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Transparency rules for derivatives, mutual funds and bonds : a comparative analysis of Canadian, Swiss… Eggen, Mirjam 2010

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Transparency Rules for Derivatives, Mutual Funds and Bonds A Comparative Analysis of Canadian, Swiss and German Laws  by  MIRJAM EGGEN  A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS  in  THE FACULTY OF GRADUATE STUDIES  THE UNIVERSITY OF BRITISH COLUMBIA (Vancouver)  May 2010 © Mirjam Eggen, 2010  Abstract This thesis examines disclosure requirements for mutual funds, bonds and retail derivatives in the Canadian, Swiss and German legal frameworks. By comparing the partially divergent Canadian and European approaches to regulating transparency in relation to these investment products, the paper aims at evaluating whether the present transparency requirements of the above jurisdictions provide investors with adequate information on the risks incurring from certain investments and enable them to compare different products and their characteristics with each other. In particular, the author argues that regulations establish adequate transparency only if they ensure that prospectuses disclose essential product characteristics in a timely manner and enable investors to clearly delimit different types of investment products from each other. The thesis demonstrates that the above goals can be best attained under a substantive approach to product regulation. However, slight modifications to the principle “same business, same risks, same rules” may be appropriate in relation to derivative structures whose characteristics require efficient procedures and simple disclosure documentation. Further, the thesis suggests that the implementation of transparency requirements is not always an adequate means to achieve an appropriate level of investor protection. Rather, transparency measures should be supported by the introduction of suitability assessments at the point of sale.  ii  Table of Contents Abstract ...................................................................................................................................................ii Table of Contents ................................................................................................................................... iii Chapter one  Introduction......................................................................................................... 1 I Research Purpose .................................................................................................... 1 II Methodology ........................................................................................................... 4  Chapter two  Theoretical Fundamentals .................................................................................... 8 I Introduction............................................................................................................. 8 II Canada 9 1. Objectives of Securities Regulation.................................................................... 9 2. Product Categories ........................................................................................... 10 3. Regulatory Disclosure Framework ................................................................... 14 III Switzerland ............................................................................................................ 17 1. Objectives of Securities Regulation.................................................................. 17 2. Product Categories ........................................................................................... 18 3. Regulatory Disclosure Framework ................................................................... 21 IV Germany ................................................................................................................ 26 1. Objectives of Securities Regulation.................................................................. 26 2. Product Categories ........................................................................................... 27 3. Regulatory Disclosure Framework ................................................................... 29 V Conclusion ............................................................................................................. 32  Chapter three Preconditions for Transparent Capital Markets ................................................... 34 I Introduction........................................................................................................... 34 II Product Delimitability............................................................................................ 35 1. Preliminary Remarks ........................................................................................ 35 2. Selected Delimitation Issues ............................................................................ 36 2.1 Canada ...................................................................................................... 36 a. Securities versus Non-Securities ......................................................... 36 b. Derivatives .......................................................................................... 38 aa. Provincial Derivatives Regulation ................................................ 38 bb. OTC Derivatives and Exchange-traded Derivatives ..................... 41 cc. Federal Principal Protected Notes Regulation............................. 42 dd. Proposed Canadian Securities Act ............................................... 43 c. Sub-conclusion.......................................................................................... 44 2.2 Switzerland ............................................................................................... 44 a. Preliminary Remarks ........................................................................... 44 b. Structured Products versus Mutual Funds .......................................... 45 aa. General Delimitation Criteria....................................................... 45 bb. Collateralization of Structured Products ..................................... 46 i. Collateral Secured Instruments (COSI) ................................... 46 ii. Mitigation of Counterparty Risk by Compartmentalization ... 47 iii. ETC .......................................................................................... 48 cc. Sub-conclusion............................................................................. 49 c. Exchange Traded Funds ....................................................................... 50 iii  d. Sub-conclusion .................................................................................... 51 3. Genuine Distinguishing Features versus Duty to Label .................................... 51 4. Sub-conclusion ................................................................................................. 54 III Disclosure of Essential Product and Issuer Risks ................................................... 55 1. Preliminary Remarks ........................................................................................ 55 2. Issuer Risk Disclosure ....................................................................................... 55 2.1 Overview................................................................................................... 55 2.2 Generic Risk Caveats and Product-specific Risk Assessments .................. 56 2.3 Continuous Disclosure .............................................................................. 57 2.4 Display of Risk Degree .............................................................................. 58 3. Point of Sale Risk Disclosure............................................................................. 59 3.1 Overview................................................................................................... 59 3.2 Suitability Assessment versus Generic Risk Disclosure ............................ 60 4. A Note on Different Types of Investors ............................................................ 62 5. Sub-conclusion ................................................................................................. 63 IV Availability of Relevant Information...................................................................... 63 V Product Comparability .......................................................................................... 65 1. Preliminary Remarks ........................................................................................ 65 2. Comparability through Prospectus Disclosure ................................................. 65 3. Complexity as Obstruction? ............................................................................. 67 4. Sub-conclusion ................................................................................................. 68 VI A Note on Regulatory Oversight............................................................................ 68 VII Conclusion ............................................................................................................. 70 Chapter four  Prospectus Disclosure ........................................................................................ 72 I Introduction........................................................................................................... 72 II Canada .................................................................................................................. 72 1. Distribution of Shares....................................................................................... 72 1.1 Overview................................................................................................... 72 1.2 Disclosure of Essential Product and Issuer Risks ...................................... 74 1.3 Availability of Relevant Information ......................................................... 75 1.4 Intra-Product Comparability ..................................................................... 76 1.5 Sub-conclusion.......................................................................................... 77 2. Distribution of Bonds ....................................................................................... 77 2.1 Overview................................................................................................... 77 2.2 Disclosure of Essential Product and Issuer Risks ...................................... 78 2.3 Availability of Relevant Information ......................................................... 79 2.4 Intra-Product Comparability ..................................................................... 80 2.5 Sub-conclusion.......................................................................................... 80 3. Distribution of Derivatives ............................................................................... 81 3.1 Options, Futures and Forwards ................................................................ 81 a. Overview.............................................................................................. 81 b. Disclosure of Essential Product and Issuer Risks ................................. 82 aa. Prospectus Exemptions ............................................................... 82 bb. Disclosure-related Concerns ........................................................ 83 c. Availability of Relevant Information.................................................... 85 d. Intra-Product Comparability................................................................ 85 e. Sub-conclusion .................................................................................... 86 3.2 Structured Notes ...................................................................................... 86 iv  a. Overview.............................................................................................. 86 b. Disclosure of Essential Product and Issuer Risks ................................. 88 aa. Principal Protected Notes ............................................................ 88 bb. Principal at Risk Notes ................................................................. 89 c. Availability of Relevant Information.................................................... 90 d. Intra-Product Comparability................................................................ 90 e. Sub-conclusion .................................................................................... 91 3.3 Credit Derivatives and Asset-backed Securities ....................................... 92 a. Overview.............................................................................................. 92 aa. Preliminary Remarks.................................................................... 92 bb. Regulatory Disclosure Requirements .......................................... 93 b. Disclosure of Essential Product and Issuer Risks ................................. 94 c. Availability of Relevant Information.................................................... 94 d. Intra-Product Comparability................................................................ 95 e. Sub-conclusion .................................................................................... 95 3.4 A Note on the Québec Derivatives Act ..................................................... 95 4. Distribution of Mutual Funds .......................................................................... 97 4.1 Overview................................................................................................... 97 4.2 Disclosure of Essential Product and Issuer Risks ...................................... 98 4.3 Availability of Relevant Information ......................................................... 98 4.4 Intra-Product Comparability ..................................................................... 98 4.5 Sub-conclusion.......................................................................................... 99 5. Preliminary Results........................................................................................... 99 5.1 Delimitability ............................................................................................ 99 5.2 Risk Disclosure ........................................................................................ 101 5.3 Availability of Relevant Information ....................................................... 102 5.4. Inter-Product Comparability................................................................... 102 5.5. Sub-conclusion........................................................................................ 102 III. Switzerland .......................................................................................................... 103 1. Distribution of Shares..................................................................................... 103 1.1 Overview................................................................................................. 103 1.2 Disclosure of Essential Product and Issuer Risks .................................... 104 1.3 Availability of Relevant Information ....................................................... 105 1.4 Intra-Product Comparability ................................................................... 106 1.5 Sub-conclusion........................................................................................ 107 2. Distribution of Bonds ..................................................................................... 107 2.1 Overview................................................................................................. 107 2.2 Disclosure of Essential Product and Issuer Risks .................................... 108 2.3 Availability of Relevant Information ....................................................... 109 2.4 Intra-Product Comparability ................................................................... 109 2.5 Sub-conclusion........................................................................................ 110 3. Distribution of Derivatives ............................................................................. 110 3.1 Options and Futures .............................................................................. 110 a. Overview............................................................................................ 110 b. Disclosure of Essential Product and Issuer Risks ............................... 111 c. Availability of Relevant Information.................................................. 112 d. Intra-Product Comparability.............................................................. 113 e. Sub-conclusion .................................................................................. 113 3.2 Structured Notes .................................................................................... 114 v  a. Overview............................................................................................ 114 b. Disclosure of Essential Product and Issuer Risks ............................... 115 c. Availability of Relevant Information.................................................. 115 d. Intra-Product Comparability.............................................................. 116 e. Sub-conclusion .................................................................................. 116 3.3 Credit Derivatives and Asset-backed Securities ..................................... 116 a. Overview............................................................................................ 116 b. Regulation ......................................................................................... 117 4. Distribution of Mutual Funds ......................................................................... 119 4.1 Overview................................................................................................. 119 4.2 Disclosure of Essential Product and Issuer Risks .................................... 120 4.3 Availability of Relevant Information ....................................................... 121 4.4 Intra-Product Comparability ................................................................... 121 4.5 Sub-conclusion........................................................................................ 121 5. Preliminary Results......................................................................................... 122 5.1 Delimitability .......................................................................................... 122 5.2 Risk Disclosure ........................................................................................ 125 5.3 Availability of Relevant Information ....................................................... 126 5.4. Inter-Product Comparability................................................................... 126 5.5. Sub-conclusion........................................................................................ 126 IV. Germany .............................................................................................................. 127 1. Preliminary Remarks ...................................................................................... 127 2. EU Prospectus Regulation .............................................................................. 128 2.1 Overview................................................................................................. 128 2.2 EU Passport System ................................................................................ 130 3. Options and Futures ....................................................................................... 131 3.1 Overview................................................................................................. 131 3.2 Disclosure of Essential Product and Issuer Risks .................................... 133 3.3 Availability of Relevant Information ....................................................... 134 3.4 Intra-Product Comparability ................................................................... 134 3.5 Sub-conclusion........................................................................................ 135 4. Structured Notes ............................................................................................ 136 4.1 Overview................................................................................................. 136 4.2 Disclosure of Essential Product and Issuer Risks .................................... 137 4.3 Availability of Relevant Information ....................................................... 137 4.4 Intra-Product Comparability ................................................................... 138 4.5 Sub-conclusion........................................................................................ 138 5. Credit Derivatives and Asset-backed Securities ............................................. 139 6. Sub-conclusion .............................................................................................. 140 V Conclusion ........................................................................................................... 142 Chapter five  Continuous Disclosure Requirements ............................................................... 145 I Introduction......................................................................................................... 145 II Issuers’ Duty to Update Information................................................................... 145 1. Regulatory Overview ...................................................................................... 145 1.1 Canada .................................................................................................... 145 a. Preliminary Remarks ......................................................................... 145 b. Continuous Disclosure for Shares and Bonds.................................... 146 c. Continuous Disclosure in Relation to Mutual Funds ......................... 147 vi  d. Continuous Disclosure in Relation to PPNs ....................................... 148 e. Conclusion ......................................................................................... 149 1.2 Switzerland ............................................................................................. 149 a. Preliminary Remarks ......................................................................... 149 b. Continuous Disclosure for Shares and Bonds.................................... 150 c. Continuous Disclosure in Relation to Mutual Funds ......................... 151 d. Continuous Disclosure in Relation to PPNs ....................................... 151 e. Conclusion ......................................................................................... 151 1.3 Germany ................................................................................................. 152 a. Preliminary Remarks ......................................................................... 152 b. Continuous Disclosure for Shares and Bonds.................................... 152 c. Continuous Disclosure in Relation to Mutual Funds ......................... 153 d. Continuous Disclosure in Relation to PPNs ....................................... 153 e. Conclusion ......................................................................................... 154 2. Enhancing Continuous Disclosure of Structured Securities ........................... 154 III Other Persons’ Continuous Disclosure Duties..................................................... 156 1. Preliminary Remarks ...................................................................................... 156 2. Securityholders............................................................................................... 157 2.1 Early Warning Disclosure ........................................................................ 157 2.2 Insider Disclosure ................................................................................... 158 2.3 Disclosure Duties and Debt Securities .................................................... 159 3. Analysts and Product Raters .......................................................................... 162 IV Conclusion ........................................................................................................... 165 Chapter six  Code of Conduct at the Point of Sale ................................................................. 166 I Introduction......................................................................................................... 166 II German Point of Sale Regulation ........................................................................ 167 III Core Aspects of Point of Sale Regulation ............................................................ 168 1. Relationship between Point of Sale Disclosure and Disclosure by Issuers .............................................................................. 168 2. Personal Scope of Point of Sale Regulation ................................................... 169 3. Content of Point of Sale Disclosure ................................................................ 170 3.1 Conflicts of Interest and Referral Agreements ....................................... 170 3.2 Specifications .......................................................................................... 172 3.3 Explanations ........................................................................................... 172 3.4 Verification of Accuracy and Completeness? ......................................... 173 4. Suitability Requirements ................................................................................ 174 IV Conclusion ........................................................................................................... 176  Chapter seven Synthesis ......................................................................................................... 177 I Introduction......................................................................................................... 177 II Formal versus Substantive Approach to Product Regulation.............................. 177 III Disclosure of Structured Investments ................................................................. 179 1. General Remarks ............................................................................................ 179 2. Scope and Limits of Structured Notes Regulations ........................................ 180 3. Continuous Disclosure of Structured Investments ........................................ 182 4. Point of Sales Disclosure ................................................................................ 183 IV Enhancement of Transparency at Point of Sales................................................. 183 V Outlook ................................................................................................................ 186 vii  Chapter eight Conclusion ....................................................................................................... 188 Bibliography  ................................................................................................................... 192  viii  Chapter one I  Introduction  Research Purpose  This paper focuses on disclosure requirements for mutual funds, bonds1 and retail derivatives in the Canadian, Swiss and German2 legal frameworks. By comparing the partially divergent Canadian and European approaches to regulating transparency in relation to these investment products, the paper aims at evaluating whether the present transparency requirements of the above jurisdictions provide investors with adequate information on the risks incurring from certain investments and enable them to compare different products and their characteristics with each other. In particular, the author argues that regulations establish adequate transparency only if they ensure that prospectuses disclose essential product characteristics in a timely manner and enable investors to clearly delimit different types of investment products from each other. This thesis will demonstrate that the above goals can be best attained under a substantive approach to product regulation. As a general rule, economically similar products should have to comply with the same regulatory requirements. However, slight modifications may be appropriate in relation to derivative structures whose characteristics require efficient procedures and simple disclosure documentation. Further, the thesis suggests that the implementation of transparency requirements is not always an adequate means to achieve an appropriate level of investor protection. Rather, transparency measures should be supported by the introduction of suitability assessments at the point of sale. The thesis will focus on primary and secondary market disclosure for retail investment products. Questions on the need to regulate derivative transactions between sophisticated investors will be touched on only briefly. Further, the ongoing discussion on tighter regulation of hedge funds and related transparency issues will not be the object of this thesis. In view of governmental struggles worldwide to overcome the effects of these trades’ non-regulation, a substantial understanding and analysis of these issues would go beyond the scope of this paper. As Swiss and German regulatory requirements often bear a substantial resemblance to each other, German regulations are discussed only if they differ significantly from their Swiss counterparts.  1  The term ‘bond’ will be used in a wide sense, including short-term debt securities such as bills, papers and notes, see also LAURENCE BOOTH/SEAN W. CLEARY, Introduction to Corporate Finance (Mississauga. John Wiley and Sons, 2008), p. 212. 2 Representing countries which are - in contrast to Switzerland - members of the European Union and, therefore, implement its legal provisions.  1  The starting point of the research consists of a brief outline of the theoretical fundamentals encompassing disclosure requirements for the above financial instruments. In particular, chapter two describes (i) the objectives of Canadian, Swiss and German Capital Markets Regulations, (ii) the relevant regulatory product categories of each jurisdiction, and (iii) the basic principles of their respective disclosure frameworks. Chapter three then introduces four fundamental preconditions for transparency in capital markets. First, securities regulations distinguish between different types of financial instruments and, accordingly, set forth different disclosure requirements or investment restrictions. In order to take informed decisions about their financial investments, investors must be able to recognize these different product types and the risks generally ensuing from the products’ characteristics. As a consequence, financial instruments with differing legal structures have to be clearly delimitable. Second, the risks involved with investments in a specific type of financial instrument must be outlined clearly and precisely. Due to the complexity of financial instruments, retail investors in particular do not have the means and time to recognize all significant risks related to their investments. While current legislatory approaches3 suggest that advisors consider their customers’ expertise, funds and risk-propensity in an unbiased manner before recommending or selling any products,4 investors must still be provided with relevant information of a product’s characteristics and risks. Advisors are required to disclose any monetary benefits they receive from third parties for selling securities to their customers.5 Further, they are not allowed to keep these earnings without their clients’ approval. However, implications and incentives of relationships between advisors and third parties are often subtle, complex and concealed. As a consequence, disclosure of relevant product and issuer risks remains an essential feature of securities regulation and cannot simply be replaced by a tighter framework at the so-called point of sale.6 Third, as financial transactions are often time-critical, information has to be easily and quickly available. If retail investors and their advisors are not able to get hold of relevant information as soon as their more sophisticated or powerful counterparts, their response to significant information will be delayed and, therefore, put them at a significant disadvantage. The fourth precondition for transparent markets exists in the comparability of  3  See, for example, FINANCIAL SERVICES AUTHORITY, “Distribution of retail investments. Delivering the RDR”, Consultation Paper 09/18 (June 2009), p. 25, expressing FSA’s “desire for adviser firms to charge for their services, rather than to be paid by commission set by product providers”. 4 I.e. no kickbacks. 5 See NI 31-101, s.3.7 - 3.13 on referral arrangements; the decision of the Swiss Supreme Court 4C.432/2005 of March 22, 2006, on kickbacks; and the decision of the German Federal Court of Justice (BGH AZ. XI ZR 56/05) of December 19, 2006 on kickbacks. 6 See below, chapter six.  2  different products and their characteristics. Investors must be given the opportunity of comparing similar products of different issuers, or different types of investment vehicles with similar investment themes to each other. If these comparisons are hampered by non-uniform presentations and different calculation criteria, disclosed data might become distorted and, as a result, would no longer enhance investors’ understanding of the transactions they are entering into. Considering the above four core principles of transparent markets, chapter four provides an overview of the Canadian, Swiss and German prospectus requirements.7 For the sake of clarity, this analysis will be confined to the issue of bonds, derivatives and mutual funds. Further, as prospectus requirements for equity securities generally provide the basis for prospectus provisions of other investment products, a brief examination of prospectus requirements for shares will also be included. Present legal frameworks feature major differences between the prospectus requirements for different types of investment products. While some of them can be explained by the underlying economic principles of the products concerned, others have resulted from the historical development of these provisions and have to be abolished. By means of an in-depth comparison of the Canadian, Swiss and German prospectus requirements, chapter four will point out aspects of the different disclosure regimes that are in need of improvement and suggest possible remedies to address these issues. Canadian, Swiss and German regulations feature continuous disclosure duties for issuers of securities. The extent of these requirements varies considerably and, therefore, requires further investigation. In particular, chapter five deliberates the question of whether the current absence of continuous disclosure requirements for structured derivatives should be replaced by disclosure duties similar to those that apply to equity securities and mutual funds. In addition to the above prospectus requirements and continuous disclosure provisions, securities regulations have implemented further provisions that should safeguard transparency in capital markets. Chapter six analyzes present and proposed regulations of the point of sale of securities and deals with disclosure obligations and suitability assessments of advisors and asset managers vis-à-vis their customers. The final chapter of this thesis considers the findings of the previous sections and discusses possible consequences. In particular, chapter seven consolidates the previous chapters’ preliminary answers to  7  I.e. those requirements that issuers have to fulfill when distributing investment products.  3  delimitability issues and point of sale regulation. Further, the chapter tries to assess the degree of disclosure that is required in relation to structured investments.  II  Methodology  As outlined above, this thesis is based on a comparison between the regulation of different financial instruments in the legal frameworks of Canada, Switzerland and Germany. The point of departure for interpreting the regulatory framework for the financial instruments concerned will be the wording and systematic of law. Swiss8, German9 and European10 legislation can be accessed via the internet. Canadian securities regulation is published by the provinces and can be largely found via the CSAhomepage11 and the homepages of the provincial securities commissions.12 Until recently, Canadian securities regulation has been considered to fall exclusively within the remit of the provinces. In order to harmonize the key aspects of provincial securities regulations, provincial securities administrators have drafted National Instruments (NI)13 or Multinational Instruments (MI).14 Although these instruments are not legally binding per se, provincial securities administrators can adopt them as rules or regulations of their securities frameworks.15 Current National Instruments contain the main features and concepts of Canadian provincial securities legislation. In July 2009, however, the Canadian Government appointed the Canadian Securities Transition Office (CSTO)16 “to assist in establishing a Canadian securities regulator”.17 On May 26, 2010, the Government of Canada released the proposed Canadian Securities Act (Proposed Act) and “referred the following question about the proposed Canadian Securities Act to the SCC [Supreme Court of Canada]: Is the annexed Proposed Canadian Securities Act within the legislative authority of the Parliament of Canada?”18 As this thesis has been written prior to the Supreme Court’s decision, the following analysis will be based on the currently effective provincial  8  <http.//www.admin.ch/ch/d/sr/sr.html>; <http.//www.six-exchange-regulation.com/index_en.html>. <http.//www.gesetze-im-internet.de/aktuell.html>. 10 <http.//eur-lex.europa.eu/de/index.htm>. 11 Canadian Securities Administrators, <http.//www.csa-acvm.ca/home.html>. 12 See, for example, <http.//www.bcsc.bc.ca>, and <http.//www.osc.gov.on.ca>. 13 And, in addition, National Policies (NP). 14 Instruments that have been adopted by some but not all provincial securities administrators (GILLEN (fn. 40), p. 101). 15 GILLEN (fn. 40), p. 101. 16 The CSTO was established by the Government of Canada in July 2009. Its mandate is to assist the Government in establishing a Canadian securities regulator. The CSTO consults with the Advisory Committee of Participating Provinces and Territories, creates a national draft Securities Act and develops a roadmap for the establishment of a national regulator (see online. <http.//www.csto.ca/en/about-csto.aspx>). 17 <http.//www.csto.ca/en/links.aspx>. 18 <http://www.fin.gc.ca/n10/data/10-051_3-eng.asp>. 9  4  frameworks. The proposed Canadian Securities Act will be mentioned only if its provisions differ significantly from current regulations. Further insight can be gained by considering the genesis of legal provisions. An analysis of legislative material19 is therefore an important factor in this thesis. When establishing the current differences between the legal provisions of Canada, Switzerland and Germany in relation to financial instruments, the research will pay careful attention to the reasoning behind their respective laws. Only an interpretation in accordance with the spirit and purpose of the regulatory framework can lead to an accurate understanding and classification of inconsistencies between different legal provisions. An essential prerequisite to integrating the differences located in the regulation of financial instruments consists, therefore, in the basic knowledge of the underlying objectives of securities regulation, information on which is available in legal commentaries on securities law.20 Relevant information on all these aspects will be extracted from both legal provisions and periodicals and/or standard references on capital markets law.21 Furthermore, the interpretation of legal provisions will be enhanced by reference to court rulings and following up on their conclusions. Further information in scientific papers and books focusing on investor’s protection and market transparency will be studied. In particular, the objectives of securities legislation have been a topic of discussion in a large number of scholarly publications. Relevant publications under Swiss law have been written, for instance, by Georg G. Gotschev22 and Rolf Watter.23 In Germany, Detlef Kleindiek,24 Jens Ekkenga25 and Petra Buck-Heeb26 have contributed to the analyses of the objectives of capital markets law. The objectives of Canadian securities regulation have been examined by Mary Condon/Anita Anand/Janis  19  Materials are available on the websitzes mentioned in fn. 8, 9, 11. For Switzerland PETER VOGT NEDIM/ROLF WATTER (EDS.), Basler Kommentar zum Börsengesetz (BEHG) (Basel. Helbing Lichtenhahn, 2007), Art. 1 SESTA; for Germany SIEGFRIED KÜMPEL, Kapitalmarktrecht - Eine Einführung (Berlin. Schmidt, 2004), p. 20; for Canada MARY CONDON/ANITA ANAND/JANIS SARRA, Securities law in Canada, Cases and Commentary (Toronto. Emond Montgomery, 2005), p. 2. 21 For Switzerland e.g. DIETER ZOBL/STEFAN KRAMER, Schweizerisches Kapitalmarktrecht (Zürich. Schulthess, 2004); for Germany WOLFGANG GROSS, Kapitalmarktrecht, third edition (Munich. Verlag C.H. Beck, 2006); for Canada JOHNSTON, DAVID/ROCKWELL, KATHLEEN DOYLE. Canadian Securities Regulation, 4th edition (Markham. Butterworths, 2006). 22 GEORG G. GOTSCHEV, Koordiniertes Aktionärsverhalten im Börsenrecht - Eine ökonomische und rechtsvergleichende Analyse der organisierten Gruppe gemäss Börsengesetz (Zürich. Schulthess, 2005), p. 64 et seq. 23 ROLF WATTER, Investorenschutz im Kapitalmarkt, AJP 1997, p. 269 et seq. 24 DETLEF KLEINDIEK, “‘Going Private‘ und Anlegerschutz“, Festschrift für Gerold Bezzenberger zum 70. Geburtstag (Berlin/New York. de Gruyter, 2000), p. 653 et seq. 25 JENS EKKENGA, Anlegerschutz, Rechnungslegung und Kapitalmarkt. eine vergleichende Studie zum europäischen, deutschen und britischen Bilanz-, Gesellschafts- und Kapitalmarktrecht (Tübingen. Mohr Siebeck, 1998). 26 PETRA BUCK-HEEB, Kapitalmarktrecht, 3rd edition (Heidelberg. C.F. Müller Verlag, 2009). 