Canada regulators build fund governance regime

Date: Monday, August 28, 2006
Author: David Clarke,

OTTAWA - It has taken a scandal-filled decade to get around to it, but the Canadian Securities Administrators recently announced a rule aimed at improving governance of all publicly offered investment funds.

The rule will affect about 150 fund managers and more than 2,500 investment funds with more than $561 billion ($C630 billion) in assets.

"This rule will ensure the interests of the fund, and ultimately the investor, are at the forefront when a fund manager is faced with a conflict of interest," said Jean St-Gelais, chairman of the CSA, the Montreal-based council of the securities regulators of Canada's provinces and territories.

"Also, managers of investment funds will benefit from having the perspective of an independent body when they encounter actual or perceived conflicts of interest."

The new rule, called the National Instrument 81-107 Independent Review Committee for Investment Funds, requires investment fund managers to have independent oversight of their management and monitoring of conflicts of interest.

All investment funds must establish an independent-review committee to oversee all decisions involving conflicts of interest faced by a fund manager. The role of the committee, depending on the nature of the conflict, will be either to approve the fund manager's decision or provide recommendations before the manager may proceed.

"We've had extensive consultations with all the stakeholders, and we believe we've found the right balance between investor protection and efficient capital markets," David Wilson, chairman of the Ontario Securities Commission, told the Toronto Star.

"We believe it's important to have an independent body in the room during a manager's decision-making processes - someone whose sole job is to look out for the investor."

On the other hand, "I'd put it in the category of 'too little too late,'" said Glorianne Stromberg, a former member of the Toronto-based OSC.

In 1995, her report to the CSA made recommendations on mutual fund governance. Since then, there have been many scandals.

Portus Alternative Asset Management Inc., a Toronto-based hedge fund now in bankruptcy protection proceedings, was at the root of the biggest of last year's scandals. Others involved Norbourg Asset Management Inc. and hedge fund operator Norshield Financial Group, both based in Montreal.

The Toronto-based Investment Funds Institute of Canada, which oversees the mutual fund industry, released a report showing that Canadians dumped $158 million ($C178 million) of their Canadian common shares last month. Also last month, there were $157 million ($C176 million) in net money market sales, just the ninth inflow into money markets in 53 months.

Opinions differ over whether that could be the result of the scandals or the result of market conditions.

Rule Details

Of course, the devil is in the details.

"The rule is the CSA's first legislated step in creating an investment fund governance regime for Canada," Stephen Erlichman, a lawyer with Fasken Martineau DuMoulin LLP of Toronto, wrote Aug. 18 in his firm's newsletter.

It will create "a regime that will apply not only to conventional public open-end mutual funds but also to many other publicly offered investment funds in Canada, including closed-end funds that trade on the Toronto Stock Exchange, [Department of Labour]-sponsored funds, flow-through-share limited partnerships and commodity pools."

The CSA expects the rule to go into effect Nov. 1. One year later, all exemptions and waivers previously granted by the CSA that deal with matters regulated by the rule will expire, irrespective of whether they contain a sunset provision.

"Fund managers may decide to comply with the rule earlier than the dates set out should they wish to be able to seek IRC approval to proceed with certain actions, which presently are prohibited, restricted or require security holder approval, such as interfund trades, investing in securities of related parties or underwritten by related parties, changing fund auditors or carrying out certain fund mergers," Mr. Erlichman wrote in his firm's newsletter.

He added: "Common law and statutory fiduciary obligations will continue to be part of the Canadian mutual fund governance framework."

In 1999, the CSA commissioned Mr. Erlichman to prepare a report setting out his recommendations for a mutual fund governance regime for Canada.

In 2002, the CSA released its vision for a renewed framework for regulating mutual funds and their managers, including "a very robust system of fund governance" based largely on the recommendations in the Erlichman report.