On March 20, 2014, the Ontario Securities Commission (OSC) published for comment proposed rules for four new exemptions to the prospectus requirement:
- an offering memorandum prospectus exemption (OM Exemption)
- a family, friends and business associates prospectus exemption (FFBA Exemption)
- an existing security holders prospectus exemption (Existing Holders Exemption)
- a crowdfunding prospectus exemption (Crowdfunding Exemption)
The proposed exemptions are intended to facilitate the ability of both reporting issuers (i.e. public entities) and non-reporting issuers (i.e. private entities) to raise capital from potential investors in Ontario without having to file a prospectus.
The new exemptions are the result of the OSC expanding the scope of an exempt market review initially focused on the accredited investor and minimum amount investment prospectus exemptions, to one focused on facilitating greater access to capital, particularly for start-ups and small and medium-sized businesses, at different stages in their growth and business cycles.
Comments on the proposed exemptions must be received by the OSC by June 18, 2014.
Key Features of the Proposed Exemptions
A summary of the OSC's proposed new exemptions, and a discussion of similar proposals in a number of other Canadian jurisdictions, follows. We should note, however, that due to the potential interest of these prospectus exemptions (and exempt market reform more generally) to issuers and their counsel, we anticipate that the OSC's invitation for comment on these latest proposals could result in substantive differences between the exemptions in their current proposed form, and the form of the exemptions that are ultimately implemented by the OSC. We look forward to providing you with an overview of the final exemptions once implemented.
The OM Exemption would be available to reporting and non-reporting issuers and would allow businesses to raise capital based on an offering memorandum (rather than a prospectus) being made available to prospective investors. The OSC is currently proposing to harmonize the form of offering memorandum with that currently used in other Canadian jurisdictions.
The proposed rules place no limit on the amount of money an issuer can raise or the number of times an issuer can go to market, and place no limitations on the length of time an offering can remain open. However, notwithstanding an issuer's ability to raise an unlimited amount of money per offering pursuant to the OM Exemption, the OSC has proposed the following investment limits on investors who are individuals: (i) the amount an individual who does not meet the definition of "eligible investor" would be permitted to invest would be capped at $10,000 per year, and (ii) the amount an individual who does meet the definition of "eligible investor" would be permitted to invest would be capped at $30,000 per year. For those familiar with the existing criteria in certain other Canadian jurisdictions for determining whether an individual is, or is not, an "eligible investor," it is important to note that for purposes of the OM Exemption the calculation of the net asset test for individuals would exclude such individual's primary residence. However, the threshold amount of net assets would be reduced from $400,000 to $250,000. In addition, the OSC's proposal does not permit investment funds to rely on the exemption; certain specified derivatives and structured finance products cannot be distributed under the exemption; and investment dealers that are affiliates of the issuer are prohibited from participating in the distribution. The OSC is also proposing that marketing materials be incorporated by reference into the offering memorandum and be delivered to the OSC.
For non-reporting issuers, use of the OM Exemption would require the issuer to deliver to the OSC and make available to purchasers (for example, by placing them on a public website), audited annual financial statements within 120 days of the issuer's year-end, together with a notice disclosing the use of the aggregate proceeds raised by the issuer pursuant to the OM Exemption. In addition, non-reporting issuers would be required to notify their investors within 10 days of certain prescribed events, including significant changes to the issuer's business or capital structure, certain material transactions and changes in its directors and officers.
Provided the OM Exemption is implemented, Ontario would be the last of the Canadian jurisdictions to adopt an offering memorandum exemption. The OSC has based the OM Exemption on one of two existing prospectus exemptions in section 2.9 of National Instrument 45-106 – Prospectus Exemptions (NI 45-106), albeit with some key differences. In Alberta, for example, the current offering memorandum exemption is available for a distribution where the purchaser is an "eligible investor" or the acquisition cost does not exceed $10,000. In contrast to the Ontario proposal, the current regime in Alberta does not limit the amount an eligible investor can invest, does not require filing audited annual financial statements, does not prohibit the distribution of complex securities and does not require all marketing materials to form part of, and be incorporated by reference into, the offering memorandum.