20  5  Sarra27 and Mark Gillen.28 Other authors have explored the information standards requested by current legislation.29 In addition, the thesis will consider internet tools such as lexis nexis, westlaw or swisslex.ch. Recent Swiss and German publications are available via internet; others I have taken along for my studies in Canada. While drawing on the above-mentioned research, the originality of this work will be found in both its perspective and its outcome. Whereas existing scholarly papers confine themselves to describing provisions for prospectuses or continuous disclosure, the aim of this thesis is to compare the regulation of different financial instruments with respect to transparency issues. The analysis will particularly consider differences between the three analyzed national legal systems. Moreover, the thesis will question whether these differences can be explained by logical reasoning – e.g. by looking at the divergent economic characteristics of the instruments concerned – or by accidental inconsistencies. Throughout the thesis, the below terms will be used as follows. The term ‘security’ is defined in chapter two, sections II.1, III.1 and IV.1 for each jurisdiction separately. If used without a particular connection to one of the national frameworks, it will follow the meaning of ‘security’ in Canadian securities regulation, albeit in its broadest form, i.e. including retail derivatives and mutual fund units. The terms ‘investment product’, ‘financial instrument’ and ‘investment vehicle’ will be used as synonyms to the above understanding of the term ‘security’. The term ‘mutual fund’ is used in accordance with the general terminology in Canadian Securities Acts30 and literature.31 In contrast to closed-end investment funds,32 mutual funds are open-ended, i.e. if investors wish “to liquidate their investment in the fund”, the mutual fund’s “securities can be redeemed”33 and the investors receive, on demand or within a certain time period after such demand,34 an amount that equals the net asset value per share of the fund. The expression ‘derivative security’ is used in accordance with general corporate finance terminology and refers to a security “that derives its value from other underlying variables such as the price of a  27  See above, fn. 20. MARK R. GILLEN, Securities Regulation in Canada, 3rd edition (Toronto. Carswell, 2007), p. 90 et seq. 29 For Canada see Gillen (fn. 28), p. 111 et seq.; for Switzerland e.g. ZOBL/KRAMER, (fn. 21), p. 181, p. 292 et seq., p. 417 et seq.; for Germany see BUCK-HEEB (fn. 26). 30 See, for example, Securities Act, RSBC 1996, c. 418 (BCSA), Definitions, “mutual fund”; Securities Act, R.S.O. 1990, c. S.5 (OSA), Definitions, “mutual fund”. 31 GILLEN (fn. 28), p. 524. 32 Closed-end funds are often referred to as non-redeemable funds. 33 GILLEN (fn. 28), p. 524. 34 See OSA, Definitions, “mutual fund”. 28  6  security or commodity or the level of an index such as stock exchange index”.35 If the term is used in the context of regulations whose definitions give a different meaning to the expression, this will be mentioned specifically in the text. In relation to the purchase of a specific investment product, the term ‘risk’ refers to the risk that an investor may sustain a loss of a part or the entirety of its initial investment. This risk generally consists of two components, namely the risks inherent to the chosen product structure itself36 and the risks related to the product’s issuer.37 ‘Systemic risk’, on the other hand, refers to “the risk that (i) an economic shock such as market or institutional failure triggers (through a panic or otherwise) either (X) the failure of a chain of markets or institutions or (Y) a chain of significant losses to financial institutions, (ii) resulting in increases in the cost of capital or decreases in its availability, often evidenced by substantial financialmarket price volatility”.38  35  GILLEN (fn. 28), p. 23. I.e. limited or unlimited potential for loss, reference to conditional or full capital protection, reference to possible early redemption options, indication that bid and offer prices can differ to a greater or lesser extent during the term of the investment (see, for example, the Swiss Bankers Association Guidelines on Informing Investors about Structured Products, <http.//www.swissbanking.org/en/999989_e.pdf>). 37 I.e. counterparty credit risk. 38 STEVEN L. SCHWARCZ, “Systemic Risk” (2008) 97 Geo. L.J., p. 204. 36  7  Chapter two I  Theoretical Fundamentals  Introduction  The content of legal provisions protecting investors can be twofold. If legislators consider that investors cannot, in certain circumstances, reach a reasonable decision, they tend to restrain liberty of action with respect to the transactions involved. On the other hand, investors can be considered mature market participants, capable of conducting transactions of all kinds. Their protection, in this case, is secured by informing them comprehensively about the nature and risks of possible transactions. Canadian, Swiss and German capital markets laws are all based on the latter conception of investors’ protection.39 Their core element of efficient and active capital markets consists, therefore, in investors’ confidence in getting trustworthy information about financial instruments. However, prospectus requirements and continuous disclosure provisions of the three jurisdictions feature major differences. Further, disclosure provisions are generally accompanied by additional protective measures that allow supervisory authorities “to assess the merit of securities offered under a prospectus”.40 Although Canadian, Swiss and German merit discretion regulations show significant similarities,41 the extent to which the issue of securities can be prohibited for public interest reasons42 does not always correlate in the above jurisdictions.43 Moreover, disclosure regulation is not confined to prospectus provisions and continuous disclosure requirements. Rather, Canadian, Swiss and German securities regulations have implemented rules in relation to point of sale disclosure. Although these provisions might not fully compensate for gaps in prospectus disclosure, point of sale regulation can complement issuers’ disclosure obligations in a significant way and, therefore, must be considered when comparing prospectus requirements of the above jurisdictions. In order to ensure that the below investigations of disclosure requirements do not neglect or misconceive the above peculiarities of Canadian, Swiss or German securities regulations, the following  39  See below, sections II.1, III.1, and IV.1. MARK R. GILLEN, Securities Regulation in Canada, 3rd edition (Toronto. Carswell, 2007), p. 143. 41 See, for example, s. 62 (2)(d) OSA and, in relation to mutual funds, s. 14 (1)(d) CISA. 42 See GILLEN (fn. 40), p. 143, fn. 133. 43 Whereas Canadian securities regulations provide supervisory authorities with general public interest discretion at the issue of securities (see, for example, s. 62 (2) OSA) or in the course of their term time (see, for instance, s. 127 OSA), public interest considerations of the Swiss legal framework tend to be integrated in the authorization procedures of specific product types (see, for example, FINMA Guidelines on the application for authorization of a fund management company, March 1, 2009, section 4) and, as a consequence, give typically less leeway to discretion of supervisory authorities. 40  8  sections will briefly outline (i) the objectives of Canadian, Swiss and German capital markets regulation, (ii) its main product categories, and (iii) related disclosure provisions.  II  Canada  1.  Objectives of Securities Regulation  Canadian securities regulation features two core objectives, which are “to provide investor protection and to foster fair and efficient capital markets and confidence in such markets”.44 These goals can be strengthened by maintaining and enhancing investors’ confidence in the integrity of capital markets.45 Such confidence, in turn, may be particularly enhanced if financial markets are transparent and informational imbalances are reduced as far as possible.46 As a result, investors’ confidence in the integrity of capital markets can be considered a link between investor protection and efficient markets.47 However, creating transparency in capital markets is not always the most appropriate means to achieve securities regulation’s key goals. In particular, Canadian scholars point out that disclosure should never “impose excessive costs”.48 Further, recent experience has shown that the complexity of innovative financial instruments might overstrain investors’ capacities to understand and classify a specific transaction and the risks involved. Bearing this in mind, disclosure provisions have to be read in connection with other protective measures; for example, the regulation of key players in capital markets49 or the introduction of behavioural constraints for more powerful, sophisticated parties.50  44  Draft Securities Act Commentary, Expert Panel on Securities Regulation, online. <http.//www.expertpanel.ca/eng/documents/Expert_Panel-Commentary.pdf>, p. 5, and Draft Securities Act, Expert Panel on Securities Regulation, <online. http.//www.expertpanel.ca/eng/documents/CAC_SBS_2009-0107.pdf>, s. 11 DSA. See also GILLEN (fn. 40), p. 90, and DAVID JOHNSTON/KATHLEEN DOYLE ROCKWELL, Canadian Securities Regulation, 4th edition (Markham. Butterworths, 2006), p. 286, 287. 45 EXPERT PANEL ON SECURITIES REGULATION. “Final Report and Recommendations” (January 2009), p. 12. 46 See, among others, GARAINT HOWELLS/ANDRÉ JANSSEN/REINER SCHULZE (EDS.), Rights and Obligations, A Challenge for Party Autonomy and Transactional Fairness (Hants/Burlington. Ashgate Publishing, 2005), p. 146. 47 GILLEN (fn. 40), p. 92, and ONTARIO, COMMITTEE ON SECURITIES LEGISLATION/JOHN ROBERT KIMBER, “Report of the Attorney General’s Committee on Securities Legislation in Ontario” (Toronto. Queen’s Printer, 1965), para. 1.07. See also JANIS SARRA, “Proportionate Securities Regulation. The Potential for Scaled Treatment of Junior Issuers, A Research Study Prepared for the Expert Panel on Securities Regulation”, p. 12. 48 GILLEN (fn. 40), p. 93. 49 As, for example, securities dealers, portfolio managers, fund management companies etc. See GILLEN (fn. 40), p. 94. 50 See, for example, FINANCIAL SERVICES AUTHORITY (fn. 3), aiming to abolish kickbacks.  9  In addition, the current financial crisis has made regulators aware of the importance of protecting markets against systemic risks.51 Whereas the Expert Panel52 still refrained from identifying systemic risk reduction as a key purpose of Canadian securities regulation,53 the Canadian Securities Transition Office (CSTO) states in section 9 (c) of the Proposed Act that the Act’s third purpose consists of contributing, “as part of the Canadian financial regulatory framework, to the integrity and stability of the financial system”. In view of this explicit commitment, the currently prevailing perception of the two core objectives of securities regulation as complimentary and closely connected elements could shift towards a slightly more protective and paternalistic stance of supervisory authorities which, in turn, may restrain the currently prevailing assumption that investor protection is generally achieved by creating transparency in capital markets.54 In spite of these considerations, disclosure in Canadian securities markets will remain an essential means to enhance retail investors’ ability to act as mature market participants. 2.  Product Categories  Definitions of ‘securities’ in Canadian Securities Acts typically contain the following three elements. First, “any document, instrument or writing commonly known as a security”55 is considered to be a security. Commonly known securities include “a bond, debenture, note or other evidence of indebtedness or a share, stock, unit, unit certificate, participation certificate, certificate of share or interest, preorganization certificate or subscription”.56 Further ‘common’ securities are, for example,  51  See INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS (IOSCO), “Objectives and Principles of Securities Regulation” (May 2003), online. <http.//www.iosco.org/library/pubdocs/pdf/IOSCOPD154.pdf>, p. 6, which states the reduction of systemic risk as one of the key objective of securities regulation. 52 The Expert Panel on Securities Regulation in Canada was appointed in February 2008 by the federal Minister of Finance. The Panel was mandated to provide advice and recommendations on how Canada could best advance proportionate and principles-based securities regulation. The Panel delivered its final report and a draft Canadian Securities Act on January 12, 2009 (see online. <http.//www.expertpanel.ca/ eng/reports/index.html>). These documents have been written in consideration of several related research studies. 53 See s. 11 DSA. See, however, s. 14 (k) DSA, which obligates the Securities Commission to consider systemic risk reduction when pursuing the objectives of securities regulation. 54 See LARRY P. SCHWARTZ, “Objectives, Outcomes and Performance Measures in Securities Regulation”, A Research Study for the Expert Panel on Securities Regulation in Canada”, p. 64, who points out that investor protection should not “be pursued at the expense of [(…) other] goals” of securities regulation and, consequently, must be clearly defined. 55 S. 1 (1) (a) OSA. See, however, also s. 1 (1) (e) OSA which covers a considerable range of conventional types of securities [see also MARY CONDON/ANITA ANAND/JANIS SARRA, Securities law in Canada, Cases and Commentary (Toronto. Emond Montgomery, 2005), p. 187]. Further, see s. 2, ‘security’, (b) of the Proposed Act. 56 S. 1 (1) (e) OSA.  10  stock options, warrants or mutual fund units.57 Second, securities acts qualify other items as securities if they “involve an initial payment that will be used to produce some further returns”.58 In particular, certificates of interest in commodities or documents “constituting evidence of an interest in a scholarship or educational plan or trusts”59 are considered securities and, consequently, have to be distributed in accordance with the provisions of securities regulation. Third, definitions of the term ‘security’ are open-ended insofar as (i) the listed items do not necessarily constrain the scope of the term, and (ii) some of the listed items are formulated so widely that their interpretation can comprise all transactions that should - from a purposive perspective - qualify as securities.60 If an investment product is considered a security, disclosure provisions apply only if said product is conveyed in a trade and if this trade constitutes a distribution.61 A trade of a security includes “any sale or disposition of a security for valuable consideration, whether the terms of payment be on margin, instalment or otherwise”.62 A distribution of securities is defined as “a trade in securities of an issuer that have not been previously issued”,63 but also includes the resale of securities that have been returned to the issuer and other relevant secondary market sales of securities.64 Given the above wide scope of the term ‘security’ in Canadian securities regulation, a strict categorization of the items listed in Canadian Securities Acts would hardly be successful. Accordingly, Canadian Securities Acts have refrained from grouping the listed items in accordance with their distinctive legal features. However, following the principles of corporate finance, securities are generally classified as either (1) debt or (2) equity securities.65 Further, Canadian securities regulations provide tailored rules for specific types of securities, in (3) particular mutual funds66 and (4) derivatives,67 and  57  See GILLEN (fn. 40), p. 117. GILLEN (fn. 40), p. 118. See, for example. S. 2, ‘security’, (g) and (h) of the Proposed Act. 59 GILLEN (fn. 40), p. 118. 60 See, for example, the term ‚investment contract’ and its judicial interpretation, BORDEN LADNER GERVAIS LLP, Securities Law and Practice, 3rd edition (Toronto. Carswell, 2003), § Int.1.42 (n). The term is also included in s. 2, ‘security’, (f) of the Proposed Act. 61 GILLEN (fn. 40), p. 115. 62 S. 1 (1), „trade“, OSA. See also s. 2, ‘trade’, of the Proposed Act. 63 S. 1 (1), „distribution“, OSA. See also s. 2, ‘distribution’, of the Proposed Act. 64 See BORDEN LADNER GERVAIS LLP (fn. 60), §Int.1.12. 65 See GILLEN (fn. 40), p. 3 and 7. Due to the emergence of so called hybrid instrument - i.e. securities with elements of both equity and debt instruments (see BOOTH/CLEARY (fn. 1), p. 741 et seq.) - a clear delimitation between equity and debt securities may be difficult. However, a hybrid security is governed by disclosure requirements for either debt or equity securities, depending on its main economic characteristics, and is generally not subject to a specific set of rules. Therefore, this category will not be examined separately in this thesis. 66 NI 81-101, NI 81-102, NI 81-107, and other fund-specific national and regional regulations. 67 See the following section. 58  11  thus indicate that these investment vehicles should be considered separate product categories in predefined circumstances. In spite of its very broad scope, Canadian securities regulation features major inconsistencies in its strategy of how to deal with derivatives. The majority of Canadian jurisdictions do not contain a comprehensive derivatives framework68 and securities regulators are increasingly concerned that this fragmentary approach does not give adequate consideration to issues arising in relation to derivative transactions. In its Final Report and Recommendations,69 the Expert Panel suggests that exchangetraded derivatives should be nationally regulated in accordance with present approaches pursued in British Columbia, Alberta and Ontario securities regulations.70 In particular, the Panel supports a regulation of exchange contracts that “would extend primarily to exchanges, clearers, and other intermediaries operating in a particular jurisdiction in the derivatives area”,71 whereas the issuers of these contracts would not be subject to disclosure requirements and further constraints. With respect to OTC derivatives, the Expert Panel has so far refrained from bringing forward concrete regulatory suggestions.72 Currently, no Canadian Securities Act features consistent regulation of OTC derivatives and some jurisdictions are doubtful whether OTC derivatives should be subsumed under their definitions of the term ‘security’ at all.73 As the Proposed Act contains “broad substantive requirements”74 and does not determine any “technical requirements”,75 it does not fully clarify the regulator’s concept of future Canadian derivatives regulation. However, section 89 of the Proposed Act determines that exchange-traded derivatives will be governed by regulations in accordance with the above suggestions of the Expert Panel. In particular, the Act focuses on monitoring exchanges where  68  See Expert Panel, Final Report (fn. 45), Appendix 5, p. 75. Expert Panel, Final Report (fn. 45). 70 Expert Panel, Final Report Final Report (fn. 45), Appendix 5, p. 78. 71 Expert Panel, Final Report Final Report (fn. 45), Appendix 5, p. 78. 72 See Expert Panel, Final Report Final Report (fn. 45), Appendix 5, p. 78. 73 See Expert Panel, Final Report Final Report (fn. 45), Appendix 5, p. 77. THOMAS WERLEN/STEFAN SULZER, “U.S. legislation on Over-the-Counter Derivatives”, caplaw 2009 n. 58, p. 2, with regard to the U.S. proposed legislation for OTC derivatives. “The proposed legislation would add securitybased swaps to the definition of "security" under the Exchange Act and would give the SEC the authority to define certain securitybased swaps as conferring beneficial ownership of the underlying securities for reporting purposes under Section 13(d) and (g) of the Exchange Act”. See also MARGARET GROTTENTHALER/PHILIP J.HENDERSON, The Law of Financial Derivatives in Canada, (Toronto. Thomson Carswell, 1999), § 10.2.3, on the question when derivatives are considered securities. See also OSC Staff Notice 91-702, p. 4, with further reference to relevant Canadian case law. 74 <http://www.fin.gc.ca/n10/data/10-051_1-eng.asp>. 75 <http://www.fin.gc.ca/n10/data/10-051_1-eng.asp>. Technical requirements and exemptions to the Act’s substantive provisions will be regulated by regulations. 69  12  derivatives are traded and does not require extensive prospectus documentation.76 Further, section 90 of the Proposed Act introduces the concept of designated derivatives.77 These derivatives can be distributed only if a prescribed disclosure document has been accepted by the regulator. The Proposed Act does not elaborate on the content of this disclosure document but clearly states that the document is not a prospectus in accordance with Part 6 of the Act.78 Derivatives that are neither exchange-traded nor designated derivatives but qualify as securities in the sense of section 2, ‘security’, of the Proposed Act must follow the disclosure requirements for securities stated in the Act and its regulations.79 Finally, recent Federal Regulations on principal protected notes (PPNs)80 have introduced specific disclosure provisions for these capital-protected investment products. If PPNs qualify as evidence of deposit issued by a savings institution,81 they are regularly exempt from provincial securities regulations and their disclosure requirements and, as a consequence, are not considered securities in the sense of these provisions. In view of the above, the following analysis will distinguish between equity securities, debt securities, mutual funds and derivatives.82 As these key categories contain a multitude of different investment instruments, the below examination will be confined to typical representatives of the above four main categories.83  76  S. 91 of the Proposed Act specifies that Part 6 of the Act do not apply in relation to exchange-traded derivatives. S. 2, ‚designated derivative‘, of the Proposed Act sets forth that “a ‘designated derivative’ means a derivative that is (a) designated under subsection 237(2) to be a designated derivative; or (b) within a class of derivatives that are designated by the regulations to be designated derivatives”. The Act does not specify what kinds of derivatives may be subsumed under this particular category. 78 S. 91 of the Proposed Act. 79 Further, s. 92 of the Proposed Act determines that certain provisions of the Act can apply to derivatives that do not qualify as securities if this is set out in the Act or its regulations. 80 Principal protected notes are investment vehicles that offer “an investor potential returns based on the performance of an underlying investment and a guarantee that the investor will receive, on maturity of the PPN, not less than the principal amount invested” (CSA Notice 46-305 - Second Update on Principal Protected Notes of August 29, 2008, p. 1). 81 See, for example, s. 1 BCSA ‚security’. 82 In spite of the legislator’s decision to qualify PPNs as evidences of deposit, PPN regulation is discussed under the title ‘derivatives’. 83 See below, chapter four. 77  13  3.  Regulatory Disclosure Framework  Until recently, Canadian securities regulation has been considered to fall exclusively within the remit of the provinces.84 Consequently, provinces have enacted provincial securities acts and issued policy statements. Further, provincial securities administrators adopt co-operatively drafted National Instruments (NI)85 or Multinational Instruments (MI) which allow the harmonization of certain aspects of provincial securities regulation.86 The disclosure framework of Canadian securities regulation has been harmonized to a large extent. NI 41-101 sets forth that most securities can be distributed only if a prospectus has been issued prior to the actual distribution.87 Further, NI 51-102 states continuous disclosure requirements for reporting issuers.88 In particular, they have to file periodic information such as their annual and interim financial statements, a management discussion and analysis89 and annual information forms.90 In addition, issuers have to disclose in a timely manner any “significant business acquired by the issuer and the effect of the acquisitions on the issuer”91 and are required to report any material changes.92 Canadian disclosure requirements are not imposed on issuers only. Moreover, insiders have to report “(a) direct or indirect beneficial ownership of, or control or direction over, securities of the reporting issuer, and (b) interest in, or right or obligation associated with, a related financial instrument involving  84  In July 2009, however, the Canadian Government established the Canadian Securities Transition Office “to assist in establishing a Canadian securities regulator” (http.//www.csto.ca/en/links.aspx). Should these efforts to establish a national securities regulator succeed, securities regulation would then become a responsibility of the Canadian Government. 85 And, in addition, National Policies (NP). 86 GILLEN (fn. 40), p. 101. 87 NI 41-101, s. 2 (1). 88 „The key feature of the definition of ‘reporting issuer’ is that it is an issuer that has issued securities under a prospectus in the province” (GILLEN (fn. 40), p. 183, 184). 89 „MD&A provides a narrative explanation from the perspective of management of how the reporting issuer performed during the financial year or interim period to which the MD&A relates” (GILLEN (fn. 40), p. 191). 90 „The AIF draws (...) information together on an annual basis providing material information about the issuer and its business as at the end of the issuer’s most recently completed financial year in the context of its historical and possible future development. It describes the issuer, its operations and prospects, and notes risks and other external factors that impact the issuer” (GILLEN (fn. 40), p. 193, 194). 91 GILLEN (fn. 40), p. 207. 92 A ‘material change’ is“(a) a change in the business, operations or capital of the reporting issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the reporting issuer; or (b) a decision to implement a change referred to in paragraph (a) made by the board of directors or other persons acting in a similar capacity or by senior management of the reporting issuer who believe that confirmation of the decision by the board of directors or any other persons acting in a similar capacity is probable” (NI 52-102, s. 1.1).  14  a security of the reporting issuer”.93 Further, the management of the issuer and third parties soliciting “proxies from registered holders of voting securities”94 must send forms of proxy95 and information circulars96 to registered shareholders. Also, the Canadian early warning provisions97 state that every person “who acquires beneficial ownership of, or control or direction over, voting or equity securities”98 has to disclose such transfer if it, “together with the acquiror’s securities of that class, would constitute 10% or more of the outstanding securities of that class”.99 In case of a public takeover offer,100 “a bid circular must be sent to all holders in the province of the securities sought”.101 Finally, Canadian securities regulation features specific disclosure provisions for mutual funds102 and - to a certain extent derivatives.103 Whereas mutual fund disclosure is basically a more customized version of general disclosure regulation,104 derivative-specific regulation provides issuers with numerous forms of relief and, as a result, leaves investors considerably less protected than the general disclosure framework.105 Canadian securities regulation features several exemptions to its disclosure requirements.106 NI 45-106 lists constellations where issuers are exempt from prospectus requirements or registration duties. The rationale for these exemptions is generally based on one of the following four elements. First, exemptions are introduced in cases where counterparties are sufficiently sophisticated and powerful to obtain the information they need to assess the value of securities.107 Second, NI 45-106 waives the duty to issue a prospectus if these documents do not feature any relevant additional information.108 Third, if  93  S. 3.3 of NI 55-104. NI 51-102, s. 9.1 (2). 95 NI 51-102, s. 9.1. “If management of a reporting issuer gives notice of a meeting to its registered holders of voting securities, management must, at the same time as or before giving that notice, send to each registered holder of voting securities who is entitled to notice of the meeting a form of proxy for use at the meeting”. 96 See GILLEN (fn. 40), p. 197 - 201. 97 MI 62-104, s. 5.2, and s. 102 OSA. 98 MI 62-104, s. 5.2 (1). 99 MI 62-104, s. 5.2 (1). 100 A definition of the term ‘take-over bid’ can be found, for example, in MI 62-104, s. 1.1, ‘take-over bid’. 101 GILLEN (fn. 40), p. 442. 102 See, in particular, NI 81-101 on Mutual Fund Prospectus Disclosure, and NI 81-106 on Investment Fund Continuous Disclosure. 103 A more detailed account of disclosure provisions in relation to derivatives will be given below, chapter four, section 3. 104 See GILLEN (fn. 40), p. 534, 535, who explains that the simplified prospectus requirements intend to ensure that unsophisticated investors understand the prospectus’s content. 105 See, for example, the recently implemented Principal Protected Notes Regulations, Consolidation, SOR/2008180 (PPN Regulations). See below, chapter four, section 3. 106 NI 45-106. 107 See GILLEN (fn. 40), p. 251. 108 GILLEN (fn. 40), p. 254 - 257. 94  15  an investment is considered comparatively safe, its issuer is exempt from distributing a prospectus.109 Fourth, Canadian disclosure policies rely on the principle of proportionate regulation;110 as a consequence, if disclosure generates considerably more costs than benefits, securities regulation tends to partially waive disclosure requirements.111 The Canadian disclosure framework follows a closed-system approach. Securities that have been distributed under one of the above exemptions cannot be resold unless (i) a regulatory exemption applies, or (ii) a prospectus is distributed prior to the transaction.112 Consequently, issuers cannot avoid disclosure requirements by distributing securities to related parties in the exempt market before these parties, in turn, resell the same securities to the public.113 As mentioned in chapter one, section II above, the Government of Canada released a proposed Canadian Securities Act on May 26, 2010. The Act’s key innovations consist in establishing a national securities regulator114 and a national framework for securities. This framework builds on the content of current National Instruments. As a result, the above outline of Canadian disclosure regulation is largely mirrored in the Proposed Act. Part 6 of the Act requires that a “person must not distribute a security unless a preliminary prospectus and a prospectus have been filed with the Chief Regulator and the Chief Regulator has issued a receipt for each of them”. The Act does not specify the prospectus requirements. However, it can be assumed that its regulations will closely track the prospectus requirements of the currently effective National Instruments.  109  GILLEN (fn. 40), p. 257. SCHWARTZ (fn. 54), p. 64. 111 GILLEN (fn. 40), p. 257, with respect to constellations where few investors, small monetary value or venture capital issuers are concerned. An in-depth study of the relation between proportionate regulation, the goals of Canadian securities regulation and adequate disclosure requirements for junior issuers can be found in SARRA, Proportionate Regulation (fn. 47), p. 12 et seq. 112 GILLEN (fn. 40), p. 135, 135, and p. 243 - 250. 113 See also GILLEN (fn. 40), p. 134, on prospectus requirements in the case of a resale of securities that have been returned to the issuer and sales by control persons. 114 This national regulator would be established as a Crown Corporation and have two divisions, i.e. a regulatory division and the Canadian securities tribunal. While the regulatory division would regulate Canadian capital markets, the tribunal’s “primary function would be to adjudicate matters arising from the CSRA, including administrative enforcement actions and reviews of regulatory decisions” (<http://www.fin.gc.ca/n10/data/10051_1-eng.asp>). 110  16  III  Switzerland  1.  Objectives of Securities Regulation  Section 1 SESTA115 states that its provisions shall “ensure transparency and equality of treatment of investors (…) and the proper functioning of the securities markets”. According to the prevailing Swiss doctrine, Swiss securities regulation aims at (i) protecting investors116 and (ii) ensuring the efficient functioning of securities markets.117 Similar to Canadian securities regulation, Swiss securities law does not intend to protect investors from taking risky and potentially loss-generating investments. In fact, section 1 SESTA points out that its core instruments for protecting investors consist in creating transparency in capital markets and guaranteeing equal treatment of investors. As a result, investor protection and market functionality do not compete against each other but, in most cases, can be pursued by establishing transparency and, consequently, investors’ confidence in capital markets.118 However, as already mentioned under section II.1, investor protection and market functionality cannot always be fully achieved by requiring transparent behaviour of all market participants. Like the Canadian regulatory framework, Swiss securities regulation has therefore introduced registration and reporting requirements for particularly sensitive market participants such as dealers,119 issuers and managers of mutual funds120 and other investment products. Swiss securities regulation has so far largely refrained from assuming responsibility for systemic risks. Although the regulator seeks to avoid market disruptions due to undercapitalization,121 a comprehensive regulation of systemic risk is neither mirrored in current regulation, nor are there any palpable indications that the legislator will implement such principles in the near future.122  115  Federal Act on Stock Exchanges and Securities Trading of March 24, 1995 (SR 941.1, SESTA). ROLF WATTER, Basler Kommentar zum Börsengesetz (Basel. Helbing Lichtenhahn, 2007), s. 1 n. 9. 117 BSK-WATTER (fn. 116), s. 1, n. 14. The provision’s draft wording explicitly stated these two main objectives. However, the wording was changed during the parliamentary debate so as not to raise any expectations that investors would be protected from taking ‘wrong’ investment decisions (BSK-WATTER (fn. 116), s. 1, n. 2, and MIRJAM EGGEN, Das Verhältnis der Angebotspflicht nach Art. 32 BEHG zum Fusions- und Kartellgesetz (Bern. Stämpfli Verlag, 2007), p. 18). 118 BSK-WATTER (fn. 116), s. 1 n. 10. See, however, EGGEN, Angebotspflicht (fn. 117), p. 21, who points out single provisions protecting investors that do not fully comply with the objective of enhancing the proper functioning of securities markets. 119 See s. 10 et seq. SESTA. 120 See s. 13 CISA. 121 See capital requirements for banks and mutual fund management companies in s. 3 (2)(b) BankA and s. 28 (2) CISA. 122 Unlike the vast majority of countries that have been hit by the financial crisis, the Swiss regulator has not been actively involved in the question surrounding the regulation of CDOs and other high-risk instruments. 116  17  2.  Product Categories  Section 2 (a) SESTA defines securities as “standardized certificates which are suitable for mass trading, rights not represented by a certificate with similar functions (book-entry securities) and derivatives”. Whether a document or right qualifies as a ‘certificate’, ‘book-entry security’ or ‘derivative’ has to be determined in accordance with the applicable law.123 Swiss law defines a certificate as “any document in which a right is incorporated in such a way that it cannot be claimed nor transferred to others without the document”.124 Swiss law contains no definition of the term ‘book-entry securities’. As a rule, bookentry securities are “created through registration with the issuer” and - for lack of a paper certificate “can neither be physically presented to the issuer (…) nor transferred by delivery or endorsement”.125 In the absence of regulatory restrictions, book-entry securities can represent those rights that can be issued as certificates.126 Derivatives are, according to the Message SESTA,127 financial contracts whose value derives from the price of another asset, which constitutes the base value of the derivative.128 Among others, forward contracts, financial futures, options or swaps qualify as derivative instruments.129 Although important aspects of Swiss securities regulation are outlined in the SESTA, the Act does not contain any primary market disclosure provisions. Rather, disclosure and registration requirements related to the issue of securities are dispersed over several product-specific Statutes. As a consequence of this segmented approach to regulation, the Swiss securities framework requires a clear distinction between different types of securities. Legal definitions of specific product categories largely follow the  123  According to the Swiss Federal Act on Private International Law and related prevailing doctrine, the qualification of documents representing ownership rights as standardized certificates is “governed by the law of the state under whose law [the company in question is (…)] organized”. Whether documents representing debt claims qualify as standardized certificates is determined by the law chosen by the parties or, in the absence of such choice of law, the state where the documents have been issued (see DANIEL DAENIKER/STEFAN WALLER, Basler Kommentar zum Börsengesetz (Basel. Helbing Lichtenhahn, 2007), s. 2 lit. a-c, n. 19). 124 Section 965 SCO. 125 MIRJAM EGGEN, „Sicherheiten an Wertrechten, Eine Untersuchung der Rechtslage ab Inkrafttreten des Bucheffektengesetzes“, SZW 2009, p. 116. 126 See EGGEN, Wertrechte (fn. 125), p. 117. On January 1, 2010, the new Federal Law on the Custody and Transfer of Securities Held by an Intermediary has come into effect. The law sets forth procedures for the creation and transfer of book-entry securities. 127 Botschaft zum Börsengesetz, February 24, 1993, BBl 1993 (Message SESTA), p. 1395. 128 Further, there has to exist a market for this base value (Message SESTA (fn. 127), 1395). See also the definition of derivatives in s. 5 SESTO. 129 BSK-DAENIKER/WALLER (fn. 123), s. 2 lit. a-c, n. 12. The prevailing Swiss doctrine does not qualify derivative contracts as certificates or book-entry securities [see FRANCA CONTRATTO, Konzeptionelle Ansätze zur Regulierung von Derivaten im schweizerischen Recht (Diss) (Zürich/Basel/Genf. Schulthess, 2006), p. 148]. See, however, BSKDAENIKER/WALLER (fn. 123), s. 2 lit. a-c, n. 12.  18  economically distinctive features of these products. (1) Equity securities are created in accordance with the legal framework for corporations.130 They can be issued as shares131 or participation certificates,132 and both can be either physical certificates or book-entry securities.133 Other companies’ equity rights, however, cannot be represented by securities, as applicable legal requirements oppose the creation of transferable equity certificates or book-entry securities.134 (2) Debt securities are issued in the form of bonds,135 medium term bonds,136 mortgage bonds,137 and units of contractual funds.138 A bond is, under Swiss law, a loan that has been split into partial amounts. The obligor enters into a multitude of contracts with different creditors. These loan agreements are closed under uniform conditions139 and within a certain subscription period. Bonds are generally issued as certificates or book-entry securities.140 Medium term bonds are issued by banks on an ongoing basis.141 Mortgage bonds can be issued only by a restricted number of institutions and their restitution is secured by a particular system of statutory mortgages.142 (3) Units of contractual funds represent the unit holders’ “claim against the fund management company to participate in the assets and income of the investment fund in accordance with the fund units they  130  S. 683, 684 SCO. S. 622 (1) SCO. “Shares shall be issued in the name of a holder or to bearer”. Shares entitle their owners to a proportionate share of the corporation’s profit and liquidation proceeds (s. 660 (1) SCO), and conveys to each shareholder “at least one vote” (s. 692 (2) SCO). 132 S. 656a SCO. „The articles of incorporation may provide for a participation capital divided into partial amounts (participation certificates). These participation certificates shall be issues against contribution. They have a par value and grant no voting rights”. See, in addition, DIETER ZOBL/STEFAN KRAMER, Schweizerisches Kapitalmarktrecht (Zürich/Basel/Genf. Schulthess, 2004), p. 202, n. 551, 552, who mention further equity securities, i.e. profit sharing certificates (s. 657 SCO) and preemptive rights (s. 652b SCO). 133 See PETER BOECKLI, Schweizer Aktienrecht, 3rd edition (Zürich/Basel/Genf. Schulthess, 2004), p. 435 - 444. 134 See for cooperatives, for example, s. 853 (3) SCO. “The participation certificates are issued in the name of the member. They cannot, however, be issued as negotiable instruments (Art. 96 et seq.), but only as evidentiary documents”. For limited liability companies see BEAT HESS/CORRADO RAMPINI/TILL SPILLMAN, Basler Kommentar zum Obligationenrecht II, 3rd edition (Basel. Helbing Lichtenhahn, 2008), s. 774a SCO n. 11. 135 Anleihensobligationen. 136 Kassenobligationen. 137 Pfandbriefe. 138 ZOBL/KRAMER (fn. 132), p. 203 - 206. Mutual funds that are organized as corporations (see s. 36 - 52 CISA) issue equity securities (shares) to their investors. 139 ROLF WATTER/MICHAEL G. NOTH, Basler Kommentar zum Obligationenrecht II, 3rd edition (Basel. Helbing Lichtenhahn, 2008), s. 1156 SCO n. 2; ZOBL/KRAMER (fn. 132), p. 203, n. 553. 140 However, there is no mandatory duty to do so (see BSK-WATTER/NOTH (fn. 139), s. 1156 SCO n. 3. 141 ZOBL/KRAMER (fn. 132), p. 204, n. 556. 142 ZOBL/KRAMER (fn. 132), p. 205, n. 558. 