Recent Developments Regarding the Accredited Investor Exemption
By Matt Epp & Andrew Wilson
The Accredited Investor exemption is well known to those who work in the exempt market. Briefly, this exemption allows an issuer to solicit prospective investors who have demonstrated financial sophistication, either because of the nature of the investor, or in the case of individuals, because they have sufficient financial assets or a large net income.
With respect to these investors, issuers are then relieved of the obligation to file and receive a receipt for a prospectus to distribute securities (assuming all other aspects of the applicable securities laws are met).1
As we know, problems can arise. What if the exemption requirements aren’t met? What if an issuer purports to distribute securities to someone under the Accredited Investor exemption but who is not, in fact, an Accredited Investor?
Until recently, based on past decisions of the Alberta Securities Commission (ASC), it was generally understood that an issuer who distributed securities to an investor who did not qualify under this exemption was in breach of Alberta securities law and would be liable. This was true even if the issuer believed the exemption applied. The onus lay on the Issuer to prove to the ASC’s satisfaction that an exemption was available and that all the conditions and requirements of the exemption had been met (Re Transcap Corporation 2).
Claiming an exemption put the onus of proof entirely on the issuer – once it was shown there was no prospectus, it was up to the issuer to prove all of its trades complied with the available exemption and that the issuer properly claimed the correct exemption. An issuer could not escape liability if they claimed one exemption, and by luck, the investors qualified for a separate exemption instead. In other words, an issuer could not satisfy the requirements, “through the back door.”
However, the recent ASC decision of Re Campbell3 may offer new guidance on the obligations of an Issuer in ensuring its investors meet the exemption requirements.
In Campbell, the Issuers marketed securities in a number of companies in the business of developing recreational land in Nova Scotia. These securities were sold to an investment group in the Edmonton area. The investment was not a good one; the land was never developed and the investors did not see a return. Staff of the ASC alleged, among other things, that the Issuer breached Alberta securities laws by distributing securities to non-accredited investors while relying on the Accredited Investor exemption. The Issuers argued that their share subscription agreement required potential investors to indicate that they were accredited before a purchase was made.
The ASC relied on evidence gathered from six investors and a salesperson who solicited investors. Out of the six investors, one was found not to qualify as an Accredited Investor. A salesperson for the issuer testified that during this transaction, he indicated to the investor that “he would probably” fall into the category of an Accredited Investor, based on his financial assets. The investor mistakenly included the value of his home in the calculation and, as a result, did not qualify.
The ASC Panel found that on at least one occasion, the issuer had sold securities to an investor that did not meet the Accredited Investor requirements. Following Transcap, one would think that the issuer would likely have been held liable. However, in Campbell, despite the fact there was a sale with no proper exemption to the prospectus requirement, the Commission declined to find the issuer had sold shares illegally.
In order to understand this decision, it is important to recognize the nature of offences under the Securities Act. Most (but not all) offences are ‘strict liability’ offences, which is to say an issuer is guilty if it commits a breach, regardless of whether they intended to do so. Intention to breach the Act is not something that the ASC has to prove.
It has long been understood that illegal distributions fall under this category of offence - whether you intended to breach the Act or not is irrelevant; if you sell shares in breach of the prospectus requirements, you will be found liable.
However, strict liability offences always have one defence available: due diligence. If you acted with sufficient care and attention, and can prove that you did so, this can constitute a valid defence.4 In the ASC decision in Euston Capital Corp5, the test was stated as requiring the Issuer to “take whatever steps are necessary to satisfy itself that it is reasonably certain that the investor to whom it wishes to sell its securities is in fact an Accredited Investor.”
In Campbell, the ASC found that while Mr. Campbell (the principle of the issuer in question) did not investigate the financial means of potential investors, there was sufficient evidence to find he did interact with them and was able to form an impression of their profession, means and financial circumstances. The ASC found that the evidence before them “together do not indicate inattention or disregard to prospective investors’ circumstances relevant to the Accredited Investor exemption” [para 104]. The ASC was also “not persuaded that the Accredited Investor exemption was unavailable for the distribution.” This was the case, despite the fact that they found at least one investor that did not qualify under the Accredited Investor exemption. The ASC made this ruling without specifically stating that a due diligence defence had been made out.
What we take from this is the following: it is up to the issuer to ensure the exemption claimed actually applies (and, after the recent amendments, to also get a signed risk acknowledgement form if selling to an individual). It is not enough to merely ask an investor if they are accredited more steps must be taken. However, if an issuer does take reasonable steps to satisfy itself that the exemption claimed applies, it may avoid a finding of liability, even if it turns out the exemption failed for one investor (or perhaps more than one). This will depend on the steps taken in the circumstances.
Interestingly, the ASC made the findings in Campbell without hearing from Mr. Campbell. Normally, in order to satisfy a due diligence defence, one would expect detailed evidence from the principle of the issuer as to all the steps that were taken.
This leads us to the second takeaway: following the language quoted above, it appears the ASC took the view that once an Issuer has shown it has taken some steps to satisfy itself the exemption properly applies, the onus then switches to Staff of the Commission to demonstrate the steps taken were not reasonable in all the circumstances.
The lesson to be learned is this: an issuer must take reasonable steps to ensure an exemption is properly available when seeking to avoid the prospectus requirements. However, if those steps are taken and a Non-Accredited Investor nevertheless “falls through the cracks,” this fact in and of itself may not conclusively lead to a finding of a breach of the Act.
Of course, it is important to recognize that Re: Campbell may be an exceptional case. The prudent course, from a regulatory oversight perspective, is to assume the worst, and take all steps reasonably possible to ensure that an exemption applies and be able to prove that these steps were taken.
 The accredited investor exemption was recently amended on May 5, 2015, adding new requirements for sales to individuals. The amendments took place after the decisions discussed in this paper, but do not alter the analysis.
2 Re Transcap Corporation, 2013 ABCA 201, para. 90.
3 Re Campbell, 2015 ABASC 604.
4 R v City of Sault Ste Marie,  2 SCR 1299.
5 Euston Capital Corp, Re, 2007 ABASC 75.