Oct. 03, 2019 - Chapter 8 of Davies Governance Insights 2019
New Capital Raising Rules Proposed by OSC
On March 20, 2014, the Ontario Securities Commission (the OSC) published for comment four new capital raising exemptions that have been under consideration since June 2012. The proposed exemptions, which Davies reported on in our 2014 Canadian Capital Markets Report, are:
- An offering memorandum exemption;
- A crowdfunding exemption;
- A friends and family exemption; and
- An existing security holder exemption.
Except for the crowdfunding exemption, the proposed exemptions are already available, with some variations, in several other Canadian jurisdictions. The proposed crowdfunding exemption was also published for comment in the provinces of Québec, Manitoba, New Brunswick, Saskatchewan and Nova Scotia. The British Columbia Securities Commission published a separate crowdfunding proposal with more limited funding levels.
The goal of the proposed exemptions is to facilitate capital raising for issuers, particularly start-ups and small and medium enterprises, while protecting the interests of investors. The proposed exemptions resulted from an exempt market review commenced by the OSC in November 2011.
Offering Memorandum Exemption
The proposed offering memorandum exemption would allow non-investment fund issuers (both reporting issuers and non-reporting issuers) to raise capital through the issuance of any securities, other than specified derivatives and structured finance products, using an offering memorandum in the form currently prescribed by Canadian securities laws. The proposed exemption places limits on the aggregate of all investments made by an individual, other than an accredited investor, in offerings by different issuers under the exemption. Investments by an individual “eligible investor” are limited to an aggregate of $30,000 and investments by a non-eligible individual investor are limited to an aggregate of $10,000, in each case, over any 12-month period. The concept of “eligible investor” is based on the net assets or the net income before taxes of an individual, alone or with a spouse. A person who has obtained advice regarding the suitability of the investment from an eligibility adviser (i.e., an investment dealer) will also qualify as an eligible investor. The proposed guidance clearly sets out the OSC’s view that it is the obligation of the issuer and its agents to take all reasonable steps necessary to ensure the purchaser meets the eligible investor criteria.
A new concept that forms part of the Ontario exemption is a requirement that the issuer incorporate by reference into the offering memorandum, and file with the OSC, any marketing materials, other than a standard term sheet, used in connection with the offering. This requirement aligns the offering memorandum exemption, to a certain extent, with the new marketing rules for public offerings that were adopted by the Canadian securities regulators in August 2013. Marketing materials used in connection with the offering memorandum exemption must be balanced, not misleading and consistent with the disclosure in the offering memorandum. In addition, if benchmarks are used for comparison purposes, the OSC expects an issuer to assess whether the benchmarks are relevant and comparable to the investment in question.
Some additional features of the exemption include: a requirement for purchasers to sign a risk acknowledgement form; a two-business-day withdrawal right for purchasers coupled with a requirement for the issuer to hold the proceeds in trust during that time; and ongoing limited continuous disclosure obligations for non-reporting issuers. The exemption would not restrict the category of registrants involved in the offering, other than certain registrants related to the issuer.
One area where the OSC has identified concerns is the use of the proposed exemption for the sale of real estate securities by non-reporting issuers. The OSC is considering developing tailored disclosure requirements for these types of issuers.
The proposed crowdfunding exemption would permit certain issuers to raise capital through small amounts of money raised from a large number of people through a funding portal. The OSC first raised the possibility of adopting a crowdfunding exemption in December 2012. The proposed exemption provides the first draft rules regarding crowdfunding, as well as the first insight into the OSC’s preferred approach to the regulation of funding portals, which includes a registration requirement.
Crowdfunding would be available to Canadian issuers (both reporting issuers and non-reporting issuers), other than investment funds, non-reporting real estate issuers and issuers without a written business plan. Under the exemption, a crowdfunding issuer, its affiliates and others in a common enterprise with the issuer would be permitted to raise an aggregate of $1.5 million within any 12-month period. (The British Columbia proposal limits a crowdfunding issuer to two offerings of a maximum of $150,000 each over any calendar year). Investment by a purchaser under the proposed OSC exemption would be limited to $2,500 per single investment with a $10,000 aggregate limit on all crowdfunding investments for each calendar year.
