Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 18 - Evidence - May 12, 1998 (a.m.)
OTTAWA, Tuesday, May 12, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 9:30 a.m. to consider the present state of the financial system in Canada (the role of institutional investors).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Senators, this is a continuation of our study of the role and governance of institutional investors in Canada. Our witnesses this morning are from the Canadian Council of Financial Analysts: Mary Ross Hendriks is their Executive Director, and she appears along with the head of the Ottawa Chapter. Thank you very much for taking the time to come, Ms Hendriks. Would you please introduce the head of the Ottawa Chapter to my colleagues? After your brief opening statement, we will have some questions for you.
Ms Mary Ross Hendriks, Executive Director, Canadian Council of Financial Analysts: Good morning, Mr. Chairman and honourable senators. It is my pleasure to introduce Mr. Dleap Hall, Director, Ottawa Chapter of the Toronto Society of Financial Analysts. This is one of the societies involved in the Canadian Council of Financial Analysts Inc., which I will refer to hereinafter as the CCFA.
I thank you again for inviting us to make a submission to you on the proposed changes regarding the governance of institutional investors. We have some comments about the Canada Business Corporations Act (CBCA). I apologize for not presenting our written submission to you today, but we will be forwarding a copy of it to you shortly.
The CCFA is a national, non-profit organization. It represents financial analysts, portfolio managers, and other investment decision-makers from each of the Canadian societies and chapters of the Association for Investment Management and Research (AIMR), and includes representatives from all of the major cities across Canada. In total, there are approximately 4,000 financial analysts who are AIMR members in Canada.
The Chairman: Can you define "financial analyst" for us? Can you define precisely who is a financial analyst, and thereby who is not?
Ms Hendriks: The AIMR is a non-profit, global organization run out of Charlottesville, Virginia. It administers the chartered financial analysts program internationally. The CFA designation is actually the designation awarded to people who have passed a series of three comprehensive exams and have three years of practical experience. They have, as well, passed certain entrance qualifications to begin with.
There are also others in the investment community who are called analysts. Many of them have taken a course offered by the Investment Dealers Association. In most of the provinces across Canada, to be a portfolio manager, for example, you must have a combination of the Canadian Securities course and at least level one of the CFA program -- if not further designations within the CFA program -- and the IDA course.
The Chairman: Is the IDA course different from the CFA course?
Ms Hendriks: Yes, it is.
The Chairman: Is virtually any investment dealer or stock broker who we may deal with a member of your association?
Ms Hendriks: They could be members. Many of them are. Most of our members would be portfolio managers, investment counsel and investment decision-makers. Many of them might be managers of mutual funds or pension funds, for example. They are not stock brokers. That is a different designation.
The Chairman: If they are in the investment counselling business, if they are in one of these myriads of small firms that manage other people's money, are they typically members of your association?
Ms Hendriks: Yes, I would say that many of them are, particularly for the larger institutional firms.
The Chairman: You say "many." Can you give me some sense of what that is? Is "many" 50 per cent or 90 per cent?
Mr. Dleap Hall, Director, Ottawa Chapter, Toronto Society of Financial Analysts: If I may interject, Mr. Chairman, you are talking about the myriads of small firms, such as financial planning firms. Some financial planners are not members, but many are, because they like the designation. The CFA is the designation for a chartered financial analyst. It is a three-year intensive home study course that one must qualify for.
Ms Hendriks: I believe that most of the major institutional investors would be hiring CFAs in the majority of cases. This is my understanding from talking to people who are actually in the business of placing people as portfolio managers. A friend of mine, who is a headhunter, prefers CFAs. However, the other designation is good as well, and it is equally viable.
The Chairman: What is the other designation?
Ms Hendriks: It is the one from the Investment Dealers Association.
The Chairman: I am sorry to interrupt you. I was trying to understand who your members are.
Ms Hendriks: There are about 4,000 financial analysts who are AIMR members in Canada. Of that 4,000, I would say that 60 per cent of them reside in Toronto, but we have members all across Canada. We have societies and chapters all across Canada, including Victoria. The numbers keep growing every year. Enrolment in the program increases each year.
The CCFA's mission is to serve AIMR members across Canada, to promote the same standards of excellence in education and professional conduct, and to foster advocacy and education initiatives across Canada. The CCFA and its member societies are volunteer organizations made up of individual chartered financial analysts and other investment professionals.
