The Investment Funds Branch of the Ontario Securities Commission recently published the April 2012 issue of its Investment Funds Practitioner. The publication provides an overview of issues identified by the Branch arising from exemptive relief applications, prospectus filings and continuous disclosure documents filed by investment funds with the OSC.
The Practioner highlights a number of issues that have come to light in the course of prospectus reviews, including amending a final prospectus to fix incorrect fee disclosure, and fund names that are inconsistent with the fund's investment objectives or strategies. On the latter issue, Branch Staff state that fund managers should select names that "closely reflect the fund's investment objectives" and that distinguish the funds from others. Branch Staff will consider whether additional guidance or rule-making is needed on this point.
Staff have also considered the issue of ETFs that track indices that are not widely used or recognized. According to the Practitioner, a fund's disclosure respecting investment objectives cannot be limited to a statement that the fund aims to replicate the performance of a specific index. Additional information is required, including with respect to primary asset composition and key features of the fund under normal market conditions. Staff have also started reviewing portfolio transparency of actively-managed ETFs in continuous distribution and advise that they expect any separate fees that are paid to a counterparty under a forward agreement (intended to compensate for the cost of hedging its exposure) to be disclosed in the prospectus of the fund.
Also discussed is Branch Staff's concern with closed-end funds that propose to invest either directly or through a derivative such as a forward agreement, in foreign-based investment funds or portfolios that are not reporting issuers in Canada. According to the Practitioner, Branch Staff will generally ask for certain disclosure concerning each underlying fund in the course of their prospectus review, and may ask that certain disclosure, such as the risk associated with enforcing legal rights against non-residents, be highlighted and put in a textbox on the prospectus cover page. Staff further express their views on how continuous disclosure obligations of the fund may be impacted and advise that they typically will request the underlying fund manager to file a submission of jurisdiction and appointment for service of process. The Practitioner advises that Staff typically will ask that the financial statements and other continuous disclosure of the underlying fund be filed on the SEDAR profile of the closed-end fund.
Finally, with respect to prospectus offerings, Branch Staff have highlighted their ongoing concerns with standalone warrant offerings by closed-end funds, including the dilutive effective on the value of units, the potential for such offerings to be coercive to existing unitholders and the potential conflict of interest that may exist with respect to the manager of the fund.
Continuous Disclosure Issues
In this area, the Practioner canvasses issues emanating from Branch Staff's recent review of select investment funds that make regular distributions to investors. A number of issues emanating from the review were identified, including the practice of paying distributions that are regularly and significantly in excess of the fund's increase in NAV from operations. According to Branch Staff, whereas terms such as "yield" or "income" imply earnings, such distributions are, in substance, a return to investors of capital.
Further, Branch Staff state that funds that pay distributions in the form of reinvested units as a default conflicts with a fund's stated focus of providing investors with regular income, as the onus falls on the investor to select distributions in cash. The Practioner thus outlines a number of disclosure related obligations required of such funds. Further guidance or rule-making may be released.
The Practitioner also discusses Branch Staff's recent reviews of portfolio disclosure (observations and guidance arising out of the review are expected by this summer) and Fund Facts risks. On the latter issue, Branch Staff remind filers that they will generally consider changes to a mutual fund's risk level to be a material change under securities legislation.
Staff of the Investment Funds Branch are accepting feedback on the Practioner and suggestions for future topics to be reviewed.