It looks like regulators will be looking at whether or not to ban mutual fund trailer fees, as did Australia and the United Kingdom two years ago. My view is that they should not be banned unless the regulators first determine all the intended and unintended consequences of eliminating them, and whether a ban would actually be in the long-term public interest.
A couple of weeks ago the Canadian Securities Administrators published the results of a study they had commissioned, which revealed that mutual-fund salespeople are more influenced by payouts they receive from fund companies than by fund performance, and that this is to the detriment of investors.
Specifically, the study by Schulich School of Business Professor Douglas Cumming and co-authors Sofia Johan and Yelin Zhang focused on the impact of trailer fees. These are fees paid by mutual fund companies to dealers. They range up to 1% of the assets a dealer has under administration for a specific fund company. The dealer pays a portion to its sales people based on the value of assets from that fund company in the advisor's clients' account.
Trailer fees, along with deferred sales charges, came into being in the mid-1980s as fund companies who sold through dealers responded to dealers' and sales people's complaints that they wanted products to compete with no-load funds. The end result is that management fees -- the fees that investors pay fund management companies -- are higher than they would otherwise be to reflect the trailer fees.
Discussions over perceived conflicts about trailers and what to do about them have been around since trailers were introduced. There is a perceived conflict that trailer fees encourage advisors to keep clients in funds despite poor performance, because the advisor gets paid regardless. On the other hand, an argument can be made that trailers encourage advisors to move clients into funds with better performance, since better returns mean more assets on which to collect trailers.
In her 1995 report, Regulatory Strategies for the Mid-'90s: Recommendations For Regulating Investment Funds In Canada, Toronto securities lawyer Glorianne Stromberg considered recommending a ban on trailer fees but did not.
She wrote "Part of my reluctance simply to recommend that trailer or service fees be banned relates to the concern expressed by industry participants that banning these fees would just encourage sales representatives to increase the transactions within their clients' accounts or to abandon their clients after the initial sale. There is concern that even with enhancing the supervisory controls and procedures, it is unrealistic to think that the measures will be sufficient to prevent switching and churning of accounts."
It's apparent or at least perceived as apparent that in an environment without trailers, small investors may not get any service whatsoever. A case in point would be the investor who invests $50,000 with a mutual fund advisor in equity funds. The trailer on that would be 1% or $500, of which the salesperson might get half depending on his or her arrangement with the dealer.
What kind of service will a client with a $50,000 account get for that money? I've seen some situations where the level of service has been abysmal and others where it has been superb (primarily because the account had promise of growth or was part of a high-net-worth family's accounts). But what I've seen may not be representative of the industry.
I recommend that the provincial and territorial regulators, in cooperation with the MFDA, retain academics to interview a large number of mutual fund investors to determine what level of service, if any, they get from their advisors in return for that service fee. This would include looking at the specific services the dealers provide their clients on an ongoing basis for the service or trailer fee and relate those services to the dollar value of those trailers.
The regulators should also look at the Australian and UK experience to see if small investors have been abandoned by advisors.
As well they should examine the arrangements that discount dealers have with fund management companies. I suspect that they will find that the fund companies feel that if they don't pay trailers to discount brokers these brokers won't offer the funds. I also suspect that the regulators will want to consider a ban on service fees payable to discount, no-advice dealers.
Also many advisors look at themselves as self-employed business people with the value of their business based largely on the trailers their accounts generate each year. The regulators should determine what impact banning trailers would have on the value of representatives' books of business and importantly the ability of the industry to attract younger people to replace those retiring.
