Canadian securities regulators have announced important proposed amendments to the private placement exemptions in National Instrument 45-106 that came into force on May 5, 2015. This article outlines what you need to know about the changes and specific action steps your business should consider as a result of the changes.
Private Issuers Beware!
These amendments are relevant not only to public companies, but also private issuers that are looking to raise private placement investment capital. The amendments will require revisions to private placement documentation that we or our clients previously may have utilized in the past. For example, private placement subscription agreements and accredited investor certificates used by companies issuing shares in reliance on the private issuer private placement exemption to issue shares to persons that qualify as accredited investors or “close personal friends” or “close business associates.”
You Need to Exercise Greater Due Diligence
In addition, issuers will need to have individual investors acquiring under the accredited investor private placement exemption complete and sign a new prescribed risk acknowledgment form. Further, companies issuing securities to individuals under the private issuer, accredited investor or friends, family and business associates private placement exemptions now need to conduct greater due diligence and obtain more information from investors to ensure that investors qualify under the applicable exemptions. This is particularly the case for non-brokered private placements where there is no registered dealer conducting this due diligence.
Action Step: This will likely require revisions to subscription documentation obtained from investors.
$150,000 Minimum Acquisition Cost Private Placement Exemption
The $150,000 “minimum amount” private placement exemption will no longer be available for issuance of securities to individuals. However, it will remain available to corporations provided that they have not been created or used to purchase securities under this exemption.
Action Step: Private placement subscription agreements previously used where the minimum acquisition cost exemption has been relied on should be revised to reflect that the exemption is not available for individuals or corporations created or used to purchase under the exemption.
Accredited Investor Definition
A new category of accredited investor has been created: individuals who beneficially own “financial assets” having an aggregate realizable value before taxes, but net of any related liabilities, exceeding $5 million. (The main purpose of including this new category is that investors that qualify are not required to sign the new prescribed risk acknowledgment form.)
In addition, trusts established by an accredited investor for the benefit of certain family members will be able to qualify as an accredited investor. There are also other minor changes to the wording of some other clauses in the definition of “accredited investor”. In many cases, accredited investor certificates attached to private placement subscription agreements list all of the categories of accredited investors as defined in the Instrument and require investors to check or initial which categories they fall within.
Action Step: Accredited investor certificates will likely need to be revised to reflect the changed wording and include the new categories.
New Prescribed Risk Acknowledgment Form
Excluding purchasers that qualify under the new $5M financial assets category, Issuers will need to obtain from individual accredited investors acquiring under the accredited investor private placement exemption a new prescribed risk acknowledgement form at the same time or before they sign their subscription.
The form requires individual accredited investors to specify the category of accredited investor they fall under. The new prescribed risk acknowledgement form must also provide information regarding any salesperson that meets with, or provides information to, the purchaser with respect to the investment.
Action Step: Where the accredited investor exemption is being relied on, subscription agreements should be revised to contemplate completion and execution of the risk acknowledgment form.
This requirement does not apply to accredited investors acquiring under the private issuer exemption.
Action Step: Even if not mandated for private issuers, issuers distributing securities to accredited investors under the private issuer exemption should consider revising subscription documents to incorporate certain of the features in the risk acknowledgement form including a plain or “accessible” language description of the categories and qualifications of the accredited investor definition that apply to individual accredited investors and requiring individual investors to initial beside a summary of risks, increasing the likelihood that investors are aware of the risks.
Private Placement Exempt Trade Reports
It was previously proposed that the form of exempt trade report required to be filed with regulators following completion of a private placement would be revised to require additional information, including identifying the category of accredited investor for each purchaser and additional information regarding persons being compensated in connection with a distribution, including which purchasers the compensation was for. This was only to be applicable in relation to reliance on the accredited investor exemption, and was not required where securities are sold under the private issuer exemption to accredited investors. In any event this change is not being implemented at this time.
