This has been the year of cannabis market sector scandals. Headlines have been thick and fast. Investor losses have been significant.
A large part of the financing that facilitated the massive growth of the cannabis sector has been through the prospectus exempt issuance of securities (more commonly referred to as a private placement). The trend in the cannabis sector is consistent with the growth in exempt market investments generally. Over the last decade, the amount of capital invested in Ontario's prospectus exempt market has roughly tripled. According to figures compiled by the Ontario Securities Commission, exempt market investments in Ontario increased from $30.7 billion in 2010 to $91.6 billion in 2017.1
The prospectus exempt market is where securities are issued to the public without a prospectus being filed with securities regulatory authorities. Exempt market investments can only be made when investors qualify for specific exemptions. Section 2.3 of National Instrument 45-106, Prospectus Exempt Distributions, provides one key exemption from the prospectus requirement—for trades in a security if the purchaser is an "accredited investor".2
The accredited investor exemption is the exemption most frequently utilized in Ontario. For an issuer selling securities, the exemption offers an inexpensive, fast and predictable alternative to undertaking, for example, an underwritten offering through a prospectus.
The regulatory justification for prospectus exemptions is typically that protections offered by prospectus disclosures and continuous disclosure are not always necessary or practical.3 The Ontario Securities Commission provides two rationales for the accredited investor exemption. First, accredited investors are assumed to be sophisticated. That is, capable of obtaining expert advice and analyzing information needed to assess an investment without a prospectus or continuous disclosure. Second, they are assumed to be able to withstand the loss of their entire investment.4
This does not change the reality that, in some cases, accredited investors who participate in an exempt offering will be provided with misleading information and will suffer a loss as a consequence.
The type of disclosure, if any, given to accredited investors as part of an offering under the accredited investor exemption is important because the absence of a prospectus or other continuous disclosures and the corresponding remedies provided in the Securities Act may introduce barriers to recovery. Commonly, the disclosure given to accredited investors takes the form of either a term sheet or an offering memorandum.5
A term sheet is not defined in the OSA but is described by the Ontario Securities Commission as a "skeletal outline of the features of a distribution without dealing extensively with the business or affairs of the issuer of the securities being distributed."6 It typically deals only with the terms of the issue. In contrast, an offering memorandum is defined as "a document, together with any amendments, purporting to describe the business and affairs of an issuer that has been prepared primarily for delivery to and review by a prospective purchaser so as to assist them to make an investment decision in respect of the securities being sold, but does not include a document setting out current information about an issuer for the benefit of a prospective purchaser familiar with the issuer through prior investment or business contacts."7
The definition of offering memorandum does not mandate use of the standardized offering memorandum form. As such, a document which is not in the standardized form may still be an offering memorandum where it "purports to describe the business and affairs of an issuer and has been prepared primarily for delivery to and review by a prospective purchaser." Indeed, the Ontario Securities Commission is of the view that a document can be an offering memorandum when it describes the business and affairs of an issuer and is "prepared in contemplation of soliciting investment from the prospective purchaser."8
A misrepresentation in an offering memorandum will attract potential liability under section 130.1(1) of the OSA, in addition to potential liability at common law, in equity and under the applicable corporate statute.9 Where an offering memorandum contains a misrepresentation, a purchaser who purchases a security offered by the offering memorandum during the period of distribution and meets the other securities law requirements has a right of action for damages or rescission without regard to whether the purchaser relied on the misrepresentation.10
That is, accredited investors who suffer loss due to a misrepresentation in an offering memorandum (or documents incorporated therein) do not need to prove reliance, negligence, fraud or any other culpable state of mind to obtain an order for damages or rescission. In effect, subject to defences,11 section 130.1(1) of the OSA only requires that: (1) a purchaser purchase a security offered by the offering memorandum during the period of distribution; and (2) the offering memorandum contains a misrepresentation.
Accredited investors who purchase securities offered by the offering memorandum must act quickly if they believe the offering was affected by a misrepresentation. Strict time limits apply for commencing an action for misrepresentations in an offering memorandum under the Securities Act. An action for rescission of the purchase must be commenced within 180 days of the transaction. An action for damages must be commenced within 3 years after the date of the transactions or 180 days from the date the investor had knowledge of the facts underpinning the action.12
Accredited investors who receive only a term sheet face comparatively more barriers to recovery. Per the discussion above, unless the term sheet "purports to describe the business and affairs of an issuer and has been prepared primarily for delivery to and review by a prospective purchaser", section 130.1(1) of the OSA will be inoperative.13 In contrast to an accredited investor who purchases under an offering memorandum, the accredited investor who acquires under a term sheet affected by misrepresentation will have to prove reliance, negligence, fraud or other culpable state of mind, as the case may be, to obtain an order for damages or rescission. The reliance requirement makes it difficult for a group of similarly situated investors to pursue recovery collectively via a class proceeding, which, depending on the size of the individual losses of the accredited investors, may be the only economic means of doing so.14
1 See: OSC Staff Notice 45-716 "Ontario Exempt Market Report", https://www.osc.gov.on.ca/documents/en/Securities-Category4/rule_20181129_45-716_exempt-market-report.pdf>.
2 NI 54-106, s 2.3.
3 See: Ontario Securities Commission, "Summary of Key Capital Raising Prospectus Exemptions in Ontario", January 28, 2016 <https://www.osc.gov.on.ca/documents/en/Securities-Category4/ni_20160128_45-106_key-capital-prospectus-exemptions.pdf>.
5 In Ontario, an issuer can voluntarily provide accredited investors with an offering memorandum; 45-501CP s 5.2(2).
6 45-501CP s 5.6(2).
7 Securities Act, RSO 1990 c S 5, s 1(1).
8 45-501CP s 5.1(2).
9 The Ontario Securities Act contains non-derogation provisions for statutory primary market misrepresentation claims, so that the ability to assert rights of action at common law, in equity, or under the federal, provincial or territorial corporation statutes is preserved. See Securities Act, RSO 1990 c S 5, s 130.1(7).
10 Securities Act, RSO 1990 c S 5, s 130.1(1).
11 Securities Act, RSO 1990 c S 5, s 130.1(2).
12 Securities Act, RSO 1990, c S 5, s 138; Persaud v. Talon International Inc., 2018 ONSC 5377 at 109-110.
13 Securities Act, RSO 1990 c S 5, s 130.1(1).
14 See e.g. Green v. Canadian Imperial Bank of Commerce, 2016 ONSC 3829 at para 13.
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