Group urges sweeping industry reform

Legislators and regulators must launch a comprehensive review of the entire savings and investment industry to provide adequate investor protection, according to a brief submitted to Quebec’s Public Finance Committee by a coalition of academics and industry professionals.

In a submission entitled “To avoid another Norbourg…and beyond: For a National Saving and Investment Policy,” the Coalition pour la protection des investisseurs called for a massive streamlining of the number of designated fiduciaries within the mutual fund industry.

“Aside from the fund itself, which is a legal vehicle with its own prospectus, there are six professionals involved in an investment: the promoter, the trustee, the manager, the custodian/depositor, the administrator and the auditor,” reads the English version of the submission. “We recommend that the structure of a mutual fund be simplified, and introduce a new balance between the investment management firm and the trustee/custodian.”

The group points out that these numerous levels of fiduciary duty are irrelevant to the retail investor anyway. In the eyes of most, the only people who count are their advisor and the managers of the funds they invest in.

“The steady increase in the types of fiduciaries has made it difficult for the individual investor and pension fund to make decisions,” the report says. “To make his selection, the investor should now evaluate the governance of a fund as much as the reliability and strategies of the investment management firm that handles it.”

In order to improve the investor’s ability to make these decisions, the coalition calls upon the government to improve investor education and access to evaluative tools — although they acknowledge that a wholesale shift in financial literacy could take half a generation to accomplish.

“Until then, investors will require the active contribution of advisors, brokers and distributors to fill the information gap,” the report says. Another consideration is that the financial system will soon face a surge in retirees, whose demands for service will strain the system. “We also need to specify fiduciary rights and obligations and to help investors better define their needs.”

The report also asserts that Canadian mutual funds are over-priced, and calls on the government to encourage consolidation of funds too small to achieve scales of economy.

Another recommendation is for the mutual fund industry to set up an Anti-fraud Indemnity Fund, modelled after the Canadian Deposit Insurance Corporation’s fund, which would partially reimburse investors in the event of fraud. This recommendation comes in response to the Norbourg debacle, which saw about $80 million in assets evaporate.

The premiums for such an insurance scheme would be paid for by both the investor, based on the size of their investment, and the fund management firm, based on its fiduciary risk as assessed by an independent organization.

“An Anti-fraud Indemnity Fund would reduce investor fear, and instil greater confidence by increasing the investor’s protection in fraud cases,” the report says. “This would allow small to mid-sized investment management firms to compete against larger institutions.”

Those smaller fund firms will need the help — as will their largest colleagues — if another recommendation is adopted: The group is calling for the extension of NAFTA to the investment funds industry. The group suggests using a passport model to allow only firms in countries which meet Canadian regulatory standards to market products to Canadian investors.

Canadian investors are already able to invest directly in individual equities listed in the U.S., the argument goes, so it would only be logical to allow them access to American mutual funds. Since mutual funds reduce risk through diversification, it makes little sense to allow investors access only to individual securities. Not only should access be given to American funds, but also to European funds, the group says.

“While Canadian investors can buy U.S. securities through U.S. stockbrokers, order cars directly from Detroit or buy clothing from U.S. department stores, they cannot freely buy mutual funds from U.S. suppliers,” the report says. “In short, the North American Free Trade Agreement (NAFTA) does not apply, and this may explain why management fees are much higher in Canada than in [the] neighbouring United States.”

The group calls on the AMF — and, presumably, all Canadian regulators — to be more open to adopting the best practices of foreign regulators, pointing to the U.K.’s Financial Service Authority as a world leader in regulatory innovation.

“When a regulator improves the access to market for investors, the AMF should follow suit immediately,” the report says. “Yielding regulation would invite more cases like Norbourg, Lancer, Norshield, and Mount Real. By contrast, discriminating regulation would isolate investors, reduce supply, and further hamper an already limited investment management industry.”

The brief was written by Andrée De Serres and René Delsanne, both of the Université du Québec à Montréal, Reynald N. Harpin, investment specialist and corporate director, Jean-Luc Landry, managing partner of LandryMorin Inc., Robert Pouliot, Centre for Fiduciary Excellence (CEFEX) and Michel Roux, from the Université de Paris 13.

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(10/27/06)

Steven Lamb