re infoThe right to lose money
by KEITH KALAWSKY
The OSC will improve access to private placements--but the quality of these investments is debatable
2001-03-05
Yeah, yeah, so you're filthy, stinking rich. But are you a sophisticated investor? To Vic Alboini, president and CEO of Toronto-based Northern Securities Inc., a six-figure salary and a hefty savings account aren't signs of investing prowess. "People can win money in lotteries or at the racetrack, so having a nest egg of $150,000 doesn't mean they're sophisticated," he says. He has a point. The assumption that wealth signals investing know-how, which underlies the Ontario Securities Commission's rules governing private placements, is misguided.
Companies sometimes raise capital by selling equity stakes to large (usually institutional) buyers to avoid the red tape and disclosure requirements of a public offering. Much to Alboini's annoyance, the OSC requires investors (with some exceptions) to pony up a minimum of $150,000 to qualify for a piece of the action. Translation: only the rich can afford to invest in private placements. This paternalistic legislation protects less wealthy (read: naïve) investors from losing money on speculative deals. Unlike publicly traded securities, which are valued by the open market and heavily regulated, private placements don't offer investors the same disclosure--or peace of mind.
But the minimum investment rule is too strict and outdated. Investors are more sophisticated than ever before. Meanwhile, the $150,000 requirement is turning away investors who have the money, but won't plunk all of it down on a private placement. They'd rather invest, say, a few thousand. This limits the pool of potential investors and forces some companies to tap the US for capital. US investors qualify for private placements with a net worth of US$1 million, annual income of US$200,000 or US$300,000 with a spouse. There's no minimum.
According to the OSC's proposals, which may be implemented by summer, the minimum investment rule could be scrapped. Instead, investors will need $1 million in financial assets, net income of $200,000 or joint net income of $300,000. Alboini isn't satisfied. There aren't enough investors in Ontario with that much money. He wants the financial asset threshold cut to $200,000 and people allowed to invest up to 20% of their cash assets.
Alboini's mission to democratize private placements is admirable. But rhetoric about the discrimination suffered by less wealthy investors shouldn't steer this debate. A better question: By relaxing the rules, what is the OSC getting investors into? While access to private placements will improve, the quality of these investments is debatable. Established companies typically restrict placements to institutional investors, so middle-class types will be left to invest in small, unproven companies.
Alboini has a huge stake in private placement reform. Northern Securities is an investment bank that raises capital for small-cap companies--those often ignored by the big banks and large venture capitalists. In 2000, Northern handled 20 deals for companies such as Icon Laser Eye Centers Inc. Northern's business will double if private placement rules are relaxed, he estimates.
But what if brokers get overexuberant? We could witness a resurgence of boiler-room tactics exploiting people who should be investing conservatively. The OSC must simply force brokerages to explain the risks of investing in private placements, Alboini counters.
It sounds weird, but Alboini figures everyone should have the right to lose money. "There's no reason why somebody can't look at a private placement and say, 'You know, this looks like a neat little company. Why don't I take a flier on this?'"
He's right. The OSC should relax the rules. But his demands go too far. The OSC shouldn't remove restrictions to the point that anyone can be talked into sinking a big chunk of their savings into highly speculative investments. Sure, investment banks worry about losing business to the US. But investor protection and access to capital for small firms are bigger concerns. Companies with solid business plans should be able to raise cash--without relying on retirees in Calabogie or Kapuskasing for a couple of thousand bucks.