoing monthly reporting relating to changes in outstanding equity compensation arrangements as a result of grant, settlement and cancellation of awards.
In particular, pursuant to TSX rules, the exercise price for any stock options granted under an equity compensation arrangement must not be lower than the market price of the securities at the time the option is granted.
2.3 Disclosure and Proxy Advisors
To obtain any requisite shareholder approval, issuers will typically need to send a management proxy circular to their shareholders (which is typically sent in connection with an issuer’s annual general meeting) containing, in sufficient detail, information regarding the matter for which approval is being sought (including various TSX-mandated and applicable Canadian securities law disclosures). Proxy advisors (e.g., Institutional Shareholder Services or Glass Lewis) will have views on the appropriate size of the share reserve (depending on whether the plan is for stock options, share units and restricted shares, or an omnibus plan covering more than one type of equity compensation), sub-limits regarding grants to non-employee directors, plan features, historical “burn rates,” the formulation of the amendment provisions, etc. Please contact any member of our Capital Markets group to discuss applicable proxy advisor voting policy guidelines.