Proceedings of the Standing Senate Committee on Banking, Trade and
Issue 46 - Evidence - March 4, 1999
OTTAWA, Thursday, March 4, 1999
The Standing Senate Committee on Banking, Trade and Commerce met this day at
11:00 a.m. to examine the present state of the financial system in Canada
Senator Michael Kirby (Chairman) in the Chair.
The Chairman: Honourable senators, I see a quorum.
Joe Oliver, with whom we are all familiar, is here from the Investment Dealers
Association of Canada. Unfortunately, neither Ron Begg, President of the
Working Ventures Canadian Fund and the Canadian Venture Capital Association,
nor Jeffrey MacIntosh, from the Faculty of Law of the University of Toronto, is
here because neither the Toronto airport nor the Montreal airport was open.
Mr. Oliver has some opening comments to make and then we should like to proceed.
Mr. Joseph Oliver, President, Investment Dealers Association of Canada:
Honourable senators, I appreciate the opportunity to present on behalf of the
Investment Dealers Association of Canada the perspective of the securities
industry regarding financing of small and medium-sized enterprises, the
My presentation will review the major sources of equity capital for SMEs with an
emphasis on the role played by our member firms. I will then offer
recommendations. Those recommendations will be the focus of my comments. My
recommendations are designed to enhance equity financing for this critical
sector of the Canadian economy. You will not be deluged by statistics; however,
I have included more data in a written brief.
If there is more data that you should now like because the other witnesses who
would be dealing with the venture side of the market are not here, I can supply
that in my verbal remarks or in response to questions.
The goal of promoting start-up and expansion SMEs is a key objective of Canadian
economic policy because small business is the engine of economic growth. Equity
capital serves as the building block since it is the key to funds and the
start-up and expansion of a business.
Let me comment on the securities industry before I get into the recommendations.
Our industry plays a key role in raising capital for small and mid-cap
Many investment dealers arrange seed capital financings, private placements and
public offerings for smaller and mid-cap companies. Larger-sized financings for
smaller and mid-cap businesses are typically structured by the firms and
underwritten and distributed through the institutional sales desks and the
retail branch networks. IDA member firms also provide research and advice on
acquisitions and mergers, and they actively trade securities to provide
liquidity for their institutional and retail clients.
Individual brokers often arrange small-sized financings, which are referred to
as "early-stage financings." Those brokers are knowledgeable about
the company and they understand the profile and interest of local investors.
The IDA has encouraged this form of early financing. However, it has imposed
special disclosure rules and availability rules to level the playing field for
the public. The objectives are to ensure fair treatment of public investors and
to promote investor confidence in the marketplace.
Some of the large security firms have merchant banking affiliates that invest
directly in promising small businesses. Some have established independent
management funds to specialize in investing in small and mid-sized companies.
Let me give you just a few statistics. There were 225 initial public offerings
or IPOs of all sizes last year for a total of $3 billion. The real focus
probably should be on IPOs under $10 million. There were 192 issues in that
category, which raised $136 million last year for an average of $700,000 per
The Chairman: The 33 IPOs not included were huge, because you went from $136
million to $3 billion. We are interested in the 192 with the average $700,000.
Mr. Oliver: Exactly. I wanted to put it in the broader perspective. It is
interesting that the 192 IPOs accounted for more than two-thirds of the IPOs
last year, but represented only 5.5 per cent of the total capital raised.
Over the past five years, about half of the money went to mining or oil and gas
companies. I could get into more detail as to where they were done, and perhaps
I can respond to questions in that connection.
Senator Austin: To clarify, you were looking at three categories of early-stage
financing for SMEs: seed capital, private placements and initial IPOs. You have
not addressed how many seed capital financings have been done.
Mr. Oliver: That is correct.
Senator Angus: Mr. Oliver, is there a distinction to be made, because so many of
those were oil-and-gas-type resource companies having a flow-through element to
them or some rinky-dink tax scheme?
The Chairman: I think I started the problem. Perhaps we should let Mr. Oliver go
through the rest of his presentation.
Mr. Oliver: I have a written submission that contains more of those details. I
would be happy to get into them for you. I was not going to do that initially
because I thought Ron Begg would cover it. However, if that is what you should
like me to do, I would be happy to do it.
The Chairman: That would be helpful, sir.
Mr. Oliver: First, let me contrast the timing. Financings under $10 million last
year totalled $1 billion versus $2 billion the previous year. The number of
deals done was 560. The year before it was 460.
As I mentioned, about one-half the money went to oil or gas companies, typically
with headquarters in Alberta, British Columbia or Ontario. The Alberta
companies generated the most deals and raised the largest amount of capital,
some $450 million in 1998.
The venture capital industry in Canada has grown steadily, although there was a
downturn about 10 years ago. In 1997, the last year for which I have
statistics, they disbursed $1.8 billion in capital to small companies. That is
up from $1.1 billion in the previous year. The total assets of venture capital
portfolios in 1997 totalled $8.4 billion, with labour-sponsored venture capital
corporations, or the LSVCCs, managing about one-half of the total venture
capital funds with assets of $4.2 billion out of the $8.4 billion.
Senator Meighen: Is there a commonly accepted definition of venture capital?
Mr. Oliver: I do not know. We would define it in terms of the stage of the
financing, the riskiness of the venture and the amount raised.
Senator Meighen: Could a bank be a venture capitalist?
Mr. Oliver: Yes, it could be.
Mr. Gerry Goldstein, Advisor to the committee: There is a definition that came
out of the study done by Jeff MacIntosh. The formal venture capital market is
comprised of formal venture capitalists who are people with funds and
professional managers of risk capital funds, capitalized both directly and/or
indirectly by institutional sources, such as governments, banks, pension funds,
life insurance companies, as well as by large corporations and by individual
investors encouraged by tax incentives. The distinction is that it is more
exhaustive when you get out of the initial two, what are called the "love
money" and the "angel market" and before you get to the IPOs.
