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New Governance, Compliance,
and Principles-Based Securities
Regulation
Cristie L. Ford
1
I. INTRODUCTION
The significance and wisdom of ‘‘principles-based’’ securities regulation
may be among the most pressing questions facing securities regulators in-
ternationally today. The Financial Services Authority (FSA) in the United
Kingdom moved to a comprehensive principles-based regime in 2003.
The shift attracted a great deal of interest as it came to light that in 2005,
for the first time in recent history, the overwhelming majority of the largest
international Initial Public Offerings took place in London rather than in
New York.
2
A report by consultants McKinsey & Co., commissioned by
r2008, Copyright the Author
Journal compilation r2008, Academy of Legal Studies in Business
1
American Business Law Journal
Volume 45, Issue 1, 1–60, Spring 2008
1
Assistant Professor, University of British Columbia Faculty of Law. I am grateful to Alex
Burton, Michael Dorf, Brandon Garrett, Harvey Goldchmid, Troy Paredes, Chuck Sabel, Bill
Simon, Peter Strauss, Susan Sturm, and participants at Brooklyn Law School’s International
Economic Law Forum, the Georgetown University Law Center Governance Series, and the
UBC Faculty Colloquium Series for comments on earlier versions of this article. I also ap-
preciate the factual assistance provided by several individuals at the British Columbia Secu-
rities Commission (BCSC), including Commissioner Robin Ford and staff members Brenda
Benham, Langley Evans, Sandy Jakab, and Michael Sorbo. Ronke Odumosu and Sarah Van-
der Veen provided excellent research assistance. Errors and omissions remain my own.
2
See, e.g., Gary Parkinson, Record Amount Raised in London This Year as Foreigners Rush to Float,
INDEPENDENT (U.K.), Aug. 9, 2006, at 40. Whether this shift actually represents a reduction in
the perceived value of an American listing is less obvious. See, e.g., Craig Doidge et al., Has New
York Become Less Competitive in Global Markets? Evaluating Foreign Listing Choices over Time (Fisher
College of Business Working Paper No. 2007-03-012, July 2007), available at ssrn.com/
abstract=982193 (arguing that the decline in cross-listings on the New York and London
stock exchanges between 1990 and 2005 is explained by changes in firm characteristics rather
than by changes in the benefits of cross-listings).
New York City Mayor Michael Bloomberg and New York Senator Charles
Schumer, primarily blamed American overregulation for the city’s con-
tinuing financial sector woes.
3
Hank Paulson, United States Treasury Sec-
retary, has suggested that, to preserve its global competitiveness, the United
States should move toward a more flexible, U.K.-style approach to regu-
lating capital markets.
4
For its part the London Stock Exchange has argued
that its superior principles-based approachFnot lax standards and not
simple distaste for Sarbanes-Oxley Act requirements in the United StatesF
was the reason behind the historic shift.
5
While the shift is surely complex and multifactorial, the role of prin-
ciples-based regulation is an important part of the puzzle. In fact, princi-
ples-based regulation, described more fully below,
6
is not unknown in
North America. The U.S. Commodity Futures Trading Commission now
uses principles-based regulation with respect to the clearinghouses and
exchanges it regulates.
7
Even the U.S. Securities and Exchange Commis-
sion (SEC), often characterized internationally as a particularly rule-
oriented and prescriptive securities regulator, has made recent moves
toward a more principles-based approach.
8
In Canada, where securities
3
Jenny Anderson, U.S. Financial Sector Is Losing Its Edge, Report Says, N.Y. TIMES, Jan. 22, 2007,
at 3. According to the McKinsey study, the United States controlled 16% of the global stock-
offering volume in the first ten months of 2006, compared with 57% in 2001. Europe’s share
increased from 33% in 2001 to 63% in the first ten months of 2006.
4
Jeremy Grant & Krishna Guha, Paulson Seeks British-Style Flexibility in Capital Markets,FINAN-
CIAL TIMES (U.K.), Nov. 21, 2006, at 1.
5
The chief executive officer of the London Stock Exchange, Clara Furse, argued that ‘‘Lon-
don’s principles-based regime, rather than a more prescriptive rules-based approach, con-
tinues to prove itself as a model that facilitates pro-competitive innovation in a tough but
sensible regulatory environment. All the important independent corporate governance sur-
veys confirm that the U.K. is number one for corporate governance standards.’’ Clara Furse,
Comment: Sox is Not to BlameFLondon is Just Better as a Market,F
INANCIAL TIMES (U.K.), Sept. 18,
2006, at 19.
6
See infra Parts II.A and II.B.
7
See, e.g., Walter Lukken, Commissioner Commodities Futures Trading Commission, Address
at the University of Houston’s Global Energy Management Institute: It’s A Matter of Prin-
ciples (Jan. 25, 2007), http://www.cftc.gov/newsroom/speechestestimony/opalukken-23.html.
8
E.g., 17 C.F.R. pts. 210, 228, 229, 230, 232, 239, 240, 242, 245 & 249 (2005), http://
www.sec.gov/rules/final/33-8518.htm#P758_198667 (establishing a principles-based defini-
tion and disclosure requirements for asset-backed securities).
2 Vol. 45 / American Business Law Journal
regulation is a provincial matter, the province of British Columbia is an
ambitious champion of principles-based securities regulation and out-
come-oriented regulatory practice. In fact, through its advocacy the en-
tire Canadian securities system may be making a momentous shift away
from its historic template, the American approach, and toward U.K.-style
principles-based regulation.
In 2004, after a series of regulatory impact analyses and public con-
sultations, the B.C. legislature introduced a bill to create an innovative new
principles-based Securities Act for the province (Bill 38).
9
Bill 38 and its
associated proposed rules and regulations (together, the ‘‘B.C. Model’’)
would have established the most comprehensively principles-based regime
in securities regulation in North America.
10
The companion piece to the
statutory reforms was so-called ‘‘outcome-oriented’’ regulation at the level
of practice.
11
Bill 38 received Royal Assent on May 13, 2004, and was set to
come into force by regulation.
12
It has not done so. Continued evolution in
Canadian securities regulationFand especially the growing momentum
behind a so-called ‘‘passport system’’ between provincial regulatorsF
means that Bill 38 is now unlikely to come into force in its current form.
13
Nevertheless, the province has not resiled from its advocacy of principles-
based and outcome-oriented regulation. The B.C. Securities Commission
(BCSC) now takes the position that, in any event, ‘‘the most important
aspect of regulatory reform is a change in how [regulators] administer
securities legislation.’’
14
It has stated that, ‘‘although the 2004 act is not
9
Bill 38-2004, Securities Act, 5th Sess., 37th Parl., British Columbia, 2004, § 203. Bill 38 and
the research studies and other documents associated with it are available on the BCSC Web
site at http://www.leg.bc.ca/37th5th/3rd_read/gov38-3.htm (last visited Sept. 7, 2007).
10
See infra text accompanying notes 67–78.
11
See infra text accompanying notes 79–84.
12
Bill 38, 5th Sess., 37th Parl., Nos. 72 and 73 (Royal Assent given May 13, 2004), http://
www.leg.bc.ca/37th5th/votes/v040513.htm.
13
British Columbia passed a more circumscribed Securities Amendment Act in 2006. Bill 20-
2006, Securities Amendment Act, 2nd Sess., 38th Parl., British Columbia, 2006. Depending on
external political factors and the results of harmonization negotiations with other Canadian
jurisdictions, the Securities Amendment Act may be more circumscribed only in the near
term. It contains several provisions that mirror those of Bill 38. However, those provisions will
only come into force if enacted by separate regulation, at an as yet unspecified date.
14
BCSC, MOVING AHEAD WITH REGULATORY REFORM IN BRITISH COLUMBIA (Mar. 2005), http://
www.bcsc.bc.ca/uploadedFiles/Moving_Ahead.pdf (emphasis added).
2008 / Principles-Based Securities Regulation 3
in force, the BCSC has moved ahead with changing [its] regulatory pro-
cesses and approach in much the same way [it] would have done under the
2004 act.’’
15
Moreover, British Columbia’s principles-based and outcome-oriented
approach is now having a clear effect across Canada through British
Columbia’s agency and advocacy within the Canadian Securities Admin-
istrators (CSA), the Canadian securities regulatory umbrella group. British
Columbia’s coherent vision of its principles-based regulatory regime
makes it a significant presence at the negotiating table. As a result, impor-
tant prospectus-related components of the B.C. Model are now in effect
across Canada by way of CSA National Instruments.
16
Also, the CSA has
issued for comment sweeping new proposed rules designed to put in place
a revised, nationally harmonized and streamlined registration regime for
firms and individuals.
17
With respect to firm compliance processes in par-
ticular, the CSA has indicated that it intends to make principles-based
rules.
18
In the last twelve months, two major reports have come out
15
BCSC, HISTORY OF THE 2004 BC SECURITIES LEGISLATION, http://www.bcsc.bc.ca/instruments.
asp?id=1894 (last visited Sept. 4, 2007).
16
See infra note 68 (discussing the Continuous Market Access approach under Bill 38). De-
pending on the province, National Instruments are typically incorporated into provincial law
through the provincial securities regulators’ rulemaking powers, by regulation, or by blanket
ruling or order. British Columbia’s most striking success so far in pushing Canadian regu-
lators in the direction of its vision occurred in late December 2006 with the adoption of Na-
tional Instrument 44-101 concerning short-form prospectuses. (Concurrent National
Instruments made parallel changes to the requirements governing shelf distribution pro-
spectuses and PREP prospectuses.) Section 2.2 of NI 44-101 provides that an issuer with eq-
uity securities listed and posted for trading on an eligible exchange, which is up to date in its
periodic and timely disclosure filings in all jurisdictions in which it is a reporting issuer, may
file a much-streamlined short-form prospectus. NATIONAL INSTRUMENT 44-101 SHORT FORM
PROSPECTUS DISTRIBUTIONS (Dec. 29, 2006), http://www.bcsc.bc.ca/uploadedFiles/NI44-
101(1).pdf. The new qualification criteria greatly expand the number of Canadian listed is-
suers that can participate in expedited short-form offerings. As such, NI 44-101 is a step
toward the Continuous Market Access model championed in Bill 38, which would have done
away with prospectuses entirely for issuers that were already in the public markets and that
were keeping their disclosures up to date.
17
CAN.SEC.ADM’R,PROPOSED NATIONAL INSTRUMENT 31-103, REGISTRATION REQUIREMENTS AND
PROPOSED COMPANION POLICY 31-103CP (Feb. 21, 2007), http://www.bcsc.bc.ca/uploadedFiles/
NI31-103_Proposed.pdf.
18
Prema K.R. Thiele et al., Canadian Securities Regulators Release Comprehensive Registration Rule
For Comment (Feb. 21, 2007), http://www.mondaq.com/i_article.asp_Q_articleid_E_46392.
4 Vol. 45 / American Business Law Journal
supporting principles-based regulation,
19
and the Chair of the nation’s
largest provincial securities regulator, the Ontario Securities Commission,
is now of the view that ‘‘the arguments in favor of principles-based reg-
ulation are very compelling.’’
20
This article looks at principles-based securities regulation as a New
Governance regimeFone that uses innovative, pragmatic, information-
based, iterative, and dialogic mechanisms to gather, distill, and leverage
industry learning in the service of a still-robust but better designed, that is,
more effective and less burdensome, public regulatory mandate.
21
Using
British Columbia’s approach as an example, this article argues that the
B.C. Model’s outcome-oriented, open-ended, and collaborative features
locate it within the ambit of that emerging analytical perspective. As such,
the B.C. Model shares the beneficial characteristics of other New Gover-
nance regimes, especially relative to the more prescriptive and inflexible
mechanisms associated with classical regulation. The New Governance
perspective also brings to light some fresh questions about the B.C. Model,
going in particular to the kinds of incentives that industry and regulators
have and the relationship between them.
This article draws connections between principles-based regulation
and New Governance in a way that transcends specific administrative
law topics and should be of interest to scholars of regulation generally.
In addition, the article seeks to engage with New Governance scholarship
itself, by providing a contextual example of a New Governance experi-
ment operating in the particular environment of securities regulation.
While one can be confident overall about the value of putting principles-
based and New Governance–inflected regulatory strategies to work in
this area, securities regulation also presents its own particular challenges.
19
CRAWFORD PANEL ON A SINGLE CANADIAN SECURITIES REGULATOR,BLUEPRINT FOR A CANADIAN
SECURITIES COMMISSION (2006), http://www.crawfordpanel.ca/Crawford_Panel_final_paper.pdf,
at 7 (‘‘to provide Canadian capital markets with a competitive advantage globally it is desirable
to have as much principles-based regulation as is feasible’’). TASK FORCE TO MODERNIZE SECURI-
TIES LEGISLATION IN CANADA,CANADA STEPS UP(2006), http://www.tfmsl.ca/index.htm (see, for
example, Volume 1, Executive Summary, at 2, recommending ‘‘that Canadian securities reg-
ulation be based on clearly enunciated regulatory principles which do not need a detailed set
of interventionist rules for sound implementation’’).
20
David Wilson, Chair Ontario Sec. Comm’n, Address at Dialogue with the OSC: Momentum
for Change: Providing the Regulation Canada Needs (Nov. 10, 2006), http://www.osc.
gov.on.ca/Media/Speeches/sp_20061110_dw_dwo-momentum.jsp.
21
See discussion infra Part III.A.
2008 / Principles-Based Securities Regulation 5
Understanding the contextual implications of decentralized, principles-
based, outcome-oriented New Governance approaches to securities
regulation in particular helps to deepen the conversation about those
approaches more generally.
The article proceeds in four parts. Part II defines ‘‘principles-based’’
and ‘‘outcome-oriented’’ regulation, by reference to classical theoretical
debates, the debate around the B.C. Model, and recent trends in public
administration. It provides an example of how regulation of a particular
compliance requirement, broker firm supervision of client accounts, might
be different under principles-based and outcome-oriented regulation. Part
III sets out the relationship between principles-based securities regulation
and New Governance theory, with specific attention to implications for
firm compliance processes and the relationship between ‘‘rolling best prac-
tices rulemaking’’ and ‘‘light touch regulation.’’ It examines the relation-
ship between regulator and industry especially in terms of the defensibility
of potentially imposing on industry actors the costs of articulating, ex post,
the specific content of principles-based regulatory requirements in the
compliance context. Part IV identifies two particular challenges presented
by the securities regulatory context, from the perspective of New Gover-
nance: firms’ uneven incentives to innovate in new product development
versus compliance and problems of small firm capacity to operationalize
principles. The article considers hybrid rules-and-principles regulatory
structures, arguing for incorporating relevant third parties into the regu-
latory structure. Tripartism can be an effective mechanism for responding
to regulatory failure, and it may be especially useful in responding to the
particular challenges posed by the many small enterprises and ‘‘junior
cap’’ issuers operating in the province of British Columbia. Part V offers
some concluding thoughts.
II. WHAT IS PRINCIPLES-BASED SECURITIES
REGULATION?
A. The Theoretical Debate
The classic example of the difference between rules and principles or
‘‘standards’’ (to use another term) involves speed limits: a rule will say, ‘‘Do
not drive faster than 55 mph,’’ whereas a principle will say, ‘‘Do not drive
faster than is reasonable and prudent in all circumstances.’’ Put another
way, a rule generally entails an advance determination of what conduct is
6 Vol. 45 / American Business Law Journal
permissible, leaving only factual issues to be determined by the frontline
regulator or decision maker. A principle may entail leaving both specifi-
cation of what conduct is permissible and factual issues to the frontline
regulator.
22
A number of scholars have used the relatively straightforward
rules–principles dichotomy as a vehicle for evaluating the structural and
analytical choices that go into lawmaking.
23
Many of the major arguments
relate to the relative certainty of rules and flexibility of principles and
the costs of these regulatory choices for regulation promulgators, enforc-
ers, and followers.
24
These broad themes echo in the debate in British
Columbia respecting Bill 38, discussed below; its proponents argued that a
22
See Louis Kaplow, Rules versus Standards: An Economic Analysis,42DUKE L.J. 557, 559–60
(1992). Ronald Dworkin’s rules–principles distinction, in which principles are reasons that a judge
takes into consideration in deciding which all-or-nothing rule should apply, uses the terms in a
different fashion than is intended here. RONALD DWORKIN,TAKING RIGHTS SERIOUSLY 22–28,
71–80 (1977).
23
See, e.g., Kaplow, supra note 22; Duncan Kennedy, Form and Substance in Private Law Adju-
dication,89HARV.L.REV.1685 (1976); Carol M. Rose, Crystals and Mud in Property Law,40STAN.
L. REV. 577 (1988); Antonin Scalia, The Rule of Law as a Law of Rules,56U.CHI.L.REV. 1175
(1989); Frederick Schauer, The Tyranny of Choice and the Rulification of Standards,14J.CONTEMP.
LEGAL ISSUES 803 (2005); Pierre Schlag, Rules and Standards, 33 UCLA L. REV. 379 (1985);
Kathleen M. Sullivan, The Supreme Court 1991 Term: Foreword: The Justices of Rules and Standards,
106 HARV.L.REV. 22 (1992); Cass R. Sunstein, Problems with Rules,83CAL.L.REV. 953 (1995).
24
For example, on the one hand, scholars usually argue that rules promote precision, formal
equality, predictability, certainty, uniformity, and judicial restraint; produce greater net social
welfare gains than principles; foster democracy and consistency; facilitate efficient allocation of
goods; provide fixed consequences for action; minimize the costs of reaching decisions in
particular cases; discourage rent-seeking behavior; and reduce the likelihood of bias, arbi-
trariness, and abuse of power by decision makers. Rules are, however, not without their dis-
advantages. Rules can be inflexible, reactive, and costly to promulgate; they require constant
amendment to meet changing circumstances; they may be simultaneously over- and under-
inclusive. Rules permit different treatment of cases that are substantially alike, mask bias, allow
people to engage in socially unproductive behavior to the extent of prohibition (to the ‘‘limits
of the law’’), restrict communication and may thwart understanding, restrict the exercise of
discretion, and can be procedurally unfair.
Principles provide advantages that are the flip side of rules’ disadvantages. They provide
decision makers with the ability to make their own choices, promote substantive equality and
justice, reduce arbitrariness, are flexible and can adapt to changing circumstances over time,
favor distributive motives, promote accountability on the part of decision makers, are less
costly to promulgate, and allow decision makers to tailor their treatment to the facts of par-
ticular cases. Principles can also be disadvantageous in that they can be unpredictable, un-
certain, costly for individuals to interpret and for decision makers to enforce, may prevent
risk-averse people from engaging in lawful conduct, and they can be manipulated.
2008 / Principles-Based Securities Regulation 7
principles-based and outcome-oriented approach would discourage ‘‘loop-
hole’’ behavior and ‘‘checklist’’ style approaches to law and would promote
a more effective and flexible regulatory approach. Opponents of the B.C.
Model worried about the uncertainty it could produce and the cost of that
uncertainty to market actors. Of course, the conversation is much enriched
by the predictable fact that there is no unanimity regarding the basis for
analyzing the advantages and disadvantages of each: scholars have evalu-
ated rules and principles in economic terms,
25
abstract normative ones,
26
in terms of regulatory design
27
and behavioral analysis,
28
and on the basis
of particular values such as freedom/autonomy,
29
democracy,
30
communi-
ty,
31
or perceived legitimacy.
32
Scholars expressing a near-unequivocal preference for either rules or
principles are relatively rare,
33
although most lean one way or the other.
Many note that rules and principles are more points on a continuum than
discrete concepts and that there is a good deal of overlap and convergence
between them.
