Canada: New Developments In Prospectus Exemptions To Enhance Opportunities For Raising Capital

Last Updated: March 2 2015
Article by Andre Garber and Jason A. Saltzman

On February 19, 2015, the Ontario Securities Commission (OSC) introduced a family, friends and business associates prospectus exemption and the Canadian Securities Administrators proposed amendments to the accredited investor, the short-term debt and the minimum amount investment prospectus exemptions. These developments are designed to make it easier for small- and medium-sized enterprises to raise investment capital. 

The family, friends and business associates exemption

On February 19, 2015, the OSC introduced a new prospectus exemption applicable to the distribution of securities to directors, executive officers, control persons or founders of an issuer, as well as certain family members, close personal friends and close business associates of such persons (the FFBA Exemption).1 The introduction of the FFBA Exemption follows up on the March 20, 2014 proposed amendments to NI 45-106 Prospectus and Registration Exemptions, among other instruments and rules, and their associated Companion Policies, which were published for comment by the OSC. The FFBA Exemption is substantially harmonized with similar exemptions available in other Canadian jurisdictions and has the potential to become an efficient and low-cost method for issuers to raise capital from investors in Ontario.

The FFBA Exemption permits issuers to distribute securities to the issuer's directors, executive officers, control persons and founders, as well as certain family members, close personal friends and close business associates of such persons without a prospectus, subject to a number of conditions. Subject to Ministerial approval2, with the introduction of the FFBA Exemption, the currently in force, "founder, control person and family exemption" in section 2.7 of NI 45-106 will be repealed.

General

The FFBA Exemption is available to both reporting and non-reporting issuers but, in Ontario, is not available to investment funds3. Subject to meeting the conditions of the FFBA Exemption, any type of security may be distributed under this exemption and there are no limits as to the size of the offering.  However, short-term securitized products (as defined in NP 45-106) may not be distributed under the FFBA Exemption. Furthermore, the use of registrants, finders or advertising, as well as payment of fees or commissions to any person to find purchasers may not be used with respect to the FFBA Exemption.4

Potential benefits of the FFBA Exemption to issuers include: (1) no investment limits for distributions; (2) no requirement for the issuer or the selling security holder to provide the investor with any disclosure at time of the distribution; (3) no right of withdrawal for investors; (4) no requirement for non-reporting issuers to provide any ongoing disclosure; and (5) no requirement to provide an offering memorandum.6 However, securities provided under the FFBA Exemption are subject to resale restrictions. Depending on conditions, securities of a reporting issuer are subject to a four month hold period and securities of a non-reporting issuer are subject to an indefinite hold period and can only be resold under a prospectus or another prospectus exemption. Issuers distributing securities under the FFBA Exemption must file Form 45-106F1 Report of Exempt Distribution within 10 days of the distribution together with the requisite filing fees.

Qualifications

As set out in subsection 2.5(1) of NI 45-106, the FFBA Exemption is available for distributions to directors, executive officers, control persons and founders of the issuer, as well as family members, close personal friends and close business associates of directors, executive officers, control persons or founders of the issuer. The issuer relying on the exemption is responsible for determining whether the terms and conditions of the exemption are met. As such, the following guidance is provided in the Companion Policy to NI 45-106 with respect to the qualification criteria for close personal friends and close business associates.

Close business friend

A "close personal friend" of a director, executive officer, founder or control person of an issuer is an individual who knows the director, executive officer, founder or control person well enough and has known them for a sufficient period of time to be in a position to assess their capabilities and trustworthiness and to obtain information from them with respect to the investment. An individual is not a close personal friend simply because the individual is: (1) a relative, (2) a member of the same club, organization, association or religious group, (3) a co-worker, colleague or associate at the same workplace, (4) a client, customer, former client or former customer, (5) a mere acquaintance, or (6) connected through some form of social media, such as Facebook, Twitter or LinkedIn. The relationship between the individual and the director, executive officer, founder or control person must be direct; it is insufficient, for example, for the individual to be a close personal friend of a close personal friend of a director of the issuer.