All the AIMR members across Canada must comply with the AIMR code of ethics and standards of professional conduct.
In our view, the capital markets issues that you are examining are very important to the financial services sector in Canada. We appreciate that your committee has focused on the growing economic influence of major institutional investors, such as pension and mutual funds, as one of its key areas of study. We agree with you that the federal government should assemble a database that would permit an analysis of the role of the institutional investors in the capital markets and an analysis of their governance practices.
Overall, we support any efforts that you, as a committee, can foster to promote the uniform application of rules and the reduction of unnecessary duplicative costs to market participants.
In our view, Canada's capital markets need a single regulatory voice; consistent, streamlined rules; and reduced filing fees, or at least filing fees that reflect the true cost of market regulation. The need for a strong and efficient securities regulator will only increase as technology advances and as transactions take place increasingly quickly and outside traditional channels.
We respectfully submit that one of the key considerations for policy makers is to ensure that a sound regulatory framework exists to protect and promote the Canadian capital markets. In our view, Canada needs a National Securities Commission to regulate its capital markets, and to eliminate the inconsistencies, duplication and costly rules associated with our present multi-jurisdictional system.
We are not convinced that these deficiencies will be sufficiently rectified by the so-called "virtual" National Securities Commission. We are mindful of the political reality that, despite all the compelling reasons in its favour, a true National Securities Commission is not likely to be achieved in the near future. We, therefore, request that the committee consider working closely with the Canadian securities administrators to ensure as much consistency between the federal and provincial rules as possible, in the hope that this will facilitate the creation of a National Securities Commission at a later date.
In particular, we are concerned that under the proposed "virtual" National Securities Commission, which is also known as the Mutual Reliance Registration System (MRRS), there will remain significant areas that will continue to be regulated under the present multi-jurisdictional system. These include: the registration of those who are not members of a national self-regulatory organization; the continuation of duplicate registration and filing forms and fees; inconsistent continuous disclosure filing requirements; rules for prospectus; and registration exemptions and enforcement matters.
For example, the MRRS that is presently proposed will only apply to initial registration requirements and to those ongoing registration requirements that flow directly from those initial requirements, such as proficiency, capital and bonding. Local jurisdictional rules will continue to apply with respect to all other ongoing matters, which include conduct of business and client disclosure.
While we support the work of the Canadian securities administrators in trying to streamline their regulatory oversight function, we remain unconvinced that the MRRS will be able to overcome most of the regulatory discrepancies affecting Canada's capital markets, which we view as an impediment to their efficiency and integrity.
In our forthcoming written submission, we will offer our views in support of adopting a comprehensive set of rules within the CBCA, and in any instrument that might create a National Securities Commission. These include provisions respecting insider trading, takeover bids, going-private transactions and enforcement. However, pending the adoption of a National Securities Commission, we support blanket exemption orders generally for issuers who are also "reporting issuers" under provincial securities laws, such as Industry Canada's Single Filing Order. We support them so that insider trading reports, interim financial statements, prospectuses, statements of material facts, registration statements and news releases and the like are no longer subject to overlapping systems of regulation. The CBCA should not add to the economic burden that duplicate regulation imposes.
In our forthcoming written submission, we will also comment briefly upon some of the recommendations that your committee made in its Corporate Governance Report, dated August, 1996. We believe there is a correlation between corporations that have high-calibre investment relations programs involving good disclosure practices, and more reliable forecasts by analysts. This, in turn, may lead to a lower cost of equity capital, as increasing numbers of interested investors create more efficient pricing.
Our organization welcomes the recent work of the Canadian securities administrators to try to streamline their functions. We would like to encourage your committee and Industry Canada to continue the harmonization efforts being made under the CBCA. While we continue to be in favour of the establishment of a National Securities Commission, we would like to encourage the use of blanket exemption orders as interim measures towards greater legislative consistency.
Finally, we support your committee's fact-finding efforts and your recommendations that seek further study of the role of the corporate governance of institutional investors and of the effect of the foreign property rule on our capital markets.
On behalf of the CCFA, I thank you for inviting us today.
