The Canadian Securities Administrators wants comments on proposals that will require exempt issuers to file certain documents using SEDAR rather than submitting paper to individual regulators.
SEDAR is the website to go to when you want to read information filed by public companies and mutual funds, all of which offer their securities by prospectus.
Exempt issuers means securities issuers who are exempt from having to file a prospectus. Issuers of these securities don't have to meet the same disclosure standards as public companies and mutual funds and can't sell to the general public. Rather, their securities are available only to accredited investors -- which includes people who have specific minimum income levels and asset thresholds -- and to non-accredited investors who can invest specific minimum amounts of money for a single security; the amounts vary among provinces but are as high as $150,000.
As I noted in a previous column, the regulatory argument behind the exemptions is that someone playing with large amounts of money has a certain level of sophistication, the ability to withstand financial loss, the financial resources to obtain expert advice and the incentive to carefully evaluate the investment, given its size. The key problem as I see it and have said before is that many exempt issues are sold to people who haven't a clue about what they are buying and are given information that they don't understand.
That's why I'm in full agreement with the premise that all issuers file on SEDAR their disclosure documents such as offering memorandums, financial statements and anything else that is material to securities holders and prospective investors. Widespread disclosure may lead to closer scrutiny. Moreover, with the move toward allowing crowdfunding, anyone seeking to raise investment funds using this method will have to file on SEDAR too.
I would even suggest regulators go further: Require exempt issuers who want to tap the retail market to prepare a point-of-sale summary document that explains the risks to potential investors, as well as the potential benefits, and make publishing it on SEDAR and giving it to prospective investors an obligation. The regulators already require mutual funds to distribute a mini disclosure document, called Fund Facts, recognizing that most investors don't read the prospectuses. Apply the same concept for exempt issues. This would be especially helpful where the dealer offering the issue is not a member of the Investment Industry Regulatory Organization of Canada (IIROC) or the Mutual Fund Dealers Association (MFDA). These organizations have specific guidelines their members must follow prior to recommending exempt issues to their clients, and that includes knowing the product as well as knowing the client.
I'm well aware that exempt issue subscription documents generally require investors to acknowledge that they may lose the entire investment. Furthermore I'm aware that the risk factor section of an exempt issue offering memorandum may span more than a dozen pages and is rarely read by those investors who seem to be dependent on their advisors for advice.
What I would like to see in a summary document is risk information specific to the explicit offering, in plain language. That way a potential investor can get, in a couple of pages, a better understanding of what is it he or she is looking at.
For instance, an investor should be informed about the specific nature of the issuer's business. It isn't enough in my opinion for a company to state its objective is to distribute double-digit rates of interest to investors. Better an issuer should disclose in plain language that it is in the business of lending money to borrowers who have been turned down by banks because they are very high risk. If it has problem loans on its books it should disclose this. To paraphrase the information found in one issuer's documents, "about one-fifth or our loans are non-performing and half of these have been in the doghouse for a minimum of five years." I admit this issuer doesn't use the word doghouse, but I'll bet that few of the investors who participated in this issue read the offering memorandum and financial statements cover to cover.
Here's a précis of how a high-risk bond fund I encountered described its business: "The sole business of [the Issuer] is to loan funds raised by it to a related party of [the Issuer]. Loans made to this related party are unsecured. The related issuer intends to acquire debt securities such as promissory notes, bonds, debentures, mortgages and other similar debt related instruments from private issuers carrying on business in North America, or debt securities from issuers such as real estate developers, factoring companies, viatical and life settlement companies, and mortgage investment corporations." One would hope that someone reading that would recognize that while the statement may be true, it provides nothing on which to base an investment decision other than avoid.
In the point-of-sale document I am proposing, that issuer could state "The sole business of the issuer is to make unsecured loans to a related party. The related issuer intends to acquire debt instruments from private companies, real estate developers, factoring companies, viatical and life settlement companies, and mortgage investment corporations." Hopefully someone reading that description would have the sense to pass or be prepared to ask questions about the underlying investments and their level of risk, none of which the issuer would likely want to answer.
It's important that investors understand an issuer's fee structure. Any sales commissions should be disclosed, along with details of management fees payable to the issuer and related companies as well as fees, if any, paid to the issuer from the recipients of the funds.
A point-of-sale document could also explain how issue and redemption prices of units are determined. This is of major importance, particularly when the values of the assets are determined by management and not based on quoted market values.
I would also like to see important terms explained because many retail investors buying exempt issues are unsophisticated. For example, investors in issues that lend money against real estate will see the term "loan to value ratio" with a percentage attached to it. A loan to value ratio of 70% would mean that on average the value of loans does not exceed 70% of the appraised value. That may be true, but it doesn't necessarily reflect the value of the property or properties at the moment the figure was released. Rather, it may reflect the future value of property if certain events take place such as obtaining a change of zoning, completing the building and getting it fully rented.
I would hope such a document would provide some detail as to the circumstances, if any, under which an investor will be able to redeem his or her investment. In some cases it will be a simple statement such as "on such and such a date we will liquidate the portfolio and you will receive your pro-rata share." In other cases an investor might discover there is no time frame for redemption. Of course when you buy high-risk debt with a maturity date you should realize that whether you get your money back may depend on whether the issuer can find new investors. That in my opinion should be spelled out if the security is aimed at retail investors.
