First published on the University of Toronto Faculty of Law Blog - https://www.law.utoronto.ca/blog/faculty/selective-use-data-in-debate-about-national-securities-regulator-canada-comment-lortie
By: Anita Anand
Pierre’s Lortie’s recent paper seeks to discredit federal reform initiatives to create a national securities commission by making the following claims: Canadian capital markets rank above those in other countries as various international bodies suggest; the empirical evidence does not exist to support such a reform; and, the current passport system that operates in tandem with the Canadian Securities Administrators “constitutes[s] an example of Canadian federalism at its best” and change should not be implemented without compelling reasons. Lortie suggests that Canadian investors, junior issuers, and the fairness and efficiency of Canadian capital markets will not benefit under a national securities regulator. Rather, the status quo is superior as it has allowed Canada’s financial system to outperform those in other countries. Arguing that the proposed model will constitute a “takeover” of securities regulation, Lortie suggests that a national securities commission will be captured by federal interests. An earlier version of his report was filed as evidence by the provinces of Alberta in the Quebec, Alberta and federal constitutional reference cases.
In this comment, I analyze the evidence on which Lortie bases his argument and argue that: the evidence that he cites does not in fact support his position; his reliance on this evidence to bolster his argument regarding enforcement in Canada is misguided in its selective use of the data; and, his review of costs is superficial. While Lortie criticizes the federal proposal for a national commission for failing to consider the evidence, his own paper falls victim to this folly. His argument involves a cursory, selective review of the academic and empirical literature and does not in fact lead, “to the inescapable conclusion that the arguments made to justify the takeover of securities regulation by the federal government lack a solid foundation…”
2. Efficiency and Effectiveness
In support of his argument that the Canadian securities system functions effectively, Lortie in his previous paper cited an OECD Report which states that Canada ranked second in terms of the quality of securities regulation, ahead of the US which ranked fourth and the UK which fell directly after the US. He briefly mentions the OECD Report in the recent version of his paper. A review of the OECD Report suggests that it is based on four broad indices: contract enforcement, access to credit, investor protection and bankruptcy procedures. Each category is constructed from sub-indices which essentially reflect aspects of transparency (information disclosure) and efficiency of legal procedures. For instance, the access to credit index combines information about public registries and private bureaus with estimates of cost to create collateral and information regarding the legal rights of lenders and borrowers. As noted in the Report, the indices have been constructed in such a way that a higher value is noted as positive for financial development and overall economic performance.
The fact that Canada ranks highly on the OECD Index is positive in a general sense but it does not exemplify the quality of Canada’s securities regulatory regime. Contract enforcement, access to credit and bankruptcy procedures are not viewed as integral components to our securities regime, yet they constitute three quarters of the indices on which the OECD Report is based. It is no surprise that the sub indices also contain indicators that are not relevant to the main objectives of securities regulation (e.g. cost to create collateral). It is inaccurate, therefore, to cite the OECD Report as evidence of Canada’s superiority “with respect to the quality of securities regulations and investor protection.”
In any case, OECD reports themselves have called on Canada to create a national system of securities regulation. A 2006 OECD Policy Brief states: Provinces currently exercise responsibility for regulating securities markets. Substantial gains could be achieved by establishing efficient and effective Canada-wide securities regulation, but governments to date have not agreed on the appropriate model to adopt. Every effort should be made to reach a decision as quickly as possible.” A more recent OECD Policy Brief states the position more strongly, “Further efforts by the Bank and other regulators are desirable to improve transparency, flexibility and competition in Canadian financial markets. The current diversity of regulations -- for example, each province has its own securities regulator -- makes it difficult to maximise efficiency, and increases the risk that firms will choose to issue securities in other countries. A single regulator would eliminate the inefficiencies created by the limited enforcement authority of individual provincial agencies.” Interestingly, Lortie does not mention these later OECD documents.
In this version of his paper, Lortie acknowledges a 2008 report in which the International Monetary Fund (IMF) stated that there is “significant duplication caused by the system of provincial regulation that should be addressed…[though] under the umbrella of the CSA the provincial regulators have made significant improvements….” It further explained that, “Overall it appears that a coordinated approach to enforcement is still partly missing, although both the federal authorities and the provincial regulators are taking measures in that direction.” Finally, in a relatively unqualified statement, the IMF stated:
…the number of cases opened or sanctions imposed in a jurisdiction are only a partial indicator of enforcement activity in a country. However, those numbers taken together with the comments from market participants do lead to the conclusion that enforcement is an area where considerable improvement is still needed.
