Investors Scrutinizing the Regulators

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Securities Regulation In CanadA

Fox Guarding the Hen House


April 2004
The OSC and independence

What is the appropriate governance structure for the regulator?

By James Langton

The three-way press release war among the Ontario Securities Commission, Ontario Finance Minister Greg Sorbara and his former employer, Royal Group Technologies Ltd., is an entertaining spectacle for those who enjoy watching public squabbles. At its heart, however, the dispute raises questions about the structure of governance and accountability at the country’s top securities regulator.

Here’s the gist, for those who haven’t followed the blow-by-blow accounts of the scrap: the OSC is part of an investigation into certain transactions involving Royal Group, the firm for which Sorbara formerly served as a board member and chairman of its audit committee. As a result, the OSC has been temporarily removed from Sorbara’s brief of responsibilities and handed over to Gerry Phillips, chairman of management board committee.

The move was made to quell any talk of conflict that could arise as a result of Sorbara overseeing a regulator that may be investigating activities at a publicly traded company that may have occurred during his watch. As Investment Executive went to press, no allegations had been brought by the regulator, or any other authority, against Royal Group or any of its officers or directors.

Putting aside what may or may not come out of the investigation, and ignoring who told what to whom and when, how does the ministerial reassignment affect the day-to-day operation of the regulator and its future?

It doesn’t, according to both the ministry and the OSC.

While the OSC no longer reports to Sorbara himself, all of the Finance ministry staff that typically deal with the regulator are on the job. None have moved over to the management board. They still report to the deputy minister of finance, Colin Andersen, who now reports to Phillips concerning securities matters.

The change has hardly been noticed at the OSC, says Wendy Dey, the commission’s director of communications. “It’s business as usual,” she says. It’s the same story from Finance media relations officer Boni Fox Gray.

While the arrangement seems workable in the short term, however, it’s hard to tell how well it will hold up over time. At this point, it’s impossible to say how long the arrangement will last — presumably until the OSC concludes its investigation of Royal Group, and the case is resolved one way or another. Dey says that there are no long-term alternatives under discussion: “All I can tell you is that there’s a new reporting relationship, and it’s working just fine.”

Veteran securities lawyer Phil Anisman says the new reporting relationship shouldn’t make much difference to the daily business of securities regulation. He says that ministers aren’t called upon to make many independent decisions on specific rule-making initiatives or similar OSC initiatives that require ministerial approval. For most issues, they tend to rely on recommendations of their staff, he says, and Phillips can presumably do that as easily as Sorbara. “It’s a workable arrangement,” Anisman says, “but that doesn’t mean it’s ideal if it were protracted.”

Nor is it ideal at a time when several highly politicized regulatory reform efforts are underway. For instance, before this whole squabble surfaced, Sorbara was openly championing a national securities regulator to his provincial counterparts. This is a goal that the OSC favours but can’t hope to achieve without major political involvement. And it will likely require some hefty horse-trading.

Officially, a national regulator is part of the Ontario Liberal government’s platform, and Fox Gray says that Phillips will be pursuing the issue in Sorbara’s place. Yet there is no progress to report on the issue. Getting to a national regulator is surely going to take more than a supportive provincial minister, and the current situation in Ontario can’t help that initiative.

Anisman says the central lesson from the whole affair is that the OSC shouldn’t be reporting on its investigations to a finance minister anyway. He says the OSC shouldn’t be reporting to the political level about enforcement policies or performance, either.

“If there’s any area in which the commission should be completely independent, it’s enforcement,” Anisman says. “It shouldn’t be reporting to the minister about investigations. The minister should learn about them when the notice of hearing is issued, like everybody else.”

On the other hand, he says, policy-making, rule-making and other issues are appropriate areas for the minister to oversee. Other critics, however, aren’t so sure that this should be a ministerial responsibility, either. One former regulator says the current system isn’t working as intended; it has politicized rulemaking, and is hampered by a lack of transparency.

The problem, it seems, stems from the decision to give the OSC rule-making power. Originally, the move was intended to speed up the regulator’s ability to modernize the rules, as the OSC had a very hard time getting its changes on the legislative agenda. However, the result is that power has been concentrated at the ministry level, which means that assiduous lobbying has the power to kill controversial rules (note the financial planning proficiency rule). Even worse, the regulator may become self-censoring to avoid initiating rules that may generate political heat.

Rather than the current reporting arrangement, Anisman proposes that a standing legislative committee could be established to provide oversight. In a paper he delivered last fall, he recommends that such a committee should be established to review every year the OSC’s activities, budget and plans. Anisman suggests that this committee could receive public submissions and engage outside counsel. As well, he says, the OSC’s chairman and executive director should be required to appear before the committee to answer questions, as the Securities and Exchange Commission chairman is required to before the U.S. Congress. Anisman allows that this model is more American in style but, he says, it’s justified by the securities commission’s broad authority and independence.

Concerns about the extent of the OSC’s power has pushed others to call for reform in that area, too. In a 2002 paper, economist Neil Mohindra, now at Finance Canada but then working for the Fraser Institute, argued that governance reforms were necessary at the OSC to provide greater financial accountability and alleviate concerns about its broad powers to impose discipline in the name of the “public interest.” The problem is that the public interest really isn’t defined, which theoretically gives the regulator carte blanche when it comes to meting out punishment. Mohindra declined to comment for this story, citing his current position at the federal government.

However, in his paper, Mohindra proposed a menu of governance reforms that could be implemented at, or imposed upon, the OSC. They include actions that could be taken within the current structure, such as improved public reporting by the regulator and inviting the provincial auditor to examine its efficiency; more fundamental reforms, such as forming an independent board of the commission consisting of the part-time commissioners; and hiving off administrative powers into an independent regulatory committee (a similar structure is used by the regulatory authority in Hong Kong).

Questions of regulatory governance and accountability aren’t just legal or theoretical abstractions; they can have big implications for the capital markets. Mohindra insists that the quality of regulatory governance contributes to a jurisdiction’s market competitiveness — providing market players with confidence that they will be treated fairly by regulators.

The relevance and importance of such fundamental questions haven’t escaped the OSC’s notice. Last year, the regulator commissioned a three-person committee to look into some of the structural issues concerning the OSC — particularly its multiple roles as rule- maker, prosecutor and judge. The committee, headed by Ontario’s integrity commissioner, Coulter Osborne, heard submissions calling for everything from the status quo to adopting independent tribunals to hear OSC cases to spinning off the commission’s enforcement arm.

Dey says the OSC now has the committee’s report and plans to release it to the public, although the timing remains uncertain. Osborne didn’t respond to a request for comment.

Another possible source of accountability reform is the legislative committee that must be struck to deal with the recommendations of the five-year review committee. The Securities Act requires that the five-year committee’s final report, delivered last spring, be referred to a legislative committee for review, to solicit comment and make recommendations for legislative changes. Fox Gray says that the government plans to refer the report to a committee in the “near future, but the specific timing has not yet been determined.”

Perhaps the eventual committee, whenever it is struck, will address some of the structural concerns. Anisman and Mohindra have both made some recommendations that could improve oversight and accountability at a time when the issues are particularly sensitive to government.

An alternative approach could be a newfangled body that reports to the legislature but isn’t itself a creature of the legislature. Such a function is served by the General Accounting Office in the U.S., and it seems to do a good job of asking tough questions and carrying out thorough, independent scrutiny of U.S. regulators.

If nothing else, the current Sorbara episode may focus attention on some of the fundamental problems with the existing governance and accountability mechanisms. IE