And: What Investors Should Know About Their Rights When Dealing With Brokers
There are compelling reasons to invest in a startup company’s shares.
But with the benefits of investing, comes risks – and there are many.
There are economic risks and the risk of having the business in which you are investing fail is a huge one. In the end, these are risks to which you, as an investor, could be exposed.
Whether you are a novice investor or an avid one, you may sometimes seek the expert advice of a broker when considering the viability of your next investment opportunity. Alternatively, you may invest based on your own understanding of the business prospects after doing your own research.
Either way, you will not only want to make sure you are aware of the risks, but you will also want to have sufficient information needed to make a balanced and informed decision. Typically you will want to review all of the legal documents and financial information to ensure that you’re buying what you think you are.
You can outsource the due diligence to your advisors, lawyers, accountants or to your stock broker.
What Brokers Need to Disclose to Investors
When you hire advisors they should make sure that you are aware of the risks. A case in point is Abrams v. Sprott Securities Ltd. (2003) (ONCA), in which the the Ontario Court of Appeal helped clarify the scope of a broker’s duties to a client. In this case, the court found that the broker had not sufficiently warned their client of the risks specific to investing in private companies, namely the limited market. Before a private company issues its first sale of stock to the public – that is before it issues initial public offerings (or “IPOs”) – there is a good chance that any individual or institution interested in the company will be unable to invest in it.
If business fails, and the company never “goes public”, investors will have a much harder time selling away their interest.
This is fairly obvious, but in this case the court held that such high level risks that must be explained to a client before deciding to invest, and that the broker had a duty to make a balanced presentation of the investment opportunities to the investor, which included full disclosure of the risks associated.
Does Experience Matter?
The answer appears to be no. At trial, the judge concluded that the investor in this case “was an intelligent and astute businessman” and, by the time he was informed of the investment opportunities, “could not be described as an unsophisticated or inexperienced investor”. His failure to take reasonable care in signing the agreements resulted in the court’s finding of contributory negligence, along with a finding of negligence for the broker.
What if You Avoid Reading the Contract?
The court also took this opportunity to reaffirm that a signor of a contract cannot avoid the legal consequences of the contract by deliberately choosing not to read its terms and conditions.
The investor in this case, prior to purchasing the special warrants and special shares, signed two subscription agreements in accordance with the brokerage firm’s procedures, in which he represented himself as an experienced and knowledgeable investor.
Private companies are illiquid investments. Do your due diligence.
Investors: read all documents. Seek independant legal advice.
Companies: request (insist) that your investors receive independent legal advice to avoid a claim that you had failed to make adequate disclosures.
Companies: work with your legal team to ensure that you’ve properly represented the risks to your potential investor.
Abrams v. Sprott Securities Ltd., 2003 ONCA 27136 (CanLII)
Writers: Ashley Andaya and Rajah Lehal
– – –
This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.