Introduction

The Minister, in his release announcing a draft bill for a new Canadian Securities Act (the Bill) or as a PDF doc.1703, repeats a statement which has become his mantra, that Canada is the only major industrialized country that lacks a national securities regulator. This invites the public to measure the Bill against legislation in those other countries. For numerous reasons, most of which are too obvious to require repetition, a comparison with the situation in the US is the most appropriate.

The desire of the federal government to assume jurisdiction over securities goes way back, to at least 1935. So it has had plenty of lead-time to come up with legislation that demonstrably would improve the plight of Canadian investors. And since issuers, dealers and mutual fund and other institutional investors have the resources and expertise to defend themselves, the validity of any new securities legislation must be judged by how well it protects the interests of the retail investor. Never forget: without the retail investor, dealers would have no clients, institutions no pools of capital to invest, and issuers would have no liquid, active markets for their securities.

Therefore, in this commentary, we will look at how the Bill stacks up, in particular in addressing current weaknesses in Canadian retail investor protection, using the US as our benchmark; for more on this comparison, see Retail investing in the U.S. and Canada: a comparison on our site IndependentInvestor.info .


Current weaknesses of the Canadian securities system

Fraud and theft, for obvious reasons, sell newspapers. And it is no different in the fields of securities and investments. And the recent tragic events, such as the Bernie Madoff affair, may give the public and even regulators, the impression that this is where investors typically lose their hard earned money. In this view, more active, coordinated anti-fraud enforcement is the answer. But Canadian market participants know better.

Far and away the biggest source of loss for Canadian retail investors are the excessive, routine, day-to-day costs in the system. How much are we talking about? In the tens of billions of dollars, year after year; see for example Robert Pouliot’s estimate doc.1559  in How to find a mutual fund manager blindfolded with your hands tied behind your back on our site
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Why don’t retail investors recognize it? It may be similar to the frog in hot water story:

The boiling frog story is a widespread anecdote describing a frog slowly being boiled alive. The premise is that if a frog is placed in boiling water, it will jump out, but if it is placed in cold water that is slowly heated, it will not perceive the danger and will be cooked to death. The story is often used as a metaphor for the inability of people to react to significant changes that occur gradually. Source: Wikipedia

• a financial system characterized by a relatively small number of major financial institutions. Of course federal legislation setting out maximum ownership levels for Canadian chartered banks undoubtedly have, and continue to, greatly contribute to this.
• provincial rules that prevent very low-cost US mutual fund organizations from directly selling their products to Canadian investors. It is most ironic, to say the least, that the Canadian banks, who through their dealer subsidiaries are the principal beneficiaries of these protectionist rules, can with a straight face argue for a national securities regulator because this would, in their words, free trade in securities with other key jurisdictions and would allow Canadians to acquire these securities in an efficient and cost-effective manner; see the CBA 2008 submission to the expert  panel Enhancing Canadian competitiveness by reforming the way securities are regulated in Canada , p.4 or as a PDF doc.1704. 
• the absence of regulations that would mandate fund structures that force the funds to act in the best interests of the fund investors. In the US, rules mandate that fund boards have a majority of independent directors. No such requirement exists in Canada.
• In the US, investment advisers must act in the best interests of their clients, notably when recommending mutual fund investments, and pressure is increasing to impose a similar obligation on brokers. No such requirement exists in Canada.

Asset Allocation

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