Notice and Proposed Rule: OSC Rule - 32-501 - Direct Purchase Plans

NOTICE OF PROPOSED RULE
UNDER THE SECURITIES ACT
PROPOSED RULE 32-501
DIRECT PURCHASE PLANS

 

Substance and Purpose of Proposed Rule

The proposed Rule 32-501 will establish a regime that will permit reporting issuers to establish direct purchase plans in Ontario under which an issuer may issue securities directly to investors without the need to sell those securities through a registrant. The proposed Rule would establish safeguards around the use of such plans that the Commission believes will provide appropriate protection for investors in respect both of the administration of the Plans and the promotion of securities offered under direct purchase plans.

Background

Direct purchase plans are a well-recognized part of the U.S. investment landscape; there are over 1600 plans listed on www.netstockdirect.com, a major U.S. website that provides information about, and permits on-line investment in direct purchase plans in the U.S. Direct purchase plans, as discussed below, are generally recognized to afford a number of benefits both to issuers and investors. The Commission is of the view that there are no compelling regulatory reasons to prevent the establishment and development of direct purchase plans in Ontario in the same manner as similar plans have developed in the United States.

The proposed Rule has been developed as the result of proposals made to the Commission by the Securities Transfer Association of Canada ("STAC"), the Canadian trade association of transfer agents. STAC recommended the implementation of the proposed Rule to the Commission based on its understanding that issuers would find such plans beneficial and because of its understanding of the U.S. market. STAC and Commission staff have worked together to develop this proposal, which is designed to facilitate the use of such plans while ensuring adequate investor protection.

The following is an outline of the nature and operation of direct purchase plans.

Terminology

The following is a summary of the key terms used in connection with direct purchase plans.

The term "direct purchase plan" means an arrangement under which an investor may acquire ownership of securities of an issuer from the treasury of the issuer or through the issuer's transfer agent in the secondary market, without the interposition of a registered dealer on the trade. In the United States, direct purchase plans generally consist of either issuer sponsored plans or bank sponsored plans.

The term "issuer sponsored plan" or "issuer registered plan" means a direct purchase plan in which investors may acquire securities directly from both the treasury of an issuer and on the secondary market. These plans are sponsored by the issuer and, in the U.S., involve the registration of the securities to be sold under the plan. The proposed Rule would permit the issue of securities under issuer sponsored plans in Ontario.

The term "bank/agent sponsored plan" means a direct purchase plan operated by a bank or transfer agent in which investors may acquire securities from an issuer through the bank or transfer agent on the secondary market. These plans are sponsored and administered by the bank or transfer agent. The issuer adopts the plan, but is not directly involved in administering it. The proposed Rule does not deal with bank/agent sponsored plans, which raise some different regulatory issues from issuer sponsored plans. The Commission requests comments on whether the proposed Rule should be broadened to provide necessary exemptive relief to permit the operation of bank/agent sponsored plans.

Operation of Direct Purchase Plans

Direct purchase plans operate in a manner similar to traditional dividend reinvestment and stock purchase plans, which are programs offered by issuers that allow participants to acquire shares of the issuer directly from the issuer by reinvesting dividends and, in many cases, by making optional cash payments. These types of plans are permitted in Ontario by Rule 45-502 Dividend or Interest Reinvestment and Stock Dividend Plans, which provides registration and prospectus exemptions in respect of the issue of securities under both the reinvestment of dividends by a shareholder and the payment by the shareholder of a cash payment option, subject to certain conditions.

Direct purchase plans are administered in a manner similar to the types of plans contemplated by Rule 45-502, except that it is not necessary under the direct purchase plan for the purchaser of securities to already be a shareholder of the issuer.

