Stepping up for exempt-market dealers

“We’ve met with the various regulators,” says Brian Koscak, chairman of the EMDA and a partner with Toronto-based Cassels Brock & Blackwell LLP, “having an open dialogue basically to increase communications and understanding of what our members do and how they do it, so the regulators can regulate better and be sensitive to this marketplace.”

Another non-profit association, recently launched in Calgary, has a very similar mandate, albeit with a more concentrated regional presence. The Western Exempt Market Association has been established to bring together exempt-market players in British Columbia, Alberta, Saskatchewan and Manitoba and to lobby securities regulators on their behalf.

WEMA was launched in part because of the growing need for the exempt market to communicate collectively as regulators zero in on this segment of the investment industry, which, until recently, largely had escaped regulatory oversight.

“There certainly is more time and energy being spent on looking at the exempt market than there ever has been before,” says Craig Skauge, president and chairman of WEMA and business development manager and director with Olympia Trust Co. in Calgary. “For any regulated industry, there’s going to be constant questions and constant changes, regulatory-wise. So, I think it’s important to have that organized voice.”

Regulators had first beefed up oversight of the exempt market through National Instrument 31-103 with the establishment of a new “exempt-market dealer” category that forces firms across the country that deal in prospectus-exempt securities to register and comply with regulations.

Firms in Ontario and in New-foundland and Labrador previously had been required to register under the “limited market dealer” category that had existed in those provinces. However, players elsewhere had never experienced this type of oversight, and have faced numerous challenges in developing and implementing compliance systems for the first time.

“Going from operating in an unregulated environment to suddenly operating in a very regulated environment — I just don’t think there was a full appreciation as to how much time and resources have to be spent on compliance,” says Skauge, noting that some firms have spent hundreds of hours and millions of dollars. “It’s been a little bit more of a burden than everybody thought it would be.”

That burden could continue to grow. The Canadian Securities Administrators and some of the provincial securities commissions have indicated they’re reviewing certain practices they consider problematic in the exempt-market sector, which suggests more regulatory changes could be in store.

“A lot of the regulators are sort of waking up to some of the issues and challenges in the exempt market,” says Geoffrey Ritchie, executive director of the EMDA and national director of compliance and risk management with Bank of Montreal’s BMO Harris Private Banking division. “There’s never been a more important time for the exempt-market space to have a strong, competent and authoritative national voice.”

The EMDA maintains that a single, national voice for the entire sector is more effective than different voices across the country. EMDA directors point out that the regulations pertaining to exempt-market dealers under NI 31-103 are national in scope.

“We think that any solution or matters that involve review and investigation,” says Koscak, “can only be done on a national basis, while being sensitive to local, regional needs — just the same way the CSA operates. If you’re there just to advocate your very specific concerns in the absence of the national debate, you may find that your voice is weakened.”

However, members of WEMA argue that there are enough discrepancies in the rules — particularly, between the eastern and western provinces -— to warrant the need for a separate voice for the exempt-market sector in Western Canada. Says Darvin Zurfluh, a WEMA director and CEO of Edmonton-based Pinnacle Wealth Brokers Inc.: “The rules are different; the players are different. There’s a lot of differences in the types of transactions that are happening.”

The most notable difference in the rules that pertain to the western provinces is the so-called “northwest exemption,” which has been adopted by securities commissions in the western provinces and the three territories. This exemption allows firms and individuals in these provinces to trade in exempt-market securities without being registered in the EMD category, as long as they’re not registered in another category of the investment industry and they’re not providing suitability advice, among other stipulations.

This exemption has been controversial. Some industry-watchers believe it should be abolished so that everyone dealing in exempt-market securities is registered and subject to the same oversight and standards. But others argue that firms that aren’t in the business of selling securities full-time should be able to raise capital for their businesses through the exempt market without having to register.

But those on both sides of the debate acknowledge that the exemption is being abused by certain players, which must be addressed by regulators.

In general, members of the exempt-market sector are not against regulation. In fact, many players support rules that protect investors and enhance the professionalism of the sector.

“If it were regulated the way it is now five years ago, I think investors would have lost a lot less money,” says Zurfluh. “And the quality of investments is higher when it’s regulated.”

But exempt-market players want to ensure that regulations are well thought out and achieve a balance between preserving the ability to raise capital and protecting investors.

They’re concerned regulators will react in a “knee-jerk” manner to issues that arise and hastily craft regulations that could have unintended consequences.

A key concern is that those developing regulations don’t fully understand the exempt market and how it works. Says Skauge: “They’ve thrown a wide net toward the exempt market. They’re trying to treat the exempt market like the rest of the capital markets, but it is different.”

To address this, both WEMA and the EMDA are actively trying to educate the regulators — as well as the rest of the investment industry and the broader public — on what the exempt market is and how it works.

Although the EMDA supports a single national voice, Ritchie says, it’s encouraging that other sector members are collaborating to raise awareness: “The more we can do to raise attention at the regulatory level, the more we can do to raise the dialogue within the exempt-market space across the country, the better off we’re all going to be.” IE