The Chairman: When we held the public hearings on the CBCA, we heard a number of suggestions. We heard that the rules should be modified with respect to the dissident proxy circular. We heard that various shareholders should have the right to get together without having to go through a whole legal framework of filing dissident proxies and so on to, at the very least, communicate their views about a company to each other. What are your views? The views of your members would be important on this, given the fact that they are managing various small pension funds.
Ms Hendriks: Yes. We will be addressing that in our written submission. Primarily, our view is that the issue of proxies, as dealt with by the federal government, should coincide with the work that is being done right now by the Canadian securities administrators.
The Chairman: You would like uniformity. No one disagrees with that. What should the position be?
Mr. Hall: Does your question, Mr. Chairman, refer to a situation in the United States involving CALPERS and dissident proxies?
The Chairman: That was not my question, but that was a question we were going to ask you. CALPERS is always used as the illustrative example, but there are others. What is your reaction to institutional investors becoming very active?
Mr. Hall: The New York one is similar to that. They all want to have a sense that the company is acting for the benefit of the shareholders, to improve earnings. That is their basic bottom line.
The Chairman: Do you people have any objections if Canadian institutional investors become much more proactive, and publicly active, than they have historically been?
Ms Hendriks: Actually, our standards of practice refer to that. Normally, pension managers, for example, have contractual as well as fiduciary relationships with the beneficiaries of the fund. Our organization's position is that it should be up to the shareholders themselves to vote shares. If it does fall into the hands of the managers to deal with, then they should be able to do that. But they need to be able to develop procedures and policies with their clients to determine ahead of time how much discretion they will have to do that.
The Chairman: That says, in practice, that they would not be active. Am I correct in thinking that would be the practical consequence of that policy?
Ms Hendriks: I think the practical consequence would be that it would depend on how far their role as fiduciary went. In some cases, a fund manager might have a very strong role. In other cases, the amount of discretion that he or she is given has actually been limited contractually, depending on the issue. It is possible that a fund manager might actually go back and request instructions on how to vote on a certain issue. It really depends on the nature of the fiduciary relationship. For example, pension law might be involved. It is dependent on whether there is a trust agreement and on the nature of the procedures.
Our standards of practice recommend that you have to assess with your client the amount of risk the client can take. You have to know your client. You have to put procedures in place to deal with that risk, so that you are not going beyond your mandate as fund manager.
The Chairman: If you are managing a small pension fund, who is the client?
Ms Hendriks: Your fiduciary duty is to the plan beneficiaries.
The Chairman: Individually or collectively? It makes a big difference. I do not see how someone can go around and solicit the views of individual pension plan members. If there are 100 shares of a company and 100 members of the pension plan, that is a different proposition from saying that each individual member of the plan owns one share.
Ms Hendriks: Right. I think what happens with pension plans is that the fund manager gets instructions and procedures from the plan about how much discretion he has when he is retained.
The Chairman: Do you people support the managers becoming active in the way that CALPERS has become active? They are, essentially, aggressively active in the way they deal with the companies they have invested in. To what extent is this a good or a bad idea?
Ms Hendriks: It is my understanding that we would support that, if that were the situation between the fund and its manager. It depends on the nature of the relationship. The fund manager really has to take care of his clients and know them. That is the fundamental premise.
Senator Oliver: How would you see them going about it? What kind of activism? Could they go to the chairman and say that they wanted things changed in the company and, if so, how?
Ms Hendriks: Actually, the standards of practice require that you meet with your client at least once a year and go through that person's or institution's investment objectives and tolerance for risk. You must describe the strategies you are thinking of employing with your client, and ensure that they understand the risk involved. Certainly, it encourages you to meet with them more than once a year, to update them on strategies and to take directions from your client.
The Chairman: It sounds to me like the real issue is whether the pension fund would decide to take action as the financial analyst rather than as the investment analyst. Is that correct?
Ms Hendriks: It might depend partly on the statutes. It might depend on who is considered to be the administrator under the Pension Benefits Act. For example, it might depend on what kind of relationship there is between the plan sponsor and the fund manager, and on who is actually the fiduciary. If you are dealing with unionized workers, collective agreements might enter into it.
Senator Stewart: I gather that it is a question on which the council has not taken a position. These questions from the chairman are coming at you, in a sense, out of the blue.