34
Others have resisted the stark dichotomy between rules
25
See, e.g., Kaplow, supra note 22.
26
MARK KELMAN,AGUIDE TO CRITICAL LEGAL STUDIES (1987); Kennedy, supra note 23.
27
See, e.g., IAN AYRES &JOHN BRAITHWAITE,RESPONSIVE REGULATION:TRANSCENDING THE DEREG -
ULATION DEBATE (1992); James W. Colliton, Standards, Rules and the Decline of the Court in the Law
of Taxation,99D
ICK.L.REV.265 (1995); Colin S. Diver, The Optimal Precision of Administrative
Rules,93Y
ALE L.J. 65, 98 (1983).
28
Russell B. Korobkin, Behavioral Analysis and Legal Form: Rules vs. Principles Revisited,79OR.L.
REV.23 (2000); Schauer, supra note 23.
29
P.S. Atiyah, From Principles to Pragmatism in the Function of the Judicial Process and the Law,65
IOWA L. REV.1249, 1272 (1980); Eric A. Posner, Standards, Rules, and Social Norms,21HARV. J.L.
&PUB.POL’Y101, 116–17 (1997).
30
Scalia, supra note 23.
31
Rose, supra note 23 (arguing that both rules and principles are metaphors for lapses of
community).
32
D.A. Rollie Thompson, Rules and Rulelessness in Family Law: Recent Developments, Judicial and
Legislative,18C
AN.FAM. L.Q. 25 (2000–1).
33
But see Scalia, supra note 23.
34
See, e.g., Russell B. Korobkin, Behavioral Analysis and Legal Form: Rules vs. Standards Revisited,
79 OR.L.REV.23, 30 (2000); Neil MacCormick, Reconstruction After Deconstruction: A Response to
CLS,10OXFORD J. LEGAL STUD. 539, 545 (1990); Frederick Schauer, The Convergence of Rules and
Standards, 2003 N.Z. L. REV. 303, 305 (2003).
8 Vol. 45 / American Business Law Journal
and principles
35
and have pointed out that, historically, the decision-
making pendulum has swung between them.
36
Some warn that the
rules-versus-principles debate should avoid setting up an artificial separa-
tion between law promulgators and law followers that fails to reflect the
true iterative quality of the legislative process.
37
More fundamentally chal-
lenging arguments also have been made to the effect that it has become an
‘‘arrested dialectic’’
38
or that the rules-versus-principles debate is really a
stand-in for other, deeper disagreements about the proper ordering of
society and the proper substantive content of legal rules.
39
There can be no question that a stark, bipolar understanding of the
rules–principles dichotomy risks overdrawing the distinction, making it less
useful in practical terms. No statutory scheme is a pure typeFas, in fact, the
FSA’s description of its groundbreaking principles-based approach as simply
‘‘more principles-based regulation’’ acknowledges.
40
Rules still admit of con-
siderable discretion and interpretation. Principles, in the fullness of context,
may congeal around a particular meaning. Moreover, calling the B.C. and
FSA Models principles-based implies that the main run of securities regu-
lation is comparatively rule based. This is not entirely the case, either con-
struing securities laws in objective terms, to the extent possible, or certainly
by reference to other administrative law schemes. The U.S. Securities Act
of 1933 and Securities and Exchange Act of 1934, for example, display
real economy in conception and drafting and exhibit nothing like the de-
tailed, rule-bound, command-and-control approach so often now associated
with bureaucratic sclerosis and ineffectiveness in other regulatory arenas.
35
Ian Ayres, Preliminary Thoughts on Optimal Tailoring of Contractual Rules, 3 S. CAL.INTERDISC.
L.J. 1, 18 (1993) (arguing that ‘‘in many circumstances the dichotomous choice between rules or
standards may be a false one, because lawmakers may prefer to enact a complementary set of rules
and principles’’); MacCormick, supra note 34 (arguing that there is no necessary opposition be-
tween rules and principles).
36
Atiyah, supra note 29; Rose, supra note 23.
37
JULIA BLACK,RULES AND REGULATORS (1997). See also Margaret Jane Radin, Reconsidering the
Rule of Law, 69 B.U. L. REV.781, 814 (1989) (discussing the problems of the rule maker/rule
follower paradigm, although not in the context of the rules–principles debate).
38
Schlag, supra note 23, at 383.
39
Kennedy, supra note 23. But see Sullivan, supra note 23 (denying that superficial liberal/
conservative political allegiances adequately explain judicial preferences for either rules or
principles).
40
See infra text accompanying notes 55–66.
2008 / Principles-Based Securities Regulation 9
Canadian securities law statutes are not appreciably more rule based than
U.S. ones.
41
Even if we assume that it is possible to distinguish meaningfully
on a large scale between rules and principles, rules as implemented may
look more like principles if decision makers use their discretion to temper
the harsh effect of a rule that is imperfectly tailored to a specific situation. At
the same time, principles may slide into rules over time because people and
systems may desire more certainty than they find principles provide.
42
Nonetheless, taken as a whole, securities regulatory regimes can be
comparatively principles or rules based.
43
A regime can choose to regulate
41
Canadian provincial securities statutes are generally very similar to the American 1933 Act
and 1934 Acts. See also LAWRENCE A. CUNNINGHAM,PRINCIPLES AND RULES IN PUBLIC AND PROFESS-
IONAL SECURITIES LAW ENFORCEMENT:ACOMPARATIVE U.S.–CANADA INQUIRY (2006), http://
www.tfmsl.ca/docs/V6(5A)%20Cunningham.pdf (arguing that the U.S. SEC and the Canadi-
an CSA show strong similarities in enforcement approach, that the SEC/CSA approach is
principles based relative to the rule-based models at the U.S. National Association of Securities
Dealers and the Canadian Investment Dealers Association (see infra note 72), and arguing
against broadly principles-based securities regulation).
42
Schauer, supra note 23 (arguing that individuals ‘‘resist excess choice as much as they resist
excessively constrained choice,’’ so law implementers and enforcers tend to ‘‘round[ ] off the
crisp corners of rules’’ as well as systematically ‘‘sharpen the soft edges of principles’’). See also
BARRY SCHWARTZ,THE PARADOX OF CHOICE:WHY MORE IS LESS (2004) (arguing that from a psy-
chological perspective there is a cost to having an overload of choice). The pressure toward
certainty is even more pronounced when the possibility of sanctions exists, and this makes
sense for due process reasons. However, this is not to say that principles-based regimes in-
herently violate the rule of law. The trick is that the regime must not be arbitrary in its exercise
of power, and it should be transparent. That it is capable of handling inevitable vagueness in
human relations should not invalidate it. TIMOTHY ENDICOTT,VAGUENESS IN LAW (2000); Keith
C. Culver, Varieties of Vagueness,54UNIV.TORONTO L.J. 109 (2004).
43
Although our analyses are compatible in many respects, at this conclusory level this article
parts ways with Lawrence A. Cunningham’s thought-provoking recent article, A Prescription
to Retire the Rhetoric of ‘‘Principles-Based Systems’’ in Corporate Law, Securities Regulation and
Accounting (Mar. 13, 2007), (Boston College Law School Research Paper No. 127), available at
http://ssrn.com/abstract=970646. Cunningham exposes the various ways in which the labels
of ‘‘principles-based’’ or ‘‘rules-based’’ systems can be misleading. He argues that, while in-
dividual provisions may be classifiable as either rule or principle when stated as a legal norm,
this does not account for how those provisions are interpreted, enforced, and applied. More-
over, he argues that ‘‘vague concepts such as materiality and fairness unaccompanied by some
specific content create risks of both managerial decision-making and arbitrary enforcement.’’
Id. at 19. Professor Cunningham and I agree on these points, and we agree that rules and
principles exist on a spectrum rather than as pure types. Where this article parts ways with
Professor Cunningham is with regard to the implications. Cunningham says that problems of
classification and implementation are foundational and make the rules–principles dichotomy
deeply suspect when used to describe systems. In his view, the most likely explanation for the
‘‘flourishing’’ rhetoric extolling principles-based systems is political: regulatory jurisdictions
10 Vol. 45 / American Business Law Journal
internal compliance processes, for example, by way of detailed checklists or
by way of sweeping administrative guidelines. Each kind of regime will
necessarily include both rule-based and principles-based elements. And,
when applied to particular contexts by human regulators, there may be
even more bleed-over than drafters intend. Still, one can make meaningful
conceptual distinctions between regimes functioning primarily around
principles and those operating mainly by way of rules. Moreover, the lan-
guage of principles is useful for understanding the regulator’s necessarily
modified role under a New Governance regime, within which the regu-
lator establishes broad goals and outcome requirements but leaves it up to
the regulated industry itself to develop effective means for achieving those
requirements.
B. The Securities Regulatory Context
In describing the B.C. Model as principles based, drafters and proponents
also were participating in a larger transnational debate, which took place
following the many scandals of this millennium’s early years, about the
proper structure of securities regulation and accounting rules. The initial
concern was national accounting rules. The primary U.S. accounting stan-
dard setter, the Financial Accounting Standards Board (FASB), was criti-
cized in the wake of the Enron debacle for relying too much on detailed
rules to determine appropriate accounting treatment with respect to ac-
counting standards.
44
Thereafter, considerable work went into drafting
more principles-based Generally Accepted Accounting Principles
operating in a competitive market for regulatory services use the term, misleadingly, for
product differentiation purposes. Id. at 54–62. This article is comparatively less gloomy about
the scalability of rules and principles to the systems level and, while it recognizes the (positive
and negative) impacts of transnational regulatory competition, it is less cynical about regu-
lators’ motives in advocating principles-based regulation. This article’s response to the prob-
lems of classification and implementation recognized here is rather that, in order to be
meaningful and effective, principles-based regulation requires a correlative shift in approach
among the frontline regulators who interpret, enforce, and apply those principles. Part II of
this article, supra, argues for a New Governance–style approach as a means of developing a
systematic, coherent, conceptually compatible approach to the crucial implementation aspect
of principles-based regulation.
44
Frederick Gill, Principles-Based Accounting Standards, 28 N.C. J. INT’LL. & COM.REG.967
(2003) (describing the criticism and the FASB response and comparing U.S. GAAP to British
GAAP). But see William W. Bratton, Enron, Sarbanes-Oxley and Accounting: Rules Versus Principles
Versus Rents,48V
ILL.L.REV. 1023 (2003) (arguing that auditor failure, rather than the existence of
a rules-based GAAP regime, was to blame for the Enron crisis).
2008 / Principles-Based Securities Regulation 11
(GAAP).
45
In Canada and the United Kingdom, the most common view
has been that those countries’ respective national GAAP are (and are
appropriately) more principles based than U.S. GAAP.
46
Europe, generally
speaking, has come out broadly in favor of a more principles-based
approach to accounting guidelines.
47
Naturally, in practice as in theory,
the site of the distinction between rules-based and principles-based
approaches is contested ground.
48
In short order, the rules-versus-principles terminology moved be-
yond accounting and into securities regulation and corporate governance
45
In the United States post-Enron, principles-based GAAP have received the imprimatur of
FASB and the SEC. FASB, PROPOSAL:PRINCIPLES-BASED APPROACH TO U.S. STANDARD SETTING
(2002), http://www.fasb.org/proposals/principles-based_approach.pdf. U.S. SEC, SEC Study
Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United
States Financial Reporting System of a Principles-Based Accounting System (2003), available at
http://www.sec.gov/news/studies/principlesbasedstand.htm.
46
In Canada, Daniel Thornton and Erin Webster have argued that Canadian GAAP principles
are more principles-based than American GAAP. Their analysis is based, inter alia, on an ex-
amination of the CICA Assurance Handbook and the CICA Accounting Handbook, which
they claim are much less prescriptive than American Institute of Certified Public Accountants
assurance guidance and FASB accounting guidance. Daniel B. Thornton & Erin Webster,
Earnings Quality Under Rules- vs. Principles-Based Accounting Standards: A Test of the Skinner Hy-
pothesis (June 2004), available at http://ssrn.com/abstract=557983. According to Robert Ker-
shaw, the commonFthough mistakenFview in the United Kingdom is that it avoided Enron-
style scandal in the early years of this millennium because its approach to accounting regu-
lation is principles based rather than rules based. I dispute the claim that U.K. GAAP really are
more principles based than American GAAP, however, and argue that the lack of an Enron-
style scandal in the United Kingdom may be attributed to good fortune, a more robust pro-
fessional culture, and/or plain ignorance of the extent of professional failure in the absence of
a high-profile scandal. David Kershaw, Evading Enron: Taking Principles Too Seriously in Ac-
counting Regulation,68M
OD.L.REV.594 (2005). The fight has gone out of this conversation
somewhat, given recent transnational convergence of accounting principles around International
Financial Reporting Standards. See, e.g., News Release, FASB, FASB and IASB Reaffirm Com-
mitment to Enhance Consistency, Comparability and Efficiency in Global Capital Markets (Feb. 27,
2006), http://www.fasb.org/news/nr022706.shtml.
47
See EUROPEAN UNION,REGULATION (EC) NO1606/2002 OF THE EUROPEAN PARLIAMENT AND OF
THE COUNCIL ON THE APPLICATION OF INTERNATIONAL ACCOUNTING STANDARDS, http://www.cesr-
eu.org/index.php?page=contenu_groups&id=13&docmore=1 (last visited Mar. 6, 2007); Pe-
ter Jeffrey, International Harmonization of Accounting Standards, and the Question of Off-Balance
Sheet Treatment,12D
UKE J. COMP.&INT’LL. 341 (2002) (comparing the American, British, and
European approaches). But see More Rules; Auditing Reform,T
HE ECONOMIST (London), Mar. 20,
2004, at 34 (observing that European principles-based accounting regulation is under pressure as a
result of European scandals and the more prescriptive and detailed Sarbanes-Oxley Act).
48
See, e.g., Gill, supra note 44 (disputing the common wisdom that American GAAP principles
are more rule based than British ones); Kershaw, supra note 46 (same).
12 Vol. 45 / American Business Law Journal
generally. In the United States, there has been a good deal of discussion
about the distinction between rules and principles,
49
although legislative
outcomes have been more mixed. To take the most obvious example, ob-
servers have identified principles-based tendencies in some Sarbanes-
Oxley provisions,
50
although the statute also imposed numerous new, de-
tailed rules.
51
Among the Commonwealth countries as well, the scandals at
Enron, WorldCom, Canada’s Nortel, Australia’s HIH, and elsewhere stim-
ulated considerable soul searching about securities regulation and a
renewed debate about the virtues
52
and vices
53
of principles-based as op-
posed to rules-based regulation and the significance of the distinction.
54
49
See, e.g., Cary Coglianese et al., The Role of Government in Corporate Governance, (Regulatory
Policy Program Report RPP-08 Nov. 2004), available at http://ssrn.com/abstract=613421 (sum-
marizing the results of deliberations at a conference on corporate governance).
50
See, e.g., John C. Coffee Jr., Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant
Reforms, 84 B.U. L. REV.301, 342–44 (2004) (arguing that Sections 302 and 906 of the Sarbanes-
Oxley Act, which require CEOs and CFOs to certify that information contained in periodic re-
ports ‘‘fairly presents’’ the financial condition and results of operations of the issuer, represent a
shift to a principles-based system for financial disclosure).
51
Practitioners, in particular, have criticized aspects of Sarbanes-Oxley for its detailed, pre-
scriptive quality. See, e.g., David S. Ruder et al., The SEC at 70: The Securities and Exchange
Commission’s Pre-and Post-Enron Responses to Corporate Financial Fraud: An Analysis and Evalua-
tion,80N
OTRE DAME L. REV.1103 (2005).
52
Championing principles-based securities regulation in Canada, see, for example, Michael
Kane, Investor Protection at Top of Agenda for Chairman,S
UDBURY STAR, July 30, 2005, at E2 (see
infra note 72, discussing Ross Sherwood, new chair of the Investment Dealers Association, and
his preference for principles-based regulation); Ben Maiden, Canadian Lawyers Take New Look
At Due Diligence,24I
NT’L.FIN.L.REV.37 (2005) (discussing Canadian regulators’ initiatives post-
Sarbanes-Oxley and the desire to remain more principles based than rule based). In Australia:
Gerry Gallery & Natalie Gallery, Inadequacies and Inconsistencies in Superannuation Fund Financial
Disclosure: The Need for a Principles-Based Approach,36A
UST.ECON .REV. 89 (2003) (arguing that
Australia’s Superannuation Fund structure should move from a rules-based structure to the
structure with corporate reporting, which the authors contend show that a principles-based ap-
proach applied to corporate reporting).
53
Editorial, Silence No More,CANADIAN BUSINESS, Summer 2004, at 208 (criticizing Canadian
principle-based regulation as soft on enforcement); John Farrar, Toothless TigerFAll Roar and
No Bite, N.Z. MGMT. (Auckland), Aug. 2005, at 72 (criticizing New Zealand’s principles-based
approach to corporate law as overly lax).
54
Neil Baker, Global Debate Over Controls,INTERNAL AUDITOR, June 2005, at 50 (discussing the
impact of the Sarbanes-Oxley Act in Europe and Britain’s attempt to defend their principles-
based approach from incursion by post-Sarbanes European regulations); Press Release, Price
WaterhouseCoopers, Financial Firms Face High Reputational Costs from Poor Compliance Risk
Management (June 27, 2005), available at http://www.pwc.com/Extweb/ncpressrelease.nsf/
2008 / Principles-Based Securities Regulation 13
From an early stage, the U.K. FSA has been a thoughtful leader on
principles-based financial services regulation. Its approach warrants a
brief sketch. What the FSA has in mind, in speaking of principles-based
securities regulation, is a comprehensive philosophy about regulation
that affects not only its approach to regulating industry, but also its own
processes. The FSA’s move toward principles-based regulation in the se-
curities area crystallized in 2001, not long after its own creation, with the
promulgation of eleven overarching Principles of Business within its
Handbook.
55
In the intervening years the FSA has replaced huge swaths
of its detailed Handbook rules with short, high-level requirements, often
accompanied by regulatory guidance.
56
Between 2002 and 2005, for
example, the FSA simplified and restructured its rules relating to listed
companies, reducing the length of the rules by 40% and adding six
listing principles plus guidance.
57
In 2006, the FSA began consulting on
simplifying its rules relating to dealings with retail customers, and it be-
gan to replace the detailed obligations established by its existing money-
laundering requirements with more streamlined provisions focusing on
ensuring that firms have effective risk management and systems and
docid/9F9DA465D3B9996F8025702D004D8763 (summarizing study findings that ‘‘organi-
sations [sic] are not rising to the challenges posed by the shift from rules-based to principles-
based regulation or supervision by taking a more holistic approach that moves beyond stat-
utory expectations to strategic and tactical decision-making’’); Lawyers to Lobby on Principle
Regulation,M
ONEY MARKETING (London), Aug. 11, 2005, at 3 (reporting on a group of lawyers
questioning the constitutionality of principles-based regulation at the FSA).
55
Jonathan Edwards & Simon Wolfe, Compliance: A Review,13J.FIN.REG.&COMPLIANCE 48,
49–50 (2005). The Principles are posted on the FSA Web site, http://fsahandbook.info/FSA/html/
handbook/PRIN/2/1 (last visited Sept. 4, 2007).
