Recently, at an evening seminar co-sponsored by CFA Society Toronto, CFA Institute and the Schulich School of Business and at a meeting of the Institute of Corporate Directors, Maureen Jensen, Executive Director and Chief Administrative Officer of the Ontario Securities Commission (OSC), discussed the commission’s new strategy for anticipating and responding to the fundamental changes occurring in the capital markets as well as how it is responding to current issues.

Ms. Jensen told attendees that as the global capital markets undergo transformational changes the OSC must also change its strategic direction. Market structures are evolving around the world as technology revolutionizes how securities are traded. New innovative investment products continue to come to market. The capital markets are moving faster and are more interconnected. In addition, the scope of securities regulation continues to widen, and the regulation of OTC markets and some systemic risks are now core functions that the OSC must undertake.

New Strategic Direction

In December 2011, the Supreme Court ruled that the proposed Canadian Securities Act was unconstitutional, which halted the recent Canadian Securities Transition Office initiative to establish a national regulator. The OSC was disappointed in the ruling but has developed a three-year strategic plan to make improvements to securities regulation in Ontario and to focus its efforts on the key issues in the marketplace.

The plan contains six major strategies that will influence programs and operations throughout the organization, including compliance and enforcement:

• expanding the OSC’s research and analytical capability;
• engaging investors more effectively;
• improving internal policy coordination and priority-setting;
• aligning operations and programs with goals and priorities and developing and reporting on key performance indicators;
• improving risk identification and management; and
• delivering excellence in execution of programs.

These strategies are designed to interact with and complement each other as part of a comprehensive plan to change the way in which the OSC works and responds to issues.

An example is the OSC’s new research and analysis group, which also supports the strategy to engage investors and facilitates policy prioritization. The research group produces focused research on current issues in Canada’s capital markets. This research helps to shape the OSC’s thinking on issues and allow it to make more informed policy choices. The research and analysis group supports efforts to improve the identification and management of risk. An emerging risk committee within the OSC is collaborating with operating branches to identify emerging risks in advance, instead of waiting until these risks become large problems in the marketplace.

The implementation of the strategic plan is underway and is being completed in stages. The six strategies are expected to support and complement the OSC’s five organizational goals to:

• deliver responsive regulation;
• deliver effective enforcement and compliance;
• deliver strong investor protection;
• run a modern, accountable, and efficient organization; and
• support and promote financial stability.

The goal to support and promote financial stability is a new one and has become a priority for all securities and other prudent regulators after the financial crisis of 2008–2009. The OSC is working closely with the Bank of Canada on this goal as well as cooperating with other regulators and agencies to mitigate systemic risk and promote financial stability.

Significant initiatives currently underway include:

• OSC Emerging Markets Issuer Review;
• Shareholder Democracy; and
• Shareholder Rights Plans.

Emerging Markets Issuer Review

As public concerns rose about several emerging market issuers, the OSC initiated a review to assess the quality and adequacy of the disclosure, board, and audit committee practices of selected Ontario reporting issuers that are listed on Canadian exchanges and have significant business operations in emerging markets. The OSC examined 24 reporting issuers whose “mind and management” are largely outside of Canada and whose principal active operations are in emerging markets. The OSC also reviewed the adequacy of the gatekeeper role played by their auditors, underwriters, and by the exchanges.

The OSC dealt directly with the issuers and their advisers and consulted with the Canadian exchanges, the Canadian Public Accountability Board (CPAB), and other provincial securities commissions.

While much of the information that the OSC examined is protected by confidentiality provisions in the Canadian Securities Act, it has released a report on its website (osc.gov.on.ca) to discuss, in general, its concerns and matters that need to be addressed for public protection.

One important concern was the apparent “form over substance” approach to compliance with applicable standards for disclosure, issuer governance, board oversight, audit practices, and due diligence practices. The OSC found that the rigour and independent-mindedness applied by boards, auditors, and underwriters in carrying out important duties—such as management oversight, audit, and due diligence on offerings—should have been more thorough.