Lortie’s response is that “it is critical that the performance of Canadian capital markets …be
assessed in a rigorous methodological manner based on solid empirical evidence.” However, the “evidence” to which Lortie refers is of questionable validity.
Lortie cites the research by La Porta, Lopez-de-Silanes, Shleifer, stating that “…based on the results of the largest and most comprehensive study of the efficiency of securities regulation and the strength of private and public enforcement of investor protection, Canada ranks 2nd out of 49 countries on the effectiveness of securities regulations.” In terms of percentage ratios, Lortie continues that in the La Porta article, the US obtained a score of 97%, Canada was at 91%, Australia at 77% and the UK at 73%. While this study may appear to bolster his argument, the La Porta study does not support Lortie’s argument as will be discussed.
The La Porta study presents data for 49 countries and finds “little evidence that public enforcement benefits stock markets but strong evidence that laws mandating disclosure and facilitating private enforcement through liability rules benefit stock markets.” It analyzes rules relating to initial public offerings and in particular includes the following variables: disclosure requirements; liability standards; supervisor or commission characteristics; rule-making powers; orders to issuers, distributors and accountants; criminal sanctions applicable to these parties; and, public enforcement. There are sub-indices for each of these variables also. For example, with regards to disclosure, six proxies are used, including obligations to: deliver a prospectus, disclose insider compensation, disclose ownership by large shareholders, disclose inside ownership, disclose material contracts and disclose related party transactions. The overall disclosure index is calculated by taking the average of the six proxies. To obtain information for their study, La Porta et al. sent one questionnaire to a lawyer in each of the 49 countries each of whom subsequently “confirmed the validity” of their answers and then coded the information on these questionnaires according to the variables chosen.
The La Porta line of studies – including the study cited by Lortie -- has been heavily criticized in the academic literature in terms of the methodology used, the quality of the data points and the simplistic conclusions. One of the most comprehensive critiques of these papers has been written by Spamann who analyzes the data used in the first of the papers entitled “Law and Finance”. He finds significant flaws in the index used and, when he inserts corrected data, the results are no longer obtained. In particular, the main thrust of the first La Porta paper, that common law systems are superior to civil law systems in terms of investor protection, is found to be inaccurate with 33 of the 46 country observations requiring correction.
Now the La Porta article cited by Lortie is a later paper in the series but still, significant issues arise relating to the methodology used. In particular, numerous studies have questioned the somewhat unscientific method of data collection (i.e. sending questionnaires to a lawyer in each country) and the inability to meaningfully compare and code information gleaned from these questionnaires. Some have argued that the methodology was driven by the thesis (i.e. that legal origin determines financial market outcomes) and that as a result, the questions presuppose the superiority of the common law system. Further, as Pistor argues, we must recognize that, “legal systems are not simply the sum of the indicators that we find in statutes or codes but instead are broad systems of social ordering.” Given the significant academic skepticism for the work of La Porta et al., Lortie’s claims about the superiority of Canada’s current securities system on the basis of this work are unconvincing.
In sum, none of the empirical studies mentioned, or in fact generally available, attest to the superiority of Canada’s current securities system over alternative models in other countries or over a national securities system in this country. The conclusive data to which Lortie refers do not appear to exist.
3. Access to Capital and Costs of Securities Regulation
Lortie’s explanation of costs involved in the offering process requires further analysis. He argues that a significant additional cost on issuers under the proposed national securities system is translation and publishing prospectuses in English and French under federal law. He then cites a chart from Koolie and Suret with data running between 1997-1999 which “show[s] conclusively that Canadian securities regulation does not impose on Canadian issuers, including junior issuers, a cost burden higher than in the US.” He then states that “the comprehensive studies which have examined the ease of access to public markets and the costs associated with public issues demonstrate the superiority of the Canadian regime in terms of responsiveness to the diversity and heterogeneous needs of the Canadian economy.” However, other than the somewhat outdated Koolie and Suret study cited, he provides no detail from, and no citations to, these “comprehensive studies”. Notably, the data presented from Koolie and Suret say nothing about the responsiveness of the Canadian regime to diversity and heterogeneity.
Whereas Lortie shuns comparisons with US regulation with regards to enforcement, he does not do so with regards to IPO costs and costs of equity, likely because the comparison benefits the case that he seeks to make. His point is that the costs of equity between Canada and the US are comparatively close and this provides evidence of the fact that the current Canadian securities regulatory system works well (requiring no major structural reform). While this is an important point in our understanding of regulatory costs, it does not dispose of the important issue regarding costs. A (perhaps “the”) crucial question is whether aggregate issuer and regulatory costs under the proposed national system of securities legislation would be less than under the current system NOT how the costs compare to those in another country.
