Introduction
The Canadian Securities Administrators (the "CSA") are conducting a review of the minimum amount prospectus exemption and the accredited investor prospectus exemption contained in National Instrument 45-106 – Prospectus and Registration Exemptions. The publishing of CSA Staff Consultation Note 45-401 – Review of Minimum Amount and Accredited Investor Exemptions (the "Consultation Note") on November 10th, 2011, commenced a public consultation process intended to solicit feedback from investors, issuers and others on a number of possible changes to these exemptions.
While this process is not yet at the proposal stage, it should be noted that a similar public consultation process led to the recent CSA proposal for a new regime for venture issuers via proposed National Instrument 51-103 - Ongoing Governance and Disclosure Requirements for Venture Issuers. The public comment period is open until February 29, 2012 and at its conclusion, CSA staff may recommend either retaining the exemptions in their current form or may propose changes.
Background
The minimum amount exemption and the accredited investor exemption are premised on an investor having:
- a certain level of sophistication;
- the ability to withstand financial loss;
- the financial resources to obtain expert advice; and
- the incentive to carefully evaluate the investment given its size.
In the CSA's view, the global financial crisis and recent
international regulatory developments have raised a number of
questions about the use of the minimum amount exemption and the
accredited investor exemption. These questions are highlighted by
the Consultation Note, including whether these exemptions should be
premised on financial resources (ability to withstand financial
loss or obtain expert advice), access to financial and other key
information about the issuer, educational background, work
experience, investment experience, or some other criteria, and
whether the involvement of a registrant who has an obligation to
recommend only suitable investments addresses any of these
concerns.
While indicating their concerns, the CSA also acknowledge that
these exemptions are widely used and that any repeal or limitation
could significantly affect capital raising, especially by small and
medium sized enterprises.
The Minimum Amount Exemption
In its current form, the minimum amount exemption provides an
exemption from the prospectus requirement where a person purchases,
as principal, securities of an issuer that have an acquisition cost
of at least $150,000 CDN in cash at the time of the
distribution.
Concerns
The CSA has noted a number of issues regarding the minimum
amount exemption. There is a concern that the size of investment
alone is an insufficient assurance of investor sophistication or
access to information. This concern is particularly applicable
where the minimum amount exemption is used to sell novel or complex
products without any accompanying disclosure.
Another concern is that the current $150,000 threshold has remained
unadjusted for inflation since it was set in 19871 and
is therefore arguably too low, thus increasingly allowing
unsophisticated investors to participate in the exempt
market.
There is further concern that an exemption based solely on the
minimum amount invested may cause investors to invest more than
prudent business or investment considerations may dictate, simply
in order to meet the minimum threshold.
Potential Options
Depending on the results of the consultation process, the CSA may propose any of the following:
- retaining the minimum amount exemption;
- adjusting the $150,000 CDN threshold (e.g., indexing for inflation);
- limiting the use of the exemption to certain investors, such as institutional investors and not individuals;
- using alternative qualification criteria;
- imposing other investment limitations; or
- repealing the exemption.
The Accredited Investor Exemption
The accredited investor exemption provides an exemption from the prospectus requirement where the purchaser of a security qualifies as an accredited investor. Accredited investors include certain institutional investors as well as individuals who:
- either alone or with a spouse, beneficially own financial assets which have an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1,000,000 CDN;
- have a net income before taxes exceeding $200,000 CDN in each of the two most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 CDN in each of the two most recent calendar years and who, in either case, reasonably expect to exceed that net income level in the current calendar year; or
- either alone or with a spouse, have net assets of at least $5,000,000 CDN.
Concerns
The concerns raised by the CSA regarding the accredited investor
exemption relate to the appropriateness of the current income and
asset thresholds for individuals. The current thresholds were
originally set by the United States Securities and Exchange
Commission in 1982, and subsequently adopted by the CSA in the
early 2000s. As with the minimum amount exemption, the thresholds
have not been adjusted for inflation2 and
consequentially there is a concern that these thresholds are now
too low, allowing unsophisticated retail investors to participate
in the exempt market.
There is further concern that income and asset thresholds are not
adequate proxies for sophistication, as individuals may have
significant wealth, but lack investment or other experience that
enables them to make an investment decision without the protections
afforded by a prospectus or the involvement of an investment
advisor.
Potential Options
Depending on the results of the consultation process, the CSA may propose any of the following:
- retaining the accredited investor exemption in its current form;
- adjusting the income and asset thresholds for individuals in the definition of accredited investor;
- using alternative qualification criteria for individuals;
- limiting the exemption to certain investors, such as institutional investors and not individuals; or
- imposing other investment limitations on individuals.
Conclusion
Please note that this is a summary only of the issues highlighted in the Consultation Note. If you have any questions concerning this bulletin or the Consultation Note, please contact the authors or your usual contact at Davis LLP.
Footnotes
1 The CSA notes that the $150,000 threshold is equivalent to over $265,000 in 2011 dollars.
2 The current threshold for an individual income is $200,000. The CSA notes that in 2011 dollars, the threshold would be over $433,000 based on 1982 dollars (the year of SEC adoption), or $245,000 based on 2001 dollars (the year the Ontario Securities Commission first adopted the exemption).
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.
