Part II describes the desirable attributes of a regulator ⁶ and the potential role of self-regulatory organizations, the enforcement and compliance work of the regulator and the need for close cooperation between regulators.

6. The Regulator

6.1 Principles Relating to the Regulator The responsibilities of the regulator should be clear and objectively stated. The regulator should be operationally independent and accountable in the exercise of its functions and powers. The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers. The regulator should adopt clear and consistent regulatory processes. The staff of the regulator should observe the highest professional standards, including appropriate standards of confidentiality.

6.2 Clear Responsibility ⁷

The capacity of the regulator to act responsibly, fairly and effectively will be assisted by:

• a clear definition of responsibilities, preferably set out by law;
• strong cooperation among responsible authorities, ⁸ through appropriate channels;
• adequate legal protection for regulators and their staff acting in the bona fide discharge of their functions and powers.

The packaging of products and services may be such that a single product or service exhibits characteristics traditionally associated with at least two of the following: securities, banking and insurance. Legislation should be designed to ensure that any division of responsibility avoids gaps or inequities in regulation. Where there is a division of regulatory responsibilities, substantially the same type of conduct generally should not be subject to inconsistent regulatory requirements.

6.3 Independence and Accountability

The regulator should be operationally independent from external political or commercial interference in the exercise of its functions and powers and accountable in the use of its powers and resources.

Independence will be enhanced by a stable source of funding for the regulator.

In some jurisdictions particular matters of regulatory policy require consultation with, or even approval by, a government, minister or other authority. The circumstances in which such consultation or approval is required or permitted should be clear and the process sufficiently transparent or subject to review to safeguard its integrity. Generally, it is not appropriate for these circumstances to include decision making on day to day technical matters.

Accountability implies:

• a regulator that operates independently of sectoral interests;
• a system of public accountability of the regulator;
• a system permitting judicial review of decisions of the regulator.

Where accountability is through the government or some other external agency, the confidential and commercially sensitive nature of much of the information in the possession of the regulator must be respected. Safeguards must be in place to protect such information from inappropriate use or disclosure.

6.4 Adequate Powers and Proper Resources

The regulator should have adequate powers, proper resources and the capacity to perform its functions and exercise its powers.

What this means in practical terms is the subject of elaboration in this document. It includes powers of licensing, supervision, inspection, investigation and enforcement, all of which are discussed in later sections.

It necessarily requires adequate funding for the regulator in order to enable the regulator to exercise its tasks. The level of resourcing should recognize the difficulty of retaining experienced staff who have skills that are valuable to the private sector.

The regulator must ensure that its staff receive ongoing training as required.

6.5 Clear and Consistent Regulatory Processes

In exercising its powers and discharging its functions, the regulator should adopt processes which are:

• consistently applied;
• comprehensible;
• transparent to the public;
• fair and equitable.

In the formulation of policy, the regulator should:

• have a process for consultation with the public including those who may be affected by the policy;
• publicly disclose its policies in important operational areas; ⁹
• observe standards of procedural fairness;
• have regard to the cost of compliance with the regulation.

Many regulators have authority to publish reports on the outcome of investigations or inquiries, particularly where publication would provide useful guidance to market participants and their advisers. Any publication of a report must be consistent with the rights of an individual to a fair hearing and the protection of personal data, factors that will often preclude publicity when a matter is still the subject of investigation.

Regulators should also play an active role in the education of investors and other participants in capital markets.

6.6 The Conduct of Staff

Staff of the regulator should observe the highest professional standards and be given clear guidance on conduct matters including:

• the avoidance of conflicts of interest (including the conditions under which staff may trade in securities);
• the appropriate use of information obtained in the course of the exercise of powers and the discharge of duty;
• the proper observance of confidentiality and secrecy provisions and the protection of personal data;
• the observance of procedural fairness.

7. Self-Regulation ¹⁰

7.1 Principles for Self-Regulation The regulatory regime should make appropriate use of Self-Regulatory Organizations (SROs) that exercise some direct oversight responsibility for their respective areas of competence and to the extent appropriate to the size and complexity of the markets. SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.

7.2 The Role of SROs

SROs can be a valuable complement to the regulator in achieving the objectives of securities regulation.

Various models of self-regulation exist and the extent to which self-regulation is used varies. The common characteristics of SROs, in most jurisdictions are a separation from the government regulator (although government oversight and authorization generally exists), and the participation of business, industry and, if appropriate, investors in the operations of the SRO.

