Investment fund industry players will have to grapple with tough questions before rules take effect in 2022
Recently, the Canadian Securities Administrators (CSA) issued the last word on a long-running debate on trailing commissions when it announced final rule amendments prohibiting fund managers from paying trailing commissions to dealers that don’t provide advice. The CSA said the rules will take full effect on June 1, 2022 – and the affected fund managers and dealers will have to grapple with crucial questions over that time.
In a new commentary, Jason Brooks, Rebecca Cowdery, and others from Bordner Ladner Gervais LLP (BLG) said that the new rules will impact order-execution-only (OEO) dealers, otherwise known as discount brokers, as well as dealers that transact in publicly offered mutual funds with certain “permitted clients” to whom they do not provide advice.
In a concession to fund managers, the regulators’ latest amendments offer a “knowledge qualifier” to clarify that the prohibition against managers’ paying trailing commissions to dealers applies only if the fund manager knows or ought reasonably to know that the dealer was not required to make a suitability determination.
“As an example, the CSA note that there may be circumstances when multiple affiliated dealers, including a full-service dealer and an OEO dealer, use a single dealer code to place orders for mutual funds with fund managers,” the experts from BLG said.
But even with such concessions, the commentary said managers and dealers will have to navigate a number of issues that will likely take more than a “one-time” fix to resolve. Those include, among others:
- Fund managers will have to consider what to do with Series D securities, units with lower trailing commissions that were generally distributed by OEO dealer platforms only. For clients with holdings in Series D securities, the authors said managers may consider redesignating Series D securities into another series without trailing commissions or, alternatively, simply stop paying trailing commissions on these series. They’ll also have to consider disclosure of such proposed changes to affected investors before they take effect;
- With respect to Series A and other trailing-commission series that are held with an OEO dealer, compliance will be a thorny problem for managers in cases where the trades were executed by the OEO dealer through an affiliated full-service dealer, or when the fund’s records do not distinguish between an OEO dealer and its affiliated full-service dealer;
- Managers must also decide which non-trailer fee-paying mutual fund series to make available on OEO platforms, as well as what fee structure would be appropriate for such securities;
- OEO dealers must weigh how to modify their fee structures so that the cost of making mutual funds available on their platforms is appropriately shouldered by clients who wish to invest in such funds;
- When switches or conversions to non-trailing commission series must be done, there’s a question on whether the move should be initiated by the dealer, the manager, or the client. Similarly, would it be enough to provide clients notice of a switch, or should their consent be obtained first?
“The amendments raise significant operational and implementation challenges for both dealers and managers that will need to be addressed before the ban comes into force on June 1, 2022,” the authors from BLG said. “We expect that many managers will begin thinking about whether any of these changes should be implemented in connection with their next prospectus renewal, as some changes will likely involve changes to prospectus disclosure.”