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 certain key issues and provides tips for investment funds issuers.
Applications for exemptive relief
Issue: In deciding whether to approve a proposed merger of public investment funds, the OSC raised questions concerning changes in the way performance fees were calculated for certain of the merging funds and how those changes were made, including whether the necessary securityholder approval was obtained.
Tip: Part 5 of National Instrument 81-102 – Mutual Funds requires the approval of securityholders in order to effect certain fundamental changes to an investment fund. Securityholder approval may be required if the method of calculating performance fees would change for any of the funds under the proposed merger.
Prospectus delivery relief
Issue: Certain filers have obtained exemptive relief from the prospectus delivery requirement for pre-authorized purchase plans. These exemptive relief orders will terminate by June 13, 2014, the date that Stage 2 of the Point of Sale disclosure initiative becomes effective, requiring delivery of Fund Facts in lieu of a prospectus.
Tip: Filers might wish to seek exemptive relief from the new requirement to deliver Fund Facts in lieu of a prospectus in respect of pre-authorized purchase plans in effect after June 13, 2014. The OSC has proposed the adoption of a statutory exemption in Stage 3 of the Point of Sale disclosure initiative, but such statutory exemption, if adopted, is unlikely to be in place as of June 13, 2014.
Bullets in prospectuses
Issue: The OSC is of the view that management fees are material information that must be included in preliminary prospectuses of investment funds.
Tip: Investment funds are encouraged to include the management fee information in their preliminary prospectuses in order to avoid a delay in obtaining a receipt for either the preliminary or final prospectus.
Flow-through limited partnerships
Issue: The OSC has observed that recent flow-through limited partnership prospectuses have included annualized after-tax returns but not annualized before-tax returns. Recently, filers have expressed the view that presenting annualized before-tax and after-tax returns for standard performance periods of 1-, 3-, 5- and 10-year periods is not relevant or useful for investors.
Tip: In a flow-through limited partnership prospectus, the OSC will allow disclosure of annualized after-tax returns of prior flow-through limited partnerships managed by the same manager provided that annualized before-tax returns are also disclosed. The OSC is generally prepared to accept annualized before-tax and after-tax returns for the period from the date of inception of the flow-through limited partnership to the date of the rollover so long as all relevant assumptions are clearly disclosed.
Issue: The OSC has noted that "finder's fees" paid to related entities that source investment opportunities in resource issuers' securities for flow-through limited partnerships represent a conflict of interest matter under National Instrument 81-107 – Independent Review Committee for Investment Funds.
Tip: Such finder's fees arrangements should be referred to the fund's independent review committee for the independent review committee's recommendation and should be disclosed in the fund's prospectus.
Portfolio disclosure of cash
Issue: The OSC received an inquiry as to how to appropriately disclose cash and money market funds in a fund's management report of fund performance (MRFP).
Tip: The OSC views cash as a portfolio holding and as a result cash must be included in a summary of the investment portfolio. In "top 25" disclosure, the OSC expects cash and cash equivalents to be disclosed on a line separate from an investment in a money market fund. However, in the portfolio breakdown, holdings in money market funds can be grouped into the same category as cash and cash equivalents. The same methodology applies for disclosure in the fund's Fund Facts document and quarterly portfolio disclosure.
Fixed income funds
Issue: The OSC has undertaken a review of the risk management processes used by portfolio managers of fixed income funds. The OSC noted that portfolio managers have engaged in shortening fixed income portfolio durations and investing in floating rate instruments.
Tip: The OSC encourages portfolio managers of fixed income funds to assess the impact of various factors including interest rate spikes, widening spreads and elongated periods of higher volatility in the fixed income markets, by conducting scenario analysis testing for those factors.
Tip: The OSC encourages managers to stress test and assess the sources of the fund's liquidity during normal periods as well as high redemption periods and lengthened periods of reduced liquidity.
Tip: The OSC encourages funds to continue providing robust disclosure in the MRFP regarding risks that have arisen due to recent events as well as the potential impact of recent actions by central governments regarding fixed income portfolios. The OSC also encourages funds to consider increasing the frequency of monitoring their risk ratings given the elevated volatility in the current fixed income markets.
Fund Facts – new delivery and filing requirements
Issue: On June 13, 2013, final amendments were published with respect to Stage 2 of the Point of Sale disclosure initiative, which when phased in will require delivery of a Fund Facts document in lieu of a prospectus within two days of the sale of a mutual fund security. The form of Fund Facts has also been amended.
Tip: As of January 13, 2014, a mutual fund that files a preliminary or pro forma simplified prospectus and annual information form must concurrently file a Fund Facts in the amended form for each class or series of the mutual fund so offered. In any event, amended Fund Facts must be filed for each retail mutual fund no later than May 13, 2014.
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