56
General guidance is contained in the FSA Handbook. For example, guidance on appropri-
ate responses to whistleblowing appears in FSA, HANDBOOK MODULE SYSC (SENIOR MANAGE-
MENT ARRANGEMENTS,SYSTEMS AND CONTROLS) 18.2: PRACTICAL MEASURES, http://
fsahandbook.info/FSA/html/handbook/SYSC/18/2 (last visited Sept. 4, 2007). From time to
time, where a matter is urgent or likely to be temporary, the FSA will publish a ‘‘Guidance
Note.’’ See, e.g., FSA, GUIDANCE NOTE NO. 8 (2003), http://www.fsa.gov.uk/pubs/guidance/
guidance8.pdf (covering Credit Union Common Bonds).
57
FSA, BETTER REGULATION ACTION PLAN:WHAT WEHAVE DONE AND WHAT WEARE DOING
(2005), http://www.fsa.gov.uk/pubs/other/better_regulation.pdf, at 7.
14 Vol. 45 / American Business Law Journal
controls and that firms’ senior management take responsibility for man-
aging money-laundering risk.
58
In some circumstances, relevant FSA guidance has been formulated
in concert with industry itself. For example, in 2004 a group of four trade
associations published industry guidance on their understanding of the
FSA’s rules with respect to trading ahead of investment research. The FSA
publicly confirmed that the guidance was consistent with the regulator’s
intent.
59
The FSA has even moved away from prescribing the specific ex-
aminations that individuals engaged in particular financial-sector activities
must pass. Now, firms choose from a list of examinations based on what
they believe is appropriate to their circumstances.
60
In terms of its own
processes, the FSA has moved to a risk-based regulatory approach (assisted
by the ‘‘Arrow’’ methodology),
61
and it emphasizes consultation with the
public and industry. The FSA consults on many aspects of its operations,
and it even began consulting on streamlining its own Enforcement and
Decision-Making manuals in early 2007.
62
Also, it has shifted some of the
innovative burden from itself to industryFfor example, in challenging
industry to propose a credible solution to conflict-of-interest issues arising
from soft commission and bundled brokerage arrangements.
63
The FSA
considers its work unfinished; its Business Plan for 2007/8, which sets out
its priorities for the coming year, focuses on the organization’s ongoing
drive toward ‘‘more principles-based regulation.’’
64
Significantly, the FSA’s move toward a principles-based approach is
something other than deregulation, outsourcing, or reduced regulation.
John Tiner, the FSA’s Chief Executive, recently described his organization’s
principles-based approach to include ‘‘[t]he heightened significance of
58
FSA, BETTER REGULATION ACTION PLAN PROGRESS REPORT (2006), http://www.fsa.gov.uk/pubs/
other/2660_Action_plan.pdf, at 8.
59
FSA, supra note 57, at 8.
60
Id. at 10.
61
See, e.g., FSA, THE FSA’SRISK-ASSESSMENT FRAMEWORK (2006), http://www.fsa.gov.uk/pubs/
policy/bnr_firm-framework.pdf.
62
FSA, REVIEW OF THE ENFORCEMENT AND DECISION MAKING MANUALS (2007), http://www.fsa.
gov.uk/pubs/cp/cp07_02.pdf.
63
FSA, supra note 57, at 7.
64
FSA, FSA BUSINESS PLAN 2007/08 (2007), available at http://www.fsa.gov.uk/pages/Library/
Corporate/Plan/bp2007.shtml.
2008 / Principles-Based Securities Regulation 15
communication in a principle-based system. Our efforts to rationalise and
focus the FSA Handbook. Our enhanced Risk-Based approach. And, man-
aging down regulatory costs.’’
65
He argued that principles-based regula-
tion produced simply ‘‘better’’ regulation, meaning simultaneously ‘‘(1) a
stronger probability that statutory outcomes are secured; (2) lower cost;
and (3) more stimulus to competition and innovation.’’
66
Like proponents
of the FSA approach, proponents of the B.C. Model argued that its prin-
ciples-based regime could produce both more effective and less costly reg-
ulation.
C. The B.C. Model as Principles Based and Outcome Oriented
Bill 38 is principles based relative to other North American securities law
regimes.
67
In terms of requirements for regulated issuers, for example,
the most striking proposal in Bill 38 would have replaced existing pro-
spectus-disclosure rules, short-form prospectus provisions, the entire
exempt-market transaction structure, and existing continuous disclosure
obligations with an overarching ‘‘Continuing Market Access’’ structure.
Continuous Market Access simply would require all companies accessing
65
John Tiner, Remarks at the SII Annual Conference: Better Regulation: Objective or
Oxymoron (May 9, 2006), available at http://www.fsa.gov.uk/pages/Library/Communication/
Speeches/2006/0509_jt.shtml. See also Clive Briault, Speech at ABI 2007 Conference: Princi-
ples-Based RegulationFMoving from Theory to Practice (May 10, 2007), available at http://
www.fsa.gov.uk/pages/Library/Communication/Speeches/2007/0510_cb.shtml.
66
Tiner, supra note 65.
67
Relative to other securities law statutes, the language of Bill 38, supra note 9, is also con-
siderably streamlined. The statute is drafted in plain language and the statutory architecture is
comparatively stripped down. Compare, for example, §§ 57 and 57.1 of the existing British
Columbia Securities Act, [RSBC 1996] c. 418, with § 27 of Bill 38. Both deal with the pro-
hibition on fraud and market manipulation. The two sections in the old Act run to 222 words,
and separately address ‘‘direct or indirect’’ engagement or participation in prohibited trans-
actions relating to trading in British Columbia (further subdivided into frauds perpetrated on
persons in British Columbia, and frauds perpetrated on ‘‘any person anywhere’’ in connec-
tion with B.C. securities) and prohibited transactions by persons in British Columbia. By contrast,
the provisions of Bill 38, supra note 9, read, in full:
A person must not engage in or participate in conduct relating to securities if the person
knows, or reasonably should know, that the conduct
(a) results in or contributes to a misleading appearance of trading activity in, or an ar-
tificial price for, a security, or
(b) perpetuates a fraud on any person.
16 Vol. 45 / American Business Law Journal
the B.C. capital markets to disclose all ‘‘material information’’ (here,
replacing ‘‘material fact’’ and ‘‘material change’’) on a real-time basis.
68
The BCSC argued that the complex rules characteristic of the existing
prospectus regime did not help gullible investors or stop fraudulent actors,
and it proposed that more effective tools for this purpose were investor
education, compliance reviews, and enforcement action.
69
As noted above,
Canadian securities regulators have since taken a collective step in this
direction through the use of National Instruments.
70
Another sweeping
principles-oriented move in the B.C. Model, relevant to this article’s con-
cern with regulatory oversight of compliance processes and procedures,
was the establishment of a Code of Conduct for dealers and advisors.
71
The B.C. Model replaced detailed rules of conduct for dealers and
advisors with an overarching Code of Conduct consisting of twenty-eight
68
See Part 5 of Bill 38, supra note 9. Canadian securities regimes do not require an equivalent
document to the Form S-1 Registration Statement in the United States, so prospectuses must
include all information that in the U.S. would be provided by way of Registration Statement.
Under the Continuous Market Access approach, public companies would still have to file a
detailed prospectus the first time they accessed the public capital markets, much as American
issuers file a Form S-1. Bill 38 §1 defines material information as ‘‘information relating to the
business, operations or securities of an issuer that would reasonably be expected to signifi-
cantly affect the value or market price of the issuer or a security of the issuer.’’ For a critical
perspective on the impact of the move to a material-information standard, see MINISTRY OF
FINANCE (ONTARIO), FIVE YEAR REVIEW COMMITTEE FINAL REPORTFREVIEWING THE SECURITIES
ACT (ONTARIO) (2003), http://www.fin.gov.on.ca/english/publications/2003/5yrsecurities
review.pdf. The Committee’s most compelling criticism is that material-information disclo-
sure seems to impose a heavy burden on an issuer to be aware of information external to that
issuer.
69
BCSC, NEW CONCEPTS FOR SECURITIES REGULATION:ANEW WAY TO REGULATE (2002), http://
www.bcsc.bc.ca/uploadedFiles/2002_New_Concepts.pdf.
70
See supra note 16.
71
Other innovations included firm-only registration (which was abandoned before the project
as a whole was abandoned), secondary market liability (which may be resurrected, accompa-
nied by similar provisions in Ontario), enhanced enforcement powers, and replacing existing
prospectus and continuous disclosure rules with a ‘‘Continuous Market Access’’ approach. See
BCSC, INVESTOR REMEDIES IN SECURITIES LEGISLATIONFAREGULATORY IMPACT ANALYSIS (2004),
http://www.bcsc.bc.ca/uploadedFiles/RIA_Investor_Remedies(1).pdf; BCSC, ENFORCEMENT OF
OUTCOMES-BASED SECURITIES LEGISLATION (2004), http://www.bcsc.bc.ca/uploadedFiles/RIA_
Enforcement(1).pdf [hereinafter BCSC, ENFORCEMENT]; CHRISTINA WOLF, BCSC, BETTER DIS-
CLOSURE,LOWER COSTSFACOST-BENEFIT ANALYSIS OF THE CONTINUOUS MARKET ACCESS SYSTEM
(2002), http://www.bcsc.bc.ca/uploadedFiles/CBA_Report.pdf; CHRISTINA WOLF, BCSC, COST
SAVINGS UNDER A FIRM-ONLY REGISTRATION SYSTEM (2004), http://www.bcsc.bc.ca/uploadedFiles/
RIA_Firm-Only_Registration(1).pdf.
2008 / Principles-Based Securities Regulation 17
rules arranged under eight broad ‘‘standards.’’
72
According to the BCSC,
the B.C. Model requires those subject to securities regulation in British
Columbia to use their own or industry experience to develop strategies,
uniquely tailored to their business, for abiding by the regulatory require-
ments. The Code of Conduct provisions dealing with compliance systems
are of particular interest here, and they impart a sense of the Code’s
generality and its high-level (almost ethics-level) abstraction.
73
As at the
FSA, each provision is accompanied by nonbinding regulatory guide-
lines.
74
The first two of the seven compliance-related provisions, which
72
Because the BCSC delegates frontline regulatory authority over most dealers and advisors
to two self-regulatory organizations, the Investment Dealers Association (IDA) and the Mutual
Fund Dealers Association, the practical impact of the Code is blunted. In addition to the ex-
isting Securities Act and Rules, most dealers and advisors (but not, for example, portfolio
managers) are also subject to rules promulgated by those self-regulatory organizations
(SROs). Participants in Commission-sponsored public consultations have argued that coordi-
nation with the SROs is required so that those organizations’ approaches do not subvert the
Commission’s. BCSC, DEREGULATION PROJECTFCOMMENTS FROM TOWN HALL AND FOCUS GROUP
MEETINGS (2002), http://www.bcsc.bc.ca/uploadedFiles/2002_ConsultationOverview_Feb.pdf.
The IDA, in particular, also has been moving toward a principles-based approach. See PAUL
C. BOURQUE,ADDRESS AT THE IDA RED TAPE CONFERENCE:NEW APPROACHES TO REGULATING THE
FINANCIAL SERVICES SECTOR (Sept. 25, 2002), http://www.ida.ca/Files/Media/RecSpeech/2002
RedTapeConference_en.pdf; see also Kane, supra note 52.
73
The compliance systems provisions are not more broadly cast than most other provisions of
the Code of Conduct. For example, the principal Code requirement with respect to conflicts of
interest states, ‘‘Resolve all significant conflicts of interest in favour of the client. Use fair,
objective, and transparent criteria. If there are conflicts of interest between or among clients,
use fair, objective, and transparent criteria to manage those conflicts. Apply the criteria con-
sistently in all cases.’’ BCSC, SECURITIES REGULATION IN BRITISH COLUMBIA:GUIDE FOR DEALERS
AND ADVISORS (2004), http://www.bcsc.bc.ca/uploadedFiles/Guide_Dealers_Advisers.pdf, at 25.
This statement is one of four that, along with general interpretive ‘‘Guidelines’’ provided by
the Commission, constitute the new regime’s approach to conflicts of interest. This can be
contrasted with the thirteen separate provisions of the B.C. Securities Rules that previously
addressed conflicts of interest. B.C. Securities Rules, 194/97 B.C. Reg. §§ 16, 53, 54, 75–85.
74
In Canada, as in the United States and the United Kingdom, administrative guidance is
nonbinding. Its promulgation does not require that the administrative agency in question
engage in notice-and-comment rulemaking. For a thoughtful discussion of the distinction
between guidance and rules in the United States, see Peter L. Strauss, Publication Rules in the
Rulemaking Spectrum: Assuring Proper Respect for an Essential Element,53ADMIN.L.REV.803
(2001). Administrative guidance has not been the subject of widespread litigation in Canada. The
notable exception is the Ainsley case, in which the Ontario Securities Commission was held to have
issued binding policy statements governing the operation of penny stock dealers without regard to
its notice-and-comment obligations. Ainsley Financial Corporation et al. v. Ontario Securities
Commission et al., 14 O.R. (3d) 280 (Ont. Ct. (Gen. Div.) 1993).
18 Vol. 45 / American Business Law Journal
will be discussed later in an example involving dealer-firm account super-
vision,
75
state:
19. Maintain an effective system to ensure compliance with this Code, all applicable
regulatory and other legal requirements, and your own internal policies and
procedures. (Associated guidelines begin, ‘‘You must develop, implement, and
monitor a written compliance system that satisfies the requirements of the
Code. . . .’’)
20. Maintain an effective system to manage the risks associated with your business. (The
Guidelines begin, ‘‘You must think about the risks associated with your busi-
ness that are additional to regulatory risks and design your compliance system
to account for those additional risks. . . .’’).
76
In support of its approach, the BCSC argues that prescriptive require-
ments emphasize the wrong things. That is, they encourage firms to focus
on detailed compliance rather than to exercise sound judgment with a view
to the best interests of their clients and the markets. Detailed and top-down
requirements also calcify the regulatory system to reflect one-size-fits-all
industry practice in a particular point in time. By contrast, the BCSC ar-
gues, general obligations subject to industry-driven reflection and amend-
ment ensure sustainability, in that industry can evolve unhindered by
overregulation. They also ensure flexibility, in that emerging issues that
should be regulated are addressed in the general course, because market
participants need to consider the purpose of the rules in the context of the
objectives of securities regulation when making compliance decisions.
77
The BCSC also argues that compliance will increase if rules are fewer,
easily understood, and adequately communicated.
78
75
See infra Part II.D.
76
BCSC, supra note 73 (emphasis added).
77
BCSC, NEW PROPOSALS FOR SECURITIES REGULATION:ANEW WAY TO REGULATE (2002), http://
www.bcsc.bc.ca/uploadedFiles/2002_New_Proposals.pdf [hereinafter NEW PROPOSALS].
78
BCSC, supra note 69. Another factor that makes British Columbia’s view on principles-based
regulation controversial is the province’s history in securities regulation. The signaling effect
of the new regime is different because British Columbia was once home to the now-defunct
Vancouver Stock Exchange, notorious in the 1980s and 1990s as the ‘‘scam capital of the
world.’’ Joe Queenan, Scam Capital of the World,F
ORBES, May 29, 1989, at 132 (describing the
Vancouver Stock Exchange as ‘‘the longest-standing joke in North America’’ and ‘‘[r]umored
to be a laundering vehicle for mobsters and undesirables’’). The regulatory environment in
British Columbia has changed profoundly since those years. See, e.g., Greg Potter, Digging in
the Dirt, B.C. BUSINESS, Aug. 1, 2005, at 30 (describing the contemporary Vancouver-based
mining industry as credible, scrupulous, and closely regulated). By contrast, when speaking of
the SEC, the notion of principles-based regulation sometimes conjures up the opposite image
2008 / Principles-Based Securities Regulation 19
The second essential component of the B.C. ModelFimplicit in its
operation but not found on the face of Bill 38Fis an outcome-oriented
approach and the attendant rolling-in of some new learning about com-
pliance and enforcement best practices.
79
Industry involvement in devel-
oping the content of rules to which industry will be subject is integral to
outcome-oriented regulation. The roots of outcome-oriented regulation
are with the insights of the ‘‘reinventing government’’ or ‘‘new public
management’’ movements in public service provision.
80
In broad strokes,
those approaches advocated a more results-oriented approach to public
administration, including substantial devolution to industry, risk-based
management, and transparency and accountability through continual re-
evaluation of government performance based on performance metrics.
81
Fthat of regulatory overreaching. See, e.g., Letter from KPMG to Jonathan G. Katz, Secretary,
SEC, re Proposed Revision of the Commission’s Auditor Independence Requirements (Sept. 25,
2000) (on file with the SEC under File No. S7-13-00), available at http://www.sec.gov/rules/
proposed/s71300/kpmg2.htm (arguing that the proposed guidelines on auditor independence
constitute substantive regulation that exceeds the SEC’s authority and that proposed principles
would create arbitrary and vague criteria for independence). This is partly a function of the
American historical worry about the overreaching administrative/regulatory state, which does not
have firm foundations in American constitutional law. See, e.g., Roberta S. Karmel, Realizing the
Dream of William O. DouglasFThe Securities and Exchange Commission Takes Over Corporate Gover-
nance,30D
EL.J.CORP.L.79 (2005) (identifying historic worries about SEC overreaching, although
not identifying the SEC’s foray into corporate governance as principles based).
79
The B.C. Model buttressed these innovations with enhanced enforcement and public in-
terest powers, including a legislative prohibition on ‘‘unfair practices,’’ the Commission power
to order disgorgement, and provisions allowing any ‘‘interested person [who] believes that
another person has contravened’’ Bill 38 or the associated regulations to apply to the Com-
mission to hold a hearing. Bill 38, supra note 9, §§ 29, 61 & 64. Proposed provisions that would
have given the Commission the power to prohibit a professional from practicing before the
Commission, if the professional had intentionally contravened the securities legislation, did
not survive to the final version of Bill 38. See NEW PROPOSALS,supra note 77, at 99–100.
80
The ‘‘New Public Management’’ reforms are commonly associated with the Westminster-
style governments, while the term ‘‘Reinventing Government’’ refers to the reform movement
in the United States. Corresponding public-sector innovations were known as ‘‘National Per-
formance Review’’ in the United States under the Clinton Administration and ‘‘Program Re-
view’’ in Canada under Prime Minister Jean Chre
´tien. See generally PETER AUCOIN,THE NEW
PUBLIC MANAGEMENT:CANADA IN COMPARATIVE PERSPECTIVE (1995); DONALD F. K ETTL,THE GLO-
BAL PUBLIC MANAGEMENT REVOLUTION (2d ed. 2005); DAVID OSBORNE &TED GAEBLER,REINVENT-
ING GOVERNMENT:HOW THE ENTREPRENEURIAL SPIRIT IS TRANSFORMING THE PUBLIC SECTOR (1992).
There are, of course, important differences between the national movements. They are be-
yond the scope of this article.
81
Recently, Patrick Dunleavy and his colleagues have identified three overarching themes
around which they suggest another diverse set of second-tier New Public Management–
20 Vol. 45 / American Business Law Journal
One scholar who emerged in response to the Reinventing Govern-
ment movement in the United States had a direct impact on the B.C.
Model. Malcolm Sparrow’s contribution was to incorporate the new learn-
ing processes, mutatis mutandis, into regulatory functions.
82
His approach
illustrates the application of outcome-oriented principles to the regulatory
(as opposed to public-service provision) task. Sparrow described how the
most effective modern regulatory techniques use sophisticated problem-
solving methods and self-reflective analysis to do the difficult work of
‘‘pick[ing] important problems and solv[ing] them.’’ He found that certain
common elements characterized the best innovations in regulation: (1) a
clear focus on results and effectiveness, based on an expanded and more
specific set of indicators including ‘‘big picture’’ high-level impacts, behav-
ioral outcomes (compliance rates, agency activities), and resource efficien-
cy; (2) adoption of a disciplined problem-solving approach; and (3) an
investment in collaborative partnerships where feasible.
