Two law firms have filed a proposed class-action suit against Bank of Nova Scotia’s investment management arm, alleging that investors in its funds paid millions of dollars in fees for advice they didn’t receive.
Ontario-based firms Siskinds LLP and Bates Barristers PC filed the $200-million action against 1832 Asset Management LP. The suit claims that investors who bought the firm’s funds through discount brokers were overcharged because the funds paid a trailing commission. Those commissions are normally provided to financial advisers who recommend funds to their clients – but investors who buy funds through a discount brokerage do not receive any advice or recommendations.
The practice of paying trailing fees to discount brokers has been controversial for years, but regulators are only now acting to ban the practice. The Canadian Securities Administrators (CSA) − an umbrella group for all provincial securities commissions – last week said it will effectively ban trailing commissions collected by do-it-yourself investing services.
The suit against 1832 regarding trailing commissions involves both Scotiabank-branded mutual funds and Dynamic mutual funds. Dynamic Funds is a wholly owned subsidiary of Scotiabank.
Scotiabank declined to comment on the action stating that “as this matter is currently before the courts, we are not able to comment.”
In April, Siskinds and Bates Barristers filed a similar suit against TD Asset Management Inc., the trustee and manager of TD Mutual Funds. As with the Scotiabank suit, the action claims damages of $200-million “and other relief.”
Consistent with the allegations in the proposed class actions, the securities regulators recently commented that there is “no justifiable rationale for the practice of paying discount brokerage dealers an ongoing trailing commission for the sale of a mutual fund.”
Last year, regulators were called in to take a closer look at Series A mutual funds that were being sold through discount brokerages. Series A, also known as adviser series funds or A-class funds, are typically sold through a financial adviser and include trailing commissions for the advice an adviser provides.
Series A funds account for 68 per cent of the total amount of mutual fund assets in Canada, according to the Investment Funds Institute of Canada, and can charge a management expense ratio (MER) between 1.5 per cent to 2.5 per cent. By comparison, Series D funds – those tailored for do-it-yourself investors that strip out advice fees – can have an MER of less than 1 per cent.
But despite discount brokerages not being allowed to provide advice to do-it-yourself investors, more than 80 per cent of mutual funds sold through discount brokerages in Canada include trailing commissions. Of the $30-billion in total assets held in mutual fund products in discount brokerages, more than $25-billion remain in fund series that bundle an advice fee within the product, according to a paper released in 2017 by the Canadian Securities Administrators.
Earlier this year, the Investment Industry Regulatory Organization of Canada (IIROC) issued guidance to online brokers (also referred to as order-execution-only – or OEO – firms) stating that funds that include advice fees pose a conflict of interest for OEO platforms since they are not permitted to offer advice.
IIROC, the industry regulator that oversees discount brokers, also stated in its guidance that platforms should address this conflict by offering funds that do not pay a commission for ongoing advice – such as Series D funds. If there is no Series D version available for the funds, IIROC recommends the online brokerage resolve the conflict by, for example, reimbursing the portion of the trailing commission that is related to advice.
Now the regulators are taking it a step further in announcing they intend to halt all trailing commissions collected by discount brokerages, although an exact date on when this will come into force has yet to be determined.
In both the TD and the Scotiabank class actions, the finger isn’t being pointed at the discount brokerage as the one responsible for overcharging clients in investment fees, but rather at the investment fund manager that created the funds and pays those fees to the discount brokerage.
Clare O’Hara