Craig Skauge, a Calgary-based exempt-market dealer, says the proposed $2,500 limit on offering memorandums is too low.Chris Bolin/The Globe and Mail
Ontario's securities watchdog is pondering new, less stringent rules for what is known as the exempt market, a buyer-beware corner of the financial world where dealers can sell securities to clients deemed wealthy and sophisticated enough to dispense with the usual disclosure before investing. But the plans are receiving mixed reviews.
The Ontario Securities Commission's current rules on the exempt market, where securities can be sold without a prospectus – the detailed disclosure document normally required when a company is selling shares – are stricter than those in other provinces, and have been under review since last year.
To play in this market, Ontario investors need to meet financial criteria. Those with an income of $200,000, or who are prepared to put $150,000 into a single investment, qualify. So do those with at least $1-million in net financial assets or $5-million in overall assets. But most of the cutoff amounts were set years ago, meaning inflation has lowered these arbitrary thresholds. And most observers agree that a big bank account does not necessarily mean a investor is sophisticated.
Proponents say the exempt market allows small companies and riskier ventures, for which full prospectuses may be too expensive to prepare, to raise capital from so-called sophisticated investors whose incomes would suggest they are better able to handle risks. But critics have long claimed the current rules are often ignored and abused by fraudsters, and that retail investors are often sucked into unsuitable investments.
Last year, the OSC launched public consultations on potential changes, including abolishing some of the existing exemptions and creating new ones. Among them is a proposal to introduce so-called crowd funding, which would allow companies to raise capital on the Internet but raises serious concerns about fraud for regulators.
But the OSC has also suggested another new exemption for which the industry has been pushing. It would allow issuers in Ontario to raise capital using what is called an "offering memorandum," which offers less disclosure to investors than a full prospectus. The goal is to broaden the pool of investors for small businesses and start-ups.
Other provinces allow this exemption. In Alberta, investors can put up to $10,000 into an offering memorandum investment. In British Columbia, there are no limits. The OSC's proposed offering memorandum regime would allow investors to put in a maximum of $2,500, mirroring the ceiling included in the OSC's crowd funding concept. Some say this is too low.
"They are saying, we want to help the small business community, $2,500 at a time. It doesn't work," said Craig Skauge, a Calgary-based exempt-market dealer and head of the National Exempt Market Association.
Mr. Skauge says that coupled with a proposed $1.5-million annual cap for issuers that would limit how much capital they could raise this way, few businesses would bother. And few dealers would deem such small investments worth the paltry commissions, he said.
But Ermanno Pascutto of the Canadian Foundation for Advancement of Investor Rights (FAIR Canada) says any move toward expansion of the exempt market is wrong-headed. Looser rules in the West have produced many multimillion-dollar frauds, he said. And there is "widespread non-compliance" with the existing rules, he added, charging that regulators appear not to have a handle on the "enormous amount" of fraud.
"What is the point of expanding the exemptions in the exempt market if the exempt market is a source of a lot of losses to investors and inefficient capital formation, with money going down the drain?" Mr. Pascutto said, arguing that securities commissions lack meaningful data on the effects of the exempt market on retail investors and should instead concentrate their limited resources on catching fraudsters.
(Jeff Gray is a Globe and Mail Law Reporter.)
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