The Canadian Securities Administrators (the CSA) have announced amendments to the rules governing rights offerings in Canada. The amendments are intended to streamline the conduct of prospectus-exempt rights offerings, and are scheduled to take effect on December 8, 2015. The impact of the amendments could be significant and merits close attention.
A rights offering is a financing method that gives an issuer's securityholders rights to buy additional securities from treasury. Rights offerings afford securityholders the ability to maintain their pro rata interest in the issuer, and are therefore considered to be an inherently fair means of raising capital. Rights offerings are common in many jurisdictions, but historically have been under-utilized in Canada where they are widely seen as a financing structure of last resort. The new amendments are aimed primarily at increasing the efficiency of rights offerings, with a view to increasing their frequency in Canada.
Details of the amendments
Under the existing rules, a prospectus-exempt rights offering is an unattractive way to access financing for two main reasons. The first is the length of time it takes to complete the offering due to regulatory compliance requirements. According to the CSA, an average rights offering takes 85 days from start to finish.1 This includes an average of 40 days for the regulators to review the main disclosure document—the rights offering circular—which the issuer then mails to securityholders. The current regime contains overlapping reviews by multiple jurisdictions (rights offerings are curiously omitted from the scope of the passport system adopted by provincial securities commissions to streamline regulatory reviews), plus stock exchange reviews on disclosure and pricing. The second reason is the cap on the size of the offering, being 25 percent of the issuer's outstanding securities. Rights offerings involving more than 25 percent dilution require a prospectus. This threshold significantly limits the amount of capital that an issuer is able to raise under a prospectus-exempt rights offering, especially when one considers that rights offerings are most common with issuers with depressed share prices and the offerings are done at a discount to the market price. Together, these factors result in slow, uncertain and expensive offerings, with limited proceeds.
The amendments aim to address each of these, as described below. The new rules are applicable only to reporting issuers that are not investment funds. Private issuers will no longer be able to conduct rights offerings and will have to rely on other prospectus exemptions.
No regulatory pre-review. Under the new rules, securities regulators will no longer vet rights offering circulars, which will go some way to addressing both the time lag and the uncertainty of completing the offering. However, note that listed issuers will still need to pre-clear terms of rights offerings with their stock exchange.
Dilution limit raised to 100 percent. Issuers will be able to distribute up to 100 percent of their outstanding securities under prospectus-exempt rights offerings in any 12-month period. The increase from 25 percent will likely make a rights offering more attractive, particularly to junior issuers. If an issuer wants to distribute more than 100 percent of its outstanding securities under a rights offering, it will have to do so by way of prospectus.
New form of rights offering circular. The CSA is adopting a new form of rights offering circular, which is presented in a question-and-answer format. The intent is to make the circular more comprehensible to laypersons and easier for issuers to prepare. It is expected that a circular prepared on the new form will not exceed 10 pages. The circular will not require disclosure about the business of the issuer as that information will already be contained in the issuer's continuous disclosure record on SEDAR and should be familiar to the issuer's existing securityholders.
Requirement to send notice instead of circular. Issuers will no longer be required to send the offering circular to securityholders. Instead they must send a notice, which is expected to be no more than two pages in length, informing securityholders as to: (i) where they can access the circular; and (ii) certain key facts relating to the offering.
Pricing. The amendments clarify that rights offerings must be priced below the prevailing market price where there is a public market for the securities, and provide clarity on how market price is determined. Previously there were no rules relating to pricing, other than to restrict insiders from increasing their pro rata position if the rights offering was priced above market. This does not amount to a substantive change from the current practice, but it will add clarity on pricing.
Statutory liability for continuous disclosure. Under the amendments, liability for an issuer's continuous disclosure record would attach to securities issued in a rights offering. Issuers must certify in the circular that there are no material facts or material changes which have not been generally disclosed. This means that if an issuer makes a significant misstatement or omission in its public disclosure—such as in a news release or financial statements—that is not corrected prior to the rights offering, then investors who participated in the offering will have a right to sue to recover any resulting loss in the value of their investment, subject to certain limitations and defences. This gives investors under rights offerings the same rights of action as those who buy securities in the secondary market.
Stand-by commitments. The amendments establish a prospectus exemption for securities issued under stand-by commitments, whereby a person who is not a securityholder commits to purchase securities represented by any unexercised rights. Originally the CSA proposed that securities purchased by stand-by guarantors who were not already securityholders would be subject to a hold period but ultimately considered it appropriate to impose a seasoning period consistent with all other securities issued under a rights offering.
Anticipated impact of the amendments
These amendments will be welcome news for beleaguered Canadian capital markets, and should make rights offerings a real and viable alternative for raising capital in Canada. Importantly, they will more closely align the rights offering framework in Canada to other markets around the world, where rights offerings are typically a capital raising structure of first rather than last resort.
Junior issuers in particular should benefit from the new rules. In the past, the 25 percent dilution cap was a significant deterrent for small market cap companies, as the amount that could be raised without a prospectus was too little to meaningfully capitalize the company while the prospectus requirements were considered overly burdensome. The simplified disclosure under the new rules will also make rights offerings easier to carry out. When one considers that the most utilized current alternative to a rights offering is a private placement with little disclosure, investor protection and regulatory oversight, the new rules should not impair investor protection.
We expect that these amendments will be warmly received by the market. Given the uncertainty in the current market and the number of "survival-oriented" financings being carried out (by junior resource companies, in particular), they are likely to be widely used upon implementation. It would not be a surprise if a number of issuers have December 8 circled on their calendars.
1 CSA Notice of Amendments Relating to Rights Offerings to National Instrument 45-106 Prospectus and Registration Exemptions and other instruments, September 24, 2015, accessible here.
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