On December 13, 2012, the Canadian Securities Administrators (the CSA) released Discussion Paper and Request for Comment 81-407 Mutual Fund Fees (the Discussion Paper). In the Discussion Paper the CSA examines mutual fund fee structures in Canada to determine whether there are any investor protection and fairness issues and, if so, whether any regulatory responses are required to address those issues. The CSA requests comments from investors and participants in the Canadian mutual fund industry and notes that comments received will help inform a roundtable that the CSA plans to hold in 2013.
The Discussion Paper focuses on mutual funds, although the CSA notes that any regulatory initiatives that may be taken as a result of the consultation process will be assessed to determine whether the same initiatives should apply to other investment funds and comparable securities products.
If implemented, the proposals made by the CSA in the Discussion Paper will significantly impact the current distribution system for mutual funds in Canada. As such, both mutual fund managers and advisors who sell mutual funds should carefully review the Discussion Paper and consider providing written comments to the CSA on the proposals raised in the Discussion Paper.
Current mutual fund fee structures in Canada
Mutual fund investors in Canada incur two primary types of fees when investing in mutual funds: sales charges and ongoing fund fees.
Several issues are identified by the CSA with respect to the current mutual fund fee structures in Canada, including:
1. imperfect investor understanding of mutual fund costs and control over advisor compensation;
2. potential conflicts of interests at the mutual fund manager and advisor levels;
3. potential for cross-subsidization of commission costs;
4. potential lack of alignment between advisor compensation and services provided; and
5. limited low-cost options for do-it-yourself (DIY) investors.
Topics for consideration
To address the issues identified by the CSA, the Discussion Paper proposes seven possible changes to the current structure of mutual fund fees, which are summarized below.
1. Advisor services to be specified and provided in exchange for trailing commissions
The Discussion Paper proposes that the purpose of trailing commissions could be defined and disclosed, and a minimum level of ongoing services that advisors must provide to investors in exchange for the payment of these commissions by mutual fund managers could be established. The CSA believes this would more clearly align the payment of trailing commissions with the provision of specified services to investors. Under this proposal, advisors and their dealer firms would be required to record and monitor the nature, extent and frequency of services provided to investors and if it was determined that appropriate services were not being delivered to investors, advisors would be prohibited from collecting a trailing commission.
2. A standard class for DIY investors with no or reduced trailing commission
The Discussion Paper proposes that every mutual fund could have a low-cost execution-only series or class of securities available for direct purchase by investors. Because DIY investors do not seek the advice of advisors, these series or classes of securities would involve lower management fees, with nominal or no trailing commissions paid to advisors.
3. Trailing commission component of management fees to be unbundled and charged/disclosed as a separate asset-based fee
The Discussion Paper proposes that the trailing commission component of a mutual fund's management fee could be unbundled and instead charged and disclosed as a separate asset-based fee to the mutual fund to increase transparency of the cost of distribution and to reclassify trailing commissions as an expense of a mutual fund, limiting the ways they may be used. This option would require that future increases in the separate asset-based trailer fee charged to a mutual fund be subject to securityholder approval in the same way that an increase in the management fee is subject to approval.
4. A separate series or class of mutual funds for each purchase option
The Discussion Paper proposes that mutual funds could maintain a separate series or class of securities for each available purchase option (i.e. front-end sales charge, deferred sales charge, low-load and no-load) either in conjunction with or as an alternative to proposal 3, above. Under this proposal the specific distribution costs incurred by each series or class of mutual fund securities would be allocated only to investors in that specific series or class rather than being borne equally by all investors in the mutual fund, allowing the management fee for each series or class to be a true reflection of applicable distribution costs.
5. Cap commissions
The Discussion Paper proposes that a maximum limit could be established on the portion of mutual fund assets that could be used to pay trailing commissions to advisors as a way to mitigate perceived conflicts of interest and the lack of alignment of advisor compensation and services. Such a limit could be achieved by imposing a cap on the separate asset-based fee discussed in proposal 3 above.
6. Implement additional standards or duties for advisors
The Discussion Paper proposes that the CSA could impose a duty on advisors requiring them to put their clients' best interests first which would, among other things, help mitigate the actual or perceived conflicts of interest that exist in the current embedded advisor compensation system that can result in the misalignment of advisors' interests with those of investors.
7. Discontinue the practice of advisor compensation being set by mutual fund managers
The Discussion Paper proposes that measures could be adopted to disallow the payment of sales and trailing commissions by mutual fund managers to advisors. Under this proposal, advisor compensation would no longer be embedded in management fees charged by mutual funds. Instead, advisors would need to discuss with their clients how they will be paid for the sale and ongoing service of their mutual fund investments and obtain client agreement to the fee-for-service model.
All interested parties are invited by the CSA to provide written feedback on the proposals by April 12, 2013.
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