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Market-timing fines should go to investors, advocates say

Managers who allowed practice should compensate long-term unitholders

Any mutual fund managers who allowed market timers to scoop up quick profits by zipping in and out of their funds should compensate long-term unitholders for their losses, investor advocates say.

"If the short-term trading pros made a profit, the long-term mutual fund owners suffered an equivalent loss," said Diane Urquhart, an investor advocate who spent more than two decades on Bay Street as a research analyst.

Glorianne Stromberg, a former commissioner at the Ontario Securities Commission and author of a landmark report in the mid-1990s calling for sweeping reforms of the fund industry, said the money from any fines the regulators might impose should go to fund investors.

The OSC targeted four of the country's largest mutual fund companies this week for potential enforcement action over alleged market-timing violations in their funds and warned that more firms may be on the hook.

"I see this whole issue as raising questions about whether the fund manager has fulfilled his fiduciary obligation to the fund or is in breach of these obligations," Ms. Stromberg said. "If they're in breach of a fiduciary obligation, then the unitholders should be made whole."

The simplest way to do this, she said, would be to have the fund company pay the money directly to the fund.

OSC enforcement director Michael Watson said yesterday that would not be the best way to compensate any individual who lost money but was no longer an investor in the fund.

"We're not going to make an order that pays a pile of money into commission coffers," he said. "Our first priority would be to ensure that anybody who might have suffered losses would stand ahead of anybody who wasn't involved in the first place."

The regulator has given Investors Group Inc., CI Fund Management Inc., AGF Funds Inc. and AIC Ltd. 10 days to explain alleged abusive-trading violations in their funds.

The commission did not level specific allegations of wrongdoing against the companies and also said it had not uncovered any late trading, a practice that is clearly illegal.

Market timing involves the rapid, in-and-out trading in a fund by hedge funds and other market professionals. The pros typically favoured overseas funds.

The time zone differences often make prices of stocks in a fund out of date because of market events elsewhere.

The practice hurts ordinary investors in a fund because market timers dilute returns for all investors in the fund. By jumping in and out, the market timers deprive long-term investors of the full value of the increase in their securities.

The practice all but disappeared in Canada last September, after U.S. regulators launched a broad crackdown into abusive trading.

While market timing is not illegal, it violates procedures many fund firms have in place to treat all investors the same. Allowing a select few investors to reap profits by darting in and out of their funds was at the expense of long-term investors.

Market timing appears to have been prevalent in Canada. Rapid, in-and-out trading in mutual funds totalled more than $220-billion between 2000 and 2003, according to a Report on Business investigation published in June.

Investors would have no way of knowing whether market timers were in funds they own. That is why Ms. Stromberg said securities regulators should initiate any action to recover money for a fund's long-term holders. "They are responsible for overseeing the funds and protecting investors," she said.

A mutual fund investor who asked not to be named also said any fund company found to have allowed market timing in its funds should make restitution to investors hurt by the practice.

"What's a fine, or a promise not to do it again?" he asked. "If people don't get a cheque, they're going to be left feeling 'I got gouged.' "

© 2007 The Globe and Mail. All rights reserved.

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