Canada: Proposed OSC Rule 72-503 To Modernize Framework For Distributions Of Securities Outside Of Ontario

The Ontario Securities Commission has proposed a new rule that would provide Ontario issuers with more certainty about how to comply with Ontario securities laws when they sell securities to investors outside Canada. The new rule would replace a 33-year old Interpretation Note that had become a source of confusion and uncertainty as market practices evolved. If the rule is adopted, Ontario issuers will be able to rely on a number of new exemptions that would eliminate the need for a Canadian prospectus in most common cross-border offering situations. However, Ontario issuers will need to file a new post-closing trade report (Form 72-503F) in many cases, including when selling to U.S. investors under Rule 144A as part of a typical Canadian bought deal or marketed offering.  New Form 72-503F would require only a description of the offering, and not a list of the names of the purchasers.

Executive Summary

Historically, in Ontario it has been somewhat less clear than in some other provinces when the sale of securities by an issuer in the province to a purchaser outside the province may be subject to the prospectus requirements of that province. In British Columbia, Alberta and Québec, the securities regulators have clearly taken the position that the sale of securities by an issuer in that province to investors outside of the province is subject to their prospectus requirements. In most cases, issuers with a head office in one of those provinces or with other significant connecting factors to that province have been required to either file a prospectus in the province or rely on a prospectus exemption, even when the issuer is selling securities primarily or entirely in the United States, Europe, the United Kingdom or other foreign jurisdictions.

In Ontario, the only guidance to market participants and advisors as to whether a sale of securities by an issuer in Ontario to a purchaser outside Ontario could be subject to Ontario prospectus requirements has been a 33-year old Interpretation Note known as Interpretation Note 1, Distributions of Securities Outside Ontario (the Interpretation Note). The Interpretation Note is mostly known to securities lawyers and other capital markets specialists. When it was adopted in 1983, it attempted to provide guidance as to when securities distributed outside Ontario would "come to rest" outside Ontario and not "flow back" into Ontario in a manner that should be subject to Ontario prospectus requirements. A common cross-border offering situation that could be subject to the Interpretation Note might involve a TSX-listed issuer seeking to carry out a public offering or private placement of securities primarily or entirely to U.S. investors without filing a prospectus in Canada. However, the Interpretation Note is not limited to offerings in the United States and could also apply to a TSX-listed issuer considering an offering of securities to U.K. or European investors. These kinds of transactions could give rise to concerns that securities sold outside of Ontario could "flow back" into Ontario by virtue of the securities being listed in Canada or the liquidity for the securities existing mainly in Canada.

The Ontario Securities Commission is proposing a new rule, Rule 72-503 Distributions Outside of Canada (the New Rule) to provide greater certainty to participants in cross-border transactions.

The New Rule provides four new, express exemptions from the prospectus requirement for certain types of distributions outside Canada, namely:

• distributions where the issuer is conducting a public offering in the United States or other specified foreign jurisdictions,
• distributions where the issuer has filed a prospectus in Ontario,
• distributions where the issuer is and has been a reporting issuer in a jurisdiction of Canada for the four months preceding the distribution, and
• other distributions that do not fall within one of the categories above.

All four of the new exemptions are conditioned on compliance with the laws of the country where the purchaser is located. Three of the four require filing a short post-closing report of an outbound distribution, new Form 72-503F Report of Distributions Outside of Canada, with the Ontario Securities Commission within ten days of the distribution date (the outbound report). Unlike a conventional private placement trade report, the new outbound report does not require identifying the names of, or any other information about, the non-Canadian purchasers.

We believe the second and third exemptions referred to above will be the most commonly relied upon prospectus exemptions in Ontario for distributions of securities outside Canada. For instance, the second exemption would apply both in the typical Canadian "bought deal" scenario as well as in connection with an initial public offering (IPO) where an Ontario issuer files a prospectus in Canada but not in the United States or another foreign jurisdiction. The third exemption would be available only in the case of follow-on or secondary offerings where the issuer has been a public company in Canada for at least four months, and therefore would not be available in connection with an IPO.

The New Rule also provides exemptions from the dealer and underwriter registration requirements that otherwise apply to Ontario prospectus qualified distributions, to facilitate qualifying a distribution outside of Canada by prospectus if so desired without the need to involve a Canadian registered dealer in the offering.

