BC Securities Commission Provides Guidance
The decision rendered by the British Columbia Securities Commission (the "Commission") in Re SunCentro(2017 BCSECOMM 58) offers important analysis of when a 'due diligence defence' might be available to individuals or corporations who contravene securities law by issuing securities and improperly relying on certain prospectus exemptions.
Suncentro Corporation ("SunCentro") is a private company engaged in the solar energy business. Having never filed a prospectus in connection with a number of its private placements, SunCentro relied on prospectus exemptions to raise capital for its operations. Re SunCentro came about as a result of the issuance of Suncentro securities to a number of investors under the "family, friends and business associates" prospectus exemption (the "Exemption").
SunCentro and a Donald Weiss ("Weiss") entered into an agreement authorizing Weiss to raise money for Suncentro. Between 2011 and 2012, Weiss referred six investors (the "Weiss Investors"). Weiss’ son was an officer and director of SunCentro, and the Weiss Investors relied on the Exemption in relation to Weiss’ son in their subscription agreements.
Two others, John Carswell ("Carswell") and Robert Helina ("Helina"), a director and officer and the chairman of SunCentro's board of directors, respectively, were directly involved in Suncentro entering into a business development agreement with YDS Corporation ("YDS"). Through this relationship, between 2011 and 2012, YDS referred nineteen investors (the "YDS Investors") to Suncentro. Both SunCentro and YDS believed YDS was an "affiliate" of SunCentro, thus permitting reliance on the Exemption. SunCentro even obtained legal advice to help with the determination of whether YDS was an "affiliate".
Finally. Carswell, himself, raised money on behalf of SunCentro from another investor (the "Carswell Investor"), who was the sister of Carswell's friend. The Carswell Investor had met only met Carswell one time.
In coming to its decision on whether the due diligence defence was available to SunCentro, the Commission provided the following guidance to sellers of securities:
- what constitutes "reasonable" steps taken by a seller will vary depending upon the facts and circumstances of the purchaser, the offering and the exemption being relied upon;
- while sellers should obtain and retain documentation of certain key facts, including obtaining representations and warranties and/or confirmation of a purchaser’s financial or other personal status, that those steps will not be sufficient in and of themselves;
- sellers should understand the terms and conditions of the exemption that they intend to rely upon;
- sellers should adopt appropriate policies and procedures to ensure that person’s acting on their behalf understand the terms and conditions of the exemptions being relied upon; and
- sellers should take steps to verify the factual basis of the information being relied upon, including asking questions of purchasers.
The Commission noted that the first of the above-noted points is the most important to consider in cases to determine the availability of a due diligence defence.
In respect of the Weiss Investors, the Commission held that SunCentro contravened section 61 of the Act. However, the Commission also held that SunCentro took reasonable steps to establish a due diligence defence by:
- establishing a board policy for the private placements;
- educating its board members on the applicable exemptions that were being used by the company;
- obtaining properly executed subscription agreements;
- delegating responsibility for completion of the administrative tasks necessary to complete the financing to a member of senior management of the company; and
- receiving express or implied assurances from a board member that the information contained in the subscription agreements was accurate.
The Commission was particularly swayed by the fact that certain members of SunCentro’s board (Weiss’ son) vouched for the identity of the Weiss Investors, being friends, family or close business associates. Thus, SunCentro and Carswell were able to use the due diligence defence in respect of the Weiss Investors. Weiss was not, however, personally able to use a due diligence defence in respect of his contravention of the Act.
Carswell and Helina were not able to satisfy to the Commission of the availability of a due diligence defence in respect of the YDS Investors. The Commission held that in deciding to make its own determination as to whether YDS was an "affiliate" of SunCentro and not seek out further legal advice, it did not take reasonable steps to establish the due diligence defence.
Carsell was also unable to establish a due diligence defence for the Carswell Investor due to his choosing to rely solely on the efforts of SunCentro in examining and approving the Carswell Investor’s ability to rely on the Exemption. While SunCentro took reasonable steps to determine the accuracy of claims made by the Carswell Investor (as noted above), Carswell, in his personal capacity, did not.
The Commission’s decision in Re SunCentro is important for a number of reasons. First, it recognizes that a due diligence defence may be available if a seller reasonably believes in a mistaken set of facts which, if true, would render the act or omission incorrect, or if the person took all reasonable steps to avoid the particular event. The decision also offers guidance on certain steps that an individual, board of directors and/or corporation should take. It also stresses the importance of positive actions taken to ensure that referral sources understand the mechanics of prospectus exemptions and that enough information is obtained from prospective investors so that available prospectus exemptions are properly adhered to.
Finally, the decision highlights the importance of obtaining full legal advice when issuing and distributing securities. SunCentro sought legal advice on available prospectus exemptions, but did not obtain 'complete' advice. That is, the board did not fully understand the term "affiliate" and, instead of asking its legal counsel, decided to make its own determination.
Re SunCentro is a clear example of the importance of seeking out comprehensive legal advice when distributing securities and contemplating the availability of certain prospective exemptions. Obtaining such advice may be the proactive step that saves an issuer from facing penalties for non-compliance with securities law, while failing to so can result in harsh penalties and sanctions.
Invitation for Discussion:
If you would like to discuss this article in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Shea Nerland LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.