Reevely: Ontario stops finance regulators from banning mutual funds that hurt investors

Ontario Finance Minister Vic Fedeli. Nathan Denette / THE CANADIAN PRESS

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The Ontario government is stopping finance regulators from banning a popular type of mutual fund that the regulators say takes unfair advantage of people trying to invest for their futures.

This happened late last week, with a dry statement from Finance Minister Vic Fedeli about “proposed amendments to National Instrument 81-105 Mutual Fund Sales Practices (Embedded Commissions).”

It all got drowned out by the Progressive Conservatives’ emergency monkeying with Toronto’s civic election, but it could affect a whole lot more people.

These investments are about a fifth of the mutual funds held in Canada (versus almost zero in the U.S. and Europe), and they’re “the purchase option that has tended to be the most difficult for investors to understand and to have the most negative impact on subsequent investor behaviour,” the regulators said, explaining their proposal to ban them on Thursday.

That sounds like something anti-business Liberals would say, Fedeli’s statement said.

“Our government has committed to making Ontario a competitive place to invest, grow and create jobs. This includes ensuring Ontario is ‘Open for Business’,” Fedeli said. “The … proposed amendments result from a process initiated under the previous government and, if implemented, will discontinue a payment option for purchasing mutual funds that has enabled Ontario families and investors to save towards retirement and other financial goals. Our government does not agree with this proposal as currently drafted.”

The regulators, including the Ontario Securities Commission and its counterparts across the country, have been working for years on rules to ban “deferred sales charges” on mutual funds that millions of Canadians use to save for things like kids’ educations and their own retirements.

Investment advisers at banks and companies like Raymond James and Investors Group make commissions when they get their clients to buy particular investments. With deferred sales charges, clients don’t have to pay those commissions directly as long as they hold onto their funds for several years. If they sell earlier, they pay penalties.

The appeal of these funds with deferred sales charges (or deferred commissions, or embedded commissions, whatever label you put on them) is obvious: as Fedeli said, they’re cheaper to buy.

But they’re more expensive to hold, less flexible, and overall worse investments than funds where you pay a commission up front, according to the Canadian Securities Administrators, the umbrella group of investment regulators from every province.

Investment advisers end up with an incentive to sell their clients funds that look cheaper but actually aren’t. Management fees for deferred-commission funds tend to be higher forever, by enough to make a big difference in long-term returns. Once people own deferred-commission mutual funds, the fear of the penalties for selling early keeps investors holding onto funds that don’t perform well, even when things change in their lives and they really could do with cash. Mutual-fund companies have less incentive to manage the funds carefully if they have investors who will get dinged for selling out.

The investment regulators — including in British Columbia, Alberta, Saskatchewan and Quebec, besides Ontario — commissioned research and focus groups. They examined their files on misbehaving investment advisers.

“Compliance sweeps and enforcement files reveal that, among other things, the higher upfront and third-party nature of the dealer compensation on the (deferred commission) option encourages poor suitability assessments and increases the risk of mis-selling,” the regulators found.

Put more rudely: Investment advisers know they’re supposed to work for their clients above all, but it’s so much easier to let a client get screwed over a very long time by somebody else than to do it yourself all at once.

They talked with mutual-fund companies, which were overwhelmingly against changing the rules.

They checked with investors and investor advocates, who were overwhelmingly in favour of changing the rules.

OK, the regulators finally said. We’ve thought about this enough.

“In our view, the problematic practices and investor harms … are significant and demonstrate the need for change,” they wrote in a public note in June that laid out where they were going. “Compliance examinations, enforcement files, investor complaints, academic research and focus groups with individual investors highlight these problematic practices and the resulting harms to investors, and reinforce the need for regulatory action.”

Fedeli’s statement promised to work with the regulators and other provinces “to explore other potential alternatives to ensure fair, efficient, capital markets and strong investor protections.” But his basic argument isn’t that there’s some wording in the rules that need adjusting, it’s that the regulators are wrong that there’s a major structural problem in these deferred-commission funds.

This is a surprising position for the finance minister in Ontario’s new government for the people.

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