131  19  acquire”.143 Although mutual fund units other than those of exchange-traded ETFs are not traded in secondary markets, they are generally considered to be securities in the sense of section 2 (a) SESTA.144 As stated by section 2 (a) SESTA, (4) derivatives may also feature the characteristics of securities. Swiss securities regulation does not contain a comprehensive framework for derivatives, nor has it established a consistent legal definition of the term.145 However, section 5 CISA has introduced specific requirements for issuers of so-called ‘structured-products’. Taking into account the wide range of these products, the legislator has deliberately abstained from defining the term in the Statute.146 Generally speaking, “a structured product combines traditional financial investments - such as equities and bonds - with derivatives”147 and its “repayment value is derived from the performance of one or more of”148 these underlying investment products. Further derivative-specific rules are scattered rather erratically throughout the Swiss securities framework;149 they lack a consistent frame and feature considerable gaps.150 Like the Canadian securities framework, Swiss securities regulation has established four key categories of investment instruments. i.e. equity securities, debt securities, mutual funds and derivatives. Considering the above sub-categories for equity and debt securities, the following analysis refrains from an exhaustive examination of all investment instruments. As a result, the below explanations relate to shares, bonds, mutual funds and a limited range of derivative instruments151 as key representatives of the four categories.  143  S. 78 (1)(a) CISA. See BSK-DAENIKER/WALLER (fn. 123), s. 2 lit. a-c SESTA n. 16, and ZOBL/KRAMER (fn. 132), p. 205. 145 See CONTRATTO (fn. 129), p. 392. 146 Botschaft zum Bundesgesetz über die kollektiven Kapitalanlagen, September 23, 2005, BBl 2005, 6395 et seq. (Message CISA), p. 6439. 147 MIRJAM EGGEN, „The simplified prospectus for structured products”, in. Daniel Lengauer/Giordano Rezzonico (eds.), Chancen und Risiken rechtlicher Neuerungen 2007/2008 (Zürich/Basel/Genf. Schulthess, 2008), p. 99. 148 EGGEN, Prospectus (fn. 147), p. 99. 149 See, in particular, s. 15 CISO-FINMA, with respect to early warning duties in relation to derivative instruments. 150 See CONTRATTO (fn. 129), p. 435. In particular, the Swiss legal framework does not provide any prospectus requirements for non-listed derivatives other than structured products. Further, there are no civil liability provisions for damages occurred in relation to the issue of derivative instruments. The general civil liability framework is not an adequate substitute for this lack of a tailored set of rules. 151 See below, chapter four, sections II.3, III.3, and IV.3. 144  20  3.  Regulatory Disclosure Framework  The Swiss disclosure framework for securities is contained in the SESTA and its Ordinances152 and in the Swiss Code of Obligations. Further, disclosure duties for mutual funds and structured products can be found in the CISA153 and its Ordinances.154 Finally, listed securities have to follow the Regulations set forth by the Swiss stock exchange, SIX Swiss Exchange.155 Unlike the Canadian legal framework for securities, Swiss securities regulation does not offer prospectus requirements that apply to all kinds of securities. Rather, specific rules for different types of investment instruments are set forth in different Acts. Issuers of non-listed shares must comply with the provisions of section 652a SCO. If a corporation offers new shares publicly for subscription, it is required to publish a prospectus. Section 652a SCO does not state any further disclosure duties. In particular, there are no specific proxy or information circular requirements.156 Continuous disclosure requirements for nonlisted shares obligate issuers to provide investors with basic periodic information such as annual financial statements and an annual report of the issuer’s business and economic and financial situation.157 However, unlike Canadian public companies, Swiss corporations are not obligated to inform investors about recent developments that might have an impact on the securities’ prices or on investors’ assessment of the securities as long as they are not listed at the Swiss stock exchange. Issuers of listed shares have to comply with the Listing Rules of SIX Swiss Exchange.158 These provisions require that issuers file a prospectus159 and disclose, upon request, further “information documents that affect the position of investors”.160 SIX provides Prospectus Schemes that issuers must use to disclose the above information161. In addition, issuers of shares have to provide periodic information such as their  152  Ordinance of the Swiss Financial Market Supervisory Authority on Stock Exchanges and Securities Trading of October 25, 2008 (SR 954.193; Stock Exchange Ordinance-FINMA, SESTO-FINMA); Ordinance on Stock Exchanges and Securities Trading of December 2, 1996 (SR 954.11; Stock Exchange Ordinance, SESTO). 153 Federal Act on Collective Investment Schemes of June 23, 2006 (Collective Investment Schemes Act, SR 951.31). 154 Ordinance on Collective Investment Schemes of November 22, 2006 (Collective Investment Schemes Ordinance, CISO; SR 951.311); Ordinance of the Swiss Financial Market Supervisory Authority on Collective Investment Schemes of December 21, 2006 (FINMA Collective Investment Schemes Ordinance, CISO-FINMA; SR 951.312). 155 SIX Swiss Exchange, online. <http.//www.six-swiss-exchange.com/index.html>. 156 See s. 689b - e SCO. 157 S. 662 and 663d SCO. 158 Of October 29, 2008. 159 S. 27 - 32 Listing Rules, SIX Exchange Regulation, October 29, 2008. 160 S. 41 Listing Rules. 161 See, for example, Scheme A, Equity Securities, online. <http.//www.six-exchange-regulation.com/ admission_manual/04_03-SCHA_en.pdf>.  21  annual and semi-annual financial statements and a corporate calendar.162 In addition, an issuer has to inform the market in a timely manner “of any price-sensitive facts which have arisen in its sphere of activity”.163 Further, it must report management transactions in issuer’s shares or related instruments164 to SIX Swiss Exchange.165 The wide difference between disclosure requirements for exchange-traded shares and those for their non-listed counterparts can have both positive and negative consequences. On a positive note, investors are free to determine whether they want to invest in a highly transparent market or accept less transparency in favour of more corporate flexibility. However, while this choice may be legitimate with regard to smaller companies with few external shareholders, the moderate degree of disclosure required of section 652a SCO cannot provide appropriate protection for a widely dispersed circle of shareholders of large non-listed companies. While Canadian and European prospectus requirements account for the economic constraints of smaller corporations by creating respective exemptions or facilitations in their disclosure frameworks,166 the Swiss framework is based on the - sometimes incorrect167 - assumption that large corporations are generally listed on a stock exchange and, therefore, are subject to the strict disclosure requirements applicable for exchangetraded securities. This chasm between prospectus and continuous disclosure requirements for exchange-traded and non-listed securities impairs consistent transparency of capital markets and may ban investors from certain investments if they are not willing to accept the low disclosure standards for non-listed companies. Further, the lack of ad-hoc publicity favours investors who have personal connections to the management of the company and, therefore, have more profound knowledge of the company’s prospects than outside shareholders. As transparency is a key precondition for the implementation of the key objectives of Swiss securities regulation - i.e. investor protection and efficient functioning of securities markets - the lack of consistent disclosure requirements for similar types of securities is not satisfactory. Chapters four and five below will further examine these inconsistencies in  162  S. 52 Listing Rules. “The corporate calendar must give information on the dates in the issuer's year that are of major importance to investors, specifically the annual general meeting and the publication dates of the annual and interim financial statements”. The corporate calendar can be published by SIX (s. 52 (3) Listing Rules). 163 S. 53 (1) Listing Rules. “Price-sensitive facts are facts which are capable of triggering a significant change in market prices” (s. 53 (1) Listing Rules). See also SIX Directive on Ad hoc Publicity of July 1, 2009. 164 S. 56 Listing Rules. 165 Which then discloses this information to the public. 166 See s. 2.4 of NI 45-106 for private issuers and s. 2.10 for minimum amount investments. See also the current proposal for a review of the EU Prospectus Directive, online. <http.//ec.europa.eu/internal_market/ securities/prospectus/index_en.htm>, which intends to introduce less comprehensive disclosure requirements for small companies. 167 See, for example, Glencore International AG, a privately held Swiss company and, at the same time, one of the world’s largest suppliers of a range of commodities and raw materials (<www.glencore.com>).  22  Swiss securities regulation and determine the gaps that must be closed in order to establish an adequate degree of transparency in Swiss capital markets. Issuers of non-listed bonds are required to follow the prospectus requirements set forth in section 1156 SCO. The content of a bond’s prospectus is based on the prospectus requirements for non-listed shares. In addition, it has to “contain the detailed information concerning the loan, especially the interest terms, terms of repayment, special security provided for the bonds (…)”.168 Like non-listed shares, the issue of non-listed bonds does not entail any ad-hoc disclosure duties. Listed bonds have to consider the SIX Listing Rules and, in addition, the Additional Listing Rules for the Listing of Bonds.169 These additional rules state particular prospectus requirements for bonds.170 Continuous disclosure provisions for exchange-traded bonds are virtually the same as those set out for shares,171 however, issuers of bonds neither have to file any interim financial statements or corporate calendar, nor do they have to disclose management transactions.172 Mutual funds are regulated by the CISA and its Ordinances.173 Sections 75 et seq. CISA require that the fund management company publishes a prospectus174 for each mutual fund. The prospectuses have to be updated as material changes occur, and in any event, at least once a year.175 Inter alia, the prospectus provisions contain requirements with regard to issue and redemption fees, management fees and the reimbursement of specific admissible expenses.176 In addition to the above prospectuses, Swiss mutual funds have to publish their annual and semi-annual reports.177 Further, the fund management company has to publish “the net asset values [per unit] at regular intervals”.178 Listed mutual funds, so-called exchange traded funds (ETFs), have to comply with the rules of SIX. However,  168  S. 1156 (2) SCO. Of October 29, 2008. 170 See, in particular, s. 14 Additional Listing Rules for the Listing of Bonds, SIX Exchange Regulation, October 29, 2008, which distinguish between stand-alone prospectuses and issuance programmes, and SIX Prospectus Scheme E, Bonds, online. <http.//www.six-exchange-regulation.com/admission_manual/04_07-SCHE_en.pdf>. 171 S. 28 Listing Rules Bonds. 172 S. 28 Listing Rules Bonds. 173 See above, fn. 154. 174 A full prospectus and - in most cases - a simplified prospectus have to be published. Annex 1 and 2 of CISO contain the minimum contents of the prospectus and the contents of the simplified prospectus. 175 S. 106 (3) CISO. 176 S. 38 CISO. See also Guidelines on Transparency with regard to Management Fees , June 5, 2005, by the Swiss Funds Association (SFA). 177 S. 89 CISA. 178 S. 83 (4) CISA. Publication has to take place whenever units are issued or redeemed or, if there is no issue or redemption, twice a month (s. 79 (2) CISO-FINMA, and PASCAL PORTMANN, Basler Kommentar zum Kollektivanlagengesetz (Basel. Helbing Lichtenhahn, 2009), s. 83 CISA n. 31 KAG). 169  23  due to the CISA provisions’ high level of detail, the SIX generally refers to these statutory provisions and has largely refrained from establishing additional rules.179 Issuers of structured notes must offer prospectuses in accordance with section 5 CISA. These simplified prospectuses bear considerably less information than prospectuses for mutual funds or listed shares or bonds. In particular, simplified prospectuses do not contain any detailed information about the issuer of the product. Further, disclosure of product charges is not regulated in detail by the section 5 CISA. Moreover, issuers are not required to disclose additional information, be it at the issue of the product or on a continuous basis.180 Listed structured notes have to comply with the specific rules for derivatives set forth by SIX.181 Issuers of these products must disclose relevant information in a listing prospectus182 in accordance with Scheme F of SIX Regulation.183 Continuous disclosure requirements are based on the general SIX provisions for maintaining listing. However, issuers of structured products do not have to file any interim reports or corporate calendars.184 The Swiss disclosure framework does not feature any prospectus requirements for non-listed derivative instruments other than structured products185 in the sense of section 5 CISA.186 Whereas the issue of shares and bonds is regulated by the Swiss Code of Obligations and mutual funds as well as structured products are regulated by the Swiss Collective Investment Schemes Act and its Regulations, the issue and distribution of non-listed derivative securities other than structured products are not governed by any legal or self-regulatory provisions. As a consequence, non-listed options, futures and contracts for difference can be distributed to retail investors without initial and continuous disclosure of the product characteristics and entailed risks. In practice, however, the majority of issuers have switched to providing issuers with basic prospectus documentation on a voluntary basis.187 The content and structure of these prospectuses are similar to simplified prospectuses in the sense of section 5 CISA.  179  See, for example, s. 110 and s. 113 Listing Rules. In particular, issuers are not required to publish product prices in secondary markets and need not provide investors with periodic disclosure information such as annual or half-yearly reports. 181 See, in particular, the Additional Rules for the Listing of Derivatives, SIX Exchange Regulation, October 29, 2008. 182 Prospectuses can be stand-alone prospectuses or prospectuses enfolded in issuance programmes (s. 21 Listing Rules Derivatives). 183 SIX Scheme F, Derivatives, online. http.//www.six-exchange-regulation.com/admission_manual/04_08SCHF_en.pdf. 184 S. 34 Listing Rules Derivatives. 185 For a definition of the term in the Swiss regulatory framework see section 2 above. 186 MIRJAM EGGEN, „Die Regulierung von strukturierten Produkten - Eine rechtsvergleichende Analyse“, SZW 2008, p. 388. 187 See CONTRATTO (fn. 129), p. 269. 180  24  Exchange-traded derivatives, as the above structured products, have to comply with the disclosure requirements set forth in the SIX Listing Rules for Derivatives. Swiss securities regulation, like the Canadian legal framework for securities, features an early warning requirement for shares and share-related securities. Section 20 SESTA requires that everyone who “acquires or sells for their own account shares or purchase or sale rights relating to shares in a company incorporated in Switzerland whose equity securities are listed, in whole or in part in Switzerland and thereby attains, falls below or exceeds the threshold percentages of 3, 5, 10, 15, 20, 25, 33 1/3, 50 or 66 2/3 of the voting rights (…), shall be obliged to notify the company and the stock exchanges on which the equity securities in question are listed”.188 Further, sections 22 et seq. SESTA list a variety of disclosure duties for persons who intend to make a public takeover offer. In particular, these offerors “shall publish [their] offer in a prospectus containing true and complete information”.189 Unlike Canadian regulations, the Swiss SESTA confines disclosure duties in the early warning and public takeover context to acquisitions of exchange-traded securities. Disclosure exemptions are set out in the above product-specific Statutes and Regulations. Their rationale is generally in accordance with one of the four elements that have been stated as exemptions in Canadian disclosure regulation.190 The Swiss disclosure regime for securities is not a closed system. If, for example, large-scale investors sell their equity securities to third parties, prospectus requirements of section 652a SCO do not apply  188  For derivative-specific disclosure provisions in the early warning context see s. 15 CISO-FINMA. Further, there are considerable differences between the Canadian and Swiss early warning frameworks, as the following brief outline clearly shows. Whereas Canadian early warning rules require disclosure of acquisitions, the corresponding Swiss provisions require that sales or writings of securities are disclosed as well. Further, the provisions contain different thresholds which trigger disclosure and reporting duties. Another major difference can be found in the fact that Swiss corporate law does not allow equity securities without attached voting rights. As a consequence, the beneficial ownership concept of Swiss securities regulation depends heavily on the question who has power over a security’s voting right. As Canadian corporate law recognizes equity securities without any voting rights attached, Canadian securities regulation’s criteria to determine beneficial ownership of securities cannot exclusively focus on the question of voting rights. Finally, the Canadian early warning rule is applicable to all publicly traded securities, whereas the Swiss early warning system applies only to securities traded on a Swiss stock exchange. 189 S. 24 (1) SESTA. 190 See above, section II.3. See, for example, s. 36 Listing Rules, or s. 2 (2) and s. 3 CISA.  25  and, as a consequence, securities that have been issued to exempt parties191 can be resold to retail investors without providing adequate disclosure.192  IV  Germany  1.  Objectives of Securities Regulation  Like the Canadian and Swiss regulatory frameworks for securities, German securities regulation features two core goals. First, its provisions seek to create prerequisites for functioning securities markets. According to prevailing legal doctrine, functioning securities markets require (i) liquidity and accessibility of markets, (ii) low transaction costs, and (iii) transparency and adequate information for investors.193 Second, German securities regulation features investor protection as another key objective of its provisions. Traditionally, Statutes and regulatory provisions have confined their scope to institutional protection of investors, i.e. provisions have primarily aimed at protecting investors as a group. In recent years, however, courts and regulators have set out increasingly to protect individual investors against inappropriate behaviour.194 Despite this emerging focus on the protection of individual rights and claims, German securities law does not intend to rid investors of the general risks that are inherent to all transactions in financial instruments.195 As seen above in the context of Canadian and Swiss regulations, German securities regulation seeks to implement the above goals mainly by creating transparency for all market participants. In addition, it requires registration and reporting requirements for key market participants196 and certain investment products.197 Finally, BaFin,198 the German financial markets supervisory authority, aims at realizing the proper functioning and stability of German financial markets by monitoring and analyzing market risks and taking measures to safeguard the integrity of the financial system.199 Like Canadian and Swiss  191  I.e. not to the ‚public’. See also JÖRN KOWALEWSKI, „Prospekt- und Kapitalinformationshaftung in der Schweiz und den USA, 18. Kapital. Schweiz“, in. Klaus J. Hopt/Hans-Christoph Voigt (eds.), Prospekt- und Kapitalmarktinformationshaftung, p. 1008. The same formal argument also applies to redistributions of securities by the issuer, see KOWALEWSKI, p. 1009. 193 PETRA BUCK-HEEB, Kapitalmarktrecht, 3rd edition (Heidelberg. C.F. Müller Verlag, 2009), p. 4. 194 By awarding damages to harmed investors BUCK-HEEB (fn. 193), p. 4. 195 KARL-BURKHARD CASPAR, Anlegerschutz in Deutschland im Lichte der Brüsseler Richtlinien, in. Stefan Grundmann/ Hans-Peter Schwintowski/Martin Weber (eds.), Anlerger- und Funktionsschutz durch Kapitalmarktrecht (Berlin. De Gruyter Rechtswissenschaften Verlags-GmbH, 2006), p. 11. 196 See BUCK-HEEB (fn. 193), p. 191. 197 For mutual fund companies see BUCK-HEEB (fn. 193), p. 246. 198 Bundesanstalt für Finanzdienstleistungsaufsicht. 199 http.//www.bafin.de/nn_721644/EN/BaFin/Functions/Crosssectoralfunctions/crosssectoralfunctions_node. html?__nnn=true#doc721650bodyText4. 192  26  securities regulations, German financial markets law has so far refrained from establishing a comprehensive regulation to cope with systemic risks. 2.  Product Categories  The legal framework of German securities regulation is displayed in several Statutes. The majority of these regulations are based on European Directives.200 Unlike Swiss securities regulation, the German legal framework governing the issue and distribution of securities has largely refrained from scattering disclosure and registration requirements for different product types in different Acts. Rather, its Statutes are organized along the various aspects that have to be regulated for all types of securities. In particular, the German Securities Trading Act201 regulates insider surveillance,202 price manipulation issues,203 early warning duties204 and other transaction-related matters.205 The Stock Exchange Act206, on the other hand, mainly contains organizational rules for German stock exchanges, but also sporadic disclosure obligations and behavioural requirements.207 Finally, the Securities Prospectus Act208 states prospectus duties for securities that are offered to the public209 or are requested to be “admitted on a regulated market”.210 An exception to this topic-based conception of German securities law is the German Investment Act. This Statute regulates (i) the issue and distribution of mutual fund units and (ii) the supervision of mutual fund companies and related entities.211  200  BUCK-HEEB (fn. 193), p. 10. See, in particular, the Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC; the Directive 2004/109/EC of the European Parliament and of the Council of 15 December 2004 on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/EC; and the Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC. 201 Gesetz über den Wertpapierhandel (WpHG), July 26, 1994. 202 § 12 - 20 WpHG. 203 § 20a, 20b WpHG. 204 § 21 - 30 WpHG. 205 BUCK-HEEB (fn. 193), p. 7. 206 Börsengesetz (BörsG), June 21, 2002. 207 BUCK-HEEB (fn. 193), p. 7. 208 Gesetz über die Erstellung, Billigung und Veröffentlichung des Prospekts, der beim öffentlichen Angebot von Wertpapieren oder bei der Zulassung von Wertpapieren zum Handel an einem organisierten Markt zu veröffentlichen ist (Wertpapierprospektgesetz, WpPG), June 22, 2005. 209 For the definition of a public offering, see, § 2 (4) WpPG. 210 Recital 12 of the Directive 2003/71/EC (fn. 200). The term ‘regulated market’ is defined in § 2 (16) WpPG. Investments that are not securities in the sense of § 2 (1) WpPG have to comply with the prospectus requirements of the German Wertpapier-Verkaufsprospektgesetz, September 9, 1998. 211 Such as the custodian bank.  27  German securities regulation centers on several definitions of the term ‘security’. Generally, securities are paper certificates which incorporate a right in such a way that it can be claimed only by the holder of said certificate.212 However, within the scope of the WpHG213 and the WpPG,214 the term has a slightly different meaning. Paragraph 2(1) WpHG sets forth that “securities within the meaning of this Act, whether or not represented by a certificate, are (1) shares, (2) investment securities which are comparable to shares and certificates representing shares, and (3) debt securities (…), if they can be traded on a market”.215 Paragraph 2(1) WpPG defines securities as transferable securities that can be traded on a market. Again, it is not decisive whether these securities are represented by a paper certificate or not.216 Although the above definitions of the term ‘security’ in the WpHG and the WpPG do not entirely correspond, their key understanding of securities concurs with each other217 and, in addition, largely mirrors the definition of ‘transferable securities’ in section 4 (1)(18) of the European Prospectus Directive.218 Further, both the WpHG and the WpPG feature a non-exclusive list of different types of securities. In particular, they mention (i) shares and similar investment securities,219 (ii) debt securities such as bonds or warrants,220 and (iii) any other securities that entitle somebody to buy or sell shares or similar investment securities or effect a cash payment depending on securities, currency prices, interest rates or other returns, indices or market prices of commodities.221 Paragraph 2(2) WpHG specifies that derivatives “are forward transactions in the form of futures or option contracts whose price depends directly or indirectly on (1) the stock exchange or market price of securities; (2) the stock exchange or market price of money market instruments; (3) interest rates or other returns; (4) the stock exchange or market price of commodities or precious metals or (5) currency prices”.222 Further, paragraph 2 (1)(2) WpHG implies that mutual fund units are not securities in the sense of this Act.223 Paragraph 1 (2)(1)  212  BUCK-HEEB (fn. 193), p. 24. Securities Trading Act. 214 Securities Prospectus Act. 215 § 2(1) WpHG. 216 MATHIAS HABERSACK/PETER O.MÜLBERT/MICHAEL SCHLITT, Handbuch der Kapitalmarktinformation (München. Verlag C.H. Beck, 2008), p. 74. 217 See also HABERSACK (fn. 216), p. 74 fn. 28. 218 See also ULRICH KEUNECKE, Prospekte im Kapitalmarkt (Berlin. Schmidt, 2005), p. 106, and HEINZ-DIETER ASSMANN/UWE H. SCHNEIDER, Wertpapierhandelsgesetz. (Köln. Verlag Otto Schmidt, 2009), § 2 n. 4. 219 § 2(1)(1), (2) WpHG, and § 2(1)(a) WpPG. 220 § 2 (1)(3)(a) WpHG, and § 2(1)(b) WpPG. 221 § 2 (1)(b) WpHG, and § 2(1)(c) WpPG. 222 [English text outdated!] 223 See also ASSMANN (fn. 218), § 2 N 33, 34. The definition of securities in § 2 (1) (2) WpHG includes only units of closed-ended investment funds. 213  28  WpPG, on the other hand, sets forth that the provisions of the Securities Prospectus Act do not apply to mutual fund units but refrains from excluding the latter from the term ‘security’. Although German securities regulation is not organized along the various types of investment instruments, its provisions frequently establish distinct product categories and define different duties for each category. In particular, paragraph 7 WpPG and sections 2 (1) and (2) of the European Prospectus Regulation feature a set of schedules and building blocks whose applicability depends on the characteristics of the issued products.224 In view of the above survey of German securities categorization, the four key categories of investment instruments that have been found in Canadian and Swiss securities regulation have also been implemented in the German legal framework for securities.225 The fine-grained differentiation established under sections 2 (1) and (2) of the European Prospectus Regulation is still based on the main categories referred to in paragraph 2 WpHG, paragraph 2 WpPG and section 2 InvG, i.e. (1) equity and (2) debt securities, (3) derivatives and (4) mutual funds. In the following, shares, bonds, mutual funds and a limited range of different derivative instruments226 shall serve as examples of the above four categories of securities. 3.  Regulatory Disclosure Framework  The German disclosure framework for securities is essentially set forth in the WpPG, the Verkaufsprospektgesetz, WpHG, AktG227, and the WpÜG228 and respective Ordinances. Predominantly, these provisions are based on European Directives229 or refer to European Regulations.230 In addition, listed securities have to comply with the requirements enacted by German stock exchanges.231  224  The Commission Regulation (EC) No 809/2004 of 29 April 2004 implementing Directive 2003/71/EC of the European Parliament and of the Council as regards information contained in prospectuses as well as the format, incorporation by reference and publication of such prospectuses and dissemination of advertisements (EU Prospectus Regulation) features 17 different schedules and building blocks which, in turn, can be combined in a multitude of ways [see WIEGEL, Die Prospektrichtlinie und Prospektverordnung. eine dogmatische, öknomische und rechtsvergleichende Analyse (Berlin. de Gruyter Recht, 2008), p. 214]. 225 See this section above. 226 See below, chapter four, sections II.3, III.3, and IV.3. 227 Aktiengesetz (AktG), September 6, 1965 (Stock Corporation Act). 228 Wertpapiererwerbs- und Übernahmegesetz (WpÜG), December 20, 2001 (Securities Acquisition and Takeover Act). 229 See above, fn. 200. 230 See, for example, § 7 WpPG, referring to the European prospectus regulation. 231 See, for example, <http.//deutsche-boerse.com>, listing, rules and regulations.  29  Like the Canadian legal framework for securities, German securities regulation features basic prospectus requirements that apply to nearly all kinds of publicly traded investment products.232 As seen in section 2 above, the WpPG governs the public issue of securities in the sense of paragraph 2 (1) WpPG. According to the WpPG, every prospectus has to be composed of three parts, which are (i) a registration document, (ii) a securities note, and (iii) a summary.233 Further provisions prescribe the format that prospectuses have to assume.234 Paragraph 7 WpPG and section 2 of the European Prospectus Regulation define the minimum content of a prospectus. Issuers of non-listed securities must comply with the same prospectus requirements as issuers of exchange-traded securities.235 Following the issue of securities, issuers must disclose periodic information to investors and the public. This periodic disclosure documentation essentially consists of annual and half-yearly financial reports,236 quarterly interim management statements,237 and an annual document listing ad-hoc announcements, directors’ dealings and changes in the percentage of voting rights held by shareholders.238 In addition, an issuer has to inform the market “without undue delay” about “all inside information which directly concerns that issuer”.239 Inside information is any specific information about circumstances which are not public knowledge relating to one or more issuers of insider securities, or to the insider securities themselves, which, if it became publicly known, would be likely to have a significant effect on the stock exchange or market price of the insider security”.240 Further, persons “discharging managerial responsibilities within an issuer of shares, are obliged to notify the issuer and the Supervisory Authority of own transactions in shares of the issuer or financial instruments based on them, in particular  232  Exceptions are made for mutual fund units (see below) and for investment products that are not considered securities (see fn. 210 above). As the latter provisions are not relevant in relation to the financial instruments analyzed in this paper, they will not be further considered. 233 See recital 14 of the EU Prospectus Regulation, and KEUNECKE (fn. 218), p. 123, as well as BUCK-HEEB (fn. 193), p. 58. On the content of these prospectus elements see below, chapter four, section IV. 234 See KEUNECKE (fn. 218), p. 126 - 133. 235 <http.//deutsche-boerse.com/dbag/dispatch/de/binary/gdb_content_pool/imported_files/public_files/10_ downloads/33_going_being_public/50_others/sm_emittentenleitfaden.pdf>, p. 65. 236 § 37v and 37w WpHG. 237 § 37x WpHG. 238 § 10 WpPG. 239 § 15 (1) WpHG. 240 § 13 (1) WpHG. The provision further states that such “a likelihood is deemed to exist if a reasonable investor would take the information into account for investment decisions”. As a consequence, German standards in relation to ad hoc publicity follow - unlike Canadian and Swiss disclosure regulations - the so called investor impact approach [see also JANIS SARRA, “Modernizing Disclosure in Canadian Securities Law. An Assessment of Recent Developments in Canada and Selected Jurisdictions”, Research Study, Commissioned by the Task Force to Modernize Securities Regulation in Canada (May 29, 2006), p. 94].  30  derivatives, within five business days”.241 Issuers of the affected company have to publish this information “without undue delay”.242 Like its Canadian and Swiss counterparts, German securities regulation features an early warning rule which - implementing the European Transparency Directive243 - requires that a person “whose shareholding in an issuer (…) reaches, exceeds or falls below”244 certain thresholds in relation to share voting rights must notify the relevant issuer who, in turn, has to publish this change in the percentage of voting rights.245 The Securities Acquisition and Takeover Act determines procedures of public takeover offers.246 As seen above,247 the German legislator has decided to create a specific Statute for mutual funds, the Investment Act. Its provisions establish particular disclosure requirements for mutual fund units. In particular, they state that issuers have to create a simplified and long-form prospectus as well as the fund rules.248 These documents have to be updated with information of material importance.249 Further fund-specific disclosure duties largely mirror those of Swiss securities regulation.250 Unlike the Swiss CISA, the German framework for securities does not feature specific rules for structured products. However, derivative instruments are subsumed under the term ‘securities’ of paragraph 2 (1) WpPG and paragraph 2 (1) WpHG and, consequently, the general disclosure requirements of WpPG and WpHG apply. In addition, the WpHG contains several provisions that apply exclusively to derivative instruments in the sense of paragraph 2 (2) WpHG.251 Nevertheless, these regulations are not suitable to create a cohesive and comprehensive regulatory framework for derivatives.  241  § 15a (1) WpHG. § 15a (4) WpHG. 243 See fn. 200. 244 § 21 (1) WpHG. 245 § 26 (1) WpHG. 246 See BUCK-HEEB (fn. 218), p. 215 - 235. 247 See section 2 above. 248 § 42 Investmentgesetz (InvG), December 15, 2003. 249 § 42 (5) InvG. See also KEUNECKE (fn. 218), p. 405. 250 See above, section III.3. 251 See, for example, § 37d, 37g WpHG. 242  31  Exemptions to disclosure rules are set out in the Statutes and Regulations mentioned above. Their rationale is generally in accordance with one of the four elements that have been stated for exemptions in Canadian disclosure regulation.252 The German disclosure framework qualifies as a closed system. Securities that have been issued under an exemption to the prospectus requirement can be resold only if (i) this second sale can be subsumed under another prospectus exemption, or (ii) the seller complies with general prospectus regulations.253  V  Conclusion  In consideration of the above summary of Canadian, Swiss and German securities regulations, the following observations can be noted. First, definitions of the term ‘security’ vary significantly among the three jurisdictions. Whereas Canadian securities regulation has adapted a very broad understanding of the phrase, Swiss and German securities concepts have chosen a far narrower route.254 As this research paper focuses on transparency rules for bonds, mutual funds and derivatives in the retail market, these differences will arguably have no decisive impact on the following analysis.255 However, for clarity’s sake, they should be kept in mind when comparing different disclosure regulations. Second, the three examined jurisdictions vary considerably with respect to their creation and use of different product categories. Canadian general disclosure regulation has largely refrained from establishing legally defined specific product categories. Exceptions have been made for mutual fund units and principal protected notes. Switzerland, on the other end of the scale, has established different legal forms for economically differing product types. Further, the Swiss disclosure framework distinguishes between listed and non-listed securities. German securities regulation, finally, has incorporated elaborate definitions of certain product categories256 and contains a highly differentiated regime to determine the form and content of prospectus disclosure. However, its disclosure framework is mostly consistent and has eliminated undue variations between different product types. Considering the above variety of regulatory approaches, the following analysis has to consider carefully whether  252  See above, section II.3. See, for example, s. 36 Listing Rules, or s. 2 (2) and s. 3 CISA. KEUNECKE (fn. 218), p. 116. 254 See also WIEGEL 224), p. 204, comparing the European and US definitions of ‘security’. Nevertheless, the Canadian framework features cases where its definition of ‘securities’ is narrower than its Swiss or German counterpart. Principal protected notes, for example, that are evidences of deposit issued by a savings institution (see s. 1 BCSA, ‘security’) are not considered as securities, whereas Swiss and German securities regulation do not contain similar exemptions. 255 Moreover, Canadian prospectus requirements apply only if a certain trade in securities qualifies as a distribution (GILLEN (fn. 40), p. 130). 256 See, for example, the definition of ‘derivatives’ in s. 2 (2) WpHG. 253  32  some of these regulatory alternatives are better suited than others to create transparency and fair market conditions. Third, Canadian, Swiss and German securities regulations require disclosure largely on the same occasions and by similar methods. In particular, the three jurisdictions feature prospectus requirements at the issue of securities and distinguish consistently between primary, periodic and timely disclosure measures. Although the contents and formats of disclosure might vary significantly,257 supervisory means to ensure transparent capital markets are not fundamentally different. Fourth, probably the most striking divergence among the analyzed legal frameworks can be located in their different approaches to prospectus regulation. While Canadian securities regulation strives to create a single prospectus scheme for all types of securities,258 Swiss securities law features different prospectus schemes for different product types. German securities regulation, finally, has taken the middle road by listing general prospectus requirements but, at the same time, featuring a multitude of schedules and modules that can be combined depending on the particular product characteristics. Fifth, all the examined jurisdictions have so far refrained from establishing comprehensive disclosure frameworks for derivative instruments. Although there exist sporadic regulations of specific products or constellations,259 they clearly do not comprise all derivative aspects in need of regulation in a consistent manner. In view of these preliminary observations, the below examination will pay particular attention to the following aspects. Prospectuses play a decisive role in capital markets regulation. Consequently, an indepth analysis of the different approaches to defining prospectus requirements is a key element for a thorough understanding of the transparency framework of the three examined jurisdictions. In addition, the above overview has made evident that Canadian and Swiss jurisdictions lack comprehensive transparency requirements for derivatives. Considering the existing fractions of a framework for derivative transparency and the more comprehensive German framework, the following analysis will investigate which of these rules could be implemented in one of the other jurisdictions and what aspects have to be considered when creating an inclusive transparency framework for retail derivative instruments.  257  See below, chapters four and five. And adds sporadic specifications for certain kinds of products (see NI 41-101F1 Information Required in a Prospectus). See, however, chapter four, II.3.4 below. 259 See, for example, the Canadian regulation of PPNs or the Swiss legal framework for structured products. 258  33  Chapter three I  Preconditions for Transparent Capital Markets  Introduction  If we aim at establishing transparent capital markets for retail investors, disclosure requirements have to be drafted with utmost care. In particular, unsophisticated investors might not be in a position to distinguish between valuable and insignificant information. Further, an overwhelming amount of data tends to confuse investors rather than guide them. As a consequence, prospectus provisions and continuous disclosure requirements cannot focus exclusively on the minimum content of these documents, but have to ensure that investors understand how certain investments may impact their funds and whether similar risks can occur with other investment products. The key aspects that have to be considered in order to create transparency in capital markets have already been mentioned under section I of chapter one. (i) Investment products must be delimitable,260 (ii) essential product risks have to be disclosed,261 (iii) relevant information has to be available in a timely and unobstructed manner262 and (iv) prospectuses have to facilitate product comparisons.263 A consistent implementation of the above criteria to disclosure provisions for issuers and intermediaries can pose a major challenge to securities regulators. Although current prospectus frameworks generally acknowledge the four preconditions mentioned above, they have not yet succeeded in fully abolishing all cumbersome factors and often struggle to prevail over the political influence of product issuers and the slowness of legislatory procedures. The following chapter briefly outlines the main characteristics of the above four preconditions for transparent capital markets. Further, it examines several issues that have arisen in Canadian or Swiss securities markets due to an incomplete implementation of these principles. As recent market developments have revealed considerable deficiencies of present disclosure requirements in relation to product delimitability, the following analysis particularly addresses related problems. Product comparability and risk disclosure are mainly fostered through coherent prospectus structures and significant risk indications in the prospectus and other disclosure documents. Consequently, an in-depth  260  See MIRJAM EGGEN (fn. 186), on the necessity to distinguish between mutual funds and derivative instruments such as structured products. 