Explaining market timing cheques to clients

(September 23, 2005) Settlement cheques began arriving this week to compensate mutual fund unitholders who were adversely affected by market timing. Although it’s early, some advisors are already beginning to get phone calls from their clients, inquiring about this “found money”, where it came from, and how it might be taxed.

In June, the Ontario Securities Commission approved distribution plans put forward by AGF Funds, AIC, CI Mutual Funds, I.G. Investment Management and Franklin Templeton Investment Corp., after the companies settled with the OSC and agreed to distribute $205.6 million to investors who suffered harm from market timing activities in funds managed by the companies.

So far, advisors say clients are generally curious about the cheques and not all that concerned about details of the settlements.

“Most of the people who were concerned called when it first came out, when this was hitting front page news media,” says Tina Tehranchian, branch manager at Assante Capital Management in Richmond Hill. “I think most people now are aware of the regulatory sanctions and the settlements and everything. The letters that have been going out from mutual fund companies have been pretty good about explaining what the reimbursement is for.”

She says when the news first came out she spend a lot of time on the telephone with clients, explaining the situation and how market timing affected their holdings. “Maybe that’s part of the reason why now I’m hardly getting any calls. All they need to know now is the tax treatment.”

Under the distribution plan, CRA International Limited, the third party responsible for determining how to effectively divide the settlement amounts, identifies which investors were adversely affected by the increased costs and volatility generated by the market timing activity, to distribute settlement amounts “proportionate to the investor’s overall adverse effect in relation to the overall adverse effect of all other adversely impacted investors in all relevant funds.” The terms do not outline any formulas or ratios used in determining payouts.

If clients held units in a non registered account and the holding has since been sold or redeemed, the settlement payment counts as a capital gain in the 2005 tax year. If clients still hold the units, payments reduce their adjusted cost base (ACB), and the payment will be taxed when they ultimately redeem the investment. Alternatively, they can choose to receive the payment and claim it as a capital gain.

For registered plans, the payments are considered to be income for tax purposes. Income taxes are automatically withheld on any payments over $200.

“Cash the cheque, there’s no reason not to,” suggests Warren Baldwin of T.E. Financial Consultants in Toronto. “There are some tricky little bits of tax treatment on these things. Some of the income is taxable, some is not, it’s just an adjustment to a cost base. That’s pretty much it. And it’s not a huge amount of money anyway.”

Payment amounts so far seem to range between $3.06 and $538. “For most of them, it’s such a small amount, you can really only do a couple of things,” says Ryan Beebe, a partner at Caplan Beebe & Associates in Edmonton. First, he says pretend Christmas came early this year, pay the phone bill or buy half a tank of gas. On the other hand, clients can use the money and top up their RRSPs.

Even though the settlements include a letter of explanation from fund companies, several advisors discussing the issue in the Advisor.ca Town Hall, say they are working on drafting letters of their own to explain the situation, but have concerns that the payouts may cause clients to question the integrity of their mutual fund companies.

“I have not yet had [to speak with] anyone who is mad or disturbed by this,” says Beebe. “When they call, I’m explaining to them that it’s a negotiated settlement with five unfortunate companies who were picked by the OSC, because market timing is not illegal, and most companies were allowing it at the time, and rather than fight it in court they’ve just agreed to pay out the shareholders.”

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Tehranchian has another way to spin the conversation: “I remind them that it’s part of the more effective governance that is coming into effect. There were some holes in the system that were brought to attention in the last few years. As a result, there have been some settlements and we’re getting some money back at this point. The good news is none of these practices have been done at any of these firms since 2003. They’ve shaped up and cleaned up their governance practices. To me, that’s good news for investors. It’s more protection for them and it means that the securities commission has been doing its job.”

Unitholders who do not receive or cash their cheques within six months are still entitled to the payment, and may claim their settlement until June 1, 2008. According to the distribution plan, fund companies will make reasonable efforts to locate affected investors who are entitled to $200 or more if they do not cash their cheques or receive their electronic transfers in the first round of payments. After June 1, 2008, any amounts remaining in the trust account for settlement payments will be returned to their respective fund’s assets, the trust account will be closed and no further claims will be allowed.

What are you telling your clients about market timing cheques? Join the ongoing discussion in Advisor’s Town Hall. .

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com

(09/23/05)

Kate McCaffery