On February 19, the Ontario Securities Commission (OSC) approved a settlement between OSC staff and AlphaNorth Asset Management (AlphaNorth) as well as its ultimate designated person (UDP) Steven Douglas Palmer (Mr. Palmer). In Vice-Chair Moseley’s reasons approving the settlement, he stressed that it was important for retail fund managers to follow the rules for conflict mitigation and allocate adequate resources for compliance programs.

Background: AlphaNorth is the investment fund manager and portfolio manager for certain funds (Funds) with retail investors. Collectively, the Funds had approximately $5.6 million in assets under management at the relevant time considered in this case. In 2016, AlphaNorth implemented certain changes to the funds to set lower “high-water marks” for the performance fees to be paid to it by the Funds. AlphaNorth informally notified investors of the changes but didn’t seek their approval or update the Funds’ prospectuses to reflect the changes.

AlphaNorth’s Auditor Spots a Problem: In February 2017, the Growth Fund’s external auditor asked for documentation to support the changes described above. AlphaNorth then engaged external counsel to develop a rectification plan, which it carried out after the Funds’ Independent Review Committee (IRC) recommended that it proceed and after AlphaNorth notified OSC staff of the issues.

What Went Wrong: The Settlement Agreement and Reasons indicate that AlphaNorth breached securities laws because it failed to:

  • Refer the proposed changes to the IRCs for the Funds, as required under National Instrument 81-107 Independent Review Committees for Investment Funds (NI 81-107);
  • Bring the lower high-water marks to meetings of the relevant classes of shareholders, as required by National Instrument 81-102 Investment Funds (NI 81-102); and
  • Make appropriate disclosures regarding the changes it had made by, among other things, updating the Funds’ prospectus documents, as required by the Securities Act and National Instrument 81-106 Investment Funs Continuous Disclosure (NI 81-106).

But Wait, There’s More: The Settlement Agreement also addressed deficiencies identified during an OSC compliance review for the period June 2016-May 2017. These deficiencies involved, among other things, inadequate oversight of AlphaNorth’s dealing activities for third-party, exempt products and failures to identify, appropriately address and disclose conflict of interests in relation to finder’s fees received from issuers. Mr. Palmer was found to have failed to discharge his responsibilities as UDP to ensure and promote compliance with securities legislation.

The Settlement Agreement describes in detail the steps that AlphaNorth took to rectify the non-compliance, including repayment for the overcharged performance fees, communications with affected shareholders, referring the matter of the applicable finder’s fees to its IRC and obtaining their recommendation to proceed, updating filings, and correcting disclosure documents.

Settlement Terms: The OSC approved a settlement in which:

  • AlphaNorth agreed to pay an administrative penalty of $147,000 as well as $10,000 costs and undertook not to increase its fees or take any other steps that would result in its clients sharing the burden of the settlement; and
  • Mr. Palmer agreed to pay an administrative penalty of $100,000 and complete an educational program in regulatory compliance and risk management within a year.

Our Takeaways: Even though AlphaNorth acted to rectify the non-compliance, repay investors and self-report to the OSC once it became aware of the problems, the firm and its UDP incurred significant monetary penalties, relative to the Funds’ assets under management. Of course, if AlphaNorth had not acted swiftly and cooperated with the OSC, the penalties and costs might well have been significantly higher.

These outcomes underscore for firms and their senior management the importance of having an effective compliance regime that enables them to, among other things, identify and mitigate conflicts of interest. And when fund managers consider making changes to elements like fund fees, it’s essential to step back and determine whether any special procedures (like IRC review, investor approval and/or updates to offering documents) are required.