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Fund firms admit role in market timing trades

Four companies to pay $156.5-million back to investors as part of OSC pact

Four of Canada's largest mutual fund companies have acknowledged that they routinely gave preferential treatment to a handful of sophisticated market professionals at the expense of their long-term investors.

The landmark settlements with securities regulators yesterday say the companies failed in their duty to protect the best interests of their funds by allowing market pros to zip in and out, thereby pocketing hundreds of millions of dollars in quick profits. The rapid, in-and-out trading inflicted significant harm on the funds by reducing returns for long-term investors, the settlements say.

In all, 15 unidentified market pros made profits totalling $300-million over a five-year period in funds managed by the four companies. The settlement specified that not all those profits came from rapid trading, commonly referred to as market timing.

The four fund companies -- a unit of Investors Group Inc., CI Mutual Funds Inc., AGF Funds Inc. and AIC Ltd. -- have agreed to pay $156.5-million in restitution to investors hurt by the market-timing activities as part of the settlements reached yesterday with the Ontario Securities Commission.

"Given its magnitude, the settlement payments will serve as a reminder for mutual fund managers of their obligation to protect the best interest of their funds through vigilant monitoring and supervision of the activities taking place within those funds," Paul Moore, vice-chairman of the OSC, said yesterday at a hearing in Toronto.

Separately, three bank-owned brokerages and the mutual fund dealer arm of Investors Group were fined a total of $46.5-million, bringing the total to $203-million that will be available to compensate investors.

Every penny will go to the investors who were negatively affected by the frequent trading, OSC enforcement director Michael Watson told reporters following the hearing. It will be up to the fund companies to retain independent consultants to determine who receives compensation, a time-consuming process that will involve sorting out which current and former investors were harmed by the market timing.

Mr. Watson said he expects the companies to have a system of distribution in place well before the end of next year.

The commission says a mutual fund manager has a duty to act honestly, in good faith and in the best interests of a fund. In carrying out that duty, a manager must take steps to protect a fund from potential harm from market timers, the commission asserts.

By agreeing to settle with the regulator, the companies avoided a contested hearing with even worse public relations fallout and potentially more severe penalties.

All four companies admit that their failure to fully protect the best interests of the funds was contrary to the public interest. And all have since adopted procedures to prevent and detect market timing in their funds, the settlements say.

In approving the settlements yesterday, Mr. Moore acknowledged that there are no rules against market timing. "In the four matters, there is no violation of specific rules. But there have been clear violations of the principles of fairness to clients going to the question of appropriate conduct for a [fund company]," he said.

Company officials did not attend yesterday's hearing and also declined to comment.

The regulators named none of the 15 market-timing traders they said reaped profits totalling $301-million on thousands of transactions. The settlements mention institutional investors, but also say there was trading by sophisticated offshore and domestic retail clients and just plain retail clients.

The only trader named in the documents is BMO Nesbitt Burns Inc. The brokerage firm is described as having done 400 market-timing trades for its own account, some involving affiliated BMO mutual funds.

The settlements show that fund companies officials were not unwitting victims of the market timers but rather made arrangements with them that permitted market timing under specific conditions.

For example, AIC investors allowed three market timers to make between four and eight switches a month in and out of funds.

AIC will pay $58.8-million, the largest amount, towards restitution because the lion's share of profits were made in its funds. The three clients made profits totalling $127-million between January, 1999, and September, 2003, the settlement says. Again, not all of this was from market timing, the settlement noted, although it did not break the numbers down further.

All four fund companies said in their annual prospectuses and other disclosure documents that they could impose short-term trading fees of up to 2 per cent if an investor pulls out his money or switches between funds in the same company within 90 days of investing. However, no such fees were ever imposed against the market timers, the settlements say.

Mr. Watson said he found it "somewhat disturbing" that the market timing problem was brought to the attention of Canadian regulators by New York State's crusading Attorney-General Eliot Spitzer, who launched a crackdown on the practice in the fall of 2003.

"There must have been hundreds of people out there who knew this activity was going on in Canada," he said. ". . . Nobody brought it to our attention."

AGF FUNDS

6 unnamed traders made profits of $47.9-million over 34 months.

AGF collected extra management fees of $2.1-million as a result.

It will make restitution of $29.2-million to investors.

AIC FUNDS

3 unnamed traders made profits of $127-million over 56 months.

AIC collected extra management fees of $3.1-million as a result.

It will make restitution of $58.8-million to investors.

CI FUNDS

5 unnamed traders made profits of $90.2-million over 60 months.

CI collected extra management fees of $7.9-million as a result.

It will make restitution of $49.3-million to investors.

I.G. FUNDS

1 unnamed trader made profits of $36-million over 25 months.

Unites of Investors Group received extra revenue of $4.2-million as a result.

I.B. will make restitution of $19.2-million to investors.

SOURCES: OSC, IDA, MFDA

© 2007 The Globe and Mail. All rights reserved.

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