In large part, whether or not to implement investment caps on the Ontario Securities Commission’s (OSC) proposed offering memorandum (OM) exemption comes down to suitability, according to experts speaking at the 2014 PCMA Private Capital Markets Conference on Monday.

In March, the OSC proposed four new exemptions including the OM exemption to expand the potential pool of investors in private capital markets. The proposed exemptions also come with potential caveats such as investment caps on individual investors. The comment period for the proposals closes June 18. (See Investment Executive, Exempt-market rules: Proposals called “game changers”, April 2014.)

The proposed OM exemption creates a new definition for eligible investors whereby the net income test would remain the same at $75,000, but the net assets test would be reduced to $250,000, not including the primary residence, from the current $400,000, including the individual’s home. Those individuals who qualify as an eligible investors would have an investment cap of $30,000 per year under the OM exemption. Accredited investors have no limitation, while all other retail investors would be capped at $10,000 per year.

The OSC included these caps to deal with a number of investor protection concerns, according to James Turner, vice chairman of the OSC who spoke at the Toronto event. For instance, disclosure documents are not a sufficient form of protection because most retail investors do not read or fully understand them. As well, investment caps would force individuals to diversify their investment portfolios.

“We’re dealing with retail investors with relatively low amounts of income and with these caps we are at least forcing some diversification across asset classes,” said Turner. “And that makes us much more comfortable than saying you can put all 100% of your assets in a particular investment in the exempt market.”

Another reason for the caps, according to Turner, is the ongoing suitability debate that has led to questions as to whether or not the industry should adopt a best interest or fiduciary standard. “We do have some concerns with respect to suitability as being the answer to the problem in these [exemption] standards,” he said.

However, Phil du Heaume, vice president of legal and compliance at Raintree Financial Solutions, an independent exempt market dealer, believes that the exempt market’s current suitability standards for registrants are the best ways to protect investors. Speaking at the conference, Du Heaume argued that the investment caps places many investors with very different circumstances and investment needs in the same category.

“The investor cap is treating the eligible investor cohort as one big homogenous group,” said du Heaume, “and we don’t think that that is in their best interest.”

Registrants must have detailed conversations with clients and consider a number of criteria including an individual’s age, number of dependents, occupation and health, said du Heaume, in order to decide whether or not an investment is suitable for a client or not. Depending on the outcome of those discussions, the potential $30,000 in investible assets may be too high or too low for a specific client or the suggested exempt product may simply not be right for the client.

Furthermore, a cap leaves eligible investors open to aggressive sales tactics from issuers, who are not held to the same suitability standards as registrants, said du Heaume, to invest the entire $30,000 allotment in one investment. “There’s another thing that can come out of this and that can be a wallet race,” he said. “Issuers are going to have every reason to try and get access to the $30,000 cap as soon as possible within every 12 month period because [they are] sharing it with every issuer out there.”

As such, du Heaume believes investment caps should not apply to eligible investors working with a registrant, but only with individuals who invest through issuers.