Christopher L. Doerksen

In December 2015, the Canadian Securities Administrators (CSA) announced an amended regime for a prospectus-exempt rights offering in Canada. This amended regime allows certain public companies in Canada to conduct a prospectus-exempt rights offering without prior CSA review of the rights offering circular, and using a greatly simplified rights offering circular that assumes, without incorporation by reference, that the shareholder is familiar with the issuer’s other continuous disclosures. While the new regime revitalized the market in Canada for rights offerings, it raised several questions regarding the extension of the rights offering to U.S. shareholders. Form F-7 under the Multi-Jurisdictional Disclosure System (MJDS) has historically provided a means for eligible Canadian issuers to register securities issued in a rights offering under the U.S. Securities Act of 1933, as amended (the 1933 Act). Based on the SEC’s determination that Canadian disclosure requirements are adequate, Form F-7 allows the offering document (whether prospectus or rights offering circular) to comply principally with Canadian requirements, imposing only a few additional SEC requirements. Unlike most SEC registration forms, conducting an offering on Form F-7 does not subject the issuer to ongoing SEC reporting requirements. However, because the securities are treated as having been issued in a registered offering, the issuer is liable under the 1933 Act for any material misstatement or omission in the offering document, as it is in other registered public offerings. Following the passage of the December 2015 amendments, it was unclear whether the SEC would allow the use of Form F-7 under the new, abbreviated Canadian regime. Preliminary verbal guidance received from the SEC’s staff suggested that the staff was not, at that time, sufficiently comfortable with the new regime to give any assurance of Form F-7’s availability in such circumstances. It was also unclear how, if such registration was permitted, an issuer would protect itself from liability under the 1933 Act for material misstatements or omissions, given the limited amount of disclosure that is required or permitted under the new Canadian regime. As a result, since December 2015, Canadian issuers have not extended rights offerings under the new regime into the United States on Form F-7, and have often prevented U.S. shareholders from participating in the rights offering. Last week, the SEC published a no action letter allowing the use of Form F-7 for rights offerings by eligible Canadian issuers under NI 45-106, as amended by the CSA. The no action letter was issued following the receipt of an acknowledgment from the law firms submitting the request that: “When so registering securities on Form F-7, an issuer would need to assure that the registration statement and the prospectus satisfied the antifraud and liability provisions under the [1933 Act]”, and assurances that: “To do so, for purposes of the offering materials made available to U.S. holders, the issuer could provide a brief description of its business, risk factors, discussion of results of operations and capital resources and such other matters as it deemed material or otherwise in the offering circular.” Therefore, it appears that the SEC will allow the use of Form F-7 for rights offerings extended under NI 45-106, as amended by the CSA; however, a Canadian issuer taking advantage of this form of registration must include in the offering document sufficient information to protect itself from liability under the 1933 Act for material misstatements or omissions. It remains to be seen how the market will react to the SEC’s no action letter, including (1) the amount of disclosure that issuers will be comfortable including, and omitting, from a rights offering circular that is filed on Form F-7, knowing that the offering will be subject to U.S. prospectus liability, and (2) how frequently issuers will decide to follow this approach.

In recent years, many Canadian companies have sought to create a U.S. market for their shares by listing on the OTCQX. Qualifying Canadian companies that have their primary listing on the Toronto Stock Exchange, the TSX Venture Exchange or the Canadian Securities Exchange may generally obtain a quotation on the OTCQX or the next lower tier of the OTC Markets, the OTCQB, without filing a registration statement with, or becoming subject to ongoing reporting requirements with, the U.S. Securities and Exchange Commission. During 2016, the initial listing requirements for OTCQX included a minimum share price of US$0.25, a minimum market capitalization of US$10 million, an operating business, no current bankruptcy or reorganization proceedings, at least 50 beneficial round lot shareholders, an exemption from SEC reporting, and an exemption from penny stock status (typically satisfied through net tangible assets of at least US$2 million, or US$5 million if the company has been in operations for less than three years). A company obtaining an OTCQX quotation was also required to retain an attorney or broker approved by the OTC Markets to serve as the company’s Principal American Liaison, or PAL.  PALs were tasked with confirming the company’s compliance with OTCQX listing qualifications, delivering a letter of introduction to the OTC Markets, and providing an annual letter to the OTC Markets confirming the company’s continued satisfaction of the OTCQX continued listing qualifications. Effective January 1, 2017, the OTCQX has eliminated the requirement for an annual PAL letter. Approved attorney or broker PALs, now referred to as “Sponsors,” will only be required to provide an initial letter of introduction, thereby reducing the ongoing cost of an OTCQX listing. Dorsey has assisted more than 80 Canadian clients in obtaining OTCQX quotations, and is an approved Sponsor (previously, an approved PAL).

