This is a quick overview of Multilateral Instrument 51-105 Issuers – Quoted in The U.S. Over- the- Counter Market (the “OTC Rule” or “MI 51-105”).
Objectives and Background of the OTC Rule
MI 51-105 was adopted in every jurisdiction in Canada other than Ontario on July 31, 2012. MI 51-015 applies to all companies which trade on the over the counter (“OTC“) market in the United States (“US“) who have a significant connection to any jurisdiction in Canada other than Ontario.
The OTC Rule is meant to increase the disclosure standards of OTC issuers with a Canadian connection to equal or exceed those required of other Canadian reporting issuers, and to discourage Canadians from participating in the creation of OTC shell companies and pump and dump schemes.
The OTC Rule is based on BC Instrument 51-509 – Issuers Quoted in The U.S. Over-the-Counter Market (“BCI 51-509“) which was adopted in BC in September of 2008. Overall, BCI 51-509 was considered a success by British Columbia securities regulators. One of the results of BCI 51-509 however, was to move negative OTC issuer market activities into other jurisdictions in Canada which is why the new OTC Rule was adopted. The British Columbia Securities Commission replaced BCI 510-509 with MI-105 at the same time as the instrument was adopted in the rest of Canada.
Who the OTC Rule Applies to
MI 51-105 applies to any issuer that has received a trading symbol from the Financial Industry Regulatory Authority, Inc. (“FINRA“) and trades on any of the OTC markets in the US, including the grey sheets, if that issuer’s securities is not otherwise cross listed on a recognized Canadian or US stock exchange, and that OTC issuer has a significant connection to any Canadian jurisdiction other than Ontario.
OTC issuers who have a significant connection to Canada will be deemed OTC reporting issuers in Canada.
What Connections are Significant?
A significant connection is deemed to exist if an OTC issuer’s business is (1) directed or administered from Canada, or (2) promotional activities are conducted in or from Canada to promote the OTC issuer’s securities; or (3) securities of the OTC issuer were on or before the ticker symbol date distributed to a person resident in Canada.
What Falls into the Category of “Directed and Administered”?
An OTC issuer will be considered to be directed or administered from Canada if (1) its head office or another office where executive functions take place are located in Canada, or (2) some or all of its directors are located in Canada, or (3) any director, officer, consultant or other person who carries out executive functions for the OTC issuer does so from an office in Canada or is resident in Canada.
An OTC issuer is not considered to have a significant connection to Canada solely because it has an asset such as mineral property located in Canada, or it has sales personnel or other employees in Canada as long as they do not perform executive functions for the OTC issuer.
What are the Disclosure Obligations of OTC Reporting Issuers and their Insiders in Canada?
OTC reporting issuers are subject to the same disclosure obligations as venture issuers as defined in National Instrument 51-102 – Continuous Disclosure Obligations, with one additional requirement: CD OTC Issuers are required to file an annual information form each year.
OTC reporting issuers are subject to the same disclosure obligations as “venture issuers” as defined in National Instrument 51-102 – Continuous Disclosure Obligations with one additional requirement: OTC reporting issuers are required to file annual information forms each year. OTC reporting issuers who are reporting issuers under the Securities Act of 1934 (“34 Act“) in the US can file forms prepared and filed with the US Securities and Exchange Commission (“SEC“) in Canada to meet their Canadian regulatory filing requirements.
OTC reporting issuers who are reporting issuers under the 1934 Act, however, have a few more obligations than just filing its US reporting forms in Canada. MI 51-105 requires that they:
- file Canadian certificates with their annual and interim filings;
- pay annual filing fees to SEDAR and to the securities regulators in each jurisdiction they are deemed an OTC reporting issuer;
- file an advance notice of promotional activities one day before these activities are to begin or within five days after the issuer became an OTC reporting issuer if the promotional activities were already underway;
- file a business acquisition report when acquiring significant assets or business; and
- file insider reports on SEDI if they do not otherwise file insider reports with the SEC;
OTC reporting issuers who are not also US reporting issuer will find the regulatory burden of MI 51-105 to be significant. These issuers must hire a CPAB registered audit firm and prepare audited financial statements, engage a lawyer to assist with setting up the initial Canadian regulatory filing documents including an annual information form, engage or learn how to file regulatory documents on SEDAR and SEDI, and if in the resource industry, prepare and file an an oil & gas report or mining technical report in compliance with Canadian securities laws.
