Regulators struggle with crowdfunding model

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The Lawyer Weekly  |  By Richard Skinulis   |  April 19 2013 issue

Circle of lawyers

When the U.S. Jumpstart Our Business Startups Act was passed last year, it included a “crowdfunding exemption” that opened the door to using social media and other Internet tools to raise capital. And while other jurisdictions, such as Australia, Britain and the Netherlands, have similar legislation, Canada remains mired in a regulatory logjam that threatens its competitive edge, especially when it comes to startups and SME’s.

Information technology is fast and fluid while regulators tend to be slow and deliberate, which is why crowdfunding is still basically illegal in Canada.

“Using our existing regulatory framework to deal with something like equity crowdfunding is like trying to jam a round peg into a square hole,” says Andrea Johnson, a partner with Fraser Milner Casgrain. “These laws were written before the Internet, before social media and before people became sophisticated in how they approach the content they see online.”

Right now in Canada, anyone wishing to raise capital must go through the cost of filing a prospectus or get an exemption, and any online portal used to raise equity must be registered as an investment dealer or advisor. Organizations such as Invest Crowdfund Canada and other organizations pushing for regulatory change, want new prospectus and registration exemptions in order to broaden the field of potential investors and funding portals using crowdfunding.

Unlike the U.S., Canada has no national securities regulator, so the battle for reform has been somewhat piecemeal and Ontario is the key battleground. The main issue there is what’s known as an offering memorandum, or OM, exemption — essentially, a dramatically shortened prospectus in which you can offer securities to pretty much anybody. A tailored OM is considered vital for attracting the relatively small investors for which crowdfunding is designed. In December, the Ontario Securities Commission published a crowdfunding paper, “Considerations for New Capital Raising Prospectus Exemptions.” It asked for comments, and got a ton.

“In our comment letter to the OSC, we said that the OM exemption is the most important capital-raising exemption that Ontario needs to adopt,” says Brian Koscak, a partner with Cassels Brock & Blackwell and chairman of the Exempt Market Dealers Association of Canada (EMDA). “We said they should rename it the ‘eligible investor exemption’ and follow the Alberta form of the OM exemption, but also institute the mandatory use of a dealer, such as an EMD, and require the public posting of OMs in a central repository and on the issuers’ website.”

Ontario is the only jurisdiction in Canada that does not have an OM exemption, and the version proposed by the OSC bears little resemblance to that used in other Canadian jurisdictions. The EMDA refers to it as “Crowdfunding II” since it is the same as the OSC’s proposed crowdfunding exemption, except there is no requirement to conduct the offering through a portal or involve a registrant unless the issuer is in the business of trading securities.

Koscak says Ontario’s proposed OM exemption will be difficult to use and is ill-suited for SMEs, since an issuer will need to find a minimum of 600 investors to raise the maximum permitted offering of $1.5 million. “No SME could do this. It would have to engage a dealer. There are few dealers that would find this engagement worthwhile given the small size of the investments permitted, the large number of investors that would have to be solicited without the aid of the Internet, and the proportionately small commissions to be earned.”

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