Canada: Major Reforms Enacted To Stimulate Public And Private Capital Raising In The United States

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act, which makes significant changes to existing U.S. federal securities laws intended to make it easier for small and emerging companies to conduct public and private securities offerings in the United States. While the extent of the application of the new laws to Canadian and other non-U.S. companies accessing the U.S. capital markets remains to be determined through rulemaking by the U.S. Securities and Exchange Commission (SEC), the new legislation (referred to as the JOBS Act) could significantly expand the opportunities that Canadian companies have for raising capital in the United States.

Executive Summary

Among other things, the JOBS Act:

  • creates a new category of "emerging growth companies" (EGCs) that are either exempt from or eligible for simplified compliance with a number of securities law requirements, including those relating to financial statements, executive compensation reporting and Sarbanes-Oxley auditor attestations;
  • liberalizes contacts among research analysts and investment bankers and company officers and permits the publication of research reports in connection with equity offerings by EGCs;
  • eliminates prohibitions against general solicitation and general advertising (publicity) in connection with Rule 144A offerings and certain other private placements of securities;
  • creates a registration exemption for public offerings where the aggregate amount of securities offered and sold in the prior 12-month period in reliance on the exemption does not exceed US$50 million;
  • relaxes the current requirements that trigger the need for a company to register its securities under the Securities Exchange Act of 1934 (the U.S. Exchange Act) and file public disclosure with the SEC so that a company (other than a bank or bank holding company) will be able to have up to 1,999 shareholders of record (so long as fewer than 500 holders are non-accredited investors) before those registration requirements apply; and
  • creates a registration exemption for "crowdfunding" transactions by U.S. non-reporting companies involving offers and sales to any investors (including non-accredited investors) of up to US$1 million of securities during a prior 12-month period, subject to limits on the amount raised from any individual investor.

Emerging Growth Companies

Exemptions and Simplified Compliance Requirements

A company (including a Canadian or other non-U.S. company) that first sells common equity securities after December 8, 2011 pursuant to an effective IPO registration statement under the U.S. Securities Act of 1933 (the U.S. Securities Act) and that has total annual gross revenues of less than US$1 billion will qualify as an EGC and will be exempt from certain disclosure and other compliance requirements for up to five years following its IPO.1 Specifically, an EGC will be permitted to:

  • provide only two years (rather than three years) of audited financial statements in its IPO registration statement; as well, management's discussion and analysis of financial condition and results of operation disclosure (MD&A) will only need to cover those two years;
  • omit selected financial data from any other registration statement and periodic report for any period prior to the earliest audited period presented in connection with its IPO (instead of providing selected financial data for the preceding five fiscal years);
  • be exempt from "say-on-pay" voting and certain significant executive compensation-related disclosure requirements; 2
  • be exempt from any new or revised financial accounting standards (other than those accounting standards that apply to private companies);
  • be exempt from the requirement to obtain an independent auditor's attestation report on the company's internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (SOX 404 Report);
  • submit to the SEC a draft of its IPO registration statement for confidential non-public review by SEC staff prior to public filing (so long as the public filing of the confidential submission and all amendments occurs at least 21 days before any roadshow); and
  • be exempt from any future rules of the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the issuer's financial statements.

Implications for Canadian Issuers

These rule changes will primarily be of interest to Canadian issuers that qualify as EGCs and that intend to file an IPO registration statement with the SEC but are not eligible to use the U.S.-Canada Multijurisdictional Disclosure System (MJDS) because they do not meet the Canadian reporting history or public float requirements. Since 1991, MJDS has enabled eligible Canadian companies to file a registration statement with the SEC based primarily on Canadian prospectus form and content requirements and to be subject to review only by Canadian securities regulators. MJDS issuers, for example, already benefit from the requirement to only provide financial statements for the years required under applicable Canadian securities laws (which cover just a two-year period for short-form eligible issuers)and are not required to follow the SEC's rules regarding "say-on-pay" and executive compensation-related disclosure requirements. The exemption from the SOX 404 Report requirement for up to five years will benefit all Canadian issuers that qualify as EGCs and that intend to conduct a U.S. IPO, whether or not they are MJDS-eligible.3

