More firms were certainly involved, and the investors behind the trading aren’t being dealt with

By James Langton | January 2005

With record fines, disgorgement and a huge restitution payment due to investors, the mutual fund market-timing issue can be forgotten, right? Well, no. Despite the fact that the settlements represent a positive step by promising investor restitution, they leave a lingering sense of dissatisfaction about both the industry’s actions and the regulatory response.

At the macro level, the market-timing settlement is precedent-setting. The size of the fines and disgorgement is substantial: more than $200 million from the eight settlement agreements worked out by the Ontario Securities Commission, the Investment Dealers Association of Canada and the Mutual Fund Dealers Association. A large part of the monetary settlement is slated to be returned to investors — about $156.5 million. And it marks the first disciplinary case for the fledgling MFDA. On all these counts, the settlement should be applauded.

That said, much has been left unresolved. For one, it appears the regulators could have done more. While more than $200 million in fines and restitution is coming from the fund companies that allowed market-timing and the dealers who facilitated it, the institutional investors that made the trades in question — adding more than $300 million in estimated profit, although not all of it from market-timing — are not to be touched.
According to the settlements, the fund companies garnered only $27 million in revenue from the market-timers, including management fees earned on assets and other fees. The vast portion of the profit from this trading went to the institutional investors that made the trades. And the OSC has indicated it can’t touch them because market-timing is not strictly against the rules.

But market-timing wasn’t strictly against the rules for the fund companies, either. Indeed, in delivering the OSC panel’s reasons for approving the settlements, OSC vice chairman Paul Moore indicated that, although the fund companies didn’t violate specific rules, they did violate the principles of fairness to clients. “We have a ‘public interest’ jurisdiction to intervene in the marketplace,” he said, “and blow the whistle when conduct goes offside [vs] basic principles.”

So, although neither the institutional investors nor the fund managers really broke any rules, only the fund managers are being asked to pay the price. Eric Pelletier, manager of media relations at the OSC, says the OSC could use its public interest jurisdiction to go after investors who seek to abuse the markets; however that would depend on the specific facts of the case, and it isn’t doing that in this case.
Moreover, not all the fund managers that allowed market-timing are being called to account, either. The OSC confirmed it has sent a letter to one more fund company, Franklin Templeton Investments Corp., indicating it still could face enforcement action. But beyond that, the OSC reports, the market-timing investigation is over and no other firms will face enforcement proceedings.

However, the settlements between the IDA and three big bank-owned investment dealers — BMO Nesbitt Burns Inc., RBC Dominion Securities Inc. and TD Waterhouse Canada Inc., all based in Toronto — indicate there were certainly more companies involved. For example, TD reportedly executed market-timing trades for clients in funds from at least 20 managers; BMO’s clients used 15 firms; and RBC DS’s clients dealt with 11.
While some of these fund companies may have been market-timing victims themselves, the settlement with RBC DS indicates one of its clients had special deals with seven fund firms. And TD’s settlement reveals it had a special arrangement to allow market-timing with TD Canadian Small-Cap Equity Fund.

So, it seems not all the firms that consciously allowed market-timing have been caught in the OSC enforcement action. Indeed, the OSC acknowledges as much. “Our purpose is not to punish all wrongdoers but to protect the market,” says Michael Watson, director of enforcement at the commission. “We have sent a strong message to the industry with the settlements reached. In fact, the market-timing practices have stopped since we began our probe, and procedures are in place to detect and prevent them in the future.”
Nevertheless, there are certainly unitholders that have been hurt by market-timing traders, but who won’t get the same treatment as those who had funds at the firms targeted by the OSC. These unitholders will probably never know they have been damaged by market-timing. It is not unusual for the OSC to make an example of firms it believes to be the most egregious offenders, in order to make a point to the rest of the industry. But it’s not typical that the commission is seeking restitution for investors.