Dealer mark-ups criticized during Thompson Committee

At last week’s hearing into the Thompson Committee report on junior resource financing, the catchphrase on many people’s lips was `dealer compensation.’ Members of the province’s mining and investment communities are starting to ask themselves: exactly how much should a securities dealer in Ontario be allowed to squeeze out of a junior resource transaction? Not as much as the Thompson Committee is recommending, said Michael Harrison, executive vice- president of corporate finance at Walwyn Stodgell Cochran Murray. “The report has some outrageous suggestions regarding dealer compensation,” he told the commissioners of the Ontario Securities Commission. “The recommendations are much too generous to the dealers.”

The report calls for an investment dealer’s commission, or mark-up, ranging from 30% to almost 100% of the proceeds to the issuer. Theoretically, for share issues up to 65 cents a 100% dealer mark-up may be permitted, boosting the price to the public to $1.30. The size of the commission tapers down as the price per share becomes higher.

“In the case of a 100% dealer mark-up, the investor should be on guard that for every buck he’s putting up, the dealer is getting around 50 cents ,” Mr Harrison told The Northern Miner. “That’s ludicrous. The remuneration is so generous that it leads to scandalous practices on the part of brokers. They will undertake to do any kind of fund-raising because, under those conditions, they can make themselves a fortune.”

Responding to Mr Harrison’s criticism of dealer compensation, Chairman Edward Thompson told The Northern Miner that his committee had small financings, of less than $1 million, in mind when it made its recommendations. “He (Mr Harrison) is used to dealing in financings of $1.5-$2 million and up,” Mr Thompson said. “And for financings in that range 30% or even 10% is reasonable as a commission.”

“No, we’re not talking in opposite directions,” Mr Harrison responded. “Mr Thompson may think that his committee is addressing the absolute grubstake situations in Ontario, but I don’t think that is correct. It is very much in the best interest of resource financing that the major dealers get involved. It can not always be done by the broker-dealers. That would create endless anxiety.” The commission should be greatly reduced, he said (though he would not say by how much).

The OSC staff seems to agree. In its written response to the final recomendations of the Thompson Committee, the staff mentions the need for reductions in the commission payable to dealers of junior resource issues.

The staff goes on to say: “We understand that members of the IDA (Investment Dealers Association) would not in any event charge 100% mark-ups to their clients as that would undermine the ongoing client relationship and make it extremely difficult to market the issue. As noted (elsewhere in the response), staff considers 100% mark-ups to be unconscionable.”

It adds, however, that dealer mark-ups are only one aspect of dealer compensation and should not be viewed in isolation.

Another aspect is `bonus shares,’ which are traditionally given by the underwriter to salesmen or promoters of the stock. The Thompson report recommends that bonus shares be maintained — specifically that the dealer may receive a bonus of 15 shares for every 100 shares sold.

Mr Harrison wants bonus shares completely scrapped from OSC policy because he is worried about a quick sale of these shares when the issue closes.”Needless to say, with a lot of the stock coming to the market, it’s going to probably drag down the issue price. The result is that the client gets hurt.”

Instead of the bonus shares, he suggests that the `compensation option’ (an option for the broker to buy a certain stock up to a certain period of time) be raised to 15% or higher for a period of no more than two years. The Thompson Commission recommends 10% for a maximum period of three years.

“Our (Walwyn Stodgell’s) opinion is that the most honest, efficacious way to pay the dealer, beyond his cash commission, is to give him an option at the initial offering price of the issue for a period of two years so that he has the interest in creating a market and promoting it. This is better than the bonus shares, which have no price whatsoever attached to them.”

Another speaker at the hearing, Douglas Reeson, vice-president and director of corporate finance of Davidson Partners, also said that the dealer compensation recommendations could be improved.

The hearing resumes Oct 27 in Toronto.