Instead of using the new JOBS Act provision permitting confidential filing of an IPO registration statement, Canadian EGCs conducting a cross-border IPO with a concurrent listing on the TSX will likely prefer to rely instead on the existing SEC policy that permits the confidential submission and review of IPO registration statements filed by foreign private issuers involving a concurrent listing on a non-U.S. securities exchange. One benefit of using the existing SEC policy for foreign private issuers, instead of the new JOBS Act process, is that the existing policy, unless modified in light of the new JOBS Act provision, does not require all previously submitted drafts of the IPO registration statement to be publicly filed; only the registration statement containing the prospectus to be used for the purposes of a roadshow (and all subsequent amendments) needs to be filed publicly.

Relaxation of Research Restrictions Relating to EGCs

The JOBS Act provides that the publication or distribution by a broker or dealer of a research report about an EGC that is the subject of a public offering of its common equity securities will not be treated as an offer of the securities for purposes of the registration requirements of the U.S. Securities Act even if the broker or dealer is participating or will participate in the registered offering of the securities. The new law also prohibits the SEC or any national securities association registered under the U.S. Securities Exchange, such as the Financial Industry Regulatory Authority, Inc. (FINRA), from adopting or maintaining any rule or regulation in connection with an IPO by an EGC:

  • restricting a broker, dealer or member of a national securities association from arranging communications between a securities analyst and a potential investor; or
  • restricting a securities analyst from participating in any communications with the management of an EGC that is also attended by other persons from a broker, dealer or member of a national securities association who are not securities analysts.

The SEC or any national securities association can no longer prohibit any broker, dealer or member of a national securities association from publishing or distributing any research or making any public appearance with respect to the securities of an EGC within any prescribed period of time:

  • following the company's IPO; or
  • prior to the expiration of any "lockup" agreement restricting the sale of company securities after its IPO.

These changes represent a sharp reversal of the restrictions previously in place, which arose following scandals during the 1990's dot-com boom when certain research analysts were found to have written favorable reports even when they personally believed the securities to be of questionable value. The separation between research analysts and others involved in the public offering process has, until now, been intended to mitigate against potential conflicts of interest between investment banks seeking public offering mandates and issuers desiring favorable research. The SEC and FINRA will be required to relax a number of their restrictions relating to these areas.4

Implications for Canadian Issuers

Analysts will now be permitted to issue research in the United States about Canadian EGCs at any time, including during the pendency of an offering and even if the analyst's firm is participating in the offering. In addition, it will no longer be necessary under U.S. rules to "wall-cross" analysts to meet with management while the underwriters are present in connection with an EGC's IPO. Canadian issuers will have to remain mindful, however, of restrictions that continue to apply under applicable Canadian securities laws. Nevertheless, it remains to be seen if the relaxation of research restrictions introduced by the JOBS Act will result in any meaningful changes in practice, especially in light of the fact that research reports will remain subject to certain liability provisions under the U.S. Securities Act and the U.S. Exchange Act.

Ability to "Test the Waters" Before Filing a Registration Statement

The JOBS Act also allows an EGC or any person authorized to act on its behalf to engage in oral or written communications with potential investors that are qualified institutional buyers (as defined in Rule 144A under the U.S. Securities Act) or institutions that are accredited investors (as defined in Regulation D under the U.S. Securities Act) prior to the filing of a registration statement with the SEC in order to determine whether those investors would have any interest in purchasing the EGC issuer's securities in a public offering.

Implications for Canadian Issuers

This new ability to "test the waters" may effectively allow Canadian EGCs and their investment bankers to talk to institutional U.S. accounts in potential registered offerings before the registration statement (including an MJDS registration statement in a "bought deal") is filed with the SEC and to not proceed with the registration statement filing (including payment of applicable filing fees) in the United States if U.S. demand is insufficient.

