On March 26, 2014, the Canadian Securities Administrators (CSA) published for additional comments their proposed amendments[1] to require delivery of Fund Facts to investors before purchase orders are submitted, rather than within two business days after purchases are completed.  It has been the CSA's intention to implement this "pre-delivery" ever since the Fund Facts regime was first proposed almost seven years ago.  However, strong industry concerns regarding (among other matters) the lack of necessary infrastructure resulted in the CSA implementing the Fund Facts regime in stages, of which pre-delivery is the final step.

How the regime will change

The proposed amendments will require that a dealer deliver the relevant Fund Facts to the investor before the dealer accepts an instruction from the investor to purchase the securities.  It is not clear whether "accept" is intended to mean "execute" or an earlier moment in the purchasing timeline such as "receive".  Though not expressly addressing this ambiguity, the related Companion Policy amendments state that pre-delivery must occur within a reasonable timeframe "…before the investor's instruction to purchase", reflecting the CSA's objective that the Fund Facts be reviewed by the investor before making a purchase decision.  The use of the term "accept" is intended to dovetail with recent amendments to National Instrument 31-103 relating to the CSA's client relationship model (CRM) that will require that each dealer provide certain cost disclosure to its client before the dealer "accepts" the client's instruction to purchase a particular security.  However, the meaning of "accept" is similarly vague under CRM.

Absent an exception, the failure to pre-deliver Fund Facts will entitle investors to the same remedies they currently have for failure to deliver the simplified prospectus or Fund Facts within 2 business days following the purchase.

Exceptions to pre-delivery

Previously received Fund Facts

The CSA confirmed that Fund Facts will not need to be redelivered to an investor who previously received the current version of the relevant Fund Facts.

Pre-authorized purchase plans

There will continue to be an exception for purchases under a pre-authorized purchase plan (PAC) equivalent to current prospectus delivery exemptions for PAC purchases.  Accordingly, investors would receive the current Fund Facts at the time of the first purchase under the PAC, but not subsequently.  Dealers must provide certain disclosure to their clients at the time of enrolment.  Dealers also must provide annual notice to their clients of how they can request the Fund Facts.  Investors will continue to have rights of action for rescission or damages if the prospectus (including Fund Facts) contains a misrepresentation.

The proposed amendments also state that the first purchase under an existing PAC after a date to be determined will be considered to be the first purchase under the PAC for purpose of the required disclosure described above.  This means that fund managers which offer PACs will need to ensure the Fund Facts and required disclosure are provided to existing PAC participants during the transition period as if the participants are being newly enrolled in the PAC.  While this makes sense for fund managers that currently do not have PAC relief, it is redundant where investors have already received equivalent disclosure under the PAC relief.

The CSA have invited comments on whether PAC investors should receive updated Fund Facts (potentially eliminating the PAC exception).  However, it is unlikely that the PAC exception will be removed.

Urgent purchases

The proposed amendments include a new pre-delivery exception for a trade where the investor has stipulated an execution deadline too short to include pre-delivery of Fund Facts.  Instead, the dealer would be obligated to make post-delivery of the Fund Facts within 2 business days after the purchase.  This "urgent purchase" exception would be available only if all of the following conditions are met:

  • The purchaser indicates that the purchase must be made immediately or by a specified deadline and it is not reasonably practical for the dealer to deliver the Fund Facts before the purchase is executed.
  • The purchaser consents to post-delivery of the Fund Facts.
  • Before accepting the purchase instruction, the dealer informs the purchaser of the existence and purpose of the Fund Facts and explains the dealer's obligation to otherwise pre-deliver the Fund Facts.
  • The dealer provides verbal disclosure to the investor of all of the following:
    • A description of the fundamental features of the mutual fund and what it primarily invests in as set out under "What does the fund invest in?".
    • The investment risk level specified under "How risky is it?".
    • A brief description of the suitability of the fund as set out under "Who is this fund for?".
    • A summary of the costs associated with buying, holding and selling the mutual fund as set out under "How much does it cost?".
    • A summary of the investor's withdrawal and rescission rights as set out under "What if I change my mind?".

Though the proposed amendments do not expressly say so, the CSA intend that all of the conditions described above be satisfied verbally before the purchase order is executed.

