On June 30, 2016, the Ontario Securities Commission (OSC) published for comment Proposed OSC Rule 72-503 Distributions Outside of Canada (Rule 72-503) and Proposed Companion Policy 72-503CP (Companion Policy, and together with Rule 72-503, the Proposed Rule).
The Proposed Rule aims to provide Ontario issuers and dealers acting for Ontario issuers with certainty regarding the application of Ontario prospectus and dealer registration rules to distributions of securities to investors outside Canada. The Proposed Rule includes four new prospectus exemptions, one new dealer registration exemption and a new form, Form 72-503F, to notify the OSC of distributions made outside Canada in reliance on certain of the new exemptions. The comment period closes on September 28, 2016.
The Proposed Rule would replace OSC Interpretation Note 1 Distributions of Securities Outside Ontario (Interpretation Note). The Interpretation Note, published in 1983, memorialized the OSC’s view that where an issuer and its intermediaries have taken “reasonable precautions” to ensure that securities distributed outside Ontario “come to rest” with investors outside Ontario and will not “flow back” into Ontario, neither a prospectus nor reliance on an exemption from the prospectus requirement is required under Ontario law.
The Interpretation Note did not provide bright line tests for determining when “flow back” risk requires an Ontario prospectus, and has therefore proven challenging to apply in various contexts. For example, an Ontario issuer with equity securities listed on the Toronto Stock Exchange that seeks to distribute such equity securities abroad is typically required to analyze — in the absence of a bright line numerical test — whether sufficient foreign trading volume will exist relative to trading volume in Canada such that the issuer and its underwriters can be comfortable that the securities will “come to rest” abroad.
Resale outside Canada by Ontario sellers of securities of non-reporting issuers originally distributed into Ontario on a prospectus-exempt basis has also proven challenging, due to the need to either rely on the Interpretation Note or determine that the percentage of beneficial ownership of the class of securities held in Canada does not exceed minimum thresholds set out in section 2.14 of National Instrument 45-102 Resale of Securities. In this connection, Quebec’s Autorité des marchés financiers recently published two blanket orders granting certain Canadian institutional investors exemptions from the prospectus requirement in connection with the resale of securities outside Canada. See our July 2016 Blakes Bulletin: Relief in Quebec Granted to Select Canadian Institutional Investors for Resale of Securities to Outside Canada for more information on that topic.
The Proposed Rule is intended to eliminate the need for the analysis required by the Interpretation Note, and the related uncertainty, in most circumstances.
SUMMARY OF THE PROPOSED RULE
Under the Proposed Rule, four new exemptions from the Ontario prospectus requirement would be available:
- Foreign Public Offering Exemption: Public offerings of securities made in the U.S. or other “designated foreign jurisdictions” provided that a receipt, notice of effectiveness or similar acknowledgment of regulatory approval of the offering document has been obtained. The list of “designated foreign jurisdictions” is lifted from National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers and is limited to Australia, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, New Zealand, Singapore, South Africa, Spain, Sweden, Switzerland and the United Kingdom.
- Concurrent Canadian Prospectus Exemption: Distributions of securities outside Canada made concurrently with a prospectus offering in Ontario and in accordance with foreign securities laws.
- Canadian Reporting Issuer Exemption: Distributions of securities outside Canada if the issuer of the securities is and has been a reporting issuer in a Canadian province or territory for the four months immediately preceding the distribution outside Canada and the distribution is made in accordance with foreign securities laws.
- Restricted Canadian Resale Exemption: Any other distribution in a jurisdiction outside Canada in accordance with foreign securities laws.
Securities distributed outside Canada under the first three new prospectus exemptions would be freely tradable and could therefore be subsequently sold back into Canada without restriction. Securities distributed under the fourth “catch-all” Restricted Canadian Resale Exemption would remain subject to restrictions on sales back into Canada, such that a resale back into Canada would be considered a distribution unless (1) the trade is to a person or company outside Canada or (2) (a) the issuer is and has been a reporting issuer in a Canadian province or territory for the four months immediately preceding the resale and (b) at least four months have elapsed from the distribution date.
Dealer Registration Exemption
The Proposed Rule would also provide an exemption from the dealer registration requirement for a dealer acting in connection with a distribution outside Canada that, among other requirements, has its head office or principal place of business in the U.S., Canada or a “designated foreign jurisdiction” and is registered or otherwise permitted under applicable foreign law to act as a dealer on the distribution.
Form Filing Requirement
Issuers that rely on the Concurrent Canadian Prospectus Exemption, the Canadian Reporting Issuer Exemption or the Restricted Canadian Resale Exemption would be required to file a trade report with the OSC on proposed new Form 72-503F within 10 days after closing. The new form would require relatively limited disclosures regarding the issuer, the underwriters and the securities distributed, including the aggregate amount and purchase price of the securities distributed. The new form would not require disclosure of the identity of purchasers in the distribution outside Canada.
Canadian securities regulators have historically been split on the question of whether the prospectus requirements of provincial securities legislation should apply extraterritorially. Alberta, British Columbia and Quebec take the view that a distribution of securities by an issuer with sufficient connecting factors to their provinces (e.g., head office location, reporting issuer in the province) to investors located outside the province must be made in accordance with the province’s prospectus requirements or an exemption from the prospectus requirements. Ontario’s current position, as expressed in the Interpretation Note, is that the prospectus requirements of the Securities Act (Ontario) do not apply if the securities distributed out from Ontario “come to rest” in a foreign jurisdiction and will not “flow back” into Ontario.