Essentially, it is formal suppliers, which the angel market and the love money
are not. It is when you get into people who are actually organized and looking
Mr. Oliver: There are many different channels. Small companies with tangible
assets of less than $3 million and no track record of earnings or business
performance will typically rely on informal sources. That is what you are
referring to as love money: friends and family and their access to seed capital
to finance start-up and early growth. We estimate that about 90 per cent of
start-up companies use love money for initial financing.
The options for small business for tapping into new sources of capital increase
as the small business builds a track record of fairly consistent earnings when
they have successfully advanced beyond the start-up business phase. Angels are
investors who supply entrepreneurial companies with equity or quasi-equity
financing through the start-up and the early growth phase. The so-called angels
do not participate beyond the time when other more conventional financing
vehicles become available.
Senator Austin: Do they come between love money and conventional financing?
Mr. Oliver: Yes, between love money and venture capital money. First comes love
money, then angels and then the venture capital money, although you can call
angels venture capital.
Senator Austin: In the terms of the trade, first there is love money, then
angels, then venture capitalists, then conventional financing; is that correct?
Mr. Oliver: That is right.
Mr. Oliver: Normally, venture capitalists do not participate above the $1
million or $2 million level. In their early stages, the SMEs will also turn to
security firms, in particular regionally based dealers who have knowledge of
local businesses. They will access local investors to raise seed capital
To facilitate access to capital in public and private markets, small business
can become a reporting issuer with a provincial securities commission and then
list on the Alberta stock exchange or the Vancouver stock exchange. At this
stage, the company would have flexibility to issue equity capital through
private placements or public distributions.
Debt financing, which is not the focus of this discussion, becomes important to
provide working capital once the company is operational. It is generally
available through a number of channels, such as the chartered banks or other
deposit-taking institutions, although the apparent reluctance to charge
risk-based rates has narrowed the source. I believe you have explored that
Government agencies such as the Business Development Corporation and the Export
Development Corporation are also sources. As well, the high-yield corporate
debt market, which is used for the financing requirements of larger companies,
that is, less than the investment grade, has represented an important source of
new capital for this category in the past few years. This is the so-called junk
bond market. It is a relatively recent phenomenon. It is huge in the United
States. It is building in Canada and becoming much more important.
Earlier, I referred to the LSVCCs and the fact that they have assets totalling
about $4.2 billion. They have become the fastest growing venture fund source in
the industry. That is because investors have responded aggressively to
available provincial and federal tax credits. However, the funds have
encountered problems allocating funds to suitable small-business investment. In
recent years, the funds have turned away capital until fund ratios move higher.
The inflow of funds into working ventures has fallen to $125 million in 1997
from $625 million in the previous year.
Senator Oliver: How much have they not invested now?
Mr. Oliver: Unfortunately, I do not have that statistic.
The Chairman: My gut feeling is that it is a very sizeable amount. Is that
Mr. Oliver: It was quite sizeable. There are tax reasons for them having to get
it out there. That has been a serious problem. Clearly, it has affected their
returns. To some extent, it has also affected the amount of money raised.
In Alberta, a tax committee examined the whole issue of the LSVCCs.
The Chairman: The LSVCC is the Labour Sponsored Venture Capital Corporation; is
Mr. Oliver: Yes. That Alberta tax committee found that the slow pace of
investment and the extensive tax credits combined with the administrative costs
for the province were compelling reasons not to create that program in Alberta.
The IDA actually was on side on that. I will address our philosophy on tax
Another specialized vehicle is the junior capital-pool program that was
developed by the Alberta Stock Exchange. It is a unique mechanism to promote
equity capital for listed emerging companies. Junior capital pools permit
emerging companies to raise equity capital without the need to identify the
business or the project that the proceeds would be spent on.
Many of the JCPs have also financed non-resource companies, including those in
the high tech sector, although their focus has been junior oil and gas.
JCPs have become an important vehicle to meet early-stage financing needs.
However, the program has accounted for only a very small portion of overall
financing that was undertaken by Alberta Stock Exchange listed companies in the
last two years. It was 2.6 per cent of total financings last year and 2.7 per
cent in 1997. Last year they totalled only $28 million, which is 20 per cent
below the number of the previous year. The financings on the Alberta exchange
amounted to $1.1 billion last year. Depressed conditions in the oil and gas
market were mainly responsible for the fall-off in financing activity.
I will now move to the situation in Vancouver. The Asian crisis and the fall in
resource prices really hit the Vancouver Stock Exchange hard. The volume of
shares dropped by 26 per cent from 1997 and the total value of shares fell
almost 60 per cent for the previous year. The composite index slid 36 per cent.
The VSE companies raised a little over $600 million in equity funds in 1998,
down 60 per cent from 1997. IPOs were down more than a half from about $52
million to $24 million. Private placements accounted for the majority of equity
raised -- 95 per cent, in fact, last year, which is about the same as the year
before. Those private placements fell 55 per cent. The financings were split
60-40 between resource companies and industrial-based companies.
The other market I should mention is the Canadian Dealer Network. It is Canada's
only organized over-the-counter equity market. It improves the visibility of
stock prices in the market for unlisted equity securities.
Unlike the listed exchanges where orders interact in an auction market, the CDN
is a competitive dealer market, but it displays all market maker quotes. It is
similar to Nasdaq. Generally, though, liquidity on the CDN is limited and
therefore the market is less relied upon than the western exchanges. Still, the
volume increased to 3 billion shares in 1997. The private placements totalled
about $100 million last year.
