Members of the Canadian Securities Administrators (CSA) have proposed further changes to the regulation of the exempt market, including a new prospectus exemption for crowdfunding.
The securities regulators in Ontario, Quebec, Manitoba, New Brunswick and Nova Scotia have proposed a new prospectus exemption for crowdfunding. 'Crowdfunding' is a term that describes raising small amounts of money from many people, usually over the Internet. At present, it is most often used as a source of funding for charities, without the issuance of securities. However, the regulators consider it to be a viable alternative for start-ups and small and medium-sized enterprises to raise capital through the issuance of securities.
The US Securities and Exchange Commission and the Saskatchewan securities regulator have already adopted rules to permit crowdfunding. Other jurisdictions, such as British Columbia, are seeking comment from the investment industry with respect to whether there is an appetite for adopting a crowdfunding exemption in their local jurisdiction.
The crowdfunding exemption proposed by the regulators is a prospectus exemption that also involves using a crowdfunding portal.
In order to make use of the crowdfunding exemption, the issuer must be incorporated or organised in Canada, with a head office and the majority of its directors resident in Canada. Investment funds will not be permitted to rely on the crowdfunding exemption. The offering can be only for a specific list of types of securities.
The crowdfunding exemption can be used only for offerings of up to an aggregate of C$1.5 million in any 12-month period by the issuer or any other issuer in common enterprise with the issuer. The offering cannot remain open for more than 90 days. The issuer must disclose the minimum offering size and, if applicable, a maximum offering size, and cannot complete the offering until the minimum offering size is met and the issuer, after completing the offering, has confirmed that it has sufficient financial resources to achieve its next milestone in its written business plan or, if it has no milestones, to complete the activities set out in the business plan.
Any offering documents must be posted only on the portal and must be filed with the regulator concurrently with delivery to investors. Specific solicitation is not permitted, but an issuer can advertise on paper or through social media.
Each investor is limited to investing C$2,500 per offering, and C$10,000 in aggregate using this exemption in any calendar year. Neither the portal nor the issuer can lend subscription funds to investors. Investors will be required to complete a risk acknowledgment form with respect to their investment.
An issuer must grant rights of action with respect to misrepresentation in any of its offering materials (if not statutorily imposed already) and allow investors 48 hours to withdraw their proposed investment offer. All securities issued using the crowdfunding exemption will be subject to a four-month hold period (for reporting issuers) or for an indefinite period (for non-reporting issuers), and issuers must file a report of exempt distribution within 10 days of the distribution.
In addition, while reporting issuers using the crowdfunding exemption must comply with their continuous disclosure obligations under securities laws, non-reporting issuers that wish to use the crowdfunding exemption will have disclosure and record-keeping requirements imposed on them. Specifically, non-reporting issuers must provide investors annually with:
- annual financial statements (audited if the issuer has raised more than C$500,000 using the crowdfunding exemption or has spent more than C$150,000 since its formation, otherwise reviewed);
- a notice describing how the funds raised using the crowdfunding exemption have been used; and
- certain other disclosures.
The non-reporting issuer must also keep:
- a record of all offering materials used for the crowdfunding exemption;
- completed risk acknowledgment forms;
- all of its annual disclosure documents;
- a list of each of the securities issued using the crowdfunding exemption and their issue price and date; and
- a list of all security holders and the securities that they hold from the issuer.
In order to make use of the crowdfunding exemption, an issuer must ensure that investments are made through a funding portal registered under applicable securities laws, as a restricted dealer. Portals will be restricted from being registered in any other category of dealer.
Generally speaking, a portal will have to comply with the general registrant obligations that are imposed on exempt market dealers, although there are certain differences. Portals will have to conduct background checks on issuers, directors, officers, promoters and control persons. They will also have to understand the general structure and terms of the securities offered. They will have to use this understanding to review and confirm the adequacy of the offering material that will be provided to potential investors under the crowdfunding exemption. If a portal considers that an issuer or its offering is fraudulent, the portal will be required to deny access to the issuer.
A portal is prohibited from providing specific recommendations or advice to investors about securities being offered on the platform and, other than through postings on its platform, cannot solicit purchases or sales of securities offered on the platform; nor can it compensate employees for doing so. A portal is also restricted from holding investor funds or securities. A portal cannot invest in any issuer or underwrite any issuer, other than through the receipt of fees in the form of securities that do not exceed a 10% ownership in the issuer.
The crowdfunding regulators mentioned above, other than Ontario, have also proposed an exemption from both the prospectus and registration requirements (the 'start-up exemption'). The start-up exemption closely mirrors the crowdfunding exemption, except that it is available only to non-reporting issuers, does not require the use of a portal and has lower investment thresholds. For example, in Manitoba the start-up exemption is limited to a maximum offering threshold of C$150,000, and C$1,500 per individual.
The exemptions and reporting obligations described above are only in draft form and are subject to comment from interested parties. The comment period is open until June 18 2014. In addition, the CSA has set out specific questions in the notice.
For further information on this topic please contact Stephen P Robertson at Borden Ladner Gervais LLP's Vancouver office by telephone (+1 604 687 5744), fax (+1 604 687 1415) or email (firstname.lastname@example.org). Alternatively, contact David Surat at Borden Ladner Gervais LLP's Toronto office by telephone (+1 416 367 6000), fax (+1 416 367 6749) or email (email@example.com).