OEO firms accused of selling shelf space to fund providers

Investor advocate argues trailing commissions charged by discount brokers create benefit for fund firms at investors' expense

OEO firms accused of selling shelf space to fund providers

Discount brokerage firms that continue to receive trailing commissions from mutual funds on their platform are engaging in an unethical quid-pro-quo relationship with fund firms, according to one investor advocate.

In a commentary published this week, Kenmar Associates pointed out that trailing commissions that discount brokers receive from mutual funds are not being used for their intended purpose – the provision of personalized advice – since OEO firms are not allowed to provide such advice.

“They also do not provide any services to fund unitholders that any client with an account at a discount broker doesn’t also receive at no cost,” the note added. And since discount brokerages aren’t permitted to recommend or promote any security – securities regulations prohibit any recommendation for purchase made without the necessary KYC information, Kenmar noted – the trailer fees they get couldn’t be for any marketing or fund promotion to clients.

Investors who pay trailing commissions on active mutual funds are not getting any unique services either, the letter argued. While such investors get full access to research, information, tools, calculators, and services, it said those resources are no different from what owners of the equivalent active ETF get. All the while, active mutual fund investors pay an average of 1% more than active ETF investors for every year that they own the fund.

Kenmar also noted that regulators have not exempted discount brokers from their constraints as OEO registrants, specifically those preventing them from providing advice or unique services to fund unitholders.

“The only possible reason left … is that the discounters agree to include the mutual fund on their authorized product shelf if the fund pays them a trailing commission,” it said. “This makes sense since inclusion will benefit both the fund manufacturer who will collect profitable management fees and of course, the discounter who will receive the ongoing payment of trailing commissions without providing advice or services.”

But Kenmar noted that under NI 81-105, shelf space payments for mutual funds are prohibited.

Ontario-domiciled discount brokers that continue to receive trailing commissions should be stopped through enforcement action by the Ontario Securities Commission, the note said. The regulatory breakdown that led to such payments, it added, has resulted in several class actions and diminished retirement savings for Canadians.

“[The OSC] should also be taking action to ensure that only Fund Facts disclosures devoid of any statements that are untrue or misleading are approved,” Kenmar said, urging sanctions that include investor rebates to offset mutual fund trailers charged on products without advice. “Fund Facts disclosures that are knowingly untruthful should not be approved and registered dealers that charge for advice/services not provided should be sanctioned for not dealing fairly, properly and honestly with their clients.”


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