A colleague recently suggested that my last contribution to Timely Disclosure called to mind the more familiar view, which has gained in prominence over the past half-decade or so [1], that the time has come for Canadian securities regulators to “vacate the field” of poison pill regulation, leaving oversight of shareholder rights plans to the courts.  I found his suggestion rather troubling.  Frankly, I do not wish to be associated with that view.

To be sure, there is some superficial similarity between the “vacate the field” perspective on poison pill regulation and my own view that Canadian securities regulators should not in principle be advancing any campaign for legislative reform that aims to limit the power of shareholders on the basis of perceived threats that shareholder activism allegedly poses to corporate North America and the economy as a whole.  Both views call for restraint from securities regulators in deference to other rule-making agencies — the courts, or the legislatures (for purposes of such a general point of comparison, the specifics don’t really matter) — that are better positioned, we claim, to adequately serve the relevant regulatory objectives.

But that’s about where the similarity ends.  Indeed, I happen to think that the “vacate the field” perspective on poison pill regulation makes a version of the mistake that I effectively accused Martin Lipton of making in my last post: it fails to give Canadian securities regulators their proper due.  Mr. Lipton gives to Canadian securities regulators more than they are properly due, implicitly vesting in them the power to legislate in the name of broad policy objectives that far outstrip the scope of their twin policy mandates of investor protection and capital market efficiency and fairness.[2] The “vacate the field” view, in contrast, makes the obverse mistake of giving to Canadian securities regulators less than they are properly due, calling upon them to vacate a field of regulation that they properly occupy by virtue and in furtherance of those mandates.

Let’s pause for a moment on that last statement: Canadian securities regulators, I am claiming, are properly authorized to regulate poison pills by virtue and in furtherance of their twin policy mandates of investor protection and capital market efficiency and fairness.  I would not have thought this to be a particularly controversial claim.  Indeed, I would have thought it rather obvious that a policy mandate of investor protection can ground regulation safeguarding the ability of investors to dispose of their investments without undue restraint and on terms of their own choosing; equally obvious that the objective of fostering fair and efficient capital markets can justify regulating third-party interference in secondary market transactions between otherwise willing buyers and sellers.

But somehow these claims have been anything but obvious to those who have argued that Canadian securities regulators should vacate the field of poison pill regulation.  They have repeatedly misapprehended the basis upon which securities regulators in Canada are competent (in fact, I’d argue duty-bound) to regulate poison pills.  

A telling example of this misapprehension is found in the June 2008 report of the Competition Policy Review Panel, which recommended on the basis of foreign investment and competition concerns relating to the “hollowing out” of corporate Canada that Canadian securities regulators repeal their policy on defensive tactics and cease to regulate conduct by boards in relation to poison pills:[3]

Unlike the US Securities and Exchange Commission, which leaves to the US courts the regulation of substantive decision making by directors, Canadian securities regulators are prepared to actively supervise the exercise by directors of their fiduciary duties in relation to change of control proposals.  Established policy is reflected in National Policy 62-202 (Defensive Tactics).

Say what?  Since when?  There is nary a whisper in the defensive tactics policy that the Canadian securities regulators “are prepared to actively supervise the exercise by directors of their fiduciary duties in relation to change of control proposals.”  Let’s look at what the defensive tactics policy actually says:[4]

[…] the Canadian securities regulatory authorities wish to advise participants in the capital markets that they are prepared to examine target company tactics … to determine whether they are abusive of shareholder rights.

No mention of policing the exercise of fiduciary duties by directors.  No mention, in fact, of director or board conduct in any way.  Rather, it is defensive tactics implemented by target companies, in the capacity of “participants in the capital markets”, that the Canadian securities regulators purport to police “to determine whether they are abusive of shareholder rights”.

How, then, did the Competition Policy Review Panel come to the suspect conclusion that the Canadian securities regulators are in the business of monitoring the appropriate discharge by directors of their fiduciary duties?  My guess[5] is that the reference in the defensive tactics policy to “shareholder rights” has contributed to a state of confusion here.  If one conceives of “shareholder rights” as necessarily correlative to whatever fiduciary duties are owed by directors of a company to its shareholders[6], an abuse of shareholder rights implies a breach of fiduciary duties.  On that view of things, determining whether defensive tactics “are abusive of shareholder rights” would be tantamount to determining whether they are consistent with the proper exercise by directors of their fiduciary duties.

