Canadian securities regulators are expected to publish the final version of National Instrument 81-107 Independent Review Committees for Investment Funds this summer. Managers of investment funds that are reporting issuers (including mutual funds, closed-end funds, exchange–traded funds and scholarship plans) will be required to establish an independent review committee by mid-2007 (within 6 months of the rule becoming effective). This is a relatively short-time frame having regard to the magnitude of issues (many of which we will cover in our Countdown to Governance series) that must be addressed.
Fund managers must appoint the first IRC members for their funds. Vacancies after the initial appointments will be filled by the remaining IRC members. We describe below some important considerations for you in setting up your IRC. If your funds already have an existing governance body, it will be important to ensure that such body and its members are organized in the manner required by NI 81-107.
Functions of the IRC: NI 81-107 mandates the IRC as an independent oversight body for investment funds that will operate within the parameters of a written charter. An IRC is required to have four primary functions, although you can decide with your IRC whether or not it should carry out other functions. The IRC must:
- Decide whether a fund can make certain investments that are currently prohibited under securities legislation.
- Review "conflict of interest matters" that you refer to it and give you recommendations about the actions you propose to take so that a fair and reasonable result is achieved for the funds. The phrase "conflict of interest matter" will be broadly defined using a principles-based / "reasonable person" approach.
- Review your written policies and procedures governing "conflict of interest matters".
- Approve certain fundamental changes specified in NI 81-107 regarding the business and affairs of the funds.
Size of the IRC: You should consider the optimum size of your IRC, subject to the stipulated 3-person minimum. How many members will facilitate "effective decision-making" by the IRC having regard to the IRC’s anticipated workload? The workload of an IRC will be dependent upon a number of factors including the size of your fund complex, the extent of affiliations between you and other financial services firms, the volume and complexity of "conflict of interest matters" and whether your IRC will have functions and responsibilities beyond what is required by NI 81-107.
Independence of each IRC member: The hallmark characteristic of an NI 81-107 IRC is that each individual member must be "independent" within the meaning of NI 81-107 and free of conflicting loyalties. Does a potential candidate have a past or current "material relationship" with, among others, you or your affiliates, partners, directors and officers or with your portfolio manager or other related entities that could, from a reasonable person’s perspective, interfere with that candidate’s independent judgment? Examples of "material relationships" that could preclude an individual from acting as an IRC member include relationships of a commercial, service provider (banking, consulting, legal, accounting), familial or charitable nature. We expect that NI 81-107 will allow individuals who are today independent directors on a fund manager’s board of directors to become members of an IRC, provided they resign as directors on the fund manager’s board. We also anticipate that NI 81-107 will allow independent directors of entities related to a fund manager to become IRC members, without necessarily having to resign as directors of that related entity.
Skills of each IRC member: You will be free to determine what particular competencies, skills and experience each IRC member should possess. Industry experience, for example, may be considered to be a critical prerequisite for some or all of your IRC members having regard to the powers of the IRC and potential complexity of the matters that will be under the IRC’s purview. Alternatively, you might want a cross-sectional or balanced representation. Due diligence, via questionnaires, interviews and/or background checks on each candidate should be carried out by you to ensure that your IRC works well together as anticipated by NI 81-107. Since the IRC will be required to appoint a member to act as chair who will be responsible for managing the mandate and responsibilities of the IRC, you should think carefully about each member and whether he or she will be in a good position to carry out the expected functions of a chair if selected to act in such capacity by the IRC.
Terms of office: The term of office of each IRC member cannot be less than 2 years or more than 5 years, although the IRC will be able to reappoint a member whose term expires for additional terms. The Canadian securities regulators recommend staggering the initial terms of office of IRC members to ensure appropriate continuity and representation on the IRC.
Documenting your decisions: Given the importance of an IRC, you should take care to document your decisions in writing, including the reasons why you set the specific size of the IRC, appointed a particular individual and set that member’s term of office. This can generally be done through minutes of the meeting of your board of directors held to establish the IRC and confirm the appointment of the members.
What’s next? Please watch for our next Practice Bulletin in our Countdown to Governance series - Practice Bulletin No. 2 will discuss the "10 Questions You Should Expect To Be Asked By an IRC Candidate". Please contact your usual lawyer in BLG’s Investment Management Group if you have any questions about NI 81-107 and the matters outlined in this Practice Bulletin.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.