Canada’s asset-management industry may have hoped regulators would turn their attention elsewhere once the furor over the market-timing scandal died down. But that’s not the case. If anything, regulators are stepping up their plans for increased regulation of money managers.

The latest regulatory proposal facing the fund industry would see firms be required to adopt formal compliance plans. The idea was floated at the Ontario Securities Commission’s annual conference in mid-November. It’s still in the formative stage, the OSC says; the commission doesn’t anticipate publishing a proposal for comment until next summer at the earliest.

Given the extended lifespan of the consultation process — the OSC’s proposal for independent review committees is an example — implementation is probably years away. The industry can breathe easy for a while yet.

The idea of mandating compliance plans was first proposed in 2000, in a report addressing fund governance that was commissioned by former OSC chairman David Brown and authored by Steve Erlichman, senior partner at Fasken Martineau DuMoulin LLP in Toronto.

Erlichman’s report made a number of recommendations for improving governance, including mandatory compliance plans; independent fund boards; an industry contingency fund; proxy voting disclosure; and several other measures designed to ameliorate possible conflicts. Most of the measures, however, have not been implemented, as Erlichman has noted in a recent update to the report.

Instead, he says, the idea of fund governance has largely been reduced to the notion of fund boards, or what regulators call “independent review committees.” And even that concept has yet to be adopted.

The proposed IRC rule, which has been kicking around in one form or another since 2002, had its latest publication in May. Following publication, the OSC received yet another slew of comments on the proposed rule, a number of which arrived after the deadline. The OSC is still wading through the comments, considering them and crafting responses.

The next version of the rule isn’t expected until next spring, or summer even. Then there’s the possibility that it may go out for comment yet again.

The commission is required to seek comments on any rule that undergoes material changes as a result of the comments received. Given that the latest version of the IRC rule expanded the rule’s scope to apply to all investment funds, not just mutual funds, it’s possible that comments from the newly included segments of the industry may motivate changes that will necessitate yet another comment period.

The proposed compliance plan initiative would probably also affect all investment funds, not just mutual funds. But it’s hard to say exactly what the rule will demand from fund managers.

“At this stage, really the only thing we know about it is that [the OSC is] thinking about it,” says John Murray, vice president of regulation and corporate affairs at the Investment Funds Institute of Canada in Toronto. “The two concepts are that there’ll be a [requirement for a] comprehensive compliance plan and a designated chief compliance officer — which is similar to the U.S. model — and that part of the compliance plan will take into account short-term trading and market-timing. And that’s really the sum of our knowledge on it right now.”

Susan Silma, director of the OSC’s investment funds branch in Toronto, says that the compliance plan initiative does have its roots in the market-timing probe, but the rule will probably go well beyond that issue. “We want to put out a rule that would put in place a framework with which someone could have a hope of catching the next ‘market-timing,’ whatever it might be,” she says.

Silma notes that the results of the market-timing probe hinted at three possible regulatory responses beyond the enforcement sanctions that the worst offenders faced: compliance plans; short-term trading fees; and fair valuing requirements. So far, she says, the OSC hasn’t developed a view on the latter two options. The commission has only decided to propose a compliance plan rule. “But it’s very early days and it’s hard to know exactly what it would include,” she says. Although the OSC hopes to publish a proposal by next summer, she regards that as a fairly aggressive deadline.

Before then, IFIC hopes to meet with the OSC, Murray says, with a view to creating a working group that would provide industry input to a possible compliance plan rule. IFIC is eager to ease the burden of implementation for its members, if possible; IFIC’s only experience with compliance plans comes through its members that have U.S. affiliates and, Murray reports, they have found “it was a horrendous amount of work and putting it together took an awful lot of senior management’s time.”

@page_break@However, at this point, IFIC has little insight into just what the regulators intend. Nor do the regulators themselves seem to know. And nailing down final rules in this area has proven elusive in the past.

So far, only a couple of Erlichman’s recommendations from 2000 have found their way into play. Proxy voting disclosure was adopted as part of the updated continuous disclosure requirements for investment funds. Indeed, Erlichman notes, the proxy voting disclosure requirements that were approved are more stringent than the ones he recommended. And limited liability for unitholders in mutual fund trusts was introduced largely to appease the income trust lobby.

The other element of the Erlichman report that is also getting some attention from regulators is the idea of fund manager registration. This is up for consideration as part of the broader registration reform project, an initiative that emerged out of the remnants of the fair-dealing model.

However, the report’s other key recommendations — a contingency fund for managers, a legislated conflict rule, business judgment rule and due diligence defence — appear to have been forgotten.

Erlichman points to Canada’s fractured regulatory system as the primary reason that more of his governance recommendations haven’t been adopted. “The reality is that we have 13 different regulators in this country. So, unless you’re willing to go it alone — and, so far, Ontario has not been willing to go it alone — you have to satisfy the highest common denominator.

“In the U.S., you have one body, the Securities and Exchange Commission, which has five commissioners, and they make the decisions for the whole country — even if it’s [a vote of] three to two. It doesn’t have to be five to zero. Even if it’s a vote of three to two, you have a decision,” he notes. “In Canada, we have 13 commissions, and if it’s a vote of seven to six, nothing happens. It has to be 13-0.”

So, even if the OSC supports all Erlichman’s recommendations, the only initiatives that are likely to move ahead are those with broad support. It then takes a long time to make any progress, and the provinces may never all agree. British Columbia, for example, has doggedly resisted the call for IRCs.

In the meantime, the issues Erlichman pinpointed in 2000 haven’t gone away. A few fund managers in Quebec have been accused of misappropriating unitholders’ funds, although no formal allegations have been made and nothing has been proven (see page 28).

Other sticky issues, such as the takeover battle raging over Clarington Corp., are also ongoing concerns. CI Fund Management Inc. has launched a hostile bid for Clarington, promising to cut unitholders’ fees as part of the deal. However, Clarington’s management has already entered a support agreement based on a friendly bid from Industrial Alliance Insurance and Financial Services Inc. The scenario places Clarington’s board in the tough position of having to weigh competing fiduciary duties — both to its funds’ unitholders and the company’s shareholders.

Although reluctant to comment on the takeover, Erlichman says that had his recommendation for a “legislated conflict” rule been adopted, the solution to such a situation would “be perfectly clear.” He had recommended a rule that would require that any such conflict must be resolved in favour of the funds’ unitholders. The decision to favour unitholders over shareholders may be an arbitrary one but, at least, it means that in the event of such a conflict the company’s board is protected as long as it follows the law.

Such reform seems unlikely to get much attention from regulators amid their other plans for fund managers, so perhaps the industry should be thinking of addressing the matter itself. The idea of a self-regulatory organization for fund managers has been bandied about before, but has never really gone anywhere. Silma says an SRO for managers is not on the table. The issue could be revived, however, given the problems the industry has recently faced and the length of time it has taken to introduce some sort of governance requirements.

For his part, Erlichman declines to comment on whether he thinks there should be an SRO for fund managers. He only says managers should be registered, and that they should face minimum capital and fidelity insurance requirements. “[The possibility of a manager SRO] is an issue that should be discussed whenever the Canadian Securities Administrators and the industry have a serious discussion about manager registration,” he says.

As regulators seem determined to ramp up the requirements faced by fund managers, it may be time for the industry to consider whether it’s approaching a tipping point. If there are going to be so many new rules, and so little progress in modernizing old ones, perhaps the industry would be better off crafting more rules for itself. IE