The Role of Self-Regulation in the Securities Business

The securities business is a regulated business. This has been so since at least 1285 when an English statute was passed to license brokers in the City of London. That is the same century in which the Magna Carta was signed.

One of the obligations of the exchange is to regulate its own members requiring them to meet the standards the exchange and informed public opinion deem proper. This obligation of self-regulation is only part of the picture. In the securities business we have a system of dual regulation. Not only is the exchange required to exercise self-discipline, it is also subject to government regulation. Since all members of the Exchange are in turn registrants under the Securities Act, the Securities Commission has always had at least an indirect power to regulate the Exchange. Now the power is more direct. Section 139 of the new act gives the Commission a clear cut right to become involved in Exchange affairs. Perhaps to some purists in administrative law there is some inconsistency in a dual system of regulation. They might argue that direct government regulation is best and self-regulating associations are unnecessary. This would be a superficial criticism of dual regulation. Even if direct government regulation is number 1, all this means is that like Avis, the Exchange being number 2 tries harder.

I believe that a dual system of regulation gives the best of both worlds. Knowledgeable administrations working in conjunction with conscientious members of the investment community should develop a system which is best for the industry and the public. The Exchange welcomes Section 139. It is a clear statement of government policy. It eliminates any misconception that may have existed and places the onus on the Exchange and the Commission to work out jointly the required regulatory rules.

Contrary to what is commonly argued by those likely to be subject to regulation, the history of regulation in the securities business shows that regulation is beneficial in the overall picture. Regulations may cause frustration on occasion, however, regulations intelligently devised and applied are for the benefit of the public and even those regulated share in that benefit. The American securities business, while heavily regulated, is the healthier for it. No securities market in the world has a higher level of public confidence and as wide a public participation.

Our law recognizes the concept of self-regulation in many fields. We have the professions such as doctors, lawyers, and others who, by statute, are given the right to regulate their own members. Many public institutions, such as hospitals and universities, have similar rights.

Securities regulation includes this concept. The Securities Act in Ontario recognizes three organizations--the Stock Exchange, the Investment Dealers' Association and the Broker-Dealers' Association. This same recognition is contained in most of the other statutes in Canada. A few years ago the Ontario Securities Commission played an active part in fostering the Canadian Mutual Funds Association which while not recognized by statute is considered by the Commission an integral part of the industry.

We frequently hear comments about our American friends and how much more effective are their regulations in the securities field than ours. This is coupled with the sub mission that we should adopt the American practices. A review of the American laws demonstrates that they take the same approach as we and rely on self-disciplining associations. The United States has its independent exchanges and dealer associations.

In 1938, when recommending certain amendments to the Securities Acts of 1933 and 1934, the Senate and House Committees of Congress reported that their legislative recommendation was a -

"Program based upon co-operative regulation, in which the task will be largely performed by representative organizations ... with the government exercising appropriate supervision in the public interest, and exercising supplementary powers of direct regulation."

On this point of self-regulation there is no substantial difference between the Canadian law and the American.

If we look to Great Britain, that other jurisdiction which has influenced our development, we find that the securities legislation exempts members of the London Stock Exchange and other recognized exchanges from compulsory licensing. When this is discussed with Englishmen they justify it on the ground that the onus placed on members to regulate themselves has established a high standard of responsibility, higher, they argue, than with those who are regulated by the government agency. Value of Self-Regulation

With the law and practice recognizing the value of selfregulating organizations it is not necessary to argue the point. What is worthwhile is to consider what self-regulation im plies. A clear implication is that it is good for those most directly involved to set the standards for their profession or industry. In fact, it is a recognition that a man should be tried by his peers.

Professor Louis Loss, the leading writer on securities regulation in North America, has this to say on this point:

"At best however, direct regulation of a complex business through the machinery of government ... divides black from white with a buzz saw when the many variations of gray call for a surgeons scalpel ... and regulation of the ethics of an industry means a substantial degree of selfregulation, properly supervised by government."

This implication that self-regulation is beneficial is based and remains valid only on the assumption that the profession or industry will in fact regulate itself and then not in its own self-interest, but in the interest of the public as a whole. The right to exercise self-discipline carries with it, as do all rights, a corresponding duty. To abdicate the duty is to ask for more direct government regulation. As I have said the Exchange, being number 2, must try harder.

One aspect of the duty is to deal fairly with those who are within the association and with those who wish to join. The power should not be exercised arbitrarily, but fairly and according to what we call natural justice. Certainly it should never be exercised in any discriminatory manner.

This aspect of fair play is not what I wish to stress today. It is the other aspect of the duty, the duty to play fair with the public interest that I wish to emphasize and relate to the operation of the exchange. I also wish to discuss the extent of the public duty and how it is related to the country, the securities business and to the regulatory commissions.