The factors that are relevant in determining the eligibility of a "close personal friend" include:

  1. the length of time the individual has known the director, executive officer, founder or control person;
  2. the nature of the relationship between the individual and the director, executive officer, founder or control person including such matters as the frequency of contacts between them and the level of trust and reliance in those previous circumstances; and
  3. the number of "close personal friends" of the director, executive officer, founder or control person to whom securities have been distributed in reliance on the private issuer exemption or the family, friends and business associates exemption.

Close Business Associate

A "close business associate" is an individual who has had sufficient prior business dealings with a director, executive officer, founder or control person of the issuer to be in a position to assess their capabilities and trustworthiness and to obtain information from them with respect to the investment. An individual is not a close business associate simply because the individual is: (a) a member of the same club, organization, association or religious group, (b) a co-worker, colleague or associate at the same workplace, (c) a client, customer, former client or former customer, (d) a mere acquaintance, or (e) connected through some form of social media, such as Facebook, Twitter or LinkedIn.

The factors that are relevant in determining the eligibility of a close business associate include:

  1. the length of time the individual has known the director, executive officer, founder or control person;
  2. the nature of any specific business relationships between the individual and the director, executive officer, founder or control person, including, for each relationship, when it began, the frequency of contact between them and when it terminated if it is not ongoing, and the level of trust and reliance in the other circumstances,
  3. the nature and number of any business dealings between the individual and the director, executive officer, founder or control person, the length of the period during which they occurred, and the nature and date of the most recent business dealing; and
  4. the number of "close business associates" of the director, executive officer, founder or control person to whom securities have been distributed in reliance on the private issuer exemption or the family, friends and business associates exemption.

The relationship between the individual and the director, executive officer, founder or control person must be direct. For example, the exemptions are not available for a close business associate of a close business associate of, for example, a director of the issuer.

Risk Acknowledgement Form Required

Form 45-106F12 Risk Acknowledgement Form for Family, Friend and Business Associate Investors must be signed by:

  1. the investor;
  2. the director, executive officer, control person or founder of the issuer with whom the investor has asserted the relationship (either directly or through the spouse of the director, executive officer, founder or control person), if applicable; and
  3. the issuer.

A potential investor must acknowledge, through the form, certain risks6 associated with the investment. Additionally the investor must disclose the identity of the director, executive officer, control person or founder of the issuer with whom they assert a relationship, that person's position at or relationship with the issuer, the category of the relationship asserted by the investor, and how long the investor has known that person. The risk acknowledgement form must be retained by the person making the distribution for a period of eight years after the distribution.

Utilizing the FFBA Exemption

Issuers should be aware of the complexity and responsibility of utilizing the FFBA Exemption and seek counsel where necessary. Issuers may look to counsel for:

  1. Developing procedures to reasonably confirm purchasers meet FFBA Exemption criteria;
  2. Advising issuers when the issuer should and should not sell securities to the purchaser in reliance on the FFBA Exemption;
  3. Informing issuers with respect to the terms and conditions of the exemption enabling the issuer to adequately explain the conditions and terms of the FFBA Exemption to purchasers;
  4. Establishing proper internal policies and procedures facilitating understanding of the terms and conditions of the FFBA Exemption7;
  5. Evaluating relationships with regard to FFBA Exemption qualification;
  6. Preparation of subscription agreements; and
  7. Facilitating proper record-keeping in connection with the FFBA Exemption8.

Amendments to certain exemptions set out in NI 45-106 of the Canadian Securities Administrators (CSA)

Concurrently with the introduction of the FFBA Exemption, the Canadian Securities Administrators (CSA) announced the adoption of two sets of amendments to NI 45-106 Prospectus and Registration Exemptions and its associated Companion Policy.