261 See, for example, s. 1.15 of Appendix 1 to CISO, which requires disclosure of specific risks of a mutual fund. See also SARRA, Modernizing Disclosure (fn. 240), p. 17. 262 See also ZOBL/KRAMER (fn. 132), p. 61. 263 See the prospectus templates of SFA for mutual fund prospectuses.  34  assessment of comparability issues under present Canadian, Swiss and German securities regulation will be the object of chapter four below. Finally, Swiss and German securities regulations feature similar product categories264 and, as a consequence, face similar challenges when delimiting or comparing different products. In view of this fact, the following analysis will be limited to an in-depth examination of the above issues under a Swiss and Canadian law perspective.265  II  Product Delimitability  1.  Preliminary Remarks  Canadian securities regulation not only features a very broad understanding of the term ‘security’, but also includes disclosure requirements that apply, as a rule, for all financial instruments qualifying as securities. Considering these facts, one might be inclined to conclude that delimitability is no issue under Canadian securities law at all. However, past experience has shown that the above two characteristics cannot fully prevent discussions on product classification and, hence, on how different product categories can be distinguished from each other. First, as the term ‘securities’ is defined in a non-exclusive manner,266 issuers of products that are not mentioned in the statutory enumeration of securities267 cannot always assess with certainty whether they have to comply with the regulatory disclosure provisions for securities.268 Second, general disclosure requirements have been replaced by specific provisions for particular types of investment products, such as mutual funds269 or principal protected notes.270 Consequently, issuers of investment instruments must assess whether a specific product belongs to one of these particular categories. In order to establish certainty about issuers’ disclosure duties, the above product categories with specific disclosure provisions have to be clearly delimitable to other types of securities.  264  See above, chapter two, section IV.2. If German regulations achieve to solve issues arising under Swiss law, these aspects will be mentioned separately. 266 GILLEN (fn. 40), p. 116. 267 See, for example, s. 1(1) BCSA, ‘security’. 268 See below, section 2.1.a. 269 See, for example, NI 41-101, s. 2.1 (2). “This Instrument does not apply to a prospectus filed under NI 81-101 or a distribution of securities under such a prospectus.” 270 See Principal Protected Notes Regulations, s. 3. Although this provision requires written information about the principal protected note in question, its requirements considerably differ from the general prospectus requirements in NI 41-101. 265  35  As shown under sections III.2 and 3 of chapter two, Swiss securities regulation does not contain a disclosure regime that applies to all kinds of securities. In contrast to the Canadian disclosure framework, specific prospectus requirements and continuous disclosure provisions are designed separately for each product category. As a consequence of this lack of general disclosure rules, unambiguous delimitability of different product categories becomes a vital condition of transparent securities markets. If a product is distributed in accordance with inadequate disclosure requirements, investors may be misled with regard to the product’s characteristics and, hence, inadvertently take risks that conflict with their investment strategy and their available resources. Considering the above, delimitability of different types of investment products is an important precondition to transparent capital markets both under Canadian and Swiss securities regulation. Whereas delimitability issues occasionally arise in the Canadian transparency framework, they come up on a more regular basis in the Swiss compartmentalized transparency regulation. The below sections will first outline current issues in Canadian and Swiss securities regulations that exemplify the above difficulties. Sections three and four will then provide first steps towards a solution for these matters. 2.  Selected Delimitation Issues  2.1  Canada  a.  Securities versus Non-Securities  As already explained in chapter two, section II.3, Canadian securities regulation features general prospectus requirements that apply, as a principle, to all kinds of securities. In consequence of this holistic approach, one of the most crucial questions prior to the distribution of an investment product is whether this product qualifies as a security and, as a result, has to comply with transparency requirements of securities regulation. Accordingly, a concise definition of the term ‘security’ has been the object of careful judicial consideration. In particular, courts have paid much attention to the scope of catch-all provisions such as ‘interest in property’ or ‘investment contract’.271 In this context, Canadian case law has been significantly influenced by precedent U.S. court decisions. In SEC v. C.M. Joiner Leasing Corporation,272 the court decided that the assignment of leases combined with the drill of a test well qualified as a sale of securities, because this business “had all the evils  271 272  GILLEN (fn. 40), p. 119, 120. Securities Exchange Commission v. C.M. Joiner Leasing Corp. (320 U.S. 344 (U.S., 1981)).  36  inherent in the securities transactions which it was the aim of the Securities Act to end”.273 In SEC v. W.J. Howey Co.,274 the court modeled the ‘common enterprise’ test to establish whether a certain transaction should be classified as ‘investment contract’. The test required “(i) a contract, transaction or scheme whereby a person invests; (ii) that the investment be in a common enterprise; and (iii) that the person is led to expect profits solely from the efforts of a promoter or third party”.275 This common enterprise test was complemented in State of Hawaii v. Hawaii Market Center Inc.276 with the ‘risk capital’ test that distinguished itself from the test developed in the Howey case insofar as it did not require that the person expected “profits solely from the efforts of a promoter”277 but rather that “the offeree does not have the right to exercise practical and actual control over the managerial decisions of the enterprise”.278 In Pacific Coast Coin Exchange v. O.S.C.,279 the Supreme Court of Canada approved “the use of U.S. cases and adopted the Howey and Hawaii tests”.280 Further, the court clarified that the third party’s endeavors had to be “undeniably significant for the success of the enterprise”281 if the respective transaction should qualify as an ‘investment contract’. Moreover, the Supreme Court specified that the enterprise did not need to be “common to the investors between themselves”.282 Rather, the efforts of the promoter should aim at creating profit for both the investor and the promoter.283 The above synopsis of the currently prevailing positions of U.S. and Canadian courts in relation to investment contracts has shown the following. U.S. and Canadian courts have chosen a purposive284 interpretation of the term ‘security’.285 In accordance with the wide scope of Canadian securities  273  Exchange Commission v. C.M. Joiner Leasing Corp. (320 U.S. 344 (U.S., 1981)), 349 (see GILLEN (fn. 40), p. 122). Securities & Exchange Commission v. W.J. Howey Co. (328 U.S. 293 (U.S. S.C., 1945). 275 GILLEN (fn. 40), p. 123. See also CONDON/ANAND/SARRA (fn. 55), p. 191. 276 Hawaii Comissioner of Securities v. Hawaii Market Center Inc. (485 P.2d 105 (U.S. Hawaii, 1971)). 277 GILLEN (fn. 40), p. 123. 278 GILLEN (fn. 40), p. 125. 279 (1977), [1978] 2 S.C.R. 112 (S.C.C.). 280 ROBERT YALDEN/JANIS SARRA/PAUL D. PATON/MARK GILLEN/RONALD DAVIS/MARY CONDON, Business Organizations Principles, Policies and Practice (Toronto. Emond Montgomery, 2008), p. 399. See also ibid., p. 401, where the court states three factors which influence the question of whether the agreement in question is an ‘investment contract’, i.e. (i) “the fixing of the base price”, (ii) “the consequent gathering up of a pool of money by the appellant”; and (iii) “the question of solvency of the appellants”. 281 GILLEN (fn. 40), p. 128. 282 GILLEN (fn. 40), p. 128. 283 GILLEN (fn. 40), p. 128. 284 See CONDON/ANAND/SARRA (fn. 55), p. 191. “Here it is assumed that the purpose in question is to protect purchasers of financial claims from those who would seek to take advantage of them.” 285 GILLEN (fn. 40), p. 129. 274  37  regulation,286 catch-all clauses of Canadian Securities Acts substantiating the term ‘security’ are generally given a wide scope of application.287 In addition, the above tests and further clarifications in Pacific Coast Coin Exchange v. O.S.C. have made evident that an abstract definition of the terms ‘investment contract’ or ‘security’ is - under the present conception of Canadian securities law - neither feasible nor desired. Although the establishment of a narrowly defined abstract test would enhance predictability of legal decisions, it would at the same time conflict with the objective of Canadian securities regulation to capture all contracts, transactions or schemes that are “the type of transaction to which securities regulation was intended to be directed”.288 Whereas standard investment products are either mentioned in the statutory enumerations of vehicles qualifying as securities289 or can be positively subsumed under one of the broader clauses of said lists,290 it may not always be possible to determine with absolute certainty whether less standardized products qualify as securities or not. As a consequence, the qualification of these borderline cases is not definite until a respective court decision has been made. b.  Derivatives  aa.  Provincial Derivatives Regulation  As outlined in chapter two, section II.3 above, Canadian securities regulation does not feature a comprehensive framework for derivatives.291 In addition, the provinces have so far refrained from harmonizing their fragmentary regulations governing derivatives. British Columbia and Alberta regulate exchange-traded derivatives292 and OTC derivatives293 “directly through their securities regulation”.294  286  See, in contrast, the Swiss and German terminology of security and their considerably narrower scope of application of securities regulation, chapter two, sections III.2 and IV.2. 287 GILLEN (fn. 40), p. 130. 288 GILLEN (fn. 40), p. 129. 289 See, for example, s. 1 BCSA, ‚security‘. 290 See, for example, GILLEN (fn. 40), p. 117, who elaborates that warrants likely fall under the term ‘any document constituting evidence of an option, subscription or other interest in or to a security’ (s. 1 (1) BCSA, ‘security’). 291 See Ontario Securities Commission Rule 91-504 - Over-the-counter Derivatives and Companion Policy 91-504CP, Introduction, for a definition of the term ‘derivative’. “Derivatives products are, generally speaking, instruments the value of which is dependent, wholly or partially, upon the price, level or value of an external benchmark such as a security, financial instrument, interest rate, foreign exchange rate, index or commodity price.” 292 Exchange traded derivatives are traded through exchanges or other intermediaries (see Expert Panel, Final Report (fn. 45), p. 75). 293 Over-the counter derivatives (OTC derivatives) are “privately negotiated contracts entered into between the contracting parties directly” (Expert Panel, Final Report (fn. 45), p. 75). See below, subsection bb. 294 Expert Panel, Final Report (fn. 45), Appendix 5, p. 75.  38  Whereas exchange-traded derivatives qualify as exchange contracts295 and “are regulated (…) by the imposition of registration requirements”,296 OTC derivatives are considered to be securities in the sense of the Securities Acts. However, “the application of most aspects of securities legislation to OTC derivatives is clawed back through broadly applicable blanket exemptions”.297 Ontario and Manitoba have enacted commodity futures legislation which governs exchange-traded commodity futures contracts and options.298 Other exchange-traded derivatives299 and OTC derivatives300 are subject to the rules of securities regulation (i) if they are considered to be securities in the sense of the respective Securities Act and (ii) if they do not fall into the scope of one of the broad exemption clauses.301. OTC derivatives that do not qualify as securities are, as a rule, not subject to provincial securities regulation. However, section 143 (1) OSA, paragraph 35,302 has been interpreted such that the commission may enact rules for derivatives usually regardless of whether they qualify as securities or not.303 Québec, finally, has enacted a Derivatives Act304 that applies to OTC derivatives and exchange-traded derivatives irrespective of whether these instruments are traditionally considered as securities or not.305  295  And, as a consequence, are “not included in the definition of ‘security’” (Expert Panel, Final Report (fn. 45), Appendix 5, p. 75, 76). 296 Expert Panel, Final Report (fn. 45), Appendix 5, p. 76. 297 Expert Panel, Final Report (fn. 45), Appendix 5, p. 76. See, in particular, BC Blanket Order 91-501 on Over-theCounter Derivatives. 298 Expert Panel, Final Report (fn. 45), Appendix 5, p. 76. Consequently, these instruments do not qualify as securities any longer [see, however, JEFFREY MACINTOSH/CHRISTOPHER NICHOLLS, Securities Law (Toronto. Irwin Law, 2002), p. 18, and CONDON/ANAND/SARRA (fn. 55), p. 190, subsuming options under the term ‘securities’]. 299 This qualification is established (i) either by means of an explicit reference (see, for example, s. 1 OSA, ‘security’ (p), in relation to commodity futures contracts that are not “traded on a commodity futures exchange registered with or recognized by the Commission under the Commodity Futures Act”), (ii) or by subsuming specific derivatives under one of the more general clauses, in particular the term ‘investment contract’ (see GROTTENTHALER/HENDERSON (fn. 73), 10-10), (iii) or, finally, by considering a derivative a common type of security (see, GILLEN (fn. 40), p. 117, with respect to warrants). 300 Expert Panel, Final Report (fn. 45), Appendix 5, p. 76. 301 Due to these exemptions, however, disclosure requirements do generally not apply to OTC derivatives that “fall within the scope of ‘securities’” (Expert Panel, Final Report (fn. 45), Appendix 5, p. 76). 302 And its statement that the Ontario Securities Commission can make rules with regard to derivatives. 303 GROTTENTHALER/HENDERSON (fn. 73), p. 10-14; Expert Panel, Final Report (fn. 45), Appendix 5, p. 76. 304 R.S.Q., chapter I-14.01. 305 S. 4 of the Derivatives Act sets forth a three-part-test with regard to the question whether hybrid products qualify as securities or derivatives. Policy Statement Respecting Hybrid Products of January 22, 2009, provides guidance in relation to the above test (see also OSLER, Québec Derivatives Act and Québec Derivatives Regulation Now In Force, February 3, 2009, <online. http.//www.osler.com/resources.aspx?id=16830>). See also s. 3 (2) Derivatives Act, where a derivative “means an option, a swap, a futures contract or any other contract or instrument whose market price, value, or delivery or payment obligations are derived from, referenced to or based  39  However, “OTC derivatives and transactions [in OTC derivatives]306 involving ‘accredited counterparties’ are carved-out from the application of most of the substantive provisions of the legislation”.307 Unlike the trade of securities, the issue of derivative instruments does not require a prospectus.308 Instead, dealers “must, before the first trade on behalf of a client, give the client the risk information document prescribed by regulation”.309 In consideration of the above outline of provincial approaches to the regulation of derivatives, the following delimitation issues attract immediate attention. All provincial regulations feature clauses that either (i) exempt certain derivative instruments from the scope of securities regulation,310 or (ii) relieve issuers of disclosure and registration duties.311 Whereas issuers of non-derivative instruments have to deal with similar uncertainties, the enormous diversity of derivative structures is bound to provoke more frequent and more fundamental ambiguities than conventionally designed products. In particular, the comparatively narrow concepts of the term ‘security’ in Ontario and Québec Securities Acts may compound issuers’ difficulties in assessing whether certain derivatives qualify as securities. Whereas Québec securities regulation has mitigated delimitability problems by introducing delimitation criteria for hybrid products,312 the Ontario securities commission still applies the above traditional tests313 in order to determine whether a derivative should be considered as a security in the sense of the Ontario Securities Act.314 According to this assessment, a tailored and cash-settled OTC derivative “entered into between sophisticated parties (…) that is not marketed to the public”315 does not qualify as a security.316 Although OTC derivatives with physical settlement may technically qualify as securities in the sense of  on an underlying interest, or any other contract or instrument designated by regulation or considered equivalent to a derivative on the basis of criteria determined by regulation”. 306 See OSLER (fn. 305); CHRISTINE DUBÉ, Canada. The Québec Derivatives Act Comes Into Force (February 19, 2009), online. <http.//www.mondaq.com/canada/article.asp?articleid=74464>. See also Avis Concernant la Décision Générale Relative à la Dispense d’Application des Articles 54, 56 et du Premier Alinéa de l’Article 82 de la Loi sur o les Instruments Dérivées (Décision N 2009-PDG-0007). 307 Expert Panel, Final Report (fn. 45), Appendix 5, p. 77. For the definition of ‘accredited counterparty’ see s. 3 QSA. 308 [abklären!] 309 S. 70 QDA. See also Schedule A (section 12) of the Québec Derivatives Regulation. 310 See, in particular, the exemptions in relation to evidences of deposit or contracts of insurance (see, for example, s. 1 BCSA, ‘security’). 311 See, in particular, BC Blanket Order 91-501 on Over-the-Counter Derivatives. 312 Schedule A. 313 See above, section 2.1.b. 314 GROTTENTHALER/HENDERSON (fn. 73), p. 10-11. 315 GROTTENTHALER/HENDERSON (fn. 73), p. 10-11. The authors state several additional prerequisites such as nonassignability and uniqueness of the product. Further, the agreement has to be “entered on a one-on-one basis” (ibid, p. 10-11). 316 GROTTENTHALER/HENDERSON (fn. 73), p. 10-11.  40  section 1 OSA, their classification is controversial and opinions have been voiced that traditional criteria do not always produce appropriate qualifications of these products.317 Exchange-traded derivative warrants with cash-settlement, structured notes and similarly designed products, finally, “are likely to be properly characterized as securities because of their standardization, the nature of the purchasers, the manner of their distribution and other similarities with conventional securities”.318 bb.  OTC Derivatives and Exchange-traded Derivatives  Canadian securities regulation distinguishes between exchange-traded and over-the-counter derivatives.319 Exchange-traded derivatives are generally described as instruments that are traded on an exchange,320 whereas OTC-derivatives are characterized as “privately negotiated contracts that may be transferred to a third party only under terms agreed to by the parties”.321 Originally, OTC derivatives were tailor-made products that were traded almost exclusively between sophisticated parties. As a result, the above derivative-specific distinction between OTC-derivatives and exchange-traded derivatives overlapped to a large extent with the widely accepted notion that sophisticated investors322 need less protection than retail investors. However, more recent product developments have made evident that non-listed derivative products may well be issued in a standardized form and then be distributed to retail investors.323 As a consequence, the above distinction between exchange-traded products and OTC derivatives has been questioned and, to some extent, amended by provincial securities regulators to address the new challenge. In particular, the recently enacted Québec Derivatives Act has replaced the conventional distinction between exchange-traded derivatives and OTC derivatives by introducing the class of ‘standardized derivatives’ “that [are] traded on a published market, whose intrinsic characteristics are determined by that market and whose [trades are] cleared and settled by a clearing house”.324  317  GROTTENTHALER/HENDERSON (fn. 73), p. 10-12. GROTTENTHALER/HENDERSON (fn. 73), p. 10-13. 319 See, for example, ROBERT M. SCAVONE/SHAHEN A. MIRAKIAN/JULIE VAN BERLO, Derivative Structures, online. <http.//www.mcmillan.ca/Upload/Publication/DerivativeStructures_RecentDevelopments_2008.pdf>. 320 S.1 BCSA ‚exchange contract’, and s. 1 Commodity Futures Act (R.S.O. 1990, c. C.20), ‘commodity futures contract’. 321 SCAVONE ET AL. (fn. 319). 322 GILLEN (fn. 40), p. 251. 323 See, in particular, the growing sectors of PPNs and principal at risk notes. 324 S. 3 QDA, ‘standarized derivative‘. See also BC Blanket Order 91-501 on Over-the-Counter Derivatives, Part two, which states. “The registration and prospectus requirements of sections 34 and 61 of the Act do not apply to a trade in an OTC derivative where each party to the trade is a Qualified Party acting as principal”, whereby the term ‘qualified party’ is defined in s. 1.1 of the Order. Further, see s.1 (d) Alberta Blanket Order 91-502 which includes 318  41  Considering the abundance of non-listed structured notes that have been distributed to retail investors in recent years, the following preliminary conclusions can be drawn from the above explanations. Delimiting OTC derivatives from other derivative investments is appropriate only if this distinction mirrors relevant differences in the product characteristics. In view of the above, the still predominant differentiation between exchange-traded and non-listed derivative products no longer seems an adequate way to structure the legal framework for derivatives. In fact, product developments mentioned in this section indicate that the approach chosen by Québec derivatives regulation - i.e. the delimitation of standardized derivative products from tailor-made derivative investments - is a more promising way to capture relevant differences in present derivative structures. However, it remains to be noted that the Québec Derivatives Act325 has so far confined its scope of standardized derivatives “whose intrinsic characteristics are determined by”326 the market they are traded on. Consequently, structured notes327 and exchange-traded options that are issued by investment banks, mostly in the form of book-entry securities or global notes, do not fall under the scope of the term ‘standard derivative’ and, consequently, issuers of such products would generally have to follow disclosure regulations for securities.328 cc.  Federal Principal Protected Notes Regulation  Another delimitation issue arises from the fact that provincial jurisdictions have largely refrained from applying their securities laws to principal protected notes and other evidence of deposit, be it by carving them “out from the definition of ‘securities’”329 or by creating exemptions from prospectus and registration obligations.330 In order to fill this regulatory gap, the federal government has issued disclosure requirements for PPNs331 which do not accord with prospectus requirements of provincial securities regulation. As a consequence, issuers of structured notes have to assess whether their products are PPNs and, therefore, subject to federal banking regulation, or whether they qualify as  the ‘qualified party’-requirement in the definition of the term ‘OTC derivative’ (see also MCMILLAN, The Law of Derivative Structures in Canada (2005), online: <http.//library.findlaw.com/2005/Jun/7/246682.html>). 325 As all the other provincial definitions of ‘exchange contracts’. 326 S. 3 QDA, ‘standarized derivative‘. 327 See explicitly Policy Statement respecting Hybrid Products, February 1, 2009. 328 As far as can be seen, these instruments are not traded Canadian stock exchanges do not feature yet. 329 MCMILLAN, Investment Funds and Asset Management Group Bulletin, Principal Protected Notes. Federal Minister of Finance Issues New Disclosure Regulations (2008), online. <http.//www.mcmillan.ca/Upload/ Publication/PrincipleProtectedNotes_0608.pdf>, p. 1. 330 MCMILLAN (fn.329). 331 Subsections 31(1) and (3) PPN Regulations.  42  another type of derivative which might require their compliance with disclosure provisions of provincial securities regulations. dd.  Proposed Canadian Securities Act  The Proposed Canadian Securities Act seeks to approach derivatives regulation in a more comprehensive manner than current provincial regulations. Part 7 of the Proposed Act clarifies that the new regulatory regime will uphold the currently predominant distinction between exchange-traded and OTC derivatives.332 Further, derivative instruments that qualify as securities in the sense of section 2 of the Proposed Act - but are neither exchange-traded nor designated derivatives333 - can be distributed only if their issuers comply with general disclosure requirements set forth in Part 6 of the Proposed Act. In order to tackle the delimitation issues described in sections (aa) and (bb) above, the Act introduces the category of ‘designated derivatives’. These types of derivative instruments are subject to specific disclosure requirements and do not have to follow general prospectus obligations. Moreover, section 92 of the Act enables the national regulator to govern specific derivative instruments that do not qualify as securities but are in need of supervision and adequate disclosure. The CSTO’s effort to create a comprehensive framework for derivatives is a highly welcome development. In particular, the regulator’s awareness that different types of derivatives may require different levels of disclosure and tailored procedures is a promising step towards a coherent disclosure framework for derivatives. In addition, the Proposed Act recognizes that the qualification of a particular instrument as a ‘non-security’ must not bar the regulator from implementing appropriate disclosure rules in relation to the derivative in question. However, the provisions of the Proposed Act refrain from further defining the different types of derivatives and their respective disclosure requirements. Moreover, the Act does not determine the relationship between its derivatives regulations and Canadian PPN Regulations. Finally, the Proposed Act does not reveal whether its regulations will adopt at least partially - the approach chosen by Québec derivatives regulation and implement different rules for standardized derivative products than for tailor-made derivative investments.334 As a result, a  332  See, in particular, s. 89 of the Proposed Act. See below in this section. 334 The distinction between exchange-traded derivatives and other derivative instruments in s. 89 of the Proposed Act will not necessarily prevent the regulator from making the above delimitation. S. 2, ‘exchange-traded derivative’, defines this type of derivative as a “derivative that is traded on an exchange under standardized terms determined by the exchange or a clearing agency”. Consequently, structured notes and exchange-traded options that are issued by investment banks, mostly in the form of book-entry securities or global notes, do not fall under the scope of the term ‘exchange-traded derivative’ and, consequently, issuers of such products would generally have to follow prospectus requirements for securities or disclosure requirements for ‘designated derivatives’. As 333  43  detailed assessment of the future Canadian framework for derivatives cannot be conducted until the derivative-specific regulations have been published and, consequently, will not be included in this thesis. However, it remains to be emphasized that the CSTO’s decision to provide the national regulator with a broad capacity to regulate exchange-traded and OTC derivatives sets a key precondition for a concise and comprehensive Canadian framework for derivatives. c.  Sub-conclusion  The above survey of current delimitation issues in Canadian securities regulation has shown the following. If questions in relation to delimitation of investment categories arise on a regular basis, this is not necessarily a sign of lacking or flawed legislation. Rather, it can also be a manifestation of the legislator’s endeavour to acknowledge each case individually and to apply disclosure provisions only if required by the purposes of securities regulation. However, if uncertainties are not limited to individual cases but extend over an entire product category, the key objectives of securities regulation335 cannot be pursued in an effective manner anymore. Consequently, the displayed regulatory inconsistencies in relation to derivative instruments are not inevitable by-products of Canada’s purposive approach to securities regulation, but can be eliminated by the implementation of comprehensive and nationally streamlined disclosure rules for derivative instruments. Chapters four, five and seven below will put a particular focus on the question of how such a framework for derivatives should be designed. 2.2  Switzerland  a.  Preliminary Remarks  As outlined in chapter two, section III.2 above, the Swiss legislator has introduced specific rules for ‘structured products’ without defining the term in the respective Statute.336 As a result of this definitory gap in the Swiss legal framework for structured products, their delimitation from other investment products has to be conducted by means of the key characteristics of these other products. The following sections will display current delimitation issues that have arisen between structured products and mutual funds. Further, uncertainties in relation to the categorization of mutual funds into index-related and actively-managed funds will be identified under section 2.2.c below.  the CSTO has not yet issued a draft of its regulations for derivative instruments, the matter cannot be further assessed in this thesis. 335 I.e. protecting investors and creating efficient capital markets 336 CISA Message, p. 45.  44  b.  Structured Products versus Mutual Funds  aa.  General Delimitation Criteria  Section 7 (1) CISA states that mutual funds “are assets raised from investors for the purpose of collective investment, and which are managed for the account of such investors”. Hence, the core characteristics of mutual funds are (i) a separate pool of assets that are (ii) managed by a third party and (iii) serve as a collective investment.337 As mentioned under section 2.2.a above, Swiss legislation does not feature a definition of the term ‘structured product’. Consequently, delimitation of mutual funds from structured products has to be approached with the key characteristics of mutual funds as the decisive delimitation criteria. As issuers of mutual funds, unlike issuers of structured products, are required to keep the fund’s assets separated from their own moneys,338 asset pools may indicate that the issuer of the respective products has created mutual funds and not structured products. However, the non-existence of a separate asset pool does not necessarily mean that an investment product does not qualify as a mutual fund.339 Further, structured products can be managed passively or actively. If the issuer of a structured product continues to have discretion with regard to the product’s composition, this product is managed actively and in a similar way to a mutual fund. As a consequence, the management of assets by a third party is not suited to the delimitation of mutual funds from structured products either. However, in contrast to mutual funds, structured products never entail a collective investment of the raised moneys.340 Rather, the issue of structured products provides investors with a claim against the product’s issuer341 but does not commit the latter to invest the funds on behalf of the investors into the product’s underlying components.342 In view of this structural difference in the design of mutual funds and structured products, the key distinctive feature between these two investment vehicles consists of the fact that a mutual fund’s portfolio manager manages assets on behalf of the unitholders, whereas  337  FRANZ HASENBOEHLER (ED.), Recht der Kollektiven Kapitalanlagen unter Berücksichtigung steuerrechtlicher Aspekte (Zürich/Basel/Genf. Schulthess, 2007), p. 210. 338 See also s. 35 CISA, which states that “in case of bankruptcy [of the fund management company], assets and rights belonging to the fund management company will be segregated in favor of the investors”. 339 Legislation requires that issuers of mutual funds keep the fund’s assets separate from their own assets. As a result, the creation of asset pools is a consequence of a mutual fund’s existence rather than a precondition (see also HASENBÖHLER (fn. 337), p. 211; SILVIO HUTTERLI, Strukturierte Produkte, Ausgestaltung, Emission und Handel aus rechtlicher Sicht (Zürich/St. Gallen. Dike Verlag, 2008)., p. 89; MATTHÄUS DEN OTTER, Kommentar zum Schweizerischen Anlagefondsgesetz (Zürich. Schulthess, 1997), s. 2 AFG n. 6) 340 HASENBÖHLER fn. 337), p. 211. 341 EGGEN, Structured Products (fn. 186), p. 382. 342 HUTTERLI (fn. 339), p. 91.  45  investors of structured products generally no longer have any relations to the issuer’s use of the invested moneys.343 bb.  Collateralization of Structured Products  i.  Collateral Secured Instruments (COSI)  Following the Lehman bankruptcy, Swiss retail investors suffered considerable losses due to the counterparty risk inherent in structured products.344 In order to meet the concerns that investors have raised in relation to the reliability of such investments, issuers of structured products and the Swiss stock exchange SIX have introduced so-called collateral secured instruments (COSI). Issuers who have signed the Framework Agreement for Collateral Secured Instruments345 agree that a third party, called the ‘collateral provider’, “undertakes to grant SIX Swiss Exchange a right of lien on selected securities”.346 As soon as certain pre-defined events347 occur, “the collateral will be liquidated (…) and the COSI shall become due and payable within a certain time period”.348 The collateral is not allocated to specific issues of certificates349 and a partial collateralization is not approvable.350 Investors have no right of lien on the securities serving as collateral.351 The above collateralization significantly reduces investors’ risks of facing a defaulting counterparty. However, in spite of this risk minimization in case of an issuer’s insolvency,352 COSI clearly neither entail a direct obligation that issuers invest investors’ moneys collectively, nor do they imply any indirect collective investment duty. In particular, investors do not have an individual right of lien on the  343  Recent product developments feature elaborate collateralization schemes and, consequently, issuers are contractually obligated to invest the investors’ money in a certain way. However, the products are not governed by mandatory requirements that might force issuers to invest these moneys in a certain way. 344 See EGGEN, Prospectus (fn. 147), p. 105. 345 See <http.//www.six-swiss-exchange.com/download/admission/cosi/framework_agreement_cosi_de.pdf> for the German wording of the framework agreement. The agreement is concluded between (i) the issuer and collateral provider conclude and (ii) SIX Swiss Exchange and SIX SIS (see <http.//www.six-swiss-exchange. com/admission/cosi/cosi_overview_en.html>). 346 Collateralization of certificates - a service of SIX Swiss Exchange, Information for investors in Collateral Secured Instruments, p. 2, online. <http.//www.six-swiss-exchange.com/download/admission/cosi/ibt_fs_aug09_en.pdf>. 347 See Collateralization of certificates (fn. 346), p. 5. 348 Collateralization of certificates (fn. 346), p. 1. 349 See Framework Agreement (fn. 345), s. 4.1.6. 350 See Framework Agreement (fn. 345), s. 4.1.4. 351 Framework Agreement (fn. 345), s. 4.2.4, and Collateralization of certificates (fn. 346), p. 2. 352 Collateralization of certificates (fn. 346), p. 2.  46  collateral. In addition, an issuer’s collateral covers all its COSI and is not allocated to specific issues. As a consequence, COSI clearly qualify as structured products and disclosure rules of section 5 CISA apply.353 ii  Mitigation of Counterparty Risk by Compartmentalization  In order to facilitate issuers’ ability to distinguish between structured products and mutual funds, FINMA has issued several non-binding354 Guidelines. In particular, FINMA has established criteria setting out how issuers should determine whether a foreign special purpose vehicle (SPV) qualifies as a mutual fund and, therefore, cannot follow the disclosure requirements of structured products. Among others, FINMA states that SPVs qualify as mutual fund vehicles if they issue only one product or if they issue several products whose assets are kept in legally separate compartments.355 Since June 2007, DWS GO S.A. (DWS), a Luxembourgish securitization company,356 has issued structured products in Switzerland that are structured as follows. First, each product is issued from a legally separate compartment of DWS. Second, DWS GO S.A. has entered into an OTC swap agreement with Société Générale S.A. (OTC counterparty), a bank based in Paris. According to this agreement, DWS swaps the proceeds from the sale of a product for “assets [that] reflect the pay-out profile of the Structured Product and ensure that DWS GO is in a position to meet its obligations to the investor under the Structured Products at all times”.357 Third, counterparty risk is reduced by means of a further agreement between DWS and the OTC counterparty, committing the latter to deposit securities as collateral for the DWS compartments, either in an account at the OTC counterparty,358 or in an account at Deutsche Bank Luxembourg S.A, the custodian bank of DWS.359 Considering the above non-binding Guidelines of FINMA, an infringement of these rules by the DWS GO products appears to be most likely. As the launch of the above products has been discussed with FINMA prior to the products’ distribution to investors, the example clearly shows that Swiss law has not yet found satisfactory delimitation criteria for compartmentalized structured products and mutual funds.  353  See also Framework Agreement (fn. 345), s. 15.3. See <http.//www.finma.ch/E/FAQ/Pages/default.aspx>. “The information contained in the "Frequently Asked Questions" (FAQ) is purely informative, does not justify any legal right nor bind the FINMA in its decisions.” 355 Frequently Asked Questions, Structured Products, s. 16, online. <http.//www.finma.ch/e/faq/beaufsichtigte/ Pages/faq-strukturierte-produkte.aspx>. 356 And a member of the Deutsche Bank group. 357 DWS GO - a New Generation of Structured Products, online. <http.//www.dwsgo.ch/EN/MediaLibrary /Auto/Document/DWSGOSwitzerland_presentation_200807_en.pdf>, p. 6. 358 Final conditions for the issue of DWS GO/Harvest 5-year Plan Beneficiaries TR Index Certificates, June 18, 207, p. 12, online. <http.//www.dwsgo.ch/MediaLibrary/Auto/Document/DWS_GO_Harvest_5JahresPlan_Bedingungen. pdf>. 359 DWS GO For Safety, online. <http.//www.dwsgo.ch/MediaLibrary/Auto/Document/Flyer%20English.pdf>. 354  47  Whereas the issue of structured products whose assets (i) are kept separate from other moneys and (ii) are invested in line with the products’ components undoubtedly converges with the issue of a mutual fund, matters are more complex if only the first of the above criteria is met by the issued products. In such cases, product documentation does not limit issuers or issuers’ counterparties360 in their investment of the investors’ moneys. Rather, investors simply have a claim against the issuer for pay-out in accordance with product documentation. From a legal point of view, investors do not buy products whose structures are in accordance with the characteristics of mutual funds. However, if these pay-out obligations are secured such that the counterparty risk inherent to conventional structured products is almost eliminated,361 the economic outcome and risk for investors buying these products is virtually the same as if they bought units of a mutual fund. In view of the above, the Swiss legislator has not yet decided whether a strict legal analysis shall prevail over a regulatory approach that is based on an economic assessment of the respective products. iii.  ETC  Swiss investors may also come across so called ETCs, i.e. Exchange Traded Commodities.362 These investment products mirror commodity indices and are traded on several European stock exchanges such as the Frankfurt Stock Exchange or the Swiss SIX Swiss Exchange.363 They qualify, from a Swiss law perspective, as structured products in the sense of section 5 CISA.364 However, the complex structuring of some of these products causes similar delimitation issues as the DWS products mentioned under section ii above. In particular, T-ETCs365 issued by Source Commodity Markets P.L.C. (Source CMP)366 feature similar collateral structures to the above DWS products.367 In addition, Source CMP does not confine itself to passing the proceeds from the product sale to their swap counterparty, but rather invest these moneys in US treasury bills. The performance of these T-bills is then swapped for the total return performance of the relevant commodity index.368  360  As above with the products of DWS GO. See below, section 3, for an in-depth assessment of counterparty risk and their relevance in relation to product delimitation. 