National Instrument 81-107 Independent Review Committee for Investment Funds had its second anniversary on November 1, 2008 with all Canadian fund managers and IRCs operating under it since November 1, 2007. Much of the past two years has been taken up with implementing National Instrument 81-107, including identifying conflicts of interest, preparing written conflicts policies and procedures and carrying out the Rule’s mandatory reporting and assessments.
As we move into the third year of the new governance regime, we expect that fund managers and IRCs will have more time to reflect on the objectives of, and practical issues raised by, National Instrument 81-107. Similarly, we anticipate that the Canadian securities regulators will be starting to consider conducting compliance reviews on elements of National Instrument 81-107. Fund managers, working with their IRCs, may find it beneficial to assess how they are complying with National Instrument 81-107 as part of a "Year Two" review.
At this early stage of working with National Instrument 81-107, nothing should be considered cast in stone and changes to practices and procedures may be appropriate. A Year Two review provides the opportunity to get it "right" by evolving practices to fit with the objectives of National Instrument 81-107 and the fund manager’s particular business and operations. We know that the regulators will expect compliance with the oversight regime established by National Instrument 81-107 in ways that go beyond meeting the bare requirements of the Rule. We would be pleased to help you achieve these objectives and help you carry out a Year Two review tailored to your fund organization.
We outline in this Investment Management Advisory some key points we consider important for a fund manager, working with its IRC, in conducting our recommended Year Two review.
Mandatory Steps Completed
The Year Two review should confirm that the following steps required under National Instrument 81-107 have been taken.
(1) First annual IRC report to securityholders posted and filed. Many IRCs should be starting to think about their second annual report, given that many mutual funds have December 31 financial year-ends. This second annual report must be filed and posted by the date that the funds file their annual financial statements (by March 30, 2009 for these funds).
(2) Fund manager annual report provided to the IRC on the fund manager’s reliance on IRC standing instructions, including details about the "instances" that the manager relied on the standing instructions.
(3) Annual review by the IRC of the "adequacy and effectiveness" of fund manager conflicts policies and procedures and IRC standing instructions and the required IRC report delivered to the manager.
(4) IRC annual assessment of its effectiveness, overall and of each member, including a review of the IRC charter.
(5) IRC annual assessment of its compensation and independence and IRC report on these issues provided to the manager.
(6) At least one meeting of the IRC held, in whole or in part, in camera, with no representatives of the manager present.
(7) IRC members provided with orientation on their role and the business of the fund manager.
The Year Two Review
A fund manager conducting a Year Two review should consider the following fundamental questions and obtain feedback from its IRC, as appropriate.
- Have the appropriate conflicts of interest matters (as that term is defined in National Instrument 81-107) been identified? Given the broad principles-based definition of conflicts of interest matters, we believe that it is important to be largely consistent with industry practice in this area, although we also are of the view that reasonable people can disagree about whether a particular matter raises conflicts of interest. For example, in light of industry practice, it might be appropriate for a fund manager to decide that a particular matter is not a conflict of interest matter requiring IRC input, even if it has previously referred the matter to the IRC and vice versa.
- Do its conflicts of interest policies and procedures accurately describe how it manages the applicable conflicts of interest? In particular, how does the fund manager deal with monitoring conflicts of interest of "entities related to the fund manager" as mandated by National Instrument 81-107?
- Does it have a policy and procedure in place to ensure on-going compliance with National Instrument 81-107? Compliance with National Instrument 81-107 means identifying how the Rule will be complied with in the future by the staff of a fund manager and constantly assessing whether any change to the fund manager’s business constitutes a conflict of interest matter.
- Do IRC meetings run efficiently and with appropriate attention to the matters being considered? Does the IRC operate in a collegial and cooperative fashion? Are specific topics identified in an agenda for each meeting and are fund manager resources available to meet with the IRC on the scheduled dates to cover the specified topics? Is the communication between the fund manager and the IRC open and complete? Which officers of the fund manager should be in closest contact with the IRC? Should the IRC have access to, or hear from other representatives?
- Do the IRC members understand the nature of the conflicts that have been referred to them and how they should provide on-going oversight over conflicts that are the subject of standing instructions? Do the IRC members understand the extent of governance provided by the fund manager over its funds – how the fund manager meets its fiduciary obligations? Do the IRC members need additional orientation and continuing education? If so, what resources are available from the fund manager?
- Do the fund manager’s board, senior management and staff understand the nature and purpose of the oversight provided by the IRC? Is additional orientation and training necessary for the board, senior management and staff?
- Should a different method of complying with the mandatory reporting under National Instrument 81-107 be adopted? Does the IRC understand the reports and do they have time to complete their review?
- Is the fund manager keeping track of industry-wide IRC compensation trends, so that it can make an informed recommendation to the IRC on future compensation?
- Does the IRC have a process in place for filling vacancies and for succession planning, orientation of new members, keeping records of its meetings, and generally complying with the mandatory steps for IRCs under National Instrument 81-107?
Lastly, is the IRC providing value to fund unitholders? If not, what changes can practically be made to enhance the value of the IRC? There will be no easy answer to these questions, but we believe these questions are at the essence of National Instrument 81-107.
In conducting a Year Two review, no doubt a fund manager, working with its IRC, will identify other considerations that are specific to their own operations. Depending on the results of its Year Two review, a fund manager may wish to make changes to its National Instrument 81-107 compliance regime and discuss those changes with its IRC.