The Canadian Securities Administrators (CSA) have published the final version of amendments (Amendments) to implement the first stage of the new point-of-sale (POS) disclosure regime (PDF). These are set out in the Notice of Amendments to National Instrument 81-101 Mutual Fund Prospectus Disclosure, Form 81-101F1 and 81-101F2 and Companion Policy 81-101CP Mutual Fund Prospectus Disclosure and Related Amendments dated October 6, 2010. Central to POS is a new Fund Facts document that is intended to be short and simple, and provide investors in plain language with the information that is most important to deciding whether to invest in a particular mutual fund. This Bulletin provides detailed guidance to mutual funds and their managers for implementing POS.
Assuming that the Amendments become law on January 1, 2011, every existing mutual fund currently in distribution using a simplified prospectus will be required to file Fund Facts on SEDAR and post them on its website no later than July 8, 2011. As well, every mutual fund prospectus filing made on or after April 8, 2011 (including a preliminary prospectus for a new mutual fund, a pro forma renewal prospectus for an existing mutual fund, or an amendment to an existing mutual fund prospectus to add a new class or series of securities) must include Fund Facts as part of the filing. (More timeline information is provided below.) Once filed, Fund Facts must be made available to investors, free of charge, upon request.
These changes are described by the CSA as "Stage 1" of implementing POS. In later stages (described below), delivery of Fund Facts to investors will become mandatory and will replace delivery of the simplified prospectus.
Content of Fund Facts
A Fund Facts document must be no more than four pages in length (i.e., two double-sided pages), though the CSA would like to see shorter Fund Facts where the mutual fund has less information to disclose. Like a simplified prospectus, Fund Facts must disclose only the prescribed information, and must use the headings and follow the order of new Form 81-101F3. (It is not permitted to incorporate information by reference into Fund Facts.) Each Fund Facts will begin with information relating to the mutual fund, and finish with information relating to the costs of investing in the mutual fund.
The prescribed information includes the following:
- Fund Facts (fund name, manager, class/series of securities, and date of Fund Facts)
- Quick Facts (fund creation date, total net asset value, management expense ratio (MER), portfolio manager/adviser, distribution policy and minimum investment amount)
- What does the fund invest in? (summary of investment objectives and strategies, top 10 holdings and asset mix)
- How has the fund performed? (average annual compound return and year-by-year returns)
- How risky is it? (manager's risk rating of the mutual fund using: "Low", "Low to Medium", "Medium", "Medium to High" or "High")
- Are there any guarantees? (description of guarantees, if any)
- Who is this fund for? (description of the investors and portfolios for whom the mutual fund may be suitable)
- A word about tax (brief overview of tax consequences)
- How much does it cost? (sales charges, redemption fees, MER, trading expense ratio (TER), total fund expenses, trailer fees and certain other fees and expenses)
- What if I change my mind? (investor statutory rights)
- For more information (manager contact information)
Fund Facts also must include various prescribed introductions, cross-references and warnings.
Currently, the interpretation of Ontario Securities Commission (OSC) staff is that past performance will not include the first stub calendar year of a new mutual fund, or new class or series. This differs from the current equivalent disclosure in management reports of fund performance, as well as the past performance information that was included in Part B prior to National Instrument 81-106.
As well, current OSC staff interpretation is that other discloseable fees and expenses exclude annual account-level fees, such as those for fee-based accounts. This will result in a significant difference between the other fees and expenses disclosed in the Fund Facts compared to what is disclosed in Part A of the simplified prospectus.
The following links will direct you to:
- A Word version template for Fund Facts prepared by Fasken Martineau
- The sample Fund Facts (PDF) prepared by the CSA and included in the notice of the Amendments.
Due mainly to the non-existence of a Flesch-Kincaid (FK) grading feature in the French version of Word, the CSA have dropped the requirement that Fund Facts be written at a FK 6.0 grade level. Instead, Fund Facts are subject to the general requirement that they be written "in plain language" and the Companion Policy refers to the FK 6.0 grade level as a guideline as to whether "plain language" has been achieved.
