OSC's ’Regulation Everywhere’ Philosophy Threatens Markets

Howard Davies, the chairman of the U.K. Financial Services Authority, once said in a speech, “Unless you have a clear idea of why you regulate, then you run serious risks of being deflected into unprofitable and unjustifiable areas.” Unfortunately, the OSC is ignoring this philosophy, and is taking a “regulation everywhere” approach to Canadian capital markets.

Over the course of the summer, the OSC has followed its “regulation everywhere” philosophy full tilt, using the excuses of declining market confidence and the need for consistency with the U.S. regulatory framework as justification for anything it does. To begin with, a few weeks ago the OSC played a pivotal role in setting up a new regulatory regime for auditors. The regime was introduced without the careful study and extensive consultation that normally occurs in advance of a significant structural change in regulation.

A governing council dominated by provincial securities regulators and chaired by David Brown, the OSC’s Chair, will oversee the new regime for auditors. Given the OSC is in the driver’s seat for ensuring the new regulatory structure is successful, it could have considered scaling back the resources that it allocates to reviewing financial statements under its Continuous Disclosure Review Program. The program includes examining whether a public company’s financial statements are prepared in accordance with CICA standards, which is precisely the responsibility of public auditors.

However, instead of scaling back the program, the OSC has chosen to do the opposite. Last week, it announced that it was increasing the resources allocated to the program in order to ensure it reviews the disclosure of the largest 100 TSX companies headquartered in Ontario. It is taking this step despite the fact that in the reviews undertaken over the past year the OSC did not, by its own admission, find any serious evidence of wrongdoing.

What did the OSC find? A recently released report on its review of 517 companies included highlights such as GAAP measurements not being presented “prominently” enough in the earnings releases of some companies, and that one company’s website displayed an inaccurate 52-week high for its share price because of a faulty link by the company’s service provider. So why is the OSC beefing up the resources it allocates to continuous review? Naturally, it cites investor confidence as its reason. One has to wonder if the OSC really has any confidence in the new regulatory regime for auditors that the OSC was instrumental in setting up if it insists on covering the same ground that auditors cover.

Still not satisfied that it has done enough this summer towards its “regulation everywhere” vision of Canadian capital markets, the OSC has now sent a letter to the TSX proposing that it abandon its disclosure-oriented corporate governance standards in favour of the command-and-control type governance standards that U.S. accounting scandals have recently demonstrated do not work.

In this case, the OSC’s logic seems to be that Canada should simply copy what the U.S. does. This means ignoring the recent recommendations made by the Joint Committee on Corporate Governance after it undertook extensive consultations and study on what is best for Canadian public companies and their investors. The
OSC’s action suggests that it believes that if Canada, as small country, wants to be successful in global capital markets, it should copy everything the U.S. does, even after the U.S. reputation is tarnished by accounting scandals. If this is the OSC’s strategy, perhaps where it really needs to beef up resources is in marketing. Market participants will tolerate excessive regulation, and the costs imposed by it, in the U.S. because it has the biggest capital markets in the world. That is clearly not the case for Canada.

If the OSC wants to build an internationally competitive regulatory environment for Canadian capital markets, it needs to take heed of Mr. Davies’ point about having a clear idea on why to regulate. There should be a clear identification of a market failure before adopting new regulation. A small country is not in the position to burden its capital markets with excessive regulatory costs. If there is a real threat to Canadian capital markets, it is the OSC’s “regulation everywhere” philosophy.