The fact that an Ontario Securities Commission investigation uncovered evidence of market timing trading in the Canadian mutual fund industry has been known for some time. The question has always been what sort of allegations may come down as a result, and how could the industry be impacted. Unfortunately, the announcement that four fund firms may face charges does little to clear up those crucial questions.

The OSC revealed in its announcement Tuesday that it hasn’t found evidence of late-trading in its 10-month old investigation of Canadian fund firms. That’s the good news. Late-trading is certainly offside, and clearly abusive of long-term investors. The fact that this practice is apparently not going on in Canada should be something of a relief to investors, and the industry.

However, the OSC has found some evidence of market-timing, which is not strictly off limits, but may be considered abusive in certain circumstances and may contravene mutual fund prospectuses. But, it has yet to bring actual enforcement allegations.

Instead, the OSC said it has sent letters to four firms (AGF, CI, AIC, and Investors Group have all issued press releases admitting that they are involved) warning them that they may face allegations as a result of its investigation.

Industry analysts suggest the harm the industry may ultimately suffer from this scandal will probably be based on the specifics of any allegations that eventually come down. “The extent to which it will damage the industry directly relates to the extent to which funds from the nation’s largest fund companies are found to be involved in improper practices,” says Dan Hallett, president of Windsor, Ont.’s Dan Hallett & Associates Inc.

The OSC cautions that other fund managers may face allegations as it completes its investigation over the next few months. But, the fund firms that have already been singled out are some of the industry’s biggest players. The four firms that have admitted they may face enforcement action represent a combined $117 billion in mutual fund assets, or almost 25% of the $476 billion in total industry assets.

Apart from the prevalence of market timing, Hallett says that other the big issue in any enforcement action will be the extent to which this sort of trading was allowed under deals between fund companies and institutional investors. These existence of these sorts of special deals would reveal that firms knowingly agreed to favour one class of investors over another and didn’t act in small investors’ best interests. Hallett suggests that the industry would probably be particularly damaged if it emerges that these sorts of deals existed.

That said, Hallett says he’s not surprised by the revelations so far. “ I have long said that market timing was in Canada and that many companies began taking measures to limit it before the [U.S. mutual fund trading investigation was initiated by New York State attorney general Eliot] Spitzer probe.”

For those that haven’t taken such measures, in late August the investment Funds Institute of Canada issued a report recommending that firms use four tools to deter market timers: daily trade monitoring, short-term trading fees, fair value pricing and outright trading bans against suspected market timers. It suggested that daily trade monitoring should be a given, but that individual firms should use a mix of other tools at their discretion.

IFIC vice president regulation and corporate affairs John Murray declined to comment on any of its members specifically, but says, “We are looking to this investigation to help clarify the standards of practice that the OSC expects of our members.”

“As both we and the OSC have said publicly, this is a very complex issue and it is important for the industry and the regulators to come to a common understanding about any activities that, although previously accepted by the regulators, may no longer be permitted,” Murray says. He notes that IFIC expects to continue cooperating with the OSC, the Mutual Fund Dealers Association and the Investment Dealers Association on this issue.

Indeed, apart from any specific charges against fund firms, the other shoe left to drop in this case is the possible involvement of securities dealers in facilitating any improper trading. Both the MFDA and the IDA took part in the OSC investigation, and charges on that end look likely too.