Investors Scrutinizing the Regulators

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Gowling Lafleur Henderson LLP
28 March 2008


Singing The Passport Blues

Perfect Harmony Eludes Provincial Securities Harmonization Efforts

Edited by D'Arcy Doherty, Paul Fornazzari, Brett Kagetsu, Pierre Lissoir and J. Jason McCormick

Overview

In 2003 provincial and territorial Ministers responsible for securities regulation across Canada acknowledged the need to streamline access to Canada's capital markets.1 A policy level solution was proposed: establish a European-type "passport system" where an issuer would only have to comply with the rules of its home jurisdiction in order to gain access to investors across the country.2 Five years later the Canadian Securities Administrators (CSA) have released rules and policies that implement this concept on March 17, 2008, in all provinces and territories except Ontario.

The passport system streamlines the review of prospectuses and exemptive relief applications, as well as the registration of securities professionals across Canada. However, the goal of avoiding overlapping review by provincial and territorial securities regulators will remain elusive as Ontario has opted out of the system. Ontario continues to support the creation of a single, national securities regulator and has taken the view that opting into the passport system would conflict with this objective. In the commentary at the end of this article, we discuss how the implementation of the passport system and Ontario's opting out may just be a significant step towards a single national regulator.

The passport system comes online at the same time as do new uniform rules for prospectuses. Proposed new rules for registration of securities professionals are also expected to become effective next year. On a technical level, all the members of the CSA, including Ontario, have also revised and improved the multiple jurisdiction coordinated review process, which will continue to apply in those instances where the passport system is not applicable.

Prospectuses In Passport Jurisdictions
Generally, the securities regulator of the province in which an issuer's head office is located will be the issuer's principal passport regulator. The clearance of a prospectus by the principal regulator will automatically trigger clearance in all other jurisdictions where the prospectus is filed, except Ontario. Under the passport system, a regulator in another jurisdiction cannot opt out and conduct its own review. The new passport prospectus process will provide a procedural improvement over the old system, in the sense that non-principal passport regulators will no longer conduct separate prospectus reviews.

Issuers will continue to file their prospectus in each desired jurisdiction through SEDAR and will still be required to confirm, calculate and pay filing fees to each jurisdiction in which the prospectus is filed. As such, the new system will not result in any fee reductions or efficiencies in fee calculation and payment. There is also a requirement for issuers to confirm with their prospectus filing that they have "delivered all documents required to be delivered under the securities legislation of each jurisdiction in which the filer filed the materials". This rather innocuous provision may well buttress a continuation of the Canadian practice of requiring issuers to obtain legal opinions in each jurisdiction in which the prospectus is filed, thereby off-setting some of the promised cost savings of the passport system.

If a non-Ontario issuer files a prospectus in Ontario, the Ontario Securities Commission (OSC) will continue to engage in a separate review before clearing the prospectus, as under the current system. Furthermore, Ontario can go as far as opting out of the coordinated review process at any time before the passport regulator clears the prospectus. If the passport regulator is able to resolve the OSC's issues, the OSC may opt back into the coordinated review process. If the OSC opts out, the issuer will have to deal directly with the OSC to resolve the outstanding issues.

Prospectuses Filed In Ontario Under The Passport System
Although the OSC is not participating in the system, the multi-lateral instrument implementing the passport system recognizes the OSC as the "principal regulator" for prospectuses filed in Ontario, just as if Ontario had joined the system. This gives market participants in Ontario access to investors across the country by dealing only with the OSC. If an Ontario issuer files its prospectus in other jurisdictions concurrently with its Ontario filing, only the OSC will review the prospectus and its decision will automatically apply in the other jurisdictions. Therefore, Ontario issuers are not prejudiced in any way by Ontario's decision not to opt in. In fact, the passport system places Ontario issuers in a more advantageous position than issuers with head offices in other jurisdictions. Ontario issuers need only deal with the OSC whereas issuers in other provinces must deal with their principal regulator and with the OSC.

