In a recent post, we examined the case of Ontario Securities Commission v. Tiffin in which the Ontario courts have been grappling with the question of whether a promissory note constitutes a "security" under the Securities Act. On November 26, 2018, the Court of Appeal granted leave to appeal in the case signalling in its reasons that it may be prepared to address the broader question of how to determine whether a debt instrument is a "security" subject to regulation under the Securities Act. In light of this new development, this post examines the possibility that certain debt instruments could soon be exempt from the requirements of the Securities Act.
Text of the Securities Act
The Securities Act defines the term "security" broadly to include a laundry list of sixteen different categories of financial instruments, including "a bond, debenture, note or other evidence of indebtedness" (section 1(1)).
The OSC has explained that the term "security" in the Securities Act" is defined broadly so as to capture most transactions". As a result of the sweeping definition of "security", the Securities Act then provides numerous statutory exemptions for certain securities transactions that do not warrant regulation. The OSC has described this approach as a "catch then exclude" system of regulation.
Tiffin and leave to appeal
The facts and procedural history of the Tiffin case are outlined in our recent post. The key point of contention in the courts below was whether the Securities Act's list of statutory exemptions is exclusive or whether it may be supplemented by judicially-created exemptions grounded in the Securities Act's statutory purpose. In granting leave to appeal, the Court of Appeal now appears set to resolve this difficult question that divided the lower courts. The Court's reasons for granting leave also signal that it plans to address "the interpretative principles to be applied to determine whether" a debt instrument is a regulated "security" under the Securities Act.
Competing approaches to classifying debt instruments under the Securities Act
The submissions in the courts below in Tiffin illustrate the stark difference in the two interpretative approaches the Court of Appeal will be asked to adopt.
The OSC argued below that the Securities Act's definition of "security" and statutory exemptions together constitute a "complete" statutory scheme that is not susceptible to further common law exemptions. Under this view, if a debt instrument (as defined in section 1(1)) does not fall within one of the express statutory exemptions already in existence, it is subject to regulation under the Securities Act.
Tiffin, however, argued below that the definition of "security" in the Securities Act must "necessarily" be limited by the purposes of the Securities Act: (1) "to provide protection to investors from unfair, improper or fraudulent practices"; and (2) "to foster fair and efficient capital markets and confidence in capital markets". Under this view, a court should be permitted to create additional common law exemptions from the sweeping definition of "security" in the Securities Act where regulation of the debt instrument at issue would be inconsistent with those purposes.
In determining whether regulation of a debt instrument would be inconsistent with those purposes, Tiffin argued that the courts should apply the "family resemblance test" used in U.S. federal securities law. Broadly speaking, under that test a debt instrument that has investment-type characteristics would be considered to be a "security" regulated under the Securities Act and a debt instrument with consumer/commercial-type characteristics would be considered exempt from the Securities Act. To determine on which side of the line a debt instrument falls, courts look to:
- The motivation for the buyer/seller to enter into the transaction;
- The "plan of distribution" for the instrument;
- The reasonable expectations of the investing public; and
- The existence of any other regulatory scheme that reduces the risk of the instrument.
The registration and distribution requirements that the Securities Act imposes on transactions of debt instruments impose a considerable cost and administrative burden on the parties to those transactions. If the Court of Appeal ultimately adopts the family resemblance test, there is the potential for transactions of certain consumer/commercial-type debt instruments to be exempt from these requirements. Regardless of which approach the Court of Appeal ultimately adopts, however, individuals and entities that transact in debt instruments in Ontario will certainly welcome clarity about whether their transactions will be subject to the Securities Act's regulatory framework going forward.