[NOTE: For convenience, in what follows I use the words "province" and "provincial" (etc.) to include the territories.]
A. What is the Case for Change with Respect to Issuers?
The case for changing the current system has been well documented elsewhere and I will be relatively brief on this point. Clearly, with the potential for 13 regulators to become involved in floating a new issue, each charging its own fees, and each potentially engaging in its own regulatory review, issuers face two kinds of unnecessary costs. The first is the increase in what I refer to as the direct costs of using the system. The principal direct costs are the various fees that must be paid to the regulators, and the cost associated with hiring professional advisors in each regulatory jurisdictions. The second, and in my view potentially much more serious burden is the opportunity costs associated with the existing system. In particular, despite the MRRS (mutual reliance review system) system, there is the potential for multiple regulatory reviews, with attendant delays. This may cause an issuer to miss a market window of opportunity.
Neither of these costs is particularly large for large public issuers. The direct costs of floating a national issue are not trivial. However, the marginal cost occasioned with exposure to multiple regulatory regimes constitutes a relatively small proportion of both offering proceeds and operating budgets. Nor do the opportunity costs appear to be large. Large public issuers have access to the prompt offering prospectus, shelf prospectus, post-receipt pricing prospectus, and multi-jurisdictional disclosure systems. The probability of attracting multiple regulatory under the MRRS review is small. Thus, the likelihood that serious delay will occur in floating a new issue is minimal. In short, the cost of multiple "entry points" into the system is small.
The situation for small and medium-sized companies ("SMEs"), however, is quite different. Regulatory costs as a proportion of offering proceeds and operating budgets are large for such firms. Thus, the marginal direct cost associated with having multiple regulatory regimes is comparatively large. More serious is the element of opportunity cost, since small issuers (and particularly those doing IPOs) experience a much higher probability of multiple regulatory reviews (i.e. of one or more provinces opting out of the MRRS). This dichotomy between large and small firms is replicated for other forms of regulation, such as the rules governing takeover bids and continuous disclosure.
One of the themes of this submission is that there is an important connection between regulatory structure and regulatory content. That is, the content of the rules is likely to be heavily influenced by the institutional structure of securities regulation. In particular, I will argue that a monopoly regulator (i.e. a national regulator) is not likely to produce optimal laws, and is indeed almost certain to over-regulate. By contrast, a de-centralized passport system in which issuers can choose their regulator (or perhaps in which the regulator is determined by the location of the head office) is much more likely to produce regulatory innovations that enhance corporate and shareholder value.
However, this debate about domestic structure is probably of little consequence to firms with a cross-listing on an American exchange. In falling under the jurisdiction of American securities laws (including, but not limited to the Sarbanes-Oxley measures), such firms are subject to the most strenuous regulation anywhere in the world. Whatever the domestic regulatory structure, Canadian regulators are unlikely to surpass the stringent U.S. standards. Thus, for such firms, this debate assumes comparatively little importance. This once again directs the focus of the inquiry on SMEs, and the relationship between domestic regulatory structure and the welfare of both SMEs and their investors.
Finally, however, I note that there is a perception that foreign firms floating new issues abroad are deterred from coming to Canada because of the need to deal with multiple regulators. While I have argued that for large firms the direct and opportunity costs of multiple compliance are quite small, this may not always be the case for foreign issuers. Large foreign issues are frequently made into a variety of jurisdictions, including Europe, North America, and Asia. The regulatory complexity of these international offerings is comparatively high, and the potential cost of delay resulting from regulatory hold-up in a single jurisdiction relatively large. Given this, and because Canada is only 2.1% of the international capital market, foreign issuers might easily choose to by-pass the Canadian market in favour of much deeper European and American markets. Thus, there may well be one very important class of large issuers for whom a single entry point into the Canadian market is important.
In sum, I believe it fair to say that there is a compelling case for reforming the institutional structure of securities laws, with a focus on SMEs and large foreign issuers.
B. What is the case for Change With Respect to Registrants?
In order to engage in trading securities in any province, any securities market professional must be registered in one of the various categories of registration. The term "trade" is defined sufficiently broadly that any act in furtherance of a trade, whether or not it actually results in a consummated transaction, is a "trade". Thus, in order to conduct any professional activity of any character in province, the actor must be registered.
At present, registration is on a province-by-province basis. This will continue to be true even with the implementation of the national application system for registrants. Existing case law suggests that in order to conduct a trade that crosses provincial boundaries, a securities market actor must be registered in both provinces. Because all provinces share the same underlying philosophy concerning admission of candidates to registration, this multiple registration system constitutes an unnecessary and costly barrier to a fully integrated internal capital market. This is particularly true in an era when trading is increasingly characterized by cross-border elements, principally due to advances in communications and computer technologies. Thus, the case for a fully-integrated system of registration is strong. Alternatively, as I discuss (and advocate) below, a de-centralized mutual reliance system also yields a single point of entry for registrants - while offering the additional possibility of a much higher level of regulator innovation.
C. What are the Alternatives?
1. Accept U.S. Regulation as Our Own
The major advantage of this system is that it would create a seamless border for securities transactions. This might well spark U.S. interest in investing in Canada. However, the major disadvantage is that Canada would be signing on to a system that in many ways is excessively complicated and costly (U.S. securities regulation is easily the most complicated in the world, and therefore the most expensive to comply with). Moreover, signing on to U.S. regulation would give Canada a monopoly regulator. As I discuss further below, this is not desirable. Finally, this solution is not politically achievable, for reasons that scarcely need elaborating. Thus, it is of academic interest only.
2. Harmonization of Provincial Statutes
Another solution is to harmonize all of the existing provincial securities enactments, so that there is effectively a single law that applies to all market participants. This is a superficially attractive alternative that simply will not work in practice. More than legislation needs to be harmonized; all supporting rules, regulations, policy statements, and other subsidiary instruments must also be harmonized. Indeed, since the application of securities law depends on how the legislation and supporting instruments are interpreted by the regulators, it is not even clear that a fully harmonized set of rules could ever really be achieved.
In any case, achieving uniformity would involve complex negotiations between all of the existing regulatory bodies to produce an agreed-upon set of documents. With 13 regulators, these negotiations will be difficult, protracted, and in all probability will ultimately fail. The likelihood of failure is only exacerbated by the fact that different securities regulatory bodies in Canada have different conceptions of what constitute ideal securities laws. These views are based on differing conceptions of the ultimate costs and benefits of alternative forms of securities regulation. In sum, getting all regulators to agree on a single set of detailed rules is an event so improbable that it is scarcely worth contemplating.
Even if the impossible could be achieved, changing the rules create another Herculean task. At present, it takes about two years for the Canadian Securities Administrators to craft a new national instrument or policy. There is no reason to believe that amending a uniform act would be any faster or easier. This by itself is fatal to the idea of harmonized laws - since our rapidly changing capital markets demand quick, flexible responses from our regulators - not the seemingly endless plodding that characterizes current efforts at promulgating national instruments and policies.
Nimble, flexible response is a sine qua non of modern securities regulation, for two reasons. First, without it, market abuses may go unaddressed. Second, securities regulation has both a regulatory and an enabling aspect. In its regulatory guise, wayward conduct is discouraged ex ante and penalized ex post. But in its enabling guise, securities regulation is grease that lubricates our capital markets, facilitating transactions by honest players. Regulators must be able to act responsively to facilitate productive new forms of capital market instruments and transactions. They can do so much more effectively if the rules can be quickly and easily updated to keep abreast of the newest 'technologies' of financial engineering employed in our capital markets.
There are two other factors that will make continued harmonization no less a chimera than initial harmonization. One is the different priorities and timetables of the various provincial legislatures. The priority given to securities regulation in the different jurisdictions will vary. Achieving new legislation even in a single province is a difficult exercise; how then to ensure that all provinces act together in promulgating changes? Second, different legislatures have differing political agendas. Whatever the regulators in a given province may believe, the legislators have the final say. If their views differ from the regulators, then proposals for change will not be adopted in all jurisdictions. As a result, the laws in different jurisdictions will inevitably diverge.
There is precedent in Canada for the inevitable divergence of harmonized laws. In the 1970's, the four western provinces plus Ontario (the so-called "uniform act provinces") passed uniform legislation and supporting instruments. Not surprisingly, regulators were unable (or unwilling) to secure amendments in all of the uniform act provinces, resulting in short order in material divergences in the laws of these jurisdictions.
It might be objected that complete harmonization is not required; all that is necessary is that substantial harmonization be achieved. Without question, the greater the extent to which the laws in the various jurisdictions resemble one another, the lesser the impediments to consummating transactions that cross jurisdictional boundaries. Indeed, this is the impetus behind the current quasi-mutual recognition system that operates in the areas of prospectus approval, annual information form approval, and applications for exemptive relief. It is also the impetus behind the CSA (Alberta-led) project to create a uniform law.
Despite its obvious benefits, however, the pursuit of harmonization carries a large cost - the sacrifice of regulatory innovation. In general, a capitalist or free market economy is based on the understanding that when suppliers of goods and services compete for business, this creates an incentive to innovate in order to capture a larger share of the market. This general principle does not operate only in respect of goods and services that are produced by the private sector. Securities laws are also a "product" that either attracts or repels securities market participants. Over-regulatory (and hence excessively costly) laws repel capital market players. Under-regulatory laws that encourage sharp practice damage the reputation of a domestic capital market, leading to an outflow of business by reputable players, and hurt local (and other) investors, resulting in political costs for local politicians. A responsive and wise regulator will thus seek to craft laws that balance the costs and benefits of regulation - being neither overly nor deficiently regulatory. The likelihood that this balance will be achieved by adopting more-or-less uniform rules is small. Uniform rules mimic the effect of a monopoly regulator; there is one set of rules that applies to all. Innovation and uniformity are virtual opposites, insofar as a uniform structure is cumbersome, slow-moving, unresponsive - and a product as much (or more) of the political weight of participating actors than of the operation of market forces. In short, pursuing uniformity in rules is not a desideratum that the Committee should embrace.
I say this with one caveat. A mutual recognition (or passport) system (discussed further below) can only work if the rules are sufficiently similar in the various jurisdictions that each jurisdiction feels comfortable in attorning to the regulatory regime of each of the others. Thus, some level of similarly is a sine qua non to a passport system. However, I believe that we already have sufficient similarity in place, without further harmonization, to support an across-the-board mutual recognition system. Despite all of the much-publicized differences between provinces between the different regulators (particularly those arising between British Columbia and Ontario), all securities market regulators in Canada share the same underlying philosophy and world-view of the ends of securities regulation. They all share an understanding of what tools should be engaged to achieve these ends. They operate out of a shared set of institutional structures that differ from jurisdiction to jurisdiction only in their details. Thus, I would suggest that the essential underpinning of a mutual recognition (passport) system already exists, and that further harmonization of laws is not a necessary condition to creating a true mutual reliance system (not the quasi-mutual reliance system that is now partially in place: see below).
