Business

Letting in the light

Mutual-fund companies face calls for tougher rules

JOHN SCHOFIELD September 30 1996
Business

Letting in the light

Mutual-fund companies face calls for tougher rules

JOHN SCHOFIELD September 30 1996

Letting in the light

Mutual-fund companies face calls for tougher rules

Business

The eight-by-10 portrait takes pride of place on Murray Reimer’s desk. Displayed prominently in the study of his Abbotsford, B.C., home, it shows the successful financial planner and his wife, Ingrid, flanking Persian Gulf war hero Gen. Colin Powell. Powell had just finished speaking to 1,500 mutual-fund dealers at a conference in Florida organized and sponsored by Mackenzie Financial Corp., Canada’s fourth-largest mutual fund company. “They’ve always had good-quality speakers,” says Reimer, who has attended similar Mackenzie junkets over the years in such sunny locales as Hawaii, Dallas and New Orleans. “It’s been extremely rewarding for us professionally.”

But if Canadian securities regulators have their way, there will soon be no more free conventions or any of the other perks mutualfund companies typically shower on their top salespeople. For years, Mackenzie and its competitors have doled out cash and nonmonetary incentives on top of their usual commissions, including the one-quarter to one-per-cent “trailer fees” that companies typically pay dealers for every year investors stay in their funds. Sup-

porters of the practice say it rewards hard work without compromising the interests of customers—the millions of Canadians who are counting on mutual-fund investments for their retirements. Critics, however, charge that the existence of unpublicized sales incentives tarnishes the image of integrity and trustworthiness that the industry has worked hard to promote. As investment writer Gordon Pape puts it: “You don’t know if the financial adviser sitting across from you is really suggesting this mutual fund because it’s the best for your needs, or because he needs ‘x’ number of points to get a trip down the Nile.”

The Ontario Securities Commission, which regulates most of the country’s mutual-fund companies, is now inviting public comment on proposed rules that would curtail, though not eliminate, most of the perks. Those regulations are based on a voluntary code that the Investment Funds Institute of Canada (IFIC), a trade group, adopted last spring. Barring a serious uproar, the OSC’s version of the code will take effect by January, just in time for the busy RRSP season. Once that happens, it is only a matter of months before they are adopted in the rest of the country, says Dean Holley, executive director of the B.C. Securities Commission.

Sales practices are not the industry’s only problem. In recent months, observers in Canada, the United States and Europe have called on firms to shed more light on private trading by the companies’ own fund managers. In May, the U.S. investment guru responsible for the world’s largest mutual fund, Fidelity Investments’ $76-billion Magellan Fund, resigned amid allegations of improper personal trading and stock manipulation. Among other things, critics accused Jeffrey Vinik of publicly praising an Idaho-based high-technology company at the same time he was unloading its stock.

Earlier this month, Altamira Management Ltd., Canada’s 10th largest mutual fund company, banned its managers, analysts and executives from trading in anything but Altamira’s own investment products. The move followed revelations that the company’s star fund manager, Frank Mersch, helped out a friend in 1993 by suggesting he buy stock in Diamond Fields Resources Inc., then a little-known junior mining company. Later, the Vancouver-based mining company struck a nickelcopper-cobalt mother lode in Voisey’s Bay, Labrador— a turn of events that Ron Meade, Altamira’s chairman and founder, describes as “sheer luck.”

While there was nothing illegal about Mersch’s advice to his friend, Meade concedes that the episode might look bad to some investors. “If you’re going to be pure, you have to do the whole nine yards,” he says, explaining the company’s new policy. “You can’t be a little bit pregnant on these things.” All large fund companies

THE FINE PRINT ON SALES INCENTIVES

Even if the Ontario Securities Commission adopts rules later this year to curtail some mutual-fund sales incentives, investment dealers will not be entirely cut off from the kindness of fund companies. The regulations would still permit

® Cash from mutual-fund companies to help pay for conferences organized by dealers and brokers. No more than two-thirds of the cost of such conferences could be covered by fund companies, with individual firms limited to 10 per cent each. Fund companies that arrange their own conferences could no longer pay dealers’ travel and hotel expenses.

