Several of Canada’s largest mutual fund companies are urging Ontario’s securities regulator to relax proposed rules that will allow them to continue to sell controversial mutual funds that charge investors early-withdrawal fees.
Investment fund giants AGF Ltd., Invesco Canada, Mackenzie Financial and Fidelity Investments Canada are applauding Ontario’s plan to allow investment firms to continue to sell deferred fee mutual funds even as other provinces have banned sales of the products. But they are recommending the Ontario Securities Commission (OSC) change proposed new restrictions that would reduce the amount of sales commission fund companies can pay investment advisers.
Mutual funds with deferred sales charges (DSCs) require investors to pay fees when they pull money out of a fund before a set date. The adviser who sells the fund receives an upfront commission from the fund company that is often higher than commissions for other types of mutual funds.
A 90-day comment period for the new rule ended last week, and several major fund companies are arguing the proposed changes will limit investment dealers from covering the costs of providing advice to investors with small accounts.
In recent years, however, regulators in other provinces have argued it is not appropriate that advisers have an incentive to recommend DSC funds over more flexible funds with lower costs. The funds sparked controversy across the investment community as cash-strapped investors found themselves unknowingly locked into mutual funds for up to seven years. In order to access their own funds, clients were required to pay significant penalties if they have to sell earlier, even if they need to unlock money owing to financial hardship.
Last December, the Canadian Securities Administrators (CSA), an umbrella group for all provincial securities regulators, announced that all provincial and territorial regulators were moving ahead to ban the sale of DSC funds, but Ontario would not participate. The province said it would instead look to place new investor protection parameters around the products to prevent any improper selling of the funds.
In May, the investment arm of Bank of Montreal announced it would no longer sell DSC funds – including in Ontario – as of November, 2020. The bank already discontinued longer-term DSC funds in 2017. Investors Group did the same in 2017 for all its DSC funds, stating the marketplace had evolved from such products.
Now, the OSC’s proposed new rules would prohibit the sale of mutual funds with the DSC option to clients who are aged 60 and older, or to people who have an investment time horizon that is shorter than the DSC schedule – which typically is seven years for a long-term investor.
The OSC rule change would also prohibit sales to clients who intend to use borrowed money to finance their purchase and would impose a maximum account size of $50,000 for all DSC investors. But the fund industry is asking the OSC to increase the maximum account size to $100,000 to capture all “modest investors” and make it “worthwhile” for investment dealers and advisers to serve such still-small clients.
“This commission is typically split between the dealer and adviser, and would not, in our view, compensate the adviser for the cost of setting up and managing a small account appropriately,” said W. Sian Burgess, senior vice-president of fund oversight at Fidelity.
Fund companies are also not happy with the age limit, and want the OSC to reconsider upping the age limit for investors who can be sold DSC funds to 65 from 60.
“The number of Canadians that continue to work in their late 60s and into their 70s has nearly doubled between 1995 and 2015,” said the Investment Funds Institute of Canada, an industry association, in a comment letter. “As a result, we believe that the limit in the proposed rule for the sale of mutual fund securities under the DSC option to investors under 60 years of age is too low.”
Fund companies also want to see the locked-in feature of the DSC funds set at a five-year term, rather than the proposed three-year term. Currently, most DSC funds have a redemption schedule that requires investors to pay a penalty to access their funds for the first seven years of the investment.
Investor advocates continue to blast Ontario for not following the rest of Canada in banning the use of such funds, stating that today small investors have alternative choices to access advice and do not need to rely on upfront commissions to work with an adviser.
“Small investors have ready access to robo-advisers, thousands of no-load mutual funds via their bank branch and hundreds of low-cost ETF’s, and advice only financial planning organizations,” said Karin Mizgala, chief executive and co-founder of Money Coaches Canada, a financial planning firm that does not receive sales commissions from fund companies.
“All of the proposed constraints will still allow exploitation of many retail investors albeit with some improved protection for seniors over 60,” she said. “A DSC mutual fund is in the best interests of dealers, not the retail investor.”
The president of the Portfolio Management Association of Canada, Katie Walmsley, said Ontario needs to reconsider its decision to “deviate” from the rest of the country in a DSC ban before it creates “untended cost consequences” for the industry and potential harm to investors.
“Harmonization is important so that investors are owed the same obligations and afforded the same opportunities, regardless of their province of residence,” she said.
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