Lastly, I note that harmonization will not cure the problem of multiple fees, the need to send out copies of each and every required document to 13 different regulators, nor the need to deal with different regulators in securing exemptive relief. Both domestic and foreign market actors will still lack a single unambiguous point of entry into our capital markets - with all the inefficiencies that multiple entry points entails.
3. A National Securities Commission: The "Pan-Canadian" Regulator with Provincially Delegated Authority
The Ontario Securities Commission has floated the idea of a "pan-Canadian" regulator that would operate nation-wide, and which would receive the delegated authority to act from each of the participating provinces. This is thus one variation on the idea of a national securities Commission.
The likelihood is high that this is constitutionally permissible. Moreover, by cutting the federal government out of the loop entirely, in this scheme securities regulation remains in provincial hands. This side-steps political problems associated with the provinces ceding a current area of provincial authority to the federal government. Arguably, therefore, this alternative has the greatest hope of bringing Quebec into the fold. Having said this, I do not in fact believe that Quebec will sign on to any of the alternative proposals for a national securities commission. Nor, it now seems quite clear, will Alberta or British Columbia. Given that there are four major capital markets in Canada (Ontario, Quebec, Alberta, British Columbia), and three of these are in provinces that will refuse to participate in a national system, the idea of pursuing any form of national regulatory structure seems increasingly moot.
I note in addition that a "Pan-Canadian" national regulator is unlikely to be stable in the long-run. Since it depends for its existence on the cooperation of all participating jurisdictions, each jurisdiction has a "threat point", insofar as it can threaten to withdraw if particular measures are implemented (or not implemented). Thus, a Pan-Canadian Commission does not resolve the problem of continued provincial involvement (the "too many cooks spoil the broth" problem, if you will). Rather, a Pan-Canadian Commission would simply become the focal point for endless negotiations over what the law ought to be. The threat or actuality of withdrawal is only exacerbated by the fact that each jurisdiction is subject to periodic changes in government. A change in government in any given province might well elevate to power a government with a philosophy of regulation that is inimical to the extant Pan-Canadian structure.
Finally, a Pan-Canadian regulator suffers from all of the substantive problems associated with a federally constituted national securities regulator, discussed next.
4. A Federally Constituted National Securities Commission
There is overlapping constitutional jurisdiction in Canada in the securities regulatory area. Provincial authority over securities regulation derives from the provincial power to pass laws in relation to "property and civil rights" in the province. Federal authority derives from the trade and commerce power, as appropriately supplemented by the criminal law power, the banking power, the residual power ("peace, order and good government"), and the power over federal undertakings. The existence of provincial jurisdiction has been confirmed many times in the courts; the existence of federal jurisdiction under the trade and commerce power has not. However, given existing constitutional jurisprudence, there is very little doubt, in my view, that the courts would affirm this jurisdiction.
There is a common misconception, however, about the effect of the passage of federal legislation. Many erroneously believe that the passage of federal legislation would effectively knock out provincial legislation, as it does in the United States. In fact, under the Canadian constitutional doctrine of "paramountcy", when there is overlapping federal and provincial jurisdiction in a given area, federal legislation only suspends the operation of the provincial legislation to the extent that there is an express inconsistency in the two laws, and only to extent of that inconsistency. Thus, for example, if federal legislation required every company filing a prospectus to include a financial forecast, while provincial legislation prohibited a company filing a prospectus from including a financial forecast, there would be such inconsistency in operation that the provincial law would be suspended. However, even in this case, the balance of the provincial enactment would continue to have full force; only the inconsistent provision would be subject to the operation of paramountcy.
Thus, unless the federal government seeks to enact yet another layer of regulation on top of the existing structure, the enactment of exclusive federal legislation and the constitution of a national commission must be a consensual act - i.e., one agreed to by the various provinces (mirroring political, rather than strictly legal reality). This makes a federal regulatory structure subject to the "threat point" problem noted in the case of a Pan-Canadian Commission. By credibly being able to threaten withdrawal, any participating jurisdiction can turn issues about regulatory content into complex and protracted negotiations with the federal government and other provincial participants.
But, as I have previously indicated, I do not in any case think that it is even remotely likely that the federal government will secure the approval of all of the provinces for a national entity, particularly those ones whose participation is vital to ensure that a national commission truly has a national impact.
Moreover, experience with the last attempt to create a national commission (in 1996-97) foundered in part because Ontario was insistent upon dominating any national entity. In this respect, little has changed. Ontario will undoubtedly renew its demand to dominate a national commission, arguing (inter alia) that approximately 80% of Canada's capital market is located in Ontario. It is almost certain that Ontario will not participate unless this demand is met. However, for obvious reasons, any agreement that a national commission will effectively be run from Ontario will be as politically unpalatable to Ottawa as it was in 1996-97. It will also be unacceptable to other provinces, and in particular the western provinces, in which there continues to be deep skepticism about whether an Ontario-based regulator would be responsive to the unique character of western capital markets.
Added to this, because each of the commissions collects various forms of fees for regulatory services, securities regulation is currently a substantial profit-centre in the four big markets (Ontario, Quebec, B.C., and Alberta). Agreeing on an appropriate structure of federal compensation for a federal takeover of this regulatory domain was thus another factor that doomed the 1996-97 attempt to create a national commission. Negotiations on this point are not likely to be less difficult this time around.
Supposing, against extremely long odds, that all of these problems could be surmounted, it remains to be determined whether we would wish to have a national commission. I suggest that we must answer this question in the negative, except in the unlikely scenario in which a passport system (a superior alternative) is not achievable.
Perhaps most importantly, a national regulator is a monopoly regulator. Law should be regarded as a product. Viewed in this way, it is clear that our understanding of the shortcomings of monopoly can be applied to a national regulator. The greatest difficulties relate to the monopolist's deficient incentive to supply efficient law, and to innovate. Since its "customers" (issuers, registrants, etc.) cannot "buy" another legal product, there is no market constraint. The monopolist can indulge a preference for excessive regulation without significant market penalty (although in the longer run, the future of our capital markets may be imperilled as market actors simply pick up shop and move elsewhere). This is true even under the current system, in which the conflicts rule that applies in securities matters ensures that, if there is overlapping regulatory jurisdiction, the strictest rule of any jurisdiction is the one that governs any given transaction. Thus, the OSC, which oversees Canada's largest capital market and assumes a broad geographical jurisdiction, effectively assumes the mantle of a de facto national regulator. So long as this is the case, its rules effectively govern all national transactions. It does not face any market penalty for over-regulating, save in respect of those who physically move out of the jurisdiction.
The same problem plagues innovation by a monopolist. A regulator would has little incentive to stay on the cutting edge of regulatory "product", since again it faces little immediate market penalty for not innovating (although again in the longer term, a failure to innovate will be disastrous for Canada's capital market).
In respect of large public companies that are subject to U.S. securities regulation, the existence of a monopoly regulator is relatively unimportant, since the U.S. system is, and is likely to continue to be, the most regulatory in the world. Large inter-listed companies that do business in the U.S. are thus already subject to a high degree of mandatory regulation, and while a national securities regulator may well regulate up to U.S. standards, it is unlikely that it would surpass U.S. standards. However, for small and medium-sized public companies ("SMEs") that are not inter-listed and not raising capital in the U.S. (and therefore not subject to U.S. regulation), it is important to maintain an innovative and responsive regulatory environment. A monopoly regulator would be neither.
Monopoly regulation permits regulators to indulge their natural preference to over-regulate. This springs from the schism between the level of regulation that is socially optimal and that which is privately preferred by regulators. Regulation that is cost-effective is consistent with a non-trivial number of frauds and scandals, since cost-effective regulation by its very nature does not seek to prevent all fraud and scandal. This is because it would not be cost-effective to do so. An analogy may be drawn to bank robbery. It would be possible to regulate banks in such a manner that no bank robbery ever occurred. This might be accomplished, for example, by mandating that all banks have armed guards at every branch and that each branch be built like Fort Knox. Even though no one is in favour of bank robbery (save the robbers), we do not do this because it would make banking excessively costly. In a very real sense, there is thus an efficient level of bank robbery - i.e. that level that trades off our distaste for bank robbery with the cost of preventing bank robbery. While framing the issue this way may strike many as offensive, these sorts of "tragic choices" inevitably underlie virtually all public policy decisions, given that scarce resources must be allocated to one use or another. Thus, we can state with some confidence that there is an efficient level of securities fraud. Cost-effective regulation does not, and cannot seek to absolutely prevent all frauds (although we can still severely penalize fraud when it occurs).
Unfortunately, when fraud or scandal occurs, the regulators are almost invariably blamed, whether at fault or not. Two recent illustrations are Bre-X and YBM Magnex. There is little that the OSC could have done to prevent a mining geologist from salting ore samples in Busang (or to detect this fraud), nor does it appear that the regulators were well-positioned to prevent the YBM Magnex scandal. However, the regulators were widely criticized in the press. It is only human that regulators will prefer to avoid such scandals and hence avoid the acerbic criticism that invariably accompanies them.
5. A Federal Commission that Includes Ontario and the Smaller Provinces
An alternative to a national commission is to forego the participation of B.C., Alberta, and Quebec, and for the federal government to establish a federal regulator that would include Ontario and the smaller provinces. This would have the virtue of reducing the number of Canadian regulators, with concomitant streamlining of the regulatory system (including reduction of filing fees, etc.).
Realistically, however, a commission of this sort would be federal in name but Ontario in substance. If it is not, Ontario has no particular reason to enter into an arrangement with the federal government that results in a loss of Ontario's power over securities regulation. And if it is Ontario in substance, that will likely discourage the smaller provinces from participating. It will also discourage the federal government from participating, since it will be politically costly to allow a nominally federal commission to be run from Ontario.
In any case, this is merely a band-aid solution to the pressing problems that we face us. It is much more important, in my view, to secure a single entry point for all capital market participants than to simply reduce the number of entry points.
6. A Provincially Constituted Commission that Includes Ontario and the Smaller Provinces
Forming a provincially constituted regulator that includes Ontario and the smaller provinces would resolve any political objections that might result from federal involvement, but again it is unlikely that the smaller provinces would wish to be dominated by Ontario.
7. A Federal Commission that Includes the Smaller Provinces
The smaller provinces and the federal government might be willing to enter into an arrangement whereby the federal government takes over securities regulation for participant provinces. This might be politically feasible, but again would only reduce the number of entry points.
8. A Provincially Constituted Commission that Includes the Smaller Provinces
Alternatively, the provinces might themselves set up a provincially constituted Pan-provincial Commission that would include only the participant provinces. Like the immediately preceding alternative, this avoids domination by Ontario and is likely to be politically feasible. However, once again it only reduces the number of entry points.
