Among all the complaints levied against the Canadian system of securities regulation, it’s enforcement that faces the most persistent criticism.

Canadian enforcement long has had a bad rap, dating from the 1980s, when Vancouver’s stock exchange was labelled the “scam capital of the world,” a tag garnered through the massive core-sample salting scandal at Bre-X Minerals Ltd. to the fraud at Livent Inc., with other notorious cases too numerous to mention occurring along the way.

But the reality is that regulators everywhere have a tough time with enforcement. Although ineffective enforcement is seen by many as a particularly Canadian failing, it is far from unique to the Canadian market.

A new working paper from the International Monetary Fund examines the challenge that securities regulators around the world face in delivering effective enforcement. It states: “In spite of the critical role enforcement plays, [assessments of regulators’ compliance with principles established by the International Organization of Securities Commissions] clearly show that many countries face significant challenges in implementing credible and effective enforcement programs in the securities arena.”

To be sure, Canada has its share of shameful enforcement failures. But the IMF paper, authored by Ana Carvajal and Jennifer Elliott, cites even more damaging episodes from around the world that should be enough to make Canadian regulators feel somewhat better about their own malfunctions.

The paper cites examples of major Ponzi schemes that have operated undetected for some time, such as the recent US$50-billion scheme perpetrated by money manager Bernie Madoff of New York; a series of scams that enveloped Albania in 1997 that led to the collapse of the government, civil anarchy and at least 2,000 deaths; trading scandals, such as the one that led to the toppling of London-based Barings Bank PLC in 1995; and a number of major market manipulations.

On the basis of these and numerous other examples of colossal enforcement failures, the IMF paper concludes: “To a large extent, these cases also prove how difficult the task of enforcement is — detection was slow in many of the cases, deterrence insufficient and punishment delayed. In each case, the reputation and credibility of the regulator as an enforcer was proven insufficient to deter large-scale violations of the law.”

The IMF paper also notes that the ongoing global financial crisis highlights the importance of enforcement to the financial system as a whole. To be sure, individual investor protection is one of the central goals of securities enforcement. But enforcement also has a broader function of bolstering overall investor confidence, and it has recently become apparent that it has a role in ensuring systemic stability.

“Enforcement is key to the credibility of regulators and, as such, fosters the achievement of all the goals of securities regulation (investor protection, fair and liquid markets, and financial stability),” the IMF paper notes. “[But] regulators throughout the world face significant challenges in implementing credible and effective enforcement programs.”

Although there is no denying the importance of effective enforcement, achieving it is much easier said than done. Nor is it exactly clear when an enforcement system can be considered effective. Public perception clearly plays a big role in that judgment, yet public attitudes can be maddeningly fickle.

Prior to the global financial crisis, Britain’s Financial Services Authority was lauded as an effective regulator and a model for others to emulate. Since the crisis, however, it has come to be seen as being too soft. The FSA has pledged to beef up enforcement.

Conversely, before the crisis, the U.S. Securities and Exchange Commission was criticized as being too tough on its market players, and scaring off foreign issuers. Policy-makers were seeking ways to soften its approach and make the U.S. market more competitive with Britain and other foreign jurisdictions. Yet, when the Madoff scandal was uncovered, the SEC was blamed for failing to discover it sooner; far from being too tough, it turns out, it is now also considered too soft.

Nevertheless, the IMF paper spells out the various elements that are considered necessary for effective enforcement based on principles developed by IOSCO. These are divided into two basic categories: an adequate framework for enforcement, and the capacity to follow through.

The essentials to a proper framework for enforcement include such things as:

> a mandate to enforce the rules;

@page_break@> sufficient authority to investigate;

> robust evidence-gathering powers;

> the ability to act immediately to shut down an ongoing scheme;

> the authority to bring charges and impose sanctions;

> the freedom to co-operate with foreign regulators, and;

> the existence of complementary criminal enforcement.

The framework in Canada appears to meet most of these criteria, with the glaring exception of the criminal-enforcement component. The authors of the IMF paper report that their analysis found: “In practice, in many countries, criminal authorities have not made financial crimes a priority.”

The paper singles out Canada in this regard: “A recent example on how the lack of active and successful criminal enforcement can undermine the credibility of a regulatory framework can be found in the case of Canada, where the lack of criminal convictions leading to imprisonment has created a perception that enforcement is weak, in spite of all the disciplinary actions taken by the securities regulators and the self-regulatory organizations (which play a significant role in that jurisdiction).”

There have been several efforts in Canada aimed at dealing with this particular problem over the years — most notably, the formation of the RCMP’s integrated market enforcement teams, which were unveiled in the 2003 federal budget.

But the IMETs program wasn’t initially able to produce the sort of results that were hoped for, and the initiative underwent a retooling process starting in late 2007. Since then, charges have been laid in a handful of high-profile cases — most notably, against a trio of former Nortel Networks Corp. executives in the summer of 2008 (although that case has yet to be heard in court, and the allegations have not been proven).

The problem has also been recognized at the ministerial level. In late 2007, the federal and provincial justice ministers received a report from a working group of regulators, police and justice officials (chaired by David Wilson, chairman of the Ontario Securities Commission), that made a series of recommendations aimed at improving securities fraud enforcement.

The Ontario attorney general’s office says that more work on the issue is being carried out by a committee of prosecutors that represent provincial and federal Crown attorneys across the country. The goal is to implement the operational recommendations contained in the Wilson report. The recommendations dealing with new legislation have been referred to Ottawa for review.

The IMF paper finds that a bigger problem for many securities regulators is whether they have the capacity to enforce their own rules.

In terms of capacity, the paper identifies elements such as staffing, resources, organizational structure, an effective court system, regulator independence and political will as necessary requirements; and the paper notes that deficiencies in these areas often present a more serious obstacle to creating effective enforcement than do gaps in the regulatory framework.

Specifically, the paper points to lack of political will and enforcement resources as particular problems, and also cites a lack of regulator independence as the most significant weakness: “Freedom from political or commercial interference is not enough. Full support for active enforcement from the senior management of the regulator is critical … in practice, many regulators are concerned about the adverse effects that enforcement could have in the market and, at senior levels, could be reluctant to support a vigorous enforcement program.”

In Canada, the question of political will and independence is complicated by the provincial fragmentation of regulation. Each regulator answers to a different minister, who almost inevitably has different priorities. Regulators in different provinces also face different resources. Moreover, the proliferation of regulators impacts the efficient use of enforcement resources, as certain functions may be needlessly duplicated in various provinces. Indeed, one of the promised benefits of a single national regulator would be improved enforcement.

Speaking to the standing committee on government agencies in April, the OSC’s Wilson said, “Enforcement could and should be better” in Canada. And he pointed to the fragmented system as one of its weaknesses.

“We believe the enforcement framework in Canada is not as effective as it could be because we have too many regulatory authorities,” he said, noting that both Ontario’s provincial government and the OSC favour the creation of a national securities regulator — “Which we feel would enhance regulatory and criminal enforcement.”

Wilson said that such a move would still leave multiple authorities with responsibility for the criminal aspect of enforcement. “However, if you can shrink the number of bodies that are involved from 25 or 30 to 10 or 12,” he added, “that’s a simplification that should make the system easier to co-ordinate, operate and function.” IE