ANALYZING THE CANADIAN THIRD-PARTY ABCP LIQUIDITY CRISIS AND
RESTRUCTURING THROUGH THE LENSES OF SECURITIES AND INSOLVENCY
LAW
VIRGINIA E. TORRIE
A THESIS SUBMITTED TO THE FACULTY OF GRADUATE STUDIES
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS
FORTHEDEGREEOF
MASTER OF LA WS
GRADUATE PROGRAM IN LAW
YORK UNIVERSITY
TORONTO, ONTARIO
APRIL 2010 Library and Archives Bibliothéque et 1*1 Canada Archives Canada Published Heritage Direction du Branch Patrimoine de Pédition 395 Wellington Street 395, rue Wellington OttawaONK1A0N4 Ottawa ON K1A 0N4 Canada Canada
Yourfile Votre reference ISBN: 978-0-494-62461-6 Ourfile Notre reference ISBN: 978-0-494-62461-6
NOTICE: AVIS:
The author has granted a non- Uauteur a accordé une licence non exclusive exclusive license allowing Library and permettant å la Bibliothéque et Archives Archives Canada to reproduce, Canada de reproduire, publier, archiver, publish, archive, preserve, conserve, sauvegarder, conserver, transmettre au public communicate to the public by par telecommunication ou par 1'lnternet, préter, telecommunication or on the Internet, distribuer et vendre des théses partout dans le loan, distribute and seil theses monde, å des fins commerciales ou autres, sur worldwide, for commercial or non- support microforme, papier, électronique et/ou commercial purposes, in microform, autres formats. paper, electronic and/or any other formats.
The author retains copyright Uauteur conserve la propriété du droit d'auteur ownership and moral rights in this et des droits moraux qui protege cette thése. Ni thesis. Neither the thesis nor la thése ni des extraits substantiels de celle-ci substantial extracts from it may be ne doivent étre imprimés ou autrement printed or otherwise reproduced reproduits sans son autorisation. without the author's permission.
In compliance with the Canadian Conformément å la loi canadienne sur la Privacy Act some supporting forms protection de la vie privée, quelques may have been removed from this formulaires secondaires ont été enlevés de thesis. cette thése.
While these forms may be included Bien que ces formulaires aient inclus dans in the document page count, their la pagination, il n'y aura aucun contenu removal does not represent any loss manquant. of content from the thesis.
1+1 Canada ANALYZING THE CANADIAN THIRD-PARTY ABCP LIQUIDITY CRISIS AND
RESTRUCTURING THROUGH THE LENSES OF SECURITIES AND INSOLVENCY
LAW
by Virginia E. Torrie
By virtue of submitting this document electronically, the author certifies that this is a true electronic equivalent of the copy of the thesis approved by York University for the award of the degree. No alternation of the content has occurred and if there are any minor variations in formatting, they are as a result of the conversion to Adobe Acrobat format [or similar software application).
Examination Committee members: 1. Stephanie Ben-Ishai 2. Mary Condon 3. Robin Schwill 4. Benjamin Geva 5. Richard LeBlanc ABSTRACT
The C$32 billion third-party Asset-Backed Commercial Paper (ABCP) liquidity crisis has arguably been the most visible impact of the American subprime mortgage crisis in Canada. This thesis examines this event as follows: Part 1 focuses on the securities law aspects of the crisis; Part 2 analyzes the restructuring from an insolvency law perspective.
Investigations have revealed that ABCP was insufficiently regulated, leaving open the possibility of a liquidity crisis. Accordingly, the first part of this thesis analyzes this event from a securities law perspective and puts forth a series of recommendations to address regulatory failures.
The restructuring of 20 third-party ABCP trusts under the Companies Creditors'
Arrangement Act represent one of the most creative uses of the statute in recent history. Therefore, the second part of this thesis adopts an insolvency law perspective in analyzing several features of this precedent setting case and the Plan of Arrangement.
IV TABLE OF CONTENTS
Abstract iv ListofTables vi List of Figures vii Introduction 1 A. Risky ABCP Business Practices and Securities Law 3 B. The Insolvency of the Canadian Third-Party ABCP Market 6 C. Literature Review 8 D. Methodology 12 E. Roadmap 13 Part 1: Securities Regulation and the Third-Party ABCP Liquidity Crisis 15 A. The (Faulty) Structure of Canadian Third-Party ABCP Securitization 19 i. The Third-Party ABCP Market and Financial Failure 19 ii. Why Third-Party ABCP Experienced a Liquidity Crisis 32 a. Disclosure Exemptions and Reliance on Credit Rating Agencies 32 b. An Investor Confidence Crisis and The Failure of Liquidity Agreements... 42 c. Investor Protection: Retail Investors in Third-Party ABCP 50 B. Looking Toward Regulatory Reform 53 i. Situating the Third-Party ABCP Liquidity Crisis amid Securities Market Failures from a Law and Economics Perspective 53 ii. Recommendations for Reform 63 C. Post-Liquidity Crisis: Regulatory Inquiry and Action 72 D. Conclusion 103 Part 2: Restructuring the Third-Party ABCP Market under the CCAA 106 A. CCAA Restructuring Proceedings 107 i. Accessing the CCAA 107 ii. The CCAA Plan 113 B. A Precedent-Setting Case: Applause and Critique 121 i. Retail Investors in Third-Party ABCP 121 ii. Third-Party ABCP: A Pseudo-Prepackaged Bankruptcy and Precedent-Setting Case 131 C. Conclusion 151 Conclusion 154 Appendix A: Timeline of Certain Significant Events in the Third-Party ABCP Liquidity Crisis and Restructuring 159 Appendix B: Glossary of Financial and Legal Terms 162 Bibliography 166
v LIST OF TABLES
Table 1: Settlements Reached ConcerningThird-PartyABCP 74
Table 2: Subprime Exposure of Coventree-sponsored Conduits and Note Series 99
vi LIST OF FIGURES
Figure 1: Structure of the Canadian Third-Party ABCP Market 21
Figure 2: Third-Party ABCP Conduits as Trusts 22
Figure 3: Tracing the Money in Third-Party ABCP Structures 23
Figure 4: Third-Party ABCP Conduits and CDS Arrangements 27
vu Introduction
In August 2007, a C$32 billion sector of Canadian money markets collapsed, evaporating investors' life savings, pension plans and working capital. This event was the most immediate, and to date the most acute, impact of the global financial crisis felt in Canada.
The financial failure of this previously little-known money market security, called third-party asset-backed commercial paper (ABCP), has accordingly had significant ramifications for Canadian securities regulation and insolvency law. Set against a backdrop of global economic turmoil, the third-party ABCP liquidity crisis and restructuring are among the many events that have contributed to heightened international scrutiny of financial markets regulation and insolvency procedures. As legal reform in these areas is much anticipated, careful research and analysis of this event and accompanying issues is both necessary and timely in order to inform future regulatory responses and policy-making.
The goal of this study is to investigate the financial failure of third-party ABCP, in order to determine the causes of its collapse and assess the court-supervised insolvency that brought about its resolution. My research builds on three prior papers on various aspects of this topic completed as part of my J.D. studies. This
1 study puts forth a series of securities law recommendations to help prevent the recurrence of the third-party ABCP liquidity crisis and offer insight into this
groundbreaking insolvency case.
The issues I deal with in my thesis are:
1. How can Canadian securities law be improved to overcome the regulatory
causes of the third-party ABCP liquidity crisis?
2. How is the restructuring of this segment of Canadian money markets, a case
that stretched the parameters of insolvency law under the Companies'
Creditors Arrangement Act (CCAA),1 likely to influence Canadian insolvency
law in the future?
The third-party ABCP liquidity crisis and insolvency were surprising and unusual
events in the Canadian legal landscape. Despite its relative obscurity prior to August
2007, the third-party ABCP market's collapse and restructuring have had far
reaching effects, underlining the significance of legal reforms in this area for the
stability of the broader Canadian economy. The loss of sizeable investments in third-
party ABCP by pension funds such as Caisse de depot et placement du Québec
(CDPQ), the largest pension fund in Canada, highlight how regulation of securities
markets and court-supervised restructurings have the potential to impact hundreds
1 Companies Creditors' Arrangement Act, R.S.C. 1985, c. C-36 [CCAA]. 2 of thousands of individuals.2 Following the outbreak of the third-party ABCP
liquidity crisis, Canadian professionals and the public have begun to critically
question why sounder securities laws were not in place to prevent this market
failure, and whether the unusual restructuring process, expected to be a powerful
precedent for future insolvency cases, created a fair result for all investors. The
study of the third-party ABCP liquidity crisis and restructuring is thus well
deserving of further study in the Canadian context.
A. Risky ABCP Business Practices and Securities Law
Marking the largest insolvency in Canadian history, the C$32 billion restructuring
resulted from a series of events triggered by a loss of investor confidence in the
underlying assets of ABCP trusts, which consisted primarily of American consumer
receivables (including subprime mortgages). Following the outbreak of the
subprime mortgage crisis in the United States, Canadian investors in third-party
ABCP were nervous about the quality of the financial assets underlying their notes.
As a result, there was a mass exodus from the ABCP market, as investors redeemed
their commercial paper and refused to purchase new notes.
2 "Quebec pension giant posts $39.8B loss" (25 February 2009} online: CBCnews
The apparently unsound business models of third-party ABCP conduits, left effectively unchecked by applicable securities regulation, contributed to the August
2007 liquidity crisis and ensuing insolvency. Canadian securities regulation
4 provided for a prospectus exemption for third-party ABCP programs, provided the notes achieved the requisite rating from an approved credit rating agency. As a result, little or no meaningful information about these securities was available to the public, which relied instead on the opinion of a single private credit rating agency,
DBRS. In effect, third-party ABCP was a black box. Further, while there probably would not have been a liquidity crisis or insolvency to speak of had Canadian third- party ABCP programs had comprehensive liquidity agreements in place fjknown as
"Global-style" liquidity arrangements), such as those employed in American third- party ABCP markets, Canadian securities law was similarly silent on any such requirements. Ironically, every approved credit rating agency except DBRS refused to rate Canadian third-party ABCP notes because the Canadian-style liquidity agreements were viewed as inferior to the Global-style liquidity arrangements. Of further note is the fact that DBRS is now the only large Canadian credit rating agency. (Standard & Poor's acquired the only other large Canadian credit rating agency, Canadian Bond Rating Service, in 2000.3)
ln the face of ongoing financial turmoil in the United States and Canadian markets, regulatory reform seems likely to play a role in market recovery and stabilization. In
Canada, several bodies have already begun an inquiry into the ABCP liquidity crisis with a view to the possible reform of existing regulatory frameworks to address the
3 See, "S&P buys rating agency ; CBRS deal leaves just 1 service based in Canada" Toronto Star (1 November 2000) F2. 5 shortcomings exposed by the third-party ABCP market freeze. These investigations have revealed that third-party ABCP was insufficiently regulated, leaving open the possibility of a liquidity crisis such as that experienced in August 2007. Accordingly, the first part of this thesis draws on existing reports in putting forth a series of proposed securities law reforms to address the regulatory gaps exposed by the failure of third-party ABCP. It is anticipated that in this regard this thesis will add to the growing securities law literature on this topic, which it is anticipated will help inform meaningful amendment of the existing securities regulatory framework governing third-party ABCP and similar financial instruments.
B. The Insolvency of the Canadian Third-Party ABCP Market
Following the third-party ABCP market freeze, investors and issuers engaged in intensive negotiations for several months in order to formulate a Plan of
Arrangement to restructure the Canadian third-party ABCP market under the CCAA.
The court supervised insolvency of 20 third-party ABCP trusts under the CCAA represents one of the most creative uses of the statute in recent times and has resulted in the successful restructuring of the third-party ABCP market in Canada.
The third-party ABCP insolvency was groundbreaking for a number of reasons.
First, the sheer size of the restructuring made the third-party ABCP insolvency the largest of its kind in Canada. Second, the proactive roles tåken on by the largest 6 investors and the third-party ABCP trusts in forming the Pan-Canadian Investor's
Committee for Third-Party Structured Asset-Backed Commercial Paper (the
Committee) and negotiating a Plan of Arrangement pose interesting points for
analysis, insofar as the third-party ABCP insolvency represents an enormous prepackaged bankruptcy. Third, the insolvent trusts were technically not permitted to file under the CCAA, however, as a result of some intriguing legal gymnastics,
counsel was able to legitimately bring the insolvency within the purview of the Act.
Fourth, even after filing the CCAA Plan legal challenges ensued, as a group of
dissident investors challenged the proposed Plan, appealing the decision of the lower court. Fifth, the presence and treatment of retail investors in third-party ABCP was yet another fascinating element of the restructuring; unknown at the time of the
August 2007 liquidity crisis, retail investors ended up in a position to effectively vote down the proposed Plan of Arrangement, leading to allegations of vote-buying
following preferential concessions to these investors designed to "sweeten" the deal.
Sixth, the apparent success of the finalized and implemented Plan of Arrangement,
for its vast complexity and detail, is worthy of study in the context of Canadian
insolvency law. Seventh, looking forward, it is interesting to consider the anticipated
impact of the third-party ABCP insolvency for future insolvency cases, especially the way in which the "rules" were stretched in this case to bring the insolvency within the realm of the CCAA. The interplay between the third-party ABCP precedent and
7 the newly enacted CCAA amendments present further interesting questions for
inquiry as one looks ahead to the future of Canadian insolvency law.
In light of the precedent setting use of the CCAA in the third-party ABCP
restructuring, as well attendant features outlined above, it is timely to consider the
insolvency proceedings and successful Plan of Arrangement from an insolvency law perspective. Accordingly, the second part of this thesis will examine the significance
of several of the unique aspects of this restructuring for contemporary Canadian
insolvency law; namely, the presence and treatment of retail investors in the
insolvency proceedings, and the significance of the restructuring as a largely
privately negotiated solution to the failure of the third-party ABCP market in
Canada.
C. Literature Review
As the third-party ABCP liquidity crisis and insolvency are fairly recent events, there
is little published academic writing as yet.
As of this writing, three influential securities law reports on third-party ABCP have been released, in addition to one comprehensive article and one forthcoming article,
8 which gives a brief overview of the crisis.4 The report of Investment Industry
Regulatory Organization of Canada (IIROC)5 details the business and financial structure of third-party ABCP issuers and discusses the participation of various investment dealers in the sale of third-party ABCP to retail investors. In a recent consultation paper, the Canadian Securities Administers (CSA]6 provide an assessment of the securities law exemptions that facilitated the sale of third-party
ABCP to investors and propose a series of reforms to address the perceived shortcomings in the governing regulations. Further, Professor John Chant7 prepared a research study on third-party ABCP for the Expert Panel on Securities Regulation.
Chant/s paper provides a comprehensive overview of Canadian third-party ABCP markets prior to their insolvency, the relevant regulation, causes of the liquidity crisis, resulting policy issues, and the implications for Canadian securities law. In an article by John Pozios and Matthew Underwood,8 the third-party ABCP liquidity crisis is outlined in considerable detail, along with the securities law aspects and
4 Research is current to March 3, 2010. 5 Investment Industry Regulatory Organization of Canada, "Regulatory Study, Review and Recommendations concerning the manufacture and distribution by IIROC member firms of Third- Party Asset-Backed Commercial Paper in Canada" (17 October 2008) online:
Insolvency law literature to date includes contributions by the following authors.10
Mario Forte11 outlines the many legal hurdles that were overcome in order to join together and bring 20 third-party ABCP issuers within the purview of the versatile
CCAA for the purpose of insolvency proceedings. Forte goes on to discuss the judicial treatment of the restructuring Plan which was challenged in the Ontario courts. In a comprehensive case comment, Professor Janis Sarra12 reflects on the restructuring of the third-party ABCP market, emphasizing its importance for the resolution of the liquidity crisis, the creative use of the CCAA, and the benefits and prejudices to certain affected parties. Fred Myers and Alexa Abiscott13 discuss the factual and legal background to insolvency litigation stemming from controversial provisions in the restructuring Plan that facilitated liability releases for third parties
9 Virginia Torrie, "Weathering the Global Financial Crisis: An Overview of the Canadian Experience" (2010) 16:1 L. & Bus. Rev. Americas 101. (forthcoming) 10 Research current to March 3, 2010. 11 Mario Forte, "Re Metcalfe: A Matter of Fraud, Fairness, and Reasonableness. The Restructuring of the Third-Party Asset-Backed Commercial Paper Market in Canada" (2008) 17 Int. Insolv. Rev. 211. 12 Janis Sarra, "Restructuring of the Asset-backed Commercial Paper Market in Canada" (2008) Annual Review of Insolvency Law 315 [Sarra 2008]. 13 Fred Myers & Alexa Abiscott, "Asset Backed Commercial Paper: Why the Courts Got It Right" (2009) 25 B.F.L.R. 5. 10 by all investors. The authors, both of whom also served as counsel in the proceedings, argue that the Ontario Court of Appeal was correct in its interpretation of the governing legislation and its decision to approve the restructuring Plan. Along similar lines, Jeffrey Carhart and Jay Hoffman,14 who also served as counsel in the insolvency proceedings, voiced their agreement with the decision of the court to approve the restructuring Plan, including the liability releases as amended by their proposed carve outs for specific types of fraud. Lawyers Jeffrey Leon and Geoffrey
White15 wrote a short article on the Ontario Court of Appeal's decision, affirming the lower court's decision to approve the Plan of Arrangement. A subsequent article by lawyers Jeffrey Leon and Shara Roy,16 adopts a litigator's perspective in outlining the third-party ABCP liquidity crisis and response, and contains a detailed look at the group restructuring of 20 third-party ABCP trusts, as well as separate efforts tåken to resolve the issues facing the two trusts excluded from the Plan of
Arrangement. Finally, in a brief article by William Scott and Philip Henderson,17 the restructuring of the Canadian third-party ABCP market is lauded as a model for other restructuring efforts around the world.
14 Jeffrey Carhart & Jay Hoffman, "Canada's Asset Backed Commercial Paper Restructuring: 2007- 2009" (2009) 25 B.F.L.R. 35 [Carhart & Hoffman 2009]. 15 Jeffrey Leon & Geoffrey White, "The Ontario Court of Appeal's Decision on the Flexibility of the Companies' Creditors Arrangement Act in the Restructuring of the Canadian Asset-Backed Commercial Paper Market" (2008] 25:4 Nat. Insol. Rev. 45. 16 Jeffrey S. Leon & Shara N. Roy, "Pain and Promise: Lessons from the Collapse of the Third-Party ABCP Market in Canada" (2009) 14:3 Corporate Securities and Finance Law Report 41. 17 William A. Scott & Philip J. Henderson, "A unique, successful, private restructuring" (2009) 28:4 Int'1 Fin. L. Rev. 11 D. Methodology
I will conduct my investigation principally by examining jurisprudence, insolvency documents, academic literature and industry reports published on the third-party
ABCP liquidity crisis and insolvency. As there is little academic writing on this topic to date, research for this thesis draws more heavily on jurisprudence, Committee
documents, interviews with key actors, and news sources. In order to address the securities law aspects of my topic, I will draw on the industry reports outlined above and the specific securities rules' provisions that were applicable to third-party
ABCP. Jurisprudential and insolvency documents research will focus primarily on those documents stemming from the third-party ABCP restructuring, including judgments, orders, and the Plan of Arrangement. This research, in addition to the aforementioned scholarly articles, will be used to inform my analysis of the third- party ABCP insolvency.
Empirical evidence drawn from interviews with key actors in the third-party ABCP
debacle will be utilized to inform the securities and insolvency law issues raised where gaps exist in the literature, and to illustrate the "street perspective" on this unique event. The approval of the Office of Research Ethics at York University has been obtained for this purpose. Interviews have been conducted with key
individuals who were involved the CCAA proceedings and related litigation.
Interview questions were aimed at confirming and clarifying aspects of the third-
12 party ABCP liquidity crisis and insolvency which are not readily apparent from other research materials.
E. Roadmap
The rest of this thesis is structured as follows. Part 1 analyzes the third-party ABCP liquidity crisis from the vantage of securities law. Subsection A outlines (in general terms) the structure and functioning of Canadian third-party ABCP programs, contending that these structures were faulty, thus leaving open the possibility of a liquidity crisis. Subsection B sets forth proposals for regulatory reform with a view to preventing future liquidity crises of this nature. Subsection C reports on the subsequent regulatory inquiry and action that has tåken place in the years following the liquidity crisis and restructuring. Subsection D offers a brief conclusion to Part
1.
Part 2 outlines the restructuring process of the third-party ABCP market under the
CCAA and critically analyzes the significant aspects thereof from an insolvency law perspective. Subsection A outlines the restructuring proceedings under the CCAA.
Subsection B critically analyzes the restructuring, offering applause and critique of several of the most significant aspects of this groundbreaking insolvency case.
Subsection C offers a brief conclusion to Part 2.
13 The final section provides a conclusion to this thesis.
14 Part 1: Securities Regulation and the Third-Party ABCP
Liquidity Crisis
On August 13, 2007, Canadian conduits18 seiling a complex financial instrument known as third-party ABCP faced a liquidity crisis when nervous investors declined to purchase more notes, leaving the conduits with insufficient funds to pay out maturing ABCP.19 After urgent attempts to access funds, in the early morning hours of August 15, 2007 the insolvent20 third-party ABCP conduits reached a temporary agreement amongst themselves and their largest investors which would grant them time to enter into a group restructuring under the CCAA.21 The result was a Plan of
Arrangement that converted the short term ABCP, ranging from 30 to 90 days on average, to longer term notes maturing in up to nine years.22 Now, nearly three years later, the 18-month long process, effectively håving simultaneously
18 "Conduit" refers to a limited purpose trust that issues ABCP, see Jay M. Hoffman & Jeffrey C. Carhart, "Canadian Asset-Backed Commercial Paper Crisis" Miller Thomson LLP (3 October 2007] online:
ABCP liquidity crisis is contained in Appendix A.] In autumn of 2009, the restructured notes begin to trade for the first time, indicating early signs of the success of the restructuring efforts.25
The Canadian third-party ABCP liquidity crisis presents many interesting issues for study, in particular in the area of securities regulation.26 A brief overview of the non- bank ABCP market and the structure of this investment vehicle immediately reveal a number of problematic features from the securities regulation perspective. Third-
23 Interview of Anonymous (19 February 2010] conducted by Virginia Torrie [unpublished] [19 February 2010 Interview]. 24 ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp. (2008), 43 C.B.R. (5th) 269, 2008 CarswellOnt 3523 (Ont. S.C.J. [Commercial]) [ATB Ont. S.C.J.]; ATB Financial v. Metcalfe & Mansfield Alternative Investments 11 Corp., 2008 ONCA 587, 2008 CarswellOnt 4811 [ATB Ont. CA.]; Jean Coutu Group (PJC) Inc. et al. v. Metcalfe & Mansfield Alternative Investments II Corp. and Other Trustees ofAsset Backed Commercial Paper Conduits Listed in Schedule "A" to this application et al. (Ont.) (Civil) (By Leave) (32765), online: Supreme Court of Canada
Guaranteed Investment Contracts (GICs),28 notwithstanding its complexity, the lack of understanding in the marketplace of how this security was structured and the fact that all but one credit rating agency refused to review it.29 Investors were encouraged to park their money in ABCP as opposed to other guaranteed investment vehicles because it offered a higher rate of return for a short-term, "safe" and highly liquid investment. Non-bank ABCP was sold primarily to institutional investors, however the insolvency has revealed that over 2,000 retail investors held third-party ABCP, which had been sold to them through investment brokerages.30
Despite the apparent risks surrounding third-party ABCP described above, ABCP
(bank and non-bank) grew exponentially in the last ten years to make up
27 McFarland, supra note 26. 28 "GICs are secure investments that guarantee to preserve [the] principal [amount invested]. [The] investment earns interest, at either a fixed or a variable rate, or based on a pre-determined formula", "Guaranteed Investment Certificates" (17 November 208) RBC Royal Bank online:
Two main questions for inquiry arise out of the non-bank ABCP liquidity crisis for securities law scholars. First, the lack of adequate securities regulation in place to govern such a complex financial instrument is troubling and raises questions about how this segment of Canadian money markets should be regulated in the future.
Second, where such measures did exist, how effective were they? In other words, were there obvious flaws in applicable securities laws which contributed to the liquidity problems faced by third-party ABCP? These questions are explored below.
This part seeks to examine the recent Canadian non-bank ABCP liquidity crisis in light of the effectiveness of securities laws that were in place, where they existed, and make some initial suggestions regarding securities regulation that may be implemented in order to help prevent a recurrence of this financial failure. The analysis of this topic will proceed in the following order. Subsection A examines the faulty structure of Canadian ABCP programs, which provides an essential grounding for the discussion to follow. Subsection A-i will explore the main reasons for the third-party ABCP liquidity crisis, looking in particular at the faulty structure and
31 "Money markets" refer to "financial markets where short-term debt securities are bought and sold", Stephen A. Ross et al., Fundamentals ofCorporate Finance, 6th ed., (Toronto: McGraw-Hill Ryerson, 2007) Glossary s.v. "money markets" at 800. 32 Gregory, supra note 29 at 6. 18 functioning of third-party ABCP programs, the evaporation of investor confidence as a result of the subprime crisis in the United States, and the failure of the credit line agreements between third-party ABCP conduits and their liquidity providers.
Subsection A-ii will engage in a critical analysis of the securities law aspects of the non-bank ABCP liquidity crisis, looking in particular at the mechanisms and regulations that were in place, those that were arguably missing, and relevant market factors. Subsection B will discuss the much anticipated regulatory reform, and offer recommendations for improving the existing regulatory framework governing third-party ABCP. Subsection C will highlight the regulatory inquiry and settlements that have tåken place in light of the third-party ABCP liquidity crisis.
Finally, Subsection D offers some closing remarks.
A. The (Faulty) Structure of Canadian Third-Party ABCP
Securitization
i. The Third-Party ABCP Market and Financial Failure
Asset Backed Commercial Paper (ABCP) is a short term debt obligation backed by specific pools of assets such as trade or credit card receivables, equipment leases, mortgages, and personal lines of credit. While the risk of regular CP [commercial paper] depends on the issuing firm's overall risk profile, the risk associated with ABCP is tied directly to the creditworthiness of specific financial assets. In order to attain the highest credit ratings by independent ratings agencies, the asset cash flows are credit enhanced. This can come in a 19 number of forms including extra assets (over-collateralization), cash accounts, bank issued lines of credit, or insurance guarantees. As a result, senior ABCP programs typically receive Rl-High credit ratings.33
The excerpt above gives a very crisp and pithy description of the basic structure of
Canadian ABCP. This section describes, in general terms, the structure of third-party
ABCP securitization programs as they relate to the August 2007 liquidity crisis.34
Canadian ABCP programs are usually set up as follows. A sponsoring entity (a bank in the case of bank-backed ABCP, and usually a corporation in the case of third-party
ABCP) created a special purpose vehicle (SPV) called a conduit.35 The conduit was charged with making ABCP available as a money market investment vehicle, which bore slightly higher rates of interest than government or bank short-term paper.36
ABCP was arranged by series, with different maturity dates and conditions attaching
33 "About Money Market" [17 September 2008) TD Secuhties online:
20 to each series of notes.37 The paper was then distributed to dealers, which in turn sold the securities to investors.38 FIGURE 1 illustrates these relationships, below.
