Venture Law Corporation

– *updated September 27, 2019 –

At one time there was very little difference between a Canadian Over-the-Counter (“OTC “) shell company and a United States (“US“) OTC shell company. Potential shell purchasers were indifferent as long as the company had a symbol, was cleared for trading by  Financial Industry Regulatory Authority, Inc. (“FINRA“) and Depository Trust & Clearing Corporation (“DTC“), and the sellers were able to deliver the number of shares they were looking to acquire. It goes without saying the shell also had to be “clean” of any issues. This changed in September of 2008 when the British Columbia Securities Commission (“BC Securities Commission“) adopted BC Instrument 51-509 – Issuers Quoted in The US Over-the-Counter Market (“BCI 51-509”). BCI 51-509 imposed continuous disclosure obligations and new fees on issuers who were quoted on the OTC market in the US that had a British Columbia (“BC“) connection as defined by the instrument. It also removed a number of the Canadian securities exemptions that the BC Securities Commission believed OTC issuers were using in an abusive fashion. The goal was to make BC a less desirable place to do business by shell makers and pump and dump promoters.

Overall the BC Securities Commission believes the instrument and its successor has had the desired effect.

Other regulators in Canada during the four year period after BCI 51-509 was adopted, noticed a significant uptick in the number of problem OTC issuers in their own jurisdictions.  On July 31, 2012 a new OTC issuer rule called: Multilateral Instrument 51-105 – Issuers Quoted in the US Over- the- Counter Market (the “OTC Rule” or “MI 51-105”),  became effective in every province and territory in Canada, except for Ontario,. BCI 51-109 was replaced by MI 51-105 in BC at the same time it was adopted in the other participating jurisdictions.

Deal Structure Limitations

MI 51-105 blocks the use of the following securities exemptions and methods to acquire control of a CD OTC Issuer:

• Non- Reporting Issuer Exemption.  The takeover bid exemption that allows the acquisition of stock of a private issuer in a private transaction in Canada if there are less than 50 securityholders;
• Private Agreement Exemption. The takeover bid exemption that allows the acquisition of stock of an issuer in a private transaction in Canada if there are less than 5 securityholders involved until two years have passed from the date a ticker symbol was original issued to the issuer;
• Accredited Investor Resale. The accredited investor exemption cannot be relied on by securityholders to sell their securities.
• Unlisted Reporting Issuer Exemption. Securityholders cannot rely on the exemption that allows a control person to sell their securities to an employee, executive officer, director or consultant of the issuer.

MI 51-105 only allows Canadian OTC Issuers access to the following exemptions and method to acquire control of a Canadian OTC Issuer:

• Takeover Bid. Transactions may be structured as a takeover bid or issuer bid in a jurisdiction in Canada;
• Amalgamation, Merger, Reorganization, or Arrangement. Transactions may be structured as an amalgamation, merger, reorganization, or arrangement that is under a statutory procedure or court order; or
• Registered Broker Sales. Sales are allowed by individual securityholders through a registered broker subject to certain volume, price and other restrictions similar to SEC Rule 144. (This exemption is unsuitable for use in a change of control transaction as purchaser may only acquire up to 10% of an issuer’s shares before triggering more onerous securities law requirements.)

As a result of MI 51-105, one of the more common deal structures used by Canadian OTC Issuers in a change of control transaction restrictions is to for an Canadian OTC Issuer to issue new shares to the new control group for their asset/business, and then cancel the pre-existing founders or control block shares.

Resale Restrictions on All Securityholders

MI 51-105 limits how securityholders of a Canadian OTC Issuer may sell their securities. Some of these limitations were mentioned above. Others limitations include:

