Investors should not expect to see a U.S.-style pullback in fees or sweeping industry reform as a result of a regulator's investigation of market timing in mutual funds.
In fact, legal and industry sources expect the Ontario Securities Commission's probe of the trading practices of up to 20 fund companies may mean higher costs for unit holders and little more than minor tinkering with the current regulatory regime. While the U.S. mutual fund scandal has ushered in greater transparency and lower fees, the Canadian industry warns reform could mean higher fees -- and definitely more headaches and paperwork.
Last Tuesday, the OSC revealed that four firms -- CI Fund Management Inc., Investors Group Inc., AGF Funds Inc. and AIC Ltd. -- may face enforcement proceedings as part of an in-depth review of trading practices from 2000 through 2003. Regulators allege they found evidence of rapid, in-and-out trading in their funds, activity characteristic of market timing.
The trading scandal may prompt the OSC, along with the umbrella group Canadian Securities Administrators, to push through disclosure and governance guidelines currently under consideration or give new life to proposals that have languished for years.
"As a result of the recent allegations . . . there will be a push by the OSC to mandate compliance plans for mutual funds," said Stephen Erlichman, the lawyer at Fasken Martineau DuMoulin LLP in Toronto who wrote a landmark report on fund governance in 2000.
But critics are concerned regulators will embrace guidelines they say are flawed.
For example, in January, the CSA proposed mutual funds be required to set up independent review committees to monitor conflicts of interest. At the same time, fund managers would be free to enter into transactions that are now prohibited, despite the fact that their interests may conflict with those of investors. Fund companies argue the plan duplicates existing checks and balances and will drive up costs.
And the expense of a new committee -- along with other proposals in the works -- will ultimately be paid by the fund itself, said Glorianne Stromberg, a former OSC commissioner.
"The message is 'you have to pay to keep us honest.' . . . Well, darn it, I am already paying 2.7 per cent per year [in management fees] for you to exercise your discretion on my behalf," she said.
There is much agreement that the OSC, a regulator often criticized for its lack of teeth, is in need of a win. Eliot Spitzer, New York Attorney-General, has received accolades for his exposure of chronic corruption in the U.S. mutual fund industry.
That said, "this is not the U.S.," said Ned Goodman, the head of Dundee Wealth Management Inc. In remarks last week, the financier was deeply critical of the media's coverage of the market timing allegations, noting that market timing "losses on a per-unit basis would be minuscule."
Indeed, Canada's allegations to date pale in comparison to what has been revealed in the United States. Mr. Spitzer found late trading at a series of firms, an illegal practice that has been ruled out by the OSC at the four firms cited last week. In addition, the Attorney-General's team uncovered a series of deals directly implicating fund managers and senior executives in market timing activities at the expense of unit holders. Again, no smoking gun has surfaced in Canada.
Mr. Spitzer has introduced a laundry list of new regulatory requirements that has overwhelmed the U.S. sector, including fair valuing of securities, disclosure of voting practices and ensuring that fund boards have a majority of independent directors, including an independent chairman. At present, none of these proposals are regulatory requirements in Canada.
"It's one wave of rule making after another. The industry is really reeling," said Donald Crawshaw, a securities lawyer at New York's Sullivan & Cromwell. "It will ultimately result in some good but it's very painful."
About $3-billion (U.S.) in fines have been paid, funds that will be returned to unit holders. The sum includes fee reductions for investors that were negotiated by the Attorney-General's office.
Don't hold your breath for similar changes here in Canada. The annual fees Canadians pay for mutual funds -- an average of about 2.5 per cent of assets under management -- are already double the going rate in the United States. Canadian fees are steep because sales and distribution costs are higher; more than 90 per cent of Canadians buy funds from a financial planner or broker, while in the United States, the same ratio of investors buy directly from a fund company.
And despite less stringent rules that govern funds, regulatory costs for Canadian fund companies are higher than in the United States. This country has 13 regulatory bodies demanding paperwork and fees; in the United States, there is only the U.S. Securities and Exchange Commission.
"Confidence in a market sector is quite ephemeral in the sense that it is difficult to predict where it will go," said Philip Anisman, a Toronto securities lawyer and former law professor. "If mutual funds perform well, I think investors will continue to invest in them. If the trust is eroded, then they may look elsewhere for other investments."
Then again, there's no easier way to regain investor trust than to put up some good numbers. "It will always be a balance between performance and levels of trust. And a lack of trust increases risk. And there may be people willing to risk it," Mr. Anisman said.
© 2007 The Globe and Mail. All rights reserved.
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