The fact that financing for small companies is done on two exchanges and an OTC
market has resulted in significant market fragmentation and reduced liquidity.
The recent discussions between the exchanges are raising the real possibility
of consolidation into a new small-business exchange not unlike the Nasdaq
bulletin board, although perhaps of a higher quality. In my opinion, that would
be a constructive development. I understand it has the preliminary support of
the securities commission. We should stay tuned on this issue.
Senator Austin: Is that similar to the Nasdaq small cap?
Mr. Oliver: Yes, that is it. There is a Nasdaq market that we all know and then
they have a bulletin board or a small-cap market as well.
I should like to move on to present some ideas and recommendations designed to
enhance equity financing for small- and mid-sized companies.
First, on the regulatory side, the dilemma that is posed by small-business
financing can be simply stated. On the one hand, small issuers usually pose
greater risk than average risk for investors. On the other hand, those
companies lack the financial and human resources to comply with a complex
The way to resolve that dilemma in the private market has been to confine
financing resources to institutions and to sophisticated individuals, with some
exceptions. However, since regulators have been reluctant to define "sophisticated
individual," they have relied on larger-sized purchases as a proxy for
sophistication. However, this approach is inefficient because it excludes many
sophisticated investors interested in purchasing investments in small
denominations. It also includes some unsophisticated investors who may have the
financial means to buy large-sized transactions.
Therefore, the approach of regulators has been to relegate small retail
investors to the public marketplace where investor protection is afforded
through comprehensive disclosure obligations on companies and reliance on
investment advisors who are subject to the know-your-client rules and the
suitability rules to recommend appropriate investments.
This leaves businesses with a dilemma. While they can issue securities in the
public market to reach a large number of investors, prospectus filings and
ongoing disclosure obligations are expensive and time consuming. On the other
hand, reliance on private markets severely limits the company's access to
Various industry groups and regulatory bodies in recent years have recognized
the small-business dilemma and have argued for improvements to facilitate
access to equity capital for small business. In particular, minimum purchase
thresholds are generally considered to be an inefficient approach that unduly
restricts access to capital for small business.
In 1997, the Joint Securities Industry Committee on Conflicts of Interest
recommended that the CSA -- the Canadian securities administrators, who are the
chairs of the securities commissions around the country, standardize different
minimum purchase threshold across provincial jurisdictions, because those
differences promote regulatory arbitrage. The committee also recommended that
the CSA examine techniques to broaden small businesses' access to capital in a
non-public or exempt market.
A year earlier, the OSC task force on small business had recommended the use of
the accredited investor exemption which would permit issuers to raise any
amount from individuals who had a net worth of $1 million and a net income of
$200,000 per year over the last two years. The task force also recommended a
closely held business issuer exemption, which is similar to regulation D in the
This exemption would permit issuing securities on a prospectus-exempt basis to
35 persons, over and above sales to accredited investors. The reform would
facilitate the investment of love money and investment by angels through
various stages of small business development.
The Alberta Securities Commission and the B.C. Securities Commission have also
adopted sophisticated investor definitions that permit small businesses to sell
privately placed special warrants in amounts as low as $25,000 to investors
that meet their definition as a sophisticated investor.
As well, a number of other regulatory proposals in the U.S. and other countries
could be adopted to facilitate small business financing in Canada. In the U.S.,
the Small Corporate Offering Registration System, the so-called SCOR
prospectus, allows small businesses to complete the paperwork without
professional assistance. The program's benefits include lower costs for issuers
and the provision of information that is more meaningful to the average
Testing the waters is another innovative U.S. approach. That permits
entrepreneurs to approach prospective investors without filing an initial
document. If the reaction is positive, the company can then incur the cost of
filing, with the confidence that a market exists for the shares.
Senator Austin: Can an investment dealer in the United States act as an agent
for that small company in doing the same thing? Is preselling permitted?
Mr. Oliver: That is a very interesting question. I wish I knew the answer for
sure. Let me define what I understand they are permitted to do.
They are not actually selling. They are soliciting interest, which they have to
confirm once the document is filed. That is like the preselling for bought
deals. It has a certain similarity.
Senator Oliver: There is not a commitment to buy.
Mr. Oliver: It is definitely not a commitment to buy. It is focused on a certain
category of companies, not big companies.
With respect to your precise question as to whether an investment dealer can be
involved, I would have thought so, but I am not absolutely sure about that. It
is not designed for financing that would be of interest to investment firms. It
is designed for real start-up situations where you are relieving the
entrepreneur of the risk that they would incur all sorts of costs and then find
there is no market. It is really a start-up mechanism. That is how it is
targeted. It would only make sense if it were adopted for very small companies.
That is what the concept is all about.
When the OSC proposed a number of recommendations in their committee in 1996,
there was some negative reaction from the B.C. Securities Commission. Since
then, no action has been taken. I have enquired and I understand that it is not
at the top of the list of things that the CSA is studying at this time. I think
it is an interesting concept and I do not see much regulatory risk involved with
Australia has also developed a popular financing mechanism. It is designed to
promote individual investor participation in the public markets. It allows
issuers to offer up to $1 million each year in public markets, up to 20 per
cent of capitalization, with abbreviated disclosure documents. Both the
underwriter and the company management are subject to holding periods of up to
I also understand that the Vancouver Stock Exchange has struck a committee to
look at a mechanism very similar to this, and I assume they will make some
recommendations in that regard.
I should like to make a quick comment on escrow policy because it is relevant.
