Investors familiar with the highly-regulated Canadian securities industry may find London’s Alternative Investment Market more like a reckless, free-fire zone. In fact, the AIM approach reflects a studied preference for leaving enforcement to the market.

Companies can list themselves on the AIM without going through the regulatory hoops that make Canadian listings such a painful experience. Instead of seeking regulatory blessing, firms appoint a “nominated advisor” — nomad, for short — that is responsible for ensuring that the issuer is fit to list.

Nomads check suitability for listing, much like retail brokers are required to check suitability for their clients’ investments.
There are few specific requirements.
Instead, nomads must ensure that their
clients comply with deliberately vague principles and make certain that a listing is appropriate. Both the nomads and an issuer’s executives and board can be held responsible for any corporate misdeeds.

To some, it surely sounds like a recipe for disaster. If issuers can come to market without so much as a sniff by regulatory authorities, then surely all sorts of junk will be unleashed on an unsuspecting public.
Skeptics might suggest that brokerage firms can’t be trusted to control issue quality when they can earn such big underwriting fees for selling new issues.

The evidence, however, has so far shown otherwise. While AIM-listed companies have proven to be volatile, they have yet to be the source of any significant market scandal.
Name any major corporate scandal of the past few years — from Bre-X Minerals Ltd. to Enron Corp., YBM Magnex International Inc.
to WorldCom Inc. — and a regulator of some sort was presiding over its financial filings.

Under the AIM model, the nomads are invested with the gatekeeper role for the market, and it’s the market that ensures compliance. The perception of the AIM in Canada and elsewhere is that it’s virtually an unregulated market that’s ripe for abuse.
In fact, the level of due diligence that gatekeeper firms do on prospective issuers is substantial, says Neil Johnson, managing director and head of corporate finance at nomad/broker Canaccord Capital (Europe) Ltd. in London.

Johnson says Canaccord probably rejects eight of 10 companies that approach it seeking a listing on AIM. In part, that’s a business decision, as Canaccord is determined to focus on higher-quality companies to cultivate a reputation with the City money managers that are the core constituency for AIM listings. Other advisors may not be so rigorous, but then they aren’t likely to see much repeat business, either.

It appears that the AIM’s ability to remain relatively scandal-free can be traced to the fact that it’s largely an institutional playground. British regulators prefer to leave it to the market to mete out discipline in areas in which there are only institutional players. The theory is that, among sophisticated players, there’s very little incentive to tout dodgy issues for fear of sullying your reputation with major investors.
The consequences are so huge — either ruining access to liquidity or losing the ability to do business altogether — that firms will work hard to ensure that prospective listings deserve to be there.

The approach doesn’t work quite as well on the retail side because of the huge information disparity that often exists between the pros and retail investors. It can take years for lousy retail products to reveal their true colours, so the incentive to cheat may be much higher.

However, when all the players involved in market transactions are sophisticated institutions, the British preference is to let the market sort it out. Indeed, Robin Gordon-Walker, press officer at Britain’s Financial Services Authority, says it does make a definite distinction between the retail and wholesale sides of the financial industry. Most of its rules prescribing market conduct apply to the retail side.

As well, the FSA’s enabling legislation requires it to facilitate innovation and not make rules that hamper competition, notes Gordon-Walker. Such an underlying principle means it’s not surprising that markets may be able to function with few prescriptive rules. IE