FIGURE 1: STRUCTURE OF THE CANADIAN THIRD-PARTY ABCP MARKET
Sponsor
Conduit #1
ABCP Series I Investor I
ABCP Series II Broker/Dealer #1
ABCP Series III
Canadian third-party ABCP conduits were arranged as trusts and were established by various declarations of trust.39 In very basic terms, trusts arise when legal and beneficial ownership of property is divided between two entities.40 ln such a scenario, a first party (the trustee) holds legal title to the property and is
37 AMF, "Autorite des marchés financiers and National Bank Financial Inc." Settlement Agreement (21 December 2009) online:
Consequently if a conduit became unable to pay out maturing notes, ABCP noteholders would have a claim against the conduit trustee. Therefore, when the market froze in 2007, outstanding third-party ABCP represented debts owed by the conduit trustees to ABCP noteholders.43 In the context of the insolvency, these noteholders are creditors. These relationships are illustrated in FIGURE 2 below.
FIGURE 2: THIRD-PARTY ABCP CONDUITS AS TRUSTS
Beneficiary
Notes issued
The money paid by investors to purchase ABCP notes flowed back to the conduits.
Conduits used the funds to acquire a portfolio of financial assets to be held (directly or through subsidiary trusts) by the trustees of the conduits.44 Assets are held in
41 Ibid. 42 Crawford Affidavit, supra note 34 at para. 33. 43 Ibid. at para. 8. 44 Ibid. 22 respect of each series of notes, and served as collateral for repayment of the paper.45
Hence, the commercial paper was said to be "asset-backed". This structure is illustrated in FIGURE 3, below.
FIGURE 3: TRACING THE MONEY IN THIRD-PARTY ABCP STRUCTURES
Financial assets held by trus tee Trustee
Subsidiary Financial collateral Portfolio
Pool of Assets Backing Proceeds from ABCP Series I sale of notes Conduit Investors Pool of Assets Backing ABCP Series II —r i i i Notes held ! 17 ABCP .byinvestors y
Most ABCP notes were considered short-term investments, maturing in 30 to 90 days.46 The remainder consisted of paper that was extendible for up to 364 days and longer-term floating rate notes.47 However, the majority of assets underlying the
45 Ibid. 46 Ibid. 47 Ibid.; the figure 364 is significant, as the prospectus exemption under which the notes were issued specified that commercial paper must mature not more than one year from the date of issue, see 23 notes were long-term in nature, including pools of residential mortgages, credit card receivables or sophisticated derivatives such as credit default swaps (CDS).48 This created a timing mismatch between the cash flow generated by the assets and the cash flow required to repay maturing ABCP.49 The timing mismatch was a fundamental flaw in the business model of Canadian third-party ABCP programs, as it created the risk of a significant cash shortfall.
To address the potential cash flow problem, many trustees entered into liquidity support agreements with third-party lenders, which agreed to provide funding to conduits in certain circumstances.50 While these agreements varied, they generally provided that funds could be drawn down in specified circumstances, such as in the case of a general market disruption.51 Though the definition of this term varied from one agreement to another, it can be generally defined as follows:
A disruption in the Canadian commercial paper market resulting in the inability of Canadian commercial paper issuers, including the Special Purpose Entity, to issue any commercial paper, and where the inability does not result from a diminution in the creditworthiness of the Special Purpose Entity or any other originator or from deterioration in the performance of the assets of the Special Purpose Entity. [Emphasis added.]52
National and Ontario Prospectus and Registration Exemptions, O.S.C. NI 45-106 (14 September 2005), s. 2.35 [NI 45-106]. 48 Crawford Affidavit, supra note 34 at para. 9. «Ibid. 50 Ibid. 51 Leon & Roy, supra note 16 at 45. 52 OFSI, OFSI Guideline No. B-5: Asset Securitization (Ottawa: Office of the Superintendent of Financial Institutions Canada, 2004) [Guideline B-5]. 24 These agreements, termed "Canadian-Style" liquidity support provided funding in more limited circumstances than so-called "Global-Style" liquidity agreements. In general terms, Global-Style liquidity support provided that funds could be drawn down in circumstances other than a general market disruption, as was required under most Canadian-Style liquidity agreements.53
In practice, however, the timing mismatch described above was not a day-to-day concern for Canadian ABCP programs because many investors did not require repayment when their ABCP matured.54 Rather, investors typically reinvested or
"rolled" their ABCP.55 In effect, ABCP programs would not face cash flow problems, even absent liquidity support, so long as they could issue new paper to repay maturing notes.
While some assets backing the commercial paper were considered "traditional" financial assets, including residential mortgages, credit card receivables and other cash-flow producing assets, a majority of the assets, totally roughly C$26 billion, was comprised of derivative contracts (known as "synthetic" assets) in the form of
CDS.56 (Note that some series of ABCP were backed by a combination of traditional
53 Leon & Roy, supra note 16 at 45. 54 Crawford Affidavit, supra note 34 at para. 9. ss Ibid. S6Ibid. at para. 38. 25 and synthetic assets, while others were exclusively backed by either traditional or
synthetic assets.)57
A CDS is established by contract and is somewhat similar in substance to insurance.
Under a CDS agreement, one party (the protection buyer) aims to protect itself
against a specified credit event or pool of credit events.58 The protection buyer pays
a fee to a second party (the protection seller) that promises to pay the protection
buyer if a specified credit event occurs.59 The amount of the fee is based on the
formula set out in the CDS contract.60 Additionally, the protection seller may be
required to post collateral as security for its obligations.61
A large number of ABCP conduits held CDS contracts as protection sellers.62 As such,
ABCP conduits received fees from protection buyers, and were obligated to provide
protection against defined credit events and post security.63 In most cases, the
security pledged to protection buyers was the same financial collateral used to back
ABCP notes.64 (Note that the security interests of protection buyers take priority
57 Ibid. 58 Ibid. at para. 39. 59 Ibid. 60 Ibid. 61 Ibid. 62 Ibid. at para. 40. 63 Ibid. 64 Ibid. at para. 43. 26 over the claims of ABCP investors.)65 This arrangement is illustrated in FIGURE 4, below.
FIGURE 4: THIRD-PARTY ABCP CONDUITS AND CDS ARRANGEMENTS
Conduit (Trust) Protection Buyers (Protection Seller) Protection against -f- er edit even ts
-4- Portfolio Pledaed collateral (Financial
J^
Nearly C$17.4 billion of the C$26 billion in synthetic assets in question were a special type of CDS known as "leveraged super senior" (LSS) swaps.66 These swaps were said to be leveraged because the amount of credit protection sold was greater than the value of the collateral posted as security for the protection seller's obligations.67 Accordingly, most LSS swap contracts include triggering events
(known as "margin triggers"), which allowed the protection buyer to make calls for
65 Ibid. at para. 40. 66 Ibid. at para. 41. e' Ibid. 27 additional collateral (known as "margin calls") from the protection seller.68 This feature of LSS swap contracts is to ensure that the protection buyer continues to have sufficient security.69 When a margin call occurs, the protection seller must pledge additional collateral to secure its obligations under the LSS swap contract.70
LSS swap triggers were usually based on the variable "market value" of the swap, and are thus termed "mark-to-market" triggers.71 Under these arrangements, the protection seller could be called to post additional security "based on an increase in the amount the protection buyer would have to pay to a third party in the market in consideration for an agreement to enter into a replacement swap that would effectively preserve the economic value of the current swap for the protection buyer."72 Mark-to-market triggers allowed the protection buyer to call for more collateral if the mark-to-market value of the LSS swap decreased to a specified level.73 The calculations of mark-to-market valuations under LSS swaps are very complex, may be based on proprietary models held by the protection buyer, and may include subjective elements.74
«8 Ibid. «9 Ibid. 70 Ibid. 71 Ibid. at para. 42. 72 Ibid. 73 Ibid. ™ Ibid. 28 Conduits that entered into LSS swaps pledged the majority of their financial assets backing ABCP notes to protection buyers as security.75 The LSS swaps are therefore the secured obligations of the trustees and the protection buyers have priority over the security interests of the interests of ABCP investors in the pledged collateral.76 If an LSS swap is declared in default (for instance, if a margin trigger is reached and the required additional collateral is not posted), the protection buyer is entitled to
"terminate the swap and satisfy any termination payment which thereupon becomes due to it by enforcing its security through seizing and liquidating the collateral."77 Due to the fact mark-to-market triggers are used, the amount of collateral necessary to cover the termination payment depends on market conditions at the time.78 Accordingly, under poor market conditions, ABCP investors in those series of notes risk significant losses, since the financial assets that back their securities are first used to meet any shortfalls incurred by the protection buyers.79
ln August 2007 the third-party ABCP market cooled, as news of rising default rates on American subprime mortgages made headlines around the world.80 Since ABCP was issued under a prospectus exemption, very little information was available
75 Ibid. ™ Ibid. 77 Ibid. 78 Ibid. 79 Ibid. 80 Crawford Affidavit, supra note 34 at para. 10. 29 about the assets backing the paper. Further, transactions were structured so that assets were purchased after, or at about the same time, as the ABCP notes they backed were sold to investors.81 This, coupled with the fact that the assets were very complex and some parties to the underlying contracts kept the terms of those contracts confidential, meant that ABCP investors did not know what assets backed their notes.82
In light of the developing subprime mortgage crisis, existing and potential Canadian
ABCP investors began to worry that the assets underlying their ABCP notes might include subprime mortgages and other, now overvalued, assets.83 As a result, noteholders stopped rolling their paper and investors stopped buying new ABCP.84
Consequently, conduits did not have cash to pay out maturing notes.85 Some trustees attempted to draw down funds pursuant to their liquidity agreements, however, most liquidity providers maintained that there had not been a general market disruption because bank-sponsored ABCP programs were not facing a cash shortfall, and consequently the conditions for funding had not been met.86 Indeed, money markets and market actors had not differentiated between bank-backed, and
81 Ibid. at para. 45. 82 Ibid. at para. 10. 83 Ibid. 84 Ibid. 85 Ibid. 86 Ibid.; "Financial Systems Review, December 2007" Bank of Canada (December 2007] online:
In addition to the liquidity problems facing ABCP conduits with respect to paying out maturing paper, in August 2007 some LSS swap protection buyers made margin calls on certain conduits, requiring them to post additional security.89 However, conduits were not able to post additional collateral because they could not issue new ABCP, roll over existing notes, or draw funds from their liquidity agreements.90
Absent the standstill agreement that was eventually reached, the protection buyers could have unwound the swaps and liquidated the collateral posted by the conduits.91 However, liquidations of assets pursuant to LSS swaps likely would have further depressed the LSS market and created a domino effect under the remaining
LSS swaps, triggering their mark-to-market triggers for additional margin calls and leading to more asset sales at very depressed prices.92
87 Paddon, supra note 29. 88 Crawford Affidavit, supra note 34 at para. 10. 89 Ibid. at para. 48. 90 Ibid. 91 Ibid. 92 Ibid. 31 ii. Why Third-Party ABCP Experienced a Liquidity Crisis
With a basic understanding of the structure of third-party ABCP, this subsection now turns its attention to the securities regulation issues arising from the third- party liquidity crisis.
The three main areas of Canadian third-party ABCP programs which could arguably have benefited from improved regulatory oversight are: the regulation of ABCP under securities law - specifically a lack of mandatory disclosure regarding the structure of conduit collateralization and the assets backing the ABCP issued, given their complexity and riskiness; lack of regulatory oversight over credit rating agencies and/or processes, which were required to obtain the ABCP prospectus exemption under securities law; and, apparent laxity among brokerages seiling
ABCP, which resulted in sale of ABCP to retail investors. This subsection will examine these aspects of Canadian third-party ABCP programs in light of their securities regulatory shortcomings.
a. Disclosure Exemptions and Reliance on Credit Rating Agencies
Both bank and non-bank ABCP were exempted from securities law prospectus and registration requirements under s. 2.35, National Instrument (NI) 45-106.93 This
93 NI 45-106, supra note 47, s. 2.35; conduits seiling commercial paper has been able to avail themselves of prospectus and registration requirement since 1963 in Ontario, when the Ontario 32 exemption applied, provided that commercial paper matured not more than one year from the date of issue; was not convertible or exchangeable into or accompanied by a right to purchase another security other than a security described in s. 2.35; and, had an approved credit rating from an approved credit rating organization.94 If the commercial paper met these conditions, it was exempt from prospectus and registration requirements and was considered "free trading", because it was not subject to any further securities regulation requirements or constraints if the original purchaser resold the notes prior to maturity.95 As a result of this exemption, both bank-backed and non-bank ABCP traded in Canadian money markets virtually free of any regulatory oversight or disclosure requirements.
The most substantial of the requirements for the prospectus exemption under s.
2.35 is the requirement that the ABCP receive an approved credit rating from an approved credit rating organization. The definitions of both "approved credit rating" and "approved credit rating organization" found in NI 81-10296 were adopted by reference in NI 45-106, s. l.l.97 These definitions specify the minimum rating from each approved credit rating agency that is required in order to qualify for the
Securities Act was first amended to include an exemption for purchases above the minimum principal or denomination amount of C$50,000, see IIROC Report, supra note 5 at 39. 94 NI 45-106, supra note 47 95 Ibid. 9(> Mutual Funds, O.S.C. NI 81-102 (12 November 1999) [NI 81-102]. 97 NI 45-106, supra note 47. 33 exemption.98 Only one approved credit rating from one approved credit rating organization is necessary to satisfy the conditions of the exemption. All third-party
ABCP conduits that experienced a liquidity crisis in August 2007 had satisfied this requirement, by håving their notes rated by DBRS." Further, the notes issued by nearly every conduit had been rated RI (high), surpassing the minimum requirement for an approved credit rating, which is RI (low).100
As a result of the securities law exemption in place for ABCP notes, disclosure to investors by ABCP conduits was entirely voluntary and varied considerably from one trust to another.101 Meanwhile, essential information about the valuation, pricing and financial structure of the ABCP flowed almost exclusively to approved credit rating agencies, which used this data to rate the notes. Accordingly, the rest of the market appeared to have relied heavily on the approved credit ratings.102
Upon close inspection, however, there were inherent problems with this structure of reliance. Only one of the approved credit rating agencies had in fact reviewed the notes, DBRS, which itself is not regulated.103 Further, due to the fact that the only
98IIROC Report, supra note 5 at 40. 99 Ibid.; NI 81-102, supra note 96, s. 1.1 "approved credit rating organization". 100 NI 81-102, supra note 96, s. 1.1 "approved credit rating". 101 IIROC Report, supra note 5 at 41-42. 102 Paddon, supra note 29. 103 IIROC Report, supra note 4 at 26; for further discussion of credit rating agencies in Canada, see Christopher C. Nicholls, "Public and Private Uses of Credit Ratings" [2005] Capital Markets Institute, online: Rotman School of Management, University of Toronto
It is submitted that in light of the complexity and risk associated with third-party
ABCP programs, the current regulatory regime, consisting of a securities law prospectus exemption based on reliance of a credit rating by an unregulated agency, is proven to be inadequate. As demonstrated by the failure of third-party ABCP programs that held a high credit rating, the rating method employed by DBRS in assessing ABCP notes did not accurately reflect the risk associated with these securities. The fact that the rating given to third-party ABCP programs by DBRS turned out to be overly high has not merely come to light due to the benefit of hindsight. Rather, as evidenced by the remarks of American credit rating agencies that refused to rate Canadian ABCP notes, DBRS failed to adequately take into account of the risks associated with these notes.104
The third-party ABCP liquidity crisis draws attention to the problems associated with the current prospectus exemption for commercial paper. Thus, it is argued that regulatory reliance on credit rating agencies, such as DBRS, as a gatekeeper to
See discussion in subsection A-ii-b, below. 35 capital markets, insofar as they are given a free hand to vet ABCP notes through assigning a credit rating, is misplaced given recent experiences.
A second issue that arises out of the prospectus exemption is the issue of agency capture. This refers to a situation where a "regulatory process is 'captured' by those it is supposed to regulate, and then turned to their advantage."105 There is an inherent conflict of interest faced by credit rating agencies, who are relied upon by securities regulators to impartially scrutinize the financial products of companies who are also the agency's own customers. Under these circumstances, both the rating agency and a customer company might be tempted to engage in unethical behavior, such that the rating agency is "captured" by one or more client(s) whose securities it is supposed to objectively rate. Moreover, DBRS comprehensively disclaims any liability arising from reliance on its credit ratings, raising legitimate skepticism as to whether this, or other credit rating agencies can be successfully sued.106 The requirement of only one rating from an approved credit rating agency and the fact that these organizations are unregulated, contributes to the likelihood of agency capture, and there is little to counteract the inherent conflict of interest situation. It is submitted that from a securities law perspective, this situation is
105 Chris Park, ed., A Dictionary of Environment and Conservation (Oxford: Oxford University Press, 2007), online: Oxford Reference Online
The main policy rationales behind the prospectus and registration exemption in s.
2.35 of NI 45-106 stem from its predecessor section in the Ontario Securities Act. In large part, the policy rationale for the original OSA exemption, which required a minimum investment of C$50,000, was that investors that could afford such a large
investment were considered sophisticated investors, or at least capable of hiring sophisticated advisors, and thus did not require the disclosure that a prospectus would provide.107 Further, the commercial paper market was dominated by institutional investors, which were not considered to need the protection and
disclosure provided by a prospectus.108 Finally, third-party ABCP was usually issued by companies listed on public stock exchanges and thus already subject to some
level of securities law disclosure requirements.109
In the wake of the August 2007 liquidity crisis, it was discovered that approximately
2,000 retail investors had holdings in third-party ABCP, comprising approximately three per cent, or C$960 million, of the C$32 billion in frozen notes.110 While the
107 Peter J. Dey, "Exemptions under the Securities Act of Ontario" in Special Lectures of the Law Society of Upper Canada (Toronto: De Boo, 1972] at 111. i°8 Ibid. i°9 Ibid. 110 Janet McFarland et al, "How ordinary investors got sold on ABCP" The Globe and Mail (8 August 2008) online:
IIROC and certain investment dealers and brokerages that sold third-party ABCP to retail clients. Therefore, it does not appear there will be any specific judicial review of, or commentary on, the sale of third-party ABCP to retail investors.
The main effect of the prospectus exemption applicable to the ABCP market was a lack of transparency and information available to investors. As has already been stated, the voluntary information that was supplied by conduits to investors was extremely varied, making it difficult to use in any comparison between ABCP notes, or between ABCP with other financial instruments. As a result, there was considerable reliance on ratings provided by credit rating agencies as a means of
111 See NI 45-106, supra note 47, ss. 1.1 "accredited investor", 2.3. 38 analyzing ABCP notes. While this arrangement is not a cause of the liquidity crisis in and of itself, it is submitted that it is a problematic structure which may have contributed to the circumstances resulting in the August 2007 liquidity crisis.
Evidence of the sale of a relatively small percentage of third-party ABCP to retail investors demonstrates that the lack of regulatory oversight facilitated by the prospectus exemption meant that a number of retail investors did not have full disclosure regarding their investment. Further, as exposed by the third-party ABCP liquidity crisis, reliance on the rating of a single credit rating agency rather than disclosure and review by regulators is arguably a not a highly effective arrangement, resulting in subsequent review of this process by the CSA.112
The opaqueness of third-party ABCP programs to investors is arguably an inherent securities law problem, due to the unique attributes of non-bank ABCP, including: third-party ABCP had evolved to become more risky in recent years;113 its financial structure was more complex than its bank-backed counterparts, yet the market recognized no distinction between the two types of ABCP programs;114 though intended to be sold only to institutional investors, lack of knowledge of its risk and
112 New Release, "Canadian Securities Regulators Release Proposals in Response to the 2007-08 Credit Market Turmoil and its Effect on the ABCP Market in Canada" (6 October 2008) online:
Securities law aims, among other things, "to foster fair and efficient capital markets and confidence in capital markets."117 To this end mandatory disclosure is required of most securities issuers to enable investors to make informed investment decisions and in order for the market to influence the value of the securities. The unique features and circumstances surrounding third-party ABCP programs strongly suggest that this was the type of security that should have been better regulated by securities law, either by way of requiring a full prospectus and registration requirement, or a more stringent prospectus exemption involving mandatory disclosure. Lack of substantive disclosure requirements meant that investment decisions about ABCP were not conducted in an adequately fair and efficient manner, and lack of information about the underlying financial assets of
ABCP programs resulted in the evaporation of investor confidence because the market incorrectly believed that these assets were tied up in doubtful or bad subprime debt. It is submitted that there were inadequate mandatory disclosure
115 ABCP fiasco, supra note 29. 116 "Financial Systems Review, June 2003" Bank of Canada (June 2003] online:
The lack of regulatory oversight over credit rating agencies is therefore a major securities law concern with respect to third-party ABCP. There has been increased reliance on credit rating agencies, especially in cases where the securities are complex and lack transparency.118 Where securities are very complex and/or lack transparency, however, there is arguably more need for diligent regulation and oversight, which at a minimum would involve regulatory oversight of credit rating agencies. Reliance on ratings has been critiqued by some commentators as being problematic because "by using credit ratings in Canadian securities legislation, regulators have effectively endorsed the ratings ... [and] such use creates value in ratings for issuers seeking lighter regulatory treatment ... and contributes to the significant market power of [credit rating agencies]."119 Accordingly, it is submitted that the lack of regulatory oversight of credit ratings agencies, given the reliance on such agencies as a gatekeeper to the capital markets for third-party ABCP programs, was a securities law failure which could be improved in the future through some form of regulatory oversight and/or less reliance on such agencies by securities legislation.120
"8 Oswald, supra note 113 at 11,13. 119 CSA Report, supra note 6 at 29. 120 Ibid. at 4, 30 (both suggestions are considered by the CSA in this report). 41 b. An Investor Confidence Crisis and The Failure of Liquidity Agreements
Following the August 2007 liquidity crisis, the Committee found that Canadian third-party ABCP conduits held approximately C$3 billion in subprime assets, which amounted to less than ten per cent of total assets.121 Nevertheless, in mid-August
2007 with news of the American subprime crisis making headlines around the world, Canadian investors in ABCP began to have doubts about the value of their investment in these asset-backed securities. With a vague understanding that consumer credit receivables, now with a greater likelihood of default, made up some portion of the assets that backed the notes, investors refused to purchase more
ABCP.122 Unable to roll more paper, and with investors wanting to redeem maturing
ABCP, conduits faced a liquidity shortfall. Since their business model was based on seiling paper, which they were no longer able to do, conduits began looking at their other alternatives to pay out maturing commercial paper. Compounding the financial strain for certain trusts was the impending prospect of margin calls for additional collateral pursuant to LSS swap agreements.123 Returns on asset portfolios were not enough to cover the mass exodus from the ABCP market, as payout depends on both returns and sale of new ABCP,124 thus conduits looked to
121 Pan-Canadian Investors Committee press release, "Pan-Canadian Investors Committee Announces Restructuring Plan for Third-Party ABCP" (23 December 2007] online: CNW Group
ABCP conduits were shut out from accessing their emergency credit lines.125
Without access to emergency funding, third-party ABCP conduits did not have enough liquidity to pay out maturing ABCP or post additional collateral, ultimately resulting in the group insolvency of Canadian non-bank ABCP trusts. In the text that follows, the reasons for the failure of the credit line agreements is explored in greater detail, in arguing that this was another problematic feature of third-party
ABCP programs which was not sufficiently accounted for in either the credit rating assigned by DBRS, nor the price of the securities.
Canadian third-party ABCP conduits obtained liquidity support from Canadian and international banks which specified that funds could only be drawn down in times of a "general market disruption".126 This type of agreement became known as
"Canadian-style liquidity".127 In contrast, many American ABCP liquidity agreements, known as global-style liquidity support, generally covered "any mismatch in asset and liability term regardless of market disruption or credit deterioration of the underlying assets."128 The more restrictive nature of Canadian- style liquidity support, utilized by nearly all Canadian third-party ABCP programs,
125 Oswald, supra note 113 at 8-9. 126 IIROC Report, supra note 5 at 19. ™ ibid. 128 Ibid. at 20. 43 was found by IIROC to be a contributing factor leading to the liquidity crisis and
investor standstill agreement of August 2007.129 When third-party ABCP conduits came up short of funds in August 2007, some liquidity providers honored the
Canadian-style credit line agreements, and others did not.130
United States ratings agencies had been critical of Canadian-style liquidity
agreements for some time before the outbreak of the third-party ABCP liquidity
crisis, and these critiques serve to illustrate the problems associated with this type
of liquidity support. American rating agencies stated that timely payment to
investors could not be guaranteed if the liquidity support was not specific to the
issuer's program.131 In other words, it was not sufficient to have a liquidity
agreement to cover instances of "general market disruption", liquidity needed to be
guaranteed in order that investors would be able to redeem their notes even if the third-party ABCP trust experienced financial difficulties which were not the result of
a market-wide disruption.
Standard & Poor's noted as early as 2002 that there were circumstances in which
liquidity issues could arise even without the occurrence of a general market
disruption or a deterioration in the quality of ABCP assets.132 Further, Moody's had
129 Ibid. at 18. 130 Ibid. at 20. 131 Ibid. 132 Ibid.; Financial Systems Review, June 2003, supra note 116 at 43, 46. 44 previously indicated that Canadian-style liquidity support was so restrictive that funds could not be drawn down in the event of the September 11, 2001 attacks on
New York City.133 Thus, the restrictiveness of Canadian-style liquidity agreements significantly curtailed the circumstances in which liquidity support was available.
