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OSC defends its market-timing inquiry

Probe ended after regulator secured settlements from five targeted firms

The Ontario Securities Commission is defending its decision to halt its probe of trading practices in the mutual fund industry, declaring that the most serious offenders have been punished.

"The case is closed with a fair result," OSC chairman David Brown said of the largest investigation in the regulator's history. He made the remark yesterday as the commission released its final report on its 15-month investigation, including proposed measures to staunch future abuse.

Five of Canada's largest mutual fund companies have agreed to reimburse $205.6-million to unitholders for permitting so-called "market timing" in their funds. An investigation published in The Globe and Mail last June found that rapid, in-and-out trading in mutual funds totalled more than $220-billion between 2000 and 2003.

The OSC's probe found evidence of market timing in funds operated by 20 fund management companies. The practice is not illegal, but hurts funds by raising costs and reducing returns for long-term investors.

Enforcement action was taken by regulators against only a handful of firms: AGF Management Ltd., AIC Ltd., CI Fund Management Inc., Franklin Templeton Investments Corp. and Investors Group Inc.

Mr. Brown defended the decision to target only five firms, claiming there was a "huge gulf" in the market-timing profits at the targeted companies compared with the remaining -- and unidentified -- 15 firms.

"Harm to investors in those funds was negligible," he told reporters. "We felt that these funds had acted appropriately. We saw no reason for us to proceed."

But sources within the five companies that reached settlements shared a sense of betrayal yesterday.

During negotiations with the OSC, the companies were told that a market-timing settlement model would be applied across the industry, stepping up the pressure to cut a deal, the companies said.

"If they had that impression, I don't know where they got it. They certainly didn't get it from us," Mr. Brown said in an interview.

In addition, several sources described the OSC's methodology of assessing market-timing activity as opaque and arbitrary. The commission gave the five targeted firms an average market-timing risk rating of 13.4 out of a maximum score of 15; the remaining companies scored seven or less.

"There are still lot of unanswered questions," said Marcia Stewart, general counsel for Burlington, Ont.-based AIC.

"I'm not sure how you reach the conclusion that you just stop [the probe] . . . there are obviously a lot of unitholders out there who were holding funds where there was market timing."

There was some relief, however, that the fund trading scandal -- and the bad publicity it has generated for the recovering sector -- had finally drawn to a close.

"You can't win this kind of a battle with the regulators," fund marketing consultant Dan Richards said. "The fund companies have accepted this and want to move on."

The OSC report includes proposals for the industry to deter future market-timing activity. They include:

New rules requiring fund managers to have a written compliance program detailing how they will monitor, detect and stop inappropriate trading;

Mandatory short-term trading fees that would penalize investors for rapid trading;

Fair-value pricing for securities within a fund, a practice that eliminates the opportunities for gains through rapid trading.

Ralf Hensel, senior legal counsel of the Investment Funds Institute of Canada, said improved regulation is a "work in progress" with broad member support provided costs are kept in check.

Still, the Small Investor Protection Association said past efforts at fund reform have been largely unsuccessful and slow in coming.

Mr. Brown told the media that the report's recommendations are "high on our priority list."

© 2007 The Globe and Mail. All rights reserved.

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