The Particularities Of Quebec
In Quebec, the passport system will not modify the current requirements governing the use of the French language in public disclosure documents. The obligation to produce documents in French will continue to apply to issuers wishing to distribute their securities in Quebec. Such documents include the prospectus itself and any documents incorporated by reference into the prospectus, such as annual and interim financial statements and MD&A, the issuer's annual information form, material change reports (including attached news releases) and information circulars. It can be expected that translation opinions from legal counsel and the issuer's auditors will continue to be required.

Principal Regulator Rules
In the past, issuers may have selected a principal regulator other than the regulator in their head office jurisdiction under previously more flexible rules or exemptive relief. For example, the technical "head office" may have been in one province but the chief executive office in another. The passport system does not "grandfather" these situations in the passport provinces. In Ontario, there is no change in law so if the OSC has become principal regulator for whatever reason the OSC will continue to consider itself as the principal regulator. Issuers in this situation wishing to avail themselves of the passport system will be required to make an application with the "legal" principal regulator for a change of principal regulator, and make a case as to why the head office jurisdiction should cede its regulatory authority. We understand based on discussions with one passport province regulator that the case would have to be made on the basis of the new rules and a "grandfathering" argument alone would not be sufficient.

Applications For Exemptions From Securities Legislation
Applications for exemptive relief are an important and costly aspect of securities regulation and compliance. Because securities legislation is very technical and prescriptive, issuers are often required to apply for exemption from a particular rule or provision that would frustrate or unduly complicate a transaction. Typically in such cases, the requirement serves no important purpose in the particular circumstances and the exemption is granted on a routine basis. Nevertheless, applications for exemptions are very paper intensive and hence expensive.

Under the passport system, an issuer will only have to file an application with, and pay fees to, its principal regulator. The principal regulator's decision to grant relief will result in an automatic exemption from the equivalent provisions in every other passport jurisdiction that was included in the application, except Ontario. Where exemptive relief is required in Ontario, an Ontario application will continue to be required from out-of-province issuers. Ontario issuers, by contrast, will be able to obtain cross-Canada relief by filing only with the OSC.

Despite these improvements, there is a noteworthy deficiency in the system. There are cases where terms and conditions imposed by the principal regulator may affect an issuer more adversely in another jurisdiction, such as where the cost of complying in the other jurisdiction are significant, but the issue requiring the terms and conditions is insignificant in that non-principal jurisdiction and could likely be exempted without terms and conditions. The one size fits all approach of the passport system does not address this likely scenario, as there is no specific mechanism in the passport rules for an issuer to obtain different relief in different jurisdictions. This problem is likely to arise for both exemptive relief applications and registration matters involving securities firms and professionals. Along these lines, it should also be noted that the passport system does not address the review and appeal mechanisms under the various securities acts that an aggrieved applicant is still entitled to use despite whatever decision the principal regulator has made. In other words, the principal regulator makes an adverse decision and the issuer appeals and the issuer appeals that decision in another jurisdiction where the issuer is more adversely affected, or where the proposal can be carried out without reference to the principal jurisdiction.

It is also noteworthy that certain types of exemptive relief applications are not covered by the passport system, most notably applications for a "reporting issuer" designation. Applications for such exemptions must still be filed with (and fees paid to) the regulator of each jurisdiction in which relief is sought. As such, the coordinated review rules will continue to apply to these applications. Under co-ordinated review, each jurisdiction may review the application and the principal regulator must consider the comments received from the other jurisdictions. The principal regulator's decision to grant relief on such an application is only made once each other jurisdiction has provided its comments and confirmed its agreement. If a jurisdiction disagrees with the proposed decision of the principal regulator, the issuer must deal directly with that jurisdiction to obtain the exemptive relief sought, on whatever conditions that jurisdiction may require.

