It’s been a grim few months for the cause of investor protection in Canada. The latest blow came from the Ontario government’s shameful decision to oppose a ban on deferred sales charges (DSC) on mutual funds.
This is just one more short-sighted victory for the mutual-fund industry over the interests of ordinary investors. A surprise statement from Ontario Finance Minister Vic Fedeli claimed DSCs have “enabled Ontario families and investors to save towards retirement and other financial goals.”
In fact, DSCs are rife with conflicts of interest that cost untold millions of dollars to individual investors, including vulnerable senior citizens, and their families.
Ontario’s announcement sidetracks a set of reforms recommended by the country’s securities regulators on how mutual funds should be sold in Canada. Those recommendations from the Canadian Securities Administrators (CSA) were already woefully inadequate after being watered-down in response to complaints from the mutual fund industry.
The proposed ban on DSCs was the most important of the surviving changes. If you own a DSC mutual fund, you pay a fee to redeem your investment during the first five to seven years that you own the fund. Typically, the charge starts at 6% the first year and declines each year to zero in the fifth to seventh year, depending on the fund.
The industry has long argued that DSCs allow smaller investors to gain access to financial advice they couldn’t otherwise afford and encourages them not to flit from one fund to another.
In fact, the real attraction for the mutual fund company is that investors are encouraged to stay put in their fund (even if it’s underperforming)—or pay dearly to exit. For advisors and their firms, the DSC brings a juicy up-front 5% commission, plus an ongoing trailing commission. It also pushes investors to stay with the advisor and his or her firm.
You can see the conflicts of interest inherent in these transactions, especially when many investors either don’t understand what they are buying or don’t understand how it works.
Despite the availability of no-load and exchange-traded funds, mutual funds sold with the DSC option still represent 18% of all mutual fund assets in Canada. That compares to just 1% of DSC mutual assets in the U.S. and Europe.
In proposing they be prohibited, the CSA said: “In our view, the conflicts of interest inherent in the DSC option give rise to a number of specific problematic practices and investor harms that warrant regulatory action.” Regulators from across Canada came to that conclusion after six years of study, consultation and debate. Fedeli rejected it at the stroke of a pen.
This setback for investors comes in the wake of the CSA backing away under industry pressure from other reforms such as banning embedded fees, also know as trailer fees, from mutual funds and requiring investment advisors to always act in their clients’ best interest.
These are dark days indeed for investor protection. However, there is one reason to be hopeful—many Canadians are waking up to the high costs, conflicts of interests and lack of transparency in the investment industry. It’s the time to demand better from governments and financial regulators.
Now, more than ever, Canadians should also vote with their money by choosing advisors who are committed to looking out for their best interests, avoiding conflicts of interest and being compensated by clients in a fair and transparent fashion.