On March 20, 2014, the Ontario Securities Commission (OSC) issued a Notice and Request for Comment (Notice) which proposed creating four new capital raising prospectus exemptions in Ontario, including: an offering memorandum (OM) exemption; a friends, family and business associates (FFBA) exemption; an existing securityholder exemption; and a crowdfunding exemption. These new prospectus exemptions were proposed by the OSC in connection with its ongoing efforts to provide startups and small- and medium-sized enterprises (SMEs) with greater access to capital markets.
Concurrent with the issuance of the Notice, various other securities authorities across Canada also published proposed frameworks for crowdfunding, with the British Columbia Securities Commission (BCSC) issuing a local publication and securities authorities in Quebec, Saskatchewan, New Brunswick, Manitoba and Nova Scotia (Participating Jurisdictions) issuing a joint publication. While the OSC’s proposals generally bring Ontario into greater conformity with other Canadian jurisdictions, there are some significant differences between the OSC’s proposed crowdfunding framework and those proposed by other securities authorities.
PROPOSED PROSPECTUS EXEMPTIONS
The following summarizes some of the key aspects of the OSC’s proposed prospectus exemptions and some of the differences with the proposals in other Canadian provinces.
Offering Memorandum Exemption
Under the proposed OM exemption, an issuer could offer securities under an OM which provides prescribed information, including the principal terms and risks of the offering. The OM would have to incorporate any marketing materials used in connection with the offering and all investors would be required to complete a form in which they acknowledge, among other things, certain risks associated with the investment. The proposed exemption would not impose any restrictions on the size or frequency of offerings by issuers, or on the length of time offerings may remain open.
If implemented, the proposed exemption would bring Ontario into greater conformity with other Canadian jurisdictions, all of which have some form of an OM exemption. The proposed Ontario exemption would, however, be somewhat more onerous on issuers and more restrictive on investors than approaches elsewhere in Canada. For example, the OSC’s proposed OM exemption could not be relied upon by investment funds or be used for offerings of certain complex or novel securities. Unlike in other jurisdictions, issuers who raise capital on the basis of the OM exemption would be subject to certain ongoing disclosure requirements, although these requirements would be less onerous than those required of reporting issuers. Investors relying on this exemption would not be permitted to invest more than C$30,000 per year.
Family, Friends and Business Associates Exemption
In Ontario, an issuer is currently permitted to distribute securities on an exempt basis to the issuer’s founders, affiliates of the founders, the issuer’s controlling securityholders, and certain relatives of the founders, directors and officers of the issuer. The proposed FFBA exemption, which would bring Ontario into conformity with all other jurisdictions in Canada, would permit distributions to a broader group of individuals, including close personal friends, close business associates and a wider range of relatives of the founders, controlling securityholders, directors and executive officers of the issuer.
Similar to the proposed OM exemption, there would be no limit on the size of securities offerings under the FFBA exemption, the type of securities offered must not fall within certain categories of complex or novel securities, and each investor must complete a risk acknowledgment form. Unlike the proposed OM exemption, the FFBA exemption would not require any disclosure by the issuer to investors, investors are free to invest any amount, and issuers would not be subject to any ongoing disclosure requirements.
Existing Securityholder Exemption
Under the proposed existing securityholder exemption, issuers that are listed on the Toronto Stock Exchange, the TSX Venture Exchange or the Canadian Securities Exchange, and that have been reporting issuers for 12 months or became reporting issuers pursuant to a prospectus, could offer securities to all existing securityholders who hold the same class and series of security. This exemption is intended to address the generally limited opportunities that retail investors have to participate in primary offerings by issuers, even if such investors have already made an investment decision to invest in the issuer through the secondary market. Unless an investor receives professional investment advice, however, the investor is limited to an investment of C$15,000 in any 12-month period pursuant to the exemption.
The proposed exemption differs from those adopted in other Canadian jurisdictions by also requiring that securities first be offered to existing securityholders on a pro rata basis with the shares that are not taken up then offered to other investors. The proposed Ontario exemption also requires that the number of securities offered not exceed the number of securities of the same class and series outstanding prior to giving effect to the offering.
