Canada: Canadian Securities Regulators Release Second Request For Comments On ‘Stage 2’ Of Point Of Sale Disclosure

In late June, the Canadian Securities Administrators (CSA) published for a second comment period proposed amendments to National Instrument 81-101 Mutual Fund Prospectus Disclosure (NI 81–101) and its companion policy, which include new proposed amendments to the form requirements for Fund Facts. This package of proposed amendments [available here] constitutes the second iteration of the CSA's 'Stage 2' implementation of the overall point of sale disclosure framework, being the proposed requirement to deliver the Fund Facts to investors in lieu of the fund's simplified prospectus, within two days of the trade.

This second round of proposed amendments was prompted by feedback, particularly from investor advocates, to the first publication in August 2011, of the proposed 'Stage 2' amendments, as well as feedback on Fund Facts, which have been available to investors since July 2011. A new sample Fund Facts document was published as part of the proposals, which is appropriate since much of the proposed amendments relate to changes to the form requirements for this document.

The Proposed Amendments

Some of the proposed amendments to NI 81-101 are positive changes that we believe will improve disclosure for investors. Some are not. The highlights are set out below categorized according to our views on "the good, the bad and the ugly".

The good:

• Fund Facts will be permitted to be bound with account application documents, registered tax plan documents, transaction confirmations and certain other documents relating to transactions listed on the confirmations, although there remains some lack of clarity on what can be included as those "other" documents. This will provide much needed flexibility.
• Funds will be permitted to disclose material changes and proposed fundamental changes in their Fund Facts. This change is a welcome one as it will eliminate the current need to submit an exemption application to allow disclosure of this important information.
• Disclosure of fund codes and other forms of identifiers will be permitted in the Fund Facts without resort to an exemption application.
• The "Quick Facts" section in the Fund Facts will disclose both the date the fund began offering under a prospectus, as well as the date the series commenced, thus correcting the misleading date information mandated currently. The "ugly" is that certain other references to "fund" in the form requirements have not been updated to reflect the fact that they are, in fact, references to "series" information.
• Funds will be permitted to present financial information as at a date within 45 days of the date of the Fund Facts, which represents an extension from the current 30 days, providing some breathing room to allow the collection and presentation of financial data.
• Additional disclosure about the relationship between risk and returns will be required, which, although a bit simplistic and somewhat negatively phrased, may be useful for some investors.
• A cross-reference to the CSA's brochure Understanding mutual funds will be required at the end of the Fund Facts. The brochure may be of assistance to some investors who need more educational and background information than can be provided in the Fund Facts.

The bad:

• Rescission and withdrawal rights across the country are still not harmonized and there is no indication as to when the CSA will tackle this long-standing problem.
• Up to four risk factors will be required to be disclosed in the Fund Facts with a cross reference to the simplified prospectus discussion of these risks. These risk factors cannot be described, which may result in such listings being ineffective, or worse, misleading, particularly given that different funds use the same terms, but with different meanings. In any event, we view this requirement as a classic example of regulated "disclosure creep".
• Although we have categorized the required cross-reference to the CSA's brochure as "good", we note that this brochure may change and we recommend that managers and dealers alike keep an eye on the information contained in this brochure.
• The "A word about tax" section of the Fund Facts has not been amended, notwithstanding BLG's (and others') comments on how this section is potentially misleading and needs to be revised to make it less generic.
• Trailing commission disclosure continues to be an issue for the CSA, fuelled by submissions by investor advocates. A new sentence highlighting the conflicts these payments may cause for dealers and sales representatives will be mandatory. The "ugly" is the mandatory statement to "ask your dealer representative for more information". What response will be expected of sales representatives when asked this question?
• Regardless of the investment objective or benchmark of a fund, a fund must compare its performance with a 1-year GIC in a year-by-year bar chart in the Fund Facts, as well as its since inception (or 10-year) performance. The GIC data is to be taken from the Bank of Canada, notwithstanding that GICs tend to be specific to their issuing financial institution. The CSA explain that this comparison is intended to highlight the risks of investing in a mutual fund when compared to a risk-free investment, but it is not clear whether this explanation (which we find helpful) could be provided in the Fund Facts. Without additional explanation, investors may not understand the trade-offs between investing in GICs and the risk of not generating enough income to enable retirement, and investing in mutual funds.

The ugly:

• Funds will be required to disclose their worst three-month performance -ever- under a new heading "Worst return". The CSA explain that this disclosure is necessary to better inform investors about the possible loss of investment in the fund. We consider this disclosure to unduly emphasize short-term performance, without a counterbalance showing the potential for upside performance over the long-term, which is the commonly understood essence of mutual fund investing. This information may also be difficult to obtain for those funds that are of a long duration, given that the data must be provided for the worst three-month period since the inception of the fund (with no 10-year cut-off), and will put those funds at a significant disadvantage because of the greater chance that those funds at some point fell into a significant down-turn situation.
• The CSA propose a six-month transition period to the new requirements and explain that they expect the industry to start making "the systems changes" now to permit delivery of the Fund Facts in lieu of the simplified prospectus. We consider this expectation to be a bit presumptuous for proposals that have not been finalized.
• The CSA are considering whether to require the Fund Facts of all mutual funds to be amended within a specific time period after the rule amendments become effective, which will be a huge administrative burden on everyone's part – including the regulators. We will urge the CSA to permit the Fund Facts to be amended to comply with the new requirements at the next renewal cycle, which is more usual for significant disclosure changes.

What 's Next?

Given that comments on these amendments are due by September 6, 2012, we anticipate that the CSA are working to publish the final form of rule amendments by year-end 2012, although the CSA explain that certain CSA members require amendments to the legislation in their province/ territory before they can finalize the proposals.¹ Whether or not they meet this deadline, we believe that this will be the last chance for the industry to provide comments on these amendments.

More changes to the Fund Facts can be expected even after these amendments are finalized. The CSA explain that they are considering mandating a specific CSA risk classification methodology, which would require all mutual funds to calculate their risk level in accordance with this methodology. This will affect the "risk classification" disclosure in the Fund Facts and we can expect the impact of any new methodology to reverberate throughout the industry, given the dependence on risk classifications for suitability purposes by dealers.

We remain disappointed that the CSA have not set a timetable for harmonizing the other disclosure documents – the simplified prospectus, the annual information form and the continuous disclosure documents, but are gratified that they recognize the need for a "single foundation" document to replace the simplified prospectus and annual information form.

Finally, the final stage of the point of sale amendments should be kept in mind – the CSA continue to work towards mandating pre-trade delivery of Fund Facts. The CSA are also considering extending the Fund Facts concept to other investment funds, in addition to mutual funds regulated under NI 81-101. No indication on timing is suggested in the CSA Notice nor in the recently completed OSC's Statement of Priorities for 2012-2013.

Footnote

1. The proposed amendments to the Securities Act (Ontario) are not yet in force, but were finalized in 2011 as part of the 2011 Ontario Budget Bill 173 [S.O. 2011, c.9]. They are included as "proposed additions" in the 52nd edition of the Consolidated Ontario Securities Act, Regulations and Rules published by Carswell and edited by Paul G. Findlay of Borden Ladner Gervais LLP.

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