The escrow rules for initial public distribution are imposed by the provincial
regulators to ensure that management and the controlling shareholders remain in
place in order to implement the company's strategic plan. However, the rules
have acted as a disincentive to invest in small business IPOs because the escrow
rules have unfairly caught certain investors, such as those investing in
venture capital funds, and they have limited the liquidity of their invested
I understand that Mr. Begg wanted to talk about that in some detail. However,
the IDA has come up with an approach to that in response to the CSA. The
securities commissions recently proposed a national escrow regime across the
country to harmonize the rules and ease the escrow restrictions. Still,
emerging companies would be subject to a six-year escrow and established issuers
to a three-year escrow. Venture capital funds would still be caught in rules.
In contrast, NASDAQ- and NYSE-listed shares are not subject to escrow, which
places the Canadian markets at a disadvantage.
The IDA has recommended an alternative approach, which would allow management
and controlling shareholders to sell their shares from an IPO 18 months after
the IPO, subject to notification to the marketplace. This approach is analogous
to the control-block selling rules. We think this makes a great deal of sense
and would level the playing field between Canada and the U.S.
A number of modifications to the Income Tax Act would encourage investment in
SMEs, and I would like to quickly run over them.
In comparison to other countries, the capital gains tax in Canada is 40 per cent
versus 20 per cent in the U.S., generally. Our opinion is that it is far too
high. As a result, investments migrate south where the tax regime provides
investors with the higher returns that justify the risks associated with SMEs.
Successive governments have recognized that the tax system plays an important
role in promoting or in discouraging investment in small business ventures.
However, the typical approach has been to rely on targeted incentives to
provide special tax breaks for business in particular sectors, such as the film
industry, or for particular types of investments, such as labour-sponsored
venture capital corporations.
Generally, the measures have proven somewhat inefficient or are a bit too
narrowly focused. I mentioned the tax committee in Alberta looking at the
A more effective approach, in our opinion, is to structure broadly based tax
incentives that rely on market forces to channel equity capital to small
business. I should like to mention several ideas designed to meet that
The federal government could first reduce the inclusion rate for taxes on
capital gains in respect to all Canadian equities. This option would increase
capital flows to the equity market by increasing after-tax return.
Senator Meighen: Is that somewhat similar to what they have done with respect to
the gifts of appreciated shares to registered charities?
Mr. Oliver: This would be a reduction in the capital gains rate, but for equity
investments, not for any type of capital.
Senator Angus: Can you give an example of this?
Mr. Oliver: We are saying that right now the rate is three-quarters of the
income tax rate. It should be lowered.
Senator Meighen: That is what they have done in terms of gifts of appreciated
stock in publicly traded companies.
Mr. Oliver: That is right, but they were hoping to eliminate it. I will leave it
to Mr. Johnson to make that case. There is an additional policy reason to
This is the broad-based reduction in the capital gains rate by reducing the 75
A somewhat more specific approach would be to exempt from capital gains taxes
investments in IPOs of companies under a threshold revenue or market
capitalization, for example, for $10 million in revenue or $50 million in
capitalization. The exemption would be granted to original purchases of
treasury shares only. I think that would result in a very positive market
reaction as well as a significant increase in capital available to small
Senator Austin: I tend to endorse that point. Would you necessarily give the
same capital exemption to the love money and the angel money? These are the
people who really are taking the risks of initial entrepreneurship. As you
mentioned, they are locked up in escrows and they cannot realize the benefits,
if any. Very often, there are no benefits; they are just straight "forget
it" investments. I would suggest that the incentive would be stronger at
that level than it would be at the initial level of a public offering.
Mr. Oliver: Another approach, which would include that concept, would be to say
that anyone investing in a company does not have to pay capital gains up to and
until the company reaches a certain size, let us say in capitalization. After
that, the capital gains would start clicking in. You could pay capital gains at
the end, but only in respect to the amount beyond that, which would be more
I am told that the $500,000 capital gains exemption for Canadian-controlled
private corporations has been a very important factor in attracting capital to
the smaller companies. However, if a small business is public, the shareholders
are taxed in the same way as if they purchased BCE. Thus, a suggestion is to
reduce the inclusion rate for capital gains that are earned on listed shares of
small companies. The measurement of that would be a matter for serious
discussion. It could relate to asset size, revenue or market capitalization.
You may need a number of alternatives because different industries produce
different kinds of results. The knowledge-based industries in particular do not
necessarily have the assets. However, they acquire the capitalization at an
Another idea is to permit the pass-through of business losses from small
companies to their shareholders. This is similar to the pass-through provisions
of subchapter S companies in the U.S.
I think the committee should also consider the U.S. approach to reducing capital
gains rates for longer hold periods to discourage free riding or flipping
Senator Meighen: Do you have any information as to how long that has been in
Mr. Oliver: I do not have that answer. I could get it for you. Would you like us
to do that?
Senator Meighen: I would like any information as to what it does or does not
generate. I am thinking that our present rules promote hanging on, doing
nothing, sitting on the asset and not disposing of it because of the capital
gains. I suppose the American rule is to the contrary, that is, the longer you
hold on to it, the less you pay. I am wondering whether it applies to all
capital gains investments or only ones in SMEs.
Mr. Oliver: I think I am correct in saying that if a stock is sold in less than
one year, then it is regular income. That applies to everything. That is one
aspect of it.
There are some dilemmas and contradictions here. You want to facilitate the
process. Venture capital money comes in. It is critical at a certain stage, but
they are always looking for an exit. When the exit is achieved, the money is
available for new financing. That is the process you want to encourage. Unless
the process is there and they see the exit, they will not put in money, or they
will put in a lesser amount, or they will demand a higher return.
One controversial program covers scientific research tax credits. They would be
beneficial for SMEs. However, I think one has to look at the program very
carefully to see that it is structured properly.
