Reporting on how post-Enron governance reform in Canada is brewing a national debate
'When the elephant rolls over, the mouse sleeping beside it must move.' Canadians often evoke that image when describing their relationship with their American neighbors. But just how far must Canadians jump to avoid being squished? When it comes to corporate governance, trajectory calculations began September 3, 2002 when David Brown, chairman of the Ontario Securities Commission, announced he was considering adopting regulatory measures similar to the Sarbanes-Oxley Act and the new governance rules proposed by US exchanges.
'Our approach to reviewing these initiatives is based on the assumption that it makes regulatory sense to harmonize with the US initiatives unless there are cogent reasons for not doing so,' wrote Brown in an open letter to market participants.
The missive sparked an anxious chorus of concern. Familiar with a corporate governance regime based on principles and guidelines - not outright rules - many Canadians bridled at going down the prescriptive road. Indeed, hadn't the Saucier Report, the latest in a litany of corporate governance studies dating back to 1994, reiterated confidence in voluntary guidelines based on disclosure? And didn't US-style rules merely encourage nogoodniks to seek loopholes?
Besides, Canada's capital markets are completely unlike those south of the border. While some 200 of the largest companies are interlisted on US markets, the rest have relatively tiny capitalizations compared to US averages. With little US investor interest to begin with, do they have the resources to comply with all sorts of onerous new obligations - particularly independent audit committees?
The OSC's Brown appeared ready to meet critics halfway. At a gathering of accountants in early December, Brown said, 'We need rules - but rules must be tailored to circumstances. The needs of small companies have to be considered; so do the unique situations of controlled companies.' Brown announced the OSC was planning rules requiring big companies to have audit committees composed entirely of independent directors while smaller ones would need only a majority of independent directors.
This not entirely unexpected scheme went a long way toward placating market participants worried about a 'one size fits all' approach. But the fundamental issue of balancing rules against principles in Canada's post-Enron environment remains - in particular how far the OSC may take its new rule-making power.
Every imaginable interested party has joined the debate with everything from reports and surveys to testimony at Senate committee hearings.
Essentially, but not exclusively, government operatives want a more prescriptive approach. Corporations and Bay Street want principles. Shareholders want good corporate governance that leads to good returns. Everyone wants a 'made in Canada' solution. What's certain is that the status quo will not endure.
Now it's personal
The prescriptive camp won the first round this past December when the Ontario provincial legislature passed Bill 198. Amidst a raft of legislation, omnibus Bill 198 gave the OSC more teeth to create and enforce rules including those regarding audit committees and CEO/CFO certification of financials.
IROs are especially interested because Bill 198 introduces civil liability for continuous disclosure, an idea that has been percolating up through Canada's corporate governance thought machine for years and was apparently tacked on to the bill at the last moment. Potential liability limits for issuers would be the greater of 5 percent of market cap or C$1 mn. Directors and officers would face maximum individual liability of $25,000 or 50 percent of total compensation.
While Canadian IR practitioners can now be on shareholders' hook, the new legislation has yet to send a quiver through the ranks at the Canadian Investor Relations Institute. 'Bill 198 is a deterrence mechanism for companies that might willfully manipulate securities markets as opposed to an opportunity for frivolous suits,' comments Ron Blunn, chair of Ciri's issues committee. 'There are firm tests litigants must meet to launch a suit.'
Ross McKee, partner at Blake Cassels & Graydon, agrees. He notes Bill 198's 'loser pays' formula and an intermediate screening of potential suits and claims will help weed out abuses. 'Having had the benefit of US experience, [lawmakers] are trying to adopt a system taking the best US elements while trying to avoid the worst US abuses,' notes McKee. The legislation includes defenses for civil liability, he adds. For instance, in determining guilt and awards, courts are instructed to take into account mitigating factors such as the 'nature of the responsible issuer'. In short, a good disclosure track record will earn issuers and individuals brownie points if they slip up.