83
Sparrow was
an explicit muse for the BCSC in devising the B.C. Model.
84
D. Examples: Investment Dealers’ Account Supervision and Cartaway
In November 2003 the BCSC published a useful regulatory impact anal-
ysis that compared account supervision systems mandated by the current,
rule-based approach with those of the proposed B.C. Model (the ‘‘Account
Supervision Case’’).
85
The BCSC’s report analyzed the impact of the B.C.
inspired approaches have been introduced: (1) disaggregationFsplitting up public-sector
hierarchies into wider and flatter hierarchies; (2) competitionFseparating purchaser and
provision to create more competition and diversity among potential providers; and (3) inc-
entivizationFrewarding performance, particularly with pecuniary incentives. Patrick Dun-
leavy et al., New Public Management is DeadFLong Live Digital Era Governance,16J.P
UBLIC ADM.
RES.&THEORY 467 (2006).
82
MALCOLM SPARROW,THE REGULATORY CRAFT:CONTROLLING RISKS,SOLVING PROBLEMS,AND MAN-
AGING COMPLIANCE (2000).
83
Id. at 99–122 & 155–70.
84
In a speech to the Task Force to Modernize Securities Legislation in Canada, the BCSC Vice
Chair Brent Aitken stated that the BCSC had been ‘‘following Sparrow’s methodology since
2001.’’ BRENT W. AITKEN, BCSC, ANOTHER WAY FORWARD FOR SECURITIES REFORM (Oct. 14,
2005), http://www.bcsc.bc.ca/uploadedFiles/Aitken_Presentation_IDA_Oct2005.pdf, at 6.
85
CHRISTINA WOLF, BCSC, STRONG AND EFFICIENT INVESTOR PROTECTION:DEALERS AND ADVISER S
UNDER THE B.C. MODELFAREGULATORY IMPACT ANALYSIS (2003), http://www.bcsc.bc.ca/uploaded
Files/Regulatory_Impact_Analysis.pdf.
2008 / Principles-Based Securities Regulation 21
Model on four firms that were members of the IDA, the self-regulatory
organization to which the various Canadian provincial securities commis-
sions delegate frontline regulatory oversight of investment dealers.
86
As
such, the four firms were subject to the IDA’s rules governing account su-
pervision. Each of the four firms studied had distinct operational charac-
teristics: two were national dealers (one Toronto based and bank owned
and one large but local and independent), and two were regional dealers
(one medium sized and the other small).
87
While account supervision was
regulated both under the existing system and the B.C. Model, the firms
believed they would change their practices significantly under the B.C.
Model.
88
According to the BCSC’s analysis, existing IDA account supervision
rules are much more detailed than the B.C. Model’s requirements. The
IDA requires daily and monthly reviews of accounts for trading violations,
suitability, and business risk factors. The IDA-mandated reviews are trans-
actional in nature. Moreover, IDA policy requires the daily reviews to as-
sess each trade against nineteen criteria (and more if the trade is in futures
or options). The policy contains many thresholds that define which trades
need to be reviewed. For example, every account with over $1,500 of
commissions in a given month must be reviewed. The IDA enforced its
specific procedures by auditing firms tightly for compliance.
89
The firms, however, did not find the transaction-based daily and
monthly reviews useful in detecting abuses characterized by patterns of
behavior, which is where they thought the biggest risks arose. Front run-
ning and stock manipulation, for example, may be ascertainable only by
way of a review of trading patterns, which are not readily visible with the
transactional focus mandated by the IDA’s daily and monthly reviews. The
firms also felt that the daily and monthly reviews were duplicative and that
the policy-derived thresholds governing the daily reviews were both too
low and too rigid. For example, the $1,500 threshold caught thousands of
86
Because SRO rules are the dominant factor for such firms, see supra note 72, to be effective
the B.C. Model would have to involve corresponding principles-based changes to those rules
as well.
87
WOLF,supra note 85, at 6.
88
Id.at7.
89
Id. at 13.
22 Vol. 45 / American Business Law Journal
self-directed trades, trades in blue chip stocks, and other sales transactions
that did not carry large risks. Yet, the threshold failed to catch mutual fund
trades, which do not generate commissions, even though very active trad-
ing in mutual funds could raise a red flag with respect to an account’s
treatment. According to one firm, up to 85% of transactions caught by the
daily reviews did not warrant scrutiny. Out of ninety mandated criteria for
daily transaction-based reviews, the firms would have eliminated twenty-
three entirely and would have modified most of the rest. In particular, the
firms felt that a supervision regime using risk-based sampling would be
significantly more efficient. According to the BCSC’s analysis, the firms
were unanimous in their view that the IDA-mandated system contributed
significantly to their regulatory burden without providing meaningful in-
vestor protection. The burden was aggravated by the need to maintain
extensive documentation of compliance (including maintaining separate
paper records, even where electronic records were generated) for IDA
audit purposes.
90
The inefficiency of the mandated reviews was a concern for the firms,
but the transaction-based reviews’ failure to detect key forms of high-risk
behavior was even more troubling. As a result of the perceived limitations
in the mandated reviews, each of the firms already had developed its own
parallel supervisory system, which it thought better managed compliance
risks. One of the large dealers stated that it detected 90% of potential
compliance problems through its proprietary system, which it ran first, and
that daily reviews caught the remaining 10% of potential problems. Yet,
each process took the same amount of time. The need to conduct the
mandated reviews drained resources away from the more effective internal
system. Regardless of the efficacy of their internal systems, dealers were
still required to comply with procedures mandated under the IDA rules.
Significantly, the dealers involved pointed out that they felt they needed to
ensure their accounts were adequately supervised regardless of regulatory
requirements, for civil liability reasons, for reputational ones, and because
they considered it to be good business practice.
91
Certainly some of the problems with the IDA’s mandated reviews
could be ameliorated by modifying the rules themselves; for example, the
IDA could eliminate its requirement for paper records where suitable and
90
Id. at 13–15 & 17.
91
Id. at 14–17.
2008 / Principles-Based Securities Regulation 23
secure electronic records existed. Perhaps following industry consultation,
it could reconsider some of its ninety mandated criteria for daily reviews.
However, this kind of tinkering does not solve the larger problem: that the
regulator, based on its own incomplete knowledge base, had issued de-
tailed and static requirements when the firm’s own experience and incen-
tives would have produced more efficient and effective ones. The IDA
requirements also treated each firm the same, even though each one
worked in a different environment and carried a substantially different risk
profile. For example, while each firm thought there was some continued
utility to transactional reviews, the firms cited several different reasons for
thinking so.
92
Moreover, each firm suggested a different alternative to the
existing policy-based thresholds for winnowing out those daily transactions
that warranted a closer look. While each of the firms would still use some
form of analytical threshold, they would have modified the thresholds in
different ways based on their own compliance experiences and their un-
derstanding of their own businesses.
93
What is required, then, is more than
retooling the rules. Static and detailed rules are blunt instruments, and
they will necessarily be ill fitting in some situations. They are also incapable
of reflecting new learning, including from the firms’ own proprietary risk-
management systems. In that context, the BCSC’s regulatory impact anal-
ysis argued that the perceived consistency benefit of the existing system
was at best outweighed by its cost and was at worst illusory.
94
In contrast, the principles-based and outcome-oriented B.C. Model
would require adequate account supervision not by way of detailed rules,
but through the Code of Conduct provisions dealing with compliance sys-
tems. The relevant provisions are the ones set out above: that a firm must
‘‘maintain an effective system to ensure compliance with the Code, other
legal requirements, and its own internal policies and procedures,’’ and it
must ‘‘maintain an effective system to manage the risks associated with its
business.’’
95
The key advantages of the B.C. Model over the existing one,
as the Account Supervision Case demonstrates, redound both to efficiency
and effectiveness. Because the B.C. Model is outcome oriented rather than
92
Id. at 13.
93
Id. at 16.
94
Id. at 18.
95
See BCSC, supra note 73.
24 Vol. 45 / American Business Law Journal
process oriented, each firm would be in a position to develop the ‘‘effective
systems to ensure compliance’’ that best suited its own risk profile. As the
firms’ own proprietary systems demonstrate, the firms are already using
outcome-oriented mechanisms.
96
The principles-based model permits
firm innovation in compliance processes, allowing firms to sharpen their
compliance practices and procedures without fear of violating detailed
(and potentially anachronistic and less effective) regulatory require-
ments.
97
The BCSC’s regulatory impact analysis did not acknowledge an-
other consideration, though it is equally valid: that an outcome-based
regulatory requirement relieves the regulator itself of the need to be pos-
sessed of perfect information about how to ensure compliance. Buttressed,
always, by credible enforcement to deal with intransigents, outcome-
oriented regulation resituates the informational burden onto the parties gen-
erally best equipped and most motivated to bear itFthe firms themselves.
Interestingly enough, the BCSC’s regulatory impact analysis and a
follow-up report issued in May 2004 also point out that in certain circum-
stances the principles-based approach would actually provide more clarity
and certainty than the existing statutory regime.
98
Alongside its specific
requirements, the existing regime accords the BCSC broad powers to act
‘‘in the public interest’’ in responding to misfeasance not covered by ex-
isting statute and rules.
99
Re Cartaway,
100
a notorious B.C. case, illustrates
the problem. In brief, the respondents were among a group of eight in-
dividual brokers employed by a registered dealer. Without adequate dis-
closure, they personally invested in a small publicly listed company they
intended to use as a shell, and they funneled some mining claims into it
through a shelf company. They entered into a private placement, which
96
WOLF,supra note 85, at 19.
97
Id.
98
Id. at 43–45; BCSC, ENFORCEMENT,supra note 71, at 10–13.
99
B.C. Securities Act §§ 161 & 162. Other Canadian provinces’ statutes have similar or equiv-
alent provisions. See, e.g., Ontario Securities Act, R.S.O. 1990, c. S.5, §127.
100
2000 BCSECCOM 88 (Oct. 2, 2000), available at http://www.bcsc.bc.ca/enforcement.asp
(search Decisions and Orders). The Commission found that it was in the public interest to
impose the maximum administrative penalty available under the B.C. Securities Act on two of
the brokers. Its enforcement decision was appealed to the Supreme Court of Canada on the
questions of what factors the Commission could consider in exercising its public interest
powers and the standard of review for judicial review of the exercise of the Commission’s
public interest powers. See Cartaway Resources Corp. (Re), [2004] 1 S.C.R. 672.
2008 / Principles-Based Securities Regulation 25
they split among friends, without disclosing to investors the material
change in Cartaway’s business from a company in the business of licens-
ing residential garbage containers in the small city of Kelowna, British
Columbia, to a mining exploration firm with claims in Voisey’s Bay, Lab-
rador, then the site of a major staking rush. A few months later they en-
tered into another private placement, with the brokers’ registered dealer
as agent. Cartaway (through its principals, the respondents) disclosed the
acquisition of the Voisey’s Bay claims during this second offering but did
not disclose the respondents’ roles in acquiring the claims, the brokers’
controlling shareholdings in Cartaway, or any of the related conflicts of
interest. The offering was oversubscribed by a factor of four to one, and all
of that offering was placed with the dealer’s clients.
101
The BCSC found that the respondent brokers had contravened var-
ious specific sections of the British Columbia Securities Act and Rules, in-
cluding disclosure requirements, but that some of the brokers’ most
egregious behavior did not contravene any specific provisions. The BCSC
therefore relied on its public interest powers to sanction the brokers for
acting contrary to the public interest, by putting themselves in a position of
conflict of interest with their clients’ best interests, by acting in their own
interests rather than their clients’, by failing in their duties as ‘‘gatekeep-
ers,’’ and by deceiving and intentionally misleading their dealer, its clients,
the relevant exchange, and the public.
102
In support of the B.C. Model, the BCSC points out that the facts in
Cartaway would have implicated directly several specific principles in the
proposed Code of Conduct for Dealers and Advisors, including prohibi-
tions on deceptive and misleading conduct, conflicts of interests, and con-
duct damaging to the reputation of securities markets.
103
The Cartaway
case emphasizes that the B.C. Model should be analyzed not by compar-
ison to a perfect rule-based system, but to the existing system, which is
characterized by sometimes ill-fitting rules, necessarily accompanied by a
sweeping residual public interest power.
104
101
2000 BCSECCOM 88.
102
BCSC, ENFORCEMENT,supra note 71, at 11–12.
103
Id. at 12–13.
104
This observation is also relevant to charges that principles-based enforcement raises con-
cerns about procedural fairness or due process. Notably, the Canadian Supreme Court has
been willing to accept that broadly worded regulatory requirements do not necessarily violate
26 Vol. 45 / American Business Law Journal
III. IMPLICATIONS FOR FIRM COMPLIANCE
A. New Governance and the New Regulator
As the above example demonstrates, the B.C. Model imagines a substan-
tially different relationship between regulator and industryFone that ac-
knowledges the value of the specific, contextual knowledge that industry
actors themselves have in establishing effective and appropriate regulatory
standards. Correlatively, the B.C. Model also requires a somewhat reimag-
ined regulator that is more pragmatic, more willing to devolve responsi-
bility to industry, and perhaps humbler about how well informed and well
equipped it is relative to industry itself. Rather than seeing the regulator as
the central articulator of non-negotiable, specific requirements, the B.C.
Model requires the regulator to define broad themes, to articulate them on
a flexible and dynamic basis, to accept input from the ground level of
regulated entities, and to effectively manage varied incoming information
from industry actors.
New Governance imagines a similar role for the regulator. The term
New Governance has emerged as an overarching moniker to refer to a new
approach in legal scholarship that emphasizes not legal doctrine or formal
jurisprudence, but rather how change actually happens within complex
real-life social systems.
105
New Governance identifies ongoing deliberation
constitutional protections. See Ontario v. Canadian Pacific Ltd., [1995] 2 S.C.R. 1031 (holding
that a prohibition in the Environmental Protection Act on polluting the natural environment
‘‘for any use that can be made of it’’ did not violate section 7 of the Canadian Charter of Rights
and Freedoms on the basis of vagueness or overbreadth); Canadian Foundation for Children,
Youth and the Law v. Canada (Attorney General), [2004] 1 S.C.R. 76 (holding that a Criminal
Code provision allowing parents and others to use force toward a child, ‘‘if the force does not
exceed what is reasonable under the circumstances,’’ did not violate section 7 of the Charter
on the basis of vagueness or overbreadth).
105
Other terms include ‘‘democratic experimentalism,’’ ‘‘reflexive law,’’ ‘‘responsive regula-
tion,’’ and ‘‘network governance.’’ A very limited list of key New Governance works would
include Michael C. Dorf & Charles F. Sabel, A Constitution of Democratic Experimentalism,98
COLUM.L.REV.267, 345–56 (1998); James S. Liebman & Charles F. Sabel, A Public Laboratory
Dewey Barely Imagined: the Emerging Model of School Governance and Legal Reform, 28 N.Y.U. REV.
L. & SOC.CHANGE 183 (2003); Charles F. Sabel & William H. Simon, Destabilization Rights: How
Public Law Litigation Succeeds, 117 HARV.L.REV. 1015 (2004); Susan P. Sturm, A Normative Theory
of Public Law Remedies,79G
EO. L.J. 1357, 1365–76 (1991); Susan Sturm, Second Generation Em-
ployment Discrimination: A Structural Approach, 101 COLUM.L.REV. 458, 555 (2001). On the sim-
ilarities and differences between various New Governance perspectives, including the ones above,
see Bradley C. Karkkainen, ‘‘New Governance’’ in Legal Thought and In the World: Some Splitting as
Antidote to Overzealous Lumping,89M
INN.L.REV. 471 (2004); Orly Lobel, The Renew Deal: The
2008 / Principles-Based Securities Regulation 27
as the most legitimate and most effective mechanism for making decisions
in complex organizational structures. Deliberation is accomplished by de-
centralized, broadly participatory stakeholder groups that can access local
knowledge and context-specific understandings of a situation. New Gov-
ernance securities regulation, then, entails a regulatory structure that
spans the so-called public/private divide, pulls industry experience into
regulatory decision making, and establishes robust ongoing communica-
tion mechanisms (rather than an information-hoarding, adversarial rela-
tionship) between industry and regulator. The regulator establishes broad
policy guidelines and regulatory goals for industry action. It cooperates
with industry where possible in determining means to achieve those goals.
However, on the basis that industry generally has access to superior con-
textual information, it refrains from describing the specific content of those
principles, including the precise means by which industry ought to achieve
the articulated regulatory goals. Individual firms thus are able to use their
own superior knowledge of their particular firm needs and vulnerabilities
to innovate, while remaining accountable for their performance. At the
same time, the regulator collects and analyzes firms’ diffuse contextual
knowledge to produce a system that is more adept at learning from its own
experience.
A New Governance–style, principles-based approach has special rel-
evance to firm compliance functionsFmeaning those policies, processes,
and systems that firms themselves must have in place to prevent and detect
internal wrongdoing and violations of law. In the compliance context, New
Governance permits a dynamic and continually reevaluated internal un-
derstanding of compliance. Most firms will try to abide by most credibly
enforced and reasonable regulatory requirements, in part for pragmatic
business reasons. The enforcement of law, like law itself, serves an ex-
pressive purpose. Regulatory approval (or at least the absence of regula-
tory condemnation) confers legitimacy on firm operations, and it has
currency with clients, suppliers, creditors, and industry peers.
106
However,
Fall of Regulation and the Rise of Governance in Contemporary Legal Thought,89MINN.L.REV. 342
(2004).
106
See Avitai Aviram, Regulation by Networks, 2003 BYU L. REV.1179 (2003) (describing ‘‘network
effects’’ as a mechanism for private ordering and self-regulation); Melvin A. Eisenberg, Corporate
Law and Social Norms,99C
OLUM.L.REV. 1253 (1999) (arguing that corporate actors are moti-
vated less by the desire to avoid liability than by the joint effect of social norms and the correlative
prospect of financial gain in the market); Edward B. Rock, Saints and Sinners: How Does Delaware
28 Vol. 45 / American Business Law Journal
a regulatory regime based on overly detailed and prescriptive rules sends
the message, even to generally law-abiding firms, that observing the strict
letter of the law is what matters and that responsible actors may take ad-
vantage of loopholes, perhaps even with a clear conscience. If adherence to
externally defined, checklist-style compliance indicators confers the legit-
imacy that firms seek, then the firms have an incentive to adhere to those
checklist-style compliance indicators and nothing more. Worse yet, firms
may purchase compliance programs modeled on the prescriptive rules,
regardless of their perceived efficacy, as insurance against enforcement ac-
tion. In this way, compliance-related regulatory requirements might actually
generate moral hazards that undermine corporate governance objectives.
107
Moreover, for that minority of industry actors that is inclined actively to seek
out loopholes and to avoid regulatory requirements, a rules-based system will
do nothing to address that inclination. Creating ever-longer lists of prohibited
behavior or checklists of compliance-related best practices will not be effective
if the basic culture of the firm does not foster law-abiding behavior.
108
By contrast, a principles-based regime sets out requirements govern-
ing, for example, ‘‘reasonable and effective’’ compliance programs and
requires industry actors to take the responsibility for determining how to
meet those outcomes in the particular context of their businesses. At a
minimum, such an approach forces firms to turn their minds to their
Corporate Law Work?, 44 UCLA L. REV. 1009 (1997) (arguing that that Delaware corporate law, as
interpreted by courts, is best understood as attempts to create social norms for senior managers,
directors, and the lawyers who advise them); Mark C. Suchman, Managing Legitimacy: Strategic
and Institutional Approaches,20A
CAD.MGMT.REV. 571 (1995) (arguing that law shapes organi-
zational conduct not only because of law’s cultural weight, but also because organizational le-
gitimacy is pragmatically linked to benefits and penalties); Cass Sunstein, Social Norms and Social
Roles,96C
OLUM.L.REV. 903 (1996).
