• Ontario Exempt Market Initiatives Update
  • April 10, 2014 | Authors: Gregory Hogan; Brian P. Koscak; Sean Williamson
  • Law Firm: Cassels Brock & Blackwell LLP - Toronto Office
  • On March, 20, 2014, the Ontario Securities Commission (the “OSC”) published for comment four new prospectus exemptions. The exemptions are aimed at opening up new ways to raise capital, particularly for start-ups and small and medium-sized enterprises (“SMEs”), while ensuring that investors are sufficiently protected. These proposed exemptions follow the Canadian Securities Administrators’ (the “CSA”) other proposed amendments to the exempt market regime which we discussed in previous e-LERTs and in our Capital Markets Bulletin.

    The four new proposed prospectus exemptions are:

    (i) an offering memorandum exemption (the “OM Exemption”);

    (ii) a family, friends and business associates exemption (the “FFBA Exemption”);

    (iii) an exemption for distributions by a reporting issuer to its existing security holders (the “ESH Exemption”); and

    (iv) an equity crowdfunding exemption (the “Crowdfunding Exemption”).

    The OM Exemption

    Ontario is the only jurisdiction in Canada where the OM exemption is unavailable. If adopted by the OSC, the OM Exemption would bring Ontario’s securities laws into harmony with those other jurisdictions which allow for such an exemption pursuant to section 2.9 of National Instrument 45-106 - Prospectus and Registration Exemptions (“NI 45-106”). The OM Exemption would be made available to both reporting and non-reporting issuers, though not investment funds. Certain derivatives and structured financed products would be prohibited from being issued under the OM Exemption. Other securities, such as common shares, would have no limits in terms of the size of offering or the number of offerings an issuer may make and there would be no requirements on the length of time an offering could remain open. Registrants who are related parties of the issuer would be prevented from participating in an offering made under the OM Exemption (i.e., no proprietary products).

    In terms of investor protection measures, the proposed OM Exemption would retain the “net income test” in the definition of “eligible investors” in NI 45-106 for individuals but not for non-individuals, and the “net asset test” for individuals would be reduced to $250,000, though the value of the investor’s primary residence cannot be included. As well, individual investors who are not “eligible investors” would be limited to investing no more than $10,000 per year pursuant to the OM Exemption, while “eligible investors” would be limited to $30,000. These changes to the definition and investment limits involving eligible investors are fundamental changes from the current form of OM Exemption which are also being considered by Alberta, New Brunswick, Saskatchewan and Quebec.

    The FFBA Exemption

    The OSC proposed the FFBA Exemption in order to assist start-ups and SMEs by expanding the network of potential investors from which they may raise money. The proposed FFBA Exemption is based on the existing exemption in section 2.5(1) of NI 45-106. Like the OM Exemption, the FFBA Exemption would be made available to both reporting and non-reporting issuers, though not investment funds. The FFBA Exemption would be available for distributions by issuers as well as selling security holders for distributions of common shares, non-convertible preference shares, securities convertible into common shares or non-convertible preference shares, non-convertible debt securities, limited partnership units or flow-through shares (collectively, “Eligible Securities”). There would be no limits on the size of any offering made under this exemption. However, advertising to solicit investors and paying finder’s fees would be expressly prohibited under the FFBA Exemption. Additionally, if an investor is provided with a ‘voluntary’ offering memorandum (as defined under Securities Act (Ontario) (the “OSA”), investors would have a statutory right of action to sue for a misrepresentation under s. 130.1 of the OSA.

    The OSC has expanded the guidance used to determine who can invest under the FFBA Exemption, though the onus will be on issuers to establish that a potential investor does meet such criteria. Factors that the OSC will consider when reviewing such relationships include length of time that the investor has known a director, officer, founder or control person of the issuer, and the nature of their relationship. The principal investor protection measure that would form part of the FFBA Exemption is a requirement for investors to fill out a new risk acknowledgement form. Additionally, a report of trade would also have to be filed in connection with a distribution under the FBBA Exemption.