New Regulatory Guidance Regarding Confirming Accredited Investor Status
The proposed revised Companion Policy 45-106CP published by regulators will contain additional guidance on steps issuers should take to verify accredited investor status including explaining the different categories and explaining the tests and how they are applied and asking questions to obtain factual information from purchasers about their income or assets before discussing the investment with the purchaser, and if there are any concerns about eligibility, requesting independent documentation to confirm the information.
The guidance makes clear that the issuer and any dealer or agent acting on its behalf must take reasonable steps to verify that each purchaser qualifies and that the issuer or dealer cannot simply rely on a purchaser’s representation or certification, or the investor initialing a category in a risk acknowledgment form.
New Guidance Regarding Close Personal Friends and Close Business Associates Private Placement Exemption
The revised Companion Policy also will contain additional guidance regarding steps an issuer should take to verify the status of purchasers under the “family, friends, and business associates” private placement exemption. The issuer should ask questions and obtain statements from purchasers designed to confirm the nature and length of the relationship with the director, executive officer, founder or control person identified by the investor.
The Companion Policy includes new guidance to the effect that an individual is not a “close personal friend” or “close business associate” because the individual is a “mere acquaintance” or co-worker, colleague or associate at the same workplace (or not a close personal friend because the individual is connected through some form of social media such as Facebook or Twitter). The revised Policy suggests that certain factors should be considered, such as:
- frequency of contacts
- level of trust
- length and nature of the relationship
A close personal friend or close business associate relationship must be sufficient to permit the investor to obtain information from the applicable director, executive officer, founder or control person with respect to the investment.
For close business associates, the regulators have further suggested that the nature and number of business dealings between the individual and the director, executive officer, founder or control person, the length of the period during which they occurred and the nature and date of the most recent business dealing is relevant. The Companion Policy suggests that how the issuer identified or located the potential purchaser is relevant to the reasonable steps that the issuer needs to take to verify the purchaser’s representations.
Action Step: It likely is appropriate to reflect this additional guidance in the definitions of close personal friend or close business associate included in subscription documents and documents obtained from investors.
The proposed changes to the Companion Policy indicate that issuers are required to collect and retain documentation and generally be able to evidence the actions taken as described above. In addition, issuers are expected to implement polices and procedures to ensure each investor qualifies for a particular exemption. For example, issuers should consider requiring investors claiming to be a close personal friend or close business associate of a director or executive officer to provide a statement disclosing the name of the director or officer and nature and length of the relationship, and then require the director or officer to sign the statement to verify that the information is true.
Action Step: As a result, issuers will have to ask for additional information and documents from investors, probably including a written statement from “close personal friends” or “close business associates”, to ensure each investor qualifies and it will not be sufficient to simply rely on subscription documentation historically obtained in many cases.
Harmonized Ontario Exemption
Ontario is adopting a family, friends, and business associates private placement exemption that is largely harmonized with exemptions in other provinces.
Although the revised Ontario exemption is largely uniform with the exemption in BC and other provinces, care should be taken to comply with all requirements, including a requirement in Ontario to obtain a risk acknowledgement form.
Action Step: Likely it will be necessary to amend precedent private placement subscription agreements where securities may have previously been offered in Ontario, as well as other provinces, in reliance on current exemptions, including the family, friends and business associates exemption.
Possible Impact on Legal Opinions
Where a distribution is made in circumstances where the issuer is required to obtain from an individual accredited investor a prescribed risk acknowledgement, the failure to obtain such a signed risk acknowledgement in the required form at the same time or before the individual signs an agreement to purchase the security would result not only in the issuer not being in compliance, but result in the exemption not being available.
Action Step: Legal counsel providing opinions on private placements to accredited investors will potentially need to include an appropriate assumption regarding compliance with this requirement or otherwise satisfy themselves regarding compliance.
As noted by the CSA, if documentation, including the risk acknowledgement form, is not completed and signed properly, the issuer should return the entire subscription package to the investor for re-signature. That probably does not reflect current practice in dealing with subscription deficiencies.
In addition, other amendments impact the “short term debt” exemption and implement a new “short term securitized product” exemption.