Notice of Proposed Change to Proposed Rule: OSC Rule - 81-501 - Mutual Fund Reinvestment Plans

NOTICE OF PROPOSED CHANGES TO
PROPOSED RULE 81-501 UNDER THE SECURITIES ACT
MUTUAL FUND REINVESTMENT PLANS

 

Substance and Purpose of Proposed Rule

On May 24, 1996, the Commission published a draft of proposed Rule 81-501 Mutual Fund Reinvestment Plans (the "Draft Rule") for comment in the OntarioSecurities Commission Bulletin at (1996), 19 OSCB 2795. As a result of comments received on the Draft Rule, staff's recommendations and furtherdeliberations of the Commission, the Commission has amended the Draft Rule. The Commission is republishing the proposed Rule, as amended, for comment inaccordance with the requirements of Section 143.2(7) of the Securities Act (the "Act").

The proposed Rule is a reformulation of two Blanket Rulings of the Commission: In the Matter of the Automatic Investment of Dividends or Distributions inShares or Units of Mutual Funds (1983), 6 OSCB 1078 (the "Automatic Plan Ruling"); and In the Matter of the Mandatory Investment of Dividends orDistributions in Shares or Units of Mutual Funds (1985), 8 OSCB 4308 (the "Mandatory Plan Ruling") (collectively, the "Blanket Rulings"). Each of the BlanketRulings has been replaced with a rule containing the same provisions that will expire on the earlier of July 1, 1998 and the date that the proposed Rule comes intoforce. Reference is made to (1996), 19 OSCB 6961 and 6962.

For background on the Blanket Rulings, the changes proposed to be made to them through the Draft Rule and a summary of the Draft Rule, refer to the Noticeof Proposed Rule - Mutual Fund Reinvestment Plans dated May 24, 1996 ((1996), 19 OSCB 2795).

The purpose of the proposed Rule is to provide relief from the registration and prospectus requirements of the Act for trades by mutual funds of securities underreinvestment plans, as defined in the proposed Rule, upon the conditions contained in the proposed Rule.

Changes Made to the Proposed Rule from the Draft Rule

Substitution of Disclosure Requirement in Place of Condition

The proposed Rule, as amended, deletes the condition contained in paragraph 2.1(1)(b) of the Draft Rule. That condition provided that the registration andprospectus exemption granted by the Draft Rule for a trade by a mutual fund of a security under a reinvestment plan was not available unless there was noobligation on a person or company to whom the security was traded to pay a deferred or contingent sales charge or redemption fee on the redemption of thesecurity. The Commission has substituted in place of this condition, a requirement that annual disclosure of these fees be given to investors participating inreinvestment plans.

"Sending" of Disclosure Statement

Paragraph 2.1(1)(b) of the proposed Rule has been amended to refer to the "sending" of the required disclosure statement on behalf of a mutual fund, as opposedto the "receipt" of the statement by securityholders, as set out in the Draft Rule.

Deletion of Revocation of Blanket Rulings

Part 3 of the Draft Rule, which dealt with the revocation of the Blanket Rulings that are deemed rules, has been deleted, as no longer being necessary.

As a result of these changes, the registration and prospectus relief provided by the proposed Rule is available upon satisfaction of two conditions, namely that nosales charge is payable on the trade and that the mutual fund has caused to be sent to the person or company to whom the security is traded a statementdescribing certain matters prescribed by the proposed Rule. Both of these conditions are consistent with the conditions provided for in the Blanket Rulings,except that the annual disclosure statement must now disclose any deferred or contingent sales charges or redemption fees payable on redemption of thesecurities traded under reinvestment plans.

Reasons for Changes

Following the publication of the Draft Rule, the Commission received two written submissions in response to the request for comments. The Investment FundsInstitute of Canada ("IFIC") commented on behalf of its members in a letter dated August 21, 1996 and Scotia Securities Inc. provided a comment on the DraftRule in a letter dated July 17, 1996.

Three principal comments were made in these written submissions and the changes to the proposed Rule from the Draft Rule were made by the Commission inresponse to two of these comments.

Substitution of Disclosure Requirement in Place of Condition

IFIC's principal comment was that the condition contained in paragraph 2.1(1)(b) of the Draft Rule should be deleted as contrary to the current practice of anumber of mutual fund managers. IFIC stated that these mutual fund managers attach a deferred sales charge to the securities acquired on the reinvestment ofdistributions made on securities that were themselves acquired on a deferred sales charge basis. The issue date of the reinvested securities, for the purposes ofcalculating applicable deferred sales charges on a redemption, is deemed to be the original issue date of the securities to which the reinvested distributions relate.IFIC noted that mutual fund managers that follow the above practice often have entered into funding arrangements that contemplate that deferred sales chargeswill be payable on redemptions of securities acquired through the reinvestment of distributions. IFIC concluded that the condition referred to in the Draft Rulemay cause severe adverse costs for many significant industry players.

 

IFIC also commented that investors make an informed investment decision when they decide to acquire securities and accordingly understand that, if they acquiresecurities on a deferred sales charge basis, they will have to pay deferred sales charges on a redemption of the securities acquired on that basis, includingsecurities issued in respect of reinvested distributions.

When it published the Draft Rule, the Commission considered the condition contained in paragraph 2.1(1)(b) of the Draft Rule necessary in order to remainconsistent in spirit with the Blanket Rulings, which contained restrictions against "sales charges". The Blanket Rulings did not deal explicitly with deferred orcontingent sales charges because the Blanket Rulings were granted by the Commission in the early 1980's, before the introduction of such purchase options asdeferred sales charges. To bring the Draft Rule into line with the changes in the mutual fund industry and to keep the Draft Rule consistent with the prohibitionagainst the levying of "sales charges" contained in the Blanket Rulings, the Commission proposed paragraph 2.1(1)(b).

