On December 5, 2013, the Canadian Securities Administrators (the CSA) proposed certain changes to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) and other rules, including a proposal to prohibit exempt market dealers (EMDs) from participating in prospectus offerings (the Proposed Amendments). I was privileged to Chair the Comment Committee of the Private Capital Markets Association of Canada (formerly, the Exempt Market Dealers Association of Canada) (PCMA Canada) that submitted a comment letter to the CSA that discussed, among other things, the Proposed Amendments.
"PCMA Canada is a not-for-profit association founded in 2002 to be the national voice of exempt market dealers, issuers and industry professionals in the private capital markets across Canada."
Below is an extract from PCMA Canada's comment letter about EMDs and prospectus offerings. A copy of PCMA Canada's comment letter is available on the Ontario Securities Commission's website here.
EXEMPT MARKET DEALERS and PROSPECTUS OFFERINGS
"PCMA Canada submits that EMDs provide a valuable capital raising function in the private capital markets and should continue to be allowed to participate in a prospectus offering. Under the Proposed Amendments, the CSA seeks to amend Section 7.1(2)(d)(i) of NI 31-103 and prohibit EMDs from participating in prospectus offerings by deleting language that had commonly been interpreted as permitting EMDs to participate in a prospectus offering (e.g., initial and subsequent public offerings or continuously offered investment funds). The deleted language is set out below.
7.1(2)(d)(i) an exempt market dealer may act as a dealer by trading a security that is distributed under an exemption from the prospectus requirement, whether or not a prospectus was filed in respect of the distribution."
We respectfully request that the CSA reconsider its proposed amendment to Section 7.1(2)(d)(i) of NI 31-103 for the reasons set out below.
EMDs are not statutory "underwriters" if they participate in a prospectus offering as selling group members of an underwriting syndicate
When invited to participate in an underwriting syndicate, EMDs typically assume the role of a "selling group member". As a selling group member, an EMD is discharging a critical function in the offering process, but is not acting as an underwriter and does not sign the prospectus. A "selling group member" is specifically carved-out of the definition of "underwriter" under, for example, the Ontario Securities Act which explicitly states that an "underwriter",excludes:
"a person or company whose interest in the transaction is limited to receiving the usual and customary distributor's or seller's commission payable by an underwriter or issuer" (the Selling Group Member Carve-Out).
Evidence of EMDs acting as underwriters and selling group members in prospectus offerings
Prior to September 29, 2009 and the implementation ofRegistration Reform, we understand that some limited market dealers (LMDs) acted as underwriters and/or were selling group members in connection with prospectus offerings, such as special warrant financings. In contrast to EMDs today, LMDs were not subject to any proficiency, insurance, capital or other requirements, and yet were allowed to act as underwriters or were selling group members in connection with special warrant prospectus offerings. EMDs today are a highly regulated category of dealer and subject to the direct and active oversight by the CSA and its members, as we have described earlier in this comment letter.
After September 29, 2009, we understand that EMDs have entered into selling group arrangements as selling group members with IIROC dealers (being registered investment dealers and members of the Investment Industry Regulatory Organization of Canada) in connection with prospectus offerings.
No evidence of investor harm
EMDs provide an important distribution channel, as well as a source of information, support and guidance, for issuers in the private capital markets, including small and medium-sized enterprises (SMEs), and accordingly, we submit that EMDs should be able to sell any type of security as a selling group member, whether or not it is offered under a prospectus, provided they restrict their sales to accredited investors. The CSA has not provided any evidence of investor harm where EMDs participate as selling group members in a prospectus offering, and we submit that, in the absence of such evidence, the CSA's restrictive proposal runs contrary to the principle of evidenced-based regulation and the CSA's broadly stated public policy goal of supporting capital raising. PCMA Canada recommends that the CSA continue to allow EMDs to participate as selling group members in a prospectus offering.
EMDs participate as selling group members to provide continuity to early stage issuers and their investors
EMDs and their investors are a critical source of early-stage growth capital for SMEs, including those in the mining, oil and gas and technology sectors, through private placements and other alternative financing stages. This type of capital formation is crucial to our economic development and it should continue to be supported and encouraged by the CSA through its regulatory framework.
When a nascent issuer reaches the stage in its lifecycle when it is able to access the public capital markets and undertakes a prospectus offering, investors and issuers alike may place considerable value on the continued participation by the EMD who supported the issuer's early growth as a private company. Companies with small market capitalizations in particular are heavily reliant on continued access to capital markets through the services provided by EMDs. These issuers, and other stakeholders, also benefit from having more dealers participating in the underwriting syndicate, particularly at the co-manager and selling group level.
PCMA Canada respectfully submits that it would be counterproductive to the capital raising process that, after nurturing the issuer's growth, sometimes over a period of years, an issuer should be denied the ability to appoint its EMD to participate in this milestone financing event; especially when that EMD and its investors played a critical role in an issuer's past financings and success. Not all issuers succeed, but when they do, it is customary and appropriate for the EMD that helped such an issuer raise early-stage capital to be formally recognized for those efforts, and to be financially compensated. An important component of that compensation is afforded by way of being granted a position, albeit a junior position, in the underwriting syndicate as a selling group member.
