What Will Be the Impact on Issuers Relying on the Northwestern Exemption if it is Revoked?

I initially wrote the below article on March 19, 2014. On August 18, 2018, the securities regulatory authorities of British Columbia, Manitoba, Nunavut, the Northwest Territories, and Yukon (the “participating jurisdictions”) announced that they will revoke their local orders that form the “Northwestern Exemption”. Alberta and Saskatchewan are still considering whether to revoke their local orders. The local orders will cease to be effective on April 30, 2019. Therefore, the below article is no longer a hypothesis but an inevitable reality.

March 19, 2014

Raising money in the private markets is an efficient and economical alternative to filing a prospectus for businesses needing funds for its operations. To do so, however, you must be able to rely on prospectus and registration exemptions.

Exemptions from the prospectus requirement are found in National Instrument 45-106 – Prospectus and Registration Exemptions (“NI 45-106”). The most common exemptions in NI 45-106 include sales of securities to accredited investors, to family, friends and business associates, under an offering memorandum or the minimum investment amount. These exemptions are often referred to as the “capital raising exemptions”.

You cannot stop at relying solely on a prospectus exemption. A registration exemption must also be available. Otherwise, you would have to consider registering as an Exempt Market Dealer (“EMD”) or dealing with an EMD as an intermediary to sell your securities.

British Columbia, Alberta, Manitoba, Saskatchewan, the Northwest Territories, Nunavut, and the Yukon provide a registration exemption for a person or company selling private placement securities under one of the capital raising exemptions. This registration exemption is most commonly known as the “Northwestern Exemption” and provides an exemption from the requirement to register as an EMD under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (“NI 31-103”).

In British Columbia, this registration exemption is found in BC Instrument 32-513 – Registration Exemption for Trades in Connection with Certain Prospectus-Exempt Distributions (“BCI 32-513”). The main criteria of this exemption are:

• the person is not registered under any securities legislation or was not formerly registered¹;
• before the trade, the person does not advise, recommend or otherwise represent to the purchaser that the security being traded is suitable;
• the person does not hold or have access to the purchaser’s assets; and
• the person has not provided financial services to the purchaser other than in connection with a prospectus-exempt distribution.

To rely on this exemption, you have to obtain a Risk Acknowledgement from the purchaser and file an Information Report with the Commission.

The British Columbia Securities Commission (the “Commission”) proposed revoking BCI 32-513 in early 2013² for the following reasons:

(a) the impact on capital raising would be negligible,

(b) those relying on the exemption are not complying with its investor protection conditions, and

(c) private placement market investors would be better protected if they purchase securities through registrants.

The Commission has not yet revoked BCI 32-513, but discussions about its revocation remain ongoing with the Ministry of Finance. If it is revoked, this will have an immediate impact on issuers that are in the business of trading in securities, but are not registered because they are relying on BCI 32-513. Some real estate developers, for example, will be immediately impacted by its revocation.

It may be difficult to understand that some real estate transactions are subject to securities regulation, but consider the scenario where a purchaser is buying a strata unit in a hotel. Although this purchaser may use this unit, one of the main reasons for purchasing is to earn returns by allowing others to book its use. The purchaser will enter into not only a contract of purchase and sale for the unit itself but also an ancillary rental pooling agreement whereby a management company, which is often affiliated with the developer, will supervise and rent the strata units. Depending on the terms of the rental pooling agreement, the strata unit owners may receive a guaranteed minimum payment from the pooled funds or variable payments. The main difference between this transaction and one where a purchaser buys a condo for personal use is the rental pooling agreement, which essentially turns this investment into a security.³

If the Commission revokes the Northwestern Exemption, real estate developers will have to become registered as an EMD or hire an EMD to sell its real estate securities. This will inevitably increase their cost of doing business and impose an additional regulatory burden on them because they will be forced to learn and consider the implications of NI 31-103.

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. This requirement is specific to British Columbia.
2. To date, the other jurisdictions that have adopted the Northwestern Exemption are not considering revoking their equivalent Instrument or Blanket Order.
3. This security is more specifically considered an investment contract. The test to determine if a real estate investment is an investment contract has been established by case law and is often referred to as the common enterprise test or the risk capital test. The test involves these three elements: 1) an investment in a common enterprise; 2) an expectation of profit by the investors; and 3) such profits will arise through the efforts of the promoter or a third party such as the developer.