Mutual Funds

Securities Law Amendments To Reduce The Regulatory Burden On Investment Funds – Corporate/Commercial Law

The long-awaited amendments to reduce the regulatory burden on
investment funds were published by the Canadian securities
administrators (CSA) in final form on October 7, 2021 and take
effect on January 5, 2022. The amendments mostly relate to
housekeeping matters that reduce very little regulatory burden,
while other aspects might actually increase regulatory burden in
the short term. We are disappointed that the CSA did not introduce
a number of additional changes that would have had a far greater
impact on reducing the regulatory burden on industry
participants.

The amendments are described by the CSA as eight
“workstreams”, the key provisions of which are summarized
below. We also have included some of our recommendations for
additional changes that were initially provided to the CSA through
the consultation process that preceded the final amendments. Most
of these recommendations remain relevant in our view.

  1. Consolidate the simplified prospectus (SP) and annual
    information (AIF) into a new long-form simplified
    prospectus.

The disclosure currently contained in the AIF is, for the most
part, being moved to the SP to produce a new long-form SP document.
The new long-form SP will be mandatory for all mutual fund
prospectus filings on or after September 6, 2022 (and optional for
filings before that date).

Moving information from the AIF to the SP merely will result in
mutual funds filing one very long SP rather than a less long SP and
medium-length AIF. Existing mutual funds will need to undergo a
one-time rewrite of their prospectus documentation for future
filings. The rewrite is likely to trigger some significant
redrafting as AIF disclosure tends to be less “plain
language” than that used in an SP. (For example, the tax
disclosure in an AIF is much more detailed and technical in nature
compared to the SP.) The location and content of the disclosure
also will need to follow the more prescriptive approach applicable
to an SP. A few items currently included in the SP or AIF will be
removed in the new format. They are:

  • The table currently in Part A of the SP that shows the
    commissions or redemption fees payable by an investor after 1, 3, 5
    and 10 years based on a $1,000 investment with a 5% annual return.
    This table will become meaningless once the deferred sales charge
    option is abolished.

  • The sentence in Part A of the SP that discloses the previous
    year’s dealer compensation paid by the manager as a percentage
    of its management fees.

  • Investor suitability disclosure in Part B of the SP. This
    information already is contained in the fund facts.

  • Additional Part B disclosure when a fund had a portfolio
    turnover rate exceeding 70%.

  • Disclosure in the AIF of ownership by any person of more than
    10% of any class or series of securities of the mutual fund. This
    change is welcomed as it will eliminate typically several pages of
    anonymized unitholder information. Though not included in the draft
    versions of the amendments, the CSA were persuaded by industry
    comments to make this deletion in the final version.

Despite similar lengths, the new long-form SP will look much
different than the current long-form prospectus used by
exchange-traded funds under National Instrument 41-101.

Our Recommendations:

There is much room for regulatory burden reduction in
prospectus disclosure and the prospectus filing process. We
recommend the following additional changes:

  • Remove all remaining time-sensitive information from the
    long-form SP. This includes disclosure in Part B of the SP of (i)
    unitholders holding securities representing more than 10% of the
    net asset value of the fund, (ii) circumstances where a portfolio
    position exceeding 10% of the net asset value of the fund, and
    (iii) fund expenses indirectly borne by investors. This information
    is of little use to investors and quickly becomes stale, while
    requiring considerable effort to compile. All important
    time-sensitive information already is contained in other regulatory
    filings (principally the financial statements and management
    reports of fund performance), and the time-sensitive information
    most useful to investors is contained in the fund facts. This
    change would facilitate our next recommendation.

  • Require that the SP be refiled only once every two years,
    similar to the shelf prospectus of public companies. This would cut
    in half the costs currently incurred for renewing
    prospectuses.

  • Enable new mutual funds to be launched by a prospectus
    amendment to the long-form SP, rather than a preliminary and final
    prospectus filing. Very little information in the long form
    prospectus is specific to any particular mutual fund, and it can
    easily be provided in the new fund’s Part B information. All
    key information provided to investors in the first instance is
    contained in the fund facts.

