Members of the Canadian Securities Administrators (the CSA) have proposed further changes to the regulation of the exempt market, including significantly increased reporting obligations for exempt market distributions and new exemptions. In particular, the Ontario Securities Commission (the OSC) has proposed four new prospectus exemptions, including:
- an offering memorandum exemption;
- a friends, family and business associates exemption;
- an existing security holding exemption; and
- a crowdfunding exemption.
The first three proposed exemptions are variants of exemptions that are currently in force in other jurisdictions, with different terms. As described below, some of the differences between the Ontario proposals and the existing exemptions will be resolved by proposed amendments in certain jurisdictions. In addition, the proposed crowdfunding exemption is also being proposed in other jurisdictions, along with an alternative that includes an exemption from the registration requirements.
In addition, new risk acknowledgment forms are proposed with prescribed wording for certain of the new exemptions which will be required to be obtained from investors and retained by the issuers relying on these exemptions.
The new exemptions proposed by Ontario will not be available to investments funds. This exclusion appears to be based on the fact that Ontario is considering investment funds separately and may not reflect a policy-based decision.
Although the proposals, taken together, bring a greater degree of harmonization to the exempt market, significant local differences remain between the exemptions available the Canadian jurisdictions which will continue to complicate exempt offering conducted in more than one jurisdiction.
INCREASED REPORTING OBLIGATIONS (ONTARIO, ALBERTA, SASKATCHEWAN, NEW BRUNSWICK AND BRITISH COLUMBIA)
Under the proposed amendments, issuers will be required to use a combination of four reporting forms, depending on the prospectus exemption relied on and the jurisdictions involved. A specific form is required for exempt distributions in British Columbia (Form 45-106F6). Distributions in Alberta, New Brunswick, Ontario and Saskatchewan will be reporting on two forms (Form 45-106F10 for investment funds and Form 45-106F11 for all other issuers). The distributions in the remaining jurisdictions will continue to be reported on the existing form (Form 45-106F1). Accordingly, distributions in multiple jurisdictions will potentially involve filing of up to three different forms, with detailed information regarding the distribution. The reporting forms for British Columbia, Alberta and New Brunswick and Ontario include additional detail regarding the distribution, any compensation paid in connection with the distribution and the purchasers of securities.
In Ontario, the filings must be entered through the OSC's online filing system, which includes spreadsheets for the investor information.
In Alberta, New Brunswick, Ontario and Saskatchewan, the exception that allows investment funds to file reports of exempt distributions on an annual basis, rather than in connection with each distribution, will be revised to require that filings be made on a quarterly basis. This may result in an increase in filing fees for some investment funds, as certain jurisdictions require fees on a per-filing basis.
OFFERING MEMORANDUM EXEMPTION (ONTARIO, NEWFOUNDLAND AND NEW BRUNSWICK, WITH ELEMENTS ADOPTED IN ALBERTA, SASKATCHEWAN AND QUEBEC)
The OSC is proposing an offering memorandum exemption (the OM Exemption) that is modelled on the version of the exemption currently in force in Alberta, with some significant differences.
Most notably, if a non-reporting issuer relies on the exemption it will be required to provide ongoing disclosure to investors (and the securities regulators) including audited annual financial statements, disclosure of the use of proceeds raised in distributions under the OM Exemption and notice within 10 days of: fundamental changes in its business; significant changes in its capital structure; a major reorganization, amalgamation or merger; a take-over bid or issuer bid involving the issuer; a significant acquisition; or changes in its directors or executive officers.
The proposed OM Exemption:
- is not available for the distribution of complex of novel securities;
- is not available to investment funds;
- is subject to investment limits of $10,000 per calendar year for investors that do not meet the definition of an "eligible investor" and $30,000 per calendar year for investors that do meet this threshold but are not accredited investors, where an "eligible investor" includes investors that: have net assets of $400,000 ($250,000 for individuals), have net annual income of $75,000 (or $125,000 with spouse) in the last 2 years and a reasonable expectation of exceeding that level in the current year, or are receiving advice from an investment dealer;
- requires that a risk acknowledgment form (Form 45-106F13) must be obtained from each investor and retained for eight years;
- requires that the existing form of offering memorandum must be provided to investors and delivered to the OSC;
- requires that any marketing materials used in connection with the distribution be incorporated in the offering memorandum;
- provides investors with rights of action for damages or rescission in the event the offering memorandum (including any marketing materials incorporated in the offering memorandum) contains a misrepresentation; and
- is subject to a two day right of withdrawal for investors.
Any securities issued pursuant to this exemption would be subject to the typical indefinite hold period for non-reporting issuers and 4 month holder period for reporting issuers.
