The Ontario Securities Commission has published a report detailing the results of its reviews of certain segments of the investment funds industry following the onset of the financial crisis. Overall, the report finds the industry in pretty good shape.

Released Tuesday by the OSC, the report summarizes the compliance review work that its’ compliance branch and investment funds branch which began in September 2008 and was initiated in response to concerns sparked by the financial market turmoil at the time.

In particular, OSC staff examined three major segments of the Canadian investment fund industry — money market funds, non-conventional investment funds and hedge funds.

“Our primary focus in all three phases was to assess fund managers’ compliance with Ontario securities laws. We did not assess the merits of the investment products covered by our reviews,” the report notes. And, in general, it found that compliance was rather good. While it did uncover deficiencies at various firms, it didn’t uncover any pervasive problems.

“Despite the overall market downturn and its impact on the returns of many of these products during our review period, we did not observe any industry-wide compliance issues,” the report explains. “We noted some instances of non-compliance during our on-site visits which we addressed separately with each individual fund manager.”

For example, the review of money market funds found that all funds being reviewed were able to meet redemption requests, no investments held by the funds defaulted or were written down, and most funds were in compliance with the securities laws regulating money market funds. “We noted some instances of non-compliance with the dollar-weighted average term to maturity requirement and with the 10% concentration restriction,” it says, yet characterizes these instances of non-compliance as “not material”, adding that they were addressed with each individual fund manager.

In phase two of the reviews, it looked at non-conventional investment funds, including open-end and closed-end funds listed on the Toronto Stock Exchange. Again, it didn’t find any widespread problems. “We observed that some of these funds adopted more protective investment strategies as a result of the market turmoil and maintained higher levels of cash. Some fund managers reorganized some of their funds. Fund managers monitored redemption levels closely and provided additional disclosure to their investors on the impact of the market turmoil,” it reports.

Hedge fund review

The OSC also reviewed hedge funds, which are sold primarily by offering memorandum. “We observed that hedge fund assets were held with independent custodians, fund portfolios were fairly liquid, well-diversified and securities were valued appropriately,” it says.

This phase of the review did find instances of non-compliance too, including:

• five funds that did not comply with the prohibited investment restrictions;

• five managers that were providing investment advice;

• some fund managers who did not have adequate written policies and procedures for things such as valuation methodology for illiquid securities, processes for reviewing NAV calculations, and processes to rectify NAV errors.

It also observed that some fund managers did not maintain adequate books and records evidencing their oversight of a service provider, and three fund managers delegated their fund administration responsibility to a service provider but did not enter into a written agreement outlining the roles and responsibilities of the service provider in administering their funds.

Overall, hedge fund managers provided adequate and clear disclosure, the OSC found, although here were six managers that did not adequately disclose risk factors associated with investing in their funds; five fund managers that did not fully disclose the fees and expenses incurred by their funds; five fund managers did not disclose the material contracts they entered into on behalf of their funds, including with service providers; and seven fund managers who provided inconsistent, incorrect or outdated information in the offering documents of their funds.

In addition to identifying deficiencies the report also includes some suggested practices. “We encourage fund managers to use this report as a self-assessment tool to strengthen their compliance with Ontario securities laws and to improve their systems of internal controls and supervision,” the OSC says.

IE