Northern exposure

Canada may be one of the more placid and well-ordered places on the planet, but the country is in the midst of a sharp debate over the future of its fragmented securities regulatory system. Some factions want to see a single securities regulator while others prefer the existing ‘passport’ system where participants deal exclusively with one provincial regulator in addition to a set of harmonized requirements.

The nation is also at work adapting Sarbanes-Oxley-inspired rules on assessing internal controls and expanding executive compensation disclosure, which also present corporate secretaries and other compliance officers with a lot to absorb.

Policy-makers have been discussing the possibility of a single securities regulator for 40 years. With the shift to this approach by the United Kingdom, Canada is now the only major economy without one. Quite a few interest groups have lined up in support of the idea including the Ontario Securities Commission (OSC), Canadian Bankers Association, TSX Group, the Canadian Coalition of Good Governance and the Investment Industry Association of Canada.

But there are still key holdouts, namely all the provincial and territorial securities regulators except Ontario’s. They are vocal with their concerns about securities regulation being dominated by the country’s most powerful province and say they don’t want to see any kind of Canadian securities commission emerging as a rebranded OSC.

The opposing sides have been pursuing separate tracks towards improved securities regulation. The cleft was made even deeper on March 28 when the dozen provincial and territorial regulators comprising the Montreal-based Canadian Securities Administrators (CSA) announced plans to implement the second phase of the passport system under the proposed National Instrument 11-102. That same day, the OSC confirmed that it would not join the other provinces, stating the passport system failed to address the problems created by having 13 different securities commissions across the country.

The OSC said it wanted one regulator to oversee markets across the nation, as per the recommendation of the Crawford Panel in ‘Blueprint for a Canadian Securities Commission’, which, after several years of study, proposed creating a new centralized Canadian Securities Commission. The Ontario government said it was ‘not prepared to participate in the passport system without a roadmap with reasonable timelines to get a common securities regulator.’

Purdy Crawford, counsel in the Toronto office of Osler, Hoskin & Harcourt who chaired the panel, isn’t deterred by the impasse. Since turning in his final report in June 2006, he and his fellow panelists of CEOs, law professors and corporate board directors have had audiences with the provincial regulators pushing their view.

Crawford says ‘two or three provinces’ recognize the inevitability of a single regulator given the strength of the economic argument: ‘We’re all volunteers on the panel. We’ve kept on working to try to influence the process. I think there has been some movement forward.’

Satisfied with status quo

Others think Canada is already in a good place. Fred Enns, a securities and capital markets partner in the Montreal office of Borden Ladner Gervais says, ‘Personally, I don’t have a position. I see the pros and cons of both and I could work with either option.’

Coming from a province as independent-minded as Quebec, Enns says he knows the jurisdictional dispute is not a trifling issue. ‘My suspicion is [a single securities regulator] is never going to happen.’

Enns notes the major revisions to the passport system. ‘The final phase seems an acceptable solution in place of a single regulator.’

Proponents of the single regulator ask some basic questions. The most essential being: How much capital is Canada sacrificing to maintain a system of securities regulation made up of 13 pieces and what is the cost to the economy?

The most mundane, but still salient problem is the transaction costs in having issuers deal with ten provincial, three territorial and one federal authority. There are fees paid to each authority, as well as costs associated with keeping up to date on the rule changes in the differing areas.

Too many cooks

Enforcement within a multi-part system is also a challenge. Some jurisdictions lack sufficient expertise to prosecute complex cases. And there are problems when issues span jurisdictions over accountability, increased cost and delays. Investors in a number of instances have sued Canadian companies in US courts for faster results. The Crawford panel has pointed out that a single regulator would have ‘the expertise, the will and the muscle to make enforcement a priority.’

International investors can also be scared off, not wanting to put money into places where markets are perceived as less safe or even marginally more costly. Multinationals may resist locating head offices in Canada, some say. ‘The international perception is that we can’t get our act together,’ Crawford says. ‘The Department of Finance gets it all the time from other countries. They say, Why do we have to talk to all these jurisdictions? We want to talk to Canada.’

The issue is becoming more of a sore point as the rest of the world moves closer together. The SEC is considering launching a pilot program with selected foreign regulators for relying on mutual recognition of listing standards. Some 200 of Canada’s largest companies are dual-listed on US exchanges. In an article that appeared in an August issue of the Financial Post, Ian Russell, the chief executive of the Investment Industry Association of Canada, discussed  the enormous benefit this would be for investment dealers who now have to comply with ‘the full panoply of complex and expensive of US regulatory standards’ when dealing with US institutions.

Crawford also sees the benefit in pushing for this possibility: ‘Obviously, it’s easier to have mutual recognition if we have one regulator and one law.’

Indeed, some of Canada’s own companies turn away from the home market as part of the fallout over the fragmented system. A 2006 study commissioned by the Allen Task Force (sponsored by the Investment Dealers Association) noted that some issuers are bypassing Canadian exchanges in favor of London’s Alternative Investment Market (AIM) in part because of the greater liquidity and easier access to global investors.

For their part, advocates of the passport system have several key points, mainly that Canada is an atypical place and needs ‘Made in Canada’ solutions. It has a large number of smaller public companies which often go public at an early stage. Some of the provincial exchanges have developed their own adaptations to support these enterprises. ‘British Columbia, Quebec and Alberta are probably the most resistant [to a single regulator],’ Enns says. ‘They feel each jurisdiction has characteristics that make it quite unique.’

