How Recent CSA Rule Changes will Affect Issuers, Selling Dealers and Institutional Purchasers
One door soon opens as another is about to close.
The recent rule amendments announced by the Canadian Securities Administrators (CSA), the long-awaited Wrapper Relief Amendments, will provide relief from the delivery of certain supplementary information to Canadian institutional investors by non-Canadian issuers. Such information has typically been delivered in the form of a "wrapper" that is attached to the front of the issuer's offering documents.
But rumours of the death of the Canadian wrapper may have been greatly exaggerated.
And questions remain whether these rule amendments will accomplish their intended goal of easing unnecessary regulatory burden on non-Canadian issuers and their distributors who only sell to Canadian institutions and other sophisticated investors. In some cases they will.
However, at the same time that the Wrapper Relief Amendments were being finalized, certain US dealers were advising their Canadian institutional investor clients that, as of July 11, 2015, they will no longer be able to participate in specific types of offerings (whether by Canadian or non-Canadian issuers) because of restrictions being placed on registered exempt market dealers in Canada. Non-Canadian issuers and dealers selling into Canada must also consider other regulatory requirements associated with conducting private placements in Canada that are not covered by the Wrapper Relief Amendments.
How these seemingly unrelated, yet very inter-related, rule amendments will apply to a specific fact situation, will depend on the nature of the issuer, the type of security being sold, how the security is sold, where the purchaser resides, and the dealer involved.
The Wrapper Relief Amendments
On June 25, 2015 the CSA published a series of rule amendments that, in effect, codified and expanded previous discretionary relief orders from the requirement to provide certain disclosure to Canadian permitted clients. ("Permitted clients" generally include institutions and ultra-high net worth investors.) Amendments to National Instrument 33-105 Underwriting Conflicts provide an exemption from the disclosure requirements relating to conflicts of interest between an issuer and the principal dealer. Amendments to OSC Rule 45-501 Ontario Prospectus and Registration Exemptions, together with Multilateral Instrument 45-107 Listing Representations and Statutory Rights of Action Disclosure Exemptions, provide relief from the requirements, in those jurisdictions where they exist, to disclose statutory rights of action for a misrepresentation in an offering document and to obtain approval of the local securities regulatory authority before making a representation regarding the listing of securities on a stock exchange. These so-called Wrapper Relief Amendments will come into force on September 8, 2015 and are a welcome relief as far as they go.
To rely on the Wrapper Relief Amendments, a number of conditions must be met, including:
- The offering must be made primarily in a non-Canadian jurisdiction of securities of a foreign issuer that is not a reporting issuer in Canada and whose head office and majority of executive officers and directors are outside Canada, or securities that are issued or guaranteed by a foreign government.
- Sales must be made in Canada only to permitted clients.
- A written notice must be delivered to the permitted client specifying the exemption relied on. A dealer may give a one-time notice to an investor that covers all future distributions that the permitted client participates in with that dealer.
To rely on the NI 33-105 conflict of interest disclosure exemptions, the following conditions must also be met:
- Canadian purchasers must be given any offering documents prepared by the issuer in connection with the distribution.
- The offering must be made concurrently in the US, and Canadian investors must receive the same disclosure as US investors.
- The offering documents must contain, if applicable, disclosure of conflicts of interest that is in compliance with rule 5121 of the US Financial Industry Regulatory Authority (FINRA) and is otherwise in compliance with US securities law.
By removing these burdensome disclosure requirements for non-Canadian issuers, the CSA explain that they hope "to facilitate participation in foreign securities offerings by sophisticated Canadian investors that qualify as permitted clients". However, the conflict of interest disclosure exemption is limited to offerings made concurrently in the US, and registered dealers participating in a trade may be required to ensure that conflicts of interest are disclosed whether or not the NI 33-105 conflict of interest disclosure exemptions are available.
Other Disclosure Requirements and Regulatory Hurdles
The Wrapper Relief Amendments provide welcome exemptions from certain disclosure that is typically included in Canadian wrappers. However, there are other securities law implications (such as those discussed below) for certain types of non-Canadian issuers who wish to offer their securities in Canada, even to sophisticated purchasers, which are not addressed in the Wrapper Relief Amendments. Supplementary documentation may still have to be provided by non-Canadian issuers. Although this disclosure may be included in another document such as a cover letter, a supplement to the subscription agreement or a side letter.
