Written by Brent W. Kraus, Christian P. Gauthier, Conrad Druzeta, James T. McClary, Nicholas A. Emter and David Bowles
On February 19, 2015, the Canadian Securities Administrators (CSA) announced amendments to National Instrument 45-106 Prospectus and Registration Exemptions (NI 45-106), which are expected to come into force this spring.
The first set of amendments enhance the requirements to rely on the "accredited investor" prospectus exemption (the AI Exemption), restrict the minimum amount investment prospectus exemption (the MA Exemption) to non-individuals and harmonize the definition of "accredited investor" in Ontario with that used in other provinces, among other changes. The CSA concurrently published a revised companion policy to NI 45-106 providing additional guidance on how to verify that investors qualify under the AI Exemption, the private issuer exemption and the family, friends and business associates exemption.
The second set of amendments modify the short-term debt prospectus exemption and introduce a short-term securitized products prospectus exemption.
The amendments are intended to address the concern that some retail investors may not understand the risks associated with investing under the AI Exemption and/or may not qualify as "accredited investors". A heightened onus is being placed on issuers and other sellers of securities to ensure that prospectus exemptions are properly relied upon and documented. Companies, shareholders and registrants should carefully consider the amendments and new guidance before undertaking any private placement and consider updating due diligence procedures accordingly.
Amendments to the AI Exemption and MA Exemption
The first set of amendments to NI 45-106 are intended to address concerns that some individual investors may not fully understand the risks of investing under the AI Exemption or may have purchased securities under the AI Exemption when they were not qualified as "accredited investors".
In addition, eliminating the MA Exemption for individual investors is intended to address the concern that a $150,000 minimum investment may not be an accurate proxy for the sophistication or ability of an individual to withstand financial loss and may encourage over-concentration in one investment. The $150,000 threshold was established in 1987 and has not been adjusted for increases in the Consumer Price Index since its inception. The MA Exemption will continue to be available to non-individual investors.
As a result of these amendments:
- Individuals who qualify as "accredited investors" under the asset or income threshold categories will be required to sign a new risk acknowledgement form (Form 45-106F9) describing, in plain language, the categories of the "accredited investor" definition under which they qualify and the legal protections they renounce by purchasing under the AI Exemption.
- Risk acknowledgement forms obtained from individual "accredited investors" will need to be retained by the issuer or other seller for eight years.
- The definition of "accredited investor" will be expanded to include family trusts established by an "accredited investor", provided that the majority of trustees are "accredited investors" and the beneficiaries include only the spouse or former spouse of the "accredited investor", or the parent, grandparent, brother, sister, child or grandchild of the "accredited investor" or his or her spouse or former spouse.
- In Ontario, fully managed accounts will be able to purchase investment fund securities under the managed account category of the AI Exemption, as is already permitted in other Canadian jurisdictions.
- The MA Exemption will no longer be available to investors that are individuals.
In addition, the Ontario Securities Commission concurrently announced a new family, friends and business associates exemption (the FFBA Exemption) for issuers other than investment funds to replace the founder, control person and family exemption in Section 2.7 of NI 45-106. The FFBA Exemption is substantially harmonized with the family, friends and business associates exemption permitted in other provinces.
Verifying an Investor's Status
As a result of the CSA's amendments, it may not be sufficient for an issuer or other seller of securities relying on income or asset threshold or relationship-based prospectus exemptions to rely only on a purchaser's representations in a subscription agreement or "ticked boxes" in an accredited investor certificate.
Instead, issuers, registrants and other sellers involved in the distribution or resale of a security are encouraged to take a more active role in vetting potential investors and should take additional steps to reasonably confirm that a purchaser meets the conditions of an exemption. The CSA recommends that issuers and other sellers:
- Ensure the purchaser understands the criteria for the relevant exemption, such as the specific assets and liabilities used to determine if an income or asset threshold is met.
- Establish internal policies and procedures to ensure all parties acting for an issuer or other seller understand the exemption criteria and can accurately explain them to purchasers.
- Confirm the purchaser meets the applicable exemption category before discussing the details of an investment, by, for example, in the case of a purchaser relying on an income or asset threshold category of the AI Exemption, asking about a purchaser's income or assets (which may include requesting supporting financial records) or, in the case of a purchaser relying on the friends, family and business associates exemption or the corresponding relationship categories of the private issuer exemption, by asking about the nature and length of a relationship, frequency of contact and level of trust.
- Keep documentation evidencing such steps (including risk acknowledgements signed by purchasers) for eight years.
Short-Term Debt and Short-Term Securitized Products Prospectus Exemption Amendments
As a result of the CSA's changes to the short-term debt prospectus exemption, the following requirements have been amended or added:
- Short-term debt must satisfy heightened Split Rating Conditions (i.e., a rating above DBRS-1, Fitch – F2, Moody's Canada – F3 or S&P Canada – A-1(Low) (Canada national scale) or A-2 (global scale)).
- The short-term debt; private issuer; family, friends and business associates; founder, control person and family (Ontario); and offering memorandum prospectus exemptions cannot be used for the distribution of short-term securitized products.
- A new short-term securitized products prospectus exemption is created in Section 2.35.1 of NI 45-106 with new disclosure and reporting requirements for issuers relying thereon.
Provided ministerial approvals are obtained, the amendments will come into force on May 5, 2015, except in Ontario, where the first set of amendments described above will come into force on the later of May 5, 2015, and the day certain provisions of the Budget Measures Act, 2009 are proclaimed in force.