Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 20 - Evidence - May 28, 1998

OTTAWA, Thursday, May 28, 1997

The Standing Senate Committee on Banking, Trade and Commerce met this day at 11:00 a.m. to examine the state of the financial system in Canada (the role of institutional investors).

Senator David Tkachuk (Deputy Chairman) in the Chair.

The Deputy Chairman: Our witness today will, I believe, be most helpful to us in our study. He is Dr. Laurence Schwartz, chief economist with the Toronto office of LECG, Inc., which is a leading North American consulting firm in the provision of expert economic analysis for litigation and regulation.

Welcome to the committee, Mr. Schwartz. I believe you will give us a short summary of your presentation and then we will have questions.

Dr. Laurence P. Schwartz, Senior Economist, LECG Inc.: I wish to take this opportunity to offer something of a dissenting opinion on the question of mutual governance. Had this session gone as originally planned, Commissioner Stromberg would have been here. Commissioner Stromberg and I have discussed these matters on a few occasions. She is well-accepting of my dissenting view, and I have every regard for the commissioner and the work she has done in this area. It is a matter of a disagreement on this point.

The chart which I have provided, headed: "Arrangements in the Mutual Fund Business," might help clarify some of the relationships that exist among mutual fund management companies, the funds that they manage, and the investors in those funds, which we call "unit holders." On the right-hand side you see the distribution, that is, how people's money gets into mutual funds. They are distributed through stock brokerages, mutual fund dealers, financial planning companies, and my happy faces are those people who are not yet unit holders but are prospects.

The relationship between the fund management company and the funds is established through a trust document and a management contract. For each pool of funds, a money market fund, an equity fund, a mortgage fund, there will be a separate trust document and management contract with the fund management company. Shifting to the right-hand side, you see the distribution agreement that the fund management company in its role as principal distributor enters into with each of the various distribution companies it want to use to distribute its funds.

I want to talk about the arrangements. When we talk about the mutual fund business we are not necessarily clear on what is meant by that, so I hope that this will assist. When we talk about mutual fund governance, we are talking about the pools, and they are circled, the money market fund, the equity fund, the mortgage fund, and what kind of governance apparatus or institutions we should have in relation to those pools. We are not talking about the distribution of mutual funds.

Many types of abuses could take place with respect to people who have put money into these pools, abuses such as self-dealing, conflict of interest, stealing, or taking assets out of the pools for one's own benefit. Those are the kinds of abuses which a governance system might attend. Frankly, we see little of that in Canada, and I am not aware of any lawsuits, any litigation, or any instances of wrongdoing in this country. That is not so in the American situation.

There is, however, abuse in the Canadian mutual fund business but it tends to be on the distributor and prospect side of this diagram. By that I mean that a salesman will attempt to bring in a prospect with outlandish claims of performance, such as claiming that the fund will double in three years or five years; or the salesperson might try to persuade an elderly investor to put a mortgage on his or her house and use the proceeds of that mortgage loan to buy into a fund that he is distributing. Those kinds of abuses are very real, and they are common. Securities regulators across the country are well aware of them and they should do something about them.

However, the governance issues we are talking about have almost nothing to do with those kinds of abuses. We should be clear, because it is not entirely clear in the minds of those who think that mutual fund governance ought to change in some way, what abuses they are trying to control.

There are now three proposals on the table to reform mutual fund governance in Canada. Commissioner Stromberg, in her report to the security administrators a couple of years ago, said, in essence, that every single mutual fund should have its own board, with directors having corporate type responsibilities, and that a majority of each fund's board should be independent. She did not go into too much detail about what would comprise independence.

That proposal was reviewed by the investment fund steering group which was set up by the chairman of the Ontario Securities Commission to review the Stromberg report. In the area of governance they agreed, unequivocally, with Commissioner Stromberg that every mutual fund should have a board, or that there should be boards, and that they should be comprised of 50-per-cent-plus independent directors.

The report made a puzzling conclusion. It found that not every single mutual fund in Canada ought to have one of these boards, but that there should be one board for every fund family. For example, if one company sponsors a money market fund, an equity fund and a mortgage fund, there would be only one board for that set of pools. That is the second proposal, a board for fund families, but still independent.

