Effective July 31, 2012, all jurisdictions in Canada other than Ontario will follow BC’s lead and commence imposing new disclosures and other requirements on companies whose only trading market is over the counter in the United States under the new Multilateral Instrument 51-105 Issuers Quoted in the U.S. Over-the-Counter Markets (the “OTC Rule“). Most of the rules about to be imposed across Canada already exist in British Columbia under BCI 51-509.

The OTC Rule applies to any OTC issuer that has a significant connection to a local Canadian
jurisdiction that has adopted the OTC Rule. Under the OTC Rule, an OTC issuer is an issuer whose securities are quoted on any U.S. over the counter market unless the issuer is also listed or quoted on the TSX Venture Exchange, the TSX, the Canadian National Stock Exchange, the Alpha Exchange, the New York Stock Exchange, the NYSE Amex, or the NASDAQ Stock Market. An OTC reporting issuer also includes an issuer if trades in its securities are reported in the grey market.

Under the OTC Rule, an OTC issuer has a significant connection to a Canadian jurisdiction if

1. it is directed or administered or promotional activities are conducted in or from the jurisdiction, in whole or in part; or
2. it distributed securities in a Canadian jurisdiction prior to obtaining a ticker-symbol for the purpose of having its securities quoted on an over-the-counter market in the U.S. and those securities became the issuer’s OTC-quoted securities.

The OTC Rule applies to an OTC issuer when the U.S. Financial Industry Regulatory Authority
(FINRA) assigns a ticker symbol to a class of its securities so that trades in those securities may be reported. Once an OTC issuer becomes an OTC reporting issuer under the OTC Rule, the
OTC Rule will continue to apply to it for at least one year. After that, the OTC Rule applies only if the issuer is directed or administered or carries out promotional activities in or from a jurisdiction of Canada. In Québec, an OTC reporting issuer will have to apply for a decision to revoke its reporting issuer status.

Disclosure Requirements

Under the OTC Rule, OTC reporting issuers must:

• meet the same periodic disclosure requirements imposed on other domestic reporting issuers under National Instrument 51-102 Continuous Disclosure Obligations, including an annual information form (AIF), management’s discussion and analysis (MD&A), and audited financial statements;
• comply with Canadian timely disclosure requirements; and
• file their public disclosure on SEDAR.

Other than the requirement to file an AIF, OTC reporting issuers are treated as venture issuers, as defined in National Instrument 51-102 Continuous Disclosure Obligations. OTC reporting issuers that are SEC filers – issuers that file disclosure with the United States Securities and Exchange Commission – can comply with the OTC Rule’s requirements to file financial statements, material change reports, MD&A and AIFs using documents they file with the SEC.

The OTC Rule also requires an OTC reporting issuer to file:

• in certain circumstances, the most recent registration statement it filed with the SEC; and
• information about persons it retains for promotional activities, the nature and scope of the engagement, compensation, and other material terms of the agreements entered into with those persons.

The OTC Rule also requires OTC reporting issuers in the oil and gas business to comply with National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities. The OTC Rule does not impose additional requirements with respect to National Instrument 43-101 Standards of Disclosure for Mineral Projects because that instrument currently applies to OTC issuers.

Insider Reports

The OTC Rule requires an insider of an OTC reporting issuer to file an insider report on SEDI unless the insider is exempted from those requirements because it has filed its insider report in compliance with U.S. federal securities law. If an insider of an OTC reporting issuer is exempted from reporting requirements under U.S. federal securities law, the OTC Rule requires that it file an insider report under Canadian law.

Personal Information Forms

Under the OTC Rule, each director, officer, promoter or control person of an OTC reporting issuer is required to deliver to the securities regulatory authorities a personal information form (PIF). This form would include the person’s consent to a criminal record search. Directors and officers of issuers listed on the TSX Venture Exchange and the TSX must file a similar form with those exchanges. If a person has submitted a PIF to the TSX Venture Exchange or the TSX and the information contained in it has not changed, the person may deliver it to satisfy the requirements of the OTC Rule.

U.S. Reporting Issuer

Under the OTC Rule, an OTC reporting issuer may rely on exemptions from continuous disclosure requirements that are available to other reporting issuers that have a class of securities registered under section 12 of the United States Securities Exchange Act of 1934 or are required to file reports under paragraph 15(d) of that Act, except for the exemption regarding material change reporting. An OTC reporting issuer must comply with the same timely disclosure requirements for material change reporting as domestic reporting issuers, except that it may use SEC Form 8-K Current Report as a material change report. The continuous disclosure and other exemptions for a designated foreign issuer under National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers are available to an OTC reporting issuer that is a designated foreign issuer.

Restriction of Exemptions

The OTC Rule deters manufacturers of shell companies from delivering to buyers of shell companies, for abusive purposes, the “public float” that is created from shares sold in private placements to Canadian residents and registered in a U.S. registration statement that an issuer files with the SEC prior to obtaining a ticker-symbol.

To effect this, the OTC Rule:

• denies the use of the private agreement take-over bid exemption that could be used for this purpose;
• requires a Canadian resident who acquired shares from an OTC issuer before it obtained a ticker-symbol to sell the shares only through a registrant, from an account in the person’s own name, into the market or into a formal take-over bid, amalgamation, merger, reorganization, or other similar statutory procedure; and
• requires a legend on the certificates or a legend restriction notation on the ownership statements representing the seed stock held by Canadian residents to that effect.

All of the usual capital raising exemptions would be available to an OTC issuer during both its private and public stages. However, the OTC Rule would place restrictions on the use of prospectus exemptions when an OTC reporting issuer is issuing securities for services.

Transition Provisions

The transition provisions are not applicable in British Columbia, as similar rules have been in effect since 2008.

When the OTC Rule comes into force, an OTC reporting issuer will have to begin making disclosure immediately. The first quarterly and annual filings would require reporting on periods prior to the effective date of the OTC Rule.

Issuers that are not SEC filers may not have an auditor or the resources and experience to meet the OTC Rule’s new disclosure requirements. To give these issuers more time to prepare for compliance with the new rule, the OTC Rule provides for a transition period following its adoption. This would give OTC reporting issuers more time to comply with their requirements to file annual financial statements and interim financial reports, related MD&A, AIFs and, if applicable, their oil and gas disclosure documents.

Proposed Fees

The securities regulatory authorities will impose the same filing fees that reporting issuers, and insiders of reporting issuers, pay to the applicable securities regulatory authority. These fees are set out in the applicable securities legislation. OTC reporting issuers will also have to pay SEDAR fees as well as late fees for failure to meet filing deadlines.

Costs

The disclosure requirements should not be onerous for OTC reporting issuers who are SEC filers because they can use the documents they file with the SEC in lieu of the Canadian forms for material change reports, financial statements, MD&A and AIF. OTC reporting issuers who are not SEC filers and who do not have audited financial statements may incur significant new costs to comply with the OTC Rule. OTC reporting issuers in the oil and gas sector, like other reporting issuers, must comply with National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities. Compliance with this rule may result in significant new costs to OTC reporting issuers.

If you have questions about the rules for OTC Issuers with connections to Canada, contact any member of Clark Wilson LLP’s Corporate Finance & Securities Law Group.