More protection urged for mutual fund investors

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Canada's securities regulators are being urged to expand the coverage of investor compensation funds because more than $225-billion of investors' money is unprotected if firms fail.

In many cases, investors are unaware of arcane rules that leave them outside the umbrella of the industry's two key reparation funds, according to a review by Canada's mutual fund industry regulator.

In a report issued Thursday, the Mutual Fund Dealers Association of Canada (MFDA) recommended securities commissions expand protection for investors because the two key funds - the Investor Protection Corp. for mutual fund clients, and the Canadian Investor Protection Fund for brokerage industry clients - have significant gaps.

Both funds protect investors' assets up to coverage limits in the event that financial firms go bankrupt.

But failed investment firms such as Portus Alternative Asset Management Inc. and Norshield Asset Management (Canada) Ltd. were not licensed as mutual fund dealers, which are covered by the IPF. Rather, they were licensed as portfolio and mutual fund managers, which are not covered at all, the report notes.

The MFDA recommends that both the fund manager and portfolio manager categories of firms be required to join either the IPC or the CIPF to ensure seamless coverage.

MFDA chief executive officer Larry Waite said few investors are aware of other unfair gaps in compensation coverage that could leave them vulnerable if firms collapse.

The report noted that in 2008, more than $225-billion in mutual fund assets owned by clients were not held by the mutual fund dealers, which are covered by investor protection funds. Rather, they were held by third-party custodians or fund managers, which are not covered by a protection plan.

At Risk

The total amount at risk is "significantly higher," the report adds, when assets under the administration of all other fund managers and portfolio managers are included.

"People should be covered no matter where their assets are held," Mr. Waite said in an interview.

He said the issue is a particular concern for the MFDA as an industry regulator because most mutual fund dealers do not hold client assets directly, while brokers typically do hold client assets in-house and are more likely covered by the CIPF. The report estimates that more than 80 per cent of clients' mutual fund assets are held at outside firms.

"Very few of our dealers actually hold assets in nominee name, so it's very rare in the MFDA world that the assets are actually at the dealer," Mr. Waite said. "They are held by others."

The report argues that it is not fair to treat clients differently when firms have collapsed and assets have gone missing just because some assets may have been held by a fund manager rather than a mutual fund dealer - a distinction few people understand.

"The coverage of ... these clients should not be at the mercy of how their assets were recorded on the books of the dealer, a matter over which they have no control," the report says.

OSC Disagrees

A spokeswoman for the Ontario Securities Commission said its staff do not agree that there are gaps in the regulation and oversight of fund managers and portfolio managers. "While mutual fund assets are not held at mutual fund dealers, these assets are held at qualified custodians which are IIROC members or Canadian financial institutions, such as banks," Susan Silma said in an e-mail statement.

Last month, the Canadian Foundation for Advancement of Investor Rights issued a report looking at the country's worst financial frauds. It called for all regulated firms - including portfolio managers and fund managers - to become members of a self-regulatory organization so they would be subject to more oversight and their clients would be covered by investor protection funds.

The MFDA report was written in 2008 at the request of the Canadian Securities Administrators (CSA), an umbrella organization of provincial securities commissions, but was not released publicly until now. It was prepared as part of a project to examine regulatory gaps in Canada.

Mr. Waite said the MFDA has been waiting for the CSA to make a decision on the issue, and decided to release the report because of growing interest and questions about the gaps in investor protection.