Oct. 03, 2019 - Chapter 8 of Davies Governance Insights 2019
The High Price of Cooperation: Davies Comments on the Latest Capital Markets Act
Davies has submitted a comprehensive comment letter on the revised draft Capital Markets Act proposed to be enacted by the participating provinces and territory. Our comment letter raises concerns over significant substantive changes to Ontario law, an inadequate consultation process, and the Act’s broad extraterritorial reach and adoption of sweeping regulatory powers and regulatory discretion.
Leading with the Wrong Foot
Many of our continuing comments and concerns flow from the initial decision made by the drafters of the legislation to model it on the British Columbia Securities Act (BC Act) and not on the Ontario Securities Act (Ontario Act). The Ontario Act governs the largest portion by far of Canada’s capital markets, and Ontario has a vigorous and involved securities bar and investment community, both of which have contributed over the years to a robust dialogue on the evolution of securities legislation. This is evident in the comment process on the initial draft of the legislation, in which the vast majority of comments came from Ontario market participants. The choice to model the Capital Markets Act on the legislation of British Columbia, where the capital market comprises smaller issuers and which has historically faced very different securities regulatory issues than Ontario, is difficult to defend on a principled basis. By proceeding on the wrong foot from the outset, the drafters of the Capital Markets Act will impose legislation on Canada’s key financial and capital markets that will be disruptive to well-established transaction mechanics and compliance practices and will impose significant costs on market participants to adapt to a new regime.
Substantive Changes Proposed Without Adequate Consultation
Although we view the achievement of consensus among the several participating jurisdictions as an accomplishment, we continue to have concerns over both the extent to which the Capital Markets Act introduces significant substantive changes into the law and the quality of the consultation process.
As we commented in our 2014 letter, the introduction of the new legislation should not be used as an opportunity to introduce major substantive changes to Ontario securities law unless the adoption of such changes is preceded by a thorough public consultation and study of the changes. We recommended at that time that the long-established process of the Ontario Securities Commission and the Canadian Securities Administrators in this regard ought to be followed here. That would require each change to be identified in the request for comments, its implications explained and its necessity justified.
We appreciate the efforts of the participating jurisdictions to engage in a consultative process; however, we do not think the process was ultimately satisfactory. In many instances, where commenters provided thoughtful and detailed comments on the initial draft legislation, the response was simply to note that the draft was consistent with legislation in other jurisdictions without addressing the specific concerns raised. We do not consider that adequate justification for a change in law.
The Capital Markets Act significantly extends the extraterritorial reach of Canadian securities law. For example, the Act would regulate sales of securities by Canadian issuers to foreign investors, adopting a British Columbia approach that is both dated and impractical and will be an impediment to Canadian issuers’ access to the United States and other international capital markets. By capturing these offerings as distributions and therefore subject to the prospectus,registration and other requirements of the Capital Markets Act, the Act will subject issuers to additional and potentially conflicting rules and will ultimately render these offerings more difficult and costly to implement, with no real corresponding benefit to the participating jurisdictions. This is another example of the participating jurisdictions electing to adopt the British Columbia approach to regulation without any justification for the fundamental shift in the approach prevailing in Ontario and other provinces.
The Capital Markets Act also extends its jurisdiction to Canadian corporations, partnerships and trusts listed only on foreign exchanges that have not sought and are not seeking to access Canadian capital markets. The Act will also apply the insider trading and tipping prohibitions extraterritorially, so that persons in a participating jurisdiction that trade in securities listed in public markets outside Canada may contravene the Act, even though the foreign publicly traded entity has no real and substantial connection to Canada. To extend the application of the insider trading and tipping prohibitions extraterritorially is particularly problematic when the conduct may be lawful in the foreign jurisdiction, a risk that is especially acute in the insider trading and tipping area in which Canada’s laws are more stringent than those of the United States and other jurisdictions.
This extraterritorial approach to regulation is not only beyond the stated purposes of the Capital Markets Act, but is intrusive and costly to market participants and creates conflicting regimes.
Broad and Sweeping Powers
The Capital Markets Act gives broad and sweeping powers to the capital markets regulatory authority (Authority). For example, the Authority can require directors, officers, promoters and control persons of an “issuer” to hand over any “information, record or thing” in their possession or under their control that relates to the administration or enforcement of capital markets laws or the regulation of capital markets. This power of the Authority extends not only to reporting issuers and market participants but to any person that has issued or proposes to issue securities, from the tiniest private entity to the largest publicly held one. No case has been made for the broadening of powers of the regulator to the point of divorcing these powers completely from the traditional focus of securities regulation – namely, public securities markets. The participating jurisdictions defended the power on the basis that it exists under the BC Act without providing an explanation as to the policy rationale for its inclusion.
Substantial Regulatory Discretion
The Capital Markets Act vests substantial discretion in the Authority. The Authority has significant power to designate persons as members of a “prescribed class” or to otherwise “prescribe circumstances” in which persons will become subject to the regulation of the Authority and the application of the Capital Markets Act. The circumstances in which the regulator may make such determinations are not clearly delineated in the legislation. For example, the Authority will be able to require all registrants to meet such standards “as may be prescribed”. The Authority will have the power to require issuers to obtain a receipt for a “prescribed offering document” in addition to requiring a receipt for a prospectus. The Authority can also deem a person to have control over another person in any “prescribed circumstance”.
This vesting of substantial discretion in the Authority, coupled with the platform approach to the legislation itself (which leaves vast sections of the law to regulation), undermines one of the key features of a sound capital market – namely, stability and predictability in the legal and regulatory regime, which allows for transaction planning.
“Catch and Release” Approach to Regulation
It appears that the general bias of the drafters of the Capital Markets Act was to adopt the most expansive prohibition from existing provincial securities acts. By way of illustration, although Ontario law was seldom the reference point for the Capital Markets Act, the drafters did decide to follow Ontario’s unique approach and regulate non-resident investment fund managers. In addition, a number of sections of the Capital Markets Act take a “catch and release” approach to regulation whereby conduct is prohibited or persons are caught within a class of regulated persons unless exempted by regulation. For example, the Capital Markets Act defines the term “market participant” broadly to catch a larger universe of persons and entities than does the Ontario Act and then contemplates exemptions by regulation from specific obligations applicable to market participants generally. As a general principle, we believe this is not an appropriate approach to securities regulation; nor is it consistent with the approach of the Ontario Act.
What We Haven’t Yet Seen
Two critical pieces of the Capital Markets Act and the cooperative regime have not yet been exposed for comment. The first is the nature of the interface between the Authority and the non-participating jurisdictions. The quality of that interface is critical to the successful implementation of the new regime, and we would expect that a seamless interface will be a precondition to the implementation of the new regime. The second critical omission is the regulation of prospectus-exempt distributions. Over the course of the last 18 months, the Canadian securities regulators have made significant strides in harmonizing the rules regarding prospectus exemptions. Notwithstanding this progress, there continue to be differences in the regulation of exempt offerings among the participating jurisdictions. Unifying these rules across the jurisdictions will be important to ensure the efficiency of the exempt market.
As we noted in our 2014 comment letter, it is critically important that the drafters of the Capital Markets Act get it right the first time. Once the legislation has been passed by the several participating provinces and territory, it will be exceedingly difficult to change. By proceeding on the wrong foot from the outset, the drafters of the Act ended up in the wrong place. We would urge the drafters to step back and rethink the wisdom of their approach. Even among those who have wholeheartedly endorsed a national, federal or cooperative securities regulator, the question is being asked: Is this too high a price to pay?