Reprinted courtesy of the National Post
by Tom Bradley

The battle rages on. A small group of investment professionals is desperately trying to keep the securities regulators from banning embedded commissions. These charges, also called trailer fees, facilitate a payment from the client to an advisor by channeling part of a mutual fund’s management fee back to the investment dealer.

For the provincial securities commissions, the big issue with trailers is conflict of interest. They make it too easy for an advisor to sell a product because it has a better compensation scheme, not because it’s best for the client. For example, many advisors won’t consider using ETFs in client portfolios because they don’t pay trailer fees. Indeed, it’s a key reason why ETFs’ penetration in Canada has lagged the rest of the world.

Silent Majority

I’ve been immersed in this issue for many years and believe a majority of investment professionals are now in favour of banning trailers. Their reasons build on the conflict issue.

First, investing is already hard for clients to understand, so compensation needs to be upfront and transparent. With new reporting regulations in place (called CRM2), clients are able to see how much they’re paying, but it’s not easy. Most dealers have done the minimum to meet CRM2 requirements, so clients either don’t see the dollars paid, or don’t know what the number means. At a party recently, I heard an advisor waxing on about trailers being the best thing since sliced bread. They make it easy for him and clients never ask questions about fees.

Second, mutual fund managers are getting tired of being unfairly compared to ETFs. Surveys like SPIVA (Standard & Poor’s Index versus Active Management Scorecard) compare mutual fund returns, which include advisor compensation, to market indices that have no fees, trading costs or performance slippage factored in. The race between indexing and active management would be closer in an apples-to-apples comparison.

And finally, getting rid of the numerous fund classes related to trailer frees would simplify the industry immensely. I asked a group of mutual fund executives if they would be disadvantaged if trailers disappeared. None said they would and some said they longed for a simpler world where they could compete on merit instead of sales incentives.

Noisy Minority

Nonetheless, various organizations are fighting tooth and nail for the status quo. Their lead argument relates to small investors. They say trailer fees allow advisors to get paid for working with smaller clients. If advisors are forced to negotiate a comparable fee directly, many clients will balk and go elsewhere. The result will be an “advice gap,” whereby many Canadians who used to get advice will go without. This possibility has given the commissions pause. No one wants voters in a lather over losing their “free” advice.

Choice is another recurring theme. Investors should be able to determine how they want to pay their advisor.

And the clincher. Banning trailers will lead to the demise of small, independent firms because they don’t have the resources to make the change.

A Trailer-less World

If embedded commissions are banned, will more investors go without advice? Most likely, but it’s happening now as brokerage offices push their advisors to cull small accounts. And in many cases, these free agents are finding a situation that’s better suited to their needs and budget.

Will the banks wipe out the remaining small, independent firms? There will be losers, but new business models are emerging. Robo-advisors are proliferating. Discount brokers are enhancing their services. And direct-to-client fund companies (where I sit) are now well established. There are now alternatives to the traditional, full-service advisor.

Will clients be better able to assess value for money? Absolutely. They’ll more easily see what they’re paying, and what services and advice they’re entitled to.

Will regulatory oversight be more burdensome? No, quite the opposite. The solutions being proposed to keep trailers, including capping or standardizing them, and regulating the amount of advice that goes with a trailer fee, will be a nightmare for already stretched compliance departments.

As this important issue drags on, I have a message for other senior executives. It’s time to break the silence and call off the fight. Trailer fees are going the way of the dodo bird. Use what remaining firepower you have to bargain for a long phase-out period. And then look forward to a time when conflicts of interest are easier to avoid and you have better relationships with your clients.