Regulators are usually loath to criticize publicly the system within which they work, lest they undermine investor confidence or alienate colleagues. But in a new paper, the Investment Dealers Association of Canada abandons that conceit and presents an impressive array of ideas for reform that, if adopted, would radically reshape securities regulation in Canada.

Last summer, the IDA endowed a task force, headed by Tom Allen, senior partner at Ogilvy Renault LLP in Toronto, to study ways to modernize securities regulation. In doing so, it indicated that the committee would be free to come to its own conclusions; the IDA would probably present its ideas to the committee, just like any other witness. Now, the IDA has done just that, in a paper that tackles the common bugbears of the existing system: lack of harmonization across jurisdictions, the need for tougher enforcement, investor restitution and the growing regulatory burden.

Canada’s patchwork of securities regulators, each with its own set of rules, is a long-standing issue in the industry. To solve the problem, numerous studies have recommended a national securities regulator. Indeed, there’s currently a task force — chaired by Purdy Crawford, counsel with Osler Hoskin & Harcourt LLP, and constituted by the Ontario government — endeavouring to come up with yet another model for a single regulator. (It published a draft model in December and plans to hold cross-country consultations later this year, after which it will present a final paper.)

Meanwhile, a council of the ministers responsible for securities regulation in every jurisdiction except Ontario is working on a project to streamline and harmonize rules. The Canadian Securities Administrators attempted this with its uniform securities legislation project. But the USL project appears to have fallen by the wayside, squandering a couple of years of hard work.

The IDA submission proposes that rather than coming up with a whole new uniform rule, the provinces should simply agree to adopt the existing legislation of one of the larger provinces. If they took this step, the provinces would be working from the same playbook. And, more important, they could more easily get on with reforming the rules.

One of the stumbling blocks for the missing-in-action USL project would have been maintaining consistency over time, as it contemplated giving each jurisdiction a fair amount of latitude — to maintain local rules and to administer the common act differently. The IDA suggests that shifting the regulatory focus from harmonization to “the more productive exercise of amending a single act” would enhance investor protection and shore up market integrity.

What would such an exercise involve, then? The IDA notes that the regulatory burden has grown rapidly in recent years, and it attributes much of that growth to unnecessary rules. “A great many unnecessary rules are created because regulators have failed to allocate properly the responsibility for achieving compliance,” it suggests. Essentially, it is advocating a move to more principles-based regulation.

The IDA calls for regulation to move away from detailed rules and toward precise, measurable regulatory objectives, leaving it up to the firms themselves to determine exactly how to meet the objectives. “Market participants should be responsible for implementing detailed rules at the firm level because, at the end of the day, it is the market participants’ livelihood that is at stake if compliance failures occur,” the IDA says.

A shift toward less detailed regulation would have a number of benefits, the IDA argues, including: curbing the growth of unnecessary rules, focusing firms’ attention on their compliance responsibilities, and speeding up the implementation of new rules. As the IDA points out, the current rule-making process often involves regulators asserting that the cost of a given rule is justified by the benefit to investors, and the industry howling that the cost is excessive. “Seemingly endless rounds of consultations ensue, multiple drafts and amendments are concocted and, finally, sometimes years later, a rule is approved,” it notes.

This protracted implementation process is the norm, despite the fact that investors are rarely represented in these consultations. But they may be more involved in the future if the Ontario Securities Commission does, indeed, make it “a priority to bring retail investors inside the circle of policy development,” as OSC chairman David Wilson told the IDA’s quarterly meeting in January.

@page_break@While retail investors certainly need a voice, this could prolong consultations even further. Witness the regulators’ efforts to come up with an acceptable fund governance rule, which is one of the few occasions when retail investors have made their voices heard.

The IDA doesn’t mention it, but these endless consultations carry an opportunity cost of their own. Once a regulatory gap has been identified, the subsequent years of consultation leave this gap wide open. If there’s a genuine need for regulation, any delay is probably not in the investors’ best interests. Crafting a regulatory response sooner rather than later is surely in the market’s interest, and leaving flexibility for firms to define the implementation would likewise be more efficient, as it would allow firms to decide how to allocate resources rather than imposing a top-down approach.

It remains to be seen whether the task forces or, more important, the securities commissions are open to a more principles-based approach. The B.C. Securities Commission’s effort to move in that direction has floundered; the British Columbia government has decided not to implement its proposed new securities act — which was written around similar concepts — until the end of 2007, if at all.