Another point to comment on is that corporate income below $200,000 is taxed at
a reduced rate of 16 per cent. The SMEs would benefit from raising the
threshold. Alternately, of course, the corporate tax rate itself could be
lowered from 16 per cent. Either initiative would improve the disappointing
productivity performance of small Canadian manufacturers.
Those are some of the tax issues. There are other possible government
initiatives as well which could be considered, provided they are properly
structured. The federal government might consider sponsoring an independent
program to assist small business obtaining equity capital. The support would be
provided to small businesses to assist in early stage financing. It would be
conditional upon private sector financing, for example, from angels. The
funding would be directed to SMEs with a certain maximum asset level or some
other criterion. These would be companies that have a potential for growth in
key areas, such as employment or exports. We are cautious because there is a
potential for waste. It should be started modestly, carefully monitored against
defined objectives and managed by specialists. I know there are other programs
Mr. Chairman, that completes my presentation. I would be happy to answer
The Chairman: In terms of changes, you laid out two broad areas. One was tax
policy in a variety of areas. Another was what I would call changes by
securities commissions with respect to adopting a number of the mechanisms
available. You talked about the U.S. and Australia. These changes make it
easier for SMEs to be launched.
You mentioned that in 1996 an Ontario commission study was criticized by the
Vancouver commission and nothing happened. What is the reluctance of securities
commissions in this country to fairly rapidly adopt some of the changes that
are being tried elsewhere in the world? Why do we seem to be so reluctant to
move into some of these new areas?
Mr. Oliver: I talked about the small business dilemma. There is also a
fundamental regulatory dilemma. The key mandate of the securities commissions
is investor protection. Typically, the smaller the company, the greater the
risk to the investor. What is being asked for here is to reduce the amount of
regulation and, potentially, the amount of investor protection in the very
companies that pose the greatest risk. That is the issue for them.
I believe that there is a distinction between effective protection and
theoretical protection, just as there is a distinction between effective
communication and technical communication.
We have seen enormously long prospectuses, including prospectuses for the
distribution of mutual funds. They are extremely difficult to get through. They
are forbidding and highly technical documents. They certainly comply with the
legal requirement of full, true and plain disclosure. However, they are often
neither readable nor understandable.
There is a theory of investor information that says that as long as some person
such as a research analyst knows and can interpret it, it will filter through.
That is not always the case for the individual who receives it.
In regard to mutual funds, until recently, there was a huge amount of material
on trust arrangements and so on. They are important, however, they do not have
to be described in any great detail. They can be filed with the commission.
Certainly the individual does not have to know about them. It is relevant for
an individual purchaser of a mutual fund to know what the objectives are, what
the purchase price is and the track record, in addition to knowing what the
investment is. That was not required.
You need to look at a graph. Compare how a fund has done on a relevant index.
I have no doubt that prospectuses could be shortened dramatically and made more
communicative without losing very much. That is what the SCOR prospectus in the
U.S. was designed to do.
To return to the question, there is a concern that if you include less, if you
try to simplify, you may be missing something. In the most risky of
investments, you are protecting the investor less.
The Chairman: It sounds like the securities commissions are designed to keep
themselves out of trouble as opposed to trying to solve the problem of how to
encourage investment in small and medium-sized businesses. Their instinct is to
play it excessively safe, which had some very significant down sides to the
problem that we are all trying to solve.
Mr. Oliver: I do not think that they are trying to keep it safe for themselves,
but they are trying to keep it safe for investors.
The Chairman: They are doing that by keeping it safe for themselves. If
investors have problems, so do the people who run the securities commissions.
Mr. Oliver: I have always felt that the commissions should have or do have a
dual mandate: investor protection and the promotion of efficient and
competitive capital markets.
In the U.S. and other major capital markets, the regulators take it as part of
their mandate to enhance the strength and competitiveness of their market. The
chairman of the SEC goes around the world trying to increase listings on the
NYSE because he wants the American capital market to be as strong as it can
Now, the challenges are different for a market that only represents 2 per cent
of the total market. However, there is always a question of necessary
regulatory balance. If you apply that principle to small business financing,
there is a way to make the financing more accessible without unduly increasing
The Chairman: The solution to that problem does not rest with government at
either the federal or provincial level; it rests with the securities
Mr. Oliver: I would say that part of it rests with the securities commissions. I
think the security commissions are attentive to the policy objectives of
governments. Signals are often taken within the context of their
responsibilities as they see them.
Senator Meighen: On a point of information, did I hear you say that a number of
these things could be achieved without incurring additional investor risk? What
I am getting at is, what is wrong theoretically with greater risk if there is
greater return? Is everything designed so that the risk profile cannot
Mr. Oliver: I am not talking about greater economic risk. I am talking about
greater risks flowing from potentially inadequate disclosure of what the risk
is. Clearly, we are talking about more risk in this sector, and that is not a
changeable by policy makers, other than through tax policy, I must say.
Senator Austin: Senator Kirby touched on the area that I did wish to explore,
and that is the role of the regulator. As you have pointed out, the risk is
higher at that level, yet the arguments are to reduce the cost of entry for
people seeking capital. It is a conundrum.
Should we approach that particular issue from the point of view of a special
administrative regulator system at the provincial level, designed to handle
only issues in this particular area? Therefore, while we have our regulators,
there are divisions among them, and there are discrete and distinctive
personnel who look only at the stimulation of activity in this area and
supervise this type of program.
I am concerned with the problem that honey attracts flies. We do not have many
systemic problems in this area because there is not much money in the high-risk
end, in the love and angels part of the business.
