Comment Deadline on Implementation Issues: December 23, 2008

On October 24, 2008, the Joint Forum of Financial Market Regulators released its long-awaited Framework 81-406 Point of sale disclosure for mutual funds and segregated funds. The Framework represents the Joint Forum’s revised proposals for changing the current disclosure regimes for mutual funds and segregated funds, which proposals take into account the comments received on the June 2007 version of the Framework.

The Canadian Securities Administrators also released CSA Notice 81-318 asking for feedback on implementation issues for mutual funds raised by the Framework. The CSA explain that they intend to use this feedback as they move forward in drafting the national rule and changes to existing regulations that will implement the Framework for mutual funds. The deadline for providing these comments is December 23, 2008.

The Canadian Life and Health Insurance Association of Canada has indicated that it will be working with its members and the provincial insurance regulators to implement the Framework as it relates to segregated funds through amendments to CLHIA’s Guideline 2 on Individual Variable Insurance Contracts related to Segregated Funds. The CLHIA expects to consult with its members on implementation issues for segregated funds during the spring of 2009.

Since its release, the revised Framework has generated much discussion, particularly among those in the mutual fund industry. The Investment Funds Institute of Canada has published its views on the Framework and is meeting with members of the CSA to discuss implementation issues. In a letter dated November 24, 2008, IFIC urged the CSA to consider a fast track implementation of a mandatory Fund Facts document for mutual funds, so that Fund Facts can be in use by year-end 2009, but to develop the rules for delivery by dealers of the Fund Facts on a longer time line. IFIC expects that this bifurcation of the production of the Fund Facts document from its delivery will allow the mutual fund industry to develop mutually satisfactory solutions to the CSA’s proposed “point of sale” delivery requirements, while not delaying implementation of the Fund Facts.

Although the Framework contains proposals that respond to the submissions made in the 85 comment letters provided on the June 2007 version of the Framework, we continue to see fundamental flaws with the proposed point of sale regime. We intend to comment to the CSA on the implementation issues we see with the Framework as it applies to mutual funds, as we did following the publication of the June 2007 Framework.

The cornerstone of the revised Framework continues to be the two-page Fund Facts document that must be developed by fund managers for each series or class of securities of a mutual fund. The fund’s simplified prospectus and annual information form must still be prepared, but will not be given to investors unless requested. Generally, advisors and dealers will be required to give an investor the most current Fund Facts before placing an initial order for securities of a mutual fund. Delivery can be achieved in person, by regular or electronic mail, via fax or by providing a link to a website posting. Simply reading or describing the Fund Facts to an investor will not be sufficient. Posting of Fund Facts on a fund company’s website will be encouraged, but will not negate the requirement for an advisor to provide the investor with a paper or electronic copy or the exact location where a specific Fund Facts is posted.

Assuming the CSA proceed with the Framework as currently drafted, it is clear that fund managers will have the obligation to annually prepare a Fund Facts for each class or series of a fund and dealers will be required to ensure that the right document for the applicable class or series of a fund being recommended gets into the hands of the prospective investor.

The revised Framework makes some important changes from the June 2007 version:

  • Identifying a trade as “advisor-recommended” or “investor-initiated” will be important. With the latter, the dealer may obtain client consent to send the Fund Facts with the trade confirmation, on the assumption that the client has conducted his or her own research about the fund and therefore doesn’t need the Fund Facts to make an informed decision.
  • Clients may also consent to receive the Fund Facts for a money market fund with the trade confirmation, since money market funds are lower risk and are generally used by investors to “park” money temporarily.
  • Dealers that provide an “order execution-only service” (discount brokers) must provide the Fund Facts with the trade confirmation, but need not provide them before the trade is completed.
  • No Fund Facts need be delivered to an investor on a subsequent trade in a mutual fund, provided the client already holds securities in the particular fund.
  • Investors must be given the option of receiving a Fund Facts for the funds they hold on an annual basis. It is not clear who will have the responsibility for reminding investors of this right.
  • The Fund Facts need only be updated annually at the time of the annual renewal of the simplified prospectus and annual information form, although it may be updated as frequently as quarterly at the option of the fund manager.

The content of the Fund Facts largely remains unchanged from the June 2007 version of the Framework and the regulators clarify that they intend to mandate:

  • The content items and their order, including which items are to go on the first page and which are to go on the second page
  • Section headings
  • Certain language
  • Plain language usage and less than grade 6.0 reading level using the Flesch-Kincaid system available with most word processing systems.

We continue to believe that the Framework does not appropriately recognize the purpose of an effective disclosure regime nor does it recognize the value provided by dealers and advisors to investors who seek advice. The Framework is based on the proposal that an advisor will physically deliver a Fund Facts to an investor before placing a trade. Although the regulators refer to electronic delivery, in our view, enhancing electronic availability of disclosure documents is of paramount importance.

A mutual fund should prepare primary disclosure documents that simply and concisely describe its fundamental features. These documents should be readily available to investors, to dealers and to the public at large. Their purpose would be to set out the essential commercial terms that investors should understand about the fund. The primary disclosure documents would be, to the greatest extent possible, “evergreen”. Information about the on-going operations of the mutual fund would continue to be provided in continuous disclosure documents (that is, the financial statements and MRFP) and should not be repeated in the primary disclosure documents. Securities regulation should mandate the content and production of these documents, as well as their accessibility through website postings and physical delivery to those investors who ask for them. We recognize that a fund manager may wish to have a simple summary of basic facts about a mutual fund available for investors and advisors on its website, but we do not believe that it is necessary for securities regulation to mandate the contents of this document or its delivery prior to an investment being made.

The suitability, know-your-client and know-your-product obligations of a dealer and its advisors in connection with mutual fund investing are well-known and of long-standing in Canada. It is curious that despite these obligations, the CSA intends to require that dealers and advisors physically give investors the Fund Facts before concluding a trade (even if that delivery is moments before a trade is placed) on the assumption that the investor will read this document and make more informed decisions. In our view, securities regulation should reinforce the responsibilities of dealers and advisors to highlight the availability of disclosure documents when making recommendations to investors. We are not convinced of the necessity for physical delivery of a disclosure document prior to a trade taking place.

In our view, the costs of the Framework remain high and the benefits of the revised system, particularly to investors, are questionable.