In his testimony before the Committee, Jeffrey MacIntosh identified three legal restraints, that he asserts, inhibit institutional investors from being as active as they might otherwise be in corporate governance issues.
One of these restraints is the absence of a confidential voting system for shareholders. Professor MacIntosh maintains that conflicts of interest prevent many institutions from being active in governance matters. He suggested that insurance companies, for example, have virtually no involvement because of their fear of getting on the "wrong side of people who are either current clients or potential clients, corporations for whom the company might be writing insurance policies or might wish to write insurance policies."(135)
Proponents of confidential voting argue that open balloting creates the opportunity for coercion by revealing the voting behaviour of shareholders to management. The OTPPB argues that proxy voting should be subject to the same safeguards as voting in any other elections and free of any potential for coercion. (136)
Opponents of confidential voting, on the other hand, argue that corporate elections do not have to be conducted in the same manner as political elections and that most companies do not engage in coercion or resolicitation. They claim that a secret ballot makes it more difficult to get the necessary votes to conduct company business. (137)
The Committee notes that both OMERS and the OTPPB support the introduction of confidential shareholder voting. It is the Committees view that confidential voting may well have the potential to increase the level of shareholder activity in corporate governance issues. In fact, Imasco told the Committee that it views its own system of confidential voting as an important part of its shareholder relations program. The Committee further notes that confidential voting would likely benefit all shareholders and not just institutional investors.
The Committee recommends that the federal government examine the issue of confidential proxy voting in respect of corporations incorporated under the Canada Business Corporations Act.
Professor MacIntosh also suggested that legal restraints on communications amongst shareholders act as an impediment to institutional investor activism. The Committee dealt with this issue in its August 1996 report on corporate governance in the context of amendments to the Canada Business Corporations Act (CBCA). (138)
The report, entitled, Corporate Governance, noted that informal discussions or personal letters criticizing management could be deemed to be solicitation under section 147 of the CBCA, thereby requiring the preparation and sending of proxy materials to all shareholders. Violations of section 147 carry a fine as well as a term of imprisonment.
Witnesses who discussed this issue before the Committee, during its 1996 hearings on the corporate governance provisions of the CBCA, solidly favoured changes to the proxy rules in order to enhance shareholder communication. At that time, the OTPPB gave a detailed presentation on the proxy solicitation rules, arguing that changes to allow for continued, informal communication amongst shareholders would foster a higher quality of corporate governance and enable better communication among institutional investors.
The Committee also notes that, in 1992, the U.S. Securities and Exchange Commission amended its rules to foster more open communications amongst shareholders
In its August 1996 report, Corporate Governance, the Committee supported proposals to promote more open and meaningful shareholder communication. At that time, the Committee recommended that the Canada Business Corporations Act be amended to encourage and facilitate such communication(139). The Committee reaffirms its recommendation on this issue.
The third legal constraint mentioned by Professor MacIntosh was the take-over bid threshold, which under the CBCA is now 10%. The take-over bid provisions are designed to protect the rights and interests of the parties involved the offeror, shareholders and the target corporation. The current take-over bid provisions of the CBCA apply if an offeror bids for shares of a target corporation that would give it control or ownership of more than 10% of any class of shares of the corporation. The take-over bid provisions of provincial securities statutes have a 20% threshold. Evidence presented in the Committees 1996 hearings, and at this set of hearings, strongly suggested that the federal and provincial thresholds be harmonized at 20%.
In its August 1996 report, Corporate Governance, the Committee recommended that the CBCA take-over bid threshold be raised from 10% to 20%(140). The Committee reaffirms this recommendation.
Another potential constraint on shareholder activism is the difficulty in identifying a corporations shareholders which stems from the modern share trading system in which shares are held by nominees, including securities depositories. With modern technology, many shareholders no longer receive share certificates; their ownership is recorded electronically. Most securities are held on deposit with clearing agencies for intermediaries. Ownership changes are made through book-entry transfers in the appropriate account rather than through actual changes in the shareholders register of a corporation.
The Committee was told that the Canadian Securities Administrators recently published a reformulation of NP 41, National Instrument 54-101, which includes procedures to permit reporting issuers to obtain a list of the beneficial owners of their shares who do not object to disclosure of their names. The Canadian Council of Financial Analysts, Inc. (CCFA) suggested that Industry Canada adopt a similar system for use by distributing corporations under the CBCA, and also provide a blanket exemption for issuers who are required to comply with NI 54-101. The CCFA suggested that such a system could help to create a more "level playing field" for persons wishing to put their views before shareholders.(141)
In its August 1996 report, Corporate Governance, the Committee recommended that the CBCA be amended to require registrants to furnish corporations with a list of all beneficial shareholders, unless such shareholders specifically request that their names not be given(142). The Committee reaffirms this recommendation because it believes that this would go some way toward rectifying the present difficulties in identifying the beneficial owners of shares.
