Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 3 - Evidence of November 6, 2002
OTTAWA, Wednesday, November 6, 2002
The Standing Senate Committee on Banking, Trade and Commerce met this day at 3:45 p.m. to examine and report
upon the present state of the domestic and international financial system (Canadian perspective to the Enron collapse).
Senator E. Leo Kolber (Chairman) in the Chair.
The Chairman: Our witnesses in the first part of the meeting are from the Canadian Council of Chief Executives.
They are represented by Mr. Thomas Paul d'Aquino, Mr. David Stewart-Patterson and Mr. Sam T. Boutziouvis.
Mr. d'Aquino and group, welcome. I understand, Mr. d'Aquino, that you have an opening statement.
Mr. Thomas Paul d'Aquino, President and Chief Executive, Canadian Council of Chief Executives: We are pleased
that you permission, which I am told is not easy to do, to conduct this hearing while the Senate is meeting. We feel
privileged, Mr. Chairman.
Having appeared before this committee on many occasions over a long period of time, I continue to be impressed by
the work that you do. As I was saying to one of your new members, Senator Prud'homme, this is a committee with a
long and glorious history. We follow carefully what you do and we congratulate you for the good work that you do.
We are pleased that you have taken on the critical issue of corporate governance.
I know you have looked at the issue of corporate governance in the past, as we did in our own organization.
However, in those days, people did not take it quite as seriously as they are taking it today. I am pleased to have this
opportunity to share some thoughts with you.
Free markets cannot function, we all agree, without a high degree of public trust. The actions of a few have
undermined both the reputation of business leaders as a group and public confidence in the integrity of our financial
markets. Earlier this year, Canada's business leaders decided that, in addition to the efforts that were already being
made to address governance within individual enterprises, we needed to act collectively. In July, the council launched a
corporate governance initiative. In the following weeks, we carried out an intensive review of reforms that were being
contemplated around the world. We laid out, in considerable detail, thoughts on how Canada could achieve norms of
governance practices unequalled anywhere in the world. Our goal was to write the gold standard for Canada. We
circulated not one, not two, but six drafts as we forged a remarkable degree of consensus among our chief executives of
companies with widely varying ownership structures. A few weeks ago, the council unveiled its recommendations in a
major statement entitled, "Governance Values and Competitiveness: A Commitment to Leadership,'' copies of which
have already been circulated to this committee. For those of you who have not read it, I strongly urge you to do so. We
put a lot of time and effort into it. It engaged in a very direct way.
We have a rule in our organization that if you are a CEO and a member of the Canadian Council of Chief
Executives you have to roll up your sleeves and do the work yourself. These drafts were read and reread by a great
number of our members.
Our first recommendation focused on the link between investor trust and the accountability of CEOs. Our members
have always signed off on their financial statements. In our statement, they made it clear that they are ready and willing
to put their word on the line in terms of a much more comprehensive personal certification, comparable to that now
required in the United States.
We called for more vigorous enforcements and tougher penalties for breaches of the law and faster and more
comprehensive disclosure of insider trading. As you and I said to one another before the hearing began, we have a lot
of laws on the books. One of the problems in Canada is that we have not had, in our view, sufficiently vigorous
enforcement of the laws that are already there.
We suggested that the board take a look at the compensation of chief executives in two key areas. First, based on the
principle that executive pay should be linked strongly to performance, we suggested that legal and regulatory sanctions
could be supplemented by something that we think is an invention of ours, that is, by actually dealing with the issue in
an employment agreement. In addition to offering rewards for good performance, boards could include contractual
provisions that would reduce or even require repayment of bonuses in certain circumstances. That is within the
Second, we addressed the broader concern about whether too many executives have been able to cash in too quickly
for corporate performance that proves to be unsustainable. Here, our members suggested that too many market
participants, including many institutional and retail investors, analysts, journalists, directors and senior executives,
have become overly focussed on short-term results. Our statement, therefore, suggests that boards consider a greater
emphasis on compensation linked to longer-term economic performance.
Two examples of means towards this end are as follows: the payment of a significant portion of bonuses in the form
of stock that must be held until departure or retirement; or a requirement that a significant portion of the after-tax
proceeds from the exercise of stock options remain invested in company stock for a minimum period.
More broadly, our members believe that the key to good governance is more a matter of values than it is of rules.
We recognize that a fundamental responsibility of the chief executive is to live up to those values. That is why our
second and third recommendations deal with the expression of a company's values — internally through a
comprehensive code of ethics and conducts and externally through good corporate citizenship and stakeholder
When we were trying to decide how we would construct this report, there were those who said,
"Values — that is so
soft, so mushy.'' Our response was that the debate on the streets of the United States, Canada, and Western Europe
and elsewhere is precisely about the issue of values. That is why we dedicated a very significant amount of time in our
report to the issue of values, to the issue of what we call the moral compass of the CEO.
We went on to recommend in considerable detail a wide range of good governance practices that should lead to
stronger, more independent boards of directors, reinforce the integrity of the audit process and enhance the degree and
extent of public disclosure.
Now, while our formal recommendations are limited to actions that could be taken within the company by
shareholders and boards, we also discussed the vital roles to be played by institutional shareholders, accountants,
analysts, investment dealers, educational institutions and the media, in addition to governments and regulators.
I should say to you again that when we decided upon a holistic approach to this issue, there were those, even within
our own constituency, who said: "Should we not just concentrate on boards, maybe the role of the CEO? Should we be
offering advice to the institutional investors, analysts and auditors, to educational institutions and to the media?'' Our
view was, yes, because this is a systemic problem. It is a problem that touches all of the actors. This problem will not be
solved by only dealing with boards of directors.
Through it all, we emphasize that much of what needs to be done to restore and enhance investor confidence in the
integrity of Canadian companies and markets can and should be achieved in the private sector. Individually and
collectively, business leaders must earn the public trust they need to build their enterprises and strengthen the economy.
No government can legislate that trust. No regulator can restore it. Business has to earn it.
In the United States, the response to Enron, as you know, and other major scandals involving breaches of the law,
has been driven by the political process. Legislators facing mid-term elections, which we saw yesterday, scrambled to
pull together a tough-looking package of new laws to add to the ones that had already been broken. The Sarbanes-
Oxley Act imposes stacks of new rules and penalties on boards of directors, senior executives, accountants, lawyers and
others involved in the corporate governance practice. It also creates a significant gap between the legal and regulatory
framework in the United States and Canada.
How then should Canada respond? This, I know, is the core question before your committee, honourable senators.
According to the Ontario Securities Commission, there is no choice but to harmonize. In its view, adoption of any
regulatory regime less comprehensive and rigid than Sarbanes-Oxley would lead to a loss of confidence that would
send capital fleeing from Canada's markets.
Other key players are sending a different message. Barbara Stymiest, for example, president and CEO of the
Toronto Stock Exchange, has pointed out that the implementation of Sarbanes-Oxley is likely to be long, complex and
messy, causing considerable uncertainty in the United States, and certain to involve numerous mistakes that will have
to be fixed. She asks this question: Why would we want to impose all of that uncertainty on Canadian markets,
especially on smaller companies that may be ill-equipped to handle a vast new regulatory burden?
At a round table on governance with leading people in the United States a couple of months ago, I asked one of
them to explain to me a particular section of the Sarbanes-Oxley Act. The fellow's replied as follows:
"Tom, I won't be
able to give you an answer for four years. We will have to litigate it and litigate it. We may not have a definitive answer
within four years. That is one of the problems with an obsessively and exclusively rules-based approach.
The Financial Times of London recently reported that dozens of publicly traded companies in the United States are
now looking for ways to delist their stocks and go private because of the burden being imposed by all the new
regulations. By adding to the liabilities of directors and to compliance costs and reducing analyst coverage and the
liquidity of shares, the new rules appear to be hurting small public companies disproportionately. This is had
significant implications for Canada, where the vast majority of public companies, cap by the standards of the United
States capital market, are very small cap.
Many of Canada's largest public companies — many of whose CEOs are members of our organization — are
directly affected by Sarbanes-Oxley. For them, the issue of its costs and benefits is moot. More broadly, though,
Canadian CEOs understand that good governance matters. Compliance with United States law may be necessary for
some, but for any company, compliance with the highest standards globally is a way to create an important competitive
At the same time, Canadian CEOs recognize that, in matters of governance, one size does not always fit all. While
some principles are universal, the way they are applied should be shaped by the circumstances. In particular, many of
the members of the Canadian Council of Chief Executives are worried that wholesale adoption of the new American
rules could hurt rather than help the ability of thousands of smaller public companies in Canada to attract capital.
As these companies do grow, so will investor expectations. In the meantime, while investors need to have confidence
in the fundamental integrity of a company's results and statements, they also need assurance that the primary focus of
management is on growing the business, not consulting with the company's lawyers.
The council's emphasis on voluntary action has been portrayed by some people as laissez-faire. Somebody said to
me, "You people are proposing the Wild West, a go-slow approach that is out of touch with today's market realities.''
Now, it is true that the council favours a principles-based rather than a rules-based approach to improving governance
practices, but this is because we believe that comprehensive guidelines built on a solid legal and regulatory foundation
and backed up by mandatory disclosure are a more effective way to improve the norms of acceptable behaviour and to
prevent future abuses of public trust than any approach that relies excessively on precise but narrow rules.
Lawyers will always get around rules. If the rules are so comprehensive and so tight that there is an assumption that
they will look after themselves, it will lead, perhaps, to negligence rather than vigilance. Canada needs to do better than
Sarbanes-Oxley, and that does not mean simply going further down the same path as the United States.
Canada's approach includes a mix of both rules and principles, and it always will. However, in looking at how to
move forward, we have to remember that rules define the minimum that is acceptable. Principles move personal and
corporate behaviour beyond the legal minimum. The question then is whether and to what extent investor confidence
will be increased by raising the minimum rather than by enhancing the norms of actual practice.
Strong investor expectations coupled with peer pressure can have an enormously powerful impact. This alone has
helped to move the norms of Canadian practice well ahead of those in the United States in key areas such as the
separation of the positions of chair and chief executive, evaluation of director performance, and director access to
outside advisers. We are already well in advance, and have been for five to seven years, of the United States.
At the same time, even a whiff of impropriety in today's highly sceptical marketplace can trigger an abrupt and
dramatic response. By using disclosure to give power to investors rather than to lawyers, a principles-based culture can
punish actions that fail the smell test far faster and often more effectively than any regulatory or legal process.
The Chairman: Could you elucidate on that? I understand you to say that if you do not follow the principles or the
values, you will be punished. Who does the punishing and how does it come about?
