In a letter to Canadian Securities Administrators (CSA) chairman Louis Morisset, Quebec's Professional Association of Financial Services Advisors (PAFSA) is asking regulators to clamp down on financial institutions' proprietary products instead of abolishing embedded commissions for third-party mutual funds.
The CSA published Staff Notice 33-318 last month. It reviews the sort of compensation and incentives that firms offer to motivate advisors, and the paper continues to arouse passions in the industry. PAFSA President and spokesman Flavio Vani has submitted a letter to Morisset, who is both CSA chairman and head of the Autorité des marchés financiers (AMF), in which he argues there is an obvious link between proprietary products and potential conflicts of interest.
Potential conflicts of interest
Instead of banning embedded commissions for non-proprietary products, Vani recommends that securities regulators crack down on the sort of compensation paid by integrated companies that distribute exclusive products. The CSA define an integrated firm as one that runs not only an asset management or product manufacturing business, but also has a distribution network.
PAFSA notes the CSA have clearly established that potential conflicts of interest result from the way integrated companies pay advisors who sell investments and mutual funds, "including integrated companies that distribute exclusive products," writes Vani.
"As researcher Douglas Cumming demonstrated in the study cited by the CSA, integrated companies and proprietary funds represent the most serious problem in terms of performance for customers," adds Vani. He quotes the passage from the study which found that funds sold by affiliated distribution companies tend to have the worst performance.
Embedded commissions are not the source of the problem
The president of PAFSA concludes that funds with embedded commissions are not the source of the conflict of interest problem. "Rather, it is the compensation arrangements and incentives offered by integrated distribution companies that should be targeted by regulatory authorities in order to stop business practices that go against the interests of customers," he says .
Flashfinance.ca, a sister publication of The Insurance and Investment Journal, obtained a copy of the letter which was sent simultaneously to 11,500 advisors. In his message, Vani emphasizes that the members of his organisation want healthy competition in a free enterprise market. He goes on to say that PAFSA will remain vigilant. The organisation wants to make sure that any regulatory responses that address conflicts of interest arising from compensation arrangements and incentives deal with the real causes identified in the CSA survey; they should not infringe on the public interest, which is best served when consumers have access to objective advice and non-proprietary products.
Recommendations to the regulators
PAFSA makes three recommendations to the regulators:
- That the option of abolishing embedded commissions in non-proprietary products be abandoned, since the CSA'S Notice 33-318 demonstrates that they are not a source of conflicts of interest.
- That the CSA should promote clear regulations in order to eliminate situations which give rise the potential conflicts of interest as identified in the CSA's compensation survey and in Notice 33-318.
- That business models for the distribution of financial products, including investment funds and securities, should be reviewed in order to promote the independent distribution of non-exclusive products.
The CSA say they have identified both financial and non-financial incentives that promote the sale of proprietary products to the detriment of third party products. "Only integrated firms reported these practices," reads Notice 33-318. This was one of the 27 worrisome compensation practices identified in the Notice, which listed among other things incentives related to both sales volume and the size of a client’s initial investment, as well as sales contests.