Education savings crackdown
All I can say is: What took them so long? The crackdown by the Ontario Securities Commission (OSC) on scholarship trusts is welcome news, but it should have happened a long time ago.
Despite their high fees and questionable marketing practices, these trusts have been operating with virtual impunity for years. Not only that, but they have acted aggressively to defend their right to do business as they saw fit whenever anyone criticized them.
Over the years, I have written several articles about the problems inherent with scholarship trusts. I also spoke about them a number of times while I was a financial commentator on CBC radio. Every time I said something that was perceived to be negative, I would receive lengthy correspondence from a public relations firm representing one or more of the trusts, telling me in polite but uncertain terms that my facts were wrong and insisting that their clients were rendering a wonderful service to the parents of Canada.
I wasn’t the only one to come under this kind of pressure. In October 2002, the OSC published a brochure entitled “Saving for your children’s education: Get the facts about RESPs before you invest”. It contain a special warning about fees, stating: “You can expect to pay enrolment fees, administration & management fees, sales incentive fees, trustee fees, advisor fees, custodian fees and transaction costs such as commission on the purchase of securities. Fees are paid up front from your contributions; you don’t earn any interest on your investment until the scholarship trust company gets paid.”
The reaction of the industry was predictable: it criticized sections of the brochure and demanded that the OSC make changes.
The following year, the Canadian Securities Administrators launched a National Compliance Review of scholarship plan dealers. That document was made public in July and led to a crackdown by the OSC.
Risk of misrepresentation
Taken as a whole, the report was a damning indictment of the way in which scholarship trusts do business. It exposed weaknesses in the compliance procedures of the organizations and was critical of managerial supervision of sales representatives. The suitability of customers was not properly assessed in some cases through the required “Know Your Client” forms, resulting in a high degree of cancellations. Sales representatives sometimes lacked knowledge of the product and its associated costs. Especially damning was the line that read: “Enrolment fees were misrepresented in some cases, leading clients to believe that the potential for loss was nil.”
There’s much more. Rates of return were misrepresented. In some cases, sales people were encouraged to say they worked for a not-for-profit organization and weren’t selling anything. Some sales materials suggested that securities regulators endorsed the product. Client statements of account were found to contain misleading information. And on and on and on. You can read all the details for yourself here.
What the report does not tell us is how much money has been lost over the years by unsuspecting parents or grandparents who were only trying to do what was best for their children and grandchildren. I won’t even hazard a guess, but based on letters, e-mails, and conversations I have had over the past decade I suspect it must be a lot. Two complaints surfaced repeatedly: the high fees that were lost if people dropped out of the program and the restrictions that were placed on eligibility for the scholarship money when children reached college age (these have since been loosened).
The scholarship trust business has now been placed under a tight rein. Let’s hope that the result as a cleaner, more transparent system. But regardless of how this plays out, I doubt that I will ever recommend that anyone buy into one of these plans. Not when every bank and brokerage house offers much cheaper and easy-to-understand alternatives.
The registered education savings plan (RESP) is a good concept and recent improvements to the rules and the introduction of the Canada Education Savings Grant (CESG) have made it even better (although not perfect). For parents or grandparents who want to put some money aside for their children’s future, it’s certainly worth considering.
The key is to minimize the costs and to invest the money in low-risk securities. For example, if you open a self-directed plan you could buy strip bonds each year that will mature during the period the child or children are expected to be in college. Interest rates are low right now but they will likely rise in the next few years and the average annual return on the RESP will probably be in the 5 per cent to 7 per cent range when it comes time to cash in. That’s very respectable given the low risk involved. The minimum amount required to purchase a strip bond can be as low as $1,000 (check before you open a plan) so this strategy should be within the range of most RESP investors.
If you want to aim for a higher return, consider a conservatively-managed balanced mutual fund with a solid track record. Mackenzie Ivy Growth and Income Fund is a good example. Over the past decade, it shows an average annual compound rate of return of 10.3 per cent. It has only lost money twice in a calendar year since it was launched in October 1992, the worst being a 1.4 per cent drop in 2002 at the height of the bear market. Who needs scholarship trusts when there are funds like that around?