On December 14, 2012, the OSC released OSC Staff Consultation Paper 45-710 – Considerations for New Capital Raising Prospectus Exemptions (the "OSC Paper")1 which examines four ideas for potential capital raising prospectus exemptions; crowdfunding, an offering memorandum exemption for Ontario, and exemptions for sophisticated investors and investors that have received advice from investment dealers. The OSC Paper makes it clear that these exemptions are still just "concept ideas" that may not be adopted in the form being considered, if at all.
In addition to examining these ideas, the OSC Paper examines many of the current prospectus exemptions in Canada with reference to available statistics and similar exemptions in the United Kingdom, the United States and Australia, and summarizes current initiatives and key issues relating to capital raising.
The OSC is seeking comments to a broad range of consultation questions relating to each of the four concept ideas as well as to proposed changes to the form and content of exempt distribution reports on Form 45-106F1 ("Exempt Distribution Reports") discussed below. In addition, the OSC has included consultation questions relating to the private issuer, closely held issuer and family, friends and business associates prospectus exemptions. Comments are due by March 8, 2013.
BACKGROUND TO THE OSC PAPER
The OSC Paper is another step in the OSC's effort to expand the scope of its review of prospectus exemptions that began after the Canadian Securities Administrators ("CSA") published CSA Staff Consultation Note 45-401 Review of Minimum Amount and Accredited Investor Exemptions (the "CSA Notice") on November 10, 2011. The CSA Notice reviewed, and requested feedback on, two commonly used capital raising prospectus exemptions, the accredited investor and minimum amount exemptions. After consulting widely on the issues raised in the CSA Notice, the OSC expanded the focus of its review to consider whether there was potential to foster greater access to the capital markets for start-ups and small and medium sized enterprises. On June 7, 2012, the OSC announced its expanded review with the publication of OSC Staff Notice 45-707 – OSC Broadening Scope of Review of Prospectus Exemptions. Further steps were taken in September 2012, when the OSC established an Exempt Market Advisory Committee. The OSC now intends to actively consult on the issues discussed in the OSC Paper to further expand the scope of its review of prospectus exemptions.
The following is a summary of the four concepts being considered. A distribution of securities made under any of these concepts, if adopted, would be an exempt distribution, and would therefore trigger the requirement to file an Exempt Distribution Report and would be subject to a restricted resale period.
Crowdfunding is a method of raising a small amount of funds for a project or venture from a large number of people over the Internet via an internet portal. The Jumpstart Our Business Startups Act (the "JOBS Act"), which was passed in the United States on April 5, 2012, included a new crowdfunding exemption to broaden access to investment opportunities in the exempt market. The SEC was required to issue final rules governing crowdfunding in the United States by December 31, 2012 though as of the date hereof, the final rules have not been released.
The crowdfunding concept proposed in the OSC Paper follows many of the rules in the JOBS Act. If adopted in the form being contemplated, the crowdfunding exemption would permit issuers, other than investment funds to whom the exemption will not apply, to make small offerings of securities over the Internet to investors, including non-accredited, retail investors, in prospectus exempt offerings.
Crowdfunding would involve three parties; the issuer, the investor and a funding portal.
(i) Issuer Restrictions
The following four restrictions would be imposed on issuers:
- Canadian Entities: The issuer, and if applicable, its parent and principal operating subsidiary must all be incorporated or organized in Canada and the issuer must have its head office in Canada.
- Limit on Offerings: Issuers will not be permitted to raise more than $1.5 million under this exemption in any 12-month period.
- Type of Security: The exemption will only apply to offerings of common shares, non-convertible preferred shares, securities convertible into common or non-convertible preferred shares and non-convertible debt securities that are linked to a fixed or floating rate of interest.
- Limit on Advertising: Crowdfunding offerings may only be advertised through the funding portal or on the issuer's website. Issuers would, however, be permitted to use social media to direct investors to the funding portal or their website.
(ii) Investor Protections and Limitations
The crowdfunding exemption could be relied on to sell securities to any investor, regardless of his/her income, net worth or investing sophistication. To help protect investors, the OSC concept encompasses the following investor protections and limitations:
- Investment Limits: Investors cannot invest more than $2,500 in any single investment nor more than $10,000 in any calendar year.