New Passport Registration Regime For The Securities Industry
The passport system will also apply to the registration of securities firms and professionals. The CSA is working towards implementing new uniform registration requirements for the securities industry, but in the meantime the existing rules continue to apply.

The passport system for registration will generally apply in the same way as it does for prospectuses. The principal regulator will be the only regulatory authority that considers the application and makes a decision regarding the application, including any terms, conditions or requirements it may impose on a registrant. Its decision will apply automatically in other non-principal jurisdictions. Registrants whose principal jurisdiction is not Ontario and who wish to carry on business in Ontario will have to file a separate Ontario applications. The OSC will conduct its own review of the application, although it is anticipated that it will coordinate its review with the principal regulator. Also, since Ontario will be adopting the uniform registration requirements, the OSC's substantive review is not likely to significantly differ from that of other jurisdictions.

Registrants whose principal jurisdiction is Ontario will benefit from one-stop cross-Canada registration since a decision made by the OSC regarding registration will automatically apply in each non-principal jurisdiction designated by the applicant, under that jurisdiction's passport rules.

As regards enforcement proceedings involving registrants, a decision made by the principal regulator to suspend or cancel a registration will apply in each non-principal jurisdiction except Ontario. In Ontario, the OSC will retain jurisdiction (and will be required) to take its own enforcement proceedings to deal with the registrant's Ontario registration.

Passport registration should save applicants time and professional expenses over the current system where applicants are required to file their application in each of the 13 Canadian jurisdictions to be registered across Canada, and address each non-principal regulator's questions or concerns. The system will also eliminate the need for the principal regulator to coordinate with and obtain decisions from the other non-principal regulators.

What Does This All Really Mean For Securities Regulation In Canada?
The passport system provides a fairly significant improvement in efficiency for Ontario-based market participants, who will henceforth have to deal only with the OSC. In large measure Ontario issuers and registrants will obtain many of the benefits of a single-regulator system. For everyone else, the passport system provides a theoretical improvement, in that they will only have to deal with their principal regulator plus the OSC. From a practical standpoint, this is very close to the status quo, since local securities regulators (other than the OSC) typically don't become substantively involved in a matter where they are not the principal regulator.

Unfortunately, the need to calculate and pay fees in each jurisdiction, the need for translation opinions, and in particular the need to verify and obtain legal opinions as to documents required to be filed in each jurisdiction will all continue to add substantial costs and complexity to the prospectus filing process, thereby off-setting the improvements in regulatory efficiency promised by the passport system.

The introduction of the passport system may ultimately have more significant impacts on securities legislative harmonization, regulation and on the single regulator debate than on streamlining procedures.

It is no coincidence that the passport system is only coming into force after much of the rules harmonization effort has been completed. Past harmonization efforts have required extensive negotiations and inevitable compromises to obtain unanimity for "national" instruments (or failing that, near unanimity for "multi-lateral instruments"). The automatic approval provisions of the passport system for non-principal jurisdictions, with no ability to opt-out in a particular case, will likely make harmonization efforts even more difficult going forward. Multi-lateral instruments to which Ontario does not subscribe will have little useful impact from a practical standpoint because of the need for most market participants to continue to comply with Ontario requirements. This does not create an environment that is conducive to further legislative harmonization.

The passport system is one of the first issuer-focused securities law developments in a long time, most recent changes having been investor-focused. It adds nothing to investor protection, and in fact it delegates to securities regulators in the principal jurisdiction the power to make decisions that directly impact investor protection in the other provinces (except Ontario). In this respect the passport system only addresses the "efficiency" concerns about the fragmented Canadian system. The enforcement challenge remains to be tackled. This, along with Ontario's decision to opt out, suggest that additional substantial reforms will be required before the "single regulator" debate is settled.

Footnotes


1. Provincial/Territorial Securities Initiative Action Plan to Improve Canada's Securities Regulatory Framework, page 1, online http://www.securitiescanada.org


2. Ibid.