What’s happening with point of sale?

Regulatory proposals calling for a new summary document, called a Fund Facts, predictably set off alarms in the industry.

It wasn’t that the Fund Facts document was so objectionable. What raised hackles is the requirement to deliver it to investors at or before entering into any binding agreement to purchase mutual funds.

The idea has been around for a while, but late last spring the CSA released draft regulation that would implement Point of Sale (POS), and asked for comments. After a flurry of activity through the summer and autumn of last year, things have been relatively quiet. Regulators are presumably digesting the detailed and lengthy submissions that were received, and are getting ready to launch the next volley.

POS is based on the idea that retail investors benefit most when clear and understandable information is delivered prior to, or at the time of, making an investment decision.

Almost no one disagrees that some version of a Fund Facts would be more useful to investors than the current simplified prospectus being delivered today. There’s also broad consensus that as a class of product, mutual funds are not exactly shrouded in darkness or mystery. Any investor who cases to dig will find no shortage of information about public mutual funds: who runs them, what they hold, how they performed, what investors paid in fees and expenses, how the funds are governed, and much, much more.

What makes the POS proposal so contentious is the timing of the delivery of the Fund Facts. Advisers, dealers and fund managers have already made considerable investments in the current post-trade prospectus delivery regime. Currently, regulatory requirements can be fully met even where the prospectus does not arrive until up to two days after the trade.

The prospectus delivery rules were originally developed without any special consideration for mutual funds as distinct from other securities; and the whole system has been built, developed and added to over the past half-century. And many of those additions have been ad hoc. People are used to it. Industry participants for the most part believe it basically works; and the investor does end up with a prospectus.

If the POS proposal becomes reality, it will mean nothing less than constructing an entire parallel Fund Facts pre-trade delivery regime, or regimes, to sit alongside the existing post-trade delivery regime. The latter will have to remain in place for other products purchased by individual investors. There will be a lengthy transition period while training courses, sales processes, back office procedures and compliance systems are designed, tested and implemented. It will all be expensive, complex and risky.

As much as there are large segments of the industry wishing the whole messy thing would go away, a number of developments, some recent and some not so, that suggest otherwise.

If the global economic crisis has taught financial regulators anything, it’s been the value of working together. Hardly a day goes by without another politician or senior regulator pledging renewed or continued cooperation and coordination across borders and jurisdictional boundaries.

This extends not only to bank regulation, where international standardization has been progressing for years, but also to areas where there is relatively limited cross-border activity, such as sales of mutual funds. Regulators are increasingly consistent in their pronouncements and are pooling resources to come up with common approaches to what they perceive to be common regulatory problems.

POS for mutual fund sales is a good example of this. The International Organization of Securities Commissions (IOSCO) published a consultation report last November called Principles on Point of Sale Disclosure. In the press release that accompanied the report, IOSCO noted “Transparency in the marketplace, particularly disclosure of information to investors, has always been a high priority of regulators in seeking to ensure that markets run efficiently and with integrity. Enhancing POS disclosure, by helping to ensure that investors are able to consider key information about [Collective Investment Scheme] products before they invest, can contribute to this goal. The recent crisis in the financial markets has highlighted the critical role that accurate, understandable and meaningful disclosure can play”.

Sound familiar? It should. Here is the CSA on its POS proposal: “By making disclosure more effective, we are giving investors the opportunity to make more informed decisions. We are also enhancing transparency in the marketplace. We think current market conditions highlight the importance for investors to understand what they are buying.”

And here is U.S. Securities and Exchange chairman Mary Shapiro in a December 3rd speech: “I believe retail investors should be provided clear, simple, meaningful disclosure at the time they are making an investment decision — disclosure that includes comprehensible and comparable information about the securities products and services being offered. At the end of the day, our investor . . . just wants to know the facts, so he is not taken advantage of by hidden fees or questionable motivations. And he needs this information when it is most meaningful — at the time he is making his investment decision.”

You can find similar statements made by the UK’s Financial Services Authority, as well as regulators from as far a field as Hong Kong and Australia. Given this remarkable consensus of regulatory views on the nature of the problem and the efficacy of the proposed solution, it’s unlikely the CSA will retreat from its POS initiative.

There are other straws in the wind, too. The British Columbia legislature just last month enacted the necessary amendments to its securities legislation to enable the POS regime. SEC chairman Shapiro appears to be settling in for the long haul in terms of the reforms that will be needed to make POS a reality. In the same December 9th speech, she acknowledged that “Based on past experience, I know that getting to the point where we can have meaningful point of sale disclosure will be difficult. There will likely be significant pushback from the industry related to cost and convenience. But anything worth doing is not easy.”

The current climate favours reforms which claim to enhance investor protection, particularly if they come at the expense of banks, financial institutions and Wall Street.

We have seen this in new measures surrounding credit cards, mortgage lending and now mutual funds. The FSA recently announced that advisor commission on investment products (trailing commissions) will be phased out and all such sales commission will be charged directly to client accounts. There is a sense, justified or not, that consumers have been unfairly taken advantage of.

So although we don’t yet have a hard timetable for POS, it is a matter of when, not if. Count on it — POS will happen.

Susan Han is a lawyer at Miller Thomson LLP in Toronto

(04/07/10)