Streamlining access to capital has been a popular topic, with regulators around the globe poised to implement various regulatory reforms aimed at simplifying the process for startup companies and small enterprises. As we’ve discussed in the past, the Ontario Securities Commission released a consultation paper on December 14, 2012, and a progress report on August 28, 2013, with respect to the OSC’s consideration of new capital raising prospectus exemptions in Ontario. According to the progress report, which will be discussed in more detail below, the OSC has been directed to focus on four new capital raising prospectus exemptions in the future, namely: (1) a crowdfunding exemption; (2) a family, friends and business associates exemption; (3) an offering memorandum exemption; and (4) a streamlined rights offering exemption. The focus of this post is crowdfunding.
Crowdfunding covers a wide range of online activities from charities soliciting donations to companies raising capital. In the case of financing a company, crowdfunding refers to a company selling small amounts of securities to a large number of investors via an internet portal intermediary. Crowdfunding can thus be considered an exchange of cash consideration for securities, which raises issues for securities regulators around the globe.
Currently crowdfunding is being used to finance companies in the United Kingdom without much regulatory oversight. According to the Financial Conduct Authority, most crowdfunding in the U.K. occurs without FCA authorization. The FCA has, however, authorized several securities based crowdfunding platforms.
Meanwhile, according to the Commissioner of the Australian Securities and Investments Commission, “crowdfunding, as a discrete activity, is not prohibited in Australia nor is it generally regulated by [the] ASIC.” That said, crowdfunding that involves offering or advertising financial products, providing financial services, or fundraising through securities requiring disclosure documents is regulated by the ASIC under the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001. The ASIC’s Class Order 02/273 – Business Introduction and Matching Services nevertheless provides exemptions from certain provisions of the aforementioned acts, effectively permitting funding portals to act as “introduction services” that bring together issuers seeking capital and investors, provided the terms of the Class Order are complied with.
As we discussed in October, the U.S. Securities and Exchange Commission recently proposed rules under the JOBS Act to permit companies to offer and sell securities through crowdfunding. Generally, the proposed ruleslimit the aggregate amount an issuer can raise through crowdfunding offerings to $1 million in any 12-month period. Investors with an annual income and net worth of less than $100,000 would be able to annually invest up to $2,000 or 5% of their annual income or net worth (whichever was greater). Investors with either annual income or net worth of at least $100,000 would be able to annually invest 10% of the greater of their annual income and net worth, up to $100,000.
Crowdfunding offerings would have to be conducted through a registered internet intermediary, either a broker-dealer or a funding portal, which would be prohibited from soliciting investments, offering investment advice, or compensating people for solicitations, and companies conducting crowdfunding offerings would be required to file certain information with the SEC, including among other things disclosure documents, financial statements and annual reports, all of which must be made available to the public.
The SEC is currently seeking public comment on the proposed rules. The Financial Industry Regulatory Authority is also soliciting public comment on a set of proposed funding portal rules and related forms.
Ultimately, the introduction of crowdfunding in the U.S., Australia, and the U.K. has prompted considerable discussion among the media, stakeholders, and securities regulators with respect to the opportunities and challenges of regulating crowdfunding in Canada.
Crowdfunding in Canada
While crowdfunding is not prohibited in Canada, companies issuing securities in exchange for capital are currently subject to prospectus requirements and intermediary online portals are subject to registration requirements, unless they can rely on existing exemptions. Pursuant to Canadian securities legislation and National Instrument 31-103Registration Requirements, Exemptions and Ongoing Registrant Obligations, any person or company “in the business” of trading in securities (e.g. an internet portal intermediary) must register with the applicable securities regulator. According to Companion Policy 31-103CP, intermediating a trade between a seller and a buyer of securities, soliciting the buying and selling of securities, and being compensated for these services is considered to be engaging “in the business.”
Internet portals soliciting securities and intermediating trades between buyers and sellers for commissions are arguably in the business of trading in securities and must register, unless they are exempt. Pursuant to Canadian securities legislation, any person or company “distributing” securities (e.g. an issuing company) must file a prospectus providing full, true and plain disclosure of all material facts relating to the securities issued. That is, unless they are exempt under National Instrument 45-106 Prospectus and Registration Exemptions, for example.
