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Watchdogs to put more bite in mutual fund conflict rules

Canadian regulators are beefing up proposed conflict-of-interest rules for the mutual fund industry and widening their scope to include all publicly traded funds such as scholarship plans and labour-sponsored funds.

The proposed rules, to be released for comment today by the Canadian Securities Administrators, represent a major makeover of draft governance regulations released more than a year ago.

Those original rules sparked a backlash from investors' groups, which where highly critical of plans to hand over the policing of conflicts to independent review committees that were chosen by mutual funds and had little power to act.

David Brown, head of the Ontario Securities Commission, which is spearheading the reforms, said the revisions are a response to those concerns.

They also reflect the findings of his staff during its probe of wrongdoing in the fund industry.

"We now feel we have a formula that will provide improved protection for investors," he said. "We have been listening very carefully to the comments we have been getting."

This newest draft backtracks on some of the most contentious issues for investors, but stops short of giving them all that they requested.

Gone, for example, are plans to eliminate a decades-old ban on related-party transactions and self-dealing at mutual funds. The lifting of that ban was a key demand of the industry in return for new rules that required independent committees to oversee fund managers.

Independent oversight is standard practice in the United States, but Canadian funds have never faced this requirement, even though it was first recommended by a federal-provincial study in 1969.

Under this latest version of the rule -- known as National Instrument 81-107 -- the ban on related-party deals will remain in securities legislation.

At the same time, fund companies will be granted new freedom to do certain related-party deals as long as they have the blessing of a review committee. Those transactions include trading between funds, buying securities from a related issuer and buying securities during the offering period that are being underwritten by a related party.

The new rules still require funds to set up independent review committees to vet related-party deals and all conflict-of-interest situations. These committees now have the power to stop transactions, rather than just voice their objections. Mr. Brown said the changes give committees "substantially more teeth."

He also said the rules have been expanded to include all publicly traded funds, because the commission saw that the same issues of conflict were present there.

But even with these changes, the latest draft rules still fall short of many key investor demands for reform. They also do not go as far as the investor-friendly reforms suggested by regulators more than three years ago.

What's missing from the latest revision is any mention of plans to implement a registration system for fund managers -- a key demand of investors and a recommendation found in a long line of reports on mutual fund reform.

The newly empowered review committees still lack the ability to fire fund managers and do not have the same powers as a corporate board. The commission also rejected recommendations that investors be allowed to exit a fund without penalty under certain circumstances.

Mr. Brown said some changes such as registration of managers are likely to come later and he suggested the powers committees have could be increased down the road.

"We are starting from scratch here," he said. "We don't see this as a final piece."

Instead, he said the latest proposal is a response to two of the biggest objections the commission heard from investors -- that committees needed more power and the prohibition on related-party deals should remain.

"I'm hoping some of them will see we have accomplished both in a rather elegant way."

© 2007 The Globe and Mail. All rights reserved.

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