NOTICE OF PROPOSED CHANGES TO
PROPOSED RULE 61-501
AND PROPOSED COMPANION POLICY 61-501CP UNDER THE SECURITIES ACT
INSIDER BIDS, ISSUER BIDS, GOING PRIVATE TRANSACTIONS AND RELATED PARTY TRANSACTIONS
AND
RESCISSION OF OSC POLICY STATEMENT NO. 9.1
DISCLOSURE, VALUATION, REVIEW AND APPROVAL
REQUIREMENTS AND RECOMMENDATIONS FOR INSIDER BIDS, ISSUER BIDS, GOING PRIVATE TRANSACTIONS AND RELATED PARTY TRANSACTIONS

Substance and Purpose of the Proposed Rule and Proposed Companion Policy

Introduction

On May 31, 1996, the Commission published proposed Rule 61-501 (the "1996 proposed Rule") and proposed Companion Policy 61-501CP (the "1996 proposed Companion Policy") at (1996), 19 OSCB 2981. Part X of the notice that accompanied the 1996 proposed Rule and 1996 proposed Companion Policy (the "1996 Notice") summarized and requested comment on 12 issues that were discussed in the 1996 Notice. Part X of the 1996 Notice also requested comment on six additional issues.

The Commission received comments on these issues, and the 1996 proposed Rule and the 1996 proposed Companion Policy, from a broad range of commenters. The list of commenters is contained in Appendix A of this Notice and a summary of their comments together with the Commission's response to those comments are contained in Appendix B of this Notice. As a result of comments received, staff's recommendations and further deliberations of the Commission, the Commission has amended the 1996 proposed Rule and 1996 proposed Companion Policy and is republishing the proposed Rule and proposed Companion Policy for comment. The republished versions of these instruments are referred to in this Notice as the "proposed Rule" and the "proposed Companion Policy".

This Notice summarizes changes of a substantive nature that have been made to the 1996 proposed Rule and the 1996 proposed Companion Policy. Certain changes that are of a purely technical nature or designed to improve the clarity of the proposed Rule and proposed Companion Policy are not summarized in this Notice, but in most cases are referred to in footnotes in the proposed Rule and proposed Companion Policy.

Terms used in the proposed Companion Policy that are defined or interpreted in the proposed Rule or definition instruments in force in Ontario and not otherwise defined in the proposed Companion Policy should be read in accordance with the proposed Rule and the definition instruments unless the context otherwise requires.

Substance and Purpose

The substance and purpose of the proposed Rule and the proposed Companion Policy is to reformulate OSC Policy Statement No. 9.1 ("Policy 9.1") with respect to the regulation of insider bids, issuer bids, going private transactions and related party transactions. The protections afforded by Policy 9.1, including independent valuations, majority of minority approval and enhanced disclosure, also form the basis of the proposed Rule and the proposed Companion Policy. The 1996 proposed Rule has been revised to incorporate certain changes resulting from a reconsideration by the Commission of the appropriate manner of regulating in this area, to address prior interpretational difficulties and to increase the number of exemptions available in a manner consistent with previously granted discretionary relief. The proposed Companion Policy sets out the Commission's views on certain matters relating to the subject matter of the proposed Rule.

For additional information concerning the background of the proposed Rule and the proposed Companion Policy, reference should be made to Appendix B of this Notice and to the 1996 Notice.

Summary of Changes to the Proposed Rule

Changes of a substantive nature that have been made to the proposed Rule are summarized here.

The Commission notes that it sought comment in the 1996 Notice on the appropriate manner of regulating related party transactions. The possibilities suggested by the Commission ranged from regulating related party transactions through a rule to not regulating related party transactions at all in a rule, but indicating in a policy that the Commission would monitor transactions involving related parties and rely on the Commission's public interest power to address abusive transactions. Ultimately, the Commission has decided to regulate related party transactions by way of rule. A more detailed discussion of the Commission's approach in this area can be found in Appendix B of this Notice.

Definition of Affected Security for Going Private Transactions

The 1996 proposed Rule defined an affected security for a going private transaction as a participating security of the issuer in which the interest of a beneficial owner would be terminated by reason of the transaction. "participating security" was given the meaning in section 182 of the Regulation. That section defines participating security as a security that carries the right to participate in earnings to an unlimited degree, including a security that by its terms is convertible into or exchangeable for or carries the right to purchase such a security.

The Commission has reconsidered the definition of "participating security" and determined that the going private transaction requirements should apply to securities that are either fully participating as to earnings or in assets on liquidation or winding up.

The Commission has further determined that it is not appropriate for the going private transaction requirements of the proposed Rule to apply to convertible or exchangeable securities, as there are too many variables involved to have a rule deal with all situations appropriately, including: the type of security, whether it is "in the money" or "out of the money", whether the security is currently convertible, the terms of the agreement between the issuer and the holder of the convertible security governing the convertible security, the appropriate voting regime, if any, to apply to holders of convertible securities and the possibility of holders of convertible securities exercising a veto right over the transaction. The Commission is of the view that it is more appropriate for the holders of convertible or exchangeable securities to deal with the issue of their interests being eliminated in their agreement with the issuer, or, in egregious situations, for the Commission to use its public interest power to intervene.

The Commission has modified the definition of "participating security" accordingly.

Definition of Affected Security for Related Party Transactions

The 1996 proposed Rule defined an affected security for a related party transaction as a security of a class of equity securities or voting securities of the issuer. The Commission has determined that the protection afforded by the proposed Rule should not turn on the vote attached to the security, but rather should be based on the equity participation of the security. The Commission has further determined that the related party transaction requirements of the proposed Rule should apply to securities that are either fully participating as to earnings or in assets on liquidation or winding up. Accordingly, the Commission has modified the definition of affected security for a related party transaction to refer to participating securities.

Definition of Holder

In the 1996 proposed Rule, holder was defined as a beneficial owner and a person or company who "exercised control or direction over" the security, except where the context otherwise required and subject to certain instances where it meant registered owner. Holder is now defined in the proposed Rule as registered owner and, where the Commission intends that a section refer to beneficial owners or persons or companies who exercise control or direction, reference is now made specifically to those concepts.

Prior Valuation Exceptions

The Commission has modified the exclusions from the definition of "prior valuation" so that an exemption is available for any draft that leads to a valuation or appraisal by the independent valuator that prepared the draft. Previously, this exemption required that the valuator did not charge, had not been and was not to be paid a fee for the draft.

The Commission has not extended this exemption to drafts of valuations that have not lead to a formal valuation. The Commission recognizes that some of these valuations may not be relevant to the transaction at hand. However, if these valuations are "prior valuations", the Commission believes they should be disclosed, with the issuer being free to explain why they are not relevant.

Quasi-Going Private Transactions

The 1996 proposed Rule contained a concept of quasi-going private transaction and generally regulated this type of transaction in a manner similar to the manner in which going private transactions are regulated.

The 1996 proposed Rule defined a quasi-going private transaction as a transaction with or materially involving a related party that would be a going private transaction but for the substitution of a securityholder's interest with an interest of equivalent value in a participating security of the issuer or a successor entity that is not substantially the same as the original issuer.

In light of the Commission's removal of the equivalent value exception from the definition of going private transaction, there is no longer a need for the concept of quasi-going private transaction, since a transaction that was formerly a quasi-going private transaction would now be caught by the definition of going private transaction. Accordingly, the Commission has deleted the definition of quasi-going private transaction and any references to that term in the proposed Rule.

Definition of Related Party

The Commission has deleted paragraph (h) from the definition of "related party" in the 1996 proposed Rule and section 9.1 of the 1996 proposed Rule. The combined effect of those two provisions was that the Director could designate a person or company to be a related party of an issuer. The Commission deleted those provisions as it felt that they were unnecessary. The Commission may use its power under section 127 of the Act if, in the Commission's opinion, a transaction that is not a related party transaction is contrary to the public interest.

Definition of Value

The 1996 proposed Rule contained a definition of value as meaning "except where the context otherwise requires, fair market value determined as at the date of the first public announcement of the transaction". That definition has been deleted, as the proposed Rule uses the term "fair market value" where necessary.

Definition of Going Private Transaction

The Commission has amended the definition of "going private transaction" to make it applicable only where the transaction is with or involving a person or company that is a related party of the issuer, if the related party (i) is not treated identically to all other beneficial owners in Canada of affected securities, (ii) receives, directly or indirectly, consideration of greater value than that paid to all other beneficial owners of affected securities, or (iii) upon completion of the transaction, beneficially owns, or exercises control or direction over, directly or indirectly, participating securities of a class other than the class of securities subject to the going private transaction. The Commission has made this change as it believes the proposed Rule should only apply to transactions that give rise to conflict of interest concerns.

The Commission has also deleted the portion of the definition of "going private transaction" in the 1996 proposed Rule that provided that a transaction is not a going private transaction if an interest of equivalent value in a participating security of the issuer or a successor entity is substituted for the securityholder's interest. While the rationale is discussed in more detail in Item 8 of Part B of Appendix B and in the footnote to the definition of going private transaction in the proposed Rule, essentially where there are conflict of interest concerns, the Commission believes that minority shareholders should have the protections of a formal valuation and majority of the minority vote.

By virtue of the proposed Rule deleting the equivalent value exception from the definition of "going private transaction", the proposed Rule may apply to transactions that may not be "going private transactions" under the Business Corporations Act (Ontario) (the "OBCA"). In the converse situation, where a transaction is a "going private transaction" under the OBCA but is not caught under the proposed Rule or is exempt under the proposed Rule, the Commission has provided relief in the proposed Rule from the OBCA.