® Money for ads and investor seminars, to a maximum of 50 per cent of the total cost.The fund company or companies involved must be identified at the seminar or in the ad.

© Promotional items such as golf balls, pen holders or theatre tickets.The value of those gifts would be limited to $ 150 a year for each dealer.

monitor their employees’ investments, says Harold Hands, an executive vice-president of Mackenzie and incoming chairman of IFIC. The OSC and other regulators represent the final line of defence, prohibiting such practices as “front-running”—in which a fund manager buys stock for himself and then invests the fund’s money in it to boost the price. In Hands’s view, those securities regulations and

the fund companies’ own internal safeguards are adequate to protect investors.

The heightened concern over mutual-fund practices is in some ways a reflection of the industry’s own success. Since 1990, the total value of fund investments has soared from $25 billion to last month’s record $181.8 billion, representing the life savings of about 4.5 million Canadian households. That remarkable growth rate is almost certain to continue as baby boomers seek higher returns on their savings and become ever more fearful that a debt-ridden government will leave them destitute in their old age. John Kaszel, IFIC’s director of research, predicts that, by the turn of the century, total mutual fund assets will likely approach $400 billion, more than half the value of all bank deposits. In the United States, where mutual-fund investments total a staggering $3.1 trillion, the fund industry has already left the banks behind.

Still, some trend-watchers fear that the headlong rush into mutual funds by often-unsophisticated investors will leave some in financial ruin, especially if the high-flying stock market goes into free fall. For the uninformed, mutual funds “are just a great mystical cloud that they pour money in to and hopefully get more money out of,” says Peter Brewster, editor of the Canadian Mutual Fund Adviser, a newsletter for investors. A complicating factor is the dizzying array of funds available—more than 1,100. Sales incentives are usually spelled out in each fund’s prospectus, but few people ever read them, scared away by their heft and legalese.

Brewster believes that most clients are not overly worried about how their financial planner is paid. But there is no doubt that the publicity surrounding certain sales practices has turned off some investors. “The stock market is a bit of snake oil in general,” says a skeptical Colin Thomson, a library assistant at the University of Calgary who has invested in mutual funds since 1985.

Most dealers and fund companies, however, insist that investors have never actually been hurt by sales incentives. In fact, the companies that sponsor conferences frequently rack up some of the industry’s highest returns, says Paul Rockel, the 69-year-old chairman of Waterloo, Ont.-based Regal Capital Planners Ltd., one of Canada’s largest independent mutual-fund dealers, with about 800 agents. “Why would I sell anything that we didn’t think was good for the client?” Rockel asks. Besides, he says, salespeople are the industry’s driving force, and “they need incentives.”

OSC chairman Ed Waitzer says the commission is not out to banish incentives entirely, only those that create a conflict of interest. “The industry should always be putting customers’ interests first,” he says. “That is the universal rule that has guided our approach to raising standards.” But those standards still need to be lifted higher, says Glorianne Stromberg, the veteran OSC commissioner whose 300-page report on the mutual-fund business released early last year launched the industry’s latest round of reforms. The new OSC rules, if adopted, would still allow fund companies to pick up part of the tab for dealer advertising and educational conferences. Educating salespeople at conferences is a great idea, says Stromberg, “but am I, the investor, supposed to pay to send you to school?” In many cases, those incentives are paid for right out of the fund, chipping away at investors’ profits. And as Stromberg points out, managementexpense ratios—which measure how much of a fund’s assets goes to management fees and other expenses— have risen significantly in recent years.

Ultimately, says Stromberg, it is up to investors to push for a better deal—by educating themselves and speaking out. “The investor is just going to have to say ‘No,’ ” she says. “When the driving forces in the market are ignorance, greed and fear, you have to have your eye on the ball.” And it won’t hurt to read that prospectus carefully.

JOHN SCHOFIELD