Direct purchase plans are designed primarily to permit investors to make regularly scheduled investments in securities of an issuer, often in small quantities. Typically, in the U.S., securities are issued under direct purchase plans accordingly to an established schedule; securities are typically issued on a weekly, bi-weekly, monthly, quarterly or semi-annual basis. The amount of notice that an investor needs to either place an order, or to cancel an order is usually related to the length of time need to deal with the matter administratively; this could be 24 to 48 hours, although if contributions are set up through a direct debit arrangement, approximately 7 days are often needed to cancel deductions. Direct purchase plans are suitable for long-term investments; because trades are processed only at regularly scheduled times, such plans are not suitable for investors who wish to actively trade or buy and sell securities quickly in response to market movements.

The issue price for securities under direct purchase plans in the U.S. is generally market, based on some rolling average of the stock price calculated at the time that transactions under a direct purchase plan are processed. The Commission expects that in Ontario, the approaches usually followed for optional cash purchases associated with dividend reinvestment plans would be followed here.

In U.S. issuer sponsored plans, provision is often made in a plan to permit purchases to be made either from treasury or on the secondary market, at the election of the issuer. For transactions effected through the market, the administrators of the plan would combine all orders received for a particular trade date, effect the transactions through a registrant, and all investors would pay the same price for securities purchased on a particular trade date.

Many direct purchase plans in the U.S. operate on a book entry basis, which reduces costs and facilitates the issuance of fractional interests in securities. Investors are, of course, entitled to request and receive at any time certificates representing their investment.

It is typically up to the issuer of a plan whether investors may sell securities within the plan. Investors also have the option of requesting a certificate, and selling their securities in the ordinary course through a broker. Some plans may permit the investor to direct that all or some of their securities are to be sold through the plan; in those circumstances, the administrator would combine all of such requests, and effect the sale at market prices through registered brokers. The days on which sales are processed are typically the same as the days on which purchases are processed.

Benefits of Direct Purchase Plans

STAC has recommended the implementation of direct purchase plans to the Commission on the basis that there are considerable benefits to both the investing community and the issuer community associated with direct purchase plans. The following is a summary of the most important of those benefits.

(a) Benefits to Investors

1. The primary reason that direct purchase plans are popular in the U.S. is that they provide a way for smaller investors to acquire securities of issuers, often in small amounts at a time, in an economically feasible way. The fees charged to investors for making purchases through direct purchase plans are typically below normal brokerage commissions, including discount brokerage commissions. Without direct purchase plans, investors could only purchase securities through a registered broker; the payment of brokerage commissions effectively prevents investors from making small purchases of securities and keeps those investors from becoming participants in the market.

2. Direct purchase plans permit investors to plan their own affairs and manage their own investment portfolios without having to pay for investment "advice" from a registered dealer that the investor does not wish to receive. One overall investment trend that has been recently noted and recognized by the Commission is that many investors are increasingly desirous of doing their own research on their investments and making their own investment decisions.

3. Direct purchase plans recognize that investors wishing to manage their own portfolios without the assistance of registered dealers are now more able to do so than at any time in the past because of the dramatically increased access to information concerning issuers that is now available, particularly through the Internet. The Commission notes that individual investors now have access to more information concerning issuers than analysts had only a few years ago.

4. The structure of direct purchase plans encourages long term investment, making direct purchase plans useful retirement planning vehicles. Because transactions under direct purchase plans may only be made according to a fixed schedule, direct purchase plans are not effective vehicles for active trading of securities. The utility of these plans forlong term investment may be especially important to those Canadians who are concerned that government pension plans might be inadequate to fund the retirement of many people now in their prime working years. The perception is that those people must take responsibility for planning for their retirement. For those who choose to use them, direct purchase plans would permit such persons to invest in equity securities on a long-term basis with minimal transaction costs.

5. Direct purchase plans have been combined in the U.S. with underwritten offerings. The combination of direct purchase plans and underwritten offerings is effected by an issuer preparing two prospectuses, one relating to a conventional underwritten offering, and the other relating to an offering that would be made directly by the issuer. This approach has the effect of permitting retail investors to participate in a portion of an issuer's equity financings, and can be seen as an effective response to the concerns often heard about underwritten offerings being made available only to institutions.

