On November 27, 2014, the Canadian Securities Administrators (CSA) published for comment proposed amendments to the regulation of rights offerings in Canada, including amendments to the existing prospectus exemption for the distribution of rights to existing security holders (Proposed Exemption). If adopted, the Proposed Exemption would allow reporting issuers—other than investment funds subject to National Instrument 81-102 – Investment Funds—to raise up to 100 per cent of the number of outstanding securities without the use of a prospectus and without prior regulatory review of the rights offering document by the CSA.
The CSA has acknowledged that rights offerings can be “one of the fairer ways for issuers to raise capital” but, to date, these types of offerings have not been viewed as a preferred method of financing in Canada. The Proposed Exemption is designed to expand and streamline the use of rights offerings as a means for reporting issuers to raise capital by reducing both time and cost, while providing existing security holders the opportunity to participate in the offering and avoid any potential dilution.
WHAT IS A RIGHTS OFFERING?
A rights offering is the distribution of rights to purchase securities of an issuer, most commonly common shares. Unlike conventional private placements or prospectus offerings, since the rights are initially distributed to existing security holders, a rights offering offers issuers a method of raising capital without seeking new investors. In Canada, a rights offering must be open for a minimum of 21 days and a maximum of 90 days, during which holders can exercise their rights to subscribe for their pro rata allocation of securities, as well as a share of any securities issuable under rights that are not exercised by other holders. The distribution by the issuer of securities on the exercise of the rights is also exempt from the prospectus requirements in Canada.
The subscription price is typically set at a significant discount to the prevailing market price to entice security holders to exercise their rights. The rights are generally listed on the Toronto Stock Exchange (TSX) or the TSX Venture Exchange (TSXV), which allows security holders to sell their rights over the exchange. It is also common for one or multiple stand-by purchasers to agree to purchase shares issuable under rights that are not exercised by other holders. This “backstop” would kick in if the issuer is unable to reach a certain amount of subscriptions through its existing security holders.
CURRENT PROSPECTUS EXEMPTION
Currently, the prospectus exemption for rights offerings is available on a limited basis. To rely on the exemption, the rights offering must not, among other restrictions, increase the number of outstanding securities by more than 25 per cent, assuming the exercise of all rights issued under the exemption during the preceding 12 months. There is also a time-consuming regulatory review process, in which the issuer must deliver a draft rights offering circular in prescribed form to the CSA Staff, who must then not object to the offering before the final circular can be delivered to security holders to commence the exercise period. The TSX and TSXV also have restrictions with respect to timing of record date and filings, pricing of the rights, insider participation and a potential shareholder approval requirement.
In its November 27 publication, the CSA states that over the last seven years, the average length of time to complete a rights offering was 85 days and the average time between the filing of the draft rights circular and its acceptance by the securities regulators was 40 days. The current process in Canada is considered more onerous than other jurisdictions such as Australia. Since the underlying securities are often priced at a discount, a lengthy timetable may put pressure on the price of the securities, expose the issuer to market volatility and decrease investor appetite for the offering. Compounded by the statutory limitations of the current exemption, rights offerings have generally been regarded as “financing of last resort” by Canadian market participants, and many issuers have avoided them as a result.
Under the Proposed Exemption, a rights offering circular in prescribed form would still be required but would no longer be reviewed by the CSA, and issuers would not be required to deliver the circular to security holders. Instead, the reporting issuer would send to all security holders a short notice setting out certain prescribed disclosure about the rights offering and how to electronically access the circular. The circular would be in a user-friendly, question-and-answer format and focus on information about the rights offering, use of proceeds and the financial condition of the issuer, without the inclusion of information regarding the issuer’s business. This is good news for resource-based issuers, as they would not be required to disclose in the circular technical information concerning material mineral projects, which would otherwise trigger the requirement to file updated technical reports under National Instrument 43-101 – Standards of Disclosure for Mineral Projects.
Most importantly, the Proposed Exemption would increase the dilution limit from 25 per cent to 100 per cent. As a result, under the Proposed Exemption, reporting issuers wanting to issue common shares could raise up to their market capitalization without a prospectus and without CSA review, with the added condition that the rights must be issued on a pro rata basis to each security holder of the underlying securities. The exercise price must be at a discount to the market price at the time of filing the notice for issuers whose shares are listed on a stock exchange, or at a discount to the fair value if the issuer’s shares are not listed.
In streamlining the disclosure and review requirements, the CSA assumes most investors exercising rights are existing holders who are already familiar with the issuer’s continuous disclosure. To balance the reduced investor protection resulting from the removal of regulatory review, the CSA has proposed extending statutory civil liability for secondary market disclosure to the acquisition of securities in a rights offering. Similar to a prospectus, reporting issuers would be required to certify that the circular contains no misrepresentation and investors would have a right of action in respect of a misrepresentation in the circular and any of the issuer’s continuous disclosure.
Certain requirements under the current exemption would continue in effect under the Proposed Exemption. Notably, the exercise period remains a minimum of 21 days to a maximum of 90 days. Stand-by commitments would still be permitted so long as the issuer confirms and discloses the financial ability of the stand-by guarantor to fulfil the commitment. Resale of the underlying securities would still be subject to a seasoning period, but in most cases no hold restrictions would apply for reporting issuers with more than four months of reporting history. However, the CSA indicated that they may impose a restricted period for securities acquired by stand-by guarantors who are not existing security holders.
The de minimis prospectus exemption would also continue to be available where the number of securities and beneficial holders in Canada and the local jurisdiction are less than 10 per cent of all of the securities or holders. This is useful for foreign companies with a limited number of security holders in Canada who may be interested in extending a rights offering conducted in a foreign jurisdiction to their Canadian investors.
The Proposed Exemption is a step towards transforming rights offerings into a more popular and viable alternative for reporting issuers to raise capital in Canada. By streamlining the regulatory review process and permitting larger offerings to be prospectus exempt, issuers may now be more inclined to consider raising capital through rights offerings.
DEADLINE FOR COMMENTS
The deadline for submitting comments to the CSA on the Proposed Exemption is February 25, 2015. The CSA proposal includes 13 specific questions regarding the amendments, which commenters are invited to address in their responses. Issuers, investors and other market participants may wish to avail themselves of this opportunity to provide comments.