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On June 21, 2018, the Canadian Securities Administrators (“CSA”) released a Status Report on their ongoing investigation into embedded commissions in the mutual fund industry.

“Embedded commissions” is the term used to describe the practice of mutual fund managers compensating dealers (and their representatives) for mutual fund sales by way of commissions, as opposed to the investor paying the dealer directly. Embedded commissions include sales charges and trailing commissions. Trailing commissions provide mutual fund dealers with an ongoing commission based on a percentage of the value of their customers’ mutual fund investment for as long as the investment in the mutual fund continues.

As the asset value of the Canadian mutual fund industry is approximately $1.50 trillion (according to figures published recently by The Investment Funds Institute of Canada), embedded commissions are a lucrative source of compensation for dealers and their representatives who sell mutual funds.

Although the Status Report will disappoint investor advocates who hoped the CSA would impose a blanket ban on embedded commissions in the mutual fund industry, it still marks a victory for do-it-yourself investors. The Status Report proposes the implementation of a prohibition on the payment of trailing commissions on mutual fund units purchased through discount brokers.

Trailing commissions are intended to compensate mutual fund dealers for investment advice they provide to investors. However, discount brokers do not provide advice and, in fact, they are prohibited from doing so. Despite this, the majority of mutual funds purchased through discount brokers have the same trailing commissions as those purchased through full-service dealers who provide ongoing advice to their clients. Simply put, do-it-yourself investors are paying for something they do not receive.

As the CSA rightly recognizes in the Status Report, there is “no justifiable rationale for the practice of paying discount brokerage dealers an ongoing commission for the sale of a mutual fund.” Instead, trailing commissions can be seen as a payment to discount brokers for “shelf-space”. That is, they serve as an incentive for discount brokers to offer a particular mutual fund to their clients, which serves the interests of mutual fund managers whose compensation is based on the value of the assets they have under management.

Unfortunately, the problem is not a small one. As of 2015, approximately $30 billion worth of mutual funds were owned by investors through discount brokers. Although some mutual funds have series available with a lower trailing commission for purchases made through discount brokers, the vast majority of mutual funds held through discount brokers carry a full trailing commission.

The CSA’s proposed reform is a step in the right direction for do-it-yourself investors. The next is for Canada’s securities regulators to fulfill their investor protection mandate and make the proposal a reality.

Anthony O’Brien and Garett Hunter are associates in Siskinds’ class actions department. Their practices focus on investor protection. They are co-counsel in class action litigation that seeks to recover compensation for investors who purchased units in mutual funds through discount brokers and suffered loss as a result of the trailing commissions paid to the discount brokers. For more information visit Mutual Fund Trailing Commissions Class Actions.

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