It appeared that some boards and audit committees had an inadequate level of engagement in their oversight of management and in their sense of responsibility for the stewardship of the issuer. The OSC found cases where boards appeared to have little contact with senior management in the emerging market jurisdictions and did not understand or address the key risks or issues within the companies.

The OSC had concerns about the extent of knowledge of some boards and audit committees of the key cultural and business practices impacting the issuers in the jurisdictions in which the issuer operated. In certain situations, it appeared that the board was not aware of environmental factors that could have a significant impact on the issuer disclosure, reporting, and ownership, such as banking practices and legal title to assets.

The OSC also observed situations in which board members apparently relied solely on a member of management to provide overviews of key business documents in another language and did not obtain appropriate English translations or question their accuracy in order to assess the documents independently.

There were 24 recommendations flowing from the review, many of them relating to governance and auditing practices (details are available on the OSC website). The emerging market issuers, their auditors and underwriters, and the exchanges are expected to take action to address these concerns.

On the auditing recommendations, the OSC is consulting with the CPAB. It has started discussions with the Investment Industry Regulatory Organization of Canada on the underwriter recommendations, and in regard to governance recommendations, it may release additional guidance to issuers with the Canadian Securities Administrators (CSA) or work with groups such as the Institute of Corporate Directors or the Canadian Coalition for Good Governance. The OSC believes that the governance practices of an issuer should never take a “form over substance approach.”

Shareholder Democracy and Shareholder Rights Plans

The debate about the proper allocation of authority between boards and shareholders of issuers within capital markets has focused on shareholder democracy issues and on the role of the board in adopting shareholder rights plans in response to hostile bids.

There have been increasing demands for regulatory intervention to:

• facilitate shareholder empowerment;
• reform the proxy voting system through which shareholder rights are exercised; and
• address potential risks of the increasing influence of third-party proxy advisers over voting decisions by shareholders.

There are three areas of shareholder democracy that the OSC has been considering:

• whether it should mandate individual director elections and majority voting for directors;
• whether it should mandate shareholder advisory votes on executive compensation (say-on-pay); and
• the effectiveness of the proxy voting system.

The OSC is working with the TSX to address concerns about the director election process. The TSX has proposed that:

• directors of listed issuers be elected individually and not by slate; and
• listed issuers disclose whether they have adopted a majority voting policy for the election of directors.

OSC staff and the TSX are discussing the comments received on the proposal relating to the adoption of a majority voting policy for TSX-listed issuers. The OSC encourages all reporting issuers to adopt a majority voting policy.

The OSC is addressing concerns that market participants have identified concerning the transparency, efficiency, and accountability of the proxy voting system and is currently considering the appropriate regulatory response. It has also heard concerns about the potential role of proxy advisors in influencing shareholder voting, and the CSA is formally soliciting stakeholder feedback about these issues. The OSC believes it is now time to review the role of proxy advisors.

The OSC believes that addressing the issue of shareholder rights plans in the context of a discussion of shareholder democracy is important. The CSA’s regulatory approach to rights plans is based on Commission decisions interpreting the national policy on defensive tactics. This interpretation has effectively meant that the role of target boards in responding to a hostile bid is limited to using a rights plan to solicit a better offer, usually through an auction. The OSC believes that this approach needs to be revisited in light of the significant market, governance, and regulatory developments that have occurred since the policy was adopted in 1986.

As a result, the OSC is working with the CSA on considering a transparent framework for rights plans that allows target boards more latitude in responding to hostile bids if shareholder approval of the rights plan has been obtained. The OSC believes that it is important that the decision on how to respond to a hostile bid be left to an issuer’s board and its shareholders rather than be made by regulators in hearings on an ad hoc basis. This is a significant change that reflects its belief about how shareholder democracy should work in the context of hostile bids.

OSC staff are currently working on several significant investor protection proposals, including cost disclosure and performance reporting by dealers and advisors to their clients, better and more understandable investment fund disclosure, as well as policy proposals to change the regulation of OTC derivatives, dark pools, and high frequency trading. Enforcement activity has also intensified, and the OSC has taken on several important and complex international enforcement files. The OSC remains focused on investor protection and will continue to work to provide a strong deterrent to fraud and investor harm.