The Ontario Securities Commission (OSC) has approved a C$164 million no-contest settlement agreement with CI Investments Inc. to compensate investors for the firm’s failure to accurately calculate the value of certain mutual funds. It is the largest investor compensation package to result from a no-contest settlement since the OSC began using them in March 2014, and reflects the intended “self-policing” outcome of the OSC’s Revised Credit for Cooperation Program.
In June 2015, CI Investments, or CII, reported that it had undervalued seven mutual funds over a five-year period, resulting in harm to investors. The OSC’s subsequent investigation determined that CII’s supervisory and control systems were insufficient to address a cash collateral feature unique to those funds, resulting in the failure to include interest earnings in their net-asset-value (NAV) calculations. Additionally, CII failed to adequately monitor a third-party firm hired to provide fund accounting services, the OSC said. Investors use NAV calculations to measure fund performance, so it is imperative for fund managers to ensure their systems are always calculating and reporting correct values.
The settlement included C$156.1 million in restitution for affected investors, a “voluntary payment” of C$8 million to advance the OSC’s “mandate of protecting investors,” and C$50,000 to cover investigative costs. Despite agreeing to the payments, however, CII neither acknowledged nor denied any of the OSC’s allegations, conclusions, or statements of fact.
The OSC concluded that CII violated the Ontario Securities Act by failing to establish, maintain, and apply a system of supervisory policies, procedures, and controls that could:
- Identify and correct valuation problems in a timely manner;
- Manage the risks associated with the development and monitoring of new products in accordance with prudent business practices;
- Ensure accurate NAV calculation;
- Monitor and supervise third-party service providers; and
- Ensure that CII and its representatives complied with securities legislation.
The OSC found no evidence of “dishonest conduct” by CII, the settlement said.
The CII agreement is by far the OSC’s largest no contest settlement, but it is only the fourth such arrangement. After CII, the second largest settlement saw TD Bank pay C$13.5 million for excessive client charges.
No contest, no admission
Ontario is the only jurisdiction in Canada with a no-contest settlement regime, which the OSC adopted in order to “strengthen enforcement”. The framework excludes serious offenses and criminal conduct, and was designed in part to liberate regulatory resources that could be used to pursue more criminal cases.
The OSC introduced no-contest settlements as part of its Revised Credit for Cooperation Program, in order to expedite enforcement matters by allowing respondents to settle cases without admitting to compliance violations. Negating such admissions was explicitly designed to give respondents an advantage if their conduct resulted in civil litigation.
As the name implies, the Credit for Cooperation Program is meant to reward self policing, self reporting, and self correction. The OSC stressed that CII’s timely self reporting of the “control and supervision inadequacy” was a mitigating factor, even if the discovery itself was deemed unacceptably overdue. The OSC credited CII for the following remediation measures:
- Formulating a plan to distribute all the unpaid interest, plus other “appropriate compensation” to affected investors, while waiving C$4 million in management fees to which it was contractually entitled;
- Retaining a financial consultant to independently investigate the alleged supervisory inadequacies, consider other potential remediation measures, and test CII’s compensation plan; and
- Implementation of unspecified “enhanced control and supervision procedures,” which must be reported to the OSC as they progress.
Despite the OSC’s assertion that no contest settlements allow regulators to focus more resources on criminal cases, opponents have argued that such arrangements encourage offenders to view fines as a mere business expense, while depriving the public and courts of agreed upon facts. The U.S. Securities and Exchange Commission (SEC), for example, was put on the defensive when a federal judge angrily rejected a $285 million settlement with Citigroup over the sale of toxic mortgage debt. U.S. District Judge Jed Rakoff accused the SEC of extracting little more than “a quick headline” from the financial giant.
One day after the OSC approved the CII settlement, the firm’s parent company, CI Financial, issued a quarterly report denying any compliance failures had taken place. It said the five-year long NAV miscalculation was an “accounting/administrative error, NOT a compliance error.”
Additionally, CI Financial stressed that the C$156 million in investor restitution would come from bank accounts belonging to the relevant mutual funds, not from CII itself. The entire settlement, including remediation expenses, will cost the firm C$10.75 million, CI Financial said in its 2015 consolidated financial statement.
With over C$141 billion in assets under management as for January 31, 2016, the settlement will not have a material impact on CII.
Regardless of CII’s relatively pain-free settlement, this case demonstrates the OSC’s willingness to work with firms that promptly self-report compliance failures.
The lessons here are twofold. First and foremost, the enthusiastic maintenance of effective supervisory, control, and reporting functions—especially where investor assets are concerned—will significantly mitigate the risk of unexpected failures. Second, in the event that regulatory violations do occur, firms would be well-advised to avail themselves of the OSC’s credit-for-cooperation program, with a particular emphasis on rapid self-reporting and remediation.
CII would likely have faced a much more complex and costly enforcement action had it failed to report and address the damage it caused to investors.
About Thomson Reuters Regulatory Intelligence
This article was produced by Thomson Reuters Regulatory Intelligence. It was written by Daniel Seleanu, a correspondent for Thomson Reuters Regulatory Intelligence in Toronto.
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