Investors must receive a disclosure document containing basic information about the offering, the issuer and the funding portal and sign a risk acknowledgement form. If the issuer has incurred expenditures prior to using the exemption, the disclosure document would be required to include annual financial statements and, if specified capital raising ($500,000) or expenditure ($150,000) thresholds have been surpassed by the issuer, the financial statements would have to be audited. Investors will have a right of action for damages or rescission if any materials made available to them by the issuer, including the disclosure document, contain a misrepresentation, and will have 48 hours prior to the disclosed offering deadline to withdraw their subscription.
The types of securities issuable under the exemption are limited, but eligible securities include common shares, non-convertible preference shares and securities convertible into such shares, as well as non-convertible debt securities linked to a fixed or floating interest rate. Non-reporting issuers that use the crowdfunding exemption would have limited ongoing obligations imposed on them, including requirements regarding the maintenance of books and records, the disclosure of use of funds raised, and the preparation of financial statements.
Under the proposed rules, a funding portal that facilitates crowdfunding offerings must be registered as a restricted dealer, and is required to comply with the general registrant requirements applicable to exempt market dealers, including minimum capital maintenance, insurance coverage, regulatory reporting, record keeping and record retention obligations. Funding portals will be responsible for most of the limited investor protection available under the proposed exemption, and will be required to conduct background checks on issuers, directors, officers, promoters and any control person of the issuer; understand the structure, features and risks of the securities being offered; and confirm that an issuer’s disclosure information sets out the appropriate information. In addition, a funding portal must deny access to an issuer if it has reason to believe the offering is fraudulent. However, unlike other registrants, funding portals may not provide specific recommendations or advice, solicit purchases or sales, or facilitate resales of securities issued under the exemption, and are not permitted to register in any other dealer or adviser category.
Family, Friends and Business Associates
The proposed family, friends and business associates exemption, which is available already in Canadian jurisdictions other than Ontario, would allow non-investment fund issuers (both reporting issuers and non-reporting issuers) and selling security holders to sell certain types of securities to family members, close personal friends and close business associates of a director, executive officer, founder or control person of the issuer or an affiliate. Eligible securities under the exemption include common shares, non-convertible preference shares and securities convertible into such shares as well as non-convertible debt securities linked to a fixed or floating interest rate.
The OSC has provided expanded guidance on the meaning of close personal friends and close business associates which clearly places the onus on the issuer to establish whether such relationships exist. A risk acknowledgement must be signed by the investor and the person with whom the relationship exists. There are no investment limits under the proposed exemption applicable to either the issuer or the investor, although the OSC has specifically requested comment on whether any such limits should be imposed.
Existing Security Holders Exemption
To facilitate harmonization, the OSC has modelled its proposed existing security holder exemption on the exemption adopted by other Canadian securities regulators on March 13, 2014. The OSC’s proposed exemption would allow issuers, including investment fund issuers, with equity securities listed on the Toronto Stock Exchange, the TSX Venture Exchange and the Canadian Securities Exchange to raise money by distributing securities to their existing security holders. Each investor must have been a security holder on the record date for the offering, which must be at least one day prior to the day the press release announcing the offering is issued. The OSC has noted it would treat as improper any effort to solicit investors to purchase shares in the secondary market in order to rely on the exemption. Under the exemption, the aggregate amount invested by the investor in the previous 12 months cannot exceed $15,000, unless the investor has obtained advice regarding the suitability of the investment.
The exemption is available to an issuer provided that (i) the issuer has been a reporting issuer for at least 12 months, or became a reporting issuer by way of a prospectus filing, (ii) the offering consists only of the class of equity securities listed on the exchange, or units including warrants to acquire such listed securities, (iii) the offering does not result in an increase of more than 100% of the outstanding securities of the class, and (iv) the offering must be available to all security holders, pro rata, although securities that are not taken up can be allocated at the issuer’s discretion to any existing security holder. An issuer is also required to file with the OSC any offering materials used in connection with the offering on the same day it provides such materials to purchasers.
To provide added protection to security holders, the subscription agreement entered into in connection with the offering must provide investors with a contractual right of action against the issuer for any misrepresentation in a “document” or “core document” that was publicly filed and where the misrepresentation was not corrected before the investor acquired a security under the exemption. The secondary market civil liability provisions of the Securities Act (Ontario) do not apply to a distribution made in reliance on a prospectus exemption. As such, the contractual right of action requirement is a “quick fix” that does not necessitate an amendment to the Act or the regulations thereunder, an alternative that is under consideration, but would take a longer time to accomplish.