    The ESH Exemption (i.e., “rights offering-lite”)

    It is proposed that the ESH Exemption would be available to existing security holders of an issuer that has been a reporting issuer for at least 12 months or which became a reporting issuer upon obtaining a receipt for a prospectus, and which has a class of securities listed on any of the Toronto Stock Exchange, the TSX Venture Exchange or the Canadian Securities Exchange. Investment funds would not qualify under this exemption. Offerings made under this exemption are limited to those securities which are listed on any of the above noted exchanges, or units consisting of such security and a warrant to acquire the listed security. Such offerings cannot result in an increase of more than 100% of the issued and outstanding securities of the same class, and all holders of such securities on a record date - which is to be at least one day before the issuance of an offering press release - must have the opportunity to participate in the offering on a pro rata basis. The pro rata share of any holders choosing not to participate in the offering may be allocated to other existing security holders.

    In order to be eligible to participate in an offering made under the ESH Exemption, potential investors must represent in writing to the issuer that, as at the record date, the investor held and continues to hold the type of listed security that the investor is acquiring under the exemption. If the investor is a Canadian resident and has received advice regarding the suitability of the potential investment from an investment dealer in the same jurisdiction, investments made under the ESH Exemption are limited to $15,000 every 12 months.

    The Crowdfunding Exemption

    The Crowdfunding Exemption would be available to reporting issuers and non-reporting issuers that: (i) are incorporated or organized in Canada; (ii) have a head office located in Canada; and (iii) a majority of its directors are resident in Canada. Investment funds, non-reporting real estate issuers and issuers without a written business plan (blind pool companies) are not eligible, nor are issuers who are not in compliance with the ongoing requirements of the Crowdfunding Exemption, as discussed below. Like the FFBA Exemption, only Eligible Securities may be issued pursuant to the Crowdfunding Exemption.

    Limits on offerings made under the Crowdfunding Exemption include that a maximum of $1.5 million can be raised using the exemption in the 12 months prior to a new offering under the Crowdfunding Exemption. This limit applies to an issuer’s affiliates and other issuer engaged in a common enterprise with the issuer, or any affiliate of such an issuer. As well, offerings made under the exemption can only remain open for 90 days. An offering document must disclose the minimum and any maximum amounts available under the offering. In order to complete the offering, the minimum amount must be fully subscribed and the issuer must have sufficient resources to carry out its business plan.

    Under the Crowdfunding Exemption, investors can only invest up to $2,500 in any single investment to an aggregate maximum of $10,000 in a calendar year. An issuer would be permitted to undertake a concurrent distribution while also raising capital under the Crowdfunding Exemption, however, such amounts are excluded from the $1.5 million limit that an issuer can raise in any 12-month period.

    Though prospectus level disclosure is not required, investors must be provided with a disclosure document containing basic information about the issuer, the offering and the registered funding portal through which the offering is being made. Audited financial statements are required if the issuer has raised more than $500,000 under the Crowdfunding Exemption or any other prospectus exemption since its formation and has expended more than $150,000 since that time.

    The exemption has ongoing disclosure requirements. Non-reporting issuers would be required to provide the OSC with annual financial statements, notice disclosing how such funds have been expended and disclosure of certain other specified events on an annual basis. Investors using the exemption will also be required to sign a risk acknowledgement form.

    The Crowdfunding Exemption also sets out the requirements to register a portal as a restricted dealer in order to sell securities on the internet. The portal can only be involved in raising capital under the Crowdfunding Exemption and no other prospectus exemptions. Similarly, no other registrant can use the Crowdfunding Exemption and therefore dual registration is not permitted. Generally, a portal will be required to comply with the requirements applicable to exempt market dealers. For example, portals will be required to conduct background checks on issuers, officers, directors and promoters; understand the nature of the securities being offered; review information provided by issuers; and provide investor education materials and obtain risk acknowledgement forms.

    Proposed New Report of Trade Forms

    In addition to the proposed exemptions above, the OSC is proposing to introduce new administrative requirements for reports of exempt distributions in order to better understand the nature and details of transactions completed in the exempt market.

    The comment period on these proposed exemptions is open until June 18, 2014 and the OSC welcomes written submissions from the public until that date.