Common exemptions for startup companies include the private issuer exemption for companies with less than 50 security holders who also satisfy certain other prescribed criteria; the accredited investor exemption for companies selling securities to institutional, high net worth, or higher income investors; and the minimum amount exemption for companies distributing securities to an investor who invests at least $150,000 in a single investment. Crowdfunding does not by definition directly fit within these capital raising exemptions.
Regulatory Changes Necessary for Crowdfunding in Canada and in Ontario Specifically
As a result of the prospectus requirements for issuers and the registration requirements for intermediary portals, regulatory changes are necessary to facilitate crowdfunding in Canada. Changing the regulatory regime is, however, particularly challenging in Canada, as securities currently fall under provincial jurisdiction. That said, on December 20, 2012, the Canadian Securities Administrators issued Multilateral CSA Notice 45-311 Exemptions from Certain Financial Statement-Related Requirements in the Offering Memorandum Exemption to Facilitate Access to Capital by Small Businesses. This harmonized interim local order, published by each of the provinces and territories with the exception of British Columbia and Ontario, provides exemptions from certain requirements set forth in Form 45-106F2, which is the required form under the “offering memorandum” exemption in NI 45-106.
The offering memorandum exemption is available in all of the provinces and territories other than Ontario. That province, meanwhile, is currently engaged in its own review of potential prospectus exemptions that could facilitate securities-based crowdfunding, with OSC Staff Consultation Paper 45-710 released on December 14, 2012 (the Consultation Paper), and OSC Notice 45-712 published on August 28, 2013 (the Progress Report).
Essentially, the Consultation Paper canvassed the crowdfunding exemptions available in other jurisdictions, including the U.S., Australia, and the U.K. With respect to crowdfunding in Canada, the paper addressed, among other things, the issuer prospectus requirements and portal registration requirements discussed above. The Consultation Paper concluded by recognizing that increased access to capital for issuers—by way of a crowdfunding exemption for example—must be balanced with concerns for investor protection. In light of the proposed capital prospectus exemptions under consideration, the OSC called for comments from various interested stakeholders on a number of issues.
According to the OSC’s Progress Report, which summarized the OSC’s progress thus far and outlined its plan for the future, four new capital raising prospectus exemptions are now being considered, namely: (1) a crowdfunding exemption; (2) a family, friends and business associates exemption; (3) an offering memorandum exemption; and (4) a streamlined rights offering exemption and a possible exemption for distributions to a reporting issuer’s existing security holders based on the issuer’s continuous disclosure obligations.
In short, the crowdfunding exemption currently contemplated by the OSC would, among other things: (a) limit issuer offerings in any 12-month period; (b) limit individual investments to $2,500 for a single investment or $10,000 in total over a 12-month period; and (c) limit intermediaries that bring issuers and investors together to registered funding portals. In addition to these limits, the Progress Report suggests that any crowdfunding exemption would require investors to sign a risk acknowledgment confirming that they understand the risk of loss, they fall within the investment limits outlined above and they understand the illiquid nature of investing in securities of a non-reporting issuer. Investors would likely also have a two business day “cooling off” period within which they would be able to withdraw from the investments.
These concept ideas for a crowdfunding exemption—which were first outlined in the Consultation Paper along with possible limits on advertising, issuer qualification criteria, and ongoing disclosure requirements—are currently being reviewed and revised by the OSC. Notwithstanding its progress thus far, the OSC is still fleshing out registration requirements for funding portals, which would be expected to vet investors and conduct due diligence on the issuer, its directors and executives, as well as refining issuer restrictions and investor protection measures with respect to annual offering limits and disclosure requirements. The OSC recognizes that for crowdfunding to be a viable method of raising capital, the regulatory framework and any exemptions must provide investors with adequate protections, while at the same time not imposing excessive regulatory costs on issuers and funding portals.
