Cutting off embedded fees for discount brokers nothing new for Questrade

Years after embedded commissions, or fees paid by mutual fund managers to advisers for ongoing investment advice to clients, were banned in other countries, and after years of study on the subject by regulators and industry groups, the matter is finally coming to a head in Canada.

Or at least they are sort of coming to a head, as recently released proposals are not yet official because they are out for additional comment until October. And given the current diversity of opinion only a brave person would predict there will be no change.

As well, the banning of such commission will not apply to all mutual fund products, only to those bought by do-it-yourself investors, where there is no ongoing investment advice.

The proposal from Canadian Securities Administrators (CSA) is being made a few months after a $200 million class action law suit was filed against TD Asset Management Inc. (TDAM) and another $200 million suit against (Scotiabank’s) 1832 Asset Management L.P. in regard to trailing commissions paid to discount brokers on mutual funds.

While both claims have not been certified, the plaintiff uses strong language, arguing TDAM received “excessive, inflated, and/or unearned management fees,” while paying trailers to discount brokers for advice they cannot provide under securities rules, is “improper, unreasonable, and unjustified.”

In CSA’s proposals, trailer fees, which are in the one per cent range, can continue to be paid to the adviser for those mutual funds bought on the adviser’s recommendation.

According to Investment Funds Institute of Canada (IFIC), at the end of May, Canada’s mutual fund industry was home to $1.50 trillion of assets; trailer fees have been estimated as a $6 billion a year business.

The proposals as they relate to ending embedded commissions are sweet music to Questrade.com, a financial organization focused on online retail brokerage formed almost 20 years back. (Questtrade also offers Portfolio IQ, where clients have their assets managed professionally in a series of ETFs.) Since then it has gathered “hundreds of thousands of accounts and customers,” and about $8 billion in client assets.

About eight years back, through a program known as mutual fund maximizer, Questtrade began to rebate trailer fees on mutual funds held at the firm. “The trailer fees, which tend to be about one per cent on the Series A funds, gets rebated back to the customer,” said Stephen Graham, chief operating officer.

But in Questrade’s case it holds back a $29.95 per month administrative processing fee. The numbers mean a customer could lose about $360 a year; based on a one per cent trailer, meaning customers gain if they had about $36,000 in mutual fund assets. If a customer had $200,000 in mutual fund assets, after the rebate they would be ahead by about $1,600 a year.

“Compounded over time, that adds up to a lot of money,” Graham said, adding, “we felt the trailer was really the customers’,” and hence should be returned to them, noting that while trailer fees are received monthly, the rebate is paid out quarterly.

Graham termed the rebate as part of the company’s mantra and mission, which is “to provide easy to use, and easy to understand financial services for Canadians at a lower cost. We are an alternative that lets them keep more of their money,” he said, adding that because it has no branch network, “customers have to find us.”

It’s not known how many of Questrade’s customers benefit from the trailer fee rebate and how much the $29.95 administrative processing fee boosts Questtrade’s revenue. Graham wouldn’t comment on the practice of other discount brokerage firms retaining the trailer fee — and not offering a rebate — but noted the proposed CSA rule “is a step in the right direction.”

And if precedent is followed, Questtrade will make it views on the proposals known to the regulators.

Financial Post
bcritchley@postmedia.com

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