In Canada, DBRS initially stated that the restrictiveness of Canadian-style liquidity agreements was sufficient to cover liquidity requirements of ABCP conduits, a position that was reflected in the consistently high ratings given to ABCP notes.134
DBRS took the stance that "Canadian ABCP is ... fully protected against timing mismatches and credit-deterioration problems, via the program's credit enhancements and operation practices."135 Further, the Bank of Canada stated,
"although ABCP poses potential legal and liquidity risks that are inherent in the securitization process, the Canadian investment community seems comfortable with them."136 Thus, in Canada there was a general lack of recognition of the, now widely conceded, problematic features in the liquidity support agreements held by
Canadian third-party ABCP trusts, and a consequent contentment with the status quo. [However, note that DBRS subsequently issued a press release on January 19,
2007, announcing that it was changing its rating criteria, and would require Global-
"3 Ibid. 134 IIROC Report, supra note 5 at 21. 135 Financial Systems Review, June 2003, supra note 116 at 46. iss Ibid. 45 style liquidity support for certain arbitrage-type transactions made by issuers and
funded by third-party ABCP.137]
In contrast, American commentary reflected an opposing opinion, warning that lack
of global-style liquidity support was a major gap in the financial structure of
Canadian third-party ABCP programs and resulted in no guarantee that funding
would be available if needed. Standard & Poor's stated:
A peculiar feature of the Canadian ABCP market is that the conduit structures do not typically incorporate widely available backup liquidity facilities. This approach might currently reduce the costs borne by the conduit's sponsors or issuers by allowing them to provide a very limited form of liquidity... Without liquidity lines, there are other imaginable ways that a conduit could try to manage through a refinancing problem, such as asset sales, the sale of commercial paper to another conduit managed by the same bank, or reliance on general support from the sponsoring bank. Each of these avenues requires a leap of faith that liquidity relief will actually be available, which is insufficient as a primary response to liquidity risk for a conduit to achieve an investment-grade CP rating.138
The Standard & Poor's commentary above aptly draws attention to the problems
with a lack of guaranteed funds in a Canadian-style liquidity agreement, which
nevertheless were largely overlooked in Canada up until the third-party ABCP
liquidity crisis of August 2007.
137 Coventree Inc. et al. (2009], supra note 22 at para. 60. 138 Financial Systems Review, June 2003, supra note 116 at 2; See M. Rabiasz, et al, "Leap of Faith: Canadian Asset-Backed Commercial Paper Often Lacks Liquidity Backup" (Toronto: Standard & Poor's, 2002]. 46 In fact, Canadian-style liquidity support was attractive to conduits because it was less costly to maintain than Global-style liquidity.139 By reducing expenses in this way, and with no price differentiation between third-party and bank-backed ABCP in the market, conduits were able to increase their returns.140
The capital requirements for Canadian banks as they relate to provision of Global-, versus Canadian-style liquidity facilities are also telling. The Office of the
Superintendent of Financial Institutions (OSFI], which regulates Canadian banks, amended regulatory requirements in 2004 such that banks under its supervision that entered into Canadian-style liquidity agreements did not have to allocate capital towards these potential obligations.141 This regulatory distinction arguably highlights the fact that the Canadian-style liquidity agreements were so restrictive in the view of OSFI that they did not warrant capital reserves. In other words, the chance of payout under one of these agreements was extremely unlikely.
The second obvious problem associated with the Canadian-style liquidity agreements was the definition of the term "general market disruption". There are several differing definitions ascribed to "general market disruption". OSFI released revised Guideline B-5142 in November 2004, which gave the following definition:
139 Leon & Roy, supra note 16 at 46. 140 Oswald, supra note 113 at 8 141 Guideline B-5, supra note 52, cited in Carhart & Hoffman 2009, supra note 14 at 40. 142 Guideline B-5, ibid. 47 A disruption in the Canadian commercial paper market resulting in the inability of Canadian commercial paper issuers, including the Special Purpose Entity, to issue any commercial paper, and where the inability does not result from a diminution in the creditworthiness of the Special Purpose Entity or any other originator or from deterioration in the performance of the assets of the Special Purpose Entity. [Emphasis added.]143
Looking at the available credit agreements between ABCP conduits and financial institutions, there are numerous variations of this definition, with some contracts specifying a general disruption, and other just a disruption, as grounds for drawing down funding.144 This clause, notwithstanding the existence of several variations, stipulated that there must be some type of market-related disruption in the ability of ABCP conduits to roll paper.
When faced with a liquidity crisis in August 2007, many third-party ABCP conduits were unable to draw down funds from their credit lines because contracting liquidity providers claimed that there was in fact no market disruption since bank- sponsored ABCP conduits were able to maintain liquidity and sales of their commercial paper.145 Bank-backed ABCP conduits were probably able to do this because they received funding from, or were able to seil ABCP to, their sponsoring financial institutions, and thus continued to be able to pay out maturing ABCP.146
143 Ibid. 144 IIROC Report, supra note 5 at 22-24. 145 Oswald, supra note 113 at 8-9 (Bank-sponsored conduits did take losses, and sponsoring financial institutions bought back large amounts of their conduit's ABCP. The key distinction is that bank- backed ABCP trusts were able to honor their CP, notes whereas non-bank ABCP conduits were not.}. 146 IIROC Report, supra note 5 at 7. 48 Consequently, though there was certainly fear in the perceived value of the underlying assets of ABCP conduits generally, the ability of bank-backed ABCP trusts to continue to pay out maturing commercial paper meant that these conduits were able to remain liquid notwithstanding the diminished demand for their notes.
While third-party ABCP trusts asserted that "market" should refer to the third-party
ABCP market, they were, by and large, unsuccessful in their claims. Money markets up until this point had not distinguished between bank-backed and third-party
ABCP, and many liquidity providers considered the "market" in "market disruption" to include types of commercial paper.147
***
Of the securities law problems discussed above, it is evident that the two primary issues were the light regulatory treatment of ABCP by securities regulation and the reliance on credit ratings to convey the value and safety of ABCP notes. These two main issues were contributing factors to many other related issues, including the sale of ABCP notes to retail investors by securities brokerages. Further, improved securities regulation in these two areas would likely have a trickle down affect, resulting in the improvement of other related issues.
147 Oswald, supra note 113 at 8 (Liquidity providers considered the broadest interpretation of "market disruption"]. 49 c. Investor Protection: Retail Investors in Third-Party ABCP
The third major securities law problem that comes out of third-party ABCP liquidity crisis is the sale of notes to retail investors by securities brokerages. This is problematic because in many cases brokerages did not sufficiently analyze the ABCP notes before seiling them to their clients, relying instead on the assumption that they were in fact a "safe" investment.148 With no other marketplace disclosure to contradict this assumption, several Canadian brokerages recommended third-party
ABCP to their clients, with the result that approximately 2,000 retail investors held frozen ABCP in August 2007. IIROC in its October 2008 regulatory study reported that of the firms interviewed that sold third-party ABCP to retail investors, none had put the notes through product due diligence or risk assessment, instead opting to rely on credit ratings in many cases.149 In response, regulators have tåken action against certain market actors [described in further detail in subsection C). This subsection analyzes the securities law issues as they relate to retail investors in third-party ABCP.
The insolvency of third-party ABCP trusts revealed that in addition to approximately 200 institutional investors, there were nearly 2,000 retail investors with third-party ABCP holdings. While the prospectus exemption utilized by third- party ABCP trusts meant that these notes could be freely traded to retail investors,
148 ABCP fiasco, supra note 29. 149 IIROC Report, supra note 5 at 55. 50 the presence of retail investors in this segment of Canadian money markets is nevertheless troubling for two main reasons. Firstly, many of these investors were not aware they held a financial instrument known as third-party ABCP until they attempted to access their funds and found a portion of their portfolio had been voluntarily "frozen" following the liquidity crisis. Needless to say, this scenario is quite undesirable from a securities law standpoint, and raises questions about the adequacy of investor protection in light of the existing prospectus exemption regime applicable to ABCP.
Secondly, those retail investors who were aware of their holdings in third-party
ABCP notes were generally not fully aware of the great complexity and associated risks that these investments carried. The recent IIROC report has revealed that in many cases dealers did not know whether or not third-party ABCP was risky for their retail clients.150 As a result of inadequate product due diligence, descriptions of third-party ABCP varied widely, with many dealers describing it as a "safe" investment for retail clients.15] The wholly inaccurate depiction of third-party ABCP by financial intermediaries seiling to retail investors is quite troublesome, though it may be somewhat understandable given the lack of disclosure provided by conduits about this financial product. Nevertheless, the aftermath of the third-party ABCP liquidity crisis has demonstrated the need for improved security research and
150 Ibid. at 59-64. 151 Watson, supra note 30. 51 disclosure by financial intermediaries in order to better match possible investment products with retail clients.152
#**
The issues canvassed in this subsection have highlighted the main contributing factors of the Canadian third-party ABCP liquidity crisis of August 2007 - namely the use of general market disruption clauses, as opposed to global-style credit support, in credit line agreements and the lack of a explicit, generally accepted definition of what constituted a "market disruption, and specifically what the relevant "market" was in the case of third-party ABCP conduits. While this has not been an exhaustive account of factors, the primary contributing factors have been discussed as they relate to the securities law aspects of ABCP and will be examined with a view to improvement in the following subsection.
152IIROC Report, supra note 5 at 59-64. 52 B. Looking Toward Regulatory Reform i. Situating the Third-Party ABCP Liquidity Crisis amid Securities Market
Failures from a Law and Economics Perspective
The foregoing analysis has served to identify the key inadequacies of existing securities law which arguably contributed to a regulatory environment in which the third-party ABCP liquidity crisis could occur. This subsection draws on academic literature to provide an initial sketch of how the third-party ABCP liquidity crisis might be situated as a securities market failure. Further, behavioral law and economics is used to highlight some of the ways that the subsequent regulatory reform recommendations may be effectively crafted to mitigate the economic impact of irrational human behavior.
Some recent academic literature has questioned the effectiveness of comprehensive regulation, particularly mandatory disclosure rules, as a remedy for market failures.353 A market failure; or more broadly construed, a market inefficiency, may be described as a "situation where the current prices do not reflect all the publicly available demand and supply information, due to negligence or breakdown of
" See e.g. Christopher J.H. Donald, "A Critique of Arguments for Mandatory Continuous Disclosure" (1999] 62 Sask. L. Rev. 85; Stephen M. Bainbridge, "Mandatory Disclosure: A Behavioral Analysis" (1999-2000) 68 U. Cin. L. Rev. 1023 at 1026,1027. 53 buyer-seller communications. "154 This may occur, for instance, in the case of a monopoly.155 While various authors voice concern over the fact that regulation is not sufficient to avert market failures,156 and may indeed prove an inflexible and blunt instrument as opposed to market forces or self-regulation,157 it is also acknowledged that regulation can be a useful tool for mitigating market inefficiencies.158 In this vein, it is submitted that the specifics of the market failure in question should properly inform potential regulatory responses.
To gain a more nuanced understanding of research in this area, it is useful to consider the findings of LaPorta et al, which indicate that securities laws do matter because "[fjinancial markets do not prosper when left to market forces alone."159
The authors go on to state that their findings "suggest that securities laws matter because they facilitate private contracting rather than provide for public regulatory
154 Business Dictionary, s.v. "market inefficiency" online: Business Dictionary Against a backdrop of North American securities markets that have recently been saddled with heavier disclosure requirements through Sarbanes-Oxley Act162-era initiatives, the third-party ABCP liquidity crisis stands out as an unusual market failure. Here was a case of a market that, unlike many other sectors of capital markets, had very little regulatory oversight, and specifically enjoyed the near absence of mandatory disclosure requirements. Thus, while some academic commentators have recently advocated in favor of lighter disclosure requirements for supposedly overburdened issuers, the same arguments do not carry the same weight for the third-party ABCP market, which could scarcely have enjoyed fewer mandatory disclosure rules. Therefore, while the academic literature in this area is informative, many of the more general recommendations against increase mandatory disclosure must be carefully scrutinized before being strictly applied to third-party ABCP liquidity crisis due the distinctive aspects of this case. IUIU. 161 Ibid. at 28. 162Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204,116 Stat. 745 [2002]. 55 Interestingly, in an article discussing the regulation of derivatives in Canada, Brent Kraus argues in favor of extending the provision of risk disclosure statements and the imposition of suitability safeguards to over-the-counter derivatives, as such financial products warrant the same balancing of market efficiency and investor protection as other instruments subject to securities laws.163 While it is acknowledged that much of this market's utility stems from its flexibility and little regulatory oversight, preventative measures are necessary due to the risk with which individual investors enter this market.164 Kraus goes on to state that "[w]hile this regulatory encroachment may impose a small degree of inconvenience and added expense to the over-the-counter market, it is necessary to protect investor confidence in financial markets."165 While there is acknowledged that academic literature in this area is correct to point out that more disclosure does not always improve market efficiency,166 Kraus' article, insofar as it deals with a market that more closely resembles the third-party ABCP market, is particularly useful. Both over-the-counter derivatives and third- 163 Brent W. Kraus, "The Use and Regulation of Derivative Financial Products in Canada" (1999) 9 W.R.L.S.I. 31 at 63, 64. ,MIbid. 165 Ibid. at 64. 166 Bainbridge, supra note 153 at 1026,1027. 56 party ABCP enjoyed very little regulatory oversight, creating a situation in which there might properly be a tendency toward increased oversight (in some form or another) in light of market failings due to inadequate information. Similar to the suggestions put forward by Kraus, the recommendations in this thesis do not call for full-scale prospectus-level disclosure by third-party ABCP conduits. Rather, it is submitted that more modest changes can be made which will assist in providing a slightly increased level of disclosure and/or limit direct investment in third-party ABCP programs to sophisticated investors. The foregoing sections have highlighted the shortcomings of third-party ABCP programs. Due to light regulatory treatment of this type of security, the market was effectively left to protect itself against the possibility of a market failure. However, market did not adequately do so in this case. In fact, some of aspects of third-party ABCP programs that may be said to have been efficient proved to be particularly weak points when it came to preventing market failures, which exacerbated the issues leading to the August 2007 liquidity crisis. Therefore, though there may have been some efficiencies stemming from light regulatory treatment of the third-party 57 ABCP market up until August 2007, these arguably left the market more exposed to a financial failure. The third-party ABCP liquidity crisis had a negative impact on many different parties, including both those directly involved in the market, as well as outside parties in the form of externalities. The failure of this structured financial product is a striking example of how the fate a relatively small segment of money markets has the potential to impact hundreds of thousands of Canadians. Further, various branches of Canadian government have played a role in the restructuring of the market, including the governments that provided margin funding for the Plan of Arrangement, the judiciary that oversaw the CCAA restructuring, and the Minister of Finance and Governor of the Bank of Canada. Therefore, because of the impact of this market failure on so many Canadians and branches of government, and especially due to the government's role in the restructuring of the market, it is suggested that there is a valid role for the government to play in implementing measures to prevent the recurrence of a similar failure. It is in this vein that some initial recommendations will be put forward for securities law reform in the area of third-party ABCP programs. At first blush, these recommendations might appear to make the third-party ABCP market less economically efficient in a strictly neoclassical economic sense. However, they are 58 with a view to improving soundness and stability of the market in order to prevent the occurrence of similar crashes in the future, and to achieve longer term economic efficiency. The rationale for this is grounded in the institutional approach to law and economics, which recognizes that certain assumptions of neoclassical economics are unrealistic (and uncharacteristic] of human behavior.167 In analyzing the third-party ABCP liquidity crisis, the literature on behavioral law and economics is particularly instructive. The field of behavioral law and economics, unlike neoclassical law and economics, explores the "implications of actual (not hypothesized] human behavior for the law."168 Most notably, this discipline recognizes the many ways in which the actions of real people depart from that of the hypothetical "homo economicus".169 It is in this regard that behavioral law and economics is particularly useful for understanding the third-party ABCP liquidity crisis, as the crisis was indeed partially precipitated by several peculiarities of human behavior. The concept of bounded willpower "refers to the fact that human beings often take actions that they know to be in conflict with their own long-term interests."170 In the 167 Peter Newman, ed., The New Palgrave Dictionary of Economics and the Law, vol. 1 (New York: Stockton Press, 1998), s.v. "American institutional economics and the legal system" at 61. 168 Christine Jolls, Cass R. Sunstein & Richard Thaler, "A Behavioral Approach to Law and Economics" (1998] 50 Stan. L. Rev. 1471 at 1476. 169 Ibid. mlbid. at 1479. 59 third-party ABCP liquidity crisis, bounded willpower is evident in the fact that third- party ABCP programs chose to secure fairly limited liquidity support in the form of Canadian-style liquidity agreements. While this had obvious short-term benefits in terms of lower costs for the trusts, it was at the expense of the longer term interest of ensuring the ongoing liquidity and viability of ABCP programs. In other words, it was reasonably foreseeable, especially given the warnings from American credit rating agencies, that there were extraordinary events that could create a liquidity crunch for ABCP programs. Nevertheless, Canadian third-party ABCP conduits chose not to adopt more comprehensive global-style liquidity support, despite the risk this posed in the long term. Therefore, insofar as bounded willpower played a role in the third-party ABCP crisis, it is suggested that the use of targeted regulatory reform may possibly be used to correct this human shortcoming. Bounded rationality "refers to the obvious fact that human cognitive abilities are not infinite."171 This concept helps to explain how "human behavior differs in systematic ways from that predicted by the standard economic model of unbounded rationality."172 The behavior of certain actors in the third-party ABCP liquidity crisis is illustrative of the bounded rationality phenomenon. For instance, the market did not recognize a distinction between bank-backed and third-party ABCP notes, nor between notes backed by global-style versus Canadian-style liquidity support. Yet in 171 Ibid. at 1477. 172 Ibid. 60 the aftermath of the third-party ABCP liquidity crisis, it has become obvious that there were marked differences in the quality of ABCP notes based on these factors. From a law and economics perspective, a more efficient ABCP market would have accurately made such distinctions by incorporating the increased riskiness of third- party ABCP and Canadian-style liquidity support into the market value of the notes.173 In as much as bounded rationality can be identified as a contributing factor to the third-party ABCP liquidity crisis, it is suggested that well-tailored government intervention may be utilized to help correct for bounded rationality factors. Externalities were yet another critical factor in the third-party ABCP liquidity crisis. An externality is "a side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved."174 The most notable externality in this case was the subprime mortgage crisis. Though it is true that certain series of notes were significantly impacted by the subprime crisis (and hence this was not a externality for these tranches strictly speaking), insofar as the majority of the assets in question were The ability of the market to absorb such information is essentially the premise of the efficient market hypothesis (EMH], which claims that securities markets are informationally efficient and market prices accurately reflect best estimates of risks and returns; see e.g. Lynn A. Stout, "Are Stock Markets Costly Casinos? Disagreement, Market Failure, and Securities Regulation" (1995) 81 Va. L. Rev. 611 at 646, 647, citing Donald C. Langevoort, "Theories, Assumptions, and Securities Regulation: Market Efficiency Revisited" (1992) 140 U. Pa. L. Rev. 851 at 856. The accuracy or inaccuracy of this hypothesis is not argued here; rather more modestly, it is simply submitted that it would be efficient if the markets did behave as they are described by the EMH. 174 New Oxford American Dictionary, 2d ed., s.v. "externality" [New Oxford American Dictionary]. 61 sound, the subprime crisis can be considered a negative externality. Externalities in turn can lead to market inefficiencies.175 In the context of the third-party ABCP liquidity crisis, this concept is closely linked to that of information asymmetry. Information asymmetry refers to a "situation in which one party in a transaction has more or superior information compared to another."176 This in turn can lead to inefficient outcomes. In the case of the third- party ABCP liquidity crisis, there was a key information asymmetry between issuers and investors, whereby the issuers had more and better information about the assets underlying the notes.177 Lack of information in turn can lead to market inefficiency.178 When the externality of the subprime mortgage crisis collided with the information asymmetries in the market, the result was a liquidity crisis for third-party ABCP conduits. While it is not suggested that regulation is a means of preventing possible impacts of negative externalities, it is submitted that regulation that helps to correct the information asymmetries in this market could mitigate the recurrence of a similar market failure. Allen Buchanan, Ethics, Efficiency and the Market (Oxford: Oxford University Press, 1985] at 19, 21, 22. l76Investopedia Dictionary, s.v. "information asymmetry" online: Investopedia Therefore, it is submitted that in order improve the overall economic efficiency of the third-party ABCP market in the long term, in essence, to prevent the recurrence of such a market failure, an institutional law and economics approach can be used to guide government intervention, in the form of regulation, with a view to better guarding against certain externalities, bounded willpower and bounded rationality factors. ii. Recommendations for Reform Drawing on the market failure analysis above, this subsection avails itself of recent studies and reports on Canadian third-party ABCP in proposing some initial 63 recommendations regarding how these problem areas might be addressed, with a view to preventing the recurrence of a similar liquidity crisis. Recommendation #1: Amend the current short-term debt exemption to make it unavailable to distributions of asset-backed short-term debt.179 Making this particular exemption unavailable to ABCP conduits would simply deny ABCP a prospectus exemption based on its nature as a commercial paper note, however, other securities law exemptions which are not based on the nature of the security would remain available to ABCP trusts.180 This would likely shift the market for third-party ABCP to investors who are better able to bear the financial risks, such as accredited investors under the accredited investor exemption.181 In the alternative, ABCP programs may elect to issue securities pursuant to a prospectus, which would provide capital markets and potential investors with meaningful information about the business and operations of the trusts, including underlying financial assets. Additionally, this amendment to the existing regulatory framework would effectively eliminate reliance on unregulated credit rating agencies as a gatekeeper to capital markets, since an approved credit rating would no longer be a requirement of the remaining available prospectus exemptions. 179 CSA Report, supra note 6 at 21. 180 Ibid. 181 Ibid. 64 It is submitted that the implementation of this recommendation would be a significant improvement in the existing regulatory regime governing ACBP programs because it would effectively limit their access to capital markets to those situations where potential investors are either sufficiently sophisticated to understand the risks of investing in ABCP notes, or provided with detailed disclosure about a given ABCP program in the form of a prospectus. Further, this recommendation would alleviate growing concerns regarding the regulation of credit rating agendes, by eliminating the availability the short-term debt prospectus exemption for third-party ABCP conduits. Additionally, it is suggested that this recommendation would help lessen information asymmetry in the third-party ABCP market by shifting the market for short-term debt to more sophisticated investors that are better able to access and digest information regarding these securities. Furthermore, this recommendation could also help mitigate bounded rationality exhibited by credit rating agencies with respect to drawing a distinction between types of ABCP through credit ratings based on such factors as the type of liquidity backstopping in the rating of the notes. This could be indirectly accomplished by shifting access to capital markets to different prospectus exemptions which place less reliance, or none at all, on credit ratings as a criterion for issuing securities. By eliminating or reducing reliance on credit ratings, it is possible that the market will take better notice of such differentiating 65 factors, rather than placing their confidence in a credit rating from an approved credit rating organization. Recommendation #2: Implement a program of regulatory oversight for "approved credit rating organizations".182 As a primary gatekeeper to Canadian money markets, approved credit rating organizations should be adequately regulated to ensure that they employ proper measures in the rating of short-term debt instruments. At a minimum it is suggested that approved credit rating organizations be required to disclose information about the securities rated and the ratings process to securities regulators.183 It is also recommended that a comprehensive regulatory framework applicable to approved credit rating organizations be devised and implemented which would specifically address the securities law issues arising from such institutions in their capacity as gatekeeper to capital markets under provisions such as s. 2.35, NI 45-106. As outlined in subsection B-ii-a, the conflict of interests arising in the duties of credit rating agencies are quite concerning from a securities law perspective given the reliance on these organizations as a form of gatekeeper to public markets under the current prospectus exemption. Additionally, it is argued that even where credit rating agencies are not directly involved in a gatekeeper role, so long as financial 182 Ibid. at 16. 