Amendments to some commonly-used prospectus exemptions, including the accredited investor (AI) exemption, have now come into effect. Among other things, the amendments:
- introduce a new risk acknowledgement form (RAF) for individual accredited investors that describes, in plain language, the categories of individual accredited investor and identifies the key risks associated with purchasing securities in the exempt market;
- provide expanded guidance on the steps an issuer should take to verify the status of purchasers acquiring securities under prospectus exemptions, including the AI exemption; and
- restrict the minimum amount investment ($150,000) exemption to distributions to non-individual investors.
In Ontario, amendments have also been made to harmonize certain local exemptions with those available in the rest of the country. Ontario has adopted a broader family, friends and business associates exemption to replace its (Ontario-only) founder, control person and family exemption. In addition, the definition of accredited investor has been amended to allow fully managed accounts in Ontario to purchase investment fund securities using the managed account category of the AI exemption, as is permitted in other Canadian jurisdictions.
According to the Canadian Securities Administrators (CSA), the revisions to the AI exemption and the minimum amount investment exemption are principally intended to enhance individual investor protection. But the devil is always in the details.
Minimum Amount Investment Exemption
Under the minimum amount investment exemption, any person purchasing securities as a principal from a single issuer with an initial acquisition cost of not less than $150,000 was previously exempt from the prospectus requirements. The amendments limit the availability of this exemption to non-individuals in order to avoid over-concentration in one investment for an individual investor.
Accredited Investor Exemption
The definition of accredited investor includes categories of high net worth individuals1 who earn in excess of a certain level of income or own more than a prescribed value of assets. Under the amended rules, these categories will still be available to angel investors (who are typically sophisticated investors meeting the income or assets criteria set out in the AI exemption). The amendments also broaden the definition of accredited investor to include certain family trusts established by an accredited investor for his or her family.
The amendments require individual accredited investors to complete and sign a RAF prior to, or concurrent to, the purchase of securities.2 The RAF will also have to be completed and signed by the salesperson or finder involved in the trade. Again, angel investors are presumed to be well aware of the risks they take in investing in early stage companies, so signing an acknowledgement that an investment is risky and you could lose all of your money will not represent anything new for angel investors.
According to the CSA, the RAF will improve investor protection “by itemizing the risks associated with products sold under prospectus exemptions”.
Additional Verification Requirements
It has always been the case that the issuer of securities that is relying on the AI exemption (or any similar exemption based on the personal characteristics of an investor or the relationships an investor may have) is responsible for determining whether the terms and conditions of the prospectus exemption are met. The typical approach in making the determination has been to obtain representations and warranties from the purchaser, as well as having the purchaser specifically initial and complete an accredited investor questionnaire prior to completion of the trade. Revised guidance in the Companion Policy to National Instrument 45-106 — Prospectus Exemptions states that such approach is “not sufficient”. The issuer now has to take “reasonable steps” to verify the representations made by the purchaser.
The Companion Policy suggests what “reasonable steps” might include, but does not prescribe specific steps, other than to indicate that whether the types of steps are reasonable will depend on the particular facts and circumstances of the purchaser, the offering and the exemption being relied on, including:
- how the issuer identified or located the potential purchaser;
- what category of accredited investor or eligible investor the purchaser claims to meet;
- in the case of the FFBA exemption, what type of relationship the purchaser 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 about the purchaser; and
- whether the person who meets with, or provides information to, the purchaser is registered.
Some of the additional steps that are suggested in the Companion Policy for issuers of securities to verify a purchaser’s status include:
- in order to assess whether a purchaser is an accredited investor, the issuer should ask questions about the purchaser’s net income, financial assets or net assets, or ask other questions designed to elicit details about the purchaser’s financial circumstances (and, if the issuer has concerns about the purchaser’s responses, the issuer should make further inquiries, including asking to see documentation that independently confirms the purchaser’s claims);
- if an exemption is based on a specific relationship between the purchaser and a principal of the issuer (for example, a family member, close personal friend or close business associate), the CSA expects the issuer to ask questions designed to confirm the nature and length of the relationship; and
- keep relevant and detailed documentation.
This may mean, at the least, that enhanced or more detailed questions will be asked that aim to ensure the purchaser understands the requisite test and to elicit details that allow the issuer to be satisfied that the test is met.
Do I Need to Give You My T4?
For issuers of securities, this poses a dilemma: how do they meet the verification requirement without offending potential investors? And, for angel investors, do you really have to provide your T4? At the moment, the answer is unclear. What is clear is that the CSA believes the previous approach undertaken by most issuers is not enough.
At the moment, issuers and their counsel are struggling with how to comply with the verification requirements. While enhanced investor protection is always welcome, it cannot impose undue burdens on issuers or make it less attractive for angel investors to invest. It remains to be seen what practices will develop in order to balance the concerns of the CSA with the concerns of issuers and their (potential) investors.
The devil is always in the details.
1 These categories include: (i) an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $1,000,000; (ii) an individual whose net income before taxes exceeded $200,000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year; and (iii) an individual who, either alone or with a spouse, has net assets of at least $5,000,000.
2 Other than those individuals with net financial assets exceeding $5,000,000.