107
See Kimberley D. Krawiec, Cosmetic Compliance and the Failure of Negotiated Governance,81
WASH. U. L.Q. 487 (2001) (arguing that placing excessive importance on compliance structures
raises dangers of underenforcement and social waste); William S. Laufer, Corporate Liability, Risk
Shifting, and the Paradox of Compliance,52VAND.L.REV. 1343 (1999) (arguing that the moral
hazard will persist until prosecutors and firms share a consistent understanding of what an
‘‘effective’’ compliance system entails, as well as a workable metric for evaluating compliance
systems). As is evident from the discussion above, this article disagrees with Laufer’s and
Krawiec’s to the extent that they argue for more specification and more certainty as a response
to problems of facial compliance.
108
For example, Enron’s Code of Ethics, with its Vision and Values platform encompassing its
RICE (Respect, Integrity, Communication, and Excellence) values statement, was once cited as
a model corporate code of ethics. BETHANY MCLEAN &PETER ELKIND,THE SMARTEST GUYS IN THE
ROOM:THE AMAZING RISE AND SCANDALOUS FALL OF ENRON (2003).
2008 / Principles-Based Securities Regulation 29
compliance processes and those processes’ relationships to their particular
business risks. This attention forcing should reduce noncompliance asso-
ciated with managerial distraction. Principles-based regulation also sends
the important message that firms should orient themselves toward under-
lying principles of responsible business practice, rather than toward facial
compliance with detailed rules. Principles-based systems, buttressed by
meaningful regulatory oversight, make ‘‘cosmetic compliance’’ harder. Re-
quiring firms to fill in the content of those principles themselves makes firms
agents rather than subjects of regulation. It has the potential to dissipate firm
resistance to externally imposed regulatory rules, which (according to some
firms) fail to appreciate the particular nuances of their business and
needs.
109
Endogenous, engaged experience is more likely to produce real
learning and a more genuine compliance culture within the firm.
110
Equally important is the regulatory system’s ability to learn. Learning
systems start from agreed premises of existing law, but they are pragmatic
and open to promising new approaches. Effective regulatory learning en-
tails, first, the ability to gather and analyze, in an open-minded way, ex-
perience from actual practice and input from industry actors and other
stakeholders, including, of course, regulators’ own experiences. Systems,
including regulatory systems, also learn better and faster where they in-
clude some sort of mechanism for amplifying ‘‘local’’ learning, for exam-
ple, by way of parallel experiments moderated and overseen by a
clearinghouse-style regulator. With New Governance, the regulator serves
as a centralized information-gathering body that aggregates experience
and permits comparative learning between industry actors.
111
New
109
See, e.g., EUGENE BARDACH &ROBERT A. KAGAN,GOING BY THE BOOK:THE PROBLEM OF
REGULATORY UNREASONABLENESS (1982) (describing causes of, and site-level frustration with,
legalistic enforcement efforts); Robert B. Cialdini, Social Influence and the Triple Tumor Structure
of Organizational Dishonesty, in CODES OF CONDUCT:BEHAVIORAL RESEARCH INTO BUSINESS ETHICS
44 (David M. Messick & Ann E. Tenbrunsel eds. 1996) (suggesting that overmonitoring can
decrease employees’ independent motivation to comply with law).
110
See Cristie L. Ford, Toward a New Model for Securities Law Enforcement,57ADMIN.L.REV.757,
791–92 & 806–10 (2005). See also Edward L. Rubin, Images of Organizations and Consequences of
Regulation,6THEORETICAL INQ. L. 347, 376–77 (2005) (attributing to a ‘‘systems theory’’ approach
the notion that ‘‘legal regulation of the corporation cannot rely on the imposition of specific
stimuli; rather, it will be effective only if it can induce an internal process that integrates the
corporation with other social systems’’).
111
See, e.g., Dorf & Sabel, supra note 105, at 287–89 & 354–56 (describing innovative regu-
latory strategies that combine local experimentation with a centralized standard-setting and
30 Vol. 45 / American Business Law Journal
Governance envisions a ‘‘learning by doing’’ structure, meaning that in-
dustry and regulator continually revise both ends and their own process
through their participation in it. Transparency and accountability, includ-
ing accountability for adhering to non-negotiable participatory norms, are
reinforced by the centralized comparative data analysis function.
112
In the Account Supervision Case above, each firm in question was
running its own live experiment with supervision processes, considerably
disciplined by real fears of civil liability and adverse reputational effects in
the event of failure. The regulator collected their experience and analyzed
the ways in which different actors reached different solutions to the prob-
lem of supervision, simultaneously learning about effective means for
achieving regulatory goals. Generally, this demonstrates the need for firms
information-processing clearinghouse, which coordinates the local experiment and generates
‘‘rolling’’ performance principles); Brandon L. Garrett & James S. Liebman, Experimentalist
Equal Protection,22YALE L. & POL’YREV.261, 291–92 (2004) (describing the continuous infor-
mation flow between local units and a central regulator). At least one scholar has argued that
experimentalism effectively eliminates the dialectic between rules and principles. See William H.
Simon, Toyota Jurisprudence: Legal Theory and Rolling Rule Regimes,inL
AW AND NEW GOVERNANCE
IN THE EU AND THE US 37 (Graı
´nne de Bu´ rca & Joanne Scott eds. 2006) (arguing that what Simon
calls the Toyota Production System combines a commitment to tightly articulated, formalized
normsFthat is, detailed rulesFwith a commitment to continually adjusting, revising, and re-
writing those rules as they come into tension with unanticipated circumstances). Simon’s per-
spective is not inconsistent with my own, although it is more ambitious. We would both probably
agree that principles-based regulation, when buttressed by outcome-oriented regulatory practice,
responds to the classic vagueness concerns about the use of principles alone and to the concerns
about literalism associated with traditional rules. Because he is dealing with a different context,
however, Simon emphasizes the detailed and democratized decision-making implementation
stage, and he backgrounds the centralized articulation of principles that is a primary concern
here. He also deemphasizes the distinction between the principle articulator (that is, the securities
regulator in this case) and the implementer (primarily industry, but also frontline regulators). In
the context of the immediate rules-versus-principles debate in securities regulation, this article is
reluctant to blur that distinction. It argues that New Governance–style regulation is best under-
stood as a coherent and rational way of filling in the content of principles, rather than a third way
altogether.
112
Similarly, Jody Freeman describes ‘‘collaborative governance’’ in administrative rulemak-
ing as a process characterized by: (1) a problem-solving orientation; (2) participation by in-
terested and affected parties in all stages of the decision-making process; (3) provisional,
revisable solutions subject to continuous monitoring and evaluation; (4) accountability that
transcends traditional public and private roles in governance, in that parties are interdepen-
dent and accountable to each other; and (5) a flexible, engaged regulator that facilitates mul-
tistakeholder negotiations, provides appropriate incentives, acts as capacity builder, and takes
its ultimate decisions recognizing that regulatory success involves industry collaboration
(although it is not ultimately limited by industry consensus). Jody Freeman, Collaborative
Governance in the Administrative State, 45 UCLA L. REV.1, 21–22 (1997).
2008 / Principles-Based Securities Regulation 31
to disclose information about their methods and experience. More partic-
ularly, where one or another actor encountered difficulty in developing a
workable supervision system, the regulator would be able to draw on oth-
ers’ successful examples to help the struggling actor or pressure it to
achieve better results. The regulator could also better identify and then
query firms that seemed to be relying on pro forma and potentially sub-
optimal compliance responses that appeared imperfect relative to the par-
ticular environment and capacities of that firm.
Importantly, as the Account Supervision Case demonstrates, regula-
tion is not the only force pushing firms toward compliance. On the con-
trary, the shift toward outcome-oriented and principles-based regulation
reflects the reality that rules are fashioned in an iterative way, through a
polycentric process, in which regulation is only one part.
113
In other
words, regulatory requirements are only one component going into what
scholars Neil Gunningham, Robert Kagan, and Dorothy Thornton have
called an organization’s ‘‘license to operate.’’
114
In the Account Supervision
Case, reputational effects, network effects, and concerns about civil liability
had already driven the firms in question to establish independent super-
visory systems to address the failings of the mandated checks.
That said, a credible enforcement function writ large (meaning both
compliance oversight and prosecution where needed) is a necessary com-
ponent of principles-based and outcome-oriented regulation. New Gover-
nance theory is to be distinguished from industry self-regulation and also
from so-called ‘‘soft law’’ options.
115
In fact, meaningful and effective en-
forcement capacity is a precondition to New Governance regulation.
116
An
113
See, e.g., Christine E. Parker, Reinventing Regulation Within the Corporation: Compliance-Ori-
ented Regulatory Innovation,32ADMIN.&SOC’Y529, 531–33 (2000) (describing ‘‘compliance-ori-
ented regulation’’ as taking seriously ‘‘the interaction of public regulation with preexisting
regulatory space,’’ within which the state must compete with other regulatory offerings); Chris-
tine E. Parker, Meta-regulation: Legal Accountability for Corporate Social Responsibility,in THE NEW
CORPORATE ACCOUNTABILITY:CORPORATE SOCIAL RESPONSIBILITY AND THE LAW (Doreen McBarnet
et al. eds., forthcoming), available at http://ssrn.com/abstract=942157.
114
NEIL GUNNINGHAM ET AL., SHADES OF GREEN:BUSINESS,REGULATION AND ENVIRONMENT 41–75
(2003) (describing interrelated social, economic, and regulatory standards that businesses
comply with in order to meet the expectations of multiple stakeholders).
115
New Governance models should not be confused with ‘‘soft law,’’ unreinforced by sanc-
tions. See, e.g., Karkkainen, supra note 105, at 485–89.
116
Bradley C. Karkkainen, Adaptive Ecosystem Management and Regulatory Penalty Defaults: To-
ward a Bounded Pragmatism,87MINN.L.REV.943 (2003) (describing the ‘‘penalty default’’). See
32 Vol. 45 / American Business Law Journal
important component of credible enforcement is the regulator’s own abil-
ity to specify, measure, and monitor its outcomes, interrogate and tinker
with its own processes, and learn from and adapt to challenges. The reg-
ulator should operate along the same outcome-oriented, problem-solving,
self-reflexive lines that it requires from industry. Outcome-oriented prac-
tice, in its best form, must mean something substantially different from
unbridled regulatory discretion to interpret principles in any way the
frontline regulator sees fit. The outcome-oriented approach, then, re-
sponds directly to worries that principles-based regulation could be arbi-
trary, inscrutable, or amount to regulatory overreaching. The continued
investigatory mindset is also the principle-minded regulator’s defense
against regulatory ossification over time.
Malcolm Sparrow’s model of problem-solving regulation is instruc-
tive both externally, in terms of the regulator’s relationship to industry,
and internally, in terms of the regulator’s relationship to its own practic-
es.
117
Another promising analytical framework, described as ‘‘root cause
analysis,’’ operates within the Toyota Production System as a problem-
solving technique. It involves asking a series of nested ‘‘why’’ questions
about a particular failure, each of which is meant to deepen the response to
the last.
118
It has clear application to organizational contexts such as secu-
rities lawFfor example, when the superficial reason for a regulatory fail-
ure is that a particular process was not in place. By asking subsequent
‘‘why’’ questions, one can access underlying causes. For example, a firm’s
compliance processes did not operate effectively to prevent wrongdoing
because the firm had not turned its mind to the scenario that occurred; it
had not turned its mind to that scenario because its compliance depart-
ment did not understand enough about its business processes; its compli-
ance department did not understand enough because it was institutionally
isolated; it was institutionally isolated because it was seen as a cost center
and a ‘‘meddler’’; it was seen this way because of a firm culture that
reinforced ‘‘making the numbers at any cost.’’ Root cause analysis on
also AYRES &BRAITHWAITE,supra note 27, at 35–41 (on regulators’ need for a ‘‘benign big gun,’’ or
heavy sanctioning option, to make less intrusive self-regulatory options viable); Parker, Rein-
venting Regulation, supra note 113, at 533–35 (identifying credible enforcement as a precondition
to what she calls ‘‘compliance-oriented regulation’’).
117
See SPARROW,supra note 82.
118
Simon, supra note 111, at 20–21 & 25–26.
2008 / Principles-Based Securities Regulation 33
the heels of a compliance failure also illustrates the important role that
enforcement learning and other forms of on-the-ground learning play in
enhancing overall regulatory capacity.
Returning to the B.C. Model, certain fundamental priorities need to
be kept in mind if the BCSC’s outcome-oriented approach is to remain
credible and respected. These priorities are not new. The first is that reg-
ulatory conduct should be as transparent as possible. In addition to being
good regulatory policy, transparency fosters credibility and trust. It rein-
forces the notion that BCSC action will not be arbitrary, which in turn en-
courages responsible firms to believe that they will be rewarded for their
responsibility. Relatedly, the BCSC must resist the temptation to seize the
low-hanging fruit of easy, technical violation cases in favor of more im-
portant (and often more difficult) cases. In the interest of allocating
resources wisely, BCSC staff should cooperate with responsible firms
where those firms continue to behave responsibly. The BCSC has multi-
ple remedies available to it, and staff should tailor the nature of their re-
sponse to the severity of the conduct at issue.
119
They should be creative
and pragmatic, within the limits of statutory power, in devising effective
remedial or enforcement measures.
120
Such measures may respond to the
need for the corporation to internalize learning and reframe ‘‘punishment
as persuasion.’’
121
119
The various Canadian provincial Securities Acts provide a range of remedial options, in-
cluding administrative penalties (cease trade orders, director and officer bars, etc.), fines, the
power to order disgorgement, plus quasi-criminal provisions. In addition, the Criminal Code
of Canada contains provisions governing insider trading, capital markets fraud, and organi-
zational liability.
120
For example, a noteworthy innovation being adopted by the BCSC, along with the FSA in
the United Kingdom and the New York Stock Exchange in the United States, is the notion of
the selective business line shutdown. See,e.g., Kip Betz, Comprehensive Penalty Review Underway
at NYSE Regulation, Official Says,36S
EC.REG. & L. REP. (BNA) 2116 (Dec. 6, 2004); Patrick
Hosking, FSA Plans to Get ’Creative’with Wrongdoers,T
HE TIMES (U.K.), Feb. 23, 2006, at 48. The
U.S. Federal Reserve has also barred Citigroup from engaging in any major acquisitions until the
company had ‘‘fix[ed its] regulatory problems.’’ Mitchell Pacelle et al., Fed Ties the Hands of Citi-
group,W
ALL ST. J., Mar. 18, 2005, at C1. Temporary business line shutdowns represent a new level
somewhere near the upper end of the enforcement pyramid described in AYRES &BRAITHWAITE,
supra note 27, at 35–41. See also infra text accompanying notes 180–86 for a discussion of reform
undertakings.
121
Pablo De Greiff, Deliberative Democracy and Punishment,5BUFF.CRIM.L.REV.373 (2002) (ar-
guing for a ‘‘communicative theory of punishment’’ under which a primary aim of punishment is
to persuade offenders about the wrongfulness of their conduct). De Greiff’s insight applies here,
even though strictly speaking the Commission cannot punish, but can only deter.
34 Vol. 45 / American Business Law Journal
A regulator should hold its greatest fire for the firms against whom
deterrent action is necessary, yet it should not hesitate to use that sanc-
tioning power where necessary. Just as importantly, it should be able to tell
the difference: the regulator’s credibility, and the so-called enforcement
pyramid approach, is premised on the regulator’s ability to identify prob-
lem firms and noncompliance accurately and to distinguish them, respec-
tively, from generally responsible firms that periodically make mistakes, as
well as from market failures not associated with law violation.
122
Risk anal-
ysis is a central tool here. The use and continual revisiting of appropriate
risk factors will also make the BCSC better at identifying ‘‘bad actor’’ firms
and at imposing its regulatory pyramid over industry appropriately. Pub-
lication of the BCSC’s risk factors would further transparency and cred-
ibility as well.
123
A closer relationship between industry and regulator is another part
of this equation. In fact, each side has incentives to be trustworthy and
open with the other. The regulator needs industry’s knowledge to remain
credible and apprised of current industry practices. Regulated firms seek
the legitimacy that regulatory approval confers, not only for culturally ex-
pressive reasons but also because that legitimacy can confer tangible ben-
efits, including currency with clients and other industry actors. Moreover,
industry and regulator are in a ‘‘repeat player’’ relationship, which ought
to strengthen incentives to behave well toward each other.
124
That said, it
remains to be seen whether the BCSC’s relationship with its regulated
entities reflects these incentives toward cooperation and mutual trust or
122
JOHN BRAITHWAITE,TOPUNISH OR PERSUADE (1985); AYRES &BRAITHWAITE,supra note 27, at
19–53 (advocating for a ‘‘minimal sufficiency principle’’ in the deployment of regulatory ac-
tion, under which most firms are coaxed or persuaded into compliance and a progressively
smaller number of progressively more difficult firms are met with a hierarchical set of in-
creasingly severe sanctions). But see SPARROW,supra note 82, at 39–42 (cautioning that a pyr-
amid approach should apply primarily in contexts where there is reason to believe that
improving compliance is an effective method of decreasing risks, that is, where law violation
rather than, for example, market effects, caused the harm in question).
123
See FSA, THE FSA’SRISK ASSESSMENT FRAMEWORK (2006), http://www.fsa.gov.uk/pubs/policy/
bnr_firm-framework.pdf; ONTARIO SEC.COMM’NSTAFF NOTICE 11-719, A RISK-BASED APPROACH
FOR MORE EFFECTIVE REGULATION (2002), http://www.osc.gov.on.ca/Regulation/Rulemaking/
Current/Part1/sn_20021218_11-719_effective-reg.pdf. The U.S. SEC has also created an
Office of Risk Assessment under Charles Fishkin, online at http://www.sec.gov/about/offices/
ora.htm, although public risk assessment guidelines are not currently available.
124
ROBERT AXELROD,THE EVOLUTION OF COOPERATION (1984).
2008 / Principles-Based Securities Regulation 35
exhibits something more like the cat-and-mouse mentality characteristic
of, for example, tax law enforcement.
125
B. Costs and Compliance
Some scholars have noted that the theoretical rules-versus-principles di-
chotomy drains away an important evolutionary, iterative, contingent, law-
in-action way in which legal prescriptions evolve and are implemented.
126
While this may be true of a rigid, essentialist understanding of rules and
principles, the worry is really only valid at that level. Principles-based reg-
ulation actually goes a long way to permitting an evolutionary, iterative,
polycentric lawmaking process. It takes seriously the role of on-the-ground
implementers in setting the content of the law on a rolling basis.
The advantage of regulatory principles, as opposed to detailed rules,
is not that they will remain forever vague, but rather that their content can
be filled in more dynamically and insightfully by those with the greatest
understanding of the relevant situations. Even in principles-based regimes,
the content of the principle will be filled in and will accrete with time. The
difference is that their content is meant to remain flexible and up to dateF
that rather than ossifying, the principles’ content will continue to evolve,
discarding older formulations as newer, more comprehensive or effective
ones emerge. Moreover, that content, as precisely articulated in a given
context, is generated by direct reference to the operative principles rather
than, as with a loophole mentality, in an attempt to avoid the spirit of the
law in favor of its letter.
127
What this means, though, is that one cannot
125
Sol Picciotto, Constructing Compliance: Game-Playing, Tax L aw and the Regulatory State,29LAW
&POL’Y11 (2007).
