The exempt market (private placements and other exempt distributions)

• Author: Christopher Nicholls
• Pages: 194-249

194

CHA PTER 7

THE EXEMPT MARKET

(PRIVATE PLACEMENTS

AND OTHER EXEMPT

DISTRIBUTIONS)

A. INTRODUC TION

1) Registration and Prospectus Exemptions

The two fundamental tools of Can adian securities law regulating the

sale of securities are t he registration requirement and the prospectus

requirement. The registration requirement refers to the rules requir-

ing individuals or companies in the business of trading securities to be

registered (i.e., licensed) under securities legislation. The prospectus

requirement refers to the rules t hat require certain k inds of securities

trades — distributions — to be undertaken only if the seller prepare s, f‌iles,

and delivers to the purchasers a prospectus, as discussed in Chapter 6.

Canadian sec urities law does provide exemptions in certain case s

from both the registration and the prospectus requirements. At one

time, the registr ation exemptions played a more signif‌icant role than

they do today, as explained brief‌ly in t he next section. This chapter

therefore focuses primarily on prospectus exemptions.

a) Registration Requirement and Exemptions

Historically, the registration requirement and the prospectus require-

ment were parallel but distinct obligations: the reg istration require-

ment was triggered whenever there was a “trade” in securities (unless

an exemption was available), and the prospectus requirement was

triggered whenever there was a “distribution” of securities (unless an

The Exempt Market (Privat e Placements and Other Exempt Di stributions) 195

exemption was available). In almost every case where a distr ibution

of securities was exempt from the prospectus requirement, that di s-

tribution was also exempt from the registration requirement, but the

registration exemptions and prosp ectus exemptions were, nevertheless,

dealt with in separ ate provisions of securities legi slation.

This approach to registration and regi stration exemptions changed

following legislative reforms in 20 09. Now, as dis cussed in Chapter 4,

instead of a tran saction “trigger,” the reg istration requirement is subject

to a business “trig ger”: in other words, it is no longer every trade in a

security th at triggers the requirement to regi ster. Instead, the registra-

tion requirement is trig gered only when someone engages in, or holds

themselves out as engaging in, the business of trading i n securities or

derivatives. Many exemptions from the registration requirements were

originally i ncluded in t he sa me national instrument th at contai ns most

prospectus exemptions (National Inst rument (“NI”) 45-106). Those

registration exemptions have si nce been removed to Par t 8 of NI 31-103

or to various local rules or bla nket orders.1

A second important change intro duced at the time of the 2009 reforms

(which came into full effect in 2010) was the introduction of a new secur-

ities dealer registration category: “Exempt Market Dealer.” Under the pre-

2009 regime, in most provinces a dealer was not required to be registered

as long as its business w as limited to transactions involvin g only securities

that could be sold without a prospectus, relyi ng on a prospectus exemption.

The situation was different in Ontar io and in Newfoundland and Labra-

dor. Those two jurisdictions imposed a “universal registration require-

ment,” which mandated registration for dealers even if they dea lt only with

exempt securities. However, the requirements to which such dealers were

subject were very modest. They were typically obliged to regi ster as “Lim-

ited Market Dealers,” a category of registration that impos ed minimal obli-

gations upon them. Under the rules in ef fect tod ay, a dealer that dea ls only

in securities t hat are distributed pursuant to prospectus exemptions must

become registered in every jur isdiction as an “Exempt Market Dealer.”

The Exempt Market Dealer registration requirements are somewhat more

demanding tha n those of the “Limited Market Dealer” category under the

prior Ontario and Newfoundland and Labrador regime. The registration

rules are dealt with in more detail in Chapter 4.

b) Prospectus Requirement

The remainder of this chapter dea ls not with registration requi rements

or exemptions but rather with exemptions from the requirement to f‌ile

1 See CSA Staf f Notice 31-312, s 1(a) (2009), 32 OSCB 6252.

SECU RITIE S LAW196

and deliver a prospectus in connection w ith the distribution of securities.

The prospectus exemptions provide importa nt examples of the balance

securities law s must reach between investor protection and the eff‌iciency

of capital markets. If investor protection were the sole, unqualif‌ied goal

of securities laws, t hen one might expect that no exemptions would

ever be granted from the requirement to produce and deliver a prospec-

tus whenever securities are distributed. After all, additional disclosure

would surely always make investors better off — even if only marginal ly

so. But requiring the delivery of a prospect us when the cost to the seller

is enormous and the benef‌its to t he buyer tr ivial would be a very unwise,

economically destructive public policy. If Canada is to continue to have

viable businesse s in which people may invest, our securities laws must

ref‌lect an informed and appropriate balancing of interests.

2) Overview of the Prospectus Exemptions:

Primary Offerings

Clearly, assembling a prospectus is not f‌ina ncially feasible for all issuers.

For example, putting a prospectus together is out of the question for a

small, start-up corporation seek ing to raise $50,000 from relatives and

friends of the corporation’s main shareholders. Any sensible scheme of

securities reg ulation recognizes that a prospectus is not cost effect ive in

such a situation and contains exemptions f rom the prospectus require-

ment to recognize the practica l realities of f‌inancing small ventures.

In other cases, buyers of secur ities do not require the level of pro-

tection afforded by a mandated prospectu s, perhaps because of their

bargaining leverage vi s-à-vis the issuer, or their sophistication in f‌inan-

cial matters, or even their capacity to sustain some f‌inanci al loss. In

such cases, the cost of prepar ing a prospectus would not be justif‌ied by

the benef‌its. Again, any sen sible scheme of securities regulation pro-

vides exemptions from the prospect us requirement to accommodate

such purchasers in appropriate circumstances. A third important class

of exemptions recognizes t hat some securities are so in herently safe

that it is unnecess ary to protect buyers by insisting that the vendor

of the securities incur the considerable time and expense of produ-

cing a prospectus. For example, the Government of Canada does not

need to prepare a prospectus when issuing bonds. For obvious reasons,

the Government of Canada i s regarded as an extremely credit worthy

debtor, more creditworthy than any Canadian corporate issuer.

Virtually al l of the prospectus exemptions, whether designed to

accommodate small issuers, recognize investor sophistication or cap-

acity to withsta nd f‌inancial loss, acknowledge the inherent safety of the