Jeffrey MacIntosh: Conflict at the OSC — Why the regulator needs to make room for dissent

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Much heat has been generated lately about what’s going on at the Ontario Securities Commission, but, tragically, little light.

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The government’s appointment of Heather Zordel as non-executive chair of the OSC in March has raised some razor-sharp hackles. The Globe and Mail published a story on June 25 that relayed many pious and unflattering incantations related to Zordel’s allegedly questionable behaviour in her previous incarnation as a part-time commissioner at the OSC. Two former part-time commissioners who served with Zordel — Lorie Haber and Craig Hayman — were said to have resigned in protest of her appointment. Readers learned that five of eight part-time commissioners opposed the renewal of Zordel’s place among their ranks.

One of the bones of contention seems to be Zordel’s tendency to occasionally disagree with her fellow commissioners, taking a different view of what protecting investors entails. For example, her critics and the Globe thought it important to highlight that OSC records show Zordel was responsible for “two of only three dissents in OSC enforcement proceedings over the past decade.”

This is indeed a truly extraordinary statistic, but not for the reason put forward by her critics. As one who has taught securities regulation for several decades, I know very well there is scarcely a square inch of the securities regulatory terrain that is not fraught with conflicting policies and textual ambiguities that create a rich potential for disagreement. The virtual absence of dissent in OSC decisions raises a troubling question about the intellectual vitality of the institution. It is suggestive of a stultifying groupthink that mistrusts, discourages, and even vilifies points of view that depart from the received dogma.

How can the OSC maintain, as it often does, that it is a world-class regulator, if its underlying regulatory paradigms are entombed in granite vaults hermetically sealed against the intrusion of conflicting ideas?

The critical issue is not whether one agrees or disagrees with Zordel’s views on this or that. Rather, the central issue is the health and vitality of our securities regulatory apparatus. As a general matter, intellectual progress is born not of stasis, but of the dialectical opposition of competing ideas. This is the very essence, for example, of Socrates’ truth-seeking heuristics (i.e. “the Socratic method”). Immanuel Kant would likely never have penned his greatest work, Critique of Pure Reason, but for his intense dislike of David Hume, who he said had awoken him from a “dogmatic slumber.” More generally, as Joseph Schumpeter observed, economies relentlessly grow via “gales of creative destruction” that usher out the old and in the new. Regulators who prefer to entertain light breezes of soporific equipoise are likely to be out of sync with the activities they regulate, and hence more of a hindrance than a help to economic growth.

Along these lines, Zordel, unlike most everyone else at the OSC, comes from a law firm that services small entrepreneurial firms, and not the titans of industry serviced by her bulge bracket compatriots. This naturally gives her a different perspective on the relative costs and benefits of regulation. It is a perspective that needs to be heard — a spice to the regulatory stew that has historically been distinguished by its absence. It is a perspective that those both within and without the OSC should embrace, and not tar and feather.

The Globe story quotes a number of respected sources who asserted that Zordel is soft on investor protection. This criticism is typically uttered as if we all share a common view of what we mean by “investor protection,” and that you’re either for it or against it. This is just plain silly.

Every rule that is promulgated in the name of investor protection (or anything else) has a cost. And that cost might well exceed the benefit. Mandatory disclosure, for example, might assist in protecting investors from unwise or improvident investment decisions. But over-zealous disclosure requirements may be so costly as to drive many issuers out of the public capital markets, to the detriment not only of the economy but the investors who the rules were meant to protect. There is evidence, for example, that after the United States introduced comprehensive prospectus disclosure for public companies in the 1930s, the number of public offerings fell dramatically. Instead of raising money from public investors, many firms chose to raise capital via private placements to institutional investors. Closer to home, the number of listed companies and IPOs in Canada has declined precipitously over the past few decades (a trend that is in fact worldwide). Increased regulation is often cited as the main cause.

Generally speaking, investors are adequately protected if expected returns (adjusted for risk) are, on average, equal to realized returns. But there is no unique set of regulatory constraints — no deterministic level of “investor protection” — that satisfies this requirement. A high-level of regulation lowers the risk of purchasing individual investments, but by imposing higher costs on issuers and their advisers, the tighter rules almost certainly result in lower average returns. Light-handed regulation may yield a greater variation in individual outcomes for investors, but would increase average returns. As long as investors have well-diversified portfolios, light-handed regulation wins.

The real challenge in achieving investor protection is thus to discover that minimal threshold of regulation at which expected returns, on average, equal realized returns. That is neither easy nor straightforward. Nonetheless, it supplies a valuable heuristic, which is to keep in mind that ratcheting up “investor protection” will do more harm than good if the cost exceeds the benefit. The presence of competing views on the relative costs and benefits is clearly a boon, and not a bust, as some of Zordel’s critics would have it.

As a final observation, I note that the Globe also reported that Zordel attempted to interfere with an OSC staff investigation into a company represented by her law firm, and in which she, at one point, allegedly held shares. The peculiar thing about this is that the identities of the two sources (who are described as “sources with knowledge of the incident” and very likely OSC insiders) are withheld on the ground that they were not authorized to speak about the matter. If they were not authorized to speak, then why were they speaking? Public market actors who flout their firm’s internal disclosure rules may well find themselves in a heap of trouble with the regulators. There are good reasons for restricting disclosure to authorized persons, not the least of which is to ensure the accuracy and completeness of the information. That OSC insiders feel free to flout their own internal disclosure rules hardly instills confidence in their commitment to their regulatory mission, nor in the accuracy of the information.

Jeffrey MacIntosh is a professor of law at the Faculty of Law, University of Toronto, and a director of the Canadian Securities Exchange.