In the report of the Quebec Consultative Committee, which reviewed the Stromberg report from Quebec's perspective, it was stated that fund family boards are the way to go. However, they could find no reason for them to be independent.

There is a whole range of proposals out there for fund governance amendment. It is interesting to note that, if you read these reports, you can find no good reason why the change is being proposed. Commissioner Stromberg's rationale was very clear. She prefers the corporate structure. She has stated that court law is a much superior way to regulate these kinds of relationships and that is why we should do it. She did not say there was any abuse in Canada, and she did not point to any court cases, any litigation, any regulatory proceedings that would affect the kinds of relationships between unit holders and mutual fund management companies that might require a board to intervene. She has a preference for corporate-style structures.

The follow-up group, the investment fund steering committee, apparently agreed with her because they also could produce no evidence. That was a group which I would have thought was well able to produce evidence, if there had been any, of the abuse of existing investors by funds and fund management companies. In fact, if you were to read that report it would strike you that there was no rationale offered as to why we ought to accept their proposal over Commissioner Stromberg's. It seems to me, if they agree with Commissioner Stromberg, as they do, then they ought to have said that every mutual fund needs its own board. They did not say that, and they did not tell us why, they just put it out for consideration. I find it very puzzling that a knowledgeable committee, struck by the chairman of the Ontario Securities Commission, should make a recommendation but not give its rationale for the recommendation. There are rumours but, since I cannot confirm them, I will not get into that.

What these models suggest to me, frankly, is a certain lack of understanding as to why the current regime in Canada is what it is. I once worked at the Ontario Securities Commission. No one was interested in the issue at that time but no one seemed to have a good grip as to why the regime we have today was in place, with one slight exception. People at securities regulatory authorities in the country are aware of the 1969 report of the Canadian Committee on Mutual Funds and Investment Contracts. That was a federal-provincial study conducted by a group of provincial financial services administrators supported by a staff. Among the administrators was a federal representative, the Honourable Marc Lalonde, and the staff was headed by Mr. James Bailey, the present head of the Tory, Tory, Deslauriers and Binnington law firm and former head of the task force into the future of the financial services sector.

In 1969 they reviewed the gamut of issues having to do with mutual funds, their regulation, and they did spend some time on the governance structure of mutual funds. That report is now approximately 30 years old and, since it is approximately 600 pages in length, it is not surprising that few people take the time to read it. I am referring to those in the regulatory community, in the business community of mutual funds, and investors. No one seems to know, without having read that report, why the current governance structure is what it is. I contend that is the reason for some of these problems.

I go into this in more detail in my paper. Suffice it to say that, on the question of governance, the committee took two views about what a mutual fund actually was. To simplify, they found that a mutual fund could be viewed as an organization in which an individual, who comes into a windfall and who does not have the wherewithal to manage his money, could invest his money. That person could go to an investment counselling firm and ask them to manage his or her money. There would be a fee arrangement. The committee suggested that perhaps a mutual fund was a vehicle which could be used by these people who have money and who do not wish to manage it themselves, but wish to leave that to a money manager. On that theory, a mutual fund is simply a vehicle that the money manager establishes in order to facilitate the pooling of the individuals who come to him for money-management services. If you have ever gone to an investment counsellor, and after a while you were dissatisfied with his performance, or the way he administered your money, you would simply take your money and go elsewhere. There would no thought that there ought to be a board of directors to whom you might appeal in those circumstances. That is not the theory of how investment counselling works. If you do not like how your money is being handled, you leave.

That was one theory of the mutual fund that this 1969 committee considered. The alternative is more like the corporate investment. They suggested that we could think of a mutual fund investment as being the equivalent of buying stock in a company. When you invest money in a mutual fund you get back units that represent your interest; similarly, when you buy stock in a publicly listed corporation you get shares and you become a shareholder.