(b) Benefits to Issuers

1. Direct purchase plans enable issuers to increase the number of individual shareholders on their register. This tends to increase the stability of the shareholding group of an issuer as direct purchase plan investors invest for the long term, and reduces the influence that major institutions, such as pension plans, mutual funds and arbitrageurs, may have on a company's stock.

2. Direct purchase plans permit issuers to know better who their shareholders are. This enables issuers to communicate better with their shareholders, and may facilitate obtaining quorums for meetings. Issuers consider this preferable to being separated from their investors by layers of financial intermediaries.

3. Participants in direct purchase plans tend to have consumer loyalty to the issuers in which they invest. Studies in the U.S. have shown that investors who own shares of a retail company are more likely to shop at that company's stores than if they did not own shares. This is considered a major benefit in the United States by a number of major retail companies that operate direct purchase plans.

4. Issuer sponsored plans can provide issuers with an inexpensive source of capital, as securities can be issued from treasury without underwriting fees.

Regulatory Issues

The most important regulatory issues raised by direct purchase plans is that the absence of a registrant in connection with the sale of securities to investors means that investors will not receive the benefit of the "know-your-client" protection normally required.

The Commission, together with the rest of the Canadian Securities Administrators, has considered this issue extensively recently in a number of contexts, including in connection with the execution of trades by discount brokers. The CSA announced on April 10, 2000 that relief from suitability obligations will be granted on an application basis to dealers who only provide trade execution services for their clients. In the announcement, the CSA said that several conditions would be imposed on dealers to whom the relief was available, including the requirement that no investment advice would be provided to investors.

These principles behind that announcement are applicable to direct purchase plans. The Commission recognizes that these types of plans are appropriate for certain types of investors, namely those that wish to make their own investment decisions and who wish to be able to build a portfolio, perhaps with a series of small investments, in a cost-effective manner.

The Commission has also taken other action that recognizes the benefits of enabling small shareholders to effect securities transactions without being effectively prevented from doing so by brokerage expenses.

The Commission has granted orders in connection with a number of the demutualizations of insurance companies in the past year that have permitted so-called "share sale facilities" to operate without registrants. These facilities enable securityholders that obtained securities on the demutualization of an insurance company to sell their securities through a trust company at market prices for very low transaction costs. One of the conditions to those orders was that no investment advice could be provided to selling securityholders.

In addition, the Commission has made Rule 32-101 Small Securityholder Selling and Purchase Arrangements, which replaces various blanket rulings made by it. In this Rule, the Commission exempts from the registration requirements certain activities conducted by an issuer or its transfer agent in connection with participation by odd lot holders in small shareholder selling and purchase arrangements under the policy of The Toronto Stock Exchange. ThisRule provides registration relief to issuers in respect of these arrangements and allows the issuer to solicit orders for the buying or selling of securities under small shareholder arrangements. The purpose of the arrangements is stated in Part XXXI of the TSE Policy on Small Shareholder Selling and Purchase Arrangements, in which it is stated that shareholder purchasing arrangements are specifically encouraged because they foster an expanded shareholder base for TSE listed companies. The TSE also stated that the "vitality of the Canadian capital markets is enhanced by the participation of such investors".

Finally, the Commission notes that the relief provided by the proposed Rule enables direct purchase plans to operate in a somewhat similar manner to dividend reinvestment plans with cash payment options, without the technical requirement that an investor already own at least one share of the issuer.

Summary of Proposed Rule

Part 1

Section 1.1 contains the definitions used in the proposed Rule.

The key definition is that of "direct purchase plan", which is defined as

"an arrangement operated by or on behalf of a reporting issuer under which a person or company is permitted to purchase securities of the reporting issuer's own issue

(a)directly from the reporting issuer; or

(b)a marketplace through an administrator of the direct purchase plan;".

