Investor Protection

September 13, 2016 | smeditor

Exempt Market Dealer: Private Issuer and the Accredited Investor

There are changes afoot. The issues include, but are not limited to, proposed amendments to National Instrument 45-106 and its definitions of Private Issuer and Accredited Investor Exemptions; and Trapeze Asset Management.

The Canadian Securities Administrators (CSA) completed public consultation meetings, here, in February to examine possible changes to the prospectus exemption and accredited investor prospectus exemption. The minimum amount exemption was created in 1966 at $97,000 and not available to individuals. In 1987 it was increased to $150,000 and expanded to include individuals. The concern is that such a finite test of minimum investment has no direct relationship to the financial sophistication of the investor. The Accredited Investor exemption is based on net financial assets, before taxes, exceeding $1 million, net income before taxes exceeding $200,000 ($300,000 including spouse), net assets greater than $5 million. These people are deemed to be able to protect their investments without regulatory interference (and the related costs), and therefore issuers do not have to provide disclosure materials to them. It is assumed these people have the ability to obtain pertinent information directly from the issuer.

The big questions:

  1. Are these criteria sufficient to determine, 1) financial sophistication, 2), ability to withstand loss, 3) resources to obtain expert advice, and, 4) appropriate incentive to evaluate the investment?
  2. Should the criteria be more subjective and include, 1) actual resources, 2) educational background (I envision complaints of discrimination), 3) work experience (same picture), 4) actual investment experience?
  3. Does a minimum investment, 1) discriminate against experienced investors who don’t meet the AI test, 2) reduce an issuer’s (especially SME’s) access to capital, 3) motivate inappropriate diversification even for AI’s, 4) create unfair access to legitimate investments, or 5) reduce access to experienced investors because such investors determine the minimum investment level is not appropriate for that specific issuer?
  4. How will changes to the exemptions impact issuers and their underlying capital investments and employment activities?

My answers: 

  1. Current minimum investments and finite net worth measurements do not ensure adequate protection of people who need to be protected. Recent widows may meet these tests, but have little to no investment experience. Investment minimums should be significantly reduced or eliminated.
  2. Since minimums have not provided protection to so many investors, they have only served to motive inappropriate investment and reduce or eliminate needed diversification. Minimums have also stifled access to capital and access to experienced and knowledgeable investors.
  3. Education and work experience requirements discrimination against self-taught experts with significant market knowledge and trading experience.
  4. Appropriate criteria to determine financial sophistication should be based on:
    1. market knowledge,
    2. trading experience,
    3. access to and actual use of (not just financial wherewithal for) “independent” expert advice,
    4. diversification of risk, and
    5. ability to withstand financial los
  5. Short form disclosure should be based on the complexity and novelty of the product and the following should be required:
    1. Issuer conflicts of interest or potential conflicts of interest,
    2. Director certification of financial information,
    3. Material risk
  6. There is overwhelming evidence that investment size does not always create an adequate incentive to evaluate risk. Therefore, independent third party evaluation of this new criteria for Accredited Investors is the best form of consumer protection.
  7. Finally, based on the colossal failure of so many “professional” investors (who would currently qualify as a “eligible securitized product investor”), to protect tax payers, shareholders and pension beneficiaries, no investor should automatically qualify without an independent third party evaluation of financial sophistication relative to their size and scope of underlying investor/investment.

Consequential Disclosure: There are many changed being proposed by securities regulators, including to securitized products. I will not go through them in detail, but I will direct you to OSC notice, here. The financial industry, especially those working in the exempt market, cannot ignore the intertwined issues of disclosure, securitization and investor/investment exemptions and possible changes to the surrounding legislation. On a macro level they are a major source of systemic risk. On a micro level they are a current or potential source of revenue and loss.

These issues can be overlapped with the recently introduced Jobs, Growth and Long-Term Prosperity Acthere, and more specifically with its amendment to the National Housing Acthere, found in the Stikeman article, here. I am not a securitized products expert, but making insured mortgage loans ineligible for covered bond collateral should motivate disclosure issues and product changes for the industry.  Though covered bond are exempt from the proposed securitized product rules, new vehicles created by this new gap may be considered securitized products.

