The much maligned and increasingly unpopular deferred-sales-charge option for mutual funds, which was about to be eliminated, has been rescued by the Ontario government. In so doing, the majority Conservative government led by Doug Ford opposes not only its own Ontario Securities Commission, which played the lead role in crafting mutual-fund reforms. It also rejects the unanimous agreement of the Canadian Securities Administrators, representing regulators across Canada.
On Sept. 13, the CSA released, for a 90-day comment period, its final position paper on how the DSC would be phased out, and how all forms of embedded fund commissions would be banned for discount brokerages. It was the culmination of a six-year process of research and consultations. This high-profile national initiative first made headlines with the December 2012 release of a CSA paper that was highly critical of embedded mutual-fund commissions that, like the DSC, are paid by fund companies to salespeople out of the management fees.
Last week's CSA announcement was swiftly superseded, in the form of a brief statement from Ontario Finance Minister Vic Fedeli, whose responsibilities include overseeing the OSC. "The CSA and OSC's proposed amendments result from a process initiated under the previous government and, if implemented, will discontinue a payment option for purchasing mutual funds that has enabled Ontario families and investors to save towards retirement and other financial goals," Fedeli said. "Our government does not agree with this proposal as currently drafted."
Fedeli added that the Ontario government "will work with other provinces and territories and stakeholders to explore other potential alternatives to ensure fair, efficient capital markets and strong investor protections." No further details were available. When contacted for comment, a spokesperson for the finance minister would only refer Morningstar back to the original statement.
What's abundantly clear is that the provincial government has veto power. "Ultimately, OSC policies are subject to final approval by Queen's Park, so the government has the power to force its will on the OSC," says Neil Gross, a financial-industry consultant and veteran lawyer. "But that doesn't mean it's a good idea to do so."
Gross says it's unwise to depart from the historical practice of letting securities commissions develop policies that are largely free from political influence. "That practice is essential for maintaining public confidence in Ontario's capital markets." Gross, a former head of the investor-advocacy organization FAIR Canada, told Morningstar the CSA reforms "were designed to help ordinary people -- average investors -- who currently are being disadvantaged by DSC charges and the fees discount brokers take unfairly for advice services those brokers can't and don't provide."
The OSC's muted reaction was one of deference to its political master. "Our minister's support is critically important to the OSC, and we are respectful of our government's authority to decide whether any rules published for comment ultimately come into effect," OSC spokesperson Carolyn Shaw-Rimmington said via a prepared statement.
Elsewhere across Canada, a spokesperson for the Alberta Securities Commission declined comment on the Fedeli statement while expressing support for the consultation process. "At the ASC, we're looking forward to the outcomes of this process and will carefully consider all feedback and comment letters received. CSA members share a mutual commitment to work together with our governments and stakeholders to reach a successful outcome that adequately addresses both investor protection and market efficiency."
Similarly, the British Columbia Securities Commission also declined to address the Ontario statement directly. "The BCSC is committed to a transparent rule-making process, the goal of which is to develop and continuously improve regulation that fosters fair, efficient and vibrant capital markets in a way that ensures investor protection, and we remain supportive of the proposed amendments," a BCSC spokesperson told Morningstar. "We will, along with our CSA counterparts, consider all comments from stakeholders at the end of the comment period and will continue to work collaboratively moving forward."
The CSA proposes a one-year transition period to eliminate the DSC. This would begin as of the effective date of amendments to National Instrument 81-105, which governs mutual-fund sales. Existing funds held under the DSC option would be allowed to run their course until the expiry of their redemption-fee schedules.
The transition period, the CSA says, should give fund companies enough time to revise their prospectuses and Fund Facts documents. A one-year transition is also proposed for elimination of all embedded commissions, primarily in the form of trailers, paid to order-execution-only discount brokers.
When first introduced in 1987, the DSC was touted as a compensation model that enabled investors to put all their money to work right away, rather than pay upfront commissions that at the time ranged up to a staggering 9%. But front-end-loads are now generally set at zero, with dealers instead being compensated with trailer commissions of 1% a year.
Also increasingly common are fee-based arrangements in which all advisor compensation is paid directly by the investor. Under current market conditions, DSC options for which advisors receive 5% upfront commissions are excessive, even if their trailer commissions are reduced.
Apart from the high upfront costs that are baked into fund-management fees, the DSC has other disadvantages. The time horizon of investors, and therefore their holding period, may be shorter than the redemption-fee schedule that can last as long as seven years. If the DSC fund performs poorly or no longer meets their needs, investors may be deterred from redeeming. There's also the temptation on the part of unethical dealers to churn accounts, generating a fresh upfront 5% payout, by switching the investor to another fund once the redemption-fee period expires.
But the Ontario government, touting its Open for Business philosophy, is supportive of the notion that fund dealers and fund companies should be able to continue a long-established compensation practice, and that investors should be free to choose how they pay for advice.
Ontario's intervention represents a triumph for Advocis, the Financial Advisors Association of Canada, whose more than 13,000 members are primarily life-insurance and mutual-fund dealers. Advocis, which maintains provincial advocacy committees to lobby politicians, has been an outspoken defender of embedded compensation in its submissions to the CSA, and behind the scenes.
Advocis was quick to lavish same-day praise on the Ontario Conservatives. "Our intention as an association is to ensure Canadians have equal access to trusted financial advice," said president and CEO Greg Pollock. "Today's announcement demonstrates that the government of Ontario shares that vision, and intends to work alongside stakeholders to protect consumers."
Advocis and other like-minded elements of the investment community contend the DSC option enables investors with small accounts to obtain investment and financial-planning advice that would otherwise be uneconomic for advisors to provide.
Yet there's ample evidence to the contrary. Canadians with modest amounts to invest have numerous accessible alternatives such as bank branches and online investment advisors.
Furthermore, Investors Group, a pioneer in providing full-service advice to small investors, eliminated the DSC option for its proprietary sales force as of January 2017. As the company noted at the time, the mutual-funds market has evolved. Will the regulatory landscape affecting advisor-compensation practices of all fund companies also be able to evolve? That's now in doubt.
