On May 5, 2015, Canadian securities regulators amended National Instrument 45-106 Prospectus Exemptions and its Companion Policy. Some of the rule changes are designed to encourage capital raising in the exempt market while others are meant to provide increased protection of retail investors.
Summary of Rule Changes
Accredited Investor (AI) Exemption: Accredited investors who are natural persons will now be required to complete a Risk Acknowledgment Form, unless their net financial assets exceed $5 million.
Minimum $150,000 Investment Exemption: Natural persons will no longer qualify for this exemption.
Short-Term Debt Exemption: This exemption has been amended with the objective of removing the regulatory disincentive for commercial paper issuers to obtain more than one credit rating. Under the new rules, only one of an issuer’s credit ratings must be at or above DBRS – R-1 (low); S&P Canada – A-1 (low) (Canada national scale); Moody’s Canada – P-1; or Fitch – F1. Obtaining an additional but lower credit rating will not disqualify the issuer from using the exemption (provided the additional rating meets a new prescribed minimum).
Family, Friends and Business Associates (FFBA) Exemption: This exemption already existed in other Canadian jurisdictions but is new in Ontario, replacing the founder, control person and family exemption. It is meant to provide early-stage issuers with greater access to capital from their existing network of family, friends and close business associates. Two investor protection measures are built into the exemption. First, the investor’s relationship with a principal of the issuer must be sufficiently close that the investor can assess the principal’s capabilities and trustworthiness and obtain information about the investment. Second, investors must sign a Risk Acknowledgement Form.
Risk Acknowledgment Forms and Sellers’ Due Diligence
The new Risk Acknowledgement Forms required under the AI and FFBA exemptions are meant to protect investors by
- drawing attention to the risks of investing in securities, and
- specifying the criteria an investor must meet to qualify under each exemption and requiring him or her to initial beside the relevant category.
The Companion Policy includes additional guidance indicating that sellers relying on a prospectus exemption based on a financial or relationship test may not rely solely on an investor’s representations in a subscription agreement or certificate, without further due diligence. Issuers, registrants and others engaged in the selling effort must take reasonable steps to verify that an investor meets the qualification criteria under an exemption—and should be prepared to justify the choice of steps taken and not taken. What constitutes reasonable due diligence ultimately depends on the facts and circumstances and may include:
- asking questions about the investor’s financial status, when relying on the AI exemption;
- confirming, with both the investor and the relevant principal of the issuer, the closeness of their relationship, when relying on the FFBA exemption;
- explaining to the investor the qualification criteria of the exemption being relied on;
- establishing policies and procedures to help ensure that everyone engaged in the selling effort understands the legal requirements of an exemption; and
- retaining documentation relating to the due diligence effort, such as written statements of the investor, meeting notes and email communications.
Related Canadian and U.S. Developments
The OSC intends to implement two new capital raising exemptions later this year or early in 2016: an offering memorandum exemption similar to that available in other provinces and territories and a crowdfunding exemption.
As in Canada, regulatory changes in the United States reflect a mix of capital formation and investor protection initiatives. Most recently, the SEC adopted changes to Regulation A+ to facilitate smaller companies’ access to capital. This rule will permit offerings of up to U.S.$50 million in a 12-month period, and the securities will generally be freely tradable. Canadian issuers not already reporting with the SEC will be eligible for Regulation A+, so a cross-border offering could be structured as a Canadian prospectus offering combined with a U.S. Regulation A+ offering. Investor protection measures under Regulation A+ include investment limits for non-accredited investors and a requirement to file a basic offering statement with the SEC.
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