Introduction

Canadian securities regulators are proposing new rules applicable when raising money via an offering memorandum. The changes would require enhanced disclosure for non-public issuers, as well as for issuers engaged in “real estate activities” and those that are “collective investment vehicles”.

Summary

On September 17, 2020, the Canadian Securities Administrators (CSA) published for comment proposed amendments (the Proposed Amendments) to National Instrument 45-106 – Prospectus Exemptions (NI 45-106) and its Companion Policy regarding the offering memorandum (OM) prospectus exemption (the OM Exemption). The Proposed Amendments set out new disclosure requirements for issuers using the OM Exemption, with emphasis on those engaged in “real estate activities” and issuers that are “collective investment vehicles” (as further described below).

Comments on the Proposed Amendments are open until December 16, 2020.

Background

The OM Exemption was originally designed to be used by relatively small businesses for relatively small amounts of capital. However, in practice, many larger and more complex issuers have utilized the OM Exemption. The CSA found that, in 2017, approximately 40% of issuers using the OM Exemption had total assets of $100 million or more. It also found that approximately 17% of issuers using the exemption operated in the real estate industry and approximately 43% likely fell under the proposed definition of “collective investment vehicles”. In addition, CSA compliance reviews have indicated that many issuers relying on the OM Exemption were unclear on many of the disclosure requirements. The Proposed Amendments seek to address these concerns by providing industry specific guidance and clarifying certain other requirements under the OM rules.

Proposed Amendments

Issuers engaged in real estate activities

The Proposed Amendments define “real estate activities” as an undertaking “with the primary purpose of generating income or gain from the lease, sale or other disposition of real property for security holders”. Excluded from the definition are activities relating to mineral and oil and gas projects.

If the Proposed Amendments are adopted, issuers engaged in real estate activities will have to provide purchasers with an independent appraisal of any interest in property and file such appraisal with the relevant securities authorities if:

• The issuer has acquired or proposes to acquire an interest in real property from a related party;
• A value for an interest in real property is disclosed in the OM; or
• The issuer intends to spend a material amount of the proceeds of the offering on an interest in real property.

Issuers engaged in real estate activities will also be required to complete the new Schedule 1– Additional Disclosure Requirements for an Issuer Engaged in Real Estate Activities (Schedule 1) to Form 45-106F2. The requirements under Schedule 1 include:

• Disclosure relevant to issuers that are developing real property, such as a description of the approvals or permissions required and milestones of the project;
• Disclosure relevant to issuers that own and operate developed real property, such as the age, condition and occupancy level of the real property;
• Disclosure of penalties, sanctions, bankruptcy, insolvency and criminal or quasi-criminal convictions for parties other than the issuer; and
• Disclosure of any purchase and sale history of the issuer’s real property with a related party.

Schedule 1 would not apply to real property that, in aggregate, would not be significant enough to influence a decision by a reasonable investor to buy, hold or sell a security of the issuer.

Issuers that are collective investment vehicles

The Proposed Amendments define a “collective investment vehicle” as an issuer “whose primary purpose is to invest money provided by its security holders in a portfolio of securities.” The definition includes issuers that hold portfolios of mortgages, other loans or receivables. The definition also includes investment funds, to the extent they are permitted to use the OM Exemption, and mortgage investment entities.

Collective investment vehicles would be required to complete the new Schedule 2 – Additional Disclosure Requirements for an Issuer that is a Collective Investment Vehicle (Schedule 2) to Form 45-106F2, which includes:

• A description of the issuer’s investment objectives;
• Disclosure of penalties, sanctions, bankruptcy, insolvency and criminal or quasi-criminal convictions for persons involved in the selection and management of the investments; and
• Disclosure of information regarding the portfolio and the performance of the portfolio.

The CSA believes these changes will provide investors with more information about the party making investment decisions, how the investments are chosen and the composition and performance of the portfolio.

General Amendments

The Proposed Amendments also include several general amendments, including:

• A new requirement that the filed copy of an OM be in a format that allows for the electronic searching of words;
• Enhanced disclosure where a material amount of the proceeds of the offering will be transferred to another issuer that is not the issuer’s subsidiary or where a material amount of the issuer’s business is carried out by another issuer that is not the issuer’s subsidiary;
• Disclosure of historical transactions involving related parties;
• The addition of disclosure regarding fees or limitations with respect to redemption or retraction rights;
• Further disclosure regarding redemption or retraction;
• A new requirement to disclose the source of funds for dividends or distributions paid that exceeded cash flow from operations;
• New cautionary disclosure for expert reports, statements or opinions where there is no statutory liability against the expert; and
• A new requirement to amend an OM to include an interim financial report for the most recently completed 6-month interim period when a distribution of securities under an OM is ongoing, as described further below.

In addition, the Proposed Amendments include changes to the risk acknowledgment form required to be signed by certain investors purchasing securities under the OM Exemption. The changes are consistent with recent amendments to the forms of risk acknowledgement required in connection with the use of other prospectus exemptions.

Practical implications for issuers and investors

The CSA has put forward the Proposed Amendments in their effort to address the most commonly occurring disclosure deficiencies noted in their review of previously filed OMs. While the Proposed Amendments may reduce the occurrence and associated costs of continuous disclosure reviews, issuers will likely incur additional costs stemming from the following new requirements:

• Independent property appraisals for certain issuers engaged in real estate activities;
• Disclosure obligations under the new Schedule 2 for collective investment vehicles; and
• Amendments to a live OM in certain circumstances.

Issuers engaged in real estate activities will be required to incur the additional costs of obtaining independent property appraisals and delivering these appraisals to purchasers at the same time as or before the OM is delivered to such purchasers. The Proposed Amendments will also result in issuers that are collective investment vehicles having to increase their level of disclosure, which will also result in additional costs.

Finally, under the current OM Exemption, issuers that are in continuous distribution typically amend their OM annually. However, the Proposed Amendments will require an amendment to include an interim financial report for the most recently completed 6-month interim period. This will bring an added cost to these issuers, who will have to amend their OMs at least once every six months.

Dentons’ insight

Ultimately, the increased disclosure requirements will likely have little impact on larger issuers who are able to absorb any additional costs of compliance. However, assuming the Proposed Amendments are adopted, smaller issuers with fewer financial resources may begin to opt for other capital raising methods. This risks exacerbating the disparity between the type of issuer the OM Exemption was intended for, and those that actually use it.

Those who wish to learn more about the Proposed Amendments and the potential implications on issuers with real estate activities or collective investment vehicles, or those wishing to submit a comment on the Proposed Amendments, should contact authors Jack Schroder or Stuart Ruffolo, or any other member of Dentons Securities and Corporate Finance group.