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Canadians like to take the moral high ground when it comes to comparisons with the U.S. We wisely stayed out of the invasion of Iraq, and we like to rein in the free market when it comes to health care. That same sense of superiority, however, could be blinding us when it comes to the Canadian mutual fund industry.

This week, the Ontario Securities Commission moved into a new phase of what at first appeared to be an Eliot-Spitzer-style crackdown on Canada's $465-billion mutual fund industry. It's a very Canadian crackdown though it was quietly launched in November, when questionnaires were sent out to 105 Ontario fund companies. Just this week the Globe and Mail discovered the OSC will conduct on-site reviews at big fund companies such as CI Fund Management Inc. and AGF Funds Inc. as part of a probe into potentially abusive trading practices.

The OSC probe comes in sharp contrast to the high-profile campaign launched by New York State Attorney-General Eliot Spitzer more than two years ago, which sent out a warning to the entire financial services industry and has resulted in several criminal and civil investigations into market timing and late trading in the fund industry.

While the U.S. mutual fund bloodletting was taking place, the OSC chose to stick with the "honour system" in this country. Fund companies have been asked to review their own ranks and weed out the trouble-makers. If trading irregularities were found, there's a good chance we didn't hear about them, and there's a better chance the victims were not compensated.

It's good that the nation's largest securities regulator plans to conduct on-site reviews, but it's a little late. The push for better governance south of the border has already dealt a serious blow to mutual fund giants like Putnam Investments, which was the first to be charged with securities fraud. The biggest impact in Canada has most likely been to send rogue mutual fund vendors underground until the air clears.

Now the Globe reports the OSC has asked Canadian fund companies to provide backup documentation including manually processed stamps that show when trades are made. The precise time of a trade is supposed to be entered electronically to provide proof of its authenticity and prevent back-dating.

The OSC probe is focusing on late trading and market timing. Late trading involves getting the current day's price on orders to trade shares placed after the market closes. The orders are supposed to be executed at the next day's price. Late trading is illegal in Canada and the United States.

Market timing, which is permitted, involves quick trades within a fund generating excessive transaction costs that eat into the returns of unit holders.

Relying on fund companies to police themselves is not the answer. Only the honest companies will comply. AGF took action on its own by imposing a fee on active traders who redeem or switch funds within 90 days. Hopefully the move will result in good publicity for AGF and bolster trust among its customers and potential customers. But being honest has its price and it's often cheaper to be dishonest.

The Ontario Securities Commission should ramp up its investigation and cast their net far and wide - and evenly. When the probe is complete, it should come out with a clear answer to the question many retail investors have been asking: Is the Canadian mutual fund industry rife with trading abuses? In this case, even not knowing is as good as a yes.

© 2007 The Globe and Mail. All rights reserved.

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