Dear Ministers, Chairs, Committee Members, Regulators, and Stakeholders,
Discovery Capital is pleased to provide our comments to the Provincial Finance Ministers Inter-Provincial Securities Initiative, as well as the Wise Persons Committee, with respect to the possibilities for Canadian Securities framework reform.
Introduction to Discovery Capital Corporation
Established in 1986, Discovery Capital is one of BC's leading venture capital firms, having worked with over 250 technology companies on an advisory, corporate finance, and/or venture investment basis. Since 1993, Discovery Capital has managed a family of venture capital funds, focused exclusively on emerging technology sectors in British Columbia. Portfolio investments have included Sierra Wireless, A.L.I. Technologies, INEX Pharmaceuticals, Bennett Environmental, and TIR Systems.
Context of Our Comments
As a venture capital firm, Discovery Capital has typically entered into its business relationships with emerging technology companies while they were private Issuers, and through the course of our involvement, we have actively participated in their transition to reporting Issuers and listed companies. Our portfolio companies have become public companies by listing on the VSE, ASE, CDNX, ME, TSX Venture Exchange, and TSX/TSE, through IPOs, Reverse Takeovers of JCPs and CPCs, and "shelf" Prospectus listings. We have had extensive experience with continuous disclosure requirements, and we have established working relationships with all registrants that have been active in financing junior technology Issuers in BC. Discovery Capital principals have worked for,
or consulted to, the BC Securities Commission and VSE, and Harry Jaako, co-CEO of Discovery Capital, has served as a Public Governor of the VSE, as an independent Director of CDNX, and currently, the TSX Group, Inc.
Situation Analysis From Our Perspective
1. For senior Issuers, we have not experienced excessive costs or delays in the receipting of Prospectuses and other regulatory documents with IPO financings, and have observed that the Mutual Reliance Review System has provided reasonably expeditious processing of regulatory approvals across the country. The regulatory cost of senior IPOs appears to be about 2-3% of the financing.
2. For junior Issuers, we have experienced excessive costs and delays in the receipting of Prospectuses and other regulatory documents with IPOs and CPC-related financings. The regulatory cost of junior financings appears to be about 10-30+% of the financing. While the timeframe we have observed for clearing a senior Prospectus is a few weeks, junior approvals can take between six and nine months.
3. The volume of rules for Issuers is up 65% in the past ten years, and the cost of compliance for junior Issuers is up by 100+% in the past 5 years (Source: BC Securities Commission).
4. Junior Issuers are not benefiting sufficiently from harmonization as a BC Securities Commission study has found that 87% of Issuers' regulatory effort is expended on regulation that is already uniform across Canada (Source: BC Securities Commission). Further harmonization or "federalization" without significant regulatory simplification appears pointless in terms of benefits to Issuers.
5. The junior market and the TSX Venture Exchange are absolutely vital to the economic growth of the BC economy. In a recent survey of member CEOs, the BC Technology Industry Association found that the number one concern facing the technology industry was access to venture capital, and yet BC's share of Canada's private venture capital under management has declined since 1995. B.C. raised $503 million of new private venture capital between 2000 and 2002, to total $1.1 billion under management. In 1995, B.C. had 6.8% of Canada's venture capital ($329 million of $4.85 billion), but by 2002, B.C.'s share had declined to 4.9% (Source: Macdonald & Associates). For the technology sector, BC must look to the public market to contribute critically needed venture capital. For the junior mining market, there is no viable private venture capital alternative.
6. The junior market is local. BC Issuers tend to have BC-based professional advisors, engage BC-based registrants as agents, raise practically all of their exempt-stage capital in BC, and, once listed, raise a significant percentage of equity in BC. Since junior Issuers rarely receive research coverage, there is typically little participation by national and international capital markets in these Issuers' financings. The lack of research coverage of junior listings is not likely to change in the future.
7. The BC Securities Commission has found that due to the junior nature of market activity in BC, a very small percentage of the regulatory actions it has prosecuted have arisen from problems with Prospectus disclosure.
