IT DOESN’T ALWAYS PAY TO BE TOUGH
Our softer approach to market regulation may not be so bad after all
Earlier this summer, Toronto-based Cinram International, the world’s largest maker of pre-recorded CDs and DVDs, made a decision that most Canadian companies would have considered unthinkable a decade ago. It deregistered in the United States, opting to stop filing financial information with market regulators there. The decision was a long time in the making— the company delisted from the Nasdaq six years ago and now trades only on the TSX— but the recent move was in part set off by onerous accounting rules it faced in the U.S. under Sarbanes-Oxley, measures passed in 2002 in the wake of the Enron scandal. “The SOX provisions were very costly,” says Lewis Ritchie, the company’s chief financial officer. “I think it was overkill and everybody is pretty well acknowledging that, including those who put in those regulations.”
Cinram isn’t alone in pulling up stakes in the U.S. Last month, International Power, the U.K.-based electricity company, said it was delisting from the New York Stock Exchange “with the aim of reducing compliance costs.” Other foreign firms have done the same, reversing a trend that had once seen listing in the U.S. as the ultimate goal for most growing firms. The tide has turned so far that even Eliot Spitzer, the New York attorney general who led the charge against Wall Street malfeasance, changed his tune on the effectiveness of U.S. market regulation. “It has created an unbelievable burden for small companies,” he said in a speech last year.
U.S. soul-searching over the reaction to Enron stands in marked contrast to the situation in Canada, where criticism that regulators haven’t gone far enough to protect investors is as loud as ever. Last month, Finance Minister Jim Flaherty delivered a stinging speech in Toronto about the need for a single national regulator, highlighting the perception that capital market enforcement in Canada is lax and that investors seem to put more faith in rules-obsessed Americans to police their markets. “It concerns me greatly that some Canadian investors
consider it necessary to rely on the United States to hold companies to account for their actions,” said Flaherty.
There’s no shortage of high-profile critics who say Canada’s regulators—particularly the Ontario Securities Commission, the country’s biggest and most important body—are too reluctant to put white-collar criminals behind bars. But as the U.S. market stumbles and investors grow weary of the market crackdown, many observers, from academics to securities lawyers, say Canadians should be careful what they wish for. If the U.S. experi-
ence has done anything, it’s raised an important question: how much regulation is too much? Even in the absence of a national regulatory body, there’s growing evidence that Canadian market enforcers haven’t done so badly with their softer approach, riding a fine line between protecting the market and not suffocating it under an avalanche of enforcement. “There are extraordinary things happening in the U.S. as the pendulum has swung back,” says OSC vice-chair James Turner, who along with the OSC executive team sat down to speak with Maclean’s. “Even more important, the U.S. has discovered they’re not the only capital market in the world.”
FIVE YEARS AGO, few observers thought Canada should hold off on aggressive, U.S.-style reforms. After Enron and WorldCom, there seemed only one way to protect investors: put executives in prison and slap tough regulations on public companies to guard against future sins. “There was a great worry that these were not simply two unusual, pathological incidents, but the tip of a very big iceberg,” says Christopher Nicholls, a law professor at the University of Western Ontario. And there was a lot of reason to believe that was true. Beyond the two high-profile meltdowns, there were plenty of other troubling cases, even in Canada, from Royal Group Technologies to Nortel Networks.
But Canadian regulators mostly resisted pressure to elbow U.S. rules onto Canadian markets, most notably by not adopting controversial Sarbanes-Oxley measures calling for strict, and many say superfluous, auditing rules, like making CEOs sign off on the accuracy of financial statements. Compliance with those rules has proved costly in the U.S. and, experts say, would have crippled Canadian markets dominated by small companies. They would have had “very, very serious adverse affects,” says Nicholls.
In the U.S., polls show that most public companies say the costs of SOX outweigh the benefits. Testifying before a U.S. government committee last month, Harvard professor Hal Scott said the cost of regulation has made U.S. markets less attractive. In the late 1990s, about half of all global IPOs (where a company raises money outside its own country) were in the United States. By 2006, that had fallen to about seven per cent, he noted. Listings of IPOs on U.S. exchanges were worth about US$50 billion last year, compared to US$62 billion in China and US$82 billion on European exchanges.
It’s long been conventional wisdom that the lack of rules and its international reputation as the “Wild West” of the financial world, as Bank of Canada governor David Dodge famously described it, is hurting the TSX. But there’s no clear evidence to that effect. “We all know Canadian markets have benefited enormously from what’s happened with commodity prices,” says Nicholls. “At the same time we can at least say it is not apparent that Canadian companies’ share prices have suffered from an approach to regulation that’s different than the U.S.” Strong market performance alone doesn’t vindicate the regulatory regime, but it does help shift the burden to the critics, he notes.
Defenders of the U.S. approach argue that troubles there are a result of the increasingly competitive world of globalized capital markets. “I don’t think first of all the sky is falling,” said SEC chairman Christopher Cox at
a Congressional hearing in June. “I think what’s happening all around us is more competition.” That may be true, but money is migrating to places that appear to strike the best balance between free flow of capital and minimal bureaucracy on one hand and suitable shareholder protection on the other.
Of all the world’s markets, London appears to have struck the right balance. The LSE and
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its junior market, the Alternative Investment Market, has been roaring lately. In June, Clara Furse, CEO of the LSE, visited the U.S. to drum up business and argued that thousands of companies have elected to do initial public offerings on AIM rather than American markets. The trend hasn’t gone unnoticed at the OSC, where chair David Wilson said it’s “something we should learn from.”