Implications for Non-Canadian Issuers not Listed on a Canadian or US Stock Exchange
Non-Canadian issuers who wish to avoid becoming an OTC reporting issuer in Canada should avoid private placements to Canadian residents.
If you have already issued securities to a Canadian resident but do not have an OTC trading symbol avoid obtaining an OTC symbol as once a symbol has been assigned you will be deemed an OTC reporting issuer in Canada.
If you already have an OTC symbol in the US and you offer securities in Canada you will be deemed an OTC reporting issuer in Canada even if no shares are sold to a Canadian resident as a result of you having conducted “promotional activities” in Canada to sell your shares.
Implications for Non-Canadian Issuers Not Listed on a Canadian or US Stock Exchange
Hiring a Canadian investor relations person or company from Canada will result in you becoming a CD OTC Issuer with Canadian reporting obligation.
Appointing a Canadian director, officer, management Company or general manager resident in Canada will result in you being deemed an OTC reporting issuer in Canada.
Implications for the Non-Canadian “Wrapper” Practice
Ontario is the only “safe” jurisdiction to continue to offer international offering on a private placement basis through a Canadian offering memorandum wrapper in Canada, unless the issuer’s securities are already listed on a recognized Canadian or US exchange.
Foreign issuers conducting an initial listing in North America concurrent with a private placement in Canada must be very careful to avoid an OTC symbol being assigned prior to the conclusion of the transaction or the issuer will be deemed to be an OTC reporting issuer.
Implications for Purchasers of Shell Companies Deemed to be OTC Reporting Issuers in Canada
There are only a couple of deal structures that will work with a shell that is considered an OTC reporting issuer in Canada. The OTC Rule allows amalgamations, mergers, reorganizations and arrangements that are under a statutory procedure or court order.
The most common deal structure that has emerged in BC over the last seven years is one where a new block of stock is issued out to the new group and the founders’ shares or control stock of the outgoing group is cancelled.
Implications for Purchasers of Shell Companies Deemed to be OTC Reporting Issuers in Canada
An OTC issuer that is considered and OTC reporting issuer in Canada does not immediately cease to be a Canadian OTC reporting issuer on close of a reverse merger or other change of control transaction with a purchaser outside of Canada. In order to cease to be an OTC reporting issuer in Canada one year must have passed since the:
- business of the issuer was directed or administered from Canada;
- last date that promotional activities were carried on from or into Canada;
- issuer received its first symbol for OTC trading from FINRA; and
- the issuer must file the required notice form;*OR:
- the issuer must have become listed on a recognized exchange and filed the required form.*
Note: In Quebec issuer’s must apply to have their OTC reporting issuer status formally revoked and cannot revoke their status by simply filing a form.
Implications for Canadian Issuers Not Listed on a Canadian or US Stock Exchange
Canadian issuers, whose business is directed and administered from Canada, need to determine if FINRA has issued them a trading symbol for any of their securities. The grey market is a one off trade market between brokers and having a symbol is more common than you might otherwise imagine, particularly if you have ever sold securities to a US resident.
If you have been issued a trading symbol by FINRA you need to get ready for your initial set-up and continuous obligations as on OTC reporting issuer.
If you have not been issued a symbol you should set up a monitor system to check on a regular basis that no trading symbol has subsequently been issued by FINRA.
Implications to Securityholders
As a securityholder of an OTC reporting issuer you have only one way to sell as an individual and that is though a registered broker. If you acquired your securities through a private placement your securities are subject to a four month hold period. If you are an insider the holder period is six months.
All OTC issuers should check if they have a Canadian connection that could inadvertently cause them to be deemed an OTC reporting issuer in Canada. The two main traps from MI 51-105 are:
- Making any issuer who sold securities to a Canadian resident that subsequently became or becomes an OTC issuer an OTC reporting issuer in Canada. (It does not matter if that Canadian resident no longer holds securities at the time the issuer obtains its symbol); and
- Making any OTC issuer, regardless of location, an OTC reporting issuer in Canada if that issuer directly or indirectly employs or retains an individual or a firm in Canada to conduct promotional activities, or conducts promotional activities from anywhere in the world into Canada. (“Promotional activities” include distributing an investment newsletter or other publication; providing information to potential investors who request information, or information to potential private placement investors; or any other activities that promotes the purchase or sale of securities.)
Obvious connections which would make an OTC issuer an OTC reporting issuer in Canada are having directors, officers etc. who reside in Canada.