Recommended Regulator Model
1. Implement the Passport System
We believe a passport system for securities regulation in Canada is the most effective method for achieving both regulatory efficiency and preserving local market characteristics. The opportunity for Issuers and their insiders to deal with a single regulator when registering or filing in more than one jurisdiction would significantly streamline the process and deliver tangible economic benefits. The passport system would also have the positive effect of encouraging elimination of remaining discrepancies and overlaps in the existing definitions, rules and regulations, as well as encouraging the harmonized development of new ones.
2. Simplify the Regulatory Regime
We believe that significant benefits of uniform laws and regulatory harmonization have already been achieved with the efforts to date in this regard by the Provincial Securities regulators, although there is ample opportunity to achieve further consistency across the country. However, the streamlining and simplification necessary to relieve junior Issuers of the unconscionable regulatory burden layered onto their relatively small financings has not yet been undertaken. For the junior market, timely simplification is critical, and should be the highest priority of regulators. Further, simplification will benefit all stakeholders - at the moment, the various cross-currents of securities initiatives, rules, pronouncements, proposals and recommended practices are costing Issuers enormous time and financial resources which cannot continue to be absorbed by their businesses.
3. Retain the Opportunity to Innovate Regionally
The Inter-Provincial Securities Framework must preserve the opportunity to innovate regionally that has resulted in significant improvements to the regulatory regime for junior Issuers in Canada. Examples of regional advancements that have resulted in Canada-wide regulatory adoption are:
1. The SHAIF system eliminated the need for special warrant financings, stimulated private placements and provided an alternative option to prospectus financing. BC developed the SHAIF system on an interim basis in late November 1997 through a policy and blanket order. Working with the Alberta Securities Commission, BC fine-tuned the system and together the Commissions adopted the SHAIF system in both jurisdictions in 1998, (Alberta adopting it by way of local rule). Because of its success, other jurisdictions expressed an interest in adopting it on a national basis. This led to the development of MI 45-102 Resale of Securities in 2000, which was adopted by all jurisdictions in Canada in 2001. This rule finally harmonized hold periods across Canada for securities issued under exemptions and allowed issuers to qualify for a reduced 4 month hold period.
2. The capital pool program was originally adopted in about 1986 or 1987 as the Junior Capital Pool program in Alberta against the universal condemnation of other provincial regulators. There were initially a lot of problems, causing others to say "I told you so", but the ASC and ASE gradually came up with solutions that made the program work tolerably well. By 1998, the VSE decided it needed to compete, and the BC Securities Commission agreed to the setting up of the "Venture Capital Pool" program, which was similar but had differences that reflected the BC market. When CDNX was formed, the two programs were melded into the Capital Pool Company program, which was a camel that did not really suit either market. There are issues to be worked out to make it viable again, but it has gained broader regulatory acceptance, with other jurisdictions, including Ontario, adopting it.
3. The new capital raising exemptions regime, adopted in BC and Alberta in 2002, has now been adopted in every Province except Ontario and Quebec.
4. The new accredited investor exemption embedded in the new exempt regime noted above, was initially developed by Ontario, and adopted in BC and Alberta.
5. Most of the new prohibitions and powers that the Ontario Securities Commission has gained over the past few years (prohibition of fraud and manipulation, prohibition of misrepresentation, power to disqualify directors and officers, fining power) are copied from legislation adopted in BC between 1989 and 1995.
If Canada had had a uniform Securities Act, and an agreement not to make unilateral amendments, it is quite possible that some or all of these ideas would not have gotten off the ground. Canadian Securities regulation must be harmonized, but must also tolerate the testing of innovative regulatory solutions, such as the BC Model, on a pilot basis within regions. By encouraging different regions in Canada to harmonize, but at the same time encouraging regulatory innovation under the passport system, market stakeholders could follow an innovation that is launched in a region, embrace it nationally if it works, and reject it if it does not.
Such a framework will continue to invigorate securities regulation in Canada and continue the development of best practices so that Canada will continue to lead the way in the world in regulating its securities markets - particularly its unique junior market.
Discovery Capital Corporation