New Securities Law Requirements

“WARNING! This investment is risky”: New securities law requirements coming this May/15 for Ontario businesses will put your Love (Money) to the test!

In many instances, the first source of funds for new ventures by Ontario entrepreneurs is so-called “love money” from family members, friends and business contacts.  But there is no doubt the bonds of love and friendship will be tested after May 5 2015 with the recently announced introduction in Ontario of a family, friends and business associates prospectus exemption (“FFBA Exemption”) to replace the current founder, control person and family exemption, along with additional changes adopted by the Canadian Securities Administrators to the accredited investor exemption (“AI Exemption”).  So don’t be caught off guard: Ontario entrepreneurs embarking on capital-raising activities are advised to seek advice well before the end of April on the changes described briefly below to the exempt market landscape.

How strong is the love or friendship of your start-up investors?

·         One highly visible change is the requirement to provide investors with a risk acknowledgement form that begins with the following words: “WARNING! This investment is risky. Don’t invest unless you can afford to lose all the money you pay for this investment.”

·         New Form 45-106F12 to be completed by all FFBA Exemption investors requires the investor to describe the relationship with the director, executive officer, control person or founder of an issuer (“principal”) or spouse of a principal, and must be signed by the investor, the principal and the issuer.

·         New Form 45-106F9 to be completed by individual AI Exemption investors requires an individual investor to confirm his or her accredited investor status using certain “bright-line” income or asset tests, and for the issuer to confirm this information.

·         In both cases, the issuer is required to keep the relevant form for eight years after the financing.

Will Ontario entrepreneurs need to keep detailed notes on their close personal friends and close business associates? 

So how “close” are you and your personal friend or business associate?  Securities regulators have tried to give guidance as to who qualifies as a “close personal friend” and “close business associate” for purposes of the FFBA Exemption and the private issuer exemption described in National Instrument 45-106 (“PI Exemption”).

Securities regulators suggest that issuers should gather details about the length of time the individual investor has known the principal, and the nature of any personal relationships between the individual investor and the principal, including, the frequency of contact between them and the level of trust and reliance in the other circumstances.  With respect to close business associates, information is also required regarding the nature of any specific business relationships between the individual and the principal, including, for each relationship, when it began, the frequency of contact between them and when it terminated if it is not ongoing, and the nature and number of any business dealings between the individual investor and principal, the length of the period during which they occurred, and date of the most recent business dealing.

Who is considered a “close personal friend” or “close business associate”?

A close personal friend of a principal is an individual who knows the principal well enough and has known them for a sufficient period of time to be in a position to assess their capabilities and trustworthiness and to obtain information from them with respect to the investment.   A close personal friend can include a family member who is not specifically listed in the exemptions, such as the aunt, uncle or cousin of a principal of an issuer.  However, securities regulators have noted that an individual is not considered a close personal friend if the individual is solely a relative, a member of the same club, organization, association or religious group; a co-worker, colleague or associate at the same workplace; a client, customer, former client or former customer; a mere acquaintance; or connected through some form of social media, such as Facebook, Twitter or LinkedIn. An individual is also not considered a close personal friend if the relationship is primarily founded on participation in an Internet forum.  Similar criteria apply for an individual to qualify (or not) as a “close business associate”.

Securities regulators have indicated as well that they are interested in the number of “close personal friends” and “close business associates” to whom securities have been distributed in reliance on the FFBA exemption or PI exemption.

These are merely a glimpse of the changes which are scheduled to take effect on May 5, 2015.  Securities regulators have clearly stated that the responsibility is on the SELLER of securities to fully understand the terms and conditions of the exemption being relied on as they must be able to explain to an investor the meaning of the terms and conditions of the particular exemption, including the difference between alternative qualification criteria for the same exemption. The person relying on a prospectus exemption is responsible for determining whether the terms and conditions of the prospectus exemption are met, and should retain all necessary documents to demonstrate that they properly relied on the exemption. Standard investor representations in a subscription agreement or an investor’s initial beside a category on an accredited investor form are not sufficient, unless additional reasonable steps are also taken to verify the representations made by the investor, including gathering background information about the investor.