The CSA have remained steadfast that a separate Fund Facts document must be prepared for each class or series of securities of every mutual fund. Accordingly, a mutual fund family with 50 mutual funds, each offering 3 classes of securities across Canada, will need to prepare 300 Fund Facts documents (50 funds x 3 classes x English/French versions). This is noticeably more onerous than the equivalent treatment for segregated funds which currently allows Fund Facts to include multiple classes/series, even though vastly different guarantee features and costs may be associated with each class/series of a segregated fund.
A number of changes have been made to the content of Fund Facts since the previous draft published in June 2009:
- There no longer is a requirement to break-out components of the MER, but Fund Facts now must include the TER and total fund expense (MER + TER). This will be a controversial change since, to date, the debate concerning the annual cost of investing in mutual funds has focused solely on MERs, not TERs. It also may represent a policy shift by the CSA who previously focused on MERs rather than total fund expenses as the relevant disclosure to be made to investors.
- Rather than prescribing a risk classification methodology, the CSA are giving each manager the flexibility to utilize its own risk classification system, provided the ultimate determination uses the scale described above (Low, Low to Medium, Medium, Medium to High, High).
- Fund Facts now must include a section briefly discussing tax implications.
- Disclosure has been added and relocated to clarify that Fund Facts are not complete and investors can obtain additional information from the simplified prospectus.
The simplified prospectus (likely in the introduction to Part B for a multiple simplified prospectus) must disclose the methodology used by the manager to assess the risk level of the mutual fund, and make such methodology available to investors, at no cost, upon request. The simplified prospectus also must disclose how frequently the investment risk level of the mutual fund is reassessed by the manager. In addition, Part B of the simplified prospectus will be required to disclose the methodology used by the manager to determine the investor risk tolerance suggested in the suitability disclosure.
Under Stage 1 of implementation, every existing mutual fund currently in distribution must file Fund Facts on SEDAR no later than July 8, 2011 for every class or series of securities that it offers. (Fund Facts will not be required for classes and series that are not in public distribution.) As well, every mutual fund prospectus filing made on or after April 8, 2011 (including a preliminary prospectus for a new mutual fund, a pro forma renewal prospectus for an existing mutual fund, or an amendment to an existing mutual fund prospectus to add a new class or series of securities) must include Fund Facts as part of the filing. Once filed, Fund Facts must be posted as soon as possible (and, in any event, within ten days) on the fund's or manager's website following the issuance of the receipt for the filing, and must be made available to investors, free of charge, upon request. According to OSC staff, a final prospectus for a new or existing mutual fund that is filed on or after April 8, 2011 will not be required to include Fund Facts if the preliminary or pro forma prospectus (as applicable) was filed before April 8, 2011.
Fund Facts that are filed prior to July 8, 2011 on a standalone basis (not as part of a final prospectus or prospectus amendment filing) will not be incorporated by reference into the simplified prospectus. They also will not be reviewed by the CSA in these circumstances. All other filings of Fund Facts will be incorporated by reference into the simplified prospectus (and therefore subject to prospectus liability standards) and reviewed by the CSA. The CSA do not expect to be able to review all Fund Facts exhaustively during the first year of implementation.
Once filed, Fund Facts must be amended whenever a material change to the mutual fund occurs that impacts the disclosure in its Fund Facts. The amendment must be as a completely new, amended and restated Fund Facts document. At a minimum, amended Fund Facts must be accompanied by a related AIF amendment. There will be no obligation to update Fund Facts more frequently than annually (except where a material change has occurred), but managers will have the flexibility to do so on a voluntary basis. Though certain comments by the CSA suggest that an amendment to add a class or series of securities must be accompanied by a "preliminary" Fund Facts document, this only was meant to signal that the Fund Facts will be reviewed by the CSA in these circumstances – not that preliminary and final versions need be filed.
