The Secondary Trade
Dean Murrison, Saskatchewan Securities Commission
(This paper does not necessarily represent the view s of the Saskatchewan Securities Commission, nor does it constitute a legal opinion. Readers are advised to seeek professional legal advice before proceeding.)
Introduction
This paper builds on the paper "New Generation Co-operatives: Key Steps Relating to the Issuance of Securities" (the Primary Trade Paper), which describes the process for a primary trade of securities of a New Generation Co-operative (NGC). A primary trade is a sale of securities of an NGC by the NGC from its treasury to investors.
A secondary trade is a sale of securities of the NGC by the holders of those securities (having acquired the securities from the NGC under a primary trade). This paper discusses if and how a holder of securities in an NGC, having purchased securities from an NGC, can resell them. An additional term of note is that, if there is a market for the securities of an NGC, organized (like an exchange such as the Canadian Ventures Exchange (CDNX) or not organized (like sales directly between individual holders of the securities of the NGC), those sales are referred to as being made in the secondary market.
Background
The first thing to note is that securities of an NGC are securities within the meaning of The Securities Act, 1988 (hereinafter the Securities Act). But for the provisions of The New Generation Co-operative Act (hereinafter New Gen Act), a trade or sale of securities of an NGC, whether it be a primary trade or a secondary trade, would be subject to the Securities Act.
The New Gen Act contains a waiver or exemption provision that says the Securities Act does not apply to a primary trade of securities of an NGC (although the NGC can elect to move its offering of securities or primary trade back under the provisions of the Securities Act if it wishes, or the Co-operative Securities Board (CSB) can direct that such offering be subject to the Securities Act if the CSB feels that it would be in the public interest to do so). There is no similar waiver or exemption provision in the New Gen Act for a secondary trade of securities of an NGC by a holder of those securities. In short, the secondary trades of securities of an NGC by the holders of those securities are subject to the Securities Act. This is true whether the primary trade with respect to the securities was carried out under the New Gen Act or the Securities Act.
When considering the application of the Securities Act to a disposition of a security like a security of an NGC (whether a primary trade or secondary trade), there are always two questions to consider. The first question is, Is the disposition of the security a trade within the meaning of the Securities Act? This generally means, is the disposition a sale or other disposition for valuable consideration? If the disposition is a trade, the person or company selling the security, whether it be a primary trade or secondary trade, must:
The second question to be considered if the disposition of the security is a trade under the Securities Act is, Is the trade a distribution within the meaning of the Securities Act? This generally means, is the disposition a sale or other disposition for valuable consideration--
A distribution does not include a disposition of a security by a person or company that acquired the security in an offering where the person or company received a prospectus under the Securities Act when they acquired the security as long the person or company is not a control person, promoter, incorporator, organizer, or underwriter of the issuer of the security.
If the disposition is a distribution, the person or company selling the security, whether it be a primary trade or the type of secondary trade discussed above, must:
An additional matter to be considered when working with the Securities Act is that the use of a statutory prospectus waiver or exemption in the Act to sell a security triggers resale restrictions with respect to that security under the Act. Resale restrictions are restrictions on the purchasers of the security's ability to resell the security. These resale restrictions (sometimes referred to as hold periods) are generally indefinite unless the purchaser can find a statutory prospectus waiver or exemption in the Securities Act to sell the security, or the issuer of the security is or becomes a reporting issuer within the meaning of the Act (usually by filing a prospectus under the Securities Act). Resale restrictions are also usually imposed by the SSC in any discretionary prospectus waiver or exemption granted by the SSC with respect to an offering of securities. Resale restrictions under the Securities Act are not triggered by trades of securities under the New Gen Act.
For more information on the workings of the Securities Act, the waivers or exemptions, and the resale restrictions discussed above, consult "How to Raise Capital Using Exemptions," prepared by the SSC. This paper is available online at www.ssc.gov.sk.ca or by calling the SSC at (306) 787-5299.
The New Generation Co-operative Act works differently from the Securities Act. The New Gen Act does not contain registration or prospectus requirements similar to those discussed above under the Securities Act. Nor does it contain resale restrictions (although, as noted earlier, the resale of securities of an NGC--that is, a secondary trade of securities of an NGC--is subject to the Securities Act).
As noted in the Primary Trade Paper, the New Gen Act provides that, with respect to a primary trade of securities of an NGC, the Securities Act does not apply unless the NGC chooses that it should apply, or the CSB directs that it should apply. If the Securities Act does not apply (if it did apply, the requirements discussed above would be triggered), an NGC must file with the CSB the information the CSB requires with respect to the primary trade and receive the approval of the CSB to do the trade. This is unless the NGC can fit itself within one of the waivers or exemptions from these requirements in the New Gen Act or the regulations to that statute or has ob-tained a discretionary waiver or exemption from these requirements from the CSB.
If the approval of the CSB is required, the approval may contain such terms and conditions as the CSB feels are suitable, a common one being that the NGC prepare and provide to the purchaser of the security a prospectus similar to that which would be required under the Securities Act. To date, it has been rare for the CSB to grant a discretionary waiver or exemption from the requirements of the New Gen Act.
For more discussion of the workings of the New Generation Co-operatives Act with respect to a primary trade of securities of an NGC, consult the Primary Trade Paper.
The Secondary Trade
As noted above and in the Primary Trade Paper, a holder of securities of an NGC could have obtained their securities by one of the following methods:
Regardless of the method by which the securities were acquired, the Securities Act applies to the secondary trade of the securities, although how the Act applies varies somewhat depending on the method used to acquire the securities. In considering the application of the Securities Act to a disposition of securities of an NGC, consider the two questions discussed above.
