The Ontario Securities Commission (OSC) and the Autorité des marchés financiers (AMF) conducted a continuous disclosure review (CD Review) related to National Instrument 81-107 Independent Review Committee for Investment Funds (NI 81-107 or the Rule) and released the Multilateral Staff Notice 81-337 Targeted Continuous Disclosure Review and Guidance for Independent Review Committees for Investment Funds (Staff Notice) on March 21, 2024.

The Staff Notice covers a number of topics, including:

• Independent review committees (IRCs) term limits;
• Skills, competencies and recruitment;
• Size and diversity;
• Compensation;
• Expanded scope of IRC review; and
• Disclosure to demonstrate IRC impact.

Background

NI 81-107 requires an investment fund manager (IFM) to identify and refer conflicts of interest to the IRC for approval or recommendation. 

Generally, the Rule captures two types of conflicts that arise in the operation of an investment fund: (i) ‘business’ or ‘operational’ conflicts, i.e., those relating to the operation by the IFM of its funds that are not specifically regulated under securities legislation, except through the general duties of loyalty and care imposed on the IFM; and (ii) ‘structural’ conflicts, i.e., those resulting from proposed transactions by the IFM with its related entities, fund or portfolio manager, currently prohibited or restricted by securities legislation.

NI 81-107 requires an IFM to establish written policies and procedures that it must follow when making a decision involving a conflict-of-interest matter and must refer the matter to the IRC for its recommendation or approval, as appropriate, before proceeding.

IRC authority

The IRC is intended to support the IFM and review its handling of conflicts of interest as they arise in the management and operation of the investment fund. If few or no conflict-of-interest matters are brought to the IRC for review, IRC members should consider whether that is reasonable, whether there is actual compliance with NI 81-107, or with securities legislation more generally. The IRC has authority to request information it determines useful or necessary from the IFM to carry out its duties.

Staff of the OSC acknowledge that in certain cases there may be instances of disagreement between an IRC and an IFM on what constitutes a ‘conflict-of-interest matter’ under NI 81-107, particularly with respect to ‘operational conflicts’ that are not prohibited by securities legislation, i.e., an IRC may be of the view that a particular matter or fact pattern should be referred to the IRC as a ‘conflict-of-interest matter’ for its recommendation or approval where required. In addition, Staff recognize that the process of identifying a conflict-of-interest matter may be challenging in certain instances. 

Responsibility for the identification and mitigation of conflicts of interest of the investment fund ultimately rests with the IFM, not the IRC. The process of identifying an operational conflict-of-interest matter should be informed by the view of a ‘reasonable person’ applied to a set of facts. In this context, IFMs are encouraged to take a broad view of what constitutes a ‘conflict-of-interest matter’ and to err on the side of caution when identifying and referring an actual or perceived conflict-of-interest matter to the IRC for approval or recommendation. 

IRCs should ensure that they understand, at all times, what is being asked of the IRC by the IFM.

Minutes of the IRC meetings should be fulsome and clearly demonstrate the deliberations of the IRC members and the considerations that factor into any decision made by the IRC when asked for a recommendation or approval on a conflict-of-interest matters.

Findings, comments and regulatory views

As set out in the Staff Notice, the OSC and AMF encourage the following:

• IRC terms beyond six years should be viewed as exceptions to the Rule in limited circumstances where appropriate, and should not become common practice;
• IRCs and IFMs should implement recruitment processes that are fair and transparent, which encourage IRC membership from individuals with relevant knowledge and experience gained from various backgrounds;
• Diversity in IRC membership beyond “skill-set” may lead to better decision-making and good governance;
• IRC compensation should be transparent (and justified) and clearly disclosed as it can be viewed as a measure of the IRC’s independence;
• IFM should take a broad view of what constitutes a ‘conflict-of-interest matter’ and to err on the side of caution to refer an actual or perceived conflict-of-interest matter to the IRC; and
• Enhanced disclosure in the IRC Report to Securityholders on the activity and impact of the IRC can better inform stakeholders about the value, role and impact of the IRC.

In addition to the above points, the Staff Notice outlines the need for disclosure of the basis for allocation of IRC costs across funds. IFMs are encouraged to include a breakdown of which IRC costs are allocated across applicable funds in the IRC Report to Securityholders and are reminded of the need for the breakdown of individual IRC costs in the fund’s prospectus going forward – and appropriate consistency in disclosure between the fund’s prospectus and the IRC Report to Securityholders.

The Staff Notice highlights the possibility of expanded scope of IRC review and notes that the IRC may perform functions additional to those prescribed by NI 81-107. Most IFMs obtain standing instructions from their IRCs concerning various matters, including proxy voting; operating costs/expense allocation; inter-fund trading; personal trading; gifts, gratuities and business entertainment; allocation of investment opportunities, trade allocation and aggregation; unitholder activity (large transactions; short-term trades, transactions-in-kind, etc.); NAV errors and adjustments; soft dollars use; transactions in securities of related issuers; fund valuation; trade errors and modifications; fund of funds; correcting portfolio pricing errors; sub-advisor selection/change; best execution; seed capital; fair value pricing; confidentiality and code of ethics; services provided by related parties/affiliates; portfolio/investment management and change; and purchases of equity/fixed income securities underwritten by an affiliate.

As the IRC Report to Securityholders is the disclosure document in which IRC activities are captured, IRCs should ensure that the disclosure in such documents is fulsome, substantive and informative and that it provides a clear picture of the scope of IRC activities and the impact of the IRC’s involvement on how conflicts of interest of the funds have been mitigated. As an example, the IRC Report to Securityholders could provide insight into any enhanced procedures adopted by the IFM as a result of an IRC approval or recommendation. Enhanced disclosure in the IRC Report to Securityholders on the activity and impact of the IRC can better inform stakeholders about the value, role and impact of the IRC.

For additional information or guidance on this Staff Notice, please contact co-authors Michael C. DeCosimo, David Coultice and Diana Nakka, or any member of Dentons Canada’s Securities and Corporate Finance group.