Other capital raising prospectus exemptions under consideration
Aside from the concept idea for a crowdfunding prospectus exemption, the OSC will continue to consider adopting a harmonized family, friends and business associates exemption, an offering memorandum exemption, and a streamlined rights offering exemption.
In Ontario, small and medium-sized companies can currently use the private issuer exemption in section 2.4 of NI 45-106 or the founder, control person and family exemption in section 2.7 of NI 45-106 to raise capital from specified family members of its executive officers, directors or founders without filing a prospectus. The rest of Canada has, however, adopted a broader family, friends and business associates exemption set out in section 2.5 of NI 45-106 that allows companies to raise capital from a wider range of family members in addition to close personal friends and close business associates of its executive officers, directors or control persons. Accordingly, the OSC will consider adopting a broader family, friends and business associates exemption, assuming the OSC can address certain concerns which have been raised with respect to the undefined scope of “close personal friends” and “close business associates.”
The offering memorandum exemption currently contemplated by the OSC, which would permit companies to distribute securities pursuant to limited disclosure documents, is in several respects similar to the crowdfunding exemption concept outlined above, only there will be no requirement for a registrant or funding portal.
In terms of a streamlined rights offering exemption, the OSC has said that it will work with other CSA members to streamline the existing rights offering exemption available across Canada pursuant to section 2.1 of NI 45-106, which allows issuers to distribute rights to acquire securities to existing security holders without a prospectus subject to certain conditions, in an effort to improve its efficiency and effectiveness for reporting issuers. To this end, the OSC intends to revise the conditions currently set out in section 2.1 of NI 45-106 by: (a) reducing the CSA review period of 10 days for rights offering circulars; (b) increasing the current dilution ceiling of 25% for rights offerings; and (c) reducing the prescribed time period of 21 days for the exercise of rights pursuant to prospectus-exempt rights offerings. Other Canadian securities regulators meanwhile recently proposed their own streamlined alternative rights offering exemption for TSX-V listed companies on November 21, 2013 under Multilateral CSA Staff Notice 45-312.
According to the Progress Report, the OSC is not considering any of the following prospectus exemptions contemplated in the Consultation Paper: (1) an investor sophistication exemption; (2) a registrant advice exemption; (3) changes to the existing private issuer exemption; and (4) the re-introduction of the closely-held issuer exemption.
The Progress Report identified the following key themes to guide the OSC’s work going forward:
- the need to facilitate small and medium-sized companies’ access to capital through expanded prospectus exemptions while maintaining adequate investor protections;
- the importance of harmonizing capital raising prospectus exemptions across Canada;
- the emergence of crowdfunding as a new way for startup companies and other small and medium-sized companies to raise capital; and
- the importance of regulatory monitoring and compliance oversight in the exempt market.
Unfortunately, the Progress Report did not set forth any timeframe for the completion of the OSC’s exempt market review or the release of a proposed crowdfunding regulatory regime. The OSC also reiterated that notwithstanding the consultation process and review, crowdfunding issuers, investors and intermediaries alike should not rely on the adoption of any new prospectus exemptions or amendments in Ontario for their capital raising needs.
That said, even in the absence of any new capital raising prospectus exemptions, there have been some recent developments with respect to the regulation of crowdfunding in Ontario. On June 17, 2013, the OSC granted MaRS VX—a not-for-profit crowdfunding platform with the stated goal of bridging the gap between impact issuers that aim to solve social or environmental problems in Ontario and accredited investors—exemptive relief from certain know-your-client and suitability requirements provided in Part 13 of NI 31-103, subject to investment limits and other conditions set out in the decision. These requirements oblige restricted dealers in Ontario to obtain information on each of their clients so as to determine their individual risk tolerance as well as the suitability of the securities that they are proposing to sell to such clients, unless of course an exemption is available as was the case in the matter of MaRS VX.
As we’ve discussed in the past, this ruling to exempt an online platform from the aforementioned know-your-client and suitability requirements, though relatively limited in scope, effectively opens the doors to crowdfunding in Ontario.