Amendments to Accredited Investor and the Minimum Amount Investment Prospectus Exemption

The first amendment to NI 45-106 is with respect to the accredited investor and the minimum amount investment prospectus exemptions. Among other changes, the amendments:

  1. introduce a new risk acknowledgement form for individual accredited investors9;
  2. provide expanded guidance10 in the Companion Policy on the steps a seller should take to verify the status of purchasers acquiring securities under prospectus exemptions, including the accredited investor exemption; and
  3. restrict the minimum amount investment exemption to distributions to non-individual investors.

An important change in Ontario is the change to the definition of accredited investor. The change now allows fully managed accounts to purchase investment fund securities using the managed account category of the accredited investor exemption. This particular amendment is designed to nationally harmonize this category of the accredited investor exemption. 

Amendments to the short-term debt prospectus exemption

The second set of amendments to NI 45-106 is to the short-term debt prospectus exemption. These amendments are intended to address investor protection and systemic risk concerns. Among other changes, the amendments:

  1. modify the credit ratings required to distribute short-term debt, primarily corporate commercial paper under the short-term debt exemption; and
  2. make the short-term debt exemption unavailable for short-term securitized products, which are primarily asset-backed commercial paper, and create a new prospectus exemption for the distribution of short-term securitized products.

Provided Ministerial approvals are obtained, the CSA's amendments will come into force on May 5, 2015. In Ontario, the amendments to the accredited investor and minimum amount exemptions will come into force on the later of May 5, 2015 and the date on which subsection 12(2) of Schedule 26 of the Budget Measures Act, 2009 is proclaimed in force.

This article was co-authored by Danijel Augustinovic, an articling student in Dentons Toronto office.

Footnotes

1 Subject to Ministerial approval, the exemption comes into effect on May 5, 2015.

2 The Rule Amendments and the Policy Changes (collectively, the Final Amendments) were delivered to the Minister of Finance on February 17, 2015. The Minister of Finance may approve or reject the Rule Amendments or return them for further consideration. If the Minister approves the Rule Amendments or does not take any further action by April 20, 2015, the Final Amendments will come into force on May 5, 2015.

3 Proposed section 2.6.1 (1) states that one of the conditions to qualify for the FFBA Exemption is that the issuer "is not an investment fund"

4 Guidance in 45-106CP.

5 If an issuer or selling security holder voluntarily provides a potential investor with an offering memorandum in connection with a distribution, the investor has certain rights of action for damages or rescission in the event of a misrepresentation.

6 Form 45-106F12 can be found on page 8 of the February 19, 2015, Supplement to the OSC Bulletin "Amendments To National Instrument 45-106 Prospectus And Registration Exemptions"

7 The issuer is responsible for confirming that all parties acting on behalf of the seller in a distribution (including any employee, officer, director, agent, finder or other intermediary involved in the transaction) understand the conditions that must be satisfied to rely on the exemption. The OSC expects an issuer to have policies and procedures in place to confirm that these other parties understand the exemption being relied on, are able to describe the terms of the exemption to purchasers and know what information and documentation must be obtained from purchasers to confirm the conditions of the exemption have been satisfied.

8 Issuers must consider what documentation should be collected and retained from purchasers to evidence the steps followed to establish that the purchaser met the conditions of the exemption. The issuer should consider whether it is necessary to have the purchaser sign that documentation before distributing securities and consider whether a director should sign a statement confirming the relationship.

9 The form includes acknowledgments regarding the risk of investment loss, liquidity risk, lack of information, lack of advice and status as an accredited investor.

10 The NI 45-106 Companion Policy provides guidance with respect  to verification of the status under the prospectus exemptions including information regarding: purchaser characteristics, understanding the terms and conditions of the exemption, and establishing appropriate internal policies and procedures to facilitate understanding of the exemptions. Moreover, the CSA states that it would not be sufficient for a seller to rely solely on a form of subscription or other agreement that only states "I am an accredited investor." Instead, the seller must obtain information to confirm the purchaser meets the criteria set out in the exemption.

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