If we create more incentives for people to raise capital in this end, then do we
create a whole new level of people skimming by providing professional services
in this particular area? Entrepeneurship is alive and well and I am all for it,
but sometimes it goes over the line. That is why we have supervision and
Could we require some level of approval or overview? When you come to the junior
capital pools, I understand that one reason why the Alberta system has worked,
contrary to the opinion of so many when it was created, is that the exchange
itself took the responsibility for approving the proposed venture. The capital
would be raised first, but they did not allow the entrepreneurs to put it into
anything they wanted in an unsupervised way. They said, "You bring us the
deal, we will vet it." That was an unusual step for an exchange to take.
Therefore, they endorsed the deal when they allowed the assets to be acquired by
the capital pool funds. I am wondering if that kind of system is in some way
importable into this level, which is anti-regulatory in the normal approach of
regulators whose first function is transparency.
I do not disagree with Senator Kirby that regulators do a certain amount of
butt-protecting, and I do not disapprove of it, having been a bureaucrat at one
time. I agree that they see their role as increasing the efficiency of the
Those are the issues at this level and I am wondering how we get at them. If you
do not have an answer, I appreciate that, too.
Mr. Oliver: I would be cautious about creating a separate structure to deal with
this category. To some degree, it already exists among the Canadian securities
administrators who, because they are provincially based, tend to have somewhat
different responsibilities in respect to financing. The Alberta Securities
Commission is looking at the issues that we have been discussing proportionally
more than the Ontario and British Columbia commissions.
One of the advantages of a provincial system is that there is sensitivity to
regional interests and, presumably, those interests are being reflected.
Having said that, it is interesting that when the Ontario commission proposed
liberalization in respect to small business financing, the B.C. commission had
the most concerns. That, I assume, reflected their knowledge of some of the
abuses and they focused on that. It can go either way.
It would be good to have special committees looking at this issue again, but a
parallel structure of regulation would not be appropriate. However, a
liberalization of access and of rules is appropriate.
Senator Austin: I submit that the mentality of the regulator of large issues and
larger and more conventional market performance is a different mentality than
the one that we would need to move this forward in a secure fashion. That is
why we have a Business Development Bank and why the Bank of Montreal calls for
a small business bank.
It is a question of culture. I have dealt with regulators in the securities
industry all my life. I question whether the culture of the regulator in this
area is the right culture for the broader and more sophisticated part of the
industry. That is a subject to which we can perhaps return. I do not want to
continue it but I did want to make the point.
Mr. Oliver: To go back to the senator's earlier comments, there was a suggestion
of vetting some of the investments. I personally would be cautious about trying
to have outside regulators getting into the investment process very much, if at
Perhaps I misinterpreted what was said. If so, I apologize.
The Chairman: Regarding Senator Austin's culture comment, this committee will
face that issue in another context. In our comments on the MacKay report, this
committee urged effectively that rules and regulations be changed to encourage
the establishment of either much smaller community banks or smaller, more
locally based financial institutions. There is a view that the corporate culture
of OSFI would mitigate against that.
We also recommended, as you have, an easier regulatory touch for the smaller
institutions. There is a very interesting culture question as to whether that
is doable under the current OSFI structure.
Mr. Oliver: There is another very big issue, which will not only change culture
but will change the nature of the Canadian capital markets. Technology and
globalization are combining to create a new world from which we cannot insulate
ourselves. We are seeing an increasing number of Canadian companies moving to
the U.S. if the capital is available there.
We must focus on being as competitive as possible. The exchanges right now are
confronting the fundamental issue of whether they can keep the order flow in
this country. Even if they do, can they keep it on the exchanges?
The world's capital markets are rapidly changing. Some of the implications of
the changes will clearly relate to small businesses.
Senator Oliver: I learned from our dinner meeting with you and your associates
that, almost to a person, you believe there is a lot of capital money in Canada
that can be used for equity financing for some of these start-up small
businesses, but you must find a way to get access to it. Right now there are
many limitations and controls.
Our chairman has carefully itemized two of the main restrictions, one being the
regulator and the second being the tax policy.
You represent the investment dealers. As an IDA, what steps are you prepared to
take to help the "angel" or the professional person with excess money
who is looking for ways to invest it? Can you help to open up some of these
doors with the OSC? Why would the Investment Dealers Association have an
interest in doing something in which they may not be able to participate or from
which there is no profit or interest?
For example, if an angel wanted to go to a mom-and-pop operation that needed
some equity, what is in it for the IDA? How far are you prepared to push to
have some of these changes made?
Mr. Oliver: In terms of pure self-interest, the ability and willingness of
angels to finance small companies implies that more companies will reach the
IPO stage and, therefore, be clients for more traditional financing.
Senator Oliver: At the beginning, the angels do not need you, do they?
Mr. Oliver: They often need our firms' employees. The officers and directors of
investment firms are very big players in private financing. Often they are, all
publicity notwithstanding, angels. That is another aspect.
Senator Oliver: That does not generate any fee income for your clients.
Mr. Oliver: It does not do so immediately, but, obviously, if individuals at a
brokerage firm have helped to start a company, it is likely that their firm
will be involved in the financing. We must be very careful that there are no
conflicts. That is one of the issues for the committee.
It is a natural kind of continuum; they supply the individual financing and then
it goes on to the next stage. Conflicts exist, but they can be addressed.
That is another type of self-interest. In addition, some of our firms are
actively involved as merchant bankers and venture capitalists. Some of them
have distinct operations, including the bank-owned firms, because if it is done
properly, it can be quite attractive.
There is one other thing to be said and this never gets a positive reaction, I
must say. Some people who are complaining about not enough capital do not
necessarily represent interesting opportunities. Sometimes companies do not get
the funds because they should not.
The Chairman: They may have a bad idea.
Mr. Oliver: I cannot quantify that, but there is clearly more money desired than
money received, and part of it relates to the soundness of the enterprise.
