Many private issuers incorrectly assume that because they are non-distributing companies (i.e. not public), securities laws do not apply to them. This is an incorrect assumption that could result in issuers unknowingly acting contrary to securities laws. The purpose of this article is to review the principal elements of the Ontario private issuer exemption.
What is the General Rule for Issuing Securities Laws?
Securities laws prohibit any person1 or company from trading in a security if the trade would be a distribution of the security unless a prospectus has been filed and a final receipt has been issued by the regulator (see section 53(1) of the Securities Act (Ontario))(the "General Rule"). This can be burdensome for private issuers that generally need flexibility, particularly with respect to raising capital and issuing shares to directors, employees, contractors and the like. As a result, the regulators have implemented several exemptions to when this General Rule applies, including what is commonly referred to as the "private issuer exemption".
The Private Issuer Checklist
The following checklist is non-exhaustive and is meant to be a high level reference. Several other requirements and exemptions might also apply.
Part 1: Does the issuer fall within the definition of "Private Issuer"?
|1.||Is the issuer a reporting issuer or an investment fund?
If the answer is no, please proceed to number 2 of Part 1.
|2.||Do the issuer's constating documents (i.e. articles of
incorporation, articles of amalgamation, bylaws, declaration of
trust, partnership grant, etc.) or securityholders' agreements
contain restrictions on transfers of securities?
If the answer is yes, please proceed to number 3 of Part 1.
|3.||Are the issuer's shares owned or beneficially owned by not
more than 50 people (not including current or former
Note, each person is counted as one beneficial owner unless the person is created or used solely to purchase or hold securities of the issuer, in which case each beneficial owner of the person must be counted as a separate beneficial owner.
If the answer is yes, then please proceed to Part 2.
Part 2: Assuming Part 1 has been satisfied, has the issuer distributed its securities to an appropriate person?
There are certain persons who may acquire securities in an issuer in reliance on the private issuer exemption. The purpose of this portion of the checklist is to set forth those persons who qualify to rely on the exemption.
Is the person who purchases the security (as principal) any one of the following?:
1. National Instrument 45-106 — Prospectus Exemptions defines a "person" (a) as an individual; (b) a corporation; (c) a partnership, trust, fund and an association, syndicate, organization or other organized group of persons, whether incorporated or not, and (d) an individual or other person in that person's capacity as a trustee, executor, administrator or personal or other legal representative.
2. Close personal friend: an individual who knows the director, executive officer or founder well enough, and has known him/her for a sufficient period of time to assess his/her capabilities and trustworthiness and obtain information from him/her with respect to the investment.
3. Close business associate: an individual who has had sufficient prior business dealings with a director, executive officer or founder to be in a position to assess his/her capabilities and trustworthiness and to obtain information with respect to the investment. Although there is no bright-line test, it must be a direct relationship (i.e. not a relationship through a friend of a friend).
- The following are a few
considerations to determine whether this exemption might be
available to the company:
- How long has this investor known the director or executive officer?
- Who does the investor know?
- What is the nature of the relationship, including the frequency of contact and level of trust?
- The following relationships are not determinative (on their own) to rely on the exemption: a relative, a member of the same religious congregation or club, a co-worker, a customer, an acquaintance, a Facebook "friend" or contact through other form of social media.
4. There are a number of ways to qualify as an accredited investor, the most common of which include:
- Financial Assets
- Does an individual either alone or with a spouse own (directly or beneficially) cash, securities or a contract of insurance having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $1,000,000?
- Does an individual own (directly or beneficially) cash, securities or a contract of insurance having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5,000,000?
- Please note that cash, securities or a contract of insurance do not include real property.
- Net Income
- An individual whose net income before taxes exceeded $200,000 in each of the 2 most recent calendar years and who reasonably expects to exceed that net income level in the current calendar year; 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 reasonably expects to exceed that net income level in the current calendar year.
- Net Assets
- An individual who, either alone or with a spouse, has net assets of at least $5,000,000; or
- A person, other than an individual or investment fund, that has net assets of at least $5,000, 000 as shown on its most recently prepared financial statements. (Please note that "net assets" unlike "financial assets" includes all of the investor's assets, minus all of his or her liabilities. This means that it could include an investor's personal residence and other real estate.)
5. Whether or not a person is a member of the public must be determined on the facts of each particular case. The courts have interpreted "the public" very broadly in the context of securities trading. Whether a person is a part of the public will be determined on the particular facts of each case, based on the tests that have developed under the relevant case law. A person who intends to distribute securities in reliance upon the private issuer prospectus exemption in section 2.4(2) of NI 45-106 — Prospectus Exemptions to a person not listed in paragraphs (a) through (j) of that section will have to satisfy itself that the distribution of the security is not to the public.