Four big mutual-fund companies have agreed to pay about $200-million in restitution for questionable trading practices in what will be an unprecedented settlement with securities regulators, sources say.
The proposed agreement, which is close to being completed, will affect hundreds of thousands of ordinary investors, though talks are continuing about whether the money will be paid directly to them or into the funds themselves.
"One of our primary interests in this process surrounds investor-protection issues," said Michael Watson, head of enforcement at the Ontario Securities Commission.
He would not comment on the settlement talks, but said he hopes to reach a resolution with the companies "sooner rather than later."
This is by no means the first time a company in Canada has agreed to make restitution to investors, but there has never been a settlement of this magnitude before.
"This is going to be a startling number," said an industry executive familiar with the negotiations. "I would say [the regulator] is being an incredibly strong advocate for small investors."
The four companies -- Investors Group Inc., CI Fund Management Inc., AGF Management Ltd. and AIC Ltd. -- collectively manage $116-billion in assets, ranking them among the largest players in the $473-billion industry.
The companies have been in talks with the OSC for the past few weeks aimed at reaching a group settlement. In September, the regulator targeted the four companies for possible enforcement action as part of a long-awaited crackdown on the mutual-fund industry.
At issue is a controversial practice known as market timing. It involves rapid in-and-out trading in a mutual fund by hedge-fund officials and other sophisticated market professionals who generally take advantage of time-zone differences in international funds, where events after overseas markets close often make stock prices in the funds out of date.
A Globe and Mail investigation published in June found that market pros were given free rein to zip in and out of some of Canada's biggest funds.
They carefully timed their trades and scooped up hundreds of millions of dollars in quick profits by playing off the difference in prices between the time zones.
Market timing is unfair to long-term investors because it is their money that has generated the profits in a given fund. When market timers jump in and out, they reap a chunk of the profits that would otherwise be in a fund, reducing the value of the pool that would be held by all investors.
The Globe and Mail probe found that rapid in-and-out trading in mutual funds totalled more than $220-billion from 2000 to 2003.
Sixteen fund companies had telltale signs of market timing in their international funds, The Globe found. The four companies targeted by the OSC had more funds with such signs than any other firms on the list.
Industry sources said yesterday that OSC staff calculated that market timers made profits ranging from $250-million to $300-million in international funds managed by the four companies.
Officials at all four companies declined to comment.
Industry sources said the companies have reached an accord with the regulator on many issues, including the amount of restitution to be paid. "We're very close on everything," one said.
It's not yet clear whether restitution would go to investors in the funds at the time or whether it would be pumped back into the funds themselves.
It would be extremely difficult and time-consuming to track down all individual investors in the various funds. Paying money back into the funds would boost the value of each unit in a fund. But that would not necessarily be as fair because it would deprive any investor no longer in a fund of any restitution while benefiting current investors who may not have held a fund at the time.
It is not known publicly which specific funds are involved.
A bigger impact may be yet to come. In the United States, where regulators have reached settlements totalling nearly $3-billion (U.S.), investors have severely punished those companies caught up in the multiple probes by pulling tens of billions of dollars out of their funds.
Industry sources said the companies and the regulator are negotiating over the exact wording of the settlement, which must be approved by a panel of OSC commissioners at a hearing.
While market timing is not illegal, a fund manager can violate his or her duties to long-term investors by allowing market timers to jump in and out.
The OSC's position is that while the fund managers may argue that they did not know how much money the market timers were making in their funds, they probably owed investors a higher standard of care, a source said.
The regulatory probe into alleged market-timing violations has broadened to include three of the bank-owned firms, as well as Investors Group's in-house sales arm, the sources said.
The OSC's enforcement arm is working together with the Investment Dealers Association of Canada and the Mutual Fund Dealers Association of Canada to publish allegations against the four fund companies, as well as the brokers and dealers, by month's end, the sources said.
Mr. Watson and Alex Popovic, vice-president of enforcement at the IDA, confirmed that the three organizations plan to release their allegations on the same day. In the case of the fund companies, a settlement hearing is expected to follow within a week of the formal allegations.
Industry sources said the IDA has not determined whether to launch enforcement action against the brokers or the firms. Mr. Popovic would not comment.
"I can't speak to that at all," he said.
© 2007 The Globe and Mail. All rights reserved.
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.