13.4 Mutual Fund Regulation, Fund Facts & Account Opening

Mutual Fund Regulation

NI 81-102 sets investment restrictions that keep conventional mutual funds diversified and liquid. Key limits include:

• Concentration: generally no more than 10% of net assets in the securities of any one issuer (government securities are exempt).
• Control: a fund may not own more than 10% of the voting or equity securities of one issuer, or invest to gain control of it.
• Illiquid assets: no more than 10% of net assets at purchase, with a 15% hard limit.
• Borrowing: only temporary borrowing (for example, to meet redemptions), limited to 5% of net assets.
• Short selling: conventional mutual funds may short up to 20% of net assets (5% per issuer), with cash cover.
• Custody: a qualified custodian must hold the fund's assets.

Mutual funds are sold by registered dealers (mutual fund dealers and investment dealers, both CIRO members) and, for exempt products, by exempt market dealers.

1. Regulatory Disclosure under NI 81-101: The Fund Facts Document

Under National Instrument 81-101 (Mutual Fund Prospectus Disclosure), Canadian securities regulators recognized that lengthy, 100+ page Simplified Prospectuses were rarely read or understood by retail consumers. In response, regulators instituted the mandatory Fund Facts disclosure regime.

The Fund Facts Document (usually two pages; never more than four):
   Part I:  Quick Facts, Top 10 Investments, Investment Mix, Risk Rating, Performance
   Part I:  Best and Worst 3-Month Returns, Who Is This Fund For?, A Word About Tax
   Part II: How Much Does It Cost? (sales charges, MER + TER, trailing commissions)
   Part II: What If I Change My Mind? (withdrawal and cancellation rights) & Unitholder Legal Rights

Core Properties of Fund Facts

1. Strict Format & Length: Form 81-101F3 sets two parts. Part I and Part II should each fit on one page, and the whole document may never exceed four pages. It must be written in clear, plain language.
2. Mandatory Pre-Sale Delivery: Under Canadian securities legislation, a dealer is legally required to deliver or send the Fund Facts document to the client before accepting an agreement to purchase mutual fund units. (Exceptions exist for certain telephone orders or pre-authorized contribution plans where delivery occurs within two business days after transaction execution).

The Seven Core Sections of Fund Facts

1. Quick Facts: Key fund data at a glance, including fund inception date, total asset value, MER, portfolio manager name, distribution frequency, and minimum initial and subsequent investment amounts.
2. What Does the Fund Invest In?: Displays the fund's Top 10 Investments (as a percentage of net assets) and the Investment Mix (asset allocation and industry sector breakdown).
3. How Risky Is It?: Features the standardized 5-tier CSA risk scale (Low, Low to Medium, Medium, Medium to High, High) based on the fund's 10-year annualized standard deviation.
4. How Has the Fund Performed?: Discloses past performance over the past 10 calendar years (net of MER), highlighting returns, negative years, and the fund's best and worst 3-month rolling returns to illustrate short-term volatility.
5. Who Is This Fund For?: Delineates the fund's suitability profile, outlining the target investor's time horizon, capital growth vs. income objectives, and ability to endure market fluctuations.
6. A Word About Tax: Explains the tax consequences of holding units in registered accounts (RRSP, TFSA, FHSA, RRIF) versus non-registered taxable accounts.
7. How Much Does It Cost?: Outlines all ongoing costs, including front-end load ranges, ongoing fund expenses (MER and TER breakdown), and ancillary costs (switch fees, short-term trading fees).

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2. Unitholder Legal Rights and Statutory Remedies

To ensure fair dealing and protect consumers from aggressive or fraudulent sales tactics, Canadian provincial securities acts provide mutual fund unitholders with robust statutory legal rights:

Unitholder Statutory Legal Protections:

1. Withdrawal and Cancellation Rights (Cooling-Off):
   • Withdraw from an agreement to buy within 2 business days after
     receiving the simplified prospectus or Fund Facts, OR
   • Cancel the purchase within 48 hours after receiving the trade confirmation.

2. Statutory Right of Action for Damages or Rescission:
   • Triggered if the Simplified Prospectus, Fund Facts, or financial statements
     contain a material misrepresentation.
   • Right to unwind trade (rescission) or sue manager/dealer for financial losses (damages).

1. The Right of Withdrawal and the Right to Cancel

Under provincial securities acts, a mutual fund purchaser has two separate cooling-off rights, as the Fund Facts itself explains:

• Right of withdrawal: The investor may withdraw from an agreement to buy mutual fund units within two business days after receiving the simplified prospectus or Fund Facts document.
• Right to cancel: The investor may cancel a purchase within 48 hours after receiving the trade confirmation.
• Amount returned: In some provinces, a cancelled purchase returns the lower of the amount invested and the current value, so a market decline in the meantime can reduce the refund.
• Remedy: The transaction is rescinded, and the investor's purchase capital is refunded in full.

2. Right of Rescission and Action for Damages

If a mutual fund's Simplified Prospectus, Annual Information Form, Fund Facts, or continuous financial disclosure contains a material misrepresentation (an untrue statement of material fact or an omission of a material fact necessary to make the statement not misleading):

• Right of Rescission: The unitholder has the legal right to unwind the transaction and receive back their original purchase capital (or prevailing NAVPS, depending on jurisdiction).
• Action for Damages: The unitholder can initiate legal action for financial damages against the investment fund manager, the fund's corporate directors, and the dealer firm that sold the security.

Opening and Updating a Mutual Fund Account

Before accepting a purchase, the dealer must open the account properly:

1. Know your client: collect personal and financial circumstances, investment needs and objectives, investment knowledge, risk profile and time horizon, as required by NI 31-103.
2. Verify identity: confirm the client's identity, and the identity of any third party with an interest, as required by Canada's anti-money-laundering law (the PCMLTFA).
3. Trusted contact person: ask the client to name a trusted contact person. Since the Client Focused Reforms, firms may place a temporary hold if they reasonably believe a vulnerable client is being financially exploited or lacks mental capacity.
4. Disclose leverage risk: if the client borrows to invest, give the required written disclosure that leverage magnifies gains and losses, and assess whether borrowing suits the client.
5. Relationship disclosure: explain the account, the products offered, costs, conflicts and how complaints are handled.

KYC information must be kept current: update it when the firm learns of a material change, and at least every 36 months for accounts that are not managed (every 12 months for managed accounts).