TSX Formalizes Position on Equity Compensation Plans for Target Employees and Tightens Backdoor Listing Rules

The Toronto Stock Exchange (TSX) is formalizing its position on equity compensation plans for target employees in connection with M&A transactions and is also amending its backdoor listing rules.¹  These changes become effective on October 1, 2014.

Equity Compensation Plans for Target Employees

Shareholder approval is generally required when a listed issuer adopts a new equity compensation plan. However, on a discretionary basis, the TSX has sometimes waived the shareholder approval requirement for new plans adopted by listed issuers in connection with M&A transactions for target employees, on the basis that equity incentives are a retention mechanism and integral to the acquisition. The TSX is now codifying this approach in its Listed Company Manual, subject to the following criteria:

• the number of securities issuable under a new compensation plan may not exceed 2% of the listed issuer's pre-transaction outstanding securities (consistent with the TSX’s rule for employment inducement awards granted to officers);
• the number of securities issuable pursuant to the acquisition, including under new compensation arrangements, may not exceed 25% of the listed issuer’s pre-transaction outstanding securities; and
• the target employees may not be insiders or employees of the listed issuer prior to the acquisition.

Like the TSX, the NYSE and Nasdaq impose shareholder approval requirements for equity compensation plans and provide certain exemptions for plans adopted in connection with M&A transactions. The U.S. exchanges also provide exemptions for listed foreign private issuers, including Canadian MJDS companies. So although the NYSE and Nasdaq do not have the same 2% exemption as the TSX, that difference is unlikely to impact an M&A transaction involving a cross-listed Canadian acquiror.

Backdoor Listings

When a transaction is a backdoor listing, the acquiring entity must generally meet the TSX’s original listing criteria. The TSX is replacing its current test for identifying backdoor listings with a broader, more discretionary test. Under the current test, a backdoor listing occurs when an unlisted company acquires a listed issuer and the transaction will result in a change in effective control of the listed issuer and the listed issuer’s securityholders will own less than half of the securities or have less than half of the voting power in the new entity. Under the new test, the TSX will consider a variety of qualitative factors to determine whether a transaction constitutes a backdoor listing, including:

• the businesses of the parties and their relative sizes;
• changes in management and the board of directors; and
• voting power, securities ownership and capital structure.

In assessing the above factors, as well as in calculating the amount of dilution of the listed issuer’s securityholders, the TSX will count securities issued in any concurrent financing transaction (whether a public offering or a private placement).

The TSX has indicated that under the new rules, listed issuers will have the opportunity to make submissions as to whether a transaction should be characterized as a backdoor listing. Nonetheless, the new, more discretionary test can be expected to result in a greater number of transactions being characterized as such. The rule change is meant to preserve the quality of the marketplace and protect investors—the same objectives that motivated the U.S. stock exchanges to toughen their listing standards in 2011 following accounting abuses at several companies who had accessed the U.S. capital markets via reverse mergers.

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¹ Also known as reverse mergers or reverse takeovers.

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