9. A Passport (Select) System
In a passport (select) system, every issuer and every registrant may choose its regulator. There are three great advantages of a passport (select) system. First, it leaves the provinces in control of securities regulation, which sidesteps the difficult problem of coaxing the various provinces to cede an important area of power to the federal government. Second, there is no monopoly regulator. Each regulator promulgates its own laws and applies these to entities that have chosen to be governed by its laws. Thus, each regulator is free to innovate in order to provide the regulatory product that it believes will supply optimal laws. This form of de-centralized system thus evinces the same benefit that makes competitive markets work - a variety of suppliers furnishing the market with differentiated products from which consumers may choose.
The third great advantage of a passport (select) system is that it provides a single regulator for corporate issuers. I have already noted that this appears to be a relatively unimportant factor for large domestic issuers, but is important for SMEs and foreign issuers.
While SMEs constitute a relatively small proportion of the economy in dollar terms, their importance to the economy is far greater than a simple dollar accounting suggests. Large public companies are often small companies that grew. While not every SME will morph into a corporate leviathan, SMEs are the pool from which the corporate giants of tomorrow are drawn. It is thus vital to the economy to ensure that SMEs are not encumbered in raising capital and in transforming themselves from Lilliputians into Brobdinagians.
10. A Passport (Location) System
In a passport (location) system, every issuer and every registrant is subject to a single regulator. However, unlike a passport (select) system, the identity of the regulator is determined by the location of the head office (or some other similar criterion), rather than being chosen by market actors. Like the passport (select) system, there is no system-wide monopoly regulator in a passport (location) system. However, each regulator nonetheless has a local monopoly, because the only way to escape local regulation is to move the head office (or whatever criterion underlies determination of the identity of the regulator) to another jurisdiction. Thus, the passport (location) system is not as likely as the passport (select) system to produce either innovative or efficient laws.
For foreign issuers that do not have a head office in the country, some other method must be used to determine the identity of the regulator. It may be that a passport (location) system for domestic issuers could be combined with a passport (select) system for foreign issuers.
D. Will a Passport (Select) System Produce a Race-to-the-Bottom?
The most important (and frequently encountered) objection to a passport regime, and in particular a passport (select) regime is that it will produce a "race-to-the-bottom", in which regulators pander to their regulated clientele by supplying lax laws that maximize the welfare of regulated entities rather than the public at large. In this section, I suggest that this is not likely to be the case. Indeed, the empirical record that we have suggests that a passport (select) system is more likely to produce cost-effective laws than a monopoly system.
The difficulties that are currently being encountered in the securities regulatory regime are a function of the difference between the choice of law rule in securities regulation and that which applies in the corporate law context. In securities regulation, the conflicts rule is that jurisdiction may be claimed by any province on the basis of a transactional nexus, a substantial connection to the jurisdiction (such as a stock exchange listing or a non-trivial number of shareholders in the jurisdiction), and possibly even the presence of a single shareholder in the jurisdiction (such as a single purchaser in an offering, a single shareholder affected by a take-over bid, etc.). This means that there is tremendous overlap in the regulatory jurisdictions of the different commissions, potentially leading to simultaneous regulation by 13 different commissions.
By contrast, the conflicts rule that prevails in the corporate law context is that the law of the incorporating jurisdiction applies. A shareholder may litigate in the courts of any province (or indeed, outside the country), and the courts of that province (or other jurisdiction) will apply the law of the jurisdiction of incorporation to matters of corporate law. Thus, there is only one substantive law that applies to any given situation. The corporate law regime is a passport (select) system.
1. A Starting Point: Is There Really a Substantive Difference Between Corporate and Securities Law That Would Justify the Different Conflicts Rule?
Why should we have a passport (select) regime in corporate law but not securities law? Arguably, the difference is mere historical accident. Securities and corporate laws are part and parcel of the same phenomenon - regulation of corporate activity. In fact, it has often been argued that the split between corporate and securities laws is an artificial one. These two aspects of corporate regulation constitute a "seamless web" constituting a single functional whole.
Indeed, the first corporate law statutes, enacted in the 19th century in the UK, included both corporate law and securities law under one statutory umbrella. There was no separate securities law enactment. The split of securities from corporate law does not appear to have been justified by any compelling functional considerations. If this split had not occurred, and securities law had remained married to corporate law, then securities law would also presumably be subject to a passport (select) regime, obviating the current problems.
The view that the split between corporate and securities law is purely artificial is the high (and growing) degree of overlap between those matters falling into the "securities" and "corporate" law domains. Regulation of takeover bids is split between corporate law statutes and securities regulatory statutes. Even where a corporate law statute does not contain provisions relating to takeover bids, takeovers implicate corporate law relating to fiduciary duties as well as the corporate oppression remedy. Insider trading is regulated under both, with corporate law statutes typically governing insider trading in private corporations, and securities law governing insider trading in public corporations. This is a practical that than a principled saw-off; historically, insider trading provisions regulating public corporations have dealt with as part of both corporate law and securities law. Prospectus disclosure, now falling under the mantle of securities law, was once a matter of corporate law. Continuous disclosure requirements are also subject to dual regulation. The proxy system, an important part of continuous disclosure, is still regulated under the corporate law statutes (in addition to the regulation found in the securities law statutes). To the extent that other continuous disclosure obligations are matters of securities law, there is no compelling substantive reason why they could not be considered to be corporate law.
The last area of securities regulation - registration - has fallen under the securities law domain. Perhaps this is because of all those topics that are subsumed under the rubric of securities law, it cuts the widest - touching conduct that extends beyond the limits of the corporate entity. However, the activity of registrants is closely tethered to corporations. Underwriters assist in raising capital for corporate issuers (although they may assist in raising capital for other entities as well). Brokers assist in the trading of corporate claims. Other professional market activity is largely associated with corporate claims or synthetic corporate claims (such as derivatives). Thus, registration could arguably be subsumed under corporate law as well.
In the past 30 to 40 years, securities regulators have increasingly assumed authority over corporate law matters, initially through policy statements purportedly deriving from the public interest powers, and now through primary and secondary legal instruments. Thus, for example, securities regulators have increasing invaded such traditional corporate law domains as directors' and officers' interested transactions, related party transactions, and corporate combinations and reorganizations (such as going private transactions). More broadly, through the public interest powers, securities regulators have asserted a seemingly unlimited jurisdiction over such traditional corporate law matters as the duty of care and fiduciary duties (e.g. in the Standard Trustco and Canadian Tire cases in Ontario). The situation as present is such that it can no longer be asserted, if indeed it ever could be, that there is any clear distinction between corporate and securities laws. This makes all the more arbitrary the difference in conflicts rules that governs the two domains.
There are some who nonetheless maintain that securities law is different than corporate law is a number of respects. One of these is the size of the enforcement apparatus needed to make securities laws effective. Relatedly, it is argued that there are economies of scale in both policy-making and enforcement that could not effectively be exploited by all jurisdictional actors in Canada, imperiling investors. I deal with these criticisms below.
A further criticism of a divided regime is that there is no single voice to articulate and assert Canada's international interests in the securities law domain, or to negotiate international treaties and other instruments. I also deal with this below.
2. Does the Passport (Select) Regime in Corporate Law Enhance or Diminish Shareholder Wealth? The U.S. Debate and Evidence
a. The Early Debate - Cary versus Winter
Because of the similarity between corporate and securities law, in this section I evaluate evidence relating to the wealth effects of the passport (select) system in corporate law both in the United States (where most of the empirical evidence has been compiled) and in Canada. This evidence strongly suggests that a passport (select) system enhances shareholder wealth. In the following section, I argue that the same is likely to be the case in the securities law domain.
b. Cary: A Shot Across the Bow
The genesis of the "race-to-the-bottom" controversy in relation to corporate law is William Cary's article (in 1974) that noted that Delaware is the jurisdiction for a majority of public corporations in the United States. In fact, we now know that about 60% of the NYSE firms are incorporated in Delaware, and a comparable fraction of the Fortune 500 firms. Thus, no one quibbles with Cary's description of Delaware's dominance in chartering U.S. corporations. However, Cary decried Delaware's dominance, arguing that Delaware's success was based on a conscious desire on the part of state legislators to collect corporate "franchise fees" (the annual fees that corporations pay to incorporate and to remain incorporated in Delaware). Cary asserted that Delaware sought to earn these revenues by crafting a corporate law that catered to the interests of corporate managers - the ones who he suggested really decide where a corporation is incorporated. Hapless shareholders are left to bear the cost, in the form of lower share prices for Delaware firms.
Thus, Cary noted, for example, that Delaware's law of fiduciary duties is less strict than the law of many, or indeed most other states (a conclusion that most commentators agree with). Cary argued more broadly that state legislators were easy fodder for lobbying by managers of corporations, who had much more power and influence at the political level than shareholders. Thus, local legislatures would almost inevitably, he argued, pass 'managerialist' (i.e. pro-manager) rather than shareholder-friendly statutes. Cary famously characterized the competition for corporate charters by states as a "race-to-the-bottom" that would lead to low standards in corporate law, a phrase that has since had a notable career.
Because of these concerns, Cary suggested that corporate law should be taken away from the states and given to the federal government, which is, he suggested, much more immune than state legislatures to lobbying by local managers for special favours.
c. Ralph Winter's Rejoinder to Cary
Ralph Winter, a Yale law professor and now a judge of the Circuit Court of Appeals, challenged Cary. Cary's argument, he suggested, amounted to an assertion that Delaware corporations will have a higher cost of capital than other corporations, because public securities markets will anticipate that shareholders of Delaware corporations will more frequently get it in the neck from the managers, and will discount stock prices of Delaware firms accordingly. He asserted that there was no evidence that Delaware firms were discounted in the market. Moreover, Cary suggested, managers have a natural incentive to avoid a jurisdiction that raises the corporation's cost of capital, since that will lead to a higher probability of bankruptcy, and also depreciate the managers' reputations in the managerial labour market.
d. Romano's Elaboration of Winter's Rejoinder: The Role of Shareholder Voting
Romano extended the theoretical foundations for asserting that a passport (select) regime will lead to superior corporate law. Romano noted that institutional shareholders, who are relatively sophisticated investors, play an active policing role in contemporary capital markets. Since shareholders must approve jurisdictional moves, savvy institutional shareholders will not vote for a charter move unless they think that it will result in an increase in share price (or at the very least, no decrease). Managers, in fact, often canvass institutional investors in advance of a jurisdictional move, or use proxy solicitation firms to secure favourable votes from institutions. If institutions appear to be negative, they will abandon the move even before it goes to a shareholder vote.
