Legal Updates

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Update

Friday, September 30, 2016

On September 28, 2016, Vault Circle Inc. (Vault Circle) announced that it had received approval by the Ontario Securities Commission (OSC) to operate as an exempt market dealer in Ontario.

The proceeds raised by Vault Circle from accredited investors will be used by Lendified Inc. (Lendified), an affiliate of Vault Circle, to provide alternative financing options to small and medium sized businesses (SMEs) in Canada. Lendified is one of a series of new financial technology companies established in Canada over the course of the past couple of years which are collectively seeking to occupy the small business lending market segment that has traditionally been viewed as underserved by larger financial institutions. 

By offering investor notes through its platform, Vault Circle will also be seeking to provide an alternative investment option directly to accredited investors resident in Ontario, with a view to expanding across Canada. 

Often referred to as “peer-to-peer” lending, it is perhaps more appropriate to refer to the collective grouping of these enterprises as “digital lenders” in much the same way as portfolio managers who offer online investment tools and product solutions are referred to as “digital advisors” rather than “robo-advisors.”

This is because true “peer-to-peer” lending platforms are designed to operate as “marketplaces” (a loaded term for securities law purposes) by matching investors with borrowers through direct nexus loan agreements or platform “pass-through” notes, whereas others, such as Lendified, are established as balance sheet lenders who are primarily seeking to diversify their capital base.

Although similar in some respects to the equity-crowdfunding platforms which commenced operating in Ontario earlier this year, there is currently no prescribed framework for issuers or sponsors seeking to establish online lending platforms. 

The OSC initially set out its expectations for businesses planning to operate “peer-to-peer” lending websites on June 19, 2015, by highlighting the concern that such online platforms and their related activities may trigger the application of dealer registration and prospectus requirements under the relevant provisions of the Securities Act (Ontario).

 The OSC conducted a corresponding regulatory review of existing marketplace participants, resulting in at least one existing business having to cease directly issuing securities to retail investors through its online platform.

Through the publication of OSC Staff Notice 33-747 on July 21, 2016, staff at the OSC provided further guidance around common deficiencies in applications for registration by entities seeking to operate online portals and trading platforms generally, as well as reiterating the prior guidance surrounding registration and prospectus concerns. 

The threshold question as to whether or not a digital lender will require registration as a dealer from a securities law perspective will center on the manner in which the business and its related activities are structured. This analysis will take into account the factual underpinnings relating to the business and will be governed by the existing securities law regime governing registration and prospectus requirements.

Certain key elements relating to this review include the following: 

Business Model

A marketplace model will require consideration of the relevant prospectus exemptions (on both the borrower and investor sides of the platform), whereas a balance sheet lender may not be in the business of trading in securities for securities law purposes.

Affiliates 

The use of an affiliated entity as a “captive dealer” necessitates consideration of conflict of interest and related party rules under applicable securities legislation. This may require different business processes, policies, procedures and corresponding investor disclosures.

Due Diligence and Know-Your-Product 

The level or degree of oversight to be exercised through the platform by the registered entity over the lending entity and related adjudication.

Type of Security 

The specific attributes of the security and related entitlements, such as whether the investment is secured or unsecured, supported by the balance sheet (entity level exposure) versus tranched (packaged into smaller pieces – whether on or off balance sheet) in order to match credit exposures within the portfolio (asset level exposure).

Lendified’s announcement demonstrates that the OSC is prepared to permit digital lending platforms to be registered as exempt market dealers, provided certain conditions are met.

It is also timely given that Maureen Jensen, Chair of the OSC, recently announced that the OSC will be establishing the OSC LaunchPad, dubbed “the first innovation hub by a Canadian securities regulator,” which will be “dedicated to working directly with FinTech companies to help them navigate our regulatory framework…including online advising, peer-to-peer lending, crowdfunding platforms and angel investor organizations….[in order] to tailor regulation and oversight to their unique business models, as long as investor protections are in place.” 

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please contact Geoffrey Cher in our Structured Finance practice group.