In 1969, the committee went back and forth between these two views. The committee said that, if the mutual fund is a corporation then we should adopt corporate governance attributes, and it may make sense to have independent director requirements for that corporate-style fund organization. That committee took the view that the corporate style was, essentially, the American model established under the Investment Companies Act of 1940. The Americans have had many problems with the way that legislation has been implemented, with the administration, with the regulations it gave rise to, and particularly the question of the independence for directors. It was asked, "Where would these people come from?" and, "Who could be a director?"

The Investment Companies Act specifies that 40 per cent of the boards of investment companies, which is what they call "mutual funds" in the States, must be independent. However, it was not clear how independent a person had to be to meet the statutory test. By way of example: A few months ago, I had occasion to speak to an American at a conference. He worked in a bank. He noticed that some of his employees in the bank were qualified and were the independent directors of the mutual funds which were managed by the bank's mutual fund management subsidiary. It is clear that in the United States if you were an employee of a mutual fund management company, you would not be independent, but apparently in the United States, when that mutual fund management company is owned by a bank, the employees of the bank qualify and can pass the independence tests. This demonstrates the problems of defining "independence."

These are some of the issues dealt with by the 1969 committee. The long and short of it is that they found that mutual funds ought not to be viewed as corporations, and that they need not be required, in their view, to have formalized corporate governance. However, they did find that it was a good idea to have independent directors but they did not recommend that it be made a law. They opted for the former model in which people give their money to a money manager, the money manager establishes a pool, and people are free to come and go from that pool. Since it is not a corporate structure, there is no formal corporate governance apparatus. That may seem inappropriate to some people, but there is a rationale for it which stems from the difficulties inherent in the alternative model.

I would suggest that what we have, not entirely but largely, is a system of very active governance on mutual fund management companies that comes from the ability of investors to come and go as they please, to redeem at net asset value on approximately a daily basis in most cases.

The 1969 committee was not content with that rationale. They did not think that the ability of people to redeem on demand would be enough to protect their interests so, rather than go the corporate route, they determined that there was reason to have strong regulation in Canada over the mutual fund business, broadly speaking.

That is what we have today. We have a system where there is strong and interventionist regulation; and there is a system where people come and go pretty much as they please at net asset value. I have yet to see any evidence that this system has not worked out extremely well. The lack of litigation, the lack of hearings, the lack of demand for corporate directors, outside of Commissioner Stromberg and the follow-up people on her review, all point to the fact that it is working well. However, there it is still an open-ended question here as to whether this open-ended governance machinery would be an improvement. I do not believe it would be because our system seems to work very well.

The Americans are finding themselves in a bit of a conundrum because they have a system which, in my submission, is slowly but surely moving towards a Canadian-style approach. In my paper I mention the 1992 report of the Division of Investment Management of the Securities and Exchange Commission. They took a look at what they called the "Unified Investment Fund," which is their name for what we have in Canada, and they contrasted it to what the American legislation requires of what they call "investment companies." The principal governance technique in the law of the United States requires that every single mutual fund or investment company have a board of directors, at least 40 per cent of whom are independent of the management company and of the fund. Quite apart from the definitions of independence and the problems that may entail, that is the rule. The Investment Companies Act also specifies that these investment companies shall issue shares. They do not issue units as we do in Canada, they issue shares; and the people who invest in these investment companies are called "shareholders." They are not called "unit holders."

It is very clear that the Investment Companies Act of 1940 is an attempt to turn the conventional mutual fund into a corporation, at least for governance purposes. It could be a corporate structure, it could be a trust, nevertheless, the Investment Companies Act imposes these corporate governance provisions on these funds.

The staff who assisted in the preparation of the 1992 report in the United States, considered the law in the United States as it applied to these UIFs, the unified investment funds, and they concluded that they liked the model they had in place, the model they adopted in 1940, and they decided not to change it. They said to change it to a Canadian-style UIF would be to contradict the legislative history of their act. They are quite right. One thing that the United States has that we have not had, as far as I can tell, is a history of abuse. The abuse that I have documented in my paper goes back to the 1920s and 1930s before the Securities Exchange Act, before the history of U.S. mutual fund or securities regulation, and there were some gross examples of abuse of investors by the managers of those mutual funds. Those abuses were so gross that they gave rise to the Investment Company Act of 1940 and to the corporate style of governance that it was believed would address those issues.

