Reforming Mutual Fund Fee Structure Critical For Canadians


 “Change will not come if we wait for some other person or some other time. We are the ones we’ve been waiting for. We are the change that we seek.” – Barack Obama

FAIR Canada has submitted comments to Canadian securities regulators, stating that urgent reforms must be made to the mutual fund fee structure in order to protect consumers. With over 12 million Canadians owning mutual funds, and 72% of Canadians with RRSPs holding mutual funds within their RRSPs, it is clear that mutual funds are important to the retirement savings and financial security of Canadians.

Improved disclosure is important but is inadequate to address the serious conflicts of interest presented by embedded (hidden) commissions (referred to as trailing commissions). These conflicts are systemic and structural in nature and are not addressed by current regulatory initiatives. To address these serious issues, we urge the banning of third-party embedded commissions.

“In a chronically leaking boat, energy devoted to changing vessels is more productive than energy devoted to patching leaks.” – Warren Buffett

Benefits of banning third party embedded commissions include:

  1. Advisors will be more likely to make investment recommendations that are in the best interest of the consumer, since the advisor will no longer be incented by higher trailing commissions or have their objectivity unintentionally clouded by the existing compensation structure; ;
  2. Consumers will know that they pay for “advice” and will have more control over the costs that they pay;
  3. Consumers will be able to assess the value of any service(s) they receive against the costs they incur;
  4. The fee structure will be simplified and made more transparent;
  5. Improved price competition for mutual funds should lower the average fees paid by Canadians, which are currently among the highest in the world;
  6. Enhanced professionalism in the financial services industry and enhanced public trust in the industry and financial markets.

FAIR Canada also recommends, until a complete ban on trailing commissions is implemented, that an execution-only series or class of mutual fund, which has no trailing commission, be immediately required to be offered at discount brokerages or direct from the manufacturer.

Strong support for banning embedded commissions was evident from numerous submissions from other stakeholders which favoured reform of the mutual fund fee structure. Many individuals wrote in support of urgent reform of the mutual fund fee structure and we are very encouraged that individual Canadians are making their voices heard on this issue. All of the comments are publically available here.

Investor Advisory Panel

The Ontario Securities Commission’s Investor Advisory Panel’s (“IAP”) submission stresses the asymmetry in knowledge, information and experience between retail investors and financial advisors. It also notes how embedded trailing commissions skew mutual fund recommendations and how the conflicts of interest align the interests of the fund manufacturer and the advisor rather than the advisor and his/her client. The IAP recommends that regulators prohibit the payment of embedded trailing commissions and also recommends the adoption of a statutory best interest standard for advisers and dealers. The IAP comments that unbundling fees charged for transactions from fees charged for advice and prohibiting trailing commissions will improve the clarity and robustness of advice, and will increase competition and enhance the reputation of the industry.

Keith Ambachtsheer

Keith Ambachtsheer, Adjunct Professor of Finance at the Rotman School of Management, University of Toronto and Director of the Rotman International Centre for Pension Management asks the question, “what will it take for the industry to produce measurable customer value at a reasonable price in the future?” [emphasis added] Mr. Ambachtsheer notes the powerful impact of informational asymmetry between buyers and sellers on market outcomes. He argues that Canada must follow the UK and Australia in providing retail investors with the basic protection, stating that, “[o]nly un-conflicted, knowledgeable people with a clear ‘duty of loyalty’ to their clients should be permitted to offer financial/investment advice on a transparent fee-for-service basis.” He states that “…it is in the public interest to completely sever the link between financial/investment ‘advice’ and fund sales-based compensation.”

Steadyhand Investment Funds

Tom Bradley, President of Steadyhand Investment Funds, advocates that “…the current structure of mutual (fund) fees should be dismantled. The payment for fund management and investment advice should be separated. Dealers, who provide advice to clients, should be left to determine how they will charge for their services.” Mr. Bradley notes that there will be costs to changing over to a new system, but these costs will be one-time in nature and arguably now is a good time to make them given systems changes needed to implement new requirements for cost and performance reporting. He notes that, when asked, the only downside to banning embedded commissions that industry executives could muster was that the current practice of embedding advice in the MER benefits the small investor. The argument is that the larger clients subsidize the costs for the smaller clients and, if they had to be charged separately, small investors would be forced to pay the full costs. They won’t be able to afford it and will be forced or will choose to go without. This argument acknowledges that (1) they are not telling people what they are paying and (2) they are creating inequities between clients. “It appears the best argument the mutual fund industry has for keeping embedded commissions is they want to protect the investors who are benefitting from the subsidization and keep the investors who are providing the subsidy in the dark.” He notes the scant evidence that the industry even cares about the small investor, since the compensation formulas at most firms incent advisors to cull small accounts from their lists.

John J. De Goey

John J. De Goey, CFP’s recommendations include (1) the immediate prohibition on discount brokerages receiving trailing commissions, (2) as an interim measure, all mutual fund prospectuses and advertising should be required to carry disclaimers similar to those mandated in the tobacco industry, and (3) abolish trailing commissions at the first reasonable opportunity.

PUR Investing

Mark Yamada of PUR Investing comments on how the findings in the Consultation Paper demonstrate that, “…as the result of sales incentives, funds may not in fact be selected in the client’s best interest, market transparency suffers, consumers remain uninformed and price discovery between mutual funds ceases. An unintended consequence of the existing regulatory and disclosure regime is that mutual fund manufacturers are best served by designing products primarily for so-called “advisors” based on compensation and not for investors based on risk and return.” [emphasis added] Mr. Yamada suggests two reforms: (1) discontinuing the practice of advisor compensation being set by mutual fund manufacturers by making advisors fiduciaries and requiring them to negotiate compensation directly with their clients. (2) Apply the principles of full, plain and true disclosure to “service-provider” titles and duties. He notes that “current registration categories do not adequately describe duty to client nor form of compensation…Giving investors an immediate understanding about the advisor’s role and duty to clients will provide several ancillary benefits.”  Mr. Yamada believes that fixing titles will make consumers aware that it is “buyer beware”. He views eliminating embedded commissions as the best choice.

