Canada: OSC Publishes Consultation Paper On Potential Capital Raising Prospectus Exemptions

The Ontario Securities Commission (OSC) has published OSC Staff Consultation Paper 45-710 Considerations for New Capital Raising Exemptions (the Paper) that discusses four concepts for new prospectus exemptions in Ontario on which the OSC is seeking feedback:

  • an exemption to allow crowdfunding subject to limits for issuers and retail investors;
  • an offering memorandum exemption;
  • an exemption based on an investor's investment knowledge; and
  • an exemption based on an investor receiving advice from a registrant.

The Paper follows a review by the Canadian Securities Administrators (CSA) of the accredited investor and minimum amount exemptions in November 2011. In June 2012, the OSC expanded on the CSA's review, broadening the scope to consider whether new prospectus exemptions should be introduced that may assist capital raising for business enterprises, while protecting investors (see OSC Staff Notice 45-707 Broadening Scope of Review of Prospectus Exemptions).

The Paper is the initial step in soliciting comments from all interested stakeholders on broadening access to the exempt market.

The Paper notes that the CSA's review of the accredited investor and minimum amount exemptions will be finalized and their conclusions publicly reported in 2013. The OSC is continuing to examine the accredited investor and minimum amount exemptions, along with the concept ideas presented in the Paper.

The OSC has developed the concepts for prospectus exemptions solely for discussion purposes and notes that it may not introduce exemptions in the concept form, or at all. In addition to questions regarding the concept exemptions, the OSC has also asked consultation questions regarding the private issuer exemption, a closely held issuer exemption and a family exemption.

Concept exemptions

Crowdfunding

Crowdfunding is a method of funding a project or venture by raising small amounts of money from a large number of people using an internet portal. In the United States, the Jumpstart Our Business Startups Act (the JOBS Act) carved out a new exemption for crowdfunding, which is still subject to rulemaking by the Securities and Exchange Commission before it will become legal in the United States.

The OSC has developed a concept idea for a crowdfunding exemption that encompasses many of the investor protection elements of the crowdfunding exemption under the JOBS Act. The exemption would only be available if the issuer (and its parent and principal operating subsidiary, if applicable) is incorporated or organized under Canadian laws and the issuer has its head office located in Canada. All investments would need to be made through a registered funding portal. Further, the issuer could not raise more than $1.5 million under this exemption in any 12-month period nor advertise an investment except through the funding portal or on the issuer's website. Only certain types of securities could be distributed under the crowdfunding exemption: common shares, non-convertible preferred shares, non-convertible debt securities that are linked only to a fixed or floating interest rate and securities convertible into common shares or non-convertible preferred shares.

The crowdfunding exemption could be used to sell securities to any investor, provided certain conditions are met: (i) the investor cannot invest more than $2,500 in a single investment or $10,000 in total in any calendar year under the exemption; (ii) a streamlined information statement, certified by the issuer, that includes basic information about the offering, the issuer, the funding portal and any other registrant involved must be provided to the investor at the time of distribution; (iii) the investor must sign a risk acknowledgement form; (iv) a two-business day right of withdrawal must be provided to the investor; and (v) the issuer must provide investors with annual financial statements and maintain books and records containing certain key information on the securities and securityholders of the issuer.

Offering memorandum

The second concept idea discussed in the Paper is an offering memorandum exemption that would permit a distribution of securities pursuant to a limited disclosure document. Ontario is currently the only Canadian jurisdiction where an offering memorandum exemption is not available. The OSC's concept idea for an offering memorandum exemption is subject to many of the same terms and conditions as the crowdfunding exemption described above, including limits on the amount that could be raised by the issuer and invested by the investors under the exemption. However, unlike the crowdfunding exemption, an offering memorandum investment would not require a funding portal or the involvement of a registrant (unless the issuer or any intermediary is in the business of trading in securities).

Investor knowledge

The third concept idea discussed in the Paper is an exemption which would permit distributions to "sophisticated" investors who do not qualify as accredited investors under the existing accredited investor exemption. To qualify as a "sophisticated" investor, one must have worked in the investment industry for at least one year in a position that requires knowledge of securities investments and hold a Chartered Financial Analyst designation, a Chartered Investment Manager designation or a Master in Business Administration degree from an accredited university.

Similar to the accredited investor exemption, there would be no restrictions on the type of security that may be distributed, the size of the investor's investment, or the size of the offering. However, the investor must be provided with basic information about the offering, such as information typically found in a term sheet, and sign a risk acknowledgement form.

Registrant advice

The Paper also outlines a fourth concept idea for an exemption for distributions where the investor has received appropriate advice from a registrant. This would apply to a distribution to an investor where: (i) an investment dealer is providing advice to the investor in connection with the distribution; (ii) the investment dealer has an ongoing relationship with the investor; (iii) the investment dealer has contractually agreed that it has a fiduciary duty to act in the investor's best interest; and (iv) the investment dealer is not providing advice in connection with a distribution of securities of a "related" or "connected" issuer of the investment dealer.

Only dealing representatives within the investment dealer who are qualified to provide advice can do so. Investment dealers do not include other types of registrants, such as exempt market dealers (EMDs). The OSC notes that EMDs are specifically excluded from this exemption because of important differences in terms of the duties owed to a client and the proficiency, solvency, and other requirements applicable to an EMD as compared with a portfolio manager or an investment dealer.

Exempt market reporting

The OSC also notes in the Paper that it does not have a complete picture of activity in the exempt market and is seeking feedback on mandating the electronic filing of Form 45-106F1 Report of Exempt Distribution (the Report) in Ontario, which is required to be filed with securities regulators when securities are sold under certain prospectus exemptions, and on requiring additional information to be included in the Report. The OSC has identified in the Paper information that would provide it with a better understanding of the exempt market, including information about the issuer's directors and executive officers, and, in the case of investors, where the accredited investor prospectus exemption is used, the category of accredited investor in which the investor qualifies, and if the investor is an individual, the investor's age range and work status.

Request for comments

The OSC has asked for comments by February 12, 2013. The OSC does not intend to make any decisions regarding new capital raising prospectus exemptions without broad consultation with all interested stakeholders, obtaining the results of further investor research, and consulting with the other members of the CSA on their review of their offering memorandum exemption.

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2013 McMillan LLP

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