It is interesting, if I may say, that most of the mutual funds in the United States in the 1920s and 1930s were close-ended corporations. That is to say, if you were an investor in one of those funds, you did not have the right to redeem on demand. You had to look to the stock exchange to find a buyer for your mutual fund shares when you wished to exit. Maybe you could find a buyer and maybe you could not. Maybe you could get a price close to net asset value or maybe you could not.

Although we have them, those funds are not so common in Canada. There are certain specialty funds, and there may be a reason to invest in them, but I would say that 90 per cent of conventional Canadian mutual funds are open-ended and, therefore, permit this redemption on demand at net asset value. Interestingly enough, most American mutual funds are now of that type. The overwhelming number of American mutual funds are open-ended, but they continue to have imposed on them the governance apparatus of the 1940 legislation that was introduced to respond mainly to the abuses in close-ended funds in the 1920s and the 1930s.

Having said that, I believe that the Americans are moving towards another type of fund, although it will not happen immediately. The 1992 report mentioned the fact that they will never have the kind of funds of which you and I speak. They have, however, taken some steps. For one thing, the staff of the securities and exchange commission suggested they ought to move the 40-per-cent independence requirement for boards up to 50 per cent plus. It is of interest to me that that proposal did not find acceptance with the Congress, although a number of their other staff recommendations were accepted.

The report also questions the success of the governance apparatus. They noticed that, despite the fact that these mutual fund companies are required to have annual meetings, very few investors attend; and when proxies are mailed out very few people respond. That might not be surprising to anyone at this table, but that is the American experience.

They also noticed that the independent directors tend not to do their job. They rarely terminate the money manager, the one who started the fund. Even when they challenged the fees that the fund was paying the manager, they would settle on a number that was only marginally below the manager's initial proposal. The staff report also suggests that independent directors rarely challenge self-dealing or conflicts of interest.

You must wonder whether the staff have engaged in a contradiction, particularly when they conclude that they will not go to the unified fund that is used in other countries.

They did, however, in the 1992 report, recommend that certain shareholder voting requirements be removed. I refer to two in my paper. They decided that, in certain cases, shareholder votes would not be held because fund investors, by investing their dollars, have already chosen the arrangements.

From this, I conclude that, in the United States, there is some movement away from the very heavy-handed corporate-style governance regime that they have imposed on their mutual funds, and that they are heading towards something that relies on redemption -- on net asset value on shareholder movement, if you will -- to discipline the fund management companies.

I believe your committee may have other concerns. Bearing that in mind, Mr. Chairman, I am prepared to conclude my preliminary remarks if members have questions.

The Deputy Chairman: We will proceed to questions. If we do not cover all of the areas you wish to bring to our attention, you can come back to them.

Senator Callbeck: Mr. Schwartz, does the sales code rule that was introduced cover the kind of abuses you mentioned in Canada where a sales person may promise unrealistic returns to encourage someone to mortgage their home?

Mr. Schwartz: It does.

Senator Callbeck: Who enforces that?

Mr. Schwartz: I cannot be sure at the moment. It is a code that was established by the industry itself through its trade organization, and I believe the Ontario Securities Commission and presumably others have attempted to give it some legal or self-regulatory basis.

Senator Callbeck: Would that address that problem?

Mr. Schwartz: Yes. Those are the kinds of abuses that they are trying to addressed by the sales code, as contrasted with the abuses that might give rise to a governance system. For example, a governance system would deal with the situation where, if you are already a fund investor the money manager changes the fees on you, converts the fund to cash and goes to South America, or where the fund has purchased assets from the staff of the fund management company in contradiction to the stated investment policy of the fund. As I said, I am not aware of any such complaints in Canada, but those abuses are not the kinds of abuses that the sales code is designed to address. The sales code is concerned with regulating the sales practices of those people who are selling the funds.

