Industry regulators in Ontario are proposing certain restrictions on the sale of mutual funds that charge investors early withdrawal fees, while the rest of Canada announces an official ban on the controversial investments.
In a notice on Thursday, the Ontario Securities Commission released a proposal for several restrictions on the sale of mutual funds that charge fees known as deferred sales charges (DSCs).
DSCs charge investors when they pull money out of a mutual fund before a set date. The adviser who sells the fund receives an upfront commission that is often higher than commissions for other types of mutual funds. In recent years, regulators have argued it is not appropriate that advisers have an incentive to recommend DSC funds over more flexible funds with lower costs.
Last December, Canadian Securities Administrators (CSA), an umbrella group for all provincial securities regulators, announced all provincial and territorial regulators were moving ahead without Ontario to ban the sale of DSC funds.
Now, if approved, the OSC rule would prohibit the sale of mutual funds with the DSC option to clients who are aged 60 and over, or who have an investment time horizon that is shorter than the DSC schedule – which typically is between three to seven years.
As well, the OSC rule change would 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.
“The proposed rule is intended to address negative investor outcomes by limiting the circumstances in which mutual funds with the DSC option can be sold and by giving clients greater flexibility to redeem these investments without penalties," the OSC said in a statement.
The proposed rule would also shorten the maximum term of the DSC schedule to three years, compared to current industry practice where the maximum term can be up to seven years. Additionally, clients would be able to redeem 10 per cent of the value of their investment without redemption fees annually, on a cumulative basis.
One of the biggest consequences of the DSC option for investors is when they have to redeem their money earlier than expected due to unforeseen circumstances. The OSC’s rule would implement an exception for investors during financial hardship circumstances, such as involuntary loss of full-time employment, permanent disability or critical illness. Clients would be able to redeem their investment without paying redemption fees.
The OSC’s proposal comes on the same day the Canadian Securities Administrators announced the rest of the provinces and territories have officially adopted rules that will end DSCs on mutual funds. As of June 1, 2022, all provinces and territories except Ontario will prohibit fund organizations from paying upfront sales commissions to dealers.
“This decision was motivated by important investor protection concerns,” said Louis Morisset, chair of the CSA. “Upfront sales commissions create conflicts of interest and impose liquidity constraints that harm investors. This compensation bias incentivizes dealers to recommend a product that may not be in the best interest of investors and has led to sub-optimal investor outcomes.”
The CSA said it had considered alternatives to the DSC ban, including regulating sales through a series of restrictions, but concluded they only “partially mitigated the investor harms” they identified and none dealt with “the conflicts of interest inherent in the DSC option, or the harmful lock-in feature imposed on investors.”
“With ample evidence of investor harm, especially for the most financially vulnerable investors, and no evidence of any benefits, we see no reason to preserve the DSC option,” said the CSA.
The OSC’s proposed rule is open for public comment until May 21, 2020, with the expectation to implement the rule by June, 2022.
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Clare O’Hara