Of the new prospectus exemptions proposed to be adopted by the Ontario Securities Commission (OSC), the “existing security holder” exemption represents, in many ways, a significantly streamlined avenue for reporting issuers to raise funds from their existing securityholders. While similar in many ways to the corresponding exemption that recently came into force in other Canadian jurisdictions (the “Counterpart Exemption”), the “Ontario Exemption” as proposed includes certain additional requirements, which we examine in detail below.
As we previously discussed, on March 20, 2014, the OSC published for comment the Ontario Exemption along with three other proposed prospectus exemptions. These new exemptions flow from the key themes noted in OSC Notice 45-712 Progress Report on Review of Prospectus Exemptions to Facilitate Capital Raising, including the need to facilitate capital raising for small and medium-sized enterprises, the importance of harmonizing exemptions across Canada and the importance of regulatory monitoring and oversight in the exempt market.
The proposed Ontario Exemption would allow issuers listed on the Toronto Stock Exchange, TSX Venture Exchange or Canadian Securities Exchange to raise capital from existing security holders. The OSC lists two primary policy rationales for the exemption, namely (i) allowing existing security holders to invest in reliance on reporting issuer disclosure and (ii) enhancing retail security holder access to primary offerings.
The Ontario Exemption is largely based on the Counterpart Exemption adopted by securities regulatory authorities in all Canadian jurisdictions, other than Ontario and Newfoundland and Labrador, on March 13, 2014; however, there are some notable differences. Under both exemptions (as discussed in our March 14 post), issuers will have to satisfy the following requirements:
- All of the issuer’s periodic and timely disclosure filing obligations must be satisfied;
- An offering news release must be issued and filed, containing reasonable details of the offering and the proposed use of proceeds including details with respect to the proposed allocation of the securities;
- The offering may only consist of a listed security or a unit consisting of a listed security and a warrant; The offering must be made available to all persons who reside in jurisdictions where the exemption or a similar exemption is available and who, as of the record date (which must be at least one day prior to the day the issuer issues its offering news release), held a listed security of the issuer of the same type as the listed security being offered; and
- The subscription agreement must provide investors with a contractual right of action in the event of a misrepresentation in the issuer’s continuous disclosure record.
Under the Ontario Exemption, the following additional conditions would apply:
- The issuer must have been a reporting issuer for not less than 12 months, or have become a reporting issuer by filing and obtaining a receipt for a prospectus;
- Subject to the investment limits described below, the issuer must allocate existing security holders a pro rata portion of the offering – any securities that are not taken up by existing security holders in accordance with the foregoing may then be allocated to other existing security holders at the discretion of the issuer;
- The issuer must file a report of exempt distribution in proposed Form 45-106F11.
The OSC has proposed the first requirement above on the grounds of investor protection, to ensure that the issuer has a base disclosure record. As the OSC is concerned that the exemption could be used in a manner that results in security holders suffering significant dilution, the second requirement has been proposed to provide existing security holders with the right to avoid dilution and to ensure that the issuer does not unfairly “cherry pick” specific existing security holders for additional investment opportunities. We note, however, that issuers would not be bound by the pro rata requirement with respect to any securities not taken up under the original allocation.
With respect to the requirement to provide investors with a contractual right of action, issuers must represent to purchasers in the subscription agreement that the issuer’s “core documents” and “documents” (as defined under Section 138.1 of the Securities Act (Ontario)) do not contain a misrepresentation and that there is no material fact or material change related to the issuer which has not generally been disclosed. Further, the OSC is considering extending the application of the statutory secondary market civil liability provisions in the Act and those that apply to misrepresentations in prescribed offering memoranda, to an offering under the Ontario Exemption and any related offering documents.
Unlike the Counterpart Exemption, the Ontario Exemption is not available to investment fund issuers. The OSC has noted that the exclusion of investment funds is consistent with the objective of facilitating capital raising for start-ups and small and medium-sized enterprises.
Although there is no requirement for securities sold under the Ontario Exemption to be sold through a registrant, provided that the issuer does not carry on the business of trading in securities (and is therefore itself required to register), IIROC dealers and EMDs involved in any distribution under the Ontario Exemption will have to comply with “know your client” and “suitability” obligations. In addition, an existing security holder will be limited to investing no more than $15,000 per year in the issuer under the Ontario Exemption, unless the security holder has obtained suitability advice from a registered investment dealer. The $15,000 cap is higher than the cap for each of the proposed offering memorandum and crowdfunding exemptions on the grounds that the issuer will be a reporting issuer and existing security holders will already have made a decision to invest in the issuer’s securities. This cap is harmonized with the cap under the Counterpart Exemption. The aggregate offering size would also be limited to 100% of the issuer’s outstanding securities of the same class.
Issuers relying on the Ontario Exemption will not technically have to provide an offering document; however, as described above, issuers will have to extend a contractual right of action for misrepresentations. Any offering materials (other than a subscription agreement) must also be filed on the same day that they are provided to existing security holders and the issuer will be required to file a material change report. As well, the need for all material facts to be disclosed, may well require additional disclosure to prospective investors.
Similar to the “accredited investor” exemption, the issuer will be required to file a report of exempt distribution within 10 days of the offering. A report of exempt distribution in proposed Form 45-106F11 will need to be filed by issuers relying on the Ontario Exemption. The proposed new form is intended to provide increased information on exempt market activity and to assist in monitoring compliance. As is the case under the “accredited investor” and other capital raising exemptions, the first trade of a security acquired under the Ontario Exemption will be subject to a four month hold.
The Ontario Exemption would be given effect by amendments to OSC Rule 45-501 Ontario Prospectus and Registration Exemptions, along with amendments to National Instrument 45-106 Prospectus and Registration Exemptions. Comments are due by June 18, 2014.