Being a “foreign private issuer” is very important to a Canadian company’s treatment under U.S. securities laws.  If a Canadian company ceases to qualify as a foreign private issuer under the rules of the U.S. Securities Exchange Commission (SEC), it must generally: Change the way in which it offers and sells its own securities to persons in Canada and other non-U.S. jurisdictions, including the imposition of U.S. legends regardless of the jurisdiction of the purchaser, Begin reporting with the SEC unless its securities are held by a sufficiently small number of persons, and Report with the SEC on U.S. domestic forms rather than the more liberal forms that apply to most Canadian companies that report with the SEC. In addition, its directors, executive officers and 10% shareholders may become subject to the reporting and liability provisions of Section 16 of the U.S. Securities Exchange Act, which is a significant inconvenience and may require restructuring some of the company’s benefit plans and practices. A company incorporated under the laws of Canada or any Canadian province will be a foreign private issuer unless, as of the last business day of its most recently completed second fiscal quarter: More than 50% of the outstanding voting securities of the company are directly or indirectly owned of record by residents of the United States (Part 1), and Any of the following (Part 2): The majority of the company’s executive officers or directors are U.S. citizens or residents, More than 50% of the assets of the company are located in the United States, or The business of the company is administered principally in the United States. Because the result under Part 2 is often easier to determine, many companies will first assess the results of Part 2 in order to determine whether analysis of security ownership under Part 1 is necessary.  If analysis under Part 1 is necessary, a company may generally rely on the address of a securityholder as set forth in properly maintained securityholder records; however, it must generally “look through” the ownership of commercial depositaries such as CDS and Cede & Co., and other nominees such as brokers and banks that hold securities for the account of their customers.  In addition, it must generally take into account information set forth in beneficial ownership reports, and cannot give credence to a structure established to evade the U.S. securities laws.  The test set forth in Part 1 therefore generally requires, for a publicly traded company, a review of beneficial ownership reports and the company’s securityholder records and the commissioning of a beneficial ownership search through a service such as Broadridge. Companies that determine they are majority owned by U.S. residents may find themselves able to maintain foreign private issuer status by ensuring that they do not satisfy any of the criteria in Part 2 – by ensuring that their board and executive officers include a sufficient number of persons that are not U.S. citizens or residents, that their business is primarily administered outside the United States, and that a majority of their assets are located outside the United States. We frequently assist Canadian companies with assessing and maintaining their status as a foreign private issuer and, where appropriate, complying with the new regulations to which they are subject when they lose such status.

Most non-underwritten private placements of securities by Canadian companies to U.S. investors are made in reliance upon Rule 506 of Regulation D. Since September 2013, this exemption has been subject to “bad boy disqualifications.” Generally speaking, a company is prohibited from relying on Rule 506 if the company, any of its predecessors, any of its affiliated issuers, or any of its directors, officers, general partners, managing members or promoters has been subject to certain convictions, orders, judgments, decrees in the United States or suspension or expulsion of membership from certain organizations in the United States. In addition, if any person has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in the Rule 506 offering, then the offering will generally not qualify for Rule 506 if the person being paid, any general partner or managing member of such person or any director or officer of any of the foregoing has been subject to any such disqualifying events. A limited exception exists if the event occurred prior to September 2013 and is appropriately disclosed to prospective purchasers prior to the sale. Canadian companies that want to ensure the availability of Rule 506 should ask their directors, officers, 20% beneficial shareholders, general partners, managing members and promoters to periodically complete an appropriate Rule 506 bad boy questionnaire. We recommend that companies obtain a completed questionnaire from such persons at least annually, and that a questionnaire be completed by any person who newly becomes subject to the requirements (e.g., a newly appointed officer or a shareholder who first becomes a 20% beneficial shareholder). An appropriate form of questionnaire is available to clients upon request. In addition, Canadian companies should not agree to pay any person any remuneration or commission (directly or indirectly) for soliciting purchasers in a Rule 506 offering (e.g., an underwriter, agent or “finder”), unless it is first confirmed that the person is a U.S. registered broker-dealer that is legally permitted to receive such a commission and the parties enter into an appropriate contract in which the person confirms that no bad boy disqualifications are applicable. Companies should seek U.S. counsel’s advice on the appropriate language.

You’re a Canadian public company with no U.S. operations.  You don’t file reports with the SEC.  You plan to merge with another Canadian public company in a share-for-share exchange, structured as a Canadian plan of arrangement.  Do you need to hire U.S. counsel to assist on this Canadian deal? Yes. Canadian public companies invariably have shareholders resident in the United States.  If the acquirer will issue shares to the target shareholders, or if there will be an amalgamation in which shareholders of both companies receive shares of amalco, the transaction will be deemed to involve the offer and sale of securities to the U.S. shareholders.  This requires either registration with the SEC and applicable states, or an exemption.  The good news is that the U.S. requirements for a plan of arrangement are relatively manageable, and exemptions are available in most states.  New York likely requires an advance filing. Other reasons to involve U.S. counsel include: The acquirer is required to analyze the U.S. tax treatment to U.S. shareholders, and disclose this in a specific tax form; Securities registration or exemptions will be required for the future exercise or conversion of any stock options, warrants or other convertible securities outstanding and held by U.S. residents; If there are any U.S. executives, the tax consequences of the transaction to them and to the company should be analyzed; and A compliance review with respect to U.S. securities and other laws, especially if a party has U.S. investors, business activities, contracts, subsidiaries, regulatory filings or is listed on any U.S. market.