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Many ordinary investors would be surprised to discover they are actually sophisticated investors who can be sold financial products without protection by any regulator. Yet this is the case in Canada, where $143-billion was placed last year in what is known as the "exempt" market, by investors considered to be sophisticated enough to understand the risks of buying unregulated products and rich enough to absorb possible losses.
The problem is not the exempt-market concept, which helps companies – especially smaller ones – raise money without having to provide disclosure documents such as prospectuses. Rather, it lies in the qualifications for taking part in what are essentially private financing deals: investing at least $150,000 in an offering, having financial assets of $1-million, or earning over $200,000 a year.
These standards are facing criticism as a flawed proxy for investment sophistication. Many people can earn large incomes or inherit money without knowing anything about business or investing. Even if monetary limits could guarantee investment knowledge, the thresholds are decades old and are no longer the standard of great wealth they once were.
A key concern is that the exempt market has been abused by fraudsters. In a commentary this year, the investor protection group FAIR Canada listed a series of fraud cases in which retail investors were lured into schemes involving exempt-market products.
Investor advocates have long complained about exempt-market rules, and Canada's securities regulators have been studying the issues. But the pace of change is discouraging. After extensive study over the past year, the Ontario Securities Commission said in June that it will extend and broaden its work over the rest of the year.
Reforms should include verification of eligibility to invest in the market, as well as new qualifying criteria that look at investment experience, work background and business education as better measures of investment sophistication than simple financial tests.
Good regulations take time to draft, but there is also a need for leadership and decisive action – two things that are hard to achieve in the securities realm in Canada. Rethinking what truly constitutes a sophisticated buyer is overdue.