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CSA FUND REGIME A BAD BARGAIN
CSA fund regime a bad bargain
If implemented, governance proposals would undermine investor protection
In January, the Canadian Securities Administrators
unveiled its proposals for a new governance regime for most of the
publicly offered mutual funds in Canada. The proposals — years in the
making — fall terribly short of what needs to be done to protect
investors. If implemented, they will probably undermine investor
protection and erode confidence in the safety and soundness of mutual
funds, which have become the investment of choice for many Canadians.
The CSA proposals contemplate the removal of all prohibitions against
self-dealing or related-party transactions among a mutual fund manager,
its managed funds and/or its respective affiliates and associates. They
also contemplate the removal of most of the investor-protection provisions
contained in the rules regulating mutual funds.
Fund managers will be free to enter into transactions that were once
prohibited or restricted, despite the fact that their interests may
conflict with those of their managed funds. In addition, fund managers
will be able to implement most of the fundamental changes they want to
make to their managed funds without seeking the approval of fund
unitholders, provided they comply with certain provisions.
The only constraint is they must establish independent review committees
and refer all matters involving conflicts of interest or fundamental
changes to their funds to these committees for review. IRCs are obliged to
consider and provide “impartial judgment on the matters referred to them
and recommend the actions the manager should take to achieve a fair and
reasonable result for the mutual fund.” Fund managers are not required
to follow the recommendations of their IRCs, and only limited disclosure
about these matters and the IRC recommendations is contemplated.
The same IRC can act for a multitude of funds, including non-related
funds, if the members meet the independence test specified for IRC
members. The cost of the IRCs is to be borne by the mutual funds. No
provision is made for decreasing management fees or other expenses charged
to the mutual funds.
Examples of once-prohibited self-dealing transactions include buying or
selling portfolio securities from a related broker (principal trading);
lending money to, or purchasing securities of, a related-party and
inter-fund trading.
Examples of other situations involving, or potentially involving, conflict
of interest include cost allocations among a mutual fund and its managed
funds, error corrections, service agreements involving related parties,
certain “soft dollar” transactions, certain performance fees,
marketing and revenue-sharing arrangements with distributors, and the
self-interested voting of proxies.
The proposals also contemplate repealing existing investment restrictions
designed to ensure that mutual funds have the requisite liquidity to meet
redemption requests on demand. In addition, other long-standing
substantive provisions regarding mutual funds that have been developed
over the years to deal with well-recognized problems would be repealed and
replaced by general principles.
The CSA proposals reflect the pressure the mutual fund industry — at
least, the fund-management side of it — has brought to bear on the
regulators. Fund managers strongly object to measures that would require
fund managers to be registered, meet certain minimum conditions of
registration and provide that their managed mutual funds have independent
boards of directors or some other type of independent governance agency.
Fund managers argue they have no experience working with independent
boards or agencies. They argue that if they are going to be subjected to
governance requirements, their quid pro quo should be the removal of the
prohibitions on self-dealing or related-party transactions, and the
removal of other substantive requirements and restrictions respecting
mutual funds.
Despite strong objections from mutual fund investors and those speaking
for them, the CSA capitulated to industry demands and agreed to this
unconscionable trade-off.
There is little evidence in the 100-plus pages outlining the proposals
that the investor’s voice was heard at all.
Worse is the fact that the CSA states it is
continuing its consultation with the industry for future regulatory
reform. Mutual fund investors have no input into this consultation
process. Their economic interests are being ignored in favour of those of
the industry, which is now dominated by huge financial institutions and
corporations. This makes a mockery of the consultation process and
completely ignores whose money is at risk.
Replacing fiduciary obligations and the other restrictions designed to
ensure the safety and soundness of mutual funds with the non-binding
discretion of an independent review committee is a bad bargain. Financial
advisors, if they are truly independent, should be lending their voices to
those of mutual fund investors in objecting to these measures. And the CSA
should have the courage to withdraw what are fundamentally flawed
proposals.
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