Passport to chaos

by Anita Anand

This commentary was first published in the Financial Post on July 25, 2007.

Finance Minister Jim Flaherty recently took an unprecedented step: He forcefully voiced the federal government's commitment to a national securities regulator for Canada. He also expressed concern that a passport system is not ideal for Canada. Without question, the passport system perpetuates cost inefficiencies as well as problems with co-ordination in enforcement. It is not a model that Canadians should accept or support. Why?

Under the passport system, jurisdictions enter into agreements in which one jurisdiction recognizes the decisions made by another on the basis of the latter's rules. Registrants and issuers need to meet the requirements of a "principal" regulator only. There is no requirement for harmonized legislation and the system only deals with certain areas of law, for example continuous disclosure. This means that there is one system for some areas of law and another system for all others. This increases the complexity of the current system, as issuers may comply with the rules of the passport system in certain circumstances, but must comply with the rules of the existing system in all others.

The passport system retains the current structure (based on 13 regulatory authorities), as well as the duplication that results from this structure. Registrants and issuers continue to pay fees in 13 jurisdictions and file forms with 13 regulatory authorities in certain circumstances. In addition, the system continues to permit differences in modes of implementation, even though two or more jurisdictions may agree to implement the same law. Jurisdictions can apply the law and undertake enforcement issues (including investigations) differently, even if the law is harmonized. Differing philosophies among securities regulatory authorities may exacerbate this problem.

The passport system is further problematic because all provinces, including Ontario, have not signed on to it. Thus, issuers and registrants need to deal separately with the Ontario Securities Commission if they use a principal regulator other than the OSC. The issuer may still suffer opportunity-cost risk from having to receive approval from two authorities (at least).

The passport system may alleviate some of the risk, but not all. If the issuer or registrant is dealing with signatory provinces only, then opportunity-cost risk stands to be reduced. But if it wishes to deal with Ontario also, this risk likely remains.

Of utmost significance is that the passport system does not address enforcement issues. Individual provinces continue to be responsible for the enforcement of securities law. A province can choose to deal with an enforcement issue through its own enforcement actions or refer matters back to the host regulator. The difficulty with this approach, from the investor's standpoint, is that matters may "fall though the cracks" without either regulator taking enforcement action, even if it would be in the public interest to do so. This is because one regulator may wrongly rely on another regulator to take actions that the other regulator never takes.

Alternatively, where one regulator is not satisfied with the actions of another regulator, it takes its own enforcement action. This creates more uncertainty and the possibility of uneven enforcement actions across the country. One recalls the list of problems with enforcement under the current system, which (as the Wise Persons' Committee notes) included: inefficient allocation of resources, coordination difficulties in multi-jurisdictional proceedings; and unjustified variation in enforcement priorities, including statutory protections for investors. Under the passport system, there exists the potential for proceedings to go back and forth between different regulators. Furthermore, variation in enforcement priorities will continue, especially in the case of differing regulatory philosophies.

Arguably, the appeal of a passport system for the provinces is that it is does not require them to cede jurisdiction or authority. However, as we have seen, there are costs and other significant problems inherent in the passport system, especially with respect to enforcement. It is a much weaker alternative to a national securities regulator.