On June 30, 2016, the Ontario Securities Commission (the "OSC") proposed OSC Rule 72-503 — Distributions Outside of Canada (the "Proposed Rule"). The Proposed Rule would replace the antiquated Interpretation Note 1 — Distributions of Securities Outside of Ontario (the "Interpretation Note"), which was published 33 years ago and has since provided Ontario issuers with uncertainty and vagueness about how to comply with Ontario securities laws when selling securities to investors outside of Ontario.
Interpretation Note 1
The Interpretation Note formalized the OSC's view that, despite the historically broad interpretations of the definitions of "trade" and "distribution" in the Securities Act (Ontario) (the "Act"), neither a prospectus nor a prospectus exemption is required where an issuer, underwriter and other participants effecting a distribution of securities take reasonable steps to ensure that such securities come to rest outside of Ontario. The Interpretation Note provided a "how to" checklist for issuers to ensure that the distribution process results in their securities being held by, or for the benefit of, non-residents of Ontario.
The Interpretation Note has been challenging for issuers to apply — and for the OSC to administer — due to the ambiguity associated with determining whether securities sold to non-residents of Canada will not "flow back" into Ontario, effectively doing an end-run around any applicable hold periods. Despite the guidance in the Interpretation Note, issuers intent on complying with Ontario securities laws had to perform a painstaking analysis to determine if there was any risk that their securities would flow back into Ontario. Adding to the ambiguity, despite the well-trodden OSC ground that prospectuses are not generally required in respect of distributions outside of Ontario, the trend in enforcement decisions suggested that the OSC would assert its jurisdiction and a distribution would be subject to Ontario securities laws if there was a "real and substantial connection" or "sufficient connecting factors" to Ontario.
The Proposed Rule
The Proposed Rule aims to end the ambiguity by providing Ontario issuers with more clarity with respect to how to comply with Ontario securities laws for outbound distributions. The Proposed Rule provides four express exemptions to the prospectus requirement:
- Foreign Public Offering Exemption — for distributions under a public offering document in the U.S. or other designated foreign jurisdiction
- Ontario Prospectus Concurrent Distribution Exemption — for distributions where a concurrent distribution is qualified under a prospectus in Ontario
- Reporting Issuer Exemption — for distributions where the issuer is and has been a reporting issuer in a jurisdiction of Canada for the four months immediately preceding the distribution
- Other Distributions Exemption — for distributions that do not fall under the above categories provided that the distribution is conducted in accordance with the applicable laws of the foreign jurisdiction but subject to restrictions on resale to Canadian persons
The framework of the Proposed Rule is extended to distributions outside of Canada, as opposed to the Interpretation Note which only addressed distributions outside of Ontario, reflecting the intervening harmonization of the prospectus requirements and exemptions across Canada.
Also contemplated by the Proposed Rule are exemptions from the dealer and underwriter registration requirements that would otherwise apply in connection with an outbound distribution. As a result, issuers conducting outbound distributions may not be required to involve a Canadian registered dealer.
The Proposed Rule is also accompanied by a proposed companion policy, which will provide additional guidance and interpretation as to when and how the proposed prospectus and registration exemptions may be available to issuers, dealers and other market participants.
Clarity comes at some cost, however. The Proposed Rule will require issuers relying on three of the four exemptions to file a post-closing report in the form of Form 72-503F — Report of Distributions Outside of Canada within 10 days of the distribution date. Form 72-503F is similar in many respects to other private placement trade reports, but does not require the names or other detailed information about non-Canadian purchasers. Three of the four exemptions will not require securities distributed outside of Canada to carry any hold periods or resale restrictions, but the Other Distributions Exemption will impose restrictions on a purchaser seeking to resell the securities back into Canada.
Further, prudent issuers and selling securityholders will wish to seek confirmation of compliance with the applicable laws of non-Canadian jurisdictions, which is a condition of three of the four exemptions, resulting in potential additional legal costs.
Foreign Public Offering Exemption
The Ontario prospectus requirement will not apply to a distribution of securities from Ontario to a purchaser outside of Canada if the issuer or selling securityholder has filed a registration statement in accordance with the U.S. Securities Act of 1933 that registers the securities being distributed or the issuer or selling securityholder has filed a document similar to a final prospectus under the laws of a “designated foreign jurisdiction”. There are no Canadian hold or resale restrictions applicable with this exemption and no reporting to the OSC is required.
We expect that Ontario issuers and selling securityholders will rely on this exemption in circumstances where they are conducting U.S.-only public offerings (including IPOs, secondary offerings and new issues), a public offering in the U.S. and Canada, a public offering only in a designated foreign jurisdiction, or a public offering in the designated foreign jurisdiction and Canada. Issuers using the Multijurisdictional Disclosure System to conduct an offering in the U.S. would also be able to rely on this exemption.
