As securities regulators eye changes to exempt market placements— non-listed companies — a prominent economist has warned against making changes in the absence of data.
“You could end up getting a lack of confidence in the markets,” says Jack Mintz, Palmer Chair of Public Policy at the University of Calgary. He was speaking at the Private Capital Markets Conference in Toronto in May.
Ontario has recently proposed to limit the amount of money that investors can put into a private offering – say a mortgage company, a real estate fund or an oil and gas concern –through an offering memorandum. For non-eligible investors, it’s $10,000 a year. For eligible investors, it’s $30,000 a year. Eligible investors have to have a net worth, excluding their principal residence, of $250,000. Other perovinces are also considering a $30,000 cap.
“I do think it’s a significant advance that Ontario is now going to adopt the OM regime for exempt markets — right now the only people who can buy are accredited investors — and this will broaden the whole market,” he says.
But he has a caveat: “my view is that we have to put the regulation on the issuer, rather than the type of investor.”
Ontario’s proposed regime, he fears, will magnify the problems of adverse selection and moral hazard, and sap investor confidence.
“When you have problems of adverse selection – that is, the seller has more information than the buyer — then what you also have is moral hazard, where people might try to misrepresent or participate in fraud,” he explains. “When those issues come up where the buyer cannot tell the good from the bad then what happens is you could end up getting a lack of confidence in the markets and the good participants, the good sellers who are trying to participate in the market, end up getting hurt by the bad apples in the cart.”
Regulating the type of investors imposes burdens on larger firms who have to seek more investors to reach their financing goals.
“The worst kind of policy is one in which you impose more costs on the good sellers as opposed to the bad sellers,” he says, “and in fact, the $30,000 cap, in my view, exactly has that property because the $30,000 cap can particularly work against the larger issuers who then have to find more investors and incur more costs to find these investors as opposed to small firms that might not be as good quality as this. Because size of the firm is at least one indicator of quality.”
There is very little data to suggest such a limit is reasonable. Apart from that, there is a paucity of data about private market issuers, even though private market issuers actually raise more money than do public companies. Compounding that is a lack of information about what sorts of enforcement issues regulators encounter in monitoring private market investments. Regulators are “shooting in the dark,” Mintz suggests.
“It’s very important in my view that regulations, taxation and other public policy tools should always be based on evidence because we want to make sure that we’re making the right decision,” Mintz says.
He suggests that better enforcement would obviate the need for more regulation. “You need less policy if you have better enforcement to ensure that the bad apples are going to pay penalties for misrepresentation, fraud or anything else like that.”
But regulation has a number of purposes, he adds, and investor protection, and concomitantly, investor confidence, is only one of them.
Another function of regulation is to encourage market efficiency. “The whole growth of financial intermediation in markets,” he says, “is to bring buyers and sellers, borrowers and lenders, together, and try to get the costs of financial intermediation as low as possible.” There are economic costs when intermediation is inefficient, he adds.
A still further purpose of regulation is “financial market stability – where you have a bank run or a profit run on a security, that can create a lot of instability where other people might start dumping the security. So the whole idea of financial regulation is also to try to reduce some of the volatility in markets as a result of a lack of confidence.”
These objectives have to be balanced. Mintz doesn’t think they are, at least in the private marketplace.
“The problem I have with the current regulatory regime is that it’s focused on the type of investor that participates in the marketplace,” he says. “That’s not really the right regulation. The problem is to meet the confidence of markets, not to identify which type of investor can participate in the markets.”