Protection versus Restriction: How to Really Achieve Investor Protection
By: Cora Pettipas & Craig Skauge
Canadian regulation of financial services has created a startling trend. The ‘unintended consequence’ of investor protection efforts has created a dichotomy of investors: the ‘haves’ and ‘have-nots.’ The ‘haves,’ or Accredited Investors, have a plethora of options and are not restricted by what main stream trendy financial advice happens to be at any particular time. High net worth investors have an army of expertise at their disposal, from portfolio managers, investment fund managers, hedge funds, and a wonderful assortment of niche financial products.
Then, there is everyone else, The ‘have-nots’ that do not meet this wealth criterion. For the 98.5%1 of the population with net worths and income under the Accredited Investor thresholds, there is a decrease of investment choices. This is a shame. Retail investors are restricted in choice, variety and selection and have to meet suitability parameters because they are not judged to be able to look after themselves.
In the Exempt Market, the implementation of the OM exemption opened up access of private securities to the retail investor. This retail Exempt Market currently exists in every province but Ontario which is looking at adopting the OM exemption, but with investor limits similar to those simultaneously proposed by the CSA.
The CSA publication on March 20, 2014, details these investor limits. The limits are intended to create investor protection, but they actually demean it. The proposed rules create investor restriction, not protection. Investor protection would be better served through continuance with the newly introduced suitability regime under NI 31-103, complemented by extra measures of enforcement.
The base underlying assumption of these proposed rules are:
(A) 98.5% of the general population (that are not accredited investors) are too stupid to be able to make good decisions when it comes to investing
(B) the products being offered are too terrible to allow 98.5% of the general population to invest without significant restrictions, or
Rather than taking away investors’ rights, regulators should focus their efforts on properly enforcing the current rules. As there are always going to be ‘bad apples’ and they need to have consequences to their detrimental or fraudulent actions.
Unenforced rules have no purpose except to burden the legitimate market participants. The commissions need to focus more resources on the enforcement of existing securities laws as opposed to writing new policies at such a pace that even legal compliance professionals cannot keep up.
There has been no cost-benefit or regulatory impact analysis on these proposals, and no time to prove or disprove if NI 31-103 is working as intended. Proposing new and contradictory changes with investor limits at this time gives the perception regulators have no confidence in, or respect for, the work of past policy makers. Our industry did a complete transformation in terms of structure, compliance, due diligence and suitability. The economic costs of the change brought in by NI 31-103 have been substantial.
Research has shown that enforcement is an essential component to market integrity and investor confidence. Even with sound securities laws, without the consequences of enforcement they are meaningless. “No matter how good the rules are for regulating the conduct of market participants, if the system of enforcement is ineffective – The confidence of investors is undermined…and Canadian securities are devalued.”2
Lack of enforcement means that unscrupulous people can operate without fear of real consequences, which in turn can attract more unscrupulous people. As the majority of participants in the retail Exempt Market are legitimate business people, it is the motivation of the vast majority of the industry to see these predatory individuals sanctioned and deterred from re-entering the industry. While we applaud recent efforts, albeit much delayed, to penalize principals who have done harm to the reputation of the Exempt Market and to investors, we feel more needs to be done on this front.
NEMA first recommends preventative measures, like creating a whistle blower system, as to help catch frauds and unlawful activities sooner. NEMA also recommends stiffer punitive measures for individuals not abiding by securities laws. More integrated partnership with law enforcement, and other jurisdictions, as well as stiffer penalties and professional consequences for those that have the intention to defraud investors through the Exempt Market are needed.
It has been well ascertained that fraud cannot be prevented, if someone wants to steal, they will find a way, and no amount of rules will stop them. These individuals need to be deterred from (all areas of) Canada’s capital markets by stiffer penalties for crimes.
These issues are much more important than paperwork improperly filled out, investment contribution size, or signage placement and get to the crux of investor protection. The enforcement needs to be focused on people operating under the Northwest exemption, or those blatantly disregarding all securities regulation, not the EMDs who actively got registered and are following the rules.
Our industry supports investor protection. The more satisfied our investors, the more our industry will flourish, it is just good business. Well thought-out investor protection mechanisms are vital to this, just not ones that aim to kill our industry and take away investor rights.
1 OSC Exempt Market Review Staff Consultation Paper 45-710 Appendix D http://www.osc.gov.on.ca/documents/en/Securities-Category4/sn_20121214_45-710_exempt-market-review.pdf 2 Critical Issues in Enforcement The Hon. Peter de C. Cory, C.C., Marylyn L. Milkington. 2006 http://www.tfmsl.ca/docs/V6(4)%20CoryPilkington.pdf