Lortie does not address this point. Indeed, his review of costs is cursory, omitting a discussion of the many costs that should be considered, including regulatory costs and issuer costs arising from multiple regulators, and revenue lost (or even potential revenue lost) from issuers that decide not to raise capital in Canada because of the existence of a fragmented regulatory regime. He also does not take into account the notion of opportunity cost risk which refers to the risk that business may be lost or delayed due to regulatory requirements. These latter costs, while difficult to quantify, were found to exist in a research study completed for the Wise Persons’ Committee. In short, Lortie’s discussion of costs draws on the existing data selectively and only as necessary to support his case.
Lortie argues that Canada is not a less law-abiding society simply because the incidence of public enforcement actions in Canada is significantly lower than in the US. He further points out that under the US Dodd-Frank Act, state securities regulators have expanded investor protection and enforcement roles. The implication is, again, that the current decentralized system of enforcement involving (limited) cooperation among the provinces is superior to any centralized enforcement structure that would be created under a national securities commission.
To begin, the fact that criticism regarding enforcement occurs in other jurisdictions and therefore we should not be surprised that it occurs here, does not address the substantive aspects of the criticism itself. These criticisms relate to the lack of a unified approach to enforcement which would ensure that an individual who committed a financial crime will be treated identically whether she or he is resident in Alberta or Ontario. Lortie addresses this point by referring to a study by Professor Mary Condon for the Wise Person’s Committee in which she argues that there is “notable consistency across the provinces in the articulation of the public interest that is the basis for making orders.”
The specific citation from Condon’s work is accurate but it does not present the full picture of her results. In the result cited, Professor Condon refers to the concept of “public interest” which is contained in the administrative power of securities regulators. Her comments do not refer to quasi criminal cases prosecuted by securities regulators or any other enforcement matters. Further, Condon did not find consistency to exist generally speaking across securities regulators. Rather, she found “significant variation in emphasis across the provinces in relation to infractions pursued to an enforcement hearing….local regulators appear to play a significant role in the setting of enforcement priorities.” Condon also found “unevenness in the application of contextual sanctioning factors to individual respondents, in order to justify specific types and quantum of penalties.” In short, Condon’s work cannot be used to support the notion that there is consistency in regulatory decision-making across all jurisdictions, as Lortie suggests in his paper.
Lortie then criticizes comparisons to the US enforcement record. He cites the Crawford Panel’s analysis which surmises that, “the high visibility of enforcement action in the United States has led many Canadian investors (justifiably or not) to conclude that Canadian regulators are failing in this area.” Lortie then “debunks” the view that the US system of enforcing securities act violations is more aggressive than Canada’s by arguing that although the ratio of public enforcement actions in the US is higher than it is in Canada, US securities litigation is excessively tilted towards ex post sanctions rather than ex ante supervision and Canada should not “blindly” follow this route. He further argues that the SEC accounts for a small proportion of public enforcement actions (17.6%) in the US compared to state securities regulator agencies which account for a higher proportion (40.8%).
Lortie selectively uses the data presented. If we refer to the Jackson study that Lortie cites in setting forth this data, we see that over the 2002-2004 period, the aggregate number of enforcement actions undertaken at the state level in the US is 1482 while the number undertaken by provincial commissions in Canada is 124. The number of enforcement actions in Canada over this period is thus less than 10% of the corresponding number of state-level actions in the US. In fact, the combined number of US state and federal enforcement actions is 2121, meaning that the number of enforcement actions in Canada is less than 6% of combined comparable US figures. This marked difference between the US and Canada with regards to enforcement is more conspicuous when one considers that the SEC took the lead in bringing forth 639 cases over the same period with no corresponding number in Canada given the absence of a centralized securities regulator. In short, the comparative data that Lortie chooses to discuss is misleading.
Lortie concludes by arguing that the evidence leads to the “inescapable conclusion that the arguments made to justify the takeover of securities regulation by the federal government lack a solid foundation and, too often, misrepresent the situation…” The above comment has demonstrated, however, that the evidence cited by Lortie has been selectively chosen and discussed, leading to inaccurate assessments of the state of the literature and authors’ arguments in certain cases. It seems relatively easy to say that Lortie’s conclusions are not, in fact, inescapable at all.