The Deemed Reporting Issuer Rule
In July 2012, all jurisdictions in Canada, other than Ontario, adopted Multilateral Instrument 51-105 Issuers Quoted in the US Over-the-Counter Markets (MI 51-105) which deems certain issuers to be reporting issuers in Canada (for reporting purposes), even if their securities were sold in Canada only pursuant to private placements and are traded over-the-counter, if those securities are assigned a ticker symbol in the US. The potential regulatory burden has given US issuers a reason to pause before offering their securities to Canadian institutional investors, and has been a significant concern to Canadian institutional investors. It should be noted that MI 51-105 does not apply at all in Ontario, and blanket orders have been issued in Alberta, British Columbia and Québec providing some relief from MI 51-105 in connection with sales to permitted clients in those provinces.
Investment Funds and Registration Requirements
Non-Canadian investment funds offering securities into Canada must consider the applicable registration requirements for their investment fund managers1. Non-resident investment fund managers wishing to rely on the applicable registration exemption in Ontario, Québec and Newfoundland & Labrador are required to provide mandated disclosure to investors resident in those provinces. Such information today often forms part of the Canadian wrapper, but after September 8, 2015 this information will still need to be provided in some form if a wrapper is not used.
Non-Canadian managers of alternative funds branded as hedge funds, private equity funds or venture capital funds must consider whether their funds are caught by the definition of "investment fund" for this purpose.
Specialized rules exist in Canada for banks and mining companies, for example, offering securities in Canada by way of private placement.
Non-Canadian issuers structured as limited partnerships that sell their securities in certain provinces of Canada must register as an extra-provincial limited partnership in those provinces.
Post-Trade Filing and Reporting
The Wrapper Relief Amendments do not relieve issuers from the requirements to file
- copies of the offering documents delivered to Canadian investors in those provinces where required, and
- exempt trade reports (and to pay associated filing fees),
generally within 10 days of the trade, although an investment fund has the option to file an annual exempt trade report (and pay the fees) within 30 days of its financial year-end.
Proposed Amendments to Reporting Requirements
On June 30, 2015, members of the CSA (other than the Ontario and British Columbia Securities Commissions) issued a multilateral notice requesting comments on proposed amendments that will require Canadian and non-Canadian issuers relying on the offering memorandum exemption in those jurisdictions, issuers relying on the crowdfunding exemption in some of those provinces, all issuers that deliver a disclosure document to residents of Québec, and all issuers in those jurisdictions filing an exempt trade report, to do so through the System for Electronic Document Analysis and Retrieval (SEDAR). SEDAR is the publicly available electronic portal used by reporting issuers in Canada to file their public documents. Although the proposed rule amendments will permit some of the above filings to be made privately (so that only the regulators have access), if the filer is unfamiliar with SEDAR or otherwise erroneously files under the wrong category, non-public information could inadvertently be made public. These requirements will also increase costs to issuers distributing into Canada, which include the very real human costs of understanding the complexities of the SEDAR system that was not originally built to accommodate filings in respect of private placements. Comments are due on these proposals by August 31, 2015.
Dealers Involved in Private Placements in Canada
Although private placement rules in Canada provide exemptions from the prospectus requirement, most of those exemptions do not provide relief from the requirement to conduct the trade through a dealer that is registered, or that has the benefit of a registration exemption, in Canada. Not all dealers are created equal, and restrictions on the ability of certain types of dealers can impact an issuer's ability to sell its securities to a Canadian investor, however sophisticated that investor may be.
Effect of Restrictions on Exempt Market Dealers Conducting Brokerage Activities in Canada
First drafted as a proposed amendment in December 2013, and then published in final form in October 2014, new restrictions on exempt market dealer activities (the EMD Restrictions) were the subject of much debate and continue to be the source of considerable confusion. In adopting the EMD Restrictions, which come into effect on July 11, 2015, the CSA intended to limit trading of freely tradeable securities to firms registered as full investment dealers, to ensure that those securities are traded under the regulatory oversight of the Investment Industry Regulatory Organization of Canada (IIROC) and subject to IIROC's market integrity rules. But the real lasting effect may be to deny Canadian institutional investors access to certain types of offerings.
The exempt market dealer (EMD) category of registration permits such a dealer to participate in trades of securities pursuant to an exemption from the prospectus requirement, such as trades to accredited investors. Prior to the EMD Restrictions coming into force, EMDs have sold securities to Canadian institutions and other accredited investors, whether or not a prospectus exemption was required for the sale, on the basis that a prospectus exemption would have been available if required. This has worked well for Canadian institutions seeking access to offerings of public securities sold exclusively through US and U.K. dealers operating as EMDs in Canada.
