In Canada, rights offerings are considered financings of last resort. Comparatively few companies have raised funds using this method, despite that it is viewed by many as the most equitable method to existing shareholders for a company to raise funds. This may change if a new proposal to streamline the regulatory process comes into effect.
A rights offering, either by prospectus or prospectus exempt circular, involves a company issuing to its securityholders rights to acquire their proportionate number of securities being issued by the company, normally at a significant discount to the market price. Typically, securityholders are also given the ability to exercise, on a proportionate basis, those rights that have not been exercised by a certain date. Normally the rights trade on the applicable stock exchange so securityholders who do not wish to exercise their rights can sell them to third parties who are interested in exercising them. In order to be sure that this type of financing will succeed, it is very common for a stand-by guarantor to agree to exercise any rights that are not otherwise exercised. Securityholders therefore have the ability to avoid dilution and even increase their interest in the company at a significant discount to the market price, and receive free trading securities. The company, on the other hand, can ensure that the fundraising is successful through the deep discount, listing the rights and obtaining a stand-by guarantor. A rights offering can be relatively inexpensive as it does not require a broker, although they can be retained as soliciting agents.
Despite these theoretical benefits, the current regulatory requirements make the process quite time-consuming from announcement to closing, usually resulting in the market price of the shares drifting down to the exercise price of the rights. This means that few rights will be exercised by securityholders other than the stand-by guarantor (if one is in place). Further, the current regulatory requirements limit a company to only a 25% dilution for rights offerings completed by prospectus exempt circular so only a limited amount of capital can be raised without proceeding by prospectus. Knowing this, companies normally prefer to pursue a private placement.
What is more, there are recent instances in which foreign companies listed in Canada have excluded Canadian shareholders altogether from participating in a rights offering made to shareholders in other jurisdictions due to the current more onerous and time-consuming procedures required for a rights offering conducted in Canada.
Recognizing calls by market participants to overhaul the process for conducting rights offerings, the Canadian Securities Administrators (CSA) published a notice and draft amendments on Nov. 27, 2014 for public comment. If the regulatory proposals are implemented, the existing prospectus exempt rights offering model would be replaced with a new flexible, more streamlined process for conducting a rights offering for public companies (technically, reporting issuers) other than investment funds. The proposal would also update the requirements for rights offerings conducted by way of prospectus. Surprisingly, the proposals would also eliminate the prospectus exemption for rights offerings by non-public companies.
The process required under the current exemption is time consuming and, in practice, of limited use as it only allows for 25% dilution in respect of the class of shares to be offered in a prospectus exempt rights offering. The CSA reviewed prospectus exempt rights offerings conducted in Canada in the recent past and notes the following statistics:
- Only 93 prospectus exempt rights offerings were conducted over the past seven years.
- It took an average of 40 days to clear a rights offering circular from the date of filing with a CSA member.
- The average time to complete a prospectus exempt rights offering, from the date of filing of the draft notice and circular, was 85 days.
Not surprisingly, public companies considering a rights offering often proceed by way of short-form prospectus rather than pursue an exempt rights offering.
The proposed amendments are intended to address each noted shortcoming. Most significantly, under the proposed model:
- There would be no review of the circular by a regulator before commencing a rights offering.
- The dilution limit on prospectus exempt rights offerings (using a circular) would be increased to 100% of the applicable class of securities to be offered (up from 25%).
- A new short form notice of rights offering, and a new simplified form of rights offering circular in a question and answer format, would be introduced.
- Once a notice is sent to securityholders and the notice and circular have been filed on SEDAR the company would be able to commence its rights offering. The offering must remain open for a minimum of 21 days and a maximum of 90 days. These time periods are consistent with the currently available rights offering exemption.
- Statutory civil liability for secondary market disclosure provisions would apply to the acquisition of securities under a rights offering. As such, subscribers under the rights offering would have a right of action for misrepresentations in the public company’s circular and other continuous disclosure documentation.