Romano does not assert that shareholder voting is a perfect protection. She acknowledges that acting rationally, many shareholders simply do not vote. In particular, well known free rider problems arise. Since shareholder activism benefits all shareholders, the incentive of each is to let someone else 'bell the cat' and monitor managers. While acknowledging this limitation, Romano argues that that shareholder voting nonetheless acts as a real constraint on managers who would act opportunistically in attempting to undertake jurisdictional moves to jurisdictions with managerialist corporate law. Thus, she concludes, managers will tend to move to jurisdictions that enhanced shareholder wealth.
As Winter's rejoinder (as elaborated by Romano) demonstrates, the question of whether shareholders are better or worse off in Delaware is fundamentally an empirical question. There are a variety of ways in which economists and legal scholars have attempted to measure comparative shareholder wealth for corporations incorporated in different states, and I now turn to a summary of the pertinent empirics.
e. The Empirical Evidence: Are Delaware Shareholders Better of Worse Off Under a Passport (Select) Regime?
i. Event Studies
The most direct way of measuring whether shareholders are better or worse off in Delaware is by means of an event study. An event study seeks to determine whether share prices go up or down when corporations reincorporate into Delaware. If share prices go down, on average, when firms reincorporate into Delaware, this indicates that the market believes that a Delaware incorporation is worse for shareholders than a non-Delaware incorporation. On the other hand, if share prices go up, this suggests that shareholders will be better off with a Delaware incorporation.
There are now eight such event studies. All eight find that when firms reincorporate into Delaware, share prices go up. While the average share price increase is small (on the order of 1%), the most comprehensive study (by Romano) found somewhat larger share price increases (from 3% to 9%). Romano found that firms tended to reincorporate in connection with significant transactions or other changes, such as embarking or a program of mergers and acquisitions, defending against a takeover bid, going public, issuing new securities, and the like. Her evidence (and that of the other event studies) suggests that Delaware has enacted law that is better, and not worse for shareholders, even though all agree that Delaware's laws are in many respects laxer than those of many other jurisdictions.
ii. Accounting Measures of Performance
Three studies examine what happens to common accounting measure of performance (return on equity and earnings before interest and taxes) after a firm moves to Delaware (in some cases, comparing that performance with that of firms moving to other states). These studies generally show no significant change in these accounting measures, although one shows a significant increase in earnings in Delaware corporations.
While these studies are not as supportive as the event studies of the view that a Delaware incorporation raises corporate value, neither do they find worse performance. It is noteworthy that studies of accounting performance are generally regarded by economists as less reliable than event studies, because accounting measures are a very imprecise measure of profitability.
iii. Direct Measure of Corporate Value
One recent study looks at a statistic called "Tobin's Q", and compares this statistic for Delaware and non-Delaware firms. Tobin's Q is the ratio of the market value of equity to the replacement cost of the firm's tangible assets (usually proxied by the book value of the assets). It is thought to be a reliable comparative measure of managerial performance, since good managers will generate a higher value of Tobin's Q with a given set of assets than will poor managers. This study shows that Tobin's Q is higher for firms incorporated in Delaware than for other firms. This evidence dovetails with the event studies showing share price increases when firms move into Delaware.
iv. Revenue Generation
While it has been known for some time that Delaware generates a large portion of its state revenues from incorporating companies (currently on the order of 22%), only recently has an attempt been made to calculate the net revenue that results from operating an incorporation "business". It has been estimated that the net revenue generated is on the order of US$500 million. This figure does not take into account the substantial indirect revenues realized by Delaware because of its success in attracting corporations; in particular, the earnings of Delaware-based lawyers and other professionals who offer services to Delaware corporations. It is very likely that these indirect revenues are substantially in excess of Delaware's direct revenues.
f. Critiques of Evidence
There are some persistent critics of the empirical evidence. I now turn to their critiques.
i. Objection: The Existence of State Anti-Takeover Legislation Shows that the Charter Market Does Not Produce Good Corporate Law
One of the strongest objections to the "race-to-the-top" theory is that Delaware, like many other states, has enacted anti-takeover legislation ("ATL"). The critics argue that ATL is bad for shareholders, as evidenced by event studies that often find that when states adopt such legislation, the value of the firms incorporated in those states goes down. This is taken as evidence that competition for charters can make shareholders worse off.
Bebchuk has been the most persistent critic in this area. He has produced empirical evidence that when firms reincorporate from their home state (the state where the firm's head office is situated) to states other than Delaware, there is some tendency to reincorporate in states with stronger ATL than the home state.
My own view is that this evidence only demonstrates that charter competition does not always leads to optimal outcomes. It is true that ATL is generally bad for shareholders. Moreover, the evidence strongly suggests that the managers of local corporations who are the subject of a takeover bid have often pressured their home states into adopting ATL. The basis for this all-too-frequently successful lobbying is that if a hostile takeover succeeds, in-state jobs will be lost. This has been the primary motivation for the adoption of so-called "other constituency" statutes that allow corporate managers to have regard to constituencies other than shareholders in evaluating (and responding to) a takeover bid.
Nonetheless, there is evidence indicating that many forms of ATL do not in fact stop bids, because acquirors find ways around them. Moreover, Delaware's ATL is milder than that of many other states, and, as against the usual pattern, Delaware was not an innovator in this area. In addition, ATL appears to be an exceptional case. As noted earlier, the evidence suggests that when firms move into Delaware, their share prices go up, not down. This increase factors in the market's view of both the positive and the negative factors associated with a move into Delaware. Consistent with this view, while ATL leads to reductions in share prices, these reductions are not as great as the increase in share price that is generally associated with a move into Delaware. Thus, in net, proponents of a passport (select) regime (including myself) would be happier if states did not pass ATL, but can nonetheless fairly assert that the evidence taken as a whole suggests that a passport (select) system operates in the best interests of shareholders.
ii. Objection: There is Only One "Competitor" in the Charter Market, and Thus No 'Real' Market
Another objection that has been made to the passport (select) system is that the "competitive" system is an illusion; there is only one competitor - Delaware. It is argued that other states do not in any sense compete for incorporations. Thus, it is questioned how much "competitive" forces really shape U.S. corporate law. Recent work does in fact indicate that for most firms the incorporation decision consists of a choice between remaining in the home state and choosing Delaware.
Despite Delaware's dominance, it can nonetheless be argued that there is a very real charter "market", and that it has had a profound impact on American corporate law. For one thing, as long as barriers to entry are low, and there are other potential competitors, economists have long recognized that even if there is only a single active competitor, you can still get a competitive outcome. As explicated at greater length below, the barriers to entry are in fact quite low.
The pattern that we observe in the development of corporate law is in fact consistent with a competitive market. Most corporate law innovations begin in Delaware and diffuse to other states. I have proposed (in a paper jointly authored with Douglas Cumming of the University of Alberta) that we can in fact distinguish between two types of competition. The first, which is that adopted by Delaware, is "active" competition, in which jurisdictions actively seek to attract incorporation business by promulgating corporate law innovations. The second is "passive" competition, pursuant to which jurisdictions simply seek to defend their turf from encroachment by active competitors by mimicking their innovations. Romano makes a similar dichotomy, distinguishing between active and "defensive" competition. The widespread adoption of Delaware innovations suggests that there is widespread passive competition, even if there is only one truly active competitor. This predominantly passive competition in the U.S. has resulted in a surprisingly high degree of uniformity in U.S. corporate laws.
It is noteworthy, however, that there are some states that have at least episodically engaged in active competition with Delaware. These include Nevada, Pennsylvania and Virginia - although admittedly none of these states has made substantial inroads into Delaware's dominance.
iii. Objection: Delaware's Advantage is Not Explained by Better Corporate Law
Some have argued that Delaware has an advantage not because is has better corporate law, but because it has a huge stock of precedents that create legal certainty that other states lack. In addition, it is argued that there are "network" advantages to most public corporations being under one law. An example: it is advantageous for everyone to use Microsoft's Word (word processing program), even though it is probably not the best word processor. That way, everyone can share computer disks. Similarly, it is argued, there is an advantage to most firms being under one corporate law. Investors can then spend fewer resources to price each firm's corporate law regime - since everyone is under the same regime. There is little evidence, however, to support this contention. There is no reason why the optimal number of "networks" in corporate law is one; there could easily be many.
That having been said, it is undoubtedly true that Delaware's legal "product" is not just the law, as embodied in the statutes and judicial precedent. It is also the deepness of the body of precedent, creating enhanced legal certainty. Value also lies in the use of expert judges, who can understand the facts (regrettably, something that not all judges in other jurisdictions are capable of doing) and render judgments that make commercial sense. Delaware has also achieved an advantage by virtue of the timeliness with which corporate disputes are litigated. However, any jurisdiction can, if it chooses, compete on any of these dimensions. This is true even of the stock of legal precedent. There is nothing to prevent any jurisdiction from adopting another jurisdiction's jurisprudence as its own (either legislatively or judicially) at the start-up phase. Indeed, Nevada has done this with Delaware's jurisprudence.
The empirical evidence thus quite strongly favours the view that Delaware shareholders are better off than shareholders in other states. This in turn supports the view that a passport (select) regime has worked to improve the quality of corporate law rather than depreciate it. In other words, the evidence suggests that a passport (select) regime results in a race-to-the-top rather than a race-to-the-bottom. In addition, running an incorporation "business" has been a hugely profitable business for Delaware. The incorporation business has been a "win-win" situation for both the citizens of Delaware and those who have invested in Delaware corporations.
Against this backdrop, it is discouraging that the Chair of the OSC has recently stated that it would be "demeaning" for regulators to attract securities-related business under a passport (select) model. The clear and pressing reality of modern commerce is that capital is highly mobile and will flow to those regions of the world offering the best regulatory regimes. Delaware's experience clearly indicates that "best" does not mean, as Ontario's regulators apparently believe, the most regulatory regime. Delaware allows managers greater freedom than the great majority of American states to craft a variety of fundamental corporation transactions. But this has operated in the best interests of investors, and not merely managers. It is no more "demeaning" for regulators to seek to craft the most effective law for market actors than it is for governments to attract industry and commerce by various forms of incentives. Forward-looking and enlightened regulators can no longer afford to apply outdated paradigms which seek to elevate unvarnished investor protection above systemic cost-effectiveness. The price to be paid is the future of Canada's capital markets.
