Beware of Exempt Market Products

People regularly ask me about a piece of investment advertising material they’ve come across that seems too good to be true. Before I even look at what they’re referring to, I can usually assume it has some relation to an Exempt Market Product or security.

So what are these Exempt Market Products (EMPs) and are they something you should be considering? An EMP is a security issued in Canada that is exempt from prospectus requirements and they require less disclosure than a prospectus offering.

To sell an EMP, the issuer must ensure that the investor qualifies under a specific “exemption”. Common exemptions include only selling to an accredited investor or only selling them to family, friends and business associates. Depending on the exemption relied upon, these products often don’t have detailed disclosures and it’s up to the investor to perform much of the due diligence themselves. Unfortunately, due to a lack of oversight, many unqualified investors are still being sold these products.

EMPs carry many serious risks that the salespeople often don’t explain. The main concerns are:

  • Lack of liquidity – Many EMPs are illiquid and investors can’t access their money if they want to.
  • Not insured – Unlike traditional investments, they are not protected by the Canadian Investor Protection Fund, the Investor Protection Corporation or Assuris.
  • Inadequate disclosure – Their offering documents are not reviewed by regulators for completeness and it can be difficult to find out what you’re really buying until it’s too late.
  • Subject to key person risks – Exempt products are generally smaller operations and the loss of a single individual involved could create significant losses in the values.
  • Conflict of interest – Unlike regulated products, there may be significant conflicts of interest that are not being disclosed to the investors.

Not long ago, the Ontario Securities Commission concluded a year-long review of firms selling EMPs. They found a range of deficiencies in many firms, primarily around selling EMPs to investors who did not qualify. The OSC said that 75 per cent of EMP dealers had inadequate processes for collecting and maintaining know-your-client information.

In the rest of the country, the situation is not any better. But the much bigger problem in all this is that even if an investor is eligible to purchase an EMP, is the product actually suitable for them?

Many of those who sell EMPs try to tell investors that their products are actually less risky than standard investment options since they’re not subject to the normal market volatility. But from a regulatory point of view, exempt product are high risk.

Many investment dealers (the “back office” responsible for compliance oversight) go so far as to require that advisors under their umbrella can’t work in the same office as someone who sells EMPs. They are very fearful of lawsuits that regularly result from these high risk investments and they don’t want to be associated with them in any way.

To be fair, there are legitimate firms and dealers that operate in the exempt market space but it’s up to the consumer to decide which ones are legit and the majority of Canadians aren’t properly informed to make an informed decision.

It’s your money and you can invest it in whatever you want but be sure to think twice before taking part in any exempt market plan. When something sounds too good to be true, it usually is…