of capital raised through exempt distributions reported
to the OSC in 2011 was approximately $142.9 billion.
Approximately $86.5 billion of that amount was raised in Ontario.
In 2011, approximately $72.8 billion was raised under the
accredited investor prospectus exemption in Ontario.”
Misuse of the AI exemption
The OSC and other Canadian securities regulators are
concerned that issuers and/or EMDs are failing to comply with the
requirements of the AI exemption by selling exempt securities to
investors who do not meet the definition of an AI. Specifically, the
OSC is concerned with:
• individuals who are purchasing exempt securities as AIs that
do not meet the minimum income or asset thresholds;
• issuers and dealers who are incorrectly interpreting the
definition of “financial assets” by including non-financial
assets such as precious metals, the investor’s primary
residence and other real estate as “financial assets”;
• failing to collect adequate know-your-client (KYC) information
to reasonably determine whether an investor is in fact an AI;
• EMDs simply relying on a statement that an investor is an
AI (e.g., self-certification) without collecting any supporting
• Examples of recent OSC decisions illustrating the
consequences of an EMD’s failure to comply with the AI
exemption include Re Morgan Dragon Development Corp. et
al and Re Blueport and Hare, which are available on the OSC’s
The AI exemption – what is it?
The AI exemption 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 definition of who is an AI is set out in the definitions section
of NI 45-106. It includes 22 categories of investors who qualify as
an AI including, specified governments, financial institutions and
individuals who qualify based on certain income and asset tests.
The AI exemption - tests for AIs who are individuals
There are three ways an individual may qualify under the AI
exemption based on financial thresholds, which are discussed
below. The Canadian securities regulators view these thresholds
as “bright-line” standards for determining whether an individual is
or is not an AI. These financial thresholds are to be applied at the
time of the distribution of, or trade in, the exempt security.
(a) Financial Asset Test
Under the financial asset test, an AI is an individual, alone
or with a spouse, who beneficially owns “financial assets” with
an aggregate realizable value, before taxes but net of any related
liabilities, of $1 million.
Financial assets means (a) cash, (b) securities or (c) a contract
of insurance, a deposit or an evidence of a deposit that is not
a security for the purposes of securities legislation, but does not
include real property such as a personal residence.
The test permits individuals to include the value of any
financial assets they “beneficially” own.
(b) Net Asset Test
Some individuals make use of the broader net asset test to
qualify as an AI where the individual, either alone or with a spouse,
has net assets of at least $5 million. Net assets are determined by
subtracting the total amount of the individual’s liabilities from the
total value of the individual’s assets. The dollar amounts assigned
to assets and liabilities must be fair estimates of value.
Unlike the financial asset test, an individual can include the
value of their primary residence in their net asset test; however,
they must also deduct the amount of any associated mortgage
on the property. The calculation does not require a deduction for
any future income taxes, but any taxes that are outstanding and
payable at the time of the trade must be included.
(c) Income Test
An individual may also qualify as an AI based on income if:
(a) their net income before taxes exceeded $200,000 in each of
the two most recent calendar years; or (b) their net income before
taxes combined with that of a spouse exceeded $300,000, in each
of the two most recent calendar years and who, in either case,
reasonably expects to exceed that net income level in the current
Who is responsible for determining AI Status?
Securities regulators have stated that a person distributing or
trading in securities is responsible for determining whether the AI
exemption is available for an investor.
Some market participants may believe they can solely rely
on the self-certification of an investor who has ticked a box in a
subscription agreement that they are an AI or otherwise factually
represented that they are an AI (i.e., self-certification), assuming
that the market participant has no reasonable grounds to believe
those representations are false. However, this in itself may not
be good enough. Prudent issuers and EMDs require additional
information that supports a self-certification and shows that the AI
exemption was properly relied upon.
The verification standard for determining AI status
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.
Decisions by Canadian securities authorities and
courts have confirmed this reasonable verification standard.
• in a British Columbia Securities Commission decision,
the Commission stated that “after making the appropriate
inquiries, the issuer must have a reasonable belief that the
facts are true and that the legal requirements for use of the
exemption have been met”;