Definition of Related Party Transaction

The Commission has added new paragraphs (b) and (e) to the definition of related party transaction to cover an issuer's joint purchase or sale of an asset with a related party from or to a third party where the consideration paid or received by the issuer is greater or less than, as the case may be, the proportion of the asset purchased or sold by the issuer.

The Commission has also clarified in paragraphs (h) and (k) that a related party transaction includes an amendment to the terms of a security or guarantee.

Liquidity Test

The Commission has modified the interpretation of "liquid market" in section 1.3 of the proposed Rule to add an aggregate trading price test of $15 million and a market value test of $75 million.

Insider Bids - Lock-up Agreements

The Commission has deleted paragraphs (b) and (c) in subsection 2.1(2) of the 1996 proposed Rule as those conditions are contained in subsections 97(1) and 97(2) of the Act. As a result, that subsection in the proposed Rule provides that, subject to one condition (instead of three conditions contained in the 1996 proposed Rule), a take-over bid is not an insider bid solely by reason of the application of the deemed beneficial ownership rules in the Act to an agreement to tender.

Valuation Exemption Based on Previous Arm's Length Negotiation - Insider Bids

This exemption in paragraph 3 of section 2.5 of the 1996 proposed Rule was predicated on a selling securityholder holding at least five percent of the outstanding securities and at least 20 percent of the securities of the class held by holders other than the offeror and persons or companies acting jointly or in concert with the offeror. The Commission has modified this exemption, which appears in paragraph 3 of section 2.4 of the proposed Rule, to allow the 20 percent test to be satisfied based on the holdings of more than one selling securityholder. The Commission also deleted the requirement in subparagraph 3(v) of section 2.5 in the 1996 proposed Rule that the offeror make reasonable inquiry in order to be satisfied that no undisclosed material change or fact had occurred in respect of the offeree issuer at the time of the previous arm's length negotiation. Subparagraph 3(d) of section 2.4 of the proposed Rule now only refers to the offeror's actual knowledge.

Valuation Exemption for Non-Convertible Preferred Shares - Issuer Bids

Paragraph 3 of subsection 3.4(1) of the 1996 proposed Rule provided a valuation exemption in respect of an issuer bid for offeree securities (i) that are neither equity securities nor voting securities, (ii) that are not convertible into equity securities or voting securities, (iii) that have never been in arrears on dividends, and (iv) for which there are no reasonable grounds for believing that there would be arrears on dividends if the securities were not repurchased.

The Commission has reconsidered this exemption and determined that the proposed Rule should provide a valuation exemption for any issuer bid for securities that are not participating securities or convertible into participating securities. The Commission has determined that a valuation should not be provided merely because the securities carry a vote, and should only be provided where the securities are participating securities. The Commission has further determined that the presence of arrears does not itself justify a valuation.

Transitional Provisions - Going Private Transactions

The Commission has added transitional relief in paragraph (d) of subsection 4.1(2) of the proposed Rule for going private transactions announced and not completed before the coming into force of the proposed Rule. As with the related party transaction transitional requirements in paragraph (h) of subsection 5.1(2) of the proposed Rule, the Commission has drafted the exclusion to clarify that it is only available if the transaction is completed substantially in accordance with the terms generally disclosed at the time the transaction was announced or thereafter before the coming into force of the proposed Rule.

Transitional relief is not necessary for insider bids and issuer bids as the requirements in the proposed Rule relating to insider bids and issuer bids are substantially similar to those found in Policy 9.1.

Exemption from 40 Day Requirement in OBCA for Going Private Transactions

The 1996 proposed Rule provided exemptions in certain circumstances for going private transactions from the valuation requirement and the minority approval requirement imposed by the OBCA. The proposed Rule continues these exemptions and provides a new exemption in section 4.3 from the timing requirement in the OBCA to send a management information circular in connection with a going private transaction not less than 40 days before the date of the meeting called to consider the going private transaction.

Valuation Exemption for Second Step Going Private Transactions

The Commission has added a new exemption (paragraph 4 of section 4.5 of the proposed Rule) which provides a valuation exemption for a going private transaction following a formal bid where the going private transaction takes place no later than 120 days after the expiry of the formal bid, the intent to effect the going private transaction was disclosed in the disclosure document for the formal bid, the consideration is at least equal in value and is in the same form as the consideration that was paid in the formal bid and, if the tax consequences are different, they are appropriately described. This exemption applies regardless of whether the first step formal bid is an insider bid or made at arm's length.

Non-Redeemable Investment Funds

The 1996 proposed Rule provided that the going private transaction requirements and the related party transaction requirements did not apply to non-redeemable investment funds. The Commission has reconsidered this matter and determined that an exemption from the valuation requirement should be provided to non-redeemable investment funds, but that there is no basis for an exemption from the minority approval and disclosure requirements. The Commission has modified the exemption accordingly.

Treatment of Lock-up Agreements for Minority Approval Purposes in Going Private Transactions

The 1996 proposed Rule provided that the shares of shareholders that effectively control the issuer and support the transaction, whether it be a one step going private transaction or a second step going private transaction, be excluded from the minority for voting purposes in a going private transaction.

The Commission is now of the view that shares should not be excluded from the minority for voting purposes, regardless of the level of share ownership of the shareholder or the circumstances in which the shares were tendered or are voted, so long as the shareholder does not (i) receive a consideration that is not available to other holders in Canada of affected securities of the same class, (ii) receive consideration of greater value than that paid to all other holders of affected securities of the same class, or (iii) upon completion of the transaction, beneficially own, or exercise control or direction over, participating securities of a class other than the class of securities subject to the going private transaction. The Commission has modified the definition of "interested party", "minority approval" and subsection 8.2(1) of the 1996 proposed Rule accordingly.

Level of Minority Approval for Going Private Transactions

For going private transactions, the 1996 proposed Rule required either a two-thirds majority approval or simple majority approval depending on whether the consideration offered involved some non-cash consideration or the consideration offered was less than the per security value or the mid-point of the range of values based on a formal valuation. The 1996 proposed Rule required a simple majority for all related party transactions, other than quasi-going private transactions.

The Commission has reconsidered its approach in respect of going private transactions and determined that tying the level of approval to the form of consideration or the relationship of the consideration to the values determined under the valuation is inappropriate. The Commission believes that a simple majority is the appropriate level and has modified the 1996 proposed Rule accordingly.

Going Private Transaction Not a Related Party Transaction

The Commission is of the view that a going private transaction carried out in accordance with the proposed Rule or exempt from the proposed Rule, or a transaction that comes within the exclusions in the definition of "going private transaction", should not be subject to the related party transaction requirements of the proposed Rule. Accordingly, the Commission has provided for this in paragraphs (e) and (f) of subsection 5.1(2) of the proposed Rule.

Application of Related Party Transaction Requirements - Grandfathering

The Commission has clarified the exemptions in paragraphs (g) through (i) of subsection 5.1(2) of the proposed Rule so that they are available only if the transaction is completed in accordance with its terms. The Commission has also introduced a substantiality concept into those same paragraphs to allow some modifications to the terms of a transaction.

Application of Related Party Transaction Requirements - Related Party Transactions Commenced Before the Proposed Rule Comes into Force

The Commission has modified paragraph (h) of subsection 5.1(2) of the proposed Rule to clarify that the exclusion is only necessary if the related party transaction was not completed before the coming into force of the proposed Rule.

Application of Related Party Transaction Requirements on Exercise of Retraction Rights

The Commission has added a reference to retractable securities in paragraph (j) of subsection 5.1(2) of the proposed Rule so that the proposed Rule does not apply to a related party transaction that is an issuance or transfer by an issuer of securities upon the exercise by a holder of a right to retract previously granted by the issuer and attached to a class of securities for which there is a published market.

Ability of an Independent Committee to Waive Valuation or Minority Approval Requirements - Related Party Transactions

The 1996 proposed Rule proposed that an independent committee be given the discretion to waive the valuation requirement in certain related party transactions and also sought comment on whether an independent committee should be given the discretion to waive the minority approval requirement.

The Commission has reconsidered this issue and has determined that it would not be appropriate to allow an independent committee to waive the valuation requirement or the majority of the minority requirement. Accordingly, the Commission has deleted the provision in the 1996 proposed Rule allowing an independent committee to waive the valuation requirement.

Elimination of Valuation Exemption based on Previous Arm's Length Negotiations -- Issuer Bids and Related Party Transactions

The 1996 proposed Rule provided valuation exemptions for issuer bids and related party transactions in the "circumstances described in paragraph 3 of section 2.5, with necessary modifications". That paragraph provided a valuation exemption for an offeror in an insider bid in connection with previous arm's length negotiations with a selling securityholder.

The Commission has decided to eliminate this exemption insofar as it pertains to issuer bids, as the Commission does not believe it appropriate for an issuer, as opposed to a third party offeror, to have a valuation exemption based on negotiations with a selling securityholder. The Commission also notes that it is difficult to envisage a situation in which the circumstances contemplated by the exemption would arise in practice in an issuer bid.

The Commission has decided to eliminate this exemption insofar as it pertains to related party transactions, as it is not necessary given other exemptions in the proposed Rule.

Valuation and Minority Approval Exemptions for Related Party Transactions Based on Less than 25 Percent of Market Capitalization

The Commission has clarified the exemption in paragraph 2 of section 5.6 of the proposed Rule so that only the part of a transaction that involves the interested parties must be valued in its entirety.

Valuation and Minority Approval Exemptions for Related Party Pro Rata Transactions

Subsection 5.6(2) of the 1996 proposed Rule made the exemption for a dividend in specie or distribution of securities that would result in a related party of the issuer holding 20 percent or more of the equity securities or voting securities of another issuer conditional on the related party undertaking not to sell the shares by means of a private agreement take-over bid for a period of two years. The Commission has eliminated this condition. The Commission is of the view that any abuses of this exemption can be dealt with using its public interest power.

