CSA Staff Notice: 81-306 - Disclosure by Mutual Funds of Changes in Calculation of Management Expense Ratio

CSA STAFF NOTICE NO. 81-306

DISCLOSURE BY MUTUAL FUNDS OF CHANGES
IN CALCULATION OF MANAGEMENT EXPENSE RATIO

Background

On February 1, 2000, National Instrument 81-102 Mutual Funds (the "NationalInstrument") came into force across Canada. Section 16.1 of the National Instrumentchanges the method of calculation of management expense ratios (MER) for mutualfunds and has the effect of requiring mutual funds to re-calculate MERs for financialperiods that ended before the National Instrument came into force. Subsection 17.2(2)of the National Instrument and the prospectus form requirements of National Instrument81-101 Mutual Fund Prospectus Disclosure require a mutual fund to disclose its MERfor the last five completed financial years in its financial statements and its simplifiedprospectus.

The National Instrument was published in final form in November 1999. After thatpublication, the staff of the Canadian Securities Administrators (CSA) receivedsubmissions from The Investment Funds Institute of Canada (IFIC) and fund companiesto the effect that calculating MERs for financial periods that ended before February 1,2000 in accordance with section 16.1 of the National Instrument would be very difficult,and in some cases, virtually impossible due to the lack of data.

The CSA considered these submissions and determined to amend the NationalInstrument to provide that restatement of MER in accordance with section 16.1 is notmandatory for financial periods of mutual funds that ended before February 1, 2000.On January 28, 2000⁽¹⁾, the CSA published for comment a series of amendments to theNational Instrument, primarily to propose a regime permitting mutual funds to lend theirsecurities and use repurchase agreements, but also to deal with certain issuesconcerning MERs.

The Proposed Amendments to the National Instrument

The Notice accompanying the publication for comment of the January 28 amendmentsstated that the CSA propose to add section 16.3 to the National Instrument, along witha revised section 20.3 of the National Instrument.

Proposed section 16.3 of the National Instrument states that the MER calculation insection 16.1 does not apply to the disclosure and calculation of the MER for a financialperiod that ended before February 1, 2000. Mutual funds will have the option ofrestating MERs for prior periods in accordance with the National Instrument ordisclosing MERs for those periods as calculated in accordance with securitieslegislation in force as at January 31, 2000. The proposed revisions to section 20.3 ofthe National Instrument will clarify that the National Instrument does not apply toreports to securityholders (as defined in the National Instrument) that include onlyfinancial statements that relate to financial periods that ended before the NationalInstrument came into force.

Purpose of CSA Staff Notice

The CSA outlined in the January 28 Notice that they are examining the implications ofthis proposed rule amendment in the context of Canadian generally acceptedaccounting principles (GAAP) and mutual fund financial statement presentation. TheNotice indicated also that the CSA would be reviewing what guidance could be given tomutual funds by the CSA on the need to disclose the effect of a change to thecalculation of MER when the MER for prior periods is not restated.

CSA staff propose to recommend that the CSA amend the Companion Policy to providethis guidance, however in the interim, CSA staff are publishing this CSA Staff notice.CSA staff are of the view that mutual funds must provide consistent disclosureconcerning changes in the calculation of MERs in order to assist investors inunderstanding the change and to assist them in comparing the MERs of differentmutual funds.

Staff Guidance

Staff are of the view that the change in the method of calculating the MER of a mutualfund required by the National Instrument should be treated in a manner which is similarto a change in accounting policy under section 1506 of the CICA Handbook. UnderCanadian GAAP, a change in accounting policy requires a retroactive restatement ofthe financial information for all periods shown. The CICA Handbook acknowledgeshowever that there may be circumstances where the data needed to restate thefinancial information is not reasonably determinable. Proposed section 16.3 permits amutual fund to follow the guidance set out in the CICA Handbook without violating theNational Instrument.

If a mutual fund retroactively restates its MER for the five years required to be shown inits financial statements and simplified prospectus, the mutual fund should describe thisrestatement in the first such documents released in which the restated amounts arereported.

If a mutual fund does not restate its MER for prior periods because, based on itsspecific facts and circumstances, the information required to do so is not reasonablydeterminable, the MER for all financial periods ending after February 1, 2000 must becalculated in accordance with the National Instrument. The mutual fund must alsodisclose:

• that the method of calculating MER has changed, specifying for which periods the MER has been calculated in accordance with the change;
• that the mutual fund has not restated the MER for specified prior periods;
• the impact the change would have had if the mutual fund had restated theMER for the specified prior periods. For example, would the MER haveincreased or decreased if the MER had been restated? If possible,provide an estimate of the increase or decrease if the MER had beenrestated; and
• a description of the main differences between an MER calculated inaccordance with the National Instrument and one calculated inaccordance with NP 39.

The disclosure outlined above should be provided for all periods presented until suchtime as all MERs presented are calculated in accordance with the National Instrument.

As outlined in the January 28 Notice, the CSA are seeking comments on the proposedamendments. Mutual fund industry participants should provide comments if they havecontinuing concerns on the impact of the change in the method of calculating MER.

Income Taxes

CSA staff have considered other inquiries regarding the proper calculation of MER asrequired by the National Instrument and are outlining their views on the followingquestions raised.

1. Should the MER include foreign withholding taxes on dividends?

Section 16.1 of the National Instrument requires a mutual fund to express its"total expenses" for a financial year "as shown on its income statement" as apercentage of its average net assets for that year. Staff are of the view thatCanadian GAAP would permit a mutual fund to deduct withholding taxes fromthe income to which they apply. Accordingly, withholding taxes would not berecorded as "total expenses" on the mutual fund's income statement and neednot be included in its MER calculation.

2. Does a mutual fund corporation have to include capital taxes and income taxesin its MER calculation?

Mutual fund trusts generally distribute all taxable income and sufficient netrealized capital gains in order that the trust is not subject to income taxes.However, this tax treatment is not available to mutual fund corporations. Staffaccept that the MER calculations for mutual fund trusts and mutual fundcorporations should be carried out in a way that causes their MERs to becomparable. This comparability is achieved when a mutual fund corporationexcludes income taxes from its calculation of the MER.

However, staff are of the view that Canadian GAAP would require a mutual fundcorporation to include capital taxes as an expense of the mutual fund.Accordingly, capital taxes should be taken into account in that fund's calculationof MER.

Questions on the matters outlined in this CSA Staff Notice should be directed to:

Noreen Bent
Senior Legal Counsel
British Columbia Securities Commission
(604) 899-6741
or 1-800-373-6393 (in BC)
[email protected]

Christopher Birchall
Senior Securities Analyst
British Columbia Securities Commission
(604) 899-6722
or 1-800-373-6393 (in BC)
[email protected]

Wayne Alford
Legal Counsel
Alberta Securities Commission
(403) 297-2092
[email protected]

Bob Bouchard
Director, Capital Markets and Chief Administrative Officer
The Manitoba Securities Commission
(204) 945-2555
[email protected]

Rebecca Cowdery
Manager, Investment Funds
Capital Markets
Ontario Securities Commission
(416)593-8129
[email protected]

Anne Ramsay
Accountant, Investment Funds
Capital Markets
Ontario Securities Commission
(416)593-8243
[email protected]

Pierre Martin
Legal Counsel, Service de la reglementation
Commission des valeurs mobilieres du Quebec
(514) 940-2199 ex. 4557
[email protected]

Jacques Doyon
Analyst
Commission des valeurs mobilieres du Quebec
(514) 940-2199 ex. 4357
[email protected]

1. In Ontario, at (2000) 23 OSCB (Suppl.)