Mr. d'Aquino: Take the example of Enron, a company with one of the best corporate governance codes in the
United States, a company with a chief executive and a senior executive cadre that were among the most respected in the
United States and a company with a market cap that was absolutely stunning. When it became clear — and remember
how swiftly that happened — that all was not as we thought it was, what happened to Enron and the top cadre and the
financial advisors? The fundamental point, and this could apply to WorldCom and Tyco, et cetera, because the list
goes on, is that the market has demonstrated that it has a brutal, infinitely swifter capability to punish those who step
out of line than the litigators or the legislators have. I will conclude and then we can move to some questions.
The reality today is that anything a company does anywhere in the world can have an immediate and real impact on
its reputation — anywhere in the world. In effect, the globalization of information means that, far from engaging in a
race to the bottom, companies are being held to the highest common denominator, and their performance effects
everything from their license to operate and their relationships with customers to their ability to recruit and retain
employees. A company's actions in any area — environmental performance, human rights record, treatment of its
labour force or the safety of its products — can significantly affect investor perceptions of risk, with immediate and
potentially severe consequences for its share price.
Canadian authorities are quite properly reviewing the measures being discussed and adopted by other countries to
consider which elements might be worth adopting here. Restoring public trust will take more than the adoption of new
governance practices or codes of ethics. We need to be constantly vigilant in catching and punishing those who break
the rules. However, there is simply no possible substitute for honesty and for personal integrity.
In an age of information overload, character matters more than ever. Canada, I would submit, starts from a very
strong base in this respect. The members of our organization, the Canadian Council of Chief Executives, are
committed to playing the leading role in the drive to build on this base. We look forward to working with other market
participants, regulators and governments in the months ahead to ensure that good corporate governance remains one
of Canada's most important competitive advantages.
What really drove us in the preparation of our major paper, which was circulated to you, is the fundamental belief
that, if we have the best corporate governance practices in the world, not only would that be good for Canadian
investors and those who have pension funds to look after, but also for our competitiveness and for the competitive
advantage that Canadian firms are seeking anywhere in the world.
One thing became clear to us, on which there is an excellent study done by McKinsey & Company that rated
countries according to their levels and practices of corporate governance: Canada is close to the top, where other
countries begin to fall down, in an age where trust is the most important element. We know that if you are an investor
and looking at a particular country or business or transaction, you will want to know what is behind that entity. We
have a good record. Can we do better? Of course, we can do better. We have suggested, in great detail in our paper,
how we can do that.
The Chairman: I will turn the floor to senators for their questions. I am hopeful that they will delve a little deeper
into Enron. Enron were punished, but how do we prevent it from happening again? How can we find well-informed
directors? There are many relevant issues that have not been touched on yet.
Senator Kelleher: I should like to delve into your suggestion that we need a national regulatory system for the stock
exchanges. As you know, there is a great deal of resistance from some of the provinces to this suggestion. Certainly, I
have been arguing for years there should be only one. I understand that some of the provinces feel that they would end
up dominated by the Toronto Stock Exchange, TSE, and Ontario in general. What thoughts or suggestions do you
have to assist in this area — to convince the provinces to go along with a national regulatory system?
Mr. d'Aquino: Senator Kelleher, from the leadership role that you played at the time of the great free trade debate,
you know that one of the issues we were concerned about was how to achieve a higher degree of integration in our
domestic market in order to compete more effectively abroad. As far back as the 1980s, our organization made the case
for a national regulator. The reasons at that time were based primarily on competitiveness, efficiency, one-stop
shopping, et cetera. It became clear that this issue was difficult — the relationship between the provinces, the regions
and the federal government — and so we became strong supporters of the idea that it should not be an
regulator that imposes a national regulatory regime on the country but, in fact, a national regime that has, as its
shareholders, the players — the provinces.
We continue to support that approach. We feel a sense of frustration that there has been much foot dragging
because people are afraid to give up their turf. This frustrates us, as well as many of the players in the capital markets. I
do not think it helps our competitiveness at a time when we are trying to make our economy more efficient. We will
continue to push that idea but the solution lies not in a federal regulator but in a national regulator that is made up of
the constituent parts. Certainly, in 2002 or 2003, we have the wherewithal to come up with a national system, where the
parties, wherever they are from, will feel comfortable, where they will not feel they are in Toronto's backyard. It will
not be easy to achieve.
Senator Kelleher: Concerning new regulations and new penalties, we have heard many people say that those laws are
already on the books, that no more laws are needed. If the laws are in place, why are they not enforced? When was the
last time someone was sent to jail for such an infraction? Some of the penalties have included doing community service
and/or fining someone who made a great deal of money from fraudulent actions. Why, in your opinion, does our
enforcement appear to be lax? Why are we not tougher? If the laws are on the books, why are they not being enforced?
Why does it take so long?
Say what you want about the Americans, but it was not long before the newspapers were filled with photos of the
offenders in shackles being led into the courtroom. Within nine months or one year, they have been sentenced. Some of
those offenders are in jail. Look how long Bre-X has been going on. Livent has taken years.
I should like to know if I am correct in assuming that the laws on our books but that they are not being enforced;
and if not, then why not?
Mr. d'Aquino: May I begin by saying that I know we are fellow lawyers.
Senator Prud'homme: That is one of the problems.
Mr. d'Aquino: That may be one of the problems. I am surprised that Senator Prud'homme has not quoted
It is a problem that not only bedevils our jurisdiction, but a problem that the British and the Americans have had to
contend with. In societies where the judicial and legal community have a long, deep and respected entrenchment, an
enormous amount of time and effort is spent on due process, as well as concern that it be done the right way. That can
explain many things, including the long lists of people who are awaiting trials on criminal cases. The other problem is
that the regulators feel they do not have the resources to do the job that has to be done.
I think it has to come in two directions: First, there must be sufficient resources; and second, there has to be a very
powerful signal delivered by the legislature that this is important and has to be done. Without strong direction, clarity
of legislation, and equally clear regulation that follows the legislation and the resources, I think you may have
problems. My colleague may wish to add to that.
Mr. David Stewart-Patterson, Senior Vice-President, Policy, Canadian Council of Chief Executives: I may have a
couple of points, in terms of why prosecution has not been pursued as vigorously as it could.
Senator Kelleher: If the law is there.
Mr. Stewart-Patterson: The law is there, which is one of our concerns. Why add new laws if the ones we have are not
being enforced? That is our concern with blindly going down the Sarbanes-Oxley path before looking at whether an
adequate job is being done with the rules that are already on the books.
I should like to go back to the chairman's earlier question, about why we think the markets are going to be a more
effective mechanism for imposing discipline and preventing abuses in the future. We are still seeing the legal processes
unfold in terms of punishing people who have broken the law or are alleged to have broken the law in the past. The
markets will put you out of business long before a court will put you in jail. It may be that both are appropriate in the
end, but I think a well-informed marketplace acts vigorously.
We have seen examples in recent weeks and months where even a suggestion by a single analyst that a company is
not doing things in an appropriate way has an immediate impact on the share price until the company responds. We
have seen companies forced to respond with massive disclosure, dealing immediately with concerns that are raised. If
they do not, it whacks their stock price, which in turn affects the compensation of senior executives and often a broader
section of employees. There are effective incentives built into the marketplace in that sense.
The other point I should make is that when the marketplace is better informed, that has an impact in terms of
prevention. The Globe and Mail, for example, recently did not only an extensive series on corporate governance, but
also produced a "league table'' to rank companies against one another. I would argue that that kind of publicity will
prompt considerable reflection and action on the part of a large number of companies, long before the regulations
needed to implement or even draft Sarbanes-Oxley.
Senator Kelleher: You are not answering my question.
Mr. Stewart-Patterson: I was responding to something the chairman said.
Mr. Sam T. Boutziouvis, Vice-President, Policy, and Senior Economic Advisor, Canadian Council of Chief Executives:
With the caveat of not having a legal background, perhaps I can make the following points. First of all, to prove
beyond a shadow of doubt that such abuses have taken place has proven difficult to achieve, both in the Canadian
context and, in particular, in the U.S. context. Witness what is going on in the United States now, where top officers in
both Enron and WorldCom have not been taken to task about the abuses that may or may not have taken place. The
process, as it is taking place in the United States, is a "bottom-up'' process, where they try to get someone who has
clearly made the abuse, then work up the chain to try and put other people in jail. To that end, Sarbanes-Oxley
includes changes in legislation and regulations that would facilitate whistleblowers coming forward when they see
ethical, moral and legal abuses taking place within the corporation. With those stronger regulations in place and with
protections in place for these people to come forward when they feel that such abuses have taken place, perhaps that is
the beginning of coming to terms with the questions you put.
Senator Kelleher: Should we be considering legislation of that nature, because we do not seem to be getting
anywhere in Canada?
Mr. Stewart-Patterson: Many of our members share your frustration. As Mr. D'Aquino said earlier, the actions of a
few can undermine the reputations of many. We have seen members of our council talk about the need to get tougher,
to enforce the laws we have and make sure the sentences do reflect the gravity of the offence, including jail time if
necessary. If it is because regulators do not have the resources, then we should make sure they have the resources.
Mr. d'Aquino: To put it another way, Senator Kelleher, the vast majority of people in the country go to work in the
morning and try to run their businesses honestly. When we read in the newspaper or hear on the news that one or two
have done something bad — and in this case we have seen an infuriated public — faced with massive losses in the
marketplace, it compounds our sense of frustration.
So how does a CEO react to that? Not well, given the loss of public trust and the questions of integrity. We took
pride in the fact that the polls in Canada showed that CEOs always ranked higher than politicians and labour union
leaders. Now our stock has fallen, which does not make us happy. What conclusion do we draw from this? We grab
them, punish them and put them in jail, and that will be good for all of us.
Senator Kelleher: It is not happening.
Mr. d'Aquino: I suggested two reasons why it is not happening.
Senator Kelleher: I think you are partly right. As a former Solicitor General, I theoretically had the RCMP answer
to me. I know they are horribly overburdened right now in the white-collar crime area. I know that if you go to the
police about it you often get the advice to hire a private firm.
Senator Fitzpatrick: I was a little concerned about comments that both Mr. D'Aquino and Mr. Stewart-Patterson
made. Maybe I took them in the wrong context. You mentioned the harshness of the market and the market punishing
transgressors. However, it is not the transgressors that get punished by the market, it is the shareholders. We need to
get to the perpetrators of the transgressions and deal with that, not wait until the shareholders get punished. Otherwise,
there will be a big problem with market confidence. I am not sure how you meant it. I do not think that is a cure. That
is a bigger problem with which we would be faced.
Mr. d'Aquino: Senator Fitzpatrick, let me elaborate on that subject. You put your finger on a very good point. It is
correct that a huge number of people have been damaged by the actions of a few. Our collective concern must be how
to ensure that the misfeasance of a few people is reduced to even fewer people. That is what our exercise on governance
was all about. That is why we strongly recommend that you read the paper.