183 Ibid. 66 instruments such as ABCP are issued without prospectus disclosure, these agencies are likely to continue to play a role in disseminating information about the value of such securities in the public markets. Thus, so long as credit rating agencies continue to serve a gatekeeper or information dissemination function, it is submitted that it is both prudent and necessary to impose some form of government regulation over these organizations. As evidenced by the third-party ABCP liquidity crisis, the lack of disclosure concerning the underlying financial assets and business organization of third-party ABCP conduits significantly contributed to the flight of ABCP investors from the third-party ABCP market. This event evidences the benefits of disclosure about the securities and ratings process both for investors and ABCP programs. Of note for Canada as well as internationally, the regulation of credit rating agencies has been articulated by the 2009 G20 Summit in London as one of the measures that will be used to address current issues with respect to the world financial system.184 It is submitted that responsible regulation of credit rating agencies will serve to promote the stated purposes of securities regulation, in particular the fostering of confidence in capital markets.185 184 Brian Laghi & Eric Reguly, "Leaders pledge $l-trillion in aid" Globe and Mail (2 April 2009) online: Globeand Mail Recommendation #3: If not Recommendation #1, then require third-party ABCP programs to have global-style liquidity support agreements in place and notes reviewed by at least two approved credit ratings agencies. Following the American approach, if ABCP programs are allowed to continue to make use of the prospectus exemption for commercial paper in s. 2.35 of NI 45-106, then it is suggested that more robust measures be tåken with respect to the liquidity support and credit ratings required for the exemption. Global-style liquidity agreements would reduce the risk of a liquidity crisis, by preventing the risk of illiquidity based on circumstances other than a "general market disruption". Further, requiring the ratings of two approved credit rating agencies would reduce the risk of credit rating agency capture, and would add an additional gatekeeper between third-party ABCP trust and Canadian money markets. 68 It is indeed unfortunate that Canadian-style liquidity agreements did not earlier evolve into the more comprehensive liquidity support utilized by American ABCP programs. Had they done so, there arguably would have been no third-party ABCP liquidity crisis to speak of. Thus, at a minimum, it is submitted that this level of liquidity support be mandated by securities law. While this recommendation does not directly target the inherent riskiness of ABCP programs, it would at least require conduits to ensure full financial backstopping of these securities. In so doing, this suggested reform would effectively overcome the obstacle of bounded willpower with respect to liquidity backstopping, as discussed in the previous subsection. Recommendation #4: Implement and/or revise the regulatory framework governing intermediaries involved in seiling third-party ABCP with respect to their responsibilities relating to product due diligence and sale of ABCP to clients.186 Product due diligence processes should be implemented which take account of the nature of the financial product in question and the target investors.187 Adequate disclosure about the financial product must be provided to clients in advance of their decision of whether or not to purchase the securities, which includes product features and risks, relevant material financial information required to evaluate the 186 IIROC Report, supra note 5 at 74-75. 187 Ibid. at 74. 69 investment, and information about the ongoing operation of the conduits.188 The particular financial needs of retail investors should also be tåken into account.189 As the insolvency of third-party ABCP trusts has revealed, retail investors in third- party ABCP were in many cases unaware of their holdings in this financial product and generally had no idea of the complexity and risk associated with these notes sold to them by financial intermediaries. Notwithstanding the fact that Recommendation #1, if implemented, would effectively eliminate retail investor protection concerns with respect to third-party ABCP, it is argued that Recommendation #4 would nevertheless be beneficial in addressing broader retail investor protection concerns relating to the sale of securities through intermediaries. It is submitted that investor protection concerns with respect to retail investors in third-party ABCP would likely be greatly alleviated by implementing this recommendation. Further, this recommendation would help ameHorate the informational asymmetries that existed in the third-party ABCP market, particularly with respect to retail investors, who appear to have had the least information of all market actors. As discussed above, correction of information asymmetries is likely to help mitigate the impact of negative externalities such as the subprime mortgage crisis, ™s Ibid. at 75. i89 Ibid. 70 which otherwise have the potential to fuel a mass exodus from the third-party ABCP market resulting in a liquidity crisis. ### The securities law discussion that has occurred in the wake of the third-party ABCP liquidity crisis is heartening. There have been notable studies and reports by securities and investment-related organizations that have analyzed the third-party ABCP programs and made practical and sensible recommendations to improve transparency and regulatory oversight.190 Further, following the lead of the Securities Exchange Commission in the United States, certain practices such as the reliance on credit rating agencies in securities legislation have been singled out for further study and review.191 The foregoing analysis has highlighted the need for securities law reform in light of the failure of third-party ABCP in Canada, and has drawn on existing reports in highlighting targeted recommendations to address the "gaps" in the existing regulatory regime, ln particular, four initial recommendations have been suggested to address issues surrounding the existing securities law prospectus disclosure exemption for short-term debt; regulator reliance on unregulated credit rating 190 See e.g., Ibid.; CSA Report, supra note 6. 191 See CSA Report, ibid. at 2. 71 agendes; lack of information disclosure about third-party ABCP programs; and, investor protection concerns with respect to retail investors. With the wise adoption and implementation of reforms for regulating third-party ABCP, it is suggested that Canadian regulators may be able to avert the recurrence of a similar liquidity crisis among ABCP trusts in the future. C. Post-Liquidity Crisis: Regulatory Inquiry and Action In the months following the conclusion of successful restructuring efforts, regulatory agencies including the Ontario Securities Commission (OSC], Investment Industry Regulatory Organization of Canada (IIROC) and Autorite des marchés financiers (AMF) launched long-awaited enforcement proceedings. As regulatory inquiry is ongoing at the time of this writing, this subsection will only deal in a preliminary manner with regulatory sanctions announced so far.192 On December 21, 2009 regulators finalized several settlements with certain institutions following lengthy investigations into the third-party ABCP debacle. The settlements announced by the OSC, IIROC and AMF, which cooperated on the joint investigation, provide for payment of C$138.8 million in administrative penalties and investigation costs; marking one the highest penalties ever imposed in 192 Please note that this sections draws heavily on the published settlement agreements and thus represents a close paraphrase of those documents. 72 connection with a Canadian securities investigation.193 Penalties to be paid as a result of the settlements are broken down by institution in FIGURE 5. 193 See IIROC, OSC & AMF, "ABCP: Settlements reach following a joint investigation" News Release (21 December 2009} online: [Table tåken from IIROC news release]194 AMOUNT INSTITUTION OBTAINED (C$) National Bank Financial Inc. $75 million Scotia Capital Inc. $29.27 million Canadian Imperial Bank of Commerce and CIBC World Markets Inc. $22 million HSBC Bank Canada $6 million Laurentian Bank Securities Inc. $3.2 million Canaccord Financial Ltd. $3.1 million Credential Securities Inc. $0.2 million The settlements put to rest allegations pertaining to the improper conduct of market actors related to the third-party ABCP fiasco. Interestingly enough, the bulk of regulatory action respecting third-party ABCP does not deal with the major issues raised in this thesis thus far. Rather, much of the regulatory inquiry and allegations surrounded suspicions that certain financial intermediaries involved in the sale of third-party ABCP improperly continued to seil the commercial paper after receiving news from the issuing conduits describing the exposure of the underlying assets to the subprime mortgage crisis in the United States. Regulators have tåken issue with the fact that the financial intermediaries did not advise prospective purchasers of this new information, and the fact that, in some cases, these entities appear to have continued seiling the commercial paper in order to get rid of their own holdings 194 Chart tåken from ABCP Settlements, ibid. 74 before the news hit the broader market, which would inevitably result in the lowering of the commercial paper's trading value. The specifics of each of these settlements are set out below. National Bank Financial Inc. — AMF began an investigation of National Bank Financial in May 2008 regarding its activities with respectto third-party ABCP.195 In the Settlement Agreement, the Respondent (NBF) admitted that: Between July 25 and August 13, 2007, NBF failed to act with all the care that may be expected of a knowledgeable professional acting in the same circumstances- as prescribed by section 160.1 of the Securities Act, R.S.Q., ch. V- 1.1, by failing to adequately respond to emerging issues in the Third Party ABCP market, particularly the July 24* email, insofar as it continued to participate, as a seller and a buyer, in Third Party ABCP without engaging compliance and other appropriate processes for the assessment of such emerging issues.196 The July 24th email refers to an email sent by Coventree to all of its dealer syndicate members (including NBF), which contained information regarding American subprime exposure in Coventree conduits as of June 28, 2007, in addition to other details pertinent to the liquidity of the trusts.197 Schedule "A" to the Settlement Agreement outlines the procedures for retention of an outside consultant to review the policies, procedures and effectiveness of the 195 National Bank Settlement, supra note 37 at para. 6. 196 Ibid. at para. 47. 197 Ibid. at para. 38. 75 Respondents' compliance efforts with respect to its activities in the fixed income market.198 Scotia Capital Inc. — On February 13, 2008, IIROC formally launched an investigation of Scotia Capital's conduct relating to the third-party ABCP.199 In the Settlement Agreement, Scotia Capital [the respondent), admitted that: Between July 25 and August 10, 2007, the Respondent failed to adequately respond to emerging issues in the Coventree asset-backed commercial paper (ABCP) market insofar as it continued to seil Coventree ABCP without engaging Compliance and other appropriate processes for the assessment of such emerging issues, contrary to Investment Dealers Association By-law 29.1 (ii) (now IIROC Dealer Member Rule 29.1 (u)).200 Pursuant to the Settlement Agreement, the Hearing Panel imposed penalties on Scotia Capital involving payment of C$28.95 million in accordance with the IIROC Dealer Member Rules; payment of C$320,000 in investigation costs; and ordered the "retention of an independent consultant to verify the remedial actions already tåken 198 Ibid, at para. 53. 199 IIROC, "In the matter of Scotia Capital Inc. - Settlement" News Release (21 December 2009) online: 76 by the Respondent in relation to its fixed income business."201 The Reasons and Decision of the Hearing Panel have yet to be released.202 Canadian Imperial Bank of Commerce and CIBC World Markets Inc. — On December 21, 2009 the OSC made an order pursuant to its public interest powers contained in ss. 127, 127.1 of the Ontario Securities Act approving the Settlement Agreement reached with Canadian Imperial Bank of Commerce and CIBC World Markets Inc. [the Respondents) for their conduct relating to third-party ABCP.203 The impugned behaviour related to CIBCs actions as an agent for issuers of third- party ABCP, in which capacity the bank bought and sold the notes, in the weeks leading up to the August 2007 market freeze.204 Regulatory inquiry focused on the failure of CIBC to notify OSC Compliance of the emerging issues in the third-party ABCP market that had been brought to the bank's attention by Coventree Inc. (the largest sponsor of third-party ABCP in Canada), and the bank's continued sale of the commercial paper without disclosing its knowledge of the new risks to its clients generally.205 ln particular, CIBC obtained information revealing the increased exposure of third-party ABCP to American subprime mortgages assets, whose increasing rate of default was straining credit markets in the United States; and, by 201 Scotia Settlement, ibid. 202 Research is current to March 3, 2010. 203 Canadian Imperial Bank of Commerce and CIBC World Markets Inc. (2009], 33 O.S.C.B. 73, online: OSC CIBC did not properly respond to changing conditions in the third-party ABCP market in 2007. Firstly, CIBC did not disclose the emerging issues in the third-party ABCP market to its senior management, nor OSC Compliance, until Saturday, August 4, 2007, resulting in a delay in engaging the appropriate processes for assessing the impact of emerging issues on the market.207 Secondly, following receipt of information relating to the issues facing the third-party ABCP market, the bank did not conduct new product review of third-party ABCP, nor the recent changes to the notes.208 Further, CIBC failed to provide formal training regarding third-party ABCP to its sales representatives.209 Thirdly, CIBC did not notify its clients of the heightened risks of third-party ABCP notes, but rather continued to seil third-party ABCP to clients who may not have been aware of these issues.210 CIBC sold third- party ABCP with exposure to American subprime assets from July 25 to August 3, 2007.211 In total, CIBC sold C$245 million in third-party ABCP notes in the weeks leading up to the market freeze, of which C$22 million was from CIBCs own inventory (this exclude sales of third-party ABCP that matured prior to August 13, 206 Ibid. at paras. 34-48. 207 Ibid. at para. 55. 208 Ibid. at para. 56. 209 Ibid. 210 Ibid. at para. 49. 2" Ibid. 78 2007).212 On August 13, 2007 CIBC held C$358 million worth of third-party ABCP in its account.213 Noteworthy is the fact that CIBC did take some positive action in the weeks leading up to the third-party ABCP market freeze. On Friday, August 3, 2007, CIBC learned that Coventree Inc. would likely default on its ability to repay its maturing third- party ABCP when market reopened on Tuesday, August 7, 2007 (following a long weekend).214 CIBC was appropriately concerned about the possibility of a market disruption in Coventree ABCP in the coming week.215 Senior management of CIBC was apprised of the emerging issues and assessed the risks to holders and prospective purchasers of Coventree ABCP over the long weekend.216 That long weekend, the Bank of Canada was notified by CIBC twice of its concerns with respect to Coventree ABCP.217 As a result of discussions among CIBC senior managers, it was decided that Coventree ABCP would not be offered for sale when markets reopened on Tuesday, August 7, 2007.218 From August 7, 2007 to August 13, 2007, CIBC did not seil, nor offer to seil, any Coventree ABCP, though the market continued functioning.219 2i2 ibid. 213 Ibid. at para. 54. 214 Ibid. at para. 50. 2i5 Ibid. 2i6 Ibid. 217 Ibid. 2i8 Ibid. 219 Ibid. at para. 52. 79 The order specifies that CIBC "shall submit to a review of its compliance practices and procedures in accordance with the Terms of Reference attached at schedule 'B' to the Settlement Agreement"; CIBC shall pay C$21.7 million to the OSC, which will be allocated under s. 3.4(2)fjb) of the Ontario Secuhties Act to or for the benefit of third parties; and CIBC shall pay the costs of the OSCs investigation, amounting to C$300,000.220 In the Settlement Agreement, CIBC admitted that: Between July 25 and August 3, 2007, CIBC engaged in conduct contrary to the public interest by failing to adequately respond to emerging issues in the third-party ABCP market insofar as it continued to seil third-party ABCP without engaging compliance and other appropriate processes for the assessment of such information and concerns.221 Schedule "B" to the Order, entitled Terms of Reference for Compliance Review, outlines in considerable detail the procedures for retention of an outside consultant to review the policies, procedures and effectiveness of the Respondents' compliance efforts with respect to its activities in the fixed income market.222 HSBC Bank Canada — On December 21, 2009 the OSC made an order pursuant to its public interest powers contained in ss. 127, 127.1 of the Ontario Secuhties Act approving the Settlement Agreement reached with HSBC Bank Canada (the 220 SecuritiesAct, supra note 117, s. 3.4(2](b); CIBC Settlement, supra note 203 at 1, 2. 221 CIBC Settlement, supra note 203, Appendix "A" at para. 57. 222 See Ibid., Appendix "B". 80 Respondent) for its conduct relating to third-party ABCP.223 The impugned behaviour related to HSBC Bank's actions as an agent for issuers of third-party ABCP, in which capacity the bank bought and sold the notes, in the weeks leading up to the August 2007 market freeze.224 Regulatory inquiry focused on the failure of HSBC Bank to notify OSC Compliance of the emerging issues in the third-party ABCP market that had been brought to the bank's attention by Coventree Inc. (the largest sponsor of third-party ABCP in Canada), and the bank's continued sale of the commercial paper without disclosing it knowledge of the new risks to its clients.225 In particular, HSBC Bank obtajned information revealing the increased exposure of third-party ABCP to American subprime mortgages assets, whose increasing rate of default was straining credit markets in the United States; and, the fact that there were liquidity issues facing the entire third-party ABCP market.226 HSBC Bank did not properly respond to changing conditions in the third-party ABCP market. Firstly, HSBC Bank did not disclose the emerging issues in the third-party ABCP market to OSC Compliance, resulting in a delay in engaging the appropriate processes for assessing the impact on the market.227 Secondly, following receipt of information relating to the issues facing the third-party ABCP market, the bank did 223 HSBC Bank Canada (2009], 33 O.S.C.B. 62, online: OSC ABCP in its inventory, depending on demand, prior to July 2007.232 On August 13, 2007 HSBC Bank held C$52 million worth of third-party ABCP in its account.233 The order specifies that HSBC Bank "shall submit to a review of its compliance practices and procedures in accordance with the Terms of Reference attached to Schedule 'B' to the Settlement Agreement"; HSBC Bank shall pay C$5.925 million to the OSC, which will be allocated under s. 3.4(2] (b] of the Ontario Securities Act to or 228 Ibid. at para. 45. 229 Ibid. at para. 47. 230 Ibid. at para. 46. 231 Ibid. at paras. 46, 47. 232 Ibid. at para. 48. 233 Ibid. at para. 49. 82 for the benefit of third parties; and HSBC Bank shall pay the costs of the OSCs investigation, amounting to C$75,000.234 In the Settlement Agreement, HSBC Bank admitted that: Between July 25 and August 13, 2007, HSBC engaged in conduct contrary to the public interest by failing to adequately respond to emerging issues in the third-party ABCP market insofar as it continued to seil third-party ABCP without engaging in compliance and other appropriate processes for the assessment of such information and concerns.235 Schedule "B" to the Order, entitled Terms of Reference for Compliance Review, outlines in considerable detail the procedures for retention of an outside consultant to review the policies, procedures and effectiveness of the Respondents compliance efforts with respect to its activities in the fixed income market.236 Laurentian Bank Securities Inc. — AMF launched an investigation of Laurentian Bank Securities (LBS) on April 22, 2008 relating to the bank's activities in the distribution and sale of third-party ABCP.237 LBS has been a broker of third-party ABCP since November 28, 1990.238 LBS had decided that third-party ABCP was not 234 SecuritiesAct, supra note 117, s. 3.4(2)(b]; HSBC Settlement, ibid. at 1, 2. 235 HSBC Settlement, ibid., Appendix "A" at 12. 236 See Ibid., Appendix "B". 237 AMF, "Autorite des marchés financiers et Valeurs mobiliéres banque laurentienne Inc." Entente de reglement (21 December 2009] online: In respect of the 2007 market freeze, LBS had limited access to information regarding third-party ABCP because it was not invited to the special meetings held between July 24, 2007 and August 13, 2007; and, LBS did not act as a liquidity provider.240 On July 24, 2007, LBS received an email sent out by Coventree to all members of its dealer syndicate.241 The email contained a table which broke down the level of subprime exposure in each of the Coventree conduits.242 LBS forwarded this information to only some of its third-party ABCP clients.243 On or about August 13, 2007 LBS noticed liquidity issues facing the third-party ABCP market.244 Such liquidity problems had been encountered in this market before, however, they had never resulted in a market freeze such as that experienced in August 2007.245 Despite this observation, LBS continued to seil third- party ABCP to its clients, including notes affected by subprime crisis, between July 25, 2007 and August 13, 2007.246 During this period, LBS sold C$1.3 billion in third- 239 Ibid. at para. 47. 240 Ibid. at para. 49. 241 Ibid. at para. 53. 242 Ibid. at paras. 54. 243/Wd. at para. 55. 244 Ibid. at para. 56. 245 Ibid. 246 Ibid. at para. 57. 84 party ABCP to clients that had not received information about the exposure of the notes to the subprime mortgage crisis and the liquidity problems facing the third- party ABCP market (excluding notes that matured prior to August 13, 2007).247 The AMF contends that in so doing, LBS failed to fulfill its obligations under s. 160.1 of the Québec Secuhties Act, which states: In their dealings with clients and in the execution of the mandates entrusted to them by their clients, all persons registered as dealers, advisers or representatives are required to act with all the care that may be expected of a knowledgeable professional acting in the same circumstances.248 The settlement agreement states that during the period of July 25, 2007 to August 13, 2007, LBS should have tåken a more careful, attentive approach in the execution of its s. 160.1 mandate vis-å-vis certain of its clients.249 Specifically, LBS should have provided all of its clients with the information contained in the Coventree email, which it considered crucial, instead of continuing to buy and seil third-party ABCP without håving provided this disclosure.250 Further, the settlement agreements states that LBS did not have adequate internal control policies or procedures in place with respect to third-party ABCP.251 Specifically, LBS did not have a committee charged with studying the various types 247 Ibid. at para. 58. 248 Ibid. at para. 59; Secuhties Act, R.S.Q. c. V-l.l, s. 160.1. 249 Laurentian Settlement, ibid. at para. 62. 250 Ibid. 251/b/d. at para. 63. 85 of third-party ABCP offered by LBS to its institutional clients, nor was there any report produced by LBS on this subject.252 LBS also did not have a training program on the particulars of third-party ABCP to educate its representatives responsible for seiling these securities.253 Finally, LBS did not have a designated person within the organization responsible for advising on compliance matters, such as informational disclosure to institutional clients.254 Based on the settlement agreement, LBS agreed to pay an administrative penalty of C$2.8 million; and, expenses of investigation amounting to C$400,000.255 Further, LBS agreed to submit to a detailed review of its compliance measures by an external consultant approved by AMF.256 Canaccord Financial Ltd. — Formal investigations pertaining to Canaccord Financial's conduct with respect to the sale of third-party ABCP to retail investors were launched by IIROC on May 7, 2008.257 In its settlement agreement with IIROC, Canaccord Financial (the respondent] admitted that: On our about 2006 and 2007, the Respondent did not take steps to adequately ensure its sales staff understood the complexities of the third-party asset- backed commercial paper (ABCP) product it offered for sale to retail clients 252 Ibid. at para.64. 253 Ibid. at para. 65. 254 Ibid. at para. 66. 255 Ibid. at para. 68. 256 Ibid. at para. 69. 257 IIROC, "In the matter of Canaccord Financial Ltd. - Settlement" News Release (21 December 2009) online: Based on the settlement agreement, the Hearing Panel directed that Canaccord Financial pay a fine of C$3.1 million [including costs), and ordered, "that the company retain an independent consultant to carry out a compliance review relating to due diligence practices and procedures relating to fixed income securities."259 The Reasons and Decision of the Hearing Panel have yet to be released. Credential Securities Inc. — IIROC launched formal investigations of Credential Securities' conduct with respect to the sale of third-party ABCP to retail investors on May 7, 2008.260 In the settlement reached between IIROC and Credential Securities (the respondent), it was admitted that: In or about 2006 and 2007, the Respondent did not take adequate steps to ensure that its Approved Persons understood the complexities of the third- party asset-backed commercial paper (ABCP) product made available for purchase to its retail clients and the consequent risks (including systemic risks and counterparty risks) related to those products and, in not taking these 258 Ibid.; between the time that investigations began and the time this settlement was reached, the Investment Dealers Association of Canada, of which Canaccord Financial was a member firm at the time of the alleged violation, merged with Market Regulation Services Inc. to form IIROC, which "is the national self-regulatory organization which oversees all investment dealers and trading activity on debt and equity marketplaces in Canada." Canaccord Financial is currently an IIROC dealer member. 259 Canaccord Settlement, supra note 257. 2«> Ibid. 87 adequate steps, did not ensure that the purchase of third-party ABCP was appropriately understood by its clients, contrary to Investment Dealers Association Regulation 1300.1(a] (now IIROC Dealer Member Rule 1300.1(a)}.261 Pursuant to the Settlement Agreement the Hearing Panel imposed a fine of C$200,000 (inclusive of costs) and ordered that Credential Securities retain "an independent consultant to verify the remedial actions already tåken relating to due diligence practices and procedures relating to fixed income securities."262 The Reasons and Decision of the Hearing Panel have yet to be released.263 *** In addition to the settlement agreements outlined above, regulators have launched disciplinary hearings against several key actors involved the third-party ABCP market freeze. 261 IIROC, "In the matter of Credential Securities Inc. - Settlement" News Release (21 December 2009) online: Coventree, as well as the company's president, Geoffrey Cornish, and former Chief Executive Officer, Dean Tai (the Respondents).264 Coventree was the largest sponsor of Canadian third-party ABCP prior to the August 2007 market freeze, sponsoring 46 per cent of third-party ABCP notes.265 The OSC outlines four main allegations against the Respondents in its Statement of Allegations: 1. Prospectus Disclosure "Coventree failed to make full, true and plain disclosure in its prospectus by failing to disclose the fact that DBRS had adopted more restrictive credit rating criteria for ABCP in November 2006."266 Pursuant to s. 56 of the Ontario Securities Act, Coventree, as a public company, was required to provide full, true and plain disclosure of all material facts pertaining to the securities it proposed to distribute.267 Further, the CEO and CFO of the company 264 Secuhties Act, supra note 117, ss. 127,127.1; Coventree Inc. et al. (2009), supra note 22 at para. 5. 265 Ibid. at para. 2. 266 Ibid. at para. 5. 267 Ibid. at para. 42. 89 and any two directors were required to certify that the prospectus contained full, true and plain disclosure in accordance with s. 58 of the Ontario Secuhties Act.268 Cornish and Tai provided this certification as a director and CEO respectively.269 Coventree filed its preliminary prospectus with the OSC on October 16, 2006 and filed its final prospectus (dated November 15, 2006) on November 17, 2006.270 DBRS was the company's only provider of essential rating services, and accordingly Coventree relied heavily on DBRS ratings of its third-party ABCP notes.271 On November 10, 2006, DBRS advised Coventree that it was immediately implementing a more restrictive approach to approving new structured financial asset-backed (SFA) transactions for ABCP conduits (which Coventree described as credit arbitrage transactions).272 While Coventree's prospectus did outline a number of material risk factors pertaining to its business, the company failed to include disclosure relating to the new, more restrictive approach adopted by DBRS in assessing third-party ABCP notes.273 Rather, the same verbiage regarding DBRS ratings that appeared in the 268 Ibid. at para 43. 269 Ibid. at para. 45. 270 Ibid. at para. 44. 271 Ibid. at para. 12. 272 Ibid. at para. 47. 273 Ibid. at paras. 46-47. 90 preliminary prospectus also appeared in the final prospectus.274 Furthermore, Coventree's final prospectus did not disclose that roughly 80 per cent of the company's revenue came from so-called credit arbitrage transactions which would be affected by the new ratings approach implemented by DBRS.275 The OSC holds that the November 10, 2006 notice from DBRS was a material change and a material fact and thus was required to be disclosed under Ontario securities law.276 Moreover, the OSC contends that both Cornish and Tai knew, or should have known, about the November 10, 2006 notice at the time they certified that the final prospectus contained full, true and plain disclosure of all material facts.277 Accordingly, the OSC argues that Coventree failed to provide full, true and plain disclosure according to s. 56 of the Ontario Securities Act.278 Secondly, both Cornish and Tai, as directors and officers of Coventree, authorized, permitted or acquiesced to this failure on the part of the company, and thus breached s. 129.2 of the Ontario Securities Act279 2. Impact of the DBRS Change in Rating Criteria 274 Ibid. at para. 48. 27SIbid. at para. 51. 276 Ibid. at para. 53. 277/b/d at para. 13 278 Securities Act, supra note 117, s. 56; Ibid. at para. 55. 279 Securities Act, supra note 117, s. 129.2; Coventree Inc. et al. (2009), supra note 22 at para. 56. 91 "Coventree failed to meet its continuous disclosure obligations by failing to disclose that DBRS's decision in January 2007 to change its credit rating methodology resulted in a material change to Coventree's business or operations."280 Coventree had continuing disclosure obligations as a reporting issuer under Ontario securities law.281 Specifically, the company was required to issue a press release forthwith pursuant to s. 75 of the Ontario Securities Act when a material change occurred in the company's business.282 At the time of going public, Coventree formed a disclosure committee of which Cornish and Tai were both members. The disclosure committee was charged with overseeing the company's disclosure practices and ensuring that securities regulatory disclosure requirements were met.283 DBRS issued a press release on January 19, 2007 which outlined the changes in its rating methodology for arbitrage-type transactions entered into by commercial paper issuers and funded by ABCP.284 This release contained detailed new rating criteria, including the requirement of Global-style liquidity support for SFA transactions.285 280 Coventree Inc. et al, (2009), supra note 22 at para. 5. 