126
See Radin, supra note 37. Obviously, laws are not always applied in keeping with the intent
of statutory drafters. For example, Peter May found, in the context of state-level land use and
development management mandates in the United States, that it is more difficult to foster
conciliatory regulatory approaches among frontline implementation staff than it is to foster
more formal, legalistic regulatory approaches. Peter J. May, Mandate Design and Implementation:
Enhancing Implementation Efforts and Shaping Regulatory Styles,12J.P
OL’YANALYSIS &MGMT.634,
653 (1993). May’s point applies most clearly to cases where mandates are developed by parties
removed from those implementing the mandates. This is less the case when discussing the BCSC, a
relatively small organization characterized by physical proximity and frequent interaction between
commissioners, policy staffers, and enforcement officers.
127
For more on this topic, see William H. Simon, After Confidentiality: Rethinking the Professional
Responsibilities of the Business Lawyer (Columbia Public Research Paper 06-119, Aug. 15, 2006),
available at ssrn.com/abstract=924409, at 14 (distinguishing between formalist and new
36 Vol. 45 / American Business Law Journal
evaluate a principles-based regime from the point of view of legitimacy or
efficacy without understanding the mechanisms and actors chosen to fill in
that content.
An outcome-oriented approach of the kind described here is not the
only means for filling in content within a principles-based regulatory ap-
proach, but it is the best one. Another possibility would be to fill in the
content of principles through regulatory discretion. For example, the
BCSC could go the way of American criminal prosecutors: the black box of
discretion.
128
This is not a good solution. Relative to outcome-oriented
practice, it is nontransparent, nonaccountable, and proceeds on an ad hoc
basis without internalizing its own learning in any systematic way. At the
other end of the spectrum would be industry self-regulation. In view of its
troubled history, British Columbia may be even more keenly aware than
other jurisdictions of the need to maintain credible regulatory oversight of
its provincial capital markets, for obvious substantive reasons as well as
with regard to the ‘‘optics.’’
129
Of course, there are also compelling, nor-
mative, and pragmatic
130
arguments, not specific to British Columbia, in
favor of some more substantial degree of ongoing regulation of the secu-
rities markets.
Relative to these options, New Governance–style principles-
based and outcome-oriented regulation spans the public/private divide,
incorporating industry experience and perspectives into a still-resilient
approaches to legal compliance and professional responsibility, even though both approaches
expect regulators and practitioners to describe their practices as explicitly as possible).
128
Most of the literature on prosecutorial discretion emerged around mandatory minimum
sentences and, later, the U.S. sentencing guidelines, which arguably increased prosecutors’
power at the expense of judges’ power. Prosecutorial discretion has been criticized for its lack
of transparency and accountability and for the differentially negative effect of discretion on
marginalized groups. See, e.g., Gerald W. Heaney, The Reality of Guidelines Sentencing: No End to
Disparity,28A
M.CRIM.L.REV.161, 192–97 (1991); Cynthia K.Y. Lee, From Gatekeeper to Concierge:
Reigning in the Federal Prosecutor’s Expanding Power Over Substantial Assistance Departures,50
RUTGERS L. REV. 199, 235–40 (1997). See also Brandon L. Garrett, Structural Reform Prosecution,
93 VA.L.REV. 853 (2007) (citing concerns about prosecutorial discretion in forcing corporate
structural reforms during settlement).
129
See supra note 78.
130
See, e.g., Robert A. Prentice, The Inevitability of a Strong SEC,91CORNELL L. REV.775 (2006);
Rafael La Porta et al., What Works in Securities Laws? (Tuck School of Business Working Paper
No. 03-22, July 16, 2003), available at http://ssrn.com/abstract=425880 (arguing, based on anal-
ysis of the securities laws of forty-nine countries, that countries with better legal protections for
investors have more developed financial markets).
2008 / Principles-Based Securities Regulation 37
regulatory capacity.
131
What this article envisions is shared implementation
of principles-based regulatory mandates within which other actors, such as
individual public issuers, broker/dealers, and portfolio managersFas well
as, potentially, trade associations, industry councils, shareholders, and oth-
er stakeholdersFmay play a role in facilitating regulation and contribut-
ing provisional content to principles. Ultimate enforcement and coercive
power remains with the regulator. The regulator uses its enhanced out-
come-oriented analytical capacity to interrogate industry action, commu-
nicate results, provide ongoing guidance, and spur laggards with a view to
effectuating its irreducibly public policy goals of safeguarding investors and
promoting efficient capital markets.
132
This kind of approach could potentially impose additional costs on
private actors as compared to a prescriptive, detailed, rule-based ap-
proach. Indeed, this was a central point made by opponents to Bill 38.
Critics like David Brown, former chair of the Ontario Securities Commis-
sion, identified that, at least in its initial stages, a principles-based regime
moves substantial costs from legislators to industry actors.
133
In the same vein, Louis Kaplow has posited that rules are costly ex
ante, as their content must be already filled in when they are promulgated,
while principles are costly ex post and those costs are imposed on a broad-
er range of individuals.
134
He has argued that the choice between rules
and principles in statutory drafting should in part come down to the
frequency with which a particular problem arises. Statutory directives
131
The literature on this topic is now voluminous and heterogeneous and beyond the scope of
this article. But see, e.g., Jody Freeman, The Private Role in Public Governance, 75 N.Y.U. L. REV.
543 (2000); Jody Freeman, Private Parties, Public Functions and the New Administrative Law,52
ADMIN.L.REV. 813 (2000); Daniel Guttman, Public Purpose and Private Service: The Twentieth
Century Culture of Contracting Out and the Evolving Law of Diffused Sovereignty,52A
DMIN.L.REV.
859 (2000); Gillian Metzger, Privatization as Delegation, 103 COLUM.L.REV. 1367 (2003); Michael
P. Vandenbergh, The Private Life of Public Law, 105 COLUM.L.REV. 2029 (2005); Paul R. Verkuil,
Public Law Limitation on Privatization of Government Functions, 84 N.C. L. REV. 397 (2006).
132
The accountability issues presented by shared public/private regulation are most fully can-
vassed in Freeman, Public Parties,supra note 131.
133
Letter from David Brown, Chair Ontario Securities Commission, to DougHyndman, Chair
British Columbia Securities Commission (June 27, 2003), available at http://www.bcsc.bc.ca/
uploadedFiles/BCN2003-12_OSC.pdf, at 3 (charging, inter alia, that the B.C. Model ‘‘is fo-
cused on a reduced role for the regulator, but overlooks the increased costs of compliance for
market participants . . .’’).
134
Kaplow, supra note 22.
38 Vol. 45 / American Business Law Journal
governing frequently recurring situations should be drafted as rules, not
principles, because economies of scale justify incurring the costs of deter-
mining the content of the law ex ante.
135
By contrast, exceptional, isolated,
or unusual situations should be governed by principles because there
would be no point, and it would be a waste of resources, to try to anticipate
the content of such laws in advance.
Whether principles-based systems really do impose greater ex post
costs on private actors is an empirical unknown. An accurate measurement
of relative costs would have to acknowledge, for example, that the cost of
rules includes not only ex ante drafting costs, but also the ex post costs
of periodically inappropriate, overly broad or overly narrow application of
rules to unanticipated circumstances. Even leaving that observation aside,
the Kaplow account fails to consider two important points, both of which
go not to the frequency but to the content of the conduct in question.
First, it is not sensible to incur the ex ante costs of rule specification
where the regulator or statutory drafter is operating under a serious in-
formation deficit. This may be the case on a relative basis vis-a
`-vis other
actors or because events are too fast moving to be able to ascertain the
proper content of rules in advance. In other words, the fact that a situation
recurs frequently does not necessarily mean that the regulator has suffi-
cient information to deal with it appropriately. In those situations, ascrib-
ing content to a legal prohibition or directive should be done by such
actors or at such time as the greatest amount of information that can be
feasibly gathered is available.
136
Edward Rubin has said that open-ended, learning systems are pref-
erable to prescriptive, command-oriented regulatory systems where the
regulator ‘‘knows the result it is trying to achieve but does not know the
means for achieving it, when circumstances are likely to change in ways
that the [regulator] cannot predict, or when the [regulator] does not even
know the precise result that she desires.’’
137
It is not an admission of
weakness for a regulator to acknowledge that at least the first two of
135
Id. at 577.
136
At some point, of course, this statement runs into the general prohibition against retro-
activity. The greatest information may only be available with the benefit of hindsight, but
effective administration of justice and basic fairness principles require that some informational
completeness be sacrificed in the interest of real-time clarity.
137
Edward Rubin, The Myth of Accountability and the Anti-Administrative Impulse, 103 MICH.L.
REV.2073, 2131–34 (2005) (citing organizational theorists).
2008 / Principles-Based Securities Regulation 39
Rubin’s conditions may reasonably exist, particularly in the context of cor-
porate compliance. It does not have to be the business of a regulator to
know the precise means for achieving corporate compliance in any given
firm. It is the business of the regulator to try to ensure good compliance
with law, but the corporations or firms themselves are in a better position,
in terms of access to information, to determine appropriate means for
reaching that end.
Second, Kaplow’s thin, industry cost–oriented approach to the choice
between rules and principles must be qualified where the nature of the
directive is such that costs must be borne ex post, by a broader group of
actors, in order to meet regulatory objectives. In those cases, costs should
be borne ex post by that broader group of actors. In other words, there are
times when firm engagement may be the sine qua non of regulatory effec-
tiveness. Regulation concerning firm-compliance processes in particular
depends on industry buy-in. Regulators in a functional system need not
anticipate every form that (right- or) wrongdoing can take, nor create ex-
haustive and detailed lists of prohibited conduct, because sanction alone is
not and could not be what keeps the system functioning.
138
If the most
promising way to make a compliance policy work, for example, is for in-
dustry actors themselves to define and implement a firm-specific and firm-
appropriate strategy for implementing it, then industry actors may well be
expected to bear the attendant costs. Our concern should be to adopt the
effective system with the lowest overall social costs, not the lowest costs to
industry alone.
139
All of these considerations are more important with respect to com-
pliance processes than to any other aspect of business conduct, because
compliance processes are so deeply enmeshed with firm culture and the
firm’s sense of itself and its relationship to its environment and its regu-
lator. Principles-based regulation is not a panacea, and it will not eliminate
all problems. However, it brings with it the exciting potential to build the
138
See, e.g., TOM R. TYLER,WHY PEOPLE OBEY THE Law (1990) (arguing that people obey the law
if they believe it is legitimate, not because they fear punishment).
139
This does not necessarily preclude a subsequent decision to compensate particular parties
for their compliance expenses. One of the assumptions behind having industry pay compli-
ance costs is that, having introduced particular business risks into the world, it should be
required to internalize the cost effect of those risks. However, where this approach turns out to
impose disproportionate compliance costs on a particular party, regulators or society may still
choose to address the iniquity through some form of compensation.
40 Vol. 45 / American Business Law Journal
buy-in from the regulated firm that is essential to a compliance program
that actually works.
C. Rolling Best-Practices Rulemaking
One of the key underlying notions of New Governance theory is that reg-
ulators can improve industry conduct and stimulate a ‘‘race to the top’’
through ‘‘bootstrapping,’’ or ‘‘rolling best-practices rulemaking.’’
140
The
idea is attractive in part because it describes a concrete mechanism for
avoiding the specterFsometimes associated with incorporating industry
standards into regulationFof a race to the bottom. Proponents of rolling
best-practices rulemaking hope for more than simply avoiding a bad re-
sult. The rolling best-practices rulemaking approach suggests a mecha-
nism for harnessing regulation to change the ground rules by which
industry operates. In its strongest form, this kind of rulemaking shifts
regulatory expectations off a static, industry-standards model toward a
model that incorporates the best practices of the highest-performing actors
as new industry-wide benchmarks. It is a fluid regulatory structure that
forces firms to strive for improvement continually and in contextually ap-
propriate, industry-generated directions. One of the regulator’s primary
roles in such a regime is to aggregate and reflect industry actors’ experi-
ences back to them, to establish careful matrices for assessing performance
across firms, and to challenge laggards with the experiences of their high-
er-performing peers.
141
In securities regulation, the notion of rolling best practices runs into
an immediate, but ultimately artificial, conceptual roadblock: the emphasis
on light-touch regulation. Light-touch regulationFmeaning regulation
based on disclosure obligations and a relatively minimalist set of regulatory
and registration requirementsFis the dominant paradigm in securities
140
Dorf & Sabel, supra note 105, at 350–54 (explaining that ‘‘[s]uch rules require regulated
entities to use processes that are at least as effective in achieving the regulatory objective as the
best practice identified by the agency at any given time. . . . benchmarking establishes and
periodically updates the standard to incorporate improvements . . .’’).
141
Id. at 354–56. The regulator’s comparative and aggregative functions, and the provisional
basis on which any particular practice is held to meet regulatory outcomes, are important
components of New Governance theory. They establish a flexible system for ascribing content
to regulatory principles. This means that, contrary to Cunningham’s assertion that the ‘‘new
governance paradigm’’ is a trend favoring rules over principles in regulatory design, Cun-
ningham, supra note 43, at 48, New Governance is actually more compatible with principles-
based and outcome-oriented regulation.
2008 / Principles-Based Securities Regulation 41
regulation. The U.K. FSA’s explicit emphasis on its light-touch approach,
in contradistinction to its characterization of the Sarbanes-Oxley–era
American approach as costly and burdensome, gives this term contempo-
rary relevance. Yet, even the Sarbanes-Oxley Act does not begin to ap-
proximate the interventionist regulatory schemes in some other areas
of administrative law.
142
It is an article of faith among both regulators
and securities industry players that the capital markets ultimately are a
dynamic and positive force and that regulation should limit itself to ad-
dressing market failures, such as information asymmetries. Regulation in
this area seeks to foster efficient and trustworthy capital markets, not to set
goals or direction for those markets.
143
In this context, it is generally pre-
sumed that regulators should not be telling business how to do its business.
The worry about rolling best-practices rulemaking, then, is that an ap-
proach that uses continually increasing best-practices benchmarks to ratch-
et up industry performance is fundamentally opposed to the prevailing
conviction that the regulator’s role is to establish only minimum standards
for industry.
In fact, rolling best-practices standards and light-touch regulation are
not mutually incompatible. The regulatory goal of setting only minimum
standards reflects a normative position, not a quantitative one, regarding
the role of regulation in the securities markets. The light-touch approach
need not (in fact, it should not, in its best form) try to describe a perma-
nent, objective, process-based floor that firms must achieve. Similarly, roll-
ing best-practices standards represent a method for identifying and
leveraging information about effective means for achieving a regulator-
determined goal. One may choose to regulate minimally according to a
series of static checklists, or one may choose to regulate minimally by ref-
erence to evolving industry learning about the most efficient, fairest, most
effective, and least costly means of achieving those minimum standards.
142
The most interventionist, command-and-control regulatory methods seem to have been
more common in the 1970s and 1980s than they are now, particularly in environmental reg-
ulation. See, e.g., ANTHONY I. OGUS,ED., REGULATION,ECONOMICS AND THE LAW (2001); Bruce A.
Ackerman & Richard B. Stewart, Comment, Reforming Environmental Law,37S
TAN .L.REV.1333
(1985); Eric W. Orts, Reflexive Environmental Law,89N
W.U.L.REV. 1227 (1995); William H.
Simon, Legality, Bureaucracy, and Class in the Welfare System,92Y
ALE L.J. 1998 (1983).
143
See, e.g., THOMAS K. MCCRAW,PROPHETS OF REGULATION 172–75 & 185–88 (Harvard Uni-
versity Press 1984).
42 Vol. 45 / American Business Law Journal
The Account Supervision Case, above, illustrates this point. Both the
detailed IDA rules and the principles-based B.C. Model seek to require
firms to meet minimum standards, in terms of establishing appropriate
and effective compliance systems to detect questionable activity in client
accounts. The IDA approach uses detailed, process-based rules as a means
of forcing firms to meet those minimum standards. The B.C. Model uses
the Code of Conduct for Dealers and Advisors as elaborated upon by ad-
ministrative guidance and ultimately industry experience. Recognizing the
IDA rules’ limited effectiveness in identifying questionable account activity,
and mindful of civil liability and reputational risks, firms developed their
own proprietary systems to meet their account supervision obligations.
However, those supervisory systems were developed as better means for
achieving the same perceived minimum level of effective supervision. The
B.C. Model’s principles-based and outcome-oriented approach would not
have demanded increasingly costly or elaborate account supervision sys-
tems from the dealers. The B.C. Model would simply have allowed those
firms to achieve existing regulatory standards using more effective and
context-appropriate methods, as those methods were generated through
industry experience itself. It would also have allowed the BCSC to collect
and disseminate that industry experience to other industry actors facing
similar challenges.
144
The Account Supervision Case also highlights two other important
conceptual relationships: the connection between the regulator and broader
144
Different regulators have somewhat differing views on the extent to which regulators
should actively disseminate best practices information. For example, the FSA produces a
range of supporting materials for industry, including statements of goodFand of less goodF
practices and case studies. Briault, supra note 65. The IDA has even incorporated best-
practices standards into its regulatory expectations on at least one recent occasion. See, e.g.,
IDA MEMBER REGULATION NOTICE MR0441FHANDLING CLIENT COMPLAINTS (Dec. 19, 2006),
www.ida.ca (follow ‘‘Regulatory Policy’’ hyperlink, then follow ‘‘Member Regulation Notice’’
hyperlink, then search ‘‘MR0441’’). By contrast, Commissioner Robin Ford of the BCSC is of
the view that, unlike consultants or trade associations, it is not the regulator’s role to try to
ratchet firms up to best-practice standards. In her view, it is the role of the industry bodies and
consultants to disseminate best-practices standards. If the regulator thinks standards are not
high enough then it should, after consulting, make the rule stricter or issue guidance to say
that it will be demanding more of firms under the relevant principle. While the Commission
should pass on information about good or best practices where it makes sense to do so, it must
remain mindful that it exists to maintain minimum standards and that it should not tell firms
what to do. In Commissioner Ford’s view, doing so is a disincentive to senior management
taking responsibility for compliance and may create a moral hazard. E-mail from Robin Ford,
Commissioner of the BCSC, to author (Apr. 3, 2007, 5:39 PM PST) (on file with author).
2008 / Principles-Based Securities Regulation 43
social or economic factors as determinants of firm behavior and the con-
nection between best practices and outcome-oriented regulation. On the
first point, the way the BCSC uses industry learning both connects its reg-
ulatory agenda with, and distinguishes its regulatory agenda from, com-
patible compliance-generating forces beyond regulation. According to
Sandy Jakab, Manager of Policy for the Capital Markets Division of the
BCSC, the BCSC’s goal is to use best or good practices in an instructive
rather than mandatory way.
145
In fact, the BCSC prefers the term ‘‘good
practices’’ to ‘‘best practices,’’ mindful that the latter can be misunderstood
in the context of a light-touch regulatory approach. Jakab notes that, in the
context of the BCSC’s role in setting minimum standards, ‘‘good’’ practices
are those methods that work to achieve the minimum standard most con-
sistently, most efficiently, and with minimal risk. Jakab emphasizes that, if
implemented literally, such that every improvement in a particular firm’s
practices automatically translated into a heightened process-based regula-
tory expectation across the board, a pure best-practices approach would
also fall prey to potentially adverse firm-on-firm competitive effects. Ac-
cording to Jakab, the BCSC’s view is that one size will not fit all in setting
regulatory standards and that regulators must be sensitive to the costs of
any new regulatory requirement.
