Private Placement "Wrapper" Sales into Canada May Result in the Issuer Becoming Subject to Canadian Public Company Reporting Requirements and Canadian Investors Becoming Subject to Onerous Resale Restrictions
The Canadian Securities Administrators in each province and territory of Canada other than the Province of Ontario have adopted Multilateral Instrument 51-105 Issuers Quoted in the U.S. Over-the-Counter Markets (MI 51-105), which comes into effect on July 31, 2012.
Who is Affected by MI 51-105?
MI 51-105 will make an issuer into a "reporting issuer" fully subject to Canadian public company reporting and other obligations if all of the following conditions apply:
- the issuer does not already have any class of securities listed or quoted on a Canadian or U.S. stock exchange;
- the issuer has any class of securities that has been assigned a ticker symbol by the Financial Industry Regulatory Authority (FINRA) for use on any U.S. over-the-counter (OTC) market, including any class of securities whose trades have been reported in the grey market; and
- on or after July 31, 2012, either: (i) the issuer's business is directed or administered in Canada (other than in the Province of Ontario), or (ii) the issuer, or someone acting on its behalf, carries on "promotional activities" in or from any province or territory of Canada other than Ontario, including any communications from outside Canada with persons in Canada in a way that promotes, or reasonably could be expected to promote, the purchase or sale of the issuer's securities.
Issuers that in the future are assigned a ticker symbol for trading in the U.S. OTC market (who are referred to in MI 51-105 as "OTC issuers") may also become reporting issuers based on previous sales of securities in Canada (other than in the Province of Ontario) which occurred either before or after the July 31, 2012 effective date. An issuer will become a reporting issuer if it is assigned its first ticker symbol for OTC trading on or after July 31, 2012 and, before that time, it distributed securities in Canada (other than in the Province of Ontario) of a class that then became OTC-quoted. So, for example, if an issuer with no OTC-quoted securities distributes shares of its common stock to any person in the Province of Alberta under any Canadian private placement exemption today, and the common stock becomes OTC traded any time after July 31, 2012, the issuer will automatically become a reporting issuer in the Province of Alberta when FINRA assigns a ticker symbol to the common stock for OTC trading. It would not matter whether or not the Alberta investor still holds the issuer's securities when the ticker symbol is issued.
One of the most troubling aspects of MI 51-105 is that an issuer cannot control whether, or when, a U.S. broker-dealer may decide to take the necessary steps to have FINRA assign a ticker symbol to a class of securities in connection with OTC trading in the United States. To the extent that FINRA requires information about the issuer to confirm compliance with Securities and Exchange Commission (SEC) Rule 15c2-11 in connection with trading on the OTC Bulletin Board or through the "pink sheets" quotation service, that information is normally supplied by the broker-dealer seeking to trade the security. Further, only a simple request form (again submitted by a broker-dealer) is necessary to obtain a ticker symbol for grey market trading.
The requirements of MI 51-105 apply to issuers of all domiciles and there is no exemption from MI 51-105 for issuers that are not Canadian companies.
Consequences of Becoming an OTC Reporting Issuer
Issuers that become reporting issuers under MI 51-105 (OTC reporting issuers) are subject to the simplified public company continuous disclosure (periodic reporting) obligations that apply to a "venture issuer" in Canada, but will be required to prepare an annual information form (annual report) document which is not required for venture issuers. Canadian reporting requirements may generally be satisfied by filing corresponding SEC reports, if the issuer is subject to SEC reporting obligations. However, OTC reporting issuers are not permitted to rely upon the Multijurisdictional Disclosure System (MJDS) exemption from Canadian material change reporting requirements. OTC reporting issuers are also subject to certain restrictions on distributing securities to a director, officer or consultant in consideration for the provision of a service or in satisfaction of a debt.
An OTC reporting issuer may not take the necessary steps to terminate its reporting issuer status until a number of prescribed conditions are met, including at least one year having passed since the last date that promotional activities were carried on in Canada (except in the Province of Ontario), and at least one year having passed since the date of the issuance of the first ticker symbol for OTC trading for the issuer by FINRA.
Implications for Non-Canadian Issuers Not Listed on a Canadian or U.S. Stock Exchange
We believe that MI 51-105 may have a serious adverse impact on Canadian private placements by non-Canadian issuers who are not already listed or quoted on a Canadian or U.S. stock exchange, and who do not wish to become a reporting issuer in Canada. It seems unlikely that any non-Canadian issuer would want to take any voluntary action on or after July 31, 2012 that would cause it to become a reporting issuer in Canada as a result of MI 51-105.
For those issuers:
- If FINRA has already assigned a ticker symbol for trading of any class of the issuer's securities on any OTC market in the United States, then the issuer is an "OTC issuer" and a distribution of securities to an investor in any province or territory of Canada (other than the Province of Ontario) will generally cause the issuer to become a Canadian reporting issuer because the distribution would be a promotional activity.
- If no ticker symbol has yet been assigned by FINRA, the issuer is not yet an "OTC issuer". The issuer may distribute securities in Canada without immediately becoming a Canadian reporting issuer. However, if a broker-dealer ever subsequently applies to FINRA for a ticker symbol for OTC trading for the same class of securities at any time before the issuer has any class of securities listed or quoted on a Canadian or U.S. stock exchange, the issuer would then immediately become a reporting issuer in those provinces and territories (other than the Province of Ontario) where that class of securities was sold, even if no securities are still held by any Canadian shareholders at the time.