281 Ibid. at para. 57. 282 Ibid. 283 Ibid. at para. 58. 284 Ibid. at para 60. 285 Ibid. 92 Coventree-sponsored conduits did not then have, nor could they gain access to, Global-style liquidity.286 Accordingly, because a rating from DBRS was required for Coventree to avail itself of the prospectus exemption for ABCP under s. 2.35 of NI 45-106, Coventree was effectively unable to continue to purchase credit arbitrage assets for its conduits.287 This change was significant because Coventree's solely operated in the business of securitization conduits and approximately 80 per cent of the company's revenue resulted from credit arbitrage transactions, which substantially funded Coventree's ongoing operations—two facts that the company had not disclosed in its prospectus or other filed financial statements.288 Accordingly, as Coventree had not disclosed that most of its revenue came from credit arbitrage transactions, the market could not recognize that the change in DBRS's rating criteria produced a change in Coventree's business or operations without further explanation by Coventree.289 From January 19, 2007 to August 13, 2007, the company failed to comply with continuous disclosure obligations pursuant to s. 75(1) of the Ontario Securities Act by failing to issue a news release disclosing the content of the material change; specifically, that the change in DBRS's rating criteria resulted in a change to 286 Ibid. at para 61. 287 NI 45-106, supra note 47, s. 2.35; ibid. 288 Coventree Inc. et al. (2009], supra note 22 at para. 62. 289 Ibid. at para. 63. 93 Coventree's business or operations.290 Moreover, Cornish and Tai knew, or should have known, that this resulted in a material change; however, they refused or failed to make this disclosure.291 Therefore, Cornish and Tai, as directors and officers of the company, authorized, permitted or acquiesced in Coventree's failure to comply with continuous disclosure requirements from January 19, 2007 to August 13, 2007, contrary to s. 129.2 of the Ontario Securities Act.292 Furthermore, from January 19, 2007 to August 13, 2007 Coventree, as well as Cornish and Tai in their capacities as directors and officers of the company, failed to file a material change report regarding the change in DBRS rating methodology, contrary to s. 75(2) of the Ontario Securities Act.293 Cornish and Tai, as directors and officers of Coventree, are also alleged to have also breached s. 129.2 of the Ontario Securities Act by authorizing, permitting or acquiescing to the company's failure to file a material change report regarding this matter.294 3. Misleading Sta temen t: "Coventree made misleading statements in April 2007 by telling the market that the total US subprime exposure in its sponsored conduits was 7.4 per cent, but failing to provide investors with a breakdown of that exposure by conduit and ABCP note 290 Securities Act, supra note 117, s. 75(1]; Ibid. at para. 65. 291 Coventree Inc. et al. (2009), supra note 22 at para. 64. 292 Securities Act, supra note 117, s. 129.2; Ibid. at para. 66. 293 Coventree Inc. et al. (2009), supra note 22 at paras. 67-68. 294 Ibid. at para. 69. 94 series. The exposure was higher than 15 per cent in three conduits, and higher than 40 per cent in one note series."295 Early in 2007, market participants became increasingly concerned about the exposure of third-party ABCP assets to the American subprime mortgage crisis.296 On April 25, 2007 and April 26, 2007, Coventree delivered a presentation to a number of ABCP dealers and investors, part of which was aimed at "Demystifying the Subprime Market".297 In this presentation Coventree advised dealers and investors that the total U.S. subprime exposure in Coventree conduits was 7.4 per cent, however, the company failed to provide a specific breakdown of exposure by conduit or note series, when in fact, exposure varied considerably.298 Coventree knew, or should have known, that U.S. subprime exposure was significantly higher than 7.4 per cent in three of its note series.299 Therefore, Coventree made a misleading statement to investors and dealers when the company advised that its conduits had a 7.4 per cent exposure, while failing to disclose that exposure was significantly higher in three note series.300 295 Coventree Inc. et al (2009), supra note 22 at para. 5. 296 Ibid. at para. 70. 29? Ibid. 298 Ibid. at paras. 70,71. 2™Ibid. at para. 71. 300 Ibid. at para. 72. 95 On April 25, 2007 and April 26, 2007, Coventree contravened s. 126.2(1) of the Ontario Securities Act when it made a statement that it knew, or should have known, was misleading in a material respect at that time and in light of the circumstances under which it was made.301 Further, Coventree did not state the facts necessary to make the statement not misleading.302 The statement in question would reasonably be expected to significantly impact the market prices or value of at least three ABCP note series sponsored by Coventree.303 Later, on July 24, 2007, Coventree provided its dealer syndicate with details regarding U.S. subprime exposure per conduit and note series as of June 28, 2007; however, the company did not generally disclose the facts necessary in order to make its April statements not misleading.304 4. Liquidity and Liquidity-Related Issues Prior to August 13, 2007 "Coventree failed to meet its continuous disclosure obligations by failing to disclose liquidity and liquidity-related events and the risk of a market disruption in the days leading up to the market disruption on August 13, 2007."305 301 Securities Act, supra note 117, s. 126.2(1]; ibid. at para. 73. 302 Coventree Inc. et al. (2009), supra note 22 at para. 73. 303 Ibid. 304 Ibid. at para. 74. 305 Ibid. at para. 5. 96 Coventree was a reporting issuer and accordingly had continuous disclosure obligations that required the company to issue a press release forthwith when a material change occurred in its business or operations.306 Coventree put its U.S. subprime transactions on an internal watch list in January 2007, and beginning in February 2007 the company began making disclosures to some of its dealers and investors regarding the exposure of its conduits to the U.S. subprime mortgage market.307 Subsequently, Coventree investors and dealer syndicate members began to make increasingly detailed inquires about the assets underlying Coventree ABCP, resulting in more frequent and specific disclosure by the company to certain parties.308 Notably, on July 11, 2007, Coventree sent an email to a member of its dealer syndicate including a breakdown of the U.S. subprime exposure of Coventree conduits.309 Further, on July 24, 2007, Coventree sent a similar breakdown by email to its entire dealer syndicate.310 The July 11, 2007 email was forwarded by the dealer to CDPQ, which held approximately 50 per cent of Coventree-sponsored ABCP in the first half of 2007.3n Upon learning of the facts disclosed in the July 11, 2007 email, CDPQ began to 306 Securities Act, supra note 117, s. 75; ibid. at para. 75. 307 Coventree Inc. et al. (2009), supra note 22 at paras. 76-77. 308 Ibid. at para. 77. 3°9 Ibid. at para. 78. 3io Ibid. 3ii Ibid. at para. 79. 97 considerably reduce its holdings of ABCP with subprime exposure.312 Very concerned about CDPQ's response, Coventree acted to reallocate subprime assets among its conduits to satisfy CDPQ, and in so doing Coventree did not consider the interests of other ABCP investors.313 The July 24, 2007 email included a table (excerpted below) outlining exposure of Coventree-sponsored conduits and note series to the U.S. subprime mortgage market as of June 28, 2007.314 Upon sending this email to its dealer syndicate, certain dealers took action to minimize their exposure to losses in the third-party ABCP market by reducing or temporarily eliminating the market-making lines and adjusting their inventory holdings of Coventree-sponsored ABCP.315 312 Ibid. sis Ibid. 3i4 Ibid. at para. 80. 3i5 Ibid. at para. 81; the term "market-maker" refers to "[o]ne (as a person or firm) that, on a continuous basis, buys and seils a security for one's own account. Market makers usually try to profit from a rapid turnover in security positions rather than from holding those positions in anticipation of gradual price movements. Specialists on the organized exchanges and dealers in the over-the-counter market are market makers", see The Free Dictionary, s.v. "market-maker" online: [Table tåken from OSC Statement of Allegations. Emphasis in original]316 TOTAL ABCP AND CONDUIT SERIES A SERIES E TOTAL ABCP FRNS FRNs Aurora Trust 0% 8% 3% 2% 3% Comet Trust 0% 42% 16% 12% 16% Planet Trust 26% 3% 17% 0% 15% Slate Trust 0% 16% 13% 0% 13% Apollo Trust Gemini Trust 0% 0% 0% 0% 0% Rocket Trust Venus Trust SAT 0% 0% 0% 0% 0% SIT III 1% 0% 1% 0% 1% TOTAL 3% 6% 5% 2% 4% DBRS notified Coventree on July 25, 2007 that it was receiving calls on a daily basis regarding U.S. subprime exposure in Canadian third-party ABCP conduits, and advised that Coventree's funding capacity may be affected.317 By early August 2007, several of the material risks outlined in the Coventree prospectus had occurred.318 These events, individually and collectively, were a material change in Coventree's business or operations.319 On August 1, 2007 Coventree held an emergency board of directors meeting to discuss declining market conditions, at which the board instructed management to 316 Chart tåken from ibid. at para. 80 [emphasis in original]. ™ Ibid. at para. 82. ™lbid. at para. 83. 3" Ibid. 99 draft a press release about the liquidity issues facing the third-party ABCP market.320 This press release was drafted and circulated to the board of directors, however, on management's advice it was not issued.321 Rather the press release was held for future release.322 The decision not to disclose the press release was significantly influenced by the fact that it was anticipated such a disclosure would have an adverse impact on the third-party ABCP market.323 In the draft press release, Cornish made the following statement: ... this spread widening has decreased the current revenues of Coventree and, if it were to continue, will result in a material decrease in the future revenues of the Company and therefore its profitability.324 The press release was eventually disclosed after the market had frozen on August 13, 2007.325 Coventree held an internal meeting to discuss market disruption procedures on July 25, 2007, and by July 26, 2007 dealers were inquiring about details of the liquidity agreements and the liquidity drawdown procedures pertaining to third-party 320 Ibid. at para. 84. 321 Ibid. at para. 85. 322 Ibid. 323 Ibid. at para. 86. 324 Ibid. at para. 85, citing Coventree Press Release. 325 Ibid. at para. 88. 100 ABCP.326 In August, market liquidity continued to deteriorate, indicating a lessening demand for Coventree ABCP.327 Coventree took comprehensive steps to prepare for a market disruption on August 6, 2007.328 This included meeting with counsel to prepare the necessary notices and notifying DBRS.329 The OSC contends that the risk of market disruptions was also a material change requiring disclosure.330 Both Cornish and Tai were aware of the issues facing the third-party ABCP market and Coventree specifically, however, in spite of their roles as members of the disclosure committee, strategic council and directors and officers of Coventree, they refused or failed to make disclosure.331 From August 1, 2007 to August 13, 2007, Coventree failed to comply with its continuous disclosure obligations set out in s. 75(1] of the Ontario Secuhties Act, by failing to issue and file a news release disclosing the nature and substance of the 326 Ibid. at para. 87. 327 Ibid. at para. 88. 328 Ibid. at para. 89. 329 Ibid. 330 Ibid. 331 Ibid. at para. 90. 101 material change, specifically, the liquidity and liquidity-related issues and the risk of a market disruption.332 Further, from August 1, 2007 to August 13, 2007, Cornish and Tai, in their capacities as directors and officers of Coventree, authorized, permitted or acquiesced in the company's failures to comply with its continuing disclosure obligations contrary to s. 129.2 of the Ontario Secuhties Act.333 From August 1, 2007 to August 13, 2007, Coventree failed to file a material change report relating to the liquidity and liquidity-related issues and the risk of market disruption, contrary to s. 72(2) of the Ontario Secuhties Act.334 Finally, from August 1, 2007 to August 13, 2007, Cornish and Tai, in their capacities as directors and officers of Coventree, authorized, permitted or acquiesced in the company's failure to file a material change report, contrary to s. 129.2 of the Ontario Secuhties Act.335 332 Ibid. at para. 91; Securities Act, supra note 117, s. 75(1]. 333 Coventree Inc. et al. (2009), supra note 22 at para. 92; Securities Act, ibid., s. 129.2. 334 Coventree Inc. et al. (2009), ibid. at para. 93; Securities Act, ibid., s. 75(2). 335 Coventree Inc. et al. (2009), ibid. at para. 94; Securities Act, ibid., s. 129.2. 102 The OSC alleges that the conduct of Coventree, Cornish and Tai, as outlined above, was in breach of the Ontario Securities Act and contrary to the public interest.335 An OSC hearing was held on January 14, 2010 in regards to the allegation set out above, at which the staff and counsel for the parties motioned for, and were granted, a confidential pre-hearing conference scheduled for February 10, 2010.337 It is anticipated that the matter will go to trial in May and/or June of 2010 and will last about six weeks.338 Deutsche Bank Securities Limited — The OSC has commenced disciplinary action against Deutsche Bank Securities, a major liquidity provider and investment dealer in the Canadian third-party ABCP market.339 As of this writing Deutsche Bank Securities and the OSC have not reached a settlement agreement.340 D. Conclusion The Canadian third-party ABCP liquidity crisis of August 2007 and group restructuring of 20 third-party ABCP trusts focused the attention of the Canadian 336 Coventree Inc. et al. (2009], ibid. at para. 95. 337 Coventree Inc., et al. - s. 127 (2010), 33 O.S.C.B. 636 online: OSC August 2007 has added a human interest element to the non-bank ABCP fiasco, with newspapers frequently picking up on the plight of these investors in coverage of the ABCP restructuring, as well as struggling pension funds and other public institutions affecting individual Canadians.341 Though it may pale in comparison to the subprime credit crunch in the United States, the third-party ABCP liquidity crisis has been the Canadian financial calamity of 2007, spurring debate over the securitization of consumer receivables and the adequacy of existing regulatory oversight and precautions. 341 See e.g., "Power to the people" Risk 21:5 (May 2008]; ABCP fiasco, supra note 29; Murray Gold, "Boiling Point" Benefits Canada 31:12 (December 2007] 77; Watson, supra note 30; Glenda Luymes, "UBC caught in economic meltdown as finance head quits" The Province (21 November 2008] online: canada.com The light regulation of ABCP programs by securities regulators and the reliance on unregulated credit rating agencies have been identified as the two major securities law problems associated with the regulatory oversight of third-party ABCP. In view of the securities law concerns relating to existing regulation of non-bank ABCP, subsection B of this part has put forth some preliminary recommendations for improving the securities law oversight of third-party ABCP. While these recommendations comprise only a brief sketch of the improvements that might be made, they serve to illustrate some of the possible securities regulation inspired reforms that could be implemented to improve disclosure and regulatory oversight with respect to third-party ABCP notes. Finally, subsection C has highlighted recent actions tåken by regulators with respect to improper behavior by certain market actors in the context of the third-party ABCP liquidity crisis. 105 Part 2: Restructuring the Third-Party ABCP Market under the CCAA The C$32 billion insolvency of 20 third-party ABCP trusts marks the largest insolvency in Canadian history. The proactive roles tåken by major creditors in forming a CCAA Plan to restructure a securities market represents one of the most creative uses of the statute in recent times and has resulted in the successful restructuring of the third-party ABCP market in Canada. Chief among the distinct characteristics of the restructuring was the presence and treatment of retail investors in third-party ABCP, who were unknown at the time of the August 2007 liquidity crisis, and yet ended up in a position to effectively vote down the proposed Plan of Arrangement. Another interesting feature of this insolvency was the high degree of collaboration and cooperation among major creditors in fashioning a Plan of Arrangement in advance of the initial CCAA filing, ln light of the precedent setting use of the CCAA in the third-party ABCP restructuring, as well as investor protection concerns surrounding the sale of this financial instrument to retail investors, it is timely to consider these particular features of the insolvency proceedings and successful Plan of Arrangement from an insolvency law perspective. Accordingly, this part sets out to examine the significance of several of the unique aspects of this restructuring. 106 A. CCAA Restructuring Proceedings i. Accessing the CCAA The genesis of the CCAA application began in August 2007 with the first voluntary standstill agreements reached by third-party ABCP conduits and their largest investors. Out of these agreements the Committee was formed, headed by Mr. Purdy Crawford and comprising a number of representatives from various stakeholder groups, notably large investors in third-party ABCP, liquidity providers, and CDS counterparties. The Committee held its first meeting in September 2007, and in the seven months leading up to the initial CCAA application, it worked diligently with a view to maximizing recoveries as efficiently and fairly as possible in a manner that would be in the best interests of the stakeholders.342 Due to the immense size and complexity of the liquidity crisis, the negotiations and agreements reached by the Committee in the months leading up to the CCAA application were integral to the successful restructuring of the market. A notable feature of the response to the third-party ABCP liquidity crisis was the proactive roles tåken by private actors in the process, making the restructuring largely a market-driven solution. However, though the restructuring resembles a prepackaged bankruptcy (or rather several dozen prepackaged bankruptcies that 342 Forte, supra note 11 at 213. 107 were joined together) in many respects, it is perhaps more properly described as a prepackaged bankruptcy that received some help from the courts.343 This is because in a true prepackaged bankruptcy, the terms of the agreement do not change once they have been assented to by the parties, which, as will be described below, was not the case in the third-party ABCP insolvency.344 The decision of the Committee to utilize the CCAA to restructure the third-party ABCP market in Canada demonstrates creative use of the statute, which brought with it a number of technical and practical obstacles centered on gaining access to the CCAA. The CCAA may generally be used to restructure a "debtor company" with debts in excess of C$5 million.345 "Debtor company", according to the CCAA definition, does not include "companies to which the Trust and Loans Companies Act applies" [emphasis added], however, a number of third-party ABCP conduits were either trust companies or were corporations acting as trustees, and thus were ineligible to apply for CCAA protection.346 Thus, the first challenge to accessing the CCAA was to bring third-party ABCP conduits within the statutory definition of "debtor company". 343 Interview of Anonymous (25 February 2010) conducted by Virginia Torrie [unpublished]. 344 Ibid. 345 CCAA, supra note 1, ss. 2, 3(1). 346 Forte, supra note 11 at 214; CCAA, supra note 1, s. 2; Trust and Loan Companies Act, S.C. 1991, c. 45. 108 In order to bring the insolvent trusts within the jurisdiction of the CCAA, the trustees that did not fall within the definition of "debtor company" were lawfully replaced with new trustees that did.347 This approach was argued as in keeping with judicial recognition of the availability of various tactical means by which to gain access to CCAA.348 In its reasons, the Ontario Superior Court of Justice held that "each trust company was now a corporation that was trustee of one or more conduits, ... and was a debtor with respect to the ABCP issued by the trustee of that conduit."349 The court found that the conversion of trusts to corporations was an appropriate means by which to access the CCAA.350 Accordingly, the new companies were considered by the court to be debtor companies within the meaning of the CCAA.351 A second problem encountered by the Committee was the issue of the "insolvency" of the debtor conduits, which was a necessary prerequisite to a CCAA application. Due to the language of the affected trust indentures,352 the liability of the trustees was limited to the assets of the trust.353 A trust is not considered a legal person under Canadian law, and thus the trustee is the obligor under a trust's covenant to 347 Forte, supra note 11 at 214. 348 Elan Corp. v. Comiskey (1990], 1 O.R. (3d) 289 (CA.} at 312-13,1 C.B.R. (3d) 101; (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 46, cited in Forte, supra note 11 at 214. 349 (2008], 42 C.B.R. (5th) 90, supra note 22 at paras. 10, 27, cited in Sarra 2008, supra note 12 at 324. 350 Ibid. 351 (2008), 42 C.B.R. (5th) 90, ibid. at paras. 28, 29. 352 A trust indenture is "[a]n agreement in the bond contract made between a bond issuer and a trustee that represents the bondholder's interests by highlighting the rules and responsibilities that each party must adhere to." See, Investopedia, supra note 176 s.v. "trust indenture". 353 Forte, supra note 11 at 215. 109 pay.354 The issue raised was that of showing the insolvency of the affected conduits, as that term is defined in the Bankruptcy and Insolvency Act.355 In affirming the conversion of the trusts to corporations, the Ontario Superior Court of Justice held that each trustee "of one or more conduits, was legal owner of the assets held in the conduit which it was the trustee".356 By owning the assets, it was possible for the newly created corporations to become insolvent if they were not able to pay the debts with respect to those assets. The insolvency threshold was then overcome by relying on the decision of the Ontario court in Re Stelco Inc., which held that a debtor company may be considered "insolvent" if it is "reasonably expected to run out of liquidity with the reasonable proximity of time as compared with the time reasonably required to implement a restructuring".357 Since no payments for third- party ABCP had been made for seven months prior to the CCAA application, it was reasonably concluded that the conduits' obligations were not being met.358 Each conduit was found individually liable for over C$5 million in outstanding notes, thereby meeting the minimum dollar value threshold for a CCAA application.359 354 Canada Deposit Insurance Corporation v. Canadian Commercial Bank (1988}, 67 C.B.R. (N.S.) 125 (Alta. Q.B.] at para 129, cited in Forte, supra note 11 at 215. 355 Note there is no definition of "insolvent" or "insolvency" in the CCAA; see BIA, supra note 20, s. 2(1) "insolvent person". 356 (2008), 42 C.B.R. (5th) 90, supra note 22 at paras. 10, 27, cited in Sarra 2008, supra note 12 at 324. 357 Re Stelco Inc., (2004), 48 C.B.R. (4th) 299 (Ont. S.C.J.) at paras. 21, 22, 26, 28; leave to appeal to Ontario Court of Appeal refused, [2004] O.J. No. 19031 leave to appeal to S.C.C. refused [2004] S.C.C.A. No. 336. 358 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 12, cited in Forte, supra note 11 at 216. 359 Ibid. 110 The third difficulty with regard to restructuring the third-party ABCP conduits under the CCAA was that the new trustees were unprepared to act as "applicants" in the insolvency proceedings. In particular, the court commented that the issuer trusts had no financial interest in the underlying debt, and consequently it was not reasonable to expect these trustees to initiate a Plan of Arrangement.360 Under the Act, if the debtor company does not apply for CCAA protection, the only other eligible applicant would be a "creditor" (or creditors) of the debtor company.361 The applicant issue was therefore easily overcome in this case, as the major noteholders in third-party ABCP were prepared to act as applicants, as they held roughly C$21 billion of the outstanding notes.362 The court was satisfied that the noteholder application was in keeping with the remedial purposes of the CCAA to allow for a "structured environment for the negotiation of compromises between a company and its creditors".363 Fourthly, the CCAA application requested that the insolvency proceedings of all affected third-party ABCP conduits be Consolidated because the claims were 360 (2008], 42 C.B.R. (5th) 90, ibid. at para. 8, cited in Sarra 2008, supra note 12 at 325. 361 Janis Sarra, Rescue! The Companies Creditors' Arrangement Act (Toronto: Thomson Carswell, 2007] at 18. 362 Forte, supra note 11 at 214; "the CCAA applicants were ATB Financial, Caisse de depot et placement du Québec, Canaccord Capital Corporation, Canada Mortgage and Housing Corporation, Canada Post Corporation, Credit Union Central Alberta Limited, Credit Union Central of BC, Credit Union Central of Canada, Credit Union Central of Ontario, Credit Union Central of Saskatchewan, Desjardins Group, Magna International Inc., National Bank of Canada/National Bank Financial Inc., NAV Canada, Northwater Capital Management Inc., Public Sector Pension Investment Board, and the Governors of the University of Alberta", Crawford Affidavit, supra note 34 at para. 72, cited in Sarra 2008, supra note 12 at FN 40. 363 (2008], 42 C.B.R. (5th] 90, supra note 22 at para. 23, cited in Sarra 2008, supra note 12 at 325. 111 inextricably linked, meaning the success of restructuring one trust was contingent on the successful restructuring of all the others.364 The court observed that the Ontario Rules of Civil Procedure permitted the joinder of claims by multiple applicants against multiple respondents.365 In this case, the application put forward by the applicants involved common questions of law and fact, and so joining the claims into a single proceeding promoted the convenient administration of justice.366 The court stated, "a restructuring under the CCAA may take any number of forms, limited only by the creativity of those proposing the restructuring".367 The court's view in this case was informed by the need for flexibility in the third-party ABCP insolvency proceedings and the likelihood of drastic and far-reaching consequences in the event of the Plan's failure.368 Finally, the application submitted requested that all claimants be grouped into a single class for the purpose of voting on the CCAA Plan. Ordinarily, the court would use a commonality of interest test to determine the classification of creditors. However, in this case the court held that "the plan was an offer to all investors and must be accepted by or made binding on all investors", making a single class of 3M (2008), 42 C.B.R. (5th) 90, ibid. at para. 39, cited in Sarra 2008, supra note 12 at 325-26. 365 [2008), 42 C.B.R. (5th) 90, ibid., cited in Sarra 2008, supra note 12 at 325-26; Ontario Rules of Civil Procedure, R.R.0.1990, Reg. 194, Rules 5.01, 5.02 [Rules of Civil Procedure]. 366 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 39, cited in Sarra 2008, supra note 12 at 326; Rules of Civil Procedure, ibid. 367 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 53, cited in Sarra 2008, ibid. 368 Sarra 2008, ibid. 112 creditors appropriate.369 Despite a number of differences in terms of investor- creditor risks with respect to the particular third-party ABCP notes held, the court found that the Plan treated all noteholders equitably.370 The court was also particularly reluctant to utilize classification approaches that might jeopardize the otherwise viable Plan of Arrangement.371 Thus, the court approved the grouping of noteholders into a single class of creditors based on its holding that the commonality of interest test should be viewed purposively based on a non- fragmentation test that takes into account the objects of the CCAA.372 Håving successfully overcome a number of technical and legal barriers to bring the third-party ABCP insolvency within the purview of the CCAA, the Committee was next able to proceed with its restructuring proposal. ii. The CCAA Plan The applicant investor-creditors of third-party ABCP sought an initial order and stay under the CCAA on March 17, 2008. The tentative Plan of Arrangement had come as the result of intensive negotiations between the Committee and major stakeholders, and proposed to convert the short term ABCP into long-term notes that will trade 369 (2008], 42 C.B.R. (5th) 90, supra note 22 at para. 51, cited in Sarra 2008, ibid. 37° Ibid. 371 Sarra 2008, supra note 12 at 326. 372 Sarra 2008, supra note 12 at 326-27. 113 freely at a discounted face value. It was hoped that over the long term a strong secondary market for the notes would develop, bolstered by less tumultuous market conditions and greater transparency regarding the underlying assets backing the notes.373 [In fact, the first signs of a developing market for the restructured third- party ABCP notes appeared in autumn 2009.374) While the details of the successful restructuring Plan are complex, they are sketched out in broad strokes below in order to give an overview of the Arrangement. The proposed Plan can be summed up as follows. The majority of third-party ABCP assets would are pooled into two master asset vehicles, MAV1 and MAV2, in order to make the notes more secure by increasing the available collateral.375 The aim of the drafters was to address three of the major issues leading to the liquidity crisis: lack of transparency, timing mismatch and likelihood of forced liquidation. The Plan provides investors with detailed information concerning the underlying assets and adjusts the maturity provisions and interest rates on the new notes to resolve timing issues.376 In addition, the Plan mitigates the risk of a forced liquidation as a result of CDS holders' prior security by amending some of the underlying CDS agreements to increase the threshold for default triggering events.377 373 Sarra 2008, supra note 12 at 323. 374 New GolcTs ABCP is in Demand, supra note 25; Long-thawed ABCP market simmering to a boil, supra note 24. 375 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 26, cited in Sarra 2008, supra note 12 at 327. 