Concerns follow regulators’ survey of mutual fund reps

Regulators’ survey of mutual fund reps at Ontario bank branches has renewed concerns about proprietary shelves and exposed potential know-your-product weaknesses under the client-focused reforms (CFRs).

In July, the Ontario Securities Commission (OSC) and the Canadian Investment Regulatory Organization (CIRO) published the results of a survey of mutual fund reps at branches of the Big Five bank–owned fund dealers in Ontario.

The regulators’ news release about the survey, which focused on the bank fund dealers’ sales culture, led with the reps’ “positive perceptions” of proprietary shelves: The majority of reps (78%) agreed that the range of products they had access to — largely proprietary mutual funds — met clients’ needs. Investment Executive’s (IE) annual Report Card on Banks reports a similar sentiment among bank branch financial planners.

Half of reps in the regulators’ survey (48%) agreed that clients would benefit from a broader range of mutual funds, including third-party funds. Meanwhile, roughly one-fifth (depending on the dealer) disagreed, saying third-party funds would create choice overload or client confusion. Some said third-party funds would require additional know-your-product (KYP) training.

The regulators responded to the findings by suggesting that if the bank-owned dealers were to consider expanding their product range, they should address reps’ “perceived barriers,” such as training.

In IE’s Report Card, bank leaders responsible for the retail-branch businesses across the Big Six said they weren’t considering expanding their product shelves; they also said advisor training is a priority.

In reference to the additional KYP training that would be required for an open shelf, Michael Thom, managing director of CFA Societies Canada in Toronto, noted the irony under the CFRs: “If you wanted a less conflicted and more competitive [product shelf] that was broadly in the public interest, [the regulators] would hold you to perhaps even a higher standard.”

The rules are “a bit hazy”

Ian Tam, director of investment research, Canada, with Morningstar Inc. in Toronto, noted in an email that the reforms’ allowance of proprietary shelves undercuts their broader intent. For example, enhanced KYP under the CFRs requires reps to show they compared a fund to a “reasonable” range of alternatives from the product shelf as part of making a suitability determination. A question arises about whether the comparison is truly reasonable when the rep is limited to proprietary products.

“The rules themselves are a bit hazy here, and I think we are overdue for some updated guidance since three years ago,” he said.

The CFR companion policy says a reasonable range depends on circumstances, including the securities offered to the client, among other things.

The CFRs, which came fully into effect at the beginning of 2022, allow for proprietary shelves, but firms must disclose and demonstrate they are addressing — in clients’ best interests — the inherent material conflict that arises when proprietary products are recommended. For example, firms could ensure their proprietary products are competitive by performing periodic due diligence on comparable non-proprietary products in the market.

Leading up to the reforms coming into force, three of the big banks trimmed their branch shelves of third-party funds, matching the others. Ontario’s finance minister directed the OSC to investigate the banks’ move to proprietary shelves, and the regulator submitted a report to the minister in early 2022, which wasn’t made public. (In a 2021 report, Ontario’s Capital Markets Modernization Taskforce, which supported the CFRs, had made several recommendations to increase shelf space at the banks for independent products.)

Also, about two years ago, the federal Department of Finance asked in a competition-focused consultation whether the big banks should be required or incentivized to offer third-party products.

Nothing came of these initiatives.

One of the purposes of the CFRs was “meaningful KYP and shelf management,” Thom said. If regulatory objectives are abandoned, regulators should be transparent about that, he said, and explain what changed and why. “The public and the public interest deserve that much,” he said.

But Laura Paglia, CEO of the Canadian Forum for Financial Markets (CFFiM) in Toronto, questioned the Ontario finance minister’s request.

“I don’t know what motivated the minister of finance to make that inquiry of the OSC,” Paglia said, “because client-focused reforms did not lead to the banks creating proprietary shelves,” given that half of the bank-owned fund dealers already had proprietary shelves. The CFRs “are very clear that proprietary shelves are permitted,” she said. “It was reviewed, discussed and approved by the [Canadian Securities Administrators].”

More generally, when it comes to the distribution of proprietary products and competition, the relevant question is, “Are we making it fair and reasonable for other entities that don’t have the size and scale of banks to also distribute proprietary products?” Paglia said.