Non-Canadian issuers that have already distributed securities to Canadian investors, and that are not already listed or quoted on a Canadian or U.S. stock exchange, may wish to attempt to arrange for the issuance of an OTC ticker symbol by FINRA before July 31, 2012 for any class of their securities if one has not already been issued. If an OTC ticker symbol is issued for any class of the issuer's securities before July 31, 2012, and no further securities of the issuer are sold in Canada (other than in the Province of Ontario) after July 31, 2012, then these issuers should not become reporting issuers in Canada on the effective date of MI 51-105 or be at risk of becoming reporting issuers subsequently as a result of MI 51-105.
In the context of a non-Canadian IPO, making Canadian private placement sales in any province or territory other than Ontario will generally result in the issuer becoming a reporting issuer in Canada if any class of the issuer's securities has previously been assigned an OTC ticker symbol, because the marketing activities conducted in Canada prior to pricing (and listing) would generally be promotional activities resulting in reporting issuer status.
Implications for the Non-Canadian "Wrapper" Practice
Traditionally, U.S. and other foreign issuers conducting SEC registered offerings, Rule 144A offerings or other public offerings elsewhere in the world have sought to extend those offerings into Canada on a private placement basis through the use of a Canadian supplement (or "wrapper") to augment the non-Canadian prospectus or other offering document.
Assuming that foreign issuers do not wish to become subject to Canadian reporting issuer requirements as a result of MI 51-105, its adoption is expected to result in the following new restrictions being adopted on Canadian "wrapper" practices commencing on August 1, 2012 if the Canadian securities administrators do not provide relief before then:
- Sales to investors in the Province of Ontario would continue without any change to conventional practices;
- Sales of securities of any issuer with any class of securities that is already listed or quoted on a Canadian or U.S. stock exchange would continue without any change to conventional practices;
- Issuers conducting an initial public offering in the United States and listing on a U.S. stock exchange must ensure that no OTC ticker symbol had been issued by FINRA for any class of their securities before the U.S. listing occurs; if an OTC ticker symbol has been issued, then "wrapper" sales should be limited to investors in the Province of Ontario; and
- No other Canadian "wrapper" sales should be made.
Implications for Canadian Issuers Not Listed on a Canadian or U.S. Stock Exchange
Canadian issuers whose business is directed or administered in Canada (other than in the Province of Ontario) will need to determine before July 31, 2012 whether or not they have been assigned a ticker symbol by FINRA for OTC trading for any class of their securities. If a ticker symbol has been assigned, they may become a reporting issuer in one or more provinces and territories of Canada (other than Ontario) automatically on July 31, 2012, whether or not they were already a reporting issuer in any other province or territory. If no ticker symbol had been assigned before July 31, 2012, then on and after that date these issuers will need to closely monitor FINRA ticker symbol issuances thereafter, as they may become a reporting issuer on the date that a U.S. broker-dealer arranges to have a ticker symbol issued for a class of their securities.
Implications for Securityholders
Special Canadian resale restrictions apply to securities of an OTC reporting issuer after the first ticker symbol for OTC trading is assigned, if the securities were acquired on or after July 31, 2012 and before the ticker symbol was assigned. These securities may only be resold in sales subject to the securities laws of the provinces and territories of Canada (other than Ontario) if (i) they carry a prescribed legend, (ii) the trade is made by a Canadian-registered investment dealer (other than an Exempt Market Dealer), and (iii) the dealer executes the trade through a U.S. OTC market. OTC reporting issuers are required, as soon as practicable after the issuance of their first ticker symbol for OTC trading, to replace all outstanding security certificates with certificates bearing a prescribed transfer restriction legend.
There are also special resale requirements that apply to securities of an OTC reporting issuer that were acquired under a Canadian prospectus exemption after the first ticker symbol for OTC trading was assigned. These include: the expiry of a 4-month or 6-month hold period (in most cases); a volume limit on the number of securities of the same class that may be sold in any 12-month period; compliance with a prescribed legending requirement; and a requirement that the trade is made by a Canadian-registered investment dealer (other than an Exempt Market Dealer), and the dealer executes the trade through a U.S. OTC market. No other exemptions from the Canadian prospectus requirements may relied upon.
Securityholders in the Province of Ontario will generally not be affected by the resale requirements of MI 51-105, except that the resale provisions of Section 2.14 of National Instrument 45-102 Resale of Securities may not be available if the application of MI 51-105 causes the issuer to become a reporting issuer in any other province or territory of Canada on the distribution date.
All securityholders of OTC reporting issuers, including those in the Province of Ontario, will be subject to Canadian insider reporting requirements and the early warning and take-over bid requirements of Canadian securities laws. In addition, persons seeking to acquire securities of an OTC reporting issuer will be denied the benefit of certain take-over bid exemptions.
Rob Lando is a cross-border corporate and securities lawyer with significant practice experience in the United States and Canada. Mark DesLauriers practises in the area of corporate and securities law, with particular emphasis on cross-border corporate finance, public company law, and the regulation of securities dealers and advisers. Kate Coolicanis a cross-border corporate and securities lawyer.
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.