The Ontario Securities Commission has found rule breaches and poor procedures in a review of securities firms operating in the “exempt” market, where products are sold to qualifying investors with little regulatory oversight.
The OSC said Friday it has completed a “sweep” launched last June of exempt market dealers and portfolio managers, calling the review its largest-ever targeted sweep of a sector.
In two cases, the OSC said it found “significant deficiencies” that led to regulatory action against the unidentified firms. Two other firms have discontinued their operations since the review was started, the OSC said.
Beyond those cases, however, the OSC warned it has found a range of deficiencies at other firms, primarily around selling securities to investors who did not qualify as “accredited” or wealthy investors eligible to buy exempt market products, and around sales of securities that were not appropriate for investors’ situations under what are known as know-your-client rules.
“Know-your-client and suitability determinations are fundamental obligations owed by registrants to their clients,” OSC chairman Howard Wetston said in a statement.
“Enhancing compliance among portfolio managers and exempt market dealers is critically important and we are taking appropriate regulatory action where we identified significant compliance issues.”
The exempt market -- where securities can be sold to qualifying investors without the need to issue prospectuses that are reviewed and approved by securities regulators -- has been a particular focus of the OSC’s in the past year. The commission is considering new rules, which it has issued for public comment, that could have the effect of broadening the range of people who can buy shares in the exempt market.
In a speech in early May to the Exempt Market Dealers Association of Canada, Mr. Wetston called on the industry to improve its adherence to existing rules if standards are broadened.
“In our view, more work needs to be done by the industry to consistently meet the existing requirements,” he said at the event.
The OSC’s review found 18 per cent of 45 exempt market dealers had sold securities to investors who did not qualify under accredited investor rules, which include a requirement that buyers must have at least $1-million in net financial assets. In most of those cases, the OSC required dealers to contact clients to explain the error and to redeem the investments and refund the proceeds.
The OSC said 75 per cent of exempt market dealers had inadequate processes for collecting and maintaining know-your-client information.
The OSC said its review also raised concerns about the high concentration some clients have in a single exempt market investment, which accounts for a large proportion of all their investable assets. Investors are allowed to invest in the exempt market if they buy at least $150,000 worth of an investment, which was a rule designed to ensure only wealthy individuals would participate in the offerings.
But the OSC said it appears people are being encouraged to meet the threshold even where that single purchase accounts for a major proportion of all their holdings.
The commission says it is now considering whether it should introduce “concentration” limits for individual investors participating in the exempt market, and said the issue is being considered by an umbrella group of provincial securities regulators as part of a separate review of changes to accredited investor rules. In the interim, the OSC said it will express its concerns to exempt market dealers that purchases of a single security that account for more than 10 per cent of a client’s net financial assets may raise concerns about suitability obligations.