361 See, for example, the DWS GO Safe products where a deposit at the issuer’s custodian bank is established. 362 Source T-ETCs Commodity Handbook, online. <http.//www.source.info/index.action>, p. 4. 363 See, for example, UBS-ETCs, online. http.//www.ubs.com/4/investch/cmci/etc_content_e.html. 364 See, for example, Final Terms of UBS ETC on UBS Bloomberg CMCI Agriculture CHF Hedged Index, p. 3, online. <http.//www.source.info/index.action>. 365 Treasury Bill Secured Exchange Traded Commodities. 366 A public company incorporated in Ireland. 367 See Exchange Traded Products, Counterparty risk, online. <http.//www.source.info/index.action>, p. 8. 368 T-ETC Handbook (fn. 362), p. 4.  48  Considering the above product structure, delimitation of structured products from mutual funds has become even more intricate. By investing the investors’ moneys in US T-Bills, Source CMP appears to conduct a collective investment of the raised moneys. Although investors in T-Source ETCs technically still do not have a holding in a mutual fund but only a claim vis-à-vis the products’ issuer, they know how the issuer is going to invest the proceeds from the product sale and can successfully assert the contractually agreed proceedings in case of the issuer’s non-compliance with the promised investment and collateral strategy. As a result, the necessity for the legislator to decide whether a legal product assessment should prevail over an economic analysis grows even more acute than under section ii above. cc.  Sub-conclusion  Section b.aa above has outlined the prevailing approach to delimiting mutual fund vehicles from structured products and has identified the collective investment of investors’ moneys as the distinctive feature that enables investors to tell apart these two types of investment products. Whereas unitholders of mutual funds own a share of the mutual fund company or the contractual fund vehicle, investors in structured products have only contractual claims vis-à-vis the products’ issuer and, therefore, may face the counterparty risk in relation to the issuer. However, recent product developments have succeeded in mitigating this risk by introducing separate compartments for each product and requiring collateralization of third parties’ obligations toward the issuer. What is more, complex mutual fund structures often feature significant counterparty risks, albeit not in relation to the product’s issuer but with regard to swap counterparties of the mutual fund vehicle.369 As a consequence of the above evolution of both structured products and mutual fund structures, collateralized structured products may bear similar counterparty risks to those borne by mutual funds. In this setting it appears at least questionable whether a strictly legal assessment of the two product types is still adequate. In view of the economic convergence of structured products and mutual funds, one might be tempted to abandon the present categorization criteria in favour of the products’ underlying economic characteristics. Section 3 below will contemplate which approach seems to be more appropriate to create an adequate balance between the legal frameworks for mutual funds and structured products.  369  See Exchange Traded Products (fn. 367), p. 3.  49  c.  Exchange Traded Funds  Section 7 CISA states that mutual funds “are assets (…) managed for the account of (...) investors”. Following this statutory definition, fund managers are free to manage the fund’s assets in their sole discretion as long as they comply with fund regulations370 and statutory provisions.371 Investors, on the other hand, are not allowed to interfere with managers’ investment decisions.372 Exchange traded funds are “exchange-listed investment funds that have no fixed maturities and are continuously tradable during official exchange hours. In most cases, the objective of an ETF is to replicate a specific underlying index”.373 As a consequence, fund managers’ discretion in the management of the fund’s assets is virtually non-existent in relation to index-related ETFs. Following the above definition of mutual funds, opinions have been voiced that passively managed funds would not be managed by the fund managers but rather by the investors who had decided to invest in said fund.374 However, other authors have argued that managers of index funds still have an adequate amount of discretion, for example in relation to the amount of liquid assets of the fund or the point in time at which specific assets are sold.375 In view of the fact that FINMA qualifies ETFs as mutual funds on a regular basis, more recent publications have abstained from further commenting on this issue. ETFs index structures bear another noteworthy delimitation issue. Although Federal Regulations and Stock-exchange Rules have so far not introduced specific rules for ETFs,376 SIX clearly distinguishes between passively managed ETFs377 and “actively managed”378 ‘investment funds’.379 However, SIX has so far refrained from disclosing to investors what kinds of changes in the index composition or the weighting of an individual index component are still acceptable if an issuer wants to label its mutual  370  Or the fund contract. FRANÇOIS RAYROUX/SHELBY R. DU PASQUIER, Basler Kommentar zum Kollektivanlagengesetz (Basel. Helbing Lichtenhahn, 2009), s. 7 CISA n. 16. 372 BSK-RAYROUX/DU PASQUIER (fn. 371), s. 7 CISA n. 17. 373 SIX ETF handbook, online. <http.//www.six-swiss-exchange.com/download/market/funds/publications/ etf_guide_en.pdf>, p. 2. 374 MARC WICKI, Der börsliche Handel mit Anlagefondsanteilen aus Sicht des Anlagefondsgesetzes, unter besonderer Berücksichtigung der Exchange-Traded Funds (ETF) (Zürich/Basel/Genf. Schulthess, 2003), p. 192, 193, in particular fn. 184. 375 ARMIN KÜHNE, Bewilligungspflicht gemäss Anlagefondsgesetz (Zürich/Basel/Genf. Schulthess, 2002), p. 118. 376 See, however, s. 106 Listing Rules which states that SIX “may issue implementing trading provisions for certain types of mutual funds, such as real estate funds and exchange-traded funds”. 377 See <http.//www.six-swiss-exchange.com/marketpulse/knowhow/products/funds/types/etf_en.html>. “Unlike actively managed investment funds, ETFs track the prices and returns of underlying indices”. 378 <http.//www.six-swiss-exchange.com/marketpulse/knowhow/products/funds/types/immo_en.html>. 379 The term is used for actively managed mutual funds in SIX regulations and does not relate to a legally defined particular type of mutual fund. 371  50  fund an ETF.380 If issuers or related parties are able to influence the index structure in a discretionary manner and on a frequent basis, index-related products do not seem to be passively managed any longer. Further, indirect replication of the index entails that a fund manager’s discretion in relation to the fund’s assets goes far beyond a mere investment in securities which “form part of the relevant index”.381 These uncertainties are even more pronounced in relation to non-listed index funds. Neither Federal Regulations nor Guidelines of FINMA clearly define the term of an index fund and, consequently, investors who are not sufficiently sophisticated to understand the index-related product documentation may never be fully certain whether they invest into an actively or passively managed product. d.  Sub-conclusion  Sections b and c above have analyzed two different delimitation issues in present Swiss securities legislation. While the search for adequate delimitation criteria in relation to structured products and mutual funds strives for a clear distinction between two product types with different regulatory frameworks, delimitation uncertainties discussed in section c refer to material differences within the same product category. However, both problems ask the legislator to choose between substance and form. The following section will briefly address this question by drawing on the above examination of Canadian and Swiss delimitation issues. 3.  Genuine Distinguishing Features versus Duty to Label  The above analysis of current delimitation issues in Canadian and Swiss securities regulation has given the following insights. First, Canadian securities law lacks a streamlined approach to derivative instruments. The existing fragmentary frameworks are not suitable to establish adequate transparency in relation to disclosure procedures for derivatives. As a consequence, delimitation issues arise due to a lack of regulation, rather than as a consequence of conflicting rules. Further, the Canadian framework features one382 vital exception to its substantive approach to product regulation. National Instrument 81-101 and, in particular, the attached Form 81-101F1, list prospectus requirements that apply specifically to Canadian mutual funds. As a result of this deviation from the otherwise strictly substance-  380  See, however, SIX Directive on Debt Securities with Specific Structures, October 29, 2008, online. <http.//www.six-exchange-regulation.com/admission_manual/06_10-DDSS_en.pdf>, s. 11 (2). “For qualification as an AMC [Actively Managed Certificate], it is negligible whether a given product is directly based on a discretionary managed basket or indirectly based on an index as its underlying security.” Consequently, SIX has created specific rules and delimitation criteria with respect to listed debt securities. 381 See Exchange Traded Products (fn. 367), p. 3. 382 In addition, product exemptions exist for those instruments that are not considered securities, such as the PPNs mentioned above.  51  oriented regulatory approach, delimitation issues examined under section 2.2.b above might arise not only under the Swiss disclosure framework, but also in the context of Canadian mutual funds regulation. Second, unlike Canadian securities regulation, the Swiss disclosure framework for securities features a significant number of different product categories and respective disclosure provisions. As a result of this abundance of differing rules, delimitation problems arise when product categories converge and, consequently, several disclosure regimes start to compete for application. While Canadian securities regulation has largely chosen to assess products with a view to their economic structure and exposure, the Swiss legal framework still struggles to harmonize its formal legal typology of investment products with the products’ distinctive substantive features. As mentioned under section 2.d above, the Swiss legislator is bound to make a choice between substantive and formal product regulation. The above issues have made evident that the fast-paced evolution of investment products no longer allows the regulator to sufficiently streamline formal product categories and constant product innovation. Whether the Swiss legislator should take the path of Canadian securities regulation or whether it would be better advised to stick to a formalistic product typology is a tough question to answer. While responses prior to the global financial crisis might have encouraged the Swiss regulator to go forward with a formal disclosure regime,383 recent incidents384 have shown that the benefits of a more substantive approach should not be easily dismissed. Third, when weighing the reasons in favour of a substantive approach to disclosure regulation against those in favour of a formal disclosure regime, legislators have to consider both key objectives of securities regulations, i.e. investor protection and fostering of efficient and fair capital markets. While a mere substantive approach satisfies the first goal385 by assessing the products from an economic perspective, the concept of formal product categorization enables investors to choose between thoroughly supervised products and their lightly regulated counterparts which, in turn, may allow issuers to respond in a timely and cost-effective386 manner to new market trends. If applied exclusively, both approaches succeed in reducing delimitability issues to a minimum, either by bypassing traditional product categorization387 or by accepting the issuer’s choice of legal form.388 However, a combination of  383  And, thus, enable issuers and investors to choose between heavily regulated investment instruments and largely unsupervised and, therefore, more flexible investment products. 384 As, for example, the bankruptcy of Lehman and the ensuing loss of moneys by retail investors who were not aware of the basic characteristics of their investment products. 385 GILLEN (fn. 40), p. 92, 93. 386 GILLEN (fn. 40), p. 93. 387 Substantive approach.  52  substantive and formal elements might be the most successful means to keep an appropriate equilibrium between the above objectives of securities regulation. In view of these observations, a decision in favour of or against a substantive or formal approach to securities disclosure appears to be more complex than originally assumed. In particular, legislators have to strike a balance between compulsory measures to protect investors and issuers’ freedom to structure investments in an efficient and innovative manner. As seen under sections 2.2.b and c, an exhaustive convergence of formal and substantive approaches to product regulation cannot be accomplished any longer under the constantly evolving market conditions. Consequently, if legislators want to combine elements of formal and substantive regulation, they must determine whether their principal approach is founded on substantive or formal regulation. Subsequently, they can define specific constellations where deviations from this principal approach are of vital importance to foster either investor protection or efficient and fair markets. If, for instance, the Swiss legislator should settle for a formal approach to securities regulation, it must, at the same time, define constellations where substantive product regulation should prevail over the overall formal framework. In particular, the Swiss legislator may choose to ban actively managed structured products for retail investors and, thus, constrain issuers to distribute all actively managed389 complex investment products under the same disclosure regulations.390 Under this regime, issuers would, however, still be allowed to create passively managed structured products and could choose, for example, between the issue of a thoroughly regulated mutual fund and a significantly less cumbersome origination of a structured product. A less radical approach to the above problem would try to find ways to protect investors’ interests within the chosen formal approach. In particular, Swiss regulators might decide to implement a distinct and consistent labelling duty for issuers and, if applicable, a clear indication that a certain product is not monitored by supervisory authorities. By doing so, Swiss securities regulation would adhere to a largely formal approach to product regulation. Consequently, issuers could adapt product structures to the investors’ requirements391 as long as they comply with the legal requirements set forth in relation to the chosen product category. Their freedom of choice would be hampered only by their duty to apply  388  Provided that it complies with the legal requirements that these predefined categories implicate (formal approach). 389 Beside the structural complexity of these products, managers’ continuous discretion on how the investors’ funds should be managed might require ongoing monitoring by supervisory authorities. 390 Such ban would effect that actively managed structured investment products would all be subject to the rules for mutual funds. 391 I.e. thorough regulation versus timeliness and cost-effectiveness of the product.  53  explicit labels and disclaimers in relation to the supervisory standards the respective product is subject to. Due to their compromising character, neither alternative fully relieves issuers and regulators from their task to delimit certain product types from others. Nevertheless, they would provoke significantly fewer borderline cases than the present Swiss disclosure framework. Further, residual delimitability issues could be understood as manifestations of the legislation’s willingness to assess individual cases in a careful manner rather than dismiss them without close attention. Whether one of the above two alternatives is better fitted to solve the present dilemma in Swiss securities regulation cannot be answered without an in-depth analysis of the present disclosure framework. In addition, it might be worth considering whether Canadian disclosure regulation should seek to complement its substantive approach by selected formal elements.392 This could be particularly promising where Canadian law has already introduced formal product categories393 and, therefore, might face similar delimitation issues to those encountered by the Swiss legal framework. These questions will be addressed - among others - in chapter seven, section II below. 4.  Sub-conclusion  Reviewing the above explanations, two aspects have attracted particular attention. To begin with, Canadian and Swiss securities regulations have chosen different approaches to govern the issue of investment products. Whereas Canadian regulators focus on a substantive analysis of issued products, Swiss legislation has sought to establish formal product categories that mirror the economic characteristics of different product types. While Canadian securities regulation may continue with its chosen approach, the Swiss disclosure framework will not be able to sustain its concept of converging substantive and formal aspects into different product categories. Considering the different options the Swiss legislator might choose, section 3 above has found that an uncompromising implementation of either a substantive or formal approach to disclosure regulation might not be the most promising way to enhance investor protection and market efficiency. Instead, concise concessions to investors’ protection needs or issuers’ growing demand for flexibility and innovation appear to be better suited to accomplish a balanced pursuit of the key objectives of securities regulation.  392  See also FOK KAM, IDA Task Force, p. 258. “We need to balance investor protection with the legitimate need of product structureers to seize business opportunities and launch new products expeditiously”. 393 I.e. in the field of mutual funds and PPNs.  54  III  Disclosure of Essential Product Risks  1.  Preliminary Remarks  Risk disclosure in relation to specific investments is generally contained in prospectuses and other key documents related to a product and its characteristics. In addition, supervisory authorities increasingly focus on the relationship between investors and intermediaries at the point of sale. The below explanations will (i) outline present Canadian and Swiss risk disclosure standards at both levels and (ii) briefly discuss in which direction possible amendments should move. 2.  Issuer Risk Disclosure  2.1  Overview  In order to make informed decisions, investors have to be aware of the essential risks connected with a certain investment and its structure. Present Canadian and Swiss securities regulations acknowledge this need by stating risk disclosure requirements in their prospectus provisions. In particular, both legal frameworks require that relevant information about the product itself and its issuer are disclosed in prospectuses394 and continuous disclosure documentation.395 Further, a limited number of disclosure frameworks even require that (i) risks inherent to the chosen product structure and (ii) risks related to the product’s issuer are explicitly displayed in prospectuses.396 These statements are required either in a generic or product-specific form. However, the latter approach to risk disclosure has not been commonly adopted yet. In particular, Swiss prospectus requirements for shares and bonds do not feature explicit explanations in relation to inherent risks.397 In addition, Canadian Principal Protected Notes Regulations do not require that issuers inform investors about any issuer-related risk disclosure.398 Moreover, continuous disclosure obligations are not yet fully implemented in the above jurisdictions. Present Swiss disclosure documentation for non-listed shares and bonds does not contain any continuous disclosure requirements comparable to those for annual reports or management, discussion and analysis (MD&A) statements implemented in Canadian law.399 Finally, neither Swiss  394  See, for example, NI 41-101F1, Information Required in a Prospectus, Items 4 to 10. See, in particular, NI 51-102 and its requirement to disclose information on an ongoing basis. 396 See for Canada, in particular, Form 81-101F1, Part A, Item 4, and Part B, Item 9. For Switzerland, see Appendix 1 to CISO, s. 1.15, or Guidelines on informing investors about structured products, s. 5.d. 397 S. 652a SCO and s. 1156 SCO. See, in contrast, NI 41-101F1, item 21. 398 See s. 3 (d) PPN Regulations which focuses on risk disclosure in relation to the respective note. This lack is particularly objectionable as PPNs are not “eligible for deposit insurance protection” [NICHOLLS, CHRISTOPTHER C. Financial Institutions. The Regulatory Framework (Markham. LexisNexis, 2008), p. 174]. 399 See, in particular, NI 41-101F1, Item 8; NI 51-102, Part 5. 395  55  structured product regulation nor Canadian provisions for principal protected notes include continuous disclosure obligations. Considering the above inconsistencies in Canadian and Swiss risk disclosure, the following issues should be paid particular attention to. 2.2  Product-specific Risk Information and Product-specific Risk Assessments  Present securities regulation has made use of explicit risk statements mainly in relation to structured and complex investment products.400 This approach has been based on the notion that investors are generally able to assess product risks on their own if they have access to all the necessary information and, in addition, can gauge the product’s structure and its implications.401 However, today’s investors are confronted with a broad variety of different equity and debt instruments and with hybrid products402 featuring characteristics of both basic forms of investment instruments. Further, investors increasingly tend to invest their savings into salient investment products instead of keeping them in their bank accounts.403 As a consequence of these developments, a summary of key information404 and disclosure of product-specific risk information might enhance investors’ ability to evaluate the overall risk they take by buying a product. In particular, issuers should be required to disclose risks that may typically occur in relation to (i) the product structure itself or (ii) the product’s issuer. With regard to the former, risk disclosure should refer to risks that may arise from the product’s design and embedded relations to third parties.405 Issuer-related risk disclosure should advise investors of their counterparty risks vis-à-vis the issuer of the product and risks that typically emerge in the business and under the legal structure of the issuer. Product-specific risk assessments in prospectuses, however, should be adopted only with caution. Detailed risk accounts may induce investors to rely heavily on issuers’ assessments and, therefore, shift the responsibility for their gains and losses on to the product’s issuer rather than maintaining their roles as mature market participants.406 Accurate valuation of an explicit product’s future performance is difficult to provide and, consequently, excessive reliance of investors on issuers’ statements should not  400  See above, fn. 396. See, for example, THOMAS WERLEN, Konzeptionelle Grundlagen des schweizerischen Kapitalmarktrechts (Zürich. Schulthess, 1994), p. 49. 402 See BOOTH/CLEARY (fn. 1), p. 738. 403 [source!] 404 See SARRA, Modernizing Disclosure (fn. 240), p. 80, in relation to secondary market disclosure. 405 As, for instance, relevant counterparties of a mutual fund vehicle. See also the swap agreements mentioned in section 2.2.b above. 406 See above, chapter two, sections II.1 and III.1. 401  56  be overly fostered. In addition, customized risk disclosure and evaluation are provided by those intermediaries who distribute securities to investors.407 Although a basic discussion of past and future risks that may arise in relation to the product or its issuer may constitute an adequate means to inform investors appropriately, more detailed information about specific risks is not desirable. As a consequence, the approach of Canadian securities regulation to require rough risk assessments in issuers’ prospectuses and MD&As appears to be the most promising way to enhance investor protection without inappropriately absolving them from their responsibility to make their own investment decisions.408 2.3  Continuous Disclosure  Continuous disclosure requirements are set forth “to provide an equality of opportunity for all investors in the market place”.409 Retail investors are particularly dependent on this publicly available information, as they may lack adequate knowledge or sufficient funds to gather advice on specific investments. As a consequence, continuous disclosure measures should be implemented in relation to all products that allow investors to influence their investment’s performance by trading the respective products with third parties or by redeeming their units to the issuer.410 Continuous disclosure rules should therefore be implemented for Swiss non-listed shares, bonds and structured products as well as for Canadian principal protected notes. In view of the present gaps in Canadian and Swiss continuous disclosure regulation, a comprehensive introduction of the above disclosure enhancements may be deemed a very ambitious goal. However, continuous updates in relation to product-specific developments appear to be crucial for investors and their investment decisions. As a result, exemptions should not be allowed without due consideration. In view of the fact that issuers of passively managed investment products411 are not able to influence the product’s design at their free discretion, relief, if any, might be established with regard to these kinds of products.412  407  See CONTRATTO (fn. 129), p. 236 et seq. And below, section 3. As already seen under chapter two, sections II.1 and III.1 above, investor protection is not meant to protect investors from taking risky and potentially loss-generating investments. 409 GILLEN (fn. 40), p. 180. 410 Mutual fund units are redeemable investments, see GILLEN (fn. 40), p. 524. 411 Such as index-based PPNs or structured products. 412 For further explanations, see below, chapter five. 408  57  2.4  Display of Risk Degree  Retail investors are confronted with the continuous necessity to assess and understand an increasing variety of investment instruments. Due to incessant market evolvements, investors cannot rely on their established knowledge but have to adapt to recent market developments and understand respective implications on their product portfolios. While sophisticated investors gladly focus on new products and ensuing opportunities, retail investors may become strained by the burden of constantly updating their skills and knowledge. A possible approach to facilitate investors’ risk awareness could be found in the implementation of standardized risk labels. Similar to the widespread labelling of mutual funds413 or to labelling techniques of consumer law,414 issuers could be obligated to highlight the key risks of a product by placing respective risk identifiers, be it by using predefined color codes, or by choosing appropriate product designations.415 Although this very basic form of risk disclosure would by no means be suited to replace existing, more sophisticated risk indications,416 it could at least serve investors as initial aid in their assessment of a product and facilitate their first triage of available products. In order to provide investors with a meaningful assessment of the risk degree of a specific product, risk labels must be confined to few key aspects that may impact the product value. In particular, risk labels should focus on the expected volatility of a product during its lifecycle.417 Less appropriate, on the other hand, are product labels that try to provide investors with an overall rating of the product, including its risks, the issuer’s liquidity, tradability of the product and any product-related charges.418 As such ratings do not reveal to investors how the single factors influence a particular rating, investors’ product assessment is hampered rather than enhanced by theses statements.  413  See, for example, s. 53 et seq. CISA, indicating the risk level of mutual funds by branding them as ‘securities funds’, ‘real estate funds’, ‘other funds for traditional investments’ and ‘other funds for alternative investments’. 414 See CONTRATTO (fn. 129), p. 412. 415 See s. 12 CISA as a first step into the introduction of labeling duties for issuers of investment products. 416 See above, sections 2.2 and 2.3. 417 See, for example, the “Indicator of Potential Risk and Reward” proposed in the context of the new Key Investor Information (KII) concept of the EU. This synthetic risk indicator “is based on the average frequency and size of the varations of the price of the fund’s assets [often called volatility] over the medium term” (Key investor information (KII) workshop of October 20, 2008, Materials tested, Variant N, online. <http.//ec.europa.eu/ internal_market/investment/docs/other_docs/materials_en.pdf>. 418 See, however, the certificate ratings provided by DDV, the German Derivatives Association, online. <http.//www.deutscher-derivate-verband.de/DE/MediaLibrary/Document/Rating/Hintergrundinfo%20zum%20 Rating.pdf>, which combine the above factors and provide investors with a rating indicator on a six-point-scale. See further information in chapter four, section IV.4.2 below.  58  3.  Point of Sale Risk Disclosure  3.1  Overview  In addition to risk disclosure by issuers, Canadian and Swiss securities regulations require that parties who distribute securities to investors assume partial responsibility for adequate risk information of investors. In particular, distributors have to customize their behaviour to their customers’ knowledge and risk potential when selling specific securities to these parties.419 Although disclosure by intermediaries has established itself as a widespread means to protect retail investors from inadequate investments, important questions have not been entirely clarified. To begin with, specific disclosure requirements do not apply to all relevant intermediaries. In particular, Swiss securities regulation imposes disclosure duties on asset managers,420 but does not feature any specific disclosure duties for advisors.421 Further, the extent and form of Canadian and Swiss obligations of intermediaries do not fully correspond with each other. A Canadian intermediary “must take reasonable steps to ensure that, before it makes a recommendation to or accepts an instruction from a client to buy or sell a security, or make a purchase or sale of a security for a client’s managed account, the purchase or sale is suitable for the client”.422 Exemptions from this suitability obligation can be made for specific types of clients423 or if the intermediary is “a registered individual who is a dealing representative of a member of IIROC”.424 However, IIROC features similar suitability obligations for its members425 and, as a consequence, Canadian dealers, asset managers or advisors have to comply with suitability duties if they advise retail investors or manage their accounts. Swiss legislation distinguishes between duties of asset managers  419  See, for example, s. 11 SESTA, or NI 31-103, part 13. See FINMA Circular 2009/1, Guidelines on asset management, December 18, 2008, s. 22 - 26. Entities qualify as asset managers if they make investment decisions on behalf of their clients and do not confine their activities to strictly advisory services (see HASENBÖHLER (fn. 337), p. 195, and ZOBL/KRAMER (fn. 132), p. 307. 421 See, however, disclosure duties for securities dealers in s. 11 SESTA. A securities dealer is “any natural person, legal entity or partnership who buys and sells securities, in a professional capacity, on the secondary market, either for its own account with the intent of reselling them within a short period of time or for the account of third parties, or makes public offers of securities to the public on the primary market, or creates derivatives and offers them to the public” (s. 2 (d) SESTA). See, on the other hand, risk related duties in relation to registrants set forth in NI 31-103, part 13. 422 NI 31-103, s. 13.3 (1). 423 See s. 13.3 (3) and (4) of NI 31-103. 424 S. 3.16 (1) of NI 31-103. 425 See IIROC Dealer Member Rules, Rule 1300.1 (p) - (t). See also Rule 3200 and s. 13.3 Companion Policy 31103CP. “SRO rules may also provide conditional exemptions from the suitability obligation, for example, for dealers who offer order execution only services”. 420  59  and securities dealers. Asset managers must consider the investment strategy chosen by their clients426 and have to inform them “of the risks associated with the investment objectives and restrictions agreed with them. This information may be provided in a standardised form”.427 Asset managers are, unlike their Canadian counterparts, not required to assess whether investments comply with the “overall financial circumstances, including net worth, income, current investment holdings and employment status, and risk tolerance for various types of securities and investment portfolios, taking into account the client’s investment knowledge”.428 Swiss securities dealers can confine themselves to informing investors “of the risks associated with certain types of transactions”.429 The information can be conveyed in a standardized form.430 Investment advisors, finally, have to comply with general contractual duties unless they qualify as securities dealers431 and, consequently, must follow the above obligations. 3.2  Suitability Assessment versus Generic Risk Disclosure  The above explanations have shown different options of how intermediaries can protect investors from taking undue risks. Whereas Swiss regulation of point of sale behaviour is mainly focused on generic risk disclosure,432 Canadian provisions of NI 31-103 and respective SRO rules433 have moved on to require that intermediaries consider the investor’s personal situation when selling a product. In particular, “portfolio managers with discretionary authority” must assess the “overall financial circumstances” and “risk tolerance”434 of investors before they make investment decisions on behalf of their clients. These rules mirror an increased awareness of regulators that their hitherto predominant focus on  426  FINMA Circular 2009/1, s. 16. FINMA Circular 2009/1, s. 23. 428 s. 13.3 Companion Policy 31-103CP. 429 S. 11 (1)(a) SESTA. 430 ERIC STUPP/DIETER DUBS, Basler Kommentar zum Börsengesetz (Basel. Helbing Lichtenhahn, 2007), s. 11 SESTA n. 44. S. 11 (2) requires that securities dealers take “the clients’ business expertise and professional knowledge” into account. However, clients are generally classified as inexperienced retail clients, experienced retail investors and institutional clients. Further, securities dealers often abstain from introducing different information strategies for these three different types of clients (ibid., s. 11 SESTA n. 44). 431 See PHILIPPE A. HUBER, Basler Kommentar zum Börsengesetz (Basel. Helbing Lichtenhahn, 2007), s. 2 lit. d SESTA n. 58. 432 S. 11 (2) SESTA, however, requires that securities dealers take “the clients’ business expertise and professional knowledge” into account. 433 See above, section 3.1. 434 s. 13.3 Companion Policy 31-103CP. 427  60  undifferentiated and general investor protection435 may not be sufficient to protect retail investors from misunderstanding investment products and their functionality.436 In spite of the above insights, regulations have to be aware of the limits of suitability assessments. First, suitability duties must conform to the intermediary’s relationship to its client. Dealers offering order execution only services must not be obligated to address the suitability of every single transaction of a client.437 Rather, (i) generic documentation about risks in securities trading438 and (ii) the client’s written waiver of a suitability determination439 must be sufficient to establish appropriate protection of investors without forcing them to process their trades through professional advisory services and, thus, significantly increasing transaction prices.440 However, as soon as intermediaries assume advisory or even managerial duties in relation to a client’s assets, their obligations to examine suitability issues must go beyond the distribution of generic risk disclosure brochures. Second, investors should be allowed to waive certain consequences of suitability assessments by intermediaries. In particular, they must be able to authorize transactions that their advisors or asset managers have advised them against.441 However, a waiver in relation to risk disclosure and suitability determination as such should be possible only if (i) investors are deemed to be sophisticated enough to do without further assistance,442 or if (ii) they are fully aware of their unprotected status.443 In the latter case, however, intermediaries should be forbidden from providing investors with voluntary and nonbinding information and, thus, undermining statutory disclosure standards. Further, it seems at least questionable whether investors should be allowed to partially waive suitability assessments of advisors and asset managers.444 Whereas the still prevailing concept of investors as mature market participants suggests permitting graded disclosure and suitability duties of intermediaries, emerging concerns about  435  ROLF WATTER, Basler Kommentar zum Börsengesetz (Basel. Helbing Lichtenhahn, 2007), s. 1 SESTA n. 9. See SARRA, Modernizing Disclosure (fn. 240), p. 9. 437 See respective exemptions in IIROC Dealer Member Rules, Rule 1300.1 (r). 438 See information brochure of Swiss Banking Association on Special Risks in Securities Trading (2008), online. <http.//www.swissbanking.org/en/11308_e.pdf>. 439 See next section below. 440 See, however, section V.3 below and its possible qualification of the above statement in relation to complexly structured products. 441 See, for example, s. 13.3 (2) of NI 31-103. “If a client instructs a registrant to buy, sell or hold a security and in the registrant’s reasonable opinion following the instruction would not be suitable for the client, the registrant must inform the client of the registrant’s opinion and must not buy or sell the security unless the client instructs the registrant to proceed nonetheless.” 442 See, for instance, s. 13.3 (4) of NI 31-103. 443 See above, fn. 437. 444 See, however, BSK-STUPP/DUBS (fn. 430), s. 11 SESTA n. 46 who claim that contractual agreements waiving disclosure duties of securities dealers are acceptable as long as they do not infringe the core content of this duty. 436  61  retail investors’ abilities to assess complex products tend to veer in the opposite direction. Chapter six below will take a closer look at this issue. 4.  A Note on Different Types of Investors  As mentioned in chapter one, section I above, this thesis focuses on retail investment markets. As a result, the paper refrains from examining disclosure measures for institutional investors and, therefore, does not elaborate on the differences between disclosure requirements for retail investors and their counterparts for professional, more sophisticated market participants. However, it may be noted that issuers must design their disclosure documents in a manner that they are understandable and meaningful for sophisticated investors as well as retail market participants.445 In particular, information must be provided in a clear and simple language that can be understood by investors who are not familiar with technical terms and may not read the entire available documentation.446 Canadian,447 Swiss448 and European449 disclosure regulations explicitly state that information must be provided in a clear and simple manner. An important means to assist retail investors in their understanding of disclosure documents consists of the implementation of a prospectus summary.450 Chapter four will examine whether current regulations of the three jurisdictions have introduced summary requirements in a consistent manner. Further, the thesis will refer to recent initiatives that have been launched to provide retail investors with readily understandable information about specific products.451 In addition, it should be considered that retail investors are not a homogenous group of market participants. Their knowledge and experience may vary significantly and their investment objectives range from conservative investments to highly speculatory activities. Issuers cannot consider these different positions in detail when drafting disclosure documents. Instead, investors‘ personal circumstances must be taken into account by point of sale entities that are in direct contact with market participants. Disclosure duties at the point of sale should be dependent on the investor’s financial  445  See SARRA (fn. 240), p. 12. SARRA (fn. 240), p. 38, 39. 447 See NI 41-101CP, s. 4.1. 448 See, for example, Guidelines on informing investors about structured products, Swiss Banking Organization (August 2007), p. 3, or s. 76 (3) CISA. 449 S. 5 (2) EU Prospectus Directive. See also the proposal for a review of the Prospectus Directive, which intends to improve the format and content of the prospectus summary (online. <http.//ec.europa.eu/internal_market/ securities/prospectus/index_en.htm>). 450 SARRA (fn. 240), p. 11. 451 See, in particular, COMMISSION OF THE EUROPEAN COMMUNITIES. Packaged Retail Investment Products (April 30, 2009), online. <http.//ec.europa.eu/internal_market/finservices-retail/docs/investment_products/29042009_ communication_en.pdf>. 