The Commission has also added an exception to the requirement in subparagraph 5(b) of section 5.6 of the proposed Rule to allow for a stand-by subscription agreement in respect of a rights offering on the terms permitted by OSC Policy Statement No. 6.2. That paragraph provides an exemption if related parties are treated identically to all other holders in Canada of affected securities and do not receive, directly or indirectly, as a consequence of the transaction, consideration of greater value than that received on a pro rata basis by all other holders of affected securities.

Valuation and Minority Approval Exemptions for Related Party Transactions for Public Offering of Securities

The exemption in paragraph 7 of subsection 5.6(1) of the 1996 proposed Rule provided an exemption for a public offering of securities to the extent the issuer met one of three conditions relating to (i) pro rata participation by all holders in Canada of affected securities, (ii) there being a liquid market and the related party contributing back to the issuer a certain amount based on the difference between the offering price and the market price or, (iii) there being a liquid market and the offering price being not more than five percent less than the most recent closing price before pricing of the offering.

The Commission has deleted this exemption. The Commission is of the view that the exemption in the 1996 proposed Rule is impractical. The Commission considered modifying the exemption so that it would only apply to a distribution under a prospectus and would be conditional on the related party participating at the same price as under the offering and not increasing its ownership interest in the issuer. However, the Commission was not comfortable with this approach and, as a result, felt that at this time it is more appropriate to deal with this issue in the context of applications for relief.

Valuation and Minority Approval Exemptions for Downstream Related Party Transactions

Paragraph 11 of subsection 5.6(1) of the 1996 proposed Rule provided an exemption for a transaction involving an issuer and one or more subsidiaries of the issuer or between two or more subsidiaries of the same issuer if no related party of the issuer held more than a nominal interest in securities of the subsidiary or received a benefit as a consequence of the transaction not available to other securityholders. The Commission has, in paragraph 10 of section 5.6 of the proposed Rule, extended the exemption to transactions between an issuer and a "downstream" interested party (even where that interested party is not a subsidiary). The Commission has done this because the definition of related party captures "downstream" entities (not just downstream subsidiaries) and the Commission is of the view that in those circumstances there is no concern about a conflict of interest as regards the issuer unless there is a common related party.

Independent Valuator - Presumptions

The 1996 proposed Rule contained a number of rebuttable presumptions in paragraphs (a) through (g) of subsection 6.1(3) relating to independence of the valuator. The Commission moved three of these paragraphs from the 1996 proposed Rule to section 5.2 of the proposed Companion Policy, so that those paragraphs are now factors that may be relevant in determining as a factual matter whether a valuator is independent. Specifically, the Commission has moved to the proposed Companion Policy paragraph (c) of subsection 6.1(3) relating to the valuator having a material financial interest in future business in respect of which an agreement, commitment or understanding exists involving an issuer or interested party. The Commission has also moved to the proposed Companion Policy paragraph (e) of subsection 6.1(3) relating to the valuator having a material involvement in an evaluation, appraisal or review of the financial condition of the issuer or an interested party, or acting as a lead or co-lead underwriter of a distribution by the issuer or an interested party within the preceding 24 months. As well, the Commission has moved to the proposed Companion Policy paragraph (f) of subsection 6.1(3) referring to the valuator or any of its affiliates being a lead or co-lead lender or manager of a lending syndicate in respect of the transaction in question or a lender of a material amount of indebtedness where the interested party or the issuer is in financial difficulty and the transaction would reasonably be expected to have the effect of materially enhancing the lender's position.

The Commission has determined that the remaining paragraphs in subsection 6.1(3) of the proposed Rule describe situations that should not be rebuttable presumptions and, accordingly, has clarified that a valuator is not independent in those situations.

The Commission has deleted the word "financial" from paragraph (b) of subsection 6.1(3) of the 1996 proposed Rule so that paragraph (b) of subsection 6.1(3) of the proposed Rule now includes the valuator or any of its affiliates acting as any type of advisor to the interested party in respect of the transaction.

Subsection 6.1(4) of the 1996 proposed Rule provided that if a valuator is retained jointly by the issuer and one or more interested parties to prepare a formal valuation in respect of a transaction, the valuator is presumed not to be independent for the purpose of the formal valuation if the valuator also provides any other advisory service to one or more interested parties in connection with the same transaction. The Commission has modified this in subsection 6.1(4) of the proposed Rule to remove the reference to advisory services and to clarify that a valuator does not lose independence merely because an interested party pays part of the valuator's fees. The Commission believes that it is clear from paragraph (b) of subsection 6.1(3) and the change made to subsection 6.1(4) of the proposed Rule, that the provision of advisory services to an interested party in respect of a transaction results in the valuator not being independent in connection with that transaction.

Independent Valuator in Context of Issuer Bid

Subsection 6.1(6) of the 1996 proposed Rule provided that, for purposes of determining valuator independence, an interested party did not include the issuer in the case of an issuer bid. The Commission has amended this so that subsection 6.1(5) of the proposed Rule provides that a valuator that is retained by an issuer to prepare a formal valuation for an issuer bid is not, by that fact alone, not an independent valuator.

Formal Valuation Disclosure

Section 6.5 of the 1996 proposed Rule prescribed the disclosure requirements applicable to a valuation summary but did not prescribe disclosure requirements for formal valuations. The Commission has added such requirements to paragraph (e) of subsection 6.4(1) in the proposed Rule. That paragraph requires that the disclosure in the formal valuation be sufficient to allow the securityholders to understand the principal judgements and principal underlying reasoning of the valuator so as to form a reasoned judgement of the valuation opinion or conclusion.

Summary of Formal Valuation

The proposed Rule now only requires the offeror or issuer to provide a valuation summary in accordance with section 6.5 where the formal valuation is not included in its entirety in the relevant disclosure document. Section 6.5 has been modified accordingly so as to only specify disclosure standards for a summary when a summary is required to be provided.

Independent Directors - Presumptions

The Commission has determined that the situations in subsection 7.1(2) of the 1996 proposed Rule should not be rebuttable presumptions and, accordingly, has clarified in the proposed Rule that a director is not independent in those situations.

The Commission has amended paragraph (a) of subsection 7.1(2) by deleting the reference to a director not being independent if during the three years before the transaction the director was an employee, insider or associate of a person or company acting jointly or in concert with an interested party. The Commission has also amended paragraphs (a) and (b) of subsection 7.1(2) by changing the time periods from three years to 12 months as it felt that three years was unduly long. The Commission has deleted the word "financial" from paragraph (b) of subsection 7.1(2) for the same reason as explained above under "Independent Valuator - Presumptions".

The Commission has amended subsection 7.1(3) to provide that, for the purposes of section 7.1, in the case of an issuer bid, a director of the issuer is not, by that fact alone, not independent of the issuer.

Summary of Changes to the Proposed Companion Policy

Issuer Bids

By virtue of section 92 of the Act, an offer to acquire securities of the issuer made by a wholly-owned subsidiary of the issuer would be an issuer bid. The Commission has amended section 3.3 of the 1996 proposed Companion Policy (now subsection 2.4(2) of the proposed Companion Policy) to state that, in its view, a purchase made by a registered dealer that is a wholly-owned subsidiary entity of an issuer is not an issuer bid if the registered dealer is not acting at the direction of the issuer in making the purchases.

Independent Valuators

The Commission has added section 5.2 to the proposed Companion Policy. That section sets out factors that may be relevant to a valuator's independence. Most of these factors previously appeared as presumptions in the 1996 proposed Rule but, as indicated above, the Commission has moved these into the proposed Companion Policy. The Commission has also added as a factor, whether, during the 24 months immediately before the valuator was first contacted for the purpose of the formal valuation, the valuator or an affiliated entity of the valuator had a material financial interest in transactions involving the interested party or the issuer.

Comments

Interested parties are invited to make written submissions with respect to the proposed Rule and the proposed Companion Policy. Submissions received by April 23, 1999 will be considered.

Submissions should be made in duplicate to:

c/o Daniel P. Iggers, Secretary

Ontario Securities Commission

20 Queen Street West

Suite 800, Box 55

Toronto, Ontario M5H 3S8

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As the Act requires that a summary of written comments received during the comment period be published, confidentiality of submissions cannot be maintained.

Questions may be referred to:

Stan Magidson

Director, Take-over/Issuer Bids,

Mergers & Acquisitions

Corporate Finance Branch

Ontario Securities Commission

(416) 593-8124

Regulations to be Amended or Revoked

In the 1996 Notice, the Commission indicated that it proposed to amend section 182 of the Regulation. After further consideration, the Commission proposes to revoke section 182 in its entirety. The Commission also now proposes to revoke subsection 46(1) of Schedule 1 of the Regulation. The Commission still proposes to amend section 203.2 of the Regulation and subsections 1(1) and 46(2) of Schedule 1 of the Regulation to change the references to Policy 9.1 to references to Rule 61-501.

Rescission of OSC Policy Statement No. 9.1

Policy 9.1 is replaced by the proposed Rule.

The text of the proposed rescission is:

"Ontario Securities Commission Policy Statement No. 9.1 Disclosure, Valuation, Review and Approval Requirements and Recommendations for Insider Bids, Issuer Bids, Going Private Transactions and Related Party Transactions is rescinded effective upon the date proposed Rule 61-501 comes into force."

Proposed Rule and Proposed Companion Policy

The text of the proposed Rule and proposed Companion Policy follows, together with footnotes that are not part of the proposed Rule and proposed Companion Policy but have been included to provide background and explanation.

