Securities Law Update
February 2002
New rules fundamentally change private placements
In October 2001, Stikeman Elliott published a Securities Law Update describing the proposed
rules on private placements. The rules took effect in November 2001 and an overview of their
impact is detailed below.
On November 30, 2001, the Ontario Securities Commission adopted two new rules that
govern and fundamentally change the nature of private placements: Ontario Securities Commission
Rule 45-501, "Exempt Distributions” and Multilateral Instrument 45-102, “Resale of Securities”.
While it is still early days in the life of these new rules, they have already been responsible for a
number of important developments.
Ontario Securities Commission Rule 45-501 - Exempt Distributions
While Rule 45-501 only applies in Ontario, the securities commissions of British Columbia
and Alberta have announced impending changes to their private placement requirements that will
largely mirror the OSC's new rules regarding “accredited investors” as described below. Meanwhile,
the Quebec Securities Commission has issued an order mandating treatment
for Quebec investors that is generally equivalent to the provisions of Multilateral Instrument
45-102, subject to a number of important qualifications.
Overview
Among other matters, Rule 45-501 replaces the popular $150,000 (all funds in this newsletter
are stated in Canadian dollars) purchase price exemption, the seed capital exemption, the exempt
purchaser exemption and the financial institution exemption with a new exemption from the
prospectus and registration requirements based on an “accredited investor” test, similar to that found
in the United States. In addition, and unfortunately in our view, the “private company” exemption
has now been replaced with the concept of a “closely-held issuer” exemption.
No aggregate purchase price minimum for “Accredited Investors”
Under Rule 45-501, no minimum amount must be invested, provided that the investor is an
accredited investor. There is also no limit, as was previously the case with the seed capital
exemption, on the number of times that the exemption can be used or on the number of purchasers.
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Additionally, accredited investors will be able to sell, on a secondary basis, securities in any dollar
amount to other accredited investors.
The Accredited Investors Test
Accredited investors include the type of institutions that one would anticipate, such as
Canadian banks, loan and trust companies, insurance companies, registered advisers and registered
dealers (other than limited market dealers), governments and pension funds. The significant change,
however, is that the accredited investor definition will now also encompass individuals and smaller
entities. The list of those characterized as accredited investors will include, among others:

an individual who beneficially owns, alone or together with a spouse, financial
assets (cash, securities, contracts of insurance, or deposits) having an aggregate
realizable value, before taxes, but net of any related liabilities, exceeding
$1,000,000;

an individual whose net income before taxes exceeded $200,000 in each of the
two most recent years or whose net income before taxes combined with that of a
spouse exceeded $300,000 in each of those years and who, in either case, has a
reasonable expectation of exceeding the same net income level in the current
year;

an individual who is or has previously been granted registration under the
Securities Act or other Canadian securities legislation;

a promoter of the issuer in question;

a spouse, parent, grandparent or child of an officer, director or promoter of the
issuer in question;

a “control block” shareholder of the issuer in question (generally a holder of
more than a 20% voting interest);

a company or other business entity (other than a mutual fund or non-redeemable
investment fund) that has net assets of at least $5,000,000 as reflected in its most
recently prepared financial statements;

public and certain private mutual funds and non-redeemable investment funds;
and a fully managed account of a registered portfolio advisor acquiring securities
other than mutual funds or non-redeemable investment funds.
Pooled Funds
As stated above, fully managed accounts of registered portfolio advisors will be considered to
be accredited investors, but not for purchases of mutual funds or non-redeemable investment funds.
Accounts that are fully managed by registered Canadian trust companies will not be so restricted.
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Pooled funds are, however, grandfathered and, accordingly, an additional exemption from the
prospectus and registration requirements is available for trades in a security of a mutual fund or a
non-redeemable investment fund that is not a “reporting issuer” if:

the purchaser purchases as principal;

the investment has an acquisition cost of not less than $150,000 or the security is
issued by a mutual fund or, under a “top-up” provision, a non-redeemable
investment fund in which the purchaser already owns securities having either an
aggregate acquisition cost or an aggregate net asset value of not less than
$150,000; and