3. What Makes Delaware So Successful?
a. Competition Consciousness
In order to actively compete, you have to be trying to compete. Up until 1920, the most vigorous competitor in the incorporation market was New Jersey. Then a reform-minded Governor (Woodrow Wilson) decided to pass a stricter statute. Delaware saw its market opportunity, and made a deliberate decision to get into the 'incorporation business'. It has been an active competitor for corporate charters ever since.
b. Legislators Have Good Incentives to Maintain Good Corporate Law
i. The Magnitude of the Net Revenues
Delaware earns about $540 million from its incorporation business, versus about $12 million in costs. This means that the net revenue is substantial.
ii. The Ratio of Revenue to Total State Revenue
Romano notes that between 1966 and 2000, Delaware derived, on average, 17% of its state budget from "franchise fees" (i.e. the annual fees that corporations pay to be incorporated in Delaware). This means that an outflow of incorporation business would be catastrophic for Delaware legislators.
iii. Indirect Revenues
In addition to direct state revenues, Delaware earns substantial indirect revenues, in the form of professional fees that are paid to lawyers and others in Delaware that service Delaware corporations.
iv. This Gives Legislators the Incentive to Enact the Corporate Law that Shareholders Like
Both in absolute magnitude, and relative to Delaware's state budget, the revenue that Delaware derives (directly and indirectly) from the 'incorporation business' is of critical importance to Delaware. This makes Delaware legislators highly attuned to corporate needs. If Delaware does not offer the legal product that shareholders like, they will pressure the managers not to incorporate in Delaware, and Delaware's incorporation revenues will decline. Thus, Delaware legislators have a keen incentive to continue to produce the 'corporate law product' that both managers and shareholders want (as evidenced by the event studies that show share prices going up, not down, when firms reincorporate to Delaware).
c. Delaware is the Most Responsive of All of the States, Measured by Corporate Law Innovation
Romano showed that Delaware is the most responsive of all the states to corporate concerns. Examining a set of corporate law innovations, Romano found that Delaware was consistently first or second in enacting these innovations, which then tend to spread to other states. Delaware legislators maintain this competitive edge because they remain in constant contact with Delaware's corporate bar, which in turn has its finger on the pulse of corporate America as to what is needed and what is not in the corporate law. This leads to this high degree of responsiveness.
d. Maintenance of a Specialty Court
Delaware is the only jurisdiction in the U.S. (and probably in the world) that maintains a specialty court that hears all corporate law disputes (the Chancery Court) (Ontario's "Commercial List", whose ranks include many judges with no corporate or commercial experience, is not comparable). The judges who sit on Delaware's Chancery Court are chosen from the ranks of corporate practitioners. They are thus knowledgeable about corporate matters and about Delaware corporate law.
e. A Deep Body of Legal Precedent
Delaware has a deep body of legal precedent, creating greater certainty for firms incorporated in Delaware.
f. Control of the Judiciary
In Delaware, judges are appointed by the state and serve fixed terms. Delaware is very careful to place judges on the Chancery Court who are knowledgeable in corporate matters. These are typically experienced corporate practitioners. These judges bring with them into the courtroom an expert understanding of corporate law legal issues - something that judges in other jurisdictions often lack. This is one way in which Delaware offers a superior legal product.
Because judicial appointments in Canada are constitutionally a federal matter, it is more difficult for a province to control who sits on its courts. The province can make recommendations, but cannot ultimately control whom its judges will be. To some extent, this would depreciate the quality of the legal product that any province could offer, although of course all provinces would be under a similar disability.
g. An Attractive Place to Live
Delaware is situated in an attractive location on the eastern seaboard. This makes it an appealing locale for high-priced corporate lawyers and other who offer corporate services.
4. Building a Competitive Infrastructure: Barriers to Entry
a. Start-Up Costs
Of course, it is costly for Delaware to maintain its corporate law system. The volume of litigation that the large number of Delaware incorporations brings to Delaware means that Delaware must expend resources to maintain its legal infrastructure (e.g. the court buildings, the administrative apparatus that oversees the statute, etc.).
However, the chartering business has proved immensely profitable for Delaware. In 2000, for example, Romano estimates that Delaware's revenues were $541 million, versus a little over $12 million in expenses (although that does not include start up costs, which were expended in the 1920's when Delaware made a very conscious decision to attract incorporation business). The profitability of Delaware's incorporation business is truly startling. This excess of revenues over costs suggests that other the market could support other competitors. While fairly large outlays might have to be made initially, with negative cash flow for the first few years, this does not distinguish the chartering business from any other business. The usual pattern is relatively large expenditures up front, followed by growth years in which no profits are realized, followed by profitability and recoupment of the initial investment.
Although Delaware's incorporation business is extraordinarily profitable, however, little is in fact known about the start-up costs of instituting a legal regime that will be competitive with other legal regimes. As noted, one advantage that Delaware has is its large body of legal precedent, a body of precedent that has been built up over years of being the dominant jurisdiction in the incorporation business. A large stock of legal precedents supplies corporations and their advisors with greater certainty about the legalities of various types of transactions. Clearly, establishing a domestic stock of precedents is something that takes a period of time to develop.
This is clearly not a show-stopper, however, in preventing other jurisdictions from entering the market competing for corporate charters. A good example is Delaware. As noted, at one time New Jersey was the predominant choice of public corporations. When it abandoned the field, Delaware aggressively entered the market. One of the ways in which they did this was to largely adopt the old New Jersey statute holus bolus. The absence of a body of jurisprudence did not deter most of New Jersey's former clientele from incorporating in Delaware. In part, this was because the Delaware courts incorporated at least some of the existing New Jersey legal precedent, establishing continuity between the old New Jersey legal regime and the new regime in Delaware.
There is no reason in principle why this could not in fact be done at the legislative level. A legislature can simply adopt an existing body of jurisprudence from another jurisdiction, as Nevada has done (adopting Delaware's jurisprudence). Indeed, the legislature could incorporate by reference decisions of the administrators or courts of another jurisdiction extending into the future. This is one way to finesse the absence of a standing body of jurisprudence.
b. Size as a Disabling Factor in Entering the Competition for Legal Business
Many have asserted that small jurisdictions lack the resources to address the policy-making and enforcement challenges of a securities regulatory regime. However, Delaware is one of the smallest states in the union. As the above discussion makes clear, this actually gives Delaware an advantage over other U.S. jurisdictions that might compete for corporate charters. It is thus a mistake to dismiss outright the notion that small provinces could compete for business.
Indeed, Romano suggests that smaller jurisdictions, such as Delaware (or P.E.I., Nova Scotia, or New Brunswick) actually have a competitive advantage over larger jurisdictions insofar as success means that a large fraction of their annual budgets derive from their corporate clientele. Because it would be very costly for the jurisdiction to lose a significant fraction of this business (and of its budget), this operates to ensure that legislators continue to produce the kind of corporate law that will attract corporate clientele. This gives a smaller jurisdiction a "credible commitment" to maintain good corporate law.
5. Is There a Charter Market in Canada? Could There Be?
In 1991, Ron Daniels wrote an article that argued not only that there was a charter market in Canada like that in the U.S., but also that it had substantially improved corporate law in Canada. Daniels cast the federal government in the role of Delaware. He argued that the adoption of the 1975 reforms by most provinces were evidence of competition for corporate charters between the provinces.
In a paper co-authored with Douglas Cumming (of the University of Alberta), I have argued a somewhat different position. In our view, the federal government cannot be cast in the role of Delaware because its incentives are very different from Delaware's. In particular, the total revenue earned by the federal government from its incorporation 'business' is a very small fraction of one percent. For this reason, the federal government cannot establish a credible commitment to maintain efficient corporate law. Legislators might change the law at any time in response to political pressures, rather than efficiency concerns.
Cumming and I empirically tested two propositions. The first is that there is charter shopping by corporations and their legal advisors. The second is that Canadian legislators have engaged in competition for charters, either of the "passive" variety (where legislators seek only to prevent an outflow of incorporations to other jurisdictions, by adopting innovations introduced elsewhere), or the "active" variety (where legislators introduce innovations to attract business away from other jurisdictions). In respect of the first, we found evidence of jurisdiction shopping based on differences in the law in the various jurisdictions. However, we found no evidence of either passive or active competition at the legislative level. We thus suggested that the widespread diffusion of the federal reforms of 1975 was simply a desire on the part of legislators and bureaucrats to achieve uniformity in corporate law across the country.
We explained the lack of competition on the part of legislators by a variety of factors (a variety of which were noted by Daniels as well). These included:
1. The lack of competition consciousness among legislators.
2. The fact that corporate law jurisprudence in Canada has tended to be a national jurisprudence because of the relative dearth of corporate law precedent in each province (something that is changing with the accumulation of jurisprudence under the oppression remedy).
3. The fact that all corporate law judgments may be appealed to the Supreme Court of Canada, resulting in the inability of any province to ensure that its judge-made law remains distinctive.
4. The inability of provinces to appoint judges and thus to select judges who are knowledgeable about corporate law matters.
5. The inability of lawyers in one jurisdiction to give advice on the corporate law of another jurisdiction (unless called in that jurisdiction) and the consequent incentive of lawyers not to recommend an out-of-province incorporation.
6. Most importantly, the fact that securities regulators have gone deeply in regulating matters in the corporate law domain, so that no province can ensure that its corporate law rules will be respected by other jurisdictions.
The biggest of these impediments is probably the last. A passport (select) system in securities regulation would cure that problem and thus open the door to real competition in the corporate law arena, and not just for securities regulation.
In a second paper, Cumming and I sent out a questionnaire to all the public corporations that we could identify that had reincorporated from one jurisdiction to another over a period of several decades. Not surprisingly, we found that corporations move for a variety of reasons. In general, as in the U.S., corporations in Canada tend to reincorporate in connection with major transactions. Foremost among these is the desire to incorporate two firms under the same statute, in order to facilitate an amalgamation (due to the statutory requirement that all merging corporations be incorporated under the local legislation). We also found, however, that firms sometimes reincorporate to take advantage of legal features of the destination jurisdiction, such as escaping the Canadian residency requirements for directors. While we were unable to conclude that legal preferences dominated jurisdictional moves, we noted that this is largely the product of the high degree of similarity between the various provincial statutes in Canada. Where legal differences are significant (for example, as between B.C., Quebec and other jurisdictions in Canada) we did in fact observe firms moving for legal reasons. The largest number of reincorporations motivated by legal reasons consisted of public corporations leaving B.C. to escape what is widely viewed as an antiquated statute.
We also found that public corporations frequently move in order to incorporate in their home province (i.e. where the head office is located). This is typically done in order to facilitate face-to-face meetings with the firm's lawyers. While a reincorporation under the federal legislation would accomplish the same end, this did not happen very often (probably because local lawyers like to incorporate under the local statute for administrative convenience or other reasons).
Finally, we found that corporations that reincorporate to the federal legislation often do so to project a "national" image, despite the absence of material legal differences in the federal statute compared to that of the origin destination.
