Effective May 5, 2015, amendments to National Instrument 45-106 Prospectus and Registration Requirements (“NI 45-106”), the primary piece of legislation setting out the mechanics for prospectus-exempt securities offerings in Canada, and its Companion Policy will change the landscape for issuers wishing to raise capital on a prospectus-exempt basis using certain exemptions. These amendments contemplate three (3) primary changes: (1)        Having individual (non-corporate) accredited investors sign a new Form 45-106F9 Form for Individual Accredited Investors, which is a risk acknowledgement that describes, in plain language, the categories of individual accredited investor and identifies the key risks associated with purchasing securities in the exempt market; (2)        Restricting the minimum exemption ($150,000) to non-individual investors where it was previously available to both individuals and corporations (the exemption will remain available for individual’s holding corporations, provided they have not been created or used solely to purchase securities under this exemption); and (3)        Providing expanded guidance on the steps an issuer should take to verify the status of investors acquiring securities under prospectus exemptions, including the accredited investor exemption. As the expanded guidance on verification steps may be the most cumbersome of these proposed amendments, it is discussed in this blog entry.  By way of overview, the Canadian Securities Administrators (in their new companion policy to NI 45-106) have generally stated the following: ·         Investor Assessments - When using exemptions such as the “accredited investor” or “family and friends” exemption in NI 45-106, the issuer will have to obtain information from the investor in order to determine whether the investor has the requisite income, assets or relationship to meet the terms of the particular exemption. It will not be sufficient for the issuer to accept standard representations in a subscription agreement or initial beside a category on Form 45-106F9 Form for Individual Accredited Investors unless the issuer has taken reasonable steps to verify the representations made by the investor. To this end, the regulators have provided examples for verification for exemptions based on income/assets (such as accredited investor) and exemptions based on a relationship (such as close personal friends/business associates):

• Exemptions based on income or assets - To assess whether an investor is an accredited investor or eligible investor, the issuer should ask questions about the investor’s net income, financial assets or net assets, or ask other questions designed to elicit details about the investor’s financial circumstances.  If the issuer has concerns about the investor’s responses, the issuer should make further inquiries about the investor’s financial circumstances. If the issuer still questions the investor’s eligibility,  the seller could ask to see documentation that independently confirms the investor’s claims
• Exemptions based on relationships - If an exemption is based on the existence of a specific relationship between the investor and a principal of the issuer (such as that of a family member, “close personal friend” or “close business associate”), the issuer should ask questions designed to confirm the nature and length of the relationship. The issuer should also confirm the nature and length of the relationship with the director, executive officer, founder or control person identified by the issuer. For example, if the investor claims to be a close personal friend of a director of an issuer, the issuer could ask the investor for the name of the director and a description of the nature and length of the investor’s relationship with the director. The issuer could verify with the director that the information is accurate. Based on that factual information, the issuer could determine whether the investor is a close personal friend of the director for the purposes of the family, friends and business associates exemption

·         Documentation Practices - Issuers will be required to retain and collect all investor documentation and overall be able to evidence the “Investor Assessment” actions (noted above) taken by the issuer. With respect to specific practices that should be followed, the regulators have stated:

• The issuer should consider whether it is necessary to have the investor sign documentation before distributing securities to that investor. For example, if the investor claims to be a close personal friend of a director of the issuer, the issuer could ask the investor to sign a statement giving the name of the director and describing the nature and length of the investor’s relationship with the director. The issuer could also ask the director to sign the statement confirming the relationship. In other cases, the issuer may determine it is not necessary for the investor to sign the documentation, for example, if the issuer is using meeting notes and email communications to demonstrate its verification efforts.
• The issuer should retain this documentation to evidence the steps the issuer has taken to verify the availability of the exemption. Certain exemptions require the issuer to obtain a signed risk acknowledgement form from the investor and to retain that risk acknowledgement for 8 years after the distribution. The 8-year period reflects the longest limitation period under securities legislation in Canada. The issuer should consider local legislation concerning limitation periods when deciding how long to retain other documentation it considers necessary to demonstrate that it complied with the exemption.
• The issuer should consider and comply with the requirements under provincial or federal legislation concerning the protection of personal information when collecting and retaining investor information.

·         Policies and Procedures for Investor Assessment - Issuers will be expected to implement policies and procedures to ensure that an investor meets the conditions for a particular exemption, such as:

• how the issuer identified or located a potential investor;
• what category of accredited investor or eligible investor the investor claims to meet;
• what type of relationship the investor claims to have and with which director, executive officer, founder or control person of the issuer;
• how much and what type of background information is known to the investor; and
• whether the person who meets with, or provides information to, the investor is registered.

·         Policies for Selling Agents/Employees -  Issuers will be expected to ensure that any party which sells securities on its behalf:

• understands the exemption being relied upon;
• is able to describe the terms of the exemption to the investor; and
• knows what information and documentation must be obtained from investors to confirm the conditions of the exemption have been satisfied.

The net effect of this new verification guidance is that issuers will likely be required to set up procedures (and potentially ask for additional documents) to ensure all investors meet the necessary exemption requirements for the particular exemption they are relying upon (ie. ensuring the investor IS an accredited investor). The regulators do not seem to have gone as far as asking for financial information for each investor (if that investor is, for example, saying they are an accredited investor) but it seems to be getting close to that point. The overall message from the regulators appears to be that something more than the standard representation letter needs to be produced by the issuer.

About the author:

Joe is an associate in the Saskatoon office where he practices in the areas of corporate finance, securities, mergers & acquisitions, and taxation.

About McKercher LLP:

McKercher LLP is one of Saskatchewan’s oldest, largest law firms with offices in Saskatoon and Regina. Our deep roots and client-first philosophy have made us a top ranked firm by Canadian Lawyer magazine (2011, 2013). Expertise, experience and capacity provide innovative solutions for our clients’ diverse legal issues and complex business transactions.