For example, we talk about the integrity of CEOs. How much time is spent today in our corporations thoroughly
examining every element that goes to what I would call the integrity of a CEO who is about to be recruited for a job? I
have worked with thousands of CEOs. A large majority of those individuals were honest and tried to adhere to a high
standard of honesty. However, there is the odd bad egg. If you look into some of the transgressions we are seeing now,
you will find that the person's background was not checked into. He may have had a Harvard MBA, but it was never
discovered that he cheated on his high school exams. There has to be a higher standard of vigilance when we are
choosing our leaders.
The second point is with regard to boards of directors. I gather all of you have served on boards. What do we expect
from our boards? We know that some are good and some are not. One of the messages coming out of this terrible crisis
is that boards of directors have to be infinitely better at doing what they are supposed to be doing. In our paper, we
outline how that should come about. We go to the details of the key committees of compensation, nomination and
audit, and point out that independence in those committees is absolutely crucial.
We lay out what I call the gold standard, which takes what is already a reasonably good system, by international
comparisons, and tries to make it better. That is the only way to protect the shareholders and the little people who were
terribly transgressed by the actions of a few.
The Chairman: There is much talk about how important it is to have independent directors, but there seems to be
almost no talk of what qualifies someone to be a director. What background and education does one need? Why is
there not a college course offered? I may be being facetious, but I have not heard anything along that line. Perhaps we
can get to that later.
Mr. d'Aquino: In our paper, senator, we call for directors to be not only well qualified but to continue to qualify as
directors. Hence, the strong emphasis on constant evaluation, director education programs and so on. You and I know
that people are busy and lazy. They know every year they are about to be audited, and if they are not up to the job,
they are out of the job.
Senator Hervieux-Payette: People talk about the need to restore the confidence of our investors and of our workers
who have pension funds. Let me share with you some US figures. Canadian figures are likely somewhat lower, but if
we adjust them, we arrive at approximately the same results. In 1970, the 100 leading chief executives in the United
States earned $3.3 million; in 1999, they earned $37 million, or one thousand times the average salary of a US worker.
In other words, one per cent of households in the United States earned the equivalent amount earned by 20 million less
fortunate citizens. When we talk about changing worlds and social justice, these figures give rise to a number of
questions. I have some questions for you concerning executive compensation.
Let us take the example of two companies, Nortel and Teleglobe, which are not doing that well on Canadian
markets. The chiefs executives of these two companies have retired and each receives one or two million per year for
life. They also received somewhere in the neighbourhood of $100 million in stock options and shares. They are living
the good life.
My hairdresser invested $50,000 in Nortel because her brother-in-law worked for the company. Twenty-five years
worth of pension savings have been virtually wiped out. She is 55 years old and she will have to work an additional ten
You mentioned something about compensation committees. Is it the responsibility of the public or of organizations
like your own or the TSE to draw up guidelines for compensation tied to performance?
Some federal government senior executives have responsibilities that are comparable to those of company
executives. They work just as hard for the public good, yet earn ten times less than these company executives, and have
much smaller pensions. We need an organization that will draw up compensation guidelines and a code of conduct. I
recently read that some people were distraught over the fact that because of US legislation, publicly traded companies
would no longer be able to lend money to their officers or directors.
What gives a person working for a publicly traded company the right to take shareholder money and make loans on
terms that are more favourable than those available to the public and to employees? My question to you is this: who
should be responsible for setting standards for chief executives who are not accountable to anyone? It is a well known
fact that at annual shareholder meetings, the board of directors controls the proceedings. The average shareholder
wields no authority whatsoever. Who should be responsible for drawing up standards?
Mr. d'Aquino: This is a critical issue when we talk about governance.
That is a view, incidentally, that is shared by many people, including many people in our own business community,
who look at the relative ratios that the senator has mentioned and say to themselves that there is absolutely no
justification for this whatsoever. In our study, which you have, we put an enormous emphasis on the importance of
tying compensation to performance, and, in particular, tying compensation to long-term performance. I have to tell
you that there was no push back from any of our CEOs on this. No one said, "I just want to be able to capitalize on
this year's phenomenal earnings.'' There was tremendous, deep support for this, because there is a general recognition
that, in the last five to seven years, in particular, with the tremendous explosion of the telecom and the Internet
businesses, the numbers bore no sense to the average person on the street. When the telecom bubble and the Internet
bubble collapsed, where people were hurt very badly, they looked back and said,
"Did that person walk away with $60
million or $100 million?'' That situation has done a huge amount of damage. One of the lessons we must learn from
this bubble — and it was one of the great bubbles of history — is that we should never allow this to happen again.
Turning now specifically to your question of who should make the decision, the Americans made a big mistake that
compounded this problem. They decided to pass legislation limiting the compensation of CEOs to $1 million a year.
What did they do? They invented the concept of the stock option.
The Chairman: Excuse me, they did not limit it to $1 million; it was only deductible at $1 million.
Mr. d'Aquino: Forgive me. It was the limitation, senator, that led to the creation of other instruments. The point I
am trying to make is that we know from that experience that we certainly did not solve a problem. In fact, one can
argue that we may have created one.
Who should do it? I do not think it should be legislators. I do not think it should be regulators. I think it should be
the boards of directors. We come back to the heart of what the enterprise is all about. You have shareholders. You
have boards of directors who are supposed to be competent and vigilant and honest and who are supposed to have not
only interests of the corporation in mind but, according to what I call a more latter day theory, also the reputation of
the company and the reputation of the company in relation to the broader elements of society. These are individuals
who should be punctilious about what they pay, who they pay, how much they pay, and about tying that to
performance. I do not think it should be done by regulators or legislators.
The Chairman: That does not seem to be an answer to the senator's question. I understand what you are getting at,
but is it a series of guidelines? If so, are they published? If you do not adhere, what will happen?
Mr. d'Aquino: I do not think you can have a set of guidelines.
The Chairman: I do not think so either.
Mr. d'Aquino: Every corporation needs to define its own guidelines. What might be good for Noranda is different
perhaps from what might be good for BCE or Nortel. What might be good for a small start-up company that is not
making any money yet would be different from what is good for one that has been around for 100 years. It is
something that has to be decided by board of directors, who are conscious of everything, frankly, such as performance,
fairness, equity, reputation, and what makes sense. If we say, "We will not give that job to the board,'' or
suggest to the board how it should be done,'' then I think there is the danger of abdication of responsibility. Either it is
the board's job or it is not. In our view, it should be the board's job. Let us be frank: In the last five to seven years,
many boards were not doing their job.
Senator Tkachuk: Senator Kelleher triggered something that we have often talked about in the past. I agree with you
that the less the government has to do with setting compensation, the better. What happened in many of these cases
was just a result of human stupidity.
Mr. d'Aquino: And greed.
Senator Tkachuk: Yes, and greed. We are all greedy, in a sense. Senator Kelleher pointed out to me that many
hockey players come from Saskatchewan. Everybody says they get paid too much money, that they are just hockey
players. I love hockey players getting all that money. The players are not the ones who decide on compensation; it is
the owners who decide. If they want to pay them obscene amounts of money to skate around a rink and shoot hockey
pucks, good for them, and good for the hockey players for getting a piece of the action — and good for the baseball
players. I say good for the CEO. If the board is dumb enough to pay a CEO that kind of money, fine, go ahead, but the
company should suffer the consequences.
Something seems to have broken down here, and this is what I want to get to. You mention that not only did you
discuss in your paper CEOs, boards and corporate governance, but also the outside analysts, et cetera. This is my
bugbear. What were the analysts and the brokerage firms doing? How did they get away with not being culpable in this
whole mess? Why are they not telling the people to whom they are selling the stock — their clients, the ones they are
supposed to be looking after, the ones they are supposed to be telling what is going on — about what was going on in
these corporations? The ordinary investor would never know what a guy is getting paid because it is not his job to
know. He expects somebody to tell him.
How can we ensure that we do not have a corruption of the marketplace? I think that is where a lot of it comes from.
The financial community itself is raising the money and analyzing, and the research offices are supposed to be
informing the business community and the investment community about each company. What did you recommend
that would help this process? In other words, analysts should be saying: "Mr. X is getting paid an obscene amount of
money. Hence, I don't think you should be investing in this company. They are all a bunch of crooks, and they are
Mr. d'Aquino: First, you said, senator: "Do not blame the CEOs. If a corporation is prepared to pay its CEO that
amount of money, then so be it.'' That is one of the things that I personally very strongly take issue with. It comes back
to the issue of the moral compass that I talk about. If someone said to you, "Last year, your company lost $100
million, but because we like you and because we fish together and because we golf together, we will give you, in
addition to your $5 million salary, a $5 million bonus,'' should you take it?
Senator Tkachuk: I would have to ask my wife, I think. It would not just be up to me.
Mr. d'Aquino: There are a number of real examples in Canada, but do I not want to use a real one. You probably
know what I am talking about. The perks were large and excessive, and to the person on the street seemed outrageous,
but the individual's response was, "That is what the board gave me, so why shouldn't I take it?'' My reaction to that is
this: "Are you a responsible, intelligent, seasoned, sensitive, smart CEO? If you are, why on earth would you have ever
accepted something like that, even if the board offered it to you?'' That is where the moral compass of the CEO come
to the fore.
Take the case of Jack Welch, who created $250 billion of value for General Electric and now is having to defend
himself on talk shows for having the Madison Avenue apartment and access to the corporate airplane, et cetera,
because when he was offered those things he did not think there was anything wrong with it. At that time, before the
bubble bursts, a lot of other people probably did not think it was wrong. Now it resonates badly.
What I am saying is that a little bit of common sense with the CEO, for starters, should help.
Second, coming back to your question about the auditors and others, Andersen was one of the most respected
auditing firms in the world. If five years ago you would have said to me that Andersen would be out of business, I
would have said, "Take this man away.'' Andersen is no longer in business. It is dead and gone. That was one way —
some people argue perhaps too brutal, given that there were many honest and good people working there — of the
system saying, "You have been a major transgressor; we will kill you.''
There have been all sorts of responses on the part of the auditing profession, for example, the creation of audit
review boards. As you know, the analysts in the United States have been told, and the major financial institutions have
been told to separate those functions.
As a result of the crisis, many beneficial things will happen. Will we forget about it eight to fifteen years from now
when the next crisis comes along? Possibly. All I am saying is that, as we speak, Canada, the U.S., the U.K. and
certainly Australia and New Zealand, countries that have had long, established good corporate governance practices,
are taking very significant steps in all the areas to ensure that they are playing by the rules and are much more
assiduous in carrying out their responsibilities.
Senator Tkachuk: You seem to have side-stepped my point. Perhaps I did not make it clear. We can all hope the
CEO of a company will be an honest person. If a company is being badly managed, the CEO should be fired.
You referred to Jack Welch from General Electric. His compensation package was filed with the securities
commission, but it was never disclosed. It was not until his divorce that these things were made public, laid out for the
world to see how they were taking shareholders' money and abusing it, as far as I am concerned.
What did you recommendation about how these people should govern themselves, the people who actually retail the
product to the customer?