In fact, if we did have a fund requirement in Canada for boards of Commissioner Stromberg's type, and those directors did observe abuses on the sales side, there is very little they could do about it. Those prospects did not vote the directors in, and the directors are not there to look after their interests. They are not the responsibility of the directors. Their responsibility is to the people who are in the fund. They voted the directors in to represent their interests.

Senator Oliver: They would be the agent for the company.

Mr. Schwartz: I believe, senator, that that is what I am disputing. If we required fund directors to be there and to be representatives of the investors in the fund, then that is how they would draw their authority, in the same way that corporate directors draw their authority from existing shareholders.

I may be wrong in this, but if I was a director of a publicly listed company and I saw a stockbroker making outlandish claims to other people, I may not like it, but I am not sure that I could do anything about it. As well, I am not sure there is anything I should do about it. I am certainly not going to dip into my company's assets to mount a lawsuit against this salesperson. That is not in the interests of the existing shareholders, at least in the normal course. For the most part, I do not believe that corporate directors see themselves as having that concern. They are not worried about people who are not stockholders; they are worried about the stockholders.

I will take my hypothetical situation one step further. If you believe that these hypothetical fund directors act in the best interests of their unit holders, then the more money in the fund the cheaper the unit costs of management. It is beneficial, therefore, for the fund to grow because the cost to the existing investors will be lowered. Thus, the hypothetical fund director, in my scenario, will turn a blind eye to the sales abuses because he is not responsible for sales people; if their money comes in, it is of benefit to the existing unit holders.

That is speculation on my part, but I almost think that this might have negative consequences for sales practices, if anything. I do not speak as an expert on this, but I have been told that I am right by some people; by others, I have been told that I am wrong, however. I believe I have an idea of what directors do and that the expertise of this body may contribute to your collective thinking about how directors would respond.

Senator Callbeck: Just to carry through on that, is it fair to say, then, that you feel that the abuses that we tend to see in Canada are addressed by that sales code?

Mr. Schwartz: I have not been involved with that in any way. I am aware that it is the intention of those sales code to address abuses of that type, as opposed to the abuses that I have discussed.

Senator Meighen: Do I have it right, Dr. Schwartz, that in effect, as I understand what you are saying -- and I agree with you at least in the logical progression -- there is no logical rationale to have "independent" boards of directors in open-ended mutual funds but that you see no harm to there being some? Would I also be right in saying that, indeed, the trend seems to be towards more "independent" boards of directors for open-ended funds?

I should tell you right away that I am the chairman of Cundill Funds, and they have had a board of directors, or the venture fund has had a board of directors since the late 1970s, early 1980s.

Mr. Schwartz: I believe that the 1969 report put it very well: It is desirable to have independent directors, if you can find them and if you can somehow make then responsible to the investors. It is not clear how you would elect them, but assuming those problems could be overcome.

I am not opposing the concept of independence. I am opposing the requirement. I am not certain, senator, whether there are many boards on mutual funds. There is a movement to advisory committees and advisory boards, and I believe there may well be a role for those. The advisory boards that I read about I believe have very little in the way of responsibility or authority. I do not know what they do. I am just a little sceptical of their impact.

I am a participating policyholder for an insurance company. This company annually establishes an advisory board of knowledgeable people to interview the manager, and interview anyone they choose, and then report to the policyholders. That is a very useful thing to do. They are independent, no doubt, and they are qualified. I am not aware of any advisory boards of mutual funds in Canada that do that. I am sure they meet and they probably do the best they can, but I do not have the sense that they are terribly influential. Senator, you may be in a minority if the fund you are part of has a board, in the corporate sense.

Senator Meighen: I believe we are. What we do is interesting. For example, we do not have a sales force; independent organizations sell our mutual fund units, if they so desire. We do not feel that we have any responsibility whatsoever as a board vis-à-vis, say, XYZ Planners Inc., who are selling all kinds of funds, including ours. They are governed by other codes and authorities, as you suggested.

We do feel we have a responsibility to try to ensure that the fund manager is doing what he says he will do in his information circular and in his annual reports -- for instance, his policy on derivatives. We try to monitor his adherence to that stated policy. We monitor that he is adhering to any other public statements that he puts out. I agree with you that if he decides to raise his fee by half a per cent, then the unit holders will vote with their feet, because it must go to the unit holders. We do not bring any judgment to bear on that necessarily.

