The Canadian Securities Administrators (CSA) once again is turning its attention toward the long-standing policy dilemma of whether to ban mutual fund trailer fees this autumn. But will the CSA finally put the issue to rest once and for all?

In January, the CSA published a consultation paper regarding the idea of banning embedded commissions, such as mutual fund trailer fees, as a way of addressing long-standing investor protection concerns about the practice. That paper generated voluminous comments from both the investment industry and investor advocates, revealing entrenched, opposing views.

Now, regulators have embarked on more public consultations. As this issue of Investment Executive went to press in mid-September, the Ontario Securities Commission (OSC) was hosting a roundtable meeting to discuss alternatives. In early October, the B.C. Securities Commission will hold its own consultation on the subject.

Although the issue has been debated endlessly, these latest consultations will be watched keenly. Indeed, the OSC had to move its meeting to a larger venue when the demand to attend the session far outstripped capacity at the regulator’s offices.

One reason for the high level of interest is the expectation that regulators finally will decide whether to ban trailer fees. The OSC indicated in its statement of priorities that, following this latest round of consultations, its staff will make a policy recommendation to both the OSC and the rest of the CSA members regarding how to deal with embedded fees by the end of this fiscal year, ending March 31, 2018.

“This roundtable is part of our ongoing consultation on the option of discontinuing embedded commissions,” says John Mountain, director of the investment funds and structured products branch with the OSC. “While no decision has been made on whether to discontinue embedded commissions or pursue alternatives, the discussion will assist us in developing a regulatory response that will better align the interests of investors and advisors and improve investor outcomes.”

At this point, the regulators’ direction on the issue isn’t clear. Although the latest CSA paper indicates that the regulators have considered, and rejected, a variety of alternatives to an outright ban – such as capping trailers or further boosting disclosure – regulators may not be prepared to face down industry opposition and simply eliminate trailers.

This discussion isn’t merely a question of which position the regulators will side with; it’s also a matter of the regulators reaching consensus. Earlier this year, members of the CSA announced they couldn’t agree on whether to adopt a “best interest” standard for financial advisors – an issue closely linked with regulators’ concerns about the use of embedded compensation.

Regarding the best interest issue, regulators now agree to disagree, with Ontario and New Brunswick developing a best interest standard and the rest of the CSA members rejecting the concept.

Regarding the trailer fee issue, there seems to be less scope for dissent among the provinces. Adopting different conduct standards for advisors who typically do most of their business in one location is one thing. However, the provinces adopting different rules on fee structures for funds typically offered in multiple provinces would be much more disruptive.

Yet, the fact regulators are still wrestling with this issue is staggering, given that concerns about trailer fees first came up in the very early days of the mutual fund industry.

Glorianne Stromberg’s original report on the fledgling mutual fund business in 1995, issued when she was an OSC commissioner, observed that trailers create fundamental conflicts of interest; that investors are paying trailers in exchange for ongoing services that they may never receive; and that clients often aren’t aware that they’re paying the trailer fees, and often don’t understand how those fees negatively affect investment returns.

Stromberg’s report noted that some in the industry viewed trailers as essentially “bribes” paid by mutual fund companies to secure distribution: “The advent of trailer or service fees has been a major contributing factor to the questionable sales practices and incentives that have developed in the investment fund industry.”

Since these worries initially were raised, the mutual fund industry has grown to $1.4 trillion in assets under management (AUM) from about $130 billion in AUM. Yet, concerns about the impact of trailers on investors, and their distorting effect on market competition, never have been addressed – or gone away.

In fact, empirical research that the CSA commissioned in 2015 validated the long-standing intuition that trailer fees drive mutual fund sales and affect investors’ portfolio returns negatively.

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