The investment fund and asset management industries encompass a broad range of vehicles and services. The term “investment funds” takes into account such diverse entities as public mutual funds, closed-end funds, private investment funds, labor-sponsored or venture capital funds, and scholarship plans. Investment funds can vary in terms of legal structure, ownership, and investment criteria or goals. In Canada, the largest of these funds are pension plans, sovereign wealth funds, private equity firms, and hedge funds. “Asset management,” also known as “investment management” or “fund management,” involves the discretionary management of securities and other assets to achieve the investment objectives of individuals and/or institutions. Clients in this space raise, invest, and manage capital on behalf of others.
Due to the scope of activities and providers serviced within this practice area, lawyers often focus on particular aspects of it. Lawyers in this area have mandates in:
- the establishment of new funds;
- offerings of fund securities by prospectus or private placement;
- advising as to regulatory compliance and disclosure obligations;
- advising as to access to US and offshore markets for Canadian funds and access of US and offshore funds to Canadian markets;
- fund mergers and conversions;
- advisor and dealer registrations;
- custodial arrangements;
- reviewing sales communications and distribution plans; and
- advising on the fiduciary duties of participants and on general governance issues.
Intense Regulation of Industry Continues
The current stream of regulatory intensity that has been shaking up the investment fund industry can be traced back to 2013, when the three-year phase-in of CRM2 (Client Relationship Model - Phase 2) commenced.
The amendments introduced new requirements for reporting to clients about the costs and performance of their investments, and the content of their accounts. They applied to dealers and advisors in all categories of registration, with some application to investment fund managers. Minor enhancements to the Canadian Securities Administrators’ (CSA) National Instrument 31-103 were implemented in July 2013. As of July 2014, dealers and advisors were required to provide pre-trade disclosure of changes and to report on compensation from debt securities transactions. In July 2015 — about two months after managers had started to amend their documents to reflect other regulatory changes affecting the most commonly used prospectus exemptions — expanded account statements became mandatory, including requirements to position cost information and determine market values using a prescribed methodology for most securities.
More recently, requirements for pre-sale delivery of the Fund Facts took effect in May 2016.
Since January 1, 2011, fund managers have been required to file Fund Facts for their funds and to post them to their website. As of June 2014, dealers have been required to deliver the document within two days of buying a conventional mutual fund. The amendments, however, now require dealers to supply the information to clients before they accept instructions to buy shares of the mutual funds. The change in timing is a significant issue, one that will create operational difficulties because dealers don’t know what funds the client will instruct them to buy at the time they set out to get those instructions.
Dealers must now also disclose the amount they receive in “trailer fees,” also known as “trailer commissions.” From an investor’s perspective, knowing whether a mutual fund salesperson has received a trailer fee can be important because of its potential to influence the advice given. The upshot is that more dealers are moving to fee-based models that charge the client directly for advice. To achieve that, however, they must go to the considerable expense of changing their documentation, including their prospectuses.
To complicate things even more, the CSA has proposed changes in risk classification methods for retail investment funds. Historically, such methodologies have been chosen by the manager, with volatility risk the preferred approach. CSA, however, is leaning to a 10-year annualized standard deviation as the risk indicator. If the changes are enacted, the Fund Facts for all retail mutual funds would be affected, as would the proposed summary disclosure documents, similar to Fund facts, that the CSA recently proposed for Exchange-Traded Funds (ETFs).
Additionally, as of July 2016, registered firms have had to provide an annual report on charges and other compensation that show, in dollars, what the dealer or advisor was paid for and the products and services it provided. The law now also prescribes an annual investment performance report that covers deposits and withdrawals to the client’s account, changes in value of the account, and percentage returns for the previous year, three years, five years, and 10 years.