While the New Rule provides clear prospectus exemptions that would apply in the most typical cross-border offering scenarios, the trade-off for this certainty is a new reporting requirement that will apply where no filing requirement has existed previously. Issuers will need to file the proposed Form 72-503F in most cases where there is a sale of securities by an Ontario issuer outside of Ontario, irrespective of whether those securities are publicly offered or privately placed in Canada.  New Form 72-503F is a very streamlined report that only requires brief information about the offering and does not require identifying the names of any of the purchasers outside Canada, so it should not be viewed as onerous by market participants.

Comments on the New Rule are due by September 28, 2016.

Background

The Ontario Securities Act imposes a prospectus requirement on sellers of securities in a distribution, which includes sales by an issuer or a control person, and resales of securities that are subject to a resale restriction hold period. When it applies, a prospectus must be filed in Ontario or a prospectus exemption must be relied upon.

When the seller and the purchaser of the securities are both in Ontario, there is no doubt that the Ontario prospectus requirement applies. It is also clear that the Ontario prospectus requirement applies to sellers of securities outside Ontario that make a distribution of securities to purchasers in Ontario.

What is not clear from the Act, however, is whether and when the prospectus requirement applies to a seller in Ontario that is selling securities to a purchaser outside Ontario, in what might be called an "outbound distribution".  Before 1983, OSC Policy 1.5 provided guidance on when and how an outbound distribution could be conducted without having to comply with the prospectus requirement.  Market participants raised concerns about that policy, objecting that it imposed undue restrictions on the ability of Ontario issuers to raise capital in global securities markets.  As a result, in 1983, OSC Policy 1.5 was replaced with the Interpretation Note.

The Interpretation Note gave guidance that a distribution of securities from Ontario (or securities of an issuer with significant connections to Ontario) made to purchasers outside Ontario should not be treated as subject to the prospectus requirement, so long as the securities do in fact "come to rest" outside Ontario in the hands of foreign purchasers, and the offering does not amount to an indirect, or backdoor, distribution to purchasers in Ontario through "flow back" into Ontario.  The Interpretation Note was also very clear in stating that the Commission reserved all of its power and authority to intervene in the public interest, if and when any market participants engaged in any conduct in connection with outbound distributions that could bring the Ontario capital markets into disrepute. 

The Interpretation Note provided specific examples to offer guidance on how an offering could be conducted, and the steps, procedures and precautions that should be taken, in order to ensure that an outbound distribution would not be considered a distribution in Ontario subject to the prospectus requirement.

The Problem

From the outset, the Interpretation Note required a careful analysis of the facts and circumstances of any outbound distribution to determine whether or not there was a risk of flow back, or an indirect distribution occurring in Ontario. That type of analysis created undesirable uncertainty, given that coming to the wrong conclusion about whether or not the prospectus requirement applied could result in a breach of the prospectus requirement and a violation of the Act. Over time, as global market practices changed and distributions of securities by Ontario issuers in the United States and other foreign jurisdictions became very common, the specific guidance provided in the Interpretation Note became less and less helpful, and in some cases was even in conflict with how outbound distributions were being conducted.

It was always open to market participants to use an Ontario prospectus exemption when conducting an outbound distribution to ensure compliance with the prospectus requirement.  However, the conditions and limitations imposed by those exemptions were often inconsistent with market practices and procedures, and investor expectations, in the country where the offering was taking place. For instance, it is difficult as a practical matter for investors outside of Canada to confirm "accredited investor" status even in an offering limited to institutional investors, and a Canadian private placement exemption could not be used in a U.S. registered or other public offering where the purchasers include retail investors.

Another alternative for Ontario issuers was to file a prospectus in Ontario to qualify the outbound distribution. This, alternative, however, is undesirable where there is otherwise no intention to file a prospectus in Canada and also often gave rise to numerous legal considerations arising from the application of Ontario rules to a foreign offering.

As a result, despite the limitations of the Interpretation Note and the fact that the specific guidance it contained had become outdated, market participants in Ontario often had little choice but to rely on the Interpretation Note when considering offerings of securities outside Canada.

The Solution

The New Rule provides four new, express exemptions from the prospectus requirement for certain types of outbound distributions. In cases where one of the new exemptions is available, there will be no need to debate whether or not the Ontario prospectus requirement applies, and market participants may rely on the exemption for the avoidance of any doubt.

Unlike the Interpretation Note, which addressed distributions outside the Province of Ontario, the New Rule is framed in the context of distributions outside Canada.  As a result of the extensive harmonization of the prospectus requirements and exemptions in all provinces and territories of Canada, the need for guidance regarding the application of Ontario prospectus requirements in the context of offerings from Ontario into other provinces and territories of Canada has effectively been eliminated, as the harmonized Canadian requirements will be followed in any case when the purchaser is in Canada. 

