Proposed federal securities legislation moves Canada a step closer to capital market regulation at a national level
On May 26, 2010, the federal Department of Finance released its proposed Canadian Securities Act (the Act). The Act builds upon the Report released last year by the Expert Panel on Securities Regulation and represents the federal government’s proposal for a harmonized national regime to govern capital markets. Following decades of deliberation by various panels and committees, publication of the proposed Act by the Canadian Securities Transition Office evidences this government’s strong commitment to the establishment of a national securities regime and regulator.
The case for regulation of capital markets at a national level is set out in the preamble to the Act. Among other things, the preamble highlights the need to be competitive and consistent, enhance the integrity and stability of the Canadian financial system, have a comprehensive and coordinated enforcement regime and promote Canada’s interests at a national and international level. While the intent is to create a harmonized federal scheme for securities regulation, provincial participation is voluntary and the Act will only apply to those jurisdictions that choose to take part in the federal scheme. As we discussed previously, the draft Act is only a proposal at this stage, and has been referred to the Supreme Court of Canada for a ruling as to its constitutionality.
Drafted as a broad “platform”, the Act provides the basic framework for major areas of securities regulation, with much of the detail to be contained in regulations and rules. The Act is based in large part on existing provincial legislation in the areas of prospectus and registration requirements, continuous and timely disclosure, regulation of take-over bids and imposition of primary and secondary market civil liability. While major substantive changes are generally not intended to be reflected in the legislation itself in these areas, significant developments are proposed in other areas, including recognition or designation of self-regulatory organizations and other similar entities as well as the regulation of derivatives, market conduct and securities-related offences and penalties. The Act also introduces a bifurcated structure for administration and adjudication by separating the Authority’s regulatory division from an independent adjudicative division. In addition to substantive changes that may be reflected in the Act or the rules themselves, regulation of capital markets at a federal level may also present the potential for broader extra-territorial application of Canadian securities laws given the federal government’s broader power over trade and commerce.
Structure and governance of the Canadian Securities Regulatory Authority
The Act establishes the Canadian Securities Regulatory Authority (the Authority), which will be responsible for administration of the new regime. The stated principles of the Act are to provide investor protection, foster fair, efficient and competitive capital markets in which the public has confidence and to contribute, as part of the Canadian financial regulatory framework, to the stability of the financial system. In pursuing these goals, the Authority is to have regard for the need to be open efficient, flexible and responsive, to take into account interests of investors and businesses in all sectors and regions of the country and to balance the costs and benefits of regulation. The primary means stated for achieving these purposes include standards for honest and responsible conduct by market participants, the monitoring of developments affecting the integrity or stability of capital markets and cooperation and coordination among financial authorities within and outside of Canada.
The Act also establishes a Council of Ministers consisting of the federal Minister of Finance and representatives appointed by each participating province or territory. The Authority will have a board of directors who are to be appointed by the Governor in Council on recommendation of the federal Minister of Finance following consultation with the Council of Ministers. This board will, among other things, have the power to make regulations and be responsible for the affairs of the Authority, other than matters relating to the Tribunal’s adjudicative functions.
The Regulatory Division of the Authority is to be headed by a Chief Regulator who is responsible for the direction and management of regulatory operations and subject to the general direction of, and accountable to, the board of directors. The independent Tribunal is the adjudicative division of the Authority and is to be comprised of full and part-time members appointed by the Minister of Finance in consultation with the Council of Ministers. The Tribunal will, among other things, be able to review decisions of the Chief Regulator and of recognized entities and will be the primary adjudicator for matters such as compliance or cease trade orders in connection with take-over bids. With respect to take-over bids, the Chief Adjudicator may authorize the Chief Regulator or one of the Deputy Chief Regulators to act as a member of a panel provided the parties to the matter have consented. While the Tribunal has the power to replace a decision of the Chief Regulator, it may only substitute its own determination of the public interest if the decision made by the Chief Regulator is unreasonable. A decision of the Tribunal may be appealed to a provincial court of appeal in the province in which the decision is deemed to have been made, which is to be determined in accordance with the Tribunal’s rules. The Tribunal is vested with the authority to make a wide range of orders in the public interest (including cease trading and other orders) and to impose administrative penalties up to a maximum of $1 million and/or for any amounts obtained or payments or losses avoided as a result of a contravention of the Act. The Tribunal also has the power to impose a cease trade order for a period of no more than 15 days on account of unusual market fluctuations material changes or other circumstances that could result in disorderly trading of a security. In addition, the Act requires that market participants provide the Chief Regulator with information necessary for the assessment of the stability of the financial system or for conducting policy analysis.
