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Regulation Strangulation
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Regulation Strangulation

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Thomas Caldwell, Chairman of Caldwell Securities, presents "Regulation Strangulation" at the 19th Annual Empire Club Investment Outlook in Toronto on January 3, 2013.

Thomas Caldwell, Chairman of Caldwell Securities, presents "Regulation Strangulation" at the 19th Annual Empire Club Investment Outlook in Toronto on January 3, 2013.

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Regulation Strangulation Regulation Strangulation Document Transcript

  • 1119THANNUAL EMPIRE CLUBINVESTMENT OUTLOOK LUNCHEONTHURSDAY, JANUARY 3, 2013Thomas S. CaldwellChairman, Caldwell Securities Ltd.tcaldwell@caldwellsecurities.comTOPIC: “Regulatory Strangulation”The task of an investment manager is to identify a trend and workwith it. The trend I plan to discuss, we must work against becauseof the existential threat it poses.I believe this may be the most important and possibly the mostdangerous talk I will ever give. My concern is I do notcommunicate the topic effectively in the time allotted, or mycomments are relegated to just “a cry in the wilderness”.We are now at a point where a major impediment to economicgrowth, job creation, innovation and business formation isregulatory strangulation within the financial services sector.
  • 22Before I am pounced upon by regulators and media, let me statethat I have, throughout my career, been a strong advocate forintelligent, clear and effective securities regulation for theprotection of investors, the securities industry and our country’seconomy.We have now gone far beyond that into the realm of regulatoryoverkill or strangulation, under the mantra that “more is better”.This has gone on undetected by politicians who do not see thecomplex issue of capital markets as having any political upside.The unintended consequences of unfettered regulators continuallyelude our law makers.The growth in size of the Ontario Securities regulations and thoseof their accompanying industry sub regulator (IIROC) has beengeometric over the years with, in my opinion, with a paralleldeterioration in investor protection. (Display relative size of Regs)
  • 33The fact that the great scandals have occurred as regulations havebecome more numerous is partly because of mis-focus and partlybecause of massive regulatory volume burying what is reallyimportant. Bre-X and Sino Forest are cases in point, with the latterbeing a replica of the former. Auditors indeed have someresponsibility here but regulators should have spotted Sino, with itsidentical modus operandi to Bre-X, on day one.Despite large, missed scandals and slow follow-up when spotted,regulators, seeking to expand their mandates and staff, insist onfocusing on the retail investor and stacking up more and moreobligations on the financial services sector, particularlyindependent brokers and advisors. Small investors are now toorisky and too costly to serve by independents who generallyprovide more personalized service and broader advice. Thus,retail investors are shoved into the wholesale products of theindustry’s larger bank controlled firms.
  • 44To assist regulators, let me inform them that the retail investor islong gone from the investment scene and they only return withtheir lawyers for an easy touch to regain long ago losses. Yes,there are legitimate claims but this is now a growth industry –spurred on by media and regulators alike.For the record, if exchanges stripped away high frequency trading(a practice indirectly encouraged abetted by regulators), thevolume of trade by individuals would be a small fraction ofhistorical numbers.Further, our regulators sponsor with our fees and governmentfunds, their own lobby group which, for example, recentlypublished a report, or should I say a reprint of a news paper article,effectively stating that investment advice was more or lessuseless. Anyone opposing their lobby group (“FAIR”) is brandedas un-“FAIR”. This is like the fire department hiring someone to
  • 55run up and down the streets yelling “fire” in order to get more fireengines and bigger budgets. Regulators are now expanding their“concerned” lobby group sponsorships.I would remind regulators that their task it to assist in building ahealthy financial services environment not to destroy it.Rarely a day goes by without our industry being slagged by media– usually fed by regulators.The recent “trailer fees” headline is a case in point. Mutual fundsare sold not bought. Not holding them long enough is the greatand common investing error. Keeping investors in place duringtough markets is a valuable role. Deliberations in the press by theCanadian Securities Administrators are highly disturbing. It is likethe CMA issuing a release “patients still dying while under medicalcare. Doctors over-paid”.
