A fundamental premise of the regulation of securities market is that investing public, if provided with full, plain and true material information concerning the investment, will be able to make its own investment decision. The Securities Act therefore requires that some trades only be completed if the purchaser of the security is first provided with sufficient information about the security. An individual or business entity which intends to trade in a security, where such a trade would be a distribution, must initially file with the Ontario Securities Commission (OSC) a preliminary prospectus and subsequently a final prospectus pursuant to section 53 of the Act. A distribution is defined in subsection 1(1) of the Act and arises in one of three types of trades: (1) where an issuer intends to issue previously unissued securities (the issuance of shares out of treasury); (2) where any person who owns greater than 20% of the voting securities of the issuer disposes some or all of his securities; and (3) a trade by or on behalf of an issuer in previously issued securities of that issuer that have been redeemed or purchased by or donated to the issuer.
For example, if a startup, Startup Inc., wants to raise a significant amount of capital from the public to expand operations by issuing shares in the startup. Startup Inc. proposes to issue and sell to the public new shares, which would be both a "trade" and "distribution" of the securities. In order to comply with the Act, assuming no exemption from sections 25 and 53 exist, Startup Inc. must prepare and file with OSC a preliminary prospectus and a final prospectus for this distribution. The proposed issuance of new shares as means of raising money for Startup Inc. is only effective if there is a market for those shares. To facilitate the offering of shares, Startup Inc. would seek to engage an investment dealer to act as an underwriter or selling agent in connection with the offering. The underwriter's function is to use its expertise in assembling information about Startup Inc. and market conditions in order to determine the best attributes to attach to the shares to attract investors and to assess an appropriate price for their sale, and to then sell the shares through its network of stockbrokers to both institutional (banks, pension funds) and retail (average Canadian investors) customers. The underwriter will either purchase the new issue at a discount and then arrange for its immediate resale to the investing public (underwriting) or act as agent to sell securities and receive a commission based on what is sold (agency offering).
As noted above, the distribution of securities requires the preparation of a preliminary and final prospectus. Only once these documents have been filed with the OSC and receipts have been issued for them may the securities be sold to the public. A prospectus is a comprehensive disclosure document which is intended to provide "full, true, and plain disclosure of all material facts relating to the securities issued." The prospectus is a long and complex document that includes a wide variety of information, including information about the issuer, a description of its share capital and in particular the class of share to be sold including its price. The prospectus must also contain historical audited financial statements. One should make references to the Act, at sections 53 to 62, Part III of the Regulation, Rule 41-501 and National Instrument 41-101 for guidance as to the type of information that must be included in a prospectus. The preliminary prospectus contains in essence the same content as a prospectus, although the preliminary prospectus has a warning which indicates that it is a preliminary prospectus and that the information contained therein is not yet complete. The preliminary prospectus is submitted electronically to the OSC and a receipt is issued. The OSC will review the document and issue a deficiency letter indicating the areas of the preliminary prospectus which need attention before the OSC will accept a final prospectus. Once the deficiencies are settled, the final prospectus will be filed and the Director of the QSC will issue a receipt.
Throughout the prospectus preparation process, lawyers and other professionals will be involved in acting for both the issuer and the underwriter. The prospectus preparation process is influenced by the danger of civil liability imposed by the Act in connection with misrepresentations in a prospectus. Certain persons, other than the issuer, may be relieved of that liability if they made adequate inquiries to afford them a reasonable belief that there was no misrepresentation. The issuer and the underwriter are principally responsible for ensuring that the prospectus discloses all material facts and will, with the assistance of their lawyers, adopt procedures which provide a record of diligent search for and disclosure of material information. The process whereby the issuer and others assemble and disclosure material information in the prospectus is known as the "due diligence" process.