  • Reduce mutual fund prospectus filing fees to reflect the
    amount of regulatory review they entail. Currently, prospectus
    filing fees in most jurisdictions are calculated as a multiple of
    the number of mutual funds contained in the SP. However, most of
    that information is common to all funds, and relatively little of
    that information typically changes materially during the prospectus
    renewal process. Two different prospectuses of approximately the
    same length and complexity should not trigger vastly different
    filing fees based on the number of mutual funds using that common
    disclosure document.

  1. Mandatory designated website.

This amendment requires that all managers have an internet
website for their funds by September 6, 2022. This likely is not a
material new requirement as most (if not all) managers of public
investment funds already maintain websites on a voluntary basis.
However, the CSA indicated that this requirement will form part of
a manager’s obligations as a registrant to have adequate
policies & procedures, and therefore the website design and
content could be the subject of future regulatory audits.

This new requirement was presented by the CSA as a first step
toward more reliance on website disclosure. The CSA had invited
comments on which current disclosure could be posted on such a
website in lieu of contained in the prospectus. However, the CSA
did not implement any of these changes at this stage.

Our Recommendation:

Now that websites for mutual funds will be mandatory, we
recommend that the CSA establish a default in securities
legislation that information is provided to investors through
website posting rather than physical delivery by mail, with an
option for investors to specifically request documents. Our
recommendation reflects the reality that individuals conduct most
of their research on the internet rather than through physical
files, and are more likely to save their documents online rather
than in hard copies. Our recommendation also would reduce the
impact on the environment caused by physical delivery of
documents.

  1. Codification of notice & access relief for
    unitholder meetings.

One of three codifications contained in the final amendments is
permission for investment funds to use the same notice & access
approach for unitholder meetings that is used by public companies.
Many fund complexes already have obtained this relief so that the
codification will not benefit them. A new feature is that the
codification also allows notice & access to be used for
solicitation by parties other than management. Though this matches
a similar functionality among public companies, it would seem of
little practical effect in the investment funds context since there
are no known cases of proxy fights at an investment fund
meeting.

Our Recommendations:

  • As mentioned above, we recommend that the principle of
    notice & access and reliance on website posting be applied to
    most (if not all) documents required to be delivered to
    investors.

  • Regarding the codification process, there is little benefit
    to industry from codifying exemptive relief after most industry
    participants have obtained it on a discretionary basis. It causes
    unnecessary costs to mutual funds, and ties up CSA resources to
    process such application. We recommend that the CSA adopt an
    approach to codify exemptive relief soon after the relief has been
    granted more than once. We believe the United States Securities and
    Exchange Commission has adopted such an approach.

  1. Elimination of personal information forms (PIFs) for
    registered or approved individuals.

Directors and executive officers of the fund manager no longer
will need to complete or refresh a PIF as part of the prospectus
filing process. The CSA acknowledged that these individuals already
have been vetted by relevant CSA due to their connection to a
registered firm, and there is no need to duplicate that vetting
process.

Our Recommendation:

The change will, indeed, reduce regulatory burden by the
CSA. However, it does not address the fact that there continue to
be parallel PIF requirements imposed by stock exchanges on funds
with listed securities. We recommend that the Toronto Stock
Exchange and NEO Exchange make similar changes to exempt from their
respective PIF requirements any individual who is exempted from
filing a PIF with the CSA, and we believe the CSA can persuade the
exchanges of the merits of making this change.

  1. Codification of conflicts of interest
    relief

A second codification in the amendments is of relief from
various conflicts of interest restrictions relating to: various
fund-on-fund investments where at least one of the funds is not
public; inter-fund trades where one or both parties is not a public
fund; investments by non-public funds in related issuers; and
various underwriting conflict restrictions.

This has been the relief most frequently granted and regranted
over the past 20 years, and most managers that have confronted
these conflicts of interests have already obtained the relief.
Their relief will not expire by this codification, and managers may
continue to rely on their relief if it contains more favourable
terms. One area where this will be essentially is for in
specie
 purchases and redemptions. Though included in the
draft codification, the CSA removed this element from the final
version, citing liquidity risk management concerns without
providing any examples. The CSA also have put industry on notice
that any future applications to modify this exemptive relief will
be granted on the terms contained in the codification, which could
eliminate other more favourable terms in the exemption.

