After decades of controversy, discount brokerages will be banned from selling mutual funds that have charged investors billions of dollars in fees for advice they did not receive.
On Thursday, investment industry regulators finalized rules that will ban fund companies from paying trailing commissions to discount brokerages, starting June 1, 2022. At the same time, discount brokerages are prohibited from accepting or soliciting similar commissions from fund companies.
Discount brokers have never been allowed to provide advice to investors under regulatory rules. But they have often collected fees known as trailing commissions on funds that have an advice fee bundled in. Several class-action lawsuits have been filed against discount brokerages, at least one of which estimates that investors have incorrectly paid about $5-billion in commissions for these funds since the early 1990s.
Now, the Canadian Securities Administrators, an umbrella group for all provincial and territorial securities commissions, is putting an end to online brokerages selling Series A funds – a type of mutual fund that was originally designed to be sold to clients through investment advisers.
These funds can charge a management expense ratio between 1.5 per cent and 2.5 per cent. By comparison, for Series D funds – those tailored for do-it-yourself investors that strip out advice fees – it can be less than 1 per cent.
The 2022 rule change for discount brokerages will be adopted at the same time that all provinces and territories – except Ontario – also implement a previously announced ban on deferred sales charges (DSC) on mutual funds. DSC funds charge investors no sales commission up front, but collect a redemption fee if buyers pull money out before a set date.
Regulators said Thursday they will be “highly attuned” to inappropriate sales of DSC products ahead of the ban.
The trailer ban for discount brokerages will also include DSC funds. Regulators expect fund companies and investment dealers to comply with the new rules in a way that “ensures the best outcome for investors,” particularly those with DSC holdings.
As a result of the ban, the CSA said it expects fund companies to not charge investors who currently hold DSC funds redemption fees, when moving their funds.
“[We] remind registrants of their obligations to treat investors fairly and recommend suitable products, as many investors face shorter time horizons and heightened needs for liquidity due to continued economic uncertainty caused by the pandemic,” the CSA said in a statement.
In 2017, the CSA published research showing that of the $30-billion held in mutual fund products in discount brokerages across Canada, more than $25-billion remained in fund series that bundle in an advice fee.
As of June 1, 2022, those investors who currently hold mutual funds with a trailing commission will no longer be permitted to keep the investment in a discount brokerage account. The discount brokerage must switch investors into a no-trailing commission series of the same mutual fund.
However, if a commission-free series does not exist, investors will have to look at other options such as being transferred out of the fund, or transfer the fund to an investment dealer who can provide advice.
Investor advocates and industry groups have long objected to discount brokerages accepting trailing commissions even though they provide no advice, and the opponents blame regulators for not immediately ending the practice.
A recent class-action lawsuit filed against Canada’s largest discount brokerages estimated that since 1993, discount brokers have incorrectly been paid about $5-billion in trailing commissions.
For prominent investor advocate Ken Kivenko, the two-year transition period is too long for a rule that the fund industry has known was coming since last December. The delay also leaves investors at risk of being charged additional fees.
“This is one of the biggest investment scandals in Canadian history,” Mr. Kivenko said in an interview last month. “All the while, discount brokers will be allowed to continue offering [advice series] mutual funds with trailing commissions of 1 per cent. It is unacceptable.”
Regulators say the two-year transition period will allow online brokerages to alter their systems and processes to comply with the new rules, reassess compensation arrangements and implement new fee-charging systems. The delay will also provide fund companies with enough time to introduce a no-trailing-commission mutual fund series for do-it-yourself investors.
CSA chair Louis Morisset, who is also CEO of the Autorité des marchés financiers, Quebec’s securities regulator, says the fund changes can occur sooner than the 2022 implementation of the new rule.
“Where possible, investment fund managers and [order-execution-only] dealers are strongly encouraged to accelerate their transition away from mutual fund series with trailing commissions,” he said in a statement.
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