In this paper we also conducted an event study to see what happened to share prices when Canadian public firms reincorporate. Our event study suggests that reincorporation will, on average, increase the reincorporating firm's share price by about 10% (whether the reincorporation is to the federal legislation, or to another province). There is, however, significant variation depending on the motive underlying the reincorporation. The occurrence of a merger, as expected, had the effect of increasing share prices by about 8%. Moving in connection with the securing of additional public financing resulted in a drop in share prices by about 10% (a result that is not unexpected, given that raising additional funds typically depresses a firm's share price, whether it simultaneously changes jurisdiction or not). One unexpected result was in relation to reincorporations that were designed to circumvent the requirement that some percentage of directors be Canadian residents. When this was a motive for reincorporating, share prices dropped on average by about 10%. This may be due to the perception that non-Canadian directors are less effective directors, or that the replacement of Canadian directors presages a transaction that will be consummated on unfavourable terms to Canadian shareholders.
Reincorporations to jurisdictions that were perceived to have greater political stability resulted in an increase in share price of about 3.5%. By contrast, reincorporations to jurisdictions that were perceived to have greater stability in their corporate law resulted in small price increases that were statistically insignificant.
Matters pertaining to the governance structure of reincorporating firms also had an impact on share prices. When there was at least one blockholder holding 10% of the firm's shares, this had a positive impact on share prices of about 8%. However, as the percentage of outside but not unrelated directors went up, share prices went down. An increasing percentage of unrelated directors had a positive impact. This suggests that there is a significant difference between the discipline effected by outside directors, who may be compromised by management, and unrelated directors, who act with greater independence.
In a subsequent re-examination of the same data with a different statistical methodology (as yet unpublished), we found that reincorporations that sought to enhance managerial freedom resulted in reductions in share prices (while reincorporations designed to circumvent the Canadian residency requirements no longer caused prices to fall). Our other results were largely unchanged.
Putting all of our results together, it would appear that when corporations move from one jurisdiction to another in Canada, the market regards this as a favourable event. This dovetails with the U.S. evidence, and suggests the passport (select) regime that operates in the corporate law domain in Canada has been beneficial to shareholders.
It is clear, however, that there are legal and other differences from the U.S. system (outlined above) that make it somewhat more difficult for the provinces to compete for legal business. Some of these are amenable to change. For example, the natural build-up of corporate law jurisprudence over time has meant that, increasingly, there are province-specific corporate jurisprudences (such as the large body of oppression remedy jurisprudence that has developed in B.C.) rather than simply a single national jurisprudence. In addition there is no particular reason why Canadian legislators could not develop competition consciousness. The various provinces could also make it easier for out-of-province lawyers to qualify. The overlap between corporate and securities law could be reduced or eliminated, or securities law could be put on a passport (select) basis like corporate law. In addition, any province could develop a corporate court (Ontario's Commercial Court does not qualify, since all of the judges who sit on this court are generalists, and many of these lack any corporate background whatever). Other factors are not so easily changed, such as the ability to appeal any judgment to the Supreme Court of Canada and the inability of provinces to appoint their own judges.
It is at least clear that important differences in law sometimes motivate firms to move from one jurisdiction to another. It also seems clear that, on average, these choices are associated with material increases in share price. It seems reasonable to believe that if there were a genuinely competitive system of corporate law production in Canada (such that there was a correlative supply-side response to the demand for good corporate law), this would be likely to exert a salutary influence on the quality of corporate law in Canada. Below, I argue that the same is true of securities law.
E. Will a Passport (Select) System Work for Securities Regulation?
1. Pro: Securities Law Will Benefit from a Passport (Select) System as Much as Corporate Law
a. Reprise: The Artificial Distinction Between Corporate and Securities Law
Does the above apply to securities law? I have already noted the artificial nature of the divide between securities and corporate law. Moreover, it is difficult to think that the incentives that drive the corporate law system (and that have resulted in a better corporate law "product" in the U.S.) would not also operate in the securities law arena. Thus, there should be no difference between the conflicts rule that applies to both securities and corporate law; in both cases, it ought to be the corporate law rule.
b. Revenue at Stake
Securities law has been a profit centre, at least in Ontario, B.C., Alberta, and Quebec. Revenue raised from various fees (prospectus fees being the largest) has vastly outstripped the costs of maintaining the securities regulatory apparatuses in all of these jurisdictions in the past several years (see Fraser Institute report by Neil Mohindra for details). This suggests that there are large revenues at stake in the competition for securities business (although competition might well put downward pressure on fees in order to attract business).
c. Revenue as a Fraction of Total Budget Resources
Smaller provinces like B.C. and Alberta have some advantage over the larger provinces (Ontario, Quebec) insofar as an equal amount of revenue derived from competing for securities business will constitute a larger share of the provincial budget, making these provinces (as in Delaware) a hostage to their own success - thus serving to make more credible their commitment to their corporate clientele.
2. Arguments that Securities Law is Somehow Different from Corporate Law
There are some who have suggested that securities law is somehow different from corporate law, and that even if a passport (select) regime has served us well in the corporate arena, it will not do so in the securities arena. I supply a rejoinder to this objection in this section.
I will assume that there are only two options that a jurisdiction may select; "participant" and "non-participant". If it is a participant in the passport (select) system, it will promulgate its own securities law (and either have its own enforcement apparatus, or use the enforcement resources of another jurisdiction). Actors may opt into that law, and all the other jurisdictions (both participants and non-participants) agree that that is the only law that applies.
If it is a non-participant, then it will not adopt any securities law, but will defer to the law of the participant jurisdiction that each market actor opts into. Thus, only one law applies to any given market actor.
a. Securities Law Requires a Larger Administrative Staff at the Enforcement Level
Corporate law is largely self-enforcing, through the mechanism of private litigation. Securities law, however, has a much larger public law component; securities laws are enforced not merely through private litigation, but through administrative and quasi-criminal proceedings. This increases the resources necessary to oversee the administration of a securities law statute, arguably making it impractical for smaller (and therefore less resource-rich) jurisdictions to offer effective enforcement. Below, I sketch out several responses to this point.
b. Make Securities Law More Dependent on Private Enforcement
As a general matter, securities law has moved substantially away from private enforcement and toward administrative enforcement in the past 30 years - coinciding with the expansion of the public interest powers, the expansion of subject matters regulated by the securities regulators, and the ceding of rule-making authority to securities regulators. It is in fact arguable that securities law has moved too far toward administrative enforcement, and could easily withstand a push back toward private enforcement. To the extent that this is done, it would diminish the public resources necessary to administer securities law.
c. Not all Jurisdictions Need be Competitors
If it is true that the resources necessary to run a securities law regime are in excess of what small jurisdictions feel that they can afford, then these jurisdictions may simply declare themselves to be "non-participants". Securities market actors doing business in these jurisdictions will then be governed by the law of the jurisdiction that they choose to opt into.
This might be the most congenial solution for some (or all) of the smaller jurisdictions. Opting out of securities law allows these jurisdictions to free ride on the securities laws and enforcement efforts of other jurisdictions, thus reducing the expenditures of these jurisdictions on securities regulation to zero.
d. Allow Enforcement Resources to be Priced by the Market
Suppose that some jurisdictions make inadequate investments? What then? As in the corporate law case, the regulatory jurisdiction will be priced. If the market believes that a jurisdiction has inadequate enforcement resources, then the market will depreciate the price paid for firms using that jurisdiction's law. One could assist the market in making this pricing decision by requiring that disclosure be made of the firm's securities law regime (via the prospectus, continuous disclosure, and/or other means), although "marginal" investors (i.e. those that drive price determination) are likely to find out this information even if it is not published.
e. Allow Enforcement Resources to be Priced, but Specify Minimum Enforcement Resources for all Participant Jurisdictions
If leaving it up to the market to determine the price of enforcement resources causes concern, the entry of a jurisdiction into the market could be conditioned on having (and maintaining) a specified complement of enforcement staff and/or resources. A failure to meet this test would mean that a jurisdiction could not be a participant in the passport (select) system. This, in essence, describes the European system of mutual reliance (discussed at length below).
f. Create Regional Commissions that Pool Enforcement Resources
It would be possible for jurisdictions to pool enforcement resources to form regional securities commissions that would enforce securities laws for regions and not merely provinces (resulting, for example, in securities commission in the west, Ontario, Quebec, and the Maritimes). This would assist in the exploitation of economies of scale in enforcement and help to resolve the resourcing problem. This might, however, give rise to provincial conflicts concerning relative contribution levels, staffing decisions, selection of enforcement actions, etc.
g. Designate Enforcement Authorities that Any Jurisdiction Can Opt Into
Alternatively, the CSA could publish a schedule of jurisdictions with acceptable enforcement regimes. Any jurisdiction that did not itself qualify could then hire the enforcement services of one of the designated commissions. Thus, for example, if the Yukon wanted to participate in the passport (select) system (rather than simply opting out of securities law entirely), it could promulgate its own securities laws and hire B.C. (or other acceptable jurisdiction) to function as its enforcement agent.
h. Securities Law Requires a Larger and More Responsive Policy-Making Apparatus than Corporate Law
The same objection to a passport (select) system as that explored immediately above has also been made in respect of policy making resources. That is, it is argued that securities law is more complicated than corporate law, requires a higher level of responsiveness to market developments and hence more frequent updating, and thus requires greater policy-making resources than all but a handful of jurisdictions can afford.
In part, this objection is simply an apology for the existing situation, in which in the past several decades securities law has poached substantial territory from corporate law. For example, prior to OSC Rule 61-501 (formerly Policy 9.1), the area of related party transactions was strictly a matter of corporate law. The public interest powers were not used (as they are today) to regulate matters that are within the traditional "corporate law" domain. If these and similar developments had not taken place via developments in securities laws, they arguably would have occurred in pertinent corporate law.
However, a similar set of responses can be made as I have suggested with respect to the issue of adequate enforcement resources, namely:
1. Let Each Jurisdiction Decide if it Wants to Compete
2. Allow policy regimes to be priced
3. Allow policy regimes to be priced subject to specifying minimum levels of policy-making resources
4. Pool policy-making resources in regional commissions
5. Pool policy-making resources in regional thinks tanks
6. Allow any Jurisdiction to Pay for Access to the Policy-Making Resources of Designated Jurisdictions
i. Markets Will Not Price the Securities Regulatory Law Selected by Each Market Actor
Some have also argued that the market will not price the securities regulatory system that each market actor opts into, resulting in a "race-to-the-bottom" scenario. I deal with this objection below.
i. This Objection Runs Counter to the Evidence
There is much empirical evidence to support the view that regulatory regime is priced. For example, there is clear evidence that various types of state anti-takeover regimes are priced by the market. Similarly, there is evidence that the U.S. Williams Act (regulating takeover bids) resulted in statistically significant downward revisions in share values of American corporations. More directly, in both the U.S. and Canada, as sketched out above, state-of-the-art empirics suggest that the value of the firm depends on its jurisdictional situs. Thus, the view that regulatory regimes will not be appropriately priced appears to be counter to the evidence.
