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This article was published 18/3/2011 (2497 days ago), so information in it may no longer be current.
Investment fraud, in theory, should be easy to spot.
The so-called red flags advocates harp about every March for Fraud Awareness Month should be etched into our collective memory to the point where the putrid scent of a marketing pitch for a dodgy real estate deal repels us.
We know promises of high returns with little risk, exclusive expert-only deals or offshore tax havens are indications something's awry. Yet in practice, spotting downright dodgy investment deals seems as if it must be much more difficult.
According to a 2011 report by the Canadian Foundation for Advancement of Investor Rights (FAIR Canada), a 2009 survey found more than 1.3 million Canadians have fallen victim to fraud at some point in their lives. While many were victimized for a few hundred or even a couple of thousand dollars through credit card fraud or other types of identity theft, others were hit much harder.
The unfortunate reality is investment fraud is thriving in Canada because few perpetrators ever get investigated, let alone sentenced to any jail time, says Ermanno Pascutto, executive director of FAIR Canada.
"I think people have come to realize that Canada is an easy target for investment fraud," says Pascutto, a Toronto securities lawyer and former head of staff at the Ontario Securities Commission.
Every year, he says, people are being defrauded of millions — if not billions — of dollars and the few scammers who do get caught are hit with sentences that are hardly a deterrent.
"Even if you're convicted, you probably will only spend a few months in jail," he says
"And you've hidden your money, so when you come out, you drive off in your Mercedes-Benz."
Take the case of investment adviser Earl Jones in Quebec, who defrauded retirees of millions. Even though new legislation has increased the time white-collar criminals must serve before parole, Jones could still serve less than four years of his 11-year sentence.
Compare that to the United States, where Bernard Madoff, who ran a multi-billion-dollar Ponzi scheme, will die in jail, sentenced to 150 years in the slammer.
Both Jones and Madoff operated in the exempt market, providing investment opportunities that are lightly regulated, not listed on exchanges like stocks and are sold without a prospectus, a detailed document that accompanies mutual funds or other securities.
It's a sector of investment, Pascutto says, that is rife with fraud.
Of the more than $66 million in penalties and fines handed out by Canada's securities regulators last year, more than $53 million were levied against individuals and firms in the exempt market.
Although more enforcement, such as a national fraud investigation agency, would help, regulations that permit just about anyone to invest have provided a source of capital to be exploited by less-than-honest players, Pascutto says.
"The concept of the exempt market is investors are sophisticated and don't need regulators to protect them," he says. "But they added an exemption for accredited investors, which means basically anyone on two legs that has some money."
Furthermore, no one checks to see if investors actually have enough assets or income to qualify as accredited, he says.
Manitoba Securities Commission fraud investigator Len Terlinski says it's true it's left mostly to firms offering exempt market investments to verify whether their investors qualify.
"There's also a requirement to file those exempt sales with the securities commission," Terlinksi says. "But because it's exempt, it's very lightly regulated and nobody's going around to every one of these companies to see if they're following the rules exactly."
The exempt market is lightly regulated for a reason, he adds.
"The idea is to let knowledgeable businessmen do business without the government interfering," he says, adding Dragons' Den on CBC is the ideal example of how the exempt market should work.
People have businesses that need capital and they seek investment from venture capitalists who understand the risks involved.
But there are many jurisdictions that allow investors with less capital and possibly less experience into the game. In Manitoba, for instance, an exemption exists permitting anyone to invest up to $10,000 as long as the investment has an offering memorandum providing details of the investment and the investor signs a risk-acknowledgment form.
"Once you start selling this stuff to the general public, that's when the problems start, because these people often really don't know what they're getting into," Terlinski says.
Yet tightening the investor requirements to the point where only high-net-worth firms and individuals can invest in this space would cut off a source of vital capital to burgeoning companies in Manitoba, argues a Manitoba-based firm specializing in the exempt market.
The current regulations aren't "optimal," says Sheldon Stier, president of Hatch Alternative Investments, a Winnipeg firm.
But he says the industry is working toward better standards, including licensing for exempt market dealers, and many reputable dealers already belong to the Exempt Market Dealers Association of Canada.
Both improve standards for dealer conduct, but Stier says it's unclear whether there would ever be a self-regulating organization like the IIROC (the Investment Industry Regulation Organization of Canada), which oversees the conduct of brokers and can impose penalties for violations.
"If you keep layering on oversight, while there might be a benefit to it, it takes away from the value of the wholesale model of the exempt market," he says.
One of the main reasons the exempt market exists is so smaller firms can access investor capital without the cost of listing on an exchange.
Savvy investors, in turn, can potentially benefit from this lower-cost model through higher returns.
And in most instances, exempt-market investment opportunities are indeed legitimate, Terlinski says.
Then again, just because it's not fraud doesn't mean it's a good deal, either. The potential risks and costs, while cited in an investment's documentation, can often be hard to find, even for professionals.
Terlinski says MSC investigators recently reviewed an offering memorandum for a real estate deal in the exempt market. It took them a few days to find while it wasn't fraudulent, it certainly wasn't a good investment.
"After fees and everything else you pay, the property would have to increase six or seven times in value to make your money back," he says.
Unfortunately, many investors don't bother to apply the same scrutiny, nor do they usually have the ability to do so.
"Before you sign on the line in a subscription agreement, you should at least be looking at getting some objective advice from somebody with business experience," he says.
Stier says these offerings that lurk in the grey area of legality often attract investors who get swept up in flashy presentations.
"The art of the snake-oil salesman is alive and well," he says.
"At the end of the day, what we're trying to do is educate investors that there are people that are a little more sensational and promotional."