The Canadian Securities Administrators’ (CSA) nearly nationwide ban on deferred sales charge (DSC) mutual funds will take effect in 2022 — except in Ontario, which will instead adopt a series of restrictions on DSC sales.
The CSA’s prohibition on fund companies paying upfront sales commissions to dealers will take effect on June 1, 2022, and is expected to result in an end to the DSC funds.
The move is intended to address a series of long-standing investor protection concerns associated with the use of DSCs, including the fact that the structure creates conflicts of interest for dealers, resulting in unsuitable sales, and keeps investors locked into inappropriate funds.
“This decision was motivated by important investor protection concerns,” said Louis Morisset, chair of the CSA and president and CEO of the Autorité des marchés financiers (AMF).
“Upfront sales commissions create conflicts of interest and impose liquidity constraints that harm investors. This compensation bias incentivizes dealers to recommend a product that may not be in the best interest of investors and has led to suboptimal investor outcomes.”
In Ontario, where the provincial government opposes the CSA’s planned ban, the Ontario Securities Commission (OSC) is proposing a series of curbs on DSCs that are intended to reduce the incidence of negative investor outcomes without undertaking a blanket prohibition.
The OSC’s planned restrictions include banning DSC sales to investors over age 60, banning the use of leverage in DSC purchases, capping account sizes at $50,000, and banning sales to investors with an investment time horizon that’s shorter than a fund’s redemption schedule.
The regulator would also limit redemption schedules to three years, require that clients can redeem 10% annually without paying redemption charges, and mandate hardship exemptions.
“The proposed rule is intended to address negative investor outcomes by limiting the circumstances in which mutual funds with the DSC option can be sold and by giving clients greater flexibility to redeem these investments without penalties,” the OSC said in a release accompanying its proposed rule.
The OSC’s proposals are out for comment until May 21. It envisions adopting the rule on the same timeline as the CSA’s ban, with the restrictions taking effect in June 2022.
The CSA said that it considered imposing a series of restrictions on DSC sales as a possible alternative to a ban, but concluded that this approach “only partially mitigated the investor harms we identified and none dealt with the conflicts of interest inherent in the DSC option, or the harmful lock-in feature imposed on investors.”
“With ample evidence of investor harm, especially for the most financially vulnerable investors, and no evidence of any benefits, we see no reason to preserve the DSC option,” the CSA concluded.
It also noted that industry innovation has improved the industry’s capability for serving smaller accounts, which addresses one of the central claims of DSC defenders.
The CSA said that during the two-and-a-half year transition period, dealers will still be able to sell DSC funds and their redemption schedules will run to their conclusion.
In the meantime, the regulators will also grant relief to dealers from tougher conflict of interest requirements that will take effect under the client focused reforms (CFRs) — which take effect Dec. 31, 2020 — to enable continued use of DSCs until the ban comes into force.
The CSA also noted that it will publish proposals for banning the use of trailer fees by discount brokers later this year. Unlike the DSC ban, that prohibition will be adopted in Ontario, too.