The urgent purchase exception will be available only on a trade-by-trade basis.  Dealers cannot obtain standing instructions from a client to treat all trades as urgent purchases.

There are some obvious compliance challenges associated with this exception, including how to evidence the purchaser's instructions and consent, as well as the adviser's communication of the prescribed disclosure.

Rejected exceptions

Previously proposed pre-delivery exceptions for purchases of money market mutual funds, purchases through discount brokers and purchases not recommended by the dealer have been deleted.  Also eliminated was a proposal for investors to have the option to receive Fund Facts annually rather than prior to their purchase orders.  The CSA received a number of comments relating to the complexity of the compliance procedures associated with these exceptions.  Rather than simplify those requirements, the CSA chose to eliminate the exceptions altogether.

Bundling of Fund Facts and timing of delivery

If sent electronically, each Fund Facts must be a separate standalone document.  If sent by non-electronic means, the Fund Facts may be attached to other Fund Facts (but no other document) provided the "bundled" Fund Facts are not so large as to make the document difficult to use.

When Fund Fact are delivered after the purchase under the "urgent purchase" exception, they may be attached to certain other documents (including the trade confirmation), in which case certain additional requirements apply.  However, it is unlikely that this exception will be widely used.

As discussed above, the Companion Policy amendments state that pre-delivery must occur within a reasonable timeframe before the purchaser's instruction to purchase.  The Companion Policy amendments also state that the CSA expect investors will be given a reasonable opportunity to consider the information in the Fund Facts before providing their purchase instructions. This suggests that pre-delivery cannot occur immediately prior to order execution.  Conversely, the CSA expect pre-delivery of Fund Facts to be related to a purchase instruction for those securities, which suggests that a bulk pre-delivery of Fund Facts will be considered ineffective.

Implementation timeline

The CSA believe that the industry can become fully compliant with pre-delivery within one year after publication of the proposed amendments in final form.  In the CSA's view, adequate technology currently exists to implement pre-delivery, and the only implementation hurdle is for each dealer and fund manager to develop an appropriate interface with the service providers of such technology.  Accordingly, industry participants should discuss with their service providers whether there will be any operational issues or unexpected costs with implementing pre-delivery on that timeline.

Issues not addressed in the Stage 3 proposals

There are a number of policy and operational issues associated with the proposed amendments which have not been addressed by the CSA.

Delivery of trade confirmations

Stage 3 will result in investors receiving two mailings (rather than one) for each mutual fund purchase order: pre-delivery of the Fund Facts and post-delivery of a trade confirmation.  Trade confirmations were originally intended to provide investors with a record of their securities transactions when none otherwise would exist.  With the implementation of pre-delivery of Fund Facts together with other disclosure made by dealers under CRM, there would seem to be little benefit, if any, from continuing to delivery trade confirmations which otherwise will double the mailing costs associated with each mutual fund purchase.

Other pre-authorized trading

To date, the CSA have granted exemptive relief to allow non-delivery of prospectuses and Fund Facts for subsequent purchases under PACs.  However, no equivalent exemption has been granted or is contemplated in the proposed amendments for other forms of pre-authorized trades, such as automatic rebalancing services.  Standing instructions for rebalancing trades are functionally the same as a PAC (e.g. the investor has pre-determined the mutual funds he or she wishes to own and the quantity of those investments) and rebalancing trades are executed without obtaining further instructions from the investor.  It is not apparent how Fund Facts can be pre-delivered to investors in these circumstances since rebalancing trades typically are executed as soon as the need to rebalance has been determined.

Electronic delivery

While the CSA have indicated that pre-delivery can be achieved through electronic means, no attempt was made to modernize the requirements for electronic delivery of documents since the CSA's views on electronic delivery were articulated almost 15 years ago.  The CSA reiterated their position that "access" (e.g. mere website posting) does not equal "delivery"[2], nor is referral to a website sufficient.  An overhaul of the CSA's position on electronic delivery is long overdue and particularly relevant in the context of pre-delivery of Fund Facts to retail investors.

