The Dirtiest Word In the Exempt Market
By: Craig Skauge
Not much in our world is black and white, and in no place is that truer than in the world of securities legislation. It is well known that the majority of securities rules and terminology are subject to significant interpretation. It is not rare to hear two lawyers argue over something like referral fees as if they were climatologists debating global warming. Over the past few years, a preposterous interpretation of one particular phrase in the securities world has hurt not just the credibility and reputation of certain individuals, but of our industry as a whole.
Within an offering memorandum it is mandatory to state that “[The Issuer] intends to spend the net proceeds as stated [and] will reallocate funds only for sound business reasons.” While providing some flexibility for issuers to adapt to changes is good common sense, the questions of what is “sound,” and more importantly what is allowed, need asking. For example, is it acceptable for an issuer to reallocate unutilized funds to a secured deposit at the bank? How about into a short term stock play? How about to finance another real estate project that the issuer’s promoters are involved with?
According to Constable Travis Dann of the RCMP Calgary Commercial Crime Section, “If capital is raised for a purpose, which has been communicated to an investor and that capital is reallocated, or diverted to, a different purpose, then a fraud may have been committed. Even if reallocated capital is used wisely and the investor receives a return, a fraud may still have been committed.” It is important for issuers to note this, and to utilize investor funds as they indicated they would and not get creative.
The heavy penalties handed down by regulators to past partakers of this type of behaviour have hopefully sent a message about what is permissible. We can also hope that the RCMP will be successful in prosecuting a number of past offenders to provide justice to investors and further send the right message to prospective fraudsters. Unfortunately, punishing past offenders alone will not be enough to curb future behaviour such as this. Exempt market dealers and their dealing representatives should ensure that they have substantial comfort and faith not only with the business deal itself, but also with the track record and ethics of whomever they are placing their clients’ money with. No matter how hard we as an industry and securities regulators try, there will always be a fox or two trying to get into the henhouse.
Our industry has done a near 180 since most of these disasters and is now under much tighter regulation, but the dirty deeds and blatant abuse of this simple wording in the past has unfortunately painted an entire industry with the same brush in the eyes of some. It is a day-to-day task for many of us to dispel the misconception that all exempt issuers just take the investor’s money and run and it is a battle that we will have to continue to fight for the foreseeable future.
While the wrongdoings of the past can’t generally be undone, our industry can and should take these hard learned lessons to heart and work towards trying to curb this type of behaviour as much as possible on a go forward.