Rules-Based or Principles-Based Securities Regulation

 In business law, securities

Rules-Based or Principles-Based Securities Regulation

In December 2013, I defended my PhD in securities law at Osgoode Hall – a six year ordeal.  There were some required courses and seminars, but the bulk of the work was done from home in the evenings and weekends, researching electronic libraries and drafting, re-drafting, and re-drafting again.

The research question was this—should the securities regulation of Ontario venture issuers (such as mining and technology start-ups) be founded on rules or principles?  Securities regulations require public companies to provide full, true and plain disclosure of all material facts and risks about their business, so that investors can make informed decisions.  It also has to do with fairness.  For example, insiders can’t trade with inside information and can’t manipulate transactions for personal advantage at the expense of their shareholders.  

The Ontario Securities Act, and the Rules and Policies of the Ontario Securities Commission, comprise a book of over 3,000 pages of small print, almost double the length of the King James Bible.  How can the average business lawyer, let alone the average business on a limited budget, comply with regulations that are so complex?  Why are they so complex?

It harkens to what my father, Bill Allen, strived to achieve in his legal precedents.  His favourite book on writing was “The Elements of Style,” written by William Strunk Jr., almost a hundred years ago.  E.B. White, who was Professor Strunk’s student in 1919, and who later became co-author of “the little book,” described how Will Strunk would stand in front of his class, exhorting his students to “Omit Needless Words.”

Over the years, and in response to various scandals, Ontario regulations have developed into an enormous web of detailed rules.  For example, suppose you have a small technology company, and you want to sell 100 shares to an acquaintance for a total of $1,000.  Grab a cup of coffee and try navigating the Ontario prospectus exemption rules here.  Other regulators (including British Columbia) have proposed a simpler, principles-based approach, with plain language objectives.

The debate between rules and principles reflects a dichotomy between language strategies: the rules approach requires the regulator to mandate as much as possible all of the legal do’s and don’ts, so that (ideally) the regulated will know in advance what to do in each situation. The principles approach is more cooperative: the regulator communicates general principles or objectives to achieve, and calibrates the interpretation of those principles over time as the need arises, through dialogue with the regulated and with stakeholders.

Of course, one size does not fit all.  Different communities will have different levels of knowledge and different cultures requiring different language strategies, including different combinations of rules and principles. By analogy, consider the detail required in a cookbook. One for the beginner can assume knowledge of such terms as “boil,” “poach,” or “garnish,” but ignorance of “braise,” “blanch,” or “flambé.” Recipes for the beginner should be rules–based since tasks should be described in detail; those for the professional chef can be shorter and more principles–based.

My PhD proposed factors to assess where along the rules/principles continuum a particular area of regulation should lie, and then applied these factors with a survey and interviews of managers of small public companies in Ontario.  The intent was to shift the debate from a philosophical discussion about how laws should be written in general, to an empirical, evidence-based, assessment about which language strategy is best in a particular context.  Just as a good cookbook is written for its audience, a novel’s worth depends on who is reading it, so too must regulations be written for the community being regulated.  Here is a link to my research.


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