I want to make sure that the person who is selling me a stock is well trained. Personally, I think the training is
horrible. Are those sorts of things looked at? Do we look at the brokers, the retail people and the research people, we
are putting out? They are the ones who are supposed to inform the customer, and they have not been informing the
customers. That is the reason for many of these problems.
No one would have believed that the entire world would shop by computer; it defies the imagination, yet it
How do we fix that problem? You said you made recommendations in those areas.
Mr. Stewart-Patterson: On the subject of investment dealers and analysts, we recognize that much work had already
been done by others with much more specific expertise. Purdy Crawford's committee reported last year with 30-odd
recommendations, which are in the process of being pursued. Basically, we felt that many people had done some good
work on this, so we did not attempt to try to duplicate that.
I should like to come back to another element in the chain. You talked about the investment dealers, the analysts
and the sell-side, senator. I should like to come back to the role of institutional shareholders. Senator Hervieux-Payette
raised the point earlier about where shareholders get their influence and whether they have influence.
Individual shareholders, small shareholders, often feel powerless, understandably. The mutual funds and the
pension funds that hold and manage the investments of many individual Canadians have become very influential
players in corporate governance.
It is important to note the pattern of their activity. We surveyed our member CEOs in the late 1990s, before the
bubble, and discovered even then an increasing involvement by institutional shareholders across a whole range of
issues, including executive compensation.
Another thing that came out of that survey of our members was that institutional shareholders as a group were
becoming increasingly focused on the short term vis-à-vis stock price instead of the longer term. In particular, our
CEOs said that it was the mutual fund sector out of the institutions that had the greatest focus on the short term.
In the late 1990s, we were seeing a growing institutional interest in short-term results. One of the things that went
along with that was a greater focus, in terms of the accepted wisdom of compensation practices and demanding reward
for performance and tying pay to performance and stock price because that would drive the company's performance
effectively. In the wake of the bubble, people are saying that we went too far. People were rewarded too much for the
short term, and then walked away with too much money while the company's fortunes went down the tubes. That is
Now we are saying that the pendulum is swinging on the institutional side. Certainly, our recommendations said
that boards should be taking a hard second look at compensation practices and policies. Boards should be thinking
about things like putting in holding periods, so that if someone cashes in his or her stock options, a good chunk of the
after-tax proceeds must be kept in company stock for a minimum period. Each board should decide the length for that.
Similarly, more compensation should be geared toward the long term, such as stock that must be held as long as a
person is with that company.
There are various mechanisms that could be used to reinforce the incentives for directors and senior executives. The
institutional shareholders, as a group, are now conscious of these kinds of issues. I would suspect that you will see a
significant shift in the mix within compensation practices.
Shareholders do have an important influence on what directors do. They were pushing in one way in the late 1990s;
we are seeing a different push in the wake of the bubble.
The Chairman: Honourable senators, Mr. D'Aquino informs me he must leave but that the other two gentlemen will
Senator Hervieux-Payette: I wish to back to your proposal that you will do it by yourself. You solution is that CEOs
will be so moral and ethical that we will not be able to intervene after the fact. However, I am concerned with before
the fact. To think that by tomorrow everybody will be good, honest and generous and that the scratch-my-back-and-I-
will-scratch-yours practice will be gone is foolish.
One of my recommendations, of course, is to appoint more women to boards. I hope your council will push that,
because women will bring a new view to boards.
The people in your organization who are informed about employees and what they are being paid in each sector,
who say that it would be helpful if the minimum wage were raised by 10 per cent, are those same people who would be
willing to give themselves a salary 100 times that of the salary of their employees.
I am not talking about legislating or implementing guidelines that would fix a cap. I am talking about ratios with
some latitude. If you want investors to have confidence and this capitalist system to work, you will have to come up
with something more than saying that it will be left to the new board, which will follow morality, be honest and
examine their conscience. I do not think that works, and I do not think it ever will when it comes to money.
You are saying give the power to the investors rather than to lawyers. Lawyers and accountants, as you mentioned
before, are doing what management wants them to do. A company is not run by consultants. It is a company that asks
them to do the job.
Which investors are we talking about — shareholders, banks or large corporations? That reference was a bit obscure
Mr. d'Aquino: Senator, we would never expect you or anyone to go to bed at night and say,
"We will count on the
enterprise system working just simply based on the goodwill and moral compass of the CEO.'' The point I was making
is that that issue, which has been largely overlooked, it is extremely important. However, having said that, what is the
kind of world that you want and that we want?
We want a world in which there is transparency, disclosure, oversight, and vigilance on the part of institutional
shareholders. These are the very same people now who tend to be critical but who, in the course of the build up of the
bubble, were saying, "Better and faster and higher quarterly results is what we expect from you.'' We want institutional
shareholders who do their jobs and take their responsibilities seriously, boards of directors who take their jobs
seriously and auditors who are genuinely independent, as auditors should be, whether that means limiting the ability of
auditors to provide outside consulting services to companies, or whether it means going even further and saying that
lawyers or even suppliers should not be sitting on a board of directors. There is a variety of ways in which we can
ensure that the system is as honest and productive as it possibly can be.
Does that include the issues of compensation, such as whether some of the salaries were out of line? Absolutely, and
I would be the first to raise my hand and say that. However, I will suggest something else. If we had had an Enron or a
WorldCom when the market cap was at the top, particularly when the high-tech companies were at the very top, I do
not think you would have seen anything like the explosion that we saw. We are seeing anger and passion because
trillions of dollars have been erased from people's accounts. People are angry and are asking themselves how this
happened. This happens every time there is excess. If you look at the history of the United States, you will have seen
the pendulum swing back and forth.
This is another example of a period of great excess. In that period of great excess, many people were playing by rules
they thought were all right but now know they are not. The only way we can ensure that the rules, the environment, are
right is through transparency, public disclosure and the checks and balances already in the system. If you are then
concerned about whether that is enough, we have the Criminal Code. The Criminal Code says if you commit fraud you
go to jail.
Senator Kelleher asked why these rules are not enforced. I ask the same question. We have many rules; let us enforce
them. The more they are enforced, the more people will pay attention. As one of our CEOs, Dominic D'Alessandro of
Manulife, who was just named CEO of the year, said, "If we saw more people in orange suits, shackled, on their way to
jail, it would wake up an awful lot of people.''
We have started to see that now in our whole enterprise system. I believe people are waking up. The vigilance level
today is 100 times that which it was. When board sit down today and tomorrow to talk about the compensation of
their CEOs, you can rest assured that they are paying much more attention to value, equity and performance than they
were, perhaps, six months ago.
Senator Taylor: I have a question about your report, on the last page, where you talk about company's action in any
area, its environmental performance, its human rights record, and treatment of its labour force — the human rights
record, in particular. Talisman just managed to get out of the Sudan. In regard to human rights, what should be the
federal government's position when a company goes into an area that obviously is not on our side as far as human
rights is concerned? Suppose a company wants to get into North Korea tomorrow?
Mr. Stewart-Patterson: The suggestion we were making on that point was that the markets themselves are looking at
any kind of inappropriate behaviour as an indication, not just of something that might invoke moral disapproval, but
as something that materially affects the degree of risk involved in investing in that company. In other words, many
things a company might do can affect investor perception of risk; for example, making a substantial investment in a
country where human rights are being disregarded, making a product that is considered unsafe or may be subject to
legal action as a result, failing to take adequate precautions in terms of environmental risks, basically anything that
might be subject either to general disapproval or specific legal action, either civil or criminal. If a company is seen as
riskier, investors demand a higher return for each dollar they invest. That means a lower share price. A lower share
price, in turn, directly affects the compensation of senior executives and the investment return of existing shareholders.
We live in a world where anything anyone does anywhere in the world is subject to scrutiny. A person cannot hide
any more. What you do anywhere in the world is going to be discovered sooner or later, for better or for worse, and
that will have an impact not only on the return to shareholders, but also on the compensation of the people calling the
Senator Taylor: I would submit that that is almost a child-like faith in the Friedman philosophy of free market, the
belief that everything will turn out fine as long as there is enough information flowing back to the investor. If it were
not for the born-again Baptists in the southern United States who tried to tie a can on Talisman there would have been
nothing done there.
I think the market rewards a certain amount of high binding, or whatever you want to call it. In other words, if a
company can get in and make a profit, put more money onto the bottom line, I do not think the market cares too much
about whether it is using child labour or enforced labour of some type in the country in which it is operating.
Do you not think there is a certain requirement for people who license companies in Canada, the United States and
Britain to stick their noses into the moral and human rights side of the equation? I do not believe that leaving it to the
Mr. Stewart-Patterson: I cannot offer you any definitive point.
The Chairman: Excuse me, we cannot let this line of questioning go on too long because we face this with every tax
bill we have had in the last five years. I do not think this committee is capable of even discussing it, nor do I think it is
within the purview of this committee, with respect, senator. We just had tax legislation with respect to doing business
with Moldova, et cetera. We cannot get into that. External Affairs has to decide what is the policy of our government.
We can only talk about the direct corporate governance and the competence of directors.
Senator Taylor's line of questioning is excellent, but it is not within the purview of our study.
Senator Taylor: Let us move on to the subject of rights and how you control the market.
Are you saying with respect to national security that you can perhaps get the securities commissions all working
together? Would there be a way of selling that if the stock exchanges were allowed to operate differently? We might
have the same national securities commission, but we would have local stock exchanges. For example, in the U.S., they
have San Francisco, Seattle, Denver, New York and so forth.
Mr. Stewart-Patterson: No matter how you regulate them, there will continue to be local capital markets and
regional capital markets as well as the local pools.
However, the actual form of how we get our regulatory act together is perhaps less critical than the underlying
substance. What matters is that we have to deal with the fragmentation of the rules themselves and the excessive costs
that go along with that fragmentation.
There are a number of approaches to the question of whether it should be a single body controlled jointly by the
provinces with federal participation. Is there a federal role there, or is it simply agreements between the provincial
regulators that clear up the damage done by the authorities?
There is more than one way to deal with the problem. The size of Canada's financial market right next door to the
United States is small enough as it is, and we should not divide up our small markets into even smaller ones in ways
that hurt the ability of Canadian companies to attract capital and grow.
It is a question of the best means to the right end, and I do not have any strong feelings in terms of whether one
model is the best. The federal government has appointed Harold MacKay to look at that from the federal point of
view. I have talked to the Ontario Securities Commission, and I had a conversation with Alberta Securities
Commission. There are different views on how to get there. One lesson that comes out of the current crisis of public
confidence is that we cannot let this kind of thing drift along any longer.
Senator Taylor: When I am interested in a company, I almost always come back to the auditor's notes. They seem to
contain the most telling information available. That leads to the question of auditors and picking auditors. I have also,
through the years — half a century now — picked auditors that I liked when I was on boards. I wonder whether the
shareholders should not be picking the auditors. However, they cannot do that. I think Oxley suggested it —
The Chairman: The shareholders do choose the auditor. It is a legal requirement.
