CSA Review of Minimum Amount and Accredited Investor Exemptions
Staff of the Canadian Securities Administrators (the CSA) recently ended the public consultation period regarding their review of the $150,000 minimum amount and accredited investor prospectus exemptions. The review, described in CSA Staff Consultation Note 45-401 – Review of Minimum Amount and Accredited Investor Exemptions (the Consultation Note), was conducted in light of the global financial crisis and recent international regulatory developments to assist the CSA in identifying issues stakeholders may have concerning the use of these exemptions and to obtain information that will assist in deciding whether changes are necessary or appropriate.
The Consultation Note states that the minimum amount and accredited investor prospectus exemptions have been premised on an investor having one or more of: (a) a certain level of sophistication, (b) the ability to withstand financial loss, (c) the financial resources to obtain expert advice, and (d) the incentive to carefully evaluate the investment given its size.
The consultation process invited reconsideration of these premises and put to the public a number of questions regarding the overall approach to these exemptions, having regard to the fact that, in the case of both the minimum amount and accredited investor prospectus exemptions, there are no limitations on the type of securities sold under the exemption, the number of solicitations, the number of purchases, or on the number of times the exemption may be relied on, with no disclosure materials required to be provided to investors.
Minimum Amount Exemption
The existing minimum amount exemption is available where a purchaser purchases a security as principal and the security has an acquisition cost to the purchaser of not less than $150,000 paid in cash at the time of distribution.
The Consultation Note identifies the concern that an exemption based on the size of an investment alone does not assure investor sophistication or access to information. As well, it notes that the current $150,000 threshold was set in 1987 and has not been changed or adjusted for inflation since, with such amount now equivalent to over $265,000 in 2011 dollars. Accordingly, there is a concern that the threshold is too low, permitting unsophisticated, retail investors to participate in the exempt market. Lastly, the Consultation Note identifies the concern that an investment based on a minimum amount may cause an investor to invest more than business or investment consideration may dictate, solely to meet the threshold.
Accredited Investor Exemption
To qualify as accredited investors individuals must meet certain thresholds which currently include:
- the individual must, either alone or with a spouse, beneficially own financial assets having an aggregate realizable value that before taxes, but net of related liabilities, exceed $1 million;
- the individual must have net income before taxes exceeding $200,000 (or $300,000 when combined with that of a spouse) in each of the two most recent calendar years and must reasonably expect to exceed that net income level in the current calendar year; and
- the individual must either alone or with a spouse, have net assets of at least $5 million.
The CSA notes that such thresholds were originally set by the SEC in 1982 and subsequently adopted by the CSA in the early 2000s, with such thresholds never having been changed or adjusted for inflation since. Accordingly, there is again the concern that the thresholds may be too low and allow unsophisticated, retail investors to participate in the exempt market. The Consultation Note also identifies the concern that income and asset thresholds are not adequate proxies for investment sophistication and that some purchasers purchasing securities under the accredited investor exemption are not accredited investors.
Potential Outcome of the Consultation Process
The Consultation Note advises that, depending on the feedback received, the CSA may take a wide range of action, including retaining the exemptions in their current form, adjusting the various exemption thresholds, using alternative qualification criteria for individuals or limiting the exemptions to certain investors, such as institutional investors and not individuals.
The CSA is cognizant that many issuers, especially small and medium sized enterprises, rely heavily on these exemptions to raise capital, and, accordingly, confirm in the Consultation Note that the CSA will be guided by the principles that (a) regulatory initiatives must effectively address the risks to investors and markets that are identified and (b) the benefits of any regulatory initiative must be proportionate to the cost to industry and the restrictions it imposes on market participants.
Many stakeholders have published their views on this matter, which include: reducing the existing thresholds to encourage further investment in start-up enterprises (subject to investors signing risk acknowledgements); removing the minimum investment exemption altogether because of its disconnect with establishing investment sophistication; or adjusting the exemptions based on whether they are securities of listed issuers subject to public continuous disclosure requirements, how complex the security is and whether the security is being sold by a member of a self-regulatory organization (such as IIROC).
As the exempt market is not insignificant in Canada, stakeholders will be watching carefully the results of this consultation process.
Significant Changes to U.S. Private Placement Rules on the Way
The global financial crisis and the accompanying negative impact on capital formation for small and emerging companies have also prompted a significant reassessment of the private placement regime in the United States. On March 22, 2012, the U.S. Senate passed an amended version of H.R. 3606, the Jump-Start Our Business Start-Ups Bill (referred to as the JOBS Act Bill), which had previously been approved by the House of Representatives and is primarily intended to make it easier for small and emerging companies to raise capital in the U.S. markets. It is anticipated that the House of Representatives will vote to pass the amended bill during the week of March 26 and that President Obama will sign it into law shortly thereafter.
Among other things, the JOBS Act would:
- eliminate the publicity prohibitions against general solicitation or general advertising in connection with certain private placements of securities under Regulation D and Rule 144A under the U.S. Securities Act of 1933 (the U.S. Securities Act);
- exempt from the registration requirements of the U.S. Securities Act so-called “crowdfunding” transactions involving offers and sales to any investors (including non-accredited investors) of up to US$2 million of securities during the prior 12-month period, subject to limits on how much can be raised from any individual investor;
- exempt certain securities offerings from the U.S. Securities Act’s registration requirements where the aggregate amount of securities offered and sold to the public in the prior 12-month period does not exceed US$50 million;
- modify the registration requirements under Section 12(g) of the U.S. Securities Exchange Act of 1934 that trigger the need for companies to file periodic reports with the U.S. Securities and Exchange Commission so that a company can have up to 2,000 shareholders of record (so long as no more than 499 holders are non-accredited investors) before Section 12(g) registration requirements apply; and
- create a new category of issuer called an “emerging growth company” (which generally would include companies with less than US$1 billion in total annual gross revenues, subject to specified limits and conditions on how long a company can remain in the emerging growth company category) that can benefit from exemptions from Sarbanes-Oxley auditor attestation requirements and disclosure requirements relating to executive compensation as well as being permitted to present two instead of three years of audited financial statements in an IPO registration statement.
These changes, which will be the subject of a more comprehensive Osler Update when the JOBS Act is signed into law, may also inform the CSA’s assessment of the existing Canadian private placement rules described above.