Securities Regulators Propose Increase to their Customer Base

Anyone following the recent actions of Canadian securities regulators can only conclude from their behavior that they are experiencing a real identity crisis. Despite more and more talk from the regulators themselves about the need to reduce the regulatory burden and eliminate rules for which the costs exceed the benefits, new regulations keep flowing out of the Canadian Securities Administrators, the umbrella group for the thirteen provincial and territorial securities regulators.

It does not seem to matter that there is no discernible problem to address. Their latest foray is a set of proposals to expand regulation over mutual fund managers, which do nothing for investors, but will add to the coffers of the securities commissions.

The majority of the revenue generated by securities commissions is from user fees charged to market participants for regulatory services. Because of declining stock market activity and fee cuts, the commissions have to be more innovative in finding ways to generate more revenue to continue financing the expansion of their bureaucratic empires.

The new proposals for the regulation of mutual fund managers will significantly expand their customer base. Unlike other corporations that have to convince customers to acquire their products and services, the commissions face no such obstacle. Under the proposals, mutual fund managers will have to register with the commissions, and presumably pay them for the privilege. The fund managers will also be required to implement or modify their governance regimes.

To meet the requirements for registration, fund managers will face a range of compliance requirements that will ultimately increase the expenses charged to investors. One of the most bizarre is capital requirements. Capital requirements are currently used in bank, insurance and securities dealer regulation as a cushion against unexpected losses to protect creditors such as depositors and policyholders. By definition, in a mutual fund investors absorb all gains and losses themselves daily based on the market values of the securities within fund portfolios so this rationale does not apply.

Instead, the best reason for capital requirements that the regulators have managed to come up with is to ensure the ability of fund managers to meet operational requirements such as paying staff and maintaining equipment. In other words, the requirements are intended to protect investors from professional investment managers unable to manage an office budget. What makes this rationale even sillier is that it could just as easily be applied to moving companies, rental property managers and private golf courses. There is no clear logical reason why mutual fund managers should be singled out just because they offer a financial service.

After successfully proving through their long absence from the Canadian marketplace that regulation-imposed governance regimes on fund managers are completely unnecessary to protect investors or maintain a vibrant mutual fund industry, Canadian securities regulators are proposing to implement one. Funds managers will be required to establish boards of directors to oversee fund management on behalf of investors.

In the absence of such regulation, many fund managers have introduced different types of governance structures to meet the needs of their customers: the investors. Investors now have choice. Whether some form of governance or other accountability structure exists is one of a number of factors that investors can take into consideration in making their investment choices. If the proposals are implemented, mutual fund investors will be forced to accept, and pay the costs of, more standardized governance structures.

If Canadian securities regulators genuinely believe that Canadian mutual fund investors suffer from the lack of regulated governance regimes, perhaps investors could be given at least temporary relief until they are in place. Why not allow them to invest in funds offered in the US where governance regimes have been required by law since 1940? In addition to the supposed regulatory protections, this would be a great incentive for Canadian fund managers to work harder to meet the needs of investors, and Canadians would certainly enjoy the greater selection and lower management expense ratios.

As a whole, the proposals will result in Canadian investors not only facing higher expenses, but less choice as the new regulations will discourage new entry. Despite the rules requiring governance regimes, fund managers will be less likely to respond to the needs of their customers given higher regulatory insulation from competitive pressures. It is a rather high price for investors to pay just to generate business for more battalions of regulators. Where improvements to governance are urgently needed is on the commissions themselves, rather than on fund managers.