Canada's largest income trusts may have the heft to play in the benchmark index majors, but when it comes to corporate governance practices they're still in the minor leagues.
Beginning in December, income trusts will be included in the S&P/TSX composite index for the first time. In anticipation of this change, this year Report on Business conducted a sample ranking of 15 of the country's biggest trusts as part of its annual Board Games study.
The results show that the trust sector still has plenty of work to do. The average score was 66 out of 100. Bonavista Energy scored below 50. (By comparison, in our primary survey of 209 companies in the S&P/TSX index, 194 scored 50 or higher.) Only one trust, Canadian Oil Sands, scored 80 or higher.
"I think that's deeply disturbing," said David Beatty, managing director of the Canadian Coalition for Good Governance. "They've just got to do better."
Income trusts have exploded in popularity over the past five years. What was a $22-billion market in 2000 is now worth more than $160-billion. Investors have been drawn to the trusts' cash distributions, which average about 9 per cent. Scores of companies have converted to the trust structure, in part because trusts pay little if any corporate tax.
"I don't believe governance has been an issue in the conversion process," Mr. Beatty said. "The underwriters and the people who are bringing them public aren't particularly interested. The law firms are following their mandates and the companies are focused on other things."
The chairman of the country's biggest trust, Canadian Oil Sands, believes they should strive for the same governance standards as corporations. "We really view ourselves as being governed by the same rules and procedures that any other board would," said Chuck Shultz, who recently completed a 12-day governance course at the Institute of Corporate Directors.
Canadian Oil Sands has made some bold governance moves over the past couple of years that helped it earn top spot. Among them was cancelling all director options.
"There was the perception that options were not right for directors," Mr. Shultz said. "So, we said we're not only going to quit issuing them, we're going to revoke the existing ones." He added that the trust's board is always looking for ways to improve.
Other trusts also expressed a desire to do better and a willingness to make changes.
"We truly do want to have the best governance we can bring to the table," said Mac Van Wielingen, chairman of ARC Energy Resources, which scored 68. "I can't see any significant reasons to justify a meaningful difference in corporate governance processes and structures between a corporate structure and a trust."
All of the trusts surveyed had a majority of independent directors. But fewer than half received full marks for a board that was more than two-thirds independent. Several trusts had committees that included former executives or related directors. Two trusts had no compensation committee. Two others had no nominating committee.
"We take the simple view that, whether they are set up as a trust or a company, it makes sense that they be governed the same way," said Brian Gibson, senior vice-president of the $88-billion Ontario Teachers Pension Plan.
There are, however, several governance issues unique to income trusts and these were taken into account in the Board Games marking scheme. Some trusts require investors to elect trustees who then hire directors to oversee the operating arm of the trust. This creates indirect lines of accountability. Of the 15 trusts surveyed, only Yellow Pages Income Fund and Fording Canadian Coal Trust had trustees and directors. In both cases, less than two-thirds of the trustees were found to be independent.
"[Income trusts] are very different creatures," said Mr. Beatty of the good governance coalition, "and very much understudied and underappreciated in terms of their governance risks."
Historically, the biggest governance issue for trusts has been the use of external management contracts. Under these arrangements, multimillion-dollar fees are often paid to executives outside the trust structure. Large break fees or change-of-control provisions can make switching management highly expensive, even when necessary.
Teachers feels such contracts can also serve as a disincentive to possible takeover bids. "Some of them are extremely onerous," Mr. Gibson said.
Of the 15 trusts surveyed, three still used external management contracts.
The use of outside management has declined dramatically in recent years, according to income trust analysts. They say institutional shareholders are having more influence on trust boards.
"The big players were instrumental in getting rid of the external management contracts," said Gordon Tait of BMO Nesbitt Burns.
"The sector has grown up," said CIBC World Markets analyst Alice Sun Dunning. "It's really a bit of a chicken and egg thing. Did the institutions instigate the corporate governance or did the corporate governance attract institutions?"
Retail investors are the majority investors in most trusts. Board Games found trusts lacking in several shareholder rights categories. For example, only Fording allows unitholders to vote for individual directors. The rest used slate voting.
"Inasmuch as I advocate the highest levels of corporate governance, I don't feel comfortable with putting people up as individuals," said Mr. Van Wielingen of ARC Energy. He feels finding suitable directors is challenging enough without electing them individually, "as if they're politicians seeking support."
Trusts fared no better than corporations when it comes to board diversity. In fact, they did worse. Just one-third of the trusts had a woman on the board. None had more than one female director.
Some trusts argue it's difficult to find women with expertise specific to a trust's business.
But at Canadian Oil Sands, where former chairwoman of the Alberta Audit Committee, Susan Evans, is on the board, Mr. Shultz says members needn't all be experts in oil and gas.
"If they can help us with the evaluation of the management team, if they're a good judge of horseflesh, there's plenty of women out there that can add to the board," he said.
If a sample of 15 of the biggest trusts produced such mediocre results, then Mr. Beatty is concerned smaller trusts will fare far worse.
"I do think there's a real opportunity for some of the bigger and more responsible income trusts to come forward and start promoting their own governance as a means of differentiating themselves from the pack."
He hopes the increased scrutiny that comes under the spotlight of index inclusion will force trusts to clean up their act. "A street lamp is the best policeman."
TRUST CHALLENGES
Income Trusts are a different animal than the average company and this can make the governance hurdles even higher.
Some trusts have both trustees and directors, adding an extra layer between unitholders and management.
Some trusts use external management contracts. The fat fees that often come with these deals make board oversight of executives very difficult.
Almost no trusts allow unitholders to vote for individual directors.
Several trusts have committees stacked with former management or related directors.
Very few trusts fully explain executive compensation.
No trusts have more than one female director.
REPORT ON BUSINESS CORPORATE GOVERNANCE RANKINGS
As part of the regular Board Games governance rankings, this year ROB took a look at the country's top trusts. They will be joining the S&P/TSX index in December, and so will be included in the survey next year.
1. Board composition
2. Compensation
3. Shareholder rights
4. Disclosure
5. Total
6. 5-year total return (%) To Oct. 14, 2005
| 1 | 2 | 3 | 4 | 5 | 6 | |
| Canadian Oil Sands | 33 | 16 | 22 | 9 | 80 | 257.8 |
| Fording Canadian Coal | 25 | 16 | 24 | 13 | 78 | n/a |
| Enerplus Resources | 37 | 15 | 20 | 6 | 78 | 140.1 |
| RioCan REIT | 31 | 12 | 20 | 11 | 74 | 123.8 |
| Petrofund Energy | 32 | 11 | 20 | 7 | 70 | 18.7 |
| PrimeWest Energy | 27 | 14 | 18 | 10 | 69 | - 1.0 |
| Superior Plus | 31 | 7 | 20 | 10 | 68 | 72.1 |
| ARC Energy | 22 | 16 | 22 | 8 | 68 | 93.9 |
| Provident Energy | 34 | 9 | 18 | 6 | 67 | 128.3 |
| Yellow Pages | 23 | 10 | 20 | 12 | 65 | n/a |
| Energy Savings | 26 | 11 | 18 | 7 | 62 | n/a |
| H&R REIT | 29 | 9 | 18 | 6 | 62 | 67.6 |
| Peyto Energy | 25 | 8 | 16 | 5 | 54 | 2,714.40 |
| Pengrowth Energy | 22 | 9 | 16 | 6 | 53 | - 2.8 |
| Bonavista Energy | 14 | 10 | 18 | 5 | 47 | n/a |
SOURCE: GLOBEFUND.COM
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