Co-author: Cody Mann, student at law
In August 2013, the Ontario Securities Commission (the "OSC") published OSC Notice 45-712 Progress Report on Review of Prospectus Exemptions to Facilitate Capital Raising (the "Progress Report"). The Progress Report provides an update on the OSC's review of the prospectus exempt market which was initiated in June 2012 (the "Review"), as well as identifies key themes of the Review. Perhaps most significantly, the Progress Report identifies the following four capital raising prospectus exemptions it will be considering going forward: (i) crowdfunding; (ii) friends, family and business associates; (iii) offering memorandum; and (iv) a streamlined rights offering exemption and possible exemption based on a reporting issuer's continuous disclosure and existing security holder base.
I. Update and key themes
The Progress Report provides an update of the work that has been completed to date in respect of the Review. The OSC reported that it has collected extensive data on exempt market activity and on the capital raising environment for small and medium sized enterprises ("SMEs"). In 2012, the amount of exempt market capital raised in Ontario was $104 billion, an increase of 20% from 2011. Notably, the accredited investor exemption accounted for 90% of the total exempt market capital in 2012. The OSC also found that the capital raising environment for SMEs is mainly composed of personal finances and credit from financial institutions. Venture capital investment in Canada, on the other hand, appears to be becoming more conservative, concentrating investment in later-stage deals as opposed to early-stage deals. The OSC has concluded that start-ups and innovative businesses are at risk of encountering financing constraints. Therefore, enhancing the capital raising options for these SMEs is warranted.
Between January and June 2013, the OSC conducted extensive consultation with stakeholders within the capital markets sector. Through this consultation the following four key themes emerged:
- need to facilitate SMEs' capital raising through expanded prospectus exemptions while maintaining investor protection. Feedback to the OSC has indicated that SMEs face challenges in raising capital. Therefore, new or expanded prospectus exemptions should be considered to assist in raising capital at different stages of a SME's business cycle. However, investors must be made aware of the high risk of failure of the SMEs they are investing in.
- importance of harmonizing capital raising prospectus exemptions across Canada. Feedback to the OSC has indicated that capital raising rules in the exempt market should be harmonized across Canada. The goals of such harmonization are to simplify the capital raising process, reduce administrative burdens for investors and reduce capital raising costs for SMEs.
- emergence of crowdfunding as a new way for some start-ups and SMEs to raise capital. The OSC found there to be significant stakeholder support for introducing a crowdfunding exemption allowing issuers to use the internet to access large numbers of investors in a cost-effective manner. Supporters cautioned that inappropriate or excessive regulation could detract from the viability of crowdfunding as an efficient and cost-effective means of raising capital. Conversely, others were highly critical of adopting a crowdfunding exemption and expressed concern that such an exemption would result in too large a degree of informational asymmetry and too great a risk of fraud and potential for investor harm.
- importance of regulatory monitoring and compliance oversight in the exempt market. As new and amended prospectus exemptions are considered, the OSC is considering methods to improve the monitoring and oversight of exempt market activity. For example, the experience of other members of the Canadian Securities Administrators (the "CSA") with the offering memorandum exemption (the "OM Exemption") has revealed a number of deficiencies principally relating to the adequacy of disclosure in offering memorandums. The OSC notes that these shortfalls confirm that educational outreach, monitoring, oversight and regulation in the exempt market must be addressed as new and expanded prospectus exemptions are developed.
II. Future work
Exemptions being considered
The OSC stated that it will continue to work on the following four new capital raising prospectus exemptions:
- crowdfunding exemption – the OSC recognizes that for crowdfunding to be a viable method of raising capital for SMEs its staff must continue to work on developing an appropriate regulatory framework. The OSC lists the following as appropriate crowdfunding measures: (i) limits of $2,500 on a single investment and $10,000 in a 12 month period; (ii) mandatory risk acknowledgement; and (iii) a two business day cooling off period. The OSC stated that it aims to further refine issuer restrictions and investor protection measures such as: (i) the appropriate limit for the amount that can be raised in a 12 month period; and (ii) the specific documentation that must be disclosed at the point of sale.
