By Nick Savona, Chief Compliance Officer, Independent Trading Group (ITG)
Regulatory fragmentation in Canada has been a hot topic since the 1930s. Over the last century, there have been many arguments for and against a federal securities act administered by a national regulator. Although it is beyond dispute that that the provinces and territories have authority under Canada’s constitution to regulate the securities industry, it is also beyond dispute that the federal government has the responsibility to minimize systemic risk, a responsibility that requires the expansion of federal powers in today’s more global world.
The 2008 financial crisis demonstrated that globalization increases the risk of contagion, and therewith the need for a national regulator to effectively coordinate action with other countries to mitigate the effects of financial dislocation. No one knows from where the next systemic risk will come, but proactive planning regarding the use of artificial intelligence (AI) in capital markets is an area ripe for consideration. Canada needs one voice to effectively participate in a drive towards internationally consistent AI standards. Can you imagine each of the provinces and territories tapping the same very few experts in financial market AI to get a handle on such a complex issue? The development of AI is running far ahead of the regulatory framework. Time is of the essence.
The existence of multiple regulators (provincial securities commissions and self-regulatory organizations) has also had a negative impact on the exercise of powers to sanction bad players in the public interest. The public enforcement of a regulated entity and its registrants has proven to be burdensome and costly. Consider that many financial firms that do business across the country and have diversified product lines are under the purview of several provincial securities commissions, the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA). In addition to enforcement and regulatory costs, there are also implicit costs to the public.
A company that was sanctioned by no less than three regulators in the span of a few years is but one case that illustrates the failure of our fragmented regulatory system to protect the public interest. In 2014, the CEO of the two related firms, a portfolio manager and distributor, was sanctioned by the OSC for self-dealing. The OSC issued the following orders: i) permanent suspension of the CEO as a registrant; ii) a requirement that the two firms each appoint a new independent CEO and Ultimate Designated Person (responsible for regulatory compliance); and iii) a nine year prohibition against the sanctioned CEO from acting as a director or officer of a registered firm or investment manager. The letter and the spirit of many of these sanctions was blatantly violated–between the period of 2014 and 2017, the original CEO continued to act as an officer of one of the firms—resulting in further OSC disciplinary action. One or more of the firms subject to the OSC disciplinary action were also sanctioned by IIROC and the MFDA several times over more than eight years for failing to maintain an adequate level of capital. What is the lesson to be drawn? Quite simply: our fragmented regulatory system fails to deter malfeasance.
If we consider disciplinary cases that involve repeat contraventions, it is quite clear that the current state of Canada’s multiple provincial securities regulators and two distinct SROs does not serve the public interest. Although not all regulatory cases involve repeat offenses, the number is not insignificant and poses a substantial risk to the public due to the broad reach of bad players. To make deterrence more robust and increase efficiency, Canada needs a unified self regulatory organization and the creation of a national securities regulator. It would better protect the integrity of our capital markets, investors and the general public, not to mention the elimination of duplicative investigative and enforcement resources.
Recently, IIROC and the MFDA have each proposed their own plan to merge and harmonize regulation. Each SRO released separate proposals rather than one developed in collaboration. The two proposals are consequently very different. IIROC proposal promises to be more effective and can be implemented in a timely fashion. IIROC suggests merging with the MFDA and having the two SROs as divisions within one SRO. IIROC believes its proposal can be implemented within three months. On the other hand, the MFDA has recommended a new SRO be developed that encompasses all registrant categories, including those currently under the Canadian Securities Administrators (CSA), and to move the capital market surveillance function from IIROC to the CSA. The MFDA proposal would require consultation on how all aspects of the new SRO would function. We simply do not have time for such a needlessly protected approach.
If the IIROC proposal is adopted, the benefits to the industry would include significant cost savings through reduction in regulatory burden. The public would benefit by having a “one-stop-shop” which would allow investors who begin with mutual fund investments (regulated by the MFDA) to add individual securities (regulated by IIROC) without switching firms. This would indeed increase investor protection by reducing regulatory arbitration.
A provincial regulatory regime, as cooperative as it may be, is still split between two SROs, a system that is simply too cumbersome to meet today’s challenges. In Canada and internationally, there has been a proactive effort to better coordinate policies among securities regulators. This international collaboration and sharing of information has put Canada at a disadvantage due to the challenge presented by the fragmentation of our regulatory system. Investors deserve a unified regulatory system.