On April 20, 2017, the Canadian Securities Administrators (CSA) released Staff Notice 45-323 (Notice). The Notice provided an update on the use of the rights offering exemption available to reporting issuers (Exemption) under section 2.1 of National Instrument 45-106 Prospectus Exemptions, as of December 31, 2016, approximately one year after it was adopted in its current form.
A rights offering is intended to allow reporting issuers to raise capital, while providing an opportunity for existing security holders to protect themselves from dilution by participating in the offering on the basis of their proportional interest. In its original form, prospectus-exempt rights offerings were underutilized, as the excessive time and costs associated with such offerings made them an unappealing option for issuers. On December 8, 2015, in an effort to encourage greater use of prospectus-exempt rights offerings, the Exemption was amended to require simplified plain-language offering materials, often using a question and answer format, and allowing for an increased dilution limit of 100%.
In the Notice, the CSA noted that in the first year of the amended Exemption, the time required to complete a rights offering was reduced from approximately 85 days to approximately 38 days. It is therefore not surprising that a total of 30 rights offerings were completed across all industries, raising approximately $247.6 million – a marked increase from the past average of 13 rights offerings per year. In these 30 rights offerings, an average of 39% of the outstanding securities of a certain class were issued and 48% of the amounts being raised were from insiders who often acted as stand-by guarantors.
While introduction of the Exemption successfully increased the use of prospectus-exempt rights offerings, the CSA did note certain deficiencies in (i) the disclosure of stand-by commitments, (ii) the discussion of use of available funds, and (iii) the closing news releases. Issuers intending to make use of the Exemption should be cognizant of the concerns raised in the Notice, as the CSA will expect improved compliance in the future.
The first area of concern for the CSA was issuers’ failure to meet the expected level of disclosure when using stand-by guarantors. The CSA is especially wary of the terms of the issuers’ relationships with the guarantors, including the securities held, or to be held, by a guarantor before and after the offering. The relationship between issuers and stand-by guarantors is a factor that the CSA considers crucial to a security holder’s ability to make an informed decision about a rights offering, specifically in circumstances where a guarantor is, or may become, a related party. The CSA also reiterated the Exemption requirement that the rights offering circular contain a statement as to the financial ability of the guarantor to fulfill its obligations, a requirement that was often overlooked by issuers.
The second area of concern highlighted by the Notice was issuers’ discussions regarding the allocation of available funds, as these were generally lacking in detail. Issuers showed a tendency to include broad statements, such as an indication that funds will be allocated to working capital, instead of providing a specific breakdown of activities and expenses to which funds will be allocated. The CSA also identified two related areas where issuers’ disclosure was often insufficient, working capital deficiencies and short-term liquidity. Issuers are required to include any deficiencies in working capital as of the most recent month end as a line item on the table of available funds. They must also provide an explanation of any significant changes in working capital, even those that are positive, to allow security holders an opportunity to consider issuers’ position and promise for future growth. Issuers must also provide a management plan in circumstances where they face insufficient funds to cover short-term liquidity and overhead expenses. Such plan should consider how management will discharge liabilities, the amounts required to meet liquidity demands and an assessment of the issuer’s ability to continue operating.
Finally, the CSA noted that in many instances issuers failed to meet the requirements associated with closing news releases. Issuers often did not provide sufficient detail about subscribers, including amounts of securities issued to insiders and stand-by guarantors, as well as distinguishing between basic and additional subscription privileges.