But that view of things overlooks that there is another perspective from which one can meaningfully ask whether poison pills unduly interfere with “shareholder rights”: namely, the perspective of those rights shareholders enjoy simply by virtue of their status as participants (i.e. investors) in the capital markets, as distinct from whatever rights they enjoy by virtue of their status as company constituents.  In other words, there are at least two questions that a concern for “shareholder rights” might cause us to ask in relation to poison pills:

1. to what extent, if any, is the use by a target company board of directors of a poison pill to effectively prevent willing shareholders from disposing of their shares to a willing buyer consistent with the fiduciary duties, if any, owed by the directors to company shareholders — in other words, to what extent is it consistent with the rights of shareholders, viewed in their capacity of constituents of the particular target company?; and
2. to what extent, if any, is the use of a poison pill by a target company (as a participant in the capital markets) to effectively prevent willing shareholders from disposing of their target company shares to a willing buyer consistent with the rights of shareholders, viewed in their capacity of investors in the capital markets?

In the United States, poison pill regulation has been dealt with exclusively by the courts and has accordingly focussed almost entirely on the first question, being the question that courts are best positioned to address in light of their responsibility for interpreting and enforcing rights and duties that arise under company law.

Of course, if one assumes that the Canadian securities regulators have been engaged in addressing the same question, establishing that they should step aside and leave the regulation of poison pills to the courts becomes a straight-forward matter.  One need simply point out that their mandates do not empower them to police the exercise by directors of their fiduciary duties, whereas courts are not only so empowered but are also much better situated to determine the proper allocation of rights and duties as between corporate constituents.  (Q.E.D.  “ATTENTION CANADIAN SECURITIES REGULATORS: your presumed authority to police board conduct in relation to poison pills is hereby revoked, effective immediately.  Please turn in your false credentials and vacate the field of poison pill regulation with all due haste.”)

Indeed, on the assumption that, in regulating poison pills, Canadian securities regulators have been monitoring the discharge by directors of their fiduciary duties, their regulation of poison pills has, from the outset, been ultra vires.  What harm, then, in calling upon them to repeal the defensive tactics policy on the basis of policy concerns – for example, foreign investment and competition concerns relating to the “hollowing out” of corporate Canada – that are alien to their twin policy mandates of investor protection and capital market fairness and efficiency?  If they’re going to act beyond the scope of those mandates regardless, let’s at least have them do so in a way that advances our preferred policy objective(s) du jour, no?

But if, as I’m suggesting, Canadian securities regulators have instead been engaged in an entirely different exercise from US courts in their regulation of poison pills, if they’ve been addressing the second question above — a question that their mandates of investor protection and capital markets fairness and efficiency leave them perfectly competent to address — it is much more difficult to make a compelling case for why they should stop.  Indeed, inasmuch as poison pill regulation directed at protecting the rights of investors in, and ensuring the fairness and efficiency of, the capital markets falls squarely within the security regulators’ mandates, it is not even clear that they are free to “vacate the field” of poison pill regulation of their own initiative and without legislative intervention relieving them of those mandates.  It is, after all, in the very nature of a “mandate” that it both authorizes action and renders that action, well, mandatory.

The most thoughtful articulation of the “vacate the field” perspective on poison pill regulation has been developed by Edward Waitzer and Sean Vanderpol, who present a barrage of arguments for why courts are better suited than securities regulators to regulate poison pills.[7] Unfortunately, at times even Messrs. Waitzer and Vanderpol appear to make the mistake made by the Competition Policy Review Panel, implying that the regulation of poison pills by the Canadian securities regulators has entailed addressing the question addressed by courts in the United States in regulating poison pills (i.e. the first question set forth above):[8]

Until recently the manner in which the Defensive Tactics Policy has been applied reflected a 1988 decision of the Delaware Chancery Court, which found that: “In the setting of a non-coercive offer, absent unusual facts, there may come a time when a board’s fiduciary duty will require it to redeem the rights and to permit the shareholders to choose.”  This endorsement of “shareholder choice” was echoed shortly thereafter in an OSC decision that stated: “The time has come when the pill has got to go.”

Again: say what?  The suggestion here that the defensive tactics policy has been applied so as to define the requirements of directors’ fiduciary duties is curious, given that Messrs. Waitzer and Vanderpol elsewhere recognize that the authority of securities regulators to regulate poison pills emanates from a source that differs from the source of court authority:[9]

[t]he jurisdiction of securities regulators is only through the exercise of … “public interest” powers (unlike courts, whose jurisdiction derives from the interpretation of duties imposed by corporate law on directors).  The law is clear that the exercise of such powers should…be…firmly rooted in the objectives of securities regulation (investor protection and market efficiency)…

Why then suggest that Canadian securities regulators have simply followed the intellectual lead of (stale) decisions of the US courts in their application of the defensive tactics policy to poison pills?  It seems doubtful that the exercise by securities regulators of their public interest power to define the requirements of directors’ fiduciary duties could ever be firmly rooted in the objectives of investor protection or market efficiency.