Three ways EMDs can participate in a prospectus offering
PCMA Canada submits that EMDs should be able to participate in a prospectus offering by:
- selling prospectus-offered securities directly to accredited investors;
- entering into a referral arrangement with an IIROC dealer in compliance with NI 31-103 (a Referral Arrangement); and
- earning a fee for providing prior and/or ongoing advisory and support services to the issuer or IIROC dealers (an Advisory Fee), as part of a selling group.
For the reasons stated below, PCMA Canada strongly believes that the CSA should allow EMDs to participate in prospectus offerings as selling group members, as previously allowed and consistent with past practices, before and after Registration Reform.
1) EMDs selling to accredited investors
PCMA Canada submits that EMDs should be able to continue to sell prospectus qualified securities to accredited investors and be part of the selling group. We submit that it is not clear, on a policy basis or practical basis, why an EMD can sell a security to an accredited investor under a prospectus exemption but not under a prospectus as a selling group member; especially when accredited investors are assumed to have a certain level of sophistication and the ability to withstand financial loss and the presence of the prospectus enhances the investor protection.
EMDs effectively can participate as a selling group member today by "wrapping" the prospectus in an offering memorandum and distributing the securities under an exemption, such as the accredited investor or offering memorandum exemption under sections 2.3 and 2.9 respectively of National Instrument 45-106 – Prospectus and Registration Exemptions (NI 45-106).
PCMA Canada submits that the requirements that are typically involved in a private placement offering, such as resale restrictions and form filing and fee payment requirements should not apply when a prospectus has been filed for that security. PCMA Canada believes that satisfaction of private placement requirements when selling securities to accredited investors despite a prospectus being available imposes an unnecessary administrative burden on issuers and EMDs, and arguably investors are worse off in such circumstances for several reasons:
- First, a report of exempt trade should not be required since a prospectus distribution report and activity fee is already paid in connection with a prospectus offering. To require another filing and payment of fees would be an unnecessary duplication of information and fees with no public benefit.
- Second, a prospectus should not be required to be filed as an "offering memorandum" as required in a private placement since the prospectus is already filed on SEDAR and publicly available and provided to the investor.
- Third, a prospectus provided to investors as an "offering memorandum" should not be required to provide different statutory rights of action applicable pursuant to those required for an offering memorandum since these rights ultimately provide investors with less protection that the statutory rights of action an investor receives in connection with a prospectus offering.
- Fourth, investors should receive free-trading shares similar to those received by other investors who purchased securities through an IIROC dealer. Investors should not be subject to a four-month resale restriction, as would typically be required when they purchase securities of a reporting issuer sold on a private placements basis.
2) EMDs and Referral Arrangements
PCMA Canada submits that EMDs should be able to enter into a Referral Arrangement with an IIROC dealer in connection with a prospectus offering. The IIROC dealer would be responsible for all of its "know-you-product", "know-your-client" and suitability obligations in connection with the sale of such prospectus-qualified securities to qualified investors and not the EMD. The referral fee would be an amount negotiated between the EMD and IIROC dealer.
3) EMDs and Advisory Fees
PCMA Canada submits that EMDs who have provided prior support of an issuer in early stage financings or for other commercial reasons as negotiated between the IIROC dealer and EMD, should be able to receive part of the aggregate selling commission in connection with a prospectus offering, even if no securities are sold by an EMD to any investors. This Advisory Fee would be an amount negotiated between the EMD and the issuer and/or IIROC dealer.
II EMDs SHOULD BE ABLE TO SELL PROSPECTUS-QUALIFIED MUTUAL FUNDS
Section 7.1 of the Companion Policy to NI 31-103 currently states that
"EMDs can sell investment funds (whether or not they are prospectus-offered) under prospectus exemptions without registering as a mutual fund dealer or being a member of the MFDA [Mutual Fund Dealers Association of Canada]."
Proposed Section 7.1(2)(d)(i) of NI 31-103 would appear to prohibit EMDs from selling prospectus-offered mutual funds since the Proposed Companion Policy related to this section adds language that states that
"exempt market dealers are not permitted to participate in a distribution of securities offered under a prospectus".
On its face, this language is overly broad and potentially impacts the interpretation of Proposed Section 7.1(2)(d)(i) of NI 31-103, which expressly acknowledges that EMDs may sell prospectus-offered mutual funds.
Unexplained removal of language about EMDs selling investment funds without registering as a mutual fund dealer or being a member of the MFDA
It is unclear why the CSA struck the language in Section 7.1 of the Companion Policy to NI 31-103 that states that EMDs can sell investment funds without registering as a mutual fund dealer or being a member of the MFDA. Is this drafting change to the Companion Policy intended to restrict EMDs and give effect to a new registration requirement? If the CSA is intending a policy change we believe this matter should be more specifically addressed.
We strongly believe that EMDs selling prospectus-qualified mutual funds should not be required to be registered as a mutual fund dealer or be a member of the MFDA as has been the policy of the CSA for some time. Accordingly, PCMA Canada respectfully requests the CSA reintroduce this language back to the Companion Policy to remove any doubt about CSA policy. We note the lack of corresponding commentary in the Proposed Amendments to explain such a change and therefore, we must conclude that no such fundamental policy change was in fact intended."
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Co-Authors – I would like to thank my co-authors and fellow directors at PCMA Canada who participated in preparing the Comment Letter: David Gilkes (Vice Chair), Geoff Ritchie (Executive Director), Marsha Gerhart (Director) and Conan McIntyre (Director).
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