Important Takeaways For Fund Managers From Recent Market-timing Decision

• Law Firm: McCarthy Tétrault LLP
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Fund Management/ REITs, Securities
• Author: Canadian Securities Regulatory Monitor, Shane D'Souza, Sean Sadler and Kevan Hanowski
• Published date: 25 April 2023

There are many important takeaways for investment fund managers from the Ontario Superior Court's recent trial decision in Fischer¹, a case in which two fund managers were found liable for failing to take reasonable steps to identify and deter "time zone arbitrage". While the plaintiffs' specific allegations concerning "market timing" trading practices are unlikely to repeat themselves in practice, the broader takeaways from this decision have significant implications for investment fund managers and their internal compliance and risk management teams.

Background

The Fischer class action was commenced against five investment fund managers that settled with the Ontario Securities Commission (OSC) following its investigation into "market timing" trading practices. The OSC investigation resulted in the five fund managers, including both defendants, entering into settlement agreements in which they paid over $200 million to their respective funds.

The plaintiffs in Fischer were unitholders in certain funds of the two defendant managers between 1998/9 and 2003. They alleged that the managers failed to prevent and in fact facilitated so-called "market timing" trading practices that allowed hedge funds to frequently trade in and out of the funds, resulting in dilution of the returns of long-term investors. The trial judge agreed, holding:

... There was ample evidence before me to demonstrate that the standard of care during the Class Period required the defendants to be aware of the dangers of frequent trading in and out of their funds and take reasonable steps to prevent it. The harm that frequent trading causes to long-term unitholders has been known for decades. Mutual fund prospectuses (including those of [the defendants]) warned that frequent trading caused harm to funds and could result in fees of up to 2% being charged to frequent traders. It was generally agreed that a 2% fee would have stopped switching or frequent trading immediately. Despite the contents of their prospectuses, the defendants not only failed to take steps to prevent frequent trading or charge the fees set out in their prospectuses when it occurred, they facilitated frequent trading by entering into "Switch Agreements" which allowed certain investors to switch in and out of funds for a fee of only 0.2%.

Takeaways

A manager is not expected to act perfectly: It must act with "care, diligence, and skill of a reasonably prudent person in the circumstances" and based on prevailing standards. It's conduct will not be judged in hindsight.

A manager must take...