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Fostering Investor Confidence in Canadian Capital Markets
June 8, 2006
The International Monetary Fund has "expressed confidence in the stability of Canada's financial system." [1]Canada's capital markets support a growing and diverse economy, attracting domestic as well as international investment in the face of rapidly evolving and competitive global markets. In order to continue to be effective engines of economic growth, Canada's capital markets must consistently engender a strong sense of confidence among investors.
In late 2001 and throughout 2002, reports of major corporate fraud and misconduct in the U.S. and elsewhere shook investor confidence and raised questions about the integrity of capital markets and their participants, including company executives, directors, external auditors, securities analysts and credit rating agencies. The impact of these scandals was felt throughout the world.
In Canada, actions have been taken by governments, regulators and industry to foster investor confidence in capital markets. Efforts have focused on strengthening enforcement, improving financial reporting and disclosure, enhancing the quality of the audit process, and strengthening corporate governance and management accountability. Reforms have involved a wide range of participants, and special attention has been paid to the unique features of Canadian capital markets.
Summary of Canadian Measures[2]
(i) Strengthening Enforcement
The federal government adopted a coordinated national enforcement approach to strengthen the investigation and prosecution of serious corporate fraud and market illegality. Up to $30 million a year was allocated for this approach, which included the creation of integrated market enforcement teams (IMETs) with the Royal Canadian Mounted Police (RCMP) in Canada's major financial centres. Six IMETs are currently operational in Canada. Three IMETs are in Toronto, with one IMET located in Vancouver, Montreal and Calgary, respectively. The plan is to set up one additional IMET in each of Vancouver, Montreal and Calgary.
Amendments to the Criminal Code to provide tougher penalties for those convicted of corporate crimes and new criminal sanctions for improper insider trading and retaliation against corporate whistle-blowers came into force in September 2004. Provincial governments have bolstered the enforcement framework for securities laws, including modernizing securities offences, increasing penalties and broadening the investigative powers of their securities commissions.
Federal, provincial and territorial regulators and law enforcement agencies maintain strong ties and cooperate with their counterparts in other jurisdictions, in order to ensure effective enforcement of all capital markets offences.
Legislation implementing civil liability for secondary market disclosure has been proclaimed in some jurisdictions and is being considered by several others. This legislation provides investors with broader rights to sue an issuer, its directors and officers, certain influential persons, experts and spokespersons, for disclosing false and misleading information or for failing to disclose information that should have been disclosed. It will strengthen the accountability of issuers and provide a strong incentive to improve the quality of public company disclosures.
(ii) Improving Financial Reporting and Market Disclosures
The bodies that regulate Canada's accounting and securities industries have made changes to their rules to bring them in line with evolving international best practices.
Canada's Accounting Standards Board (AcSB), the body responsible for establishing standards and guidance for financial reporting in Canada, recently completed several important initiatives.
In January 2004, new standards were implemented requiring public companies to recognize expenses for all employee stock-based compensation, making Canada the first major jurisdiction to require expensing of these transactions. Also, in June 2004, new requirements dealing with the disclosure of employee future benefits, designed to improve transparency regarding corporate pension plan performance, became effective.
As well, in January 2005, the AcSB issued new standards for financial instruments, specifying when instruments should be recognized on the balance sheet and how they should be measured. The standards require that certain categories of financial assets and liabilities (e.g., derivatives) now be measured at fair value. The standards, which become effective in October 2006, bring Canada more in line with the U.S. and international environment.
In March 2004, securities regulators implemented enhanced continuous disclosure measures, which include shortened filing deadlines for financial statements, updated and expanded annual information form requirements and new requirements for filing business acquisition reports, requirements for boards of directors to review the Management Discussion and Analysis (MD&A) section in financial reports, and requirements for the MD&A to contain more forward-looking information. In addition, the Investment Dealers Association of Canada (IDA), a self-regulatory organization, finalized new rules to promote the independence of research analysts employed by securities firms in February 2004.
A special task force on insider trading commissioned by securities regulators released a report in November 2003, which made 32 recommendations for preventing, detecting and deterring illegal insider trading. Many of these recommendations have been implemented, while others are being analysed by securities regulators.
(iii) Enhancing the Quality of the Audit Process
Regulators and professional organizations reviewed the framework governing public company auditors. This has led to a number of important changes, including the establishment of the Canadian Public Accountability Board (CPAB) to review the practices of public company auditors. The CPAB has issued two public reports on the results of its inspections, in October 2004 and August 2005.