DATED: January 22, 1999

1. Anita I. Anand

2. Canadian Bankers' Association by letter dated November 1, 1996.

3. Canadian Institute of Chartered Business Valuators by letter dated September 27, 1996.

4. Davies Ward & Beck by letter dated October 11, 1996.

5. Fairvest Securities Corporation by letter dated December 10, 1996.

6. Gerry Finkle by letter dated June 1, 1996.

7. Investment Dealers Association of Canada by letter dated October 18, 1996.

8.* Leith Wheeler Investment Counsel Ltd. by letter dated January 6, 1997.

9. McCarthy Tetrault by letter dated October 4, 1996.

10. McMillan Binch by letter dated October 4, 1996.

11.* Montrusco Associates Inc. by letter dated January 24, 1997.

12.* The General Accident Assurance Company of Canada by letter dated January 14, 1997.

13. The Jim Pattison Group by letter dated September 30, 1996.

14. RBC Dominion Securities by letter dated September 30, 1996.

15.* Sceptre Investment counsel by letter dated January 2, 1997.

16. Phillippe Tardif by letter dated September 30, 1996.

17.* Task Force on the Churches and Corporate Responsibility by letter dated January 10, 1997.

18. Tory Tory DesLauriers and Binnington by letter dated November 7, 1996.

19. TransAlta Corporation by letter dated September 27, 1996.

20. Vancouver Stock Exchange by letter dated September 26, 1996.

* As these commenters generally supported the comments submitted by Fairvest Securities Corporation, reference is made to Fairvest and them as one commenter in Appendix B.

The Commission received 20 submissions on the 1996 proposed Rule and the 1996 proposed Companion Policy.

The Commission considered the comments received and thanks all commenters for providing their comments.

The following is a summary of the comments received, together with the Commission's responses. Generally, this summary follows the ordering in the 1996 Notice. Unless otherwise provided, references to section numbers in this Appendix are to section numbers in the 1996 proposed Rule and the 1996 proposed Companion Policy.

A. DISCUSSION OF GENERAL COMMENTS

1. Regulatory Treatment of Related Party Transactions

The 1996 proposed Rule proposed to regulate related party transactions in substantially the same manner as Policy 9.1 (although by rule) and, in doing so, attempted to clarify some areas of uncertainty in Policy 9.1 and provide a significantly larger number of exemptions from the valuation and minority approval requirements than Policy 9.1. A number of the proposed exemptions codified current staff practice.

The 1996 Notice sought comment on regulating related party transactions by way of rule or through two alternatives identified in the 1996 Notice. The first alternative would involve a more focussed rule which would cover those particular transactions that have given rise to a number of complaints over the years (quasi-going private transactions and dispositions to a related party of a substantial part of an issuer's property) and would also provide a companion policy warning of the Commission's concerns and ability to intervene on a public interest basis in the context of abusive transactions. The second alternative would restrict related party transaction regulation to the type of policy suggested under the first alternative.

Comments

Four commenters supported regulation of related party transactions through a rule and did not support adopting either of the two alternatives discussed in the 1996 Notice. Of those commenters, one proposed modifying the 1996 proposed Rule to include requirements aimed at increasing investor protection. Otherwise, in the view of that commenter, the cumulative effect of the changes proposed in the 1996 proposed Rule would be to "significantly reduce the protection now provided minority shareholders by Policy 9.1 in connection with related party transactions". That commenter felt there was no principled basis for distinguishing between different types of related party transactions and that a policy would be ineffective.

Another of those commenters, commenting mainly with the junior markets in mind, supported regulating through the 1996 proposed Rule as that commenter felt that the two alternatives were not broad enough to capture many transactions that have been the source of abuse. That commenter suggested that the addition of the exemptions contained in subparagraphs (b)(i) through (iv) of Schedule "B" to the 1996 Notice would provide issuers with relief where the costs of compliance may not be reasonable in the circumstances.

Another of those commenters encouraged tougher regulation of related party transactions and stated that independent directors and valuators are not really independent from those they are being paid by.

Two commenters supported adoption of the first alternative approach discussed in the 1996 Notice.

Those commenters believed regulatory compliance should be imposed on those transactions that have raised concerns and, since the 1996 Notice indicated that the vast majority of complaints received involved those transactions covered in the first alternative, the first alternative should be adopted, leaving the threat of regulatory intervention, in other cases where there is abuse, as a sufficient threat. In addition, those commenters felt that the first alternative approach would provide a clear set of rules, facilitate compliance and eliminate concerns of inadvertent non-compliance with the proposed Rule, which non-compliance could affect legal validity of related party transactions with various potential consequences.

Another commenter supported the definition of "related party transaction" proposed in the first alternative approach but did not support the adoption of the proposed companion policy. That commenter felt that the definition of "related party transaction" in the 1996 proposed Rule was too broad, potentially resulting in regulatory backlog and/or incentive for non-compliance. That commenter also felt that the "warning" contained in the proposed policy under the first alternative would create uncertainty, resulting in many applications to the Commission or unnecessary interference with transactions for fear of regulatory intervention. That commenter noted that the Commission has the jurisdiction to intervene without the policy and was of the view that the policy provided little guidance and could unnecessarily alarm market participants.

Four commenters supported the second alternative approach of regulating related party transactions through a policy.

One of those commenters stated that the definitions of related party and related party transaction are very broad and will catch many transactions. That commenter indicated that, in its experience under Policy 9.1, it has been able to advise clients that the concerns behind the related party transaction rules are either relevant or not relevant to a particular transaction regardless of the precise wording of Policy 9.1. In the view of that commenter, this produces transactions that are procedurally and substantively fair with less discussion with staff than would otherwise be the case under the 1996 proposed Rule.

A second of those commenters stated that, in its view, the policy in Schedule "A" (which would be used in either of the alternatives) should be modified to:

i. provide that the board of directors should determine what protections (valuation, minority approval etc.) are appropriate in a particular transaction;

ii. not encourage discussion with the Director; and

iii. make clear the standard under which the Commission would invoke its public interest jurisdiction and intervene in a transaction, which standard should be consistent with that articulated in Commission decisions.

The commenter's reasons for its approach were that (i) a detailed policy has led to an overly technical approach (increasing the risk that management will make determinations that the rules do not apply and bypass board review of potentially abusive transactions), (ii) directors should determine how the interests of shareholders are protected, (iii) institutional shareholders are increasingly active and have a strong influence on issuer activity, and (iv) the Commission's public interest jurisdiction would allow it to properly discharge its regulatory responsibilities.

The third of those commenters stated that regulation of related party transactions should be removed from the 1996 proposed Rule and a policy should indicate the circumstances in which the Commission will exercise its cease-trade power regarding transactions that appear to be abusive or unfair. That commenter felt that corporate law statutes are the proper place for regulating such transactions.

Two commenters concurred with either of the two alternative approaches in recognition of the benefits of easing the burden of regulatory compliance by focussing regulation only where complaints have been encountered.

Response

The Commission has not adopted either of the two proposed alternatives. In the Commission's view, the broad and detailed approach contained in the proposed Rule is an appropriate approach and should not be relaxed. Because of the concentration of ownership or control of Canadian corporations, there is at a minimum the perception of opportunities for self-dealing at the expense of the minority shareholders in the context of related party transactions. Policy 9.1 has been in place in its current form since 1991 and, in the Commission's view, has struck a fairly good balance in its attempt to protect minority shareholder rights without unduly impeding the ability of issuers to conduct their businesses. The proposed Rule proposes to clarify some ambiguities in Policy 9.1 and cut back on its breadth to the extent it seems reasonable, given the experience to date. The Commission is not convinced that a policy would provide sufficient protection for minority shareholders.

In response to one commenter's suggestion that the Commission add certain exemptions contained in Schedule "B" to the 1996 Notice to the definition of related party transaction contained in the 1996 proposed Rule, the Commission notes that the exemptions that were in that Schedule "B" were already built into the 1996 proposed Rule.

2. Treatment of Lock-up Agreements for Minority Approval Purposes in Going Private Transactions (Paragraph (b) of Subsection 8.2(1) and Paragraph 2 of Subsection 8.4(1))

Policy 9.1 currently excludes from the minority vote (i) in a second step transaction (such as a going private transaction following an arm's length take-over bid), any shares tendered in the first step transaction under a lock-up, and (ii) in a one step going private transaction, any shares of a shareholder that affects materially the control of the issuer and has entered into an understanding to support the transaction.

The 1996 proposed Rule departed from Policy 9.1 and proposed that only the shares of shareholders who effectively control the issuer and support the transaction (whether it be a one step going private transaction or a second step going private transaction) be excluded from the minority vote. This is the same standard applicable in the OBCA.

Comment was sought on the appropriate treatment of lock-up agreements for the purpose of minority approval in the context of one and two step transactions.

Comments

One commenter agreed with the treatment in the 1996 proposed Rule.

Four of the commenters suggested revising the 1996 proposed Rule to provide that as long as the parties to a lock-up agreement are acting at arm's length with each other and the "locked-up" shareholder is being treated identically to other shareholders, the agreement should not disenfranchise the "locked-up" shareholder (nor exclude shares it tendered to a previous bid) from the minority vote even if the shareholder effectively controlled the issuer prior to the transaction. Those commenters noted that excluding locked-up shares may serve as a disincentive to a person or company making a bid. Those commenters felt that the locked-up shareholders end up negotiating on behalf of the minority and it is unfair to exclude the locked-up shareholders' shares.

One of the four commenters stated that a lock-up that reserves to the agreeing shareholder the right to tender to or vote in favour of another transaction with a greater consideration should not result in disenfranchisement. That commenter also noted that a simple understanding should not be sufficient to disenfranchise the votes. In the absence of a binding commitment or agreement, the shareholder is always entitled to change its mind.

