It was in the summer of 2008 that Jenn Lofgren first began to suspect that the $80,000 she'd invested in real estate funds was in jeopardy.
The fund managers at Calgary-based Shire International Real Estate Investments Ltd. weren't returning her calls.
When Shire had notified its investors about delays with its development projects, the Calgary woman called its offices to learn more, but there was no answer.
A year later, after complaints from other investors, the Alberta Securities Commission imposed a cease-trade order on Shire "because of allegations of misrepresentations and fraud."
"We knew at that point, we were done," Lofgren told CBC News.
Shire is now in receivership, and Lofgren says there's "no hope" of recovering her money.
She and other Shire investors have launched a $75-million lawsuit against the officers of Shire in the hope of getting some of their investment back.
Among other things, the suit alleges misrepresentation and breach of trust. None of the allegations have been proven in court. CBC News was unable to reach a Shire spokesperson.
Shire raised capital in the exempt market, something Lofgren now says should not be allowed.
"I would never invest again in any exempt market type of program or funds," she said.
Greater onus on investors to assess risks
Although not well known, the exempt market is a significant one. In 2008, Alberta companies alone raised more than $10 billion there, more than double what they raised on the TSX and the TSX Venture exchanges.
The idea of the exempt market is that promising, small companies on shoestring budgets can raise capital without the expense of a public listing and the associated reporting requirements. Unlike publicly traded companies, they aren't required to provide a prospectus — a detailed explanation of their business and of the investment risks — and have it reviewed by a securities commission.
The onus on investors to check out the risks is much greater than in the public markets.
Recent controversies involving exempt issuers underline those risks.
On June 10, 2009, a court ordered Concrete Equities — another Calgary-based real estate investment fund — into receivership in a move that has left some investors with only pennies on the dollar and others with no more than 50 per cent of their original investments.
In another case, the Alberta Securities Commission alleged that Milowe Brost and Gary Sorenson, two Alberta men accused of running a Ponzi scheme that defrauded investors of $100 million, were involved with Arbour Energy Inc., which raised capital on both the public and the exempt markets. Brost and Sorenson were charged in September 2009 with fraud and theft.
The Canadian Securities Administrators — an association representing securities commissions across the country — in September 2009 introduced new rules on exempt issuers.
When implemented, those rules will ban people from selling exempt market securities if they have criminal records or lack securities training.
Exempt market good for 'niche ideas'
The exempt market has its defenders. One of them is Stephen Johnston, a partner in Calgary-based Agcapita Partners, a farmland investment fund that has used the exempt market.
"It's useful for smaller ideas to get off the ground without the overhead of participating in the public markets," said Johnston. "It allows people with niche ideas to raise capital effectively."
Agcapita has come up with a list of the top 10 questions investors should ask themselves when considering investments in the exempt market (see sidebar).
What to watch for when investing in exempt market:
- Fund managers with a proven track record of generating good returns.
- A clear investment premise. If you don't understand the business, don't invest.
- Tax efficiency. Make sure reasonable steps have been taken to manage tax obligations.
- Financial statements. Management's past failure to publish statements is a red flag.
- Regular reporting by managers on their operations and a willingness to answer investors' questions.
- A clearly defined hold period for assets in the fund. Investors need to know exactly when they will receive repayment from their initial investment.
- No sales of previously bought assets by managers into the fund, even if disclosed, for an upfront profit to them.
- No upfront fees where managers get paid a portion of the capital to be deployed.
- Management fees should not be tied to appraised asset value increases but only on gains made on actual sales.
- Management fees should only reward performance, where managers' rewards match investors' returns.
Source: Agcapita Partners
Lofgren accepts that it's a good thing when legitimate companies can get access to cheap capital, but even following Agcapita's list of questions, she said, won't protect investors from companies that set out to commit fraud.
Jason Dunn, another Calgary investor who has lost at least $10,000 in the Concrete Equities collapse, doesn't share that view. He wants investors to have as many choices as possible — even high-risk ones — but he does agree that investors should be protected against fraud.
Lofgren has set up a blog about her experience with Shire. In the eight months since she launched it, 800 Shire investors and concerned citizens have contacted her. Lofgren has formed connections with a dozen other investor groups across Canada who believe they have been defrauded both in the public and the exempt markets.
"I realized that this is a widespread problem, and this isn't just a case of one or two companies finding a loophole in the law," she said.
Together, they are lobbying the federal government for tougher penalties and more resources for the RCMP to investigate commercial crime.
Lofgren wonders how ordinary investors can hope to scrutinize financial statements to catch outright falsehoods or undisclosed deals with related companies and individuals.
"That's an awful lot of research," she said. "How far does the average Canadian need to go [to detect fraud before investing]?" she asked. "Do we need to hire a forensic accountant?"
She suggests that without tougher enforcement, the amount of effort required by Canadians to detect fraudulent investments will undermine the confidence of all investors.
"People just wouldn't invest anymore," she said, "if they knew that this is what you have to do."