Disproportionate industry impact

Pre-delivery will impact different market participants differently.  Some managers commented that mutual funds which are purchased on-site (such as at branches of financial institutions) can be expected to have fewer logistical issues with pre-delivery than mutual funds that are sold through distributors typically without in-person meetings.  The CSA dismissed these concerns  by assuming that adequate technology currently is available to eliminate any imbalance.  Whether adequate technological solutions exist will be determined during the implementation phase.  Even if they do, the costs and procedures associated with using that technology likely will be greater for independent fund companies than for institutions which mainly sell their mutual funds onsite.

Consistency with other regimes

The Fund Facts regime began as an initiative of the Joint Forum of Financial Market Regulators and was intended to be applied consistently to both mutual funds (by the CSA) and segregated funds (by the Canadian Council of Insurance Regulators).  However, before Stage 1 was implemented, the insurance regulators diverged materially from the CSA by (among other matters) requiring Fund Fact delivery only with the initial contract purchase (rather than each subsequent investment in a segregated fund), and permitting multiple classes or series to be included in same Fund Facts document.  To date, the CSA have not provided a rationale for the more lenient treatment of Fund Facts in the context of segregated funds despite their functional equivalency to mutual funds.  There also is no requirement to deliver Fund Facts in the context of linked note sales (another product that is functionally equivalent to mutual funds).  While the CSA have stated that they expect disclosure for all types of investment products to evolve over time, past experience suggests that the Fund Facts regime for mutual funds will not be applied beyond investment funds.

Investor education and the role of the adviser

The Fund Facts initiative is based on the premise that investors will make more informed investment decisions by receiving Fund Facts.  However, the initiative has never addressed the low level of financial literacy of the average Canadian investor.  There is no evidence to support the conclusion that the average Canadian investor understands the information provided in Fund Facts.  The CSA's own research confirmed that overall knowledge of basic investment concepts is low, many investors overestimate their investment knowledge, and investors are likely to be influenced by whether they recognize the names of the companies in which a mutual fund invests its assets[3].  As well, a "more informed" investment decision is not necessarily a "better" investment decision.  Time will tell whether the performance of average retail accounts will improve as a result of the information in Fund Facts.

Canadian securities legislation has long recognized that investing in securities requires specialized expertise which generally is obtained only after extensive proficiency training.  For this reason, a long-standing investor protection feature of Canadian securities legislation has been the requirement for investors to place all purchase orders through registered representatives who first perform know-your-client and suitability reviews before executing the purchase order.  The Fund Facts regime is effectively encouraging investors to rely more upon their own judgement, even though a large portion of investors prefer to rely upon the recommendations of their advisers.

Rationalizing existing disclosure and reporting

The myriad of reports and information delivered or available to mutual fund investors under securities legislation is staggering.  They include the simplified prospectus, annual information form, Fund Facts, annual financial statements, interim financial statements, annual management report of fund performance, interim management report of fund performance, quarterly portfolio disclosure, trade confirmations, account statements, report of the independent review committee, proxy voting record, and soft dollar arrangements.  Each of these items entails a cost and administrative burden on the management of mutual funds.  If Fund Facts now are the cornerstone of disclosure to investors, the CSA should revisit the usefulness of other information still required to be prepared under securities legislation with a view to reducing and streamlining this less-essential disclosure.

Cost-benefit

Once again, the CSA have provided no meaningful cost-benefit analysis of the proposed amendments.  There was no attempt to quantify their costs or benefits and, in fact, the CSA expressly acknowledged that these are "difficult to quantify".  Nonetheless, the CSA still concluded that the "…potential benefits of the changes to the disclosure regime…are proportionate to the costs of making them".  The CSA invite submissions concerning the anticipated costs of the proposed amendments, thereby effectively placing the onus on the industry to perform the cost-benefit analysis.  Due to the CSA's commitment to implementing pre-delivery, it is unlikely that cost-benefit submissions will have any impact on the proposed amendments.

Other concurrent initiatives

The CSA reiterated that they are seeking to standardize the mutual fund risk classification methodology[4].  It is unclear whether this change will be implemented on the same timeline as pre-delivery of Fund Facts or as a separate initiative.

The CSA also stated their intention to introduce a summary document, equivalent to Fund Facts, for delivery to investors in exchange-traded funds within two days after purchasing securities of the fund.  This proposal is expected to be published for comment in the fall of 2014.