Several other Canadian jurisdictions have published for comment proposed amendments to their offering memorandum exemptions, including New Brunswick, which has proposed to conform its existing offering memorandum exemption with the one proposed by the OSC. In addition, the securities administrators in Alberta, Quebec and Saskatchewan have recently proposed exemptions to their existing proposals, which differ somewhat from what the OSC is proposing. For example, these proposals do not contemplate changing the definition of "eligible investor," nor do they propose to prohibit the use of the offering memorandum exemption by issuers that are non-redeemable investment funds, mutual funds that are reporting issuers or investment dealers that are affiliates of the issuer.
The FFBA Exemption would be available to reporting and non-reporting issuers and would allow businesses to raise capital by tapping into their network of family, close personal friends and close business associates, without having to file a prospectus. The FFBA Exemption would also be available to a selling security holder if the conditions to the exception are met.
The proposed rules place no limit on the amount of money an issuer can raise or the number of times an issuer can go to market, and the proposed rules place no caps on the amount that any individual investor can invest. In addition, unlike the OM Exemption, which also applies to non-reporting issuers, it would not be a requirement for non-reporting issuers to provide ongoing disclosure to investors.
In connection with the proposal, the OSC proposes to provide expanded guidance on the meaning of close personal friend and close business associate; however, the onus to establish that a close relationship exists will be on the issuer. Interestingly, the OSC has noted that it will not generally consider an individual with whom a friendship is primarily founded on participation in an Internet forum or social media to be a close personal friend or close business associate.
The FFBA Exemption would not be available to investment funds or for distributions of novel or complex securities. Furthermore, under the FFBA Exemption, advertising to solicit investors would be prohibited, as would the payment of any commission, finder's fee or similar fee.
The FFBA Exemption is intended to provide start-ups and other early-stage issuers with better access to capital from their networks than is currently permitted under the existing founder, control person and family exemption in section 2.7 of NI 45-106. Implementation of the FFBA Exemption would repeal section 2.7 of NI 45-106 and would harmonize the FFBA Exemption with the existing friends, family and business associates exemption in section 2.5 of NI 45-106 already adopted by all other Canadian jurisdictions (except Saskatchewan).
Existing Holders Exemption
The Existing Holders Exemption would only be available to reporting issuers (other than investment funds) whose securities are listed on the Toronto Stock Exchange, the TSX Venture Exchange or the Canadian Securities Exchange. The exemption would allow a reporting issuer to raise capital from its existing security holders without a prospectus, provided the securities to be distributed pursuant to the exemption are either listed on one of the foregoing exchanges (or are units consisting of the listed security and a warrant to acquire the listed security), and the issuer has been a reporting issuer for at least a year. Pursuant to this exemption, the securities offered pursuant to the offering must be allocated among existing security holders on a pro rata basis, after which any securities not taken up by existing security holders can be allocated by the issuer, at its discretion, to its other existing security holders. It will be interesting to see how issuers will structure an offering in reliance on the Existing Holders Exemption, especially issuers that are relatively widely held.
The proposed rules place no limit on the number of times an issuer can go to market, however, the amount of money an issuer would be able to raise is limited by the fact that an offering cannot result in an increase of more than 100% of the outstanding securities of the same class being offered. Furthermore, unless an investor has obtained advice from an investment dealer (and if the investor is a Canadian resident, the investment dealer is registered as such in the applicable jurisdiction), the amount that an investor would be able to invest would be capped at $15,000 per year.
On March 13, 2014, each of the other Canadian securities regulators (except Newfoundland and Labrador) provided notice that they either have, or will adopt, an exemption similar to the Existing Holders Exemption. The exemption adopted by the other jurisdictions is similar to the one proposed by the OSC, except that it does not contain the obligation that an issuer has been a reporting issuer for at least a year; it is available to reporting issuers that are investment funds; and it does not contain the pro rata allocation requirement.
For a further discussion of the Existing Holders Exemption, please see our recent blog post, Prospectus Exemption for Distributions to Existing Security Holders – A New Tool for Reporting Issuers to Raise Equity.
The Crowdfunding Exemption would be available to reporting and non-reporting issuers and would allow issuers incorporated or organized and with head offices located in Canada and a majority of directors resident in Canada to raise capital pursuant to a proposed disclosure document called a "crowdfunding offering document," rather than a prospectus. The exemption would not be available to investment funds, to non-reporting real estate issuers or for distributions of novel or complex securities.