Managers are permitted (but not required) to file documents under the new disclosure system prior to April 8, 2011. For example, standalone Fund Facts can be filed at any time after January 1, 2011, and mutual funds can include the new disclosure in any new or renewal prospectus filing after January 1, 2011.
Binding and Delivery of Fund Facts
When filed on SEDAR, all Fund Facts of the mutual fund(s) in the simplified prospectus may be bound together. (We suggest that it would clutter a mutual fund's SEDAR database to file Fund Facts in any other manner). However, when posted on the manager's website, each Fund Facts document must be posted separately and must be easily visible and accessible.
Fund Facts may be bound to a simplified prospectus that is delivered to an investor only if the investor purchased the particular mutual fund(s) and class(es) or series to which the Fund Facts relate. When bound to the simplified prospectus, the Fund Facts must appear as the first document.
Other Changes Resulting From POS
For the time being, the CSA are no longer attempting to replace the current patchwork of investor statutory remedies with a single, harmonized set of rights.
The Amendments include minor changes to the wording for AIF certificates.
The Amendments also change the description of documents incorporated by reference into a simplified prospectus. Where Part B is bound separately from Part A, the new wording suggests that all disclosure documents relating to a specific mutual fund (including its financial statements and management reports of fund performance, in addition to Part B and the Fund Facts) are required to be delivered in order for the simplified prospectus to be complete. However, OSC staff has advised that they will interpret this wording as capturing only Part B and the Fund Facts.
A number of comments on the previous draft of POS were not fully addressed by the CSA in the Amendments. This likely was due to pressure on the CSA to have some version of POS in force by January 1, 2011 to match the insurance industry's POS regime which will be fully operational on that date. The main issue – how to deliver Fund Facts to an investor before the purchase order is submitted – has been deferred to a later stage of implementation. Other issues remain and likely will be resolved on an ad hoc basis through the comment/response process of prospectus filings.
Overly Simplistic Disclosure: Our firm's experience earlier this year assisting with the preparation of Fund Facts for segregated funds suggests that managers will struggle to meet the requirements of Fund Fact disclosure without creating misunderstanding among investors based on partial disclosure. For example, the CSA have assumed that the treatment of deferred sales charges during switches or under an annual 10% free redemption right can be summarized within a few lines, even though these features often include numerous rules and exceptions. Similarly, the CSA's sample Fund Facts assumes that short-term trading fees and switch fees are the only additional charges paid by investors, even though there can be a myriad of other account-level fees. Another challenge will be satisfying the CSA's new requirement for brief tax disclosure which was introduced without the benefit of industry comments. The CSA's sample Fund Facts assumes (for example) that it is sufficient to state that no tax is paid on income earned inside a registered plan without warning that tax will be paid when such income is withdrawn from the plan.
Determining what is meaningful information for investors: At numerous junctures, managers will need to make decisions concerning the most meaningful information to include in Fund Facts. This process is made difficult by the fact that, regardless of the quality of disclosure made in Fund Facts, there always will be a significant portion of the investing population that misunderstands fundamental concepts associated with personal investing. The fund risk disclosure scale is an example: some commentators already have noted that there will be confusion over whether the scale reflects the mutual fund's historical volatility (which managers can attempt to provide based on objective metrics), or will be interpreted by investors as grading each investor's risk tolerance (a subjective exercise).
Continuing References to Flesch-Kincaid: The CSA, through the Companion Policy, will continue to use the FK grade level scale as a benchmark for assessing plain language. However, FK is a very simplistic tool that only measures a document by the average number of words per sentence and average number of syllables per word. Managers will find that explanations otherwise believed to be simple and straightforward may result in a Fund Facts document rated above a grade 6.0 level due simply to the length of words or sentences used in the Fund Facts.
Separate Fund Facts for each Class/Series: Despite the insurance industry now accepting a different view, the CSA have not backtracked from their original position that separate Fund Facts must be prepared for each class or series of securities of a mutual fund. This likely will raise both operational and disclosure issues since investors may need to review multiple versions of nearly identical Fund Facts documents in order to select the class or series most suitable to them.
