The Canadian Security Administrators recently released new amendments to National Instrument 31-303. NI 31-303 will now require registered investment firms to identify each potential and actual conflict of interest. In addition, it requires firms to provide prior written disclosure of a conflict of interest to a client, while dealing with such conflicts in a fair, equitable, and transparent manner. Specifically, the subsection addressing adviser conflicts (i.e. trailer fee commission payments) reads as follows:
2. INVESTMENT FUND MANAGERS
We have added a requirement under subsection 14.1.1 [duty to provide information] for investment fund managers to provide dealers and advisers with information concerning deferred sales charges and any other charges deducted from the net asset value of securities, and trailing commissions to dealers and advisers in order that they may comply with paragraphs 14.12(1)(c) [content and delivery of trade confirmation] and 14.17(1)(h) [report on charges and other compensation]. We have provided a transition period of three years for this requirement and for the corresponding requirements for dealers and advisers. We expect investment fund managers and dealers and advisers who distribute their funds to work together to ensure that clients will be provided with the required information in trade confirmations as of July 15, 2016, and in reports on charges and other compensation for periods from that date forward.
Trailer fees are paid to financial advisers from mutual fund companies for servicing clients’ needs, and keeping them invested in their products. These ongoing commissions are paid to the adviser by the mutual fund itself, as long as the client owns the investment. They typically range from 0.25 per cent to 1.0 per cent per year.
The CSA notes these commissions are on the rise, and have come to account for almost two-thirds of financial adviser revenue. It reports that, in 2011, mutual fund manufacturers paid an estimated $4.6 billion in trailing commissions, representing 34 per cent of total revenue from management-expense ratios for the year. Furthermore, it says since 2006, trailing commissions for stand-alone mutual funds have risen slightly.
“The trend appears to be towards higher average trailing commissions for both bank and non-bank mutual funds and across asset classes,” it says.
The problem is these payments are not clearly disclosed to clients. While the information is buried in the simplified prospectus of the investment fund, it is generally glossed over or ignored by most financial advisers. And even if a detailed account is given to the client, it is probably too complicated for the average person to understand.
Trailer fees are a clear conflict of interest, with many advisers selling the highest fee funds to their clients, regardless of suitability. NI 31-303 will now require more disclosure in this area.
As long as there have been financial advisers, there has been debate about how much and how clients should be charged for financial advice and investment management. While there is no perfect answer, trailer fees should be banned outright, because they are a clear conflict of interest. Other countries such as Australia and Great Britain have done so already. While Canada is not there yet, at least with NI 31-303, there is better disclosure.