The Canadian Securities Administrators (CSA) have announced that they are implementing significant changes to the “accredited investor” (AI) and “minimum amount” prospectus exemptions set out in National Instrument 45-106 Prospectus and Registration Exemptions. On the same date, the Ontario Securities Commission also announced that it was adopting a new prospectus exemption, the “family, friends and business associates” exemption (the FFBA exemption).
Assuming that the necessary governmental approvals are obtained, the amendments will come into force on May 5, 2015. In Ontario, the amendments to the AI and minimum amount exemptions will come into force on the later of May 5, 2015 and the date on which applicable budget legislation is proclaimed in force. Other changes to the exempt market regime were also announced, but this bulletin focuses on the changes to the AI and minimum amount exemptions and the new Ontario FFBA exemption.
What Are the Most Important Changes?
The most important changes are as follows:
- The minimum amount exemption will no longer be available for distributions to individuals.
- Under the AI exemption, if an issuer is distributing to an individual investor, the issuer will now have to provide a risk acknowledgement form to the investor, unless the individual beneficially owns net financial assets exceeding CAD $5 million.
- The CSA have provided new guidance which describes the steps that sellers are expected to take in order to verify whether purchasers are eligible to acquire securities under capital-raising exemptions such as the AI and FFBA exemptions (such exemptions being based on purchaser characteristics such as income, assets or relationships with the issuer’s management).
- The new Ontario FFBA exemption, which is substantially similar to the family, friends and business associates exemptions which have existed in other Canadian jurisdictions for some time, allows issuers (other than investment funds) to distribute securities to directors, executive officers, control persons and founders of an issuer, as well as family members, close personal friends and close business associates of directors, executive officers, control persons or founders. This exemption requires that a risk acknowledgment form be delivered to the purchaser.
Why Have Canadian Securities Regulators Made These Changes Now?
Of the four key changes listed above, you will note that the first three are aimed at addressing investor protection concerns, while the fourth is aimed at benefiting early-stage issuers and facilitating access to capital.
The changes to the AI exemption arise from concerns, which the CSA have been expressing for some time, that many individual investors do not properly understand the risks of investing in the exempt market and furthermore, that too many individuals subscribing under the AI exemption do not in fact qualify as accredited investors. Similarly, the CSA have also been expressing concerns for many years that the minimum $150,000 investment threshold under the minimum amount exemption was not an appropriate proxy for investor sophistication or an investor’s ability to withstand financial loss, and furthermore that the threshold may have resulted in individual investors over-concentrating in certain investments just to satisfy the threshold.
The OSC has stated that the new FFBA exemption should benefit early-stage and smaller issuers, given the fact that such an issuer’s network of family, friends and business associates is usually the obvious first available source of funds for these enterprises.
How Do these Changes Affect Issuers Who Need to Raise Capital?
Subscription Agreements and Forms Will Need to be Revised
One of the specific steps that issuers and other market participants will have to take in order to adapt to these changes is that existing “standard” forms of subscription agreements will have to be revised in time for the expected May 5, 2015 implementation date.
The New CSA Guidance: Issuer Due Diligence Procedures and Concerns
The biggest concern in the marketplace, however, has to do with the new “guidance” that the CSA have provided on the steps that are to be taken in order to verify purchasers’ eligibility for the exemptions (particularly when purchasers are representing that they are accredited investors, or close personal friends or close business associates of principals). The CSA says in its guidance that “it will not be sufficient for the seller to accept standard representations in a subscription agreement or an initial beside a category on [the risk acknowledgment form] unless the seller has taken reasonable steps to verify the representations made by the purchaser.” In this respect, the CSA seem to have made the process of capital raising more onerous for issuers. Consider the following points:
- Brokered Private Placements: The guidance says that registered dealers and representatives “must not only establish that a prospectus exemption is available”, but must also comply with their registration obligations, such as determining whether an investment is suitable for a purchaser. Elsewhere in the guidance the CSA state that the “reasonable steps” required by a seller of securities in order to confirm the purchaser’s eligibility may depend on, among other things, “whether the person who meets with, or provides information to, the purchaser is registered.” So does this mean that, in a fully brokered private placement, an issuer may rely on the broker’s due diligence in this regard? The guidance doesn’t specifically say. Yet it would seem redundant and inefficient to require both a fully registered dealer and the issuer to carry out this sort of due diligence in the context of a fully brokered offering. It would therefore seem prudent for issuers to clarify who exactly is to be responsible for determining subscribers’ eligibility (for example via explicit language in the agency agreement for the offering).
- Non-Brokered Private Placements: The guidance seems to suggest that in any non-brokered private placement, an issuer should implement and carry out due diligence and verification procedures regarding subscribers’ eligibility that go significantly beyond anything that has been done in terms of “standard market practice” until now. This will likely result in increased time, costs and paperwork for issuers when carrying out such offerings. This would also apply to situations where an issuer has a separate “President’s List” in an otherwise brokered private placement, because the issuer would not be able to rely on the registered dealer’s due diligence and related procedures in the case of purchasers who subscribe directly through the issuer.
- Collection of Personal Information from Subscribers: The guidance states that those additional “reasonable steps” to verify eligibility should include the seller asking “questions about the purchaser’s net income, financial assets or net assets, or…ask[ing] other questions designed to elicit details about the purchaser’s financial circumstances.” And “if the seller has concerns about the purchaser’s responses…the seller could ask to see documentation that independently confirms the purchaser’s claims”. However, the guidance does not go on to say specifically what “documentation” they are talking about — could that be pay stubs, tax records, or an affidavit from the purchaser? Note that there are significant personal information and privacy law concerns that come into play here.
- Procedures, Checklists, Record-Keeping, Etc.: The guidance states that a seller of securities should have policies and procedures in place to ensure that all parties acting on behalf of the seller in a distribution (including employees, officers, directors, agents, finders, etc.) understand the exemption being relied on, 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. At least in the context of non-brokered private placements, we can foresee some sort of “best practice” procedure emerging whereby issuers and their personnel involved in the offering would use written questionnaires and checklists and create a written record of their discussions with subscribers.
A link to the CSA and Ontario notices describing the amendments is here.