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New rule proposed to boost transparency around funds with embedded fees

Rule would ensure mutual funds that carry an embedded adviser fee are only sold in channels where advice is offered.

The industry group charged with protecting investors wants to ensure that Canadians buying mutual funds through online brokers aren't paying for advice they'll never receive.

The Investment Fund Institute of Canada on Monday proposed regulators adopt a rule that would ensure mutual funds that carry an embedded adviser fee are only sold in channels where advice is offered. The regulators include the Investment Industry Regulatory Organization of Canada and all provincial securities commissions.

These so-called Series A funds bundle an advice fee within the product and are usually sold to investors who deal directly with an investment adviser. But these funds are also currently sold through discount brokerage channels. As such, do-it-yourself investors could be paying for investment advice they aren't receiving.

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"Investors who buy funds directly, for example though a discount broker, should be confident that they are not inadvertently overpaying by selecting a series that includes fees for services that are not available through that platform," said Paul Bourque, IFIC's president and chief executive.

IFIC's proposal to the regulators request investment fees be more aligned with the services that investors receive. Most companies who sell Series A funds also provide fund series that have no or nominal trailer fees that do-it-yourself investors can purchase or want to pay for advice separately. But those options may not be as transparent as they should, Mr. Bourque said.

Series A funds account for 68 per cent of all funds sold in Canada, according to IFIC, and can typically charge a management expense ratio between 2 per cent to 2.5 per cent. By comparison, Series D funds – which strip out advice fees – can be as low as less than 1 per cent.

IFIC isn't the only industry group looking at embedded fees. Earlier this year, the Canadian Securities Administration released a paper seeking industry comment on the topic of discontinuing embedded commissions. The paper, Consultation on the Option of Discontinuing Embedded Commissions, includes the issue of funds being sold with embedded advice fees through channels that do not offer advice.

"The CSA has identified three key issues stemming for the payment of embedded commissions," Louis Morisset, chair of the CSA, says. "One of the issues identified is the fact that embedded commissions paid generally do not align with the services provided to investors. As an evidence of this issue, we have identified in [our paper] that discount brokers who provide execution-only services often distribute fund series that pay them the same trailing that would be paid to a full-service dealer." Having investment dealers and advisers charge directly for financial advice is one arrangement that should be considered to manage the issue, Mr. Morisset says.

The CSA is currently requesting industry feedback on the paper until June 9, 2017.

The call for more transparency in the fund industry comes on the heels of IFIC's recent request for regulators to expand client disclosure requirements to include the full management expense ratio on client documents – an initiative commonly being referred to as CRM3.

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The second phase of the client relationship model – CRM2 – was implemented in July, 2016, to help investors gain greater transparency concerning the cost of their investments and the cost of financial advice.

But those changes did not include the costs imposed by mutual fund managers.

"Both initiatives are good measures to take but the timing of these announcements [by IFIC] strikes me as more of an effort to fight off a possible commission ban," said Dan Hallett, vice-president of HighView Financial Group. "If the true intent was to be more transparent and forthcoming to end investors, both of these issues would have been addressed many years ago."

As mutual fund fees continue to come scrutiny, advisors may need to prepare for a rise of commission-free investing options.
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