Discount brokerage Series A funds come under regulatory scrutiny

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Securities regulators are stepping up efforts to review the types of funds being sold through discount brokerages, particularly those funds that charge for advice where no advice is given.

Earlier this year, the Investment Funds Institute of Canada (IFIC) reached out to regulators, asking them to adopt a rule that would ensure mutual funds that carry an embedded adviser fee are only sold in channels where advice is offered. These funds – commonly known as Series A mutual funds – account for 68 per cent of the total amount of funds sold in Canada, according to IFIC.

The debate surfaced after the Canadian Securities Administrators (CSA) discussed the conflict with Series A funds in a paper it released last January that tackled the topic of discontinuing embedded commissions. The paper prompted IFIC – as well as several other industry groups and individuals – to say that all Series A funds should be prohibited on discount-brokerage platforms.

The Investment Industry Regulatory Organization of Canada (IIROC) confirmed this week it has begun to examine the issue further and is in the process of "fact-gathering," with the assistance of the CSA.

"We are starting to approach these issues from the perspective of considering how our [discount-brokerage] dealers can meet their obligations under our conflicts-of-interest rule if offering the Series A funds," said Marsha Gerhart, vice-president of member regulation policy at IIROC, during the annual IFIC leadership conference on Wednesday.

"Those are the areas that we have started to explore. We have not reached any conclusions at this time about what our next step will be."

IIROC has an ongoing review of the discount-brokerage channel, and while it initially did not target the Series A offering directly, it did include issues such as product offerings and what constitutes advice.

Discount brokerages are not permitted to provide adviser recommendations, yet the majority of those operating in Canada offer Series A funds on their platforms.

Out of 13 discount brokers, 11 of them confirmed to The Globe and Mail that Series A funds were made available for purchase to online investors on their platforms – including all six discount brokerages of the Canadian banks.

About 83 per cent of mutual funds sold through discount brokerages in Canada include commissions that are typically charged by financial advisers for the advice they provide. Of the total $30-billion in assets held in mutual-fund products in these discount brokerages, more than $25-billion remain in Series A funds, according to the CSA.

Series A funds can charge a management-expense ratio between 1.5 per cent and 2.5 per cent. By comparison, Series D funds – those tailored for do-it-yourself investors that strip out advice fees – it can be less than 1 per cent.

Paul Bourque, IFIC's president and chief executive, is pleased with the response by regulators.

"It is up to the regulators to decide on what to do and how to respond," Mr. Bourque said.

"I think the data gathering is an appropriate thing for a regulator to do because before they move forward on a resolution, they need to define the problem, find out how big of a problem it is and to what extend that problem goes.

[We] have publicly made it known that we do not feel investors should pay for advice if they don't want it, as well, investors who pay embedded commission should be made aware of what they are paying for."

FAIR Canada – a investor advocacy group – has also asked regulators to consider a requirement for discount brokers or fund companies to offer only a class of funds that has no trailing commissions. In addition, FAIR has recommended that all firms that offer a particular mutual fund be required to offer the "F" class version of the fund, which does not have a trailing commission and typically is for fee-based clients who pay for advice separately.