Investors recover $358 million from compliance failures

The list of financial-services companies that have reached "no-contest" settlements for overcharging or shortchanging their clients keeps growing. The first of nine such settlements with the Ontario Securities Commission was in November 2014 with three TD Bank subsidiaries. The most recent, on Dec. 21, was with CI Financial Corp.'s Assante subsidiaries.

In all cases, there are no admissions of intentional wrongdoing. But the grand total to date of the make-good payouts -- $358 million -- speaks volumes about how thousands of retail investors were poorly served by their trusted financial providers.

Most of the settlements involve brokers and dealers that charged twice for the same advisory services, and allowed fund investors to bear excessive management fees. The biggest single settlement involved mutual funds that weren't credited with income that the funds had earned.

The companies responsible for these multi-million-dollar miscalculations aren't obscure, marginal players. On the contrary, they are some of the biggest, best known and most established names in the financial-services industry. There are subsidiaries of banking's Big Five. There's a major life-insurance company. And one is a major independent asset manager.

Each of the offending companies have the personnel, systems and financial resources to get things right for their clients, but failed to do so. Investors expected and deserved better from these industry leaders, and from their individual advisors.

First, consider that one of the very basic principles of fee-based accounts is that financial advisors must not engage in double-dipping. If the account holds securities that pay trailer commissions, these assets must be excluded when calculating the asset-based fee payable to the advisor. Yet these types of excess charges were imposed on thousands of fee-based accounts. How could no advisors have noticed that they were being overpaid?

The other fee-gouging practice identified by the OSC was to keep investors with large accounts in the higher-fee retail series of mutual funds after they'd met the asset thresholds to qualify for lower-fee series. This, too, affected thousands of investors who failed to receive competent advice on one of the main determinants of returns: the fees that investors pay.

In yet another type of blunder, a major mutual-fund company understated the net asset values of a suite of derivatives-based funds by failing to credit interest earned on the fund's assets.

In each of the nine settlements, the companies negotiated some important concessions. The OSC stated that it didn't allege nor find evidence of dishonest conduct. It accepted the companies' assertions that they neither accepted nor denied the statements of facts and conclusions of OSC staff. The regulator also cited mitigating factors, including the self-reporting of the failings of oversight, and co-operation with OSC staff.

In return, the companies agreed to compensate investors for what they admitted were their failures to implement appropriate systems of controls and supervision. They also agreed to make additional "voluntary" payments to "advance the OSC's mandate of protecting investors" and to cover the costs of its investigations.

The following, in alphabetical order, are some highlights of the nine settlements:

Eligible investors in 5,427 accounts weren't placed in CI Investments' preferred-pricing program, missing out on management-expense ratio (MER) savings of 10 to 51 basis points.

The largest portion of the settlement was $39.3 million paid to 39,613 fee-based accounts at BMO Nesbitt Burns. The brokerage levied asset-based fees on investment products with embedded trailer commissions. All four BMO entities overcharged fund investors whose account sizes qualified them for MER savings.

This was by far the largest of the nine settlements, and it was with a fund manager rather than financial advisors. For seven derivatives-based funds that maintained cash balances as collateral for forward contracts, CI failed to credit the interest earned to the funds. Though the fund administration was outsourced, CI was held responsible for failing to ensure that net asset values were accurately calculated and reported. A total of 23 CI mutual funds and 69 segregated funds invested directly or indirectly in the derivatives-based funds.

Mutual funds and structured notes that paid trailer commissions were incorrectly included in the calculations of asset-based fees in fee-based accounts at CIBC Wood Gundy. The brokerage agreed to reimburse a total of $23.6 million to 21,621 accounts. Another $19.1 million was paid in connection with exchange-traded funds and closed-end funds that paid trailer commissions and that were held in fee-based accounts at Wood Gundy. CIBC-owned dealers also made payments of $30.6 million to 23,867 accounts of clients who were eligible for lower-fee classes of CIBC, Axiom/Optimal and Renaissance funds.

Mutual funds, ETFs, structured notes and closed-end funds -- all of which paid advisor compensation embedded in their management fees -- were unfairly included in the calculations of asset-based fees for 5,483 fee-based Manulife accounts. The dealers paid $6 million to reimbursed investors in these accounts. They made a further $5.7 million in payments to 3,937 client accounts that ought to have been invested in lower-fee Elite series of Manulife funds.

Quadrus, a mutual-fund dealer, overcharged clients in 3,329 client accounts holding Quadrus mutual funds that ought to have been invested in the lower-fee L series of the funds. MERs of the L series were, on average, 35 basis points lower than the retail series of the same funds.

RBC Dominion Securities and RBC PH&N Investment Counsel charged excess fees totalling $19.5 million in fee-based accounts, because they included assets held in trailer-fee products in their calculations. There were 40,504 affected accounts in which investors held mutual funds, ETFs and closed-end funds that paid trailer commissions, and 6,969 accounts in which other trailer-commission products were held. In addition, 2,974 client accounts received $2.3 million in compensation because of the failure to place them in lower-fee series of RBC, PH&N and BlueBay funds for which they were eligible.

Most of the payments by investment brokerage ScotiaMcLeod and mutual-fund dealer HollisWealth resulted from holding structured notes that paid trailer commissions in fee-based accounts, while failing to exclude these assets when calculating fee-based compensation. The Scotia entities paid compensation totalling $10.3 million to 30,218 accounts. In addition, they paid $589,673 to 2,823 fee-based accounts holding ETFs that paid trailer fees, and $152,709 to 111 clients accounts in which trailer-paying mutual funds were held. The firms paid another $8.9 million to compensate 12,751 accounts for their failure to place clients in lower-fee funds for which they met the account-size requirements.

This was the first of the nine no-contest settlements. TD Waterhouse Private Investment Counsel, a discretionary asset manager serving high-net-worth clients, placed TD funds that pay trailer commissions in fee-based accounts while failing to exclude these assets when calculating asset-based fees. The firm paid $1.7 million in compensation to 4,680 client accounts. To compensate for similar miscalculations, TD Waterhouse paid $780,000 to 1,840 accounts in which mutual funds and other trailer-paying products were held. TD Waterhouse also paid $11.1 million to 3,960 accounts for failing to place eligible clients in the lower-fee Premium series of TD mutual funds. TD Investment Services paid $291,000 to 40 accounts that held TD Managed Assets Program mutual funds and that were not placed in the Premium series for which they qualified.

More to come?

Will there be more non-contest settlements involving overcharging and shortchanging investors in 2018? The OSC won't say.

"As a matter of general policy, we do not confirm or comment on the existence, status or nature of any complaint, review or investigation," an OSC spokesperson told Morningstar via email. "This is to protect the integrity of investigations, to ensure the complaint process is not used to affect the market and to promote fairness toward those who are the subject of investigations." Nor does the OSC comment on whether any settlement discussions are under way.

It's fair to assume that the nine OSC settlements don't capture all of the incidents in which investors were similarly overcharged or were otherwise financially harmed. My advice: If you hold a fee-based account that holds trailer-paying investments, ask your advisor to confirm that you're not paying fees on top of fees. Secondly, if you hold a six-figure mutual-fund account, find out whether you qualify for a discounted fee.