the fund is managed by a registered portfolio advisor (or by a trust corporation
registered under the Loan and Trust Corporations Act).
Non-resident fund managers have also been granted the ability to continue to use the old
$150,000 exemption (excluding the “top-up” provision) in limited circumstances.
Closely-Held Issuers
Rule 45-501 also eliminates the so-called “private company” prospectus and registration
exemptions. However, Rule 45-501 permits “closely-held issuers” to sell up to an aggregate
$3,000,000 in securities on an exempt basis over the lifetime of the issuer, subject to certain
conditions. This is substantially more restrictive than the old private company exemption, and is
causing a number of difficulties in situations involving private business, large and small, as we feared
it would. This exception is not expected to be adopted in British Columbia and Alberta.
A closely-held issuer is defined as an issuer (other than a mutual fund or non-redeemable
investment fund):

whose shares are subject to restrictions on transfer; and

that has no more than 35 beneficial holders of its securities (debt or equity),
exclusive of (i) accredited investors, (ii) current or former directors, officers or
employees, and (iii) certain current or former consultants.
A trade in a security of a closely-held issuer will not be subject to the dealer registration and
prospectus delivery requirements if the following conditions are met:

following the trade, the issuer will be a closely-held issuer and the aggregate
proceeds received by the issuer, and any other issuer engaged in “common
enterprise” with the issuer, in connection with trades made in reliance upon this
exemption will not exceed $3,000,000 (lifetime);

no promoter of the issuer has acted as a promoter of any other issuer that has
issued a security in reliance upon this exemption within the twelve months
preceding the trade; and
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no selling or promotional expenses are paid or incurred in connection with the
trade, except for services performed by a registered dealer.
The $3,000,000 threshold is a lifetime limit on the proceeds (not an amount per issuance) that
may be raised by a closely-held issuer in reliance on this exemption. Amounts received by a closelyheld issuer under other exemptions, or prior to the Rule coming into effect, are not included in the
$3,000,000 threshold. As an anti-avoidance measure, the $3,000,000 threshold also includes amounts
received under this exemption by issuers in a “common enterprise” with the closely-held issuer.
Issuers will therefore need to monitor the amounts issued under this exemption.
The seller must provide to purchasers an “information statement” (which is effectively a
prescribed risk factor statement) at least four days prior to the trade unless, following the trade, the
issuer will not have more than five beneficial holders of its securities. The information statement
does not have to be filed with the OSC and no fee is payable in connection with a trade made in
reliance on this exemption.
Early experience has shown that on a practical level the closely-held issuer provisions are
subject to a number of problems. You are urged to consult with your Stikeman Elliott contact if
involved in business matters with closely-held issuers.
Multilateral Instrument 45-102 – Resales of Securities
Multilateral Instrument 45-102, adopted by all securities commissions in Canada other than
Quebec, provides for abridged resale restrictions on securities issued pursuant to prospectus
exemptions, shortening the traditional twelve months to what is generally a four-month period for
“qualifying issuers.” Securities of a qualifying issuer that are privately placed to accredited investors
will then generally only be subject to a four-month resale restriction. Private placements by reporting
issuers that are not qualifying issuers will generally continue to be subject to the twelve-month resale
restriction period.
Qualifying Issuers
In order to be considered a qualifying issuer, an issuer must:

be a reporting issuer in any of the provinces of Alberta, British Columbia,
Manitoba, Nova Scotia, Ontario, Quebec or Saskatchewan;

be an electronic filer (and, therefore, file documents under SEDAR);

