Proposed new rules for exempt-market financings are meeting a wall of opposition. Included in the initiative are four new prospectus exemptions in Ontario, reforms to the offering memorandum (OM) exemption in a trio of other provinces and several new exemptions to facilitate equity crowdfunding (see sidebar, right), among a range of other changes.
The proposals generated hundreds of submissions during the comment period, which closed in late June, although comments were still coming in as late as early July.
The exempt market is growing at a serious clip, driven mostly by lower regulatory hurdles; the market now outpaces public markets by a substantial margin. More than $100 billion was raised in Ontario’s exempt market in 2012, up from $70 billion in 2009. Only $32 billion was raised on all of Canada’s public equities markets in 2012.
Given the rising stakes, perhaps it’s not surprising that the strongest pushback is coming directly from industry participants. In addition to comments from the usual industry associations, law firms and lobby groups, the proposals sparked a deluge from exempt-market dealers (EMDs), investors and issuers, many voicing concerns about the proposed reforms to the existing OM exemption in Alberta, Saskatchewan, and Quebec that would impose investment limits on non- accredited investors.
Boosting investor protection is an unjustified curb on investors’ freedom, these critics argue, which actually limits investors’ ability to diversify, hampering returns and forcing exempt-market investors into the regulated market.
Much of the collective ire is captured in the submission from the National Exempt Market Association (NEMA), which states: “The biggest risk to the exempt market at present is regulator risk,” the comment says, noting that new limits designed to protect investors will have the opposite effect. “The proposed rules create investor restriction, not protection,” it says.
The NEMA comment adds that the reforms are based on false assumptions about the superiority of the prospectus regime, which holds that more rules equal better investor protection and that wealth is an appropriate proxy for investor sophistication. According to the NEMA submission, this approach “is a mistake and a threat to our portion of the capital markets, leading our industry and Canada’s regulation in the wrong direction.”
Notwithstanding the huge volume of comments on this single aspect of what is a set of wide-ranging, complex proposals, the quantity of criticism may reflect the talent of the exempt-market industry for organizing letter-writing campaigns. Nevertheless, putting aside the voluminous opposition to investment limits, many of the other comments reflect similar dismay over some other regulators’ proposals.
Among the numerous contentious issues, probably the biggest complaint is the fact that the proposals would lead to even more disharmony in the exempt-market regimes of various provinces. For example, several comments point out that the proposals will result in four OM exemptions in Canada: a new OM exemption in Ontario; a modified version of Alberta’s existing exemption, which would be adopted in Quebec and Saskatchewan; the old, Alberta-style exemption that would remain in several provinces and territories; and British Columbia’s version.
The variety doesn’t end there. The Investment Industry Association of Canada (IIAC) points out that along with four possible OM exemptions, the proposals could mean that the market will be left with three types of “friends & family” exemptions, three flavours of crowdfunding and two different approaches to exemptions for existing shareholders – a result the IIAC’s comment calls “a confusing and complex patchwork” of provisions that ostensibly achieve the same objectives.
This increased policy divergence is coming at a time when both supporters and opponents of a new, co-operative national regulator are talking up the need for greater harmonization among the provinces.
As the IIAC comment states: “The complexity and inefficiency introduced into the Canadian capital markets through this provincial approach cannot be justified and runs counter to the philosophy of creating efficient and effective Canadian markets.”
The resulting complexity introduced by the proposed policies also means that the exempt market probably doesn’t work as well as it could – and, for many commentators, it’s not clear that there’s any offsetting benefit to having all of these disparate rules.
Notes the comment from the Investment Funds Institute of Canada (IFIC): “For an issuer seeking to raise capital in more than one jurisdiction, this significantly adds to the expense and difficulty of using what is meant to be an efficient and relatively low-cost mechanism, without clear explanation of how the differences [among] jurisdictions improve investor protections.”
The IFIC comment suggests that even if various provinces do have divergent views on the appropriate level of investor protection, these differences shouldn’t be so great that regulators can’t find a way to agree on a single set of protective regulations.
There will also be a significant impact on investment funds, IFIC’s comment notes. The amendments will result in “a number of different, but similar, trade reports to collect the same basic information, and different and inconsistent requirements for filing the reports, depending on the jurisdiction.”
Ironically, the exempt market is one area in which Canadian regulators seemingly had successfully achieved greater harmonization in recent years. Now, to the dismay of much of the industry, regulators appear to be tacking in the opposite direction once again.
Opponents unite over crowd funding
New rules for crowdfunding are a major plank in the Canadian Securities Administrators‘ (CSA) exempt-market proposed reforms. The controversial idea is uniting some strange ideological bedfellows.
Allowing fledgling companies to raise small amounts of money from a large number of ordinary investors online has been gaining traction in various markets over the past couple of years. Late last year, Saskatchewan introduced the first framework for equity crowdfunding in Canada; earlier this year, several other regulators proposed their own versions of the concept.
But there’s strong resistance from factions of the securities industry that typically sit on opposite sides of any given issue. In this case, however, both the industry and investor advocates seem to agree that equity crowdfunding is simply a bad plan.
Since the concept of crowdfunding was first floated, investor advocates have spoken out against it.
The comment from the Canadian Foundation for Advancement of Investor Rights (FAIR Canada) says that this sort of funding model “is flawed and presents significant potential for serious investor harm.”
The Investment Industry Association of Canada (IIAC) echoes that view: “The lack of investor suitability thresholds, accountable intermediaries, due diligence, and client review,” are in direct conflict with mainstream securities regulations in matters such as suitability and underwriting due diligence. The result, the comment continues, creates a “skewed risk proposal for potential investors.”
For investor advocates, the primary concern is that investors will almost certainly lose money in most crowdfunding offerings involving honest ventures, and also may be subject to greater risk of outright fraud.
The IIAC harbours similar concerns about investor losses, but also worries that this could undermine investor confidence generally and end up harming small dealers. Adds the IIAC comment: “It is not appropriate to try to improve capital raising conditions by lowering standards to levels [at which] investor losses are certain, as a result of inadequate regulation, portal inexperience and potential fraud.”
The unintended result, the IIAC believes, is that the crowdfunding initiative could erode investor confidence in the entire market.
However, if the proposals are to go ahead, these critics agree that should only happen with more robust investor protection measures.
In particular, they emphasize that greater oversight of the portals that would match issuers and investors is required. FAIR Canada’s comment recommends that regulators restrict the marketing and advertising of offerings to registered portals and impose low limits on investments. They also call for portals to belong to both a self-regulatory organization and the Ombudsman for Banking Services and Investments in order to deal with the inevitable complaints.
The IIAC also suggests that portals face tougher requirements than currently contemplated, as well as be subject to close supervision by regulators, and that existing dealers be allowed to set up portals: “Permitting existing registrants to operate portals under a separate registration category would inject a higher level of expertise into the process, and minimize the risk of non-compliance and fraud.”
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