Eliminating Publicity Restrictions for Certain Private Placements

The JOBS Act directs the SEC to revise its rules to remove the prohibition against general solicitation and general advertising in connection with offers and sales of securities made in reliance on Rule 506 of Regulation D, provided that all actual purchasers of the securities are accredited investors. The provision contemplates that the revised SEC rules will require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the SEC. Similarly, the new law directs the SEC to revise Rule 144A to provide that securities may be offered to persons other than qualified institutional buyers, including by means of general solicitation or general advertising, provided that the securities are actually sold only to persons that the seller and any person acting on behalf of the seller reasonably believe to be qualified institutional buyers. These revisions must be in place by July 4, 2012.

Implications for Canadian Issuers

For Canadian issuers conducting prospectus-qualified public offerings in Canada with concurrent U.S. private placement sales in reliance on Rule 506 of Regulation D and/or Rule 144A, depending on the outcome of the SEC's rule changes, the practical effect of this change may be that press releases issued in Canada in connection with such offerings can be freely disseminated in the United States as well (instead of the current practice of prohibiting the dissemination of the Canadian press release in the United States). Other public marketing of such offerings in the United States may also be permitted, eliminating current concerns about participating in industry conferences and other meetings in the United States prior to the offerings.

It should be noted, however, that offers and sales of securities in Canada in a Canadian public offering are, from the SEC's perspective, made in reliance on Regulation S under the U.S. Securities Act, which prohibits "directed selling efforts", meaning any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for any of the securities being offered in reliance on Regulation S. The prohibition on directed selling efforts is generally understood to have the same effect as the prohibition on general solicitation and general advertising. It remains to be seen whether the SEC will make a corresponding change to the prohibition on directed selling efforts. If the SEC chooses not do so, the elimination of the prohibition on general solicitation and general advertising may not be meaningful in the context of Canadian public offerings with U.S. private placement tranches because the prohibition against directed selling efforts would still have to be observed.

Exemption for Certain Private Placements Involving Offer and Sale of Less Than US$50 Million of Securities

The JOBS Act provides for a new class of securities that are exempt from the registration requirements of the U.S. Securities Act where the aggregate amount of all securities offered and sold in reliance on the exemption within the prior 12-month period does not exceed US$50 million.5 The exemption permits these securities to be offered and sold publicly and they will not be subject to resale restrictions. The exemption applies to equity securities, debt securities and debt securities convertible into or exchangeable for equity interests, as well as any guarantees of such securities.

Unlike the other registration exemptions under the U.S. Securities Act, this "small issue" exemption requires the issuer to file audited financial statements annually with the SEC. In addition, the exemption provides that the SEC may create rules or regulations that require an issuer relying on the exemption to make available to investors and file with the SEC an offering statement and periodic disclosure containing prescribed information about the issuer, its business operations, financial condition, corporate governance principles, use of investor funds and other matters. Issuers relying on the exemption will be permitted to solicit investor interest prior to the filing with the SEC of any required offering statement on such terms as the SEC prescribes.

The small issue exemption expressly provides investors with a litigation remedy under Section 12(a)(2) of the U.S. Securities Act for the use of false or misleading statements or omissions in any offering document or oral communications related to the offer or sale of the exempt securities. This liability standard is more onerous for issuers than the Rule 10b-5 liability standard that also applies to private placements. For example, unlike Rule 10b-5, various court cases have established that Section 12(a)(2) imposes liability without requiring proof of either scienter (fraudulent intent/recklessness) or reliance. A plaintiff need only demonstrate some causal connection between the alleged communication and the sale of the security.

Implications for Canadian Issuers

Depending on the outcome of related SEC rulemaking, the new small issue exemption may be of particular interest to Canadian public companies that make a limited number of U.S. private placement sales concurrently with their Canadian prospectus-qualified offerings. It is possible that the contents of any information statement requirement prescribed by the SEC will already be addressed in the Canadian prospectus, and U.S. investors may find the prospect of receiving freely tradable, unlegended securities to be especially appealing. However, Canadian issuers will have to weigh any increased investor interest and pricing-related benefits against the prospect of being required to file information with the SEC and facing a more onerous liability standard than applies in a Regulation D or Rule 144A private placement.6