This definition restricts the ambit of the proposed Rule to "issuer sponsored plans" because it requires that a plan be "operated by or on behalf of a reporting issuer", which is not the case with bank sponsored plans. The definition also permits trades to be made under a plan either from the treasury of the issuer or on the secondary market.

The definition of "administrator" refers to the entity that administers the plan for the relevant reporting issuer. This is often the transfer agent of the issuer, and will typically be the same organization that administers dividend reinvestment plans for issuers; however, the definition also includes issuers, for plans administered directly by the relevant issuer.

The definitions of "plan advertisement" and "promotional activities" are used in Part 4 of the proposed Rule, which regulates the manner in which a direct purchase plan may be promoted. The definition of "public medium" is used in the definition of "plan advertisement".

Part 2

Section 2.1 provides the regulatory relief necessary to permit the operation of direct purchase plans, namely relief from the registration requirements of section 25 of the Act to permit trades to be made other than by a registrant. The Commission has imposed three conditions to the relief. First, the administrator of the direct purchase plan must comply with Part 3 of the proposed Rule in connection with the plan. Second, the investor must be provided with a free-standing investor disclosure statement that contains the information described in section 4.2 of the proposed Rule. This disclosure document, together with a prospectus, should provide investors with adequate information about both the issuer and the securities being purchased, and the risks associated with direct purchase plans, to permit them to make informed investment decisions relating to their purchase through such plans. Third, the investor must be provided with a prospectus relating to the plan.

Part 3

Part 3 contains a number of operational safeguards designed to ensure the operational integrity of direct purchase plans. The provisions require the segregation of funds used for investment in direct purchase plans, the segregation of securities issued under direct purchase plans, and that the administrators of the plans maintain proper bonding and insurance and record keeping, and provide investors with statements of account, in relation to such plans. These provisions are designed to replicate the requirements of the Regulations that impose similar obligations on registered dealers. Section 3.6 exempts from the bonding and insurance, record keeping and statement of account requirements banks and trust corporations, and other entities that are subject to substantially similar obligations under their governing legislation. The Commission understands that banks and trust corporations are subject to such obligations.

Part 4

Part 4 regulates the promotion of direct purchase plans.

Section 4.1 provides that no person or company may engage in promotional activities concerning a direct purchase plan, unless permitted by subsections (2) or (3). Subsection (2) allows the use of advertisements for direct purchase plans that contain only information about the operation of a direct purchase plan and information about how to obtain a prospectus relating to a direct purchase plan.

Subsection (3) provides that no person or company, other than a registrant, shall provide any investment advice or recommendations in connection with the purchase of securities under a direct purchase plan.

Section 4.2 provides that an issuer or plan administrator shall provide to any person or company purchasing securities through a direct purchase plan a disclosure statement; the section provides the text of the disclosure statement and is designed to emphasize to the investor that no investment advice is being made in connection with any investment under a direct purchase plan and that the investor is responsible for the investment decisions. This statement must be provided before the investor enters into a binding agreement of purchase and sale relating to a plan; this would typically take place when the investor joins the plan and makes an initial subscription.

Part 5

Section 5.1 provides that the Director may grant an exemption to the proposed Rule, in whole or in part, subject to such conditions or restriction as may be imposed in the exemption.

Authority for Proposed Rule

Paragraph 8 of subsection 143(1) of the Securities Act (the "Act") allows the Commission to make rules providing for exemptions from the registration requirements under the Act. Paragraph 13 of subsection 143(1) of the Act allows the Commission to make rules regulating trading or advising in securities to prevent trading or advising that is fraudulent, manipulative, deceptive or unfairly detrimental to investors. Paragraph 18 of subsection 143(1) of the Act allows the Commission to make rules designating activities, including the use of documents or advertising, in which registrants or issuers are permitted to engage or are prohibited from engaging in connection with distributions.

Alternatives Considered

The Commission is of the view that direct purchase plans are appropriate investment vehicles for certain investors, and believes that the appropriate way to permit such plans to operate is through the relief from the registration requirements provided by the proposed Rule. Therefore, the Commission has not considered any alternatives to the proposed Rule.