The Toronto Stock Exchange is the largest and foremost market place for equity securities in Canada. Of all the exchanges in Canada it most fully performs the function of a national exchange. Consequently its public duty lies not only in the residents of Ontario, but to the residents of all of Canada.

Further, because of its important position, it must be a leader, not only in that area of the securities business directly affecting the exchange, but in the whole of the securities business. It is not possible to departmentalize the securities business in the minds of the investing public. To them a person who deals in securities is a stock-broker, no matter whether he is an exchange member, an investment dealer, broker-dealer or mutual fund salesman. The health of the securities business depends on the health of each segment thereof. Each part of the industry must be his brother's keeper and as a big brother this responsibility must be one of the burdens of the Toronto Stock Exchange.

Equally, we cannot departmentalize Canada. Mr. Gordon and Mr. Sharpe may have different opinions on foreign investment in Canada, but whatever is the right or wrong of that argument there is no place in our thinking to scare off foreign investments by permitting the existence of any shoddy concept of the value of Canadian securities or of the Canadian market place. To the foreign investor a security is a Canadian security no matter in what province it originates or trades. When we consider regulation there must be no room in our thoughts for competition between the various provinces or exchanges based on the lowering of standards. If the exchanges are to compete, let us compete on facilities and services. This type of competition is healthy. The real beneficiary will be the public.

The Exchange advocates uniformity of legislation and standards of self-regulation across Canada. A country of 20 million people cannot afford the luxury of a variety of approaches. Variety maybe good for the Heinz Soup Company, but it has no place in the field of securities regulation.

It is interesting to note the adoption by several of the provinces of Ontario's new securities act. British Columbia, Alberta and Saskatchewan have new legislation substantially similar. It is encouraging that these provinces have been willing to move quickly for the sake of uniformity, without sitting back and letting Ontario bear the brunt of any mistakes its act may contain. The Ontario act is better than anything previously existing in Canada. To adopt it is progress. The contrary is the case if one waits to see what time may dictate as to how Ontario's act can be improved.

Another encouraging sign of uniformity is the co-operation between all the jurisdictions in a study on mutual funds now underway. This is an interesting example of true co operative federalism. Here we have the federal government and all the provinces entering into a study on an equal basis. Any political rivalries have been put aside in the recognition that uniform legislation in this field is essential and that a joint effort was the most likely method to obtain it.

I have spoken about the extent of the public to whom the Exchange owes a duty, and of the duty of the Exchange to the whole securities business. But I must not fail to look at the Exchange's duty in a narrower or more immediate sense. Using the word both figuratively and actually, what must it do within its own house? There is a duty on the Exchange to establish an efficient and properly functioning market place with up-to-date tools. I do not direct my remarks, however, to the mechanical side of the operation of an exchange. This is important, but what is of even greater importance is the responsibility to maintain a market place where the public can trade with confidence, confident that their trades are effected equitably, free of abuse from manipulation and from unfair advantage by those in whom they must place their trust.

It is in this area that self-regulation is most important. If the Exchange wishes to have the freedom to manage its own affairs it must meet the corresponding duty of taking appropriate action to avoid abuses of the public in any area where the Exchange can exercise jurisdiction.

It has a jurisdiction in at least two situations. One is over its own members and their employees; the other is over companies listed on the Exchange. The Exchange has a duty to ensure that the public receives fair and equitable treatment at the hands of its members. The public interest must take precedence over the private interests of members. With listed companies the Exchange has a duty to insist that these companies supply the public with the information necessary to enable the public and its advisors to assess the value of their shares.

Individuals who acquire membership on the Exchange hang out a sign stating--"We will carry on our business according to the rules of the Exchange." So also do com panies which acquire a listing by having a membership or a listing there is a representation that the public may Zeal confidently both with the member and the securities of the listed company. It is up to the Exchange to make certain its standards are the right ones and that the standards are observed so that the feeling of confidence is never impaired.

It is important that the Exchange work to the same end as the legislature, through its agency, the Securities Commission. Since this end is the public interest there should be no conflict between the two. The effort must be a co-operative one. Co-operative regulation was the theme of the abovementioned report of Congress in 1938 and the Securities Act of 1966 leaves room for this co-operative approach. This is the strength of Section 139 of the new Securities Act. The Act does not lay down specific and detailed rules but gives the Commission a wide power to make rules when it is in the public interest to do so and in conjunction with the Exchange, a situation similar to the Securities & Exchange Commission's position under the Exchange Act of 1934. It is contemplated that under this section there will evolve the necessary standards to benefit the public.