Moreover, there are various measures that securities regulators can take in order to ensure that regulatory regimes are priced. In particular, various participating regulators could be required to publish a document tantamount to a prospectus, giving details of the policy-making resources of the jurisdiction, enforcement resources, etc.
ii. Restrict the Passport (Select) System to POP Eligible Issuers (or similar test based on size, breadth of distribution, etc.)
Mis-pricing is more likely to occur for smaller firms. Thus, worries about mis-pricing or regulatory regimes can be allayed by restricting the passport (select) system to larger issuers, perhaps along the lines of the current distinction between POP-eligible and non-POP eligible firms. A different system, such as a passport (location) system might then govern small firms.
This opens up the possibility that smaller jurisdictions could continue to regulate small firms, while opting out of the passport (select) system for larger firms.
3. Inter-jurisdictional Enforcement Issues
One of the more pressing objections that has been raised to a passport (select) system is that enforcement is rendered problematic, whether the means of redress is private, administrative, or criminal enforcement. Suppose, for example, that a market actor selects into British Columbia's regime, and the aggrieved party is located in Newfoundland? The geographical remoteness of the regulatory regime from the situs of the complainant makes it more difficult and expensive for the complainant to communicate with his/her lawyer, the regulators, the opposing party, and so on. Moreover, once a judgment is rendered, it has been suggested that it may be difficult, both as a practical and a legal matter, to enforce that judgment in a remote jurisdiction.
I note that the same difficulties apply in the case of corporate law (although there is little use of administrative enforcement in the corporate domain), and these have not seriously prejudiced the operation of the system. Moreover, to the extent that securities regulation requires greater enforcement resources, there are some solutions to this potential problem.
a. Private Enforcement: Allow Local Judicial Proceedings
As in the case of corporate law, the aggrieved party could be allowed to bring local judicial proceedings. Expert testimony would establish the law in the non-local jurisdiction. The courts will allow for enforcement of the judgment in the non-local jurisdiction, as they presently do for foreign judgments.
b. Quasi-Criminal Proceedings
Quasi-criminal enforcement proceedings cannot be brought in a remote jurisdiction. However, since the cost of a quasi-criminal proceeding is borne by the Crown, this creates relatively little disincentive for the remote aggrieved party to put such proceedings in motion. However, the complaining party might still have to travel to the jurisdiction in which the proceeding occurs. The following solution overcomes this difficultly.
c. Quasi-Criminal Proceedings: Adoption by Parliament of Criminal Law that Makes a Provincial Securities Law Offence a Federal Offence
Parliament could adopt legislation effectively incorporating by reference all provincial securities law offences. This would make any provincial securities law offence a federal offence. That would mean that the Crown in any jurisdiction could bring a proceeding to enforce the provincial law of any province. This device would thus ameliorate the problem of remote aggrieved parties, since any aggrieved party could seek relief from the local Crown.
d. Administrative Proceedings: Regional Offices of Participant Jurisdictions
With respect to administrative proceedings (if not also providing back-up on quasi-criminal matters), participant jurisdictions could maintain a variety of regional offices to assist in information gathering for investigations, administrative hearings, etc. One complication, however, is that the demand for enforcement services in remote jurisdictions may be subject to variability over time is, complicating staffing decisions. It may be, however, that each participant would have to maintain at least some presence in each of the major markets, although the use of commercial enforcement services (below) may work more effectively.
e. Inter-Delegation by the Provinces of Administrative Enforcement Powers
The problem of remote administrative enforcement can also be overcome in part by allowing each participant jurisdiction to delegate to the other jurisdictions the power to act on its behalf in administrative proceedings. There might, however, be constitutional problems with this solution, since provincial authority over securities law derives from BNA 92(13) - "property and civil rights in the province". It is questionable whether another provincial authority could hold a hearing, and mete out a penalty in relation to conduct that took place in another province.
It is virtually certain, however, that a province can agree to offer investigatory support to another province, as long as it is that other province that eventually decides the penalty. This is unobjectionable since the Supreme Court of Canada has ruled that provincial securities commissions can offer enter into agreements with foreign regulatory authorities to offer assistance in investigations (Global Securities Corporation v. B.C. (Securities Commission),  1 S.C.R. 494). I believe that the reasoning of that case would apply to a passport (select) system.
If each participant could anticipate that it would spend about the same amount of time as its regulatory counterparts in other jurisdictions in investigating out-of-province matters, one could probably get away with not having any cost-sharing agreement. However, that factual premise is unlikely to hold up. Because of differences in the number of market actors choosing different jurisdictions as their regulator, and because of asymmetries in the physical location of market participants (the majority will be based in Ontario), it may be that a payment-for-services agreement would have to be negotiated.
In addition, it seems unlikely that the various provinces would agree to supply services on demand. They would probably wish to retain the discretion of whether to use their scarce enforcement resources working on an out-of-province matter. That problem might be addressed in the following manner:
f. Commercial Enforcement Services
Each participant could hire law firms and/or specialized services set up to offer assistance in investigations, enforcement, etc. On the law side, these might be, for example, specialized law firms, specialized departments within law firms, or simply the ad hoc provision by law firms of legal services to regulatory clients. There is precedent; securities regulators have often contracted with private legal firms for the provision of regulatory support with respect to functions such as reviewing prospectuses.
The major disadvantage of hiring external parties is the cost, especially if one is contemplating using legal talent from the larger law firms. The major advantage is not having to maintain remote offices, with the expense that that entails (especially if demand for enforcement services is lumpy rather than steady). It may be, however, that in a passport (select) system there would be parties who would set up boutique enforcement firms that might well be cheaper than employing high-priced big firm talent. Using such services would put the risk of variations in demand for remote regulatory services on the external agent.
g. Delegation to the Federal Government
One way to spread the cost of the administrative enforcement mechanism is to have all participant jurisdictions delegate authority to conduct investigations, etc. to the federal government. In a sense, this is an automatic cost-spreading device, because the costs of the system are borne by all Canadian tax payers. It may be that the federal government could be induced to offer this service so as to be seen to be part of the solution to our current problems (although Quebec will not likely delegate to the federal government). Moreover, the federal government is better situated than many of the provinces to offer enforcement services.
h. Some Combination of the Above re Administrative Proceedings
There is no reason why the "remote access" problem cannot be cured by some combination of the above. The cheapest route might be to use other securities commissions (or federal services), but this solution will not always be available. Thus, it could be supplemented as required by the hiring of external legal talent and/or investigatory resources. In addition, small regional offices might be maintained for more convenient liaison with other securities commissions and/or external service providers.
4. The Role of the Stock Exchanges
The stock exchanges would play a pivotal role in a passport (select) system, because the stock exchanges adopt governance rules that overlap both securities regulation and corporate law. For example, the TSX requires shareholder votes (including, on occasion, majority of the minority votes) when an issuance of shares will increase the capital of the corporation by more than a stated amount, or when stock options in excess of stated amounts are to be issued. After Sarbanes-Oxley (and despite the TSX's current resistance to following that path) it may be that we will see more intrusion of the stock exchanges into corporate governance, especially re requirements for unrelated directors, audit committees, etc.
The difficulty is that these stock exchange requirements will effectively trump the securities law of the jurisdiction that an issuer decides to opt into. Thus, if Alberta chose not to require that an audit committee be composed entirely of unrelated directors, that would come to nought if the TSX imposed such a requirement on its listed firms.
The amalgamation of the various stock exchanges only exacerbates this problem, since there is no longer any competition between different stock trading venues; the TSX controls both big and small equity boards. Moreover, the TSX is regulated by a single province - Ontario. With its strong regulatory bent, the OSC could use its authority over the TSX to effectively mandate national standards of conduct through stock exchange rules. That would obviously imperil the very raison d'etre of a passport (select) system.
This is a difficult problem to address. It seems unlikely, in the short term that meaningful competition between stock trading venues will emerge. It would be helpful, however, if any stock exchange may, like any other market actor, choose its regulator. However, if the TSX chose to opt into Ontario's regime, this would effect no change from the current system and would not address the power of Ontario to dominate the securities regulatory system. Thus, a meaningful passport (select) system must impose a limit on the extent to which participants jurisdictions can governance standards on a stock exchange. The stock exchanges must be free to choose their own path. In addition, however, to prevent the stock exchange from itself becoming a de facto national regulator, any agreement to create a passport (select) system should impose a limit on the extent to which a stock exchange can venture into matters of corporate governance, or other matters overlapping securities and corporate law.
5. Constitutionality of a Passport (Select) System
The Constitution Act, 1867, s. 92(13) extends provincial authority with respect to securities regulation only so far as "property and civil rights in the province." This raises the question of whether it is permissible for a provincial authority to apply its law to a market actor that has no more connection with the jurisdiction than that of opting into its law
I believe that it is. First, there is the analogy to corporate law. The corporate law of the incorporating jurisdiction governs the corporation's internal affairs, no matter where the corporation is physically situate. Thus, a business located in British Columbia may incorporate in Newfoundland, although it has no other connection with Newfoundland than as a situs of incorporation. The courts of all of the provinces will recognize the application of Newfoundland corporate law. While strictly speaking this is a conflicts rule, rather than a constitutional principle, its well-settled status suggests that it would be surprising if any Canadian court were to find that it unconstitutional. A passport (select) system in the securities law domain would be no less immune from attack.
Support for the above can be found in recent conflicts law cases decided in the Supreme Court of Canada that come close to giving conflicts principles a constitutional basis. Further support can be found in the broad reading given s. 92(13) by both the Ontario Court of Appeal and the Supreme Court of Canada gave in the Asbestos cases.
F. The Role of Regional Interests
Western (i.e. B.C. and Alberta) and Quebec regulators, and a number of other commentators have suggested that a national commission would not serve the regional interests of the various provinces. The western and Quebec versions of "regional interests" are somewhat different (but with some overlap). I deal with each in turn.
The western version of regional interests focuses mainly on two factors: i) size; and ii) differences in sectoral mix. With respect to the first, the average size of regulated firms in B.C. and Alberta firm is much smaller than that in Ontario. Western regulators have suggested that the art of regulating small firms differs from that of regulating large firms, and that a national commission run from Ontario would focus on the large firm sector and pay insufficient attention to the interests of small firms.
I concur in the western view. As I have previously noted, the ratio of the cost of regulation to either the proceeds of financing or operating budgets is much greater for smaller firms than larger. This is because the cost of regulatory compliance is relatively fixed. For example, a $10 million financing will not cost much less to orchestrate than a $25 million or $50 million financing. Thus, the burden of regulation falls more heavily on small firms than on large. Because efficient securities regulation must balance both costs and benefits at the margin, this may lead to either different types of regulation for small firms, or different stringencies of regulation.
Similarly, the benefits of small firm regulation frequently differ from that of large firms. The benefit of a financial forecast to investors, for example, may be much greater in the context of smaller firms. In like fashion, the benefits of historical financial disclosures may be different for smaller firms. Again, this can lead to a different cost/benefit analysis in deciding the appropriate level of regulation. In some cases, more regulation will be called for - in others, less.
