On April 13, 2012, the Investment Funds Branch of the Ontario Securities Commission released the April 2012 issue of The Investment Funds Practitioner (the "Practitioner"). The Practitioner provides an overview of recent issues arising from applications for discretionary relief, prospectuses and continuous disclosure documents and is intended to provide fund managers and their counsel with a view as to Branch staff's ("Branch Staff") approach to resolving such issues.
The Practitioner highlighted three general prospectus-related issues that Branch Staff recently encountered, namely (i) the correction of fund fee disclosure, (ii) misleading fund names and (iii) counterparty hedging fees. Where a fund has incorrectly disclosed its fee structure in a prospectus, Branch Staff may require the filing of an amendment, a securityholder vote on ways to address issues arising around the fee correction and reimbursement of either the fund or securityholders. Securityholders that purchased securities prior to the correction should also be notified of the error and the fees going forward. With respect to fund names, fund managers must select a name that closely reflects the fund's investment objectives and distinguishes the fund from other funds. In connection with hedging fees, where a fund intends on paying a separate fee to its counterparty under a forward agreement as a means to compensate such counterparty for the costs of hedging its exposure under the forward agreement, Branch Staff expects the fund to disclose the amount of this fee, the range or the maximum expected counterparty hedging fees to be paid by the fund annually.
In addition to the foregoing, Branch Staff identified specific concerns with exchange-traded funds ("ETFs") that track an index and the portfolio transparency of actively-managed ETFs in continuous distribution. Branch Staff indicated that it is not sufficient for the investment objectives of an ETF that tracks a specific index to merely state that the fund aims to replicate the performance of such index without stating the primary asset composition and key features of the fund under normal market conditions. Additionally, the investment strategies section of the fund's prospectus has to sufficiently describe each index, state the key factors in determining which securities form part of each index and indicate where the public can access the composition of each index at any given point in time. Fund managers of actively-managed ETFs in continuous distribution should be aware that Branch Staff may request (i) how often the ETF portfolio holdings are publicly disclosed on the fund manager's website and (ii) whether the ETF portfolio holdings are disclosed to the fund's designated brokers or market makers, how often this disclosure is made, if there is a contractual obligation to do so and whether the frequency of this disclosure differs from the frequency of disclosure of the portfolio holdings to the public.
Some managers of closed-end funds have proposed investing a significant portion of their fund's assets directly or indirectly through a derivative in one or many foreign-based investment funds that are not reporting issuers in Canada (each an "Underlying Fund"). In such circumstances, Branch Staff will require prospectus-level disclosure and complete financial reporting for each Underlying Fund. Additionally, through the closed-end fund's SEDAR profile, the closed-end fund will be required to provide timely access to the continuing disclosure of each Underlying Fund including financial statements, management reports and all material changes.
Fund managers should be aware that Branch Staff noted their concerns with the increased use of standalone warrant offerings by closed-end funds. Such concerns include the dilutive and potentially coercive effects of such offerings and the possible conflicts of interest that may exist with respect to the fund manager.
Continuous Disclosure Issues
Branch Staff conducted a review of select investment funds that make regular distributions to investors and noted certain practices that may lead investors to incorrect conclusions about the funds' returns. In particular, Branch Staff noted that several funds pay distributions which are regularly and significantly in excess of the respective fund's increase in net asset value. In such instances, notwithstanding that the distributions are often described as "yield" or "income", which implies underlying performance or earnings to investors, Branch Staff view such distributions as a return to the investor of their own capital. Additionally, Branch Staff noted that some funds pay distributions in the form of reinvested units, unless investors expressly choose to receive cash distributions. In these circumstances Branch Staff will ask that fund managers include (i) prominent disclosure that investor action is needed if distributions in the form of cash are desired, (ii) bold-faced disclosure that any distributions in excess of the fund's income represent a return of the investor's capital and (iii) financial disclosure where a distribution or yield is quantified in a prospectus, sales communication or on a website.
Branch Staff take the view that the posting of mutual fund sales communications on participating dealers' intranet websites is considered a cooperative marketing practice governed by NI 81-105. Mutual fund companies should document whether or not they were solicited by a participating dealer to engage in this cooperative marketing. If so, mutual fund companies must pre-approve the participating dealer's costs for this marketing to ensure that the costs will be consistent with the requirements of NI 81-105, and that the costs are reasonable.
Branch Staff are imposing a new timing deadline for responses to their comment letters in connection with exemptive relief applications and prospectuses. In general, where a response has not been received within three months of a comment letter, Branch Staff will notify filing counsel that it will close the file without notice within two weeks of the most recent correspondence.
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