Proposed revisions to continuous disclosure obligations, Ontario’s short selling regulatory regime and more
On January 22, 2021, the Ontario Capital Markets Modernization Taskforce (the “Taskforce”) published its 115-page final report (the “Report”) outlining over 70 recommendations with a view towards amplifying growth and competitiveness in Ontario’s capital markets. Through this Report, the Taskforce aims to position Ontario as one of the most attractive capital market destinations by applying an adaptive and forward-thinking approach to modernizing the province’s current regulatory framework.
In the Report, the Taskforce identifies, among other things, a concerning decline in new issuers and public offerings in Ontario and proposes recommendations to foster the development of junior issuers by reducing regulatory burden and providing new opportunities to raise capital. The recommendations of the Taskforce also include supporting enhanced enforcement powers to further facilitate investor protection and ensure a level playing field for all market participants.
This summary article will focus on ten of the Taskforce’s recommendations dealing with: (i) regulation as a competitive advantage; (ii) ensuring a level playing field; and (iii) fostering innovation.
Regulation as a competitive advantage
Through consultation with various stakeholders, the Taskforce has been informed that significant barriers to participation in Ontario’s capital markets include cost and access to capital. This is especially true for smaller issuers who have expressed that they are in favour of reducing regulatory burden and streamlining regulatory requirements. To accomplish this goal, the Taskforce has put forward recommendations which include efforts to strengthen the province’s exempt market, provide greater flexibility for both large and small public issuers, as well as address specific policy issues such as short selling.
1. Taskforce recommendation: Mandate that securities issued by a qualified reporting issuer using the accredited investor (“AI”) prospectus exemption should be subject to a reduced hold period of 30-days, and be eliminated within two years.
Under current securities law, securities issued by a reporting issuer pursuant to certain prospectus exemptions are subject to a four-month and one day hold period before such securities become freely tradable. The underlying policy rationale for this restricted period is to allow for the dissemination of material information, particularly in a non-digital capital markets environment. Through the consultation process, various market participants have indicated that the current restricted period is an unnecessary regulatory burden on AIs given their depth of sophistication and market knowledge regarding investment opportunities.
Based on the foregoing, the Taskforce recommends that the hold period for securities distributed under the AI exemption by reporting issuers that have developed a continuous disclosure record of at least 12 months be initially reduced to 30 days and then eliminated altogether within two years. The Taskforce believes that the increased liquidity resulting from the implementation of this recommendation will spur the secondary market and provide qualified issuers with additional opportunities to raise capital.
2. Taskforce recommendation: Streamline the timing of disclosure (e.g., semi-annual reporting)
Publicly listed companies in Ontario are currently required to produce quarterly interim financial results accompanied by Management’s Discussion and Analysis (MD&A). These reporting requirements cause issuers to incur significant costs associated with the preparation of such disclosure. The Taskforce notes that while quarterly financial statements provide timely information to investors and intermediaries, for smaller issuers and issuers working towards generating revenue, the regulatory burden and associated costs of quarterly reporting may exceed the benefits.
As such, the Taskforce recommends modifying the requirement for quarterly financial statements to allow eligible reporting issuers the option to file semi-annual financial reporting. To be eligible for this option, an issuer must have at least a 12-month disclosure record, have an annual revenue of less than $10M and must not be, or recently have been, in default of their continuous disclosure obligations. Additionally, if an eligible issuer who has adopted the semi-annual filing option achieves revenue of $10M or greater, such issuer would be required to resume quarterly filing subsequent to the filing of its next audited financial statements. The Taskforce further recommends that an eligible issuer’s decision to opt for semi-annual reporting must be approved by a majority of shareholders entitled to vote (excluding any related parties of the issuer), and reconfirmed at least every three years. Issuers who take advantage of the semi-annual reporting option will not be permitted to benefit from the proposed reduced 30-day hold period highlighted above.
3. Taskforce recommendation: Introduce an alternative offering model for reporting issuers
Preparing and filing a prospectus can be a costly endeavour for issuers and may create a significant barrier for smaller or early-stage issuers to raise capital. In response to this barrier, the Taskforce recommends creating an alternative offering model whereby reporting issuers can raise capital (up to an annual maximum of 10% of their market capitalization) by relying on their continuous disclosure record and a short disclosure document updating their disclosure for recent events, in lieu of filing a prospectus. In order to qualify for this prospectus exemption, an issuer must be a reporting issuer for at least 12 months and be up to date with their continuous disclosure requirements.
