Much of the mutual fund sector, faced with the prospect of regulatory upheaval, is fighting to preserve the status quo. At the margins, however, there are signs that some sector members are prepared to embrace fundamental change.

Members of the fund sector frequently complain that their business is unfairly singled out by regulators. Indeed, from the mutual fund sales practices rule (which was created in the mid-1990s) to point-of-sale disclosure reforms (which are ongoing), the fund sector often has been a target for regulatory reform.

So, when the Canadian Securities Administrators (CSA) released a discussion paper late last year examining the mutual fund sector’s fee structure and proposing a variety of possible reforms – including the unbundling of trailer fees, or their outright elimination – it’s not surprising that the sector largely opposed those proposals and feels that it is, once again, being unjustly targeted.

The Investment Funds Institute of Canada’s (IFIC) comment on the CSA paper points out that other financial products use embedded fees and maintains that it’s unfair to single out mutual funds. (See column on page 26.)

The IFIC comment concedes that the embedded fee structure does represent a potential conflict of interest for fund dealers. But, it argues, the conflict is mitigated by the fact that trailer commissions generally are uniform within asset classes and that existing disclosure obligations for advisors mitigate the potential conflict.

The IFIC comment notes that trailers aren’t just compensation for advice: they also compensate dealers for a variety of functions they provide. The comment stresses that embedded trailers favour small investors who may not be able to afford fee-for-service billing.

The IFIC comment also points to other ongoing regulatory initiatives, such as the new cost and performance reporting obligations being imposed by the CSA. Those reforms should be allowed to take effect before deciding if any further action is necessary, the IFIC comment argues.

Many of these views were echoed in comments from individual fund firms and dealers.

To some in the fund sector, the suggestion that embedded fees be scrapped and that dealer and advisor compensation be explicitly agreed upon is simply unworkable.

Says Manulife Asset Management Ltd.‘s comment: “In many cases, we do not believe investors have sufficient financial literacy to have a meaningful discussion with their advisors about how the advisor will be paid for the sale and ongoing service of mutual fund investments.”

On the other side of the discussion, many of the individual investors who made submissions to the CSA, as well as investor advocacy groups such as the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) and the Ontario Securities Commission‘s investor advisory panel, are just as convinced that the solution is to outlaw trailer commissions altogether.

Vancouver-based fund firm Steadyhand Investment Funds’ comment, for example, says the firm “strongly [believes] the current structure of mutual fees should be dismantled” and that payments for fund management and investment advice should be separate.

ING Direct Asset Management Ltd.‘s comment says removing fund managers from advisor compensation decisions is the “optimal long-term ideal for the Canadian mutual fund marketplace.”

A couple of U.S.-based fund-sector giants that don’t support scrapping trailers are willing to consider some of the CSA’s other proposals. BlackRock Asset Management Canada Ltd.’s comment supports unbundling – requiring fund firms to charge and disclose trailers separately from management fees – and submitting changes in those trailers for unitholder approval.

The comment from Fidelity Investments Canada ULC – which completely opposes the elimination of embedded compensation – warns that the consequences could be “catastrophic” for investors and suggests that the firm wouldn’t object to regulators requiring that advisors deliver a minimum level of service in exchange for their annual trailers.

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