Stages 2 & 3 of Implementation
As summarized above, the first stage of implementing POS requires that Fund Facts be filed on SEDAR, posted on the manager's (or mutual fund's) website and delivered to investors, free of charge, upon request. Initially, there will be no immediate obligation to deliver Fund Facts to investors as part of the purchase process.
Stage 2 of implementation will occur at a later date and will permit Fund Facts to be delivered in lieu of simplified prospectuses. Commentators have noted that this may not generate much cost savings since the largest cost component – postage – of current prospectus delivery will continue to be incurred. Unresolved is how the industry will deliver Fund Facts to investors prior to investors submitting their purchase orders since, currently, no such system exists.
Stage 3 of implementation will make delivery of Fund Facts, rather than simplified prospectuses, mandatory. The CSA are promising that following Stage 3, they will consider changes to reduce duplication in the overall mutual fund disclosure regime.
Currently, POS will apply only to mutual funds that use a simplified prospectus. It will not apply to other types of publicly offered mutual funds (such as exchange-traded funds (ETFs) or commodity pools), nor will it apply to closed-end investment funds. As part of Stage 3, the CSA will consider whether to extend POS to these other types of funds.
What Should Managers be Doing?
Consider the implementation timeline: Under the transition rules described above, any preliminary or pro forma prospectus filing on or after (but not before) April 8, 2011 must include Fund Facts. As a result, a mutual fund that ordinarily would file its pro forma renewal prospectus after April 8, 2011 might consider advancing its pro forma filing to occur before April 8, 2011 since this will "grandfather" the filing and provide the mutual fund with more transition time to prepare its first Fund Facts.
If a mutual fund ordinarily would file its pro forma prospectus after July 8, 2011, this will result in the mutual fund filing its Fund Facts twice during a short period of time – once to meet the July 8, 2011 deadline, and again as part of its renewal prospectus filing. In these circumstances, managers might consider advancing the timeline of the renewal prospectus filing to avoid the duplication of workload.
If a mutual fund is proposing to add a new class or series of securities, it is advisable to do so prior to April 8, 2011 to avoid the requirement to include Fund Facts with the amendment. Otherwise, filing such an amendment on or after April 8, 2011 will trigger related amendments to the simplified prospectus disclosure in order for certain information in the Fund Facts to be complete.
Begin preparing a template Fund Facts document: We recommend that mutual fund managers begin preparing a template Fund Facts for their mutual funds that covers the information that is not specific to any particular mutual fund. Our experience is that the most significant challenges to managers will involve simplifying the general disclosure that is common to most mutual funds and classes or series. Once the template is established, it can be populated with the fund-specific information fairly easily.
For the fund-specific disclosure, two difficult areas will be:
- Providing a brief description of the investment objective and strategies of the mutual fund, and
- Devising and applying the risk rating methodology for each mutual fund in a consistent manner that also dovetails into the investor suitability disclosure.
Revisit website posting practices and relationships with dealers and other users: Managers also should begin planning changes to their website posting practices to ensure that Fund Facts can be posted quickly after filing on SEDAR, as well as ensuring that the system removes old Fund Facts as they are superceded by new Fund Facts. This includes ensuring that dealers and other users of this information will access the correct documents.
Consider early implementation of Stage 2: In CSA Staff Notice 81-319 Status Report on the Implementation of Point of Sale Disclosure for Mutual Funds published on June 18, 2010, the CSA indicated that they would consider granting discretionary relief to mutual funds wishing to move immediately to Stage 2 of implementation. Managers may wish to consider whether it would be worthwhile to seek such expedited implementation. It is not clear at this stage whether the CSA would expect Fund Facts to be delivered to investors prior to purchase orders being submitted (rather than within two days after the purchase order) as part of granting such relief.
We will continue to report to our readers on the implementation of POS.