446  62  circumstances and investment knowledge, the services provided by the point of sale entity and the complexity of the products involved. As seen above, Swiss regulation of point of sale behaviour is focused on generic risk disclosure and has not yet implemented comprehensive suitability requirements. The Canadian securities framework, on the other hand, has taken important steps to ensure that the suitability of a specific transaction is monitored by point of sale entities. Whether these measures are sufficient to establish an adequate level of investor protection at the point of sale and how German regulations govern point of sale disclosure will be examined in detail in chapter six below. 5.  Sub-conclusion  The above analysis has provided the following insights. First, present Canadian and Swiss risk disclosure provisions require that issuers disclose relevant information in the products’ prospectuses and other key documents. As investors can assess a product’s risk only if they have continuous information about its characteristics and developments, continuous disclosure requirements should be implemented for all types of products. In addition, explicit risk considerations must be implemented in all prospectuses and may be further emphasized by introducing risk labels for investment products. Second, recent developments have shifted regulators’ focus on risk disclosure duties of intermediaries. While Canadian securities commissions and SROs have implemented suitability assessments for advisors and asset managers, Swiss regulations have so far adhered to generic risk disclosure duties. While suitability determination seems an adequate means to protect retail investors against serious errors or deception, regulations must still put investors in a position to opt out of some of the above assistance duties of intermediaries. In particular, they should still be free to pursue investments that are, according to their intermediaries, not suitable for their background and means. However, it remains to be determined to what extent asset managers and advisors should be able to exclude their personal assessment duties upon explicit contractual agreements with their clients.  IV  Availability of Relevant Information  Retail investors depend on publicly available product and issuer information. If issuers do not impart relevant knowledge on a timely basis, investors are not able to make appropriate investment decisions.452 As indicated under section III.2.3 above, Canadian and Swiss securities regulations have taken this need into account by introducing continuous disclosure obligations for issuers. However, the  452  See also SARRA, Modernizing Disclosure (fn. 240), p. 8.  63  above analysis453 has shown that Swiss disclosure requirements for non-listed shares and bonds still lag behind in terms of timely disclosure obligations. Further, Canadian and Swiss legal frameworks for derivative instruments have so far largely refrained from introducing continuous disclosure duties. These discrepancies do not reflect different needs of investors in relation to the above products. Rather, they are the results of fragmentary and uncoordinated legislation and, as a consequence, have to be adapted to general disclosure requirements. Further, Canadian and Swiss continuous disclosure regulations have chosen different approaches to determine the trigger for ad hoc publicity duties of issuers. While Canadian securities regulation requires timely disclosure of ‘material changes’, Swiss regulations set forth that issuers have to inform the market in a timely manner “of any price-sensitive facts which have arisen in its sphere of activity”.454 The Canadian term ‘material change’ is narrower than its Swiss counterpart. A ‘material change’ is“(a) a change in the business, operations or capital of the reporting issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the reporting issuer; or (b) a decision to implement a change referred to in paragraph (a) made by the board of directors or other persons acting in a similar capacity or by senior management of the reporting issuer who believe that confirmation of the decision by the board of directors or any other persons acting in a similar capacity is probable”.455 Swiss ‘price sensitive facts’, in contrast, are any “facts which are capable of triggering a significant change in market prices”.456 As a result, Swiss listed companies have to disclose price relevant facts regardless of their root cause, whereas Canadian issuers can confine their ad hoc disclosure to changes related to their business, operations or capital. In view of the core purposes of both Canadian and Swiss securities regulations, communication of any price-relevant incidents appears to be meaningful for investors. Consequently, the Canadian differentiation between ‘material change’ and ‘material fact’457 seems to be a redundant complication of investors’ needs to learn about pricesensitive developments.458 In accordance with this notion, the TSX Company Manual requires that listed  453  Section III.2.1. S. 53 (1) Listing Rules. See also SIX Directive on Ad hoc Publicity of July 1, 2009. 455 NI 52-102, s. 1.1. 456 S. 53 (1) Listing Rules. 457 The expression is used in relation to “disclosure requirements for a prospectus and in the context of the prohibition of insider trading” (GILLEN (fn. 40), p. 212). 458 See also the former CSA Policy NP 40 which suggested that ‘material facts’ should also be disclosed by ad hoc communication, the opposing decision of the B.C. Court of Appeal Pezim v. British Columbia (Superintendent of th Brokers) [(1992), 66 B.C.L.R. (2d) 257, 96 D.L.R. (4 ) 137 (B.C. C.A.)], and the mediating decision of the Supreme Court of Canada in Pezim v. British Columbia (Superintendent of Brokers) [(1994) 2 S.C.R. 557 (S.C.C.)]. See further GILLEN (fn. 40), p. 212 - 214. See SARRA, Modernizing Disclosure (fn. 240), p. 14. 454  64  issuers report ‘material changes’ and ‘material facts’ that might have an impact on the market price or the value of the issuer’s securities.459  V  Product Comparability  1.  Preliminary Remarks  In order to make adequate investment decisions, investors have to be able to compare different products with each other. Comparability is hampered if (i) disclosure documentation is not appropriately streamlined, and if (ii) the complexity and variety of products’ designs complicate a simple juxtaposition of apparently similar products. 2.  Comparability through Prospectus Disclosure  Prospectuses generally contain the key data that investors need in order to compare different products and their key characteristics. As a consequence, comparability can be considerably facilitated or hampered by the structure and content of these documents. Canadian and Swiss prospectus requirements have largely considered the importance of coherent prospectus contents when implementing related rules. In particular, Form 41-101F1460 lists items that all securities prospectuses have to feature. Form 81-101 F1461 features requirements for simplified prospectuses of mutual funds. Swiss regulation lists the mandatory content of share462 and bond463 prospectuses, simplified prospectuses for structured products,464 and prospectus requirements for mutual funds.465 As a consequence of the above requirements, investors can find the same level of publicly available information in relation to all products that are subject to the same prospectus provisions. Difficulties may arise, however, if an investor tries to compare products that have to comply with different prospectus requirements. In view of the fact that Swiss securities regulation has not yet streamlined its product-specific prospectus standards, investment products issued under Swiss law are particularly prone to hamper comparisons of different types of products.466 Although Canadian securities regulation features a uniform prospectus requirement for the majority of securities, the fragmentary regulation of  459  TSX Company Manual, online. <http.//tmx.complinet.com/en/tsx_manual.html>, s. 407, and GILLEN (fn. 40), p. 214. 460 F1 to NI 41-101, Information Required in a Prospectus. 461 F1 to NI 81-101, Contents of Simplified Prospectus. 462 S. 652a SCO. 463 S. 1156 SCO. 464 Guidelines on informing investors about structured products, Swiss Banking Organization (August 2007), online. <http.//www.swissbanking.org/20070712-4500-sstrukturierteprod_e_def-fro.pdf>, s. 5.d. 465 Appendices 1 and 2 of CISO. 466 See above, section II.2.2.  65  disclosure requirements for derivative instruments has caused inconsistencies in relation to the available knowledge about publicly distributed securities. In view of the above considerations, the implementation of a coherent prospectus framework would significantly enhance investors’ abilities to compare products of different structures in both the Canadian and the Swiss legal framework for securities.467 Product comparability does not depend only on the consistent content of prospectuses but is also considerably facilitated by consistent prospectus structures. Prime examples of uniform prospectus structures are the model prospectuses for mutual funds recognized by FINMA.468 It is common practice for issuers applying for authorization to point out where their documents differ from model documents. This enables FINMA to streamline its examination procedures and ensures that investors are provided with largely uniform prospectuses for different mutual funds of different providers. However, as mentioned above, product comparisons are not confined to products of the same legal form. Rather, investors must also be able to compare different product types which each other and, by doing so, detect the differing characteristics of each type. Therefore the structures of prospectuses for investment products should be standardized as far as possible. Considering the scattered disclosure provisions of Swiss securities regulation, it is not surprising that prospectus structures of different legal types of securities are not, to a large extent, consistent with each other. Canadian prospectus rules, in contrast, apply to a broad range of securities469 and, consequently, prospectus structures of different types of securities tend to be more consistent with each other than their Swiss counterparts. However, the recent introduction of Canadian Principal Protected Notes Regulations constitutes a significant breakout of the so far largely consistent disclosure framework. Further, the considerable gaps in prospectus regulation in relation to derivative instruments have constrained an unhampered comparison of different product types. As a result, the examination of prospectus requirements in chapter four below will arguably reveal significant need for improvement in both Canadian and Swiss requirements with regard to prospectus structures.  467  See already CONTRATTO (fn. 129), p. 402, with further reference to BÜRGI WOLFHART F./NORDMANN-ZIMMERMANN URSULA, Zürcher Kommentar zum Schweizerischen Zivilgesetzbuch (Zürich. Schulthess, 1979), s. 752 SCO n. 22, and ZUFFREY, JEAN-BAPTISTE ET AL., Finanzmarktregulierung und -aufsicht in der Schweiz, Schlussbericht (Bern, November 2000), p. 60. 468 See SFA, online. <https.//www.sfa.ch/self-regulation/fund-management?lang=en>. 469 Prospectus requirements for mutual funds are regulated separately and, consequently, their structures are not fully consistent with the general prospectus provisions set forth in NI 41-101F1. Whereas the majority of the substantive differences can be explained with the peculiarities of mutual funds, a more consistent structure of both prospectus types might be feasible without too many unnecessary constraints (see below, chapter four).  66  3.  Complexity as Obstruction?  Besides inconsistent requirements in relation to prospectuses’ content and structure, complex product designs can also impair product comparisons by retail investors. In particular, different maturities,470 differing underlyings471 or a different collateralization of products472 may influence a product’s performance without being noticeable for non-sophisticated investors. Indeed, today’s broad range of product structures makes a detailed comparison nearly impossible for non-professional investors. As a consequence, the creation of transparency might not be an adequate means to protect investors against inappropriate investment decisions. What alternatives does capital markets law offer? In view of the positive impacts that complex product structures may have, a total ban of these structures473 or a prohibition of selling them to retail investors appear to be over-rigorous measures against the above comparability issues. However, a more gentle means to protect and inform investors may consist of the introduction of a mandatory consultation of advisors for retail investors who intend to buy complex products. Whether investors should be allowed to by-pass this additional step by buying their products from dealers offering order execution only services or by waiving advisory duties prior to their purchase cannot be assessed in an isolated manner. Therefore these issues will be further analyzed in chapter six and seven. An additional way to enhance the comparison of different complex products can be adopted from mutual fund regulation. Canadian and Swiss regulations require that performance data is calculated and presented in a certain manner.474 In addition, Swiss mutual fund managers are obligated to publish on a regular basis either the net asset value475 or issue and redemption prices476 of a mutual fund.477 Further, Canadian and Swiss securities regulations state specific calculation methods in order to determine this  470  If, for example, a structured product with a maturity of four years promises a minimum profit of 4%, it does not outclass a similar product with a maturity of one year and a minimum profit of 1%. However, investors might not perceive this easily. 471 Different maturities of similar underlyings can influence the product’s price and profit in a rather unobvious manner. 472 See above, section 2.2.b. 473 However, the above rejection of a ban of complex product structures does not imply that certain structures should not be forbidden (see, for instance, the suggestions above in chapter three, section II.2.2.b. 474 See s. 15.10 of NI 81-102 setting forth calculation standards for standard performance data, and Guidelines on the calculation and publication of performance data of collective investment schemes of May 16, 2008, by the Swiss Funds Association (SFA). 475 S. 83 (4) CISA. 476 S. 79 (1) CISO-FINMA. 477 Canadian mutual funds are not legally required to disclosure the above information (see s. 14.2 (6) of NI 81106). However, current standards imply regular publication of redemption and issue prices on the homepages of the mutual fund manager or the national press.  67  data.478 Although a product’s price and performance are significant indicators of its worth and potential future development, these factors obviously cannot replace a thorough analysis of the product’s characteristics and components. However, transparency in relation to prices and product performance might at least enable investors to recognize misconceptions that are closely related to product prices or annual coupon payments.479 4.  Sub-conclusion  The above explanations have shown that product comparisons largely depend on coherent prospectus regulation. In particular, prospectuses of different types of securities must be structured uniformly to the largest extent possible. Further, the mandatory components of prospectuses should vary only if some information is virtually irrelevant for one type of security whereas it is meaningful for a different type. In addition, section 3 above has demonstrated that coherent prospectus requirements are not suitable to address all issues arising in relation to product comparisons. In particular, today’s complexity of products would significantly hamper product comparability for retail investors even if all prospectuses were perfectly in accordance with each other’s structure and content. Possible answers to this problem could lie in (i) the implementation of mandatory professional advice for retail investors in relation to complex product purchases or (ii) additional disclosure requirements with regard to product prices and performance.  VI  A Note on Regulatory Oversight  The implementation of the four key preconditions for transparent capital markets entails significant expense for market participants issuing securities. As a result, issuers may be tempted to shirk some of the more bothersome requirements or fail to establish professional and comprehensive disclosure documentation. In order to prevent serious deviations from the legally required format and content of disclosure documents, there are several measures that legislators can introduce. The most powerful means to ensure compliance with regulatory requirements consists of a comprehensive regulatory oversight of market behaviour and prospectus disclosure. This strategy is generally pursued by Canadian securities laws. All prospectuses distributed to the public must be vetted and approved by securities commissions.480 Although this vetting procedure may not detect all flaws with regard to the prospectus’s content, it ensures that the document complies with the basic requirements of prospectus disclosure  478  For Switzerland, see s. 83 CISA, for Canada, see part 14 of NI 81-106. See the example of fn. 470. 480 GILLEN (fn. 40), p. 136 et seq. The vetting can also be delegated to self-regulatory bodies such as stock exchanges (see below, chapter four, section III.1.1 for the vetting of Swiss listed shares by SIX Swiss Exchange). 479  68  and provides interested investors with all of the information they need to understand the prospects and risks of a product. Further, a comprehensive regulatory oversight includes the continuous monitoring of market participants. If securities regulators question a participant’s compliance with regulatory requirements, they may appoint “a person to conduct an investigation and make a report”481 about the participant’s compliance with securities regulation. Regulators can enforce regulatory compliance by means of administrative and penal sanctions.482 Another, less thorough and, therefore, less costly and time-consuming alternative to ensure compliance with regulatory provisions is based on a selective approach to regulatory oversight. While the means of the regulator to enforce securities regulation are identical to those of the comprehensive approach, the regulator’s vetting of prospectuses is confined to new product types, random sample products or products that are particularly fraught with risk. This approach has been chosen by Canadian regulators in relation to prospectus supplements of linked notes distributed under a shelf prospectus. According to CSA Staff Notice 44-304, “before the securities regulators issue a final receipt for a base shelf prospectus that qualifies linked notes, issuers will be asked to file an undertaking to pre-clear prospectus supplements or templates for prospectus supplements pertaining to linked notes that the issuer has not previously distributed in a jurisdiction in Canada”.483 While a comprehensive oversight of securities markets and distributed documents is generally more favourable than this selective approach, there may be constellations where comprehensive vetting procedures would hamper a timely product issue in an inappropriate manner and, therefore, a selective oversight could be more beneficial for issuers and investors. In particular, reduced examinations may be adequate in relation to structured notes whose characteristics generally require a prompt and undelayed product issue.484 Finally, regulatory compliance can also be enhanced by the introduction of civil sanctions for rescission or damages if an issuer fails to deliver a prospectus or makes a misrepresentation in prospectuses or other publicly distributed documents. Civil sanctions may be introduced in jurisdictions with comprehensive or selective regulatory oversight structures,485 but also in jurisdictions without any regulatory body governing the distribution of securities.486 In addition, a jurisdiction’s approach to regulatory oversight may vary in relation to different products. While Swiss securities regulation has  481  GILLEN (fn. 40), p. 578. For Canada, see GILLEN (fn. 40), p. 567 - 575. See also Part 11, Divisions 5 and 6 of the Proposed Act. 483 CSA Staff Notice 44-304, Undertaking to pre-clear prospectus supplements. 484 See below, chapter four, sections II.3.2 and III.3.2. 485 See GILLEN (fn. 40), p. 575, for Canada. See also Part 12 of the Proposed Act. 486 See, for non listed Swiss shares and bonds, chapter four, sections III.1 and III.2 below. 482  69  refrained from introducing comprehensive or selective regulatory oversight in relation to non-listed shares and bonds, exchange-traded equity and debt securities are vetted and monitored on a continuous basis by the Swiss stock exchange SIX.487 Generally, prospectus requirements should not be supported by civil sanctions only. Less sophisticated or prosperous investors may not be able to enforce securities law by means of civil actions and, as a result, are dependent on a regulatory body that oversees and monitors adequate behaviour in securities markets.  VII  Conclusion  The above sections have outlined four important aspects that Canadian and Swiss disclosure frameworks for securities have to consider to be in accordance with the core goals of securities regulation, i.e. investor protection and efficient capital markets. Hereby, the following key findings have been discovered. First, most disclosure frameworks have both substantive and formal components. While a substantive approach focuses on the economic characteristics of a product and not on its legal structure, a formal concept is guided instead by the legal form an issuer has chosen for its product. As different legal structures can involve different regulatory standards, the latter approach tends to enhance efficiency of capital markets. The substantive approach, however, focuses on investor protection and represents the view that economically similar products should have to comply with the same regulatory requirements. Unlike Canadian securities regulation, the Swiss disclosure framework for securities features several legally defined product categories with different disclosure provisions. The Swiss legislator has so far struggled to place products with similar substantive characteristics with one particular legal form. In view of the examinations under section II.2.2.b and c above, a convergence of substantive and formal elements appears to be no longer practicable. As a consequence, Swiss legislation must essentially follow either a substantive or a formal approach to product regulation. Further, both the Swiss and Canadian legal frameworks have to determine if and where they want to provide issuers and investors with a choice between different regulatory levels for economically similar products. Chapters four and seven will examine these issues in the context of present disclosure regulations of both jurisdictions. Second, the above examination of Swiss and Canadian disclosure provisions has made evident that both frameworks still lack consistent continuous disclosure rules and risk statements in several product categories. Further, a brief outline of point of sale regulation has shown that generic risk disclosure by  487  See below, chapter four, sections III.1 and III.2.  70  advisors and asset managers may not be an adequate means to protect retail investors. Rather, the recently introduced focus of Canadian securities regulation on suitability assessments by the above intermediaries appears to be a significantly more promising manner in which to ensure adequate investor protection. Chapters five and six will deepen the conceptual framework of this approach by considering whether investors should be allowed (i) to waive suitability determination or (ii) to purchase complex products from dealers offering order execution only services. Third, timely availability of relevant information mainly depends on investors’ unobstructed access to disclosure documentation and the implementation of effective continuous disclosure rules. Swiss securities regulation features serious gaps with regard to both aspects. Canadian securities regulation, on the other hand, is still not fully consistent on the circumstances that trigger issuers’ duty to disclosure recent information. Chapters four and five of this paper will assess how these defects can be best corrected. Forth, comparability of products is enhanced by consistent requirements in relation to structures and contents of prospectuses. Divergence of this uniform model should be introduced only if specific product characteristics require additional components or a differing format. Chapter four will assess how Swiss and Canadian prospectuses could be further streamlined in relation to substance and form.  71  Chapter four I  Prospectus Disclosure  Introduction  Chapter three outlined four crucial preconditions for transparent capital markets. All of these elements are in some way related to disclosure provisions of securities regulation and make specific demands on the content or format of prospectus disclosure. The above outline of the Canadian, Swiss and German prospectus frameworks and the brief assessment of their compliance with the four preconditions for transparent markets have shown significant gaps and inconsistencies. Consequently, this chapter will focus on present prospectus provisions for shares, bonds, derivatives and mutual funds and analyze their fitness to enhance product delimitability and comparability and to provide investors with relevant risk information on a timely basis. As an examination of rules in relation to product delimitability is meaningful only if prospectus provisions of different product types can be contrasted with each other, this aspect is not discussed separately under each product type. Rather, it will be assessed for each jurisdiction from a comprehensive perspective at the end of sections II, III, and IV.  II  Canada  1.  Distribution of Shares  1.1  Overview  As mentioned under chapter two, section II.3, Canadian issuers are generally required to file a prospectus before they distribute securities to the public. If the issuer complies with the requirements set forth under section 2.2 of NI 44-101,488 it is allowed to issue a short form prospectus instead of the long form version set forth under NI 41-101. Short form prospectuses relieve an issuer of the obligation to disclose information in relation to its corporate structure, the development of its business and other financial and managerial information that has been disclosed to the public through continuous disclosure documents required under NI 51-102.489 Because investors are not deprived of the above information when issuers are allowed to offer a short form prospectus, the following outline will focus on the structure and content of long form prospectuses.  488  National Instrument 44-101, Short Form Prospectus Distributions. Basically, the issuer has to be a ‘reporting issuer’ (the term is defined, for example, in s. 1 (1) BCSA, ‘reporting issuer’), “an electronic filer under NI 13-101”, and its equity securities must be listed on a ‘short form eligible exchange’ (s. 1.1 of NI 44-101). Further, it must have filed all disclosure documents required in section 2.2 (c) and (d) of NI 44-101. 489 GILLEN (fn. 40).  72  To begin with, Form 41-101F1 enjoins specific structural requirements. In particular, item 1 of the Form obligates the issuer to display essential product information such as the price of the distributed security,490 investors’ opportunities to trade the security on the secondary market, information on the underwriter491 and references to prospectus sections that describe risk factors “of an investment in the securities being distributed”.492 Further, items 2 and 3 of Form 41-101F1 specify that long form prospectuses must feature a table of contents and a summary of the key information of the prospectus. Following these introductory pages, issuers have to provide detailed information about their corporate structure, their business and the securities’ characteristics.493 However, neither NI 41-101 nor Form 41101F1 require that these elements are arranged in the order or under the headings of Form 41-101F1. Although the majority of issuers largely align their prospectus formats to the suggested sequence,494 they tend to adjust the form’s order to the specific issue of shares and do not always subsume relevant information under the suggested headings. With regard to the content of long form prospectuses, Form 41-101F1 distinguishes between issuerrelated information and information about the shares themselves. In particular, item 5 obligates issuers to describe their business, including a brief overview of past and expected future developments, and its audit committee and corporate governance structure.495 Further, issuers must indicate “each of the principal purposes, with approximate amounts, for which (a) the net proceeds will be used by the issuer”.496 In addition, issuers of shares have to describe these securities and their “material attributes and characteristics”497 such as dividend or voting rights, pre-emptive rights or conversion or exchange rights.498 Moreover, the prospectus must display previous price developments of the issuers’ securities499 and, if the shares are distributed by an underwriter, relevant information about the underwriter’s obligations and further related matters.500 Finally, item 21 of Form 41-101F1 requires that issuers disclose “risk factors relating to the issuer and its business”, risks “that securityholders of the issuer may become liable to make an additional contribution beyond the price of the security”, and “any  490  Form 41-101F1, s. 1.4 - 1.8. Form 41-101F1, s. 1.9. 492 Form 41-101F1, s. 1.10. 493 See, in particular, items 4, 5 and 10 of Form 41-101F. 494 See, for example, the preliminary prospectus of Asian Resource Global Strategies Inc. of November 27, 2009, or the final prospectus of BE Resources Inc. of September 30, 2009, available on <www.sedar.com>. 495 Form 41-101F1, s. 19. 496 Form 41-101F1, s. 6.3 (1). 497 Form 41-101F1, s. 10.1. 498 Form 41-101F1, s. 10.1. 499 Form 41-101F1, s. 13.2. 500 Form 41-101F1, s. 20.1 - 20.13. 491  73  risk factors material to the issuer that a reasonable investor would consider relevant to an investment in the securities being distributed”.501 1.2  Disclosure of Essential Product and Issuer Risks  Section III of chapter three above identified four alternatives to disclose risk in securities prospectuses. Two of them have been implemented by Canadian securities administrators in relation to share prospectuses. First, Canadian prospectus requirements provide investors with appropriate information on a product and its issuer. As mentioned above, issuers must describe their business and the product’s material features. Further, issuers are not allowed to confine disclosure to present information. Instead, Form 41-101F1 obligates them to relate relevant past developments and material forward-looking information.502 Moreover, issuers are instructed to provide a summary of material information “near the beginning of the prospectus”.503 Second, specific risk information stresses even more poignantly the risks that may be involved in the purchase of shares. Item 21 of Form 41-101F1 requires that issuers disclose risk factors “relating to the issuer and its business”.504 Due to the nature of shares as “common, divided, participation interest[s] in the corporation’s business”,505 share prices are closely related to the success or failure of a company. Consequently, the requirement of item 21 to disclose the issuer’s key risks covers, at the same time, virtually all essential risks that are related to the product as such.506 As a result, the legislator’s decision to confine risk disclosure to risks that may arise in relation to the product’s issuer does not result in fragmentary risk-disclosure. However, it might be appropriate to call investors’ attention to (i) their position in case of the issuer’s insolvency507 and (ii) the close relation between the issuer’s business and shareholders’ profits. Further, generic risk caveats should point out that price fluctuations may not always be explained by the issuer’s performance and, therefore, could create negative impacts on the investors’ portfolios without due premonition.508  501  Form 41-101F1, s. 21.1. See Form 41-101F1, s. 5.2. 503 Form 41-101F1, item 3. 504 Form 41-101F1, s. 21.1 (1). 505 CHRISTOPHER C. NICHOLLS, Corporate Law (Toronto. Emond Montgomery, 2005), p. 355. 506 Further, risks can arise in relation to shareholders’ standing compared to shareholders of other classes of shares. These risks are also disclosed - although not explicitly labeled as ‘risks’ - under section 10.1 of Form 41101F1. 507 I.e. the ranking of their claims in insolvency proceedings and the risks inherent to such ranking. See, for example, FELICIA H. KUNG, “The Regulation of Corporate Bond Offerings. A Comparative Analysis” (2005) U. Pa. J. Int’l Econ. L., p. 429. 508 See GILLEN (fn. 40), p. 64, on aspects that do not correspond with the efficiency of securities markets and, therefore, might influence prices in a ‘non-efficient’ manner. 502  74  The third alternative mentioned under section III of chapter three consists of the implementation of risk assessments regarding issuer- and product-related risks. Canadian securities regulation has so far been cautious in the adoption of these evaluative disclosure mechanisms.509 In view of the respective considerations of chapter three, section III.2.2 above, this reservation appears to be appropriate. Fourth, section III.2.4 of chapter three has raised the question of whether securities prospectuses should contain standardized risk indications, either by means of predetermined product names or other readily identifiable risk labels. However, as structures and characteristics of shares are mostly homogenous, these suggestions are not suitable for share prospectuses. Complexity in relation to shares does not generally derive from their product design, but is rather based on the issuer’s business and economic strength. As a consequence, the informative value of standardized risk labels would be moderate at best and, therefore, could not fulfill retail investors’ expectations in reliable indications of the overall product risk. 1.3  Availability of Relevant Information  Prospectuses must be filed with the competent securities administrator. Once the administrator agrees with the content and structure of the preliminary prospectus, the issuer can file the final prospectus and, upon a receipt of the administrator, begin to sell its securities.510 Selling and advertising activities between the submission of the preliminary prospectus and the receipt for the final prospectus511 are constrained by provisions limiting the issuer’s proactive efforts to sell its shares.512 In view of the above, prospectus disclosure in Canadian securities regulation takes place on a timely basis. Considering issuers’ economic restraints to provide accurate information on pricing details prior to the actual distribution of shares,513 the exemptions of NI 41-101, section 7.2 in relation to non-fixed price offerings and reductions of the offering price do not excessively curtail investors’ interests in timely disclosure of relevant information.  509  Form 51-102F1, part 2, 1.4 (g). See also Form 41-101F1, item 8. GILLEN (fn. 40), p. 137, 138. 511 I.e. during the so called ‘waiting period’ (see, for example, s. 78 (1) BCSA). 512 See, for example, allowed behaviors listed in s. 78 (2) BCSA. Further, see also CP 41-101, s. 6.5 (1), on advertising or marketing activities during the waiting period. See also GILLEN (fn. 40), p. 141, on procedures in national offerings and the passport system established in MI 11-102 of December 24, 2009. 513 GILLEN (fn. 40), p. 137. 510  75  1.4  Intra-Product Comparability  Shares are well-known investment instruments in securities markets. Consequently, investors are familiar with the central role that an issuer’s business and financial standing play with regard to the development of share prices. If investors have to make an investment decision in relation to shares, their choice will be significantly influenced by their preference of a certain business or market segment. At first glance, comparability of different shares might therefore seem a rather straightforward matter. As long as prospectuses provide investors with adequate business descriptions, the latter should be able to make appropriate investment decisions. However, a closer examination of the subject at hand reveals that a thorough comparison of different shares is more complex than originally assumed. To begin with, meaningful business comparisons can be drawn only if respective information is standardized to a certain extent. Otherwise, issuers might provide investors with fragmentary information which, in turn, would prevent them from a thorough assessment of different shares. Moreover, investors are confronted with a wide array of additional information relating to shares. In particular, corporations are free to create different classes of shares514 or to choose between various options of how to organize the shares’ distribution.515 Further, investors may be interested in the issuer’s corporate structure, its board members and executive officers and its corporate governance structure. In view of the above exemplary enumeration of information that might influence investment decisions of potential shareholders, streamlined and predefined prospectus structures are essential to cope with the information investors receive prior to their investment decisions. Canadian prospectus regulations essentially acknowledge the need for consistent prospectus contents and designs. As seen under section 1.1 above, Form 41-101F1 determines the material information that has to be displayed in prospectuses and obligates issuers to disclose essential facts on the cover page of a prospectus. Clarity is further enhanced by the form’s requirement to include a table of contents in each prospectus. However, neither Form 41-101F1 nor NI 41-101 or its companion policy516 define a sequence that issuers have to follow with regard to the required items. Further, regulatory provisions have so far refrained from establishing predefined and mandatory headings for the sections that are featured in Form 41-101F1. Considering the above necessity of comparable share prospectuses, the structural harmonization of disclosure documents is an essential means to further enhance comparability of share issues.  514  See, for example, s. 52 (2) BCCA. Form 41-101F1, item 20. 516 S. 4.1 of CP 41-101 which requires that issuers “should apply plain language principles when they prepare a long form prospectus”. However, the document does not give further guidance in relation to the order and headings that issuers have to choose. 515  76  1.5  Sub-conclusion  The above analysis of the present Canadian prospectus framework has shown the following. Productspecific prospectus disclosure for shares informs investors about relevant risks and enables them to compare different share issues. Additional transparency could be achieved by implementing explicit notice of the implications that issuer-related developments can have on shareholders’ investments. Further, a fixed sequence of prospectus items and predefined headings would significantly improve investors’ ability to compare different products with each other. 2.  Distribution of Bonds  2.1  Overview  Canadian disclosure provisions for debt securities do not vary considerably from those for equity securities.517 As a consequence, the requirements of Form 41-101F1 outlined under section 1.1 above must also be considered at the issue of bonds. This homogenous approach is based upon the view that “investors in debt securities (…) [have] the same informational needs as investors in shares”.518 Specific characteristics of debt securities are considered only if they require special emphasis or create a need for additional information. In particular, cover page disclosure has to include the effective yield of bonds “if held to maturity”519 and must display pricing details as percentages.520 Further, issuers of “debt securities having a term to maturity in excess of one year”521 must disclose earnings coverage ratios in accordance with section 9.1 of Form 41-101F1. Moreover, section 10.2 of the form points out the specific characteristics that must be considered in the prospectus description of debt securities. Section II.3 of chapter two has shown that issuers do not have to follow disclosure requirements if one of the exemptions of NI 45-106522 applies. Compared to disclosure reliefs for equity securities, exemptions applying to debt instruments affect a significantly larger number of the total of issued products. In particular, section 2.35 of NI 45-106 sets forth that the “prospectus requirement does not apply to a distribution of a negotiable promissory note or commercial paper maturing not more than one year from the date of the issue, if the note or commercial paper distributed (a) is not convertible or exchangeable into or accompanied by a right to purchase another security (…), and (b) has an approved  517  See also KUNG (fn. 507), p. 428, comparing the U.S. prospectus regime to European prospectus regulations. KUNG (fn. 507), p. 428, 429. 519 Form 41-101F1, s. 1.4 (5). 520 Form 41-101F1, s. 1.4, Instructions. 521 Form 41-101F1, s. 9.1 (1). 522 Prospectus and Registration Exemptions. 518  77  credit rating (…)”. As a consequence of this rule, Canadian asset-backed commercial papers are largely exempt from the prospectus requirements of NI 41-101 and investors have no other choice but to rely on information that is provided by issuers on a voluntary basis.523 Issues in relation to asset-backed commercial papers and credit derivatives in general will be examined under section II.3.3 below. 