When Change is the Only Constant: The Importance of an Open & Decisive EMD Response to Issuer Material Changes
By: Peter Kinkaide, CFA
In the past, a material change in an Offering Memorandum (OM) might have set off a wave of panic with investors. How should an Exempt Market Dealer (EMD) manage change halfway through an offering? What role does a dealer have in monitoring risk? And finally, how do they help clients understand the change?
The launch of NI 31-103 regulation in 2010 revolutionized the private capital investment market in Canada (also known as the Exempt Market), and retail investors are better protected. There is a greater accountability and responsibility to the clients, and this task falls mainly on the EMDs to oversee. Despite new legislation, reporting corporate information about an issuer is a grey area for EMDs. Nevertheless, during an offering, an EMD must meet its due diligence requirements, otherwise known as Know Your Product (KYP) – particularly in the event of a material change to the OM.
Raintree Financial Solutions has had to address a number of material change events mid-offering. Sometimes these are routine financial information updates; and sometimes these are more impactful operational changes. In the public market, when there is a significant change like this, the market response is almost instantaneous. The investor’s anxiety in response to the uncertainty is almost always reflected immediately in the share price.
In the Exempt Market, the same anxiety and uncertainty exists among clients. However, due to the illiquid nature of private investments and lack of continuous reporting requirements, no market fluctuations can be seen immediately. This illiquidity may also amplify clients’ anxiety.
In times of uncertainty, having a transparent platform for discussions is crucial. This is where an EMD, together with its team of Dealing Representatives (DRs) and advisors play a vital role in ensuring that clients receive timely and accurate information. Generally, in the case of a material change, an issuer’s OM is void, and all transactions and orders should be halted until dealers can assess the continued viability of a fund. Getting familiarized with what has changed, analyzing potential risks, and being comfortable with any changes moving forward are all part of the EMD’s role. Also, the dealer can play a critical role in acting as a conduit of information exchange between the issuer and existing investors. This can be done by helping the issuer communicate new information to DRs, who are there to help inform their clients.
Reestablish confidence in the business model.
Dealers need to work closely with issuers to assess the situation and reestablish its confidence in the business. An EMD needs to set the scope of due diligence to assess the impacts of a material change. This is critical to educating clients about the business model and the strength in the offering fundamentals. This can be done simultaneously to updating clients with what has changed and the potential impacts of those changes. We believe information and education is critical to clients making the right investment decisions with their DRs. However, it is always important to realize that a material change may have the unfortunate impact of making the offering unsatisfactory going forward.
It is vital to provide an open platform to encourage discussions among clients, advisors, the dealer and the issuer. Timely, full disclosure and transparency is always a challenge, but necessary when keeping investors’ best interest at the forefront. When people have the right information, and are confident in their DR’s information, it instills ongoing confidence in the in the marketplace .
We encourage all issuers to develop a consistent reporting strategy that includes the flexibility to announce major changes. This can be one of the hardest areas for EMDs to ensure issuers do a sound job. As EMDs, we do always have the incentive of access to additional capital that can be used to leverage reporting and disclosure out of issuers.
The DR’s role.
We asked one of our top DRs, Ilan Handelsman, on his approach on managing his clients’ expectations. Mr. Handelsman believes that it is important to be proactive. He further explains:
“My attitude is that change can be good. One of the advantages of investing in smaller private companies is that there is nimbleness in the operations that allow these companies to take advantage of change that other businesses cannot. I go out of my way to ensure I’m comfortable with a material change. This gives me confidence as an investor (I always invest before my clients do) and also gives me more knowledge when walking my clients through the change.
I believe that while illiquidity has risk in any investment, it also often saves investors from themselves. By this I mean many investors might simply sell when there is a material change. In the Exempt Market this is usually not an option and allows companies to adapt and change to best perform in the ever-changing market.”
In an industry where change is the only constant, it may be challenging to establish a template for each individual scenario. However, EMDs and DRs can work together to create an information conduit between issuer and investor.
The only thing worse than alarming information is silence. It is critical to respond as soon as possible to change. It is also important to acknowledge that a lot of time and effort go into making business decisions and it is not worthwhile to make hasty judgments about material changes. Issuers and dealers need to hit material changes head on, and create an action plan that ensures their commitment to acting openly, honestly and in good faith.