Ms Hendriks: We have not really taken a formal position on those rules, although many of these issues are addressed in the Standards of Practice Handbook. All AIMR members must agree to uphold the code of ethics and the standards of practice. The handbook describes some of the rules. There are fiduciary rules in the standards of practice. There are rules about fair dealing with your clients. Also, in our written submission, we touch on some of the issues that fall under the CBCA.
Senator Meighen: Did you say that you would make your position known on the foreign property rule in your written submission, or do you have a position on that now?
Ms Hendriks: We are considering it, and we are finalizing it for our submission, yes.
Senator Meighen: Can you give me a little hint?
Ms Hendriks: I am not supposed to, actually.
Senator Meighen: Would I be surprised if you came out in favour of the abolition of the rule, like everybody else has?
Ms Hendriks: No. If we take a stand, you will not be surprised.
Senator Meighen: In your submission, it appeared that you were making a connection between the greater disclosure and greater accuracy of financial analysts. I understand that, even if you take consensus forecasts, financial analysts do not have a terrific track record of getting it right. In your view, is the reason for that the limited disclosure by corporations, or is it, with all the objectivity you can muster, due to the poor quality of financial analysts?
I believe there is a U.S. study that says that only 29 per cent of analysts get the consensus forecast.
Ms Hendriks: That is a good question. A study was done by an academic at the University of Michigan. It found that if corporations have frequent meetings with analysts and high-disclosure practices, and they disseminate a lot of information to the public, then they get a larger following by analysts and they also get more reliable predictions by them. Better corporate disclosure is certainly a cornerstone to that.
That improves the position of those corporations because, once they get better analysts' followings, they tend to take an improved position in the market as they get more public attention.
Your comment is a fair one. I think it is a difficult business. It is difficult to predict. No one has a crystal ball. Certainly, chartered financial analysts try very hard to be objective and fair, and they do very detailed research. Many firms have whole investment research departments. Therefore, it is not clear to me why the results are not more accurate.
Senator Meighen: Do you have any view on this private report that was allegedly commissioned on Newcourt? It was not available to the general public, but simply to the people who paid a fee to have it done.
Ms Hendriks: I am not actually familiar with that particular situation. Again, in the Standards of Practice Handbook, there are rules respecting proprietary research. There are also rules respecting how you deal with reporting when it is your own client. Certainly, if your firm is also the underwriter for a client, you might decide to put that particular client on a restricted list and only produce factual information about that client if you feel that, otherwise, you have a conflict of interest reporting on it.
Senator Meighen: What is the sanction laid down by your handbook if somebody breaks one of those rules?
Ms Hendriks: The sanctions are imposed by the AIMR. They do an investigation. They can include different types of censure, including revocation of your CFA charter designation and other penalties.
Senator Meighen: Would the revocation of the CFA designation be the most severe penalty?
Ms Hendriks: That would be the most severe penalty meted out by the AIMR. However, in situations like that, chances are very high that you are also being investigated by the securities regulators.
Senator Meighen: Will there be a comment in your written brief about any governance difficulties that you and your organization see, with respect to institutional investors?
Ms Hendriks: Our written brief is really structured more in terms of the regulatory issues, of which we are mindful. We are concerned that that must be part of the governance discussion, so we are trying to bring that back to the table. Is there a specific issue you would like us to address?
Senator Meighen: No. Institutional investors, as you know, are a growing part of the Canadian market scene, as opposed to private investors. Obviously, the way they govern themselves is of some interest with regard to public policy. That is really what we are interested in learning about. We want to see whether there are any ways of improving that or if there are any suggestions that this committee should make, either in legislative form, eventually, or by way of moral suasion.
Ms Hendriks: I will take that back to our committee and we will consider adding that in.
Senator Tkachuk: You, along with many others, are talking about the formation of a National Securities Commission. But the provinces see this as their own preserve. There has been talk about this for a long time. Why do you advocate a National Securities Commission? Rather, the efforts of the provinces could be streamlined to ensure that, with the clearance of one province, you clear others, which would get rid of the paperwork just as quickly.
I think many of the small investors do not want a National Securities Commission. They would rather deal with people close to home. Why would you go to Ottawa to clear something in Saskatchewan or British Columbia? Why do you think a National Securities Commission would be better than the situation we have now? I know some of the obvious reasons, but give me some of the non-obvious ones, if you could get pre-clearance.
