Fund managers could be doing a better job of revealing the details of the fees and expenses they charge, and how they allocate expenses to their funds, according to a review by the Ontario Securities Commission (OSC).

In OSC Staff Notice: 81-724 – Report on Staff’s Continuous Disclosure Review of the Fees and Expenses Disclosure by Investment Funds published Thursday, the OSC’s investment funds branch sets out several recommendations to fund managers for improving disclosure in the wake of a targeted review of investment funds’ disclosure practices involving fees and expenses.

That review, which was carried out last year, found “good general compliance” with disclosure requirements in this area, but also uncovered areas where disclosure could be better.

For example, the OSC found that the prospectuses it reviewed generally didn’t give enough detail for investors to determine which costs and services are being paid for out of management fees, and which are being charged to funds as operating expenses. The OSC notes that firms often use generic “catch-all” wording in their disclosure, and that its staff often had to refer to funds’ trust agreements, or management agreements, for greater detail.

The OSC found that firms’ expense allocation practices — whether they allocated part of their expenses to the funds they manage, and if so, how — was another area where the disclosure was often lacking. It also found that most of the fund managers who allocate expenses to their funds “did not provide related party disclosure.” And, it says that “only a few provided note disclosure with respect to the allocation, but failed to provide details such as the amount or measurement basis of the transactions.”

“The fees and expenses of a fund are an important consideration for investors,” the notice says. “We encourage fund managers to clearly disclose fees and expenses to provide more transparency and clarity, where possible, on what services are paid for out of the management fees, which services are charged as operating expenses and how all the fees and expenses are being allocated.”

The notice stresses that fund managers should be providing specific disclosure about what is covered by management fees and what is charged to a fund as an operating expense. “Investors should not have to refer to the management or trust agreement to determine whether a particular cost is covered by management fees or charged as a separate operating expense to the funds,” it says. “Having all the relevant fees and expenses information disclosed in the prospectus will enable investors to compare the different fee models and structures, and make an informed investment decision.”

Additionally, it says that “fund managers should consider enhancing the transparency of their expense allocation” in order to mitigate the conflicts of interest that are inherent in these practices. “For example, a fund manager should, to the extent possible, ensure that its funds’ prospectus specifies the types of costs the fund manager may recover from its funds. We also remind fund managers to disclose the particulars of the material conflicts of interest in the prospectus,” it says.

In terms of continuous disclosure, the OSC says that fund managers must comply with related party disclosure requirements, and provide the details of these transactions in their funds’ financial statements and performance reports. This disclosure should also explain how these conflicts are mitigated, it says.

The notice points out that expenses that are allocated to particular funds should “have a direct relationship to the daily operation of the funds” and that they should be negotiated at arm’s length to be fair and reasonable to the funds. It says fund managers should not be recovering expenses through “opaque or complex methodologies that are not intuitive and not directly linked to the services being performed for the funds.”

The question of allocating expenses should also be referred to independent review committees (IRCs), the notice says; and, fund managers should have policies in place to deal with the allocation of expenses between the fund manager and its funds, the commission notes.

The review looked at the disclosure practices of 18 fund managers from conventional mutual fund managers, to exchange-traded fund and closed-end fund managers. It looked at both their prospectus disclosure, and various elements of their continuous disclosure records, including financial statements, management reports of fund performance, and independent review committee reports. The firms included in the review manage combined assets of $210 billion.