146
Jakab points out that the more literal meaning of best practicesFin
other words, the most state-of-the-art and highest, and perhaps the most
comprehensive and elaborate, practices being used by industry leadersFis
available to be put forward by other stakeholders, such as industry asso-
ciations and trade councils. According to Jakab, industry councils and
trade associations have a central role to play in articulating best-practices
standards. But, it is not the place of the regulator to rank practices as
‘‘best’’ or ‘‘second best.’’ Rather, it concentrates on sharing information on
those practices that have been shown to work in achieving regulatory
goals.
147
Significantly, by reconciling light-touch regulation and the desire
for effective and improving standards, the notion of ‘‘best practices’’
becomes bifurcated between regulator and other third parties. The
BCSC explicitly recognizes the role of other forcesFsocial, reputational,
145
Telephone Interview with Sandy Jakab, Manager, Policy, Capital Markets Division, BCSC
(Feb. 22, 2007) [hereafter ‘‘Jakab Interview’’].
146
Id.
147
Id.
44 Vol. 45 / American Business Law Journal
economic, and legalFthat go into ensuring that firms remain law abid-
ing.
148
While using the tools of industry-based good- or best-practices ex-
perience to disseminate learning about effective means for achieving
regulatory goals, the BCSC is neither the overseer nor the repository for
all industry learning.
149
By tying its approach to industry best practices
and establishing an ongoing dialogic relationship between its regulatory
requirements and other standard-setting bodies, regulatory action be-
comes an organic piece of constantly moving, innovating industry action.
In keeping with this, the BCSC’s industry-derived information on best
practices may appear in guidance (policy papers, interpretive statements,
and the like) but not in actual rules.
The Account Supervision Case also illustrates the connection between
rolling good or best practices and outcome-oriented administrative action.
That is, the more basic reason that best practices are not the subject of
official notice-and-comment rulemaking is that an outcome-based system
would not mandate any particular good or best practice. The B.C. Model’s
principles-based and outcome-oriented approach seeks, by definition, to
avoid prescribing process. Indeed, for this reason an outcome-based reg-
ulatory approach is the essential underpinning for making use of good or
best practices in principles-based regulation. Outcome-oriented practice
presumes that there may be more than one path to an acceptable compli-
ance goal, thereby reconciling its best-practices approach with its light-
touch regulatory mandate.
IV. CHALLENGES AND OUTSTANDING QUESTIONS
British Columbia has claimed that its principles-based and outcome-
oriented approach is more flexible, more capable of learning from expe-
rience, and better at safeguarding investor interests, all while still mini-
mizing unnecessary costs to industry. With respect to compliance, for
148
See GUNNINGHAM ET AL., supra note 114; Parker, Reinventing Regulation, supra note 113.
149
In Jakab’s view, industry actors also could be more proactive and effective if they under-
stood that guidance does not set out mandatory standards and that they are free to develop
their own tailored approaches to achieving regulatory outcomes. Jakab notes that the con-
sulting industry can, unwittingly, be unhelpful when it concentrates on developing more
comprehensive and elaborate means of achieving ever-increasing compliance standards, rath-
er than on the most effective and efficient means to achieve minimum standards. Jakab
Interview, supra note 145.
2008 / Principles-Based Securities Regulation 45
example, the aim has been to move away from a technical and literal,
checklist-style approach to regulatory mandates, toward something more
dynamic and geared specifically toward reaching underlying regulatory
goals. The idea behind outcome-oriented regulation is that the securities
regulator should not be policing technical rule violations, and industry
should not be primarily concerned with technical compliance. Both reg-
ulator and industry should be focused on achieving good regulatory
results on important issues, in the most efficient manner.
Even an optimist would agree, however, that challenges exist. The
B.C. Model shares important features with other New Governance ap-
proaches to regulation and public service provision. As such, cautionary
tales from other New Governance–style experiments, such as the ones
emerging from the No Child Left Behind Act in the United States, are
relevant.
150
The decentralized, pragmatic, information-based, and partic-
ipatory structures that New Governance uses to produce continually ratch-
eting standards of performance are vulnerable to many familiar regulatory
failings, including lack of political will, failure of credible enforcement, and
a potential misfit between means and ends. In the same way, making prin-
ciples-based securities regulation in British Columbia work, and enabling it
to leverage all the advantages of a New Governance regime, means paying
careful attention to context.
The B.C. Model is promising and noteworthy because New Gover-
nance–style securities regulation opens the possibility of thoroughgoing
change for the better, including meaningful reform of corporate compli-
ance and the relationship between regulator and industry. However, mak-
ing those changes stick requires that catalysts for change be embedded in
institutional arrangements. There is more work to be done before one
should venture to say whether principles-based and outcome-oriented se-
curities regulation in general, and the B.C. Model in particular, operates
on the ground in a way that can move industry compliance forward in
measurable and sustainable ways. The purpose of this article is to develop a
framework for pursuing those questions as part of a broader research
150
The New Governance potential of the No Child Left Behind Act has been explored in, for
example, James S. Liebman & Charles F. Sabel, The Federal No Child Left Behind Act and the Post-
Desegregation Civil Rights Agenda, 81 N.C. L. REV.1703, 1704–07 (2003); Liebman & Sabel, supra
note 105, at 184–85, 191–92 & 303–04. These authors also acknowledge the significant problems
with that Act, including the weakness of the Act’s formal enforcement mechanisms. See Liebman
& Sabel, supra, at nn. 78–86 and accompanying text.
46 Vol. 45 / American Business Law Journal
agenda. The following sections flag two issues in particular that deserve
closer attention: first, firm incentives to innovate in compliance practices
(as opposed to, for example, product development) and, second, the prob-
lem of varied firm capacity to operate effectively under a principles-based
regime, with special attention to using a hybrid rules-and-principles ap-
proach to help smaller and less-well-resourced firms cope. Provisional re-
sponses to these challenges, including a proposal for regulatory tripartism,
are developed below.
A. Firm Incentives to Innovate
According to Stephen Bland, Director for Small Firms at the FSA, his
agency is approached with some frequency to sign off, under its principles-
based approach, on a firm’s assessment of the compliance bona fides of
new business products. The wholesale market, in particular, is a sector that
regularly seeks principles-based regulatory accord (which is something less
than approval per se) to issue innovative products and business practic-
es.
151
The banks and private firms that regularly develop new structured
finance products for sale into the wholesale market are likely to be among
the most sophisticated of market players. They are the market actors most
likely to have the capacity to work effectively within a principles-based
system, to seek the competitive advantages offered to innovators under a
flexible, discursive, regulatory approach, and to advocate on behalf of their
products and those products’ consonance with regulatory goals. Principles-
based regulation will be attractive to wholesale market participants to the
extent that it helps them bring creative products to market more quickly
and easily.
It is less clear that a market actor’s innovative mindset with respect
to structured finance products will necessarily translate into innovation in
the area of compliance. High-functioning firms will excel in both areas.
However, the pressure to innovate and improve may not be uniformly as
intense in compliance areas as in new product development. Among
more problematic firms, one can even imagine an inverse relationship:
the same drive for innovation that pushes a firm to create new products
also pushes it to take risks and cut corners in corporate governance and
compliance. Among firms that see their internal compliance departments
151
Interview with Stephen Bland, Director, Small Firms at the Financial Services Authority, in
Vancouver, British Columbia (Sept. 28, 2006).
2008 / Principles-Based Securities Regulation 47
as cost centers or, worse, obstacles to be circumvented wherever possible,
the mere presence of principles-based regulatory opportunities to improve
their compliance practices, or to learn from others’ best practices, will not
generate the internal will to do so.
This distinction between product development and compliance high-
lights a number of questions about principles-based regulation. Specifical-
ly, what makes rules ‘‘roll’’ under a rolling best-practices regime, and what
prompts a revision to the content of a regulatory principle? Are revisions
likely to be common where firms have obvious, built-in incentives to in-
novate, such as in creating highly profitable financial instruments for sale,
and uncommon when it comes to compliance processes and procedures?
How can regulators keep compliance on the agenda? Should compliance
even be subject to a rolling deliberative process in this environment, or are
prescriptive rules a better solution in terms of protecting investors and
fostering fair and efficient capital markets?
Not all compliance rules should be subject to deliberation and argu-
mentation. A participatory, principles-based regulatory regime should still
maintain a phalanx of non-negotiable rules governing topics on which
there is consensus, such as extreme misconduct and misbehavior. Circum-
scribing these outer boundaries of permissible conduct actually makes
reasonable deliberation possible with respect to topics on which there is not
consensus. Of course, this is not a full answer. The Account Supervision
Case demonstrates that compliance processes, like other areas of firm con-
duct, benefit from an outcome-oriented, rolling best- (or good-) practices
approach. Some rules may well roll more automatically than others, for
perceived self-interest reasons. Therefore, part of the job of the regulator
may be to help industry players see that meaningful compliance is in their
self-interest.
Regulators can provide short-term incentives and rewards to firms
that exhibit consistently good compliance. In particular, regulators en-
courage compliance when good actors benefit from a reduced regulatory
burden and a more hands-off approach. High-risk actorsFfirms whose
compliance systems have been shown to be materially inadequate to ad-
dress the compliance risks posed by their particular business, whether or
not that business is itself high riskFshould be subject to increased over-
sight. They should attract more compliance visits, more scrutiny of their
practices between visits, more explicitly defined outcomes emanating from
regulators, and eventually even caution letters, potential conditions or
restrictions on the firm’s license, or a referral to enforcement staff. The
48 Vol. 45 / American Business Law Journal
BCSC does this.
152
While somewhat instrumental, differential regulatory
treatment based on a firm’s compliance history does establish clear incen-
tives for firms to remain on good terms with the regulator.
Looking to more endogenous mechanisms, a firm is more likely to
maintain good compliance processes and to exhibit a genuine culture of
compliance where it is able to identify a link between its long-term business
success and good compliance processes. For example, a firm’s compliance
staff may be able to demonstrate that preventive compliance processes are
less costly in the long run than enforcement and civil liability arising from a
compliance failure.
153
In the Account Supervision Case above, the fact that
firms had created internal supervisory programs on their own initiative
demonstrates that they were convinced of this calculation.
Also, one may hope for deeper points of convergence between com-
pliance and profits. In other spheres of activity, finding the leverage points
that establish, in the organization’s view, the connection between good in-
ternal practices and external success has effected measurable progress on
previously intractable problems.
154
Here, Neil Gunningham’s notion of
the ‘‘license to operate’’ may be language that both compliance and busi-
ness sides of the firm understand.
155
The ‘‘license to operate’’ encompasses
not only regulatory requirements, but also the full range of social, business,
and environmental factors that go into a firm’s ability to flourish. Where
firms are subject to pressures from a broad range of stakeholders to prac-
tice good corporate governance, that license to operate becomes thicker
and more substantial.
156
152
E-mail from Michael Sorbo, Manager, Examinations, BCSC Capital Markets Regulation
Division, to author (Feb. 21, 2007, 13:54 PM PST) (on file with author) [hereafter Sorbo e-mail
#1].
153
Penny Tham, Group Compliance, Head of North Asia, ABN AMRO, Remarks at British
Columbia Securities Commission’s Capital Ideas Conference in Vancouver, British Columbia
(Sept. 28, 2006), transcript at 17, available at http://www.bcsc.bc.ca/uploadedFiles/news/
publications/CompleteTranscript-Capitalideas2006.pdf [hereinafter Capital Ideas Conference].
154
Susan Sturm, The Architecture of Inclusion: Advancing Workplace Equity in Higher Education,29
HARV.J.L.&GENDER 247 (2006).
155
GUNNINGHAM ET AL., supra note 114.
156
Id. at 141. Business representatives participating in the Gunningham study also observed
that the social license standards to which they are held may be higher than the regulatory
ones. Id. at 52–55.
2008 / Principles-Based Securities Regulation 49
Broker-dealer firms may also be able to integrate the principles set
out in the Code of Conduct for Dealers and Advisors, based as they are on
a coherent set of ethical standards, with broader (and potentially status-
conferring) professional standards.
157
At the internal level, firms may
come to see that good compliance processes actually improve the internal
environment and make employees more committed and more willing to
innovate, confident in the knowledge that the firm’s compliance safety net
will prevent them from inadvertently engaging in impermissible conduct.
Firms that explicitly live by and reinforce ethical principles for their em-
ployees may even come to be seen as more rewarding places to work, with
associated benefits in the labor market. Locating the precise leverage
points for this to happen in the securities regulatory contextFincluding
concepts, processes, and structuresFis part of the work that remains to be
done to understand and enable compliance standards to roll upward.
B. Capacity Issues and Hybrid Rules-and-Principles Models
As the BCSC recognizes, not all firms under its regulatory ambit will be
possessed of equivalent capacity.
158
The B.C. securities environment is
characterized by a large number of junior-cap companies, small natural
resource venture issuers, and small portfolio managers that do not have
the means to engage large compliance departments. Neil Gunningham
and Darren Sinclair have pointed out that many small and medium sized
enterprises (SMEs) operate at the margins of profitability and cannot
afford to devote many resources to such non-bottom-line issues as envi-
ronmental protection, or as suggested here, to state-of-the-art compliance
processes.
159
Also, they often lack awareness and expertise; they may not
have integrated compliance priorities into their business decisions; and
they are likely to be less frequently inspected because as a group they are
numerous, but each individual SME presents a quantitatively lower risk to
157
Gary Hagland, A Critical Evaluation of the Compliance Administrative Control System Within Al-
bert E Sharp and its Motivational Impact Upon Those It is Supposed to Control, 3 J. FINAN.REG.&
COMPL.28, 33 (1994) (early compliance-related case study of stockbrokers firm, noting that com-
pliance controls were reinforced where firm equated corporate quality control with the codifica-
tion of professional standards).
158
See Jakab Interview, supra note 145.
159
NEIL GUNNINGHAM &DARREN SINCLAIR,LEADERS &LAGGARDS:NEXT-GENERATION ENVIRONMEN-
TAL REGULATION 13–40 (Greenleaf Publishing 2002).
50 Vol. 45 / American Business Law Journal
regulatory objectives. SMEs’ focus on economic survival means that they
may lack the bandwidth to take action on issues like compliance, unless they
are facing specific overt threats or pressure through, for example, regula-
tory action.
160
Moreover, a principles-based regulatory regime may impose
additional competitive pressures on smaller firms because larger industry
actors with greater capacity to innovate are rewarded in such a system.
One option for responding to smaller firms’ more limited capacity is
to create a hybrid rules-and-principles system. Conceptually, this could
entail either some sort of midpoint between two approaches or a system
that gives industry actors a choice between principles-based and rules-
based alternatives. The latter would effectively locate principles-based reg-
ulation adjacent to, rather than in lieu of, existing regulatory rules, such that
firms that lack the desire or the capacity to innovate in compliance systems
could rely on detailed, preexisting rules. This is the approach adopted by
two regimes in Europe: the continental comply-or-explain regime for cor-
porate governance
161
and the U.K. FSA’s approach. The U.S. Commodity
Futures Trading Commission is also moving along what it calls a hybrid
rules-and-principles spectrum, which includes the statutory core principles
in the Commodity Futures Modernization Act.
162
Under the FSA model,
which is probably the most fully developed, firms have the option of either
abiding by the safe harbor of established rules or applying innovative
practices that nevertheless meet the FSA’s principles-based regulatory
guidelines. If a firm chooses to use the principles rather than the rules,
it must convince the FSA that its alternative mechanism is likely to achieve
the same regulatory goal. If the firm succeeds, the FSA uses its exemptive
authority to deactivate the operative rule, while giving effect to the oper-
ative principle and the firm’s proposed innovation.
160
Id. at 13–14.
161
See EUROPEAN CORPORATE GOVERNANCE FORUM,STATEMENT OF THE EUROPEAN CORPORATE
GOVERNANCE FORUM ON THE COMPLY-OR-EXPLAIN PRINCIPLE, (Feb. 22, 2006), http://ec.europa.
eu/internal_market/company/docs/ecgforum/ecgf-comply-explain_en.pdf. The European
comply-or-explain model emphasizes transparency and disclosure, but leaves the details up
to the particular issuer. As it stands, the principle is essentially a straightforward disclosure
requirement. It assumes a high level of shareholder sophistication. Firms have the option of
simply rejecting the nonbinding regulatory suggestion, which leaves it up to shareholders to
discipline the firm. This hands-off approach especially does not make sense in a less trans-
parent and liquid market arena such as British Columbia’s, which is characterized by a large
volume of exempt transactions and closely held companies.
162
Lukken, supra note 7.
2008 / Principles-Based Securities Regulation 51
This approach is not unlike the prophylactic-rules approach suggest-
ed by some New Governance scholars.
163
In theory, it has the advantage of
sharing with the regulators on-the-ground information about potential
emerging best practices in real time. Regulators can then disseminate in-
formation about those best practices to other industry actors, including
smaller or less well-resourced ones, who can benefit from the innovations
without having to reinvent the wheel themselves.
164
This approach also
conserves each firm’s resources, allowing a firm to make incremental mod-
ifications to a compliance rule as it learns about what works.
165
A hybrid
rules-and-principles system may also allay industry fears about regulatory
discretion and overreaching under a purely principles-based regime.
166
As
the FSA example demonstrates, the shift to a principles-based system, in
163
Dorf & Sabel, supra note 105, at 403. The concept also shares some ground with what Ian
Ayres and John Braithwaite call ‘‘enforced self-regulation,’’ which permits firms to substitute
their own privately devised compliance rules for the public ones. One difference, however, is
that in the Ayres and Braithwaite model, the default public rules are more onerous, as well as
being less tailored, than the privately developed alternative. Additionally, the enforced self-
regulation model is useful primarily for large firms with the internal compliance capacity to
develop a comprehensive set of compliance rules and to self-monitor for compliance with
those rules and for lessons derived from experience with them. AYRES &BRAITHWAITE,supra
note 27, at 101–32. The hybrid FSA model permits a more piecemeal approach to substituting
a particular innovation for a specific rule.
164
The sociolegal literature illustrates the important role that mimicry, or ‘‘isomorphism,’’
plays in disseminating new practices. Paul J. DiMaggio & Walter W. Powell, The Iron Cage
Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields,in THE NEW
INSTITUTIONALISM IN ORGANIZATIONAL ANALYSIS (Walter W. Powell & Paul J. DiMaggio eds.,
University of Chicago Press 1991). Depending on context, the phenomenon can be functional
as well as dysfunctional.
165
Contrast this with, for example, the costs imposed by the Sarbanes-Oxley Act § 404, as
ultimately implemented. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, § 404, 116 Stat.
779, 789 (codified as amended in 15 U.S.C. §§ 7201–7266 and scattered sections of 18 U.S.C.
(Supp. II 2002)). Professor Langevoort has argued that Sarbanes-Oxley § 404 has been as
expensive as it has in part because ‘‘accountants, lawyers and consultants captured the mean-
ing of the statutory text early on in ways that . . . have generated large rents for their pro-
fessional activities.’’ Donald C. Langevoort, The Social Construction of Sarbanes-Oxley, 105 MICH.
L. REV.1817, 1828 (2007). Anecdotally this does not seem to have been a problem in the appli-
cation of British Columbia’s principles-based requirements, at least so far, but it is a potential risk
in British Columbia as well and one that calls for a more detailed examination than can be un-
dertaken here.
166
Also relevant to fears about regulatory overreaching is the fact that capital markets inter-
nationally are now very much in competition with each other. See also Capital Ideas Confer-
ence, supra note 153, transcript at 87–89.
52 Vol. 45 / American Business Law Journal
practice, is more evolutionary than it is revolutionary. Preexisting rules
continue to provide a baseline, and change happens at the margins.