376 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 25, cited in Sarra 2008, ibid. 377 Ibid. 114 The grouping of all noteholder-creditors into a single creditor class for the purposes of voting on the CCAA Plan, while expedient from a judicial standpoint, produced interesting practical results. At the outset of the third-party ABCP liquidity crisis the Committee was aware of approximately 100 large noteholders, however, as time went on, it came to their attention that there were nearly 2,000 retail investors holding the frozen paper.378 Thus, in order for the voting requirement contained in the CCAA to be met, which specified that a majority of the creditors holding at least two thirds of the value was required approve the Plan, it was imperative that the Committee gain retail investor support in order for the Plan to be successful.379 Quite obviously, the retail and institutional investor were in considerably different situations with respect to the frozen notes. While institutional investors were suffering financially, retail investors, many of whom had their life or retirement savings tied up in third-party ABCP, were hardest hit. These investors could not realistically afford to wait up to nine years to recover the money they had invested, nor could many of them afford to seil their notes at a deep discount soon after the Plan was approved. Realizing this, and cognizant of the need for retail investor approval of the proposed Plan, a side deal was struck with retail investors, whereby if the Plan was approved, noteholders with less than C$1 million would be eligible to 378 Watson, supra note 30. 379 CCAA, supra note 1, s. 6(1). 115 receive the full value of their notes, plus interest and costs, thereby exempting most retail noteholders from much of the financial burden that would be born by investors after the Plan was approved.380 This offer was put forward to retail investors by certain third-party ABCP dealers.381 The court noted that these initiatives were apparently designed to win the votes of these retail investors, and that if the Plan was successful, they would offer substantial relief to these smaller investors.382 Of note in respect of the retail investors is the concept of a "convenience class" of creditors in Canadian bankruptcy and insolvency law. Such a class is comprised of those creditor claims that are so small in value that they are not material in the context of the restructuring.383 Convenience class creditors are ordinarily paid out by the debtor prior to voting, and hence members of this class do not participate in the CCAA vote. The group of retail noteholders in third-party ABCP was not a proper convenience class because their claims were not paid out in full by the debtor (where their claims were paid, it was by a third-party). Further, because claims were not paid out until after the restructuring, retail noteholders participated in the voting under the CCAA. 380 (2008), 42 C.B.R. [5th) 90, supra note 22 at para. 27. 381 Ibid. 382 Ibid. 383 lg February 2010 Interview, supra note 23. 116 Nevertheless, the materiality assessment undertaken with respect to retail investor holdings was similar to that utilized for convenience class purposes. While the C$1 million cut-off may seem high in absolute terms, claims below this threshold were found to be immaterial within the context of the restructuring based on the financial analysis conducted by J PM organ.384 Further, the fact that this group of investors was made whole, even after the restructuring, bear some resemblance to the convenience class concept in Canadian insolvency law. As a part of the deal struck with retail investors, the Committee required them to vote in favour of the CCAA Plan, which included liability releases for various third parties involved with the third-party ABCP market. Notably, these parties included the Canadian banks, dealers, noteholders, asset provides, issuer trustees, liquidity providers, as well as other market participants.385 Due to market and time constraints, the court allowed.the Committee to proceed with holding the vote on the proposed CCAA Plan, however, it required votes be tallied in such a manner as to indicate who objecting noteholders were and the amount of their holdings in third- party ABCP. This measure was adopted in order to allow the vote to proceed without requiring noteholders be divided into different classes beforehand.386 ln 384 Ibid. 385 "Amended Plan of Compromise and Arrangement" (19 March 2008) online: Ernst & Young The vote proceeded on April 25, 2008, with 96 per cent of all noteholders voting in favour of the Plan.388 The tallies revealed that while some retail investors voted against the Plan, the majority of votes east by both pools (those that were involved with the creation of the Plan and those that were not] were in favour of the Plan proceeding.389 The success of the vote satisfied the court that reclassification of creditors would not alter the outcome, and hence the applicants sought court approval of the proposed arrangement.390 The proposed liability releases presented the most controversial aspect of the proposed arrangement for the court to consider in deciding whether or not to approve the Plan. (It is important to note that CCAA proceedings would normally only release the debtors from liability, and thus the insertion of third-party releases was required in order to effectively immunize these entities from liability following 387 (2008), 42 C.B.R. (5th) 90, ibid. at para. 12. 388 Sarra 2008, supra note 12 at 330. 389 Ibid. 390 (2008], 42 C.B.R. (5th) 90, supra note 22 at para. 27, cited in Sarra 2008, ibid. 118 the restructuring.] The releases had been sought by the Committee in order to gain much needed fmancial support from third parties, which would be unable to contribute to the Plan if money was used to defend against costly litigation.391 Nevertheless, the court raised concerns about approving comprehensive releases for fraud claims without knowing whether or not there were noteholders that had legitimate claims. In particular, the court found that it did not have sufficient information to decide whether or not the Plan, including the release provisions, was fair and reasonable within the meaning of the CCAA.392 Therefore, the court adjourned the application, sending the parties back to the negotiating table to develop a revised proposal with respect to the liability releases.393 The result was an amended version of the proposed Plan, which included the same comprehensive liability releases and the addition of a carve out provision for fraud claims against third-party ABCP dealers.394 The Ontario Superior Court of Justice approved the amended Plan on June 5, 2008, holding that it had authority to approve liability releases and that the Plan was fair and reasonable with the meaning of the CCAA.395 39i (2008), 42 C.B.R. (5th) 90, ibid. at para. 30. 392 ATB Financial v. Metcalfe & Mansfwld Alternative Investments II Corp. (2008), 43 C.B.R. (5th) 260, 2008 CarswellOnt 2820 (S.C.J. [Commercial List]). 393 Ibid. 394 "Third Amended Plan of Compromise and Arrangement" (12 January 2009) online: Ernst & Young Ontario Court of Appeal found that the criteria for leave had been met, but denied the appeal on its merits. In particular, the court found: On a proper interpretation, in my view, the CCAA permits the inclusion of third party releases in a plan of compromise or arrangement to be sanctioned by the court where those releases are reasonably connected to the proposed restructuring. I am led to this conclusion by a combination of (a] the open-ended, flexible character of the CCAA itself, (b) the broad nature of the term "compromise or arrangement" as used in the Act, and fe] the express statutory effect of the "double-majority" vote and court sanction which render the plan binding on ali creditors, including those unwilling to accept certain portions of it. The first of these signals a flexible approach to the application of the Act in new and evolving situations, an active judicial role in its application and interpretation, and a liberal approach to that interpretation. The second provides the entrée to negotiations between the parties affected in the restructuring and furnishes them with the ability to apply the broad scope of their ingenuity in fashioning the proposal. The latter afford necessary protection to unwilling creditors who may be deprived of certain of their civil and property rights as a result of the process.397 Leave to appeal to the Supreme Court of Canada was denied without reasons.398 396 ATB Ont. CA., supra note 24 at para. 3, leave to appeal refused (2008), 2008 CarswellOnt 5432 (S.C.C.) at para. 9; Application for leave to appeal dismissed without costs (without reasons) September 19, 2008 [2008] C.S.C.R. no 337, cited in Sarra 2008, supra note 12 at 338. 3" ATB Ont. CA., ibid. at para. 48. 398 ATB Ont. CA., supra note 24, leave to appeal refused (2008), 2008 CarswellOnt 5432 (S.C.C) at para. 9; Application for leave to appeal dismissed without costs (without reasons) September 19, 2008 [2008] C.S.C.R. no 337, cited in Sarra 2008, supra note 12 at 338. 120 B. A Precedent-Setting Case: Applause and Critique The successful conclusion of the protracted restructuring process of third-party ABCP has been lauded as a brilliant use of Canadian insolvency law and held out as an example to other countries.399 The creativity of the Committee in drafting the Plan and the purposive interpretation employed by the court in applying the CCAA brought about what was perhaps the best possible resolution to the third-party ABCP liquidity crisis. It has been suggested that such a feat could not have been accomplished in the United States, where the bankruptcy code is more prescriptive and allows less judicial flexibility in its application.400 Coming during a time of economic turmoil, the flexibility and adaptability of Canada's existing commercial insolvency regime has demonstrated its usefulness and stabilizing effect for Canadian businesses, securities markets and economy. i. Retail Investors in Third-Party ABCP The application of the CCAA to the group insolvency of the third-party ABCP market in Canada resulted in a series of technical and legal hurdles, as outlined above. The unusual factual situation underlying the insolvency proceedings contributed greatly to the unique approach adopted by the court and the Committee in the restructuring. The court's approach to resolving some of these issues raise 399 See e.g., Scott & Henderson, supra note 17. 400 Sarra 2008, supra note 12 at 346. 121 particularly interesting points for analysis, as they are likely to have significance in the development of Canadian insolvency law. This section will critical analyze several aspects of the insolvency proceedings from an insolvency law standpoint, looking in particular at the Plan from the perspective of the retail investors in third- partyABCP. Notwithstanding applause for this great restructuring accomplishment, certain aspects of the proceedings are deserving of a more critical analysis. In particular, the situation of retail investors throughout the proceedings and their position at the conclusion of the arrangement leaves something to be desired. Firstly, the fact that retail investors owned third-party ABCP is concerning from a securities law standpoint. Third-party ABCP was sold under a securities law prospectus exemption, which meant that it arguably should not have been sold to retail investors at all.401 (A fact that has received some recognition in light of the regulatory sanctions described above.] What is even more troubling, however, is that many retail investors did not have any idea they held a security called "third- party ABCP" in their investment portfolios. Further, those who were aware of their holdings had bought in because their investment advisers had promoted the notes as a very low risk, liquid, flexible investment, comparable to financial instruments 401 See NI 45-106, supra note 47, s. 2.35; NI 81-102, supra note 96. Note that under this prospectus exemption, ABCP is free trading after it is initially purchased, however, the purposes of securities legislation and investor protection concerns would likely lean in favor of preventing its sale to retail investors. 122 such as GICs. However, these investors were never informed of the very complex nature of the assets and agreements backing third-party ABCP, nor of the fact that there was very little disclosure regarding the particular pools of assets backing the notes. Thus, while retail investors thought they were buying an investment that was "like a GIC", they were usually unaware of the distinctions between third-party ABCP and GICs, and the resulting differences in risk level. The issue of retail investor ignorance becomes a larger concern in the context of the concluded restructuring Plan, due to the inclusion of liability waivers for parties involved in the Canadian third-party ABCP market. The waiver of liability included in the arrangement contained a carve out provision for fraud claims; however, any other legal recourse is strictly off-limits for these investors. Under the Plan, allowable fraud claims are limited to instances where there was an express fraudulent misrepresentation made by a person who knew the representation to be false, and which was made with the intention to induce a purchase.402 Further, the damages for such claims are limited to the value of the notes less any funds distributed under the CCAA Plan.403 Thus, this pointed definition excludes such cases as where the dealers were negligent in informing themselves regarding the risks of third-party ABCP, and misled or misrepresented the security to their clients as a consequence. Any claims for breach of fiduciary duty or failure to act prudently 402 Sarra 2008, supra note 12 at 333. *°3/Wd. 123 as a dealer or advisor are also barred by the CCAA Plan.404 With a full understanding of the rationale for such liability waivers, this aspect of the Plan is still concerning from a consumer protection standpoint, because the main issue arising from the sale of third-party ABCP was not that retail investors were victims of widespread dealer fraud, but rather that they suffered due to other dealer actions [or omissions] that would fall broadly under tort law. Thus, the carve out is unlikely to provide meaningful recourse to most retail investors, while severely limiting legal remedies for these noteholders. The absence of private litigation as a means of recourse is disconcerting from a consumer protection standpoint in light of the facts surrounding the sale of third- party ABCP to retail investors, (though regulatory action has ostensibly disciplined those dealers that were involved and reports have proposed more rigorous regulation). While it is readily acknowledged that the restructuring proceedings undertaken by the Committee were fraught with numerous challenges, not the least of which was securing much needed financing from certain parties, it is submitted nevertheless that the impact of the liability waivers on retail investors, combined with other contextual factors, has produced an undesirable result. 404 (2008), 42 C.B.R. (5th) 90, supra note 22 at paras. 29, 30, cited in Sarra 2008, supra note 12 at 333, FN 105. 124 The lack of a consumer advocate in the Committee negotiations from the outset, and indeed the very lack of awareness by the Committee of the retail investors in third- party ABCP, was an unfortunate set of circumstances for these individuals. Consequently, retail investors were not only left out of the negotiations, but were largely unaware of the progress made by the Committee. In its review of the Plan of Arrangement, the court also gave voice to these concerns, stating that despite the Committees care and diligence, it was not able to communicate to the same extent with all noteholders.405 In reviewing the initial comprehensive set of liability waivers contained in the Plan, the court noted that the retail noteholders, who were those with potential fraud claims, had not been consulted prior to the development of the Plan.406 Further, it observed that their voices may "well be of a different kind and quality from the votes of other noteholders in terms of a willingness to compromise claims in negligence in all its forms".407 Of further note is the fact that the Plan, dealing as it did with very complex structured financial products, was practically unintelligible to many non-institutional investors. While some consultation was conducted as a result of the court's remarks, little was changed in light of these consultations, as most of the Plan had already been formulated in the seven months prior to the CCAA application. 405 ATB Financial v. Metcalfe & Mansfield Alternative Investment II Corp. (2008), [2008] O.J. No. 1943, 42 C.B.R. (5th) 260 (S.C.J. [Commercial List]) [[2008] O.J. No. 1943] at para. 16, cited in Sarra 2008, supra note 12 at 332. 406 [2008] O.J. No. 1943, supra note 405 at para. 19, cited in Sarra 2008, supra note 12 at 332. wibid. 125 The fact that the Committee did not know that there were retail investors in third- party ABCP for so long raises further concern about dealer seiling practices in the Canadian third-party ABCP market. This in turn would tend to lend credence to enforcement proceedings. While the Plan of Arrangement was eventually approved by the court as being fair and reasonable in the circumstances, it is nevertheless unfortunate that retail investors were not more involved in the negotiation process, as their position and concerns were in many respects quite far apart from those of institutional investors in third-party ABCP. It is suggested that had a consumer representative been on the Committee, the concerns of retail investors would likely have been better addressed in the Plan of Arrangement, probably producing a more desirable result for individual investors without sacrificing the viability of a successful Plan. The buy-back programs and interim credit facilities implemented by the major dealers to repurchase ABCP from retail investors with less than C$1 million in holdings did improve the position of these investors under the Plan of Arrangement. However, the buyback programs left those retail investors with over C$1 million in third-party ABCP to bear the longer-term financial burden of the restructuring alongside institutional investors. The court noted that the C$1 million threshold for the buy-back program had the result of excluding some retail investors who held 126 their entire savings in third-party ABCP through corporations.408 The court did not order a hardship consideration process in this instance, however, it did request for this issue to be considered and reported on.409 In addition, the buy-back programs did not all take effect until after the successful implementation of the Plan, meaning retail investors were left with frozen paper, despite not håving been consulted regarding the standstill agreement, for a full 18 months before realizing financial relief from this initiative.410 The substantial support shown by retail investors in voting for the proposed Plan arguably evidences their support for these proposals, however, this show of support is mitigated in light of the fact that there were few, if any, other options available to these financial strained investors. It is submitted that while these initiatives were positive changes to the position of retail investors, they have perhaps been painted more favorably in the public eye then they should have been when one considers the financial hardship that many investors suffered. While a similar arrangement might be a very favourable one for a corporate creditor, this is arguably not the same measure that should be used when assessing whether or not this Plan was a fair result for Canadian consumers, especially given the dubious circumstances under which these noteholders were sold third-party ABCP. Thus, it is argued here 408 [2008] O.J. No. 1943, supra note 405 at para. 39, cited in Sarra 2008, ibid. 4«9 Ibid. 410 Though there were some interim credit facilities offered to retail investors holding frozen third- party ABCP. 127 that while the buy-back deal struck with small investors may seem advantageous at first blush, in light of the factual context, it was less than ideal from a consumer protection perspective. It is readily acknowledged that in a situation of restructuring one or more debtor companies it is usually the case that unsecured creditors will see the expected return on their investment drop considerably. Nevertheless, in the unique case of the third-party ABCP restructuring, retail investors were in a disadvantageous financial position vis-å-vis the other creditors because they had a very high percentage of their savings in third-party ABCP and were relying on the liquidity of that investment, in some cases to meet basic living expenses. Further, many were not aware they even owned third-party ABCP until they tried to access money tied up in their investments and were informed that it had been frozen due to a "voluntary" agreement between third-party ABCP conduits and investors. Retail investors were nearly entirely left out of the negotiations and were barely kept apprised of the developments in the Committee, for the most part due to the fact that the dealers that had sold these investors third-party ABCP did not have readily accessible records regarding which of their clients held the now frozen paper. It was not until after the initial CCAA application that the retail investors came to the attention of the Committee. Once the proposed Plan was nearly ready to be put to a vote, it became apparent to the Committee that because there was a single class of 128 creditors, the votes of the majority of retail investors would be needed to approve the Plan. Thus, the buy-back arrangement was formulated in order to encourage retail investors to vote in favour of a Plan that otherwise did not advance their interests. Certain investors then accused the Committee of buying votes; an allegation which is arguably not very far from the truth. Among retail investors, it is worth taking a closer look at the impact of the completed Plan on larger retail investors that were not eligible for the buy-back program. For this group of creditors, it is particular noteworthy that the Plan was negotiated and drafted by non-retail investors at a time when they were not aware that such individuals held third-party ABCP. Further, though a numerical majority of noteholders (comprising a majority of retail investors) voted in favor of the Plan, one must critically question what the retail investors were actually voting for. Plausibly, most retail investors voted for the Plan in order to avail themselves of dealer-initiated programs to receive a full refund, including costs and interest, on their notes. However, dissenting retail investors (many with holdings in excess of the C$1 million convenience class cap) ended up with the worst position of all noteholders. Not only were these investors ineligible for the dealer reimbursement programs, but the Plan was made binding on these investors, barring them from most conceivable legal recourse. Instead, these noteholders were left with restructured notes, worth only a fraction of their pre-liquidity crisis value, and only 129 a glimmer of hope that they would eventually recover the value of their initial investment. Though this is essentially the same situation that institutional noteholders were left in, these smaller investors will likely feel the financial impact much more acutely. While there is probably no ideal solution in the case of an insolvency of such large proportions and with as many complexities as the third-party ABCP liquidity crisis, it is submitted that there are at least a few aspects of the restructuring that could have been conducted in a manner that would likely have improved the outcome for retail investors from a consumer protection standpoint. Initially, better regulation (and enforcement of regulation] surrounding the sale of third-party ABCP to retail investors would have been desirable. Secondly, recognition of the unique situation of retail investors early on in the standstill agreement stages, and the appointment of a consumer representative to the Committee to communicate with these investors and advocate for their interests during the negotiations. Thirdly, in light of the factual context, a Plan that better took into account the financial strain suffered by all retail noteholders, perhaps by extending the buy-back program to all retail investors, or to the first C$1 million of all retail investor holdings. The author is not particularly critical of the process employed by the Committee in their efforts to restructure the third-party ABCP market, however, with the benefit 130 of hindsight it is acknowledged that certain aspects of the proceedings could have been conducted in a manner which would have better addressed the unique circumstances of retail investors, many of whom unwittingly found themselves in the thick of the liquidity crisis. Though very little is for certain in the situation of a restructuring, and especially given the evolving market conditions that served as a backdrop to the third-party ABCP insolvency, it is argued that one or more of the suggestions noted above would likely have had a positive impact on the situation of retail investors in this instance, which would have been desirable from a consumer protection standpoint. ii. Third-Party ABCP: A Pseudo-Prepackaged Bankruptcy and Precedent- Setting Case The third-party ABCP insolvency is unique among Canadian insolvencies for a number of reasons, not the least of which is the largely private nature of the restructuring. The market-driven solution formulated in response to the failure of the third-party ABCP market is termed a "pseudo-prepackaged bankruptcy" in this thesis. Prepackaged bankruptcies, as opposed to court-supervised insolvencies under the CCAA or Bankruptcy and Insolvency Act (BIA), are increasingly being used in Canada 131 to reorganize businesses.411 This means of reorganization is attractive to businesses for many reasons, including the perception that such a procedure avoids the negative stigma associated with traditional bankruptcy processes.412 In general terms, a prepackaged bankruptcy is a privately negotiated and executed restructuring in which debtor and creditors agree on the terms for the reorganization.413 Accordingly, prepackaged bankruptcies are a market-driven process, which involve a high degree of cooperation among affected parties. While the third-party ABCP restructuring was not a prepackaged bankruptcy in the strict sense of the term, neither was it a traditional CCAA insolvency. Rather, the reorganization is more accurately described as a large, prepackaged bankruptcy that received a little help from the courts under the purview of the CCAA.414 (Hence the term, pseudo-prepackaged bankruptcy]. The third-party ABCP restructuring shares much in common with a traditional prepackaged bankruptcy because it was the effort of private actors that effectively negotiated the freeze of the market and formulation of the draft Plan of Arrangement in the months following the August 2007 liquidity crisis. When CCAA 411 19 February 2010 Interview, supra note 32. 412 Ibid. 413 Ibid. 414 Ibid. 132 protection was eventually sought in March 2008, it was with a Plan already in hand and the agreement of many major parties to the restructuring. The challenge of negotiating a mutually agreed upon draft Plan is not to be underestimated. In effect, several dozen private restructurings were completed through the Plan, with nearly every party effectively håving a veto over the entire group restructuring (which they indeed used to extract their pound of flesh].415 Further, over the course of months of negotiations, ongoing turmoil in world credit markets made revisiting credit-related terms of the Plan an inevitability.416 Of further note, the third-party releases, contentious though they were, constitute another of the prepackaged bankruptcy aspects of the third-party ABCP restructuring.417 This is due to the fact that third-party releases do not result simply by virtue of filing under the CCAA, and hence these terms must be privately negotiated and agreed upon.418 Once the Plan was filed under the CCAA, however, certain protocols, including voting requirements, had to be adhered to with respect to the Plan. Moreover, certain noteholders then put forward an argument as to whether a CCAA Plan could sanction third-party liability releases. However, despite the subsequent litigation, the terms themselves, being as they are not automatically «s Ibid. 416 Ibid. w Ibid. 418 Ibid. 133 granted under the statute, may be considered a characteristic of a prepackaged bankruptcy. In a traditional prepackaged bankruptcy, the terms of the agreement, once set and agreed upon, are not subsequently altered. Thus, the third-party ABCP case departs from the strict definition of a prepackaged bankruptcy because certain contentious terms, namely the third-party liability releases, were subsequently challenged before the courts.419 Additionally, though the third-party ABCP restructuring was significantly private in nature, the involvement of certain public processes and parties detract from the extent to which it can be characterized as a proper prepackaged bankruptcy. Filing under the CCAA obviously draws the reorganization into a public insolvency process.420 Moreover, the liquidity contributed to the Plan by various governments adds further public flavor to an otherwise largely privately negotiated restructuring.421 «9 Ibid. •20 j9 February 2010 Interview, supra note 23. 421 Lou Brzezinski, "Canada's ABCP Crisis - The Aftermath" (February 2009) Commercial Litigation Update, online: Blaney McMurtry LLP Firstly, the answer to the aforementioned question will hinge on how "success" is defined in the insolvency context. A very low threshold of success would be to simply complete the restructuring, as reorganization is widely considered to be a superior result to the alternative of liquidation. By that measure, the third-party ABCP case is certainly considered successful. Indeed, the fact that the restructured notes began to trade for the first time in autumn 2009 may also indicate the success of the restructuring. Nevertheless, it is posited that it is not appropriate to mark the success of the restructuring by whether or not the restructured notes eventually regain their pre-liquidity crisis value, as this was the hopeful result of reorganization efforts, but was in no way a certainty.424 422 See e.g., ATB Ont. CA., supra note 24 at paras. 55-57, where the held that third-party liability releases were necessary in order to restructure the third-party ABCP market. 423 Interview of Hy Bloom (25 February 2010) conducted by Virginia Torrie [unpublished], in August of 2009 Mr. Bloom appeared before Judge Wagner in Montréal requesting leave to continue an action against the banks that were involved with seiling third-party ABCP under the Québec Civil Code. 424 Crawford Affidavit, supra note 34 at para. 16. 