Proposed amendments to the version of the OM Exemption that is in force in Alberta, Saskatchewan and Quebec would adopt elements of the Ontario OM Exemption, including:
- the annual limits on investments by individual pursuant to the offering memorandum exemption;
- the requirement that all marketing materials relating to a distribution under an offering memorandum be incorporated by reference and subject to rights of action in the event of a misrepresentation; and
- the requirement that an issuer provide ongoing annual audited financial statements and specified disclosure of its use of proceeds.
Proposed amendments to the exemption in force in New Brunswick will substantially harmonize the offering memorandum with the Ontario model.
FRIENDS, FAMILY AND BUSINESS ASSOCIATES EXEMPTION (ONTARIO)
The OSC is also proposing a prospectus exemption for friends, family and business associates of directors, executive officers, control persons and founders of an issuer (the FFBA Exemption). The FFBA Exemption is based on the form of the exemption adopted in the other jurisdictions, but is subject to additional conditions, including:
- the issuer is not an investment fund;
- the security is one of a prescribed type (i.e., a common share, non-convertible preference share, security convertible into a common share or non-convertible preference share, non-convertible debt security, limited partnership unit, or flow-through share); and
- the person making the distribution must obtain a risk acknowledgement form (Form 45-106F12) signed by the purchaser and the individual that the purchaser has a relationship with.
In view of the fact that the FFBA Exemption is based on the existence of a close personal relationship with individuals involved with the issuer, no commission, finder's fee, referral fee or similar payment may be made in connection with the distribution and advertising to solicit purchasers is prohibited.
Any information provided to a purchaser will be subject to statutory rights of damages or rescission in the event that such information contains a misrepresentation.
Proposed amendments to the Companion Policy provide guidance for determining whether a close personal relationship exists and indicates that the onus is on the issuer to make the determination.
EXISTING SECURITYHOLDER EXEMPTION (ONTARIO)
The OSC also published for comment a proposed capital raising prospectus exemption for existing securityholders of a reporting issuer (the Existing Securityholder Exemption), which is available to an investor who holds an issuer's security that is listed on one of the Toronto Stock Exchange, the TSX Venture Exchange, or the Canadian Stock Exchange (the Listed Security), however acquired.
While the OSC stated that they were aiming to facilitate harmonization by modeling their exemption on a similar exemption enacted by the majority of the CSA on March 13, 2014 (see our bulletin on the adopted exemption here), there are some material differences between the two forms of exemption. Specifically: (i) the Existing Securityholder Exemption is not available for use by investment funds; (ii) the Existing Securityholder Exemption is limited to a maximum of 100% of the then outstanding securities of the class being offered; and (iii) subscribers using the Existing Securityholder Exemption are initially limited to subscribe for a maximum of their pro rata portion of the outstanding securities being offered based on their existing holdings (but the issuer has the discretion to allocate any portion of the offering not taken up to other existing securityholders). The Existing Securityholder Exemption otherwise substantially follows the requirements of the similar exemption adopted by other members of the CSA.
In essence, the Existing Securityholder Exemption closely resembles a rights offering, albeit without the requirement for a rights offering circular or prospectus. The Existing Securityholder Exemption does not lend itself to allowing an issuer to raise funds in the short order, as practically an issuer must allow sufficient time between announcement and closing for the holders of the Listed Security to receive and review the press release, contact the issuer to demonstrate their interest, to receive and complete the relevant subscription documentation, and then potentially make an additional offer to interested securityholders for any pro rata portion of the Listed Securities not otherwise taken up.
Any securities issued pursuant to the Existing Securityholder Exemption would be subject to a 4-month hold period, and the issuer would be required to file a report of exempt distribution within 10 days of completion of the offering.
CROWDFUNDING (ONTARIO, QUÉBEC, MANITOBA, NEW BRUNSWICK, NOVA SCOTIA, SASKATCHEWAN)
The securities regulators in Ontario, Québec, Manitoba, New Brunswick and Nova Scotia (the Crowdfunding Regulators) proposed a new prospectus exemption for "crowdfunding" (the Crowdfunding Exemption). Crowdfunding is a term that describes raising small amounts of money from many people, usually over the internet. It's currently used most often as a source of funding for charities, without the issuance of securities. However, the Crowdfunding Regulators consider this a viable alternative for start-up and small and medium enterprises to raise capital through the issuance of securities.
The United States Securities and Exchange Commission and the securities regulator in Saskatchewan have already adopted rules to permit crowdfunding. Other jurisdictions, such as British Columbia, are seeking comment from the investment industry with respect to whether there is an appetite for adopting a crowdfunding exemption in their local jurisdiction.
