Small dealers resign from the MFDA en masse

The Mutual Fund Dealers Association of Canada could be on a path to becoming a self-regulatory organization without any members to oversee.

The number of MFDA member firms is dropping at a rate of approximately 10% a year, down from a high of about 220 firms in 2002 to its current level of 170. And that statistic shows no sign of abating, which has some industry insiders predicting a new round of consolidation.

This year, 16 firms have announced their intention to resign from the SRO and three more have already left. While some new blood is coming in, it’s not enough to offset the flood of firms heading for the door.

Despite repeated attempts, no one from the MFDA was available to respond to questions about its shrinking membership or the SRO’s future. Had someone been available, they would likely say that while membership is on the decline, the total assets under management by its members are up significantly, currently sitting at approximately $280 billion, up from $262 billion in 2005 and $224 billion in 2002.

Still, those numbers are less impressive when you consider IFIC pegs total mutual fund assets at just under $630 billion, as of Oct. 31. In fact, total industry assets are growing at a faster clip. Total industry assets are up 35% since 2002 whereas assets managed my MFDA firms are up 20% over the same period.

Even the number of MFDA sales reps is falling. In 2005 there were approximately 75,000 of them, but as of October 2006 that number had dropped to about 69,000.

Small dealers are being affected the most. Many of them are shifting their practices so they can continue operations exclusively under the IDA umbrella, while others, like Fiscal Agents, a small mutual fund dealer based in Oakville, Ont., are realigning themselves with larger companies.

It’s not as if these small mutual fund dealers haven’t given the MFDA its fair shake. Most would agree that if they had the choice they would prefer to remain independent. “The corporate ego does not give up its licence lightly,” says David Newman, president and principal director of Fiscal Agents, which has opted for a “supplicant relationship to another master” to survive, that master being IPC Investment.

One of Newman’s most senior staffers spends eight days a month on compliance issues alone, or “non-profit producing activity” as Newman calls it, and that doesn’t include costs the firm would have to incur if the MFDA ever found a problem. “The threat of misstepping is far more critical for the smaller firms,” he says. “If you don’t have sufficient human resources to manage some of the imagined complaints that might come your way you might just fall afoul of the whole bureaucracy.”

The increase in regulation, the demands on supervision and the technology needed to live up to the MFDA requirements are all too much for the smaller firms, says IPC president Chris Reynolds. “Those all require huge amounts of capital and infrastructure that small firms have a hard time affording based on the rather thin margins that continue to plague our industry,” he says.

This leads Reynolds to a bold conclusion. “I certainly think this is the next round of consolidation.” The first round involved mid-tier shops and saw firms like Assante, Dundee, IPC and Wellington West come out on top. After this round of consolidation, Reynolds figures only about 50 firms will remain, as smaller dealers either align themselves with larger firms or leave the industry entirely.

“We’ve done the math every way possible and unless you have north of $5 billion under management and growing, I don’t know how you could possibly stay in business with out a real, real stripped-down value proposition and then what’s the point?”

One departing dealer from the SRO, who requested anonymity, calls the MFDA “a very user-unfriendly place.” In his words, the rule book is unintelligible and unnecessarily complex. The MFDA was meant to come in and simplify things, which was why he decided to set up a dealership in the first place.

Fed up with the regulator, he says he’s moving to a larger firm like Newman. “I’m going to get back to being a financial advisor, which is what I should be.”

Glorianne Stromberg, a securities lawyer and former OSC commissioner, has a lot of opinions about the MFDA. And understandably so, considering it was a paper wrote she penned back in the mid-1990s that led to the creation of the SRO in the first place (although she never actually envisioned the MFDA per se, rather a new single SRO that would also oversee mutual funds).

At first, Stromberg is surprised by Reynolds’s prediction that the consolidation within the mutual fund dealers would whittle the number of firms down to 50, but after some thought she says she wouldn’t argue with that number. “The marketplace is almost forcing it,” she says. “It’s easy to blame regulation, but that’s an ancillary matter.”

There are other issues at play. “Firstly, a lot of these dealers are very, very small and the only way they could be in business was because of the support that they got from the fund companies in co-op marketing,” she explains. “This became really unsustainable once the sales practices were curtailed.”

Second, clients are becoming more knowledgeable about financial products and want full-service advice. And as a result, they’re more demanding. They want more than simply mutual funds, insurance, seg funds or types of insurance that carried an investment component.

Another reason Stromberg says small dealers are having problems is the economics of their business where they are paying out anywhere from 80% or more in commissions. “That’s just not sustainable,” she says. “Even though you have desk fees and you charge for services, the dealer just doesn’t have enough left over to invest in growing the business and making sure it has good systems and procedures and oversight. It is that pressure that is also coming to bear in forcing them to look for a more economic way of carrying on.”

Whether it’s the MFDA’s rules that are forcing small dealers out of the industry or whether the marketplace in which they operate has changed in a way where these firms no longer make sense, the result is the same. As smaller dealers are culled from the fray, the more likely it’ll be that the members populating the MFDA will run on both the MFDA and IDA platforms, which includes firms such as Dundee, Assante, Berkshire and IPC, not to mention the banks. Ultimately this could put even more pressure on the MFDA to merge with the IDA and RS. While the IDA and RS have agreed to such a merger, the MFDA has remained steadfast in its position to remain separate.

“For companies like ours it would be advantageous if we only had one SRO because we have to have double the infrastructure to deal with both sides,” says Reynolds.

Stromberg thinks it’s inevitable that the MFDA will consolidate with the other SROs, due to economic pressures. “I understand why they held back,” she says. “They just got themselves up and running and their work is beginning to show good results so it is hard to let that go, but I think it is time that they joined the party.”

Ideally, Stromberg would like to see the SROs start anew. In her paper back in 1995 she called for the creation of a new SRO with the known participants, designed to work in today’s marketplace without bringing the history of the three separate regimes. “I wish that that had been the approach that they had adopted” she says. “That said, it will come together, but I don’t think the MFDA should allow itself to be put too far behind.”

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com

(12/27/06)