Regulations designed to make it easier for companies to raise capital are once again proving hazardous for investors.

Last month, the B.C. Securities Com-mission issued a notice of hearing against a Richmond, B.C., man and his company, Horizon FX Investments, alleging he and the company had fraudulently induced almost 1,000 people to invest $34 million in foreign-exchange contracts.

The BCSC alleges that Cem Ali, as president and sole director of Horizon, represented in an offering memorandum that investors’ money would be placed with traders who had been carefully selected based on their professionalism and “proven track record of performance.”

In fact, the money was placed with a New York foreign-exchange trading firm, Razor FX, which was exposed as a Ponzi scheme in January 2008 and collapsed in spectacular fashion. Horizon investors, most of whom are residents of British Columbia, have so far lost $25.5 million, the BCSC notice says.

BCSC investigators deserve credit for acting quickly in this matter. Ali filed Horizon’s offering memorandum to raise up to $80 million in September 2006; by October 2007, investigators had issued a “cease trade” order.

This is not an enforcement problem. It’s a policy problem — one that has been rearing its ugly head with great regularity in B.C. The problem is that the BCSC has adopted rules that enable issuing companies such as Horizon to raise money without issuing a prospectus, a document that remains the most important tool used by securities regulators to ensure that investors have all the information they require to assess an investment properly. The prospectus route is also still the best way for regulators to monitor continuous-disclosure requirements, including documents such as quarterly financial statements and news releases announcing material developments in a company’s business affairs.

And, of course, the presence of a prospectus also ensures that the investments can be sold only by a registered dealer.

Most provinces permit a range of exceptions to the prospectus requirement. One of the most common — and the most troublesome — is the offering memorandum exemption. (Ontario is the only province that does not permit this type of exemption.)

Under this exemption, B.C. permits the sale of securities without a prospectus to virtually any kind of investor. All that is required is an offering memorandum — a much less rigorous document than a prospectus — and a written acknowledgement of risk.

In the case of Horizon, that company used the offering memorandum exemption, which in B.C. enables issuing companies to raise any amount of money from anybody, regardless of the investors’ financial circumstances or sophistication level. (Some provinces, including Alberta and Quebec, set an upper limit on such investments of $10,000.)

This situation is risky enough when dealing with real estate development or mineral exploration issues; it is indefensible when dealing with extremely complicated and risky investments such as foreign-exchange contracts, in which leverage enables inves-tors to make or lose large bundles of money in the blink of an eye.

In fact, the BCSC issued its own warning about the inherent risks of foreign-exchange trading, and the possibility of fraud, in a consumer advi-sory in April 2007.

Despite the risks, the BCSC allowed Ali — an information-technology specialist with no credentials in foreign-exchange trading, who is not registered to do any sort of trading — to form a private company that is not registered as an investment dealer for the express purpose of raising millions of dollars from largely young and unsophisticated investors for reinvestment in one of the riskiest trading products available.

It remains unclear if, and when, regulators might change the rules. In September 2009, the Canadian Securities Administrators issued standardized exemption rules across the country in National Instrument 45-106. It is one more step toward securities harmonization, a long and difficult process that no province will want to upset at this point by asking for changes.

So, while it’s apparent that the offering memorandum exemption needs to be addressed for the protection of investors, it seems unlikely that such a change will arrive in the foreseeable future. IE