Mr. Schwartz: I wish to restate that I am not opposed to the independence of directors or people operating in that advisory role. If we were to make our system more or less like the American one, then I would expect a higher degree of litigation and a higher degree of regulation, which is characteristic of their system. I have some familiarity with one particular line of cases in the United States, called the excessive fee litigation. In this instance, under the class action rules that apply in the United States, someone will get up and say that the fund manager has arranged for himself to be paid too much. The last time I checked there were at least 60 of these cases, which is perhaps not a large number, but it is there and they always lose in court.

We never see anything like that in Canada. I am not aware of any instance where a mutual fund investor sued the management company, but we do have, interestingly enough, in some of the provinces, class action litigation capabilities, I believe in Ontario, Quebec and British Columbia.

If we were to go the American route, we would be opening the door to what I regard as largely frivolous litigation. That would mean, of course, that there would need to be more rules to control the activity. People may wish to compare the Investment Companies Act of 1940 and the regulations thereunder with the lesser degree of regulation of our security rules.

Senator Meighen: I tend to agree with you, I would not like to see that. In the end, the statement can be made that the board that I am familiar with is more of an advisory board than a corporate board, an advisory-type board, which I believe you were alluding to earlier.

On the question of closed-ended funds, I understand that they are not nearly as common in Canada as they are in the United States. However, am I not correct that there is a requirement that some of them be incorporated under the Canada Business Corporations Act, or the Ontario Business Corporations Act, or whatever, where there is a requirement for a board?

Mr. Schwartz: Those funds are indeed corporations so they must meet the corporate law requirements.

I might say -- and I have written about this, although not in this context -- that many of the specialized funds, and it may be more true in the United States, deal in non-liquid securities. If you wish to buy a Korea fund, say, that invests in Korean securities and the Korean Stock Exchange, or whatever -- countries are of this type tend to be non-liquid, they are not often traded. In that case, the fund would be well advised to be organized on a closed-end basis, because if I, as an investor in the Korea fund, wished to get my money back, the fund manager would need to start liquidating the fund's assets. Holding a portfolio of the non-liquid securities, Korean stock exchange listed securities that cannot be sold readily, would put the fund manager in a bit of a bind if he was required to meet daily redemptions because he might not be able to find buyers for the stock of the fund. That is a good reason to have closed-ended funds. And since they are closed-ended, they should have corporate governance. Someone then must be watching over the manager because there is less of a market test.

Senator Austin: My understanding about open funds is that the manager is required to protect the fund holders by placing assets in a trust company holding. Am I correct in my understanding?

Mr. Schwartz: Not a trust company. There is a declaration of trust by which the management company establishes the pool. That pool, therefore, must have trustees.

The 1969 report asked whether the trustees established pursuant to the trust arrangement should not be required to be independent, and that committee said "no" and they noted a problem. For example, Montreal Trust Company, which offered mutual funds back in the 1960s, or wished to do so, would need to get, say, Central Trust to be its trustee. The committee decided that having competitors be trustees for each other's products was not a practical arrangement.

Senator Austin: What is the value in day-to-day terms of that trust company arrangement? They will act on the instructions of the fund manager. What independent role do they play?

Mr. Schwartz: As I said, at the moment there is no requirement for a trust company, there is a requirement for a trustee.

Senator Austin: Correct, and most have used trust companies at one time or another.

Mr. Schwartz: Senator, that is not my impression. My impression is that the trustees are often employees of the management company but they are subject to the declaration of trust. What there is, is a custodial relationship, where the fund's assets, or increasingly these days the computer chips on which the fund's assets are recorded, are held in a bank or some financial institution.

One arrangement that is not on this chart is the custodial relationship. There is a difference between the trustee and the custodian.

Senator Austin: In the event of the commission of a serious crime that diminished the assets of the unit holders, what would be the responsibility of the trustee?

Mr. Schwartz: I do not know. Of course, senator, that is the concern.

