In the wake of the massive financial crisis attributable — at least, in part — to failures in corporate governance, it’s no surprise that regulators are contemplating reforms. But the sort of reforms being proposed by Canadian regulators are apparently not what investors had in mind.

Back in December, the Canadian Securities Administrators proposed a fundamental overhaul of corporate governance regulations in Canada. These changes weren’t in response to the financial crisis, but rather reflected an effort to try to keep up with the ever-changing world of governance.

Securities regulators only really got into the business of establishing governance requirements in the wake of the Enron Corp., WorldCom Inc. and other scandals of 2001, which led to sweeping changes in the U.S., largely in the form of the Sarbanes-Oxley Act.

Canadian regulators responded by adopting some of the measures introduced for U.S. companies in the SOX. Prior to that, governance requirements were imposed by the Toronto Stock Exchange (now TMX Group Inc. ) as part of its listing requirements, stemming from the Dey Report of 1994. But after the succession of corporate scandals, and the major U.S. response, Canadian regulators tried to improve governance disclosure by making it part of their compliance agenda.

The CSA’s latest proposals are supposed to represent the next stage in the evolution of corporate governance requirements in Canada. In announcing the planned changes, the CSA said its intent is to improve the standard of governance, thereby bolstering confidence in the Canadian capital markets. However, much of the feedback from the investment community suggests that it believes the proposed changes may have exactly the opposite effect.

The regulators are proposing fundamental changes to the existing regime, such as replacing the existing requirements with a more principles-based policies and replacing the existing “comply or explain” disclosure requirement (which demands that issuers either comply with industry best practices or explain why they don’t) with a more general requirement. And the CSA wants existing bright-line tests for audit committee independence to be replaced by a more principles-based definition.

The proposals contemplate expanding the scope of issuers’ governance responsibilities to include: managing conflicts of interest, overseeing and managing risk; and improving shareholder engagement — albeit in a principles-based way.

Although the proposals have their supporters, the overwhelming reaction from the investment community has been negative. Those who have submitted comments on the proposals warn that the proposed changes would represent a weakening of corporate governance in Canada by doing away with minimum requirements and scrapping the “comply or explain” approach.

The Ontario Teachers’ Pension Plan Board warns in its comment: “We think it is a drastic step backwards to replace the current comply-or-explain regime … Replacing the current regime, in our view, will lead to deterioration of corporate governance practices at a time [when] need for transparency around these practices has grown even further.”

RiskMetrics Group Inc.’ s comment says: “The sole merit, if any, of a principles-based vs the current ‘comply or explain’ approach to corporate governance is perception as opposed to reality.”

RiskMetrics argues that the Canadian approach is already very flexible, particularly when compared with the rules-based U.S. regime. “We do not believe that the proposed principles-based approach improves on the current corporate governance guidelines and disclosure requirements. In fact, we believe that the proposed changes may create substantial uncertainty and confusion for reporting issuers, perhaps resulting in a lower bar for corporate-governance best practice in the Canadian market generally and certainly among mid-cap and small-cap issuers.”

Many other comments suggest that instead of moving away from imposing specific governance requirements to a more principles-based regime, the CSA should be beefing up the existing requirements.

Several comments (including those from the Canada Pension Plan Investment Board and the Pension Investment Association of Canada) suggest that regulators should simply retain the “comply or explain” policy, and simply add the new areas of board responsibility to the existing requirements.

“We welcome the proposal to broaden the scope of corporate governance policy to encompass conflicts of interest, risk management and shareholder engagement,” advises Northwest & Ethical Investments LP in its comment. “But now is not the time to move to a fully principles-based policy, or to abandon the ‘comply or explain’ approach to disclosure.”

In addition, N&E reports that its research into the state of existing corporate governance in Canada indicates that a “significant proportion of Canadian companies need to improve governance practice and disclosure, and that the companies that most need to improve are those least likely to respond to a regime that is not based on clearly defined standards.”

@page_break@N&E’s statement notes worries that without clear disclosure standards to follow: “The proposed changes could encourage poor-quality, incomplete disclosure.”

Indeed, the results of a study submitted by the CA-Queen’s Centre for Governance indicates that compliance with the existing regime already falls short. The study looked at more than 300 TSX issuers and slightly fewer than 150 TSX Venture Exchange issuers, and found that about 80% of the TSX issuers have adopted best practices in the area of ensuring board independence, another 10% provide explanations as to why they don’t comply and another 10% just ignore the requirement completely.

“For example, only 73% use a compensation committee composed only of independent directors, and 7% provide an explanation of their alternative approach to comply with the principle of oversight,” notes the CA-Queen’s report. “Yet an astounding 20% do not comply and do not discuss this noncompliance with disclosure.”

Similarly, in terms of various executive compensation requirements, the CA-Queen’s study found that about 80% are in compliance, 4% explain why they aren’t and 16% don’t comply or explain.

The CA-Queen’s report concludes: “Overall, the non-compliance rate should give the investment community, and therefore the CSA, cause to hesitate.”

It adds that the CSA’s proposed new approach to corporate governance represents a retreat from obligations that are already fairly undemanding and warns that this represents “a return to the pre-1995 setting, where basically anything goes in corporate Canada. A curious choice of direction, in today’s uncertain economic climate.”

Indeed, the CSA’s decision to make such a wholesale change to governance regulation in the current state of economic and financial market turmoil is another common complaint among commenters. Even those who are less critical of the CSA’s proposed approach question whether such a move makes sense when boards are already facing major real-world challenges.

“Even if one agrees that the proposed changes in the materials would improve corporate governance,” notes Deloitte & Touche LLP in its comment, “it seems unlikely to us that in today’s volatile economic environment, any board’s time would currently be best spent contemplating and fine-tuning these matters.”

Earlier this year, the Ontario Securities Commission ran into similar objections over a proposed overhaul of its fee model, with firms and issuers questioning whether it made sense to make such fundamental changes amid extreme market conditions. Ultimately, the OSC largely backed away from those proposals.

In the case of the CSA’s proposals, it’s not just the economic and market conditions that have market players worrying about the regulators’ plans; other comments point out that major issues, such as the looming shift to International Financial Reporting Standards in 2011, are more pressing.

This view is echoed even by the one group that would seemingly stand to benefit from a less prescriptive, principles-based approach to corporate governance: directors themselves. The comment from the Toronto-based Institute of Corporate Directors, which convened a task force to study the CSA’s proposed changes and held a roundtable to discuss them, says: “There is an overwhelming sense that the amendments you are proposing will not enhance governance practices or disclosure in Canada. There is also a strong feeling that changes to the CSA’s approach to governance at this time would be imposing too great a bur-den on both issuers and investors who are currently dealing with very time-consuming issues that cannot be deferred. The continuing economic crisis and the conversion to IFRS are among these.”

The ICD calls on the CSA not to move forward with the proposed changes, and to work more closely with firms to improve corporate governance.

There is no shortage of suggestions for ways to improve governance, and more may yet be forthcoming, once the economic and financial crises have passed and firms, regulators and academics are able to try to devise reforms in response to this episode.

Changes are already afoot in the U.S., with the Securities and Exchange Commission proposing reforms to proxy access rules that would improve shareholders’ ability to nominate and elect directors. In addition, New York senator Chuck Schumer has proposed sweeping changes to the way boards function, including mandatory advisory votes on executive compensation and a requirement for independent chairpersons.

The Canadian Coalition for Good Governance recommends reforms such as requiring all public companies to elect directors on an individual basis (not as a slate), to adopt a majority voting policy and to require the separation of the chairperson and CEO roles. IE