Ken Kivenko of Kenmar Associates

“Clearly, banning trailer commissions outright would be the most straightforward way to align the interests of both the mutual fund manufacturers and the dealer Reps (advisors) with those of investors. The entrenched Canadian business model of financial firms is an enormous challenge to actually foster integrity and trust. Other countries are clearly willing to be bold re investor protection. Canada is falling behind the United States, the U.K. and Australia in eliminating the conflicts-of-interest that harm retail investors and enrich industry participants….It is our conviction that conflicts-of-interest are so fundamentally harmful that they should be dealt with now by regulators. Even with heightened awareness, the limited financial literacy and numeracy of Canadian mutual fund investors, information/knowledge asymmetry and perfected adviser sales pitches will keep ordinary Canadians vulnerable to mis-selling. Studies elsewhere in the world provide clear and convincing evidence that only the prohibition of trailers will stop the commission-driven abuses. Action, not more monitoring, is required to protect retail financial consumers. We do not need to reinvent the wheel to make advice professional.”

Small Investor Protection Association

Stan Buell, President of the Small Investor Protection Association (“SIPA”) states that the distribution system must change before the advice business can be considered professional. SIPA recommends that F series funds be made available to retail investors and that online brokerages not be permitted to sell funds with embedded trailers since these brokerages do not provide investment advice. It calls on the CSA to research why the average hold period for mutual funds is 4.5 years given that they are long-term investments. SIPA supports ending “cross-subsidization” of mutual funds and that the CSA compel fund firms to articulate precisely what services are included in trailing commission (until they are prohibited). Their main recommendation is to prohibit embedded trailing commission altogether and let investors contract for advice separately.


Ms. Johanna Robertson, Principal, Robertson-Devir, who has a practice and considerable experience in the mediation of investment and financial disputes and in the appraisal of investment complaints prior to litigation, comments on investor’s lack of understanding of and control over fees. She comments that better and earlier disclosure is needed but won’t be sufficient given the complexity of the existing fee structure and the lack of control over the costs of investing. Ms. Robertson suggests that paying fees directly will allow investors to clearly understand the fees and to have some control over the costs they are paying. On the issue of conflicts of interest, she notes how compensation drives behaviour and says that the best interest duty standard will not be a solution to the flaws that exist with an embedded fee structure. It is better to get rid of the conflict by changing the fee structure than to let the conflict continue and try to manage it through a best interest duty. She also sees a lack of alignment between advisor compensation and the services that are provided to consumers and comments that consumers should pay directly for the advice they receive so that they can assess what level of financial advice they want to receive and whether they are receiving value for the fee they pay. The best solution is to eliminate trailing commissions and replace it with a simple and transparent flat fee.

Glenn Belanger

Glenn Belanger, Professor of Economics and Compensation, wrote: “It is my view that most, if not all value added by the adviser is at point of sale and not in the provision of ongoing service. As such, their compensation should be entirely or primarily based on fees paid at point of sale. Ongoing trailer fees should be eliminated or at least capped at much less than 1% (a rate that many funds do pay). An analogy would be if the real estate agent that found you a home, knocked on your door to collect an ongoing fee every year. I am sure no one would pay him/her.”

Ben Yevzeroff

Ben Yevzeroff, Investor, submitted comments including the following:

“I was told advice was free and that such advice would help me plan my retirement. I never realized that my contact person was actually being paid by the mutual fund Company. No wonder I was sold expensive funds and encouraged to take out a Home equity loan. There is a clear conflict-of-interest at play here. The fact that trailer commissions as a percentage of “adviser” income has risen since 1996 is not generally known to retail investors .The lack of disclosure has added to investor risks and may explain the rapid rise of mutual fund wrap accounts and borrowing to invest.

As I now understand it, the trailer commission is really a sales commission. He only gets paid if he sells me mutual funds. I have no problem paying for professional advice but I object to paying for conflicted recommendations. I actually received no advice on saving, investment or tax saving ideas.

The DSC sales charge option was never explained to me. If it had, I would never have been convinced to buy it at my age.

Investing my life’s savings is not like buying a car.

Since you are asking for comments I have these suggestions:

  1. Provide investors Fund Facts when they are being sold the mutual fund not AFTER!
  2. Disassociate trailer commissions fund fees from the MER so investors can determine if they want to pay for advice and nature of advice required. Charging for advice directly gives investors freedom of choice and a basis on which to assess their advisors. This will lead to better financial outcomes and in the end, an improved reputation for the mutual fund industry.
  3. Ban the sale of mutual funds that mostly provide an investor’s own money back. This is deceptive and leads to many, many problems.
  4. Do not allow DSC funds to be sold to seniors- it only leads to trouble.
  5. Initiate a program to protect seniors from abusive advisor practice.”

FAIR Canada strongly encourages Canadians Securities regulators to listen to what investors and investor advocates are calling for. We encourage prompt reform in the interests of investor protection and a competitive marketplace.

We also note that roundtables are planned to continue the consultation and we encourage investors to continue to participate in the dialogue. If you made a submission, you can eligible to participate in the roundtable if you indicate you wish to do so.

April 24, 2013