The proposed rules limit the amount of money that an issuer can raise to $1.5 million per year and place a limit on the length of time an offering can remain open to 90 days. In addition, the completion of an offering would be subject to a subscription for a minimum offering amount that must be disclosed in the offering document, and the issuer having sufficient financial resources to achieve the next milestone or activity set out in its business plan. The OSC has also proposed restrictions on solicitation and advertising, including how offering materials can be made available to potential investors through a "portal website." In addition, the OSC has proposed that the amount an investor would be able to invest is capped at $2,500 per offering and $10,000 per year.
For non-reporting issuers, use of the Crowdfunding Exemption would result in the issuer having to deliver to the OSC and make available to purchasers (for example, by placing them on a public website), audited annual financial statements within 120 days of the issuer's year-end, together with a notice disclosing the use of the aggregate proceeds raised by the issuer pursuant to the Crowdfunding Exemption. Disclosure of certain specified fundamental events would also be required.
A key aspect of the proposed regulatory framework regarding the Crowdfunding Exemption is the concept of a "crowdfunding portal" through which investments under the exemption must be made. The portals would have to comply with general registrant requirements applicable to exempt market dealers, with certain exemptions and would be prohibited from certain activities.
The Crowdfunding Exemption is substantially similar to the crowdfunding prospectus exemption proposed by the securities administrators in Quebec, Saskatchewan, Manitoba, New Brunswick and Nova Scotia. In addition, the securities administrators in these jurisdictions, together with British Columbia have also proposed a start-up crowdfunding prospectus exemption.
The proposed start-up crowdfunding exemption is aimed at earlier stage issuers and differs from the Crowdfunding Exemption in several key ways, including the following: (i) it is only available to non-reporting issuers; (ii) it has a lower maximum allowable investment of $1,500 per investor; (iii) it has a lower maximum offering of $150,000, and an issuer can only complete up to two offerings under this exemption per year; (iv) the issuer must provide a basic offering document to investors, but it is not required to include financial statements, and will not be subject to ongoing continuous disclosure requirements following the offering; (v) the online funding portal through which all investments must be made is not required to be registered as a dealer and is not subject to dealer qualification requirements; and (vi) the funding portal cannot hold or have access to investor funds.
The securities administrators in Quebec, Saskatchewan, Manitoba, New Brunswick and Nova Scotia have indicated that their proposed crowdfunding and start-up crowdfunding exemptions are intended to be complementary and to offer issuers at various stages of development the opportunity to raise financing. The securities commission in British Columbia has only proposed the start-up crowdfunding exemption, but has indicated that it will monitor the developments with respect to the more general crowdfunding exemption in other jurisdictions. The Alberta Securities Commission has not proposed either type of crowdfunding exemption, but will consider the public comments provided in the other jurisdictions.
For further information on the Crowdfunding Exemption, please see our recent blog post, OSC Publishes Progress Report on Exempt Market Review and Crowdfunding.
Implications of the Proposed Exemptions to Issuers
The Existing Holders Exemption and the Crowdfunding Exemption have been designed to further the OSC's objective of facilitating capital raising by start-ups and small to medium -sized businesses. In addition, the Crowdfunding Exemption will enable smaller investors to obtain equity stakes in start-ups rather than simply receiving rewards of products or services. It is the OM Exemption and the FFBA Exemption that will likely be most appealing to more seasoned issuers. In particular, the OM Exemption will be useful to reporting and non-reporting issuers looking to raise an unlimited amount of capital, over any length of time, from an undefined investor base, with the added benefit of higher caps on how much any one investor is able to invest than the amounts available under the Existing Holders Exemption and the Crowdfunding Exemption. The FFBA Exemption will be useful to reporting and non-reporting issuers looking to raise an unlimited amount of capital, over any length of time, from their internal networks, with the added benefit of there being no cap on the amount any one investor is able to invest.
From an administrative perspective it is worth noting that, together with the proposed exemptions, securities regulators (including the OSC) have also proposed changes to the post-offering reporting obligations, which would impose more cumbersome reporting obligations on issuers. In addition, in connection with offerings pursuant to the OM Exemption, the FFBA Exemption and the Crowdfunding Exemption, the OSC has proposed that issuers will be required to obtain a risk acknowledgment form from all investors who participate in an offering.
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