The foreign property rule (FPR), which limits to 20% the foreign component held in RRSPs and pension plans of Canadians, has a significant impact on Canadian pension funds.
In its August 1996 report, Corporate Governance, the Committee recommended that the federal government undertake a study of the FPR on Canadian capital markets with a view to phasing it out in the near term. (143)None of the witnesses who addressed the FPR issues during this round of hearings favoured the retention of the FPR.
The Investment Funds Institute of Canada (IFIC), which represents 99% of mutual fund managers, supports an increase in the FPR limit to at least 30%, to be phased in through annual increments of 2%(144). IFIC told the Committee that the preliminary results of a Conference Board study it had commissioned on the impact of an increase to 30% suggest that it would have a neutral impact on the capital markets and the economy generally(145). Furthermore, an Ernst & Young study commissioned by IFIC demonstrates that an increase in the limit would provide investors with more opportunity to diversify their investments and earn higher returns. Indeed, the study notes that a 30% foreign content over the last 25 years would have allowed Canadian investors to earn up to 1.6% more per year on their retirement income portfolios.(146)
IFIC also maintained that a higher FPR would mitigate some of the concerns associated with institutional investors having major holdings in Canadian companies. Lessening the influence of institutional investors and improving market liquidity would be two notable benefits of an increased FPR limit.
Assets under management have grown more than 50% in the past twelve months alone. We estimate that 7 million Canadian households own at least one mutual fund.
A great deal of these funds is being invested by, or on behalf of, Canadians for retirement. When you consider the magnitude of these flows, and the fact that 80% of the funds invested for retirement must be invested in Canada owing to the FPR, you can clearly see that institutional investors often have no choice but to take larger positions in individual companies than they would otherwise.
The FPR often forces individual Canadian equity mutual funds to become bigger players in a small market than they would prefer.
The implication of this is that it is making institutional investors very powerful. It is also reducing liquidity in the market because it is difficult to sell larger blocks of shares.(147)
Finally, IFIC contended that increasing the FPR limit would reduce market inefficiency and keep Canada in step with the global trend toward market liberalization.
The FPR has prompted Canadians to use derivative products to reap the benefits of greater diversification in foreign markets, while staying under the 20% foreign investment threshold. As derivatives must be rolled over at considerable cost over the long term, it would be much more efficient to give investors the choice to invest in foreign markets directly. Indeed, an increase in the FPR would be consistent with the direction Canada has traditionally taken towards liberalising capital markets through eliminating capital controls. (148)
Representatives from PIAC also opposed the 20% limit.
In looking at the foreign property rule, it is a limitation on proper risk management because you cannot diversify adequately. We know that this is costly because we have done studies which indicate that it cost pension funds approximately $4 billion to arbitrarily include this limit in the past.(149)
Mr. Keith Ambachtsheer felt that removal of the 20% limit would have no observable consequences on currency changes. He pointed out that in economies where there are no restrictions, such as the United Kingdom, foreign content seems to level off at approximately the 30% level.
It is not like the natural position will be 2 per cent Canadian, 98 per cent outside. We believe the natural resting point and we have checked this with pension funds would be about 70 per cent domestic and 30 per cent external. (150)
OMERS believes that a 30% to 35% limit would allow for the appropriate level of portfolio diversification. OMERS argued that limiting the ownership level to 20% hampers job creation in Canada.
There has always been an interest in companies buying other companies, particularly transborder between Canada and the United States. Under the free trade agreement, American companies are freely able to invest in Canadian companies and, because of the relative levels of markets, American shares are currently trading at a higher level than Canadian shares, creating a purchase advantage. That happens to create an interesting anomaly for all major pension funds, and that is, the market for Canadian securities can actually shrink. This has a job impact and quite the reverse of what one might expect.
Everyone will recognize that if a Canadian company is bought by an American company, chances are that the next plant will not be constructed in Nova Scotia, New Brunswick or Ontario, it will probably be constructed in Ohio. However, if a Canadian buys an American company, chances are that plant will be built here. Restricting the ownership level to 20 per cent can "de-create" jobs in Canada. We can actually create employment in allowing a freer flow of capital.(151)
Mr. Claude Lamoureux, of the OTPPB, pointed out that the 20% limit is not a big handicap for large funds because they can circumvent the rule by using derivatives.(152). Small funds, however, do not have the size or the ability to use such tools and are forced to stay under 20%. He would like to see the foreign property limit climb to 30% to level the playing field between large and small investors. (153)
The Chairman of Sceptre Investments felt that the FPR has cost Canadians in two ways: first, it has reduced retirement savings and second, it has hindered the development of a community of international investing expertise in Canada. He recommended that the 20% limit be increased to 30% in 2% annual increments, after which, the limit could be removed altogether.(154)
The Committee wishes to restate the position it took on the FPR in its 1996 report: the rule should be phased out.
The government should begin the process of phasing out the Foreign Property Rule in the near term by increasing the 20% limit to 30%, through annual increments of 2%.