NIN 96/45 - Special Warrants Prospectus Filings [NIN - Rescinded]

A significant portion of the capital raised by reporting issuers in British Columbia during recent years has been by way of special warrant transactions. The purpose of this Notice is to identify concerns that have been raised by Staff of the Corporate Finance Division during the course of vetting special warrant prospectuses and to provide guidance to issuers, underwriters and their advisers in addressing these concerns in the preparation of special warrant prospectus filings that should, in turn, expedite the regulatory review process of these prospectuses.

Nature of a Special Warrant Transaction

A special warrant is a security that is convertible into another security (the underlying security) without payment of material additional consideration and requires the issuer of the special warrant or the underlying security to file a prospectus to qualify the distribution of the underlying security.

A special warrant transaction involves two separate distributions. The first is the distribution of the special warrants under exemptions from the trading registration requirement set out in section 20(1)(a) of the Securities Act and the prospectus requirement set out section 42 of the Securities Act. The second is the distribution under a prospectus of the underlying securities issued upon the exercise of the special warrants. It is Staffs position that, in substance, these two distributions represent a single distribution. This position is similar to the position taken by Staff of the Ontario Securities Commission in the notice entitled Use of Special Warrants in Connection with Distributions of Securities by Prospectus published in (1989) 12 OSCB 2641.

Deadlines

Frequently under the terms of the special warrant the issuer is required to obtain a receipt from the Commission for the final special warrant prospectus by a specified date (the Deadline). Failure to obtain a receipt by the Deadline usually requires the issuer to pay a penalty to investors of an amount up to 10-15% of the total underlying securities being qualified under the prospectus or to return the proceeds raised under the special warrant offering to investors.

Staff have noted an increasing trend towards the use of unrealistic Deadlines. For example in one case, a junior issuer filed a preliminary prospectus on July 22, 1996 where the Deadline was August 3, 1996.

Staff recommends issuers establish Deadlines based on a reasonable period of time from the date that the issuer files its preliminary prospectus with the Commission. Staff considers that a Deadline of less than 60 days from the date of the preliminary receipt will not provide sufficient time to conduct a comprehensive review of the file and resolve any deficiencies identified in the course of this review. Although Staff will use its best efforts to assist issuers in meeting the Deadline, Staff will not give preferential treatment to special warrant prospectus filings at the expense of other prospectus filings. Further, the Commission is not responsible for Deadlines missed. Accordingly, setting Deadlines, in particular unrealistic Deadlines, may result in the issuer paying a penalty or refunding the proceeds.

Use of Proceeds

As noted above, staff considers the initial exempt distribution of special warrants and the subsequent conversion into fully tradable securities through the filing of a prospectus to be one distribution. Accordingly, although the issuer generally realizes no proceeds under a special warrant prospectus, Staff considers that the proceeds raised under the initial exempt distribution of the special warrants, together with any other proceeds raised under the prospectus, to be the proceeds for the purposes of:

(a) disclosing the use of proceeds under the prospectus,
(b) determining whether the issuer is a Qualifying Issuer under section 12.1(b) of Local Policy Statement 3-02 ,
(c) section 109 of the Securities Rules,
(d) section 114 of the Securities Rules, and
(e) section 114(9) of the Securities Act.

With respect to the requirement to provide disclosure of the use of proceeds in the prospectus, issuers are reminded that they must disclose the amount and a break down of the proceeds that have been spent to date, and they must disclose the remaining balance in the use of proceeds table.

Property Reports

Section 109 of the Securities Rules requires a natural resource issuer to file up to date property reports on those properties on which the issuer proposes to spend a material amount of the proceeds. Property reports are required to be prepared by a mining engineer, geologist or other qualified individual acceptable to the Executive Director. Generally, these individuals should be independent persons who are registered with the Association of Professional Engineers & Geoscientists of B.C., or an equivalent organization in another jurisdiction. Staff generally has not required the author of the report to be independent where the issuer has been approved to use the Prompt Offering Qualification System under National Policy Statement No. 47.

