The quality of share holder democracy in Canada has recently come under scrutiny from both Bay Street and financial services regulators. Now, a regulator is facing some heat about its own electoral processes.

In mid-January, the B.C. Securities Commission handed down a decision sharply criticizing the Mutual Fund Dealers Association of Canada for its proxy solicitation practices in advance of a special meeting of members in the autumn of 2009.

Says the BCSC’s decision: “We find that the MFDA board’s decision to conduct the proxy solicitation process as it did for the October 2009 special meeting would have led an objective observer to question the integrity and credibility of the MFDA in managing that process.”

The BCSC decision stresses that its comments concern only the MFDA’s governance practices, and should not impugn the MFDA’s overall integrity or credibility as a self-regulatory organization. In fact, the BCSC decision says, the MFDA has been built into “an effective and credible regulator.”

But, as far as that MFDA meeting is concerned, and the proxy solicitation that preceded it, the BCSC has ruled that the MFDA’s proxy process was inherently flawed and that the bylaw changes passed at that meeting must be set aside until they are approved under a process that meets the standards set by the BCSC in its decision.

The scolding came in the wake of a hearing the BCSC held to consider a complaint about the MFDA’s governance practices that was originally brought by a fund dealer, Regina-based Partners in Planning Financial Services Ltd. PIP ultimately withdrew its application for a hearing, but the BCSC hearing panel denied the joint request of the MFDA, PIP and the BCSC executive director to discontinue the proceedings. Instead, the BCSC decided to go ahead with the hearing, saying that the case raised some serious public interest issues that had to be addressed.

Those issues first came to light following the MFDA’s annual meeting in late 2008. At that meeting, the SRO had sought to make changes to its governance rules, which would have allowed two public directors to extend their terms on the SRO’s board.

When those changes weren’t approved, the MFDA decided to allow those two directors to stay on the board while it worked on further governance reforms. Then, in October 2009, the MFDA called a special meeting to consider proposed changes to its governance bylaws. Ahead of that meeting, the regulator had solicited proxies from members to vote in favour of the proposed changes.

During the BCSC’s hearing, the commission reviewed whether it was proper to allow the two directors — whose terms had expired — to stay on the MFDA board, and whether the proxy solicitation process that accompanied the second meeting was appropriate.

The BCSC then ruled that the decision to leave the directors whose terms had expired in place was acceptable, but that the proxy process for the special meeting was not. The BCSC panel found that the proxy solicitation strategy, which was led by the board, didn’t simply seek to maximize participation at the special meeting; it also sought to ensure the proposed bylaw changes were approved.

While this process may be acceptable for a public company, the BCSC panel suggests, it is not for an SRO. Further, the MFDA board’s basic failing was in not considering the difference between a corporation soliciting proxies from its shareholders and a regulator soliciting proxies from members that it also oversees: “Clearly, the relationship between the MFDA and its members is not the same as the relationship between a corporation and its shareholders.”

The BCSC decision adds that dealers could feel pressure to vote in favour of management-sponsored resolutions when proxies are being solicited by their regulator: “Apart from whether pressuring members was the intent, it would have been obvious to an objective observer that the process was fraught with the risk of members feeling pressure to vote, and to do so in favour of the amendments.”

Since this episode, the MFDA has revised its proxy policy; but the BCSC has indicated that the proposed new policy isn’t good enough, either. While the BCSC agrees with several elements of the MFDA’s new policy, the BCSC says that the problem remains that the MFDA’s board would still be in control of the proxy process, noting that the 2009 special meeting “shows that board oversight alone is no guarantee of an appropriate outcome.”

Instead, the BCSC maintains that the MFDA’s proxy solicitation process should be conducted through an independent proxy solicitation service; that the MFDA board should be limited to overseeing the process; and that the SRO’s directors, executives, and other employees should not have any other involvement in proxy solicitation. As a result, the BCSC directs the MFDA to revise its process further to meet these standards of independence and confidentiality.@page_break@Following the release of the BCSC’s decision, Larry Waite, president and CEO of the MFDA, said that the SRO is reviewing the decision with its legal counsel.

It’s possible that the MFDA could decide to appeal the BCSC’s decision, but it seems more likely that the SRO will abide by it and try to revise its proxy process further still to conform with the BCSC’s direction. The MFDA has a board meeting scheduled for later this month, when it will probably decide how to proceed.

The industry’s other SRO, the Investment Industry Regulatory Organization of Canada, is also taking note of the BCSC’s decision. IIROC’s vice president of public affairs, Connie Craddock, says that IIROC has hired a firm to analyze the BCSC decision “so that we can understand the standards it has set for the MFDA” and compare these standards with the SRO’s existing processes to determine whether changes to its practices will be needed.

IIROC was already mindful of the issues being raised in the MFDA’s case, Craddock notes, and had hired a third party to conduct the proxy solicitation for its most recent annual meeting.

While devising a credible proxy solicitation process is particularly important for a regulatory organization — and somewhat trickier than for a public company, as the BCSC decision points out — the proxy voting system for public companies is facing its share of criticism, too.

Last autumn, Bay Street law firm Davies Ward Phillips & Vineberg LLP published an extensive research paper into the proxy voting system in Canada. It did so after finding that the firm and its clients have “encountered a variety of obstacles” in making sure that shareholder votes are properly cast and counted.

Davies spent 16 months examining the corporate proxy voting system, finally concluding that it is impossible either to prove that systemic problems exist or to satisfy itself that they don’t. Instead, the firm concluded: “The problems with the proxy voting system are so layered and complex that, in our view, a number of issues must be addressed before effective solutions can be proposed.”

The provincial securities commissions are aware that the proxy voting system in general needs to be improved. Last spring, the Canadian Securities Administrators proposed rule changes designed to make the proxy system more efficient — albeit possibly at the expense of voter turnout — by proposing to introduce a notice-and-access model (allowing issuers to provide notice of and access to voting materials rather than automatically sending materials to all their shareholders) for routine shareholder meetings.

However, in response to that proposal, many participants in the proxy process pointed out that the problems with the system go much deeper than worries about efficiency. There are concerns about overvoting, empty voting and unequal treatment for shareholders. But, most important, there is also a simple lack of confidence in the tallying of votes.

In response, the Ontario Sec-urities Commission now says it’s considering broader reforms to the proxy voting system. In mid-January, the OSC published a staff notice indicating that it “recognize[s] the need for an effective proxy voting system that allows shareholders to make informed voting decisions and ensures that their votes are counted at shareholder meetings.”

So, in addition to the proposed CSA reforms to introduce its notice-and-access model, OSC staff are reviewing the proxy voting system overall to determine whether there is a need for additional reform; and, if so, the extent to which this should be done under securities laws.

This work is at an early stage. For now, the OSC is soliciting feedback from the industry on the sorts of reforms it should consider (comments are due by March 31). Then the OSC must co-ordinate this work with the rest of the CSA before actual rules are proposed.

It remains to be seen whether regulators can make democracy work, both among the issuers they oversee and within their own walls. IE