Proposed New OM Exemption Rules
The Canadian Securities Administrators (CSA/ASVM) have been busy over the summer; presumably locked away in home offices with keyboard keys clacking away and change tracking functions turned on for their Word documents. The results have now been published and there are quite a few.
The CSA/ACVM have proposed a number of amendments, revisions, changes and outright new material to become part of National Instrument 45-106 and its key form, Form 45-106F2.
This proposal was released September 17, 2020 and is called – “Proposed Amendments to National Instrument 45-106 Prospectus Exemptions and Proposed Changes to Companion Policy 45-106CP Prospectus Exemptions Relating to the Offering Memorandum Prospectus Exemption” with the actual details of the proposal per Ontario Securities Commission found HERE.
While the document spans 139 pages that provide detailed wording and denote how/ where the changes would be seen in NI 45-106 & 45-106F2, I am only going to speak to what they’ve put forward as the overview of key changes. Be aware though, I did note that there may be seemingly minor wording changes throughout which, for some issuers and/ or those relying on the Offering Memorandum (“OM”), may also have material impact.
With that caveat, let me begin.
The raison-d’etre for the changes to 45-106 are in the name of providing greater disclosure for investors relying upon the information included in OMs when making their investment decisions. Further, in the CSA’s reviewing of issuers using the OM for capital raising, they found a large proportion have their operations related to real property – be that mortgages, land development and/ or operating properties (e.g. apartment buildings). In a more practical, almost cynical way, there have been too many headline grabbing incidents involving negative consequences for investors in real estate related OM issuers leading to upset phone calls to politicians and in turn, unhappy calls to the regulators putting those commissions and overseers in a bad light and now requiring a means to protect against future occurrences.
There are two general but actually specific areas that are being proposed.
Creation of two new definitions for those relying on OM Exemptions and then additional expectations of disclosure within the OM document.
“Real Estate Activities” - this becomes a new term for those issuers involved in ‘real estate activities’ with specific requirements:
“Providing an independent appraisal of an interest in real property to the purchaser if
- the issuer has acquired or proposes to acquire an interest in real property from a related party (Related Party), as that term is defined in NI 45-106,
- a value for an interest in real property is disclosed in the offering memorandum, or
- the issuer intends to spend a material amount of the proceeds of the offering on an interest in real property.
Completing new Schedule 1 Additional Disclosure Requirements for an Issuer Engaged in Real Estate Activities (Schedule 1) to Form 45-106F2, which includes:
- 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, such as a party acting as developer.
- Disclosure of any purchase and sale history of the issuer’s real property with a Related Party, so investors can better evaluate transactions involving Related Parties.” Page 2 of proposal. * [*Bold is my emphasis]
The proposed comments are not particularly difficult and seem like a reasonable expectation of information to be provided to a prospective investor. The burden is in the obtaining of information from parties outside of the issuer such as an appraiser. They are typically readily available but they do come at a cost meaning available margins are going to shrink - will it be the issuer or investor or both feeling the reduction in returns?
Many historical reasons that I can look back on that would have influenced the above proposed information disclosure. The related party transaction is one that I am very happy to see being proposed as there have been many land sales/ purchases where I would question the reliability of the price being reflective of market value.
“Collective Investment Vehicle” – this is defined as “… an issuer whose primary purpose is to invest money provided by its security holders in a portfolio of securities. This definition would include issuers that hold portfolios of mortgages, other loans, or receivables. To the extent they are permitted to use the OM Exemption, the definition would also include investment funds.” Page 2 of proposal.
Those issuer meeting the definition would have to complete additional disclosure on a new Schedule 2 Additional Disclosure Requirements that would be part of th Form 45-106F2. The disclosure would ask an issuer for:
- “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.
- Disclosure of information regarding the portfolio.
- Disclosure regarding the performance of the portfolio.” Page 2-3 of proposal. * [*Bold is my emphasis]
Again, nothing overly onerous but more time and information to be shared by an issuer. Concerns will involve competitive disclosure risks for mortgages but to date those issuers already providing the information have been able to offer, in my mind, sufficient information that does not give away the borrower’s identity.
The last part, and perhaps the area that really is more of a summary and tying together of the above two definition insertion, are general changes to the information provided within the OM. The Form 45-106F2 is updated with revised language for the above points while also adding in addition or perhaps, repetition of what is viewed as key information contained in an OM.
Here are all of the points they’ve noted -
“The General Amendments include:
- Making the provisions in the OM Exemption that deal with the standard of disclosure for an offering memorandum and amending an offering memorandum clearer and more user-friendly for issuers and investors.
- Requiring that the filed copy of an offering memorandum allow for the searching of words electronically. This change is intended to make reading and reviewing offering memorandums more efficient for all recipients.
- With respect to Form 45-106F2:
o The addition of several more disclosure items to the cover page to highlight those matters for investors.
o 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 a material amount of the issuer’s business is carried out by another issuer that is not the issuer’s subsidiary. This is intended to give investors better disclosure as to arrangements of this nature and the ultimate use of the offering proceeds.
o Disclosure of any purchase or sale history of any business or asset of the issuer’s (excluding real property) with a Related Party, so investors can better evaluate transactions involving Related Parties.
o The addition of Related Parties that receive compensation to the compensation disclosure and securities ownership table.
o For item 3.3, adding disclosure of criminal or quasi-criminal convictions. This is consistent with disclosure requirements for more recently developed prospectus exemptions.
o The addition of disclosure regarding fees or limitations with respect to redemption or retraction rights.
o Further disclosure regarding redemption or retraction, including requests made to the issuer, requests fulfilled by the issuer including the price paid and the source of the funds, and outstanding requests.
o A new requirement to disclose the source of funds for dividends or distributions paid that exceeded cash flow from operations.
o Reference to the requirements of National Instrument 33-105 Underwriting Conflicts.
o New cautionary disclosure for instances where expert reports, statements or opinions are included in an offering memorandum and there is no statutory liability against the expert.
o A new requirement to amend an offering memorandum to include an interim financial report for the most recently completed 6 month interim period when a distribution of securities under an offering memorandum is ongoing.
o Other amendments intended to clarify or streamline existing provisions or provide improved disclosure.” Page 3 of proposal. * [*Bold is my emphasis]
Looks good but there is a lot of information now being required of an issuer that may not be looking to raise large amounts of capital. The changes certainly do ask for clearer information about all the parties involved yet there is repetition in the ask for info disclosure such as the fees and redemption/ retraction rights which typically always were part of section 5.1 in an OM – always a key section to review. A very positive piece is the ask for electronic searchability within the document. Yes, folks will have to employ people who know how to work with Adobe PDF and potentially pay for additional software licensing but for someone such as myself, who has scrolled through at least a thousand OMs, this is a very welcome addition.
Of course there are more changes and wordsmithing throughout the proposed change document, I have only just hit the high-level big ticket items. I very much recommend that those looking to make offerings or in particular have continuous offerings currently, read through the document with an eye for areas that may be of greater import than I noted above. Each issuer will have differing areas of interest in the proposed changes.
One last part – in Annex E for Ontario (the version which I’ve linked above) has a very interesting piece that attempts to quantify the costs and in turn put into a percentage of capital raised. They have put some detailed estimate and rationale for them into the Annex E. I have not commented on that section as it will require a more in-depth analysis of the assumptions which may come out in a future posting or if your firm would like, I can complete the analysis for you specifically.
All the best as the world of securities does nothing the same but change.
Thanks,
Aaron
Aaron Taylor
Managing Director
Rhythm Capital Corp.