On May 5, 2015, several amendments to the Canadian prospectus exempt regime came into force including changes to National Instrument 45-106–Prospectus Exemptions (“NI 45-106”), and to its Companion Policy (“CP 45-106”).
Of particular importance are the changes relating to the Accredited Investor (“AI”) and minimum amount investment prospectus exemptions. CP 45-106 now includes more detailed guidance on the obligation for issuers to verify purchaser status particularly for exemptions based upon the characteristics of the potential purchaser. A person distributing or trading securities now has to verify if the purchaser of a prospectus exempt security meets the characteristics necessary to determine when a prospectus exemption is available. This new purchaser status-verifying obligation requires issuers to request details on how prospective purchasers fit within the applicable exemption. In addition, issuers will no longer be able to rely on standard purchaser representations contained in commonly used subscription agreements. Consequently, issuers must now play a more active role in the distribution process.
The former version of CP 45-106 required issuers to keep documentation to show that a person properly relied on an exemption. However, the amended CP 45-106 now recommends that those relying on an exemption should have processes in place to ensure that those responsible for identifying or approaching potential purchasers on behalf of the issuer fully understand the conditions of the exemption sought. To comply with the new recommendation in CP 45-106, issuers will need to gather more details about a potential purchaser and not limit their inquiry to asking whether a given purchaser qualifies for an exemption. For example, with respect to the AI exemption, it is now important for an issuer to gather information on: (a) how the issuer identified or located the potential purchaser; (b) what category of AI the potential purchaser claims to be; and (c) how much and what type of background information is known about the potential purchaser in order to reasonably confirm that the potential purchaser meets the condition for the AI exemption. This information gathering process must also be documented and we recommend that it be kept for a period of eight years (to align with the period NI 45-106 requires a Risk Acknowledgment Form to be kept) and be in a format readily available.
In light of these amendments, we recommend that issuers establish policies and procedures in order to streamline the information gathering process, record such information, and ensure compliance with all aspects of NI 45-106, and specifically ensure:
- The policies and procedures require issuers, and persons acting on their behalf, to be able to explain the conditions of the prospectus exemption relied upon. This includes understanding and being able to explain to a potential purchaser the meaning of legal terminology used in NI 45-106. For example, a person relying on the AI exemption should be able to explain to a potential purchaser the nuances of the terms “financial assets” and “net assets” used in the AI definition.
- The policies and procedures require issuers, and persons acting on their behalf, to verify if the potential purchaser meets the conditions of the prospectus exemption relied upon. For example, a person relying on the AI exemption should describe the conditions of the exemption to potential purchasers and gather information from the potential purchasers to confirm their status. For an AI, this could include asking the potential purchaser questions about their income or assets in order to establish that they fit the characteristics of the exemption. A standardized questionnaire shouldbe developed for this purpose.
- The policies and procedures include record keeping obligations. The issuers, and the persons acting on their behalf, should ensure that each purchaser sign such documentation before distributing the securities to that purchaser.
Creating such policies and procedures, along with a questionnaire, is good business practice for an issuer for the following reasons:
The amendments have already come into effect. Drafting policies and procedures and designing a questionnaire to ensure compliance ahead of future transactions will help speed up and streamline the information gathering process and the training of staff. This will greatly assist issuers should an investment window open up in the future.
- Defence in case of investigation
In the event that a private placement is subsequently investigated by securities regulatory authorities, having compliant CP 45-106 policies and procedures and a questionnaire already in place may act as the basis for a defence.
- Standardizing internal information gathering process
Creating policies and procedures and a questionnaire provides for the standardization of the information collection process, which results in fewer errors and ensures proper compliance with regulation. By completing the same questionnaire for each purchaser, accurate information about each participating purchaser can be gathered and analysed for future reference.
- Recordkeeping purposes
Having written policies and procedures in place and having one predetermined questionnaire allows an issuer to have a well-organized file for each purchaser and each private placement.