Unpublished Studies

In proposing the proposed Rule, the Commission has not relied on any significant unpublished study, report or other written materials.

Anticipated Costs and Benefits

The proposed Rule would permit investors to invest in securities of an issuer on a cost-effective basis through direct purchase plans, and would provide issuers with the advantages relating to direct purchase plans discussed earlier in this Notice. The proposed Rule would require issuers establishing a direct purchase plan to incur the costs of prospectus preparation and other administrative expenses necessary to allow the direct purchase plan to operate. Similarly, administrators of a plan would be required to ensure that the requirements of Part 3 of the proposed Rule be satisfied, which could result in some costs. However, the proposed Rule does not require issuers to establish plans or persons to act as administrators, and so these costs will be borne only by those that elect to establish or administer direct purchase plans.

In the Commission's view, the benefits justify the costs.


Regulations to be Amended or Revoked

The adoption of the proposed Rule does not require any regulation to be amended or revoked.

Comments

Interested parties are invited to make written submissions with respect to the proposed Rule. Submissions received by February 16, 2001 will be considered.

Submissions should be made to:

John Stevenson, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario M5H 3S8

A diskette containing an electronic copy of 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 received cannot be maintained.

Questions may be referred to:

Randee Pavalow
Manager, Market Regulation
Ontario Securities Commission
(416) 593-8259

Barbara Fydell
Legal Counsel, Market Regulation
Ontario Securities Commission
(416) 593-8253


Text of Proposed Rule

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


November 17, 2000

 

PARTTITLE

PART 1DEFINITIONS AND INTERPRETATION
1.1Definitions

PART 2EXEMPTION FOR TRADES UNDER A DIRECT PURCHASE PLAN
2.1Exemption for Trades Under a Direct Purchase Plan

PART 3OPERATIONAL SAFEGUARDS
3.1Segregation of Funds
3.2Segregation of Securities
3.3Bonding and Insurance
3.4Record Keeping
3.5Statements of Account
3.6Exemption for Regulated Institutions

PART 4ADVERTISING AND DISCLOSURE REQUIREMENTS
4.1Advertising Requirements
4.2Disclosure Statement

PART 5EXEMPTION
5.1Exemption

 

PART 1 DEFINITIONS AND INTERPRETATION

1.1Definitions - In this Rule

"administrator" means, for a direct purchase plan,

(a)a trustee, a custodian or an administrator of the direct purchase plan, or

(b)if the reporting issuer administers the direct purchase plan itself, the reporting issuer;

"direct purchase plan" means an arrangement operated by or on behalf of a reporting issuer under which a person or company is permitted to purchase securities of the reporting issuer's own issue

(a)directly from the treasury of the reporting issuer, or

(b)on a marketplace through the administrator of the direct purchase plan;

"plan advertisement" means a communication that is published or designed for use on or through a public medium for the purpose of disseminating information about a direct purchase plan;

"promotional activities" means any activities or communications intended to induce the purchase of securities through a particular direct purchase plan; and

"public medium" includes announcements, newspaper, television or radio advertisements, circulars, notices, investor fairs, and Internet Web sites.


PART 2EXEMPTION FOR TRADES UNDER A DIRECT PURCHASE PLAN

2.1Exemption for Trades Under a Direct Purchase Plan - Section 25 of the Act does not apply to a trade by an issuer or an administrator of the issuer in a security of the issuer's own issue under a direct purchase plan of the issuer if the following conditions are met:

1.The administrator of the plan satisfies the requirements of sections 3.1 and 3.2 in connection with the plan, and, if applicable, the requirements of sections 3.3, 3.4 and 3.5.