A fifth commenter felt that the only circumstance in which a locked-up shareholder should be restricted from voting in the minority is when it is acting jointly or in concert with the offeror. That commenter felt that the opportunity to negotiate should not disqualify the locked-up shareholder and it is inappropriate to attempt to protect the minority from the pricing decision of the locked-up shareholder. That commenter was of the view that it is unnecessary to condition the provision on all shareholders being treated identically because the Act already provides that requirement in the take-over bid rules.

A sixth commenter indicated that if the approach in the 1996 proposed Rule is adopted, that commenter would support the inclusion in the proposed Companion Policy of a provision to the effect that the Executive Director will be favourably disposed to granting discretionary relief in cases of lock-up agreements that meet certain defined criteria: for example, that contain a functional "competing bid" clause, provide a "window shopping" exception to any "no-shop" prohibition, and do not contain any preclusive financial penalties for terminating the "lock-up" (a reasonable "topping fee" and expense reimbursement provision would not be considered to have such a preclusive effect). In its view, such a provision would be consistent with past decisions under Policy 9.1 and would provide guidance for circumstances involving a controlling shareholder.

A seventh commenter was in favour of retaining the approach currently in Policy 9.1. That commenter was of the view that lock-up agreements entered into by non-controlling shareholders have the same effect on minority shareholders as lock-ups entered into by controlling shareholders. The commenter noted that an offeror will only seek to negotiate lock-up agreements with shareholders holding sufficient shares to enable the offeror to obtain control of the target. If their shares are later counted toward minority approval, their decision to sell determines that other shareholders must also sell their shares at the same price. This approach supported by the commenter is based on the following views: locked-up shareholders cannot be counted on to represent the interests of other shareholders; the inability of an offeror to ensure the votes under a lock-up can be subsequently voted would not necessarily lead the offeror to forgo the opportunity to acquire control; and the proposal is contrary to the 90 percent squeeze out threshold provided in the OBCA.

Response

Traditionally, the reason for excluding locked up shares has been that lock-up/support arrangements may effectively preclude or severely limit an auction process, thereby removing any practical alternatives from other shareholders.

The proposal in the 1996 proposed Rule represented a more uniform and flexible approach than that currently in Policy 9.1, as it recognized that disenfranchisement represents a significant imposition on the rights of substantial shareholders whose actions may be of benefit to the minority. It recognized that support/lock-up arrangements generally serve to reduce risk to the offeror who might otherwise be reluctant to make an offer, thereby bringing offers to minority shareholders that might not otherwise appear. In addition, a substantial shareholder can bring to the negotiations a sophisticated and informed party with negotiating power, looking for the best price, whereas the minority have only the opportunity to withhold approval with no certainty of obtaining a better offer.

The Commission notes that staff have over the past two years provided no-action letters in connection with proposed take-over bids involving lock-up/support arrangements where comfort was sought that the shares subject to the lock-up/support arrangements would not be disenfranchised in a second step transaction. In each of these cases, the subject shareholders were at arm's length to the bidders and were treated identically to the remaining minority.

The Commission recognizes that the proposal in the 1996 proposed Rule is somewhat of a compromise position, chosen partly in an attempt to be consistent with the OBCA requirements and partly because it is a middle ground approach. On further reflection, the Commission has determined that consistency with the OBCA should not be a strong reason for adopting a particular approach. The Commission has further considered whether any locked-up shares should be excluded and, if so, whether a line should or should not be drawn at disenfranchising only a controlling shareholder (and not any other shareholder) that enters a lock-up/support arrangement.

The Commission continues to believe that, at a minimum, shares held by non-controlling shareholders should not be excluded. In considering how shares held by controlling shareholders should be treated the Commission recognizes that to permit a controlling shareholder to enter into a lock-up/support arrangement without having the subject shares excluded from the minority vote could conceivably lead to situations where the lock-up/support arrangement severely limits or ends an auction process. However, the Commission also recognizes that there is a fundamental question of why a controlling shareholder receiving the same consideration as others should not be able to do what it wants with its shares regardless of the impact it will have on the ultimate outcome of the transaction. Since the shareholder can control the outcome by voting its shares at a shareholders' meeting (for a going private transaction) or tendering its shares to a take-over bid, why should the shareholder be prevented from locking-up its shares or supporting an acquiror prior to the shareholders' meeting or the expiry of the take-over bid, as the case may be?

After considering the opposing positions, the Commission believes that an offeror should not be precluded from voting, in a second step transaction, shares tendered under a lock-up agreement or counting the votes of locked-up shares in a one step transaction, regardless of the level of share ownership of the shareholder, so long as the shareholder (i) is not receiving a consideration that is not identical to that paid to all other beneficial owners in Canada of affected securities of the same class, or, (ii) is not receiving consideration of greater value than that paid to all other beneficial owners of affected securities of the same class, or, (iii) upon completion of the transaction, does not beneficially own, or exercise control or direction over, participating securities of a class other than affected securities. In those circumstances, the Commission does not accept the distinction between shares tendered by a controlling shareholder and shares tendered by other shareholders.

Accordingly, the Commission has modified the definition of "interested party" and sections 8.1 and 8.2 of the 1996 proposed Rule to provide that the votes attaching to securities are only excluded if the securityholder receives a consideration that is not identical to that paid to other beneficial owners in Canada of affected securities of the same class, or receives consideration of greater value than that paid to all other beneficial owners of affected securities of the same class or, upon completion of the transaction, beneficially owns or exercises control or direction over, participating securities of a class other than affected securities.

3. Ability of an Independent Committee to Waive Valuation or Minority Approval Requirements in Related Party Transactions (Paragraph 2 of Subsection 5.6(1))

The 1996 proposed Rule proposed that an independent committee be given the discretion to waive the valuation requirement in a related party transaction (other than a quasi-going private transaction or substantial asset sale). This was a departure from Policy 9.1 which does not give an independent committee any such discretion.

Comment was sought on whether, in the context of these related party transactions, an independent committee should be given the discretion to waive the valuation requirement and whether it should also be given the discretion to waive the minority approval requirement.

Comments

Two commenters felt that independent committees should not be given the discretion to waive valuation and minority approval requirements.

One of those commenters felt that the only benefit would be the reduction in compliance costs, but that the downside would be the significant pressure that independent committees would feel from related parties to waive these requirements.

The second of the two commenters also felt the proposed valuation exemption would be inappropriate. Instead, the commenter thought it should be necessary to fit within one of the automatic exemptions or obtain a discretionary exemption from the Director, as there is no principled basis for distinguishing between types of related party transactions in determining whether independent committees be given discretion. Furthermore, it was of the view that the exemption should not be extended to minority approval requirements, as otherwise minority shareholders would lack any real bargaining position, and it is difficult to see any basis on which directors could determine that shareholders do not need to vote.

A third commenter suggested that an independent committee be given discretion to waive the formal valuation requirement, but not the minority approval requirement. That commenter felt that permitting a waiver of the valuation requirement may save substantial time and costs in certain instances where an independent committee has considered the matter. However, the independent committee's opinion should not be substituted for the shareholders' right to decide the fairness of a transaction. The commenter concluded that, as there is potential for abuse given the pressure often brought to bear on independent committees, the minority approval requirement would act as a good discipline on a committee considering the valuation issue.

Two other commenters felt that discretion to waive the valuation and minority approval requirements should be given to the board of directors (or to the independent committee, if a board has constituted one), with the exception of going private transactions (and in the view of one of the commenters quasi-going private transactions) which should always be subject to minority approval. Those commenters felt that directors are capable of exercising their fiduciary duties appropriately and their discretion would always be subject to the Commission's public interest jurisdiction.

One commenter supported the 1996 proposed Rule's introduction of the discretion to waive valuation requirements for most related party transactions and believed it should be extended to permit waiver of the majority of the minority vote and to permit independent committees to waive valuation requirements in going private transactions and quasi-going private transactions.

Response

The Commission reconsidered the issue of allowing an independent committee to waive the valuation requirement and determined that it would be inappropriate. The Commission is concerned about the pressure that will be brought to bear on directors to waive the valuation requirement. The Commission is also of the view that, without a valuation, shareholders will not be able to make a reasoned decision concerning the transaction they are being asked to consider. Accordingly, this exemption does not appear in the proposed Rule. For the same reason, the Commission is not prepared to extend the exemption to allow an independent committee to waive the minority approval requirement.

4. Level of Minority Approval for Related Party Transactions and Going Private Transactions (Section 8.3)

For going private transactions, the 1996 proposed Rule adopted the requirement in Policy 9.1, which is either a two-thirds or simple majority of minority approval. The two-thirds approval level is required where the consideration to be received by minority shareholders takes the form of some non-cash consideration or where the consideration being offered is less than the per security value or the mid-point of the range of values based on a formal valuation.

The 1996 proposed Rule departed from Policy 9.1 in that it only required a simple majority for all related party transactions (other than quasi-going private transactions) regardless of the form of consideration to be received by minority shareholders or the value of the consideration offered as against the values under the valuation. Comment was sought on the appropriateness of the proposed levels of minority approval for the different types of transactions under the 1996 proposed Rule.

Comments

Seven of the commenters felt that a uniform standard should be adopted for all of the types of transactions covered by the 1996 proposed Rule and that a majority of the minority would be sufficient. Those commenters were of the view that anything more would give the minority inappropriate veto power. Further, they felt it would be inappropriate to link the level of approval to either the results of the valuation or the form of consideration being offered. Relating the level of approval to the results of a valuation would, in their view, place undue reliance on that opinion (which is highly dependent on the valuator's professional judgment), put inappropriate pressures on valuators and often result in valuation ranges that are negotiated between the valuator and the interested party. Those commenters thought the valuation process should establish a more level playing field in terms of access to information for minority shareholders, rather than a negotiating lever to attract the highest possible price. They noted that relating the level to the form of consideration would create a bias in favour of cash irrespective of the quality of paper offered.