Our Recommendation:

The current conflicts of interest regime is a patchwork of
various random and often duplicative restrictions. They are
fact-specific and can produce different conclusions based on minor
differences in facts. These restrictions were created before
managers were required to be registered with the CSA and have
adequate policies & procedures for identifying and managing
conflicts of interest. It is time for these specific restrictions
to be replaced by the duties and standards now imposed on
registered fund managers by securities legislation. We recommend
that the specific conflicts of interest restrictions which are the
subject of this codification be abandoned in favour of a
principles-based approach.

  1. More grounds for CSA pre-approved fund
    mergers

The most common reasons for requiring CSA approval of a merger
of two investment funds are that (i) the merger will be implemented
on a taxable basis; (ii) the investment objectives of the merging
funds are not sufficiently similar; and/or (iii) the fee structure
of the continuing fund is higher than that of the terminating fund.
CSA approval in these circumstances is being replaced by prescribed
additional disclosure in the information circular to unitholders,
together with a requirement that the manager reasonably believes
that the merger is in the best interests of the affected funds
despite these facts. Unitholder approval of these mergers will
continue to be required.

Our Recommendation:

We do not believe there is any need to obtain unitholder
approval of this type of merger if the manager has made the
determination that the merger is in the best interests of the
funds. Like other types of mergers, unitholders not wishing to move
to the continuing fund will be adequately protected if they are
given 60 days’ advance notice to switch to another fund or
redeem their units at net asset value before the merger occurs.
Accordingly, we recommend that the requirement to obtain unitholder
approval of these mergers be deleted in favour of the same advance
notice requirement that applies to other fund mergers.

  1. Elimination of the need for CSA approval under NI
    81-102 for a change of manager or change of control of a
    manager.

Transactions to acquire control of a manager or to acquire its
business typically trigger two parallel approval processes: under
section 11.9 or 11.10 of NI 31-103 and also under section 5.5 of NI
81-102. While the applications shared a common fact pattern, the
review under NI 31-103 typically focuses on new conflicts of
interest of the manager arising from the new ownership, while the
review under NI 81-102 typically focused on the potential impact of
the transaction on unitholders of the funds. The requirement for
CSA approval under NI 81-102 is being deleted.

The CSA have indicated that the scope of review under NI 31-103
will not expand to include those matters currently covered by NI
81-102, but this could change in the future. In particular, it is
unclear whether the review under NI 31-103 now will include whether
a change of control of the manager is to be treated as effectively
a change of manager for NI 81-102 for the purposes set out in OSC
Staff Notice 81-710 and subsequent regulatory practice.

Our Recommendation:

OSC Staff Notice 81-710 has been an impediment to merger
activity, particularly among smaller managers seeking to achieve
greater economies of scale and become more competitive. It expects
that either the purchaser will not consolidate
with the acquired manager in the short term, or that the parties
will pay the costs of seeking unitholder approval of the
acquisition. Neither option is reasonable for smaller transactions.
OSC Staff Notice 81-710 was introduced without public consultation,
and it creates unitholder approval requirements for changes that,
in the absence of a contemporaneous acquisition transaction, do not
require unitholder approval under NI 81-102 (such as rebranding
funds or changing senior executive management of the manager). We
recommend that OSC Staff Notice 81-710 be deleted.

  1. Codification of fund facts and ETF facts pre-delivery
    relief

This is the third codification included in these amendments and
relates to exemptions from pre-delivery of fund facts and ETF facts
for various trades associated with auto-rebalancing services, model
portfolio programs and automatic switches between series based on
sizes of the accounts. It also introduces a new exemption from any
delivery where the purchaser is a managed account or permitted
client.

Our Recommendation:

The exemption codified by the amendment from delivering fund
facts in connection with model portfolio programs only applies to
rebalancing trades to return portfolio holdings to their target
weightings. It does not extend to other types of trades associated
with model portfolios (such as changes to portfolio compositions or
target weightings), even though fund facts delivery relief has been
granted for those trades. We recommend that this codified exemption
be expanded to all forms of trades arising in model portfolio
programs so that multiple subsequent applications by other market
participants will be avoided. Alternatively, we recommend that the
CSA expressly confirm that no fund facts need be delivered to
investors in model portfolio programs due to their accounts
qualifying as “managed accounts”.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.


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