• Legends. Seed stock and securities issued after an OTC symbol has been assigned must carry a specific OTC legend:
  • Seed Stock OTC legend:[spacer height=”15px”]“Unless permitted under section 11 of Multilateral Instrument 51-105 Issuers Quoted in the U.S. Over-the-Counter Markets, the holder of this security must not trade the security in or from a jurisdiction of Canada unless:[spacer height=”10px”] (a) the security holder trades the security through an investment dealer registered in a jurisdiction of Canada from an account at that dealer in the name of that security holder, and
    (b) the dealer executes the trade through any of the over-the-counter markets in the United States of America.” [spacer height=”15px”]
  • Private placement OTC legend:[spacer height=”15px”]“The holder of this security must not trade the security in or from a jurisdiction of Canada unless the conditions in section 13 of Multilateral Instrument 51-105 Issuers Quoted in the U.S. Over-the-Counter Markets are met.” [spacer height=”15px”]
  • Seed Stock Resale Rule. Seed stock investors may only sell their securities from an account in their own name, through a registered broker in Canada into the OTC market once symbol issued on the same terms as issuers who received their securities in a private placement after an OTC symbol has been assigned.
• Private Placement Resale Rule. Private placement stock acquired after an OTC symbol has been assigned may be sold only if:
  • a four month hold period has passed (6 months for insiders);
  • no more than 5% outstanding securities is sold over 12 months;
  • the trade is made through a registered broker in Canada who executes the trade through an OTC market in the U.S.;
  • no extraordinary commission is paid;
  • no unusual effort to prepare the market is undertaken;
  • the required OTC legend is on the securities to be sold; and
  • if an insider, the seller believes the issuer is not in default.

CD OTC Issuer Continuous Disclosure Requirements

CD OTC Issuers in participating jurisdictions in Canada are deemed OTC reporting issuers in the jurisdictions they have a presence. OTC reporting issuers are subject to the same disclosure obligations as “venture issuers” as defined by the National Instrument 51-102 – Continuous Disclosure Obligations with one additional requirement: CD OTC Issuers are required to file annual information forms. Canadian reporting requirements are not problematic if a CD OTC Issuer is a US reporting issuer under the Securities and Exchange Act of 1934 (“1934 Act“).  Generally, CD OTC Issuers can file forms prepared and filed with the SEC under the 1934 Act in Canada to meet Canadian regulatory disclosure requirements.

CD OTC 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 CD 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 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 an an oil & gas report or mining technical report in compliance with Canadian securities laws.

Ceasing to be an OTC Reporting Issuer in Canada

Closing Comments

CD OTC Issuers in Ontario are not subject to the requirements of MI 51-105 unless that issuer also has a connection to a participating jurisdiction in Canada.

CD OTC Issuers subject to MI 51-105 have more obligations and limitations than OTC issuers with no Canadian connection.  An OTC issuer incorporated or resident outside of Canada can be deemed to be a CD OTC Issuer if it has a significant Canadian connection. An OTC issuer will be deemed to be a CD OTC Issuer if:

• The OTC issuer’s business is directed or administered in Canada; or
• “Promotional activities” in or from Canada, are carried out to promote the OTC issuer’s securities; or
• Securities of the OTC issuer were on or before the ticker symbol date distributed to a person resident in Canada (it only takes one Canadian resident investor).

A business is considered to be directed or administered in Canada if:

• its head office, or another office where executive functions (president, vice president, secretary, treasurer or GM) take place, is located in Canada;
• some or all of its directors are located in Canada; or
• 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.

A business is not considered to be conducted in Canada solely because:

• an asset, such as a mineral property or distribution or warehouse facility is located inCanada; or
• sales personnel, or an expert, none of whom performs executive functions for the issuer are located in Canada.

Promotional activities are broadly defined and include:

• hiring an individual or firm to conduct promotional activities from Canada;
• conducing promotional activities into Canada; or
• by distributing an investment newsletter or other publication; providing information to potential investors who request information, or to potential private placement investors; or conducting any other activities that promotes the purchase or sale of securities.

If you are looking to acquire an OTC shell company and are resident in Canada, be aware that you will trigger the OTC reporting issuer requirements of MI 51-105 as soon as you acquire control of an OTC shell company.

US and Canadian shell purchasers should also be aware that being an “OTC reporting issuer” is not the same as being a “reporting issuer” in Canada. CD OTC Issuers are not eligible to list on the TSX, TSX Venture Exchange , CSE or Aequitas Neo unless they file and clear a prospectus with at least one securities regulator in Canada.