Modifying U.S. Exchange Act Registration Thresholds

The JOBS Act modifies rules that have been in place since 1964 governing when companies must become public companies subject to specific periodic and current reporting requirements under the U.S. Exchange Act. Until now, any U.S. company with more than US$10 million in assets and equity securities "held of record" by more than 500 persons has had to register that class of equity securities under Section 12(g) of the U.S. Exchange Act. "Held of record" is defined in Rule 12g5-1 of the U.S. Exchange Act to count as record holders only those persons identified as holders in the company's records or as participants in the book entry system maintained by the Depository Trust Company (DTC) or another depositary. For investors in most public companies today, their securities are held by their broker in nominee or "street name" instead of directly in the name of the beneficial owner. As a result, the number of holders in public companies is "undercounted" because any one broker with an account at DTC is holding securities for numerous clients but is only counted as one holder for purposes of U.S. Exchange Act Rule 12g5-1. Most private companies, however, do not have their securities held through DTC and therefore can have much higher numbers of holders of record of their securities, which can cause them to be confronted with U.S. Exchange Act registration obligations before they are ready to conduct an IPO.

The JOBS Act raises the "held of record" threshold at which the registration requirement will apply for issuers other than banks and bank holding companies to (i) 2,000 persons or (ii) 500 persons who are not accredited investors (as defined by the SEC). The new law also permits an issuer to exclude from its "held of record" analysis any securities held by persons who received their securities through an employee compensation plan in transactions exempt from the registration requirements of the U.S. Securities Act, as well as holders of securities issued under the "crowdfunding" exemption discussed below. Additional provisions amend the U.S. Exchange Act registration requirements as they relate to banks and bank holding companies. The new law directs the SEC to adopt final rules to implement these modifications no later than one year after the JOBS Act is enacted (i.e., April 5, 2013).

Implications for Canadian Issuers

Many Canadian issuers that qualify as foreign private issuers will already benefit from the exemption from U.S. Exchange Act registration provided by U.S. Exchange Act Rule 12g3-2(a), which exempts foreign private issuers with fewer than 300 beneficial holders in the United States, or Rule 12g3-2(b) which, in general terms, provides an exemption for a foreign private issuer that is not otherwise required to file periodic reports with the SEC, has a primary trading market and listing outside of the United States, and makes available English language versions of information required by its home jurisdiction though its website or an electronic information delivery system (such as SEDAR in Canada). However, the higher U.S. Exchange Act registration threshold may be helpful to Canadian privately held companies that have large numbers of U.S. shareholders, and to other Canadian companies that are for any reason not eligible to rely on U.S Exchange Act Rule 12g3-2(b).7

Exemption for Crowdfunding

The JOBS Act permits the offer and sale of securities without registration under a new Section 4(6) of the U.S. Securities Act where the aggregate amount sold within the previous 12-month period in reliance on the exemption does not exceed US$1 million. In order to use the exemption, the issuer must be organized under and subject to the laws of a U.S. state or territory or the District of Columbia and cannot be subject to requirements to file reports with the SEC pursuant to Section 13 or Section 15(d) of the U.S. Exchange Act. As a result, the crowdfunding exemption will not be available to Canadian issuers, except potentially through a U.S. subsidiary. The aggregate amount of securities sold to any investor within the previous 12-month period in reliance on the exemption cannot exceed:

  • the greater of US$2,000 or 5% of the investor's annual income or net worth if either the annual income or the net worth of the investor is less than US$100,000; and
  • 10% of the investor's annual income or net worth, not to exceed a maximum aggregate amount sold of US$100,000, if either the annual income or net worth of the investor is equal to or more than US$100,000.

An investor purchasing securities in a crowdfunding offering cannot transfer those securities during the one-year period beginning on the date of purchase other than to (i) the issuer, (ii) an accredited investor, (iii) as part of an SEC-registered offering, or (iv) to a member of the purchaser's family or the equivalent, or in connection with the death or divorce of the purchaser.

Crowdfunding offerings must be conducted through an intermediary that is registered with the SEC as a broker or funding portal and with any applicable self-regulatory organization. In facilitating such transactions, the intermediary must provide such disclosures, including those related to risks and other investor education materials, as the SEC by rule deems appropriate. The intermediaries will be required to take a number of steps designed to protect investors.

