Protecting Investors

Neil Gross

Neil Gross is the executive director of the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada). During his 30 years as a lawyer, he specialized in investment malpractice litigation and securities law.

As regulators enter the final stage of deciding the fate of trailing commissions, they rightly insist on real evidence-based analysis

By Neil Gross |

Canada's 13 provincial and territorial securities regulators recently fired an intriguing shot across the investment industry's bow. That warning was woven into a publication from the Canadian Securities Administrators setting out answers to "frequently asked questions" about Douglas Cumming's report on the effects of mutual fund trailing commissions. Prof. Cumming and his research team supplied the answers, but the subtext surely came from the regulators themselves.

In essence, the regulators signalled that the issue of trailing commissions' legitimacy has reached a defining moment and, from this point forward, there will be no tolerance for the casting of bogus doubts on scientific proof pertaining to that matter. Such tactics will not be allowed to disrupt development of regulatory policy on the reform of mutual fund fees. This is especially relevant to the question of whether trailing commissions are harmful and should be banned.

Cumming's research showed that trailing commissions, deferred sales charges and affiliated dealer flows do, indeed, cause considerable harm. They warp investment flows, hurting investors by channeling them into suboptimal mutual funds, and harming the market by facilitating deterioration in mutual fund performance.

See: CSA commissioned analysis reiterates, expands conclusions of Cumming's report

Stung by these findings, some players in the mutual fund industry have tried to imply there might be flaws in Cumming's research methodology or analysis. But Cumming's reply is witheringly blunt. It can be paraphrased as follows: Those of you who question my team's methodology are wasting your time. The methodology was carefully developed in accordance with econometric and statistical standards and it is well crafted. The data set we examined was extremely robust. We analyzed it meticulously. We've double-checked our calculations, our findings accord with all other valid studies previously done in this area, and our conclusions on the data stand.

Oh, and one other thing — if you use junk science to challenge our findings, we will respond with precision and rigour, even if it humiliates you.

Actually, Cumming doesn't use the term "junk science" to describe an as-yet unpublished Investor Economics Inc. report that the Investment Funds Institute of Canada (IFIC) commissioned. But Cumming and his team pointedly eviscerate the report, stating, frankly, that it "studies the wrong measure of returns with insufficiently detailed data, and completely incorrect econometric methods that ignore over half a century of econometrics and statistics."

Thus, Cumming's group concludes, the Investor Economics/IFIC study "can say absolutely nothing about the relationship between mutual fund performance and mutual fund flows or about other pertinent factors that may affect those flows."

Hopefully, these harsh words will stop others from trying to inject fog into what should be a clear-eyed discussion. With so much at stake financially for millions of Canadians holding mutual funds, any policy decision on the fate of trailing commissions must be made in an atmosphere of rationality. And the path to that decision should be lit by unbiased empirical research, as investment industry stakeholders themselves insisted not so long ago.

Moreover, there's no strategic imperative for those stakeholders to go to ludicrous extremes in defence of trailers. The mutual fund industry isn't facing potential regulatory intervention designed to deprive it of customers. This is not a fight to the death. The mutual fund industry's survival doesn't depend on perpetuating an unhealthy state of affairs.

Instead, mutual fund manufacturers and distributors have a more positive option: They can accept the scientific evidence, acknowledge that it requires them to redesign the way customers pay for mutual funds, and move forward with a new business model that aligns both their interests and those of their customers.

The existence of that option — that possibility — should count as a critical factor influencing the ruling on trailing commissions. And it is time for that ruling. Science has provided the requisite evidence. Now, it's up to regulators to fashion a final judgment that accords with that evidence and the public interest.
 

Responses

Read the response from Advocis to this column: Banning commission has proven to be a failure, investmentexecutive.com, February 25, 2016

Read the response from an advisor to this column: Argument is nothing but bluster, investmentexecutive.com, February 25, 2016

Read the response from portfolio manager John De Goey: Arguments in favour of commissions ignore some key points, February 26, 2016

Read the response to the Advocis letter: A refreshing read, February 26, 2016

Read the response from an insurance agent and financial planner: Banning commissions not in the public interest, February 26, 2016

Read the response from the Investment Funds Institute of Canada: Cumming research leaves many unanswered questions, February 26, 2016

Read the response from investor advocate Ken Kivenko: It's well past time for reforms, February 29, 2016

Read the response from an advisor: Commissions exist only as a choice, March 1, 2016