135 In the unique context presented by the third-party ABCP insolvency, success may alternatively be measured by the probable practical results stemming from whether or not the market was restructured. That is, comparing the likely situation that would have ensued had the market not been restructured (ie. CDS counterparties pursued their rights against the conduits under the CDS contracts, noteholders sued conduits, brokerages, etc), versus the situation that has resulted post-restructuring (ie. most investors left with restructured notes, which are trading at a discount).425 It has been argued that under the former scenario the only parties to be made better off would be the lawyers, as various parties retained counsel as a result of the anticipated "cascade of litigation".426 The inconvenience and expense incurred by all other parties involved, however, would arguably be an awful scenario, with litigation stretching out for years (and possibly bankrupting numerous entities), and actual recoveries being quite low (net of litigation expenses), where they existed at all.427 Viewed in light of this gloomy alternative, the results achieved through the insolvency proceedings begin to look quite rosy. While much focus has been paid to the dissident noteholders, it is worth recalling that the Plan was approved by 96 per cent of creditors. Further, less than a year after the reorganization was completed, 425 lg February 2010 Interview, supra note 23. 426 Ibid.; [2008] O.J. No. 1943, supra note 405 at para. 34. 42719 February 2010 Interview, supra note 23. 136 the restructured notes began trading at a 30 per cent discount.428 In light of the alternative, it has been suggested that this is in fact a huge success.429 Whether viewed as a restructuring triumph or not, the legal significance of the third-party ABCP case is already making it a powerful precedent in Canadian insolvency law.430 The legal hurdles that were overcome with court approval in order to bring the case within the purview of the CCAA have undoubtedly broadened the potential scope of CCAA application. To recall, ineligible trustees of the affected conduits were replaced with new trustees in order to meet the CCAA definition of "debtor company".431 Next, the trusts were converted into corporations and the applicants relied on the Re Stelco Inc. decision to meet the "insolvency" threshold for filing under the CCAA.432 The court then assented to the noteholders' actions, as creditors of the insolvent trusts, in bringing the CCAA application.433 Consolidation of the insolvency proceedings was permitted, due to the interconnectedness of the claims, and the common issues of fact and law.434 Finally, the court approved the adoption of a single class of creditors, effectively dispensing with the commonality of interest test in this case, because the Plan was considered «8 Ibid. «9 Ibid. 430 Ibid. 431 Forte, supra note 11 at 214. 432 (2008), 42 C.B.R. (5th] 90, supra note 123 at paras. 10, 27, cited in Sarra 2008, supra note 12 at 324; Re Stelco Inc., supra note 331. 433 (2008}, 42 C.B.R. (5th] 90, supra note 22 at para. 23, cited in Sarra 2008, supra note 12 at 325. 434 (2008], 42 C.B.R. (5th] 90, supra note 22 at para. 39, cited in Sarra 2008, supra note 12 at 326. 137 to be an offer to all noteholders, which had to be accepted by or made binding on all investors, which made a single creditor class appropriate.435 The judicial sanctioning of third-party releases as part of the Plan of Arrangement has similarly broadened the possibilities that may be pursued when restructuring a debtor company under the CCAA (whether for better or worse). Though it remains to be seen what impact the amendments to the CCAA, which have subsequently come into force, will have in mitigating the third-party ABCP precedent. In particular, certain provisions in the amendments specify that third-party releases for fraud that are contained in a CCAA Plan can only be granted if the victim of the fraud in question votes in favor of the arrangement or compromise.436 In other words, fraud releases cannot be made binding on non-consenting fraud victims through a double-majority vote of creditors (in number and value] under the CCAA. Further, the amendments significantly flesh out the otherwise anemic statute, possibly curtailing future arguments in favor of judicial discretion. The liability releases for third-parties were the most contentious point in the third- party ABCP restructuring. The inclusion of such releases was a primary ground on which the lower court's was appealed, and accordingly it was a primary issue dealt with by the Ontario Court of Appeal. Well-crafted arguments were presented on 435 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 51, cited in Sarra 2008, supra note 12 at 326. 436 CCAA, supra note 1, s. 19(2)(c). 138 both sides of the debate, however, it is submitted that the inclusion of third-party releases was both lawful and appropriate in this case. On this issue, the reasons of the Ontario Court of Appeal can be critically analyzed from the perspective of statutory interpretation of the CCAA. Where Campbell}. had relied on inherent jurisdiction to fill a perceived gap in the statute in approving the third-party releases, Blair J. held that the statute implicitly allowed such releases.437 Indeed, the submissions of the Committee, though not explicitly touched on in the court's judgment, are instructive. Looking to the text of the statute [prior to the 2009 amendments), s. 5.1. was the only provision to touch on the topic of third-party releases within a CCAA. Taking a careful approach to the interpretation of this section, counsel for the Committee argued that the text supported the view that CCAA Plans can contain third-party releases. Claims against directors — compromise 5.1 (1) A compromise or arrangement made in respect of a debtor company may include in its terms provision for the compromise of claims against directors of the company that arose before the commencement of proceedings under this Act and that relate to the ATB Ont. CA., supra note 24 at para. 43. 139 obligations of the company where the directors are by law liable in their capacity as directors for the payment of such obligations. Exception (2) A provision for the compromise of claims against directors may not include claims that (a) relate to contractual rights of one or more creditors; or (b) are based on allegations of misrepresentations made by directors to creditors or of wrongful or oppressive conduct by directors. Powers of court (3) The court may declare that a claim against directors shall not be compromised if it is satisfied that the compromise would not be fair and reasonable in the circumstances.438 Specifically, s. 5.1 [1) provides that claims against directors of a debtor may released where they arise by statute due to the director's role as a director.439 It is unclear whether such statutory liabilities could otherwise be released through contract between the debtor and its creditors, and thus this subsection appears to be driven by a Parliamentary intent to ensure that full and complete releases are available to directors in such cases.440 Section 5.1(2], however, goes on to say that the release of directors is not permitted for specific misconduct, regardless of whether the liability is a statutory liability under s. 5.1(1).441 The Committee argued that s. 5.1(2) would be unnecessary if the releases of directors listed in this subsection were not otherwise available under the s CCAA, supra note 1, ss. 5.1(1], 5.1(2), 5.1(3). 9ATB Ont. CA., supra note 24 (Factum of the Respondents at para. 96). "Ibid. 1 Ibid. at para. 97. 140 CCAA.442 This interpretation appears to be particularly tenable given the utility of such releases in a formulating a CCAA Plan and the remedial function of the Act in promoting such compromises and arrangements between debtors and their creditors. The alternative interpretations of this section raised by the appellants are unconvincing. Certain appellants argued that the existence of the prospect of third- party releases contained in s. 5.1 in fact signal the intent of Parliament to only allow such releases within this context.443 In other words, the fact that third-party releases are expressly allowed in s. 5.1 indicates that they are not otherwise allowed under the CCAA. This argument is not compelling for two main reasons. First, the CCAA is a skeletal statute, and it has long been recognized that judges play a role in fleshing out the details of the statute.444 "It is beyond controversy ... that the CCAA is remedial legislation to be liberally construed in accordance with the modern purposive approach to statutory interpretation. It is designed to be a flexible instrument and it 442 Ibid. 443 ATB Ont. C.A., supra note 24 (Re-Amended Factum of the Appellants Air Transat A.T. Inc., Transat Tours Canada Inc., The Jean Coutu Group (PJC) Inc., Aéroports de Montréal Capital Inc., Domtar Inc., Comtar Pulp and Paper Products Inc., Giro Inc., Labopharm Inc., Vétements de sport R.G.R. Inc., 131519 Canada Inc., Air Jazz LP, Services hypothécaires La Patrimoniale Inc., Tecsys Inc., Petrifond Foundation Company Limited, Petrifond Foundation Midwest Limited, Société Générale de Financement du Québec and VibroSystm Inc. at paras. 87-90) [Re-Amended Factum of the Appellants]. 444 ATB Ont. CA., supra note 24 at para. 44. 141 is that very flexibility that gives the Act its efficacy."445 Second, even assuming a more narrow reading of the statutory wording, this reasoning does not account for the types of third-party releases that are not expressly included in s. 5.1(1), but nonetheless are excepted in s. 5.1(2). There appears to be no logical way to answer the question of where the authority for these third-party releases comes from, as it does not explicitly stem from s. 5.1(1) and, according to the appellants, neither does it arise implicitly through the CCAA, nor may it be read into the statute as a result of inherent jurisdiction, or "gap filling".446 It was further argued by the appellants that since the purpose behind s. 5.1 was to encourage directors of a debtor to remain in office during an insolvency in order to achieve the purpose of the CCAA, the directors were not true third-parties to the proceedings.447 Therefore, as there was not a similar policy rationale for immunizing directors against their negligent statements or misrepresentations, which the appellants assert are true third-party relationships, ss. 5.1(2) and 5.1(3) were included to limit the releases granted to directors in the context of a CCAA.448 Indeed, much of the controversy surrounding the releases centered on the fact that the parties being released were solvent, third-parties. It was argued that such 445 ibid. 446 Ibid. at para. 41. 447 ATB Ont. CA., supra note 24 (Re-Amended Factum of the Appellants, supra note 417 at paras. 88). 448 Ibid. 142 releases had no proper place in a compromise or arrangement between debtors and their creditors under the CCAA. However, as discussed above, this does not appear to be a reasonable interpretation of the statute. Nevertheless, assuming it is somehow more palatable to release parties that are not "true third-parties", the third-party ABCP case actually does not push the envelope very far. As acknowledged by the court, the parties being released in this case were not true third-parties to the restructuring, as these entities in fact wore several hats in the Canadian third-party ABCP market, including that of ABCP dealer, asset provider and liquidity provider.449 As such, the financial institutions in question were simultaneously and respectively: third-parties, creditors, and prior secured creditors to the noteholders.450 Given the concurrent roles played by these entities, it is submitted that it is inappropriate and simplistic to label these institutions as "third-parties" to the restructuring. (In addition to their other roles, these were also, in many cases, the same parties that have contributed value to the Plan in order to see the restructuring proceed.] Rather, one should take a more realistic view of the Canadian third-party ABCP market that acknowledges the multiple roles played by a variety of market actors. (Moreover, even if one were to boil down the involvement of these parties to a single role, the choice of "third-party" is highly questionable ATB Ont. C.A., supra note 24 at para. 55. 143 because it is overtly misleading as to the involvement of these entities in the restructuring and the third-party ABCP market generally.) Of further note is the fact that the court adopted the Committee's submissions which framed the Plan as a contract.451 Following this reasoning, the court held that third- party releases could be included as such releases may lawfully be included in a contract.452 To make out this argument, the Committee argued that a CCAA Plan was analogous to a proposal under the BIA. In its submissions, the Committee states that the "Supreme Court of Canada and this Court have held that a proposal under the Bankruptcy and Insolvency Act is a contract between the debtor and his creditors. This contract, when entered into under the statutory machinery, binds all the creditors, even a dissenting minority."453 The Committee then went on to show that "a compromise or arrangement pursuant to section 4 of the CCAA has been held to be a contract between the creditors and 451 See ATB Ont. CA., supra note 24 at paras. 62, 63; ATB Ont. CA., supra note 24 (Factum of the Respondents at paras. 80-87]. 452 Ibid. 453 ATB Ont. CA., supra note 24 (Factum of the Respondents at para. 81, citing Employers' Liability Assurance Corp. Ltd. v. Ideal Petroleum (1959) Ltd. (1976), 75 D.L.R. (3d) 68, [1976] S.C.J. No. 114 at 7; Society ofComposers, Authors & Music Publishers of Canada v. Armitage (2000), 20 C.B.R. (4th) 160, 50 O.R. (3d) 688 at para. 11 (C.A.); Re Air Canada, [2004] O.J. No. 1909, 2 C.B.R. (5th) 4 at para. 6 (S.C.J. [Commercial List]). 144 the debtor that, through court sanction, becomes binding even on creditors who did not expressly agree to its terms by voting for it. Accordingly, it may include anything that could lawfully be included in a contract."454 The Committee argued that there is good reason to interpret section 4 of the CCAA as permitting third-party liability releases because the very purpose of the statute is to facilitate restructurings.455 Further, in understanding a CCAA Plan as a contract between the debtor and its creditors, the Committee stated that provisions that may lawfully be included in such a contract outside of an insolvency situation may also legitimately be included in a CCAA Plan.456 The CCAA voting requirements and court sanctioning of the Plan then ensure that the requisite majority of creditors are in favor of the Plan, and that the Plan is fair and reasonable. If these two thresholds are met, then the Plan, including the liability releases, properly becomes binding on all creditors as if they had all agreed to it.457 Therefore, by permitting plans of compromise or arrangement between debtors and creditors, the Committee argued that section 4 of the CCAA in fact does allow third-party releases.458 ATB Ont. C.A., supra note 24 (Factum of the Respondents at para. 82, citing Olympia & York Developments Ltd. v. Royal Trust Co., [1993), [1993] O.J. No. 545,12 O.R. (3d) 500 at 518 (Gen. Div.]- 455 ATB Ont. CA., supra note 24 at para. 83. 456 Ibid. 457 Ibid 145 Applying this reasons to the third-party ABCP case, the Committee highlighted the fact that 96 per cent of noteholders voted in favor of the Plan, including he third- party liability releases.459 It was submitted that since third-party releases could lawfully be included in a CCAA Plan and a much greater majority of creditors than the minimum required by the statute had in fact voted in favor of the Plan, the lower court was correct to sanction the Plan, and the dissenting minority of creditors should be bound by the terms of the Plan.460 The Committee went on to state that the "fact that the Court will not sanction a plan unless it is fair and reasonable is what protects the majority from being denied the benefits of the Plan by a recalcitrant minority."461 The decision of the Ontario Court of Appeal then explicitly adopted the Committee's reasoning in its judgment: A proposal under the Bankruptcy and Insolvency Act, R.S., 1985, c. B-3 (the "BIA") is a contract: Employers' Liability Assurance Corp. Ltd. v. Ideal Petroleum (1959) Ltd. (1976), [1978] 1 S.C.R. 230 at 239; Society of Composers, Authors & Music Publishers of Canada v. Armitage (2000), 50 O.R. (3d) 688 at para. 11 (C.A.). In my view, a compromise or arrangement under the CCAA is directly analogous to a proposal for these purposes, and therefore is to be treated as a contract between the debtor and its creditors. Consequently, parties are entitled to put anything into such a plan that could lawfully be incorporated into any contract. See Re Air Canada, (2004), 2 C.B.R. (5th) 4 at para. 6 (Ont. S.C.J.); Olympia & York Developments Ltd. v. Royal Trust Co., (1993), 12 O.R. (3d) 500 at 518 (Gen. Div.). Ibid. at para 84. "Ibid. 1 Ibid. 146 There is nothing to prevent a debtor and a creditor from including in a contract between them a term providing that the creditor release a third party. The term is binding as between the debtor and creditor. In the CCAA context, therefore, a plan of compromise or arrangement may propose that creditors agree to compromise claims against the debtor and to release third parties, just as any debtor and creditor might agree to such a term in a contract between them. Once the statutory mechanism regarding voter approval and court sanctioning has been complied with, the plan - including the provision for releases - becomes binding on all creditors (including the dissenting minority).462 The use of the CCAA to effect the restructuring of a market, as opposed to simply a debtor company is another a unique aspect of the third-party ABCP insolvency. This has been criticized as an action that falls outside the proper scope of the CCAA.463 Nevertheless, the third-party ABCP case may perhaps now stand for the proposition that this is a possible outcome under the CCAA. ln the Ontario Court of Appeal decision, Blair J. held: An interpretation of the CCAA that recognizes its broader socio- economic purposes and objects is apt in this case. As the application judge pointed out, the restructuring underpins the financial viability of the Canadian ABCP market itself. The appellants argue that the application judge erred in taking this approach and in treating the Plan and the proceedings as an attempt to restructure a financial market (the ABCP market] rather than simply the affairs between the debtor corporations who caused the ABCP Notes to be issued and their creditors. The Act is designed, they say, only to effect reorganizations between a corporate debtor and its creditors and not to attempt to restructure entire marketplaces. 462 ATB Ont. CA., supra note 24 at paras. 62, 63. 463 See, e.g., Anonymous Student, "Judicial Discretion - How Far is Too Far?" (LL.M. Seminar Paper, Osgoode Hall Law School, 2009] [unpublished] at 28-30. 147 This perspective is flawed in at least two respects, however, in my opinion. First, it reflects a view of the purpose and objects of the CCAA that is too narrow. Secondly, it overlooks the reality of the ABCP marketplace and the context of the restructuring in question here. It may be true that, in their capacity as ABCP Dealers, the releasee financial institutions are "third-parties" to the restructuring in the sense that they are not creditors of the debtor corporations. However, in their capacities as Asset Providers and Liquidity Providers, they are not only creditors but they are prior secured creditors to the Noteholders. Furthermore - as the application judge found - in these latter capacities they are making significant contributions to the restructuring by "foregoing immediate rights to assets and ... providing real and tangible input for the preservation and enhancement of the Notes" ... In this context, therefore, the application judge's remark ... that the restructuring "involves the commitment and participation of all parties" in the ABCP market makes sense ...464 Blair J.'s decision goes on to say that while the lower court had phrased the third- party ABCP restructuring as that of an entire market, it was in fact the restructuring of the 20 third-party ABCP trusts, which, in effect restructured the market465 The focus of the court on the effect of the restructuring, Blair J.'s decision then states, is "a perfectly permissible perspective, given the broad purpose and objects of the Act."466 While it is difficult to conceive of a substantially similar set of facts ever arising again, one is left to wonder how these facts and reasons in the third-party ABCP decision might apply to future insolvencies under the CCAA. At this stage, and based 464 ATB Ont. CA., supra note 24 at paras. 53-55. 465 Ibid. at para. 56. «s Ibid. 148 on the arguments voiced by the appellants and respondents, it appears that some aspect of Canadian insolvency law was expanded as a result of the interpretation and application of the statute in this case. Finally, the third-party ABCP case is quickly becoming the leading Canadian precedent on purposive statutory interpretation.467 In the Ontario Court of Appeal judgment, Blair J. held: The CCAA is skeletal in nature. It does not contain a comprehensive code that lays out all that is permitted or barred. Judges must therefore play a role in fleshing out the details of the statutory scheme. The scope of the Act and the powers of the court under it are not limitless. It is beyond controversy, however, that the CCAA is remedial legislation to be liberally construed in accordance with the modern purposive approach to statutory interpretation. It is designed to be a flexible instrument and it is that very flexibility which gives the Actits efficacy... ...I am satisfied that it is implicit in the language of the CCAA itself that the court has authority to sanction plans incorporating third-party releases that are reasonably related to the proposed restructuring, there is no "gap-filling" to be done and no need to fall back on inherent jurisdiction ... There is nothing to prevent a debtor and a creditor from including in a contract between them a term providing that the creditor release a third party. The term is binding as between the debtor and creditor. In the CCAA context, therefore, a plan of compromise or arrangement may propose that creditors agree to compromise claims against the debtor and to release third parties, just as any debtor and creditor might agree to such a term in a contract between them. Once the statutory mechanism regarding voter approval and court sanctioning has been complied with, the plan - including the provision for 467 lg February 2010 Interview, supra note 23. 149 releases - becomes binding on all creditors [including the dissenting minority).468 Thus, the reasoning of Blair J. effectively affirmed the ability of the court to interpret statutory wording in a manner that would accomplish privately negotiated and agreed upon transactions.469 That is, if one interpretation would allow the CCAA Plan to proceed, and the other would effectively kill the Plan, purposive statutory interpretation should lead the judge(s) to adopt the former interpretation of the statute.470 This judicial decision is the first one to frame purposive statutory interpretation in these terms.471 As much as the third-party ABCP restructuring may serve as a precedent for the more technical and interpretation points discussed above, it is also submitted that the spirit of the court in the case may serve as a touchstone for future insolvency jurisprudence. The judicial flexibility and cooperation with the Committee evidenced in this case set a distinct tone for the restructuring, which has arguably captured the very purpose and spirit of the CCAA itself. Though reliance on the third-party ABCP case to replicate any one of these precedents in a subsequent CCAA proceeding will be fact specific and subject to 468 ATB Ont. CA., supra note 24 at paras. 44, 46, 63. 469 lg February 2010 Interview, supra note 23. 470 Ibid. 471 Ibid. 150 judicial approval, this case has arguably opened the door to far more "creative" uses of the statute in future restructurings. Indeed, the court poignantly remarked, "a restructuring under the CCAA may take any number of forms, limited only by the creativity of those preparing the restructuring".472 Thus, for all the attention the third-party ABCP garnered as it tested and stretched the limits of the CCAA, it is perhaps merely a harbinger of things to come for Canadian insolvency law. C. Conclusion The successful completion of the CCAA group restructuring of the Canadian third- party ABCP market is in many respects a triumph, marking the largest restructuring in Canadian history. The final Plan of Arrangement was the result of 18 months of intensive negotiations and proactive measures tåken by the largest investors in the formation of the Committee. As a result of the Plan, the third-party ABCP market in Canada was saved from collapse and institutional investors expect to recover the value of their holdings over the next several years. The unusual restructuring process has also broken new ground in the area of insolvency law under the CCAA, demonstrating the flexibility and purposive interpretation of the legislation as adopted by the court. 472 (2008), 42 C.B.R. (5th) 90, supra note 22 at para. 53, cited in Sarra 2008, supra note 12 at 326. 151 The restructuring has nevertheless produced some arguably undesirable outcomes with respect to the position of retail investors from a consumer protection standpoint. In particular, this part has voiced concern regarding the circumstances surrounding the sale of third-party ABCP to individual investors, and the implications of the liability waivers contained in the restructuring Plan for regulation and enforcement of wrongful practices in this regard. The absence of a consumer advocate on the Committee, and the lack of attention paid to retail investor concerns throughout much of the negotiations process have also been raised as problematic in light of the circumstances. Finally, the buy-back arrangement has been critically analyzed, and it has been suggested that while this effort represents an admirable attempt to address the particular concerns of retail investors, it was perhaps not enough in light of the contextual factors of the liquidity crisis and its impact on individual investors. To this end some initial suggestions have been put forth, with the benefit of hindsight, which might serve to inform future proceedings of this nature. It is hoped that this discussion will further serve to highlight the awkward and undesirable position of retail investors involved in such a restructuring and therefore the importance of sound securities regulation and industry practices that will help prevent such a situation from recurring. The third-party ABCP insolvency has also been analyzed in terms of its significance as a pseudo-prepackaged bankruptcy, which broke new ground in the existing CCAA 152 jurisprudence. Though it is still early days, a number of unique features of the third- party ABCP case have been highlighted which have arguably expanded the scope of the CCAA as a reorganization tool. Already, the third-party ABCP case is becoming the "go-to" precedent for many CCAA matters, a trend that may continue to impact Canadian insolvency law for many years to come. 153 Conclusion From 2007 to 2009, thanks to the voluntary standstill agreements that had the effect of freezing the third-party ABCP market, a sizeable segment of Canadian money markets teetered between the prospects of reorganization, and liquidation. A market that had historically thrived under little regulatory supervision had suddenly realized the flip side of light regulatory treatment, and now faced impending insolvency. The Canadian third-party ABCP market, historically left largely to its own devices, had failed to protect itself. Third-party ABCP conduits, however, were not the only parties to suffer as a result of this so called failed experiment. Countless others now also found themselves embroiled in the restructuring process that unfolded over 18 months; notably, investors, CDS counterparties, sponsors, liquidity provides, not to mention the small army of professionals that were retained to help navigate the reorganization attempt. As the process progressed, the courts were also eventually engaged to oversee the restructuring under the purview of the CCAA, and several regulators also subsequently pursued investigations of certain market actors. Thus, numerous organizations and individuals were impacted by this market failure. 154 The first part of this thesis has examined several securities law aspects of the third- party ABCP liquidity crisis. Particularly drawing attention to certain problematic features, such as: existing disclosure exemptions and reliance on credit rating agencies under applicable securities law; the impact of an investor confidence crisis and the failure of Canadian-style liquidity agreements; and, investor protection concerns with respect to retail investors in third-party ABCP. Despite the presence of the third-party ABCP liquidity crisis as a market failure of unprecedented proportions in the Canadian landscape, the potential for effective regulatory reform appears promising. Drawing on several securities law reports on third-party ABCP, this thesis has put forward four initial recommendations for reform: 1. Amend the current short-term debt exemption to make it unavailable to distributions of asset-backed short-term debt.473 2. Implement a program of regulatory oversight for "approved credit rating organizations".474 3. lf not Recommendation #1, then require third-party ABCP programs to have global-style liquidity support agreements in place and notes reviewed by at least two approved credit rating agencies. 473 CSA Report, supra note 6 at 21. 474 Ibid. at 16. 155 4. Implement and/or revise the regulatory framework governing intermediaries involved in seiling third-party ABCP with respect to their responsibilities relating to product due diligence and sale of ABCP to clients.475 While Canadian securities regulators have not announced proposed amendments to the regulation of third-party ABCP programs at the time of this writing, the widely publicized example of market failure in the case of Canadian third-party ABCP, regulatory sanctions, and a flurry of discourse around improving securities regulation in this area suggests first strides toward meaningful improvement in this area. The second part of this thesis has tåken a close look at the third-party ABCP restructuring through the lens of insolvency law. The efforts of the Committee have been examined in view of the numerous technical hurdles that were overcome in order to gain access to the CCAA, and several of the most significant features of the finalized Plan of Arrangement. The perilous position of retail investors vis-å-vis the restructuring was critically analyzed in arguing that, though the efforts of the Committee are admirable as it navigated an insolvency that was fraught with a myriad of challenges, treatment of retail investors, who were arguably the most 475IIROC Report, supra note 5 at 74-75. 