Investment bankers, sales representatives and company executives beware! Those who assume that a lawyer-prepared securities purchase agreement, signed by the investor and containing an "accredited investor" certification, will provide adequate protection from a charge of illegally trading in securities, do so at their own risk. As certain senior executives and sales representatives of Euston Capital recently learned, penalties for contravention of the prospectus and registration requirements of provincial securities laws can be very stiff. In a recent decision (In the matter of Euston Capital - February 9, 2006), the Saskatchewan Financial Services Commission imposed fines totaling $100,000 as well as 10 and 5 year bans on trading in securities on the President and two sales executives of Euston as a result of faulty reliance on the accredited investor exemption.
Accredited Investor Exemption
The "accredited investor" exemption provides a dispensation from the prospectus and registration requirements for trades of securities to persons who qualify as "accredited investors". The basic qualification criteria for individuals include having: i) either alone or with a spouse, net financial assets of over $1,000,000; or ii) an annual income of over $200,000 (or $300,000 if combined with that of the investor's spouse). Typically investors who purchase securities offered on a "private placement" basis sign a subscription agreement containing a representation and warranty or certification that they meet the requirements for accredited investor status. The issuer and the sales representatives (or promoters) selling the securities rely on these certifications as the basis for an exemption from the prospectus and registration requirements.
In the Euston case, investors were targeted using an "infoCANADA" publication that lists businesses in various parts of the country and provides credit ratings, number of employees and estimated annual sales. Commission sales representatives working for Euston would "cold call" target investors derived from the list. The target investors were not screened as to whether or not they met the accredited investor test. Investors who agreed to buy shares were asked to send in a cheque and were sent, in exchange, share certificates together with a standard 5-page share purchase agreement to be signed and returned. Schedule "B" to the share purchase agreement, entitled "Purchaser's Representations, Warranties and Covenants", contained (buried in the fine print) the criteria required to meet the accredited investor test.
At the hearing of the case, most witnesses who had signed the purchase agreement admitted that they either did not read the Schedule at all, or just "skim read" or scanned it. None of the investors in fact met the accredited investor test.
The Commission held that the sales were complete before the securities purchase agreements were signed and returned. It based this finding on the fact that the cheques were received and confirmations of purchase and related share certificates were issued to the investors before they returned their signed purchase agreements. Thus the Commission ruled, technically, that at the time of purchase, accredited investor status had not been established. However, the real wake-up call in the decision is a statement by the Commission that the securities purchase agreements were also insufficient to satisfy the accredited investor test in the circumstances. The Commission specifically noted that it was "too little" to require an investor to feret out information from a 5-page purchase agreement when "there was no inclination by an investor to do so", having already purchased the securities.
Implications of the Euston Decision
The Commission did not go on to say what would have satisfied them in terms of due diligence. However, one can glean from the Euston decision that the following precautions should yield a better result:
As a post-script, we note that a practice is developing in the institutional market to do away altogether with securities purchase agreements or subscription agreements, particularly for sales of investment grade debt securities. In such cases, investor "deemed" representations and warranties are sometimes included in the offering memorandum (if one is used). While we do not recommend that this practice be completely abrogated because of the efficiencies it represents, we can conclude that the practice, in and of itself, does not appear to satisfy the onus on issuers and their investment bankers to satisfy themselves that they are dealing with accredited investors. There is no legal requirement for investors to read an offering memorandum and therefore they cannot be held to have made any particular representations and warranties just because of a unilateral statement in an offering memorandum that they have done so. It should be noted also that in the institutional market sales are confirmed electronically and the subscription agreement, if one is used, is a legal appendage tacked on after the sales process but before closing - a procedure that seems to have been discredited by the Euston decision. In such cases, there are a number of other steps that can be taken to ensure that the transaction is indeed exempt and these should be considered very carefully in light of the targeted investor class.
Guy David is a partner of Gowling Lafleur Henderson LLP specializing in large debt capital markets financing, both private and public. He can be reached at (613) 786-0247 or by email at firstname.lastname@example.org .
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This article was originally published in Gowlings MarketCaps newsletter.
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