New rules means clarity for some funds

The impact of National Instrument 81-107 will reach far beyond the mutual fund industry, according to a leading lawyer in the investment industry. NI 81-107 will apply not only to open-end mutual funds, but also to closed-end structured funds, exchange-traded funds, labour-sponsored funds, commodity pools and even scholarship plans.

NI 81-107 was originally designed to govern the mutual fund industry, but in its approved form, it now provides clarity for some investments that had previously been in a regulatory grey area.

“This is a good clarification — closed-end funds have been in an ambiguous territory up to now,” says Rebecca Cowdery, partner at Borden Ladner Gervais, and former investment funds regulator at the OSC. “As long as you are an investment fund, you don’t have to do the corporate governance, which really is difficult to apply to an investment fund.

“At least this is tailored to investment funds, so it’s a good thing,” she says. “It makes things more clear, not necessarily easier.”

According to Cowdery, NI 81-107 finally achieves a regulatory division between corporate issuers and investment funds as a group, beyond just mutual funds. “A lot of the closed-end funds were required by TSX listing rules to have some sort of independent oversight,” she says. “They either have independent board members or a separate advisory board.”

The biggest challenge these firms will face will be analyzing what conflicts of interest they may have and putting policies in place to manage these conflicts. Cowdery says the Canadian Securities Administrators have intentionally given little guidance on what conflicts may exist, forcing each firm to re-examine their own operations.

The rule even applies to index-tracking ETFs, where investment choices may be made by an outside party, such as Standard & Poors. One of the main selling points on ETFs is that investors incur negligible fees, but the implementation of an investment review committee would likely see costs rise.

Cowdery points out that some “weird and wonderful” funds would have very few conflicts of interest, and that an exemption could be granted for funds that can prove implementation would carry no benefit to investors.

Other structured products, such as deposit notes, are not covered by NI 81-107, nor are income trusts.

“Income trusts still have to comply with the governance that is mandated for corporate issuers, because they are thought of as being akin to being a corporation, as an operating business,” she says. “That’s the dividing line. It’s a little grey in areas.”

While NI 81-107 provides clarity for closed-end funds, Cowdery thinks it muddies the waters somewhat for labour-sponsored investment funds. These funds are usually structured as corporations — not trusts — so each fund already has a board of directors overseeing operations.

“This is one area where we need further discussion. The CSA does say that, to the extent that an LSIF does have independent members on its board, it’s possible these board members can serve on the LSIF’s IRC. This leads me to believe that there has to be something else separate from the LSIF board, which doesn’t make a lot of sense to me.”

That seems to be the interpretation at Canada’s largest LSIF firm, which says it is setting up the separate IRC, partially populated by board members.

“In order to comply with the instrument, members of the IRC would be independent of the manager, which includes the research team at the funds,” says Michael Cohen, managing general partner, VenGrowth Private Equity Partners.

Cohen says the corporate board of directors for each fund already makes decisions in respect to potential conflicts of interest.

“Our funds are already accustomed to having an independent body pass upon matters of potential conflict,” he notes. “Some of our board members will qualify for the IRC. To the extent the members of the IRC are not otherwise subject to confidentiality obligations, contractual obligations will be put in place.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(08/04/06)

Steven Lamb