Upcoming Amendments to National Instrument 45-106 Prospectus and Registration Exemptions (NI 45-106)

Upcoming Amendments to National Instrument 45-106 Prospectus and Registration Exemptions (NI 45-106)

Amendments to the individual accredited investor (AI) exemption and the minimum amount investment exemption, more commonly known as the $150,000 exemption will come into force on May 5, 2015¹in NI 45-106, which incidentally, will be renamed to National Instrument 45-106 Prospectus Exemptions. In its Notice of February 19, 2015, the Canadian Securities Administrators stated that the amendments intended to address concerns that:

• some individual purchasers may not understand the risks of investing under the AI exemption or may not qualify as an AI; and
• the threshold of $150,000 in the minimum amount investment exemption does not necessarily represent an individual purchaser’s sophistication in investing or such purchaser’s ability to withstand financial loss and may also encourage over-concentration in one investment.

Individual AI Exemption

The AI exemption is found in section 2.3 of NI 45-106, except for Ontario where it is located in subsection 73.3(2) of the Securities Act (Ontario). The categories of individuals who will qualify as an AI are as follows:

• an individual who, either alone or with a spouse, beneficially owns financial assets having an aggregate realizable value that before taxes, but net of any related liabilities, exceeds $1,000,000 (the $1,000,000 financial asset test);
• an individual who beneficially owns financial assets having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds $5,000,000 (the $5,000,000 financial asset test);
• an individual whose net income before taxes exceeded $200,000 in each of the 2 most recent calendar years or whose net income before taxes combined with that of a spouse exceeded $300,000 in each of the 2 most recent calendar years and who, in either case, reasonably expects to exceed that net income level in the current calendar year (the net income test); and
• an individual who, either alone or with a spouse, has net assets of at least $5,000,000 (the net asset test).

It is crucial that the seller understands and is able to explain the different definitions in the individual AI categories to a purchaser. For example, the definition of financial asset is different from net asset. “Financial assets” are cash, securities, or a contract of insurance, a deposit or an evidence of a deposit that is not a security for the purposes of securities legislation. The financial asset test does not include the value of a purchaser’s personal residence. “Net assets”, by contrast, are all of the purchaser’s total assets minus all of the purchaser’s total liabilities. The net asset test includes the value of the purchaser’s personal residence minus any liabilities, such as a mortgage on that personal residence. In addition, the $1,000,000 and $5,000,000 financial asset tests refer to beneficial ownership of financial assets. This may include financial assets that are held in a trust or in another type of investment vehicle for the individual’s benefit provided, however, it can be easily determined that such financial assets are beneficially owned by the individual.

It should be noted that the $1,000,000 financial asset test, the net income test, and the net asset test (collectively, the Three AI Tests) treat spouses as a single investing unit. The financial asset test is the exception.

An individual AI purchaser who qualifies under one of the Three AI Tests will be required to complete and sign a new risk acknowledgement form, Form 45-106F9 Form for Individual Accredited Investors (Form 45-106F9) as of May 5, 2015. The seller and AI purchaser must each receive a copy of Form 45-106F9 signed by the purchaser and the seller is required to keep a copy for 8 years after the distribution.

The seller is further required to determine whether an individual AI purchaser meets the criteria under at least one of the AI categories before selling securities to that purchaser. It will not be sufficient for the seller to rely solely on the standard representations and warranties that a purchaser acknowledges and agrees to in a subscription agreement or the applicable AI category that the purchaser meets and confirms by initialling in the Form 45-106F9. The seller is expected to ask questions and elicit information about the purchaser’s financial assets, net income or net assets. If the seller has any concerns about the purchaser’s eligibility, the seller may have no other choice but to request documents that independently confirm the purchaser’s eligibility as an AI². Such documents may include tax returns, bank statements or financial statements. Depending on the circumstances, it may be sufficient for the seller to obtain a letter from the purchaser’s accountant setting out his/her knowledge of the purchaser and the purchaser’s eligibility as an AI as well as the category under which the purchaser qualifies as an AI.

Minimum Amount Exemption (150,000 Exemption)

The $150,000 Exemption is found in section 2.10 of NI 45-106. As of May 5, 2015, this exemption will no longer be available for distribution to individuals. In British Columbia, an individual means a natural person, but does not include a partnership, unincorporated association, unincorporated syndicate, unincorporated organization or trust. It also excludes a natural person acting in the capacity of a trustee, executor, administrator or personal or other legal representative.

Subsection 2.10(2) prohibits using the $150,000 exemption to distribute securities to a person if that person was created, or is used, solely to purchase or hold the securities. Therefore, if 10 shareholders form a new company and contribute $15,000 each to purchase securities under the $150,000 exemption, neither the shareholders nor the company meet the requirements of this exemption.

Private Issuer Anomaly 

Subsection 6.1(1) of NI 45-106 requires sellers to file a report of exempt distribution if securities are distributed under the AI or $150,000 exemptions. The required form is Form 45-106F6 in British Columbia and Form 45-106F1 in the remaining jurisdictions. A report of exempt distribution is not required, however, if securities are distributed under the private issuer exemption found in section 2.4 of NI 45-106 even though a private issuer may distribute securities to an accredited investor under subsection 2.4(2)³.

Similarly, subsection 6.5(0.1) will indicate as of May 5, 2015 that the required form of risk acknowledgement for securities distributed to an individual AI purchaser who qualifies under one of the Three AI Tests⁴ is Form 45-106F9. This subsection, however, does not address securities distributed to an equivalent AI purchaser under the private issuer exemption. Although this may be the case, it is still highly recommended that a seller obtain a risk acknowledgement from an AI purchaser whether securities are distributed to that purchaser under the AI or private issuer exemption.

This article contains general information only and is not intended to provide a legal opinion or advice. Please consult a lawyer or compliance advisor for matters related to your situation before relying on any of the statements made in this article.

1. In Ontario, the amendments to the individual AI and $150,000 exemptions will come into force on the later of May 5, 2015 and the date on which subsection 12(2) of Schedule 26 of the Budget Measures Act, 2009 is proclaimed into force.
2.  In my view, it is prudent practice for sellers to obtain independent verification.
3. The same comment can be made for securities distributed to family, friends and business associates under the private issuer exemption.
4. See subsection 2.3(6) of NI 45-106.