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Keep a closer watch on the mutual funds

An Ontario Securities Commission probe of Canada's mutual fund industry has turned up alleged trading improprieties at four of the largest companies, all involving the controversial practice of market timing. And regulators say they could target as many as 20 other companies in their search for evidence of similar activities. The crackdown on market timing is long overdue -- so long, in fact, that both the industry and the OSC describe it as yesterday's problem.

That will be cold comfort for ordinary investors who unwittingly lost money, or overpaid for their funds, because of a practice they did not even know was occurring. Yet with proper monitoring of trading activity, it would have been remarkably easy to spot and eliminate.

Market timing involves the rapid-fire in-and-out trading of mutual fund shares to take advantage of discrepancies between a fund's daily share price and the value of its underlying stocks. This can occur, for example, when events happening after overseas markets close make stock prices in international funds out of date. It is not illegal; but it is unfair, because a handful of hedge funds and other sophisticated traders can profit at the expense of most fund shareholders, who tend to be long-term investors.

It is also a clear breach of the fund manager's duty to protect the interests of all investors. Market timing depletes returns for all shareholders. Worse, investors have had no way of knowing whether it was happening in their funds, because the detailed monthly trading data providing such crucial information as sales, redemptions and transfers in and out of funds are not easily available to the public.

A Globe and Mail investigation in June found that a select group of hedge fund managers and other market professionals siphoned off hundreds of millions of dollars of value from Canadian mutual funds over a four-year period. The activities of a small number of traders boosted fund costs and diluted returns for the vast majority of Canadians who seek out mutual funds as a fairly conservative way to build retirement nest eggs.

Many reputable firms have actively discouraged market timing for years. And it virtually disappeared after Eliot Spitzer, New York State's crusading Attorney-General, triggered an assault last year on questionable, and sometimes illegal, practices of major U.S. mutual fund companies. Faced with a barrage of state and federal investigations, firms have so far paid nearly $3-billion (U.S.) in penalties and are making restitution to investors harmed by market timing and other abuses. The fund companies have also agreed to reduce fees, improve oversight and reform their governance practices. The scandal has sparked tougher regulation of the entire U.S. industry.

It also prompted the OSC to take a close look at Canadian practices. The four Canadian companies -- Investors Group Inc., CI Fund Management Inc., AGF Funds Inc. and AIC Ltd. -- have been asked to explain the alleged market-timing violations, but the securities watchdog has not yet indicated what action, if any, it will pursue.

Regardless of what else the OSC probe uncovers, it is plain that the Canadian mutual fund industry needs tighter oversight, stronger governance and better disclosure. It would also help if the Investment Funds Institute of Canada, the industry's lobby group, dropped its $1,000 fee for a year's worth of fund data and restored its former practice of making detailed monthly statistics readily available to the investing public.

© 2007 The Globe and Mail. All rights reserved.

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