 Pierre Lortie, “Securities Regulation in Canada at a Crossroads.” 3:5 The School of Public Policy Research Papers, University of Calgary, October 2010. This paper builds on an earlier paper by Lortie which was filed as evidence in the constitutional references cases in support of provinces that oppose the creation of a national securities regulator. This comment paper was written as a response to the earlier Lortie paper and has been updated here.
 Lortie, ibid.
 Lortie, ibid.
 Lortie, ibid.
 Lortie, supra note 1 at 5 citing the OECD Report “Going for Growth” (2006).
 OECD Economic Studies No. 43 2006/2 at 90 ff.
 Lortie, supra note 1 at 5.
 Organisation for Economic Co-operation and Development, “Policy Brief: Economic Survey of Canada 2006” OECD Observer at 6.
 Organisation for Economic Co-operation and Development, “Policy Brief: Economic Survey of Canada 2008” OECD Observer at 4 [emphasis in original].
 International Monetary Fund, “Canada: Financial Sector Assessment Program” (February 2008) [hereinafter IMF Report].
 Lortie supra note 1 at 4.
 R. La Porta, F. Lopez-de- Silanes, A. Shleifer, “What works in Securities Laws” (2006) 60:1 Journal of Finance [hereinafter La Porta study].
 Lortie, supra note 1 at 5. Lortie also cites the La Porta study to support his point that enforcement works well in Canada. See Lortie, supra at note 39 and discussion infra. For discussion of the La Porta et al thesis regarding legal origins, see Paul Mahoney, “The Common Law and Economic Growth: Hayek Might be Right” (2001) Journal of Legal Studies.
 La Porta study, ibid.
 See, for example, Robert Schmidbauer, “On the Fallacy of LLSV Revisited” (2006); Coffee “The Rise of Dispersed Ownership” (2001); Baums and Scott “Taking Shareholder Protection Seriously” (2003); Braendle “Shareholder Protection in the USA and German: On the Fallacy of LLSV” (2005).
 Holger Spamann (2008) "'Law and Finance Revisited", Harvard Law School John M. Olin Center Discussion Paper No. 12, Feb. 2008 (Discussion Paper No. 12), online: SSRN <http://ssrn.com/abstract=1095526> analyzing R. La Porta, F. Lopez-de-Silanes, A. Shleifer, R. Vishny (1998) Journal of Political Economy 106 : 1113-1155.
 Ibid. See also Katharina Pistor, “Rethinking the ‘Law and Finance’ Paradigm (2009) Brigham Young University Law Review.
 Pistor, ibid at 1669.
 Lortie, supra note 1 at 10.
 Lortie, supra note 1 at 10.
 Lortie, supra note 1 at 9 ff. citing M. Koolie and J.M. Suret, “How Cost-Effective are Canadian IPO markets”, Canadian Investment Review 61(1), 2003.
 Lortie, supra note 1 at 20.
 Lortie cites J. Witmer and L. Zorn (2007) and L. Zorn (2007) cited in Lortie supra note 1 at 21.
 Anita Anand and Peter Klein, “The Costs of Compliance in Canada’s Securities Regulatory Regime” in A. Douglas Harris, ed. Research Studies prepared for the Wise Person’s Committee (2003) 517 [WPC Research Studies].
 Lortie, supra note 1 at 14.
 Lortie, ibid.
 Lortie, supra note 1 at 15 quoting Mary Condon, “The Use of Public Interest Enforcement Orders by Securities Regulators in Canada” prepared for the WPC Research Studies supra note 27 at 415.
 Condon, ibid. at 415.
 Condon, ibid.
 See e.g. Lortie, supra note 1 at 15.
 Lortie, supra note 1 at 12 citing Crawford Panel on a Single Canadian Securities Regulator, “Blueprint for a Canadian Securities Commission, Final Paper” (June 2006).
 Lortie, supra note 1 at 13.
 Lortie, supra note 1 at 14.
 See also Pierre Lortie, “The National Securities Commission Proposal: Challenging Conventional Wisdom”, The Montreal Gazette, May 24, 2010, online: <http://www.montrealgazette.com/pdf/May24-Challenging-Conventional-Wisdom.pdf>. For the original data, see Howell E. Jackson, “Regulatory Intensity in the Regulation of Capital Markets: A Preliminary Comparison of Canadian and U.S. Approaches” prepared for the Task Force to Modernize Securities Legislation in Canada, July 30, 2006, at 110 and 113, where the data used in Lortie’s paper was obtained.
 Jackson, ibid.
 Jackson, ibid.
 Lortie supra note 1 at 38.