By Michael Hanley
While Ontario has recently implemented an Offering Memorandum Prospectus Exemption (the Ontario OM Exemption), dealing representatives (DRs) of Exempt Market Dealers (EMDs) must remember that the Ontario rules, although substantially similar to those previously implemented in other Canadian jurisdictions, can be different in some important respects, particularly in the areas of investor eligibility and investment limits. The Ontario OM Exemption will also be implemented in Alberta, New Brunswick, Nova Scotia, Quebec and Saskatchewan, subject to certain variations, on April 30, 2016. The following are some key considerations for EMDs when selling a private placement under the Ontario OM Exemption.
Can any issuer use the Ontario OM Exemption?
No, there are exclusions. An investment fund is not eligible to use the Ontario OM Exemption in Ontario, nor in New Brunswick or Quebec following implementation. However, investment funds will be able to use the Ontario OM Exemption in Alberta, Nova Scotia and Saskatchewan, but only if they are non-redeemable investment funds or mutual funds that are reporting issuers. DRs should pay particular attention to whether an issuer is a non-redeemable investment fund which is broadly defined and can capture many different types of private funds. A non-redeemable investment fund is essentially an entity whose primary purpose is to invest money provided by its security holders and which does not invest its funds for the purpose of exercising or seeking to exercise control, or for the purpose of being actively involved in the management, of an investee. Mortgage investment entities such as mortgage investment corporations are eligible to use the Ontario OM Exemption as Canadian securities regulators have taken the position that they are not investment funds.
What Are the Investment Limits?
Individuals are subject to limits on the dollar amount of securities that they can purchase unless they are an accredited investor or would qualify under the ‘Family, Friends and Business Associates’ prospectus exemption, in which case they will not have any investment limits. Corporations and other entities which have not been established for the purpose of using the Ontario OM Exemption will not have investment limits. The investment limits applicable to individuals will depend on whether the individual qualifies as an ‘eligible investor’ and whether they have received positive suitability advice from an EMD or other registrant. An ‘eligible investor’ includes an individual who meets any of the following financial tests:
· whose net assets, either alone or with a spouse, exceed $400,000;
· whose net income, before taxes, exceeded $75,000 in each of the last two years and reasonably expects to exceed such income level in the current calendar year; or
· whose net income together with a spouse, before taxes, exceeded $125,000 in each of the last two years and who reasonably expects to exceed such income level in the current calendar year.
The investment limits under the Ontario OM Exemption are described in the table below.
Securities regulators have said that the investment limits in the Ontario OM Exemption are an important investor protection measure, particularly for retail investors, to reduce their risk of loss and prevent over-concentration in exempt market securities which are subject to less stringent requirements and less oversight in comparison to prospectus-offered securities. It is important to note that an individual eligible investor who has received positive suitability advice may not be entitled to invest the $100,000 maximum amount referenced above. For example, an EMD may determine that $100,000 is not suitable for a particular investor and that a lesser amount of between $30,000 and $100,000 is suitable for the investor. A subscription from an individual eligible investor in excess of $30,000 cannot be accepted by an issuer for an amount exceeding that which the EMD or other registrant has determined to be suitable for the investor.
One potential consequence of such investment limits is that some investors who maintain significant holdings of exempt market securities may not be able to replenish them at the same rate and time as they are typically be sold, in large blocks, from time to time. This can cause an unwanted underweighting of exempt market securities in the investors’ portfolios. In relation to such concerns, securities regulators have pointed to the importance of investment limits as protective measures, particularly for retail clients, and to the flexibility built within the exemption for higher purchase limits, or no purchase limits, for qualifying investors.
Are the Term Sheet and other Marketing Materials Incorporated into the OM?
The Ontario OM Exemption requires an issuer to provide disclosure to each purchaser by an offering memorandum in prescribed form (the ‘OM,’ in Form 45-106F2). The OM must include a statement that all OM Marketing Materials used in connection with the offering are incorporated by reference into the OM. OM Marketing Materials are defined as a written communication intended for prospective purchasers regarding a distribution of securities under an offering memorandum delivered under the Ontario OM Exemption that contains material facts relating to an issuer, securities or an offering, however OM Marketing Materials do not include a term sheet in the standardized form as described in National Instrument 45-106 (NI 45-106). Consequently, EMDs must ensure that the OM Marketing Materials are consistent with the disclosure in the OM and must be fair, balanced and not misleading as their content will be subject to the same liability for rescission or damages for a misrepresentation as the OM itself. EMDs should note that pursuant to NI 45-106 they must not distribute any OM Marketing Materials unless and until they have been approved by the issuer in writing. Such OM Marketing Materials must be filed with securities regulators together with the OM.
Issuers which post OM Marketing Materials on their web sites may have concerns as to whether a reference to their web site in the OM may effectively incorporate the contents of their entire web site into their OM and thereby subject the ever-changing content of their web site to the liability for rescission or damages for a misrepresentation in the OM. In this regard I refer to the definition of OM Marketing Materials and note that only information on an issuer’s web site that is intended for prospective purchasers of securities pursuant to an Ontario OM Exemption offering would fall within such definition. Although securities regulators have not issued specific guidance as to best practices for posting OM Marketing Materials on web sites, I suggest that, rather than include a general reference to the issuer’s web site in the OM, the OM include a specific reference to the name and/or a description and location of the OM Marketing Materials on the web site (which may be organized on one or more separate pages on an issuer’s web site and accessible from the home page via a named tab). In this way the OM Marketing Materials on an issuer’s web site can be readily identified and accessed by a potential investor, and filed as a discrete document together with the OM.
What Other Documentation is Required?
The Ontario OM Exemption also requires that the risk acknowledgement form (Form 45-106F4) to be executed by investors include two schedules, the first schedule being the ‘Classification of Investor Under the Offering Memorandum Exemption’ with respect to eligibility of individual investors and the second schedule being ‘Investment Limits for Investors Under the Offering Memorandum Exemption’ with respect to investment limits. Both schedules are in checklist format and the second schedule includes a Part to be completed by an EMD which has given suitability advice to an individual eligible investor in connection with the investment. Although the schedules to the risk acknowledgement form include specific representations and warranties as to investment limits and eligibility, securities regulators expect issuers and EMDs to take additional steps to verify such representations and warranties. For example, DRs should discuss the investment limits with the individual eligible investor to ensure that they are understood and should make enquiries as to other investments that the eligible investor may have made under the Ontario OM Exemption within the prior twelve month period. DRs are encouraged to keep notes and records of such additional steps so that they may serve as a record of having done so and be made available to a regulator if requested pursuant to a compliance audit.
Michael Hanley is a partner in the corporate finance group of Torkin Manes LLP in Toronto. He can be reached at firstname.lastname@example.org.