In raising capital from outside investors, a company may avoid the registration and prospectus requirements of the Ontario Securities Act by relying upon what is called the “accredited investor” exemption. But the company has to make some effort to confirm that the investors are indeed “accredited”.
The case of R. v. Maitland Capital Ltd., 105 O.R. (3d) 503, provides some guidance.
The failure to take reasonable care in ensuring shareholders were “accredited investors” deprived the issuing company from relying upon the accredited investor exemption from the registration and prospectus requirements of the Securities Act. The company and its two executive officers were convicted of trading in securities of the company without being registered and without a prospectus. .
In the Maitland case, a company primarily involved in raising capital to buy shares of a Calgary oil and gas venture, along with the company’s two executive officers, one its president and a director, and the other its secretary-treasurer, were charged with certain offences under the Securities Act, including trading in securities without being registered and without a prospectus. Potential investors were told by the company’s employees that the oil and gas venture was soon to be listed on a stock exchange and that they should buy shares before the price went up.
The venture was not as represented, since it was still in its infancy with no land and insufficient resources to explore and produce. The defendants relied upon the accredited investor exemption, which exempts from the registration and prospectus requirements those trades with individual investors having (on their own or with a spouse) at least $1 million in financial assets, or earning before taxes $200,000 a year on their own or $300,000 a year with their spouse. The definition of “accredited investor” is now set out in section 1.1, and the exemption is now set out in section 2.3, of National Instrument 45-106 Prospectus and Registration Exemption.
On being convicted by the Ontario Court of Justice, the defendants were held not to have exercised reasonable care in confirming that the investors were accredited investors. They were also convicted of making undertakings regarding the future value of the shares and representing that the shares would be listed on a stock exchange.
In stating that offences under the Securities Act are matters of strict liability, meaning that the accused are not liable if they prove that they were duly diligent in complying, the Court held (at page 526) that they did not take all reasonable care in determining that their trades fell within the exemption, as follows:
All of the other investors … stated specifically that they were not asked about their income or assets. Defence counsel did not demonstrate through investors, employees or any other representative of [the company] Maitland Capital that any other investors were asked, in conversation, about their income or assets.
Instead, counsel relies on the purchase agreements, which contain a clause in which the investor attests by signature that he or she meets the definition of accredited investor. In my view, the evidence on this point falls far short of meeting the test [for due diligence]. … First, [the witness] Dunlop’s testimony and the date on many of the documents make it clear that the purchase agreements were sent out after the subscription agreements were signed and the cheque picked up. In other words, the definition of accredited investor was not conveyed to the investor until after the purchase had been made. Second, the majority of investors testified that they were unsure as to whether they received the purchase agreement and returned it.
While the Maitland case deals with the accredited investor exemption now found in section 2.3 of NI 45-106, it also provides guidance to those companies relying upon the “private issuer” exemption found in section 2.4 of NI 45-106. That exemption defines a private issuer as having restrictions on the transfer of its shares in its articles or shareholder agreement and limits the number of its shareholders to 50, excluding employees. It also restricts the issuing of shares to certain categories of buyer, including accredited investors.
In other words, if a company intends to issue shares to accredited investors, it should attempt to confirm that those investors actually meet the tests for being accredited.