Another commenter felt that the 1996 proposed Rule should retain the minority approval levels in Policy 9.1. That commenter felt that if the Commission is concerned that a minority approval level dependent upon the results of a valuation may give rise to inappropriate pressures on valuators, then the Commission should be concerned about the whole valuation process itself. That commenter also noted that there may be circumstances in which a greater majority than a simple majority would be appropriate and would provide a greater assurance of fairness to minority shareholders.

Response

The Commission agrees with the seven commenters that tying the level of approval to the form of consideration or to the relationship of the consideration to the range of values is inappropriate. The Commission agrees that there should be a uniform standard for all transactions and that a simple majority is the appropriate level. The Commission has amended the definition of "minority approval" accordingly.

5. Disclosure of Smaller Related Party Transactions (Section 3.9 of the 1996 Proposed Companion Policy)

Policy 9.1 currently requires disclosure in proxy circulars of any related party transactions which individually or in the aggregate are material to the issuer. Section 3.9 of the 1996 proposed Companion Policy contained a similar provision to the disclosure requirement in Policy 9.1 and also referred issuers to section 3840 of the Handbook of The Canadian Institute of Chartered Accountants. Comment was sought on whether the proposed disclosure requirement for smaller related party transactions is sufficient or whether the Commission should expressly require more detailed and specific disclosure of such transactions on an annual basis in the proposed Rule.

Comments

Two commenters felt that the current proposal is sufficient.

One commenter was of the view that the 1996 proposed Companion Policy would reduce the requirements in Policy 9.1. That commenter felt that at the least, the disclosure contemplated in the 1996 proposed Companion Policy should be required in the proposed Rule. The commenter suggested that the proposed Rule require annual disclosure of the aggregate value of (i) all related party transactions, and (ii) related party transactions not previously disclosed. The commenter thought the proposed Rule should also require review of all related party transactions by an independent committee of directors, and disclosure of the processes generally followed by the issuer with respect to related party transactions. Such disclosure should be supplemented by a more detailed description of transactions in which the issuer diverged from its normal procedures.

Response

The Commission is of the view that the current proposal, which appears in section 4.3 of the proposed Companion Policy, is sufficient. The Commission believes that there is no need to supplement the proposed Companion Policy and the CICA requirements through requirements in the proposed Rule.

6. Valuation Disclosure (Subsection 6.5(1) of the 1996 Proposed Rule and Section 3.7 of the 1996 Proposed Companion Policy)

Section 6.5 of the 1996 proposed Rule prescribed the disclosure requirements applicable to a valuation summary. Section 3.7 of the 1996 proposed Companion Policy expressed the Commission's view of the required level of disclosure and referred to the proposed valuation disclosure standards of the Investment Dealers' Association of Canada (the "IDA") and of the Canadian Institute of Chartered Business Valuators (the "CICBV") as being reasonable. Comment was sought on the appropriateness of the proposed valuation disclosure provisions of the 1996 proposed Rule and the 1996 proposed Companion Policy.

Comments

Two commenters supported the proposal in the 1996 proposed Rule and 1996 proposed Companion Policy.

One commenter felt that the 1996 proposed Rule was deficient because it did not prescribe a general disclosure standard for formal valuations, only for summaries. That commenter felt that the following test of overall disclosure adequacy should be added to the proposed Rule:

Disclosure should be sufficient to allow the directors and securityholders of the issuer to understand the principal judgments and principal underlying reasoning of the valuator in its formal valuation so as to form a reasoned view on the conclusion expressed in the formal valuation.

That commenter felt that using a disclosure standard for valuation summaries that is the same as that used for valuation reports is unworkable and a summary should have a more modest disclosure objective. That commenter was also concerned with the practice of summarizing valuation reports. Where the complete valuation report accompanies the disclosure document sent to shareholders and has been prepared in accordance with recognized standards, the commenter was of the view that a statement as to the valuation conclusions should be a sufficient summary in the disclosure document. However, if those circumstances are not present, it felt that a summary should be provided in the disclosure document which describes the formal valuation in sufficient detail to permit securityholders to form a reasoned view with respect to the formal valuation.

One commenter felt that the current provision in Policy 9.1 (subsection 24.5(3)), as carried forward in the 1996 proposed Companion Policy, should be contained in the proposed Rule instead. That provision requires that the prescribed disclosure entail a sufficiently detailed review of all material factors contained in the formal valuation so that the reader can understand the valuator's thought processes and assumptions in arriving at its opinion. As well, the commenter thought the provisions of the 1996 proposed Companion Policy, which require disclosure of a limitation on the scope of the valuator's review and its implications for the valuator's conclusion, should be in the proposed Rule. The commenter noted that the 1996 proposed Rule does not prescribe the contents of a formal valuation report or specify a standard for its preparation. It felt that the approach taken by the Commission of subdelegating disclosure standards to the CICBV and the IDA should be contained in the proposed Rule, which should provide that a summary of a formal valuation shall be prepared in accordance with their disclosure standards and any applicable provisions of the proposed Rule. This would encourage vigorous enforcement of the disclosure standards by the CICBV and IDA.

Another commenter agreed with the proposed valuation disclosure provisions of the 1996 proposed Rule and the 1996 proposed Companion Policy, except it felt no summary should be required if the valuation is provided to shareholders, and the board of directors should be given the authority to determine what information should be disclosed (the 1996 proposed Companion Policy suggests the discretion is only given with respect to "additional" information).

One commenter was of the view that, in practice, the process that covers related party type transactions heavily favours the related party. The commenter's concern was that there are no competitive forces at work to ensure that "fair value" is achieved and the controlling shareholder has a virtual monopoly on the most important information that shareholders need in order to make an informed decision as to "fair value".

That commenter was of the view that the position of the minority shareholders would be best protected by full and complete access to pertinent valuation data when a controlling shareholder initiates a transaction because there will be no competition. In its view, to establish a legislative and policy framework that ignores or diminishes the minority's access to information would leave the affected shareholders facing incredibly costly legal remedies and begs the question as to why the controlling shareholder should refuse to share key information with the parties they claim to be treating "fairly". The commenter indicated that, in its experience, a fairness opinion does not provide it with enough information. The commenter also indicated that it is extremely uncomfortable relying solely on valuations prepared for "independent" directors as strong biases exist in virtually all situations with the bias being in favour of the cheque writer.

Response

The Commission agrees with the comment that the proposed Rule should prescribe a general disclosure standard for valuations in addition to summaries of valuations. Accordingly, the Commission has added a general standard to paragraph (e) of subsection 6.4(1) of the proposed Rule.

The Commission is not prepared to insert into the proposed Rule the provisions of section 5.1 of the proposed Companion Policy requiring disclosure of limitations on the scope of the valuator's review.

The Commission feels that subdelegation of disclosure standards as suggested by one commenter is not workable at this point, as not all valuators will be members of the bodies described in the proposed Companion Policy and therefore not subject to their rules and sanctions for non-compliance. Further, the Commission has not formally approved these standards and recognizes that they may not be the only standards that can be suitably followed.

The Commission agrees with the comments that no summary should be required if a formal valuation is provided in the disclosure document and has modified the 1996 proposed Rule accordingly. If a formal valuation is not included in the disclosure document the Commission requires the disclosure of a summary, with the disclosure standard conforming to that for valuations.

The Commission disagrees with the suggestion that the board of directors be given authority to determine what information should be disclosed. The Commission is of the view that it is important to have a minimum set of standards in this area. Further, boards or possibly independent committees may be subject to pressure from sizeable shareholders in respect of the disclosure.

The Commission believes that the proposed Rule strikes an appropriate balance between the controlling party and the minority shareholder, as it provides the minority shareholder with a basis upon which to determine whether the transaction is fair or whether to pursue other remedies available to the minority shareholder. In the proposed Rule, the Commission requires in many cases that a valuation be prepared and specifies the type of disclosure expected. The Commission is not prepared to insert into the proposed Rule a requirement that the minority shareholder be given full and complete access to the pertinent valuation data that the valuator is using in preparing the valuation. The Commission does not believe this is practical or warranted.

7. Limitation of Application of Going Private Transaction and Related Party Transaction Provisions to Reporting Issuers and CDN-quoted Issuers (Paragraph (a) of Section 4.1 and Paragraph (a) of Subsection 5.1(2))

Policy 9.1 currently applies to all issuers if they have accessed the Ontario capital markets by prospectus or under certain private placement exemptions. The 1996 proposed Rule did not apply to non-reporting issuers where the only access to Ontario investors had been by private placement unless such issuers were CDN-quoted. Comment was sought on the appropriateness of the limitations on the application of the going private transaction and related party transaction elements of the 1996 proposed Rule to reporting issuers and CDN-quoted issuers.

Comments

Three of the commenters felt that the proposal to limit the application of going private transaction and related party transaction provisions to reporting issuers and CDN-quoted issuers is appropriate. One of those commenters was of the view that all CDN issuers should be required to be reporting issuers.

One commenter supported the thrust of this change, but believed the proposed Rule should retain a de minimis exemption for non-reporting issuers, whether or not their shares are quoted on CDN.

Another commenter felt that the application of the proposed Rule to CDN-quoted issuers may not be workable in all cases. CDN-quoted issuers that are not reporting issuers in Ontario are generally not subject to Ontario securities law and it would be difficult to enforce their compliance with the proposed Rule. As an alternative, the commenter suggested it might be preferable to arrange with CDN to require that non-reporting issuers, as a condition of being quoted on CDN, contractually agree to comply with the proposed Rule.

