FAIR Canada
FAIR Canada Newsletter

July 2013

Exempt Market - Lack of Compliance, Lots of Fraud, Why Expand it Further?

Widespread non-compliance with the laws and regulations governing the loosely-regulated "exempt market" coupled with a high level of fraud and weak oversight harms investors and weakens confidence in the Canadian capital markets. FAIR Canada believes that fixing the existing regulatory framework for those firms and registrants who operate in the exempt market should take priority over broadening the exemptions. There will be a greater risk of harm to retail investors if exemptions are broadened without first better understanding the extent of fraud and investor losses in the exempt market and improving compliance with the rules.


Compliance Problems


The findings outlined in numerous CSA-member notices and compliance reports, including recent reports by the OSC (OSC Staff Notice 33-740) and the CSA (CSA Staff Notice 31-334), clearly demonstrate that many exempt market registrants are not following the rules and that the rules and oversight need to be strengthened. Serious widespread compliance problems have been identified by securities regulators - including: sales of exempt securities to investors who are not Accredited Investors; sales of investments relying upon the $150,000 exemption that allocate a large portion of an investor's financial assets to one high-risk investment (contrary to "suitability" obligations); lack of a "suitability" assessment for the investor; non-disclosure of the risks of using borrowed money to finance the purchase of an investment; and non-disclosure of conflicts of interest (and, by implication, not appropriately avoiding or managing those conflicts). 


Widespread Fraud


Just three of the recent scandals in the exempt market amount to almost half a billion dollars' worth of investor losses and these are only the most notorious cases that have made recent headlines (see Financial Post Reporter Barb Schecter's story "Welcome to Canada's exempt market: Exclusive, anything goes investments - but play at your own risk"). The recent cases are only the tip of the exempt market fraud iceberg. David Baines has been writing about exempt market frauds (like the recent case of the Victoria, BC financial advisor David Michaels) for the Vancouver Sun for many years. (Note: FAIR Canada's A Decade of Financial Scandals report details several high-profile exempt market frauds).


The CSA appears to lack data on the total dollar amount of investor losses from fraud or other wrongdoing that has occurred in the exempt market. The information that is publicly available from securities regulators and from the media suggests that investor losses as a result of exempt market fraud are large (a billion or more) and the number of investors affected is significant.


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Crowdfunding Update


OSC Roundtable


On June 11, 2013 the OSC hosted an "investor" roundtable to hear from investors and potential investors on investing in start-ups and small and medium sized enterprises ("SMEs"). This event focused primarily on an OSC concept idea which contemplates allowing businesses to sell shares through equity crowdfunding. FAIR Canada's Ermanno Pascutto represented investor interests on the OSC's panel, along with long-time investor advocate and former OSC Commissioner Glorianne Stromberg. Both voiced serious concern over this concept idea and opposed the introduction of equity crowdfunding in Ontario. Brian Koscak of the Exempt Market Dealers Association of Canada represented the industry perspective and spoke in favour of allowing crowdfunding if certain regulatory protections are put into place. While billed as an "investor" roundtable, the event was attended primarily by industry representatives, including those involved in running or servicing SMEs, who stand to benefit from a potential crowdfunding exemption.


OSC Grants Questionable Crowdfunding Exemption


More recently, whilst the OSC has publicly stated that it has not decided on whether it will proceed with the crowdfunding concept proposal, it has taken a step in that direction by granting an exemption from know-your-client and suitability requirements to MaRS VX, permitting it to operate an online portal that will "bring together" accredited investors and issuers that are social impact and/or environmental impact issuers. This exemption was granted in the absence of public consultation, despite its direct relevance to the current debate about the appropriateness of current exemptions (especially the accredited investor exemption), crowdfunding and investor protection. In light of serious compliance deficiencies with the accredited investor exemption noted in recent regulatory reports, FAIR Canada is concerned that the OSC is permitting the operation of a portal model that relies upon an exemption that is flawed in principle and practice. FAIR Canada questions whether it was appropriate: (1) to grant an exemption to MaRS prior to a determination of the appropriateness of current and potential exemptions, and (2) for the OSC to remove investor protections (i.e. know your client and suitability) from over 350,000 Ontario retail accredited investors so that they can be solicited to invest in highly speculative ventures without any public process. 