Senator Taylor: That is exactly it. They do not.
The Chairman: They do.
Senator Taylor: You must believe in Santa Claus and the tooth fairy.
The Chairman: It comes to an annual meeting, and they vote on it.
Senator Taylor: I am talking about Oxley's suggestion that an auditor should not stay in place for any more than
three years, and I read about another system in which the names of auditors that are approved by the commission are
put in a hat, pulled out and are allowed to make a deal for every two or three years.
The Chairman: Senator Taylor, he is talking about the audit partner. There is a great antipathy towards changing
auditors every three years because huge mistakes are made, according to research. It is the auditing partner from the
same company, but with a different guy in charge.
Senator Taylor: That is true. They did not go as far as changing the auditing partner. I do not know what that would
do because, as far as I see it, auditing partners talk to each other all the time.
Do you have any suggestions or ideas about how to make auditors more representative of the shareholders and less
representative of the management?
Mr. Stewart-Patterson: One suggestion included in our recommendations is that the auditor should, as Sarbanes-
Oxley requires, report to the audit committee, not to management. The chair of the audit committee would sign the
letter of engagement to the auditor to make that relationship clear.
Senator Taylor: Is the auditing committee picked by the management?
Mr. Stewart-Patterson: Again, that is where the independence of the board as a whole and the independence of the
audit committee become critical elements in that chain.
The rotation of the audit partner has costs and benefits. The more frequently you rotate somebody, the less
likelihood there is of getting what the profession refers to as "familiarity risk,'' personal relationships developing. On
the other hand, every time you hand over a file, mistakes are made and people have to go up the learning curve again.
Rotation is one way to deal with it.
The other significant element is the separation of the audit function from other services that have in the past been
supplied by audit firms. That relationship and the potential for conflict are central in the thinking of the accounting
profession these days.
Senator Setlakwe: I have read your statement, and it is excellent. Perhaps the Banking Committee should submit it
to the government for legislation.
Many things in there are very true, but it strikes me that they are the result of the bubble and that had there not been
a bubble there would not have been a statement. To what extent can we rely on good governance on the part of
administrators and directors of companies to ensure that what you suggest would be an ideal world will actually
happen, and what can we properly recommend to the government as legislation?
I know that you prefer values to rules, but there must be a point where perhaps the government should intervene
after having gone through what we have gone through in the last couple of years.
For example, you talk about the necessity of expensing options. Should the government legislate on that? Should the
government recommend? I do not know. These things have come up as a result of the bubble.
With respect to legislating criminal offences, civil offences or fixing jail terms, I do not know if that can be set by
good governance rules or by government. What are your views on that?
Mr. Stewart-Patterson: As we said earlier, the first priority before considering what else to legislate is to look at how
effective the existing legislation is. Is it being adequately enforced? Before adding to the pile, make sure what we have
Second, in some areas there appears to be constructive discussion about whether further legislation or regulatory
measures might be appropriate. Our members have indicated they do not have a problem with a much more extensive
personal certification of a company's quarterly and annual reports. That is a legal requirement in the United States.
The markets are demanding something equivalent, whether it is regulated or not. Is that an area where a regulatory
response might be more appropriate? I have not looked at the draft legislation, but my understanding is that the
Ontario government is looking in that direction with the initial legislation it recently introduced.
There also may be cause to look at a regulatory response from the point of view of consistency. That is a major
concern of a number of our members in terms of the stock option expensing issue. It is very clear. Investors want to
know what options are being issued and what impact that has on their returns down the road.
The big concern is what happens if I put it on my income statement and my competitors do not. Am I going to get a
fair shake in the market when I do that? There is a benefit to consistency on issues like that. I believe the Accounting
Standards Board is looking at whether to make that a mandatory requirement in Canada. That is an appropriate kind
of conversation to have.
Generally speaking, there may be areas where we want to look selectively at an action, whether at the federal or
provincial level or the area of stock exchange listing requirements and so on. The fact is that every board, director and
CEO knows that the heat is on, that they are under extremely stringent scrutiny by every investor and would-be
investor in the marketplace. I do not think that scrutiny is going to slack off in the foreseeable future. I think the
bursting of the bubble has been a wake-up call to everybody in the chain of decision making, and that is going to have
a lasting impact on the kind of behaviour that we see taking place at the board-of-director level and the kind of
decisions that are made there.
Senator Setlakwe: It is a question of good behaviour on their part. There has not been proof of that in the past. That
is the problem.
Senator Fitzpatrick: Mr. Stewart-Patterson, I have actually been encouraged by some of the things that both you
and Mr. d'Aquino have said this afternoon. I have heard you talk about a moral compass or a set of ethics, the
problem with options on a short-term basis versus a longer-term basis, the pursuit of determining the integrity of CEOs
or potential CEOs, and the measures of compensation that can be utilized. I think these are very positive issues that
need to be examined very carefully. I think that there are some answers that can be put forward as to how these things
It is a question of leadership. I can see no better body to provide that leadership, particularly with your concern
about the legislation, than the Council of Chief Executive Officers. I have not had a chance to study your material, but
I got the impression from what Mr. d'Aquino said that the council is prepared to provide some leadership in this
regard. It seems to me that that is a big job that would require a consensus amongst the council. It would require a
lecture circuit, a lot of publication and a lot of communication, which seems to be part of it. To get these points, if we
are going to avoid a reaction of government and others that these things do not happen, legislation has to happen.
Let us say a new moral compass can be established. The other part of it is how do we make sure these things are
happening? Reference was made to the responsibilities of the board of directors. The difficulty I see with that is time
and cost. I have served on boards of directors of large national companies and I have served on the audit committee.
Most members of the boards have other responsibilities. To have the time that is necessary to do the work that should
be done or to have the advice that is required is a major cost. Even though companies have auditors, I think the audit
committees, perhaps, have to seek outside advice, and that is a major cost.
I see two elements here that I would like to have your comments on as to how they might be pursued. First, is this a
mandate that you, as members of the executive of the Council of Chief Executive Officers, have or could it be? Do you
see ways in which, without crippling companies — particularly small and medium-sized companies — companies can
build and develop because of the cost that is going to be required to administer a new moral compass or a new set of
ethics? I think that is probably where we will have to get.
It is hard to start reversing salary levels or option levels, but it can be done and it can be done by shareholders.
Option arrangements can have more scrutiny by shareholders. There is more now than there used to be, but there could
be even more.
I am interested in your response to the comments I have in this regard.
Mr. Stewart-Patterson: I think what our members tried to express in the long statement we issued in late September
is our consensus of what we believe should be done. On the other hand, we are also cognizant of the fact that we cannot
act alone on issue of corporate governance. As a matter of fact, one of the first letters we received shortly after we
launched the corporate governance initiative publicly in July was from the Ontario Teachers' Pension Plan Board, who
told us it is neither the responsibility nor the prerogative of management to set the standards for corporate governance,
that that is a privilege that belongs to shareholders. I think our response was,
"Well, you are right, it is the shareholders
who are going to make that decision and boards are going to act on behalf of shareholders, but surely we have a
responsibility to play a leadership role to make things happen.'' I think that is the consensus position expressed by our
members, that we are going to do our bit in encouraging action towards better governance, not only within our own
enterprise, but also within the broader business community.
That leads to your question about how we deal with the smaller public issuers, companies that are trying to grow
that do not have the same resources, the companies that are likely the most heavily affected by any new regulatory
requirements. We are certainly seeing evidence, as we said earlier, of a disproportionate impact on smaller issuers in the
United States already. That is certainly the greatest fear being expressed by some of the market participants here in
Canada as well, if we go down the same road.
That said, I think there is a recognition that if you look at compliance with the highest standards of corporate
governance in terms of norms of practice, you are going to see higher norms of practice in the larger companies. That is
partly because the larger companies tend to be exposed to more than one national jurisdiction. As I say, basically you
have to play by the highest common denominator of anywhere you do business. Partly it is a question of resources.
Larger companies can afford to pay good money to hire better directors and more outside directors.
We have to recognize that that is how we take smaller companies and bring them up to a higher standard as they
grow. We are worried about trying to come up with a single set of rules that will apply to everybody. There is a
continuum here, and you have to start somewhere and bring people along one company at a time. One of the things we
are suggesting is that it is market expectation that will bring companies along. As they get bigger and seek capital from
deeper pockets, as they seek capital in different markets, they are going to have to meet a higher set of expectations.
I am not sure if I am answering your question, but that is why our members, who tend to be the larger companies,
are saying that they know they are being held to the highest standard, and many of them are being held to the highest
standards in the United States, Canada and in other jurisdictions. As far as we are concerned, one, it is a requirement
to do business and attract capital and, two, it is doing the right thing that we see as a competitive advantage for our
companies. If we do the right thing and our competitors in other countries do not, we will have an easier time
attracting capital at a good cost.
The incentives are in the marketplace. How to make it happen fastest in Canada is the issue. The CEOs of larger
companies are willing to play a role in trying to pull up the norms across the country.
Senator Fitzpatrick: There are different ways to measure market expectations. We have seen this problem during the
build up to the bubble of being concerned about quarterly performance, which is driven by stock option expectations,
et cetera. I suppose the council could spend some time on the proper measurements for company performance. For
example, what should the market rely on, and are you giving any consideration to that? We have been driven by price-
earnings ratios, but there are other things such as cash flow measures and asset measures. Perhaps that could be done
in respect of the approach that the analysts in the financial houses take.
Another area that could be helpful is talking to business schools to establish an ethical standard that is promoted
and supported by the major companies. Not all CEOs will have an MBA because many come from business schools. It
is a different standard and a different environment that they come into. Part of the problem, as someone mentioned,
could be greed and, unfortunately, over the last several years that has probably been the biggest incentive that we have
seen in the lead up to the bubble that burst. Perhaps it would be beneficial if a different mentality were instilled in those
people taking on the responsibility of a major company, in which there are thousands of shareholders — pensioners,
investors, et cetera. It is a preaching role that someone has to take on in order to create real concentration, or focus, on
The Chairman: This moves into an area of esoteric challenges. When Mr. Greenspan used the words
exuberance,'' he was not just referring to the boards or to the CEOs; he was also referring to the vast investing public
who thought this good fortune would never end. If Nortel sold at a price that meant they had to compound their
earnings at 25 per cent for the next 50 years in order to justify it, somebody had to stand up and say,
"This is nuts.''
However, it never happened. If a stock is selling at 50 times earnings one year and the next year at 25 times earnings, it
is still the same company. I will be interested to hear your answer to Senator Fitzpatrick's question because I do not
think there is an answer.