Further, the New Rule is accompanied by a companion policy that carries forward the underlying principle of the Interpretation Note that an outbound distribution by an Ontario issuer or selling security holder, when conducted the "right way", is not a distribution in Ontario that is subject to the prospectus requirement. The old and outdated guidance on what is and is not the "right way" has, very helpfully, not been carried forward, but it is still open to market participants to determine, based on the facts and circumstances and applicable law, that an outbound distribution is not a distribution in Ontario. The continuation of this general policy statement is a safety valve that will avoid the potentially significant problems, and disruption of current market practices, that could otherwise result from moving abruptly from a general principles-based regime such as the Interpretation Note to a new regime that may not anticipate every possible situation.

It is also still open to market participants to rely on a conventional prospectus exemption for an outbound distribution, such as the "accredited investor" exemption, or to qualify the outbound distribution by prospectus.

The Four New Prospectus Exemptions for Outbound Distributions

The four new exemptions can be relied on in a variety of situations.  Three of the four require filing a short post-closing report of an outbound distribution, new Form 72-503F Report of Distributions Outside of Canada, with the Ontario Securities Commission within ten days of the distribution date. Unlike a conventional private placement trade report, the new outbound report does not require identifying the names of or any other information about the non-Canadian purchasers.  The outbound report is required to be filed when an issuer is relying on the exemption, and is not required to be filed by a selling security holder relying on the exemption (consistent with the current regime for Canadian private placement trade reports, which are not required for selling security holder sales).  Three of the four new exemptions result in the securities sold outside Canada being completely free of any Canadian hold periods or resale restrictions, while one of the four imposes a restriction on the ability to resell those securities back into Canada. 

All four of the new exemptions are conditioned on compliance with the laws of the country where the purchaser is located.

1. Foreign Public Offering

Under the new foreign public offering exemption, the Ontario prospectus requirement does not apply to any distribution of securities from Ontario (whether by the issuer or a selling security holder) to a purchaser outside of Canada if the issuer files a registration statement registering the securities under the U.S. Securities Act of 1933, as amended, or has filed a document similar to a final prospectus under the securities laws of certain other countries (Australia, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, New Zealand, Singapore, South Africa, Spain, Sweden, Switzerland or the United Kingdom). No reporting to the Ontario Securities Commission is required.

This exemption can be used by an Ontario issuer or selling security holder:

• conducting a U.S.-only public offering or public offering in both the United States and Canada (IPO, secondary offering or new issue);
• conducting a public offering only in the designated foreign jurisdiction or in both Canada and the foreign jurisdiction (IPO, secondary offering or new issue).

This exemption is broad enough to allow sales of the securities to be made in any country outside Canada, even if the country is not on the approved list of foreign countries, so long as a U.S. registration statement has been filed in the United States or a foreign prospectus has been filed under the laws of the approved foreign countries referred to above.

The foreign public offering exemption would be available for Ontario issuers seeking to use the Canada / U.S. Multijurisdictional Disclosure System (MJDS) to conduct a registered offering in the United States, with or without a concurrent prospectus in Canada. A Form F-10 registration statement can be filed with the Ontario Securities Commission under the "notification of clearance" procedures for review of MJDS registration statements by Canadian securities regulators, and the foreign public offering exemption will be available, making it unnecessary to file an Ontario prospectus to qualify the distribution under Ontario securities laws.

Securities sold under this exemption are not subject to any Canadian hold periods or resale restrictions.

2. Concurrent Ontario Prospectus

Under the new concurrent Ontario prospectus exemption, the securities being sold outside Canada in an outbound distribution are exempt from the prospectus requirement if a prospectus has been filed in Ontario qualifying a concurrent distribution of the securities in Ontario.  The securities sold outside Canada will not be qualified by the Ontario prospectus when this exemption is used, eliminating any uncertainty about whether foreign purchasers may be entitled to any of the rights and remedies available to Ontario purchasers under an Ontario prospectus, including statutory rights of withdrawal.  When using this exemption, for the avoidance of doubt, the Ontario prospectus should include an express statement that the prospectus does not qualify the distribution of the securities to any purchaser outside Canada.

The use of this exemption must be reported to the Ontario Securities Commission on a post-closing basis using the new outbound distribution report.

