Master ISE Element 4 covering corporate structures, prospectus requirements, exempt market, primary vs secondary distributions, and Canadian equity market features. 13% of the exam (13 questions).
ISE Element 4: Equities (13%)
This element covers corporate structures, capital raising mechanisms, and the unique features of Canadian equity markets that institutional professionals need to understand.
Corporate Structures
Sole Proprietorship
Simplest business form with no legal distinction between owner and business. Owner has unlimited liability - personal assets can be seized for business debts.
Partnership Agreement
The "constitution" for a partnership defining:
- How profits and losses are split
- Voting rights of partners
- Procedures for bringing in new partners or dissolving
Corporation
A separate legal entity from its owners. Primary advantage: Limited Liability - shareholders can lose their investment but personal assets are protected from corporate creditors.
Public vs. Private Corporations
| Public | Private |
|---|---|
| Shares trade on exchange (TSX) | No public exchange trading |
| Quarterly disclosure required | No public disclosure required |
| Many shareholders | Fewer shareholders |
| Liquidity for investors | Data secrecy advantage |
Capital Raising - Prospectus Requirements
NI 41-101
The National Instrument mandating a prospectus - comprehensive disclosure document - whenever a company distributes securities to the public. Ensures investors have all "material facts."
Preliminary Prospectus ("Red Herring")
First version filed with regulators to gauge market interest:
- Called "Red Herring" due to red ink disclaimer
- Lacks final price and exact share count
- Used to collect indications of interest
Waiting Period
Time between preliminary and final prospectus filing. Dealers can distribute the Red Herring and collect interest, but cannot legally sell shares or take firm orders.
Exempt Market (NI 45-106)
Rules allowing companies to raise capital without a prospectus. "Private placements" restricted to sophisticated investors.
Accredited Investor (AI) Exemption
Most common path for institutional capital raising. Allows unlimited securities sales to:
- Institutions (pension funds, banks)
- Individuals meeting high income/net worth thresholds
Minimum Amount Exemption
Skip prospectus if a non-individual (corporation) invests at least $150,000 in cash in a single transaction.
Distribution Types
Primary Distribution (Treasury Offering)
Company issues newly created shares directly from treasury. Proceeds go to the company to fund operations or growth (e.g., IPO).
Secondary Distribution
A control person (owning >20%) sells already-issued shares to public. Proceeds go to the selling shareholder, not the company.
Right of Rescission
If a prospectus contains a material misrepresentation, investors can cancel the trade and get their money back.
Share Structures
Common Shares
Represent "residual" ownership. Common shareholders are last in line during bankruptcy - only receive value after creditors, bondholders, and preferred shareholders are paid.
Pari Passu
"On equal footing" - all shares within the same class must be treated exactly the same regarding dividends, voting rights, and asset claims.
Dual-Class Shares
Common in Canada (Rogers, Bombardier). Two classes where one (founders) has superior voting rights (e.g., 10 votes per share) while public class has 1 vote.
Coattail Provision
Protective clause for dual-class companies: if a takeover bid is made for superior voting shares, restricted voting shareholders must receive the same offer.
Escrowed Shares
Shares held in "lockbox" by third party. Prevents founders from "pumping and dumping" - selling immediately after IPO.
Canadian Equity Features
Canadian Depository Receipts (CDRs)
Allow Canadians to buy fractional ownership of US blue-chip stocks (Apple, Amazon) in Canadian Dollars on domestic exchanges (NEO/Cboe Canada).
Currency Hedge Shield
Built-in CDR feature. Currency-hedged so investor returns are driven only by underlying US stock performance, not CAD/USD exchange rate fluctuations.
Corporate Actions
Stock Dividends
Company pays dividends in additional shares instead of cash. Often tax-deferred until shares are sold.
Stock Splits
Company increases share count (e.g., 2-for-1). Total value stays same but lower price per share provides psychological benefit and increases liquidity.
Consolidation (Reverse Split)
Opposite of split (e.g., 1-for-10). Often a sign of distress - used to artificially raise share price to avoid delisting.
Normal Course Issuer Bid (NCIB)
Standard mechanism for companies to buy back shares on open market. Done when stock is undervalued or to return excess cash by reducing share count.
Ex-Dividend Date
One business day before Record Date. Buy on or after this date = no dividend. Stock price usually drops by dividend amount.
Preferred Shares
A "hybrid" security - legally equity but behaves like bonds with fixed dividends.
Cumulative Preferreds
If company misses dividend, unpaid amount accumulates as "Arrears." Company cannot pay common shareholders until all preferred arrears are paid.
Straight Preferreds
Perpetual shares with no maturity date. Highly sensitive to interest rates like long-term bonds.
Rate-Reset Preferreds
Dividend fixed for 5 years, then "resets" based on 5-year GOC bond yield. Protects against rising interest rates.
Non-Viable Contingent Capital (NVCC)
"Bail-In" securities. If bank's capital falls below critical level, these automatically convert to common equity to absorb losses without taxpayer bailout.
ISE Exam Tips for Equities
- Corporation provides limited liability; sole proprietorship has unlimited
- Red Herring lacks final price; cannot take firm orders during Waiting Period
- Primary = new shares to company; Secondary = existing shares to selling shareholder
- Dual-class shares are common in Canada - know Coattail provisions
- CDRs provide currency-hedged access to US stocks
- NVCC = Bail-In securities that convert if bank fails