The other provinces have left it open to market participants to determine that distributions of securities to foreign investors are not subject to such provinces’ securities regimes, presumably on the basis that foreign investors are more appropriately protected by the securities regulations of their home jurisdictions.
Notably, when consultation drafts of the regulations under the uniform provincial capital markets legislation, the Capital Markets Act, for the proposed Cooperative Capital Markets Regulatory System were published for comment late last year, the regulators (including Ontario) had proposed to adopt the Alberta, British Columbia and Quebec position that distributions from the jurisdiction are distributions in the jurisdiction for purposes of determining whether the provincial prospectus requirements would apply.
As a result of the purported extraterritorial application of their provincial securities laws, Alberta, British Columbia, Quebec and, to a lesser extent, Ontario issuers, have faced practical difficulties accessing foreign capital markets. For example:
- Issuers offering securities into the U.S. in private placements under Rule 144A have been required to receive representations from U.S. purchasers regarding such purchasers’ status as “accredited investors” under Canadian law.
- Canadian incorporated issuers that are “domestic issuers” for U.S. securities law purposes, or are not reporting issuers in Canada eligible to use the U.S.-Canada Multijurisdictional Disclosure System (MJDS), may be required to either (1) file and have receipted a Canadian prospectus in order to IPO in the U.S. or (2) receive “accredited investor” representations from U.S. IPO purchasers and impose transfer restrictions on the offered securities (which is impossible to implement in practice).
- The regulators in Alberta, British Columbia and Quebec require the issuer or underwriters to list all purchasers of securities in the offering, including the U.S. purchasers, in the Form 45-106F1 Report of Exempt Distribution filing made in connection with a private placement in Canada.
IMPLICATIONS, ANALYSIS AND COMMENTARY
Uncertainty Regarding Extent to Which Preventing “Flow Back” Still Animates OSC Policy
Rule 72-503’s new prospectus exemptions would appear, on their face, to reflect a reduced concern regarding the risk of flow back into Canadian markets, except where the issuer is not a Canadian reporting issuer and the securities are not being distributed to the public in the U.S. or a “designated foreign jurisdiction.” In place of prevention of “flow back,” the principle underpinning Rule 72-503’s prospectus exemptions appears to be related to the availability of sufficient acceptable disclosure to substitute for a Canadian prospectus. If an issuer is filing Canadian continuous disclosure documents or foreign offering documents in the U.S. or a designated foreign jurisdiction, the implicit presumption seems to be that such documents will sufficiently protect any Canadian “flow back” purchasers, and restrictions on sales back into Canada need not be imposed.
Interpretation Note Preserved as “Fall-Back” Position in Companion Policy Guidance
The OSC continues to state its view in the Companion Policy that: “[It] does not interpret the prospectus requirement as applying to a distribution of securities outside of Canada . . . provided that the issuer, underwriters and other participants in the offering take reasonable steps to ensure that the securities come to rest outside of Canada and are not redistributed back into Canada.” This additional interpretive gloss is helpful in that it preserves the Interpretation Note as a fall-back position or safety valve for issuers and underwriters that sell securities abroad but which cannot easily fit into the enumerated exemptions. For example, under this guidance it may be open to an Ontario incorporated issuer to conclude that a Rule 144A offering of US$ denominated debt securities may be made in the U.S. without putting a Canadian restrictive legend on the notes or otherwise imposing Canadian resale restrictions, on the basis that the risk of flow back into Canada is minimal.
New Form Filing Requirement Would Apply to Rule 144A Tranches of Canadian Public Offerings if Concurrent Canadian Prospectus Exemption is Relied on
Under the Proposed Rule, U.S. Rule 144A tranches that are added on to Canadian public offerings would trigger the requirement to file new Form 72-503F within 10 days after closing if the Concurrent Canadian Prospectus Exemption is relied on for the U.S. tranche.
Clarity on “Name Give Up” for Offerings by Ontario Issuers
Where an issuer with connections to Ontario offers securities abroad (usually in the U.S.) and concurrently sells the securities into Ontario in a private placement, market practice has been to list only the Ontario purchasers — and not list the foreign purchasers — on the exempt distribution report filed on Form 45-106F1. The Proposed Rule would provide important certainty on this point since none of the new prospectus exemptions are to be included on the list of prospectus exemptions that trigger a filing on Form 45-106F1. The new Form 72-503F does not require disclosure of purchaser information.
New Dealer “Exemption” Raises Possibility of Extraterritorial Regulation of Foreign Dealers Selling Securities of Ontario Issuers Abroad
The Proposed Rule’s new dealer exemption would only apply to dealers that are (1) registered in the U.S. or in one of the designated foreign jurisdictions and (2) in compliance with “all applicable dealer registration requirements and other broker-dealer regulatory requirements” applicable in connection with the distribution. This raises the question of how the OSC would intend to handle either a dealer in a non-designated foreign jurisdiction or a U.S. broker-dealer that might be in technical non-compliance with any conduct and other regulatory requirements of U.S. federal and state securities law and Financial Industry Regulatory Authority rules in connection with the distribution.