Ms Hendriks: You are right, the effort to create a virtual National Securities Commission is a good start. However, there are some flaws in it. You still have to register in every province. You still have to pay fees in every province. You still have the duplication of fees issue. With the junior markets and regional issues, we were thinking that if the national body had a rotating chair system or some other way of rotating different types of authority, including maintaining regional offices across Canada, that it would be possible to maintain some of the benefits of local commissions, but still develop one process where you have one set of rules and one set of forms.
At present, under the proposed MRRS system, you can pre-clear a prospectus if you file in one jurisdiction, but there is an opt-out where all the other jurisdictions, I believe, have ten days to decide if they are going to go along with it on a case-by-case basis. They reserve the right to change their minds.
In addition, that system will not work in Quebec unless the company actually has an office in Quebec, where you must file separately.
You are correct that it resolves some of the glaring deficiencies. However, it does not eliminate all of them. Certainly, it does not solve the problem of enforcement, which can be a difficulty across Canada. Sometimes people fall between the cracks. It does not solve the difficulty of bargaining internationally.
For the time being, I think that the ongoing matters, conduct of business and client disclosure, will fall outside of that proposed system. I also understand that the staff of the commissions are still trying to negotiate the mechanics of it. It might not be easy if the market keeps growing. The concern is whether it is a viable, long-term solution as the Canadian capital markets keep growing.
I think it is a good short-term solution, and I encourage it. We all encourage it.
Mr. Hall: Senator Tkachuk, you gave as an example a British Columbia company that would like to operate in British Columbia. However, your shareholders may be worldwide. Under which jurisdiction would they be covered?
I am in Ontario. If I have a problem, I would go to the Ontario Securities Commission and tell them what British Columbia is trying to do. We had that situation with the takeover of Doman and the sale of some shares by the ex-premier of B.C. Shareholders in Ontario could not take any action because Doman was listed in B.C. and its head office was there. All the work was done in B.C. Ontario shareholders did not have access unless they went individually, and the Ontario Securities Commission could not take action as a body for its shareholders in Ontario.
Ms Hendriks: I should add that there is a developing upstairs market. I recently attended a forum at the Ontario Securities Commission where the upstairs market was discussed. The ability of local securities stock exchanges across Canada to govern different organizations is changing with the rapid advancement of computer technology. Ultimately, all of these issues need to be addressed on a national basis.
Senator Tkachuk: When you speak of sharing information and the role of financial analysts with the companies that they may be analyzing, I think of the people who actually sell the shares. In a sense, all brokerage firms are in a conflict-of-interest situation. This bothers me. I do not know if this problem can ever be addressed because there is a bit of a "Wild West" aspect to it.
Take, as an example, a brokerage firm doing an offering on a company like Philips Environmental. A national brokerage firm was very high on it here in Canada, perhaps six or eight months ago. Of course, when a firm does that, it has a lot of stock in that particular company. I like to do my own investing because I really have a feeling, and I think others do, too, that sometimes the brokerage firms are getting themselves out of a jam by promoting stock that they own to their clients, and that they know is going to go bad. I am making that assumption here. It is hard for them not to do that. Of course, I am an honourable man and I say that I would not be tempted. Perhaps, though, if I were put in that position, I might be tempted.
How do you resolve some of these issues that I think are a problem, because corporations do not reveal information that should properly be revealed, that should be made public?
Some of the problems in Philips Environmental and, obviously, in Bre-X, were problems of non-disclosure. The analysts were sitting around analyzing Bre-X, which had not yet mined one ounce of gold. It is unbelievable that people drove that stock up to over $100 a share when the company had never mined an ounce of gold. It had no record of mining gold.
These are questions that we should be concerned about because, of course, pension funds are involved. Many lost their life savings in organizations like that. The analysts were all saying that these were great companies.
Ms Hendriks: There are actually a few issues there.
The first issue that you have touched on is that, ultimately, there is always the possibility of types of fraud in the securities industry. I think what you have described are different examples of potential fraudulent issues that I am sure the regulators are going to pursue.