The Crowdfunding Exemption proposed by all of the Crowdfunding Regulators is a prospectus exemption, that also involves using a crowdfunding portal (the Portal).
Crowdfunding Prospectus Exemption
In order to make use of the Crowdfunding Exemption, the issuer must be incorporated or organized in Canada, with a head office and the majority of its directors resident in Canada. Investments funds will not be permitted to rely on the Crowdfunding Exemption. The offering can only be for a specific list of types of securities.
The Crowdfunding Exemption can only be used for offerings of up to an aggregate of $1.5 million in any 12 month period by the issuer or any other issuer in common enterprise with the issuer. The offering cannot remain open for more than 90 days. The issuer has to disclose the minimum offering size and, if applicable, a maximum offering size, and cannot complete the offering until the minimum offering size is met and the issuer, after completing the offering, has confirmed it has sufficient financial resources to achieve its next milestone in its written business plan or, if no milestones, to complete the activates set out in the business plan.
Any offering documents must be posted only on the Portal, and has to be filed with the securities regulator concurrently with delivery to investors. Specific solicitation is not permitted, but an issuer can advertise in paper or through social media.
Each investor is limited to investing $2,500 per offering, and $10,000 in aggregate using this exemption in any calendar year. Neither the Portal nor the issuer can lend subscription funds to investors. Investors will be required to complete a risk acknowledgment form with respect to their investment.
Issuers must grant rights of action with respect to misrepresentation in any of its offering materials (if not statutorily imposed already), and permit investors with 48 hours to withdraw their proposed investment offer. All securities issued using the Crowdfunding Exemption will be subject to a 4 month hold period (for reporting issuers) or for an indefinite period for non-reporting issuers), and issuers must file a report of exempt distribution within 10 days of the distribution.
In addition, while reporting issuers using the Crowdfunding Exemption are required to comply with their continuous disclosure obligations under securities laws, non-reporting issuers who wish to use the Crowdfunding Exemption will have disclosure and record keeping requirements imposed on them. Specifically, non-reporting issuers must annually provide investors with annual financial statements (audited if the issuer has raised more than $500,000 using the Crowdfunding Exemption, or has spent more than $150,000 since its formation, otherwise reviewed), a notice describing how the funds raised using the Crowdfunding Exemption has been used, and certain other disclosure. The non-reporting issuer must also keep a record of all offering materials used for the Crowdfunding Exemption, completed risk acknowledgment forms, all of its annual disclosure documents, a list of each of the securities issued using the Crowdfunding Exemption and their issue price and date, and a list of all securityholders and the securities that they hold of the issuer.
Crowdfunding Portal Requirements
In order to make use of the Crowdfunding Exemption, an issuer has to ensure that investments are made through a funding portal registered under applicable securities laws, as a restricted dealer. Portals will be restricted from being registered in any other category of dealer.
Generally speaking, a Portal will have to comply with the general registrant obligations that are imposed on exempt market dealers, though there are certain differences. Portals will have to conduct background checks on issuers, directors, officers, promoters and control persons. They will also have to understand the general structure and terms of the securities offered. They will have to use this understanding to review and confirm the adequacy of the offering material that will be provided to potential investors under the Crowdfunding Exemption. If a Portal considers that an issuer or its offering is fraudulent, the Portal will be required to deny access the issuer.
A Portal is prohibited from providing specific recommendations or advice to investors about securities being offered on their platform and, other than through postings on its platform, cannot solicit purchases or sales of securities offered on their platform nor can they compensate employees for doing so. A Portal is restricted from holding investor funds or securities as well. A Portal cannot invest in any issuer or underwrite any issuer, other than through the receipt of fees in the form of securities that do not exceed a 10% ownership in the issuer.
Crowdfunding Prospectus and Registration Exemption (Québec, Manitoba, New Brunswick, Nova Scotia, Saskatchewan)
The Crowdfunding Regulators, other than Ontario, have also proposed an exemption from both the prospectus and registration requirements (the Start-up Exemption).
The Start-up Exemption closely mirrors the Crowdfunding Exemption, except that it is only available to non-reporting issuers, does not require the use of a Portal, and has lower investment thresholds. For example, in Manitoba the Start-Up Exemption is limited to a maximum offering threshold of $150,000, and $1,500 per individual.
The exemptions and reporting obligations described above are only in draft form, and are subject to comment from interested parties. The comment period is open until June 18, 2014. In addition, there are specific questions the CSA has set out in the notice, which is available here.
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.