  • 66Non-major violations of OSC regulations are typically branded as“acting against the public interest”, which to the public sounds likea crime against humanity.The Ombudsman for the Financial Services Industry tries to punishfirms that disagree with their judgements in the media. That hurtsevery firm in our industry.To some degree it is self promotion by regulators at the expense ofthose they regulate – a recurring theme. Looking at the above, onecould easily ignore the fact that billions of dollars change handseach day in hundreds of thousands of transactions by tens ofthousands of people who are both hard working and highly ethical.Let me provide some overkill perspective using the U.S.experience.1) The villans from Tyco, Enron and Worldcom were already in jail,yet optics driven government and regulators, came up with the
  • 77Sarbanes-Oxley regulations (“SOX”) which have cost corporations(hence investors) billions of dollars in compliance costs, withoutsaving investors one dollar. “SOX” may, in fact, have contributedto the financial crisis of 2008, as corporate directors focused moreon “SOX” requirements and penalties than corporate risk. “SOX”also raised the cost and risk of being a public company toexorbitant levels. New public issues, international listings and theU.S. economy in general have all been directly and negativelyimpacted by “SOX”.2) The banking crisis arose because regulators agreed to scrapthe Glass-Steagall act which separated commercial banking frominvestment banking and kept the U.S. banking system secure foralmost 70 years. With its removal, investment bankers had accessto customer deposits and the rest is history.Glass-Steagall’s replacement, Dodd Frank has more words in itsguidelines (not specific regulations) than the Old Testament, New
  • 88Testament and Koran combined. Glass Steagall was 53 pages intotal – policy and rules.The theme of simplicity, to complexity, to gaming, to moreregulations continues in other areas such as shorting stocks(removal of the “up-tick” rule), to allowing anyone with a computerto set up a securities exchange.A clear result of this regulatory thicket is the complete demise ofthe NYSE to a simple tag end of an upstart commoditiesexchange. This has massive economic implications.Canadian regulators, mesmerized by America’s slow suicide aredetermined to appear tougher and their sub-industry regulator,even tougher. The U.S. economy has size and depth in its favourto partly absorb regulatory over-reach and abuse. Canada lacksthat bulk and is at a different historical phase in its development.Our imitating U.S. knee jerk regulatory changes is removing the
  • 99opportunity for Canada to becoming a world financial centre – a“Switzerland of the North”.Securities regulations should be simple and clear in order toeffectively police and to comply with. That is far from the currentcase. As one securities firm’s compliance officer recently stated:“I need roller skates just to keep up”. Compliance now comprisesbetween 30% to 50% of administration costs for independentbrokers and advisors. That is simply not sustainable as regulatorshave lost all sense or concern for the costs and consequences oftheir actions.The immediate Canadian consequences of unchecked regulatorycompetition to be the toughest and most restrictive is as follows:1.) Investors are being deprived of investment choices, interms of both products and service providers. Although ourbanks are also suffering from regulatory overkill, they have
  • 1010size and diversity to sustain their business models.Independent firms do not. They are dying.2.) Entrepreneurs and innovators are being starved forfunding to try new things. Banks fulfill a key roll in oureconomy but backing new or small enterprises with equityinvestment is not one of them. Apple, Intel, Microsoft, RIMplus hundreds more, including many of our large resourcecompanies may never have got off the ground in our currentCanadian regulatory environment. Remember ---smallerindependent brokers finance new enterprises. Kill the former,the latter dies or goes elsewhere.3.) Mis-focus and not knowing what is important on the partof regulators have allowed and indeed encouraged an overlycomplex financial market to develop (multiple exchanges,dark pools etc.) along with the replacement of real investmentwith gaming between exchange venues on the basis of feediscrepancies (“taker-payer” models). This high frequency
  • 1111trading now accounts for a significant portion of all equitytrading. Note - you are not an investor if your holding periodis a fraction of a second. Regulators, conned by thegamesters, continually parrot the line “it adds to liquidity – andcuts costs” – nonsense.In addition, the folks with faster computers or better programsare continually able to jump in front of legitimate investors.4.) The destruction of “open and visible” trading markets, assanctioned and encouraged by regulators, has now undercutthe basis of all investment and trading, that is the accuratedetermination of the price at which a trade should take placeor “price discovery”. It is too easy now to fix prices.
