Tom Caldwell: ‘Regulatory strangulation’ is killing economic strength

The following is a condensed and edited transcript of a speech given by Thomas S. Caldwell at the Mines and Money Americas conference in Toronto in late September on the health of Canada’s independent investment houses and its relation to the resource industry. Caldwell is chairman and founder of Toronto-based Caldwell Investment Management, CEO of Urbana Corp., a past governor of the Toronto Stock Exchange, and chairman of the Canadian Securities Exchange.

Governments say a lot of things: We want new jobs; we want new organizations growing.

But there’s a disconnect between their words and their actions. It’s a disconnect between policymakers and rulemakers.

There are three levers to control the economy, but the government is only thinking of two. One lever is monetary — that’s interest rates. The other one is fiscal — let’s go build some bridges.

But there’s a third lever: Regulatory.

If you have the first two levers but aren’t using the third, you’re just going to spend money and not have economic growth.

I personally think we’re past the tipping point in the regulatory role. Not just in securities regulations, but across a whole spectrum of activity. If you look at the mining industry typically you now need 10 years to bring a mine into development — you’ve got land claims, you’ve got environmental claims, and so on.

We’re in the post-enterprise era. You’ve got rules and regulations that really transcend everything, including the enterprise itself.

In the investment industry, where I’ve spent most of my time, you’ve seen a massive increase in regulatory or procedural environments. Probably regulations eat up about 50% of independent investment firms’ [time and effort] in Canada.

And all kinds of lobby groups make a living at slagging “bad” brokers, and everyone’s an expert at these things. The media are just as complicit, because they’ll say if you read our paper, you’re going to do well, because brokers are greedy and get no results, and passive investments are better, and you should just buy ETFs [exchange-traded funds].

But remember: ETFs do not add to an economy. They don’t do anything for building an economy.

Even our self-regulatory association IIROC [Investment Industry Regulatory Organization of Canada], their motto is “Protecting Investors.” They may as well say, “Protecting You From Sleazy Brokers.”

In the legal profession, they don’t have an association that says, “Protecting You From Incompetent Lawyers.” Same thing for accountants and doctors.

But our association has this pejorative view of ourselves.

There are specific culprits, and I don’t blame everybody here. We do have the banks, which are a major factor in our industry, and their model is to purchase, absorb and then obliterate an industry. There are no more independent trust companies, or automobile leasing companies, etc, they don’t exist anymore.

And the regulators are very much influenced by the biggest players in the industry.

Hence their influence in our going to fee-based from commission-based as the revenue model for the investment industry, after hundreds of years of commission-based in the world, which works and has worked well.

When I call you for an idea, you want to get paid. But the abuse isn’t from the broker side, the abuse is from the client side. We’ll take a good idea from the broker and then run off to a discount broker to make the trade. That’s what we have to deal with.

The long and short of it is that banks are a major factor for us, and their view of the world is fee-based.

But the challenge for the resource industry is that banks are not traditional sources of funding. Debt is often not the right funding for resource developments.

Gone

If you look at my industry, one third of all independent investment firms vanished in the last two years. One third of the whole industry is gone. And I would say that a quarter to a half of remaining firms will be gone in the next year or so.

This has significant ramifications in terms of funding, because these are the firms that finance new prospects, whether they be in minerals, scientific, corporate, whatever. These are the ones that create jobs and build an economy. We’ll miss that.

What’s happening in the resource area and other areas is private financing such as private equity is taking more and more of a place. Even in mining you see institutional funds, large funds, coming out of the woodwork to fund large exploration programs. You can raise ten, twenty million dollars.

Technology is helping. It is so much better and more efficient now than 20 years ago. So you can get into a little more certainty before you’re funding a project, than 20 years ago.

What’s happening in our industry and in the mining industry is people are waiting longer to do an IPO [initial public offering], because the danger in an IPO is it can become an orphan, where no one is trading your stock.

There are some wonderful companies at this convention but you have to get somebody to buy into your idea. Otherwise it’s a cry in the wilderness.

To give you an idea what happened, the number of IPOs coming to market in early 2016 was single digit. It was around five in the first six months in Canada. That’s incredible. It’s off-the-Richter-Scale bad.

There are all kinds of unintended consequences, too. Maureen Jensen was here from the Ontario Securities Commission, and she was saying we’re going to get rid of [trader fees on mutual funds].

You might ask, how does that affect us in resources? What happens is independent firms live off those traders selling mutual funds, and if you take away that source of revenue, you may lose those firms that are financing the resource area.

And all of this affects speculative financing — not directly, but indirectly. We have a client relationship model that has fiduciary responsibility.

Brokers are afraid to recommend junior stocks to people. Even with massive disclosure to clients, brokers aren’t going to do it, because sooner or later, the son-in-law comes and says, Mrs. Smith didn’t have the knowledge to buy this thing, and the broker is on the hook for it.

Somebody asked me on television recently, what my solution was. And the only one I can see to this regulatory overload is a kind of 12-step program called “Regulation Anonymous” because these guys are addicted to ever-more regulation.

One of the things we’re trying to do at the Canadian Securities Exchange [Caldwell is a co-founder and chairman] is bring costs down and ease the process because the other exchanges in this sector are really buying into this procedural overload.

We’ve tried to make it as simple as possible, and that’s very, very important.

Ned Goodman and myself are shareholders of this company, and we control it, and we think it’s a wonderful opportunity for new companies to grow.

We can’t solve the problem, but we can make it a little bit easier on the exchange side, even if we can’t get into the regulatory stuff.

There’s the Goldfinger movie where the villain says to James Bond, who’s been captured, “No, I expect you to die.” Sometimes I think that’s what we’re confronted with.

The traditional model for funding resources has been deteriorating, but it’s interesting because if you look at the drug companies, they have taken on the old prospecting companies’ prospecting model. It’s a good model.

Best execution

The other one that is killing our industry is the demise of financial boutiques. For example, we now have “best execution”, which means you can’t pay a commission for an IPO.

I once paid a broker a $70,000 commission for an investment idea where I made $10 million on the trade. Seventy grand for ten million kinda works for me. That was the process then.

But “best execution” means you can only pay for that trade. That makes every broker a discount broker.

When “best execution” was instituted, what that meant for those boutiques is that their in-between cash filler evaporated. Terry Salman’s Salman Partners in Vancouver — great company and good guy — his firm went from $1 million a month in revenues to $50,000. [Salman Partners closed shop in December 2015.]

What we’re seeing is larger pools of capital are looking for successful operators. Osisko is a great example: big land space, big sources of capital. They did a bang-up job of going into an area like Urban Township in Quebec, where my company is.

I think there are going to be fewer piecemeal projects, because these big pools are going to want projects to be moved along a little further than before.

It’s a pretty glum picture, but we have to make sure elected officials understand the down side of unregulated regulators. You have to make them realize what is happening in the real world, so they have some degree of influence on this process.

The basic issue is regulatory strangulation is killing economic strength.

I think the new job description for every resource executive includes being an advocate at the political level. You can’t just sit on the sidelines. You have to be out there stating your case, writing letters, making a call, sending an email, and influencing the process. Because if you’re not involved, then the one responsible for the industry’s decline is you.

We have to be more involved, otherwise it won’t change.