156 vulnerable group in the restructuring, could probably have been substantially improved through a couple of suggested measures. Namely, the presence of a retail investor representative on the Committee from the early stages of the restructuring to voice the concerns of, and communicate with, individual investors; and, a Plan that better took into account the financial strain suffered by all retail investors, perhaps by extending the buy-back program to all retail investors, or to the first C$1 million of all retail investor holdings. Finally, several notable aspects of the third-party ABCP restructuring have been considered for its significance in Canadian insolvency law. Particularly, the character of the reorganization as a pseudo-prepackaged bankruptcy, the "success" of the restructuring, and the anticipated precedent set by this groundbreaking case, which is already at the forefront of leading insolvency jurisprudence and is expected to powerfully influence future CCAA insolvencies for years to come. Amid global financial turmoil, the third-party ABCP liquidity crisis and restructuring stand out as the most marked Canadian financial failure of the recent recession. This portion of money markets that froze overnight was restructured haltingly over 18 tense months of negotiations and litigation. Though it may pale in comparison the subprime mortgage crisis in the United States, the Canadian third-party ABCP liquidity crisis was steeped in its own personal, institutional and economic drama. 157 Moreover, the resulting regulatory inquiry and insolvency jurisprudence has ushered in a wave of discussion and debate regarding securities law reform and the future of CCAA reorganizations in Canada. To that end, it is intended that this thesis will contribute to a growing body of literature concerned with the third-party ABCP liquidity crisis and restructuring, as the impact of these events is more fully realized in the years to come. 158 Appendix A: Timeline of Certain Significant Events in the Third-Party ABCP Liquidity Crisis and Restructuring Mounting concerns about credit markets, ABCP Market Begins especially American subprime mortgages, cause Encountering Summer investors to worry about the potential exposure of 2007 Liquidity Problems ABCP notes. Credit spreads widen posing liquidity problems for the ABCP market Spooked by the news of rising default rates on American subprime mortgages, investors redeem maturing ABCP notes en masse. Unable to find Third-Party ABCP 13-Aug-07 buyers for the notes, and not able to draw down Market Freezes funds from Canadian-style liquidity agreements, third-party ABCP trusts cannot afford to pay out maturing notes, resulting in a market freeze. A standstill agreement is reached by major parties in the third-party ABCP market, dubbed the Montréal Accord 16-Aug-07 "Montréal Accord". The agreement is intended to give the parties time to reach a negotiated agreement. A Committee is formed, Chaired by Mr. Purdy Crawford, to restructure the third-party ABCP market. Extensive negotiations are conducted by Negotiations 14-Aug-07 to the Committee to facilitate the group restructuring Conducted by the 16-Mar-08 of 20 third-party ABCP trusts. Negotiations are Committee continually challenged by volatile credit market conditions. The voluntary standstill agreement is extended numerous times. Campbell)., of the Ontario Superior Court of Initial CCAA Order 17-Mar-08 Justice, grants an initial order for the restructuring Obtained of 20 third-party ABCP conduits under the CCAA. To pass creditor approval, 2/3 of creditors (in number and value) must vote in favor of the Plan. It is discovered that there are nearly 2,000 retail Presence of Retail investors (ten times the number of institutional Investor votes Spring 2008 investors) in third-party ABCP. Retail investor threatens to kill the sentiments are largely against receiving Plan restructured notes under the Plan. Accordingly, obtaining creditor approval now becomes a hurdle in the restructuring. A "sweetener" is announced in an effort to win retail investor votes in favor of the Plan. Canaccord promises to give its third-party ABCP clients with holdings of under C$1 million all of their money Canaccord Relief back, plus interest and costs. Clients of Canaccord Program is 09-Apr-08 holding up to C$1.3 million in frozen notes may Announced participate in the program if they elect to receive a maximum refund of C$1 million. The initiation of the Canaccord program is contingent on the successful passing of the Plan proposed by the Committee. The Ontario Superior Court of Justice rules to allow a noteholder vote on the Plan on April 24, 2008. Plan receives double- The following day, an overwhelming majority of majority noteholder 25-Apr-08 96% of investors vote in favor of the Plan. The final approval sanction hearing is scheduled to be heard by Campbell J. Court requires Plan Campbell J. rules not to approve comprehensive to include process for releases to third-parties for fraud claims and 16-May-08 treatment of fraud instructed the parties to report back with claims proposals for dealing with potential fraud claims. 160 The Applicants revise the third-party liability Campbell J. Approves releases in the proposed Plan to include so-called the Plan of 05-Jun-08 "fraud carve-outs". These carve-outs provide that Arrangement certain types of fraud claims would be exempted from the global releases. A dissident group of noteholders appeals Campbell Dissident J.'s decision to approve the Plan; objecting to the Noteholders Seek 18-Jun-08 third-party liability releases. The appeal is heard Leave to Appeal Plan by the Ontario Court of Appeal on June 25-26, 2008. Blair J., on behalf of a unanimous court, approves Ontario Court of the decision of Campbell J., finding that the third- Appeal Approves the 18-Aug-08 party releases were indeed necessary to the Plan Unanimously success of the restructuring efforts. Dissident noteholders seek leave to appeal the Supreme Court of Ontario Court of Appeal's decision to the Supreme Canada Refuses 19-Sep-08 Court of Canada. The Supreme Court of Canada Leave to Appeal announces that it will not hear the appeal and no reasons are provided. The Committee announces that the Plan has been The Plan is 21-Jan-09 fully implemented, completing the 18-month long Implemented restructuring process. Investigations of National Bank, Scotia Capital, Regulators begin CIBC, CIBC World Markets, HSBC Bank, Laurentian investigations of a 2008-2009 Bank Securities, Canaccord Financial, Credential number of ABCP Securities, Coventree, and Deutsch Bank, are market actors launched in a joint effort by IIROC, 0SC and AMF. Regulators finalize settlement agreements with National Bank, Scotia Capital, CIBC, CIBC World Settlement Markets, HSBC Bank, Laurentian Bank Securities, Agreements 21-Dec-09 Canaccord Financial and Credential Securities. announced Penalties and investigation costs to be paid total C$138.8 million. Appendix B: Glossary of Financial and Legal Terms Arbitrage - The simultaneous buying and seiling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.476 Bank-Backed/Bank-Sponsored Asset-Backed Commercial Paper (ABCP) - A short term debt obligation backed by specific pools of assets such as trade or credit card receivables, equipment leases, mortgages, and personal lines of credit. While the risk of regular [commercial paper] depends on the issuing firm's overall risk profile, the risk associated with ABCP is tied directly to the creditworthiness of specific financial assets. In order to attain the highest credit ratings by independent ratings agencies, the asset cash flows are credit enhanced. This can come in a number of forms including extra assets (over-collateralization), cash accounts, bank issued lines of credit, or insurance guarantees. As a result, senior ABCP programs typically receive high credit ratings.477 ABCP is issued by trusts sponsored and managed by Schedule I chartered banks.478 Third-Party/Non-Bank Asset-Backed Commercial Paper (ABCP) - ABCP issued by trusts sponsored and managed by non-bank sponsors (ie. a third party).479 For a more detailed explanation of this type of ABCP please see Part 2, subsection A-i, above. Canadian-Style Liquidity Agreement - A credit line agreement between a ABCP conduit and a financial institution which provides that funds can be drawn down in times of a general market disruption. What constitutes a "general market disruption" varies from one contract to another.480 Capital Markets - Financial markets where long-term debt and equity securities are bought and sold.481 Collateralized Debt Obligation (CDO) - An asset-backed security whose underlying collateral is typically a portfolio of (corporate or sovereign) bonds or bankloans.482 476 New Oxford American Dictionary, supra note 174, s.v. "arbitrage". 477 About Money Market, supra note 33. 478 Hoffman & Carhart 2007, supra note 18 at 1. 479 Ibid. 480 See IIROC Report, supra note 5 at 21-24. 481 Ross et al, supra note 31, s.v. "capital markets" at 19. 162 Collateralized Loan Obligation (CLO) - An asset securitization structure which enables institutions such as banks to seil portions of large portfolios of commercial loans (or in some cases, the credit risk associated with such loans) directly into the international capital markets, and offer banks a means of achieving a broad range of financial goals. The resulting "securities" which are sold are also referred to as CLOs.483 Commercial Paper (CP) - Short term, unsecured debt issued by large corporations. The commercial paper market is dominated by financial corporations, such as banks and insurance companies, or financial subsidiaries of large corporations. Commercial paper is a popular investment vehicle for portfolio managers and corporate treasurers with excess funds on hand that they wish to invest on a short- term basis.484 Conduit - A limited purpose trust that issues ABCP.485 Counterparty Risk - The risk that either of the parties to a contract (counterparties) will fail to honor their obligations under the contract.486 Credit Arbitrage Transactions - Credit arbitrage opportunities resemble derivative transactions that are designed to transfer risk from one highly sophisticated financial institution to another. Credit arbitrage transactions have evolved to include a broad array transaction structures and asset classes.487 Credit Default Swap (CDS) - A contract that pays off when a credit event occurs (that is, default by a particular company termed the reference entity), giving the buyer the right to seil corporate bonds issued by the reference entity at their face value.488 482 Darre]] Duffie & Nicolae Gårleanu, "Risk and Valuation of Collateralized Debt Obligations" (2001) 57:1 Fin. Analysts J. 41. 483 Kenneth E. Kohler, "Collateralized Loan Obligations: A Powerful New Portfolio Management Tool for Banks" (1998) 1:2 The Securities Conduit 6 online: Financial Collateral - Financial instruments pledged as security for repayment of a loan, to be forfeited in the event of a default.490 Global-Style Liquidity Agreement - A credit line agreement between an ABCP conduit and a financial institution which provides that funds can be drawn down to cover any mismatch in asset and liability term regardless of market disruption or credit deterioration of the underlying assets.491 Guaranteed Investment Certificate (GIC) - GI Cs are secure investments that guarantee to preserve the principal amount invested. The investment earns interest, at either a fixed or a variable rate, or based on a pre-determined formula.492 Both banks and trust companies issue GICs, which are popular short-term liquid investments instruments in Canada.493 Indicative Value - A value determined using a mid-market model valuation for a swap, or the bid of a security. The value is an indication and not a market price because it does not represent a firm bid for a swap or asset. Ultimate market prices for such assets may vary based on size, bid/offer, liquidity, transparency etc.494 Also known as "intrinsic value". Market-Maker - One [as a person or firm] that, on a continuous basis, buys and seils a security for one's own account Market makers usually try to profit from a rapid turnover in security positions rather than from holding those positions in anticipation of gradual price movements. Specialists on the organized exchanges and dealers in the over-the-counter market are market makers.495 Money Markets - Financial markets where short-term debt securities are bought and sold.496 *mIbid., s.v. "derivative securities" at 797. 490 New Oxford American Dictionary, supra note 174, s.v. "collateral". 491IIROC Report, supra note 5 at 20. 492 Guaranteed Investment Certificates, supra note 28. 493 Corrado et. al., supra note 28 at 318. 494 JPMorgan, "Report on Restructuring" (14 March 2008) online: Ernst & Young Prepackaged-Bankruptcy - A plan for financial reorganization that a company prepares in cooperation with its creditors.499 Structured Financial Asset-Backed Transactions (SFA) - See "credit arbitrage transactions" (above). Synthetic Collateralized Debt Obligations (Synthetic CDOs) - CDOs in which the underlying assets are comprised of credit derivatives, such as credit default swaps (CDS) instead of actual security.500 Systemic Risk - The risk of an adverse change in the overall financial system or market that cannot be avoided through diversification.501 Treasury Bill (T-Bill) - A short term government debt instrument. The Treasury bill market is the largest market for short-term debt securities in the world.502 Trust - The relationship between persons where one person holds property on behalf of, or for the benefit of, another.503 Trust Indenture - An agreement in the bond contract made between a bond issuer and a trustee that represents the bondholder's interests by highlighting the rules and responsibilities that each party must adhere to.504 Underlying (Financial) Assets - The (financial) assets that underlie a derivative. 497 "Mortgage Backed Securities Defined" MortgageNewsDaily (17 November 2008) online: LEGISLATION Statutes Federal Bankruptcy andInsolvency Act, R.S.C. 1985, c. B-3. Companies Cr editors' Arrangement Act, R.S.C. 1985, c. C-36. Trust and Loan Companies Act, S.C. 1991, c. 45. Ontario Secuhties Act, R.S.0.1990, c. S.5. Québec Secuhties Act, R.S.Q. c. V-l.l. United States Sarbanes-OxleyActof2002, Pub. L. No. 107-204,116 Stat. 745 [2002). Regulations Ontario RulesofCivilProcedure, R.R.0.1990, Reg. 194. Securities Commission Rules Ontario National and Ontario Prospectus and Registration Exemptions, O.S.C. NI 45-106 (14 September 2005]. Mutual Funds, O.S.C. NI 81-102 (12 November 1999]. Office of the Superintendent of Financial Institutions Guidelines OFSI, OFSI Guideline No. B-5: Asset Secuhtization (Ottawa: Office of the Superintendent of Financial Institutions Canada, 2004) JURISPRUDENCE Alberta Canada Deposit Insurance Corporation v. Canadian Commercial Bank (1988), 67 C.B.R. (N.S.) 125 [Alta. Q.B.). Ontario ATB Financial v. Metcalfe & Mansfield Alternative Investment II Corp. (2008), [2008] O.J. No. 1943, 42 C.B.R. (5th) 260 (S.C.J. [Commercial List]). ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp. (2008), 42 C.B.R. (5th) 90, 45 B.L.R. (4th) 201 (Ont. S.C.J. [Commercial]). ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp. (2008), 43 C.B.R. (5th) 260, 2008 CarswellOnt 2820 (S.C.J. [Commercial List]). ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp. (2008), 43 C.B.R. (5th) 269, 2008 CarswellOnt 3523 (S.C.J. [Commercial List]). ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp., 2008 ONCA 587, 2008 CarswellOnt 4811, leave to appeal refused (2008), 2008 CarswellOnt 5432 (S.C.C.); Application for leave to appeal dismissed without costs (without reasons) September 19, 2008 [2008] C.S.C.R. no 337. Elan Corp. v. Comiskey (1990), 1 O.R. (3d) 289,1 C.B.R. (3d) 101 (C.A.). Employers' Liability Assurance Corp. Ltd. v. Ideal Petroleum (1959) Ltd. (1976), 75 D.L.R. (3d) 68, [1976] S.C.J. No. 114. Olympia & York Developments Ltd. v. Royal Trust Co., (1993), [1993] O.J. No. 545,12 O.R. (3d) 500 (Gen. Div.). jean Coutu Group (PJC) Inc. et al. v. Metcalfe & Mansfield Alternative Investments II Corp. and Other Trustees ofAssetBacked Commercial Paper Conduits Listed in Schedule "A" to this application et al. (Ont.) (Civil) (By Leave) (32765), online: Supreme Court of Canada Re Air Canada, [2004] O.J. No. 1909, 2 C.B.R. (5th) 4 (S.C.J. [Commercial List]). Re Stelco Inc., (2004), 48 C.B.R. (4th) 299 (Ont. S.C.J.), leave to appeal to Ontario Court of Appeal refused [2004] O.J. No. 19031, leave to appeal to S.C.C. refused [2004] S.C.C.A. No. 336. 167 Society ofComposers, Authors & Music Publishers of Canada v. Armitage (2000], 20 C.B.R. (4th) 160, 50 O.R. (3d) 688 (CA). Facta ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp., 2008 ONCA 587, 2008 CarswellOnt4811 (Factum of the Respondents). ATB Financial v. Metcalfe & Mansfield Alternative Investments II Corp., 2008 ONCA 587, 2008 CarswellOnt 4811 (Re-Amended Factum of the Appellants Air Transat A.T. Inc., Transat Tours Canada Inc., The Jean Coutu Group (PJC) Inc., Aéroports de Montréal Capital Inc., Domtar Inc., Comtar Pulp and Paper Products Inc., Giro Inc., Labopharm Inc., Vétements de sport R.G.R. Inc., 131519 Canada Inc., Air Jazz LP, Services hypothécaires La Patrimoniale Inc., Tecsys Inc., Petrifond Foundation Company Limited, Petrifond Foundation Midwest Limited, Société Générale de Financement du Québec and VibroSystm Inc.). SECONDARY SOURCES Dictionaries and Encyclopedias Business Dictionary, online: Business Dictionary Investopedia Dictionary, online: Investopedia New Oxford American Dictionary, 2d ed. JURIST Canada Legal Dictionary, online: The Free Dictionary, s.v. "market-maker" online: Jonathan Law & John Smullen, eds., A Dictionary ofFinance and Banking (Oxford: Oxford University Press, 2008) s.v. "counterparty risk", online: Peter Newman, ed., The New Palgrave Dictionary ofEconomics and the Law (New York: Stockton Press, 1998). Simone Briscoe & Jane Fuller, eds., Harhman's Financial Dictionary (Petersfield, Hampshire, Great Britain: Harriman House, 2007] s.v. "systemic risk", online Books Economics Allen Buchanan, Ethics, Efficiency and the Market (Oxford: Oxford University Press, 1985). Finance Charles J. Corrado, Bradford D. Jordan & Ayse Yuce, Fundamentals of lnvestments Valuation and Management (Toronto: McGraw-Hill Ryerson, 2005). Darryl Smith & Clare Chua, Business Statistics, 4th ed., (Boston: Pearson Custom Publishing, 2008). Edmund J. Andrews, Busted (New York: W. W. Norton & Company, 2009). Edward M. Gramlich, Subphme Mortgages (Washington D.C.: The Urban Institute Press, 2007). Mark Zandi, FinancialShock (New Jersey: FT Press, 2008). Robert J. Shiller, The Subphme Solution (Princeton: Princeton University Press, 2008). Stephen A. Ross et al, Fundamentals ofCorporate Finance, 6th ed., (Toronto: McGraw-Hill Ryerson, 2007). Thomas Sowell, The Housing Boom and Bust (New York: Basic Books, 2009). Law Eileen E. Gillese & Martha Milczynski, The Law of Trusts, 2nd ed., (Toronto: Irwin Law, 2005). Janis Sarra, Rescue! The Companies Creditors'Arrangement Act (Toronto: Thomson Carswell, 2007). Scholarly Articles Law 169 Anonymous Student, "Judicial Discretion - How Far is Too Far?" (LL.M. Seminar Paper, Osgoode Hall Law School, 2009] [unpublished]. Brent W. Kraus, "The Use and Regulation of Derivative Financial Products in Canada" [1999) 9 W.R.L.S.I. 31. Christine Jolls, Cass R. Sunstein & Richard Thaler, "A Behavioral Approach to Law and Economics" (1998) 50 Stan. L. Rev. 1471. Christopher C. Nicholls, "Public and Private Uses of Credit Ratings" (2005) Capital Markets Institute, online: Rotman School of Management, University of Toronto Christopher J.H. Donald, "A Critique of Arguments for Mandatory Continuous Disclosure" (1999) 62 Sask. L. Rev. 85. Douglas W. Arner, "The Global Credit Crisis of 2008: Causes and Consequences" (2009)43Int'lLaw91. Donald C. Langevoort, "Theories, Assumptions, and Securities Regulation: Market Efficiency Revisited" (1992) 140 U. Pa. L. Rev. 851. Fred Myers & Alexa Abiscott, "Asset Backed Commercial Paper: Why the Courts Got It Right" (2009) 25 B.F.L.R. 5. Janis Sarra, "Restructuring of the Asset-backed Commercial Paper Market in Canada" (2008) Annual Review of Insolvency Law 315. Jeffrey C. Carhart, "Reflections on the Muscletech Case" (2008) Annual Review of Insolvency Law 499. Jeffrey Carhart & Jay Hoffman, "Canada's Asset Backed Commercial Paper Restructuring: 2007-2009" (2009) 25 B.F.L.R. 35. Jeffrey Leon & Geoffrey White, "The Ontario Court of Appeal's Decision on the Flexibility of the Companies' Creditors Arrangement Act in the Restructuring of the Canadian Asset-Backed Commercial Paper Market" (2008) 25:4 Nat. Insol. Rev. 45. Jeffrey S. Leon & Shara N. Roy, "Pain and Promise: Lessons from the Collapse of the Third-Party ABCP Market in Canada" (2009) 14:3 Corporate Securities and Finance Law Report 41. 170 John Pozios & Matthew Underwood, "Musical Chairs: Who's Left Standing When the ABCP Music Stops?" (2009) 9 Asper Rev. Int'l Bus. & Trade L. 65. Lynn A. Stout, "Are Stock Markets Costly Casinos? Disagreement, Market Failure, and Securities Regulation" [1995) 81 Va. L. Rev. 611. Mario Forte, "Re Metcalfe: A Matter of Fraud, Fairness, and Reasonableness. The Restructuring of the Third-Party Asset-Backed Commercial Paper Market in Canada" (2008) 17 Int. Insolv. Rev. 211. Margot Priest, "The Privatization of Regulation: Five Models of Self-Regulation" (1997-1998) 29 Ottawa L. Rev. 233. Peter J. Dey, "Exemptions under the Securities Act of Ontario" in Special Lectures of the Law Society of Upper Canada (Toronto: De Boo, 1972). Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, "What Works in Securities Laws?" (2006) 61J. of Finance 1. Stéphane Rousseau, "Regulating Credit Rating Agencies After the Financial Crisis: The Long and Winding Road Toward Accountability" (2009) Capital Markets Institute, Rotman School of Management, University of Toronto, online: SSRN Stephen M. Bainbridge, "Mandatory Disclosure: A Behavioral Analysis" (1999-2000) 68 U. Cin. L. Rev. 1023. Stephen P. Sibold, "Assessing Canada's Regulatory Response to the Sarbanes-Oxley Act of 2002: Lessons for Canadian Policy Makers" (2009) 45 Alta. L. Rev. 769. Sukanya Pillay, "Forcing Canada's Hand? The Effect of the Sarbanes-Oxley Act on Canadian Corporate Governance Reform" (2004) 30 Man. L.J. 285. Virginia Torrie, "Weatheringthe Global Financial Crisis: An Overview of the Canadian Experience" (2010) 16:1 L. & Bus. Rev. Americas 101. William A. Scott & Philip J. Henderson, "A unique, successful, private restructuring" (2009) 28:4 Int'1 Fin. L. Rev. Zohar Goshen & Gideon Parchomovsky, "The Essential Role of Securities Regulation" (2005) American Law & Economics Association Annual Meetings, Paper 9. 171 Finance Daniel A. Bens & Steven}. Monahan, "Altering Investment Decisions to Manage Financial Reporting Outcomes: Asset-Backed Commercial Paper Conduits and FIN 46" [19 September 2007) online: SSRN Darrell Duffie & Nicolae Gårleanu, "Risk and Valuation of Collateralized Debt Obligations" (2001) 57:1 Fin. Analysts J. 41. Sarai Criado & Adrian Van Rixtel, "Structured Finance and the Financial Turmoil of 2007-2008: An Introductory Overview" (2 September 2008) Banco de Espana Occasional Paper No. 0808 online: SSRN Studies and Reports "Securities Regulatory Proposals Stemming from the 2007-08 Credit Market Turmoil and its Effect on the ABCP Market in Canada" Consultation Paper of the Canadian Securities Administrators (October 2008) online: Ontario Securities Commission Investment Industry Regulatory Organization of Canada, "Regulatory Study, Review and Recommendations concerning the manufacture and distribution by IIROC member firms of Third-Party Asset-Backed Commercial Paper in Canada" (17 October 2008) online: John Chant, "The ABCP Crisis in Canada: The Implications for the Regulation of Financial Markets" (2009) Research Study Prepared for the Expert Panel on Securities Regulation online: Pan-Canadian Investors Committee Documents "Amended Plan of Compromise and Arrangement" (19 March 2008) online: Ernst & Young "Pan-Canadian Investors Committee Completes CCAA Restructuring" (21 January 2009) online: Canaccord Capital JPMorgan, "Report on Restructuring" (14 March 2008) online: Ernst & Young Pan-Canadian Investors Committee press release, "Pan-Canadian Investors Committee Announces Restructuring Plan for Third-Party ABCP" (23 December 2007) online: CNW Group Purdy Crawford Q.C., Affidavit, 17 March 2008, filed as part of application materials for commencement of CCAA proceedings, online: Industry Publications "Financial Systems Review, June 2003" Bank of Canada (June 2003) online: "Financial Systems Review, June 2007" Bank of Canada (June 2007) online: "Financial Systems Review, December 2007" Bank of Canada (December 2007) online: James Goodfellow, "The ABCP Liquidity Crunch - questions directors should ask" Director Alert, 2007 online: Jay M. Hoffman & Jeffrey C. Carhart, "Canadian Asset-Backed Commercial Paper Crisis" Miller Thomson LLP (3 October 2007) online: 173 M. Rabiasz, et al, "Leap of Faith: Canadian Asset-Backed Commercial Paper Often Lacks Liquidity Backup" (Toronto: Standard & Poor's, 2002). Michael Gregory, "The ABCs of Canadian ABCP" Focus (31 August 2007) online: Neal Oswald, "Canadian Asset Based Commercial Paper (ABCP) - Basic Primer" PricewaterhouseCoopers (21 February 2008) online: Treasury Management Association of Canada Regulatory Sources AMF, "Autorite des marchés financiers and National Bank Financial Inc." Settlement Agreement (21 December 2009) online: AMF, "Autorite des marchés financiers et Valeurs mobiliéres banque laurentienne Inc." Entente de reglement (21 December 2009) 7:2 , online: AMF Canadian Imperial Bank ofCommerce and CIBC World Markets Inc. (2009), 33 O.S.C.B. 73, online: OSC Coventree Inc. et al. (2009), 32 O.S.C.B. 10247, online: OSC Coventree Inc., etal.-s. 127 (2010), 33 O.S.C.B. 636 online: OSC HSBCBank Canada (2009), 33 O.S.C.B. 62, online: OSC IIROC, OSC & AMF, "ABCP: Settlements reach following a joint investigation" News Release (21 December 2009) online: OSC IIROC, "In the matter of Canaccord Financial Ltd. - Settlement" News Release (21 December 2009) online: IIROC 174 IIROC, "In the matter of Credential Securities Inc. - Settlement" News Release (21 December 2009) online: IIROC IIROC, "In the matter of Scotia Capital Inc. - Settlement" News Release (21 December 2009) online: IIROC Author Notes from Hearings, Lectures, Interviews etc. Author notes from Coventree Inc. et al. OSC Hearing (14 January 2010). Interview of Anonymous (19 February 2010) conducted by Virginia Torrie [unpublished]. Interview of Anonymous (25 February 2010) conducted by Virginia Torrie [unpublished]. Interview of Hy Bloom (25 February 2010) conducted by Virginia Torrie [unpublished]. Securities Law Disclosure Documents "Coventree Prospectus: Initial Public Offering and Secondary Offering" (15 November 2006), online: SEDAR News Sources Canada "Brokerages failed to protect investors in ABCP fiasco: regulator" CBC (17 October 2008), online: cbcnews.ca "Chronology: Twists and turns in Canada ABCP saga" Reuters (18 August 2008) online: "Ex-Caisse CEO accepts blame" Toronto Star (10 March 2009) B4. "Financial literacy lost in translation" Toronto Star (26 ]uly 2009) A13. 175 "National Bank of Canada sees ABCP plan proceeding" Reuters (9 September 2008) online: "National profit surges 46%" Toronto Star (29 May 2009) B4. "Nobody's business", The Globe and Mail (14 October 2009) B2. "Quebec pension giant posts $39.8B loss" (25 February 2009) online: CBCnews "Sting of ABCP chargés eases" Toronto Star (28 August 2009) B4. "The missing ounce of prevention" The Globe and Mail (21 December 2009) A18. Andrew Chung, "Quebec pension fund loses 25%; Analysts blame risky investment strategy for Caisse's $40B loss" Toronto Star (26 February 2009) A7. Andrew Willis, "ABCP and pintos: It was buyer beware" The Globe and Mail (31 July 2009) B9. Andrew Willis, "Deutch Bank gears up for ABCP scrap" The Globe and Mail (9 December 2009) B13. Boyd Erman, "Banks and watchdogs near ABCP deal" The Globe and Mail (8 December 2009) Bl. Boyd Erman, "DundeeWealth a step closer to ending ugly ABCP saga" The Globe and Mail (30 December 2009) B4. Boyd Erman, "Long-thawed ABCP market simmering to a boil" The Globe and Mail (26 November 2009) B20. Boyd Erman, "National facing biggest ABCP hit" The Globe and Mail (11 December 2009) B3. Boyd Erman, "New Gold's ABCP is in Demand" The Globe and Mail (26 November 2009) B13. 176 Boyd Erman, "Ottawa under fire for credit market strategy" The Globe and Mail (13 July2009)Bl. Boyd Erman et al, "The ABCP black box explodes" The Globe and Mail (16 November 2007) online: Boyd Erman & Tara Perkins, "With ABCP penalties out of the way, spotlight shifts to regulators" The Globe and Mail (19 December 2009) Bl. Boyd Erman, Tara Perkins & Jacquie McNish, "Banks brace for battle over fines" The Globe and Mail (31 July 2009) B3. Brian Laghi & Eric Reguly, "Leaders pledge $l-trillion in aid" Globe and Mail (2 April 2009) online: Globe and Mail David Paddon, "Investment industry's regulator finds ABCP wasn't understood by most dealers" The Canadian Press (17 October 2008) online: 660 News Doug Alexander & Joe Schneider, "ABCP restructuring set to miss another deadline" Bloomberg (24 November 2008) online: Financial Post Glenda Luymes, "UBC caught in economic meltdown as finance head quits" The Province (21 November 2008) online: canada.com Janet McFarland, "Regulator says brokers failed on ABCP, sets new guidelines" The Globe and Mail (18 October 2008), online: Janet McFarland et al, "How ordinary investors got sold on ABCP" The Globe and Mail (8 August 2008) online: 177 Jim Middlemiss, "ABCP restructuring granted extension" Financial Post (29 October 2008), online: Jim Middlemiss, "Vote buying denied in ABCP deal" The Vancouver Sun (6 September 2008) online: John Greenwood, "Coventree at centre of ABCP collapse: OSC" Financial Post (14 December 2009), online: Madhavi Acharya & Tom Yew, "ABCP penalties to total $138.8M; Regulators hardest on National Bank and Scotia Capital" Toronto Star (22 December 2009) Bl. New Release, "Canadian Securities Regulators Release Proposals in Response to the 2007-08 Credit Market Turmoil and its Effect on the ABCP Market in Canada" (6 October 2008) online: Tara Perkins, "Ratings agencies at the crossroads" The Globe and Mail (15 September 2009) Bl. Tara Perkins, Jacquie McNish & Boyd Erman, "Regulators seek record settlements" The Globe and Mail (25 July 2009) B2. United Kingdom "Wall St hit by home payment fears" BBC News (13 March 2007) online: Justin Webb, "Sub-prime crisis sours US dream" BBC News (5 April 2007) online: United States "Mortgage Backed Securities Defined" MortgageNewsDaily (17 November 2008) online: Jenny Anderson & Heather Timmons, "Why a U.S. Subprime Mortgage Crisis Is Felt Around the World" New York Times (31 August 2008) online: Magazines "Power to the people" Risk 21:5 (May 2008). Kenneth E. Kohler, "Collateralized Loan Obligations: A Powerful New Portfolio Management Tool for Banks" (1998) 1:2 The Securities Conduit 6 online: Murray Gold, "Boiling Point" Benefits Canada 31:12 (December 2007) 77. Thomas Watson, "Hunter and the Hunted" Canadian Business 81:9 (Summer 2008) 12. Websites "About Money Market" (17 September 2008) TD Securities online: "Guaranteed Investment Certificates" (17 November 2008) RBC Royal Bank online: DBRS, online: Disclaimers 179