2.2  Disclosure of Essential Product and Issuer Risks  Like investors of equity securities, potential bondholders have access to essential information on issuers and distributed bonds. In addition, explicit risk statements highlight risks that might surface for investors after buying specific debt securities.524 However, section 21.1 confines the above statements to (i) “risk factors relating to the issuer and its business”,525 the risk of additional contributions of investors526 and any other “risk factors material to the issuer”.527 Consequently, the obligations on issuers of debt securities are basically reduced to the disclosure of issuer-related risks to investors,528 but issuers are not required to specifically refer to risks that arise from the product structure itself. Unlike shares, debt instruments may harbour risks that are not related to the securities’ issuers. In particular, investors face partial losses of the product’s principal or coupon payments if third parties or their securities do not perform in accordance with the issuer’s expectations.529 Although information about these risks is implicitly530 displayed under section 10.2531 of Form 41-101F1, retail investors might overly rely on the explicit risk cautions of securities prospectuses and, therefore, not associate the debt securities’ characteristics listed under section 10.2 to risks that might arise prior to or at maturity of these products. As a result, item 21 of Form 41-101F1 should not be confined to risks that arise from the debt instruments’ issuers. Rather, all material risks that are related to purchases of a specific product should be briefly explained under this prospectus section.  523  NICHOLLS (fn. 398), p. 188. Form 41-101F1, s. 21.1. 525 Form 41-101F1, s. 21.1 (1). 526 Form 41-101F1, s. 21.1 (2). 527 Form 41-101F1, s. 21.1 (3). 528 The French version of Form 41-101F1, s. 21.1 (3), requires that prospectuses describe “les facteurs de risque important pour l’émetteur" and, consequently, uses the same phrase as in s. 21.1 (1), which requires prospectuses to disclose “les facteurs de risque pour l’émetteur et ses activités”. It is not clearly conceivable what kinds of risks can be subsumed under subsection (3) that are not already included in subsection (1). 529 See these risks in relation to asset-backed commercial papers in section 3.3 below. 530 See, however, s. 10.3 (14) that requires a description of “any risk factors associated with the asset-backed securities”. 531 And, for asset-backed debt securities, in section 10.3. 524  78  Drawing on the considerations about product-specific risk assessments in section 1.2 above, the implementation of brief risk evaluations can enhance investors’ abilities to take appropriate investment decisions. However, issuers should not be required to file risk evaluations in relation to third parties and their products. Investors who decide to invest in bonds that are collateralized by third parties or whose interest rate structures depend on other products’ developments must be able to assess related risks by consulting publicly available information about these products and respective risks.532 As productspecific risk information draws investors’ attention to risks that may arise in relation to third parties and their products, investors are adequately aware of their responsibility to investigate these factors. However, retail investors might benefit from additional risk labelling in relation to complex debt structures. In particular, debt securities whose principal repayment is dependent on the development of underlying investment instruments or third party-behaviour should be required to emphasize this additional risk by featuring respective product names or predetermined risk labels. Similar techniques should apply in relation to floating bonds, participating bonds or other structures whose coupon payments may considerably vary.533 2.3  Availability of Relevant Information  Issuers of bonds are required to provide prospectus information on a timely basis. They must follow the same procedures as outlined for the issue of shares under section 1.3 above. Further, information contained in prospectuses covers - for the most part534 - all relevant information that investors need in order to make an informed decision in relation to the securities in question. As a consequence, investors can access relevant information on issued debt securities in a timely manner. However, this positive assessment is valid only if prospectus requirements of NI 41-101 are not abolished by an exemption under NI 45-106. In particular, the availability of relevant information is seriously hampered by the legislator’s decision to exempt short-termed debt securities from prospectus disclosure.  532  Risk assessments in relation to third parties might be appropriate if the latter are not legally required to disclose information about themselves and their products. In such cases, investors do not have the means to assess risks related to third parties and, as a consequence, cannot gauge the overall risk related to the bond. 533 See SIX trading training, online. <http.//www.six-swiss-exchange.com/download/trading/training/ education/material/1_2_dept_sec_en.pdf>, p. 5. 534 See, however, section 2.2 above and its conclusion that prospectuses of debt securities do not necessarily refer to all relevant risks factors under the present disclosure framework.  79  2.4  Intra-Product Comparability  Section 1.4 above established that product comparability can be enhanced by introducing prospectus schedules and mandatory headings for relevant sections of securities prospectuses. This basic statement applies not only to the issue of shares but also to distributions of debt securities. As investors must balance a significant number of different factors when taking their investment decisions, they are dependent on disclosure documentation that enables them to make efficient choices between the wide range of available products. Although the Canadian disclosure framework has taken important steps in this direction, the introduction of homogenous prospectus structures and harmonized designations of prospectus sections would be suitable to further improve comparability of debt securities. 2.5  Sub-conclusion  The above examination of prospectus disclosure in relation to bonds has shown that Canadian investors are provided with overall sound and comprehensive prospectus structures. However, the following amendments could additionally enhance transparency in primary markets for bonds. First, Form 41101F1, section 21, confines risk disclosure in prospectuses to issuer-related risks. In view of the significant risks that investors may have to face irrespective of the issuer’s solvency or behaviour, issuers should be obligated to point out significant product-related risks. This approach has been implemented in relation to asset-backed debt securities. Issuers are required to disclose “any risk factors associated with the asset-backed securities, including disclosure of material risks associated with changes in interest rates or prepayment levels, and any circumstances where payments on the asset-backed securities could be impaired or disrupted as a result of any reasonably foreseeable event (…)”.535 However, analogous issues may also arise in relation to other debt instruments. Consequently, similar risk statements should be required for all types of publicly distributed debt securities. Second, more complex debt products might require the application of predefined risk labels, be it in the form of distinctive product names or by introducing standardized risk labels. Third, section 2.4 above has made evident that comparisons between different bond products could be significantly improved by harmonizing prospectus structures and obligating issuers to follow predetermined section headings.  535  Form 41-101F1, s. 10.3 (14).  80  3.  Distribution of Derivatives  3.1  Options and Futures  a.  Overview  As mentioned under chapter three, section II.2.1.b.aa, provincial securities regulations have established differing disclosure concepts for derivatives. In particular, Ontario,536 Manitoba537 and Québec538 have enacted Derivative Acts that govern the issue of futures and option contracts to a greater or lesser extent. Whereas Ontario and Manitoba confine the scope of their Commodity Futures Acts to commodity futures or option contracts that are traded on an exchange, Québec has abstained from similar fragmentations and the scope of its Derivatives Act extends, as a general rule, to all kinds of derivative contracts.539 British Columbia and Alberta, on the other hand, have refrained from creating separate Statutes for derivatives but have established specific rules for ‘exchange contracts’, i.e. exchange-traded futures or options contracts whose “performance is guaranteed by a clearing agency”.540 Futures and options that do not fall under the scope of the above special rules qualify as securities. However, derivative-specific exemptions mostly relieve issuers of plain options of the obligation to issue respective prospectuses.541 In return, provinces impose registration requirements on dealers and advisors542 and obligate them to provide investors with risk disclosure statements.543 In view of this great variety in Canadian disclosure regulation for options and futures, an exhaustive assessment of these complex and fragmentary frameworks would go beyond the scope of this paper. Consequently, the following examinations will focus on derivatives regulation in British Columbia. Other frameworks are mentioned only if their content differs significantly and fundamentally from the provisions set forth by the legislator of British Columbia.  536  Commodity Futures Act (R.S.O. 1990, Chapter C.20). Commodity Futures Act (C.C.S.M. c. C152). 538 See fn. 304 above. 539 See above, chapter three, section II.2.1.b.aa, referring to the generous carve-out provisions for OTCtransactions involving accredited counterparties. 540 S. 1 (1), ‘exchange contract’. 541 See, in particular, BCI 91-505, and OSC Rule 91-502. 542 For Québec, see Expert Panel, Final Report (fn. Error! Bookmark not defined.), p. 77; for British Columbia see s. 34 (a) and (b) BCSA and GROTTENTHALER/HENDERSON (fn. 73), 10-63. 543 See s. 70 QDA for Québec, BC FORM 91-903F for British Columbia, and 2.1 (b) of OSC Rule 91-502 for Ontario. 537  81  b.  Disclosure of Essential Product and Issuer Risks  aa.  Prospectus Exemptions  Exchange contracts do not qualify as securities544 and, consequently, their distribution does not trigger a prospectus obligation.545 However, investors are allowed to trade in exchange contracts only if these trades are conducted by registered dealers or advisors.546 Further, these intermediaries have “to provide each prospective client with a copy of the Risk Disclosure Statement (Exchange Contracts), prior to opening the client’s account”.547 Risk disclosure statements contain generic risk caveats548 informing investors on the principal risks that they take by investing in futures or options. In addition, they refer to risks that are not necessarily linked to the characteristics of options or futures but tend to arise in the course of such transactions. In particular, BC Form 91-903F requires that disclosure statements mention potential negative impacts of market illiquidity, fee charges, currency risks and risks related to deposits for derivative transactions.549 Call and put options550 that do not qualify as exchange contracts in accordance with section 1 (1) BCSA can still be exempt from the prospectus obligation of section 61 BCSA if their design complies with the requirements set forth in BC Instrument 91-505.551 Moreover, issuers of physically settled commodity futures are generally exempt from prospectus requirements of section 61 BCSA.552 Considering the above, the following can be concluded. First, the derivative framework of British Columbia does not require prospectus disclosure in relation to exchange traded futures and options contracts. Second, plain option structures are also exempt from prospectus disclosure. Third,  544  See s. 1 (1) BCSA, ‘security’. “security includes (….) whether or not any of the above relate to an issuer, but does not include an exchange contract”. 545 See s. 61 (1). “Unless exempted under this Act, a person must not distribute a security (…)”. Exchange contracts, however, are not mentioned under this section. See also s. 89 and 91 of the Proposed Act. 546 GROTTENTHALER/HENDERSON (fn. 73), 10-63, s. 34 BCSA. 547 BC form 91-903F, Instructions. 548 See chapter three, section III.2.2 above. 549 BC Form 91-903F, Contents of Form, Additional Risks Common to Futures and Options. 550 I.e. options “which permit the holder of the option to sell or purchase from the writer of the option a specified amount of securities at a specific price, on or before a specified date or the occurrence of a specified event” (BC Instrument 91-505). 551 Which are the following. “(a) the option has been written by or the performance under the option is guaranteed by a member of an exchange recognized by the commission for this purpose, (b) the securities that are the subject of the option are listed and posted for trading on an exchange recognized by the commission for this purpose, and (c) the option is in the required form” (BC Instrument 91-505). 552 See ONTARIO COMMODITY FUTURES ACT ADVISORY COMMITTEE. “Final Report” (January 2007), p. 12, on the definition of ‘commodity futures contract’ and the need for updating respective definitions. See also Blanket Order 91-503 (BC), part 1.  82  commodity futures with physical settlement are exempt from the scope of the securities act. Fourth, futures and options for retail investors553 that do not fall under one of the above derivative-specific exemptions have to comply with general prospectus regulations. As a general rule, these instruments can be distributed only if respective prospectus disclosure has been provided to investors. However, prospectus exemptions of NI 45-106 may relieve issuers of prospectus duties in significant ways. bb.  Disclosure-related Concerns  How do the above insights blend into the risk disclosure examinations of chapter three, section III? Issuers of futures and options that do not fall under a prospectus exemption have to comply with prospectus provisions of NI 41-101. As a result, these products face similar disclosure issues as listed under sections 1.2 and 2.2 above. In particular, prospectuses lack a mandatory structuring of their contents and risk-based labelling duties. However, section 10.4 (g) of Form 41-101F1 requires that prospectuses display “the risk factors associated with the derivatives”. As a consequence, unlike prospectuses for shares and bonds, derivative prospectus disclosure includes significant risks that are related to the product in question. Prospectus exemptions for commodity futures with physical settlement554 do not give cause for concern. Retail investors are generally not involved in these kinds of transactions; further, market participants concluding these transactions are driven by the need to physically acquire or sell commodities rather than by speculative reasons. Consequently, prospectus exemptions based on Blanket order 91-503 (BC) do not compromise transparency in securities markets.555 Moreover, the exemption meets international standard practice.556 Prospectus exemptions of BC Instrument 91-505 for call and put options on exchange-traded securities significantly facilitate and expedite the issue of plain options with physical settlement.557 As long as investors can find all relevant information in the option or futures contract forms set forth by 91-505F1  553  See, however, BC Blanket Order 91-501 for broad exemptions in relation to OTC derivatives that are distributed to Qualified Parties as defined in the Blanket Order. 554 See BC Blanket Order 91-503. 555 See, however, the IOSCO TASK FORCE ON COMMODITY FUTURES MARKETS, “Final Report” (March 2009), p. 15, requiring that regulators may obtain additional information of issuers of commodity futures contract in order to assess the market’s functioning. 556 See CONTRATTO (fn. 129), p. 139, 140, and Bericht zum Vorentwurf der Expertengruppe zur Ausarbeitung eines Bundesgesetzes über die Börsen- und den Effektenhandel of January 22, 1992, p. 26 et seq. See also EU Prospectus Directive, s. 1 (1), and s. 1 (4) Council Directive 93/22/EEC of Mai 10, 1993 on investment services in the securities field. 557 Although there is no explicit statement in relation to the settlement of the option, the contracts under 91505F1 and 91-505F2 implicate that the settlement is meant to be physical.  83  and 91-505F2, they are not necessarily disadvantaged by this lack of a prospectus. Further, relevant information on members “of an exchange recognised by the commission”558 can be found in publicly available continuous disclosure documentation of said entity.559 In view of the present form of 91-505F1 and 91-505F2, the following information might additionally improve transparency for investors. Unlike section 10.4 (g) of Form 41-101F1, contract forms for put and call options do not point out any risks associated with the product’s issuers or its structure. Considering the design of call or put options with physical settlement, structural and issuer-specific risks do not significantly differ between different product issues. Consequently, the implementation of generic risk caveats in the option contracts would be sufficient to adequately inform investors of relevant risks. Whereas the above prospectus exemptions are narrowly confined to specific constellations, the legislator’s decision to relieve exchange contracts of prospectus requirements deprives a wide range of investors of prospectus disclosure. Canadian exchange contracts are currently exclusively traded on the Montréal Exchange. They are issued by the Canadian Derivatives Clearing Corporation560 as soon as two parties have settled a transaction in an option561 or futures contract.562 Consequently, options or futures contracts are not mass-traded derivatives. Rather, these investment instruments do not come into existence until the settlement date of each single transaction.563 Capital market laws have so far not established a consistent understanding as to whether exchange contracts qualify as securities or not.564 However, within the three legal frameworks examined in this thesis, there is an implicit consensus that exchange contracts can be distributed without prospectus disclosure. Instead, the obligations of exchanges or issuers are confined to the disclosure of the conditions of the standardized contracts in a publicly available form.565 In addition, Canadian investors are protected by (i) the intermediaries’ duties to distribute risk disclosure statements to their clients and (ii) the fact that exchange contracts must be  558  BC Instrument 91-505, s. 2 (a). See also the rationale for short-form prospectuses in GILLEN (fn. 40), p. 296, 297. 560 <www.cdcc.ca>. 561 CDCC Rules, Part B, Options, B-107 (1), online. <http.//www.cdcc.ca/f_rules_en/B-01.pdf>. 562 CDCC Rules, Part C, Futures, C-105 (2), online. <http.//www.cdcc.ca/f_rules_en/C-01.pdf>, i.e. CDCC produces “a Futures Consolidated Activity Report with respect to each account of a Clearing Member”. 563 See also CONTRATTO (fn. 129), p. 157. 564 See in relation to Swiss law CONTRATTO (fn. 129), p. 159, ZOBL/KRAMER (fn. 132), p. 212, and BSK-DAENIKER/WALLER (fn. 123), s. 2 lit. a-c, n. 12. In relation to the EU Prospectus Directive, see DIRK VAN GERVEN (ED.), Prospectus for the Public Offering of Securities in Europe, Volume I, European and National Legislation in the Member States of the European Economic Area (New York. Cambridge University Press, 2008), p. 244, 254. 565 See, for example, CDCC Rules, Part B, Options, Rule B-5. 559  84  guaranteed by a clearing agency.566 In view of these additional safeguards, the absence of a general prospectus requirement for exchange contracts is largely absorbed by other effective measures and does not leave an undue gap in the transparency framework of Canadian securities regulation. For clarity’s sake, it remains to be noted that exchange-traded options that have been issued en masse by investment banks567 do not qualify as ‘exchange contracts’ and, therefore, have to comply with prospectus disclosure of securities regulation.568 c.  Availability of Relevant Information  Looking at the wide range of disclosure provisions for options and futures, availability of relevant information is largely dependent on the applicable disclosure framework. Investors in exchange-traded options and futures can rely on timely and trustworthy information provided by stock exchanges. Investors who acquire options subject to general prospectus requirements are able to gather information from the products’ prospectuses. As a result, investors can generally access information in a timely manner.569 d.  Intra-Product Comparability  Futures and options that are issued as exchange contracts are designed in a highly standardized manner. Information about these contracts can be found on the website of the Montréal Exchange and the Canadian Derivatives Clearing Corporation.570 As a consequence, product comparability is generally not problematic in relation to these products. Call and put options that are distributed in the form of 91505F1 and 91-505F2 can be compared with each other without restriction. If issuers distribute options in accordance with prospectus requirements of NI 41-101, comparability could be enhanced as presented under sections 1.4 and 2.4 above.  566  For British Columbia, see s. 1 (1) BCSA, ‚‘exchange contract‘. As mentioned above, exchange contracts can be traded on recognized exchanges only (see fn. 546). 567 See above, chapter three, section II.2.1.b.bb. Although these instruments are not traded at Canadian stock exchanges yet, they are fairly wide-spread in European markets (see, for example, Scoach, a European stock exchange for structured products, online. <http.//www.scoach.ch/EN/Showpage.aspx?pageID=230>, where the products in question are called ‘warrants’). 568 See, however, exceptions for plain call and put options mentioned in section b.i above. 569 However, this assessment applies to options only if they are distributed to retail investors. If the trade is concluded between qualified parties, BC Blanket Order 91-501 largely exempts issuers from mandatory prospectus disclosure. 570 See, in particular, CDCC Rules, online. <http.//www.cdcc.ca/publi_regles_en.php>, and the contract descriptions on the website of Montreal Exchange, on. <http.//www.m-x.ca/produits_options_actions_en.php>.  85  e.  Sub-conclusion  The above examinations have provided the following insights. First, Canadian investors are confronted with nuanced disclosure provisions for futures and options. Whereas issuers of exchange contracts establish standardized contract specifications, information about plain call and put options can be found in the forms set forth by Blanket Order 91-505 (BC). Other options and futures comply with the general prospectus provisions of Canadian securities regulation. Second, different disclosure standards do not necessarily imply that investors obtain too little information. If the product design or additional protective mechanisms result in a lower need for disclosure, issuers should be rewarded with streamlined and less costly disclosure provisions. Third, these differentiations do not overly constrain product comparability as long as information is accessible and presented in a well-structured manner. Fourth, present disclosure provisions for options and futures that are distributed to retail investors do not feature significant gaps. However, further improvements could be made by implementing risk disclosure for call and put options in Blanket order 91-505. Finally, the arguably most significant impediment for streamlined disclosure in relation to options and futures can be found in the nonharmonized provincial derivatives regulations. 3.2  Structured Notes  a.  Overview  Structured notes can be issued either as principal protected notes (PPNs) or as principal at risk notes (PRNs).571 As seen in chapter two, section II.3, and chapter three, section II.2.1.b.cc, PPNs usually qualify as evidence of deposit572 and, therefore, are exempt from prospectus requirements.573 In view of the complex structures of these instruments and the lack of disclosure that results from the above exemptions, the Canadian Department of Finance has issued Principal Protected Notes Regulations (PPN Regulations), determining the level of disclosure for the issue of PPNs. Among others, issuers of PPNs must disclose the term of the note, its charges, interest accrual and “any risks associated with the note”.574 Information must be furnished orally and in writing,575 and “in language that is clear and simple  571  For a description of the design of structured notes, see ANDRÉ FOK KAM, „Implications of the Use of Investment Wrappers”, Research Study (May 12, 2006), p. 255. 572 See, for instance, s. 1 (1) BCSA, ‘security’. 573 See also NICHOLLS (fn. 398), p. 174. Another way to exempt PPNs from prospectus requirements is to qualify them as debt instruments issued by Canadian financial institutions (NI 45-106, s. 2.34). See CSA Notice 46-303 on the concerns arising in relation to PPNs. 574 PPN Regulations, s. 3. 575 PPN Regulations, s. 3.  86  and in a manner that is not misleading”.576 Further, issuers have to disclose the current net asset value of the note upon request of investors577 and must inform investors about impending amendments to a particular note.578 Exemptions to these requirements apply solely to the point in time when issuers have to disclose the above information, but do not relieve issuers of disclosure as such. Finally, it remains to be noted that PPN Regulations apply only if these instruments are issued by federal financial institutions. Other PPNs may either be subject to general prospectus requirements of NI 41-101 and NI 44-102 or fall under the scope of an exemption of NI 45-106.579 PRNs are generally distributed under shelf prospectuses in accordance with NI 44-102. Shelf offerings allow reporting issuers to file a base shelf prospectus for securities that may be distributed within a predefined time period.580 These base prospectuses are short-form prospectuses and “must set out the aggregate amount of securities expected to be offered under the prospectus over a period of 25 months”.581 Basically, a base prospectus has to disclose all information that is normally contained in a short-form prospectus but can omit all aspects that relate to the offering of a certain tranche and are not known at the time when the prospectus is designed.582 In addition, issuers must issue a shelf prospectus supplement for each tranche that is distributed to the public.583 In relation to derivatives, NI 44-102 states that ‘novel’ derivatives584 can be distributed only if issuers have pre-cleared the content of prospectus supplements with the competent securities commission.585 In CSA Staff Notice 44-304,586 securities regulators point out certain disclosure-related issues that have to be complied with when distributing linked notes. Among others, the Staff Notice declares that an “issuer will generally find it difficult to meet the full, true and plain disclosure requirement without adequately disclosing the risks relating to the issuer and the particular linked note it is offering”.587 PRNs can be exempt from prospectus disclosure if a prospectus exemption of NI 45-106 applies. In particular, issuers may call on (i)  576  PPN Regulations, s. 2. PPN Regulations, s. 9. 578 PPN Regulations, s. 10. 579 See CSA Staff Notice 46-304 Update. 580 GILLEN (fn. 40), p. 307. 581 GILLEN (fn. 40), p. 309. 582 NI 44-102, s. 5.5 and 5.6. 583 NI 44-102, part 6. These supplements contain all information on a specific tranche that have been omitted in the base shelf prospectus in accordance with s. 5.6 of NI 44-102 (see s. 6.3 of NI 44-102). 584 A derivative is novel if its “type has not been distributed (…) before the proposed distribution, or (…) has been distributed” but features salient new components as described under NI 44-102, s. 1.1, ‘novel’, A.ii. 585 See also Companion Policy 44-102CP, s. 2.4, clarifying the meaning of ‘novel’ in relation to derivatives. 586 CSA Staff Notice 44-304. 587 CSA Staff Notice 44-304, General Disclosure Matters, lit. l. 577  87  section 2.3 when purchasers are ‘accredited investors’588, (ii) section 2.10 if the cost of the investor amounts to a minimum of CAD 150,000, or (iii) section 2.34 if unsubordinated PRNs are issued or guaranteed by a Canadian financial institution or Schedule III bank. b.  Disclosure of Essential Product and Issuer Risks  aa.  Principal Protected Notes  PPN Regulations require institutions589 to disclose the essential characteristics related to a specific issue of PPNs. Among other obligations, institutions have to describe the product and its main characteristics. Issuer-specific information, on the other hand, is scarce. As information on issuing institutions can be obtained from public sources,590 this absence of issuer-related disclosure does not seem critical per se. However, as PPNs are generally issued and distributed en masse,591 these instruments may well be issued by one institution and distributed by another.592 Although this segmentation does not yet represent the norm in current Canadian practice, legislation does not, as far as can be seen, bar issuers of PPNs from implementing such procedures in the future. In view of the distribution structures applied in European countries,593 it seems highly likely that Canadian banks will adopt similar proceedings. If issuers delegate their oral communication duties594 to the products’ distributors, investors might fail to notice that the product’s issuer is not identical to its distributor if issuer-related information is not clearly displayed in disclosure documentation of the respective PPN. PPN Regulations further require that disclosure documentation refers to “risks associated with the note”.595 As a consequence, institutions have to draw attention to all product-related risks. In particular, they must inform about “the risk that no interest may accrue”.596 However, PPN Regulations abstain from requiring issuer-related risk disclosure.597 Moreover, PPN Regulations do not feature any risk  588  See s. 1.1, ‘accredited investor’. PPN Regulations, s. 1‚ ‘institution‘. 590 Subject to these rules are merely federal financial institutions as defined under PPN Regulations, s. 1. 591 See, for example, <https.//www.bmocm.com/investorsolutions/getFile.aspx?fileID=7217>. 592 These procedures and inadequate information led to significant losses of Swiss retail investors upon the bankruptcy of Lehman Brothers. Although the products had been distributed and labeled by Credit Suisse, they were issued by the later insolvent Lehman Brothers and, consequently, investors had to bear the issuer risk related to the notes. 593 As mentioned in fn. 592, similar settings have been accepted standards in Switzerland and other European countries for years. 594 PPN Regulations, s. 2. 595 PPN Regulations, s. 3 (d). 596 PPN Regulations, s. 3 (d). 597 See also FOK KAM (fn. 571), p. 255, on the importance of issuer-related risk disclosure. 589  88  labelling requirements. As both means could significantly enhance transparency for retail investors without overly constraining PPN issuers, they should be taken into account by the Canadian legislator. Finally, PPN Regulations confine their scope to the regulation of PPNs that are issued by federal financial institutions.598 As a result, other issuers have to resort to general prospectus requirements and exemptions. This differentiation cannot be fully explained with characteristics inherent to the respective products. Rather, it is the result of competence issues in Canadian securities and banking regulations599 and lacks inherent persuasion. bb.  Principal at Risk Notes  Disclosure issues arising with regard to PRNs do not significantly defer from those mentioned in sections 1.2, 2.2 and 3.1.b above. Compared to disclosure provisions for shares and bonds, specific risk disclosure is enhanced by section 10.4 (g) of Form 41-101F1 and its requirement to disclose all “risk factors associated with the derivatives”.600 Further, CSA Staff Notice 44-304 points out that risk disclosure for linked notes generally requires the disclosure of risks that are related to issuers and a specific product. 601  In view of this detailed account, product-specific risk information appears to be largely sufficient in  relation to PRNs. Prospectus requirements do not obligate issuers to apply pre-defined risk labels to their PRNs. As these investment instruments generally feature complex structures that are unfamiliar to retail investors, risk labels could considerably improve investors’ ability to correctly assess a product’s risks and its suitability for their investment purposes. Consequently, the lack of labelling duties appears to be particularly unsatisfactory. Finally, prospectus exemptions relieve issuers of prospectus requirements in various constellations. As prospectuses would generally be required if the underlying components of the products were distributed separately, these exemptions are highly problematic602 and should be abolished.603  598  CSA Staff Notice 46-304, CSA’s Proposed Course of Action. See also CSA Staff Notice 46-305, Conclusion, in relation to PPNs that are distributed by financial institutions of Québec. 599 See, GILLEN (fn. 40), p. 77 et seq., on the constitutional division of powers with regard to Canadian securities regulation. 600 Form 41-101F1. See also Form 44-101F1 for short-form prospectuses whose content has to be mirrored for shelf prospectuses as long as contents are not explicitly excluded by s. 5.6 of NI 44-102. 601 CSA Staff Notice 44-304, General Disclosure Matters, lit. l. 602 See also NICHOLLS (fn. 398), p. 174. 603 See FOK KAM (fn. 571), p. 258.  89  c.  Availability of Relevant Information  Issuers of PPNs must provide information “at least two days before entering into an agreement to issue a principal protected note to an investor”.604 If investors agree to receive information at a later date, section 4 of PPN Regulations allows that issuers provide disclosure “at any time before entering into the agreement”.605 PPN Regulations do not allow any content-related disclosure modifications and, therefore, investors of PPNs are always informed about the main characteristics of their investment prior to concluding the respective agreement with the product’s issuer. However, PPN documentation is not vetted by securities commissions or other independent bodies. Consequently, investors cannot fully rely on the information provided by a product’s issuer. Although systematic preventive supervision of each PPN issue might not be adequate for these flexible and fast moving products, random examinations could significantly increase investors’ confidence in disclosure documentation for PPNs. PRN prospectuses are prepared and distributed in accordance with general prospectus requirements of NI 41-101. In particular, investors are not allowed to enter any binding agreements prior to the issue of the final prospectus.606 As a consequence, investors do not acquire a PRN until they are adequately informed about key details such as the exact product price. However, if issuers are exempt from issuing a prospectus for a specific product, investors have no guarantee that they will receive all relevant information prior to acquiring the product. d.  Intra-Product Comparability  PPN Regulations do not set forth a specific structure that issuers have to follow when drafting the written information statement of section 3 PPN Regulations. Consequently, issuers fulfill disclosure requirements if they use “clear and simple”607 language and provide investors with the information required by section 3 PPN Regulation. As long as issuers’ information statements are constrained to the minimum amount of information, comparability should not unreasonably suffer. However, issuers are not obliged to limit their statements to the minimum content set forth in section 3 PPN Regulations. In fact, present PPN statements have proven to be of a similar length to short form prospectuses acting in accordance with Form 44-101. In view of this considerable amount of information, investors’ abilities to compare different products by their prospectuses might become significantly hampered. Mandatory  604  PPN Regulations, s. 3 and 5. Further, the issuer and the investor must conclude their agreement on the purchase of PPNs in person if the exemption of section 4 shall apply. 606 GILLEN (fn. 40), p. 136. 607 PPN Regulations, s. 2. 605  90  structures and pre-defined headings could solve this problem without additional expenses by issuers. As a minimum, information statements for PPNs should have to apply the form-related requirements for short form prospectuses and provide investors with a harmonized front page, a table of contents and headings that clearly identify where significant information can be found in the document. Comparability between different PRNs suffers the same drawbacks as those outlined under sections 1.4, 2.4 and 3.1.b above. As PRNs are designed in a complex manner and prospectuses refer to a multitude of formulae, data and sources, the lack of mandatory product structures is particularly apparent in relation to these products. e.  Sub-conclusion  The above analysis of the Canadian disclosure framework for PPNs and PRNs has shown the following. First, both PPNs and PRNs lack labels indicating the degree of risk investors take by buying certain types of products. Considering the complexity of these instruments, the absence of clearly visible risk signals is dissatisfactory. Moreover, disclosure regulations for both types of structured notes leave certain products outside their scope. In addition, PPN Regulations do not explicitly require that information statements disclose issuer-related risks. In view of the massive losses retail investors in Swiss and German markets suffered upon the bankruptcy of Lehman brothers, counterparty risks should be taken seriously and, consequently, related disclosure should be specifically required by PPN Regulations. Second, information on PPNs and PRNs is disclosed in a timely manner. However, the above gaps in disclosure regulation mean that issuers cannot always access all relevant information in due time. Further, PPN documentation is not vetted by independent bodies and, consequently, incomplete or deficient information might be given to investors. Third, comparability of structured notes could be enhanced by the introduction of structural requirements for prospectuses or information statements. In particular, predefined schemes would enable investors to find relevant information in an efficient manner and, moreover, to compare corresponding data. Finally, concerns have been raised that current PPN Regulations follow an institutional rather than a functional approach.608 In particular, FOK KAM argues that “substance should prevail over legal form”609  608  NICHOLLS (fn. 398), p. 179. See also THE TASK FORCE TO MODERNIZE SECURITIES LEGISLATION IN CANADA, “Canada Steps Up”, Final Report (October 2006), p. 105. 609 FOK KAM (fn. 571), p. 267. Fok Kam refers to the OSC Report on the Task Force on Debt-Like Derivatives (January 5, 1999). The report, p. 14, suggests to keep up the general prospectus exemptions for debt securities in relation  91  and, therefore, that structured notes should be regulated “according to the underlying investment”.610 FOK KAM’s recommendations are in accordance with the overall substantive approach of Canadian securities regulation.611 Whether this regulatory route is better suited for a satisfactory coordination of the needs of investors, product issuers and intermediaries than the present approach to PPN and PRN regulation will be investigated in section 5.1 below and in section II of chapter seven. 3.3  Credit Derivatives and Asset-backed Securities  a.  Overview  aa.  Preliminary Remarks  The global spread of complex credit derivative structures and asset-backed securities has proven to be one of the key reasons for the present financial crisis.612 The recent surge in demand for safe but lucrative investments and the market’s reaction by designing complex, highly leveraged products613 were crucial factors of market participants’ loss of confidence in their counterparties and the consequential meltdown of financial markets. In view of the multi-faceted impacts of credit derivatives on financial markets and their participants,614 the implementation of adequate disclosure rules for credit derivatives and asset-backed debt instruments in the retail market can be no more than a drop in the ocean. However, if regulators and issuers decide to adhere to present models of debt securitization, disclosure regulation has to ensure that investors are provided with important information.615 Therefore, the present prospectus framework for retail credit derivatives and asset-backed debt securities will be briefly reviewed below. Definitions of the term ‘credit derivative’ are based on an economic background and do not necessarily fit into the existing legal framework. Further, the term has been applied to a variety of different  to structured derivatives, but to improve investors’ position by requiring the distribution of risk disclosure statements and term sheets. 610 FOK KAM (fn. 571), p. 259. 611 See above, chapter three, section II.3. 612 FINANCIAL SERVICES AUTHORITY, “The Turner Review - A regulatory response to the global banking crisis” (March 2009), p. 14. 613 The Turner Review (fn. 612), p. 14. 614 See The Turner Review (fn. 612), p. 51 et seq., and JANIS SARRA, “Credit Derivatives, Market Design, Creating Fairness and Sustainability, Network for Sustainable Financial Markets. Consultation Paper No. 1” (January 2009), p. 15, 16, on possible regulatory responses to the present financial crisis and related credit derivatives issues. See also BASEL COMMITTEE ON BANKING SUPERVISION, The Joint Forum, “Review of the Differentiated Nature and Scope of Financial Regulation”, Key Issues and Recommendations (January 2010), p. 10, p. 72 - 82. 615 See INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS (IOSCO). “Unregulated Financial Markets and Products”, Consultation Report (May 2009), p. 15 - 25.  