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Market timing at heart of class action

Suit alleges fund firms allowed sophisticated investors to do quick trades


When Dennis Fischer began stashing his savings into Investors Group mutual funds in the early 1990s, he expected the fund company would treat all investors equally.

He was shocked when IG Investment Management Ltd. negotiated a settlement with regulators for its role in a market timing scandal along with CI Investments Inc., Franklin Templeton Investments Corp., AGF Investments Inc. and AIC Ltd. in 2004-2005.

The five agreed to pay a total of $205.6-million in restitution for secretly allowing some market pros to zip in and out of funds, and pocket millions in quick profits without paying maximum fees to do so.

"It's unethical," suggested the 45-year-old Lake Cowichan, B.C.-investor and former child-youth counsellor who is now on a disability pension. "These market timers made a lot of money using my funds."

Mr. Fischer is among the five plaintiffs involved in a class-action lawsuit filed in Ontario Superior Court against the fund companies. The mutual fund companies plan to defend themselves and declined to comment.

They allege the firms breached their fiduciary duties between September, 1998, and September, 2003, by allowing sophisticated investors to do quick trades contrary to their fund prospectuses, and that the negotiated restitution was not enough. The certification hearing to determine if this class action can proceed to trial begins today in Toronto.

"The case potentially represents the largest breach of trust in Canadian history from a financial perspective," said lawyer Joel Rochon with Toronto-based Rochon Genova LLP. "We are seeking to recover the actual harm suffered by unitholders in these funds."

In addition to monies paid back to investors under a settlement with the Ontario Securities Commission, "we believe ... that as much as several hundred millions of dollars remains unpaid to unitholders," said Mr. Rochon, whose case represents investors outside of Quebec.

In an affidavit filed by Eric Zitzewitz, an economics professor at Dartmouth College who has done studies on short-term trading practices in U.S. funds, he calculates the actual harm done to Canadian investors by the five firms was between $330-million to $831-million depending on the methodology used.

Market timing is an investment strategy whereby investors try to profit from taking advantage of the difference between the "stale" value of shares in a fund because of time zone differences, and the expected price movement of a foreign fund the following day. Like the Canadian firms, many U.S. fund companies also dealt with market timers.

When compared with 20 U.S. regulatory settlements, Prof. Zitzewitz found the American cases achieved an average unitholder reimbursement of 56 per cent of estimated harm (or 94 per cent when including penalties) compared with about 27 per cent for the OSC settlements.

In Canada, the five companies were granted a two-year extension this year to June, 2011, to track down remaining investors owed money.

Most fund companies last summer said there was less than $3-million left to pay back, but Investors Group would not give an indication of its balance. "Investors Group will not comment on this matter," spokesman Ron Arnst said yesterday in an e-mail.

While most fund companies sent cheques, Mr. Fischer, who owned funds such as IG Global and IG European Growth from 1994 to 2002, received his compensation in additional fund units worth about $60.

But he wants to know how fund companies calculated the amounts owed. "We have no idea," he said. "This was a decision done in camera [behind closed doors] between mutual fund companies and the OSC."

A similar class action suit, meanwhile, has been launched in a Quebec court against the same five fund companies in addition to Mackenzie Financial Corp. and the mutual fund arm of CIBC. A hearing to obtain "authorization" (similar to certification) was held last spring, but there has been no judgment yet.

This suit also alleges harm to unitholders from the special treatment given to market timers. "They [fund companies] knew, or should have known that it would cause damage to unitholders," said lawyer Normand Painchaud, who filed the suit.

The market-timing trades in this country were done by "sophisticated or hedge fund investors" who had contractual agreements with the five fund companies to do so, Mr. Rochon said. "We don't know much about the people or the hedge funds that were involved ... It has never been disclosed publicly [by the OSC]."

These investors could invest in funds on a Monday afternoon and leave the fund by Thursday morning, or "within a five-day turnaround typically" to take advantage of events occurring in Asia, Mr. Rochon said.

"When they pulled money out, the fund companies had to pay them [market timers] because they had made a technical profit even though the money had not gone to work in the underlying shares of the funds."

In the statement of claim, the plaintiffs allege that long-term unitholders could suffer from market timers redeeming early because that action could force fund managers to sell stocks and trigger undesired taxable gains, or sell stocks at an inopportune time to raise cash for redemptions. Fund companies also might keep cash on hand - instead of being invested - to pay the timers' profits, the claim says.

The claim suggests that the firms involved had ways to fight against market timers - from rejecting their purchases to imposing early redemptions fees. Some like Fidelity Investments Canada and Phillips Hager & North Investment Ltd. - now owned by Royal Bank of Canada - were not involved with market timers, it said.

Instead, the five mutual fund companies mentioned in the suits would often waive early redemption fees, while the firms - not the unitholders - received management fees generated by the market timers, Mr. Rochon added.

The claim seeks compensation from all of the defendants, which puts privately held AIC in an unusual position after its retail fund assets were sold to Manulife Financial Corp. in September. Any liabilities that could be incurred - if the class action suit was ultimately successful - would actually fall on the shoulders of AIC's owner Michael Lee-Chin and his holding company Portland Holdings Inc., which owns stakes in a variety of companies.

"The continuity would be with our lawyers" who will be attending the hearing, said Jonathan Wellum, chief executive officer of Portland Investment Counsel (formerly AIC Investment Services).


Restitution under OSC settlements, 2004-2005

AIC Ltd.


Market timers: Three from January, 1999 and September, 2003

Timers' profit: $127-million*


CI Investments Inc.

(formerly CI Mutual Funds Inc.)


Market timers: Five from September, 1998 and September, 2003

Timers' profit: $90.2-million*


Franklin Templeton Investments Inc.


Market timers: Three from February, 1999 and February, 2003

Timer's profit: $120.8-million*


AGF Investments Inc.

(formerly AGF Funds Inc.)


Market timers: Six from August, 2000 and June, 2003

Timers' profit: $47.9-million*


IG Investment Management Ltd. (unit of Investors Group Inc.) $19.2-million

Market timers: One between October, 2000 and November, 2002

Timer's profits: $36-million*

Source: Ontario Securities Commission

*Not all of the profit came from market timing.

© 2007 The Globe and Mail. All rights reserved.

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