Deep inside the British Columbia Securities Commission’s computer systems, an unfailingly patient program spends its days tackling the mundane task of reading companies’ regulatory filings.
Scanning reports filed with the BCSC about money raised in the province’s sizable exempt market, the computer is looking for potential risk factors to alert staff that rules may have been broken in the private market sector.
A company issuing new shares has a high turnover of officers and directors? Red flag. The securities were sold to a suspiciously large number of “accredited” or wealthy investors in the same small town? Red flag. The owner sold shares to more than 50 people using the supposedly narrow exemption for close friends and family members? Another red flag.
Introduced in 2014, the new computer system is allowing the B.C. regulator to focus staff efforts and improve its track record in spotting problems in the murky exempt market, where companies are allowed to issue securities and raise money without having to issue a prospectus that is approved in advance by the commission. They instead submit a report on exempt offerings after the deals are completed.
Executive director Paul Bourque said the BCSC is the only regulator in Canada reviewing all exempt market reports using a computerized “predictive risk model.” He said commission staff members have attended global conferences to talk about the merits of their new system for small organizations.
“Given the fact that resources will never keep up with regulatory demands – ever – we have to figure out how to work smarter with the resources we have,” Mr. Bourque said.
He said the regulator has put stronger emphasis on the exempt market because it accounts for far more of the money raised from investors in B.C. than the more transparent public markets.
B.C. residents invested $124-billion in private placements in the four years from 2010 and 2013, for example, and just $25-billion in public offerings issued with a prospectus.
Richard Remillard, a director of the Private Capital Markets Association of Canada, said it is early days to determine what the B.C. process means for companies raising money in the private market, but it should be beneficial if it focuses the work of regulators.
PCMA executive director Georgina Blanas said exempt-market companies are already highly regulated – despite a common misperception that the sector operates without scrutiny – and they are looking for efficiencies.
“Compliance is a huge fact for all of our members and everyone who functions in this space,” she said.
The BCSC’s model uses 38 risk factors aimed at identifying companies that sell securities to unqualified people. The exempt market is supposed to be limited to certain types of investors, such as wealthy accredited investors who can absorb losses, or close friends and family members who know the company’s executives well.
Yet past enforcement cases have shown that those rules are sometimes bent or ignored, leaving small investors facing large losses on bad deals. Mr. Bourque said regulators across Canada are placing more emphasis on the exempt market because the deals can entail bigger risks.
“I’m not saying they’re all high risk – not by any means,” he said. “Most of the private placement market is large issuers issuing very secure investments. But there is a part of the exempt market where it is small startup companies with no track record, no ability to obtain financing anywhere else. Those are very high-risk investments.”
While deals are completed before the reports are reviewed, the BCSC can still cease trade on an offering, order it to be rescinded and even take enforcement action against the people involved.
The system has helped flag areas of concern in its short life so far. From April, 2014, to July, 2015, the system scanned 5,300 exempt distribution reports, but staff reviewed just 115 in detail. Eighty cases were opened on unregistered people receiving commissions for exempt market sales, one deal was subject to a cease-trade order and seven companies were referred to the enforcement division for investigation, the BCSC said.
The BCSC has expanded its use of risk models far beyond the exempt market.
The regulator has another system launched in 2013 that scans public company financial reports to try to identify which companies are most at risk of having to do a financial restatement. Half the companies flagged by the model last year ended up having to amend or refile their financial statements, which Mr. Bourque said is a sign of its effectiveness at spotting problems.
Another system reviews registration applications from individuals wanting to work in the financial sector in the province, and another helps staff look for red flags at dealers regulated by the BCSC, such as portfolio managers and investment-fund managers.
Mr. Bourque said the regulator is now working on a new system to assess hundreds of cases of unusual market trading that are flagged each year to help staff narrow down the most likely cases of illegal insider trading.
“The work outpaces the staff resources we have to put against it, so we want to make sure staff are working on the highest-risk market participants,” he said.Report Typo/Error