There can be substantial benefits from self-regulation:

• SROs may require the observance of ethical standards which go beyond government regulations;
• SROs may offer considerable depth and expertise regarding market operations and practices, and may be able to respond more quickly and flexibly than the government authority to changing market conditions.

SROs should undertake those regulatory responsibilities which they have incentives to perform most efficiently. The actions of SROs will often be limited by applicable contracts and rules.

7.3 Authorization and Oversight

The regulator should require an SRO to meet appropriate standards before allowing the organization to exercise its authority. Oversight of the SRO should be ongoing.

Moreover, once the SRO is operating, the regulator should assure itself that the exercise of this power is in the public interest, and results in fair and consistent enforcement of applicable securities laws, regulations and appropriate SRO rules. ¹¹

The effectiveness of an SRO may be compromised due to conflicts of interest. The regulator should monitor and address the potential that may arise for conflict of interest. The regulator must ensure that no conflict of interest arises because of the SRO's access to valuable information about market participants (whether or not they are members of the SRO itself). The risk of conflict arising may be acute when the SRO is responsible both for the supervision of its members and the regulation of a market sector.

As a condition to authorization, the legislation or the regulator should require an SRO to:

• have the capacity to carry out the purposes of governing laws, regulations and SRO rules, and to enforce compliance by its members and associated persons with those laws, regulations, and rules;
• treat all members of the SRO and applicants for membership in a fair and consistent manner;
• develop rules that are designed to set standards of behaviour for its members and to promote investor' protection;
• submit to the regulator its rules for review and / or approval as the regulator deems appropriate, and ensure that the rules of the SRO are consistent with the public policy directives established by the regulator;
• cooperate with the regulator and other SROs to investigate and enforce applicable laws and regulations;
• enforce its own rules and impose appropriate sanctions for non-compliance;
• assure a fair representation of members in selection of its directors and administration of its affairs;
• avoid rules that may create uncompetitive situations; and
• avoid using the oversight role to allow any market participant unfairly to gain advantage in the market.

Regardless of the extent to which self-regulation is used, the government regulator should retain the authority to inquire into matters affecting investors or the market. Where the powers of an SRO are inadequate for inquiring into or addressing particular misconduct or where a conflict of interest necessitates it, the regulator should take over the responsibility for an inquiry from an SRO. It is important, therefore, to ensure that the information provided by the SRO to the regulator allows these matters to be identified at an early stage.

SRO's should follow similar professional standards of behaviour on matters such as confidentiality and procedural fairness as would be expected of the regulator. ¹²

8. Enforcement of Securities Regulation

8.1 Principles for the Enforcement of Securities Regulation The regulator should have comprehensive inspection, investigation and surveillance powers. The regulator should have comprehensive enforcement powers. The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.

8.2 Inspection and Compliance Programs ¹³

Supervision of market intermediaries' conduct through inspection and surveillance helps to ensure the maintenance of high standards and the protection of investors. These preventative programs are a necessary complement to investigation and enforcement programs.

The regulator should have the power to require the provision of information ¹⁴ or to carry out inspections of business operations whenever it believes it necessary to ensure compliance with relevant standards. The suspicion of a breach of law should not be a necessary prerequisite to use of inspection powers in respect of authorized or licensed persons.

Inspections may be carried out by the regulator itself or another competent authority. Alternatively, the regulator might consider delegating such authority to SROs or using third parties, properly supervised, to carry out some of this inspection work on its behalf. These third parties should also be subject to disclosure and confidentiality requirements. Such inspections must be carried out with adequate instruments and techniques, and these may vary between jurisdictions.

In some areas, for example the scrutiny of trading on an exchange, the use of technology will be necessary for effective regulation. In other areas, including the inspection of broker conduct, consideration needs to be given to the balance between on-site inspection and interview and the requirement to provide information from time to time which can be reviewed off-site.

Inspection visits may be rotational or driven by risk assessment or complaint. In making decisions on the efficient use of resources, the regulator must consider both the need for wide market coverage and the importance of adequate inspection in areas of high risk to investors or which threaten systemic stability.

8.3 Comprehensive Enforcement Powers ¹⁵

The complex character of securities transactions and the sophistication of fraudulent schemes require strong and rigorous enforcement of securities laws. Investors in the securities markets are particularly vulnerable to misconduct by intermediaries and others.

