Canada: Amendments To Prospectus Exemptions And Additional Obligations For Issuers And Brokers

Last Updated: April 2 2015
Article by Bernard Pinsky and Nafeesa Valli-Hasham

On May 5, 2015, changes to National Instrument 45-106 Prospectus and Registration Exemptions ("NI 45-106") will come into force which will put additional responsibility on issuers and brokers to take "reasonable steps" to ensure investors who participate in a private placement and who represent themselves as accredited investor or friends and family are in fact eligible for those prospectus exemptions. In addition, the amendments include new documentation requirements for the accredited investor exemption and restrictions on the availability of the minimum amount exemption.

1. Issuers and Brokers Must Take Steps to Ensure the Status of Purchasers and Availability of Prospectus Exemptions

The Companion Policy to NI 45-106 ("45-106CP") sets out the requirements whereby issuers and brokers must take additional steps to ensure the status of an investor and the availability of prospectus exemptions:

(a) Exemptions based on purchaser characteristics

Some of the prospectus exemptions in NI 45-106 require the purchaser of the securities to meet certain characteristics or have certain relationships with a director, executive officer, founder or control person of the issuer. These exemptions include:

  • Exemptions based on income or asset tests - The accredited investor exemption and the "eligible investor" test in the offering memorandum exemption in some jurisdictions require a purchaser to meet certain income or asset tests in order for securities to be sold in reliance on the exemption.
  • Exemptions based on relationships - The private issuer exemption, the family, friends and business associates exemption and the "eligible investor" test in the offering memorandum exemption in some jurisdictions require a relationship between the purchaser and a director, executive officer, founder or control person of the issuer, such as that of a family member, close personal friend, or close business associate.

When distributing securities under these exemptions, the seller will have to obtain information from the purchaser in order to determine whether the purchaser has the requisite income, assets or relationship to meet the terms of the exemption.

It will not be sufficient for the seller to accept standard representations in a subscription agreement or an initial beside a category on Form 45-106F9 Form for Individual Accredited Investors unless the seller has taken reasonable steps to verify the representations made by the purchaser.

(b) Reasonable steps for confirmation of exemption

Described below are procedures that a seller could implement in order to reasonably confirm that the purchaser meets the conditions for a particular exemption. Whether the types of steps are reasonable will depend on the particular facts and circumstances of the purchaser, the offering and the exemption being relied on, including:

  • how the seller identified or located the potential purchaser;
  • what category of accredited investor or eligible investor the purchaser claims to meet;
  • what type of relationship the purchaser claims to have and with which director, executive officer, founder or control person of the issuer;
  • how much and what type of background information is known about the purchaser; and
  • whether the person who meets with, or provides information to, the purchaser is registered.

The Securities Commissions expect a seller to be in a position to explain why certain steps were not taken or to be able to explain how alternative steps were reasonable in the circumstances. It is the seller that is relying on the prospectus exemption and it is the seller that is responsible to ensure the terms of the exemption are met. If the seller has any reservations about whether the purchaser qualifies under the exemption, the seller should not sell securities to the purchaser in reliance on that exemption.

Registered dealers or representatives may be involved in distributions under prospectus exemptions in different ways. The registered dealer or representative may be acting on behalf of a seller in connection with a distribution using a prospectus exemption, or for the purchaser.

In both cases, the registered dealer or representative must not only establish that a prospectus exemption is available, it must also comply with its registration obligations. For example, even if a registered dealer or representative has determined that a purchaser qualifies as an accredited investor or eligible investor, the registered dealer or representative must still assess whether the investment is suitable for the purchaser.

2. New Risk Acknowledgement Form for the Accredited Investor Prospectus Exemption

The amendments to the accredited investor prospectus exemption introduce a new risk acknowledgement form for individual accredited investors and provide guidance on the steps a seller needs to take to verify the status of purchasers acquiring securities under prospectus exemptions, including the accredited investor exemption. In addition, in Ontario, the definition of accredited investor has been amended to allow fully-managed accounts to purchase investment fund securities using the managed account category of the accredited investor exemption as is permitted in other Canadian jurisdictions.

The new risk acknowledgement form on Form 45-106F9 is required when investors are relying on one of the following categories in the definition of accredited investor:

  • an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that, before taxes, but net of any related liabilities, exceeds $1,000,000 (paragraph (j) of Section 1.1 "accredited investor" in NI 45-106);
  • an individual whose net income before taxes exceeded $200,000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year (paragraph (k) of Section 1.1 "accredited investor" in NI 45-106); and
  • an individual who, either alone or with a spouse, has net assets of at least $5,000,000 (paragraph (l) of Section 1.1 "accredited investor" in NI 45-106).

The risk acknowledgment terms sets out the risks associated with the investment including loss, lack of liquidity, lack of information and lack of advice and requires the investor to specifically acknowledge each risk. The categories of accredited investors for individuals are also explained in plain language and the individual investor is required to select which category applies to them. The form must also be signed by the salesperson, whether they are a representative of the issuer, a registrant or a person exempt from registration.

Where an investor and an issuer are relying on the categories above for availability of the accredited investor exemption, the issuer must obtain a signed risk acknowledgement in the required form at the same time or before the individual investor signs the agreement to purchase the securities or the accredited investor exemption will not be available. In addition, both the investor and the issuer must receive a copy of the signed form, and the issuer must retain the completed risk acknowledgment form for at least 8 years after the distribution.

3. Restrictions on the Availability of the Minimum Amount Prospectus Exemption

The minimum amount prospectus exemption at section 2.10 of NI 45-106 provides an exemption from the prospectus requirements to investors who subscribe for a minimum of $150,000 in securities in a private placement.

The amendments to NI 45-106 restrict the availability of the minimum amount exemption to distributions to non-individual investors only. The practical effect on most investors using the minimum amount exemption will be limited as the majority of these investors likely will also qualify as an accredited investor and will have another prospectus exemption available to them. However, as noted above, additional documentation will be needed to establish their qualification as accredited investors.

For a blackline copy of NI 45-106 showing the complete amendments, please go here.

To see more detail about the new requirements, Companion Policy 45-106CP, they can be accessed 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.

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