This exemption can be used by an Ontario issuer or selling security holder:

• conducting an IPO in Canada and making Rule 144A sales or other private placements in the United States, or any other country of the world (and not only the approved countries referred to above); or
• conducting a bought deal or other secondary offering or new issue in Ontario, and also making Rule 144A sales or other private placements in the United States, or any other country.

This exemption would also be available when an issuer has filed a U.S. registration statement or a foreign prospectus in an eligible country concurrently with the Ontario prospectus, but in those cases the foreign public offering exemption will also be available, which has the advantage of not requiring the filing of an outbound report.

Securities sold under this exemption are not subject to any Canadian hold periods or resale restrictions.

3. Distribution by Reporting Issuers

If the issuer is and has been a reporting issuer in any province or territory of Canada for at least four months, the issuer and its selling security holders can use the distribution by reporting issuer exemption to conduct an outbound distribution to purchasers in any country of the world.  If the issuer is making the distribution, it must file an outbound report, but reporting on the use of this exemption is not required for selling security holders.

This exemption can be used:

• by an Ontario reporting issuer making Rule 144A or other private placement sales in the United States or any other country in the world;
• by an Ontario reporting issuer conducting a public offering in a country that does not qualify under the foreign public offering exemption; and
• by a control person of an Ontario reporting issuer, or a shareholder who acquired securities still subject to a Canadian four month hold period, to resell securities of the reporting issuer to purchasers in other countries, or on an exchange or market outside Canada.

Securities sold under this exemption are not subject to any Canadian hold periods or resale restrictions.

The ability of selling shareholders to use the distribution by reporting issuer exemption is of particular benefit to them, as the prospectus exemption in Section 2.14 of National Instrument 45-102 Resale of Securities often relied on by Ontario investors to make resales outside Canada is not available for securities of a reporting issuer.

4. Other Distributions

A fourth new exemption, the "other distributions" exemption, is available to issuers and selling security holders for all other outbound distributions that do not fit into any of the first three new exemptions.  However, the consequence of using this exemption is that Canadian resale restrictions apply, including a four month hold period. Resales of the securities will be deemed to be a distribution under Ontario securities laws, unless the resale is made to a person outside Canada, or the issuer has subsequently become a reporting issuer in any province or territory of Canada with at least a four month reporting history, and at least four months have elapsed since the original distribution of the securities outside Canada was made under the other distributions exemption. An issuer relying on the other distributions exemption must file an outbound report.

The other distributions exemption provides three significant advantages over relying on the Canadian "accredited investor" exemption, or another prospectus exemption under National Instrument 45-106 Prospectus Exemptions.  First, it is not necessary to ensure that purchasers outside Canada satisfy the conditions of a Canadian prospectus exemption, such as the "accredited investor" exemption, which are based on Canadian standards that foreign purchasers often will not be familiar with.  Second, it is only necessary for the issuer to file the new outbound report, and not a conventional Canadian private placement trade report, so the names and other information about outbound purchasers need not be included.  Third, it is not strictly necessary to comply with the Canadian legend requirements prescribed by Section 2.5 of National Instrument 45-102 Resale of Securities in order to preserve the possibility for the securities to become freely tradeable back into Canada four months after the issuer has become a reporting issuer.  Compliance with Canadian legending requirements can present challenges under the securities laws or market practices of other countries.

This exemption will be useful for an Ontario issuer that is not a reporting issuer in Ontario or any other jurisdiction of Canada, and that is not yet ready to make a registered offering in the United States or file a prospectus or similar public offering document in an approved foreign jurisdiction.

New Dealer and Underwriter Registration Exemptions

The New Rule also provides an exemption in certain circumstances from the dealer and underwriter registration requirements that might otherwise apply to foreign dealers participating in a distribution of securities that is qualified by prospectus in Ontario or another province of territory of Canada, or that is exempt from Ontario prospectus requirements under one of the prospectus exemptions in the New Rule..  When available, this exemption will help facilitate the ability of an Ontario issuer to engage the services of a foreign dealer to conduct offerings in the United States or other designated jurisdictions, eliminating uncertainty about whether Ontario dealer or underwriter registration requirements might be applicable to those activities.

Summary of Available Options for Ontario Outbound Distributions.

After the new rule comes into effect, Ontario issuers and selling security holders will have all of the following options available to them for making outbound distributions from Ontario:

Comments on the New Rule are due by September 28, 2016. The New Rule does not provide an implementation date.

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.