A joint committee called the “Regulatory Policy Forum” is charged with considering and developing the authority’s regulations, policies, practices and activities. This committee is also to obtain the views of capital market participants and others on these matters and will consist of the chairperson of the board of directors of the Authority, as well as the Chief and Deputy Chief Regulators and the Chief and Associate Chief Adjudicators. The Authority is also required to establish an “Investor Advisory Panel,” comprised of those with knowledge and experience with investors’ issues, for the purpose of representing the interests of investors by advising the Chief Regulator on securities regulations, polices and practices.
Recognition of self-regulatory organizations and designation of various entities
The Chief Regulator has the authority to recognize a self-regulatory organization, an exchange, a clearing agency or an auditor oversight organization on application, with recognition being mandatory for anyone carrying on business as an exchange or a clearing agency. To facilitate the work of a recognized auditor oversight organization, the Act requires its participants to provide certain types of information relating to the audit or review of financial statements to be filed under the Act but has built-in safeguards to protect privileged information and to prevent compelled evidence or testimony by a recognized auditor oversight organization. The Act also gives the Authority power to designate certain entities such as credit rating organizations, investor compensation (contingency) funds, dispute resolution services, information processors, trade repositories or other entities that provide investors or markets with prescribed services. While conferring the power of recognition and designation, the Act is thin on related rules and requirements. These will likely be set out in the rules.
Regulation of Derivatives
The Act presents an opportunity for significant development with respect to the regulation of derivatives. As discussed in our more detailed piece on derivatives, the Act distinguishes between different categories of derivatives identified as “prescribed derivatives”, “exchange-traded derivatives”, and “designated derivatives.” While detailed requirements will be set out in the rules, the Act sets out a broad framework that requires exchange-traded derivatives to be traded on recognized or accepted exchanges only, and for specific disclosure to be provided in connection with designated derivatives. Prescribed derivatives, meanwhile, would generally be treated much like traditional securities.
The market conduct provisions of the Act impose a duty on registrants to deal fairly, honestly and in good faith with their clients. In addition, investment fund managers are required to perform the duties of their office honestly, in good faith and in the best interests of the fund and to exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in the circumstances. The Act also imposes positive requirements relating to the identification, disclosure and management of conflicts of interests by registrants and in connection with take-over bids and other similar transactions. Specifically, it imposes a duty on offerors, offerees and their directors and officers to identify, disclose and manage conflicts of interest that may arise among security holders in connection with certain types of transactions. In addition to insider trading and tipping prohibitions, which are currently contained in provincial legislation, the Act also prohibits front-running, which is defined as trading activity by any person connected with an investor who knows of information related to an unexecuted order or to the intention of an investor to purchase or trade a security where the order or intention would reasonably be expected to significantly affect the market price of the security (referred to in the Act as “material order information”). Persons are also prohibited from engaging in an unfair practice in relation to investor relations activities. Unfair practices for these purposes include putting unreasonable pressure on another person and entering into a transaction with a person who is unable to protect his or her own interest because of physical or mental disability, illiteracy, age or other inability to understand the character, nature or language of any matter relating to a decision to purchase, hold or sell a security.
The Act contains new provisions relating to both general offences and punishment and criminal offences and punishment. For general offences, a person could be liable on a proceeding by indictment for a fine of up to $5 million or imprisonment for up to five years and on a proceeding by summary conviction for a fine of up to $250,000 or imprisonment for up to one year. The Act also contains new criminal offence provisions relating to fraud, market manipulation, misrepresentations with the intent to induce a person to, or not to purchase or trade a security or to deceive a person about an issuer or a security and affecting the market price of a security with the intent to defraud. These offences carry a maximum imprisonment term of 10 or 14 years, and a fraud offence is subject to a minimum imprisonment term of two years if the total value of the subject matter of the offence is more than $1 million. It is also a criminal offence for a person in a special relationship with a reporting issuer to use knowledge of an undisclosed material fact or material change to engage in trading activities (i.e. insider trading). For these purposes, a court is permitted to infer from the fact that a person had knowledge of a material change or material fact at the relevant time that the person used that knowledge to purchase, trade or enter into a transaction. There is a similar criminal offence for tipping, with both carrying a maximum imprisonment term of up to 10 years. The Act also sets out specific aggravating circumstances to be considered when imposing a sentence in connection with a criminal offence and lists specific non-mitigating factors that may not be considered in sentencing (including a person’s status or reputation), where those factors were relevant, contributed to or were used in the commission of the offence.
As stated above, the Act represents a voluntary federal regime that will apply only in provinces and territories that choose to participate. However, certain provisions of the Act have been drafted to apply throughout Canada regardless of whether a province or territory has or has not opted into the federal regime. These include provisions relating to criminal offences and punishment, which are conceivably intended to replace the existing securities-related criminal offences currently contained in the Criminal Code. Laid before Parliament as a Ways and Means motion, the Act has been referred to the Supreme Court of Canada for a ruling on its constitutionality and is expected to be introduced as a bill (with or without amendments) once that issue is resolved.