Senator Austin: What is the policy behind a trustee?

Mr. Schwartz: I presume the fund is set up as a trust to separate the assets of the fund from the assets of the management company, and I presume the trustee is there in some sense to look out for the interests of the investors. I fully admit that it looks terrible on paper if the trustees are employees of the fund management company, but I counter that with the absolute lack of any such crimes in our history. I do not know how many years you wish to go back; as bad as it may look on paper, there just does not seem to be a problem here.

Senator Austin: You refer to the Hirsch matter in your paper, and there have been other, more recent, news stories about front running by managers.

Mr. Schwartz: I was thinking less of the front running than by this Altamira employee, Frank Mersch.

From my reading of Hirsch and Mersch, their behaviour indicates, from my point of view, if I were an investor, a certain lack of ethics, a certain lack of understanding of my interests as an investor, but they have not done anything to diminish the interests of their unit holders. Mersch is alleged to have lied on a totally unrelated matter to a securities commission. I do not see in that anything that has damaged his investors. People will leave that fund now, to some extent, I am sure, because they now view their fund manager as lacking certain ethical characteristics.

Senator Austin: May I offer the conjecture that if they were acting totally as fiduciaries for their holders, those opportunities that were put in the names of others -- and their explanations were that the others were the true beneficial owners -- should have been for the benefit of the unit holders.

Mr. Schwartz: I am not aware, senator, that that has happened, although it may be the case. The subsidiary point perhaps is that there is a lot of rumour here in the community. Everyone I talk to seems to know something wrong that happened somewhere. There is much innuendo but there is no evidence. No one ever comes forward with evidence that such and such a person did such and such to his investors on this date. All there is at this point is speculation.

Your committee would benefit the country if you asked for evidence, asked people to put what they know on the record, and then we can judge whether our governance machinery is working or not. The rampant speculation that I get is just that. For example, Hirsch was out before she started. Fidelity bought her off from AGF -- she was to be the manager -- but her own personal investing malfeasance came out before that fund got started. When it came out, the Fidelity people wasted no time, they tossed her out. They knew that they could not have a person like this managing their fund. I believe the Altamira people came to the same conclusion about Mersch. Even if it is only alleged, people will redeem out of these open-ended funds on a whim. Any whiff of bad conduct or bad ethics is enough to get people to leave.

One of the very strong aspects to our system is that there is a certain alignment of incentives. The management company has no incentive to hire people who will harm the investors. Under a closed-ended structure, yes, because the management company does not care. It is up to the people who deal on the stock exchange to get rid of their units, and that of course was the problem in the States in the 1920s and 1930s.

Senator Oliver: I first wish to know whether you know John Por and whether you know of his writings and work in terms of corporate governance for institutional investors? Have you seen the evidence he has given before this committee?

Mr. Schwartz: I have not.

Senator Oliver: He drew a relationship between good governance and good performance of the funds, and, in his view, there is a correlation and a strong relationship.

I also wished to ask you a series of questions about institutional investor activism. It is not one of the topics that you have addressed today, but it is something that we have had much evidence on and that we likely will be addressing in our reports. I wish to hear from you whether or not there are any governance principles involved in institutional investor activism -- I am talking about the CalPERS examples -- that you feel we ought to be having a look at; and, if so, what are some of them and do you have any view on the way these funds vote their proxies, and so on?

Mr. Schwartz: I have not done much work in the field. I did, however, co-write a paper with Professor Jeff MacIntosh, who is with the University of Toronto law school, that was given at an Industry Canada conference a couple of years ago. We tried to find some evidence for the relationship that controlling shareholders, whether they were institutional or not, on one level, and then if they were institutional, on the other level, made a difference to the performance of the company. We found some. I would be happy to look for the reference and send it to you.

Senator Oliver: Professor MacIntosh appeared before us. He also wrote a background paper and we are familiar with his work and his statistics.

Mr. Schwartz: There does seem to be a link. It is not as strong a link as I might have hoped, if you collected data and do the studies -- and I believe that is the way policy in this area should be done. There should be reasons to do things. The reasons that I found, and I believe Professor MacIntosh would agree, for us, who think of ourselves as enthusiasts in this area, the research could be stronger.

