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Emerge Canada Inc. has liquidated its 11 ETFs that have been under a cease-trade order since April, but the fund manager still has not repaid the millions it owes to five of those funds.

Emerge told unitholders Wednesday that the six Emerge ARK ETFs and the five Emerge EMPWR ETFs were “fully liquidated by Oct. 31,” with the sale proceeds held by RBC Investor Services Trust earning 4% interest.

Unitholders received the proceeds of their investment minus liabilities and fund expenses, and without receiving the money owed by Emerge Canada Inc. to five of the six Emerge ARK ETFs.

The ETFs had been untradeable since the Ontario Securities Commission (OSC) placed a cease-trade order (CTO) on all 11 of Emerge Canada Inc.’s ETFs on April 6, after Emerge missed its deadline to file audited annual financial statements. The order represented the first time a CTO had been placed on a family of ETFs in Canada.

On May 11, the OSC suspended Emerge Canada’s registration for capital deficiency, highlighting a receivable owed to five of its Emerge ARK ETFs that had grown to $5.5 million.

As of Dec. 20, Emerge told unitholders that the outstanding receivables totalled $4.69 million, which is about $800,000 lower.

The flagship Emerge ARK Global Disruptive Innovation ETF (EARK) and the Emerge ARK Genomics & Biotech ETF (EAGB) are owed the most, with the outstanding receivables for each fund representing about 5.6% of the net asset value (NAV) for each ETF as reported by Emerge on Dec. 15.

The receivables represent between 0.55% and 1.50% of the NAV for the remaining three ETFs with money owed.

In a notice to unitholders, Emerge said that if it can repay the receivable by Dec. 29, the payments will go to unitholders via their dealers, with no expenses deducted. The five ETFs will then be terminated.

If the receivable is not paid by Dec. 29, the unitholders will become unsecured creditors of Emerge Canada and the ETFs terminated.

Dan Hallett, vice-president of research and principal with Oakville, Ont.’s HighView Asset Management Ltd., said he can’t recall another instance of unitholders becoming creditors to an ETF sponsor in the past 30 years.

Hallett said he hopes the receivable is repaid, but suggested that unitholders “not actually count on it unless the final payment has been received, just based on how long this has been tied up.”

If the receivable isn’t paid, “it’s not a massive percentage” of the NAV, he said, acknowledging this is cold comfort to unitholders. “It’s meaningful enough that it will hurt, but it’s not the most costly of lessons” since investors are still receiving the sale proceeds.

“Emerge’s disclosure to unitholders is completely inadequate,” said Garth Myers, a partner with Kalloghlian Myers LLP in Toronto, which has filed a proposed class-action lawsuit against Emerge. “It fails to contain particulars in relation to the costs to unitholders caused by their misconduct, particularly in relation to the liquidation of these assets.”

Myers said his firm intends to move forward with the class action even if Emerge fully repays its receivables by Dec. 29, because “we still don’t know the extent of the damages caused,” he said. “The receivables are only part of it.”

The class action has not been certified.

Emerge Canada Inc. declined to comment for this story.

Toronto-based AUM Law was appointed on Nov. 1 to monitor the wind-down of the ETFs. Following the orderly wind-down of all 11 ETFs, Emerge Canada Inc.’s registration will be fully suspended by the OSC.

Lost opportunities

“If we recap the experience investors have had, the communications have been poor, the transparency has been lacking,” said Yves Rebetez, partner with Credo Consulting Inc. in Oakville, Ont. “And then the execution of it all and the end result leave me going ‘Wow.'”

The Oct. 31 liquidation date means the Emerge ARK ETFs missed out on the spectacular technology run-up last month. Cathie Wood’s ARK Innovation ETF, upon which EARK is based, returned 31.1% for the month of November following three straight months of losses. The returns represent the ETF’s strongest month since inception.

Furthermore, “in November, the BMO ARK Innovation Fund was the top performing equity fund in Canada, inclusive of mutual funds and ETFs,” said Danielle LeClair, director of manager research with Morningstar Canada. “This year, cryptocurrency funds have had the strongest performance, but in November [the BMO fund] beat out even those strategies.”

Returns on a NAV basis for the six Emerge ARK funds between April 6, the day of the cease-trade order, and Oct. 31 range from -19.80% for EAGB to 2.36% for the autonomous tech and robotics ETF. The EARK fund returned -6.67%.

Rebetez questioned why investors needed to wait until late December to receive the net sale proceeds if the funds were fully liquidated by Oct. 31, adding that with Canadian and U.S. markets moving to next-day settlement in 2024, the delay seems even less reasonable.

“It’s not T+1 [yet], but it shouldn’t be T+50,” he said. By holding on to the proceeds, the manager was “taking away from the investor that opportunity to do market timing…. You don’t get to redeploy the funds, and you missed out on the investment that you wanted in the first place, which has since then exploded.”

Lessons learned

Rebetez said he hopes the Emerge case will lead to industry and regulatory reflection.

“What’s the reasonable amount of time so investors don’t find themselves in this kind of situation again? How do we close the gap between [Emerge’s issues] having initially been disclosed and [granting] access to people’s funds so it doesn’t take as long?” he said. “The regulators need to revisit this kind of situation and find out how they can prevent this from reaching the stage it reached so [they] can protect investors prior to this becoming a problem.”

Rebetez and Hallett also pointed to the accounting rules that allowed Emerge to accumulate such a large receivable.

“What does that say about the governance model for mutual funds and ETFs that [the receivable] was allowed to persist and grow to the extent that it did?” Hallett said. (A receivable was first reported by Emerge in its 2019 financial statements.)

“It goes back to acceptable accounting principles and materiality,” Rebetez said. “If the [receivable] is $100,000 and there’s $100 million in assets, it’s not a big deal. But by the time it gets to a million dollars and then it grows to $5 million, Houston, we have a problem, right? What it says to me is the oversight is flat-footed or lacking, and by the time some action is taken, it’s already too late.”

Hallett said the main lesson for the industry is the importance of due diligence on fund companies — for financial advisors and retail investors alike.

The receivable information “was right there in the financial statements; there was nothing hidden,” Hallett said. “It was a big number and it grew every time.”

And Hallett, who has spent the majority of his career advocating for investors, said do-it-yourself investors must also perform this type of analysis, though he recognizes that many DIYers choose securities based on rumours and stories.

“You have to have a good due diligence process where you have a checklist on every product, because you don’t know where you’re going to find a problem if there’s a problem,” he said. “If you’re doing it yourself, it’s incumbent on you to know what you’re buying.”

Emerge ETFs timeline