Mr. Stewart-Patterson: One of the questions that the senator raised will provide the basis for many doctoral theses
to come. What are the lengths between good governance and superior corporate performance? There is clearly a belief
that good governance matters. Research done by companies such as McKinsey & Company, worldwide, on the
perceptions of institutional investors globally, shows that good governance does matter and that we will pay a
premium price for companies that practice a package of good governance as opposed to a company that does not. In
countries where we do not trust the overall business environment, that premium is much higher. The premium in
Russia was in excess of 30 per cent and in much of Latin America and Asia it was over 20 per cent. In Canada, it was
the lowest in the world, at 11 per cent.
On the one hand, it means that the global perception of Canada's business environment — the integrity of our
markets — is pretty high. On the other hand, it is a firm statement that people managing big piles of money around the
world believe that good corporate governance matters. Is there research to be done to know how much it matters or
which governance practices actually make a difference in helping companies grow faster, sustain their growth over
time, grow with less volatility, et cetera? There are many unanswered questions, and I am sure that many good minds
will be working on them.
The Chairman: Do you not believe that the business community, and there is nothing you can do about this, invents
things every 10 years to make things look better? Think about the concept for one second. When Bob Campeau went
after Federated Department Stores, Inc., he called me one day and said that he wanted us to invest with him. I asked
him why and he said, "Well, the EBITDA.'' I asked him what that was, and he said,
"earnings before interest, taxes,
depreciation and amortization.'' That was only 15 years ago. I thought it was a totally meaningless number, and I said
so at a board meeting and was laughed at because the entertainment business used it extensively. Thank goodness,
about four months ago, Warren Buffet, a very successful investor, wrote an essay and said that he had never heard of
such nonsense as EBITDA.
Mr. Stewart-Patterson: If I may, senator, think back a couple of years when we were reading papers by senior
academics who suggested that Canadian managers were way behind the times, not up to it, too cautious, too stick-in-
the-mud and too unwilling to take risks. In the wake of the bubble, we are beginning to read the opposite comments,
such as "Weren't we smart not to take those silly risks.''
The Chairman: How long ago was internal rates of return, IRR, invented?
Mr. Boutziouvis: That goes back further. Senator Fitzpatrick raised an intriguing question. There is an indicator that
could serve as a proxy, and people are returning to it right now — the payment of a dividend. Many investors and
analysts are suggesting that if you go back to the old-fashioned way of investing, whereby a corporation pays out its
dividends year in and year out, that would be a good indicator that the corporation is solid.
The Chairman: The cycle is complete.
Mr. Boutziouvis: Yes, because it has returned. There is something to be said.
Senator Hervieux-Payette: My question concerns the telecommunications area. When Nortel predicted they would
make X, Y and Z, the analysts were pushing them. In reality, every baby in Canada would have to be born with three
cell phones for the company to meet such forecasts. Why did no one tell Nortel that the forecast did not make sense?
Nortel hired 3,000 people every six months just to spend the money that had been invested. Certainly, there were
people who did not know what they were doing. Perhaps some companies are able to instantly implement new projects
with everybody working together to produce terrific products. However, why did no one mention that? Everybody was
simply taking the money — one group or another — and at the end of the day, nobody had any money left.
The Chairman: It happens that way — you cannot legislate integrity and you cannot legislate against stupidity.
Senator Hervieux-Payette: It was not a case of stupidity, but of complicity. They are different.
The Chairman: Gentlemen, thank you for your time.
Our second witness is from the Certified Management Accountants of Canada. We have with us Mr. Bill Langdon,
Vice President, Knowledge Management.
Mr. Bill Langdon, Vice President, Knowledge Management, Certified Management Accountants of Canada:
Honourable senators, I want first to say that, unlike your previous speaker, this is my first time addressing this group. I
have been abandoned by my friends, who are at the back of the room. All you get today is me.
Thank you for inviting CMA Canada to appear before you this afternoon to present our views on accounting and
auditing standards and corporate governance. We believe addressing these two issues is critically important to
restoring public confidence in the business community and in the capital markets. We applaud your committee for
undertaking these hearings and we look forward to your report.
Today, I will summarize the key points we have made in our written submission, which we delivered to the clerk last
week. I will then be pleased to respond to any questions you may have.
Looking first at the issue of auditing standards, CMA Canada welcomed the announcement on July 17 of the
establishment of the Canadian Public Accountability Board. This to us was an important first step in restoring trust in
capital markets and the auditing profession. We do, however, have three concerns with the CPAB system.
First, CPAB fails to take into consideration the activities of the many accounting professionals in Canada, including
CMAs, who are involved in the auditing side of the profession. This, to us, is a serious oversight. It is important to
point out that CMAs have full public practice rights, including the right to audit publicly traded companies, in Alberta,
Saskatchewan, Manitoba and Newfoundland. CMAs also have public practice rights to conduct audits for
municipalities and school boards in British Columbia and Quebec.
Furthermore, legislative initiatives are now being undertaken in other jurisdictions, such as Ontario, that will
potentially increase the number of non-CA accounting professionals who will have public practice rights.
It is clear that CPAB, as designed and currently constituted, is deficient and not entirely independent, given the
number of seats reserved exclusively for appointees of the Canadian Institute of Chartered Accountants. We believe a
more inclusive approach would bring greater transparency to, and public confidence in, CPAB's activities.
Second, while the new system introduces some valuable initiatives to strengthen and monitor the inspection of
auditors of public companies, the focus appears to be on enhancing existing standards in auditing and accounting
rather than establishing better reporting and auditing standards.
Our third concern is that the CPAB system fails to separate the critical functions of auditing and accounting
standards-setting, since both activities currently reside within the domain of the Canadian Institute of Chartered
So far as we are aware, Canada is the only advanced economy in the world, except for Denmark, where accounting
standards are established and overseen by one professional body, rather than by a fully independent organization
acting in the broad public interest.
We believe that a Canadian accounting standards-setting body is required that is truly independent of all business
and professional organizations. This body would establish and improve standards of financial accounting and
reporting for the guidance and education of the public. It would be made up of people who prepare and use financial
information, as well as auditors, accounting academics, and representatives from the securities industry. All of these
people would have a high level of expertise in financial accounting and reporting issues. Members of this Canadian
accounting standards-setting board would be required to sever all ties with institutions they served previously.
The new body would not be a government agency, but it could report, for example, to a Canadian Securities
Administrators type of organization.
We feel strongly that establishing a separate accounting standards-setting body that is truly independent of business
and professional organizations is vital to restoring public confidence in our capital markets.
The recent corporate scandals also raise serious questions about the state of corporate governance in Canada. While
we have all read about the high profile corporate failures in the United States, we must recognize that there have been
significant Canadian failures as well. The less-than-stellar performance of corporations like Northland Bank, Royal
Trust, Confederation Life, Phillips Services, Cinar, Livent, Bre-X, Corel, YBM, and Nortel have seriously damaged
public confidence in our own capital markets.
A serious re-examination of the relationships among independent auditors, corporate management and boards of
directors of public companies is certainly needed. However, the question remains: Will this type of review result in
boards that are more effective in delivering results?
In our view, it would be a mistake to focus solely on prescriptive rules of corporate governance, such as requiring
that positions of the board, chair and chief executive officer be split. While helpful, setting such rules does not, by itself,
ensure effective corporate governance. It is essential to focus on outcomes rather than exclusively on form.
One of these key outcomes is to be able to quickly identify, and improve, an organization's ability over the long run
to deliver on what it promises to its customers, shareholders, employees and the broader public. The failure of many
corporations is due not just to the activities of poor auditors or devious CEOs, but rather, the lack of an appropriate
strategic performance measurement system for a board of directors. The lack of such a system results in inadequate
board oversight, which in turn leads to the occurrence of improper activities.
Another major output of good corporate governance is having a board that understands the strategy of the
organization, is aware of the risks associated with that strategy, and has control systems in place to flag issues that
surpass risk thresholds. It is far from clear that many boards currently meet this objective.
Boards need new tools to better understand risk and to measure the performance of their organizations and their
own performance. To that end, CMA Canada has published a new management accounting guideline that presents
best practices companies can adopt to achieve more effective corporate governance.
The English version, which I believe was handed out today, is hot off the press. We are currently finalizing the
French version of the guideline and will be able to send you copies at the end of this week.
This guideline is entitled "Measuring and Improving the Performance of Corporate Boards'' and applies the
principles of a balanced scorecard in a corporate governance setting. The balanced scorecard represents a system of
measures and processes that will reduce the potential for, or provide early detection of, a deterioration in a company's
competitive position. This is an accurate predictor of future performance.
Typically, boards are provided traditional accounting-based performance measures, such as earnings and return on
investment, to assess corporate performance. However, financial accounting has limited value as a strategic
management tool. This is because it tends to be a lagging indicator, measuring past performance, rather than
presenting leading indicators predicting future performance or motivating behaviour aimed at attaining future goals.
Our new corporate governance guideline is intended to supplement a board's reliance on financial performance with
new, real-time measures to evaluate corporate leadership, corporate performance, and a board's own performance.
In the appendix to our written submission we set out the metrics for a board's balanced scorecard. I do not propose
to go into detail in my remarks about that appendix, but let me say just a few words about this approach.
It uses a multi-dimensional set of financial and non-financial performance metrics and is based on four dimensions
relating to the core values of a company.
The first dimension is financial. The focus here is on the shareholders' interest and whether or not the company's
strategic approach has succeeded financially.
The second dimension involves the various stakeholders of a company, including employees, customers and the
community. This requires an examination of measures reflecting how a company is meeting the needs of its various
stakeholders through its strategies and actions.
Third, it is essential to look at internal business processes and assess how well a company performs on its key
internal systems and processes.
Last, but not least, there was a focus on organizational learning and growth to measure how well a company is
preparing to meet the challenges of the future through its organizational and human assets.
We do not pretend that our balanced scorecard approach is the only answer to improving corporate governance, but
we believe it is an important tool that can assist boards to meet their obligations.
We would ask that this committee encourage the development, dissemination and adoption of new tools such as this
to improve corporate board performance, and to enable directors of public companies to better understand one
essential ingredient, at least, which is risk. Enhancing the ability of directors to understand and deal with risk would be
a critical step on the road to rebuilding public confidence in how publicly traded companies are run.
We also believe it is timely to look at treating corporate directors in Canada as a distinct professional group with
specific skills and knowledge. Like other professionals, corporate directors would embrace a code of ethics and share
best governance practices. Establishing a professional framework for corporate directors could be done in conjunction
with organizations devoted to promoting sound corporate governance, such as the Institute of Corporate Directors.
In closing, I am sure we all agree that we must restore public confidence in capital markets, in the business
community generally, and in the auditing profession specifically. While we do not profess to have all the answers, we
believe the following steps would contribute to a restoration of public confidence.
One: Bring greater transparency to, and build public confidence in, the Canadian Public Accountability Board's
activities through a more inclusive approach. This would include the participation of CMA Canada and other
professional accounting bodies.
Two: Establish a Canadian accounting standards-setting body that is independent of government, business and
professional organizations to help improve standards of financial accounting and reporting.