The regulator or other competent government authority should, therefore, be provided with comprehensive investigatory and enforcement powers including:

• regulatory and investigative powers to obtain data, information, documents statements and records from persons involved in the relevant conduct or who may have information relevant to the inquiry;
• power to seek orders and/or to take other action to ensure compliance with these regulatory, administrative and investigation powers;
• power to impose administrative sanctions and / or to seek orders from courts or tribunals;
• power to initiate or to refer matters for criminal prosecution;
• power to order the suspension of trading in securities or to take other appropriate action; ¹⁶
• where enforcement action is able to be taken, the power to enter into enforceable settlements and to accept binding undertakings.

As a general matter, these enforcement powers should not compromise private rights of action. Private persons should be able to seek their own remedies (including, for example, for compensation or specific performance of an obligation).

It is not necessary that the responsibility for all aspects of enforcement of the securities law be given to a single body. There are several models that have been shown to be effective. These include models in which responsibilities are shared between several government or quasi-government agencies or where responsibility is shared with SROs.

The sharing of responsibility and the need for close cooperation may be particularly important in ensuring that only those who have necessary authorization are active participants on the markets; unlicensed persons should be prosecuted.

8.4 International Enforcement

The international nature of the securities markets and the fact that, frequently, a course of conduct will cross several jurisdictions give rise to a number of particular issues.

Legislation and the enforcement powers of the regulator should be sufficient to ensure that it can be effective in cases of cross-border misconduct. Therefore, the regulator should strive to ensure that it or another authority in its jurisdiction has the necessary authority to obtain information, including statements and documents, that may be relevant to investigating and prosecuting potential violations of laws and regulations relating to securities transactions, and that such information can be shared directly with other regulators or indirectly through authorities in their jurisdictions for use in investigations and prosecutions of securities violations. ¹⁷

The general topic of international cooperation and its importance to effective regulation is addressed in Section 9.

8.5 Money Laundering ¹⁸

The term "money laundering" covers a wide range of activities and processes intended to obscure the source of illegally obtained money and to create the appearance that it has originated from a legitimate source.

Securities regulators should consider the sufficiency of domestic legislation to address the risks of money laundering. The regulator should also require that market intermediaries have in place policies and procedures designed to minimize the risk of the use of an intermediary's business as a vehicle for money laundering.

9. Cooperation in Regulation

9.1 Principles for Cooperation in Regulation The regulator should have authority to share both public and non-public information with domestic and foreign counterparts. Regulators should establish information sharing mechanisms that set out when and how they will share both public and non-public information with their domestic and foreign counterparts. The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquiries in the discharge of their functions and exercise of their powers.

9.2 The Need for Domestic Cooperation ¹⁹

There may be an important need to share information at a domestic level where regulatory divisions based on institutional form exist or where the securities law overlaps with the general law of a jurisdiction. So, for example, cases of fraud or money laundering that involve dealings in securities may require close cooperation between two or more domestic regulators, including law enforcement, regulatory and judicial authorities.

The need for domestic cooperation may extend beyond matters of enforcement and include information relevant to authorisation to act in a particular capacity and the reduction of systemic risk, for example, where there are divisions in responsibility for the securities, banking and other financial sectors.

9.3 The Need for International Cooperation

International cooperation between regulators is necessary for the effective regulation of domestic markets. The inability to provide regulatory assistance can seriously compromise efforts towards effective securities regulation. Domestic laws need to remove impediments to international cooperation. ²⁰

The increasing internationalization of financial activities and the globalization of markets mean that information relevant to authorisations or approvals is often beyond the immediate jurisdictional reach of the competent regulator. For example, an application for a licence may be received from a person known to be registered in another jurisdiction, or registration may be sought for the same offer documents in several jurisdictions. Similarly, threats to systemic stability are not confined to domestic factors and may include the behaviour of individual financial institutions in another jurisdiction. Regulators must consider whether they have adequate information sharing arrangements with regulators in other jurisdictions to allow them to identify and address these threats.

Further, an increasing number of companies have securities listed in more than one jurisdiction and it is common for a significant part of an issuer's commercial activity to take place in a country other than the one in which its stock is listed. Investors frequently invest in foreign markets and securities either directly or in managed funds. An increasing number of collective investment schemes are marketed across jurisdictional boundaries. It is also common for scheme promoters, managers and custodians to be located in several different jurisdictions and they may not be in the same jurisdiction as investors to whom the scheme is promoted.

Similar financial products may be traded on various markets in several countries; moreover, there are many derivatives in which the underlying product or reference price is traded, produced or derived on foreign markets.

Fraud, market manipulation, insider trading and other illegal conduct that crosses jurisdictional boundaries can and does occur more and more frequently in a global market aided by modern telecommunications.

