Positive Onus on Sellers: 3 Key Changes to Prospectus Exemption Rules & 3 Compliance Tips
May 22, 2015
By Danielle Daigle, Lawyer at McInnes Cooper,
Basia Dzierzanowska, Regional Lead Partner | Corporate at McInnes Cooper
On May 5, 2015, the Canadian Securities Administrators (CSA) adopted amendments to National Instrument 45-106 Prospectus Exemptions (“NI 45-106”) changing the accredited investor and minimum amount exemptions – and squarely placing a positive onus on securities issuers and sellers to make sure an investor actually qualifies for the exemption. The Ontario Securities Commission adopted similar amendments and also introduced the family, friends and business associates exemption.
Under Canadian securities law, any distribution of a security requires the issuer or seller to file a prospectus disclosing detailed information that regulators deem necessary to protect investors from making an investment they don’t understand – unless one of several exemptions applies to the distribution. Before these amendments to NI 45-106, the issuer or seller was entitled to simply rely on the investor’s representations that she qualifies for the exemption she’s relying on. These amendments to NI 45-106 and the related Companion Policy modifications make it clear that in certain circumstances, this is no longer enough.
The CSA says these amendments to the prospectus exemption rules address concerns that:
- some investors don’t understand the risks of investing under the accredited investor exemption, or don’t qualify as accredited investors; and
- the current $150,000 minimum amount investment threshold isn’t a proxy for sophistication or ability to withstand financial loss for individual investors – and could encourage over-concentration in one investment for an individual (versus a corporate) investor.
An issuer or selling security holder is no longer entitled to accept an individual investor’s standard representations in a subscription agreement or initials beside the applicable category on the relevant form: the seller now has a positive responsibility to take reasonable steps to verify the investor’s representations and ensure the terms of the exemption relied upon are met, and to retain relevant documentation to evidence the steps it took to establish that the investor met the exemption’s conditions.
3 KEY CHANGES TO PROSPECTUS EXEMPTIONS
Here are the three key changes the amendments implement to the prospectus exemption rules:
- Accredited Investor Exemption. There are several changes to the accredited investor exemption:
- New Investor Category for Assets of $5M. There’s a new category of individual accredited investor for an individual who owns financial assets with an aggregate realizable value net of liabilities of more than $5M. These individuals don’t have to sign the risk acknowledgement form.
- New Investor Category for Family Trust. There’s also a new category of accredited investor for family trusts established by an accredited investor for the benefit of her family.
- New Risk Acknowledgement Form. “Natural persons” (real people as opposed to legally created “persons” such as corporate entities, for example) who are accredited investors by virtue of the existing income or asset tests (found at paragraphs (j), (k) or (l) of the “accredited investor” definition in NI 45-106) must complete and sign a new prescribed risk acknowledgement form. It includes specific disclosure of the risks of investing in securities, and requires the investor to acknowledge exactly how she satisfies the “accredited investor” exemption test and to identify any salesperson who provided her with information respecting the investment. The investor must sign this form when she signs the subscription agreement; the issuer must retain the form for 8 years after the distribution.
- Ontario Harmonization – Managed Account Category. To harmonize with the rest of the CSA jurisdictions, in Ontario, fully managed accounts are now also permitted to purchase investment fund securities under the managed account category of the accredited investor exemption.
- Minimum Amount Investment Exemption. The minimum amount investment exemption is no longer available for distributions to individuals. However, it’s still available to holding companies if they haven’t been created or used solely to purchase securities under the exemption.
- Ontario Family, Friends and Business Associates Exemption. Contemporaneous with the amendments to the accredited investor and minimum amount investment exemptions, the Ontario Securities Commission introduced the family, friends and business associates exemption to both reporting and non-reporting issuers in Ontario by amending NI 45-106 and related national instruments, rules and policies. This new exemption includes all the same categories available in the existing exemption for other CSA jurisdictions with one difference: it’s not available to investment funds. Subject to other conditions, a purchaser must sign Ontario’s risk acknowledgment form (Form 45-106F12) for an issuer to rely on this exemption. The Ontario form mirrors the CSA’s new risk acknowledgement form – but both the purchaser and the issuer must sign the Ontario form and, if applicable, the issuer’s director, executive officer, control person or founder with whom the investor asserts the relationship must also sign it. With this new exemption, the existing founder, control person and family exemption for Ontario in section 2.7 of NI 45-106 was repealed.
3 COMPLIANCE TIPS
As a result of these amendments, the CSA modified Companion Policy 45-106CP to provide additional guidance on the steps that issuers and sellers relying on certain prospectus exemptions (including the accredited investor exemption) should take.
Here are three tips to help issuers comply with the new rules:
- Seller Due Diligence. The seller – not the investor – is responsible to ensure the exemption relied upon applies to the transaction. Practically, this means that sellers and issuers and registrants must exercise reasonable due diligence and obtain information from investors who are relying on prospectus exemptions to substantiate and support that exemption in order to comply with Companion Policy 45-106CP. What constitutes reasonable due diligence will depend on the specific circumstances of each investor. The seller should ask questions about the investor’s financial means, explain qualification criteria for the exemption and retain copies of any emails or meeting notes with the investor. Issuers should consider implementing internal policies to ensure everyone involved in selling the issuer’s securities understands the qualification criteria of applicable exemptions and other legal requirements.
- Subscription Agreement Review. All issuers should review their standard form of subscription agreement to ensure it includes the new categories of accredited investor exemptions and otherwise complies with the revised NI 45-106.
- Risk Acknowledgement Form. Issuers and registrants who sell securities must ensure individual investors who are natural persons relying on the existing income and asset tests to qualify as “accredited investors” sign a Risk Acknowledgment Form. The issuer or the selling security holder must complete Parts 1 and 6 of the Form; the salesperson of the distribution (which could include the issuer or a registrant) must complete Part 5 of the Form.
Each province and territory that has adopted the Amendments posted a notice on its website. Read Ontario’s notice here.
Please contact your McInnes Cooper lawyer or any member of our McInnes Cooper Corporate Finance & Securities Team to discuss this topic or any other legal issue.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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