Putting your interests ahead of the interests of your clients is a direct contravention of the standards. The AIMR has strongly recommended that firms set up internal procedures, where all the employees of a firm have to disclose their own shareholdings or any beneficial shareholdings that they might be able to control. They cannot deal in those stocks in any way. In some cases, some firms have policies where they cannot have any holdings whatsoever. You must have procedures in place within a firm to prevent those kinds of issues from occurring.
You are also dealing with the second issue of perhaps favouring one client over another. You appeared to be leading in that direction. There are also rules in the standards that prevent you from not running transactions on a simultaneous basis, or if you buy a block of shares, of not dividing that block equally. You have to treat your clients fairly, and you have to put your client's interests ahead of your own. That is in the standards of practice. To do otherwise would be a breach of fiduciary duty in common law, if not a breach of securities law.
Using your example of Bre-X, or other examples of analysts taking a position on shares, all analysts can do is analyze the information that the companies disseminate. Analysts have to be able to rely on what is out in the public domain. They do their own, very meticulous research. Ultimately, however, they rely on the information put out by the issuers. They need to be entitled to rely on that information and do their own background checks and have meetings. However, they must be able to come up with some basic ideas and premises, or else new issues would not be able to take off.
I think that you are touching on a need for strong disclosure by the corporations themselves, as issuers initially.
Senator Tkachuk: This should apply to brokers and analysts, too. A broker should inform a client when he is telling them about a stock. For example, when a broker from RBS Dominion is phoning a client, advising him to buy a particular stock, he should also tell the client that his company owns 500,000 shares of that stock and that it paid $12 a share for it.
Ms Hendriks: Yes. Disclosure of that nature is set out in the standards.
Senator Tkachuk: Brokers do not do that, though.
Ms Hendriks: Analysts are supposed to disclose their company's holdings. They are supposed to set up Chinese walls around other holdings. As I said, if they are also the underwriter for a company, they should put that company on a restricted list so that any information they disseminate is purely factual, rather than reports that might encourage people to go out and buy it. That is in the standards. I think that addresses that conflict.
The standards also require that you know your client. That is also in all of the securities acts across Canada, that you have a fiduciary obligation to understand your client, his risk and his need for diversification. Perhaps some clients can afford to have a little bit of Bre-X in their portfolios, if they have a very well-diversified portfolio and they understand the risks involved. However, risks can multiply if that is the only holding one has. I think what you are describing might be more an issue with the way some individual clients actually behaved.
You do not want to stifle the markets to the point where new issues cannot come out and be successful. That is the trade-off.
Senator Tkachuk: Of course, I do not. This leads me to the next question. I am trying to tie all this together.
There is a question that we have discussed here from time to time, and that is of the pension funds and the large mutual funds perhaps taking a more active interest in how a company runs. When shareholders start behaving like owners, then perhaps they should be on the board and face the legal consequences if things go badly.
I have a real concern about this activism. It is my view that, if you buy shares in a company and you want to know all about it, you do your own analysis. If it is not working out well, you get out. By taking part in the actual management, in other words, by changing management, you are wielding undue pressure. That pressure comes from your large power and the holdings of thousands of individual shareholders, to whom you are responsible, as they are perhaps the beneficiaries of a pension fund. Once you become active, then perhaps you should take the consequences of ownership, too.
Ms Hendriks: That is an interesting point. I will take that point back to our regulatory committee and add that into our submission, and address it formally in that regard. That is a fairly detailed point. I think it might be helpful if we did that.
Senator Austin: Ms Hendriks, the thrust of your presentation this morning was with respect to the justification for a single regulatory entity in Canada. I want to pursue some questions in that area.
You have given some reasons why you think that this is the time for a single regulatory entity. You alluded in passing to the electronic trading systems that are now being established. As you well know, in the U.S., to a very considerable extent today, there are major businesses that provide web sites and Internet access for direct trading. These are the so-called electronic discount brokers. I wonder if you see the development of that kind of trading activity in Canada, and how that kind of trading activity would be regulated, when we have a number of different jurisdictions, and the trading is essentially non-jurisdictional.
Ms Hendriks: That is a good point. That was discussed at a full-day forum that I recently attended, put on by the Ontario Securities Commission. They discussed the upstairs market. It is not just Internet access for direct trading, where one thinks of people using their laptops at home to make their own trades. It is also international companies that are very profitable, based on the volume of trade.
