Ontario's proposed prospectus exemptions: family, friends and business associates exemption

April 24, 2014

The Ontario Securities Commission’s (OSC) proposed family, friends and business associates exemption (the Ontario Exemption), if adopted, would allow small to medium-sized enterprises (SMEs) to raise capital in Ontario from a broader range of permitted individuals, while imposing concurrent parameters and obligations which promote investor protection and consistency of application. With a view to facilitating capital raising by SMEs and harmonizing the exemption across all provinces, the Ontario Exemption is based largely on the existing private issuer and family, friends and business associates exemption available in the other Canadian provinces (the Existing Exemption) with a few notable differences, as summarized below. The OSC’s proposal also calls for the repeal of the existing founder, control person and family exemption in section 2.7 of NI-106 upon enactment of the proposed Ontario Exemption.

As we previously discussed, the Ontario Exemption is one of the prospectus exemptions proposed by the OSC last month.

Current Regime

In Ontario, issuers can currently raise capital from certain family members of their executive officers, director or founders without the need to file a prospectus by way of the private issuer exemption in section 2.4 of National Instrument 45-106 Prospectus and Registration Exemptions or the founder, control person and family exemption in section 2.7 of NI 45-106. In the other Canadian provinces, however, a much broader family, friends and business associates exemption is available in section 2.5 of NI 45-106 (and section 2.6 of NI 45-106 in Saskatchewan), whereby companies can raise capital from a wider scope of family members, as well as close personal friends and close business associates of their or their affiliates’ executive officers, directors or control persons.

Similar Features

Like the Existing Exemption, the Ontario Exemption would be available to both reporting issuers and non-reporting issuers and selling security holders, imposes no restrictions on the size of the offering, the jurisdiction of incorporation or organization of the issuer, or the nature of the business, and does not provide investors with a right of withdrawal. Also consistent with the Existing Exemption, there is no requirement for principals to invest their own money in the business prior to making an offering under the exemption, and investors can invest an unlimited amount of money into the company. The resale restrictions would be the same under the Ontario Exemption, with securities of a reporting issuer being subject to a four-month hold period, and securities of a non-reporting issuer being subject to an indefinite hold period unless resold under another prospectus exemption or the issuer becomes a reporting issuer.

Distinguishing Features

In contrast to the Existing Exemption, however, the Ontario Exemption is not available to investment funds, as the OSC notes it seeks to address investment funds in separate initiatives targeted towards the modernization of product regulation and point of sale disclosure. Also, unlike the Existing Exemption under which the distribution of any type of security is permitted, only specific categories of securities can be distributed under the Ontario Exemption, namely: common shares, non-convertible preference shares, securities convertible into common shares or non-convertible preference shares, non-convertible debt securities linked to a fixed or floating interest rate, units of a limited partnership or flow-through shares under the Income Tax Act (Canada). Novel or complex products are purposefully excluded from distribution under the Ontario Exemption, as it is the OSC’s view that SMEs would be unlikely to issue complex products and that such securities only be sold with the full protection afforded by a prospectus.

While the use of registrants, finders or advertising is not prohibited to solicit investors in connection with a distribution under the Existing Exemption, the Ontario Exemption prohibits such advertising as well as any corresponding finder’s fees or commissions. Given that investors must be within the personal networks of the executive officers, directors or control persons of the issuer or its affiliates, the OSC reasons that any such advertising would be unnecessary and any need for advertising would raise concerns about the application of the exemption in the first instance. Another proposed change under the Ontario Exemption provides that if potential investors are voluntarily supplied with an offering memorandum in connection with a distribution under the exemption, then statutory rights of action, including rights of action for damages and rescission, would be available to investors.

Of note, the most significant differences found in the Ontario Exemption include additional guidance on the scope of “close personal friends” and “close personal business associates”, which has been a longstanding concern, and imposing additional and/or more comprehensive reporting requirements. Each of these changes is described in greater detail below.

Close Personal Friends and Close Personal Business Associates

Although the Ontario Exemption contemplates substantially similar categories of investors as those found in the Existing Exemption, being family members, close personal friends and close personal business associates, the OSC also proposes expanded guidance on the meaning of “close personal friend” and “close personal business associate” in the companion policy to NI 45-106 in its attempt to mitigate against improper use of the exemption. The expanded guidance would add more colour to the guidance accompanying the Existing Exemption, which the OSC considers to be insufficient, and would place the onus on the issuer to establish whether such close personal relationship exists. In addition to providing definitions of “close personal friend” and “close personal business associate”, the proposed amendments to the companion policy also enumerate specific factors that the OSC would examine in its determination of the existence of such relationships. In recognition of the rise of social media, the OSC also notes that a friendship that is primarily founded on Facebook, Linkedin or other internet forums would generally not meet the standard of a close personal friend or close personal business associate.

Risk Acknowledgment Form

Notably, the Ontario Exemption would require any investor who is an individual to sign a risk acknowledgment form (RAF) upon purchasing a security in reliance on the exemption. Such prerequisite currently exists in Saskatchewan but not in the other jurisdictions where the Existing Exemption is available. In order to promote greater investor awareness and protection, the proposed RAF would require the investor to acknowledge, among other things, the riskiness of the investment, that the investor could lose all of the money invested, and that the investor will not have the benefit of protections under securities laws that are afforded under prospectus distributions. Furthermore, the investor must disclose which category of investor he or she satisfies and provide specifics of his or her relationship, including the length of time the investor has known the director, executive officer, founder or control person with whom he or she is claiming to be a close personal friend or close personal business associate. The issuer as well as the director, executive officer, founder or control person with whom the investor has directly or indirectly asserted the exempt relationship must sign the RAF and the person making the distribution must retain a copy of the form for eight years following the distribution.

Report of Exempt Distribution

Consistent with the approach taken in other provinces, issuers relying on the Ontario Exemption would be required to file a report of exempt distribution on proposed Form 45-106F11. Beyond simply identifying the exemption relied upon, however, additional disclosure concerning the identity and position of the individual with whom the investor has declared a relationship and the category of relationship asserted must also be provided. Such additional disclosure would be provided in a confidential schedule to the report of exempt distribution and would not appear on the public record. Such information is intended to help monitor compliance with the Ontario Exemption and create a more uniform interpretation of the close personal friend and close personal business associate categories.

Comments on the proposed Ontario Exemption will be accepted by the OSC until June 18, 2014.

This article is the third in a series of posts discussing the prospectus exemptions proposed in Ontario. Our first post on the existing security holder exemption was published on March 20 and our second post on the crowdfunding exemption was published earlier this week.

DISCLAIMER: This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal advice and must not be treated or relied on as such. Please read our full disclaimer at www.stikeman.com/legal-notice.

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