On May 8, 2014, the Staff of the Investment Funds Branch of the Ontario Securities Commission (Staff) released a notice setting out recommendations based on their observations from a targeted continuous disclosure review of the fees and expenses disclosure practices of investment funds.
Staff conducted a targeted, continuous disclosure review of the fees and expenses disclosure practices of a sample of 18 fund managers offering various types of investment funds, including conventional mutual funds, exchange-traded funds and closed-end funds.
Staff made the following recommendations:
1. Transparency in Disclosure of Management Fees and Expenses
- Prospectus and continuous disclosure documents should disclose the specific services that the fund manager provides to the fund in consideration of the management fees and the types of expenses charged to the fund as operating expenses. General “catch all” terminology should be avoided.
- The prospectus should provide details sufficient for investors to clearly distinguish the types of expenses, in particular the types of administrative and operating expenses, that are covered by management fees from those that are covered by operating expenses. Investors should not have to refer to the management or trust agreement for the information.
- Fund managers should clearly describe the major services paid for out of the management fees in their funds’ MRFPs, as well as provide the required line items in the funds’ financial statements. Relevant and descriptive line items, in addition to the mandated line items, should be used.
2. Transparency in Disclosure of Expense Allocation
- Fund managers should consider enhancing the transparency of their expense allocation. 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.
- Fund managers should explain how conflicts in expense allocation are mitigated by including, for example, information concerning the expense allocation policies of the funds or the manager in the annual information form.
3. Conflicts of Interest in Expense Allocation
- Fund managers should allocate expenses in accordance with their duty of care and should be able to demonstrate that they are not putting their own interests ahead of those of the fund and its securityholders.
- The general expenses allocated to a fund should have a direct relationship to the daily operation of the fund and be fair and reasonable to the fund, as if the result of arm’s length bargaining.
- Fund managers should avoid recovering expenses using opaque or complex methodologies that are not intuitive and not directly linked to the services being performed for the funds.
4. Compliance with NI 81-107
- Given that the allocation of expenses is generally viewed as a conflict of interest matter, it should be referred to the independent review committee and fund managers should have policies and procedures in place with respect to expense allocation.
5. Appropriate Expense Allocation
- Staff expect the expenses allocated to funds to generally be limited to:
- costs and expenses that were necessarily incurred in the daily operation of the funds;
- reasonable costs and expenses that are reasonably incurred in the operation of the funds;
- expenses that are closely linked to the specific operation of the funds; and
- the proportionate share of the allocated expenses that can be accurately and readily determined.
- Staff are generally of the view that it is not appropriate for funds to pay for:
- costs and expenses that the fund manager would normally incur in the ordinary course of their operations, such as the compensation of officers and directors; or
- costs driven by the fund manager’s business and organizational initiatives, such as restructuring and rationalizing funds line-up.
The Staff notice indicated that further guidance on expense allocation will be issued by staff in the Compliance and Registrant Regulation Branch in their upcoming publication – OSC Staff Notice 33-743 Guidance on Sales Practices, Expense Allocation and Other Relevant Areas Developed from the Results of the Targeted Review of Large Investment Fund Managers.