For example, in a submission to the consultation on principal distributors’ sales practices, the CFFiM says allowing principal distributors to distribute more than one fund family would promote competitiveness.

When asked about the OSC’s report on bank branches’ move to proprietary shelves as the CFRs came into effect, OSC spokesperson Andy McNair-West said in an email that the CFRs “remain a priority, and we are aiming to publish more on this soon.”

Regulators plan to publish a CFR report, including guidance, by year-end, said CIRO CEO Andrew Kriegler at the annual leadership conference of the Securities and Investment Management Association in Toronto in mid-October. Earlier this year, CIRO said CFR sweeps found that dealers need to be more specific about their policies and procedures related to such things as product due diligence, and processes for identifying and evaluating a reasonable range of alternatives as part of suitability assessments.

A regulatory review of the CFRs’ conflicts requirements a couple of years ago found that firms with only proprietary products often relied on disclosure and suitability assessments to address conflicts, which aren’t enough, the regulator said.

More generally, Kriegler said at the event that regulation is best considered in whole, not in part, with a view to the desired policy outcome. For example, rather than perceiving KYP requirements as onerous, “doing documentation on product due diligence once [centrally in a firm] is fine,” Kriegler said.

MER shocker

The regulators’ survey of mutual fund reps also found that 23% of reps didn’t correctly answer a question about the definition of an MER. Just 12% didn’t correctly answer a question about an MER’s impact on performance.

Tam described the MER finding as a “shocker.” A fund’s MER is “prominently displayed on Fund Facts and is essentially the price tag for the fund,” he said.

Further, “If a representative cannot accurately identify MER, then they are in breach of the CFRs because they have not understood the security’s structure, features, risks and the initial and ongoing costs,” Tam said, referring to enhanced KYP requirements under the CFRs.

The survey finding about MERs “floored me,” investor advocate Harvey Naglie said. “These are the fees that eat away at investors’ returns, and if the people selling funds can’t explain [MERs] clearly, their customers are left in the dark.”

Cost is one of the most reliable predictors of long-term fund success, Morningstar’s latest fund family digest says. “In Canada, where fees remain relatively high compared with other markets, this relationship is especially important.” Morningstar rates Vanguard and Fidelity International as best-performing among large asset managers in Canada — including bank-owned managers — when it comes to risk-adjusted, net-of-fee returns.

When asked if improved proficiency for mutual fund reps would be a good way to address the lack of MER knowledge identified in the regulators’ survey, Naglie scoffed: “I don’t know that the most proficient, well-intentioned salesperson in the world is going to be able to deliver a more satisfactory outcome for the investor” if the sales culture at the bank-owned dealers doesn’t change.

A key finding of the regulators’ survey — which, again, focused on sales culture — was that 25% of the reps said clients have been recommended products or services that aren’t in their interests at least “sometimes.” The finding may be tied to pressure to meet sales targets and the use of scorecards to track those targets, the regulators said.

“The combination of incentives that are geared to sales volume, together with a proprietary shelf of products, is just a cauldron mix of likely bad results for investors,” Naglie said.

The survey’s findings indicate that branch advice is “one of the weak spots of the CFRs — or at least what the CFRs were intended to do, which is to have financial advisors (or representatives, in this case) act in the best interest of the client,” Tam said in his email.

The regulators said they’re conducting compliance exams at the bank-owned dealers related to the survey findings — a response that was met with some skepticism.

After conducting the exams, the regulators said they’d “consider the regulatory tools available and determine whether further action is required to ensure ongoing compliance with securities laws.”

The OSC’s business plan for 2026–28 references the CFRs and conflicts, “including those related to [a] firm’s product shelves.” The CSA’s business plan for 2025–28 includes reviewing National Instrument 81-105 Mutual Fund Sales Practices in light of the CFRs and specifically mentions principal distributors’ sales practices.

Given the survey findings, Tam welcomes the forthcoming CFR guidance, which he suggests should include proprietary-only channels. “Branch advice is the bedrock of our largest financial institutions, and often a first touchpoint for new investors and new Canadians,” he said. “Clarity from our regulators … is much needed.”