Fund review committees approved by regulators

It’s been seven years since the Canadian Securities Administrators retained Stephen Erlichman, a partner at law firm Fasken Martineau, to pen a report on mutual fund governance. The result of that report — National Instrument 81-107 — is finally ready to be adopted. While over the years Erlichman’s recommendations have lost some of its teeth, the instrument still has some bite.

NI 81-107, or the Independent Review Committee for Investment Funds, requires all investment funds that are reporting issuers to create independent review committees (IRCs) to oversee all management decisions and monitor potential conflicts of interest faced by fund managers.

In a press release, the CSA says the committee will be able to either approve the manager’s decision or provide recommendations on how to proceed. The regulators use stronger language in the full report. In some instances the IRC will be able to block a manager from proceeding with a transaction, if it’s prohibited by securities legislation, such as inter-fund trading.

In all other instances, the IRC will only be able to either ask the manager to seek regulatory approval or shareholder approval before proceeding with a proposed action.

The rule also requires managers to establish and follow written policies and procedures before referring issues to the committee.

Responding to concerns that the rule was becoming a toothless tiger, the CSA rolled out several changes in its 2005 proposal. Included in those changes was a decision to expand the scope of the rule to include all publicly-offered investment funds. In that same proposal the CSA kept existing conflict prohibitions and restrictions in place and, more importantly, it introduced a number of tools for the IRC to use if it finds a fund manager has placed his or her interests ahead of the fund when there is a conflict.

While the CSA cites Erlichman’s report as the beginning of talks about mutual fund governance, the issue first surfaced back in the late-1960s in the Canadian Committee on Mutual Funds. The issue came to the fore again in the mid-1990s when Glorianne Stromberg, a securities lawyer and former Ontario Securities Commissioner took a fresh look at the issue of regulation of mutual funds.

Stromberg, who has been a vocal critic of the rule throughout its various machinations, still has some reservations. “On the surface it sounds good,” she says, but worries about IRC members’ understanding of the investment industry and whether the cost of this rule will outweigh the benefits.

While Stromberg doesn’t want to belittle the talent of the people who are recruited to sit on these committees, she notes how hard it is for people outside the industry to know how everything works.

Analyst Dan Hallett says based on his initial scan of the instrument, there appear to be some positive changes. Still, he also wonders where fund companies are going to find enough qualified people to populate the new committees.

Cost is another matter. Those expenses include not only the extra oversight required, but continuing education for IRC members, all of which will be passed on to the unitholder.

Several fund companies have already set up IRCs. AIM Trimark, for instance, put one in place in 2004 and has had a fund advisory board with mostly independent members since 1999. “Investors are entitled to effective fund governance and a company culture that really looks out for their interests,” says Phil Taylor, AIM Trimark Investments’ senior managing director. “An independent board provides much broader oversight and security for investors than the planned review committees will.”

But, Taylor adds this is only a first step. “As an industry we need to go further.”

Shortly after the CSA made its announcement on the rule, RBC Asset Management put out a release of its own endorsing the new rule. RBC adopted its own governance model in 1994. George Lewis, chair and chief executive officer of RBC Asset Management, says the new instrument “provides Canadian mutual fund investors with additional investor protection through enhanced governance of the very large, and still growing, Canadian mutual fund industry.”

The rule could be in force as early as November 1, 2006, the CSA says.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(07/28/06)