Options for small players

Enns notes the advent of Capital Pool Companies (CPC) started on the TSX Venture Exchange located in Calgary, a key incubator of small-cap companies. The CPC program is a two-step introduction to the capital markets for development-stage companies. Unlike traditional IPOs, it enables directors and officers to form a CPC with no assets other than cash and no commercial operations, list it on TSX Venture and raise a pool of capital. The CPC then uses the funds to seek investment opportunities in a growing business. Once it has acquired an operating company that meets the listing requirements, its shares continue trading as a regular listed company on the exchange.

‘It’s a way for small enterprises to find a route to the public market and it has been very effective,’ he says. ‘A policy like that would never have been approved in Ontario. It has created a whole aspect of the capital markets that otherwise would not have been able to exist.’

‘I think the provincial regulators would say that is why we need local regulators,’ Enns continues. ‘They feel they can do these things within a passport system.’

The provincial and territorial exchanges, except for Ontario, have been at work perfecting Canada’s existing passport system. Phase I was introduced in 2005 giving participants certain exemptions when dealing with different securities jurisdictions, except Ontario. Beginning in 2008, Phase II will enhance the ‘single-window’ concept by allowing access to the capital markets through only the regulator in the home jurisdiction. The other authorities will automatically accept its decisions. What makes this possible is a set of increasingly harmonized regulatory requirements, which regulators aim to consistently interpret and apply throughout Canada.

The Crawford panel says the single-window still falls short of the more simplified system it is proposing. When the OSC rejected it in March, it said: ‘Although the proposal may add incremental administrative improvements and efficiencies to our current regulatory processes, it does not resolve the need to modernize Canada’s securities regulatory structure.’ A spokesperson for the OSC said she had no other comment other than what was in the release.

Crawford says developers of the plan for a single securities regulator made adaptations for smaller provinces. ‘We talked about various measures of weighting, whether by GDP or population. Ultimately, we decided unanimously to have one jurisdiction, one vote. The plan has the potential to lessen the impact of Ontario. We see this as a positive.’

Enns says the passport system is workable. ‘As a practitioner, it’s sometimes a bit frustrating, but there are fewer and fewer problems.’

If anything, complaints are probably due to how much the regulatory landscape has changed, not that the passport system itself is overly problematic, he continues. ‘The problem is not that we have 13 different sets of rules, but because securities law is evolving rapidly now. There have been constant changes in regulations over the last five years. You’ve had a harmonization and a modernization.’

Growing disclosure requirements

Amid these two currents, Canada, which has about 4,000 public companies, has amended its criminal code to endorse corporate whistleblowing and increased funding for prosecuting insider trading. It has strengthened auditor independence rules and disclosure rules for corporate governance. It is also planning CEO and CFO certifications of financial statements after delaying them to observe their effect in the US.

Enns goes on to say, ‘The Securities Act is as thick as the Tax act.’ And as a result, ‘Securities lawyers have as much to keep up with as tax practitioners and that’s a scary proposition.’

Among the modernizations specifically, are new rules on monitoring internal controls, along the lines of Section 404 of the Sarbanes-Oxley Act. Beginning in 2008, CEOs and CFOs will have to evaluate the effectiveness of internal controls over financial reporting including descriptions of the process used to evaluate the controls and their own conclusions. Unlike when Sarbanes-Oxley was introduced in the US, Canada is including guidance on using a top-down, risk-based approach to help lower cost.

The CSA will also start requiring companies to report expanded executive compensation data in the 2008 proxy season. Among other things, the new rules will give a clearer figure for total compensation. Still, some are pushing for even better disclosure. The Institute of Corporate Directors (ICD) in June, released a policy paper criticizing the rules for focusing so much on the dollar value of the compensation as opposed to the ‘crucial governance-related function that compensation plays within an organization.’ The ICD would like to see compensation arrangements also written so that directors, on behalf of investors, can clawback bonuses and long-term incentive payments on the basis of ‘malfeasance’ or when accounting adjustments warrant.

Crawford contends that these new disclosure measures were held up by having 13 different securities commissions. ‘Certainly, the Sarbanes-Oxley equivalents would have moved faster,’ he says. ‘It’s not necessarily bad in this instance since we’re backing off the US somewhat [after witnessing its difficult experience]. The provincial jurisdictions have to negotiate among themselves as to how to do these things, which can be a very long process.’

After a series of meetings with provincial securities regulators, the Crawford panelists have no more planned. Recently, Canada’s federal minister of finance, James Flaherty, called for appointing an expert panel to advise on new securities legislation and alternatives for its implementation under a passport system or a common securities regulator. It is expected to be a collaborative process involving the federal government and the provinces. Advocates of a single regulator are pushing for the involvement of individuals like Howard Davies and John Tiner, former chief executives at the UK’s Financial Services Authority, which created and began operating a unified system within the span of two years.

While the Crawford panel will continue, to some extent, advocacy for a single regulator, Crawford himself says: ‘The new group will take the ball.’

In his Financial Post piece, Russell says this outcome is a surprise to many who thought Canada had reached a ‘tipping point’ for a common regulator.

Those practitioners closer to the ground don’t find the status of the initiative so unexpected. ‘Politically, I don’t think it’s ever going to fly,’ Enns says. ‘The practical view is that the compromise is not that bad.’