In the mid 17th century, a Neapolitan banker by the name of Lorenzo Tonti appeared at court with an interesting idea for Louis XIV. In order to raise money for France's rather expensive military campaigns, Tonti suggested that the state raise capital buy selling the shares of a specially managed fund to its citizens.
The proposal, in very simple terms, was that members of the French public would be permitted to purchase dividend-paying shares of a government fund. These dividends were set at a fixed rate, and would be paid annually for as long as the shareholder lived. When an investor died, his or her dividends would then be divided amongst the survivors - think of it as an old age lottery, where whoever lived the longest received the highest income. At the death of the last shareholder, all the capital would become the property of the state. The king agreed and France launched its first "Tontine" in 1689, raising more than 3.5 million livres.
The tontine, however, is more than just a financial anecdote; it lives on in the structure of certain education savings plans-specifically pooled group scholarship trust plans. These plans can be structured so that, should a client's child not go on to post secondary studies, his or her earnings will be forfeited and given to those who do qualify. Just as in the original tontine, the returns of those who "survive" are enhanced by those who drop out.
There's just one problem - according to a report on scholarship plan dealers released by the Ontario Securities Commission (OSC) compliance team last month, some education savings plans subscribers may have no idea that they're handing their money over to the modern-day successors of Lorenzo Tonti.
"There are many fees associated with the purchase of scholarship plan units, however, we noted a lack of disclosure and clarity to clients on the nature of these fees and their implications on the plans' returns," says the OSC report. Not only did sales representatives "lack adequate knowledge of the product being sold to clients", but the OSC also uncovered instances where enrolment fees were being misrepresented, "leading clients to believe that the potential for loss was nil".
The report goes on to enumerate other problems, including the lack of a consistent methodology for calculating rates of return and marketing materials that use terms like "superior returns", "excellent rate of return", and "earns the highest income" without providing any sort of substantiating evidence.
Clearly concerned about the business practices of some scholarship plan dealers, the OSC is now requiring Allianz (recently sold to Heritage Education Funds Inc), The Canadian Scholarship Trust Plan (CST), and Children's Education Funds Inc. to file written progress reports until the authorities are satisfied that they have corrected their deficiencies. Another two firms, USC Education Savings Plans and Global Educational Marketing Corp., must also file reports and are also barred from hiring new representatives until cleared by the OSC.
Thanks to this highly publicized regulatory crackdown, financial planners may have to field more questions than usual about different kinds of RESPs over the next few months. In situations where the true terms and conditions of a plan may be difficult to ascertain, the best advice may be to simply avoid pooled group scholarship trust plans entirely and opt for a self-directed registered education savings plan instead. Set up like a standard investment account, SDRESPs offer clients a straightforward fee structure and the ability to choose the individual securities that are best suited to their particular situation.
While consumers may be interested in hearing about tontines and 17th century finance, given the choice they would probably prefer something more transparent for their 21st century children. The story of Lorenzo Tonti looks better in a history book than it does in an investment prospectus.
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