The Pessimist, the Optimist, and the Realist
By: Craig Skauge
On September 28, 2010, if you asked someone in the know of the potential impact NI 31-103 would have on the Exempt Market, you would likely have received three fairly distinct, yet opposing answers:
The pessimist would have told you that despite enhanced regulations, the Exempt Market would not change its stripes and investors would continue to lose money in much the same fashion as they had pre-registration. Regulators would now get an extra pound of flesh, but the crooks would continue to flourish and NI 31-103 was nothing more than ‘lipstick on a pig.’
Ask an optimist, a freshly minted Dealing Representative, the same question and they would have told you that with the combination of securities sheltered from market risk and improved investor alignment (and due diligence) gained through 3rd party dealerships and enhanced regulation; the holy grail of capital markets had been born.
A realist would tell you that, as it often does, the truth would fall somewhere between their two points of views.
It has been four years and change since that transformative date, and the dust has settled. Now regulators and industry participants alike should be able to better conclude what the post NI 31-103 Exempt Market is, and what it is not.
While it is still far from perfect (and no industry is), it cannot be denied that the Exempt Market has improved leaps and bounds due to the implementation of NI 31-103. Despite consistent scrutiny of both Issuers and EMDs from securities regulators in search of the proverbial smoking gun, participants in the Exempt Market are, generally speaking, rising to the occasion and meeting, and exceeding, the standards to which they are held.
Most investments sold via 3rd Party EMDs have performed as expected (or better) and are a testament to the effectiveness of the concept of investor alignment. So why isn’t it the Holy Grail then? Quite simply: it is because despite 3rd Party EMDs batting nearly 1.000 in the first three years, by all appearances that average is about to decline due to a relatively high profile ‘blow up.’
A potential red flag was missed, and it is going to cost certain EMDs, DRs, and investors’ money through lost business, litigation, and lost funds respectively. Just how much will be lost and when those losses will be realized is still to be determined, but it is well known in industry that it is coming.
So what do the pessimist, optimist, and realist have to say now?
The pessimist is thinking the worst. They will tell you that they were right. The Exempt Market has not changed! This particular Issuer is simply a sign of things to come and investors are going to lose and lose big, no matter what Issuers they have invested in, and what EMDs oversaw their transactions. If you are thinking about investing or advising in the Exempt Market, they will encourage you to stay away. If you are already there, they will tell you to get out while you can or better yet say that they “told you so.”
Now what about the realist... they will probably tell you that this was bound to happen; as a system with little guidance out of the gate was bound to have flaws. They will tell you that no one in the industry will be unaffected from this. It is a small community, and word spreads quickly. They will tell you that regulators will misfocus their efforts and spend vastly more
resources scrutinizing and punishing those that raised the funds than those that (allegedly) diverted them. They will also tell you that lawsuits are likely forthcoming and E&O insurance in this marketplace will now be tested.
But what about the optimist? What does that smiley happy go lucky SOB think? Well, I’ll probably tell you that what does not kill this industry will only make it stronger. I’ll tell you that I have already witnessed how industry has, and will continue to, learn from the mistakes made here and adapt. I’ll tell you that I think our industry is about to grow at a wicked clip and that in the long run, once the scar of this heals, our industry will be stronger.
The big question now is which one of these three characters do you want to be when the new year begins? I think I
will stick with optimism myself....