Concurrent Distribution and Ontario Prospectus Exemption
A distribution of securities outside of Canada will not require a prospectus if the issuer or selling securityholder complies with the securities law requirements of the non-Canadian jurisdiction and has filed and received a receipt for a final prospectus in Ontario that qualifies the concurrent distribution of such securities in Ontario. However, issuers may choose to only qualify the securities distributed under the prospectus to Ontario purchasers, in which case the prospectus would not qualify the distribution of securities to purchasers outside of Canada and such purchasers would not be entitled to rely on certain rights and investor protections such as statutory rights of withdrawal. A prospectus that is filed under this exemption should clearly state whether or not it qualifies the distribution of securities to non-Canadian purchasers. A report on Form 72-503F will be required.
We expect that Ontario issuers and selling securityholders will rely on this exemption when conducting offerings in Ontario and also making sales on a private placement basis in the U.S. or other foreign jurisdictions.
Reporting Issuer Exemption
A distribution of securities outside of Canada will not require a prospectus if the issuer or selling securityholder complies with the securities law requirements of the non-Canadian jurisdiction and the issuer has been a reporting issuer in a jurisdiction of Canada for at least four months prior to the distribution. There are no Canadian hold periods or resale restrictions applicable with this exemption, however a report on Form 72-503F will be required.
We expect that Ontario reporting issuers will rely on this exemption when making private placement sales in the U.S. or other countries, or when conducting public offerings in countries that do not qualify as “designated foreign jurisdictions”, thus preventing use of the Foreign Public Offering Exemption. Selling securityholders that have securities still subject to Canadian hold period may also rely on this exemption to resell their securities to purchasers in other countries or on a non-Canadian exchange or market. Issuers and selling securityholders will need to be satisfied that the securities are being purchased by residents of the U.S. or other countries and not just in the course of a series of sales and resales, otherwise the hold periods applicable to Canadian private placements could easily be circumvented.
Other Distributions Exemption
For distributions that do not fall under any of the three exemptions above, the Proposed Rule provides for a fourth "catch all" exemption from the prospectus requirements if the issuer or selling securityholder is distributing securities to purchasers outside of Canada and the distribution complies with the securities law requirements of the non-Canadian jurisdiction. In these circumstances, the securities would be subject to hold periods and/or resale restrictions. A distribution report on Form 72-503F will also be required.
This exemption provides for an alternative to the use of the "accredited investor" exemption that issuers typically rely on for the sale of securities to foreign purchasers, since there is no need for foreign purchasers to complete the Canadian "accredited investor" analysis.
Dealer and Underwriter Exemptions
The Proposed Rule provides an exemption from dealer and registration requirements for foreign dealers and underwriters acting in connection with a distribution outside of Canada pursuant to one of the four new exemptions in the Proposed Rule. In the context of distributions to purchasers of securities in the U.S. or a designated foreign jurisdiction, the exemption requires that the person or company be registered with the Securities and Exchange Commission and the Financial Industry Regulatory Authority (for distributions in the U.S) or in a category similar to a dealer (for distributions in a designated foreign jurisdiction). We note that, as currently drafted, the Proposed Rule would not provide an exemption in circumstances where the person or company is exempt from the requirement to register as a dealer in its home jurisdiction or principal place of business. The exemption may also apply to persons or companies that have a head office or principal place of business in Canada but are not registered as a dealer in Canada. However, the exemption is not available to (a) persons or companies registered as dealers in any province or territory of Canada, (b) persons or companies (other than certain U.S. broker-dealers and advisers servicing U.S. clients from Ontario) that carry on business as a broker or dealer in Ontario, or (c) persons or companies (other than the issuer or selling securityholder) that trade securities to, with or on behalf of anyone in Ontario.
We note, however, that while this exemption does provide some clarity that the dealer and underwriter registration requirements do not apply to foreign dealers in certain circumstances, foreign dealers should still consider whether or not other activities they are performing in connection with the distribution would otherwise require registration under Ontario securities laws.
Implications for Investment Funds
While the Proposed Rule provides much-needed clarity with respect to prospectus requirements for outbound distributions, the dealer and underwriter exemptions may cause angst among Ontario investment fund managers in the context of distributions of Ontario investment funds to non-residents of Canada. Many Ontario investment fund managers are also registered as exempt market dealers in order to facilitate investments into any domestic investment funds which they manage. As noted above, the Proposed Rule indicates that the dealer and underwriter exemptions will not be available if the person or company is registered as a dealer in any province or territory of Canada. This would mean that the investment fund manager would be required to also comply with its obligations as a dealer (for example, the “know your client” and “suitability” obligations) for all foreign investors in the domestic funds which it manages in the same manner as it does with all Canadian investors in the fund.
As privately offered investment funds are not reporting issuers, they would be offering securities to non-residents of Canada in reliance on the fourth (Other Distributions) exemption from the prospectus requirement discussed above, meaning that the distribution would need to be conducted in compliance with the applicable securities laws of the foreign jurisdiction and that the fund would be required to prepare and file a report in Form 72-503F within 10 days of the distribution date. As permitted under National Instrument 45-106 — Prospectus Exemptions, most investment funds in Canada currently file reports of exempt distribution on an annual basis. As currently formulated, the Proposed Rule does not excuse investment funds from complying with the 10-day reporting requirement, which would mean that investment funds would have two deadlines for the filing of distribution reports, further complicating their compliance efforts.
The comment period for the Proposed Rule ends on September 28, 2016.