Senator Oliver: A number of angels who have money and who would like to place it
would like to get rid of as much red tape as possible in making that
investment. That is where the regulator comes in. How far are you prepared to
go in terms of a minimum cap of, say, $100 million? Should we do away with a
lot of the traditional regulator red tape in equity start-ups? How far are you
prepared to go, or are you afraid that the risks could be so great that we
could do irreparable damage to investing in Canada?
Mr. Oliver: I think we can go quite far without incurring too much additional or
inappropriate risk. Lowering the thresholds to bring in money in smaller
amounts makes a lot of sense. Those higher numbers do not really have the
impact they should.
As I mentioned, many sophisticated people would be prepared to invest smaller
amounts because they would like to diversify that kind of investment. I think
the numbers should be reduced because the size of the individual investment is
a very rough measure of sophistication. It is not directly related to
sophistication at all. It is related to the amount of money available to an
This issue was examined by the OSC, and there was much concern about opening it
up. The most difficult thing was to come up with a definition of "sophistication."
They could not seem to do it directly. They could not relate it to taking a
course or investing for a certain period of time.
We all know that people can inherit money and not have any investment
experience. There is a lot of concern that someone who has inherited a good
amount but has no other means of support would somehow see that money eroded
because of unscrupulous advisors.
Size was not a way to arrive at the "sophistication" definition. I
think they were being cautious in deciding not to change it. That was a few
years ago. However, I think something must be done.
Senator Oliver: Senator Angus threw out the phrase "flow-through shares"
earlier. They were very popular in the mining industry in Quebec and were a way
of raising capital. Are flow-through shares and other share structures
something you would recommend as a way of getting access to more of this
Mr. Oliver: I am not up-to-date on that specific vehicle, although it has been
In respect to some vehicles -- not that one particularly -- there is a tendency
to purchase based upon the tax advantage rather than the economic value of the
investment. Often in these cases someone will include, for example, the RRSP
deduction, which is available for any type of investment, and attribute to that
tax advantage investment that additional tax break, which has nothing to do with
it. Then they will take a look at the return and include the tax rebate as part
of the first-year return. That is analytically wrong. They should really look
at the after-tax investment and see what return they get on that.
The advantage of the tax break is that a larger amount of money is available
than was actually invested on an after-tax basis. Eventually, you have to
recover that amount or you will be behind the eight ball.
Senator Oliver: Is the IDA thinking of bringing others forward?
Mr. Oliver: Not at the moment, no.
Senator Kroft: I wish to continue or broaden the subject of tax-related
solutions to enhancing investment in small and medium-sized businesses. Senator
Oliver came at it from the perspective of flow-through shares. You had a list
of tax-related items. Most of them have been on my personal list for 25 years.
Whether it is the flow-through of losses, preferential capital gains rates, or
the ability to file a consolidated return, we have never been very good at
using tax policy to enhance investment. The exception is targeted industrial
areas, and they tend to have been in the cultural field. Obviously, it has been
used in science with either too great a success or mixed success.
I happen to be a great believer in the use of tax policy as a way of encouraging
investment in an area where the government has a policy objective, particularly
as we are taxed at a disadvantage to our large neighbour and have to try to
close some of that ground. As this committee continues to work, I will
therefore always be preoccupied, among other things, with tax opportunities to
achieve some of these goals.
Do you have an overall view as to how you would rate this by way of importance,
but more broadly as to the cultural environment of tax issues? How far have you
gotten with these issues when you raised them? Where were you rebuffed? Who
said that will not work and why?
Mr. Oliver: I agree that tax policy is probably the most effective way to
achieve fundamental objectives in respect to small business financing. As to
why, there is no taxpayers' revolt in Canada yet.
I raised this question in the visits we have had with provincial finance
ministers across the country. I raise the issue of tax policy with the Minister
of Finance when we see him once a year.
The Government of Alberta, in particular, as you might imagine, is frustrated
that there is not as much enthusiasm for tax reductions as one might have
thought because, in principle, why would anyone want to pay more taxes?
I think they felt that a reduction in tax policy is viewed by people as a code
for a reduction in certain specific, highly valued programs. They think about
the program most important to them, and they think that will be reduced. Of
course it may or may not be reduced, but probably will not be in the short
The public, understandably, is not always attuned to all the economic
consequences of fiscal policy. I do not think they have been convinced yet that
a reduction in taxes ultimately enhances employment, wealth and the ability to
finance government programs.
Senator Kroft: You are coming at this in a very broad way. I am referring to the
specific area of a small business looking for financing assistance, forgetting
whether the taxpayer will get a benefit because that is too often a
preoccupation of politicians looking over their shoulders.
The other side of that same coin is that some person trying to start a small
business may have capital available that they would not have if there were no
incentive to provide that capital. I am coming back to your annual meeting with
the Minister of Finance. I would like some idea of the enthusiasm or
specificity with which you and your organization have tended to pursue tax
areas, or have they not been a significant part of your agenda?
Mr. Oliver: We have, each year, raised with the Minister of Finance the question
of capital gains, and specifically more favourable capital gains treatment for
small enterprises. We have, I think it is fair to say, not been given any
indication that the government is about to do anything in that respect at this
time. They have not necessarily disagreed with the concept, but we have been
given no indication that they are about to do anything in that regard.
I would make one other broad comment in that respect, and this is something that
we raised in our last visit. If you look at the U.S. experience, there is a
paradox at work. When you reduce capital gains rates, the capital gains taxes
collected increase. The government is therefore at an advantage, as are the
individual investors who then feel liberated to dispose of investments. The tax
policy is thus less intrusive and does not distort the economic process.
Some academic studies go the other way, but there is a lot of evidence to
suggest that that does in fact work.