The upstairs market does not appear through the normal stock exchanges. In the presentation that I heard, the stock exchanges across Canada were quite concerned about that, as are the stock exchanges around the world. I understand that the Pacific Exchange in California has hired a technology expert to help them track those issues.
The Canadian securities administrators have not come out with a formal position on it yet. They heard from everyone at the forum. They are reviewing the issue. I think it is a global issue. As the technology advances, it becomes a more pressing issue. I think they started studying it about eight years ago, but every time you turn around, the technology is that much more improved and the ability to conduct these transactions is that much greater.
Senator Austin: What you have, as you know, is the ability to completely obviate insider trading regulations, because someone who might be an insider can sit in an offshore jurisdiction and trade, using insider information, using what you call upstairs market activity, and not be traceable. The system is becoming quite porous.
Ms Hendriks: I agree with you there. I think it is beyond our realm of expertise to opine on that, but I think that the regulators are looking at it. Certainly, the stock exchanges in Canada were quite concerned about that issue, because you can buy a block of shares anonymously in the upstairs market. You can buy a large block, and the volume that you want does not necessarily show up on the computer screen. You can make it look like you want 2,000 shares, when really you want 1 million. You just keep refilling the 2,000 until you get the number you want. It is a tremendous issue.
I understand the U.S. Securities and Exchange Commission recently put out a paper on that.
Senator Austin: I have noticed that Canada is the only G-7 country, or even G-8 country, without a national securities regulatory system.
Ms Hendriks: That is correct.
Senator Austin: All the other competing countries, in terms of global markets and the movement of capital, have a single regulatory point in national standards. My impression has been that one of the greatest difficulties in reaching a national standard is the unwillingness of the Province of Ontario to surrender its jurisdiction, and particularly to surrender the revenues that it derives from the Ontario Securities Commission and the operations of the Toronto Stock Exchange. Do you know anything about their position?
Ms Hendriks: Last fall, we wrote to all the Ministers of Finance across Canada, including the federal minister, and the majority of them wrote back. Minister Eaves wrote back in favour of a National Securities Commission. I do not know what the hold-up is behind closed doors in terms of what they are really negotiating. The memorandum of understanding to put in place the virtual National Securities Commission has not been released publicly yet. It is not going to come out until June. I do not know the details of what is going to be in the virtual National Securities Commission yet.
I think there are some stumbling blocks between the provinces. There probably are some issues that they are trading back and forth, but I am hoping that they can surmount them.
Senator Austin: If you have any information to add to your brief, I would appreciate it.
The other issue in creating a National Securities Commission is the position of the Province of Quebec, which has not supported a single regulatory entity in Canada. In the history of national securities commissions, the first recommendation was from a Royal Commission chaired by H.H. Stevens. This was a commission set up in the R.B. Bennett period. In 1933 or 1934, the Stevens commission recommended that the federal government set up a National Securities Commission, and it pointed to the federal jurisdiction as being paramount, to use the constitutional language of the day. In other words, the provincial governments could not legislate unless and until the federal government occupied the field. That was the constitutional position of the time. The configuration of political will today may make that somewhat more difficult.
I wonder how serious you think the issue is. The federal government has the constitutional power under clause 92(10)(c) to declare the securities regulatory system, including the stock exchanges, as a work or undertaking for the benefit of Canada. The federal government has the power, probably without using clause 92(10)(c) , but it could certainly use clause 92(10)(c) to eliminate any constitutional questions. One of the issues is whether the federal government should use that kind of power. That depends on how serious it is for Canada to be the only major economy without a national securities regulatory authority.
Ms Hendriks: We view it as a very serious issue. When we file our submission, we will include a copy of the position paper that we gave to the Ministers of Finance in the fall. Whether or not the federal government should occupy the field unilaterally is probably beyond the mandate of the CCFA to decide. But, certainly, we view it as a very serious issue.
