Thursday Thinkpiece: Nichols on Corporate Finance Law

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Corporate Finance and Canadian Law, Second Edition
Christopher C. Nicholls
Toronto: Carswell, 2013

(Footnotes converted to endnotes in this excerpt.)


If a nineteenth century corporate solicitor could step across time and through the office doors of a 21st century law firm, he would surely be dazzled by the technological wizardry that has utterly transformed the speed and efficiency at which law is practiced today. But he would be surprisingly familiar with many of the time-honoured legal concepts still important to his 21st century counterparts. The law surrounding the creation of corporate equity and debt, their legal attributes, rules regarding dividends, stated capital, share repurchases, trust indentures and the like all have a venerable history. Certainly a number of the specialized, technical rules have been expanded and refined in excruciatingly tedious detail. The modern lawyer’s role in relation to today’s impressive bureaucratic regulatory is also a comparatively recent development. But much of the foundational knowledge of corporate finance law is remarkably stable, and will no doubt continue to form an indispensable part of the corporate lawyer’s repertoire for the foreseeable future.

What has changed is that another dimension has been added to the law and practice of corporate finance. A wave of financial innovation that began in the 1970s has led to a proliferation of derivatives and other hybrid financial instruments that stubbornly defy simple classification as either debt or equity. The ready availability of financial derivatives such as swaps, options, futures and forwards, and a variety of sophisticated financial techniques, including various forms of structured finance, have made it possible to craft financing solutions that meet ever-more precise corporate needs and investor demands. They have also helped to make the practice of corporate finance a dynamic and exciting, not to mention highly remunerative, venture.

These new financial technologies, originally heralded as a breakthrough in risk management technology, have introduced complex new financial system risks and new legal and regulatory challenges. The international financial crisis that began in the U.S. subprime mortgage market in 2007, for example, is importantly linked to at least two of the innovative financial techniques discussed in this book: securitization and credit default swaps.

The increasing complexity of financial instruments and financial processes has been accompanied by an expansion of the role and scope of financial legislation and regulation. Thirty years ago, a consolidated version of the Ontario Securities Act and related regulatory instruments produced by a commercial publisher took up fewer than 600 pages, with the Act itself reproduced in large print. A consolidation of Ontario’s securities laws current at the time the first edition of this book was published in 2001 filled over 1,700 pages of very small type. The most recent edition of that consolidation, by the same publisher, now runs to well over 3,000 pages. To be fair, much of the increased volume can be accounted for by a welcome increase in regulatory transparency. Policy decisions that, in past, may have been based upon ad hoc exercise of regulators’ discretion, or perhaps inflexible application of provisions in non-public internal staff manuals, are now embodied in publicly-accessible policy statements and rules enacted after exposure to industry and public comment and debate. Yet there can also be little doubt that the financial industry is, in fact, subject to significantly greater levels of regulatory scrutiny than in the past. In the wake of the recent jarring financial turmoil there is no doubt that the level of regulatory intensity will increase for some years to come.

The potential link between financial regulatory regimes and financial practice has attracted the attention of scholars.1 But the impact of the new financial revolution on the training of finance lawyers has been proceeding at a cautious rate, at least in Canada.

Ontario’s Securities Act contains a provision stating the two purposes of the Act:

(a) to provide protection to investors from unfair, improper or fraudulent practices; and

(b) to foster fair and efficient capital markets and confidence in capital markets.2

The first of these purposes falls squarely within the expertise and traditional training of lawyers. The second begins to stray into the field of financial theory which is typically less familiar to Canadian lawyers and law students, particularly those who have come to law school immediately following undergraduate studies in the liberal arts.

To assist in the design of creative new instruments, and to play a constructive role in the development of appropriate legal and regulatory responses to innovation in the financial sector, lawyers must increasingly be prepared to stretch themselves beyond the reassuring boundaries of precedent agreements, judicial opinions and legislation. There will be almost limitless opportunities for creative financial lawyering in the future; but financial creativity must be grounded in an understanding of, and appreciation for, some of the basic financial economic concepts and principles that have been steadily propelling the current spate of financial innovation.

The influence of modern financial theory upon financial practice and regulation has been controversial. But to thoughtful observers, the link between theory and real-life innovation is hard to miss. In 1992, Peter L. Bernstein wrote:

Today’s financial markets are the result of a recent but obscure revolution that took root in the groves of ivy rather than in the canyons of lower Manhattan … In their quiet way the academics overcame the old guard and liberated the city of capital. Before they were done, they had transformed today’s wealth of nations and the lives of all of us, as citizens, savers and breadwinners.3

Bernstein was writing before the dramatic collapse of Long-Term Capital Management in 1998 and the more recent international financial crisis—both events widely linked to the proliferation of complex financial products. In the first edition of this book, I expressed the hope that it might make a modest contribution toward encouraging corporate law students and new practitioners to think broadly about the effects of the “obscure revolution” Bernstein described and about the proper role of finance law and finance lawyers in the modern era. Alas, if the book did contribute to any similar revolution in the thinking of Canadian lawyers and law students, I am afraid it must have been the most quiet revolution in history. But I continue to be convinced that the goal is sound, and so the purpose of this second edition, like the first, is not only to introduce some of the basic ideas of corporate finance but also to suggest how fundamental financial principles and modern financial innovations may be contextualized within a complex business, accounting, legal and regulatory matrix. There is still no easy path to avoid the care and rigour of traditional legal analysis, and no substitute for practice experience. But insights and information from other disciplines can help supplement legal knowledge, inform legal analysis and illuminate and enrich practical experience. Because this book is intended to function as a free-standing introduction to corporate finance law that will be accessible to law students with no prior business or financial background, there is much basic material here. Experienced practitioners will, I hope, overlook this necessary shortcoming, and consider whether and to what extent any of the ideas surveyed here could be useful “add ons” to their own practical wisdom and seasoned judgment.

It must be remembered, too, that this is not a book about “doing deals”, but rather about the framework within which corporate finance deals are done in Canada. The discussion of the law relating to financing practices, financial instruments and financial institutions will be integrated with a consideration of some of the topics that comprise modern finance theory. The hope is that readers might be encouraged to pursue particular topics of personal interest with greater rigour and depth in more specialized sources.

1 See, e.g., Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer & Robert W. Vishny, “Legal Determinants of External Finance” (1997) 52 Journal of Finance 1131; and Rafael La Porta, Florencio Lopez-de-Silanes & Andrei Shleifer, “Law and Finance” (1998) 106 Journal of Political Economy 1113.

2 Securities Act [Ontario], R.S.O. 1990, c. S.5, as am., s. 1.1.

3 Peter L. Bernstein, Capital Ideas: The Improbable Origins of Modern Wall Street (New York: The Free Press, 1992) at p. 2.

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