Three: Encourage the development, dissemination and adoption of new tools, such as our new corporate
governance guideline, as a means of assisting directors of public companies to better understand risk and put into place
the appropriate control systems.
Finally: Encourage the professionalization of corporate directors in Canada.
Your committee is a vitally important voice in promoting policy initiatives that will help build public confidence and
trust in Canada's capital markets and business community. We would be pleased to work with you to help you put new
ideas into action. Thank you for your time and attention.
Senator Hervieux-Payette: You did not go into detail on the treatment of stock options, but there are different
schools of thought. What is the CMA recommending for the treatment of stock options in financial statements?
Mr. Langdon: We do not have a particular view on that. It is in the balanced scorecard approach. It should be
expensed, and also a delay should be put in place in terms of when the stock options are exercised. The idea that you
get stock options and immediately turn around and sell them in a short space of time does not bode well for the
shareholder in the long run. It would be our suggestion that they be expensed, as some of the banks have done in
Canada, and that there be a time limit as to how long they should be held.
Senator Hervieux-Payette: What is the remedy for CPAB not recognizing you? Why are you not accepted? What
standards do you not meet? What requirements are you not fulfilling?
Mr. Langdon: I do not know, senator, what standards we are not meeting. We have members who are in the audit
field, but it is a small percentage. Most of our people, as you may know, are in the management accounting function
and work inside companies. They have quite rewarding and fulfilling careers in that field. Nevertheless, there are some
who are allowed to do auditing, and do so.
As mentioned in my comments, some of the provinces, in particular, Ontario, seem to be coming forward with the
introduction of legislation that will open up the audit area to other bodies. The key thing to look for in this is that
whoever sets the standards for auditing must be truly independent. I am not here to lobby for CMA to be included in
this, but from a Canadian perspective, it would be important to have a truly independent oversight board for all
auditing activities in Canada and not situations where either violations or standards are set by one particular
Senator Hervieux-Payette: When we met with the people from Teachers' and asked them if they had a lot of shares
in Enron, they said no. I asked why. They said, "Because we read the footnotes. When we receive the financial
statement and the yearly report, et cetera, we always have different comments to make.''
Is it the responsibility of the auditor, of the accountant, to give the facts on how much exposure there is and the
reality of the company's economic situation? The big figures, on the one hand, can present a nice picture, but in the
end, if you do not read all the footnotes, you do not know the financial situation of the company.
Mr. Langdon: I have been to a few presentations on the Enron case. It is an interesting case to follow. One of the big
issues I have heard about Enron, which I do not think would appear in the footnotes, and which we hope with the
balanced scorecard approach the board of directors would be aware of, was that they were unable as a board to
determine the risk of the various lines of business the company was in. They moved from a fairly staid pipeline
company to one that traded in energy futures. That was a quantum leap in risk, yet the board of directors did not seem
to understand they were in a much riskier business. Some presentations I have seen indicated that some members of the
board of directors did not understand how the company made money. They could understand the pipeline business,
but they got into this other very sophisticated kind of energy trading and were not sure how the money comes to be
generated. That is a big issue.
The people who were on the Enron board, a fair number of them, were highly respected and reputable people, but
they were not asking the right questions. I believe that is because they were not given the right information, such as the
risk of the business they were in. Even the chairman of the audit committee, a highly respected academic in the United
States who had been on several audit committees, did not understand the risk.
Another issue was at play in Enron as well. Some people within Enron were intent on committing fraud. When a
group of people in different parts of the organization are intent on committing fraud, it is hard for anyone, even the
auditors, to find that out. Ultimately, the shareholder has to rely on the board of directors to ask the right kind of
questions, and they should be fully independent and fully informed.
Senator Hervieux-Payette: You talked about it being sophisticated. As far as I am concerned, these complicated
reporting structures were just a kind of smokescreen for activities that were not necessarily transparent. We were
talking about transparency a few minutes ago. If the experts could not understand the whole picture of the financial
situation of the company, just think of the ordinary shareholder, or even people with normal knowledge of accounting
but not necessarily experts in the sector.
Mr. Langdon: I would agree, senator, entirely with that analysis. The problem at Enron was that nobody asked, two
or three times, why. After three "whys,'' you should have the responder sweating over something. There is a built-in
inertia on some boards if you do not have the information to continue to ask why. They are making money and
everything looks rosy, so what is the problem here? There is none. Nevertheless, if they were aware of the risk issues,
they could come back and ask why is this, and why is the risk increasing here, and what is going on in the company? It
is a matter of being more transparent and direct with the information they need to do their job as directors.
Senator Tkachuk: You mentioned stock options, so I am going to get back to a bugbear of mine. You brought up
two things. You said that stock options should be held, or that there is some rule or regulation to hold the stock
option. How can someone hold the stock options if taxes will be charged as soon as they are exercised?
Mr. Langdon: They should not exercise it until some time in the future.
Senator Tkachuk: Most stock options are for some time in the future — an option can be given for a number of
Mr. Langdon: It could be, but I think that they need a longer term to track the value a person did bring to the
company that attracted the stock option in the first place.
Senator Tkachuk: You would give a 10-year stock option, but it could not be exercised until five years down the
Mr. Langdon: Yes.
Senator Tkachuk: I have difficulty getting my head around the question of how you expense a stock option. Where
does it go in the financial statement?
Mr. Langdon: You are asking me some tricky questions about which I do not have the necessary knowledge. I know
that there are many different ways to look at this. I will try to get an answer to the clerk on it.
Senator Tkachuk: If we are going to expense stock options so that ordinary investors can understand it, you have to
be able to explain it to me in a way that I can understand. If only accountants and lawyers understand it, it is useless
Mr. Langdon: You are absolutely right. A person could probably give a three- or four-hour lecture on expensing
Senator Tkachuk: Those accountants are going to charge us by the hour for that, and we still will not understand it.
Mr. Langdon: It is an important point. Clarity is an essential ingredient in the communication of these financial
Senator Hervieux-Payette: I have a question about off-balance sheet financing, transparency and a clear picture of
what is happening. You mention in your brief that the financial statements are supposed to present fairly the situation
of the company. If you present a nice picture on the balance sheet, and then all the problems are on the off-balance
sheet, I believe it is up to professionals like you to establish the rules and standards so that the shareholders know that
the risk may not show at the beginning of the financial statement, but at the end of it.
Mr. Langdon: Enron had special purpose entities. A number of companies in Canada have these to unload certain
debts. The rule in Canada is much stricter as to when you would consolidate those.
Enron did have a standard, which I believe was 3 per cent ownership of the special purpose entity. Enron did not
meet the 3 per cent rule. It was not a matter of the accounting rule being incorrect. It was a matter of no follow-
through on the audit side or by the board of directors. Once they realized that fraud could be committed, because
neither the auditors nor the board were checking, they decided to create many more of those holdings. Enron was at
only 2.9 per cent.
In many cases the standards are there, but they are not being adhered to. It goes back to reasons of fraud.
The Chairman: Did they have something like 800 of them?
Mr. Langdon: They had quite a few. They were naming them after Star Wars characters.
The Chairman: Thanks for being with us, and good luck. Our next witness is from the Social Investment
Organization. Eugene Ellman is the Executive Director.
Mr. Eugene Ellmen, Executive Director, Social Investment Organization: I will speak for 10 minutes, and then I will
be happy to take questions. Thank you for the opportunity to bring our views on corporate governance to you.
Tessa Hebb, who is on my board of directors, was hoping to be here today, but she had an illness in the family and
was detained this afternoon.
We appeared before the committee in the past when you were holding deliberations on the Canadian Investment
Corporations Act. The last time I was here, I was talking about shareholder rights and the clause in the old CBCA that
allowed management to exclude shareholder proposals based on social and environmental issues. We were very pleased
with the version of the legislation that passed last year in which that clause was eliminated. We commended the
government for that.
I represent the Social Investment Organization, which is a trade association for the socially responsible investment
industry in Canada. We have about 400 members across Canada, representing staff and directors of some of the major
financial institutions that invest clients' monies in investment funds according to social and environmental guidelines.
They take into account all the issues around human rights, the state of the environment, how companies treat their
employees and their communities and how they relate to developing countries.
We estimate that this element of the market represents about $50 billion in assets that, in one way or another, are
screened or managed according to social and environmental guidelines. It is a small part of the market.
We estimate it to be about 3 per cent of funds under management, but it is growing. It is growing among mainstream
financial institutions, pension funds and other financial institutions that are interested in applying more than just
financial criteria to their investment selection process.
I will briefly summarize the argument we included in our brief to you, and I hope you all had a chance to read it, and
then I will briefly go through the five recommendations that we are making here today.
Most of the presenters who have appeared before you come from two points of view — either auditing or board
governance. If we look at the problems with companies such as Enron and WorldCom, we find that these corporate
collapses have been caused by two essential things — management that abused auditing standards to either understate
their debt on the balance sheet or overstate their earnings, and governance failure at the board of directors level, where
boards imposed insufficient oversight on management and permitted these auditing abuses to continue. These twin
problems, improper auditing combined with lack of board accountability, are at the heart of the current crisis of
confidence among investors.
SIO supports measures to reform auditing, managing and board accountability. For example, we support the bill
that was introduced in Ontario last week to strengthen penalties under the Securities Act and set up a civil liability
regime. We also support measures to strengthen auditing standards, accountability and analyst independence in the
Sarbanes-Oxley Act in the United States. We have also sent submissions to the New York Stock Exchange supporting
their new listing standards, which, among other things, calls for CEOs to personally vouch for their financial
Where we come from on this whole issue is that we think these new rules are insufficient to fully reform the
governance system in Canada, or in other jurisdictions. We believe that these governance reforms fail to understand
the corporation in its most holistic sense. They fail to understand the corporation in its role as a corporate citizen, in its
role as the arbiter of various stakeholders. We believe that if the aim of these corporate governance reforms is not just
to clean up auditing and governance abuses in the short term, but to help build long-term shareholder value, that a
more comprehensive view of corporations is going to have to be introduced here.
We are essentially calling for, in the spirit of transparency and disclosure, some simple reforms that would require
companies to report on their social and environmental policies and social and environmental risks. Our philosophy
here is that sunlight is the best disinfectant, so if you open up corporate reporting, if require management to disclose
the hidden social and environmental risks that are currently embedded in their balance sheets, then you are going to
open up their entire social and environmental profile to investors and to the investing public.
Briefly, our recommendations are laid out in our report, but to go through them one by one, we recommend that the
various federal and provincial statutes, the CBCA and the provincial corporations laws and provincial securities acts,
be amended to require publicly listed companies to have corporate codes of conduct. We are not stipulating that social
and environmental measures have to be put in place in these corporate codes, but simply a requirement to have a
corporate code, and then corporations would have to report on their performance in terms of that code.
We commend the work of the Global Reporting Initiative, which is an international endeavour to lay down uniform
social and environmental standards for multinational corporations, and we recommend that as a good place to start
for these corporate codes.