With Disclosure being my suggested 2013 word of the year, the mention of disclosure obligations in the world of securitized products will no doubt translate into similar obligations in the private issuer and exempt market world.

Risk Identification: What is the significance of Trapeze? I will let you google the recent issues with IIROC, the OSC and various plaintiff lawyers who have launched client claims or are considering class action lawsuits. This is just one of many cases involving exempt issuers and exempt investors and these types of investor loss cases form part the motivation for prospective changes by the OSC and CSA. It is only when investor losses are made public that investors, investment advisors, portfolio managers and regulators are motivated to identify risk and implement loss control tools.

The ultimate risk is loss of some or all of the underlying investment.

Loss Control Opportunity:

  1. Strict adherence to Know-Your-Client rules,
  2. Strict adherence to Client / Investment suitability rules and guidelines,
  3. Limited separation of portfolio/product management from client and communication management,
  4. Independent third party review of issuer/manager/advisor practices and procedures,
  5. Independent audit of client accounts for suitability and risk disclosure,
  6. Direct and probing questions of issuers/managers/advisors (the creators and regulators of the exempt market have made the assumption that investors have adequate knowledge of and access to the issuer and the product details; therefore, the investor must take action to protect themself),
  7. Creation and support of investor networks and investor protection advocacy groups,
  8. Independent research and advice (even some of the biggest professional investors do not seek adequate independent research and advice),
  9. Investors requesting evidence of Insurance (D&O, E&O and Fidelity – see below), and determine adequacy of limits based on potential loss, (it provides at least some evidence that a risk review of the issuer/manager/advisor has been done by a third party financial institution, who has accepted some financial risk and has a vested interest in the successful operation of the issuer/manager/advisor),
  10. Investors to request quotations for contingent fraud/negligence insurance (see below), because this motivates a risk review of the issuer/manager/advisor by a third party financial institution, who has accepted some financial risk and has a vested interest in the successful operation of the issuer/manager/advisor and in the loss control activities of the investor),

Insurance Spin:

There is no readily available market for investors to purchase their own (first-party) insurance protection for contingent advisor/manager/issuer fraud and/or negligence to cover loss of their investment. There is great need for such product but there is low demand and pricing seems to be too expensive to make this a common risk management tool. But, showing interest and demanding quotations for such insurance will eventually expand market appetite and reduce insurance premiums.

Fidelity insurance (FIB or Crime or 3D), directors’ and officers’ liability insurance (D&O) and professional liability insurance (aka E&O) are common insurance policies available to financial advisors and fund managers. However, these insurance products are not always purchased by issuers/managers/advisors, and if they are the limits may be inadequate when compared with the potential loss. Another downfall of this insurance is that the individual being accused of negligence or fraud might be the same person who purchased the insurance policies, and their negligence or fraud could be the basis of the insurance company’s denial of coverage.

If you are a professional investor, individual investor, fiduciary, private issuer, fund manager, investment advisor, exempt market dealer, or have clients who fall in any of these categories, and you would like to discuss risk management and insurance, please don’t hesitate to call me directly.

Greg Shields is a D&O, Professional Liability and Crime insurance specialist and a Partner at the University and Dundas (Toronto) branch of Mitchell Sandham Insurance Services. He can be reached at,  416 862-5626, or Skype at risk.first. And more details of risk and loss control can be found on the Mitchell Sandham blog at

CAUTION: This article does not constitute a legal opinion or insurance advice and must not be construed as such. It is important to always consult a registered and truly independent insurance broker and a lawyer who is a member of the Bar or Law Society of the relevant jurisdiction with regard to this material before making any insurance or legal decisions. All material is copyrighted by Mitchell Sandham Inc. and may not be reproduced in any form for commercial purposes without the express written consent of Mitchell Sandham Inc. Anyone seeking to link this document from any external website must receive the consent of Mitchell Sandham Inc. by sending an e-mail to

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