4. Taskforce recommendation: Introduce a finder category of registration and provide the Ontario Securities Commission (“OSC”) with rulemaking and designation authority to modernize and provide greater certainty regarding application of “promoter” status
The common use of finders in non-brokered private placements suggests that some issuers, particularly smaller or early-stage issuers, may be having difficulties in accessing capital through Exempt Market Dealers (“EMDs”) or investment dealers.
The services provided by a finder are usually considered registerable activity. However, the EMD registration requirements are often seen by individual finders as being overly burdensome, which has led to a proliferation of unregistered finding activity.
In an attempt to reduce the reliance on unregistered finders, which may raise concerns regarding proficiency and integrity of capital markets, the Taskforce recommends introducing a finder registration category that is more relaxed than the registration regime for EMDs. This new registration category for finders would eliminate some of the obligations imposed on EMDs or investment dealers while maintaining many requirements relating to integrity, proficiency standards and conflicts of interest, as well as compensation disclosure requirements, in order to support investor protection.
The Taskforce has also identified a need to update the definition of a “promoter” in the Securities Act (Ontario), particularly with respect to providing greater certainty on who qualifies as a promoter and at what point their status as a promoter ends, and offering guidance on adapting the definition of a promoter to a myriad of circumstances.
5. Taskforce recommendation: Introduce greater flexibility to permit reporting issuers, and their registered advisors, to gauge interest from institutional investors for participation in a potential prospectus offering prior to filing a preliminary prospectus
The Taskforce also recommends broadening the ability of reporting issuers to pre-market transactions to institutional accredited investors before filing a preliminary prospectus. This recommendation aims to reduce the risk of failed transactions while bringing Ontario’s testing-the-waters regime in line with recent changes made in the United States, which allowed issuers to gauge interest from qualified institutional buyers and institutional accredited investors for a potential offering of securities before filing a registration statement.
6. Taskforce recommendation: Modernize Ontario’s short selling regulatory regime
Under current Ontario securities law, any market participant who wishes to engage in short selling must have a reasonable expectation of settling any trade that would result from the execution of a short sale order. The Taskforce is of the view that the Universal Market Integrity Rules (“UMIR”) of the Investment Industry Regulatory Organization of Canada (“IIROC”) lack sufficient rigour to ensure that short sellers are taking appropriate steps to confirm that adequate securities are available to them for settling any short sale executions prior to the entry of the order in the marketplace.
To address the above concern, the Taskforce recommends that IIROC revise its UMIR to require broker-dealers to confirm the ability to borrow securities prior to accepting short orders from market participants or entering a short order for their own account. The forms of recommended confirmation include: confirmation that the security has been borrowed; confirmation that a bona-fide arrangement has been made to borrow the security; or confirmation that there are reasonable grounds to believe that the security can be borrowed (identified as “easy to borrow”), so that it can be delivered on the settlement date. In addition to the confirmation requirement, the Taskforce recommends that short sellers be subject to mandatory buy-ins should a short sale fail to settle. To account for settlement failure arising from administrative delay, the Taskforce proposes that the buy-in requirement be triggered two days following the settlement date and the obligation to execute the buy-in would fall to the broker-dealer.
We note that this recommendation is particularly relevant in light of the recent events surrounding GameStop Corp. and other “meme” stocks where retail investors, through utilizing social media and internet forums, have made coordinated efforts to increase the demand and price of such stocks, identified as heavily shorted.
7. Taskforce recommendation: Prohibit short selling in connection with prospectus offerings and private placements
During the consultation period, multiple stakeholders advised the Taskforce that short selling in connection with prospectus offerings and private placements has complicated the pricing and execution of such offerings. Due to the fact that prospectus offerings and private placements are by and large priced at a discount to the market price, investors and other market participants who expect to purchase under these offerings may seek to depress the price through aggressive short selling prior to the offerings. Furthermore, stakeholders have informed the Taskforce that bought deals pre-arranged with hedge funds who are shorting the stock before the bought deal is announced are all too common in Canadian markets.
In response, the Taskforce recommends that the OSC adopt a rule prohibiting those who have previously sold short securities of the same type as those offered under a prospectus or private placement, from purchasing securities under the prospectus or private placement.
