Bringing the offering memorandum (OM) exemption to Ontario presents risks for investors. It’s doubtful those risks can be truly mitigated. But if regulators decide to go forward with this initiative, they should at least adopt whatever measures they can to ensure the OM exemption doesn’t do more harm than good.

The potential for harm has been amply demonstrated in provinces that allow the use of OMs. Regulators have repeatedly found widespread, serious defects in the OMs being used. They’ve also found extensive non-compliance with basic practice requirements by several exempt-market dealers (EMDs). Furthermore, the media continue to report on frauds linked to OM use and provincial securities commissions acknowledge receiving many complaints from retail investors about substantial resulting losses.

Public confidence in the exempt market can’t be sustained this way. If legions of investors get burned there, they will flee. Accordingly, the OM exemption will not yield real and sustainable capital formation unless it’s introduced with adequate investor protection measures. Those measures should include, at a minimum, the following:

  • Requiring issuers to file OMs and have them reviewed for compliance prior to permitting their use (as is done in Australia), and examining all registrants’ levels of compliance on a periodic basis. (Many EMDs in Canada have yet to be audited by a securities regulator).
  • Excluding the value of a retail investor’s home, pension assets, RRSPs and RESPs when determining whether the investor is eligible to purchase securities through the OM exemption.
  • Imposing investment limits keyed to the size of an individual’s existing portfolio so as to avoid lack of diversification and overconcentration in high-risk, illiquid securities. These limits also should bear a real relationship to the investor’s income and/or annual average RRSP and TFSA contributions.
  • Developing and enforcing mechanisms to ensure actual compliance with those limits.

The current OM exemption proposal relies heavily, instead, on risk acknowledgement forms as a key mechanism to protect investors. But the form has not been tested to see whether it actually makes prospective investors aware of the risks associated with purchasing securities in the exempt market.

Will investors read the form before signing it? Can most investors understand it, particularly unsophisticated investors? Will the warnings tend to be seen as boilerplate, or “overkill”, and be discounted or disregarded as such? Without testing, no one knows the answers to these questions.

Likewise, we don’t know whether the risk acknowledgement form’s effectiveness materially wanes if it’s presented after, rather than before, a purchase decision is made. If timing might matter that much, shouldn’t consideration be given to mandating an appropriate presentation procedure and developing an enforcement protocol? Testing would inform decision-making here.

Of course, testing is costly. But the expense likely pales when compared to the price of cleaning up even one serious debacle caused by a bad or badly used OM.

It’s true that testing also takes time, but are we really in a rush here? Sure, it’s important to make it easier for small and medium-sized enterprises (SMEs) and startups to raise capital, but it isn’t clear that they view the OM as a critical fundraising tool. There’s scant empirical data on this in the public domain. What evidence we do have, however, suggests that in overall dollar terms, OM use by SMEs and startups may be fairly limited compared with other options.

It may be that the only compelling reason for Ontario to adopt an OM exemption is national harmonization. But if that’s the case, there ought to be a debate first on whether the experience in other provinces — the high incidence of defective OMs; the widespread non-compliance by EMDs; and the persistent accounts of OM-related fraud and significant investor losses — all make it more prudent to achieve harmonization by simply doing away with the OM exemption rather than bringing Ontario into the fold.

Perhaps there’s no appetite for that debate. Even so, there should be reluctance to proceed without better information than regulators currently possess. At the very least, there should be insistence on better investor protection measures than those currently proposed.

With contributions from Marian Passmore, director of policy and chief operating officer with the Canadian Foundation for Advancement of Investor Rights (FAIR Canada)