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One-third of Canada's largest income trusts do significant side deals with insiders while more than 20 per cent are operated by outsiders under a management contract, a Report on Business review of trust governance has found.
As part of its annual survey of corporate governance in Canada, ROB this year conducted an extensive review of the country's largest income trusts — those trusts recently included in the benchmark S&P/TSX index.
While many large income trusts are making changes that reflect their evolution into mature business giants, ROB found that governance practices are all over the map, with a sizable proportion of trusts still operating in outdated ways rarely seen among large companies in the corporate sector.
For example, 22 per cent of the country's largest trusts continue to be managed under external contracts, which means they do not have in-house management teams who report directly to the board. A further 7 per cent have a combination of internal management and an external management contract.
One-third of trusts did related-party transactions last year valued at more than 1 per cent of the trust's total revenue, opening the door for potential conflicts of interest.
And ROB also found that while trusts don't have dual-class shares like some corporations, that doesn't mean there aren't democratic gaps. Twenty per cent of trusts have at least one director who is unelected while 16 per cent grant voting rights to unitholders or managers that are significantly out of proportion to their ownership stakes.
"There are basically no rules," says Brian Gibson, vice-president of public equities at the powerful Ontario Teachers Pension Plan. "It's like the Wild West."
Investors have flocked to trusts in recent years, praising the steady cash payouts and the disciplined approach to investing capital.
With the recent plans by blue-chip giants such as Telus Corp. and BCE Inc. to join the trust sector, it is fast approaching the $250-billion mark in value.
But that doesn't mean income trust structures have matured at the same rapid pace. And investors are especially concerned that if any problems emerge as a result, they have few legal protections to fall back on.
Corporations are governed by the Canada Business Corporations Act (CBCA) and parallel provincial corporations acts. They outline key obligations of companies and rights of shareholders — such things as the obligation to hold an annual meeting and the right of shareholders to band together to call a special meeting or submit proposals for a vote.
The CBCA also gives shareholders the right to launch a legal challenge whenever they feel their rights have been oppressed by a company.
Because they are not corporations, trusts are not covered by any of this legislation.
In the absence of government-imposed rules, unitholders are left to settle for whatever rights are granted to them when a trust is created. At their inception, all trusts create declarations setting out the rights of investors. But there are no requirements about what has to be included in this document and the rights vary widely.
"The average investor doesn't appreciate that their legal rights are quite different when they invest in a trust, and they may not even have legal rights," Mr. Gibson said.
David Beatty, head of the Canadian Coalition for Good Governance (CCGG), a group of large shareholders, believes Canada has created an industry "with absolutely no regulatory guidelines or oversight. ...
"I really find it astonishing that in an age where corporate governance has received such focus, that a whole major class of assets, widely invested in by ordinary Canadians, has not found an interest in any regulatory agency across the country. It's quite an astounding gap."
Defenders of the industry say the lack of regulation is no reason for investors to dash for the exits. Most trusts do provide some unitholder protection in their trust documents, and just because they are not standardized is no reason for investors to lose sleep, they argue.
"The differences between trust declarations and corporate law are not particularly significant," says Toronto lawyer Stephen Pincus, who heads the governance committee of the Canadian Association of Income Funds, an industry group. "This has become a very important structure for the capital markets and it is so widely used. It would be inaccurate to say that there is some gaping hole."
Teachers and the CCGG have embarked on a quiet campaign to persuade trusts to add a full list of investor protection features to their governing documents. Earlier this year, Teachers and partner Sherritt International Corp. spun off coal producer Royal Utilities Income Fund and tried to include all the rights granted to corporate investors in its declaration of trust.
Mr. Gibson says he wants to position the document as an example of a model trust declaration that others can copy.
