Widespread use of the depository system in Canada and the U.S. imposes practical limits on income trusts’ ability to monitor and control non-resident ownership of their units. Many income trusts are subject to restrictions on the ownership of their units by non-residents of Canada (see the article by Doug Richardson Restrictions On Non-Resident Ownership). However, an income trust faces obstacles when it attempts to determine the exact extent of beneficial ownership of its units by non-residents or to impose restrictions on transfers of units to non-residents, in each case arising from the widespread use of the depository systems in the Canadian and U.S. securities markets. While many income trusts will allow unitholders to hold their units through certificates registered and issued in their name, most unitholders hold their securities through the depository systems in Canada, or in Canada and the United States if the income trust is listed in both jurisdictions. These depository systems, CDS in Canada and DTC in the United States, are operated on behalf of financial and capital markets participants to facilitate trading in securities. For units which are within the depository system, the depository is the registered owner of the units but holds on behalf of "participants" (dealers, banks, trust companies and other financial market participants), who can trade securities simply by making book entry changes in the participant records maintained by the depository, avoiding the need for the issuance and transfer of physical certificates. While this system has greatly reduced the problems associated with physical certificates, it imposes significant barriers to determining the identities of beneficial owners of securities.
It is not uncommon for over 90% of the units of an income trust to be held through the depository system. The trust can request from the depository a list of the participants holding its units, although it is almost certain that the participants will not be the beneficial owners of the securities but rather will hold on behalf of the participants’ clients, who may but need not be the beneficial owners. Accordingly, information as to the participants’ holdings will not of itself permit a determination of the residence of the beneficial owners of the units.
Some additional information can be obtained by requesting ADP Investor Communications (which contracts with almost all of the Canadian and U.S. participants in the depository systems to forward shareholder communications to participants’ clients) to contact the participants to determine the mailing addresses that participants have for their clients which own the units in the participants’ accounts at the depository. While ADP cannot provide the issuer with the specific names of the participants’ clients, it can provide a geographic breakdown by country, province or state of the number of units which the participants hold for their clients. This method, however, can be unreliable as the mailing addresses need not reflect the residence of the beneficial owners. A more trustworthy approach is for an issuer to request that ADP send clients a residency declaration to be completed and returned by the client. However, this approach can be expensive and moreover there is generally no effective way to require the clients to complete and return the declaration.
An additional difficulty is that the system by which ADP obtains this breakdown from participants has a significant time lag built into it. A combination of the settlement time for trades and the time required for ADP to get responses from participants means that the information available from ADP will be at least 7 to 8 trading days out of date when the issuer obtains it. As a result, the present system is imperfect as it does not allow an issuer to obtain accurate, real time information with respect to the beneficial ownership of its securities.
The depository system also complicates any attempt to enforce transfer and non-resident voting restrictions which a trust may wish to impose. With respect to transfer restrictions, CDS and DTC are apparently unable to impose transfer declaration requirements or transfer restrictions with respect to transfers between their participants. CDS will require residency declarations and monitor residency transfer requirements only for transfers of units into or out of its depository system, but not in connection with transfers within its system. If a trust that is listed on a U.S. exchange imposes restrictions on transfers to non-residents, the U.S. exchange will cease trading the units. While this may make the units less attractive to U.S. investors, such investors can continue to hold their units through participants in the depository systems.
Where a trust wishes to monitor non-resident beneficial ownership in connection with the voting of its units, the trust can require ADP, when providing the proxy materials to participants’ clients, to include a declaration as to whether or not the person beneficially owning units is a resident of Canada. A trust may rely on the response provided by the participants’ clients, although most declarations of trust allow the trust to also require evidence of residency to support the declaration, if requested.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