There is, however, one large danger in the use of such a hybrid sys-
tem: it may be subject to being gamed. Specifically, noncompliant industry
actors could choose to rely strategically on existing detailed rules whenever
they had a colorable basis for arguing that they were in compliance with
the rule, regardless of whether their actions were in keeping with the un-
derlying principle. The firm could selectively look for loopholes in the
rules, falling back on principles only if and when the regulator decided to
challenge the conduct in question. In this context, the innovations for
which principles-based regulatory approval would be sought in advance
would be limited to those that were obviously impermissible under existing
rules.
167
Firms would avoid the delay, cost, and risk of seeking regulatory
approval for innovations that could somehow be shoehorned into existing
rules. This in turn would cut the regulator out of the learning loop. In
effect, the rules-versus-principles choice would devolve to rules wherever
possible.
168
Principles-based regulation would be reduced to the service of
last recourses and ex post justifications.
The response is as follows: first, while a principles-based regulatory
approach may use existing detailed rules as prophylactic rules, it must be
clear that industry actors are expected to abide by regulatory principles as
well. Rules-based and principles-based regulatory expectations must op-
erate serially, not in parallel. An enforcement response should be swift and
unequivocal where a firm appears to be using a loophole in detailed rules
to avoid abiding by a regulatory principle. And, enforcement sanction
must be available for violation of principles themselves.
169
Second, sepa-
rate from the enforcement context, the regulator should be conscious of
the need to maintain an ongoing dialogue with firms about their practices.
167
This is reminiscent of the familiar phrase with respect to Project XL in the environmental
arena: ‘‘if it ain’t illegal, it ain’t XL.’’ SPARROW,supra note 82, at 23.
168
Schauer, supra note 23.
169
See, e.g., Stephen Bland, Director, Small Firms, U.K. FSA, Remarks, in Capital Ideas Con-
ference, supra note 153, transcript at 23–24 (describing the Citigroup case in which that firm
was fined d11 million for breaching two FSA principles); David Wilson, Chair, Ontario Se-
curities Commission, Remarks, in Capital Ideas Conference, supra note 153, transcript at 53–
54 (discussing Canadian mutual fund market timing probe, which resulted in mutual fund
firms disgorging C$209 million to investors based on having violated their obligation to treat
their clients fairly).
2008 / Principles-Based Securities Regulation 53
Where a firm has shown an historical propensity to operate close to the line
or to abide by the letter rather than the spirit of the law, that firm should be
supervised more closely. Firms that have demonstrated bona fides may be
granted more leeway.
170
Under this approach, the regulator may seek to
enhance struggling firms’ capacity by providing examples of others’ good
practices and refrain from pursuing formal enforcement where firms are
engaged in a bona fide effort to abide by regulatory principles.
171
Again, a
renewed relationship between regulator and industry, based on trust and
information sharing, is an important piece of regulatory effectiveness.
172
And maintenance of an ongoing, regular, and collaborative dialogue be-
tween the regulator’s compliance (not enforcement) function and industry
actors could mitigate any relative delay, cost, and risk associated with seek-
ing principles-based regulatory approval.
C. A Partial Proposal: Tripartism
The BCSC already recognizes a particular role for third-party industry
councils and trade associations, as a way of encouraging firms to learn from
each others’ best practices while maintaining an explicit light-touch regu-
latory focus.
173
More ambitiously, Ian Ayres and John Braithwaite have
advocated for what they call ‘‘tripartism’’ as a form of responsive regula-
tion.
174
Ayres and Braithwaite describe regulatory tripartism as a regula-
tory policy that fosters the participation of third-party public interest
170
The BCSC’s Capital Markets Regulation Division uses a risk-based matrix to assess the risks
presented by different industry actors, and it accords more leeway to firms that have dem-
onstrated compliance bona fides. Sorbo e-mail #1, supra note 152. This is consistent with the
so-called ‘‘enforcement pyramid.’’ AYRES &BRAITHWAITE,supra note 27, at 35–40.
171
See, e.g., Capital Ideas Conference, supra note 153, transcript at 63: ‘‘For these small firms,
sometimes they don’t know what good business practice is, and we’re not saying, of course,
that we know. But what we do have the ability to do is go to a large number of these small
firms, observe what works, what is good, what doesn’t work, and then play it back to the
community as a whole as a sort of service to them, if you like, to help them improve their
standards and run their businesses in good business practice ways.’’
172
The BCSC’s Capital Markets Regulation Division also works with trusted industry actors to
develop principles-based win-win outcomes where possible. E-mail from Michael Sorbo, Man-
ager, Examinations, BCSC Capital Markets Regulation Division, to author (Feb. 21, 2007,
13:19 PM PST) (on file with author).
173
See Jakab Interview, supra note 145.
174
AYRES &BRAITHWAITE,supra note 27, at 54–100.
54 Vol. 45 / American Business Law Journal
groups in three ways: by giving third parties access to all the information
the regulator possesses, by giving them a seat at the negotiating table, and
by giving them the same standing to sue or prosecute that the regulator
has. Ayres and Braithwaite suggest that a strategy of meaningful tripartite
dialogue can facilitate attainment of regulatory goals, prevent corruption,
and prevent the kind of agency capture that is harmful to the public good
and regulatory goals. At the same time, it encourages helpful capture in
which the regulator saves enforcement resources by overlooking minor or
technical compliance breaches, and the firm more efficiently spends its
resources on meeting the underlying goals of the regulation, including
even making extralegal beyond-compliance efforts, rather than meeting
the literal rules of the regulation.
175
The notion of tripartism also has been advanced in the work of Neil
Gunningham and Darren Sinclair, with respect to SMEs in the environ-
mental regulatory arena.
176
Gunningham and Sinclair propose that, where
government’s capacity to regulate SMEs is limited, regulators may harness
a credible third party to play a surrogate regulatory role. Regulatory sur-
rogacy through trusted third parties may be particularly important in an
environment like British Columbia, which is characterized by many small
firms and junior-cap issuers. Third-party intervention is useful in this
context as a means of helping SMEs meet regulatory requirements while
not overstretching regulatory resources.
177
Third-party regulatory surro-
gates with commercial power or some other basis of authority relative to
SMEs may also help break through SME resistance.
175
Ayres and Braithwaite also argue that the more complete ‘‘republican regulatory tripar-
tism’’ they describe fosters democracy, both in terms of citizen empowerment and because the
outcome under tripartism is more likely to be closer to the legal standard settled upon
through the democratic process. Id. at 81–94. Like many scholars working under the New
Governance umbrella, broadly defined, Ayres and Braithwaite see in their proposal the pos-
sibility of furthering not only better regulation, but better governance at large and, ultimately,
a more effective, equitable, engaged, and legitimate democracy. Id. at 12–18. See also Dorf &
Sabel, supra note 105; Michael C. Dorf, After Bureaucracy,71U.C
HI.L.REV.1245 (2004).
176
GUNNINGHAM &SINCLAIR,supra note 159, at 13–40.
177
The costlier option (and one that is more interventionist than anything existing in securities
regulation to date) would be to establish an information arm within the BCSC that is in a
position to respond to inquiries and conduct one-on-one compliance audits, completely sep-
arate from enforcement. This option is by the U.S. Occupational Safety and Health Admin-
istration with respect to SMEs under its regulation. See U.S. DEP’TOFLABOR,OCCUPATIONAL
SAFETY AND HEALTH ADMINISTRATION, OSHA’SCONSULTATION PROGRAM, http://www.osha.gov/
dcsp/smallbusiness/consult.html (last visited Sept. 7, 2007).
2008 / Principles-Based Securities Regulation 55
An appropriate third party might be a trade association or industry
council, or it might include professionals like bankers or accountants who
have preexisting relationships with the SMEs. Such a third party could
provide face-to-face information, ongoing support, and clear practical
guidance to SMEs, focusing on the ways in which good compliance prac-
tice is also good business practice. The third party could facilitate self-in-
spection and self-audit by publishing key criteria and communicating
information about best and acceptable practices. Given the right incen-
tives, an industry association, for example, could go furtherFrequiring
self-reporting; establishing awards for high performers; conducting audits;
and supporting a streamlined, simple, inexpensive, and SME-appropriate
accreditation process.
178
An additional possibility for increasing the public
effect of regulatory approval of a particular best practice would be to in-
stitute a reward program for compliance leaders, under which they are
permitted to use a revocable certification mark. Certification marks have
gained real currency as it has been shown that they have value in the
marketplace.
179
Tripartite relationships may also be useful in the enforcement envi-
ronment, as the use of what one might call ‘‘reform undertakings’’ at the
U.S. SEC suggests. Reform undertakings are more open-ended, discursive
problem-solving remedies embedded within traditional enforcement
mechanisms. They seem to be a promising avenue.
180
Under a reform
undertaking arrangement, the regulator’s enforcement staff and the firm
enter into a settlement agreement relating to an action that enforcement
has initiated for violation of the securities laws. One term of the settlement
agreement is that the firm shall retain, at its own expense, an independent
third-party monitor to oversee its compliance processes and procedures
for a period of time after the settlement has been concluded. That third
178
GUNNINGHAM &SINCLAIR,supra note 159, at 16–24.
179
Consider, for example, the International Principles Organization’s ISO 9000 (management
systems), 14001 (environmental), and 26000 (social responsibility) certifications. Certification
regimes also have crossed the divide between ‘‘technical’’ matters like management systems or
Kosher certification, and more political questions, like those underlying ISO 26000 social re-
sponsibility mark. See also Ian Ayres & Jennifer Gerarda Brown, Mark(et)ing Nondiscrimination:
Privatizing ENDA with a Certification Mark, 104 MICH.L.REV.1639 (2006) (proposing a voluntary
mark to designate businesses that do not engage in employment discrimination on the basis of
sexual orientation).
180
Ford, supra note 110. See also Garrett, supra note 128 (describing the deferred prosecution
phenomenon in criminal prosecutions).
56 Vol. 45 / American Business Law Journal
party should have credibility and the right skill set and should be both
independent and accountable. The third party’s role is to intervene in the
firm over a more extended period of time, identifying compliance failures
and reasons for the alleged law violation. It then reports back to the reg-
ulator on its findings, recommendations, and the steps taken by the firm in
response to those recommendations. Reform-undertaking provisions are
generally drafted in prospective, principles-based language, giving the
firm and third parties substantial scope to interpret what constitutes a
reasonable or appropriate remedial recommendation. In an ideal case, a
reform-undertaking third party uses best-practices learning in other con-
texts to ratchet up compliance performance in the subject firm. It operates
in a transparent, reasoned, problem-solving manner and engages firm
employees and officers in a dialogic process, both as an information-gath-
ering tool and as part of challenging existing assumptions and forcing
positive endogenous change.
Returning to the B.C. Model, there is nothing about Canadian juris-
prudence that would preclude such creative remedies. To the contrary,
similar remedies exist in multiple Canadian regulatory arenas and are
consistent with Canadian approaches to public policy.
181
Reform-under-
taking–style remedies have already been used by the IDA
182
and Market
Regulation Services, Inc. (another SRO),
183
as well as the Ontario Securi-
ties Commission.
184
Reform undertakings or something approximating
181
See Cristie L. Ford, In Search of the Qualitative Clear Majority: Democratic Experimentalism and
the Quebec Secession Reference,39ALTA .L.REV.511, nn. 26–33 and accompanying text (2001)
(identifying Canadian precedents for New Governance–style regulation).
182
Settlement Agreement, In the Matter of Union Securities Ltd. and John P. Thompson
(Apr. 18, 2006), available at http://www.ida.ca/Files/Enforcement/SettlementAgreements/
SA2006041801_en.pdf (retaining Grant Thornton LLP as a Compliance Monitor, tasked
with, among other things, ‘‘monitoring and evaluating Union’s compliance systems and cor-
porate governance procedures’’).
183
Market Regulation Services Inc., commonly known as RS, is the independent regulation
services provider for Canadian equity markets. See Offer of Settlement, In the Matter of UBS
Securities Canada Inc. (Oct. 8, 2004), available at http://docs.rs.ca/ArticleFile.asp?
Instance=100&ID=4CDF42F183D6455D903D528E03DF0330 (settlement agreement wherein
UBS Securities agreed, inter alia, to retain an independent consultant to review its supervisory
and compliance systems to ensure that they comply with Universal Market Integrity Rules).
184
See Order, In the Matter of Agnico-Eagle Mines Limited (Apr. 28, 2005), available at
http://www.osc.gov.on.ca/Enforcement/Proceedings/RAD/rad_20050428_agnico-eagle-mines.pdf
(settlement agreement wherein Agnico-Eagle Mines agrees to ‘‘initiate a review of its disclo-
sure and reporting practices and procedures by an independent third party, acceptable to
2008 / Principles-Based Securities Regulation 57
the deferred prosecution agreement in the United States also are a clear
possibility under the organizational sentencing provisions of the Criminal
Code.
185
In their recent treatise on risk management, authors Todd Ar-
chibald, Kenneth Jull, and Kent Roach make a case for ‘‘embedded audi-
tors’’ as a component of sentencing. Such sentencing orders would
provide, under authority of court order, that regulatory inspectors be
placed on site of the convicted corporation to monitor compliance for a
period of time.
186
Thus, reform-undertaking–style third-party involve-
ment already has roots in Canadian soil.
Regardless of the specific tripartite mechanism in question, involving
a third party in governance increases the scope of perspectives available to
the regulator. It also permits broader participation from stakeholders and
others that typically do not have a voice in securities regulation, notwith-
standing the importance of securities regulation to individuals and broader
both Agnico-Eagle and Staff, at the expense of Agnico-Eagle’’ and ‘‘implement any recom-
mendations made by the independent third party referred to above that are approved by
Staff, within a reasonable period of time, as approved by Staff ’’); Order, In the Matter of
Murray Hoult Pollitt and Pollitt & Co. Inc. (Nov. 17, 2004), available at http://www.osc.
gov.on.ca/Enforcement/Proceedings/RAD/rad_20041117_pollitt.pdf (settlement agreement
wherein Pollitt & Co. agrees to ‘‘forthwith retain Cassels Brock Regulatory Consulting Inc.,
at its sole expense, to ensure that its revised practices and procedures have been properly
implemented and to ensure that compliance staff and trading officers are properly trained in
their obligations, roles and responsibilities’’). The brevity of both Orders, and the absence of
detailed terms governing the third party’s retainer and obligations, is striking relative to those
from the IDA, the RS, and the U.S. SEC. See Ford, supra note 110, at nn. 140–43 and ac-
companying text.
185
Criminal Code of Canada, Part XXIII: Sentencing: Probation. §732.1 (3.1) states, in rel-
evant part,
The court may prescribe, as additional conditions of a probation order made in respect of
an organization, that the offender do one or more of the following: . . .
(b) establish policies, principles and procedures to reduce the likelihood of the organi-
zation committing a subsequent offence; . . .
(d) report to the court on the implementation of those policies, principles and proce-
dures; . . .
(g) comply with any other reasonable conditions that the court considers desirable to
prevent the organization from committing subsequent offences or to remedy the harm
caused by the offence.
186
TODD L. ARCHIBALD ET AL., REGULATORY AND CORPORATE LIABILITY:FROM DUE DILIGENCE TO
RISK MANAGEMENT zz 12:20:10.20, 12:50:60.20 (2005) (describing the statutory basis for, and
rehabilitative potential of, placing state compliance auditors in companies convicted of crim-
inal or regulatory offenses).
58 Vol. 45 / American Business Law Journal
social interests. The examples above involve third-party expertise actors
like compliance consultants and industry associations, but depending on
the context this does not necessarily represent the universe of potential
third parties. Tripartism plays a role in providing transparency and en-
hancing accountability, as examples from the larger world of corporate
governance and corporate social responsibility activism demonstrate. For
example, third-party–certified best or good practices affect consumers, as
Forest Practices Certification has shown in the forestry industry.
187
Entire
corporate compliance and corporate social responsibility consultancy in-
dustries now exist, and ethical investing funds and advocates pressure for
triple-bottom-line reporting.
188
Other potential third parties include in-
dustry associations like the Canadian Bankers Association, nonprofit cor-
porate social responsibility organizations like the Global Reporting
Initiative, or for-profit firms like Innovest or Institutional Shareholder
Services, which operates the Investor Responsibility Research Center.
189
Shareholder representatives and major accounting firms could even play a
role. One should resist trying to identify the right third parties ex ante.
One should also resist dismissing any potentially suitable third party out of
hand, given the important role these actors could play in broadening the
regulatory conversation beyond the dyadic.
187
Errol Meidinger, The New Environmental Law: Forest Certification,10BUFF.ENVTL. L.J. 211
(2003) (describing standard setting, certification, accreditation, and labeling for enforcing sus-
tainable forest management standards in the absence of applicable national law); Richard B.
Stewart, A New Generation of Environmental Regulation,29C
AP.U.L.REV. 21, 34–43 (2001) (de-
scribing reflexive law information strategies for disseminating information about an organiza-
tion’s environmental performance, with the goal of giving stakeholders sufficient information to
pressure organizations to ‘‘behave better’’).
188
John M. Conley & Cynthia A. Williams, Engage, Embed, and Embellish: Theory Versus Practice
in the Corporate Social Responsibility Movement (UNC Legal Studies Research Paper No. 05-16,
Mar. 25, 2005), available at http://ssrn.com/abstract=691521 (discussing, with some skepticism,
the corporate compliance industry in London).
189
Paul Rose, The Corporate Governance Industry (Ohio State Public Law Working Paper), avail-
able at http://ssrn.com/abstract=902900 (identifying major for-profit and not-for-profit play-
ers in the corporate governance industry).
2008 / Principles-Based Securities Regulation 59
V. C ONCLUSION
Principles-based regulation and outcome-oriented regulation are respons-
es to a visceral recognition that traditional, rule-oriented legal regimes are
limited in their ability to deal with some broader organizational and cul-
tural problems. Resistance toward effective compliance and other forms of
corporate cultural dysfunction are not easily dislodged. Principles-based
regulation forces agency on firms, making them active participants in de-
fining the compliance processes that will best address their particular busi-
ness risks and situation. Some version of outcome-oriented regulation is a
necessary correlative to principles-based regulation, in that it is a respon-
sible way to force accountability into a system that leaves articulation of the
content of those principles to on-the-ground actors. Securities regulators
can do quite a bit to advance their vision of modern securities regulation
without statutory change. The decision of the BCSC to proceed with a
principles-based and outcome-oriented regulatory approach, despite the
fact that Bill 38 has not come into force, is a prime example of this option.
Securities commissions have substantial discretion and extensive rulemak-
ing powers. The practice of securities regulation can continually improve
notwithstanding its statutory architecture in the implementation phase.
Principles-based regulation is important primarily because it identi-
fies that on-the-ground implementation is more important than idealized
(principles-based) statutory design. A principles-based and outcome-ori-
ented regulatory approach consistent with New Governance, like the B.C.
Model, does not advocate simply removing rules, leaving the capital mar-
kets to self-regulation or subject to the whims of a regulator’s discretion.
Rather, it provides a rational, systematic alternative to an unscripted lay-
ering-on of rules on rules to deal with each new situation and their cor-
responding adverse system effects. The most promising aspect of the B.C.
Model is not the opportunity for open-ended and flexible securities reg-
ulation, viewed from the stratospheric level of statutory drafting and policy
making. Rather, it is the opportunity for dialogic and transparent securities
regulation, viewed from the ground occupied by industry, frontline reg-
ulators, corporate social responsibility advocates, and shareholders.
60 Vol. 45 / American Business Law Journal
