NOTICE 2015-003 Regulatory Guidance on Plans of Arrangement and Capital StructureJanuary 23, 2015
During 2014 the Canadian Securities Exchange (“CSE” or the “Exchange”) noted a significant increase in the number of listing applications received from companies that became reporting issuers through a statutory plan of arrangement (“POA”). This development has created regulatory concerns on the part of the Exchange, regulators and investors. This notice provides guidance on the Exchange’s intended course of action to address these concerns.
Plans of arrangement are often used to optimize the division of assets in a public company, and ensure that shareholders have the opportunity to realize the value of those assets. They have been commonly used in the context of bankruptcy and insolvency situations, and other corporate re-organizations. Issuers created by way of a POA become reporting issuers in the same jurisdictions as the original issuer, and depending on the assets or business, may meet the qualifications for listing on the Exchange. Under this process, investors have the benefit of the continuous disclosure record of the original issuer, and the information circular published for the POA which has been approved by the supervising court.
Many of the recent issuers created by way of POA and applying for listing on the Exchange have only a minimal amount of cash and a letter of intent (“LOI”) to complete a transaction with a private company. The applicants do not have a hard asset or operating business formerly held by the parent company. Following the transaction described in the LOI and the distribution of shares to the shareholders of the original issuer, the resulting issuer meets the minimum listing requirements of the Exchange on its face. When the focus of the new issuer, however, is clearly to establish a capital structure that satisfies the minimum listing requirements, rather than on the development and financing of a business, the intent of the listing policies has been subverted.
Capital Structure and Builder Shares
An issuer’s capital structure must be acceptable to the Exchange. The Exchange, for example, introduced specific restrictions on shares issued at a nominal price (“Builder Shares”) to address concerns of securities regulatory authorities and the CSE. The intent was not to create a template for a listed company’s capital structure but to strike a balance between ownership and contributions made by entrepreneurs and public investors. The Builder Share requirements include certain conditions (the “Substantial Float”) under which the Exchange will consider permitting a greater percentage of Builder Shares than what would normally be allowed. The intent of this Substantial Float consideration was to ensure that the constraints set out in the policy were not unnecessarily restrictive to a company that may be developing rapidly with significant public interest and investment. A greater percentage of Builder Shares in the capital structure is offset by the fact that the public float meets a higher standard in value, size, percentage of outstanding shares, and shareholder distribution. In determining the suitability of any capital structure, the exchange will consider:
- The track record, quality and experience of management and the board of directors;
- Percentage of time devoted by management to the issuer;
- Capital contribution by Related Persons;
- Relationship of capital contribution to ownership by Related Persons; and
- Relationship of share price in pre-IPO financing rounds to the IPO price.
Note: A financing concurrent with, or the final financing prior to listing, or a small financing simply to qualify for listing is generally considered an IPO financing for the purposes of pricing and capital structure.
The Policies were developed and have evolved to allow earlier access to public capital than what has historically been available with the traditional exchange model in Canada. A company that is already a public company (i.e. a reporting issuer) in Canada, or a company that is ready to “go public” can get listed at an earlier stage. The intent of the policies is not, and has never been, to provide instant access to the public markets for a company with no history of operations, financing, or public disclosure.
The Exchange is considering Policy amendments that would restrict the eligibility for listing of issuers that became reporting issuers by way of a plan of arrangement. More specifically, an asset or business that was separated from an existing reporting issuer that held the asset or business for a significant period of time before completing a plan of arrangement would be considered eligible for listing. Except in specific circumstances, an asset or business that simply goes “through” an existing reporting issuer to become a reporting issuer would not be eligible for listing unless it first filed and obtained a receipt for a prospectus.
Listing applicants that became reporting issuers by way of a POA, or through a transaction or business combination with a reporting issuer created by way of a POA, should consider the guidance below.
1) Business Development Prior to Listing:
Subject to the Substantial Float considerations, a company with little or no operating history, a limited history of financing or minimal expenditures to develop the business or proposed business in which they operate or intend to operate, will not likely be considered for listing. Furthermore, meeting or exceeding the Substantial Float criteria does not exempt an issuer from any requirements, but rather provides an example of when the Exchange may exercise discretion. Listing fee expenses or fees for professional services to qualify for listing will not be considered as developing the business. The Exchange may determine that a financing at $0.10 per share or higher for a small number of shares should not be used to calculate the float value or the board lot size for the purpose of listing.
2) Share Distribution:
The requirement for a minimum number of shareholders is intended to facilitate the development of a reasonably efficient price discovery mechanism on the Exchange. The minimum number of shares held by each shareholder is meant as a threshold below which a shareholder would not be included in the calculation. The minimums were not intended to be a blueprint for the public float. A public float that has near the minimum number of shareholders, each of whom holds only a number that is close to the minimum number of shares, will not be considered adequate for the purposes of listing.
3) Capital Raised:
The Builder Share restrictions were introduced to prevent abusive structures while still providing for natural development of an entrepreneurial endeavour into a public company, such as an issuer with a history of raising capital or issuing shares for services or non-cash contributions during the development of the business. An issuer with a capital structure resulting from a series of share issuances within a short period of time calculated to result in a compliant structure, rather than to meet the capital needs of the company, is not likely to be acceptable. For example, a capital structure in which
- A small percentage of shares is issued to the shareholders of the original issuer;
- 25% of the outstanding shares were issued at $0.005 (or below $0.02, being the threshold for Builder Shares);
- 70% were issued at $0.02;
- A small percentage of shares is issued at $0.10,
4) Conditions on the Plan of Arrangement:
An application from an issuer that will be created by way of a plan of arrangement will be rejected immediately if the plan of arrangement is conditional upon receiving approval for listing.
If it appears to the Exchange that an issuer was created to meet the minimum listing requirement and the primary focus of the applicant is to obtain a listing rather than develop the stated business objectives, the application will be denied. Listing applications from issuers that obtained reporting issuer status by way of a plan of arrangement will be subject to additional scrutiny, and the Exchange may require specific undertakings from the management and/or the board of directors of the issuer as a condition of listing.
The Policies of the Exchange have been put in place to serve as guidelines to Listed Companies, issuers applying for listing, and their professional advisors. The Exchange reserves the right to exercise its discretion in applying the policies in each circumstance. The CSE can waive or modify an existing requirement or impose additional requirements in its absolute discretion. In exercising this discretion, the Exchange will take into consideration facts or situations unique to a particular party. The Exchange may grant or deny an application for an exemption, or an application for listing, notwithstanding the published Policies.
Reporting issuers that have never filed a prospectus or completed a public distribution have the potential to introduce additional risk to the Canadian capital markets. As always the CSE seeks to mitigate the risks without overly prescriptive or restrictive policies. This guidance notice is not intended to create new obligations or listing requirements, but to clarify the Exchange’s position with respect to the interpretation and intent of the existing requirements.
For questions about this notice, please contact:
Mark Faulkner Mark.Faulkner@thecse.com or Rob Theriault Rob.Theriault@thecse.com