STILL, ALL OF THIS has done little to dispel the notion that when it comes to actually punishing incidents of wrongdoing when
they happen, Canadian regulators lag badly behind their American counterparts. The U.S. has racked up an impressive list of high profile white-collar cases that ended with big prison sentences: former Tyco CEO Dennis Kozlowski received up to 25 years in prison. Enron CEO Jeffrey Skilling was given a 25year prison sentence, and Enron founder Kenneth Lay faced spending the rest of his life in prison before dying of a heart attack last year. More recently, the Conrad Black saga underscored the lengths the U.S. government, FBI, and SEC will go to in pursuit of white-collar crime. The OSC, on the other hand, tends to attract attention for its failures—from the acquittal this week of John Felderhof (the only person charged in the notorious 1997 Bre-X mining scandal which cost investors $6 billion) to the case against ex-investment banker Andrew Rankin (whose conviction on stock tipping was overturned) to the muted response to the stock option backdating scandal (which has cost dozens of U.S. executives their jobs). To some critics, the lack of high-profile white-collar cases in Canada is a cause for concern—a sign that the enforcers aren’t doing their job.
The OSC says criticism that’s soft on crime overlooks the work it does either successfully settling cases or avoiding them by focusing on compliance. “What is unseen are the cases that have been prevented. Cases where it’s not necessary to proceed with enforcement proceedings because the decision is made that public markets have been adequately protected,” says Larry Ritchie, a vice-chair with the OSC. It also overlooks cultural differences between Canada and the United States, which tends to view prison as a more useful deterrent, adds Ritchie.
OSC chair David Wilson bristles at the notion the SEC is more aggressive when it comes to market enforcement. A question about recent high-profile white-collar cases elicits an abrupt, defensive response. “Those are not SEC cases,” he says, complaining about a common misconception. The SEC, of course, does investigate wrongdoing in cooperation with law enforcement (and has played a highly visible role in virtually every fraud case in the post-Enron crackdown) but, as Wilson stresses, actual criminal proceedings in the U.S. are handled by the justice department.
Nevertheless, the defining image of the U.S. approach to white-collar criminal enforcement is the so-called “perp walk,” where police, flanked by SEC-types, lead executives from their offices in handcuffs. That doesn’t happen in Canada, nor do such theatrics jibe with the mentality found among Canadian regulators, say former OSC employees. “The ones who are the most thoughtful,” says Joe
Groia, a securities lawyer and former head of enforcement at the OSC, “get the most satisfaction out of a case that’s properly investigated and then settled on a fair basis with a respondent.” The last thing an agency like the OSC wants is a collection of bullies investigating cases, says Larry Waite, also a former OSC enforcement chief, and now president of the Mutual Fund Dealers Association of Canada. There is no pressure on OSC investigators to put people in handcuffs, says Waite, but “there is pressure to do the job right and be fair.” Critics also tend to overlook the difficulty of successfully prosecuting a criminal case. “It’s easy to open an investigation; it’s very hard to close one,” adds Waite.
The notion that there’s a lack of enforcement activity in Canada is actually off base, experts say. Earlier this year, the Investment Dealers Association commissioned Harvard professor Howell Jackson to look at differences between Canadian and U.S. securities regulators in light of the “apparent effectiveness of enforcement actions in the United States.” His conclusion: Canadian budgets and staffing might actually be more intensive than in the United States.
Over the past several years, the OSC has significantly boosted its enforcement efforts— a process that began long before Enron. There’s been considerable activity lately to show for it, too. In the six months from October 2006 through March 2007, Canadian Securities Administrators members report there were 69 cases resulting in fines of $2.4 million and three cases resulting in prison sentences ranging from 15 months to four years. Over the last year, the OSC had 24 matters before the courts, 18 cease trade orders and 12 bans on directors or officers. “They’ve shown no reluctance to lay criminal charges when it’s appropriate,” says Groia, “I do think they are unfairly criticized by way of comparison to the American experience.”
The role of the police in market regulation is also frequently overlooked. Criticism of the OSC has to be shared by the RCMP, which through its Integrated Market Enforcement Teams, plays a crucial role in policing white-collar crime—casual observers often forget that the OSC (like the SEC) has no power to arrest anyone. The IMETS have accomplished virtually nothing since being set up in 2003, failing to score any high-profile convictions.
If there’s a basis for criticism it may be the softer way enforcement is handled in Canada, rather than the lack of it. The OSC pursues the majority of its cases not in provincial courts (where it can pursue criminal cases), but before its own administrative hearings, where there is a lower burden of proof and punishment comes in the form of fines, not
prison time. “You have a combination of a very active enforcement program by the OSC combined with a reluctance to go in front of a court and those two factors together I think have been responsible for a large portion of the criticism,” says Groia. That causes concern among many securities lawyers (who see the OSC playing the role of judge and jury), but doesn’t mean things aren’t happening on the enforcement front.
Regulators and police also appear to lag in the speed and tranparency with which cases are handled. The OSC tends to react to alleged misdeeds in a slower and more cautious manner than the SEC, says Philip Anisman, a Toronto securities lawyer. Anisman points
DURING THE LAST YEAR, THE OSC HAS HAD 24 CASES BEFORE THE COURT
out the recent Dowjones insider trading case in which the SEC filed a lawsuit against two people accused of buying the stock in advance of reports that News Corp. planned to buy the company. The OSC, he says, would typically pursue such a case with a cease trade order, something that wouldn’t get as much publicity, but is not necessarily less effective. “It’s fair to say that the SEC is sometimes quicker off the mark than the Canadian commissions, but I’m not always sure being quick off the mark is indicative of quality.”
Wilson stands out as the first in a long line of OSC chairs not to promise to get tough on crime. “Our focus is to contribute in a positive way, not to beat the drumbeat of more criminal cases,” he says. While this isn’t the kind of approach likely to satisfy critics or change public perceptions that Canada is soft on white-collar crime, it might just be the best thing for the future of the Canadian stock market. M