Fundcos to refund millions to investors

(December 16, 2004) The four mutual fund companies at the centre of a regulatory investigation into market timing have agreed to a settlement totaling $156.5 million.

AGF Funds, AIC, CI Mutual Funds, and I.G. Investment Management agreed to penalties and investor restitution as the Ontario Securities Commission announced it had concluded its year-long investigation into the fund industry.

“Every penny of the $156.5 million will go to the people who were negatively affected by the frequent trading market timing,” said Michael Watson, OSC director of enforcement. “The fund managers will pay for the distribution of the funds to unitholders under the supervision of an independent consultant, under a plan that will need to be approved by the chair and a vice-chair of the OSC.

“As well, the fund managers will ensure that the investors who were responsible for the frequent trading market timing do not receive any of these funds.”

The settlement comes after the OSC found certain funds had been used by institutional investors in the execution of a market timing strategy between 1998 and 2003.

The investigation found that six investors had profited $47.9 million using the strategy in AGF funds, resulting in fees totaling $2.1 million accruing to the firm. AGF faces a penalty of $29.2 million.

At AIC, three investors made $127 million in profits, with the fund company earning about $3.1 million. AIC had levied frequent trading penalties totaling $0.5 million against these traders over the period in question. AIC will pay $58.8 million in restitution.

CI funds were used by five investors, which profited $90.2 million and the firm charged $9.4 million in trading penalties. CI earned $7.9 million and now faces a $49.3 million penalty.

At I.G., market timing investors made a profit of $36 million and were never charged frequent trading fees. Investors Group earned $4.2 million through these accounts, but must now repay $19.2 million.

The settlement with I.G. Investment Management required approval from the Manitoba Securities Commission as well, since the firm is located in Winnipeg.

“We have strict and effective measures in place to remove the risk of market timing trading,” stated Murray Taylor, president and CEO of Investors Group. “Our clients can be confident that their investments will not be adversely affected by this type of activity.”

The settlement was agreed to by a three-member panel of the OSC, chaired by Paul Moore. In delivering the panel’s reasons for accepting the settlement, Moore emphasized that the payments the fund companies face were “neither remedial nor punitive” but were meant to serve as a deterrent to other firms that may allow abusive trading practices.

Moore also said the settlement was an example of principle-based regulations, since there was no rule against the trading practices. But allowing the trades to occur was contrary to the principles of mutual fund investing, since it was to the detriment of long-term investors.

“We hope the OSC will introduce some form of guidance on what it considers to be inappropriate activity,” said Ralf Hensel, senior counsel for IFIC. “We’d like to know what steps a manager could take to fully protect the best interests of its funds and therefore be in line with the public interest.”

“The allegations are that they took certain measures to protect but not sufficient measures to negate the harm that resulted from market timing activities.”

Under Ontario securities law, a mutual fund manager’s duty to unitholders is defined as taking “reasonable steps to protect a mutual fund from such harm to the extent that a reasonably prudent person would have done in the circumstances.”

Hensel argues that since two of the firms did charge the frequent trading penalties that were laid out in their prospectuses, they did act in a reasonably prudent manner in the circumstances. Hensel says much of the activity in question occurred between 1998 and 2000, which is before the harmful effects were realized, in 2001.

“Would reasonably prudent people have understood enough about market timing to know that there was this concept of dilution?” he asks. “My submission would be, no, they probably would not. I’m not sure you could have been more reasonably at that time. One of the risks to this is they are applying 2004 intelligence and knowledge to activity that dates back to 1998.”

While the investigation is now closed, the OSC is yet to reach a settlement with Franklin Templeton Investments, the last remaining case in the probe.

“We have concluded our investigations into possible late trading and market timing activities in mutual funds authorized for sale in Ontario,” said OSC Chair David Brown. “Letters have been sent to all other fund managers confirming that the OSC is not contemplating proceedings against them.

“Investors can now be confident that our year-long probe has uncovered the frequent trading market timing that has taken place and that the activity has been stopped.”

At a separate hearing also held on Thursday, the MFDA settled a market timing disciplinary action — which included a $2.65 million fine and an additional $2.65 million to compensate investors — with Investors Group Financial Services. It was the first-ever settlement of its kind for the mutual fund dealers’ self-regulatory organization.

As part of the agreement, Investors Group acknowledged that between October 2000 and November 2002, it allowed a client to engage in frequent trading market timing of certain of its funds. The arrangement allowed the client to realize significantly higher returns than could have been obtained by long-term investors in those same funds.

In addition to $5.3 million in fines and restitution, the fund company will pay the MFDA $50,000 to cover the costs of the disciplinary investigation and proceedings. It also has agreed to report to the MFDA board within six months on its compliance status with MFDA by-laws. The text of the settlement agreement notes that between May 2003 and July 2004, Investors Group implemented additional procedures to prevent and detect market timing activities and that those policies have been effective.

MFDA disciplinary panel chair Thomas Lockwood said the settlement agreement was broad enough to prevent the conduct from taking place in the future.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com,with additional reporting by Advisor’s Edge associate editor Philip Porado.

(12/16/04)

Steven Lamb