Mutual Fund Reform Edges Closer

Overhaul of the system could lead to lower fees and fewer conflicts of interest. But opposition to changes is strong.

Slowly – painstakingly slowly – we are edging towards what could be a complete overhaul of the way mutual funds are sold in Canada.

With consumer advocacy groups facing off against industry associations, the move away from the current system, with its inherent conflicts of interest, is not a sure thing. But regulators are pushing hard for reform, citing precedents in Great Britain and Australia as examples of the ideal goal.

At the core, there are two fundamental issues at stake.

The first is dealer compensation. Right now, anyone who sells you a mutual fund receives two forms of payment: a commission from the initial sale and an annual trailer fee for as long as you retain the units. The trailer fee is supposed to be the fund industry’s way of compensating financial professionals for the advice they render.

Not all funds carry both expenses. No-load funds, such as those purchased at your local bank, charge no up-front sales commission although most do pay trailer fees. Only a few companies, such as Vancouver-based Steadyhand and Leith Wheeler, have neither sales commissions nor trailers.

As a first step, Canada’s securities regulators are proposing to have all fees shown in terms of actual dollars spent on year-end statements. That way, investors will be able to see how much they are actually paying for mutual fund “advice” – and decide whether it is worth it.

But that’s only a stop-gap measure, at least if investor advocates get their way. The end game is to eliminate trailer fees entirely, a move that is being vigorously fought by the industry.

The second issue is one of responsibility. Polls show the majority of investors believe their financial advisers are legally required to act in their best interests. This is not the case. An adviser’s only requirement is to ensure an investment is appropriate for the client. It may not be the best security of its type, or the cheapest, but as long as it is deemed to be appropriate the adviser has done what is required.

The potential conflicts of interest are obvious. An adviser may recommend a U.S. equity fund as a good choice for a client. The idea may be perfectly valid. But there is nothing to prevent an adviser from suggesting a load fund that offers better compensation instead of a no-load fund that pays little or nothing in trailer fees. Both are suitable under current standards. But in the case of the latter fund, the adviser gets a better payday while the client may lose out because higher expenses translate into reduced returns.

Investor advocates want regulators to implement a system of fiduciary responsibility similar to that which exists between lawyers and clients. This means an adviser would be required to put the client’s interest first in any recommendation, regardless of the personal cost to him.

Last month, the Ontario Securities Commission (OSC) held a round-table discussion to examine these ideas. Predictably, there were heated exchanges on both sides. Investment Executive, the trade newspaper of the advisory community, quoted Greg Pollack, CEO of Advocis, an association of financial advisors, as saying that if the proposals were adopted “financial advice would become unaffordable and therefore inaccessible to the average Canadian”. Joanne De Laurentiis, head of the Investment Funds Institute of Canada, took a similar stance, claiming such moves would either force small investors to pay higher fees or squeeze them out of the market leaving them with no advice at all.

Obviously, the industry is going to do everything is can to prevent these changes from ever coming into effect.

However, the Canadian Securities Administrators, an umbrella group for Canada’s provincial and territorial securities commissions, seems determined to effect some meaningful, change this time around. The problem is that it is taking far too long to achieve results to satisfy investor advocates.

“Canadian investors cannot afford this slow pace of reform,” commented the Investor Advisory Panel of the OSC. “Justice delayed is justice denied…We need to move beyond talking.”

Right on! All the arguments are now on the table. It’s time for our regulators to take action.


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