- For rights offerings of listed securities, the subscription price for shares issuable upon exercise of rights must be lower than the market price for such securities as at the time the notice is filed. For rights offerings of unlisted shares, the subscription price must be lower than fair value at the time of filing of the notice provided this requirement would not apply if insiders are restricted from increasing their proportionate interest in the public company through the rights offering or a stand-by commitment. Further, insider participation in a rights offering would not be restricted if the market price or fair value, as applicable, falls below the subscription price during the offering.
- The proposed exemption would make it clear that the public company must make the basic subscription privilege available on a pro rata basis to all existing shareholders. This is distinct from the currently available exemption which is not clear in this regard. We note that this could raise issues that cause delays or increase costs if shareholders reside in foreign jurisdictions where a distribution of rights to them requires a prospectus or reliance on a prospectus exemption.
- Stand-by commitments would still be permitted. There would be certain requirements such as a confirmation by the public company that the stand-by guarantor has the financial ability to carry through with its stand-by commitment.
- Shares issued under the proposed exemption would be subject to a seasoning period on resale such that in most cases this would not result in a hold period. This is consistent with the current rights offering exemptions.
Stand-by Guarantor Prospectus Exemption
The CSA proposals introduce a new separate prospectus exemption for securities issued to stand-by guarantors. This would not be necessary for a stand-by guarantor that is a current securityholder as the existing rights offering exemption would apply to such a trade. However, if the stand-by guarantor is not a current securityholder then the public company needs to rely upon a separate prospectus exemption. Securities issued to a stand-by guarantor that is not a securityholder before the rights offering would be subject to a restricted period on resale.
The proposals leave it open to further discussion as to whether or not securities issued under a stand-by guarantee to a stand-by guarantor that was a securityholder before the rights offering should be subject to a restricted period on resale or not in respect of securities acquired as stand-by guarantor. We believe that if the intent of the proposals is to facilitate rights offerings, given the pivotal role that is played by stand-by guarantors in the success of the offering, they should be incentivized to act in that capacity by being treated equally with securityholders in terms of the applicable hold period to all securities issued under a rights offering to existing securityholders.
Rights Offerings by Prospectus
The CSA proposals introduce proposed housekeeping changes to provisions related to the conduct of a rights offering by way of prospectus, which for the most part are consistent with the current regime governing a rights offering by way of prospectus.
Whether by way of a prospectus or a circular, a public company making a rights offering to shareholders in Québec must provide such documents, and any disclosure documents incorporated by reference into a prospectus, in French. Where the public company is headquartered outside of Québec and has very few Québec shareholders holding in the aggregate less than 2% of the issued and outstanding shares, the public company can apply to the regulator in Québec for the de minimis exemption. Such exemption is only issued on a discretionary basis by the regulator in Québec in view of the facts of the rights offering.
Proposed Removal of Rights Offering Exemption for Non-Public Companies
The proposals go to some length to make the point that the new rights offering exemptions are intended to streamline the process and reduce the costs for public companies that plan to raise capital from existing securityholders. For public companies this should be welcome news, allowing them greater flexibility and a less onerous and less time-consuming process to complete a rights offering. Surprisingly, the proposals would eliminate the prospectus exemption for rights offerings by non-public companies.
The only rationale given by the CSA for eliminating the rights offerings exemption for non-public companies is that securityholders for such a company do not have access to the same degree of disclosure as would be the case for a public company. The same is true with regards to many other prospectus exemptions as well, such as the accredited investor exemption. Further, many shareholders of non-public companies negotiate various contractual disclosure rights in shareholder or other agreements. Eliminating the rights offering exemption for non-public companies, even if it is only used sparingly, would place additional restrictions on the ability of such companies in raising capital. If the overall goal of this proposal is to provide additional flexibility in the capital raising process why take this opportunity to add these restrictions?
The Consultation Process
The CSA are seeking feedback on the proposed exemptions generally, as well as on specific questions that have been provided. The comment period ends on Feb. 25, 2015.