92  products.616 Arguably the most wide-spread form of unstructured credit derivatives are credit default swaps (CDS).617 However, these instruments are generally not distributed to retail investors without further structuring. Therefore, the legal provisions governing disclosure in relation to these products will not be discussed in this paper. If illiquid assets or cash flows deriving from assets are transformed into marketable securities,618 these products can be structured as credit-linked notes or asset-backed securities. While the former are clearly of a derivative nature and combine characteristics of debt securities with those of a CDS,619 the latter need not necessarily feature derivative characteristics. As a result of this diversity, the legal categorization of credit-linked debt securities has not settled yet.620 However, credit-linked notes and asset-backed securities pose closely related challenges to present disclosure frameworks. Therefore, disclosure issues arising from these instruments will be discussed in parallel in sections b to e below, regardless of their classification as derivatives or non-derivative debt securities. bb.  Regulatory Disclosure Requirements  Credit linked notes qualify as structured notes considered in section 3.2 above. Consequently, credit linked notes have to follow disclosure rules for either PPNs or PRNs, depending on whether investors’ capital is protected or at risk. In principle, asset-backed securities are subject to general Canadian prospectus requirements. In particular, section 10.3 of Form 41-101F1 sets forth specific requirements for this type of security. However, section 2.35 of NI 45-106 exempts issuers of commercial papers “maturing not more than one year from the date of issue” from the requirement to produce a prospectus in accordance with the provisions set forth in NI 41-101. Consequently, asset-backed commercial papers are largely exempt from prospectus disclosure.  616  See ROBERT HORAT, „Kreditderivate - Variantenreiche Finanzinstrumente mit Potenzial für die Praxis“, ST 2003, p. p. 970. 617 CHRISTIAN STAUB, „Instrumente des Kreditrisikotransfers im schweizerischen Bankenaufsichtsrecht“, SZW 2009, p. 325. 618 STAUB (fn. 617), p. 325. 619 STAUB (fn. 617), p. 325. 620 See form 41-101F1, s. 10.3. For accounting purposes, asset-backed securities do not qualify as derivatives (see ACCOUNTING STANDARDS BOARD STAFF, “Non-Bank-Sponsored Asset-Backed Commercial Paper. Implementing the Restructuring Plan, Financial Reporting Commentary” (February 2, 2009), p. 3. This assessment is based mainly on the fact that the CICA Handbook, CICA Standards and Guidance Collection, Canadian Institute of Chartered Accountants, paragraph 3855.19 (e), sets forth, among others, that a derivative “requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors”.  93  b.  Disclosure of Essential Product and Issuer Risks  Principal-protected credit-linked notes are subject to the disclosure requirements of PPN Regulations. Consequently, the most noteworthy gaps in current disclosure regulation consist of the fact that PPN Regulations feature neither any risk labelling requirements nor the duty to disclose issuer-related risks.621 Credit-linked notes whose principal is at risk must comply with general disclosure requirements of NI 41-101. However, section 3.2.b.bb has shown that the numerous exemptions of NI 45-106 prevent an effective disclosure regime for complex debt securities. Further, those products that fall under the scope of NI 41-101 are not required to display pre-defined risk labels. Issuers of asset-backed securities which are not exempt from prospectus regulation of NI 41-101 must inform investors about the material characteristics of the distributed securities.622 In addition, issuers have to describe risks that may arise from the products’ structure or issuer-related developments. In particular, section 10.3 (14) of Form 41-101F1 specifies that issuers must describe “any risk factors associated with the asset-backed securities, including disclosure of material risks associated with changes in interest rates or prepayment levels, and any circumstances where payments on the assetbacked securities could be impaired or disrupted as a result of any reasonably foreseeable event (...)”.623 However, issuers of asset-backed securities do not have to apply pre-defined risk labels to their products. Finally, the above disclosure requirements do not apply to products that are exempt from prospectus disclosure. As a consequence, investors acquiring asset-backed commercial papers or other short-term debt instruments cannot access information on material risks related to the product in question or its issuer. c.  Availability of Relevant Information  Purchasers of credit-linked notes or asset-backed securities that are issued under a prospectus in accordance with NI 41-101 can obtain relevant prospectus information within an appropriate time frame. Investors who acquire products exempt from prospectus regulation, on the other hand, have no enforceable means to access trustworthy and comprehensive information. Finally, investors of capitalprotected credit-linked notes may receive incorrect or fragmentary information due to the fact that PPN prospectuses are not vetted by any independent authority.  621  See section 3.2.b.aa above. In particular, s. 10.3 (3) requires that prospectuses feature “financial disclosure that describes the underlying pool of financial assets”. 623 S. 10.3 (14) of Form 41-101F1. 622  94  d.  Intra-Product Comparability  Credit-linked notes or asset-backed securities whose main characteristics are disclosed in a prospectus or written PPN documentation can generally be compared with each other by means of the information disclosed in the above documents. However, comparability could be significantly enhanced by introducing a pre-determined prospectus structure and - in relation to principal-protected credit-linked notes - a central electronic platform where disclosure documents of different product issuers can be retrieved and compared. Moreover, credit-linked notes and asset-backed securities that are not accompanied by a prospectus can hardly be compared at all and retail investors may fail in choosing a product that fits their investment purposes. e.  Sub-conclusion  Considering the above observations, the following concerns have become apparent. First, products that are distributed under prospectus regulations of NI 41-101 or PPN Regulations lack risk labels and predefined prospectus structures. Second, the most pressing issue is the fact that a surprisingly large number of credit-linked securities are not subject to any disclosure regulation at all. As a consequence, investors lack timely information and cannot properly compare different products with each other. Third, due to the sometimes complex structuring of debt-linked securities, enhanced disclosure may not be sufficient to protect retail investors from inappropriate investments. Although further measures cannot be discussed in detail in this paper, they should be kept in mind when deliberating over adequate disclosure procedures. 3.4  A Note on the Québec Derivatives Act  As mentioned in section 3.1.a above, the Québec Derivatives Act abandons the widespread distinction between exchange-traded derivatives and OTC derivative products. Instead, the Act extends, as a general rule, to all kinds of derivative contracts.624 Further, the Québec Derivatives Act is focused on the regulation and continuous supervision of entities distributing derivative products rather than the establishment of tight disclosure obligations for issuers.625 In particular, standardized derivatives must be traded on a regulated published market626 which determines their intrinsic characteristics.627 OTC  624  See above, chapter three, section II.2.1.b.aa, referring to the generous carve-out provisions for OTCtransactions involving accredited counterparties. 625 See s. 12 Québec Derivatives Act. 626 I.e. “an exchange, an alternative trading system or any other derivatives market that (1) constitutes or maintains a system for bringing together buyers and sellers of standardized derivatives; (2) brings together the orders of multiple derivatives buyers and sellers; and (3) uses non-discretionary methods under which the orders  95  derivatives, on the other hand, are not traded on published markets. However, all persons who create or market OTC derivatives must be recognized regulated entities628 or “qualified by the Authority, as prescribed by regulation, before the derivative is offered to the public”.629 Exemptions to these requirements apply if OTC transactions involve accredited counterparties.630 Although the approach to derivatives regulation introduced by the Québec Derivatives Act clearly differs from other provincial derivatives frameworks, the differences are less pronounced than one would assume at first glance. To begin with, the implementation of NI 31-103 and its comprehensive registration requirements for dealers and advisors have significantly raised regulatory standards for intermediaries. While the disclosure requirements for derivatives dealers set forth by Division II.1 of the Québec Derivatives Regulation631 additionally enhance the general regulations of NI 31-103, they are no longer unique insofar as NI 31-103 requires virtually all securities dealers to comply with similar regulatory requirements. Further, as mentioned in chapter three, section II.2.1.b.bb, structured notes632 and exchange-traded options that are issued by investment banks, mostly in the form of book-entry securities or global notes, do not fall under the scope of the term ‘standardized derivative’ and, consequently, issuers of such products would generally have to follow disclosure regulations for securities. Therefore, the Québec Derivatives Act’s waiver of prospectus requirements for exchangetraded derivatives differs from the derivatives legislation of other Canadian jurisdictions only in relation to standardized derivative contracts that are traded on a published market other than an exchange.633 As a result, the Québec Derivatives Act may be considered a valuable step towards a more consistent derivatives regulation. However, its design does not provide any comprehensive regulatory responses to disclosure issues in relation to structured notes, exchange-traded options issued by banks or assetbacked securities and, therefore, does not fill the key gaps identified in sections 3.1 to 3.3 above.634  interact with each other and the derivatives buyers and sellers entering the orders agree to the terms of a trade” (s. 3 Québec Derivatives Act). 627 S. 3, ‘standardized derivative’, Québec Derivatives Act. 628 S. 2, ‘regulated entity’, Québec Derivatives Act. 629 S. 82 of the Québec Derivatives Act. 630 S. 7 Québec Derivatives Act. 631 Of December 2008, online: <http://www.lautorite.qc.ca/userfiles/File/reglementation/instrumentsderives/090928-instderra-vadmin.pdf>. 632 See explicitly Policy Statement respecting Hybrid Products, February 1, 2009. 633 I.e. an alternative trading system or any other derivatives market in the sense of section 3, ‘published market’ of the Québec Derivatives Act. 634 This conclusion is further supported by the fact that the Proposed Act does not abstain from requiring disclosure documentation for derivative instruments. Rather, section 90 of the Act determines that designated  96  4.  Distribution of Mutual Funds  4.1  Overview  Mutual fund distribution is subject to prospectus disclosure set forth in NI 81-101. Mutual fund prospectuses are called ‘simplified prospectuses’635 and have to contain the information determined in Form 81-101F1. According to these provisions, simplified prospectuses must follow specific structural requirements. In particular, Form 81-101F1 instructs issuers to “present each Item in the Part A section and each Item in the Part B section in the respective order provided for in this Form”.636 Further, each “Item shall be presented under the heading or sub-heading stipulated in this Form”.637 Finally, each simplified prospectus must feature a front cover,638 a table of contents639 and clear indications of where further information can be obtained.640 The content of simplified prospectuses is determined by Part A and B of Form 81-101F1. Part A requires that prospectuses feature information about (i) risks that are generally linked to mutual fund investments,641 (ii) the fund’s organization and management,642 (iii) the processing of purchases and redemptions,643 and (iv) fees, expenses and compensations related to the fund.644 Part B specifies that prospectuses must disclose (i) the fund’s investment policy,645 (ii) its key objectives,646 (iii) risks related to these strategies,647 and (iv) suitability issues. Mutual fund regulation contains no significant exemptions from prospectus requirements. On June 19, 2009, the CSA proposed to introduce a so called fund facts document. The document would have to be distributed at the point of sale and would contain key information about the mutual fund such as the costs and risks involved when buying and owning mutual fund units.648 The draft document bears significant resemblance to the key investor information  derivatives must not be traded unless a prescribed disclosure document has been delivered in accordance with the respective regulations. 635 S. 2.4 of NI 81-101. 636 Form 81-101F1, General Instructions, (12). 637 Form 81-101F1, General Instructions, (6). 638 Form 81-101F1, Part A, Item 1, Front Cover Disclosure. 639 Form 81-101F1, Part A, Item 1, Table of Contents. 640 Form 81-101F1, Part A, Item 3, Introductory Disclosure. 641 Form 81-101F1, Part A, Item 4, General Investment Risks. 642 Form 81-101F1, Part A, Item 5, Organization and Management Details for a Multiple SP. 643 Form 81-101F1, Part A, Item 6, Purchases, Switches and Redemptions. 644 Form 81-101F1, Part A, Items 8 and 9, Fees and Expenses and Dealer Compensation. 645 Form 81-101F1, Part B, Item 7, Investment Strategies. 646 Form 81-101F1, Part B, Item 6, Fundamental Investment Objectives. 647 Form 81-101F1, Part B, Item 9, Risks. 648 See NI 81-101 [Amendment Proposed] and Form 81-101F3.  97  document whose implementation into European mutual fund regulation has been proposed by the European Commission.649 4.2  Disclosure of Essential Product and Issuer Risks  As outlined under section 4.1 above, mutual fund prospectuses provide investors with material fundspecific information. While Part A features general information and procedural details, Part B depicts the fund’s objectives and strategies and relates to characteristics investors should or should not have in order to invest into a specific fund. As mutual funds are regularly structured as trusts or, less frequently, as corporations,650 the funds’ assets are legally segregated from other funds and rights of the fund management company and third parties. As a consequence, investors are not necessarily disadvantaged by the lack of detailed information on the fund’s originator or fund manager. Item 9 of Part B requires that prospectuses list “material risks associated with an investment in the mutual fund”.651 Moreover, item 4 of Part A sets forth that prospectuses must display generic risk caveats. Form 81-101F1 does not provide investors with explicit risk labels but takes first steps in this direction by stating that mutual funds must disclose the “type of mutual fund that the mutual fund is best characterized”.652 4.3  Availability of Relevant Information  Mutual fund prospectuses have to be filed with securities commissions in the same manner as prospectuses of other securities.653 Consequently, mutual fund units cannot be distributed before the prospectus has been examined and approved by the relevant securities commission. Investors are therefore provided with material information prior to their investment. 4.4  Intra-Product Comparability  So far, the above comments on comparability of products with products of the same kind have found fault with the absence of comprehensive structural requirements for prospectuses. In particular, Form 41-101F1 does not feature any pre-defined headings or other instructions that would obligate issuers to  649  See <http://ec.europa.eu/internal_market/investment/investor_information_en.htm>. DAVID P. STEVENS, Trust Law Implications of Proposed Regulatory Reform of Mutual Fund Governance Structures, A Background Research Report to Concept Proposal 81-402 of the Canadian Securities Administrators (March 2002), p. 1, 12. 651 Form 81-101F1, Part B, Item 9, emphasis added. As mutual fund investors are protected against insolvency of the fund manager or originator by the segregation of the fund’s assets, assessments on the risks related to these parties do not appear necessary. Further assessments must be conducted by the investors themselves. 652 Form 81-101F1, Part B, Item 5 (a). 653 GILLEN (fn. 40), p. 532, NI 81-101, s. 2.1. 650  98  align information in a clear manner. As outlined under section 4.1, this lack of structure does not arise in relation to mutual fund prospectuses. Rather, Form 81-101F1 instructs issuers of mutual fund units to use the headings provided for in the Form and states that “a simplified prospectus shall present each Item in the Part A section and each Item in the Part B section in the respective order provided for in this Form”.654 As a result of these clear structural standards, investors need less time and effort to find comparable information in different prospectuses. Comparisons between mutual funds are, therefore, considerably less cumbersome than comparisons between different issues of shares, bonds, futures or structured notes. Consequently, the approach followed in Form 81-101F1 should be kept in mind when considering how comparability of prospectuses could be enhanced. 4.5  Sub-conclusion  Prospectus provisions for mutual funds and general prospectus disclosure of NI 41-101 feature significant common characteristics. To begin with, both regulatory frameworks require that issuers disclose material facts to investors. Further, simplified prospectuses for mutual funds and prospectuses in accordance with Form 41-101F1 inform investors about risks that are related to the products in question. However, the above analysis has shown that mutual fund prospectuses contain a number of characteristics that further enhance disclosure for retail investors. First, simplified prospectuses must be designed in accordance with the structural requirements of Form 81-101F1. In particular, issuers have to adopt pre-determined headings and follow the order of items as displayed in Form 81-101F1. Second, mutual fund prospectuses contain generic risk caveats and first steps in the direction of risk labelling. Third, disclosure regulation for mutual funds offers no significant prospectus exemptions. As a result, problems from exemptions that are too broad arise less frequently than they do with other investment products. 5.  Preliminary Results  5.1  Delimitability  The above examination of prospectus requirements for shares, bonds, derivatives and mutual funds has confirmed the preliminary conclusions of chapter three, section 2.2 above. While disclosure standards for shares and bonds are essentially consistent with each other, prospectus requirements for different derivative products vary considerably. On the one hand, the Canadian framework for securities facilitates disclosure for exchange contracts, plain put and call options, commodity futures and principal  654  Form 81-101F1, General Instructions, (12).  99  protected notes. On the other hand, NI 45-106 exempts derivative debt instruments from prospectus regulation without substitution. While the material characteristics of the former product types do not require the same degree of disclosure as other instruments, the exemptions applying to principal-at-risk notes, asset-backed securities and other complexly structured debt securities do not seem appropriate. By invoking exemptions such as sections 2.34655 or 2.35656 of NI 45-106, issuers have managed to issue complex derivative products without providing material information to investors. As a consequence, investors’ efforts to delimit different types of products and assess the benefits of an investment instrument have become considerably hampered.657 How can the above inconsistencies be approached? FOK KAM argues in his research study on Implications of the Use of Investment Wrappers for a consistent pursuit of the substantive approach in relation to derivative products. In particular, he suggests that structured notes “should be subject to the same disclosure and sales practices requirements as the underlying investment”.658 At first glance, this concept seems most convincing. Canadian prospectus regulation is based on a substantive approach. As a result, it seems logical that all products should be subject to disclosure rules that consider the products’ inherent characteristics or - in the case of structured finance - the characteristics of their underlying components. However, there are a number of reasons that speak against an uncompromising implementation of this substantive approach. First, issuers of structured derivatives are commonly not identical to those of the underlying securities. Therefore, it would not be adequate if they were required to provide investors with the same prospectus information as the issuers of the underlying products. Second, today’s structured derivatives are often not confined to one single underlying. Rather, they refer to a multitude of different securities or to other wrapper products such as ETFs, hedge funds or credit-linked securities. In addition, product managers are sometimes allowed to restructure underlying securities during the life span of a product. As a consequence, full disclosure of all product components in the same manner as if these components were issued on a standalone basis may become too complex to manage. Third, structured products are complex debt securities. As a result, they do not necessarily have the same characteristics as their underlying instruments and investors may need different or additional information to those investing in the underlying products as such. Fourth, lean regulatory structures allow issuers of structured derivatives to react to market  655  Specified debt. Short-term debt. 657 See also FOK KAM (fn. 571), p. 299. 658 FOK KAM (fn. 571), p. 304. 656  100  developments and investors’ needs in a timely manner.659 The introduction of lengthy prospectus filing procedures could considerably hamper the development and timely issue of innovative investment instruments. Considering the above assessment, the implementation of thoroughly substantive prospectus regulations for structured derivatives does not seem entirely satisfactory.660 Therefore, the introduction of separate disclosure procedures for certain instruments might be worth considering. While the form of disclosure could be consistent with current shelf prospectus requirements,661 the content should be amended to the products’ characteristics and risks. In particular, extensive disclosure of the underlying instruments is appropriate only if investors have no access to product information provided by the issuer of these instruments. Instead, disclosure of structured products should focus on appropriate risk information and refer to structural characteristics that might lessen investors’ prospects. However, areas of separate disclosure regulation must be narrowly defined to a delimitable range of products. Otherwise, issuers might take advantage of facilitated disclosure regulations and issue structured derivatives which are not suited to retail investors. In particular, actively managed structured derivatives tend to have similar characteristics to mutual funds. Mutual funds are highly regulated and pricetransparent entities. It would be unsatisfactory and confusing for investors if identical economic characteristics could be achieved with considerably less regulated products. Consequently, the scope of structured derivatives should not extend to actively managed products. In addition, not all structured derivatives might be suited for retail investors. As a result, the introduction of mandatory consultation might be an adequate amendment to mere prospectus disclosure. This subject will be further considered in chapter seven of this thesis. 5.2  Risk Disclosure  The above examinations of prospectus requirements for shares, bonds, derivatives and mutual funds have shown the following. Disclosure documentation generally informs investors about the key risks that are involved with investments in a certain product. Nevertheless, there are a number of aspects that could significantly enhance investors’ risk awareness. In particular, prospectuses in accordance with Form 41-101F1 partially refrain from disclosing risks related to the structure of a certain product.662 PPN risk information statements, on the other hand, do not explicitly instruct investors to disclose issuer-  659  See also FOK KAM (fn. 571), p. 281 and p. 285. FOK KAM (fn. 571), p. 303, 304. 661 See also FOK KAM (fn. 571), p. 304. 662 See, in particular, sections 1.2 and 2.2. 660  101  related risks inherent to these products.663 Moreover, no prospectuses other than those of mutual funds contain generic risk caveats or risk labels cautioning investors to be aware of the risks that may generally arise from investments in certain product types. Finally, prospectus exemptions of NI 45-106 compromise disclosure for investors of structured notes and asset-backed securities in a disproportionate manner. 5.3  Availability of Relevant Information  As mentioned under the above product-specific sections, prospectus information is generally available on a timely basis. However, products without adequate disclosure requirements do not provide issuers with necessary information. In particular, a multitude of complex structured notes or credit-linked securities can be issued without prospectus documentation. In such cases, investors have no access to key information and, consequently, cannot properly assess the risks that are related to these products. 5.4  Comparability  Comparisons between different product categories are feasible as long as these products are issued under the same disclosure regime. However, comparability is slightly hampered by the fact that neither NI 41-101 nor the information statements of section 3 of PPN Regulations obligate issuers to arrange information in a certain order or under pre-defined headings. These measures have been implemented in relation to mutual fund prospectuses664 and allow investors to compare different funds in an efficient manner. Although a comprehensive harmonization of headings or section orders might not be feasible in relation to all kinds of securities, an implementation of basic mandatory disclosure structures could make a considerable contribution to enhanced product comparability. 5.5  Sub-conclusion  In view of the above analysis of prospectus disclosure for shares, bonds, derivatives and mutual funds, the following conclusions can be drawn. First, Canadian securities regulation’s substantive approach to product regulation provides investors with relevant information and risk disclosure in most cases. However, limitations have been identified in relation to complex derivative and credit-linked products that make use of traditional prospectus exemptions to escape disclosure of material product and issuer risks. A possible strategy to eliminate these tendencies without unduly inhibiting innovative product strategies might be found in the implementation of derivative-specific prospectus requirements for  663 664  Section 3.2.b. See above, section 4.4.  102  structured products. First steps in this direction have already been taken by introducing PPN Regulations in July 2008. Second, disclosure could be further enhanced by risk labels and additional structural requirements for prospectuses. Although more complex comparisons might need the assistance of professional advisors or asset managers, well-arranged prospectus structures and risk indications can considerably increase investors’ abilities to assess the appropriateness of a specific product. Third, some product structures as, for example, actively managed structured notes might be too complex for the purposes of retail investors and, therefore, should be banned from mass trading. Canadian securities regulation has so far not chosen to introduce such prohibitions. Chapter seven, section II will return to these considerations.  III.  Switzerland  1.  Distribution of Shares  1.1  Overview  Section III.3 of chapter two has shown that Swiss securities regulation distinguishes between exchangetraded shares and shares that are not listed at a stock exchange. Issuers of non-listed shares do not have to produce a prospectus at the incorporation of the company.665 However, if a corporation raises its capital and distributes shares to the public,666 it must publish a so-called ‘issue prospectus’.667 Section 652a SCO does not provide any structural requirements for this document. With respect to the prospectus content, the provision sets forth that the issue prospectus must disclose information on (i) the corporation’s structure and share characteristics,668 (ii) “the latest financial statement (…) with the auditors’ report”,669 “dividends paid during the last five years”,670 and “the resolution on the issue of new shares”.671 Prospectuses for non-listed shares are not vetted or approved by any regulatory bodies and companies issuing non-listed shares are not subject to any oversight regulation. However, section 752 SCO introduces civil liabilities for any damage due to the fact that “statements have been made or disseminated which are incorrect, misleading or not complying with the legal requirements in issue prospectuses (Art. 652a) or similar instruments”.  665  S. 629 SCO et seq. See GAUDENZ G.ZINDEL/PETER R. ISLER, Basler Kommentar zum Obligationenrecht II, 3rd edition (Basel. Helbing Lichtenhahn, 2008), s. 652a SCO, n. 1 - 3b, and s. 652a (2) SCO. 667 S. 652a (1) SCO. 668 S. 652a (1)(1) - (4) SCO. 669 S. 652a (1)(5) SCO. 670 S. 652a (1)(6) SCO. 671 S. 652a (1)(7) SCO. 666  103  Issuers of exchange-traded shares have to follow far more detailed prospectus provisions. In particular, they must comply with Scheme A for equity securities of SIX Regulation.672 The scheme requires that issuers indicate “risk factors that are of key importance in assessing the market risk attached to the issuer, its sector and the securities that are being offered”.673 Further, share prospectuses have to inform investors about the issuer and its business activities674 and must contain the issuer’s financial statements “for the last three full financial years”675 and “material changes since the most recent annual or interim financial statements”.676 In addition, prospectuses must contain information on the shares themselves, in particular on the nature of the issue,677 restrictions on transferability and tradability,678 and the form,679 number, type and par value of the distributed securities.680 SIX Regulation does not feature a prospectus summary or any structural requirements except that risk factors must be presented “in a prominent place” and “under a specific ‘Risk factors’ heading”.681 1.2  Disclosure of Essential Product and Issuer Risks  Prospectuses for non-listed shares fail to provide investors with adequate information. In particular, issuers are not required to provide information on the future prospects of the corporation682 or material developments since the most recent financial statements.683 Further, prospectuses acting in accordance with section 652a SCO do not call attention to any risk factors related to the issuer and the distributed shares. Considering the scarce information that investors can take from these prospectuses, section 652a SCO does not conform to international disclosure standards684 and is distinctly below the standard of the Canadian prospectus regulations outlined above.  672  <http.//www.six-exchange-regulation.com/admission_manual/04_03-SCHA_en.pdf>. S. 1 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 674 S. 2.1 - 2.6 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 675 S. 2.7.1 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 676 S. 2.7.5 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 677 S. 3.2 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 678 S. 3.6 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 679 S. 3.11 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 680 S. 3.3 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 681 S. 1 of Scheme A, Equity Securities, SIX Swiss Exchange Regulation. 682 Bericht zum Vorentwurf der Expertengruppe zur Ausarbeitung eines Bundesgesetzes über die Börsen- und den Effektenhandel of January 22, 1992, p. 22, CONTRATTO (fn. 129), p. 249. Unlike Canadian securities regulation (NI 51102, Part 4a), the Swiss legal framework does not provide any standards if the company should publish information about its future prospects on a voluntary basis. 683 BSK-ZINDEL/ISLER (fn. 666), s. 652a SCO, n. 5. 684 BSK-ZINDEL/ISLER (fn. 666), s. 652a SCO, n. 5, and PETER BOECKLI, Schweizer Aktienrecht, 3rd edition (Zürich/Basel/Genf. Schulthess, 2004), § 2 n. 105. 673  104  Prospectuses of exchange-traded shares inform investors about the essential aspects of the issuer’s business and the shares’ characteristics. Further, prospectuses must advise investors of risks that are related to the issuer and the shares. However, these risk statements do not comment on effectively impending risks and the probability of their occurrence. Rather, prospectus disclosure provides the tools for risk assessments but refrains from giving any indications of the issuer’s views on potential issues. Finally, prospectuses of exchange-traded shares do not contain any pre-defined risk labels. As section II.1.2 has shown, risk labels do not appear meaningful in relation to shares. As a consequence, Scheme A of SIX Regulation complies with the core disclosure strategies applicable in relation to shares. Improvement could be made by the introduction of brief MD&As discussing the likelihood that one of the displayed risks will actually occur. 1.3  Availability of Relevant Information  Prospectuses of non-listed shares are not vetted by any regulatory bodies. As a consequence, investors have no guarantee that they obtain information in the correct form and in good time. This lack of control has been explained with efficiency reasons and investors’ choice between supervised and largely unregulated securities markets.685 However, recent experience has shown that efficiency does not necessarily imply well-functioning and balanced markets. If investors have no appropriate access to relevant information, they are not able to make adequate investment decisions and are therefore entirely exposed to the issuer’s goodwill and honesty. Moreover, the absence of adequate risk disclosure and control is unique in securities regulation of European countries. As will be outlined under section IV below, member states of the European Union require that issuers provide elaborate prospectuses and have implemented prospectus due diligence by governmental authorities.686 If Swiss securities markets intend to keep up with global disclosure standards, the introduction of prospectus due diligence cannot be circumvented.687 Issuers of prospectuses of exchange-traded shares must be filed with SIX Swiss Exchange. If the exchange approves the listing,688 issuers are required to publish the relevant documents “no later than  685  CONTRATTO (fn. 129), p. 407. ZOBL/KRAMER (fn. 132), p. 1131. 687 See also THOMAS WERLEN, „Die Neuregelung des europäischen Primärkapitalmarktrechts durch die Prospektrichtilinie - Anstoss zur Revision des schweizerischen Primärkapitalmarktrechts?“ in. Hans-Caspar von der Crone et al. (eds.), Aktuelle Fragen des Bank- und Finanzmarktrechts (Zürich. Schulthess, 2004), p. p. 469; dissenting, however, CONTRATTO (fn. 129), p. 407. 688 See s. 42 - 48 of SIX Listing Rules for the listing procedure. 686  105  the day of listing”.689 Although prospectuses are not vetted by a government agency, the approval procedure of SIX seems to be adequately designed as to guarantee that investors obtain relevant information in due time. 1.4  Intra-Product Comparability  As outlined under section II.1.4 above, investors must be able to compare different share issues by means of the prospectuses accompanying these shares. Consequently, the implementation of harmonized and structured prospectus information is a key element of transparent capital markets. Swiss prospectus regulation for non-listed shares fails to provide investors with adequate information.690 In addition, it does not define a sequence that issuers have to follow with regard to the required items. Finally, prospectuses of non-listed shares are not available on a public platform but have to be requested from each issuer separately. In view of these hurdles that investors have to overcome in order to obtain meaningful information, the present legal framework does not enable product comparability in an adequate manner. Prospectuses of exchange-traded shares, on the other hand, can be obtained on the website of SIX Swiss Exchange.691 However, availability is confined to a relatively short time span.692 Section 30 (4) SIX Listing Rules determines that the “Regulatory Board reserves the right to make approved and published listing prospectuses (…) available in suitable form via an electronic system”. The period of publication is not defined by any regulatory provision and is within the discretion of the SIX Regulatory Board. Generally, prospectuses are available for approximately six months to one year following the issue of the securities. As a result, investors who consider buying shares on the secondary market after this time period no longer have access to information provided in the prospectus. Further, SIX Regulation determines neither the order in which information must be arranged nor the headings that should be used to structure prospectuses.693  689  S. 39 of SIX Listing Rules. See above, sections 1.1 and 1.2. 691 <http.//www.six-exchange-regulation.com/publications/prospectus/equities_en.html>. Further, listing notices can be published on <http.//www.six-exchange-regulation.com/publications/notices/equity_securities/equities/ initial_listing_en.html>. 692 In February 2010, for example, investors have access to prospectuses that have been issued between July 2009 and February 2010. 693 The requirement in S. 1 of Scheme A, Equity Securities, to describe relevant risk factors under the heading ‘Risk Factors’ is the only exemption to the above assessment. 690  106  1.5  Sub-conclusion  Taking into account the above insights, Swiss prospectus regulation in relation to publicly distributed shares features several gaps. First, prospectuses of non-listed shares lack crucial information such as the indication of relevant risk factors. Second, investors of exchange-traded shares do not obtain a brief risk prognosis as set forth in Canadian MD&As694 or a summary of all material prospectus information. Third, availability and comparability of prospectuses is seriously hampered by the fact that Swiss securities legislation has not introduced a centralized storage of public securities documents.695 Fourth, the Swiss prospectus framework for shares lacks provisions defining a clear design for share prospectuses. As a result, investors need more time and expertise to select comparable information from different prospectuses. 2.  Distribution of Bonds  2.1  Overview  Swiss securities regulation does not feature a harmonized disclosure framework. As a consequence, legislation does not contain a uniform prospectus framework for all kinds of debt securities. Section 1156 SCO specifies that non-listed bonds696 can be distributed to the public only if they are accompanied by a prospectus. The content of a bond’s prospectus is based on the prospectus requirements for nonlisted shares. Further, the prospectus has to “contain the detailed information concerning the loan, especially the interest terms, terms of repayment, special security provided for the bonds (…)”.697 Prospectuses for non-listed bonds are not vetted or approved by any regulatory bodies. SIX Swiss Exchange has implemented additional prospectus requirements in relation to exchange-traded bonds. Scheme E requires that issuers disclose information on the issuer of the bonds698 and the distributed securities.699 While the issuer-related requirements are largely identical to those set out for exchange-traded shares, information relating to the product itself is customized to the general  694  See above, fn. 509. See, in contrast, the Canadian SEDAR system on <www.sedar.com>. Although investors can access information on exchange-traded shares via the website of the Swiss stock exchange, there is no centralized database for Swiss corporations. In particular, the SIX website generally refers investors to homepages of listed companies and, thus, further complicates availability of documents. 696 See above, chapter two, section III.2, for the definition of a bond in Swiss securities regulation. As SIX Regulation contains more detailed prospectus rules for listed bonds, requirements of s. 1156 SCO are relevant in relation to non-listed bonds only. 697 S. 1156 (2) SCO. 698 Section 1 of Scheme E, Bonds, SIX Swiss Exchange Regulation. 699 Section 2 of Scheme E, Bonds, SIX Swiss Exchange Regulation. 695  107  characteristics of bonds. In particular, prospectuses must display the terms and conditions of the securities,700 such as the issue and redemption price,701 the interest rate,702 and duration and “terms and conditions of repayment”.703 Further, issues of convertible bonds or warrant bonds require additional disclosure.704 Prospectuses of asset-backed bonds must feature a transaction summary705 and risk disclosure in relation to legal risks, “risks associated with the structure of the transaction, including third-party risk”, and “all other significant risks associated with the structure and with the assets serving as collateral”.706 Scheme E does not require a prospectus summary or any structural obligations in relation to bond prospectuses. Consequently, issuers are free to choose orders and headings at their discretion. 2.2  Disclosure of Essential Product and Issuer Risks  Prospectuses for non-listed bonds feature the same gaps as those described in relation to non-listed shares in section 1.2 above. In particular, they fail to provide information that would allow issuers to gauge issuer-related developm