Often the issuer will have access to the proceeds raised under the exempt transaction prior to obtaining a final receipt for a special warrant prospectus. As a result, exploration activities may be underway at the time that the issuer files its preliminary prospectus. In order to provide full disclosure, issuers are expected to update the prospectus to reflect all known exploration results. In some circumstances, the original independent author must prepare and file an updated property report. However, Staff generally will not require the original independent author to prepare and file an updated property report where:

(a) the prospectus discloses the results,
(b) the issuer has a director, officer or employee who is qualified to assess the accuracy of the results disclosed in the prospectus,
(c) the prospectus discloses the name and qualification of the person who assessed the accuracy of the disclosure, and if the person is not a director, the person files a consent under section 106 of the Securities Rules, and
(d) the results have not or are unlikely to have a material impact on the market price of the issuers securities.

Assessment Reports

Local Policy Statement 3-17 requires the preparation of assessment reports for certain issuers. The assessment report is used by the underwriter as part of its due diligence in assessing whether to proceed with the offering as well as in preparing the preliminary prospectus. Where assessment reports are required under LPS 3-17 and have been prepared at the time of the exempt distribution in accordance with the requirements of LPS 3-17, those assessment reports may be used in connection with the special warrant prospectus subsequently filed to satisfy the assessment report requirement under LPS 3-17.

Underwriter Certificates

Issuers are reminded that where an arrangement, written or otherwise, exists with respect to a person participating in the distribution of special warrants, or the distribution of the underlying securities under a special warrant prospectus, that person may be an underwriter as defined by section 1(1) of the Securities Act. If so, the person is required to be registered as an underwriter prior to participating in the exempt distribution (see NIN#96/41) unless an exemption has been granted. In addition, the prospectus must contain an underwriters certificate where required under section 50 of the Securities Act and, where applicable, the underwriter must prepare due diligence reports and file the certificates and undertakings required under LPS 3-17.

Statutory Rights of Action

A purchaser of a security offered under a prospectus is entitled to certain statutory rights of action for rescission and damage where a misrepresentation has been made in the prospectus. (See section 114 of Securities Act.) Where the misrepresentation has been made in a special warrant prospectus, the statutory rights of action for rescission may only entitle the holder of the special warrant to the return of the holders special warrant and not the consideration paid to acquire the special warrant. Statutory rights of action act as an incentive to encourage underwriters, issuers and selling security holders to carry out due diligence on the prospectus disclosure. If the statutory rights are ineffective, i.e., limiting the rescission to the return of the special warrant and not the consideration paid for the special warrant, the incentive to conduct due diligence is reduced. This result is inconsistent with the policy underlying the Securities Act. The filing of the prospectus renders the underlying securities freely tradable in the secondary market. As the secondary market relies on the disclosure in the prospectus, it is important that there be no reduction in the incentives aimed at accurate and complete prospectus disclosure.

To ensure that investors have meaningful rights and to encourage underwriters, issuers and selling security holders to carry out meaningful due diligence, Staff requires that purchasers of special warrants be provided with contractual rights of action for rescission and damages that are comparable to the rights contained in section 114 of the Securities Act and that the contractual rights are disclosed in the prospectus. (See Purchasers Statutory Rights in Forms 12A, 12B, 14A and 14B.)

Inquiries

Inquiries regarding the use of exemptions for the placement of the special warrants should be directed to the Exemptions and Orders Division (660-4877). Inquiries regarding special warrant prospectus filings should be directed to the Corporate Finance Division (660-4127).

DATED at Vancouver, British Columbia, on December 5, 1996

Wayne W. Redwick
Director, Corporate Finance

REF: NIN#96/41
LPS 3-02
LPS 3-17
NPS 47
Form 12A
Form 12B
Form 14A
Form 14B