Notwithstanding that setback, the OSC’s Wilson has declared that he is sensitive to the impact of the growing regulatory burden. “Fostering confidence depends on striking the right balance and carefully avoiding excessive, unproductive burdens on market participants,” he told the IDA meeting.

But as there have been no meaningful rules issued by the OSC since Wilson took over this past November, it’s hard to gauge whether his sympathetic words will translate into action.

Doug Hyndman, chairman of the BCSC, senses a greater willingness throughout the CSA to embrace more principles-based regulation — including the OSC. Despite the B.C. government’s decision to mothball its new securities act, Hyndman stresses: “We are still committed to changing the approach to regulation. The ideas in the new legislation still make sense and we are pursuing many of them through our CSA work.”

This sentiment is echoed by Michael Greenwood, president and chief operating officer of Vancouver-based Canaccord Capital Inc. Greenwood also senses the will to reform. “We have had very good conceptual discussions on the right approach with Purdy Crawford and David Wilson,” he says. “People are finally engaging in what the debate should be about — the vision and content, not the structure, which is always the last piece.”

A less rule-heavy approach would be welcomed by the securities industry. Firms that commented on the BCSC’s proposed move in that direction generally supported the idea, although they worried about uniformity among jurisdictions (which shouldn’t be a concern if the reform occurs in the context of a common securities act) and uncertainty about just what they do and don’t have to do.

To work in practice, the rule objectives would have to be quantifiable and, the IDA says, the regulators would have to become risk managers. Paul Bourque, senior vice president of member regulation at the IDA in Toronto, suggests that a system that puts more responsibility on the firms’ shoulders would also help separate the scrupulous firms from those that are either unscrupulous or careless about compliance. These riskier firms could then be subject to more frequent reviews, closer supervision and more detailed requirements — raising the compliance costs on those that pose greater risks, which ultimately either causes them to change their behaviour or drives them out of business.

Tougher enforcement

For those that are chronically offside, the IDA submission proposes some significant reforms designed to toughen enforcement. It calls for a single national securities tribunal to hear all cases brought for violations of securities legislation. This follows the recommendation of the Osborne report in Ontario, which suggested that the adjudicative function of the OSC be spun off into a separate body, and the draft Crawford report, which also calls for a separate tribunal as part of its design for a single regulator. Such a body, the IDA suggests, would be more efficient than the current system and would eliminate any perception of bias.

Second, the IDA recommends that the securities commissions be given the responsibility for prosecuting capital market-related criminal cases. The IDA notes that while white-collar crimes typically have a low priority for Crown prosecutors, the commissions’ litigators have market expertise and are highly motivated to see these sorts of cases prosecuted. Giving them the job, it suggests, would increase prosecutions and penalties for offenders, bolstering confidence in the markets.

As well, the IDA calls for more enforcement powers for self-regulatory organizations. These recommendations are nothing new. The IDA has been pushing for these added powers for some time — the ability to compel witnesses, statutory immunity for self-regulatory organizations, the power to enforce SROs’ decisions through the courts and the power to seek court-ordered monitors in certain cases.

Also on the enforcement side, the IDA considers the problem of improving investors’ access to restitution. It notes that greater efforts to gain restitution for investors would bolster investor confidence and save them the hassle of going to the courts. However, the IDA worries about managing clients’ expectations, and notes that restitution orders may make sense in only a limited number of cases. While legislative change is not necessary for IDA hearing panels to make restitution orders, Bourque suggests that it is preferable that restitution powers be legislated.

The IDA submission also calls for other reforms, including a legislated “gatekeeper” obligation for dealers and advisors, similar to the one that market regulators impose on trading firms. It suggests that practical prospectus disclosure could be improved with the introduction of a two-page, plain-language prospectus summary to take the place of the fat, legalistic prospectuses that are now the norm (although these would still be available).

Finally, it recommends reforms to the registration system, which it views as highly fragmented and inefficient. It suggests delegating registration of its members to the IDA, delegating registration in the other categories to a firm’s principal jurisdiction and adopting a uniform registration system.

Candid criticism such as this may be the first step toward genuine reform. The IDA’s wish list is a long and ambitious one, but much of it appears practical and sensible, and remarkably little of it is self-serving. Hopefully, the securities commissions — and their political bosses — are listening. IE