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On reverse takeovers, OSC is behind the times

You've probably never heard of Mt. Kearsarge Minerals Inc. Named after a scenic New Hampshire peak, it was a shell company that traded briefly on the Alberta Stock Exchange in the early 1990s.

Mt. Kearsarge and a second dormant company would later, and now infamously, become Sino-Forest Corp. via a reverse takeover, a technique that allows a publicly-listed company, typically with few assets, acquires a private company in a share swap.

The allure of the reverse takeover (RTO), often called a "backdoor" merger, is that a private company can morph into a public one quickly and more cheaply than through an initial public offering. More enticingly, a reverse takeover can be done beyond the prying eyes of a full securities commission review, which is "often intense and time-consuming," as a leading Canadian law firm points out on its web site.

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In the aftermath of Sino-Forest's messy demise, Ontario Securities Commission head Howard Wetston was talking tough. He vowed last year to take a hard look at RTOs, particularly those involving companies operating in China and other emerging markets, such as Sino-Forest, once a $6-billion forestry company that is now formally accused of fraud.

But after looking under the hood, the OSC now says there's nothing inherently wrong with RTOs. A staff notice issued this month found numerous "disclosure deficiencies" involving Canadian-listed companies operating in emerging markets. Strangely, the report makes no mention of reverse takeovers – the gateway for many of these companies into Canadian financial markets. And in March, the OSC concluded in another review that reverse takeovers are "not specifically problematic."

That puts the OSC out of step with both the U.S. and Britain, where regulators are cracking down on backdoor listings. Reacting to a series of embarrassing accounting scandals, the U.S. Securities and Exchange Commission tightened the rules on these deals a year ago, essentially eliminating the regulatory loophole.

Britain's Financial Services Authority is similarly moving ahead with rules to ensure backdoor listings aren't used to take otherwise ineligible companies public.

Why no action here?

Maybe there's a sense that heavy-handed regulation isn't needed in Canada's small and clubby financial markets, where regulators and deal makers often know each other.

Regulators insist they have a handle on the situation. Leslie Byberg, the OSC's director of strategy and risk, said in an e-mail that the commission holds companies accountable to investors "regardless of their particular location or the vehicle used to access our marketplace."

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That may be so. But the reality is that bypassing a more stringent IPO review shifts the burden of oversight to the stock exchanges.

Here's the problem: Canada's major exchanges are controlled by TMX Group, a profit-making company owned by the country's major banks and other financial institutions.

"The exchange is clearly conflicted," said Ed Waitzer, a prominent securities lawyer and former OSC chairman. "It is no longer a public interest entity." Because it's a private company which is accountable to its shareholders, he says, "they don't owe duties to the public at large."

Mr. Waitzer said it's "curious" the commission is ignoring the issue, including the role of the TMX in "facilitating" risky reverse takeovers.

"When you list via a reverse takeover, you're not filing a prospectus, you're not going through the regulatory review process that goes with an IPO," said Mr. Waitzer, who is also chair of corporate governance at York University's Osgoode Hall Law School. "The question is, 'How certain are you that the company is clean?' You're backing into a shell and you don't know what's gone on there."

As a gatekeeper, TMX has little reason to discourage reverse takeovers. Quite the opposite: the TMX sees itself as a financing hub for global resource companies. Reverse takeovers bring companies, investors and deals to Canada. More listings and more deals are good for business. They also lead to more work for the bank-owned securities dealers.

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There were 13 reverse takeovers on the TSX, the TSX venture exchange and the NEX exchange in the first nine months of this year, and nearly 70 in total since 2009.

Lurking somewhere in those deals could be another Sino-Forest.

The obvious lesson of the Sino-Forest fiasco is that more scrutiny is needed to protect investors and the integrity of financial markets, not less.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More


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