Raising Capital in the Exempt Market: The OSC May Implement Four New Prospectus Exemptions

The Ontario Securities Commission (OSC) has published a progress report on its ongoing review of capital raising in the exempt market. The report indicates that four new prospectus exemptions are being considered: a crowdfunding exemption; an exemption for sales of securities to family, friends and business associates; an offering memorandum exemption; and a streamlined rights offering exemption. The OSC staff will work toward implementing these exemptions with the overall objective of facilitating access to capital, particularly for smaller issuers, while ensuring appropriate investor protection and better harmony of Ontario’s rules with those in other Canadian jurisdictions.

Crowdfunding

Of the prospectus exemptions being considered by the OSC, an exemption for crowdfunding, which involves issuers raising capital via the Internet, is the most novel. Adoption of such an exemption would likely include limits on both the amount of capital that can be raised and the size of each investor’s investment, resulting in the crowdfunding exemption being available only for relatively small transactions. In this respect, the OSC may borrow from the U.S. JOBS Act, which requires the SEC to implement crowdfunding rules for offerings of up to U.S.$1 million.

Funding portals will likely be subject to dealer registration requirements, although exemptions from some of these requirements may be considered. The OSC is also considering the extent of due diligence that should be required of funding portals and whether or not issuers should have to provide financial statements or other disclosure to investors. The challenge will be to keep regulatory burdens and associated compliance costs reasonable for small issuers but sufficiently robust to prevent abuse and maintain the market’s integrity.

Offering Memorandum Exemption

The OSC is likely to adopt an offering memorandum exemption modeled after the Alberta regime, which requires purchasers to satisfy certain eligibility criteria in order to invest more than $10,000. In developing a rule for Ontario, the OSC staff will be considering investor protection issues such as the extent of disclosure required, appropriate investment limits, and whether or not complex securities like securitized products or derivatives should be excluded. The OSC recognizes that having a consistent OM exemption across the country would reduce inefficiencies and confusion in the market, ultimately improving issuers’ access to capital.

Sales of Securities to Family, Friends and Business Associates

The OSC may also adopt a prospectus exemption similar to the "family, friends and business associates" exemption currently available in the rest of Canada. Safeguards may be imposed to deter abuse of the exemption; in particular, to prevent sales of securities to investors who lack a sufficiently close relationship with the issuer’s principals. Other safeguards may include a mandatory risk acknowledgment form for investors.

Rights Offering Exemption and Sales to Existing Security Holders

The OSC will be working with other Canadian securities regulators to consider a streamlined rights offering exemption, possibly modeled on a TMX proposal to shorten the regulatory review period, increase the dilution ceiling and shorten investors’ exercise period. In addition, the OSC may consider adopting a separate exemption that would permit reporting issuers to sell securities to existing security holders without an offering document, relying instead on the issuer’s continuous disclosure record.

Comparison to U.S. Private Placement Reforms

The U.S. JOBS Act was enacted last year to encourage capital raising and stimulate job creation by smaller companies. The reforms significantly liberalize the U.S. private placement regime but also include "bad actor" rules that can disqualify an issuer, on the basis of past wrongdoing, from relying on a private placement exemption. The SEC, like the OSC, has a mandate to strike an appropriate balance between facilitating capital raising, particularly by smaller issuers, and protecting investors, particularly retail investors.

Although the U.S. and Canadian private placement regimes are under reform, issuers’ basic ability to conduct cross-border private placements by selling securities to accredited investors in both jurisdictions has not changed. This is important since sales to accredited investors represent a very significant proportion of the U.S. and Canadian private placement markets. It is also notable that the SEC’s new "bad actor" rules and the due diligence obligations associated with general solicitation and advertising do not apply to Rule 144A sales to qualified institutional buyers. This may make Rule 144A an even more popular way for Canadian issuers to add a U.S. tranche to their Canadian public or private offerings.