Bottom line:  There are now more rules around raising love-money from family, friends and business associates and accredited investors.  Ontario entrepreneurs are advised to proceed with caution and to obtain advice on the changes described above to understand the impact on their capital raising activities and to avoid costly securities law mistakes.    

American Broadcasting Companies v. Aereo

The U.S. Supreme Court’s decision in American Broadcasting Companies v. Aereo, 573 U.S. ___ (2014) is an interesting case that had the potential to change the way television programs were broadcasted in America.  The case had a small start-up, Aereo, pitted against broadcasters including Fox and ABC.   Aereo was providing a service through which customers could pay a small monthly subscription to “rent” one of Aereo’s several antennae. The service essentially allowed a subscriber to remotely record and watch via the cloud, programs being broadcasted over-the-air with only a slight delay.  Though this business model may have appealed to consumers with its small subscription fee and cordless nature, the broadcasters took the position that Aereo’s business model could threaten the “retransmission fees” that cable companies pay the broadcasters for the use of their over-the-air transmissions. These retransmission fees account for billions of dollars of profit for the broadcasters.

“Retransmission fees” do exist in Canada but cannot be collected for the retransmission of specialty and pay television services (e.g. Food Network, BBC Canada, etc.) as they are copyright-cleared.  However, these fees are collected for channels and programs that do not fall under the specialty and pay-television category by retransmission collectives like the Canadian Retransmission Collective (CRC).

Returning to the case at hand, the broadcasters argued that Aereo had essentially “performed” their copyrighted works publicly.  Aereo attempted to argue that because it was not one central antenna broadcasting to all its customers, but several antennae transmitting to individual customers, their business model would not constitute a “public performance” of the copyrighted works.  Ultimately, the Court would decide against Aereo, and it would be required to obtain permission from the copyright owners of the programs it broadcasted.  The decision resulted in Aereo filing for Chapter 11 bankruptcy, and its trademarks and other intellectual property were sold to TiVo. The decision was a 6-3 decision, and the dissenting minority noting that the broadcasters had made similar predictions regarding the potential impact of the VCR.

Would Aereo have been decided differently in Canada?  Under the Copyright Act (Canada), the case would likely turn on the Court’s interpretation of Section 29.23(1) which states that it is not an infringement of copyright to fix signals and record programs for later listening or viewing, subject to the following six conditions[1]:

    (a) the individual receives the program legally;

    (b) the individual, in order to record the program, did not circumvent, a technological protection          measure, (defined under Section 41 of the Act), or cause one to be circumvented;

    (c) the individual makes no more than one recording of the program;

    (d) the individual keeps the recording no longer than is reasonably necessary in order to listen to or      view the program at a more convenient time;

    (e) the individual does not give the recording away; and

    (f) the recording is used only for the individual’s private purposes.

The first two conditions under 29.23(1) are not problematic. Over-the-air transmissions can be legally received by anyone with an antenna within the reception range, and the signals are not encrypted. It’s definitely problematic whether the remaining conditions were satisfied by Aereo’s service. However, if each of Aereo’s subscribers would have had the exclusive use of a single antenna (i.e. the exclusive use of its signal), and the attached equipment for recording the signal and later viewing, Aereo might have had a different outcome in Canada.

[1] note, there is also an additional condition under 29.23(2) which prohibits recordings generated from on-demand services.

Sources: https://scholar.google.ca/scholar_case?case=12966915270831588740&q=American+Broadcasting+Companies+v.+Aereo+Inc.&hl=en&as_sdt=2006&as_vis=1

http://www.nytimes.com/2014/06/26/business/media/supreme-court-rules-against-aereo-in-broadcasters-challenge.html?_r=1

http://www.crc-scrc.ca/english/downloads/CRC_Brochure_Eng.pdf

http://www.cb-cda.gc.ca/tariffs-tarifs/proposed-proposes/2013/retrans-2014-2018.pdf

Due Diligence Analysis: Copyright