The Auditing and Assurance Standards Oversight Council was created in October 2002 to oversee the activities of the Auditing and Assurance Standards Board (AASB), which sets professional standards for the provision of assurance and related services in Canada. The AASB continues to develop robust standards to help public accountants better meet the expectations of preparers and users of financial statements, and to ensure that the public interest is being served.
The following significant new auditing standards have been recently issued by the AASB:
- Audit risk (provides guidance on how auditors should identify, assess and respond to the risk of material misstatement of financial statements).
- Quality control (two standards providing guidance on the quality control policies and procedures applicable to assurance engagements to be established by a public accounting firm and specific quality control procedures to be performed by the public accountant and other members of an engagement team in an assurance engagement).
- Terms of the engagement (provides guidance on establishing an understanding of, and agreement on, the terms of the engagement for the audit of financial statements).
- Management representations (provides guidance on the use of management's representations as a complement to, but not as a substitute for, other audit procedures that the auditor performs to obtain sufficient appropriate evidence to be able to draw reasonable conclusions on which to base the audit opinion).
In addition, new auditor independence standards were adopted in Canada, effective for engagements starting after December 31, 2003, incorporating the principles-based framework developed by the International Federation of Accountants, and supplemented by provisions that are consistent with the auditor independence rules adopted by the U.S. Securities and Exchange Commission pursuant to the Sarbanes-Oxley Act. The standard includes certain prohibitions on the provision of non-audit services to audit clients and also requires the firm to identify any threats to independence and to apply appropriate safeguards. Compliance with auditor independence standards is required for all public company auditors as a condition of their participation in the CPAB.
(iv) Strengthening Corporate Governance and Management Accountability
Canada has a strong tradition of fostering sound corporate governance and has been recognized internationally as having strong practices in this area. In the mid-1990s, with the leadership of the Toronto Stock Exchange, Canada was among the first countries to implement improved governance and mandatory disclosure.
Canada's securities regulators have adopted rules governing audit committees, as well as CEO/CFO certification of financial statements. These steps were designed to strengthen accountability and improve the quality of financial disclosures. The audit committee rules require all reporting issuers to have an audit committee that is responsible for nominating the external auditor, pre-approving all non-audit services provided by the auditor, and reviewing all financial disclosures. Companies listed on the Toronto Stock Exchange (TSX) are required to have audit committees that are fully independent and financially literate. For their part, TSX Venture Exchange issuers and unlisted issuers are required to disclose which audit committee members are independent and financially literate. The certification rule, applicable to all public companies, requires CEOs and CFOs to attest to the accuracy of their company's financial statements and other financial information and will in time require certification of disclosure controls and internal controls over financial reporting.
In June 2005, securities regulators implemented corporate governance measures, applicable to public companies, consisting of a set of guidelines combined with disclosure requirements. As with the audit committee rule described above, smaller public issuers are subject to more flexible requirements.
Institutional investors have been active in pushing for reforms in corporate governance practices at Canadian public companies. A number of large Canadian institutional investors established the Canadian Coalition for Good Governance (CCGG) to share information and improve governance practices. The Coalition has published corporate governance guidelines for boards of directors and has been actively promoting good governance practices across Canada.
The federal government has been actively consulting with the CCGG and other stakeholders on corporate governance matters and has been considering these issues in the context of the Canada Business Corporations Act (CBCA). The CBCA contains a statutory requirement that it be examined by a committee of Parliament to be constituted no later than November 2006. While the composition and mandate of the committee have yet to be decided, it is likely that a variety of corporate governance issues will be examined in the context of the review.
Conclusion
Investor confidence in the integrity of capital markets is critical for a well-functioning economy. The collapse of Enron and other financial scandals caused investors to question whether financial abuses, conflicts of interest, and mismanagement are endemic to the system. To strengthen the integrity of capital markets and bolster investor confidence in those markets, governments, regulators and industry in Canada, the U.S. and other countries have undertaken significant reforms.
In Canada, significant actions have been taken to strengthen enforcement, improve financial and other disclosures, enhance the quality of the audit process, and strengthen corporate governance and management accountability. Reforms have recognized the unique nature of Canadian capital markets and Canadian systems of regulation. Close coordination among industry, regulators and governments has been important for achieving many of these improvements in a timely fashion.
Governments, regulators and capital market participants will continue working together to ensure that the standards for capital markets and public companies in Canada remain of the highest order.
1 Source: 2005 IMF Article IV Consultation Report on Canada. [Return]
2 This document is not exhaustive and does not include all initiatives taken by individual provinces, standard-setting bodies and self-regulatory organizations. [Return]