Senator Angus: You mentioned that you could supply us with studies and
background materials. I think the capital gains tax must be the critical area
here. I have always been of the view that at these high levels that currently
exist in Canada, there are millions of dollars tied up in unrealized gains that
would, in the normal course, be reinvested and used exactly for the type of SME
investment we are talking about here. The net result would be levered many
times over in terms of an industrial and economic plus. Yet, the naysayers and
the people that Senator Kroft suggests are out there inhibiting progress keep
saying, "No, no, it is revenue negative." You just said that there are
studies that show that for every rate percentage you go down, there is more
It seems to me that some very persuasive statistics must be available to show
that if, for example, we went from 40 to 20 right away, there would be a
fantastic boon to our economy, but those statistics are not coming out. People
like ourselves, who could, as Senator Kroft suggest, aggressively advocate such
a change, with some credibility, do not have the tools. Can you provide us with
something like that?
Mr. Oliver: I believe that there are studies available. I will attempt to locate
them and present them to your committee, if I can do that.
Senator Angus: That would be great.
I agree with nearly everything you have said about the constructive things that
your own members do in terms of supplementing the regulator and making
prospectuses user-friendly to your clients. I cannot tell you how many dealers
have told me that they would have so much more business if the capital gains
tax were reduced. They have said that they would invest millions in trying to
present the case in a proper way.
You also talked about regulatory arbitrage in Canada. Could you elaborate by
telling us how prevalent it is in this country, giving a few specific, striking
examples to make the point, and to show how it is detrimental to the flow of
capital to small businesses?
Mr. Oliver: Happily, regulatory arbitrage is decreasing rapidly as the provinces
harmonize regulations across the country. I referred to regulatory arbitrage in
the context of the escrow policy. I understand there are some differences, but
I guess there is a possibility of a company doing a financing in one provincial
jurisdiction as opposed to another because the hold period is less. It is that
kind of issue.
Regulatory arbitrage will be more of a problem for Canada overall compared to
other jurisdictions if our rules are more stringent, regulation is more
complicated, duplicative or costs more money, or if there is more regulatory
uncertainty. That is why, in a period of globalization, we need to be as
efficient and competitive as we can be.
Senator Angus: This is the argument for the national securities commission.
Mr. Oliver: It is certainly an argument for regulatory harmonization.
Senator Angus: I am interested in the flow-through shares. I have the same list
as Senator Kroft. I do not know whether I have had it for 25 years, but it
certainly seems to me to be a growing list. To the extent that some of these
so-called tax incentives have been employed as ways of raising capital, I have
come to the conclusion that they have been almost like an investor con. At the
end of the day, it is never properly explained. You do your investment and you
get your write-off on next year's tax, as you describe, but there is always a
day of reckoning. First, you end up with a zero cost base on the shares, but
also, to the extent that you have taken the write-offs, you have wiped out your
access to the $500,000 capital gains exemption. Far from being an incentive,
other than some short-term medicine on a guy's tax return, they end up creating
terrible problems. They have been abused, perhaps unwittingly, by members of
your association. Do you have any comments on that? Do I have it wrong?
Mr. Oliver: One of the problems with tax incentive programs is that sometimes
people are just attracted by the immediate tax reduction without first looking
at the fundamental economics of the investment and then how the tax program
actually works. I think that if one does that, then there should not be a
problem with these programs and they can be looked at objectively. They do make
sense for many people. The problems come if they are being purchased without
knowledge of the consequences.
Senator Angus: They give you one apparent quick fix.
The Chairman: They are a "here and now" solution.
Senator Angus: People are not aware of the complexity. They are taking away
another incentive to investment in the SMEs. Clients are just blown away when
they wake up to this fact. They are ready to make an investment in a small
business and then find that the advantage that was supposedly there is not
there. They are surprised.
As Senator Austin said, the menu is huge. I hope this is the beginning of many
days like this so we can talk about it.
The Chairman: As a one-person round table, this has been terrific. I do not know
how we would have handled two other witnesses.
Senator Meighen: I think the ground has been well tilled by everyone, but I want
to go back to one point. I was passed a note that reinforces the problem of
perception that seems to exist out there. I am informed that in the budget
speech there was a mention that a 5 per cent reduction in the capital gains
rate would result in a lost revenue of approximately $113 million. This is the
mindset that is there. No doubt it would initially, if you just look at one
side of the ledger, but there are other aspects that seem to be ignored. Most
people, particularly in government, seem to think that capital gains deal solely
with financial assets. They also deal with plant, equipment and immovable
property and all kinds of things that are affected by the way we treat them.
I would hope that the IDA and others would hone in on the statistics, because we
need to get at this perception that capital gains affect the rich only. In the
public's mind, I think it covers the quick flipper in the stock market. I go
back to that point about the American regulation that differentiates between
the length of time the financial asset is held and the rate of tax it is
subjected to when sold. That might go some way to alleviating the false
Senator Angus said he was interested in the flow-throughs and indicated how he
came at the question. I think he is quite right. To me, across-the-board,
generalized reform would be better than putting too much faith in this
cherry-picking. Governments, to be charitable, are no wiser than anyone else in
picking the area they want to improve. In fact, they often get it wrong, as do
the rest of us. That is more of an editorial comment than anything else, but I
would think that an across-the-board reduction in capital gains, perhaps
following the period an asset has been held, would do much to decide that we
would favour this or that particular sector by a tax scheme for an
indeterminate period of time.
The Chairman: Thank you very much for attending. You will give the data you have
to our research staff, and we will be back to you. We have such a huge number
of issues here that we will want to use the help of you and your staff as much
Mr. Oliver: I could also suggest that there are some members of our association
whose firms are actively involved in this area, and they would be able to
provide additional insight, if that is something in which you would be