Regulation fight an uphill battle for Feds

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Whatever you think about the proposal for national securities regulation, the persistence of the Federal Government is admirable. Despite opposition from Alberta and Quebec, waffling support in British Columbia and doubt about the legality of the policy itself, Ottawa has unveiled draft laws, put together a “Transition Office” to manage the process, and done their best to ensure that everyone expects that some form of national regulation is on its way.

By now, the terms of this debate are well known: If you’re for national regulation, you agree that a federal body will harmonize existing regimes and cut transaction costs, be on guard for risks that transcend the oversight of provincial regulators, pool technical and investigatory skills, and have greater reach for large-scale enforcement actions with an international dimension.

If you oppose it, you worry that the new regulator is unnecessary, will be out of touch with local economic conditions and the priorities of investors, and may favour one region over another. No matter what you’re position, you might be surprised to learn these arguments probably don’t matter, as the courts look likely to have the final say on the issue. And if a recent judgment is any clue as to how things will turn out, national regulation is permanently doomed.

Today, the Supreme Court of Canada will hear arguments on whether the constitution allows the Federal Government to regulate the securities industry. We have a preview of the arguments the Supreme Court will consider courtesy of the Alberta Court of Appeal, who released an opinion on the subject earlier this month at the request of the Government of Alberta. What’s at issue is not the efficiency or scope of the regulatory regime but rather the decision of the Fathers of Confederation in 1867 to award the power to legislate over “trade and commerce” to Ottawa, preserving for the provinces the right to make laws governing “civil and property rights”. If the Supreme Court follows the reasoning of the Alberta Court of Appeal, national regulation doesn’t stand a chance.

Historically, the Courts were very comfortable with the idea that securities regulation fell squarely within the “civil and property rights” power. The Court of Appeal readily accepted that Canada’s existing securities laws (including the Federal Government’s proposed legislation) serve two main purposes: the first is to control how capital is raised from the public, which is a question of individual contracts between investor and issuer and therefore a “property right”; the second is to regulate industry participants, in the same way that lawyers, doctors and engineers are provincially licensed, which is a “civil right”. This basic position is so entrenched that the Government of Canada, in its arguments in the Alberta case, didn’t even bother to challenge it.

Instead, the Federal Government tried to separate the aims of the proposed national regulatory mechanism from those of the current regime, hoping to convince the Court that its proposed laws were not mere duplicates of the provincial legislation and would achieve policy goals that are out of the provinces’ reach. This argument — that some things can only be done nationally — is how the Courts have made a distinction between the obviously contradictory powers of “trade and commerce” and “civil and property rights”. The new, different policy goals identified by the Federal Government boiled down to the desire to create “comprehensive national securities regulation” and the need to counter future, now-unseen systemic risks that could imperil the financial universe as we know it.

The Court of Appeal was not convinced by either argument. They dismissed the want for comprehensive national regulation out of hand, noting that any law the Federal Government chose to pass, constitutional or not, would apply comprehensively across Canada. The second argument, however, is more complicated. The question to be answered is this: What sorts of systemic crises can happen that cannot be prevented by provincial laws controlling the marketing of high-risk investments, or by Federal laws targeted at banks?

Banking is singled out in the constitution as an area of federal legislative power. The Court of Appeal highlighted the existence of the CDIC and the Office of Superintendent of Financial Institutions as examples of the sort of entity already in the front lines of systemic risk prevention. The Court reviewed the draft Federal legislation and could not find anything in it that protects against a systemic risk outside the provinces’ regulatory capability.

This analysis opens the door to a potentially different result from the Supreme Court. The Alberta judgment examines the specific constitutionality of the proposed Federal legislation, but also wonders whether the trade and commerce power could ever be used to justify any form of national securities law. If the Government of Canada can identify a systemic risk that does not relate to the capital adequacy ratios of banks, or to selling restrictions a province might introduce, the Supreme Court could give leeway to accommodate the regulation of that risk and other matters related to it which might normally be within provincial scope. It might not be the regulator the Federal Government wants, but it’s a start.

In the Alberta reference, the Federal Government made brief arguments that the Canadian capital markets have changed significantly in the last ten years. The Court of Appeal didn’t think this mattered to the constitutional discussion, but it might. Again, the question is whether the way Canadians buy, trade, promote, and issue securities has evolved in a way that the provinces are inhibited from regulating a particular participant or market activity.

It’s not a question of whether national regulation is better, but whether the provinces can regulate with any degree of success at all. If the Federal Government wants to convince the Supreme Court of the constitutionality of national regulation, they should provide a better explanation of precisely how the provinces are abjectly failing in the face of today’s securities market.

For those who favour a national regulator, it’s frustrating that an antique division of powers, designed when securities were issued locally by dour men handwriting numbers on ornate certificates prevents what they see as the best policy in terms of efficiency and competitiveness.

It is a defining feature of Canadian governance that the provincial and federal powers overlap and Canadian courts have a long history of siding with the provinces in the face of compelling cases for a centralized bureaucracy of one type or another. The Alberta Court of Appeal does not bind the Supreme Court, but its judgment is instructive as to how big the Federal Government’s job will be to ground the national regulator on a firm constitutional footing.

Brandon Barnes is a lawyer at Davis LLP in Toronto. Having gained professional experience in Calgary and London, his practice is focused on financial services litigation and commercial fraud, with a special interest in the alternative investment industry.