have a current annual information form (AIF) filed on SEDAR, which for
issuers not eligible to use National Instrument 44-101 (the “POP” system) must
include the most recent audited financial statements of the issuer; and
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have equity securities listed (and not suspended) on any of The Toronto Stock
Exchange (TSE), Tier 1 or: Tier 2 of the Canadian Venture Exchange (CDNX),
the Montreal Exchange, the American Stock Exchange, NASDAQ (either
national market or small cap market), the New York Stock Exchange or the
London Stock Exchange, and not have been notified by such market that it does
not meet the requirements to maintain a listing. With respect to debt securities,
the securities must have an approved rating by an approved rating organization,
namely Dominion Bond Rating Service, Fitch, Moody’s or Standard & Poors.
Further Requirements
In order for a mineral resource issuer to be considered a qualifying issuer, if the issuer is not
entitled to file a short-form prospectus under the POP system, the company may have to file, along
with its AIF, technical reports in accordance with National Instrument 43-101, the resource
disclosure policy. The obligation to file a technical report turns on whether the issuer has disclosed
new material technical information not previously disclosed, all as described in Staff Notice 45-301.
Similarly, in order for an oil and gas issuer to be considered a qualifying issuer, if the issuer is
not entitled to utilize the POP system, a technical report and certificate prepared in accordance with
National Policy 2-B must be filed with the AIF.
In addition, any identified deficiencies must have been resolved in the current AIF and in the
case of a resource company, the technical reports. Capital pool companies are subject to additional
requirements.
Qualifying Issuer at the “Distribution Date”
In order for its privately placed securities to be subject to a reduced four-month restricted
period, the issuer is required to be a qualifying issuer at the date of the distribution of the securities in
question. In the case of a private placement from treasury of common shares or convertible
securities, the operative date would be the date of issue of the common shares or convertible
securities. Otherwise, a twelve-month period will apply.
Initial Public Offerings
Securities distributed in accordance with a prospectus exemption prior to an initial public
offering to employees, executives and consultants will now, in most cases, have a four-month hold
period from the date of the initial public offering, reduced from the current twelve-month period.
Share Certificate Requirements
Under Multilateral Instrument 45-102, share certificates issued in a private placement will be
required to contain a specific legend.
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The Toronto Stock Exchange Undertaking
Every placee under a private placement from treasury completed by a TSE - listed issuer must
file a private placement questionnaire and undertaking. The undertaking currently provides that the
placee will not resell the securities without the consent of the TSE for the longer of six months or
such period as is required under applicable securities law. The TSE has amended the provisions of
the undertaking required to be signed by placees so as to reduce it to four months. The CDNX has
for some time required a four-month undertaking.
“Control Block” Holders and Certain Promoters
Similarly, a four-month hold period will apply to holders of “control blocks” of qualifying
issuers (twelve months otherwise), and additional purchases will not restart this time period, as was
previously the case in Ontario. This will also apply to “promoters” who acquire securities under a
number of exemptions. In both cases, control block shareholders and promoters will have to prefile
notices with securities regulators advising of proposed sales.
Resales in Quebec
On November 30, 2001, the Quebec Securities Commission issued a decision that in essence
provides Quebec investors with treatment equivalent to that set out in Multilateral Instrument 45102, subject to a number of conditions similar to those found in Miltilateral Instrument 45-102,
provided, however, that the issuer must have been a reporting issuer in the Province of Quebec for
at least a four-month period prior to the distribution date. The AIF must also comply with Quebec
rules.
What This All Means
These two new rules, taken as a whole, will likely have a profound effect on how private
placements are completed in Ontario and, later in British Columbia and Alberta.
Broader Universe of Placees
There will be a broader universe of potential private placement investors, given the ability of
accredited investors to participate in private placements in amounts smaller than the former $150,000
(or $97,000, depending upon the province).
Structural Matters
If the issuer is a qualifying issuer, private placements will no longer need be completed by way
of a “special warrant” structure as a means of providing early liquidity to investors, except in cases
where dealers or purchasers feel that a prospectus could be qualified more rapidly, or require the
comfort associated with a post-investment prospectus, as in a special warrant transaction. The
traditional special warrant transaction provided a period of time (usually between 90 to 140 days)
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within which to qualify the underlying securities for resale by the filing of a prospectus. Under
Multilateral Instrument 45-102, without having to proceed as a special warrant transaction, placees
from a qualifying issuer will generally be free of resale restrictions after a period of four months from
the closing date (subject always to “control block” considerations).
Become a Qualifying Issuer
An issuer that is not already a qualifying issuer (recall the requirements for AIFs of non-POP
issuers to contain financial statements) should become one as soon as possible. Practically speaking,
if listed on the TSE or Tier 1 or Tier 2 of CDNX, and for other than non-POP resource issuers,
there is no significant obstacle to becoming a qualifying issuer. The key is ensuring that an AIF
containing audited financial statements is filed under SEDAR. Under the rules, the AIF must include
current audited financial statements which, during the first 139-day period of an issuer’s fiscal year,
can be the previous year’s audited financial statements. Companies should ensure that the AIF
complies with Quebec requirements. Mineral resource issuers are reminded that there may be an
additional obligation to file technical reports.
Generally speaking this should not be a hardship. Ontario issuers, even if they are not entitled
to use the POP system today, must generally under OSC Rule 51-501 file an AIF as required by
Form 44-101F1 within 140 days of year end if, in the prior fiscal year, the issuer’s shareholders’
equity or revenue exceeded $10,000,000 or the aggregate market value of the issuer’s outstanding
equity securities for which there was a published market was $75,000,000 or more on the last day of
the previously completed financial year. Only the audited financial statements will have to be added.