Selling to AIs: Why is it important?
The accredited investor exemption (the AI exemption) is set
out in section 2.3 of National Instrument 45-106 – Prospectus and
Registration Exemptions (NI 45-106). It states that the prospectus
requirement does not apply to a distribution of securities if the
purchaser purchases the security as principal and is an AI.
The AI exemption is the most commonly used exemption
from the prospectus requirement in Ontario and in most
other jurisdictions. For example, according to OSC statistics,
approximately $104 billion was raised in Ontario’s exempt market
in 2012 of which $94 billion or 90% was raised under the AI
exemption. According to ASC statistics, approximately $11 billion
was raised in Alberta’s exempt market in 2012 of which $9.24
billion or 84% was raised under the AI exemption.
An individual may qualify under the AI exemption based on
either the (a) “bright-line” financial thresholds reflected in the
“financial asset test”, (b) the “net asset test” or (c) the “income
test”, each of which were discussed in our previous article.
The Companion Policy to NI 45-106 states that the verification
standard for determining AI status must be reasonable, after
careful consideration of the facts, which standard has been
confirmed by Canadian securities regulatory decisions and case
law. Unfortunately, there are no step-by-step rules from Canadian
securities regulators on what exactly an issuer and/or EMD is
required to do to ensure compliance with the AI exemption.
Given the absence of clear rules regarding AI verification, it
is not surprising that some exempt market participants are selling
exempt securities to non-AIs – the public - nor is it surprising that
securities regulators would be concerned about this. As many
readers have noted, the simple response to this concern would be
for regulators to offer additional guidance to the industry: over half
of our survey respondents agreed that further guidance regarding
the verification of AI status is needed from our securities regulators,
with 75% agreeing that specific steps should be provided for each
type of investor regarding what procedures and information can,
and cannot, be relied upon for each AI category.
Although prescriptive guidance with respect to AI verification
would be ideal, we have not seen any indication such guidance
is forthcoming from regulators in Canada, or for that matter their
counterparts in the United States at the Securities and Exchange
Commission (the SEC). In the absence of such prescriptive
guidance, we recommend EMDs and issuers apply ‘best practices’
when determining an investor’s AI status, some of which were
discussed in our previous article.
Three-quarters of survey respondents agreed that issuers
should be able to solicit new investors through a website, a widely
disseminated e-mail or social media solicitation or through a
newspaper (each being a General AI Solicitation). This is consistent
with securities law in Canada.
For example, NI 45-106 does not prohibit the use of advertising
in any form (e.g., internet, e-mail, direct mail, newspaper or
magazine) to solicit purchasers under the AI exemption. However,
any solicitation activities that aim to identify an AI should clearly
state the criteria that investors will be required to meet, and if
any print materials are used, they should clearly and prominently
state that only AIs should respond to the solicitation. If advertising
is undertaken by EMDs in connection with a distribution, they
should review other securities legislation and securities directions
for guidelines, limitations and prohibitions on advertising intended
to promote the interest in an issuer or its securities.
Issuers looking to engage in General AI Solicitation should be
extremely cautious before engaging in such activities in connection
with a distribution since such activities may require the issuer to
be registered under applicable securities law and are subject to
detailed regulations especially when it involves public offerings.
General solicitation and general advertising in connection
with a private placement offering has been prohibited under
U.S. securities law for over 80 years, however, that has recently
changed. Effective September 23, 2013, the SEC has lifted the ban
on general solicitation and general advertising under Regulation D
in connection with a new Rule 506(c) offering.
The JOBS Act directed the SEC to lift the ban so long as:
(a) the purchasers are all AIs, (b) the issuer took “reasonable
steps to verify” that the purchasers were AIs and (c) other
conditions including compliance with the anti-fraud provisions of
U.S. securities law. (For discussion on the verification methods
considered by the SEC, see Part I or this article in the previous
edition of the Exempt Market Update.)
What this means is that since September 23, 2013, issuers
and U.S. broker dealers can now advertise in all media including
print (e.g., Wall Street Journal), radio, television (e.g., CNBC)
and social media (e.g., Twitter or LinkedIn) for investments in
various companies including start-ups and small and medium
sized issuers. However, take note that the SEC has established
a dedicated team who will be monitoring Rule 506(c) offerings for
fraud and co-ordinating compliance with state regulators.
General Advertising and Soliciting of AIs