December 22, 2011

On December 22, 2011 the Supreme Court of Canada unanimously held that the proposed Canada Securities Act, as presently drafted, is not valid under the general branch of the federal government's power to regulate trade and commerce conferred by section 91(2) of the Constitution Act, 1867. The Act had sought to create a national system of securities regulation subject to the oversight of a single national securities regulator. The Court concluded that (a) the Act "overreaches" genuine national concerns because its main thrust is the day-to-day regulation of all aspects of contracts for securities within the provinces, which remain essentially provincial concerns under section 92(13) of the Constitution, and (b) the area of securities has not been so transformed that it justifies a "complete takeover" of the regulation of the securities industry by the federal government under the general trade and commerce power.

For federal securities legislation to be genuinely national in scope, the situation must be such that if the federal government were not able to legislate a solution that the provinces, acting either individually or in concert, could not effectively achieve, would result in there being a constitutional gap. The Court found that the aspects of the Act concerning the management of systemic risk and national data collection are beyond provincial competence and appear to be related to the general trade and commerce power. The proposed Act, however, was for the most part a provincial securities act writ large.  The constitutionally valid aspects of the Act with respect to systemic risks therefore were insufficient to allow the Act as a whole to pass constitutional muster.

As a result of this decision, the federal government does not have constitutional authority to enact a comprehensive national system of securities regulation that essentially duplicates the regimes already in place in the provinces. If the federal government still wishes to pursue securities regulation, it will need to identify the appropriate "constitutional gap," to enact legislation tailored to that gap, and to work with the provinces to create a harmonious system of securities regulation that achieves the appropriate constitutional balance. 

Analysis of the Court's Decision

The Court was concerned there must be a coherent principle to limit the potential scope of the federal power to legislate in respect of matters of trade and commerce. To do otherwise would upset the balance between the federal and provincial heads of power, which are coordinate and not subordinate to one another. A federal head of power cannot be given scope that would eviscerate a provincial legislative competence. To avoid such a result, the trade and commerce power is confined to matters that are genuinely national in scope and "qualitatively" distinct from matters within provincial powers.

The Court upheld the established test for the scope of the trade and commerce power as having two branches: (1) interprovincial and international trade and commerce, and (2) general regulation of trade affecting the whole nation. The government of Canada ground its submission in support of the Act's constitutionality entirely on the "general" power. As a result, the Court did not consider whether—or to what extent—the proposed Act could be supported as interprovincial and international trade and commerce.

The Court held that to satisfy the general trade and commerce test, the situation must be such that if the federal government were not able to legislate, there would be a constitutional "gap." As the Court observed, such a gap is anathema in a federation.

The burden of argument for the government of Canada was to establish there was a gap—something that the provinces, acting either individually or in concert, could not effectively achieve.

The Court found that with respect to securities, there was indeed a constitutional gap in the control of systemic risks that can affect capital markets. By systemic risks, the Court meant "risks that occasion a 'domino effect' whereby the risk of default by one market participant will impact the ability of others to fulfill their legal obligations, setting off a chain of negative economic consequences that pervade an entire financial system." Therefore, to the extent a province acting on its own could not insulate itself from the domino effect of market disturbances in other parts of the country, there would be a constitutional gap to be filled through the federal power in relation to trade and commerce. The Court specifically identified parts of the proposed Act that might be upheld on this basis, namely, provisions relating to derivatives, short-selling, credit rating, urgent regulations and data collection and sharing.

Had the proposed Act been limited to these matters, it would presumably have been within the scope of the general trade and commerce power. The proposed Act, however, went much further. The Court opened its judgment referring to the proposed Act as "a comprehensive foray by Parliament into the realm of securities regulation." The proposed Act, by attempting to regulate all aspects of the securities industry, "was simply a provincial securities act writ large." The Court characterized it as a "complete takeover" and a "wholesale takeover" of provincial regulation of the securities industry.

As a result, the Court found that the "main thrust" (or "pith and substance") of the legislation was concerned with day-to-day regulation of securities, instead of safeguarding against systemic risks that the provinces were incapable of safeguarding individually. Moreover, this was not a situation where the other elements were essential to the effective regulation of the systemic risks that could otherwise be supported under general trade and commerce.

Accordingly, the proposed Act was not supportable under the general trade and commerce power.

The government ground its submission solely on the general trade and commerce power. The case was not presented on the basis of interprovincial and international trade and commerce. In its reasons, the Court noted that the Commerce Clause in the United States Constitution gives the federal government the power to "regulate commerce … among the several states." Owing to this language, while states may regulate all aspects of securities trading within their jurisdiction, the federal government may choose to regulate all aspects of interstate securities trading. In Canada, given the cross-country use of the CDS system physically located in Ontario and given the widespread use of the Internet for trading across provincial borders, it is arguable that a good proportion of Canadian securities activity could be regulated under the interprovincial trade and commerce branch. The extent of this power was not explored by the Court, as it was not put in issue.

This reference decision does not finally resolve the issue of national securities regulation. The Court repeatedly emphasized the desirability of resolving complex governance problems, not by the bare logic of either/or, but by seeking cooperative solutions that meet the needs of the country as a whole as well as its constituent parts.

The decision leaves the door open for federal legislation that regulates the genuinely national aspects of securities. To the extent the regulation of securities might be made more efficient through a more harmonized scheme than currently exists, this would have to be achieved through federal-provincial cooperation. Nonetheless, any province would still be constitutionally able to opt out of the cooperative scheme, to favour local priorities over the achievement of the benefits of national participation.

The authors would like to thank Catherine Simonet and Vincent Cerat Lagana for their assistance in the revision and translation of this bulletin.