Ontario Securities Commission Chairman David Brown today explained why the regulator sanctioned five of the 20 mutual fund firms that allowed market timing trading, but none of the traders themselves.

Brown offered his explanation in a speech to the Economic Club of Toronto when he released the final Report on Mutual Fund Trading Practices Probe providing the details of the biggest investigation in OSC history that resulted in $205.6 million being returned to harmed investors.

Brown said the OSC went after the fund managers because, “We believe it is a fund manager’s responsibility to put in place policies, procedures and other mechanisms to monitor trading that could be disruptive or harmful to the funds and take reasonable steps to protect the fund. The market timers owe no such duty to the other investors in the funds. They broke no laws.”

As to why only five firms were sanctioned when the OSC uncovered evidence of market timing at 20 firms, Brown suggested that the five were the worst offenders and that investors suffered the most damage as a result. He said the other 15 unnamed firms “identified market timing at an early stage and shut it down with negligible harm to investors”.

“Five fund managers stood out in clear contrast,” he explained. “The average risk rating for market timers’ profits for those five was three times as high as the rest. The average risk rating for gross management fees from allowing this activity earned by those referred was four times as high as the rest. The average risk rating for volume of redemptions for them was almost three-and-a-half times as great as the others. The average total risk rating was three-and-a-half times as high.”

“The responses by the remaining 15 fund managers produced markedly different results,” he said. “Some took active steps to discourage and ultimately stop all short-term trading, after detecting it in their funds. Some had policies in place to refer trading activity that was of potential concern to a review committee. Some used fair valuation techniques to reduce price discrepancies between stale values of securities within a fund’s portfolio and the current market value.”

The OSC report details possible policy responses that may result from the market timing investigation; and sets out suggested best practices for deterring market timing.

The report notes that the OSC is beginning consultations on initiatives that it believes will serve to enhance overall fund compliance generally and deter frequent trading market timing practices specifically, including: requiring all fund managers to have a compliance program; mandatory short-term trading fees; fair value pricing of portfolio securities; and enhanced prospectus disclosure.

Brown said the year-long probe of all mutual funds available to retail investors in Ontario found no late trading, no insider abuses and no systemic market timing.

“We found some market timing had occurred, but it had been shut down. We then ensured that investors would be reimbursed for losses. The case is closed with a fair result, and a clear message.”

In a statement, the Investment Funds Institute of Canada said it is looking forward to working with the OSC on any further steps necessary to resolve the issue of inappropriate short-term trading. “The interests of investors must always come first, as the guidelines we recommended to our Members last summer indicate,” said Tom Hockin, IFIC’s president and CEO. “We now welcome the opportunity to help bring any additional refinements to IFIC’s present recommended approach to detecting and deterring inappropriate short-term trading.”

Last August, IFIC released guidelines aimed at finding and stopping inappropriate short-term trading and market timing. IFIC recommended effective procedures to monitor trades, and also provided its members with a toolbox of measures that would give them flexibility in deterring inappropriate short-term trading. Similar solutions, consistent with the highest possible fiduciary responsibilities, have since been adopted by European and U.S. regulators, Hockin noted.

“Like the regulators, IFIC’s main goal is to maintain the highest standards of fiduciary responsibility in the mutual funds industry by all market participants,” Hockin said.