- Disclosure Requirements: At the time of distribution, investors must be provided (i) a streamlined information statement, certified by management, which describes key risks facing the issuer as well as basic information about the offering, the issuer and the funding portal, and (ii) one year of financial statements which statements must be audited if the issuer is a reporting issuer or if the proposed offering will exceed $500,000 (otherwise the statements may be certified by management). On an ongoing basis, the issuer must provide the investor with annual financial statements within 120 days of year end and must maintain prescribed records regarding the offering. The investor must sign a risk acknowledgement form confirming that they fall within the investment limits, understand the illiquid nature of the investment (if in a non-reporting issuer) and understand that they may lose, and can bear the loss of, their entire investment.
- Statutory Rights and Cooling Off Period: The investor must be given statutory rights in the event of a misrepresentation in the information sheet as well as a two business day "cooling off" period during which they can withdraw their investment.
(iii) The Funding Portal
All investments made under the crowdfunding exemption must be made through a registered funding portal. The funding portal would play a "gatekeeper" role and take reasonable steps to reduce the risk of fraud. The funding portal must be registered in an existing or restricted dealer or adviser category although the OSC may consider exempting funding portals from such requirements depending on the portal's proposed business model and the OSC's continued review of crowdfunding.
Offering Memorandum Exemption
Under section 2.9 of NI 45-106, every Canadian jurisdiction, other than Ontario, currently has an offering memorandum exemption. The OSC is now considering such an exemption. The OM exemption being considered imposes most of the issuer restrictions and investor protections and limitations contained in the proposed overcrowding exemption. Two notable differences, however, are that: (i) an OM investment would not need to be conducted through a funding portal, and (ii) a registrant would not be required unless the issuer or an intermediary is in the business of trading securities. The OM exemption would not be available to investment funds.
This exemption would allow an issuer to distribute securities to "sophisticated" investors even if they did not qualify as accredited investors. Unlike the crowdfunding and OM exemptions, though similar to the accredited investor exemption, there would be no limit on the size of the offering or the type of security that may be offered to a sophisticated investor. This exemption would be available to investment funds.
In order to qualify as a sophisticated investor, an investor must have worked in the investment industry for at least one year in a position that requires knowledge of securities investments and must have a chartered financial designation, a chartered investment manager designation or an MBA.
The issuer must provide the investor with a term sheet that sets out basic information regarding the offering and the investor would be required to sign a risk acknowledgement form. Since a term sheet would likely not constitute an offering memorandum under the Securities Act (Ontario), no rescission rights would apply.
Advice from Investment Dealer
The fourth concept would exempt distributions to investors that have received appropriate advice from a registered investment dealer. The investor would not need to qualify as an accredited or sophisticated investor though an investment dealer must:
- provide advice to the investor regarding the distribution,
- have an ongoing relationship with the investor,
- contractually agree that it has a fiduciary duty to the investor, and
- not otherwise be acting for the issuer or in connection with the distribution.
The OSC Paper includes specific questions regarding whether this exemption should be available for the distribution of securities of investment funds and also asks whether the current exclusion of investment funds from the managed account exemption in the accredited investor exemption should be maintained.
REPORTING OF PRIVATE PLACEMENTS
To improve the quality and availability of information contained in Exempt Distribution Reports, the OSC is considering, and is requesting comments to related consultation questions, requiring that such reports be filed electronically and include additional information regarding the issuer, the investor and the registrant, if applicable. Although any expansion of reporting requirements would be subject to additional consultation, the OSC Paper contemplates requiring disclosure of far more information regarding exempt market transactions, particularly for investment funds.
Please contact the author of this Bulletin or your usual lawyer in BLG's Securities & Capital Markets Group if you would like further information regarding the OSC Paper or if you would like to make a submission.
1 For a copy of the full OSC Paper, please go to http://www.osc.gov.on.ca/documents/en/Securities-Category4/sn_20121214_45-710_exempt-market-review.pdf or click here.About BLG
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