This issue has recently been highlighted in relation to whether Canadian regulators should adopt the various reforms (including Sarbanes-Oxley) recently adopted and implemented by the U.S. Congress, the SEC, the U.S. stock exchanges, and U.S. accounting and other bodies, relating primarily to corporate governance. The Toronto Stock Exchange has rightly suggested, in my view, that the different size of firms in Canada makes wholesale adoption of these reforms highly problematic.
In my view, a national regulator, which inevitably would be run from an Ontario with an Ontario perspective, will be insufficiently sensitive to unique small firm issues. Because most large firms are based on Ontario, Ontario has focused the bulk of its regulatory efforts on these large firms. Ontario regulators have relatively little experience with, or understanding of the unique character of small firms. The natural tendency would be to regulate small firms in the same manner as large firms.
The second way in which western firms are different relates to sectoral mix. B.C. regulators have historically dealt principally with mining companies, and Alberta regulators with oil and gas companies. I agree with the view that these primary resource extractors present unique regulatory challenges. However, Ontario has also regulated its fair share of primary resource extractors. Thus, I would not rank this concern as strongly as that with respect to size in advancing the cause of regional interests. Nonetheless, I would suggest that the size factor is sufficient by itself to lend substantial credence to the view that western regulators face unique regulatory challenges.
Quebec's primary concern about regional interests is quite different. Quebec has long used (or been willing to bend) securities regulation, on an ad hoc basis, as a tool of regional and industrial development policy. Thus, for example, the admission of NASDAQ terminals into Quebec was a political decision essentially dictated to securities regulators. The Quebec Stock Savings Plan, and the introduction of Labour Sponsored Venture Capital Corporations are further illustrations of the willingness of Quebec to sacrifice investor protection concerns in the interests of regional and industrial development. Quebec's interest in advancing the cause of "regional interests" is to preserve the freedom it currently enjoys to make securities regulatory policy at the political, rather than the regulatory level. To a much lesser extent, this concern is shared in the west, which has, for example, introduced junior capital programs that are not available elsewhere in the country. In short, the argument that a centrally constituted regulatory authority would pay insufficient attention to regional interests has merit.
It has been suggested that a centrally-based regulator could alleviate this concern with regional offices. Regrettably, this is not a reliable solution to the problem, since regional policy is ultimately under the control of the central office. There can thus never be any guarantee that the central office will be sympathetic to legitimate regional concerns.
G. Creating a Passport (Select) System
There are various techniques that can be used to create a passport (select) system.
1. Extending the MRRS (the quasi-mutual reliance system currently in place for prospectus and AIF review, and applications for exemptive relief)
The MRRS currently covers prospectus review, review of annual information forms, and applications for exemptive relief. It is a quasi mutual reliance system insofar as there are strict rules that govern the identity of the principal regulator; market actors are not given the freedom to choose their regulator. In addition, any participant regulator may opt out of the system and make its own decision. Indeed, in some cases under the current system, if a non-lead jurisdiction does not respond to a lead regulator's decision, that jurisdiction is deemed to have opted out of the system. Thus, the MRRS is not a true mutual reliance system. Because one of the primary objectives of reform must be to ensure that only one regulator governs, no matter what, merely extending the MRRS is not an adequate solution.
However, amending the MRRS to eliminate opt outs and to allow market actors the freedom to choose their regulator would convert the MRRS from a quasi mutual reliance system into a real mutual reliance system. In order, however, to ensure that the various provincial authorities do not resile from their agreements, the basic principles of a rejuvenated MRRS system should be enshrined in statute law.
2. Legislating the Corporate Law Conflicts Rule for Securities Law
As noted earlier, the current difficulties extend from the difference in the conflicts rules applicable to corporate laws and to securities laws. One way to resolve the difficulty is thus to legislate the corporate conflicts rule in the securities law context. To be effective, this would require passage of similar or identical legislation in all 13 regulatory jurisdictions.
3. Uniting Corporate and Securities Laws under One Statute in each Participating Jurisdiction
It is arguably unnecessary to legislate a new conflicts rule for securities law. The same might be achieved by folding the securities law statutes into the corporate statutes (retaining the corporate name), so that the courts would apply the corporate conflicts rule to securities laws. This, however, would also require both the cooperation of, and the passage of legislation in all participating jurisdictions. Thus, little is gained over the previous solution.
4. Inter-Provincial Delegation
Provinces might delegate to each other the authority to regulate market actors who have chosen to be regulated by that particular authority. This is not very different from all jurisdictions legislating the corporate conflicts rule for securities laws.
5. Need for Inter-Provincial (and possibly Provincial-Federal) Agreements
Whichever of the above solutions is employed, it will be necessary to secure inter-provincial agreements to support a passport (select) system. Such agreements may not, as either a practical or a legal matter, be enforceable in court either for damages or specific performance. And, even if accompanied by supporting legislation, such agreements cannot bind a legislature as to its future conduct. Nonetheless, agreements of this character serve a precatory function that will remind each government of the serious of its commitment to a passport system. Moreover, such agreements (and supporting legislation to implement the system) will make it clear that the mutual reliance system springs in the first instance form the legislature, rather than securities regulators. This will help preserve the stability of the system.
Depending on the mechanisms of enforcement, it may be necessary to secure inter-provincial and perhaps provincial-federal agreements to support the enforcement regime. It may also be necessary to secure agreement with respect to the conflicts rule that will govern the application of securities laws. Compensation and cost-sharing, and other agreements may also be necessary.
H. The Passport (Location) Model
In a passport (location) model, market actors may not choose their regulator. Instead, the identity of the regulator is determined by the application of mechanical rules that depend on criteria such as the location of the firm's head office. A system of this character shares two important advantages with a passport (select) model - it gives each market actor a single regulator. It also leaves the provinces in control of securities regulation, sidestepping the potentially difficult political issue of getting the provinces to cede an area currently under provincial control to the federal government.
However, it also has one marked disadvantage. Because market actors cannot choose their regulator, there is relatively little incentive for each regulator to innovate. Each regulator is a monopolist within its own territory. It is true that within this system, market actors can choose their jurisdictions "with their feet". This creates some pressure for regulators to regulate efficiently, since inefficient regulation will encourage market actors to locate in other jurisdictions. There is precedent for this in relation to small firms in Canada; many small firms have chosen to locate in B.C. or Alberta in order to take advantage of more congenial private placement exemptions.
However, this is not likely to be a strong regulatory motivator for a number of reasons. First, switching the location of a business is very costly. It would take a very serious inefficiency in securities regulation (which is only one of many costs confronting a public corporation) before a large number of firms decide to re-locate to another jurisdiction. Second, market actors naturally tend to locate their head offices in the centre of economic activity. This means that the majority of regulated entities will be located in Ontario, and will thus be regulated by Ontario regulators. There will be little or no serious market pressure on Ontario regulators to regulate efficiency. There is in fact good evidence that this type of system, which corresponds to Europe's siege reel corporate law model, greatly limits regulatory competition between jurisdictions. For this reason, a passport (location) model is significantly inferior to a passport (select) model.
There are reasons to believe that the current regulatory structure of securities regulation could be improved upon. I have suggested, however, that the focus of the inquiry must be on the effect of securities regulatory structure on small and medium-sized domestic corporations, since large corporations that are inter-listed on U.S. exchanges are already subject to American regulation, which is the most demanding in the world. It is unlikely that any domestic regulatory structure will add materially to that burden. It may also be, however, that ease of system access for foreign issuers should also be a priority, since the marginal benefit of accessing the Canadian market is small and even a relatively small marginal cost of using the Canadian system may persuade such issuers to confine their international business to other countries.
In this submission, I sketch out various alternatives for change. The alternative that has garnered the greatest attention in this debate is that of a national securities commission, whether federally or provincially constituted. This alternative promises certain improvements over the existing situation - in particular, the provision of a single regulator for all market actors. However, it also has serious disadvantages. Chief among these is that a national regulator would be a monopoly regulator that would face little pressure either to innovate or to supply efficient laws. In addition, a national regulator might well be inattentive to legitimate local concerns relating to national differences in the size of issuers, the sectoral mix of issuers, and the desire of some provinces to retain the freedom to use the regulation of capital markets as a tool of industrial and regional development.
In addition, a national regulator is not likely to be politically stable. Whether federally or provincially constituted, establishing a national system involves political forbearance on the part of each participant province. Such forbearance may wax and wane over time. In the face of a credible threat to defect and de-stabilize the system, each province (or at least those provinces in which Canada's major markets are located) can inveigle itself into the policy-making process, rendering making one of the nominal advantages (simplicity in policy-making) illusory.
Perhaps most importantly, it may simply be impossible to achieve the formation of a national regulator. Of the provinces in which Canada's four major capital markets are located, three of these - Quebec, B.C., and Alberta - have indicated that they will not join a national regulator. Thus, this alternative, for all intents and purposes, appears to be off the table at the present time.
It might be possible to constitute a sub-national regulator with some, but not all of the provinces. This would reduce the number of regulators and would thus be an improvement over the current situation. However, this solution is inferior to other alternatives.
Harmonization of provincial laws is another alternative that has received a good deal of attention. However, there is no greater prospect of achieving and maintaining true harmonization than there is of creating a national regulator. In any case, complete harmonization is not desirable, as it replicates all of the defects of having a national regulator. It would be extremely unwieldy to maintain, slow to change and thus slow to innovate, and ultimately highly unresponsive to changes in today's fast-paced capital markets.
The solution that I have pressed upon the committee is a mutual reliance, or "passport (select)" regime in which each market actor chooses a regulator and the other provinces recognize the sole authority of that regulator over the market actor. This solution has many benefits. These include the provision of a single regulator for all market actors. But perhaps more importantly, this regime gives regulators an incentive to supply efficient, responsive, and responsible regulation of our capital markets. As is the case with corporate law in Delaware, market actors will provide valuable feedback to regulators, and regulators will have an incentive to listen to these actors, in order that they not experience an outflow of business. As against fears that this will lead to a regulatory "race-to-the-bottom", in which regulators shamelessly pander to corporate desires, I have suggested that the experience with corporate law in the United States (and, to some extent, in Canada) suggests that the more likely result is a "race-to-the-top".
A passport (select) model can be achieved in a number of different ways. These include combing corporate and securities law in one statute, legislating the corporate choice of law rule in the securities area, provincial inter-delegation, and extending the MRRS system to all securities-related subject matters while simultaneously eliminating provincial opt-outs, and allowing each market actor the freedom to choose its regulator.
Implementation of this system would do no more than extend to securities law the conflicts rule that has governed corporate law for in excess of a century. I hope that the Committee will extend serious consideration to this alternative.
JEFFREY G. MACINTOSH