Companies that raise capital in the exempt market have a poor understanding of the rules that govern that activity, according to a new report from the British Columbia Securities Commission (BCSC).

The BCSC Friday released a report on its Private Placement Review Program (PPRP), which monitors companies that raise money in the exempt market.

According to the report, while most companies intend to comply with the rules, BCSC staff found that “companies have a poor understanding of the exemptions, do not keep adequate records of their private placements, and use professional advisors who do not have specialized knowledge of the securities industry and the private placement market.”

Notwithstanding these compliance concerns, the report finds that the exempt market has outstripped the regulated, public market as a venue for raising capital over the past few years. It says that, from 2010 to 2013, companies reported that they raised $45 billion in the exempt market in B.C., compared with $25 billion that was raised in the public market. And, including companies outside B.C., the gap gets even larger, with the amount raised in BC’s exempt market over this period rising to $79 billion. It also reports that, since 2010, 2,400 private companies have filed exempt distribution reports with the BCSC.

With this shift toward the exempt market, investor risk may be on the rise, too. The commission notes that some of the exempt securities sold to retail investors “are high-risk and illiquid, and can result in significant losses.”

The BCSC says that its staff have completed 284 in-depth reviews of companies filing exempt distribution reports. And, as a result, 15 files have been referred to its enforcement division, and 17 were referred to other divisions in the BCSC and to other securities regulators. Enforcement has since opened brought allegations in several cases, it notes. Some of those cases remain ongoing, it notes. So far, one case has resulted in a BCSC hearing and findings of fraud, illegal distributions and breach of a cease trade order (CTO); and, in another case, the company reached a settlement with regulator, agreeing to pay $10,000 to the BCSC.

Additionally, the commission says that 42 cease trade orders have been issued. Of these, 21 have since been revoked because the deficiencies identified were addressed. The other 21 companies remain cease-traded, and the commission says they “have shown no progress in having the cease trade order revoked, were likely higher risk, and are no longer raising money from investors.”

Another, eight companies rescinded their offers to their investors, it reports.

The BCSC also says that the review program has led it to enhance the surveillance of its private placement market. In January, it launched a private company risk model based on both field data from all of the exempt distribution reports it has reviewed since January 2011, along with data from a variety of internal and external databases, that analyzes each new exempt distribution report using a set of 38 risk indicators to identify high-risk companies.The commission reports that in the first three months using the new risk model, 50 cases were opened on unregistered finders, and five enforcement cases were initiated related to issuers.

It is also stepping up its educational efforts. Last year, the commission launched a program that aims to contact entrepreneurs who could unintentionally violate the capital raising rules to educate them through a guide it developed, presentations to small business groups, a webinar, and a video.

The commission says that these continuing education and outreach efforts, along with its monitoring of the exempt market “should help to raise the level of understanding and compliance in the private placement market.”

“The private placement market is critically important to the economic well-being of our province, and the BCSC has demonstrated leadership in regulating this market,” said Brenda Leong, chair and CEO of the BCSC. “In overseeing this market, we want to ensure that companies are playing by the rules, and that investors understand the risks and receive the information they need to make informed investment decisions. If we find evidence of misconduct, we will investigate and take appropriate enforcement action.”