- family, friends, and business associates exemption – the OSC recognizes it would be beneficial for Ontario's SMEs to have greater access to capital from their network of family, friends and business associates. The OSC staff will consider adopting a broader family, friends and business associates exemption, based on Section 2.5 of NI 45-106, with the aim of substantially harmonizing the exemption across Canada. The OSC restated its concern that the exemption allows securities to be issued to an unlimited number of undefined "close personal friends" and "close business associates". To mitigate this concern, the OSC will consider if additional conditions, such as: (i) requiring relevant officers, directors and founders to certify the nature of their relationship with the issuer; and (ii) requiring the investor to sign a risk acknowledgment, could be added to the exemption.
- offering memorandum exemption – the OSC recognizes that as issuers develop and their need for capital increases, there is a concurrent need to access investors who can invest larger amounts of money. Such amounts are generally not available through crowdfunding or other early-stage prospectus exemptions. The OSC intends to propose an OM Exemption in Ontario that is substantially harmonized with the existing Alberta offering memorandum model.
- streamlined rights offering exemption and possible exemption based on a reporting issuer's continuous disclosure and existing security holder base – the OSC is currently considering the following two proposals.
Amendments to streamline the rights offering prospectus exemption
Section 2.1 of NI 45-106 allows an issuer to distribute rights to acquire its securities to the issuer's existing security holders subject to the following conditions: (i) the issuer must send to its security holders a rights offering circular; (ii) the issuer cannot issue more than 25% of the number of outstanding securities in the class of securities to be issued under the offering; and (iii) restrictions on the time period for the exercise of rights prescribed. The TMX recommended the following amendments to the rights offering exemptions: (i) reducing the CSA review period for a rights offering circular from ten days to three business days; (ii) removing the 25% dilution ceiling for rights offering on the basis that prospectus-level disclosure is not necessary for existing security holders who are already familiar with the issuer and can access the issuer's continuous disclosure on SEDAR; (iii) reducing the minimum period during which rights must be exercisable from 21 days to 10 business days on the basis that existing security holders do not need 21 days to make an informed investment decision as they are also familiar with the issuer and the investment decision of a secondary market purchaser is not primarily based on receipt of a disclosure document; and (iv) allow for electronic delivery of documents to reduce time and cost. The OSC stated that it will work with other CSA members to determine if the efficiency and effectiveness of the existing rights offering exemption can be improved.
Prospectus exemption for existing security holders of a listed issuer
The OSC is currently considering an existing security holder exemption. The key elements of this exemption are: (i) an issuer listed on a recognized stock exchange would be permitted to issue its securities to its current security holders on a private placement basis subject to certain terms and conditions; (ii) a security holder would have to have held the issuer's listed securities for at least 60 days prior to execution of a subscription; (iii) a security holder could purchase up to $10,000 of the issuer's securities in a 12 month period; (iv) eligible securities would include those of the class that were listed, securities that were convertible into listed securities, preferred shares and non-convertible debt securities; (v) dilution would be limited as contemplated by the current exchange rules for private placements, which differ depending on whether the issuer is listed on the TSX or TSX Venture Exchange; and (vi) a listed issuer would have to be in good standing under securities laws. The OSC stated they will consult with other CSA members to determine whether there is a need to develop a separate exemption for distributions to an issuer's existing security holders.
Exemptions no longer being considered
The Progress Report identifies the following exemptions that will not be considered by the OSC going forward:
- investor sophistication exemption - an exemption proposed for investors who have investment knowledge but do not qualify for the accredited investors exemption.
- registrant advice exemption - an exemption proposed for investors that have an ongoing relationship with the investment dealer or advice from the investment dealer in respect of the distribution.
- changes to the existing private issuer exemption – a proposal to re-consider the 50 security holder limit of the private issuer exemption and amend the exemption accordingly.
- re-introduction of the closely-held issuer exemption – a proposal to re-introduce an exemption, previously in force from 2001 to 2005, which allowed issuers to raise a specified amount of money from a specified number of investors, without requiring the investors to meet certain qualifications that would be required under the private issuer exemption.
The OSC is not going forward with these exemptions because it has only observed limited support for them in the feedback that it has received.
The OSC is in the process of completing a broad review of the exempt market, specifically to consider whether any new prospectus exemptions should be implemented in response to recent market changes. So far, the OSC has confirmed that there is a need to facilitate capital raising for SMEs through expanded prospectus exemptions. In the Progress Report the OSC lists the following four prospectus exemptions as exemptions they are going to consider implementing: (i) crowdfunding; (ii) family, friends and business associates; (iii) offering memorandum; and (iv) streamlined rights offering 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.
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