Thomas S. Caldwell: The Canadian economy is regulated to death

The following is an edited excerpt of a speech given by Thomas S. Caldwell at the Empire Club in Toronto on Jan. 3.

We are now at a point where a major impediment to economic growth, job creation, innovation and business formation is regulatory strangulation within the financial-services sector.

Before I am pounced upon by regulators and media, let me state that I have, throughout my career, been a strong advocate for intelligent, clear and effective securities regulation for the protection of investors, the securities industry and our country’s economy.

We have now gone far beyond that, into the realm of regulatory overkill or strangulation, under the mantra that “more is better.”

This has gone on undetected by politicians who do not see the complex issue of capital markets as having any political upside. The unintended consequences of unfettered regulators continually elude our law makers.

The number of Ontario securities regulations, and the size of the regulatory bodies, has grown exponentially over the years, with a parallel deterioration in investor protection.

The fact that the great scandals have occurred as regulations have become more numerous is partly because regulators are unfocused, and partly because of a massive regulatory volume burying what is really important. Bre-X and Sino Forest are cases in point, with the latter being a replica of the former. Auditors indeed have some responsibility here, but regulators should have spotted Sino, with its identical modus operandi to Bre-X, on day one.

Despite the fact that regulators have let big scandals slip right under their noses, and have been slow following-up when they’re finally spotted, regulators, seeking to expand their mandates and staff, insist on focusing on the retail investor and stacking up more and more obligations on the financial-services sector, particularly independent brokers and advisors. Small investors are now too risky and too costly to be served by independents, who generally provide more personalized service and broader advice. Thus, small investors are forced to buy the wholesale products offered by the big banks.

The unfortunate reality is that the small investor is long gone from the investment scene. If exchanges stripped away high-frequency trading — which is done by computers and indirectly encouraged by regulators — the volume of trade by individuals would be a small fraction of their historical levels.

To make matters worse, our regulators support lobbyists who are critical of the investment industry, and have created a vicious cycle in which the lobbyists have a pecuniary interest in investment advisors being penalized. This is like the fire department hiring someone to run up and down the streets yelling “fire,” in order to get more fire engines and bigger budgets. Regulators are now expanding their “concerned” lobby group sponsorships. I would remind regulators that their task it to assist in building a healthy financial-services environment, not to destroy it.

Rarely a day goes by without our industry being slagged by media — usually fed by regulators. Non-major violations of securities regulations are typically branded as “acting against the public interest,” which to the public sounds like a crime against humanity. The ombudsman for the financial-services industry tries to punish firms that disagree with the regulators’ judgements in the media. That hurts every firm in our industry.

To some degree, it is self-promotion by regulators at the expense of those they regulate. Looking at the above, one could easily ignore the fact that billions of dollars change hands each day in hundreds of thousands of transactions by tens of thousands of people who are both hard working and highly ethical.

We also have to contend with a situation in which Canadian and American regulators are in a “race to the bottom,” each trying to out-regulate the other. Canadian regulators, mesmerized by America’s slow suicide, are determined to appear tougher. But the U.S. economy has the size and depth necessary to partly absorb regulatory over-reach and abuse. Canada lacks that bulk and is at a different historical phase in its development. By imitating U.S.’s knee-jerk regulatory changes, we are removing the opportunity for Canada to become a world financial centre — a “Switzerland of the north.”

Securities regulations should be simple and clear in order to effectively police and to comply with. That is far from the current situation. As one securities firm’s compliance officer recently stated: “I need roller skates just to keep up.” Compliance now comprises between 30% to 50% of administration costs for independent brokers and advisors. That is simply not sustainable, as regulators have lost all sense of, or concern for, the costs and consequences of their actions.

The immediate consequences of unchecked regulatory competition here in Canada are as follows:

1. Investors are being deprived of investment choices, in terms of both products and service providers. Although our banks are also suffering from regulatory overkill, they have the size and diversity necessary to sustain their business models. Independent firms do not. They are dying.
2. Entrepreneurs and innovators are being starved for funding to try new things. Banks fulfill a key roll in our economy, but backing new or small enterprises with equity investment is not one of them. Apple, Intel, Microsoft, BlackBerry plus hundreds more, including many of our large resource companies, may never have got off the ground in our current Canadian regulatory environment. It’s important to remember that smaller independent brokers finance new enterprises. Kill the former, and the latter dies or goes elsewhere.
3. Because the regulators have lost focus, they have allowed, and indeed encouraged, an overly complex financial market to develop. High-frequency trading now accounts for a significant portion of all equity trades. You cannot be considered a true investor if your holding period is a fraction of a second. The situation we have now is one in which the folks with faster computers, or better programs, are continually able to jump in front of legitimate investors.
4. The destruction of “open and visible” trading markets, as sanctioned and encouraged by regulators, has now undercut the basis of all investment and trading: The accurate determination of the price at which a trade should take place. It is too easy now to fix prices. Many individual investors now see the game as rigged against them and are opting for other investment choices, such as commodities, condos, land, etc.
5. Companies seeking financing are now avoiding public markets whenever possible. They currently seek funding in the private capital world or — in the case of the U.S., U.K. and Australia — “crowd financing” on the Internet. Anything to avoid the regulatory costs and threats of public markets.
6. The main concern of industry regulators still appears to be procedures and paper trails. One firm was recently fined for doing the right thing, but not having a written procedure for doing the right thing.

The new Client Relationship Model being developed by Ontario regulators will complete the overkill. It is similar to holding car salesmen responsible for all future breakdowns or accidents. This should keep brokers fully focused on paper trails.

With every crisis, the regulatory strangulation is accelerated, whether relevant or not to the individual securities industry registrant. As Oscar Wilde said, “The bureaucracy has to expand to meet the needs of an expanding bureaucracy.”

There are, however, a few things that can be done to start rectifying the situation:

1. Take the Ontario Securities Act and cut it in half. Remove the redundant, dated and unnecessary regulations, and focus on what really matters: principles and goals. At the same time, we need to stop funding lobby groups whose role is to slag the investment industry and aggrandize regulators.
2. Regulate the regulators, at all levels. A mechanism must be established to curtail regulatory abuse, other than appealing to the regulator itself, whose only interest is building upon what already exists — despite the cost and overall economic consequences of their actions or inaction.
3. Provincial securities commissions should not outsource their regulatory responsibilities, and should focus on those regulations that lead to good governance and disaster prevention. This step is particularly important to provinces other than Ontario, as a national industry sub-regulator using a “one-size-fit- all” model can be regionally destructive. Farming out regulation has removed broader capital market accountability. Also, self funding of regulators has led to self-aggrandizement.

At present, with no effective check on securities industry regulators, they have become destructive forces impacting the public, the securities industry and the economy as a whole. The regulators themselves need to be regulated.

National Post

Thomas S. Caldwell is the chairman of Caldwell Securities Ltd.

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