U.S. S.E.C. Reduces Investor Protection: Will Canadian Regulators Follow Suit?


A recent editorial in the New York Times criticized the decision of the U.S. Securities and Exchange Commission (S.E.C.) to allow mass advertising of investments that are not publically traded, stating that it is an invitation to "hucksters, rip-off artists and bad actors to prey on individual investors." "Bad actors" are excluded but the "bad actors" exclusion only applies to persons convicted or sanctioned after the new rule comes into effect - fraudsters convicted in the past are free to prey on retail investors under the new rules!


FAIR Canada hopes that Canadian securities regulators do not follow the S.E.C. actions.  It is essential that regulators protect investors from unfair, improper or fraudulent practices. Investor protections should not be sacrificed in the pursuit of perpetuating an inefficient or flawed capital raising model (eg. equity crowdfunding).


Things Aren't Alright in Saskatchewn


It appears that on July 9, 2013 the Saskatchewan Financial and Consumer Affairs Authority (FCAA) held a seemingly lightly-publicized "information session" and discussion regarding a proposed exemption which would allow equity crowdfunding in Saskatchewan. While no public consultation document has been issued by the FCAA, it has released a concept proposal and media backgrounder outlining an equity crowdfunding exemption that:


  • does not require portals to be registered with the FCAA;
  • places no restrictions on advertising,
  • requires minimal disclosure (including no requirement for financial statements or audits);
  • allows investors an unlimited number of investments with different issuers; and
  • permits any type of issuer to issue any type of security.
It is unclear what next intended steps might be, including whether the FCAA plans to formally consult with stakeholders on its concept proposal. In FAIR Canada's view, an equity crowdfunding exemption would be completely inconsistent with modern principles of securities regulation in Canada, and, at a minimum, warrants a fulsome, transparent public consultation in order to ensure that the issue is fully canvassed and potential risks are identified and mitigated in the drafting of any unprecedented exemptions. Other Canadian regulators, including the Ontario Securities Commission, have undertaken formal consultations on an equity crowdfunding exemption concept idea, and FAIR Canada urges Saskatchewan's FCAA to undertake formal consultation which will include all stakeholders including consumers and consumer advocates.


FAIR Canada Governance


Glorianne Stromberg Joins FAIR Canada Board

FAIR Canada is pleased to announce that Glorianne Stromberg, a former Commissioner of the Ontario Securities Commission and author of several seminal reports, has joined FAIR Canada's Board of Directors. Directors and staff welcome Glorianne to the Board and look forward to working with her.


FAIR Canada also announces that Stan Buell has stepped down from his position on our Board. Stan was a pioneer of investor protection in Canada, and his insight and input into FAIR Canada's positions and activities were tremendously valuable. We wish Stan all the best in his retirement.


Recent Media


Quotas, contests and bonuses for sales, not good advice


In a Globe and Mail article ("Why your financial advisor might not have your best interests at heart") Preet Banerjee points out that common financial "advisor" sales targets are misaligned with the goals of putting clients in the best possible investments or providing a great financial plan.


He explains how compensation is tied to sales and that this creates a conflict of interest between the advisor's interests and the client's. Until regulators adopt a best interests standard, investors should be warned that their interests may not be the main considerations that influence their advisors' recommendations.


Battle for Investor Rights


The June 2013 issue of the Toronto CFA Society publication The Analyst features an interview of Executive Director Ermanno Pascutto entitled "The Battle for Investors' Rights". The interview discusses the most important issues for retail investors and challenges facing FAIR Canada.


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