EDITORIAL PAGE — Avoiding conflicts

Last October, in the wake of the Cartaway Resources fiasco and other “controversial incidents” that shook investor confidence and cast a pall over otherwise buoyant equity markets, Canadian securities regulators formed a committee to examine the potential conflicts of interest that arise when brokers and investment firms participate in junior (or emerging) company investments.

The committee’s mandate was not to focus on specific incidents. Rather, its priority was to determine whether market confidence was being harmed by current practices and, if so, to make recommendations to ensure that the integrity of the markets be maintained.

In developing the report, the committee spent three months consulting with investors, corporate issuers, brokers, investment-firm executives and regulators. The first part of the exercise was designed to determine if existing rules and regulations adequately protect investors.

The committee concluded that, for the most part, the existing regulatory framework works well. It noted, however, that gaps do exist, and that, on occasion, these have resulted in the unfair treatment of investors and issuers.

The committee also concluded that imposing a prohibition on the financing activities of investment firms and brokers in this market area would be “unnecessary and counter-productive” and have a detrimental impact on capital formation, given the key role played by the industry in providing early-stage financing for small business. Even so, the committee concluded that new rules are needed to fill gaps in the existing framework and strengthen market confidence.

In late February, the Joint Securities Industry Committee on Conflicts of Interest released an interim report containing eight recommendations designed to offer further protection for investors who buy newly offered securities of emerging companies. Three main recommendations were made.

First, the committee called for the implementation of more stringent client-preference rules, requiring investment firms to give priority to client orders over orders from members of their firms.

It was also recommended that disclosure be made to investors in investment firm and broker holdings, before the investors buy those securities. In our view, this call for enhanced disclosure is critical and ought to implemented — the sooner, the better.

Lastly, it was recommended that, once investment holdings reach a specific threshold, certain requirements be placed on investment firms and brokers that sell privately placed securities and that trade in and underwrite public- and private-placement securities.

It was also suggested that provincial securities commissions implement appropriate rules to govern conflicts of interest (especially those involving personal investments) experienced by the investment managers of mutual fund companies.

At this stage, these are only recommendations, and the committee is now soliciting comment on its proposals. Submissions are welcome until April 11, at which time the committee will begin preparing a final report for the provincial securities commissions and the self-regulatory organizations.

This attempt to bring about clear and concise conflict-of-interest rules and regulations is necessary and overdue. Retail investors should not have to take a back seat to brokers and investment firms that participate in the financing of junior companies. Nor should they be left in the dark about conflicts of interest that arise when industry professionals invest in emerging companies. The best protection for investors is “full, true and plain disclosure.”