Issuers offering or selling securities in reliance on the new Section 4(6) exemption will be required to file with the SEC and provide to investors information such as:

  • a description of the business and its anticipated business plan;
  • a description of its financial condition (including audited financial statements where the specified target offering amount exceeds US$500,000 or such other amount that the SEC determines);
  • the stated purpose and intended use of proceeds;
  • the specified target offering amount and deadline to reach that target;
  • the price of the securities;
  • a description of the ownership and capital structure; and
  • such other information as the SEC prescribes by rule.

Issuers relying on the crowdfunding exemption will not be permitted to advertise the terms of the offering, except for notices that direct investors to the intermediary. Crowdfunding issuers will be required to file with the SEC (not less than annually) and provide to investors such reports of their results of operations and financial statements as the SEC determines, by rule, to be appropriate.

The new law specifically provides that any intermediary will not, in that capacity, be required to register as a broker under the U.S. Exchange Act. In addition, as noted above, any securities held by persons who purchase them pursuant to the crowdfunding exemption will not be counted for purposes of determining the application of U.S. Exchange Act registration requirements, meaning that use of the crowdfunding exemption will not make an issuer more likely to trigger an obligation to register as a reporting company under the U.S. Exchange Act and incur ongoing reporting obligations.


1 An "emerging growth company" is defined as an issuer that had total annual gross revenues of less than US$1 billion (as such amount is indexed for inflation every five years by the SEC to reflect the change in the Consumer Price Index for All Urban Consumers published by the U.S. Bureau of Statistics, setting the threshold to the nearest $1 million) during its most recently completed fiscal year. An issuer that is an emerging growth company as of the first day of that fiscal year will continue to be deemed to be an emerging growth company until the earliest of:

2 The exemption permits EGCs to omit the pay performance graph required under changes introduced by the Dodd-Frank Act and CEO pay ratio disclosure requirements and also to comply with the less onerous Regulation S-K Item 402 requirements that apply to smaller reporting companies. This would permit ECGs to omit the detailed Compensation Discussion and Analysis narrative and generally provide information for only its top three (as opposed to top five) most highly compensated executive officers for two (as opposed to three) fiscal years. Canadian foreign private issuers are not subject to the SEC's "say-on-pay" proxy voting requirements and may comply with Canadian executive compensation disclosure requirements instead of SEC executive compensation disclosure requirements unless they choose to comply with SEC requirements. As a result, the exemptions from "say-on-pay" and executive compensation-related disclosure requirements will only benefit those Canadian EGCs electing to file on U.S. domestic forms or who have determined to comply with SEC executive compensation disclosure requirements.

3 Currently, the auditor's attestation on effectiveness of internal control over financial reporting is only required in an issuer's second annual report after its IPO. Non-accelerated filers within the meaning of Rule 12b-2 of the U.S. Exchange Act (which generally includes issuers with a market capitalization of less than US$75 million) are not required to comply with the auditor attestation requirement.

4 Not all SEC and FINRA rules, however, will be affected by the JOBS Act. For example, the FINRA conflict of interest rules (Rule 5121) will still apply, research analysts will still be prohibited from participating in efforts to secure investment banking mandates and Regulation AC will still require research analysts to certify that their research reports reflect their personal views.

5 This new provision is similar to the existing Regulation A under the U.S. Securities Act, which provides for exempt offers and sales on a comparable basis, but only to a maximum of US$5 million.

6 In addition, Canadian issuers offering securities in reliance on the exemption that are not "covered securities" for the purposes of the U.S. Securities Act (such as securities listed on a U.S. national securities exchange) will still need to comply with, or determine that an exemption is available under, the registration requirements of applicable state blue sky laws.

7 Rule 12g3-2(a) of the U.S. Exchange Act also provides an exemption from U.S. Exchange Act registration requirements for foreign private issuers that have fewer than 300 holders resident in the United States.

Jason's primary emphasis is on assisting Canadian and U.S. clients with U.S. corporate finance and mergers and acquisitions transactions. Kevin practices U.S. mergers & acquisitions and securities law. Rob is a cross-border corporate and securities lawyer with significant practice experience in the United States and Canada. Jim's practice covers corporate financing, M&A and U.S. securities law matters for U.S., Canadian and other foreign clients.

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.

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