You asked me another question.

Senator Oliver: The question of activism of institutional investors and taking an active role in management and directing management of the corporations in which they have substantial holdings.

Mr. Schwartz: If you would accept, sir, I do not have a strong view on that.

Mr. Chairman, and members of the committee, I had made the point that I thought the U.S. is initially moving away from this corporate-style governance model that came under the 1940 legislation. Something happened quite recently in the United States. It is in my paper, the Navellier management problem. Navellier was a money manager of two funds in the United States and he did what we would call in Canada apparently a related party transaction. He was planning to merge the two funds. I do not have all the details at hand but that transaction led the directors of one of his funds to fire him. It was very unusual for a board to fire the money manager, but they did it. They had the right to do it; they thought it was the right thing to do.

Navellier then launched a proxy fight. He went directly to his fund investors and told them that he was acting in their best interests and had a lot of money for them over the years. Surprisingly enough, he won the proxy contest. So what we had there was a situation where the fund directors tried to get rid of him and the investors wanted him back in. The directors went to the securities and exchange commissioner, according to the reports that I have seen, and asked for some support. The securities and exchange commission told the directors that it was their fund, and to handle it.

This is one of the things that is wrong with the United States that is right with Canada. If that situation had ever occurred in any Canadian province, I do not believe our securities regulators would have wasted two minutes thinking about whether they ought to do anything, which in this case was, on the surface at least, patently abusive.

If we go to the American model in Canada and we give our fund boards, these directors, the authority to act, and the unit holders do not like it, can they then go to the securities commission to appeal the directors' decisions? If we allow that, we have introduced another level of supervision. On the other hand, we in Canada have adopted a regime of more activist securities regulation than in the United States, and no one -- and I include Commissioner Stromberg -- has said that that should be changed. I believe she likes and agrees with the current style of interventionist securities regulation to protect fund investors. And so we have a bit of a problem if we now establish boards, because in the United States they have devolved certain powers from the regulatory authority, the boards, and so the senior regulator is not interested any more in some of these issues. I do not believe that that fits with our history; I see problems with doing it.

If I may make one other observation -- and I would like to admit a certain embarrassment or lack of facility in these matters because they are ultimately political. The Province of Quebec, through its consultative committee that I mentioned earlier, has said that they do not like the notion of requiring independent fund boards. They want fund family boards, and they do not even think they must be independent. I ask myself what will happen if the Ontario commission goes ahead and adopts something like Commissioner Stromberg wants -- and Alberta and B.C. may also do the same. You can imagine what will happen. We have the scenario of a Quebec-based mutual fund that does not have these onerous rules in its own province wishing to get distribution across the country. If that fund comes to the Ontario commission asking be distributed, the securities commission must reply that the Quebec-based mutual fund does not meet governance requirements. The fund from Quebec, or its management company, will then ask for an exemption from the securities commission under the governance rules in order to get distribution in Ontario.

Under this scenario, the commissioners, in my submission, have an onerous burden. If they grant the exemption for the Quebec-based fund, all the other funds that have gone the route of complying will be, let us just say, very upset. There will be enormous screaming and complaining about how all the funds have gone to the expense, and it is a significant expense, of complying and then someone who does not comply gets an exemption.

On the other hand -- and this is difficult for me to speak about -- if they deny the exemption to a Quebec-based fund they will be taken in some quarters to simply have added to the list of things that some people keep about how the country does not work. Some people will say that this is once again an opportunity for the rest of Canada to tell us in Quebec how we should do things.

That is just an unbelievably difficult situation. I do not believe it should happen. I do no see any way around it if we go this route and, in the end, if I have not convinced anyone that on its own merits we should not go that route, I believe the politics of it are very clear. I would not wish to give people an opportunity, even in this relatively minor matter, to claim that this is a situation where the rest of Canada is doing things and ultimately imposing them on us.

The Chairman: Thank you very much, Mr. Schwartz.

The committee adjourned.