Indeed, the suggestion that securities regulators are nevertheless policing the exercise by directors of their fiduciary duties is doubly curious given that the OSC decision to which Messrs. Waitzer and Vanderpol refer in the quotation above[10] — Canadian Jorex,[11] which applied the defensive tactics policy to a poison pill for the first time in Canada and which has been interpreted as standing for the proposition that there comes a time when a poison pill “has got to go” — was at pains to distinguish the issues being addressed by the OSC from those that might be addressed by a court:

[…] from the Commission’s perspective, the central issue is not whether the board of directors of a target company acted in good faith[12] in adopting a poison pill or, indeed, any other defensive tactic (as might be the case were the matter before the courts), but rather where the public interest, in its broadest sense, lies.[13]

[…]

Underlying our conclusion was our view of the public interest in matters such as this.  As is amply reflected in [the defensive tactics policy],[14] the primary concern of the Commission in contested take-over bids is not whether it is appropriate for a target board to adopt defensive tactics, but whether those tactics “are likely to deny or severely limit the ability of the shareholders to respond to a take-over bid or a competing bid”…or may have the effect of denying to shareholders the ability to make a [fully informed] decision and of frustrating an open take-over bid process…If so, then as [the defensive tactics policy] clearly indicates, the Commission will be quite prepared to protect the public interest as we see it.  For us, the public interest lies in allowing shareholders of a target company to exercise one of the fundamental rights of share ownership — the ability to dispose of shares as one wishes — without undue hindrance from, among other things, defensive tactics […][15]

Clearly the OSC did not consider itself to be speaking to the fiduciary duties of directors when it proclaimed in Canadian Jorex that “there comes a time when the pill has got to go.”[16]  Unless one wants to claim that the OSC was confused about what it was doing (or, worse still, dissembling), the “shareholder rights” sought to be protected in Canadian Jorex, and in the long line of decisions that have applied the defensive tactics policy since, therefore cannot be understood as rights that are correlative to whatever fiduciary duties may be owed by directors to shareholders under applicable corporate law (since delineation of such rights would logically imply delineation of those duties).

Instead, Canadian Jorex speaks of the protection of “one of the fundamental rights of share ownership.”  Such broad language gives us a clue that the rights at stake are not rights that shareholders enjoy as owners of this particular company — that is, they are not rights that fall out of the allocation of entitlements and responsibilities among various target company constituents with competing interests — but rights they enjoy simply as owners of shares (in a company, any company) or, in other words, as investors.  Indeed, one might reasonably restate the central dictum of Canadian Jorex as follows: “For [Canadian securities regulators], the public interest lies in allowing shareholders of a target company to exercise one of the fundamental rights of investors — the ability to dispose of their investments as they wish — without undue hindrance from, among other things, defensive tactics.”

This way of putting things makes clear that Canadian securities regulators have a basis, firmly rooted in their statutory mandates of investor protection and market fairness and efficiency, and quite separate and independent from any basis that the courts may have, for actively regulating poison pills.  Once this is clear, any argument that securities regulators should “vacate the field” of poison pill regulation on grounds that they are illegitimately usurping the right and responsibility of courts to define the content of directors’ fiduciary duties and monitor the observance of those duties simply falls away.

Of course, I do not claim to so easily dispense with all of the various arguments advanced by Messrs. Waitzer and Vanderpol for why Canadian securities regulators should step aside and leave the regulation of poison pills to the courts.[17]  A number of their arguments encourage Canadian securities regulators to “vacate the field” of poison pill regulation even on the assumption that they have a legitimate basis for such regulation.[18]  As I suggested earlier, however, such arguments are much tougher to make successfully, particularly as they require securities regulators to turn their backs on regulatory action that they are mandated to take.  My own view is that Messrs. Waitzer and Vanderpol fail to get their arguments through successfully.  Often (though not always) that failure is owing to a more fundamental (and by now familiar) failure to maintain a clear distinction between the bases upon which securities regulators and courts each have independent jurisdiction to regulate poison pills.

These matters have recently taken on added importance as a result of a proposal to reform poison pill regulation made earlier this year by the Canadian securities regulators.[19]  In a nutshell, the proposal effectively adopts the recommendation that securities regulators “vacate the field” of poison pill regulation, relying upon a number of arguments made by Messrs. Waitzer and Vanderpol for taking a much less active role in the regulation of poison pills.  In light of my misgivings regarding the soundness of those arguments, and my concern that securities regulators are in fact obligated to regulate capital market activity in furtherance of their statutory mandates, I will be examining those arguments in detail in upcoming contributions to Timely Disclosure.  My conclusion, as you may well have anticipated, will be that the Canadian securities regulators cannot cheerfully turn their backs on the tradition of poison pill regulation that traces its lineage back to Canadian Jorex.