The Canadian Securities Administrators (“CSA”) announced the adoption of amendments relating to several common distribution exemptions from the prospectus requirement under Canadian securities law.
On February 19, 2015 the CSA announced the adoption of amendments to National Instrument 45-106 - Prospectus and Registration Exemptions (“NI 45-106”) relating to several common distribution exemptions from the prospectus requirement under Canadian securities law (most notably to the accredited investor and minimum amount investment prospectus exemptions but also, with reference to the Companion Policy, certain aspects of the private issuer prospectus exemption, the family, friends and business associates prospectus exemption and, in some jurisdictions, the eligible investor definition under the offering memorandum prospectus exemption). Note that these are distribution exemptions from the prospectus requirement under Canadian securities law, not trading exemptions from the registration requirement under Canadian securities law, and as such NI 45-106 does not provide exemptions from the requirement to be registered as a dealer, adviser or investment fund manager for those determined to be “in the business of trading” . These prospectus exemptions are in many cases the distribution corner-stone of private equity and private placement financing, particularly with respect to small and mid-sized issuers, and all issuers and their management should be aware of the changes and adjust future proposed prospectus exempt financing (including intended solicitation, due diligence, documentation and reporting procedures) accordingly.
Provided all necessary ministerial approvals are obtained, the amendments will come into force on May 5, 2015. In Ontario, the amendments will come into force on the later of May 5, 2015 and the day on which subsection 12(2) of Schedule 26 of the Budget Measures Act, 2009 is proclaimed in force.
The accredited investor prospectus exemption and the minimum amount investment prospectus exemption have historically been premised on the investor having one or more of (a) a certain level of sophistication; (b) the ability to withstand financial loss; (c) the financial resources to obtain expert advice; and (d) the incentive to carefully evaluate the investment given its size. These exemptions were intended to provide cost-effective objective measures for issuers to distribute securities to raise capital or for other purposes.
However, securities regulators were increasingly concerned that:
the thresholds for individuals to qualify as accredited investors have not been changed or adjusted for inflation since they were originally set;
some individual investors may not understand the risks of investing under the accredited investor exemption or may not in fact qualify as accredited investors; and
the threshold of $150,000 in the minimum amount exemption may not be a proxy for sophistication or ability to withstand financial loss for individual investors and may encourage over-concentration in one investment for an investor who is an individual.
In February, 2014 the CSA published proposed amendments seeking to address these concerns and certain concerns with the use and application of other common prospectus exemptions, and invited comment from stakeholders and the public.
After considering the comments received, the CSA has now made revisions to the originally proposed amendments and has published the final amendments which will likely be effective by early May, 2015. The key issues for all issuers and management to be aware of are as follows:
Persons relying on the accredited investor prospectus exemption in section 2.3 of NI 45-106 (and section 73.3 of Securities Act (Ontario)) will be required to obtain a signed risk acknowledgement in Form 45-106F9 - Risk Acknowledgement Form for Individual Accredited Investors from certain individual accredited investors who are not permitted clients. The CSA has amended the Form 45-106F9 originally proposed to make it easier for persons using the accredited investor exemption to complete and for investors to understand and have now clarified that the categories of individual accredited investor who must sign the risk acknowledgement form are those individuals set out in paragraphs (j), (k) and (l) of the definition of “accredited investor”. The CSA has also removed the requirement for salespersons and finders to sign Form 45-106F9.
The minimum investment amount exemption will only be available for distributions to non-individuals to address investor protection concerns associated with the use of the exemption to distribute securities to individual investors.
The Companion Policy now confirms that registered dealers or representatives must not only establish that a prospectus exemption is available, but must also comply with its registration obligations. For example, even if a registered dealer or representative has determined that a purchaser qualifies as an accredited investor or eligible investor, the registered dealer or representative must still assess whether the investment is suitable for the purchaser.
The Companion Policy now confirms that a seller of a security (including an issuer) when seeking to rely upon the accredited investor exemption and the “eligible investor” test in the offering memorandum exemption or any of the private issuer exemption, the family, friends and business associates exemption will have to obtain information from the purchaser in order to determine whether the purchaser has the requisite income, assets or relationship to meet the terms of the exemption. It will not be sufficient for the seller or issuer to accept standard representations in a subscription agreement or an initial beside a category on Form 45-106F9 unless the seller has taken reasonable steps to verify the representations made by the purchaser.
The Companion Policy now describes, in considerable detail, the obligations of a seller of a security and the expected practices for verifying whether purchasers meet the conditions of certain exemptions, including the accredited investor exemption, the private issuer prospectus exemption, the family, friends and business associates prospectus exemption and, in some jurisdictions, the eligible investor definition under the offering memorandum prospectus exemption.
The Companion Policy now provides additional guidance on the meaning of close personal friend and close business associate by, while still not providing a “bright-line” test, setting out several factors that are to be considered in determining such status as well as outlining several circumstances in which a potential purchaser will not be considered either a close personal friend and close business associate.
The Companion Policy now confirms that, before discussing the details of an investment with a prospective purchaser, the seller is expected to obtain information that confirms the purchaser meets the criteria set out in the exemption. The CSA has made it clear that it would no longer be sufficient for a seller to rely solely on a form of subscription agreement or other document that only states: “I am an accredited investor” or “I am a friend of a director”.
The Companion Policy now confirms that a seller of a security is responsible for determination of the availability of prospectus exemptions and must have policies and procedures in place to confirm that potential purchasers understand the exemption being relied on and are able to describe the terms of the exemption to purchasers and know what information and documentation must be obtained from purchasers to confirm the conditions of the exemption have been satisfied. Sellers should seek to retain such information and any certifications for up to eight years, the longest limitation period under securities legislation in Canada.
The amendments also amend the definition of accredited investor in Ontario to allow fully managed accounts to purchase investment fund securities under the managed account category of the accredited investor exemption, as is already permitted in other Canadian jurisdictions. The CSA has deferred making amendments to the report of exempt distribution and will address changes to the report of exempt distribution as a separate CSA project.
The amendments to these commonly used prospectus exemptions, and the guidance now provided in the revised Companion Policy, represent perhaps the most significant change to the legal analysis and process of prospectus exemption reliance and application of a typical private placement transaction since the wholesale changes to the registration exemption regime in September, 2009 with the adoption of National Instrument 31-103 - Registration Requirements and, Exemptions and Ongoing Registrant Obligations. All issuers and management should understand that it is not business as usual, so to speak, in the exempt or private placement market after the adoption of these amended rules and policies and seek appropriate legal advice prior to engaging in any exempt market or private finance related activities.
Does not constitute legal or other advice and must not be used as a substitute for legal advice from a qualified legal professional in your jurisdiction who has been fully informed of your specific circumstances. Information may not be up-dated subsequent to its initial publication and may therefore be out of date at the time it is read or viewed. Always consult a qualified legal professional in your jurisdiction.