The functions of the two bodies must be complementary. The Exchange, in its sphere must accept its responsibility, and if it does not it is properly subject to criticism from the Commission. The Commission has the added responsibility of ensuring the protection of the public from abuse in those areas and from those people who do not come within the Exchange's sphere of control. The Exchange is an arm of the Commission, but equally so the Commission is a power which the Exchange must be able to call upon for assistance.

Philosophy of Regulation

An important first stage in developing regulation is that there be an understanding of the philosophy of regulation. There may exist a clash between two philosophies. On the one hand a desire to ensure the public against risk; on the other not to eliminate risk but to restrict the element of abuse. I submit that in Canada the philosophy was resolved in 1935 when the Royal Commission on Price Spreads stated that legislation should not be designed to eliminate the individual's "inalienable right to make a fool of himself", but to prevent others from making a fool of him.

This is the philosophy of regulation as I understand it. It should not be the task of the Exchange to attempt to ensure people against loss. In fact, part of the obligation of the Exchange is to make certain the public is aware that with the possibility of gain there is the ever present risk of loss. No rules of the Exchange can protect the public wholly from persons who set out on a deliberate plan of criminal activity. Nor can our laws. The Jenkins Report on Company Law in England in 1962 enunciated a fair approach to securities legislation by recognizing--"The undesirability of imposing restrictions which would seriously hamper the activities of honest men in order to defeat an occasional wrongdoer, and the importance of not placing unreasonable fetters upon business which is conducted in an efficient and honest manner."

This standard for legislation is a reasonable approach, but it places a responsibility on the legitimate businessman and the legitimate broker to live up to the highest standards of the community.

This brings me to my next point. I have spoken of the duty that the securities industry has to regulate itself in the public interest. Also of the necessity of working in close conjunction with the regulatory authorities. This duty, when met, will lead to a healthy securities business,--one where capital may be raised by businessmen at the lowest cost. Since businessmen are beneficiaries of a strong securities market they must in turn work in conjunction with the regulators. Officers and directors of companies and their advisors, such as lawyers and accountants, must assume a role in ensuring the health of the securities market. He is part of the regulatory team and is as much subject to selfdiscipline as are those directly in the securities business.

Two weeks ago, Mr. Lawrence addressed your club on the report of the Lawrence Committee. Despite the fact that the following remarks may duplicate his, I cannot set aside my desire to make some public comments on that report. Frankly, I had intended to make that report the main topic of this address,--but Mr. Lawrence beat me to it.

My personal reaction to the report is one of enthusiasm. The committee and those associated with it are to be congratulated. The committee adopted an imaginative and practical approach to many aspects of corporation law--for example, the recommendation for one man companies. The committee freed itself of any antiquated concepts and its recommendations when adopted will eliminate many of the useless fictions attached to the corporate entity.

From the position of public confidence in the marketplace, the parts of the report which are of most interest are those recommending legislation for the establishment of a standard of care and diligence on the part of directors; the clarification of a director's obligation to his company when contracting with it; coupled with a simplified procedure for shareholders to enforce the director's duties--these are valuable weapons for the protection of the investor.

Under the present law, shareholders can be very much at the whim of directors. There has been a lack of any practical method for removing defaulting directors, for bringing them to account, or for investigating their activities. The recommended legislation eliminates this lack and also the frustration that it caused.

A practical weapon has been added to the arsenal of investor protection. In addition to the disciplinary power which government agencies and self-regulating associations can wield, we will now have an effective weapon directly in the hands of investors,--a weapon they should wield whenever there is abuse.

A comment made is that this new legislation may cause capable people to refuse to act as directors. I doubt that this is so. The majority of directors already observe the higher standards the legislation now imposer on all. This majority has nothing to fear in the new legislation. The remainder, some of whom have been associated with our corporate scandals, may well be concerned with the new legislation. If they abandon their directorships, they will be missed, but not with regret.

Finally, I recognize regulation as being part and parcel of the securities business. That the obligation to regulate falls upon various shoulders. The industry must assume the obligation of regulating itself, the businessmen who avail themselves of the securities market must assume an obligation to that market, the investors have the obligation to pursue their remedies, and, lastly, governments must assume the role of supervisors over the whole of the industry and be involved directly by supplementary regulation and action, in those areas which cannot be governed by self-regulation. The aim of all regulation must be the strengthening of our securities markets in the public interest. To achieve this end, governments, associations and individuals must work together, each complementing the work of the other. The goal is an important one for Canada, for the strengthening of our securities market will not only best serve the investing public but the best interests of our whole economy.

Thanks of the meeting were expressed by Mr. F. Gerald Brander.