Current Legal Developments in the Mutual Fund Industry: Abuses and Governance
| Author | Stephen I. Erlichman |
| Pages | 385-402 |
Current Legal Developments
in
the
Mutual Fund Industry:
Abuses
and
Governance
Stephen
I.
Erlichman
A.
INTRODUCTION
I
thank
the Law
Society
of
Upper Canada
for the
honour
of
being asked
to
speak about current legal developments
in the
mutual
fund
industry
at
these
2004
Special
Lectures,
especially
in
light
of the
fact
that
I
under-
stand today
is the
first
time
in the Law
Society's
history that mutual
funds
have been discussed
at the
Special Lectures.
Because
of the
short time allotted
to me
this
morning,
I
intend
to
briefly
discuss only
the
following
publicized developments
in the
mutu-
al
fund
industry,
many
of
which relate
to
conflicts
and
other issues that
have become prominent
in the
last eight months
in the
United States:
late trading, market timing,
soft
dollars, directed
brokerage,
and
fund
governance.
I
will conclude with some closing thoughts that
I
hope will
engender
further
thinking
by
others.
Stephen
I.
Erlichman,
LL.B.
(Toronto),
LL.M. (New
York),
M.B.A. (Harvard).
Senior Partner, Fasken Martineau DuMoulin
LLR
This paper
is
current
to
April
6,
2004, which
is the
date
it was
submitted
to
the Law
Society
of
Upper Canada
for
insertion
into
the
program materials
for
the
2004
Special Lectures.
385
386
STEPHEN
I.
ERLICHMAN
B.
CURRENT DEVELOPMENTS
1)
Late
Trading
I
would wager that
before
September 2003
few
people knew what
the
term "late trading"
meant,
but in
light
of the
ongoing scandal
in the
U.S.
mutual
fund
industry that
we
read about
on
almost
a
daily basis most
of
you now
know what late trading means.
In
case
you are not
aware
of
the
concept,
late trading occurs
when
a
purchase
or
redemption order
for
mutual
fund
securities
is
received
after
the
day's
close
of
business
(which
in
Toronto
is 4
p.m.,
the
time that trading
on the
Toronto Stock
Exchange
closes
for the
day)
yet the
trade
is
processed
by
"backward
pricing,"
which means
the
trade
is
still processed
at
that
day's
price (i.e.,
at
the net
asset value
per
security calculated
at
4:00 p.m. Toronto time
on the day of the
order) instead
of at the
price determined
at the
close
of
business
on the
following
day
(i.e.,
at the
next
day's
net
asset value
per
security).
If the
securities
of a
mutual
fund
are
permitted
to be
pur-
chased
or
redeemed
by an
investor utilizing "backward pricing," then
that late trading investor
may
have
the
advantage
of
knowing
informa-
tion, which
after
the
close
of
business
has
been publicly disclosed
by
one or
more companies
in the
mutual fund's
portfolio
and
could utilize
that information
to
purchase
the
mutual
fund
securities
if the
portfolio
information
is
good
(and therefore
the net
asset
value
of the
mutual
fund
securities
is
expected
to
rise
the
next day)
or to
redeem
the
mutu-
al
fund
securities
if the
portfolio
information
is bad
(and therefore
the
net
asset value
of the
mutual
fund
securities
is
expected
to
fall
the
next
day).
According
to the
1969 provincial
and
federal
study entitled "Report
of
the
Canadian Committee
on
Mutual Funds
and
Investment Contracts"
(1969
Mutual Funds Report), late trading
was
common
in
Canada
in the
1960s
but the
1969 Mutual
Funds
Report found
this
practice
to be
abu-
sive. Thus, shortly
after
laws were passed
to
prohibit late trading
in the
United States,
and
laws also were passed
to
prohibit
the
practice
in
Cana-
da.
Today,
under section
9.3 of
National Instrument 81-102
(NI
81-102),
the
issue price
of a
mutual
fund
security
is
required
to be the net
asset
value
per
security next determined
after
the
mutual
fund
has
received
the
purchase order. Under section 9.1(5)
of NI
81-102,
a
mutual
fund
is
deemed
to
have received
a
purchase order
for its
securities when
the
order
is
received
at an
order receipt
office
of the
mutual
fund.
According
to the
Investment Funds Institute
of
Canada
(IFIC),
there
are
significant structural
differences
that distinguish
the
Canadian
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