The Ontario Securities Commission (OSC) recently released its annual Summary Report for Investment Fund Issuers, providing an overview of key policy initiatives, emerging issues and compliance reviews concerning the investment fund industry. This legal update summarizes the key trends and provides tips for investment fund issuers.
Automatic reinvestment of distributions
Issue: The OSC raised concerns regarding investment funds that pay regular distributions and establish the automatic reinvestment of those distributions in additional securities of the fund as the default option for investors rather than payment in cash. Staff is concerned that the default reinvestment option benefits the fund manager and may result in a conflict of interest.
Tip: The OSC has advised that any new investment funds that propose to have automatic reinvestment of distributions as the default payment option will be closely examined prior to their launch, and managers should expect to answer questions regarding any such structure. An existing fund may be asked to provide additional disclosure regarding the default option in the fund’s prospectus and Fund Facts. Managers of existing funds should also be prepared to provide feedback to the OSC in respect of plans to transition away from such structures.
Dual dealer compensation
Issue: During 2014, the OSC raised concern with investment fund series being intended for fee-based accounts but also having a trailing commission embedded as an ongoing cost. Staff has expressed the view that this type of dual compensation structure is potentially misleading to investors as it does not provide complete clarity to investors and blurs the lines between the attributes of a fee-based series and a series with an embedded trailing fee.
Tip: The OSC has advised that any new fee-based series of an investment fund should not also have an embedded trailing commission. For existing fee-based series, during the review period for renewal prospectuses managers should anticipate the OSC asking about the manager’s plans to close out the series to new investments and switch current investors out of the series.
Changing short-term trading fees
Issue: The OSC has noted that in the past year certain fund managers changed the applicability period for their short-term trading fee from 30 days to seven days. Staff intends to seek clarification from managers regarding the rationale for this type of change.
Tip: Where managers change the applicability period relating to short-term trading fees, managers should be prepared to explain to staff: (i) how the change is considered an effective means to deter short-term trading while remaining consistent with the manager’s statutory duty to act in the best interests of its funds and investors; (ii) what other policies and procedures are in place to monitor, detect and deter short-term trading, including in particular whether the manger varied its policies and procedures to take into account market timing and excessive trading (two different types of short-term trading) and whether the manager will continue to use the previous applicability period (e.g., 30 days) to monitor trading activities; (iii) how effective the manager’s policies and procedures have been to date in monitoring, deterring and detecting short-term trading activities; and (iv) whether the independent review committee reviewed the change prior to its implementation and how often reviews of such policies and procedures will be made going forward.
Issue: The OSC reviewed investment funds that had management expense ratios (MERs) in excess of 5% and that absorbed a high level of expenses to be able to present MERs after absorption at a level within industry standards. The purpose of the OSC’s review was to see whether funds with such practices were sustainable.
Tip: If a high MER fund is not able to demonstrate its sustainability after a reasonable period of time, the OSC expects the fund’s manager to consider all available options to reduce MER, including improving performance, increasing the fund’s size, managing costs better and achieving efficiencies. The OSC also noted that where a fund has set a pattern of high absorption for numerous years, this could influence investor expectations. In such a case, managers should ensure investors understand that a decrease or cessation in absorption for the fund in the future could result in an increase to the fund’s MER.