The importance of international cooperation in investigations and inquiries into possible breach is also apparent from some of the common characteristics of breaches of securities law, such as shifting the proceeds of crime to foreign jurisdictions; wrongdoers fleeing to a foreign country; routing transactions through foreign jurisdictions to disguise the identity of parties or the flow of funds; the use of foreign accounts to hide beneficial ownership of shares; and the facilitation of cross-border breaches through the use of international communications media, including the Internet.

In circumstances such as those described above, effective regulation can be compromised when necessary information is located in another jurisdiction and is not available or accessible. ²¹

Cooperative mechanisms should, therefore, be put into place at the international level to facilitate the detection and deterrence of cross-border misconduct and to assist in the discharge of licensing and supervisory responsibilities. Among these are memoranda of understanding.

9.4 The Scope of Cooperation

The form and content of the cooperation will vary from case to case. ²² It is important that assistance can be provided not only for use in investigations but also for other types of inquiry, as part of a compliance program for the purpose of preventing illicit activities. There may also be a need to exchange general information about matters of regulatory concern, including financial and other supervisory information, technical expertise, surveillance and enforcement techniques, and investor education.

Memoranda of understanding or other documented arrangements help to add certainty to the process of information exchange. ²³ Nevertheless, the mere formality of an arrangement is no substitute for a close and cooperative arrangement.

These arrangements, whether formal or informal, should have several basic characteristics:

• identification of the circumstances under which assistance may be sought;
• identification of the types of information and assistance that can be provided;
• safeguards of the confidentiality of information transmitted;
• a description of the permitted uses of the information.

The design of these information sharing mechanisms should take into account the following factors:

• which market authority or regulator has access to and is able to provide the information or assistance;
• how such access can be obtained under applicable law;
• confidentiality and use restrictions under applicable law;
• the form and timing of the assistance or information sharing;
• the applicability of other arrangements, including MOUs, between such authorities for sharing investigative and financial information.

The arrangements may also provide for the limitation of liability and the rights of third parties, routine consultations between authorities, and a public policy exception to the provision of information.

Where assistance to another authority is provided through the provision of confidential information gathered by the regulator in the exercise of its functions or powers, particular care must be taken to ensure that the information is provided subject to conditions which, to the extent consistent with the purpose of the release, preserve the confidentiality of that information.

The removal of any "dual illegality" conditions to information sharing and regulatory cooperation is important. As a transitional matter, while a jurisdiction moves towards the removal of dual illegality conditions, it is important that any conditions be interpreted flexibly and in a manner that minimises impact upon international cooperation.

Assistance in taking substantive action may also be necessary. When it is within their powers, regulators can more effectively enforce securities laws when they are able to prevent the dissipation or secreting of the fruits of fraud or other misconduct, thus facilitating the return of money to injured investors. ²⁴

The form of assistance may include: ²⁵

• assistance in obtaining public or non-public information, for example, about a licence holder, listed company, shareholder, beneficial owner or a person exercising control over a licence holder or company;
• assistance in obtaining banking, brokerage or other records;
• assistance in obtaining voluntary cooperation from those who may have information about the subject of an inquiry;
• assistance in obtaining information under compulsion - either or both the production of documents and oral testimony or statements;
• assistance in providing information on the regulatory processes in a jurisdiction, or in obtaining court orders, for example, urgent injunctions.

9.5 Cooperation on Financial Conglomerates ²⁶

The growing emergence of financial conglomerates that combine the activities of firms in different financial sectors and, in some jurisdictions, of financial and non-financial firms has heightened the need for cooperative efforts to improve the effectiveness of supervisory methods and approaches. Without proper cooperation between regulators it may be difficult to be aware of all the activities of a group. Such cooperation is particularly important when, as is commonly the case, the group is active in several jurisdictions.

The particular procedures used for the supervision of financial conglomerates must reflect the domestic law of the places in which they operate and must take account of the possibility that relevant regulatory responsibility may continue to be shared between agencies. It is nevertheless possible to identify some general issues that should be considered as matters requiring close supervisory cooperation:

• Structure of financial conglomerates;
• Capital requirements in conglomerate groups;
• Investments in companies within the same group;
• Intra group exposures and group-wide exposures;
• Relationships with shareholders;
• Management responsibility and the control of regulated entities.

It is also appropriate to consider the regulator's capacity to exchange information with other regulators, for example in the banking and insurance sectors at both the domestic and international levels. Again, such exchanges of information must be consistent with the proper maintenance of confidentiality and the protection of personal data.