One commenter noted that there was no factual basis compelling either position and, as a result, it would be inadvisable for the Commission to exclude issuers that have sold securities in Ontario under a private placement exemption from the proposed Rule's application. At the most, the commenter thought exemptions from the valuation and minority approval requirements and possibly the obligation to publish a press release should be provided for those issuers, so that the Commission would retain authority to require compliance with the proposed Rule in specific instances of unfair going private transactions or related party transactions by denying the exemption.

Response

The Commission does not propose to make any changes in this area. The limitations are now contained in paragraph (a) of subsection 4.1(2) and paragraph (a) of subsection 5.1(2) of the proposed Rule.

The Commission currently does not have the ability to deem issuers to be reporting issuers.

The Commission notes that the 1996 proposed Rule and the proposed Rule both contain a two percent de minimis test.

The Commission believes that it has appropriate enforcement powers to enforce compliance by CDN issuers with the proposed Rule, without requiring that compliance with the proposed Rule be part of the CDN quotation contract.

The Commission does not agree with the comment that issuers who have completed private placements in Ontario should be subject to the going private and related party requirements of the proposed Rule. The Commission is of the view that the proposed Rule should only apply to those transactions if the issuer has accessed Ontario's public markets by becoming a reporting issuer here or having its securities quoted on CDN.

8. Retention of 90 Percent Going Private Transaction Minority Approval Exemption (Paragraph 2 of Subsection 4.7(1))

The 1996 proposed Rule continued the exemption in Policy 9.1 from the minority approval requirements in a going private transaction where the interested party holds 90 percent or more of the affected securities. Comment was sought on the appropriateness of retaining this 90 percent exemption or whether it may be more appropriate to limit its use to situations involving a substantial value of minority security holdings.

Comments

Four of the commenters felt that the exemption should be retained. They thought that without it, controlling shareholders could be subject to the "tyranny of the minority", who seek to be paid for a blocking premium rather than fair market value. They were of the view that dissent and appraisal rights would provide sufficient protection in the circumstances. As one commenter put it: "[i]mposing a minority vote in these circumstances would generally reduce market values for these stocks by eliminating speculative going private premiums, would perpetuate inefficiencies in the utilization of corporate resources of the enterprises involved, and, where buy-out transactions are proposed, would place disproportionate bargaining power in the hands of short-term speculators to the possible disadvantage of long-term investors." Three of the four commenters stated that the value of the minority interest is irrelevant to the issue.

Another commenter noted that, while the OBCA accepts that a 90 percent controlling shareholder should be entitled to squeeze out minority shareholders without having to take the minority's interests into account, the power must be exercised fairly. That commenter felt that the appraisal and oppression remedies are often not realistic protection for the minority because of the costs of litigation. It stated that a minority shareholder's need for protection is not lessened because the interested party holds over 90 percent of the shares. The commenter was of the view that the exemption should only be available in defined de minimis cases and should not be available where the consideration offered is less than the mid-point of a formal valuation.

Response

The Commission agrees with the four commenters and continues to support the retention of the 90 percent minority approval exemption, which appears in paragraph 2 of subsection 4.8(1) of the proposed Rule. The Commission does not feel that it is appropriate to link minority approval to the amount of the consideration offered relative to the valuation or to the value of the minority's holdings in the issuer.

9. Disclosure of Directors' Commercial Links

Comment was sought on the appropriateness of requiring disclosure of directors' commercial links, direct or indirect, with an issuer and its controlling shareholder or entities controlled by the controlling shareholder.

Comments

One of the commenters felt that, in the Canadian corporate environment of interlocking directorships, independence of directors is difficult to gauge given the limited disclosure of a director's links to the issuer or its controlling shareholders. In the commenter's view, it would be useful to require directors to disclose all of their commercial connections with an issuer or such issuer's controlling shareholder and any entity controlled by such shareholder, either directly or indirectly, in a manner similar to Item 404 of Regulation S-K of the SEC.

A second commenter felt that this disclosure should be required in the annual information circular relating to the election of directors and supplemented, if necessary, in a later disclosure document relating to a transaction.

A third commenter felt that materiality is the standard against which disclosure obligations should be measured and that the only links that should be disclosed are those that are material in the context of the relevant transaction.

A fourth commenter was unclear as to what the Commission had in mind concerning the disclosure. It noted such links may be relevant to shareholders' consideration of a related party transaction, but said it is difficult to assess whether the benefit of this disclosure would be worth the detailed inquiries that would be needed to obtain this information.

A fifth commenter did not support this additional disclosure. It thought that the disclosure being contemplated was unclear. The commenter felt the need for additional disclosure has not been demonstrated, especially in light of recent changes in Canadian corporate law and practice in the area. The commenter expressed concern about legislative changes that could encumber corporate governance in Canada and discourage capable individuals from serving as corporate directors.

Response

The Commission accepts the comments that a general requirement in the proposed Rule to disclose directors' direct and indirect relationships with an issuer and its controlling shareholder entities is too broad and potentially unclear.

10. Timing of Valuations in Insider Bids

The 1996 proposed Rule adopted the requirement in Policy 9.1 that an insider cannot make a take-over bid without having first completed a valuation, unless the insider can avail itself of one of the valuation exemptions. This requirement is imposed on the theory that the insider may have information about the target that could affect its determination of value, creating an informational imbalance between the offeror and the minority shareholders.

The possible valuation exemptions in the context of an insider bid include the auction exemption (where the insider makes a bid during the currency of another bid) and the lack of knowledge and access exemption (where the insider has no knowledge, and has not within the preceding 12 months had board or management representation or other access sufficient to enable it to acquire knowledge, of undisclosed material information).

The valuation requirement can make it difficult for an insider to make a take-over bid because, while the bidder may have had access (such as board or management representation or otherwise) to the target in the 12 months prior to the bid, it may no longer be on friendly terms with the target and therefore may not necessarily be able to get sufficient access to complete a valuation. Alternatively, a former director may be prevented by his or her fiduciary obligations to the target from using the information obtained as a director of the target for valuation purposes in the context of an insider bid without first obtaining the consent of the target.

Comment was sought on whether an offeror making an insider bid should be able to launch the bid with the valuation by the independent directors to follow, perhaps accompanied by a longer time period, or whether independent directors need to be involved before rather than after the making of the bid and, if such a process were to be adopted, the amount of time that should be provided to the independent directors.

Comments

Three of the commenters felt that an offeror should be able to launch an insider bid without a valuation, with the valuation to be subsequently obtained by the target directors under the supervision of an independent committee. Those commenters felt the bid period would need to be extended from 21 to perhaps 35 days to enable the target directors additional time to complete the valuation process. One of those commenters was of the view that the independent committee of the target should be left to determine whether a valuation is needed at all and, where a valuation is obtained, the cost of obtaining the valuation should be incurred by the target. In that commenter's experience, the current rules result in insider bids being highly negotiated transactions between the bidder and the target with the bidder not being shown the valuation until the conclusion of the negotiation process.

A fourth commenter was of the view that the mechanism under Policy 9.1 to determine who controls the preparation of the valuation, which is also adopted in the 1996 proposed Rule, has led to significant and unnecessary manoeuvring on the part of independent committees to avoid being characterized as hostile and thereby losing control of the preparation of the valuation. This stems from the approach that only one valuation, overseen by the issuer's board, should be prepared in respect of an insider bid. That commenter did not see any reason why an insider bid should be treated differently from a take-over bid in this respect. The insider, like any offeror, will be motivated to have a valuation to show the appropriateness of the bid. The commenter felt the question of access is one that should be determined between the parties as it is in all take-over bids (the incentive on the board to provide access to obtain a better price is no different here). The board of directors of the issuer would be required to decide whether a separate valuation is necessary in order to properly respond to the insider bid. Once the question of issuer involvement in the insider's valuation has disappeared, that commenter saw no reason to allow the insider to launch a bid without a valuation where one is to be provided.

A fifth commenter did not favour shifting the valuation requirement to the target directors in responding to a hostile insider bid. Rather, it felt a valuation exemption should be provided for an insider holding less than 35 percent of the target's voting shares where such insider lacks sufficient access to the target to have a valuation performed, has no knowledge of material non-public information regarding the issuer, and has a reasonable basis for believing and did in fact believe that a bid by the insider would be regarded as hostile by the majority of the issuer's board. If the insider holds greater than 35 percent of the target's voting shares, satisfactory arrangements could be expected to be made with the target's board to comply with the valuation requirement. The commenter suggested that in such cases, an actual indication of hostility from the board, as currently contemplated by paragraph (b) of subsection 2.2(2) of the 1996 proposed Rule, should be required to qualify for a valuation exemption.

Response

The Commission continues to believe that a valuation should appear in the take-over bid circular and that, subject to the exceptions currently in Policy 9.1, the valuation should be prepared under the supervision of the target board. The Commission has therefore determined to continue the position in the 1996 proposed Rule which is a continuation of the requirement in Policy 9.1. While it may not present a perfect solution, it has proven generally workable and, to the extent that it is not appropriate in a particular case, it can be dealt with on a case by case basis by application for exemption. While the proposals suggested by the commenters each have their own merits, they each raise their own concerns.

11. Appropriateness of the 1996 Proposed Rule's Treatment of Related Party Transactions Involving Junior Resource Issuers

Comment was sought on the appropriateness of the 1996 proposed Rule's treatment of related party transactions involving junior resource issuers.

Comment

The Commission received one comment on this issue, which is summarized in the comments in Item 1, Regulatory Treatment of Related Party Transactions. That commenter was not in favour of adopting either of the two alternatives for regulating related party transactions as they applied to junior issuers.