Senator Hervieux-Payette: I wish to have a point of clarification. I would like Senator Austin to come, make a speech, and convince the Quebec authority of using clause 92(10)(c) to enter into the jurisdiction of securities in Quebec. On a serious note, by coincidence, I met with the President of the Quebec Securities Commission yesterday. He informed me that he intended to re-establish contact with the banking committee, and that he would like to follow our work. Eventually, he would like to make a presentation and send a brief. Since the Quebec Securities Commission has been away from a dialogue with us for quite some time, for me this was a significant, new, positive gesture. They have a new law. They operate more at arms-length from the government, and they intend now to participate fully with the federal authorities. I would rather have them as a player working with us than, of course, have it appear as if we were going to impose on them.
It may take some time to make the adjustment go in the same direction but, of course, you understand that I will strongly resist any kind of imposition of a National Securities Commission, without having all the provinces participate. The case has to be done and I do not oppose it. I have proposed it.
Senator Austin: I want to make it clear to my colleague that I hope she understood that, in asking a series of questions, I was not making an argument for a proposition that we use clause 92(10)(c) or even a Supreme Court ruling. I was simply explaining the background. Your comment leaves the implication that I was advocating something that I was not doing. I find that troublesome. I do not know if you were in the room when I noted that the Province of Quebec would not agree to a National Securities Commission.
Mr. Hall: I would like to make one comment about a National Securities Commission. It would be better for Canadian industry and the companies that want to go public to have a national market. At present, many small organizations are going directly to the U.S. market for their financing, where they have only one regulatory body to deal with. They are circumventing the Canadian regulations and duplication. They are saying that is enough. We do not have the numbers of how many people are doing this directly. But eventually, if enough are doing it, if an increasing number of people are going to use the Securities Exchange Commission as a clearance agency, it makes a National Securities Commission obsolete for this country.
Ms Hendriks: Although the memorandum of understanding is not out yet, I understand that Quebec was one of the signatories to the virtual National Securities Commission, which is a sharing of powers. I am encouraged by that.
Senator Stewart: The discussion has become so lofty that I am hesitant to raise this little question. I wonder if the Council of Financial Analysts is concerned with what I will call the bubble phenomenon. I am prompted to ask this question by your response to one of Senator Tkachuk's questions. He mentioned Bre-X. There was a comment that there had not been adequate information before the bubbling took place. I am prompted also by what you said in response to one of Senator Austin's questions. You mentioned the upstairs market, and he, if I heard correctly, in a sense accepted that point and referred to the increasing porousness of the system.
When one of your well-trained analysts is giving advice, does that analyst focus entirely on the fundamentals, the sort of data that would be available with full disclosure, or does that analyst also take into account the market?
Let me give you a fictitious comment. I am dealing with my broker and the broker says, "I do not believe there is any gold over there. However, there is no question the stock is going up, and I think you should get on that elevator for two or three weeks." So I get on the elevator for two or three weeks. Of course, the broker down the block is giving exactly the same advice, and so you get the bubbling, which is totally irrelevant to the fundamentals. In fact, the brokers know that it is irrelevant. Of course, a lot of money is made.
Now the question is: How concerned is your council with the bubbling phenomenon?
Ms Hendriks: I think that the analyst looking at any stock for any portfolio has to go back to the fundamentals of how much risk the client wants to take; what the relationship is with the client; whether there is discretion involved or not; and also whether the client is in for the short term or the long term. Something with a bubbling effect is a short-term investment and might be considered high risk. If you were involved for an institutional investor and you are looking at the long term, then I think a strategy might have to be employed, if you want to deal with that.
Senator Stewart: You seem to be saying that that would be acceptable in the case of an investor who was prepared to take a very, very high risk for a short term.
Ms Hendriks: I believe that would be between the analyst and his or her client, yes. It would depend on exactly how much risk that investor was prepared to take. Certainly, the analyst has an obligation to do his homework and to read all the reports before making a decision and giving any advice. Then it really depends on whether the investor wants to leave it to the analyst's discretion or not, or whether the investor wants to pay for advice and then make his or her own decision.
Senator Stewart: What it says to me is that disclosure of accurate information is only one of the legs on which the broker stands. The other is what the madness of the market may very well do. Be sure to ride the madness and get off early.
Ms Hendriks: Those are the practical realities. Going back to your mandate as an analyst, if you are dedicated to your profession, you want to make sure that you are giving your clients sound investment advice. They may choose not to take your advice.
The Chairman: Thank you, Ms Hendriks and Mr. Hall. We appreciate you taking the time to be with us today.
The committee continued in camera.