Lawyers, dealers worry about exempting short form prospectus if firms raise less than $10 million
The Canadian Securities Administrators has proposed the introduction of a new prospectus exemption for issuers listed on a Canadian stock exchange, expecting the change to provide a more efficient way to raise smaller amounts of capital.
However, McMillan LLP partner Leila Rafi says that she and other lawyers and market participants are worried that some proposals would be a “massive change” to the Canadian capital markets.
“It calls into question the premise of the closed system and the necessity of hold periods,” she says, adding it could “potentially will burn a hole through the closed system.”
Louis Morriset, CSA chair and president of the Autorité des marchés financiers, says the organization of regulatory bodies has “heard from market participants that the time and cost to prepare a short form prospectus is a barrier to capital raising for many smaller issuers.” He says the proposal would reduce regulatory burden while maintaining robust investor protection.
The CSA says that the proposed “Listed Issuer Financing Exemption” should reduce costs for issuers raising smaller amounts of capital through the public markets. In its announcement at the end of July, the CSA says it would also allow smaller issuers greater access to retail investors and provide retail investors with a broader choice of investments.
The prospectus exemption would not be available to issuers that have been a reporting issuer for less than 12 months, nor to issuers that have not filed all continuous disclosure documents required under Canadian securities legislation.
Eligible issuers would file a short offering document, and the securities they issue would be freely tradeable. Under the proposed exemption, issuers could raise up to the greater of $5 million or 10 per cent of the issuer’s market capitalization, to a maximum of $10 million annually.
The proposed exemption is in response to comments received from CSA consultation paper “Considerations for Reducing Regulatory Burden for Non-Investment Fund Reporting Issuers.” The CSA says it also reflects research on capital raising requirements in other countries and other stakeholder feedback about the prospectus system.
The CSA also wants comments on the proposed changes, with an Oct 26 deadline for written submissions.
However, Rafi, a partner in McMillan’s capital markets and securities group, says this is “the first time a prospectus exemption can be used to sell securities to such a wide variety of investors — any type of investor — without a hold period from the distribution date.
“The type of purchaser for this prospectus exemption is unlimited and we have never seen that before in the existing prospectus exemptions that are identity-based as opposed to transaction-based, as typically they are tied to income or relationships.”
Rafi adds that the proposal will impact the short-form prospectus market by “obliterating” offerings for less than $10 million, representing about 20 per cent of the market. It will “likely deter issuers from relying on the accredited investor prospectus exemption as there is a four-month hold in connection with use of that prospectus exemption,” Rafi says. As well, this method of raising cash requires a regulatory report that is more extensive than needed under the proposed new prospectus exemption.
Rafi notes that the CSA reflects some of the thinking that came out in a report of the Ontario government’s capital markets modernization taskforce, released in January. “One of our main objectives is to amplify growth and competitiveness in Ontario’s capital markets,” the report says.
“The decline in new issuers and initial public offerings in Ontario is alarming. The real consequences of this trend are fewer head offices, fewer entrepreneurs, and fewer growth investment opportunities, all of which could drive Ontario to become a ‘branch plant’ economy.”
To address this, the taskforce proposed recommendations to incubate junior issuers in this province by reducing the regulatory burden, providing new opportunities for capital-raising through the expansion of prospectus exemptions, and streamlining disclosure requirements, among others.
The taskforce recommended a prospectus exemption similar to one the CSA is now proposing, allowing issuers to raise capital based on their continuous disclosure record and a short offering document rather than a prospectus filing. Investors would assume the same level of risk as purchases of the same securities in the secondary market.
Rafi says what is “novel” in this proposal is the extension of civil liability and creation of contractual rights of rescission in a treasury offering that doesn’t use an offering memorandum or prospectus, or that doesn’t fall into one of the other categories, such as a rights offering or a “control person trade” or “existing security holder” exemption.
“The [proposed] exemption envisions a prescribed disclosure document that will be treated akin to a core document in the secondary market liability regime,” she says.
While the proposed changes may help issuers access the retail market, over the long-term, it may be harmful to issuers, Rafi says, “including to their reputation,” depending on how the liability framework plays out post-closing of an offering. “Issuers may fail to see that now but should be concerned with that risk long-term.”
There is also a concern, Rafi says, that purchasers under this prospectus exemption will decide to exercise their rescission rights because a reporting issuer’s continuous disclosure record may contain a misrepresentation. “This is particularly true for smaller issuers whose business depends on a wide variety of variables which means their disclosure can become inaccurate fairly easily.”
For lawyers, Rafi says, the proposed changes mean “we will have clients who will wish to issue securities using the new prospectus exemption and [we] will assist in preparing and reviewing disclosure provided in the required ‘core document’ to be used in the offering.”
Lawyers will also need to assist issuers in understanding their potential liability in connection with relying on this prospectus exemption.
“It will also likely mean that fewer of our clients will conduct short-form prospectus offerings under $10 million or conduct private placements using the accredited investor prospectus exemption.”
Rafi expects that the CSA will likely receive a lot of feedback on the proposed changes. Dealers, for example, may react negatively as they “have no real role in this exemption.” Law firms may also question whether the new prospectus exemption will maintain investor protection.
“Whether or not it comes to fruition will be interesting,” she says, but “one thing is clear, it looks like it is time to re-evaluate the closed system and its parameters.”
Rafi says regulators may also want to evaluate other prospectus exemptions the securities regulators are exploring, including mirroring the well-known seasoned issuer model in the United States, “which most in the market are supportive of.”