McKee points out a key defense to any claim of civil liability remains the so-called 'due diligence' defense: IROs must prove they did a reasonable investigation leading them to believe there hadn't been a misrepresentation.
In an unusual twist, the legislation sets out a specific list of factors for the court to use in determining whether an investigation was reasonable. One factor is the existence and nature of any system to ensure the issuer meets its continuous disclosure obligations. 'You have to start off with a disclosure compliance system that works so it is therefore reasonable for you to rely on it,' says McKee. But Canadian investor relations professionals must go a step further. 'IROs must systemize what they probably already do via informal, ad hoc practices into formal, written and consistently followed practices.'
Pulling up their sox
In the end, of course, most investor relations officers aren't overly concerned about Bill 198 because they believe they already do a good job for ethical, well-governed companies.
Canada has had its share of corporate scandals, but its reputation for relatively good corporate governance remains intact. Much of the credit goes to the Toronto Stock Exchange, which got boards thinking about corporate governance long before their US counterparts raised the flag. Since 1995, the exchange has fostered a corporate governance regime based on disclosure. Companies not complying with guidelines must tell investors why in their annual report.
Still, the market's crisis of confidence must be addressed and Canadian investor relations officers shouldn't be surprised if more regulation trickles through their offices. For many, it will hardly change the way they do business. However, Susan Soprovich, senior consultant at PR firm GPC International, says companies must still work to change market perceptions. 'Investor confidence is getting worse,' says Soprovich. 'But the reality is Canadian corporate governance has been pretty good.'
In any event, with corporate governance the flavor of the day, regulations are merely a benchmark. 'Companies of any size should naturally implement Canadian rules but be proactive about [applying higher standards] if they are reasonable and appropriate,' advises Soprovich. 'Then tell people about it on your web site or annual report.'
One Canadian company at the head of the pack is Potash Corporation of Saskatchewan. When Enron et al left investors spinning, Betty-Ann Heggie, senior vice president of Potash Corp, was in a position to take advantage of the momentum. 'I did not take it for granted that people assumed we had good corporate governance,' says Heggie. 'I viewed it as my role to communicate how important it was to us and that we had a competitive advantage in that we had already taken care of a lot of the issues suddenly on the table.' With a strong story to tell, second quarter results included comments by Potash's CEO on the company's strides toward better corporate governance.
Bill Mackenzie, president of proxy advisor Fairvest, suggests a largely undiscovered medium for touting a company's corporate governance record is the proxy circular. 'Over the years I've seen a ton of boilerplate,' says Mackenzie. 'If you have been doing some good stuff on corporate governance, why not strut it?'
For their part, Canadian shareholders are increasingly keen to listen to a good governance story and to chastise companies not participating in a dialogue with owners. Indeed, investors are learning more and more about what it means to be the owner of a company. Look at the Canadian Coalition for Good Governance, launched in June 2002. Controlling the proxy vote for more than C$400 bn worth of assets, the group of institutional investors plans to focus on several areas of corporate governance including conservative and transparent accounting, board independence and functioning, and a fairly standard set of shareholder rights issues with respect to things like option plans and dual class share structures.
'Some institutions had been pursuing these areas on their own,' says George Lewis, president and CEO of RBC Global Asset Management. 'Now the coalition is focusing on them together. While the OSC, TSX and others work to [adapt US Sox rules to Canada] our view is that companies may as well get out in front of that now. The necessity exists regardless of the rules. Market forces will encourage them to do these sorts of things whether mandated to or not.'
Of course a stricter governance system can't stop plain crooks. 'Boards, even independent boards, can be manipulated by fraudsters,' concludes Tom Merinsky, director of investor relations at Teck Cominco. 'So while being seen to be scrupulously clean is an advantage, it boils down to corporate leaders being honest, upstanding citizens working within the spirit of the system.'
Any system - rules, principles or somewhere in between - with the spirit to incentivize that sort of behavior, will help restore confidence in equity markets. But for now, it looks like Canada will take the middle road.