Peter R. Johannes
To exempt market Issuers, hoping to use the Offering Memorandum (OM) Exemption in Ontario and the other five provinces in the ‘participating jurisdictions’ (which includes Alberta, New Brunswick, Nova Scotia, Quebec and Saskatchewan), the amendments proposed by the CSA to section 2.9 of NI 45-106 may seem like ‘the good, the bad and the ugly.’ Like the spaghetti western of the same name, these changes will likely receive a favourable endorsement, produce a satisfactory ending and imperfectly lead to improved capital raising opportunities for issuers in Ontario.
This opinion is based on my experience as the manufacturer of the SecureCare Bond offerings, operating as an exempt market Issuer across Canada over the last four years. Under the prevailing NI 45-106 rules, SecureCare has sold $196 million worth of bonds, largely relying on the offering memorandum exemption to do so. Due to the absence of the OM exemption, only 9.6% of SecureCare’s bond sales have been to Ontario residents. By comparison, British Columbia, with only one third of Ontario’s population but governed by the least restrictive version of the OM exemption, produced over 45% of SecureCare bond sales.
Back to the movie analogy: from an Issuer’s perspective, what might be considered ‘ugly’ about these amendments? Looking back at some of the opinions provided by actual Eligible Investors during the Spring 2014 comment period, such as “This proposal [to cap Eligible Investor annual amounts] is highly unconstitutional …,” the amendments continue the process of arbitrarily limiting an investor’s right to invest as they choose. The more militant investor, attracted to the low volatility, high yield ‘panacea’ of non-prospectus offerings, may not disclose the true amount of their exempt market holdings to their Advisor, subverting the intended protections.
Another ugly possible consequence of the Eligible Investor caps could arise if issuers felt motivated to protect their capital raise by directly contacting investors to ensure the capture of the $30,000 portion of that investor’s twelve month maximum. This activity would circumvent dealer KYC and suitability safe-guards.
The features of the amendments that are merely ‘bad’ is a somewhat longer list. While aligning the OM exemption in six provinces, the CSA has missed the goal of national harmonization and instead allowed the creation of three versions. Exempt market investing continues to remain a confusing and inequitable process, depending on the province of residence.
This SEC derived method of protecting junior investors from themselves and non-prospectus issuers once again avoids building a meaningful process of how to address investor risk tolerance. According to Bob Carrick of the Globe and Mail (Just how much risk can you stand, G&M, November 28, 2015 B11), a recent study done for the OSC’s investor advisory panel concludes that regulators need to do more to guide Advisors on how to assess investor risk. It seems that the regulators in the ‘participating jurisdictions’ have side stepped this challenge, electing to continue to use a one-size-fits-all approach.
The OM exemption amendments carry on the practise of requiring the Eligible Investor to sign an onerous looking, but in practise largely ignored, risk acknowledgement form. Exempt market Issuers and Advisors who have worked in jurisdictions that presently require this form have questioned its value, except to scare investors back to volatile public markets where such forms are not required.
The imposition of a rolling twelve month period for OM exemption securities purchases is a recipe for problems. Besides being difficult to enforce, this rule does not take into account the myriad of situations where this restriction would be unduly prejudicial to investors and issuers. For instance, if an investor’s security matures (SecureCare Bonds were available in one year terms), does the reinvestment of that security use up part of the investor’s twelve month maximum, thereby depriving that investor of opportunities to grow and diversify their exempt market portfolio?
The most controversial part of the amendments, is of course, the amount of the twelve month cap. At $100,000, assuming the participation of a registered Advisor, this amount is substantially higher than what the OSC and the CSA proposed in spring 2014. This amount will still likely have an adverse effect on exempt market capital raises. With minimum dealer enforced diversification of at least 25%, the most an issuer could hope to raise from a willing eligible investor would be about $25,000. SecureCare’s historical average eligible investor bond purchase amount has been over $33,400, suggesting that it would take 34% more effort and cost to raise the same amount of capital under the new rules.
Now to the ‘good.’ Obviously, the introduction of the OM exemption in Ontario is great news to advisors, who have spent all their time searching for the rare Accredited Investor, and even better news to beleaguered Ontario Eligible Investors who have been locked out of the private markets. For dealers and issuers, having caps applied to the other five participating jurisdictions is a small price to pay for access to over 1.5 million potential new eligible investors in Ontario (Statistics Canada, CANSIM, table 111-0008).
Another positive step is that the important role of exempt market dealer (or portfolio manager or investment dealer), has been recognized in these amendments. Eligible investors are only able to buy between $30,000 and $100,000 of exempt market securities if the dealer confirms the investment is appropriate.
Issuer public filings of OM’s and marketing materials, as well as ongoing disclosures, all required by the amendments, are another positive step for the exempt market industry.
The fledgling Canadian exempt market is too important to Canada’s growth and economy to not be treated with respect and care. On the whole, the changes and expansion of the OM exemption to Ontario, seems to reflect a compromise between the traditionally open markets of the West and the tightly controlled market in Ontario. For the first time, Canadian Eligible Investors will have access to the OM exemption right across the country and the average Ontarian will be able to contemplate diversifying their investment portfolios to include private market opportunities… and that’s something good.
Peter Johannes is the founder and President of SecureCare Capital Inc., a proud member of NEMA. Peter’s experience in real estate, finance and investments dates back 27 years. He has held registrations as a real estate and mortgage broker, exempt market dealer and dealing representative. As an investment product manufacturer and issuer, Peter has help drive five private capital offerings, most recently two successful offerings under the SecureCare brand, currently serving over 4,200 bondholders across Canada.