The EMD Restrictions now prohibit an EMD from participating in the trade of a security that is freely tradeable on a marketplace (Canadian or foreign). These restrictions effectively prevent EMDs from participating in a prospectus offering of listed securities and from trading in listed securities in the secondary market unless there is a restriction on trading that would only permit a further trade of the security in reliance on a prospectus exemption.
If one of the goals of the EMD Restrictions was to stop international dealer firms from operating in Canada under the "registration-lite" EMD category, rather than as full investment dealers (members of IIROC), the effect was not fully appreciated. The CSA's thinking was that international firms would simply use their Canadian affiliates that are members of IIROC (many international firms have such affiliates) to conduct this type of trading.
Things are not that simple. Not all international firms have an affiliated IIROC member. A Canadian issuer offering corporate debt securities in US dollars might, for a number of reasons, only use a US dealer (rather than a Canadian dealer) to underwrite the offering. Certain of those offerings will no longer be available to Canadian investors if a Canadian investment dealer does not participate. Early indications from a number of international dealers are that neither their Canadian affiliates nor any other Canadian dealers will have access to many such offerings, even after July 11, 2015.
What has exacerbated this brewing crisis (and for many Canadian institutional investors this does represent a potential crisis) is confusion over the full impact of the EMD Restrictions.
In the companion policy to NI 31-103, the CSA have indicated that EMDs will continue to be able to participate in:
- A distribution of securities, including securities of investment funds or reporting issuers, made under an exemption from the prospectus requirement (i.e. a private placement).
- A resale of securities that are subject to resale restrictions.
- A resale of securities that are freely tradeable if the securities are not traded on a marketplace (e.g. they only trade over-the-counter).
For example, EMDs will continue to be able to participate in a private placement of Canadian or foreign securities to accredited investors in Canada, where no prospectus has been filed in Canada in connection with of that offering, whether or not the issuer is a reporting issuer in Canada and the class of securities offered is listed on an exchange. EMDs may even trade those privately placed securities in the secondary market until such time as the applicable restricted period or seasoning period expires. It is only after the securities become freely tradeable that an EMD may no longer participate in trades of such listed securities. These clarifications are not intuitively obvious when reading the words of the EMD Restrictions.
In light of the continued lack of clarity and potential confusion, we strongly recommend that Canadian counsel be consulted to determine whether a firm registered as an EMD in Canada may participate in a specific treasury offering to Canadian investors and if or when they may support trading of those securities in the secondary market.
The International Dealer Exemption as an Alternative
International firms may, rather than register as an EMD in Canada, choose to rely on the international dealer exemption that allows them, and will continue to allow them even after the EMD Restrictions come into force, to (among other things): trade in a Canadian or foreign debt security with permitted clients during the security's primary distribution if the debt security is offered primarily outside of Canada and a prospectus has not been filed in Canada in respect of the distribution; trade in a foreign debt security with permitted clients in the secondary market; and trade in any foreign security with permitted clients except during the security's primary distribution if a prospectus has been filed in Canada in respect of the distribution.
In some cases this will permit trading in securities that EMDs are prohibited from trading under the EMD Restrictions (for example, an international dealer may trade in a non-Canadian security in the secondary market even if the security has been qualified by prospectus and is freely tradeable on a marketplace). It is important to note, however, that international firms relying on the international dealer exemption in Canada have, and will continue to have, disclosure requirements to Canadian clients, as well as other conditions applicable to their business if they wish to continue to rely on this exemption.
Untangling Canadian Regulations
The rule amendments, including the proposed rule amendments, we refer to in this Bulletin must be carefully considered for any private placement that takes place after the rule amendments or proposed amendments come into force. It is evident that the CSA still have some work to do if they wish to facilitate the participation in foreign securities offerings by sophisticated Canadian investors — not the least of which is the further harmonization of securities laws in Canada. The rule changes discussed in this Bulletin have come fresh on the heels of dramatic changes to Canada's prospectus exemptions, which became effective on May 5, 2015. We discuss those changes in our Bulletin Significant Changes to Canada's Exempt Market Effective May 5, 2015: Implications for Issuers and Dealers as well as for Retail Investors.
1. Please see Two Distinct Regulatory Approaches for Non-Resident Investment Fund Managers Finalized in Canada – Effective September 28, 2012 Investment Management Bulletin July 2012 Borden Ladner Gervais LLP
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.