The Ontario Securities Commission (OSC) recently released a new edition of the Investment Funds Practitioner, providing an overview of recent issues arising from applications for exemptive relief, prospectuses and continuous disclosure documents filed by investment funds. This legal update summarizes key issues and provides tips for investment funds issuers.
Dual dealer compensation
Issue: The OSC raised concern with investment fund series being intended for fee-based accounts but also having a trailing commission embedded as an ongoing cost. In staff's view, this type of dual compensation structure is potentially misleading to investors as it does not provide complete clarity to investors as to the cost and type of dealer services. The OSC also notes that a dual compensation practice may raise the issue of double-charging by dealers, which is contrary to their duty to deal fairly, honestly and in good faith with clients and could be contrary to the duty of investment fund managers to act in the best interests of their funds and investors.
Tip: The OSC has advised that any new fee-based series of an investment fund should not also have an embedded trailing commission. For existing fee-based series, during the review period for renewal prospectuses managers should anticipate the OSC asking about the manager's plans to close out the series to new investments and switch current investors out of the series and how long a reasonable transition period to effect this would be.
Bullets in prospectuses
Issue: Staff has noted that preliminary prospectuses for both long form and simplified prospectuses often contain bullets for items that should be disclosed in full in the preliminary documents. The OSC has noted that if a preliminary prospectus does not contain all material information, this may delay the prospectus from being receipted.
Tip: The following information is considered material and should be included in the applicable preliminary long form or preliminary simplified prospectus: (i) the auditor's name in the auditor's report; (ii) expenses and fees; (iii) the custodian's name; (iv) if applicable, the minimum offering amount (even if this is just the minimum listing requirement); (v) if applicable, the maximum offering size, if this can be reasonably anticipated; (vi) if applicable, any assumptions about the offering size if the offering size is not disclosed but assumptions were made as to the offering size for other disclosure in the prospectus.
Redemption of closed-end funds
Issue: As a result of amendments to National Instrument 81-102 – Investment Funds (NI 81-102), which became effective September 22, 2014, the redemption price of a security of a non-redeemable investment fund (or closed-end fund) cannot be more than the NAV of the security determined on a redemption date specified in the fund's prospectus or AIF. Since certain closed-end funds currently permit investors to request on a monthly basis that the fund redeem securities at a price determined with reference to the market price of the securities, the monthly redemption amount could be more than the fund's NAV, contrary to NI 81-102 (as recently amended).
Tip: The prospectuses for closed-end funds that offer the above monthly redemption pricing option should include a statement that, in any event, the monthly redemption amount will not be more than the fund's NAV. Note that the OSC does not consider this disclosure to mean that the redemption amount is calculated with reference to the NAV of the fund, and as a result, the inclusion of such a statement does not mean that the OSC will deem the fund a "mutual fund" under Ontario securities laws.
Issue: Where substantially all of a fund's foreign currency exposure is hedged and the hedging is not at the discretion of the portfolio manager, the OSC considers the currency hedging to be a fundamental feature of the fund and expects disclosure in the fund's prospectus.
Tip: Issuers should disclose the above currency hedging feature of the fund in the investment objectives section of the fund's prospectus.
T+2 settlement for European securities
Issue: Effective October 6, 2014, the majority of European Economic Area markets transitioned to a T+2 settlement period for all trading venue transactions, resulting in a time discrepancy between the settlement time for European securities held by an investment fund in Canada and the T+3 settlement period applicable for securities of such funds.
Tip: The OSC expects managers to evaluate their ability to accommodate T+2 settlement of transactions in European securities held by the fund. Staff notes that borrowings by a fund within the 5% limit of paragraph 2.6(a) of NI 81-102 incurred specifically to settle European securities trades and that cause the fund to be in a state of overdraft for a prolonged period of time will not be offside with that section. However, staff expects funds to seek exemptive relief where T+2 settlements would cause the fund to exceed the 5% borrowing limit.
Securities lending disclosure
Issue: As a result of the amendments to NI 81-102 effective September 22, 2014, disclosure is required in the prospectus and AIF of a fund with respect to securities lending arrangements and securities lending agents.
Tip: The new requirements affect both mutual funds and non-redeemable investment funds and require disclosure of: (i) the name of the fund's securities lending agent; (ii) whether the agent is independent of the manager; and (iii) the key terms of the securities lending agreement with the lending agent.
Issue: The OSC is increasingly focused on the fixed-income funds that have exposure to senior loans, in part because of potential mismatches between the timing of the settlement of such loans and the settlement of redemption requests by investors in the funds.
Tip: Funds that have a specific mandate to invest in senior loans or that invest the majority of their assets in senior loans should include a textbox on the cover page of the prospectus disclosing that: (i) the funds invest in senior loans that are not investment grade; (ii) settlement periods for senior loan transactions may be longer than for other types of debt securities such as corporate bonds; and (iii) senior loans are not an alternative to holding cash or money market securities. The disclosure should also appear in the summary disclosure documents or Fund Facts of the funds. The OSC also expects managers to be able to describe to staff how they actively assess liquidity levels, including specific metrics, and to engage in stress testing of individual fund holdings as well as senior loans as an asset class so funds can be prepared to meet higher-than-normal redemption demands. To minimize redemption settlement mismatches, such funds should consider including in their portfolio assets that are generally more liquid, such as cash.
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