Canadian rules governing at-the-market offerings may soon be streamlined in a manner that would facilitate both Canada-only and Canada-U.S. ATM offerings. ATM offerings involve an issuer selling securities from time-to-time at prevailing market prices on a stock exchange. Under the existing Canadian regime, issuers wishing to conduct ATM offerings must obtain exemptive relief from securities regulators because certain Canadian public offering requirements are incompatible with ATM offerings, e.g., the requirement to physically deliver a prospectus to investors disclosing the rights and remedies available if the document contains a misrepresentation. The exemptive relief orders generally require the number of equity securities sold per trading day not to exceed 25% of the total trading volume. Moreover, the maximum amount that may be sold in an ATM offering in Canada is 10% of the market value of the issuer's outstanding equity securities.
A cross-listed issuer with an effective shelf registration statement in the United States may by-pass the above restrictions by conducting a U.S. ATM offering. The incentive to by-pass Canada could be much reduced under the proposed Canadian rule changes because the 10% limit on total sales would be removed and exemptive relief would no longer be necessary. The Canadian securities regulators are still considering whether to retain the existing 25% trading volume limit on sales per trading day. One alternative is to remove this requirement entirely, and another alternative is to remove it for issuers whose securities are highly liquid. Regardless of the outcome on that particular point, which will be driven by feedback from Canadian market participants, the Canadian ATM rules are expected to soon be substantially more issuer-friendly and conducive to cross-border ATM offerings.
Financial statements in connection with significant acquisitions
Separate financial statements of an acquired business are required to be presented under SEC rules when the transaction is significant at the 20% level based on an asset test, investment test or income test. Existing Canadian rules for business acquisitions align closely with the SEC rules.
While maintaining the 20% threshold, the SEC is proposing several notable rule changes. Canada's securities regulators are likewise considering reforms aimed at reducing the regulatory burdens associated with significant acquisitions.
The current investment test compares the acquisition price to the acquiring company's total assets. The SEC is proposing that instead, the acquisition price would be compared to the acquiring company's aggregate worldwide market value of its voting and non-voting common equity. (The current investment test would still be used if the acquiring company does not have a worldwide market value.)
The current income test compares the acquiring company's and target's relative income from continuing operations before income taxes. The SEC is proposing that income would instead be measured after income taxes. The SEC is also proposing to add a revenue prong to this test—applicable only if both companies have recurring annual revenue—under which the target's total revenue would be compared to the acquiring company's total revenue. An acquisition would only be considered significant under the income test if both the net income and revenue prongs exceed 20%.
The proposed changes to the U.S. significance tests are notable from a cross-border perspective. Existing Canadian rules do not include a market value prong in the investment test or a revenue prong in the income test. Foreign private issuers, including Canadian MJDS companies, are not subject to the SEC's requirements for significant acquisitions under Form 8-K, so aligning Canada's rules with the SEC proposals is not crucial in terms of harmonizing cross-border transaction requirements. That said, Canadian securities regulators have undertaken to streamline issuers' reporting requirements for significant acquisitions - potentially including changes to Canada's significance tests. If the SEC adds a market value prong to the investment test and a revenue prong to the income test, we would expect Canadian securities regulators to carefully consider doing the same, particularly if a number of market participants in Canada encourage the regulators to do so.
Required periods for financial statements
Current SEC rules require three years of audited comparative financial statements of the target if an acquisition exceeds 50% significance. The SEC is proposing to reduce this to two years (which would align with existing Canadian requirements).
Provided an acquisition is below 40% significance and the acquiror is not registering securities to be offered to a target's shareholders, interim financial statements would only be required for the most recent interim period, not for any comparative periods. Current Canadian rules require two years of interim financial statements but, as noted above, Canada's securities regulators may take account of SEC rules changes in deciding whether similar changes are appropriate for the Canadian market.
Pro forma financial statements
The SEC is proposing to divide all permitted pro forma adjustments into two categories: transaction accounting adjustments and management's adjustments. The former would be adjustments made in compliance with U.S. GAAP or IFRS-IASB. The latter would be any other adjustments reflecting management's discretion, and these would be limited to synergies and transaction effects that are reasonably estimable, have occurred, or are reasonably expected to occur. A separate column would have to show the effect of management's adjustments. The notes to the pro forma financial statements would have to include qualitative disclosure of synergies or transaction effects that would be important to investors but that are not reasonably estimable. In contrast to the SEC's proposals on pro forma financial statements, Canada's securities regulators are taking a very different approach by considering eliminating altogether the requirement to present pro forma financial statements in business acquisition reports.
FINRA corporate financing rule
FINRA recently proposed amendments to Rule 5110 Corporate Financing - Underwriting Terms and Arrangements. Rule 5110 prohibits unfair underwriting arrangements in connection with the public offering of securities. FINRA's rules apply to offerings in the United States by U.S. issuers and non-U.S. issuers alike, including offerings by Canadian issuers under the MJDS. As such, any rule changes will impact underwritings of cross-border transactions. The amendments are broad in scope and for the most part would simplify and streamline FINRA's rules, including in relation to filing material and deadlines. Some of the more notable proposed changes would
- clarify the requirement to disclose rights of first refusal granted to underwriters and securities acquired by underwriters, including material terms such as piggyback registration rights, lock-up periods, exercise terms and demand rights;
- provide more examples of items that do not constitute underwriting compensation, e.g., non-convertible debt securities and derivatives acquired in an unrelated transaction;
- require lock-up periods to begin on the date of commencement of sales, not the date when the registration statement becomes effective;
- relax the lock-up requirements for transfers of securities to the underwriter's affiliates or back to the issuer in an exempt transaction; or where the securities meet the requirements of Forms S-3, F-3, or F-10; or where acquired securities are not subject to the underwriting compensation requirements; and
- require that if an offering is not completed, but the underwriter has received compensation, FINRA must be notified and given a copy of the relevant documents.
Simplifying exempt offerings
The SEC recently published a concept release on possible ways to simplify and streamline the U.S. exempt offering framework to promote capital formation. The concept release solicits feedback from market participants on, among other things, the cost and complexity of the current framework; potential barriers to accessing the exempt market faced by companies at different stages of development; investment opportunities available to retail investors; the impact of technology on issuers' communications with potential investors; secondary market liquidity and its effect on companies' capital-raising decisions; and companies' ability to transition from the private to the public capital markets.
SEC rule changes that streamline access to capital will be of benefit to both U.S. and Canadian issuers – the latter have historically met a significant proportion of their capital needs by accessing the U.S. exempt market. The SEC is accepting comments on the concept release until September 24, 2019.
Smaller reporting companies
The SEC is taking another step to promote capital formation among smaller companies by proposing rule changes that would increase the number of SRCs who enjoy relaxed compliance requirements. SRCs are permitted, among other things, to provide two rather than three years of financial statements and MD&A in their registration statements and periodic disclosures; are not required to disclose selected or supplemental financial information; are not required to provide an auditor's attestation of their internal controls; may provide less detailed executive compensation and compensation committee disclosure; and are not required to provide disclosure about contractual obligations or market risks. The SEC is proposing to relax the definitions of "accelerated filer" and "large accelerated filer" so that any SRC that meets the revenue test of < US$100M will be excluded from those definitions and can therefore take advantage of the SRC accommodations.
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