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Last night, while writing this article at a beach bar in Florida, I saw heavily lubricated locals and evenly browned tourists cutting a rug while my pasty self sat nursing a Bud writing about Canadian securities law. If the elements of this scene sound somewhat inconsistent, you are already in the spirit of this column, which is all about an inconsistency within Canada's securities regulation.

Earlier this year, I wrote about the Canadian Securities Administrators' decision not to lower the threshold for filing an early warning report from 10 per cent to 5 per cent. An EWR keeps companies appraised of the actions of large stakeholders well before they acquire the 20 per cent of securities needed to trigger Canada's take-over bid protections. Tucked within the CSA's decision, however, was another decision that received a bit less fanfare: the call not to include "equity equivalent derivatives" in the calculation of that beneficial ownership threshold.

This decision was no less important than the top line decision not to drop the filing threshold.

Thanks to the miracle of modern finance, one can acquire an ownership interest in a company without actually buying a company's stock. Derivatives allow investors to take an economic interest in a company's performance, and the most common derivative instruments – such as options and forwards – allow investors to convert their interest into the actual ownership of shares in the company.

Where securities laws don't explicitly provide that investors disclose equity-equivalent derivatives, cagey investors can use derivatives to avoid revealing their stake in a potential takeover. In this year's most high profile and contested takeover battle – the fight between Valeant Pharmaceuticals International Inc. and Pershing Square Capital over Allergan – arch-activist Bill Ackman used short dated, just in the money options to build his stake in Allergan. He presumably did this in order to avoid U.S. competition review under the Hart Scott Rodino Antitrust Improvements Act, which would have revealed his intentions.

Notably, Mr. Ackman's use of options did not exempt him from the U.S.'s equivalent of the EWR system., Schedule 13D. However, by using derivatives to avoid HSR filings, Mr. Ackman was able to accumulate a larger toehold in Allergan before the 13D filing deadline.

By failing to include equity equivalent derivatives in its revisions to the EWR system, the CSA has preserved an opportunity for activists and acquirers to collect large stakes in companies prior to giving those companies disclosure. This is inconsistent with Canada's take-over bid rules, which include options and other equity-like derivatives in calculating whether an investor has crossed the 20 per cent threshold.

The discrepancy creates opportunities for activists and acquirers to avoid the EWR regime and accumulate large stakes in a company before those same derivative instruments are counted towards a company's beneficial ownership for the purposes of our takeover bid rules. This means that activists and acquirers with an economic and eventual legal interest in a company obtained through derivatives can more stealthily, and with a larger ownership share, challenge a company's existing management than they could using shares. This inconsistent treatment defeats the policy purpose of the EWR system.

The CSA will be providing guidance on the role of derivatives in EWR reports in the new year. At minimum, that guidance should endeavour to harmonize the treatment of options and similar derivatives in the EWR system and the takeover system.

Otherwise, we might want to think about adapting Warren Buffett's famous quote for Canadian purposes: derivatives won't be financial weapons of mass destruction, but financial weapons of significant acquisition. Hardly catchy, I know, but what do you expect at this point: I've got a beach to get back to.

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