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Mutual Fund Abuses Found In Canada

Nov 24, 2003 | The Globe and Mail

A U.S. economist who tracked mutual fund abuses in the United States says there is evidence of similar trading problems occurring in Canada.

Stanford University economist Eric Zitzewitz, who helped New York State Attorney-General Eliot Spitzer probe the mutual fund industry in the United States, tracked a "small sample"' of Canadian global equity funds and found that trading irregularities shaved up to a half a percentage point off rates of returns.

"I believe that there is a problem in Canada. It may not be as big as in the U.S., but some of these revelations will start to come out about Canadian funds," he said in a recent interview.

"The same basic problem exists in that they are pricing their funds the same way the U.S. companies are pricing their funds.''

He said the main problems occur in global equity funds. The underlying shares trade heavily in overnight markets, opening up "stale pricing" arbitrage opportunities for traders. However, Mr. Zitzewitz said more Canadians funds have some type of fee for rapid trading, which would reduce the opportunity to make profits on temporary differences in the prices of the underlying stocks and of the funds themselves.

The rapid transaction fee "is not a perfect solution because the fee doesn't get applied to everybody, but all things equal, it's likely to lead there to be less of this kind of trouble," he said.

Mr. Zitzewitz would not reveal which Canadian funds he examined, though he emphasized his sample included only a "small handful" of Canadian funds.

The economist calculated the average losses in Canada are roughly 0.3 per cent to 0.5 per cent of assets, compared with 1 per cent of assets in the United States.

As a result, a Canadian fund with an 8-per-cent rate of return would have that lowered to between 7.5 per cent and 7.7 per cent.

Eric Pelletier, a spokesman for the Ontario Securities Commission, confirmed that OSC officials had consulted with Mr. Zitzewitz regarding his study, but said his Canadian sample "wasn't sufficient to draw any conclusions from.'' While U.S. regulators have been aggressively reviewing trading data and laying charges against firms that permitted stale price or late-day trading, the OSC has asked 105 fund companies to review their own trading data and inform the commission of any potential problems.

Mr. Pelletier said the OSC is also conducting its own review of data, but OSC officials have suggested Canadian funds are not as open to abuse as the U.S. ones.

Mr. Zitzewitz, who is temporarily attached to Columbia University, produced a provocative paper two years ago that quantified that financial damages that improper trading practices were inflicting on the U.S. mutual fund industry, worth $7-trillion (U.S.) a year. He estimated the damages at $5-billion; he has not attempted to quantify the losses in Canada.

Mr. Spitzer cited that research Sept. 3, when he held his first news conference alleging widespread abuses in the mutual fund industry.

Since then, the scandal has widened to include criminal charges against executives at Boston-based Putnam Investments, which has seen about $15-billion in withdrawals in the past several weeks.

On Friday, Mr. Spitzer said there would be more charges filed, and that he expects some executives will serve prison time and some fund companies will disappear as a result of investors' loss of confidence.

He also promised that any settlement with the industry would seek to reduce fees by improving competition and disclosure.

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