OSC Issues Staff Notice Regarding Reliance on Accredited Investor Prospectus Exemption
On May 13, 2011, the Ontario Securities Commission (the “OSC”) issued OSC Staff Notice 33-735 (the “Notice”). The purpose of the Notice is to respond to OSC concerns that issuers and dealers may be selling securities on a private placement basis in reliance on the “accredited investor” prospectus exemption (the “AI Exemption”) contained in National Instrument 45-106 – Prospectus and Registration Exemptions (“NI 45-106”) to individuals who do not in fact meet the definition of “accredited investor”. The Notice sets out the OSC’s expectations regarding how issuers and dealers should take steps to ensure investors properly fall within the AI Exemption.
Financial Assets vs Net Assets
There are several categories of “accredited investor” under NI 45-106. Two of the most common such categories relate to the investor’s financial assets or net assets, as follows:
- An individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value before taxes, but net of any related liabilities, that exceeds $1,000,000; or
- An individual who, either alone or with a spouse, has net assets of at least $5,000,000.
The Notice cautions that there is a common misunderstanding relating to the concepts of “financial assets” and “net assets”. “Financial assets” include: (i) cash, (ii) securities, or (iii) a contract of insurance, deposit or an evidence of a deposit that is not a security for the purposes of securities law, and does not include the value of the investor’s house or other real estate. On the other hand, “net assets” include all of the investor’s assets less his or her liabilities, and does include the value of the investor’s house and other real estate.
Guidelines – Checking the Box Is Not Sufficient
It is ultimately the issuer’s responsibility to ensure that it is distributing securities only to investors who meet the “accredited investor” definition when distributing securities in reliance on the AI Exemption. However, any dealer involved in the distribution must comply with, among other things, National Instrument 31-103 – Registration Requirements and Exemptions (“NI 31-103”) and the ‘know your client’ (“KYC”) rules thereunder as well as the terms of any agency agreement or underwriting agreement governing the distribution, pursuant to which the dealer will be responsible for determining that the investor meets the definition of “accredited investor”. In most instances, the subscription agreement used in connection with a private placement distribution will contain a form that each investor is to complete by checking off a box of the appropriate category of “accredited investor” into which the investor falls and certifying the accuracy of same. While the subscription agreement will generally contain a provision that will allow both the issuer and the dealer to rely on the representations of the investor contained in this certificate, the Notice provides that this (alone) is not sufficient from the OSC’s perspective. In addition to the investor certifying which category of “accredited investor” it falls into, the Notice sets forth a list of non-exhaustive steps that dealers should take to ensure they are meeting their obligations under securities laws, including NI 31-103, when selling exempt securities pursuant to the AI Exemption. These include:
- Understanding the definition of “accredited investor” and the difference between “financial assets” and “net assets”;
- Developing an accurate form for collecting KYC information and reviewing and updating the form to ensure that dollar thresholds used for net assets and financial assets are correct;
- Carefully explaining to clients the definition of “accredited investor” before the client completes the KYC form to ensure the forms are properly completed;
- Not selling an exempt security if there is insufficient information to determine whether the client qualifies as an “accredited investor”;
- Complying with the suitability rules set forth in NI 31-103. This encompasses understanding both the client’s investment needs and objectives and the attributes and risks associated with the securities the dealer is selling to them;
- The COO of the dealer reviewing the completed KYC form to ensure the information is complete and that the relevant category of “accredited investor” intended to be relied upon can in fact be relied upon; and
- Maintaining accurate and complete records, including the dealer representative’s notes on a meeting, since verbal representations of an investor to a dealer representative that are not documented will not be sufficient support that the investor meets the applicable “accredited investor” category.
Issuers, dealers and investors should all be mindful of the importance of ensuring an investor fits within a category of “accredited investor” where there is a distribution in reliance on the AI Exemption. The OSC has indicated in the Notice that it will closely monitor issuers and dealers who sell securities in reliance on the AI Exemption, which will include compliance reviews and enforcement proceedings or other regulatory action where issuers and dealers are in breach of securities laws.
This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.
If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.Top