by Craig Skauge
Despite an unprecedented amount of opposition to the idea, the discussion surrounding the necessity for investment limits under the Offering Memorandum (OM) exemption continues nearly a year after it was first proposed. While ASC Chair Bill Rice alluded to the concept being shelved in the ASC 2014 Annual Report, rumblings indicate that this ill-conceived idea may yet again sprout to the surface in 2015. While industry and investor comments may not have fell entirely on deaf ears, regulators may not have gotten the message entirely in 2014…even though it was sent 916 times.
The ASC’s rationale for limits was simple. They had received “numerous complaints from investors that have invested significant amounts under the OM exemption and incurred significant losses.” Despite the ASC not being able (or willing) to back up that statement with statistics, I would be remiss to deny that what they said was true (albeit mischaracterized). It has been well documented that thousands of Albertans lost money in the exempt market during the ‘wild west’ era of 2005-2009.
While there was the ‘Great Financial Crisis,’ and no shortage of inexperience and incompetency amongst those managing investor money, a majority of the losses that occurred during this era were in fact due to fraud. And just as I can’t deny that investor losses occurred, I can’t deny that the majority of these individuals invested under the OM exemption. But was the OM exemption itself to blame? While an OM may have given an aura of credibility to the perpetrators (despite all the risk factors), the fact of the matter is that the multiple individuals that have since been charged by the ASC would have mislead just as many people had they raised the money in another fashion. These individuals got investors’ money because they told a good story in a hot real estate market, not because they used a particular exemption under securities laws. Exemptions from prospectus requirements don’t steal money. People do.
Due to this history, select regulators are looking to take a hard line with policy development, taking away investor choice in the name of investor protection, ignoring the root cause that they already addressed with NI 31-103. The underlying message of NI 31-103 would lead you to believe that in regulators’ minds the main problem with the ‘05-‘09 exempt market was the lack of oversight and qualifications of the people vetting and selling exempt market securities. To address this problem, they created the Exempt Market Dealer regime, introducing the principals of Know Your Client, Know Your Product, and Suitability Advice to those who wished to sell ‘alternative’ products. The new regime appears to be working, and regulators need to recognize the dangers of crafting ill-advised policy based on superficial research. Investor loss is heartbreaking and industry best practises need to focus on due diligence and issuer governance rather than following arbitrarily set limits. To create policies that restrict investors’ abilities to invest amounts appropriate for their individual circumstances enters the realm of dictating portfolio composition, which is a registrant’s job; not a regulator’s.
As is often the case when regulations are thought up in a vacuum, a very real world flaw with the theory of hard caps has been missed entirely. This is of course that people who commit fraud generally don’t concern themselves with following securities regulations in the first place. Enacting a hard cap limit, such as $30,000 will not deter or penalize the type of people that took advantage of investors in 2005. It will only penalize the legitimate EMDs, DRs, and Issuers trying to earn an honest living and provide respectable returns to their clients today.
Meanwhile, 2700 kilometers away from the ASC offices, the OSC is finalizing Version 1.0 of the OM exemption for Ontario. While the final version of the ‘Ontario Model’ is yet to be seen, despite all my hooting and hollering, I cannot imagine that it will not have some sort of investment limits. While I am ultimately a believer in freedom of choice, it is an understandable move given their historic inexperience with this exemption. As such I’ve made my peace with it. Hopefully as time goes on, and the industry has more substantive data, the OSC will gain comfort with the OM exemption being used responsibly by Ontario EMDs and remove whatever limits they come out of the gate with.
Alberta is a different story. Beyond implementing limits in those cases where the sale is being conducted by a non-registrant (where the past problems occurred), limits are unacceptable.
How can that be you may ask? How would you be okay with the same set of rules in Ontario but not in Alberta?
Simply, it’s about give and take.
Ontario investors are about to be given something they have never had before: an opportunity to invest outside the public markets. The Ontario small business community is being given access to an exponentially larger pool of investors from which to raise funds. Ontario EMDs, who are small businesses themselves, are being given an opportunity to actually have a viable business model, and will no longer be restricted to raising funds from just the ‘1%.’ While it would be ideal if there were no limits in Ontario; it’s a start.
Albertans on the other hand, would have a historic right taken away. While far too many Albertans lost money in the exempt market of the past, many have also made money and the shortcomings that allowed for those losses were largely dealt with in 2010. To add fuel to the fire, there has literally never been a worse time in Alberta to hinder access to capital by entrepreneurs. Alberta’s reliance on the price of a barrel of oil has never been more apparent and diversification of the provincial economy will take money, capital that may well be found in the exempt market. Given the beating that many Alberta based companies have taken on the exchange, Alberta investors who were over weighted in public oil and gas stocks may also see some logic in further diversification. It would be foolish to restrict them to only placing $30,000 outside the markets where they were just burned.
Ultimately, to propose, let alone adopt a hard cap rule so shortly after implementation of the gargantuan piece of legislation that is NI 31-103 is not well thought out, nor is it justifiable. It is lazy and flew in the face of the very foundation of securities law in Canada, being that our system is principals based, not rules based. That was the whole point of NI 31-103 wasn’t it?
NEMA and our members (and their clients) sent a strong message to regulators last year, but if my intuition is correct, it may not have been enough. A fight is coming. And if we want to put the idea of limits to bed for good, it is going to be ugly.
See Craig’s Bio in last Exempt Edge and input here. Change on www.nemaonline.ca too please .
 CSA Request for Comment March 20, 2014, Annex B, Page 2