  • 1212Many individual investors now see the game as riggedagainst them and are opting for other investment choices, eg.commodities, condos, land etc.5.) Companies seeking financing are now avoiding publicmarkets whenever possible. They currently seek funding inthe private capital world or, in the case of the U.S., U.K. andAustralia, “crowd financing” on the internet. Anything to avoidthe regulatory costs and threats of public markets. A goodillustration is the information overkill of prospectuses, whichonly protects the lifestyle of those who write them. No oneelse reads them.6.) The main concern of industry regulators still appears tobe procedures and paper trails versus substance. Primaryfocus areas seem to be along the lines of how up-to-date newaccount forms are. One firm was recently fined for doing the
  • 1313right thing but not having a written procedure for doing theright thing.Soon regulators will be contacting individual investors directlyto check on a firm’s documentation – assuring those clientsthat nothing is amiss with their advisor firm. That will not bethe client reaction.The new Client Relationship Model will complete the overkilland is similar to holding car salesmen responsible for allfuture breakdowns or accidents. This should keep brokersfully focused on paper trail.With every crisis, the regulatory strangulation is acceleratedwhether relevant or not to the individual securities industryregistrant. As Oscar Wilde said, “The bureaucracy has toexpand to meet the needs of an expanding bureaucracy.”
  • 1414I could go on but time limits.A few suggested solutions:1.) Take the Ontario Securities Act and start by cutting it inhalf, to the point of reality and addressing what is important toall. Remove redundant, dated and unnecessary regulationsand go back to principles and goals based regulation. Stopfunding lobby groups whose role is to slag the investmentindustry and aggrandize regulators.2.) Regulate the regulators, at all levels. A mechanismmust be established to curtail regulatory abuse other thanappealing to the regulator itself, whose only interest isbuilding upon what already exists – despite the cost andoverall economic consequences of their actions and inaction.
  • 15153.) If I ran a province (the domain of securities regulation) Iwould take the regulatory function in house at the provincialsecurities commission level and focus on a smaller sub-set ofregulations that are meaningful for good governance anddisaster prevention.This step is particularly important to provinces other thanOntario as, in my opinion, a national industry sub-regulatorusing a “one size fits all” model can be regionally destructive.Further, I believe farming out regulation has removed broadercapital market accountability. Also, self funding of regulatorshas let to self aggrandizement.Keep in mind that throughout my career I have also been astrong advocate of a national securities regulator. I did notforsee the extent to which regulators would lose sight of theiroverall function and simply opt for bulk or empire.
  • 1616This talk is supposed to end with some investmentrecommendations:I would like to give you two guaranteed winners and onereasonably good recommendation.1.) Do an IPO on any securities regulator or sub-regulator.Imagine an industry where you can fine your customers fornot using your products – no matter how irrelevant. Remindsone of the “Dilbert” cartoons.2.) Failing that, try to get legal firms specializing in securitieslaw to issue public shares. Most spend their time oncompliance now versus deals. Remember, regulators are theonly people on earth who believe hiring more lawyers willsolve a problem.
  • 17173.) Finally, a non-guaranteed investment group would beCanada’s major banks, because their massive dominance(80%) of the Canadian investment industry will become total(100%) as a result of the regulatory strangulation of all of theirindependent competitors. Has anyone noticed manyindependent trust companies, auto leasing companies,mortgage insurance companies of late?Bottom lineAt present, with no effective check on securities industryregulators, they have become destructive forces impacting thepublic, the securities industry and the economy as a whole.My MessageThe Regulators themselves need to be regulated.