We believe that provincial securities regulations and the listing standards on the Toronto Stock Exchange should be
changed to require companies to disclose social and environmental policies and social and environmental risks. The
policies would be measured against the corporate codes of conduct in recommendation one, and the risks would be laid
out in documents that are currently required, such as the management discussion and analysis documents, the annual
information form documents, but which typically do not include social and environmental measures.
One of the pieces of information in our brief points to a staff study at the Ontario Securities Commission that
surveyed a number of management discussion and analysis reports that are out there now and found that corporations
frequently failed to mention material elements in their management discussion analysis that would have an impact on
the operations and the financial position of the company. Therefore, we specifically state that social and environmental
risks of a material nature should be disclosed.
Audit committees should be mandated to review these disclosures, rather than just management doing it in a pro
forma way, and be required to sign off on them. This is a requirement in some recent reforms that have been put in
place in the U.K. under the Turnbull committee, which covers London Stock Exchange listed companies, and it is
beginning to create a new attitude towards long-term risk management on the part of boards.
Getting away from just corporate disclosure into disclosures in the financial community itself, we think that to
increase transparency, mutual funds and pension funds should be required to disclose their proxy voting policies and
how they cast their votes on particular shareholder issues.
This is based on a recent recommendation of the Securities and Exchange Commission in the United States. It is
currently out for consultation now. The deadline is December 6. The SEC is proposing that mutual funds and financial
advisers be required to disclose their shareholder proxy voting policies in their public materials that go out to investors
on their Web sites.
In addition, we recommend going a step further and requiring mutual funds and pension funds to actually post how
they cast ballots on various shareholder issues. Typically, mutual funds and pension funds simply vote their proxies to
management, and management decides how to vote on these various shareholder proposals. Some pension funds, most
notably the Ontario Teachers Pension Fund, now disclose the results of their votes and how they cast their votes on
shareholder proposals. Many of our members, led by the ethical mutual fund group, have been doing this for a number
of years. We believe that it should be more than just a voluntary activity on the part of mutual funds and pension
funds. It should be a requirement.
Our next recommendation is to give pension fund plan members better knowledge and better information about the
degree to which social and environmental issues are being taken into account in the investment of their pension dollars.
We are recommending that the federal and provincial pension statutes be amended so as to require pension funds to
disclose how, if at all, they take into account social and environmental factors in their investment decision-making.
This is based on a regulation that was put in place two years ago in the U.K. that affects all pension funds. It is serving
to open up the pension community in the U.K. to more social and environmental analysis of its portfolio and the
voting of its proxies.
We recognize there are not many jurisdictions in the world that are currently doing this. In our brief, we point to the
U.K. and South Africa as two jurisdictions that are. Even at the SEC, there are more stringent requirements than in
Canada for some environmental reporting, but the regime we are talking about is not there.
Our argument is that if your concern is to help to build a governance system that is in there for the long term, to help
build long-term shareholder value, it is important to look at the corporation in the most comprehensive way, and that
is, the social and environmental context in which it operates. While some of these may be more farsighted than some of
the jurisdictions in the world we are now operating in, to make Canada a leader in this area will give it a national
competitive advantage, because we feel that over time, the financial markets will look more and more towards social
and environmental analysis of companies.
I am happy to answer your questions.
Senator Tkachuk: I understand what you mean by "environmental.'' What do you mean by
Mr. Ellmen: We have written a brief to the Canadian Securities Administrators on their continuous disclosure
policy, and we have specified what "social'' means. It refers to the various impacts that a company has on its
stakeholder groups. We are leaving it open-ended.
Senator Tkachuk: Are you requesting that companies be mandated —
Mr. Ellmen: To disclose it, not to do anything in particular. We are not calling for a new standard of responsibility
here, but simply to disclose what their social and environmental policies are as well as their material risks.
Senator Tkachuk: Do they write a report?
Mr. Ellmen: That is right. Some corporations do sustainability reports that are attached to the annual reports or
submitted separately. What we are calling for is similar to what the corporations are now doing on a voluntary basis, to
make that a requirement.
Senator Tkachuk: Is that not the best way to keep it? First, it would be difficult for small companies to do it.
Secondly, if companies want to attract dollars for investments that your pension funds or your investment funds are
looking for, does that not give them a great deal of incentive to do that, because people are looking at investing that
Mr. Ellmen: That is true. For the companies that want to do this as a positive thing, nothing would prevent them
from being industry leaders on human rights, for example.
We feel that requiring companies to report on their policies will gradually move them along that spectrum.
However, the most significant factor is we will also be requiring companies to report on social and environmental risks
of a material nature. For example, carbon content, in oil and gas companies, and their Kyoto Protocol-related risks
would be disclosed in a more forthright way.
Senator Tkachuk: They have to be disclosed because of government action. In other words, before Kyoto, there was
no risk. Now that there is Kyoto, maybe there is a risk, but maybe not. I do not care whether or not companies do this.
It is good if they do and they want to attract the money you have to invest, and if they want to show they are
environmentally friendly, social responsible and so forth.
I find it difficult to get my head around how they would do it, especially if it is mandated. You have lawyers,
government and regulators, and right now companies are doing it because they want to attract investment dollars, to
be good corporate citizens and for all the right reasons. Why do you not lobby pension funds to look more at
companies that do that? Is that not better?
Mr. Ellmen: We feel it needs to be written into the securities regulations as a reporting requirement because so few
companies right now do report on these issues. For example, there was recently a report by the World Resources
Institute looking at 16 multinational oil and gas companies and their disclosure of risks under the Kyoto Protocol.
Only three of the 16 mentioned it at all, which is unbelievable when you think of the potential impact that will have on
their balance sheets.
We see it more as a disclosure of risk issue than a positive issue, but we also recognize that companies should be
encouraged to report on their social and environmental policies as well, to try to move the corporate community along
Senator Tkachuk: Companies, in turn, can say they are not reporting on any of that because they do not think it is
worth the money. They are here to get the highest return on investment and compete with all the companies that are
doing it. There would be nothing wrong with that, either.
Mr. Ellmen: That is right.
Senator Tkachuk: You will not invest in it, but other people who want a good investment will.
Mr. Ellmen: It is just to put companies on an even playing field, so they all have to report to a single standard.
Senator Tkachuk: I have your testimony. I do not want to argue with you.
You mentioned that corporations with positive social and environmental records have superior stock performance.
Could you give me examples of those companies?
Mr. Ellmen: Our association represents the investment community. Therefore, I am not in the business of doing
social and environmental ratings. I cannot give you specifics, but I can point to data that is in the report as well.
Innovest Strategic Value Advisors, a Toronto-based company that is represented around the world, has commissioned
research that looks at companies listed on various stock exchanges and how they rank on what Innovest calls the
efficiency scale.'' They found that companies that rate highly on that scale have had an annual return — I believe it is
in the report — of over 12 per cent, compared to the S&P 500, which is at about 8 per cent per year. Over the five-year
study, there was a three and a half percentage difference in the overall performance of the stocks.
Senator Tkachuk: Did they start that way, or is it just that as they matured, they said, maybe they should be more
environmentally friendly? They spent 10 years building the company and now want to change. In other words, is this
long term, start-up or in the middle?
Mr. Ellmen: They did do an analysis of various factors that went into that. They included industry sector, age of the
company, some particular technical and stock market factors, and they found at the end of that statistical analysis that
there truly is an eco-efficiency factor.
Senator Tkachuk: You mentioned Talisman, the refinery in Sudan. Now that the state-owned corporation of the
Government of India has bought the refinery, will you advise your pension funds not to invest in India at all?
Mr. Ellmen: That is a good question. This was just announced in the last few days, so the people in our community
are still grappling with it. My understanding is that the Indian oil company that bought it is state owned, so I do not
believe it has any stock market float anywhere in the world.
Senator Tkachuk: The country of India owns that company. Why would you be investing in India at all?
Mr. Ellmen: Our investors make decisions on a company-by-company basis, not a country-by-country basis, with
some exceptions. Burma, for example, is an exception. Many of our members will not invest in Burma at all because it
is under international sanction. India is not in that situation right now. Therefore, on a company-by-company basis,
there could be companies that operate in India that, at the leadership end of the spectrum, have good codes of conduct
and high standards. Just because the state oil company of India has invested in Sudan does not rule out those public
companies for investment by our members.
Senator Tkachuk: You sound like the Government of Canada. We can trade with China, which is a big country. It is
easy to pick on a little company in Calgary and get it to divest. To me, human rights are human rights.
India is now the abuser, or at least their policies are abusive. Supposedly they are the same kind of abuser as
Talisman from Calgary was. It seems to me you have to be consistent in some way.
Mr. Ellmen: There have not been many examples where an entire country has been subject to a boycott. South
Africa was one, and Burma is another.
Senator Tkachuk: They are your investment dollars.
Mr. Ellmen: Generally speaking, the social investment community makes a decision, along with the international
community, to boycott a particular country. In the case of South Africa, literally all the Commonwealth countries were
boycotting it, as were quite a number of other countries. It is the same for Burma.
Senator Hervieux-Payette: We once had Caisse de dépôt in Québec, where the pension fund could buy shares per
some legislated percentage. They removed that. Of course, we saw the results thereafter. When some people are the
trustees for numerous people's pensions, the insurance industry has compulsory guidelines imposed by legislation,
which is being monitored closely. You will see the inspector of financial institutions coming in to ensure that they
respect the guidelines. The banks also have guidelines when it comes to the kind of investments that can be made.
Pension funds have no such guidelines. There is no legislation, no guidelines and no supervision. I am not aware if
they are limited in any way. They could probably have the entire pension fund in one place. Perhaps they have internal
guidelines, but I am talking about having a public policy applied to pension funds, even though it might be mostly
provincial jurisdiction. What is the view of your group on the protection of these pension funds?
Mr. Ellmen: I am not an expert in pension regulation; however, I do not think that is quite correct. I believe that the
Office of the Superintendent of Financial Institutions, federally, and the provincial regulators in this area do keep a
watch on pension funds. People in the pension fund industry have explained to me that certain tests are done of
pension funds to ensure that they have assets that are sufficient to pay their liabilities in case a company, for example,
There is a certain amount of regulation in the pension fund industry at present.
Senator Hervieux-Payette: There were some rules about foreign investment, for instance. However, they found a
way to increase the foreign investment by some kind of artificial legal means.
I am uncomfortable when we are doing indirectly what we cannot do directly. What would your group recommend
with regard to these rules? Should we always go by the backdoor when the rule at the front door does not suit our
Mr. Ellmen: You are probably talking about futures and hedging strategies, senator, that allow some pension funds
to boost their foreign content. Our group generally feels that the foreign content restrictions are there for a purpose, to
ensure that tax-assisted retirement dollars are invested in Canadian markets. We agree with that and feel they should
be abided by.