Canada: CSA Proposes Amendments To The Accredited Investor And Minimum Amount Prospectus Exemptions: Additional Requirements And Narrowed Availability

On February 27, 2014, the Canadian Securities Administrators (the "CSA") released a number of proposed amendments to National Instrument 45-106 – Prospectus and Registration Exemptions. The most significant changes for issuers and investors are those to the two most commonly used exemptions, the accredited investor exemption (the "AI Exemption") and the $150,000 minimum amount exemption (the "MA Exemption"). The amendments to the AI Exemption would principally require that individual investors be presented with, and complete and sign a new risk acknowledgement form, however the income and asset thresholds would remain the same.  The amendment to the MA Exemption would remove the ability for individual investors to rely on this exemption.

The CSA proposed these amendments in order to address concerns that some individual investors may not understand the risks of investing under the AI Exemption or may not in fact qualify as accredited investors and that the threshold of $150,000 in the MA Exemption may not be an accurate measure of the sophistication of individual investors or their ability to withstand financial loss.  The proposed amendments also provide much stricter guidance related to the procedures that issuers/sellers are required to take in order to verify the status of individual accredited investors to ensure that they in fact qualify under the particular exemption relied upon.

The Accredited Investor Exemption

The CSA has proposed the following amendments to the AI Exemption which would create additional requirements in documenting offerings made to such investors:

  • Individual accredited investors (other than those individuals qualifying under a new "permitted client" category) would be required complete and sign a new risk acknowledgement form, Form 45-106F9 – Risk Acknowledgement Form for Individual Accredited Investors (the "Risk Acknowledgement"), which describes, in plain language, the categories of individual accredited investor and the protections an investor is renouncing by purchasing under the exemption. The investor would be required to indicate on the Risk Acknowledgement which category of accredited investor they satisfy.
  • Individual accredited investors who meet a new accredited investor category on the basis of owning financial assets in excess of $5 million would also meet the "permitted client" test under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations and would not be required to complete and sign a Risk Acknowledgement.
  • Any salesperson or finder, whether registered or not, involved in the trade to the individual accredited investor would be required to complete and sign the Risk Acknowledgement.
  • Guidance on the steps issuers should take to verify accredited investor status, including explaining the different tests and asking questions to obtain factual information from purchasers about their income or assets before discussing the investment.
  • The definition of accredited investor would be amended to include family trusts established by an accredited investor for his or her family, provided the majority of trustees of the family trust are accredited investors.
  • The Ontario Securities Commission proposes to amend the definition of accredited investor to allow registered advisers of fully managed accounts to purchase investment fund securities in Ontario, which if implemented, would harmonize the managed account category of the AI Exemption across Canada

The requirements related to explaining, delivering, completing and signing the Risk Acknowledgement are stringent.  The following requirements would apply to the Risk Acknowledgement form:

  • it must be printed on one double-sided page;
  • each of the investor, the issuer and salesperson (if any) must sign 2 copies of the form;
  • each of the investor and issuer must receive a copy of the signed form;
  • the salesperson (if any) must ensure that the purchaser and the issuer receive originally signed copies; and
  • the issuer is required to retain a copy of the form for at least 8 years after the distribution. 

It is unclear whether a Risk Acknowledgement form  is permitted to be signed in counterparts and there does not currently seem to be an accommodation for the provision of electronic or PDF copies of such form in the case of the involvement of a salesperson in the distribution.

Proposed amendments to the Companion Policy 45-106CP – Prospectus and Registration Exemptions stipulates that the responsibility for determining when and if an exemption is available lies with the person distribution or trading the securities and that simply relying on standard representations in a subscription agreement will not suffice unless such person has taken reasonable steps to verify the representations. The types of steps that are considered to be reasonable will depend on the particular facts and circumstances and the exemption being relied upon, but may involve asking a purchaser additional questions about their past net income and expectations of future incomes. It would be the responsibility of the person relying on the exemption to determine what sort of documentation should be collected and retained to evidence that the appropriate procedures have been followed to verify that the purchaser has met the conditions of the exemption and may include requesting copies of documents such as income tax returns, bank statements, investment statements, tax assessments or appraisal reports issued by independent third parties.

The Minimum Amount Exemption

The MA Exemption is the second most frequently relied upon prospectus exemption, however, investments falling under this category accounted for only 1% of all distributions to Canadian investors.

The proposed amendment to permit only non-individual investors to rely on the MA Exemption is meant to deal with concerns that: (a) the MA Exemption is often relied upon despite the investment clearly not being suitable for an investor; (b) individual investors are being encouraged to borrow funds in order to qualify for the MA Exemption where other exemptions such as the accredited investor exemption are unavailable; and (c) individual investors are being pressured to invest $150,000 when they would rather invest less.

Exempt Distribution Reports

In addition to the above noted changes to the AI and MA Exemptions, the CSA recommends several changes regarding the reporting requirements on the Form 45-106F1 – Report of Exempt Distribution ("Form 45-106F1") which is intended to assist regulators in verifying compliance with the new rules. Under the revised Form 45-106F1, issuers would have to disclose each category of accredited investor relied upon by each purchaser, rather than just the exemption relied upon under NI 45-106 and provide additional information on any person receiving compensation in connection with the distribution, including whether such person being compensated is an insider of the issuer or a registrant and the specific purchasers in connection with which it is receiving compensation. 

The CSA acknowledges that the proposed amendments and the additional requirements related to the collection of the Risk Acknowledgement, the verification of a purchaser's exempt status and the completion of Form 45-106F1 may impose additional administrative burdens and costs to issuers, sellers and registrants, but have determined that such costs are anticipated to be limited and are outweighed by the added investor protections afforded by the proposed amendments.

The CSA welcomes comments on the proposed amendments and will be accepting submissions from interested parties until May 28, 2014.

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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Sean Williamson
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