Registration (Is the Disposition a Trade?)
Assuming the disposition is a sale or other disposition for valuable consideration, as opposed to a gift, which is not trade, it is a trade under the Securities Act no matter which method was used to acquire the security. As a trade, unless you are registered to sell securities, can find a statutory registration waiver or exemption in the Securities Act to sell the security, or have obtained a discretionary waiver or exemption from the SSC to sell the security, you cannot sell the security. You must continue to hold it.
For a discussion of statutory and discretionary waivers or exemptions please consult "How to Raise Capital Using Exemptions," prepared by the SSC. This paper is avail-able online at www.ssc.gov.sk.ca or by calling the SSC at (306) 787-5299.
A statutory registration waiver or exemption in the Securities Act that might be helpful in some circumstances would be the isolated trade statutory registration waiver or exemption (the corresponding isolated trade statutory prospectus waiver or exemption differs from the statutory registration waiver or exemption and will be less helpful in the context of a prospectus).
There is also a statutory registration waiver or exemption in the Securities Act that allows for trades through a registrant under the Act. This may not be useful in the initial stages of development of an NGC, but should an NGC grow to a size where a registered dealer under the Securities Act runs an over-the-counter market for the securities of the NGC, or the securities of the NGC are listed on an exchange like the CDNX, this may provide a method for a holder of the securities of the NGC to sell them. This is not discussed in the above paper, but the provision can be found in clause 39(1)(j) of the Securities Act. In such cases, the holders of the securities would be holding freely tradable securities.
Prospectus (Is the Disposition a Distribution?)
Assuming the disposition is a trade, the next question is, Is the trade a distribution? If it is, then the sale of the securities of an NGC will be subject to resale restrictions under the Securities Act. Only the use of a statutory prospectus waiver or exemption in the Act to trade securities will trigger resale restriction under the Act on those securities in the hands of the purchaser of those securities. Whether the sale is a distribution depends on the method under which the securities were acquired. Should you find that your sale would not be a distribution under the Securities Act, you are holding freely tradable securities in the prospectus context, although you still need to consider the registration requirements discussed above.
Method 1--If you acquired the securities under this method, unless you are a control person, promoter, incorporator, organizer, or underwriter of the issuer of the security, the disposition will not be a distribution, and the securities you hold are freely tradable.
Method 2--If you acquired the securities under this method, unless you are a con-trol person, promoter, incorporator, organizer, or underwriter of the issuer of the security, the disposition will not be a distribution, and the securities you hold are freely tradable.
Method 3--If you acquired the securities under this method the securities you hold are subject to the resale restrictions set out in the Securities Act. Consult "How to Raise Capital Using Exemptions," available online at www.ssc.gov.sk.ca or by calling the SSC at (306) 787-5299. You may be subject to additional requirements if you are a control person, promoter, incorporator, organizer, or underwriter of the issuer of the security.
Method 4--If you acquired the securities under this method, unless you are a control person, promoter, incorporator, organizer, or underwriter of the issuer of the security, the disposition will not be a distribution, and the securities you hold are freely tradable.
Method 5--If you acquired the securities under this method, the securities you hold are subject to whatever resale restrictions the SSC imposed on you in the waiver or exemption it granted with respect to the trade of the securities to you. You may be subject to additional requirements if you are a control person, promoter, incorporator, organizer, or underwriter of the issuer of the security.
Method 6--If you acquired the securities under this method, the securities you hold are subject to whatever resale restrictions the CSB imposed on you in the waiver or exemption it granted with respect to the trade of the securities to you. You may be subject to additional requirements if you are a control person, promoter, incorporator, organizer, or underwriter of the issuer of the security.
Trades of securities of an NGC by a control person, promoter, incorporator, organizer, or underwriter of the NGC will always be a distribution under the Securities Act.
In addition to the application of the Securities Act, you should always consider:
The Market-Making Mechanism
It may be that an NGC has grown to a size where it has a large number of freely tradable securities outstanding held by a large number of security holders, but there is no registered dealer under the Securities Act running an over-the-counter market for the securities of the NGC, and the securities of the NGC are not listed on an exchange like the CDNX. In this situation, an NGC may consider running its own market-making mechanism to provide liquidity to its security holders.
The market-making mechanism is a means whereby an NGC can create a secondary market for its securities. It does not provide a way for holders of its securities to avoid the resale restrictions discussed above; it just provides them with a place to go to find someone to buy them.
An issuer usually conducts a market-making mechanism by:
Under the Securities Act, this activity by an issuer of securities requires the issuer to become registered under the Act to carry it out or obtain from the SSC a discretionary waiver or exemption of the registration requirement in the Act. A number of issuers have obtained such a waiver or exemption, and the SSC instituted General Ruling/ Order 45-903 for Community Bond Corporations to carry out this activity. The SSC will shortly institute a General Ruling/Order to allow all issuers to carry out these activities.
Because the New Generation Co-operatives Act provides that the Securities Act does not apply to trades by an NGC of its own securities, these activities by an NGC, as long as it deals only with its own securities and does not provide any investment advice (which is a registerable activity under the Securities Act not exempted under the New Gen Act), are not subject to the Securities Act, and no registration or discretionary waiver or exemption from the registration requirement in the Act is needed from the SSC.
Although it may not be clear, it appears by the wording of the New Gen Act that the approval of the CSB or a discretionary waiver of exemption from the CSB would be necessary for an NGC to carry out these activities, unless the NGC chooses or the CSB directs that the trades be subject to the Securities Act. Once the SSC has its General Ruling/Order in place for these activities for all issuers (which will occur shortly), this may be a reasonable course of action. As far as the writer is aware, the CSB has not yet considered this issue.