01 Report highlights commission conflicts
A report commissioned by the CSA and prepared by The Brondesbury Group calls for an overhaul on how fees are paid on mutual funds. “There is conclusive evidence that commission-based compensation creates problems that must be addressed,” the report says. Problems include:
- funds that pay commission underperform. Returns are lower than funds that don’t pay commission, whether looking at raw, risk-adjusted or after-fee returns; and
- advisor recommendations that are sometimes biased in favour of alternatives that generate more commission.
So, where does this leave advisors and clients?
John Hall, a partner at Borden Ladner Gervais in Toronto, asks whether regulators are “rushing to the conclusion that the embedded nature of fees is not something that can be sufficiently understood.” He adds that the average consumer doesn’t have the financial clout or leverage to negotiate better rates under a fee-based structure.
And, since dealers face mounting compliance costs as they try to maintain smaller accounts, says Hall, “the last thing they want to do is get into a haggling match over whether the fee-based rates they want to charge are appropriate.”
Jurisdictions such as the United Kingdom and Australia have banned or limited commission-based compensation, but Hall isn’t convinced that a fee-only system would be better for Canadian retail investors. In an embedded commission model, “the smallest investor doesn’t do badly relative to what they might get in a fee-for-service model. In many cases, the only thing they would get with fee-for-service is knowing the precise dollar amount they’re paying.” But, he asks, “would regulators do better to wait a couple of years and see whether the combined impact of Fund Facts and CRM2 don’t achieve that understanding?”
02 CSA wants Fund Facts for ETFs
The CSA is inviting comments on its proposed Fund Facts for ETFs. Just like the mutual fund version, ETF Facts would summarize funds’ characteristics in plain language, accompanied by graphs and other reader-friendly visuals. The ETF Facts would eventually appear on manufacturer websites.
“They’re trying to create a consistent disclosure framework between the mutual fund and ETF industries,” says Kevin Rusli, a partner at Blake, Cassels & Graydon in Toronto.
“They’ve appropriately focused on secondary market purchasers, in particular retail investors, and [are] taking the opportunity to educate them.”
Rusli notes that, south of the border, the SEC pursued a similar requirement as far back as 2007. “ETFs took off much quicker in the U.S. Here, regulators have followed suit as ETFs started to take off.”
He welcomes the proposed ETF Facts, though he doesn’t find it too different from current ETF documentation. “It’s just better disclosure, and it’s codifying previously granted exempted relief.” In 2013, the CSA granted exemptions to specified dealers so they could deliver an ETF summary disclosure document instead of a prospectus to investors within two days of purchase. Also since 2013, most ETF companies have been producing a summary document that isn’t far removed from Fund Facts, adds Carol Derk, a partner in the Toronto office of Borden Ladner Gervais (BLG). “They’re used to dealing with a very short summary of the key terms of each ETF.”
That said, she reminds advisors it’s still important they develop a detailed understanding of the fund, especially its risks, by examining the entire prospectus.
Whitney Bell, an associate at BLG, echoes Derk’s caveat, but notes a common problem with these detailed disclosure documents. “Though a lot of time is spent preparing prospectus documents, some investors may not read [them]. When they do read parts of them, they may not fully understand what they’re reading.”
She welcomes the ETF Facts as a supplement. “Something that includes charts and tables, which are easier for investors to read and understand, is probably a useful tool.”
The comment period closes September 16.
The report is ambivalent on whether fee-based compensation is the answer. “There is not enough evidence to state with certainty that it will lead to better long-term outcomes for investors.”
03 Pitch that wrapper
The CSA has made it easier for sophisticated Canadian investors to put money into foreign offerings. As of September 8, foreign issuers no longer need to include extra disclosure documents—commonly known as a “wrapper”—when they offer securities (except mutual funds) to Canadians.
The news was expected and welcome. “The pension plans and the big fund managers were finding they were getting locked out of some international deals because the international issuer either couldn’t or wouldn’t comply with Canadian law,” says Ron Kosonic, a partner at BLG in Toronto. “And with the growth of compliance departments in the dealer firms, they were saying, ‘If these guys don’t provide a wrapper, we can’t sell it.’ Simple as that.”
The wrapper would take weeks to prepare, and that meant extra costs. “In certain circumstances, an underwriter or foreign issuer would decide not to extend that offering into Canada, because there are expenses in preparing the wrapper and related documents,” explains Adam Freedman at Torys in Toronto. “I think the regulators saw that sophisticated investors in Canada would not be able to get a hold of potentially excellent investment opportunities.”
Pam Hughes, a partner at Blakes in Toronto, had acted for 24 dealers that sought the wrapper exemption that CSA proposed in late 2013. “Canada [was] the only country in the world that require[d] these disclosure documents in the private placement context as opposed to a prospectus for a public offering,” she explains. She says the exemption will benefit Canadian capital markets and large institutional investors. “It’s better to have the access to the offerings than to have the additional disclosure.”
by Allan Tong, a Toronto-based financial journalist.