Response

The Commission's response is in Item 1, Regulatory Treatment of Related Party Transactions.

12. Cost/Benefit Analysis

The 1996 Notice requested comment on anticipated costs and benefits of the 1996 proposed Rule and the alternative approaches to the regulation of related party transactions.

Comments

Generally, cost/benefit comments were only received in relation to specific sections of the 1996 proposed Rule and 1996 proposed Companion Policy.

One commenter indicated that it found it difficult to comment on the anticipated costs and benefits of the 1996 proposed Rule. While there are considerable costs, the commenter acknowledged that transactions with an inherent conflict of interest raise special concerns and require appropriate safeguards for minority shareholders. That commenter believed that, if related party transactions are regulated through a policy, an appropriate balance would be struck.

Response

The Commission discusses the comments relating to specific sections in this summary in the context of those sections.

The Commission's views on regulating related party transactions are set out in Item 1, Regulatory Treatment of Related Party Transactions.

13. Requiring Independent Committees for All Substantial Transactions Governed by the 1996 Proposed Rule

The Commission sought comment on whether independent committees should be mandatory for all substantial transactions governed by the proposed Rule or even more generally for all transactions involving related parties.

Comments

One commenter noted the important role independent committees play in connection with related party transactions with respect to the objective application of statutory exemption standards, selection of independent advisors and adequacy of disclosure and, overall, contributing to shareholders' confidence in the decision making process. That commenter felt that independent committees should be required to review (and in some cases approve) all transactions that are subject to the proposed Rule, retain the valuator and supervise the valuation, where a valuation is undertaken, and generally supervise the approval process and disclosure in connection with the transaction. It felt independent committees should also be responsible for determining whether a related party transaction comes within any exemption from the proposed Rule's requirements.

A second commenter was also of the view that only directors independent from the interested party should be involved in decisions regarding substantial transactions governed by the proposed Rule. That commenter felt that whether a subset of such independent directors is formed as an independent committee or whether all independent directors are involved should be left for boards to determine on a case by case basis.

A third commenter felt that the Commission should not formalize the use of independent committees, but should leave to the board of directors the decision as to the appropriate procedures to be followed.

A fourth commenter felt that the decision as to whether to form an independent committee to consider a related party transaction should be left to the board of directors of the issuer. It was of the view that boards of Canadian public companies can effectively protect the interests of minority shareholders in the context of each related party transaction, subject always to the Commissions's public interest jurisdiction.

Response

The Commission continues to be of the view that, except in connection with insider bids, the proposed Rule should not mandate the use of independent committees.

B. DISCUSSION OF SPECIFIC COMMENTS

The Commission received a number of comments on specific provisions of the 1996 proposed Rule and the 1996 proposed Companion Policy. The comments are summarized here, together with the Commission's response, in the order of the sections in the 1996 proposed Rule and 1996 proposed Companion Policy.

The 1996 Proposed Rule

1. Subsection 1.1(1) - Definition of "director"

Comment

The definition in the 1996 proposed Rule included a person "acting in a capacity similar to that of a director of a company". One commenter was of the view that the phrase could have at least two meanings. It might be a reference to a person performing a role in a non-corporate vehicle similar to that of a director in a company or it might be a reference to a person not elected as a director of a company but performing the same function, i.e. a shadow director. That commenter felt the phrase should be clarified and should not cover a "shadow director".

Response

This definition is based on and is the same as the definition of "director" in the Act. As the Commission believes the definition in the Act is appropriate, it has deleted the definition here since, under Rule 14-501 Definitions, terms used in a rule that are defined in section 1 of the Act have the meaning given in section 1. As well, as the portion of the definition of "director" in the Act that causes concern is in relation to a director of a person and not of a company, the shadow director comment is not of concern here.

The Commission has added section 2.1 to the proposed Companion Policy that provides that in appropriate circumstances a director of a general partner of a limited partnership can be considered to be a director of the limited partnership under the definition of "director".

2. Subsection 1.1(1) - Definition of "fair market value"

Comment

One commenter believed that the words "maximum monetary" should be deleted from the definition of "fair market value". The word "maximum" is unnecessary and the word "monetary" improperly excludes consideration in other forms, such as securities.

Response

The Commission disagrees with the change both because "fair market" value has to be based on the maximum consideration and because, even if non-cash consideration is being offered, the fair market value of the consideration is to be determined based on the cash equivalent value.

3. Subsection 1.1(1) - Definition of "formal insider bid" and "formal issuer bid"

Comment

One commenter noted that the defined term "formal insider bid" would be confused with the defined term "formal bid" in the Act (which is incorporated into the 1996 proposed Rule). A formal bid is a take-over bid that requires a circular. Since a "formal insider bid" is defined as one that occurs through a stock exchange, the commenter suggested that perhaps a better defined term would be "stock exchange insider bid".

The commenter made a similar comment in respect of "formal issuer bid".

Response

The Commission agrees with the commenter and has made the changes suggested.

4. Section 1.1(1) - Definition of "holder" and "to hold"

Comments

Three of the commenters felt that the reference to "exercising control or direction" should be deleted from these definitions. They noted that the meaning of the phrase is uncertain and is the focus of discussion itself in connection with the proposed rule on early warning reporting. They were of the view that this concept would create uncertainty while not remedying any identified defect.

One of the commenters felt that if the extended definition is adopted, it should only be used in specific instances in the proposed Rule where it is considered necessary and, if used, the phrase should be more clearly defined.

Response

"Holder" is now defined in the proposed Rule as registered holder and, where the Commission intends that a section refer to beneficial owners or persons or companies who exercise control or direction, reference is now made specifically to those concepts.

5. Subsection 1.1(1) - Paragraph (c) of "interested party"

Comment

One commenter noted that, under Policy 9.1, control persons who enter into an understanding to support a going private transaction are included in the definition of "interested party" in respect of a going private transaction, and an interested party is excluded from voting as part of the minority. While the 1996 proposed Rule continued to exclude such control persons from the minority for voting purposes, it was done in a section defining minority approval and not through the definition of "interested party". The commenter felt that this proposed departure from Policy 9.1 would affect the standards applicable in determining the independence of valuators and directors. For example, while the 1996 proposed Rule dealing with determining the independence of valuators sets out a presumption that a valuator is not independent of an interested party if the valuator or any of its affiliates advise the interested party, the control person is not defined as an interested party and therefore a person who advises the control person would not be presumed to lack independence.

Response

As indicated previously, control persons are no longer excluded from the minority solely by virtue of being control persons. In any event, the Commission disagrees with the comment. The Commission does not want to deal with the issue of whether persons advising control persons are independent indirectly through the definition of "interested party".

6. Subsection 1.1(1) - Definition of "market capitalization"

Under Policy 9.1 and the 1996 proposed Rule, market capitalization is generally defined as the product of the outstanding equity securities of the issuer and the market price of the securities. The 1996 proposed Rule provides that market price is to be determined in accordance with section 183 of the Regulation, which allows the calculation to be based on a 20 day period. Policy 9.1 requires that the calculation be made using securities outstanding over the three calendar months preceding the transaction. Provision is made for inclusion in the calculation of convertible and similar type securities and for obtaining a price per security where there is no published market including, as a last option, relying on the directors' determination.

Comments

One commenter suggested that it would be preferable to retain in the proposed Rule the method of calculating market capitalization currently in Policy 9.1. It thought a three month period would minimize the effect of short term market fluctuations whereas a 20 day period would permit short term share price fluctuations to affect the calculation. As the day on which a related party transaction is agreed to is within the discretion of an issuer's management, the commenter felt the formula in the 1996 proposed Rule would increase an issuer's ability to time a transaction to come within the exemption. The commenter also noted that if the public announcement of a transaction preceded the date of agreement, the situation would be further aggravated.

That commenter also noted that the definition of "market capitalization" in the 1996 proposed Rule contained a residual provision allowing a board of directors to make the determination where it cannot be made under the other parts of the definition. That commenter felt that if any such determination is to be made, the proposed Rule should require that it be made by an independent committee of directors and that the basis of the committee's determination be disclosed in the material change report required under section 5.2 of the 1996 proposed Rule concerning the transaction.

Another commenter noted that the definition of "market capitalization" only includes the equity capitalization of an issuer and that debt securities should be included. Some issuers have a large amount of debt capital outstanding with a relatively small equity capitalization that is wholly-owned by a parent corporation. The commenter stated that in these situations, the related party transaction requirements would arguably apply to transactions that are not material to public debt holders.

A third commenter proposed using the day before the transaction is agreed to rather than using the number of outstanding securities at month's end to calculate "market capitalization".

Response

The definition under the proposed Rule is intended to simplify the calculation of market capitalization. The Commission believes that, as in the private agreement provisions in the Act's take-over bid rules, the 20 day calculation is sufficient and considers it unlikely that issuers will structure related party transactions in periods where the price has been high in order to take advantage of short term share price fluctuations.

The Commission believes that equity securities are the appropriate benchmark for calculating market capitalization and that debt securities should not be taken into account in determining market capitalization. Most issuers have material amounts of debt which, if added to the calculation of market capitalization, would likely result in an increased number of related party transactions being exempt from the proposed Rule's requirements by falling under a 25 percent threshold that would be raised due to the inclusion of the issuer's outstanding debt, which is not a reasonable means of calculating the overall value of an issuer. In addition, in the situation raised by the commenter, the exemptions in the proposed Rule involving transactions with a wholly-owned subsidiary should be of assistance.

The Commission does not see the difficulty in using the month end as the date for fixing the number of outstanding shares and believes it provides more certainty than a calculation that would rely