However, the Commission has reconsidered this approach in light of the above-noted comments. The Commission has decided that disclosure of such fees is theappropriate regulatory response and has deleted paragraph 2.1(1)(b) of the Draft Rule.

The Commission believes that an investor purchasing securities of a mutual fund on a deferred load basis must receive full disclosure of fees potentially payable ifdeferred or contingent sales charges or redemption fees will be charged upon a redemption of securities issued under a reinvestment plan. This disclosure isnecessary both at the time the investor first acquires the applicable deferred load securities and annually thereafter for so long as the investor participates in thereinvestment plan. The Commission reminds industry participants that the general mutual fund prospectus disclosure requirements require disclosure of theapplicable fees in mutual fund prospectuses or simplified prospectuses. The proposed Rule contains a new requirement to provide disclosure concerning thesefees in the annual disclosure statement required by paragraph 2.1(1)(b) of the proposed Rule.

IFIC commented that the rationale described above with respect to informed investment decisions concerning deferred sales charges would seem to apply also toup front sales commissions. The Commission is not prepared to delete the condition contained in paragraph 2.1(1)(a) of the proposed Rule. The proposed Rulegives mutual funds and their managers and distributors the right to carry out trades under reinvestment plans without the necessity of such trades being carriedout through a dealer or broker.

IFIC suggested that, if paragraph 2.1(1)(b) of the Draft Rule was not deleted, the proposed Rule should "grandfather" those fund managers that follow thepractice of charging deferred loads on reinvested securities. In light of the Commission's proposal to delete the applicable condition, this suggestion is no longerrelevant.

Both IFIC and Scotia Securities Inc. commented that paragraph 2.1(1)(b) of the Draft Rule should be amended to provide that it does not apply to thoseredemption fees that are payable by investors to mutual funds on the redemption of securities within 90 days of the date of issue. The Commission wouldsupport such an amendment if the condition was to remain in the proposed Rule.

"Sending" of Disclosure Statement

IFIC commented that the wording of paragraph 2.1(1)(c) of the Draft Rule [now 2.1(1)(b) of the proposed Rule] should be amended to refer, not to the "receipt"of the applicable annual information statement by securityholders, but to the "sending" of such statements by or on behalf of mutual funds. The Commissionagrees with this comment and has amended the drafting of this paragraph.

The Commission is satisfied to make the exemption provided by the proposed Rule available to a mutual fund so long as mutual fund does all things within itscontrol to provide the disclosure to an investor. The Commission also recognizes that it may be impractical for a mutual fund to confirm when an investor hasactually "received" the disclosure document; this would raise practical difficulties for mutual funds in knowing when a reinvestment transaction could becompleted.

In connection with the comment referred to above, IFIC also indicated that fund managers may experience difficulties in sending the requisite annual informationstatement if they have elected to include those statements in their annual report or current prospectus and the preparation and sending of those documents havebeen delayed by the fund manager with the appropriate regulatory approvals. In such circumstances, IFIC commented that fund managers would be obliged tosend out a special notice, which may cause the fund managers to incur additional costs. The Commission is of the view that the condition in the Automatic PlanRuling that securityholders receive an annual information statement containing the required information continues to be important and has not amended theproposed Rule to account for IFIC's comment. Fund managers have flexibility in how they can provide the required information and should conduct theiroperations accordingly.

Deletion of Revocation of Blanket Rulings

It is not necessary that the proposed Rule revoke the Blanket Rulings that are deemed rules as these will expire on March 1, 1997 under the Act. The rulesreplacing those deemed rules will expire, by their terms, when the proposed Rule comes into force, and so it is also not necessary that the proposed Rule providefor their revocation.

Other Comments Received by the Commission

The Commission did not change the proposed Rule in response to the third principal comment made by IFIC on the Draft Rule.

IFIC suggested that the Draft Rule be extended to cover investment options offered by some fund managers that permit investors to agree that distributions paidby one mutual fund be invested in securities of another mutual fund. The Commission has, to date, granted relief from the prospectus and registrationrequirements of the Act to a limited number of fund managers to permit these investment options to be carried out, on certain conditions that are in addition tothe conditions contained in the proposed Rule, without compliance with the relevant requirements. The Commission does not propose to extend this relief, on ablanket basis, in the proposed Rule. The Commission and staff will deal with any applications made by fund managers in this regard, on a case by case basis, andwill monitor whether the proposed Rule should be extended in the future to cover these investment options. The Commission notes that blanket relief of thisnature would imply a significant expansion of the rationale behind the proposed Rule and its predecessor Blanket Rulings.

Comments

Interested parties are invited to make written submissions with respect to the proposed Rule. Submissions received by March 17, 1997 will be considered.

Submissions should be made in duplicate to:

Daniel P. Iggers, Secretary
Ontario Securities Commission
20 Queen Street West
Suite 800, Box 55
Toronto, Ontario
M5H 3S8

A diskette containing the submissions (in DOS or Windows format, preferably WordPerfect) should also be submitted. As the Act requires that a summary ofthe comments received during the comment period be published, confidentiality of submissions received cannot be maintained.

Questions may be referred to:

Rebecca Cowdery
Special Counsel
Market Operations
Ontario Securities Commission
416) 593-8129

Proposed Rule

The text of the proposed Rule follows, together with footnotes that are not part of the proposed Rule but have been included to provide background andexplanation.

DATED February 14, 1997.