Fund probe zeroes in on four firms

(September 21, 2004) The Ontario Securities Commission (OSC) has warned four mutual fund companies that they could face enforcement proceedings as a result of the regulator’s ongoing probe into trading practices in the fund industry.

Notice was served to the four companies after the market closed on Monday. In a release issued Tuesday morning, the commission declined to name the fund companies, but did say it expected the firms would step forward under their continuous disclosure obligations.

Four firms issued statements today, admitting they had been contacted by the OSC. AGF, CI, Investors Group and AIC all said the regulatory notices concerned frequent trading activity between 1999 and 2003. Combined, the four fund companies manage around $116 billion, according to IFIC data, representing about 25% of Canada’s total fund industry assets.

The OSC had been examining seven fund companies in the latest round of the probe, with these firms representing 40% of Canadian mutual fund assets. The commission says a number of other fund firms are also under review, representing an additional 40% of industry assets.

Not surprisingly, the four companies are pledging their full co-operation with the investigation and say they have corrected the deficiencies that allowed the questionable practices in the first place, which mostly related to market timing and frequent trading.

“The OSC has stated the results to date have found no indication of late trading and that the industry, including AGF, now has in place effective measures to prohibit the practice of market timing,” read a press release from AGF. Similar comments were made by the other firms.

“As we near the end of our investigation into the four fund managers, we are following our routine practice of providing them an opportunity to respond to our concerns and with any reasons why we should not initiate proceedings against them,” said Michael Watson, enforcement director of the OSC.

However, it’s unclear just what kind of enforcement action the fund companies could face. Market timing is not illegal, although it may contravene a fund manager’s fiduciary duty to investors, but it is considered unethical, as the tactic can drive up a fund’s costs, which are ultimately shouldered by investors. In addition, OSC chair David Brown noted that there has been no ongoing market timing activity since the OSC began its inquiry last year and the commission has seen “no evidence of continuing harm.”

Fund industry analyst Dan Hallett says he’s not surprised by today’s announcement. “I have long said that market timing was in Canada and that many companies began taking measures to limit it before the Spitzer probe,” he says. “Past press releases from some fund companies confirms this as they disclosed the existence of institutional investors to explain large one-month redemptions.”

“In my mind, the question will be how prevalent market timing has been — as a percentage of assets in the involved funds — and the extent to which special arrangements were made to accommodate big trades by institutions,” adds Hallett. “The latter, to the extent that it existed, will be damaging to the industry.”

“Market timing seems to be a smaller issue,” said Bill Holland, president and CEO of CI Fund Management. “In our response they talked about frequent trading. It’s an interesting approach but market timing seems to be relatively subdued and there’s no late-trading.”

The OSC emphasizes that it has uncovered no evidence of late trading in Canada. Few expected to find such evidence, since the Canadian mutual fund industry is kept on-side in this respect through FundServ, which processes the bulk of fund trades in the country based on end-of-day pricing.

The OSC investigation into the fund industry began last November in the wake of scandals south of the border, where a number of major companies were fined over late trading and market timing abuses.

The commission sent letters to 105 Ontario-based fund companies, asking if they had policies and procedures in place to detect and prevent trading abuses. In February, the commission moved on to phase two of the investigation, asking 31 fund firms for extensive trading data, and followed up with phase three: on-site reviews at selected companies.

The MFDA and IDA are working with the OSC on the fund probe, and the OSC says both those organizations are currently undertaking their own investigations, which are nearing completion.

Related News Stories

IFIC releases guidelines on fund trading Brown: Fund issues not systemic

Last month, IFIC released a series of recommendations to its mutual fund industry members aimed at addressing potentially abusive trading practices, including market timing.

At the very minimum, fund companies should adopt “effective and consistent monitoring of trades” on a daily basis to detect abusive trading practices, said IFIC president Tom Hockin.

In addition, IFIC suggested that member firms adopt at least one of three tools to address abusive trading if and when it is detected: mandatory deterrence fees for inappropriate short-term trading, fair value pricing, and restricting future purchases in client accounts where market timing or inappropriate short-term trading is identified.

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What do you think about the OSC’s fund investigation? Will it result in any substantial changes to fund industry practices? Share your thoughts about this topic in the Talvest Town Hall on Advisor.ca.

Filed by Steven Lamb and Doug Watt, Advisor.ca

(09/21/04)