2.For a trade of a security from treasury of the issuer,

(a)the issuer or the administrator of the plan, unless it has previously done so, sends by prepaid mail or delivers to the purchaser the latest prospectus relating to the plan and any amendment to the prospectus filed either before the purchaser enters into an agreement of purchase and sale resulting from the order or subscription or not later than midnight on the second day, excluding Saturday, Sundays and holidays, after entering into such agreement; and

(b)the issuer provides to the purchaser, in the prospectus, the right to withdraw from the purchase analogous to the rights of a purchaser, and subject to the conditions, contained in section 71 of the Act.

3.An investor disclosure statement containing the information described in section 4.2 has been provided to the purchaser of the security in accordance with subsection 4.2(2).

PART 3OPERATIONAL SAFEGUARDS

3.1Segregation of Funds - All funds received by the administrator for investment through the direct purchase plan shall be deposited promptly into a segregated bank account with a Canadian financial institution, and used only to purchase securities under the direct purchase plan or to pay fees associated with the direct purchase plan.

3.2Segregation of Securities

(1)All securities issued under a direct purchase plan held on behalf of purchasers by the administrator shall be

(a)maintained in a separate account directly in the names of the purchasers, or in the name of the administrator, and allocated to each purchaser on a register maintained by the administrator; and

(b)kept separate from any other securities held by the administrator.

(2)For securities deposited with a depository or clearing agency that operates a book-based system, the administrator shall ensure that the applicable participants in the book-based system or the administrator contain a designation sufficient to show that the beneficial ownership of the securities is vested in the purchasers under the direct purchase plan.

3.3Bonding and Insurance - An administrator of a direct purchase plan shall maintain bonding or insurance, by means of a broker's blanket bond, in an amount of not less than $25,000.

3.4Record Keeping - An administrator of a direct purchase plan shall maintain books and records necessary to record properly all transactions involving the direct purchase plan, and in doing so shall keep the records referred to in subsection 113(3) of the Regulation.

3.5Statements of Account - The administrator of a direct purchase plan shall send to each investor in the direct purchase plan the statements of account referred to in subsections 123(1) to (4) of the Regulation.

3.6Exemption for Regulated Institutions - Sections 3.3, 3.4 and 3.5 do not apply to an administrator of a direct purchase plan that is an institution that is subject to requirements under its governing legislation that are substantially similar to those contained in sections 3.3, 3.4 and 3.5.

PART 4ADVERTISING AND DISCLOSURE REQUIREMENTS

4.1Advertising Requirements

(1)No person or company may engage in promotional activities concerning a direct purchase plan, except as permitted in subsections (2) or (3).

(2)A person or company may place or distribute plan advertisements relating to a direct purchase plan that describe only

(a)the existence and availability of the direct purchase plan;

(b)the name of the reporting issuer whose securities are distributed under the direct purchase plan, and a brief description of the business carried on by the reporting issuer;

(c)the securities to be issued under the direct purchase plan;

(d)a description of how the direct purchase plan operates; and

(e)information about how a person or company may obtain a copy of the prospectus for the direct purchase plan.

(3)No person or company, other than a person or company that is registered under the Act, shall provide any investment advice or recommendations in connection with the purchase of securities under a direct purchase plan.

4.2Disclosure Statement

(1)An issuer or plan administrator shall provide to any person or company purchasing securities through a direct purchase plan the following disclosure:

"Securities sold through the [name of issuer] direct purchase plan are sold under a rule of the Ontario Securities Commission that permits these sales without the involvement of a registered broker or dealer. A person or company making such a purchase therefore receives no investment advice concerning the purchase, does not have the benefit of the assistance of a broker or dealer and is solely responsible for assessing the appropriateness of the investment for himself, herself or itself. A person or company that wishes to receive investment advice in connection with the direct purchase plan should contact his, her or its broker or dealer."

(2)The disclosure required by subsection (1) shall be contained in a separate document given to the purchaser before he, she or it enters into a binding agreement of purchase and sale for securities under a direct purchase plan.

PART 5EXEMPTION

5.1Exemption - The Director may grant an exemption to this Rule, in whole or in part, subject to such conditions or restrictions as may be imposed in the exemption.