More changes for exempt market

Most significantly, the OSC paper lays out a possible model for both the controversial fundraising method known as “crowdfunding” and bringing back the offering memorandum (OM) exemption. The paper also contemplates introducing new exemptions for investments based on advice from an investment dealer, and another that’s contingent on industry experience.

In the paper, the OSC stresses that it’s not proposing to introduce these exemptions just yet. Rather, it’s looking for feedback, and may decide not to proceed with any of these ideas. But the paper nevertheless reveals the sorts of innovations that regulators are contemplating.

The high-technology sector has begun pushing securities regulators to allow some form of equity-based crowdfunding. This would allow companies to raise small amounts of capital online from a large number of retail investors without regard for the criteria for more traditional exemptions, such as the accredited investor exemption or the minimum investment exemption.

The crowdfunding model has become increasingly popular in recent years as a way of funding creative projects or providing microfinancing, but this model is not currently contemplated under securities laws as a way to raise equity. However, the OSC paper sketches out a possible model to do just that.

The OSC paper contemplates a crowdfunding model that would allow issuers to raise up to $1.5 million from investors in a 12-month period. Investors wouldn’t have to qualify (in terms of income or net worth) to participate, but they would be subject to limits – they’d be allowed to invest only $2,500 in crowdfunding investments with a single issuer, up to a maximum of $10,000 per year.

The proposed model also would set some initial and ongoing minimum disclosure requirements for issuers, prescribe the types of securities that could be issued and impose some limits on advertising. Investors would be required to sign a waiver acknowledging the risk involved in the investment. Investors also would receive a two-day cooling-off period in case they change their mind.

In addition, the investments would have to be made through a funding portal that is registered as a dealer or as an advisor, which would put the investments under the OSC’s oversight. The OSC paper also imagines imposing certain restrictions on these portals: they wouldn’t be able to offer advice or pay to solicit investments. The portals also may be exempt from certain registration requirements, given that they wouldn’t be offering a full range of traditional services.

The OSC paper indicates that its crowdfunding model emulates many of the protections that are expected to be built into forthcoming rules in the U.S. The U.S. Securities and Exchange Commission (SEC) was to have its crowdfunding rules ready to go by the end of last year, but missed that deadline. The idea of allowing equity crowdfunding remains controversial.

The North American Securities Administrators Association, a group of both state and provincial regulators in both Canada and the U.S., has been very vocal in its opposition to crowdfunding in the U.S.

And the investor advocacy group, the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada), also is opposed, calling it “a dumb idea whose time has come.” FAIR Canada believes that permitting equity crowdfunding would pose great harm to investors and should not be allowed in Canada.

@page_break@The OSC paper acknowledges investor protection concerns in regard to crowdfunding, as well as the risks in general of opening exempt markets to retail investors. The paper indicates that the OSC would have to step up its oversight of the exempt market if any of these new exemptions are introduced, particularly in the case of exemptions for which investors aren’t required to receive any sort of professional advice.

The OSC paper notes that the possibility of allowing small, retail investors greater access to the exempt market also highlights ongoing concerns about financial literacy. Therefore, the OSC is carrying out additional research in an effort to assess retail investors’ appetite for startup investing, their understanding of the risks of the exempt market, their disclosure needs, the role of advice in their investment decisions and the experiences of existing exempt-market investors.

The OSC has scheduled four public-consultation sessions to consider the issues raised in this paper. They are slated for Jan. 21 and 30, and Feb. 7 and 8. The comment period for the paper closes on Feb. 12.

Although the introduction of a crowdfunding exemption is the biggest innovation proposed in the OSC paper, several other possibilities also are contemplated. For one, the paper examines the idea of reintroducing the OM exemption in Ontario, subject to similar limitations being contemplated for crowdfunding. Issuers would be limited to raising $1.5 million within a 12-month period; investors would be restricted to $2,500 investments in single issuers, and $10,000 per year.

The paper indicates that the OSC considers crowdfunding and OM exemptions to be “along the same continuum,” as they both would open up the exempt market to retail investors. Most of the other key features of the crowdfunding model would apply in the case of an OM investment.

The key differences, the OSC paper notes, are: a funding portal would be involved with crowdfunding transactions, whereas a portal wouldn’t be required for an OM investment; there would be no requirement for the involvement of a registered firm when an OM is used.

In addition to these possibilities, the OSC paper also contemplates the introduction of a couple of other new exemptions: a “knowledgeable investor” exemption and an advice-based exemption.

The latter exemption would open up the exempt market to greater access for retail investors, albeit with the guidance of specific advice from an investment dealer. In particular, the model contemplates that the advice would have to be made under a contractually agreed fiduciary duty, so the financial advisor is explicitly working in the investor’s best interest. This exemption wouldn’t be available for distributions from related issuers, and it would be available to investment dealers only, not to exempt market dealers (EMDs).

The OSC paper notes that it is excluding EMDs from this concept because of differences between investment dealers and EMDs regarding their duties toward clients, proficiency and other requirements. The paper states that OSC compliance reviews have sparked concerns about the willingness of some EMDs to comply with their suitability obligations, among others.

The knowledgeable investor exemption would allow investors who have worked in the investment industry for at least a year – and have either a chartered financial analyst or chartered investment manager designation, or an MBA degree – to buy into exempt distributions.

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