8. Taskforce recommendation: Give the OSC additional designation powers
With the emergence of digital and crypto assets, the Taskforce recommends expanding the OSC’s authority to designate such novel products as securities. According to the Taskforce, such action would provide regulatory clarity to businesses with unique offerings while supporting investor protection. The Taskforce notes that the OSC should exercise such designation authority with caution as certain financial assets, such as cryptocurrencies, are likely to benefit from the OSC’s regulatory oversight, whereas other assets or business models may not benefit from such oversight since they raise fewer investor protection concerns. The Taskforce is of the view that providing the OSC with powers to designate certain crypto assets (e.g. Bitcoin and Ethereum) as securities and/or derivatives would reduce market uncertainty.
Such reform is responsive to the emergence of digital and crypto assets in capital markets around the world, including the rapid rise of non-fungible tokens (NFTs) like NBA Top Shot, as well as the technological advances that spur new variations and classifications of these assets, which issuers and investors alike are eager to develop and finance.
Ensuring a level playing field
Investors and issuers have come to realize that diverse boards and executives tend to provide more effective and capable oversight and strategic direction. The Taskforce has identified a need to ensure that issuers take action to promote greater levels of diversity within the executive and corporate boards of issuers, as well as internally within the regulators.
9. Taskforce recommendation: Improve corporate board diversity
In recognition of the need to better support corporate board diversity, the Taskforce recommends the following: (i) require public issuers to set board and executive diversity targets, as well as implementation timelines; (ii) require public issuers to adopt a written policy regarding the director nomination process, which specifically addresses the identification of diverse candidates; (iii) establish a 12-year maximum term limit for directors of public issuers, subject to certain exceptions; and (iv) ensure that diversity is similarly represented at the board and executive levels of the OSC.
The Taskforce emphasizes the need for the regulatory regime in Ontario to continue adapting to meet the needs of emerging business models and products in the province.
10. Taskforce recommendation: Allow for greater access to capital for start-ups and entrepreneurs
The Taskforce acknowledges that the COVID-19 pandemic has underlined the importance of capital formation for start-ups and entrepreneurs in promoting sustainable economic growth. The role played by angel investor groups in this process is critical as they provide early-stage funding and mentorship to entrepreneurs. On occasion, such angel investor groups are structured to earn a fee from their members as they collectively work to finance up-and-coming entrepreneurs and emerging businesses. Such arrangements may, in certain circumstances, trigger registration requirements under the current regulatory framework.
In response, the Taskforce recommends that the OSC update the rules to better facilitate early-stage financing of start-ups. To accomplish this goal, the Taskforce proposes that amendments be made to the current registration requirements to permit angel investor groups to work with their “accredited investor” members to further encourage investment in early-stage issuers. Based on its consultation with various stakeholders, the Taskforce suggests that the OSC provide blank order or discretionary relief to angel investor groups that meet certain criteria. Such criteria could include: the angel organization must be a not-for-profit organization; the angel organization must limit its membership to accredited investors; no promotion of any investment takes place; no advice is given on the suitability of any investment opportunities; fees collected by the angel organization are limited to reasonable membership fees necessary to meet the operational expenses of the group; and the angel organization cannot hold, handle or have access to investor funds or securities.
The select recommendations of the Taskforce summarized above are not meant to be an exhaustive list or intended to summarize the entire scope of the Taskforce’s proposals for the regulatory framework surrounding Ontario’s capital markets. It is the Taskforce’s view that such recommendations will foster the kind of regulatory framework necessary to position Ontario as a global capital markets leader by, among other things, strengthening the exempt market, streamlining the timing of financial disclosure for smaller issuers, modernizing the province’s short selling regime, expanding the OSC designation powers to encompass crypto and other digital assets, as well as increasing access to capital for start-ups and entrepreneurs.
Readers are encouraged to review the Taskforce’s full Report.
If you have any questions with respect to this legal update, please contact Jonathan Tong (firstname.lastname@example.org), Desmond Christy (email@example.com), Brandon Meyer (firstname.lastname@example.org) or any other member of our Capital Markets & Securities Group.
The authors of the publication would like to thank Christopher Fallis, Miller Thomson Articling Student, for his assistance with this publication.