Specifically intended to facilitate capital raising activities by startups and SMEs, the crowdfunding exemption is the most novel exemption proposed by the OSC in the Notice. Crowdfunding generally involves the funding of a specific project by raising small amounts from a large number of people over the Internet in exchange for a “perk” which can include, for example, an early copy of an artistic work or a reference in the credits of a movie.
To date, crowdfunding in Canada has not generally included the sale of securities by issuers to investors because in order to do so an issuer would be required to prepare a prospectus or rely on a prospectus exemption pursuant to securities laws. Moreover, in order to facilitate such transactions, crowdfunding portals would very likely be required to register as dealers under securities laws.
Each crowdfunding framework proposed by the OSC, the BCSC and the Participating Jurisdictions is intended to accommodate securities crowdfunding while ensuring an appropriate level of investor protection; however, each framework appears to strike a different balance. The OSC’s proposed framework consists of issuer disclosure requirements and the regulation of crowdfunding portals, whereas the BCSC’s proposed framework imposes less onerous obligations on both issuers and crowdfunding portals, but limits offerings to smaller startup financings. The framework proposed by the other jurisdictions is a hybrid system that is consistent with the OSC’s approach, but also provides for a less onerous startup exemption.
Proposed Ontario Framework
Under the OSC’s proposed framework, an eligible Canadian issuer would be permitted to raise up to C$1.5 million in any 12-month period through the issuance of securities, provided that the issuer prepares a written business plan and provides investors with a streamlined disclosure document setting out, among other things, the principal terms of the offering. The disclosure document would have to include reviewed – and in some cases audited – annual financial statements if the issuer has incurred any expenditures. Investors would have a right of action for damages or withdrawal in the event that the disclosure document contains a misrepresentation. Issuers would only be permitted to post materials, advertise the offering and solicit investors on the crowdfunding portal’s website, although this would not prohibit directing investors to the crowdfunding portal via paper notices and social media. Issuers would also be required on an ongoing basis to provide investors with annual financial statements, disclose how proceeds have been spent, disclose certain significant events and keep appropriate records. Investors would be subject to certain monetary restrictions and required to complete risk acknowledgment forms.
Crowdfunding portals, meanwhile, would be required to register as restricted dealers under securities laws and consequently comply with minimum capitalization and other regulatory requirements. They would also be required to undertake key gatekeeping activities, such as running appropriate background checks, reviewing materials and rejecting offerings which they believe to be fraudulent. Crowdfunding portals could not provide investment advice, hold investor funds or securities, or invest in or underwrite offerings.
The proposed startup exemption would be the only crowdfunding exemption in British Columbia, a possible alternative exemption in the Participating Jurisdictions and unavailable in Ontario. Under the proposed startup exemption, non-reporting issuers could raise a maximum of C$150,000 twice in each calendar year, while each investor could not invest more than C$1,500 in any one issuer. Issuer disclosure requirements under the proposed startup exemption are similar to the OSC’s proposed framework, except that issuers would not be required to provide investors with financial statements or any ongoing disclosure. Furthermore, crowdfunding portals would not be required to register as dealers under securities laws, although they would still be prohibited from providing investment advice, holding investor funds or securities, or investing in or underwriting offerings. The gatekeeping activities of crowdfunding portals under the startup exemption would also be significantly reduced.
Ontario’s proposed OM, FFBA and existing securityholder exemptions would likely facilitate capital raising activities by startups and SMEs and would bring Ontario into greater conformity with other jurisdictions in Canada. These exemptions may also, in some cases, facilitate capital raising activities by some larger issuers. The crowdfunding frameworks proposed by the OSC, BCSC and Participating Jurisdictions could assist capital raising activities by startups and, in some cases, SMEs, although their approaches are divergent in certain important respects. While the OSC’s framework appears to be the most onerous on both issuers and crowdfunding portals, the more accessible BCSC framework is subject to stricter monetary limitations. The framework proposed by the Participating Jurisdictions attempts to find a middle ground. Each of the proposed frameworks is open for comment until June 18, 2014.
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