It's no secret I'm leery about securities regulators' moves to make it easier for retail investors, sophisticated or not, to invest in companies under prospectus exemptions. I've written a number of columns on the topic of exempt issues over the years.
As of Jan. 13, new harmonized rules started rolling in that allow small retail investors in most of Canada to invest in securities previously available only to high-net-worth investors. The so-called offering memorandum exemption allows companies seeking to raise capital to solicit money from a wider range of investors than they could under previous prospectus exemptions. Moreover, the rules will be harmonized among participating jurisdictions.
This, in my opinion, is a big mistake because it exposes more unsophisticated investors to what are often high-risk -- if not speculative -- investments than under the old rules. The Jan. 13 date applies to Ontario while April 30 applies to Alberta, New Brunswick, Nova Scotia, Québec and Saskatchewan. Other provinces have their own rules in place.
From the perspective of small and medium-sized companies, the changes are positive because these companies can seek money from small investors without going through the expense and level of disclosure required when raising money through a prospectus.
There will also be new measures of investor protection, including the requirement to release audited financial statements and disclose how money raised was spent. I suspect that many investors who have bought into exempt issues in the past were totally unaware that exempt issuers didn't have to provide such basic information.
Similarly, marketing materials will now be considered as part of the offering memorandum, so that if there is a misrepresentation the issuer would face the same liability it would face if a misrepresentation were included in the offering memorandum. Whether that will be a deterrent remains to be seen given securities regulators' dismal record for collecting penalties and costs. Ontario's lengthy list of non-payers is called Respondents Delinquent in Payment of Commission Orders. I prefer to call it the Delinquent Delinquents List.
Also, securities regulators will impose limits on the amounts individuals can invest for what they term non-eligible investors and eligible investors (limits don't apply for accredited investors and individuals purchasing under the friends and business associates exemption).
Generally, eligible investors include individuals who have in prior years had $75,000 in pre-tax income or $400,000 of net assets. Eligible investors are limited to investing $30,000 in offering memorandum exempt securities in the previous 12 months, while non-eligible investors – individuals with lower income and assets -- have a $10,000 limit.
So, to borrow a phrase from some provincial lottery and gaming corporations and further disclose my concerns about what I see as erosion of protections for retail investors, "know your limits."
A key paragraph in the regulators' notice is, "The fact that investment limits have been established for eligible and non-eligible investors who are individuals does not mean that these amounts are suitable investments in all cases. If a registrant is involved in a transaction, the registrant must still conduct a suitability assessment to determine that the amount of the investment and the investment itself is suitable for the purchaser. This may result in a lower investment amount for a purchaser."
Another paragraph states that "The $30,000 investment limit may be exceeded by an eligible investor who receives advice from a portfolio manager, investment dealer or exempt market dealer that exceeding the investment limit of $30,000 and the investment itself is suitable for the eligible investor. In this case, the investment limit for all securities acquired by the purchaser under the offering memorandum exemption in the preceding 12 months is $100,000."
The image of a fox guarding a hen house came to mind when I read this paragraph because $100,000 of what is likely a high-risk investment would be a significant portion of a non-accredited investor's portfolio. However, most investment and mutual fund dealers who are also exempt market dealers have guidelines to prevent undue concentration in a client's account. But not every dealer selling exempt issues is a member of IIROC or the MFDA.
If you are approached under the new rules to invest in an exempt issue, ask yourself some questions. Do you fully understand the risks? How long are you locked into the investment? Can you sell it if you need your money? If you lose all your money, will it affect your lifestyle in the near term and in retirement? Do the people behind this issue have any experience? What are their past successes or failures?
You should also look at whether the individual trying to sell you the investment is registered with your provincial securities commission. Some jurisdictions allow referral agents who have no obligation to determine whether the investment offered is suitable for you. A dealer is supposed to perform a suitability review, but often this doesn't happen.
