Canada’s regulators aren’t prepared to say yes to banning embedded commissions just yet – but they’re not prepared to say no either.
At a roundtable hosted by the Ontario Securities Commission (OSC) in mid-September, OSC president and chief executive officer Maureen Jensen told members of the investment community that regulators are reviewing the more than 140 comment letters they have received following the release of a consultation paper published in January.
Regulators seemed to be at a crossroads. They want to do away with conflicts of interest that stem from embedded compensation. But at the same time they have heard from many in the industry who believe that an outright ban would be bad for small investors. So they said, they are looking for alternatives.
“I want to emphasize that we are not here to debate whether the harms from embedded compensation warrant regulatory action, but to discuss what that action could be,” said Jensen. “The status quo is not an option.”
The roundtable centred around three areas of discussion that could act as the alternatives to an outright ban.
They included: capping or standardizing trailing commissions; the potential impacts of eliminating the deferred sales charge (DSC) purchase option and ways to increase investors’ awareness, understanding and control of embedded commissions.
On the issue of capping or standardizing trailing commissions, there appears to be little agreement in the industry, said Warren Collier, managing director and head of Canada iShares, BlackRock Asset Management Canada Limited.
The onus is on the industry to prove that one of the alternatives will be better for both investors and the markets in general than an outright embedded commission ban, Collier said. The problem is: there is nothing in any of the written submissions that prove one is better than the other, he said.
Capping and standardizing would involve getting security regulators involved “for which they neither have a mandate or expertise. To me, that sounds like a recipe for a more complicated, more burdensome regulatory regime for us and mandate for you [regulators]. It doesn’t address all the underlying conflicts,” said Collier.
He characterized standardizing and capping commissions as “incredibly blunt hammers…a step backwards.” It would also mean that all clients, including do-it-yourself investors, would be paying the same fee as all other investors.
When it came to discussing the potential to discontinue the DSC option – or introduce additional standards for using the DSC – Sonny Goldstein, president of Goldstein Financial, acknowledged that there are times when DSC does not do investors any good, including short-term investments and leveraged accounts.
But for the most part, Goldstein said DSC fees prevent investors from making knee-jerk reactions and pulling out of an investment during a volatile down market.
DSC is also a choice for investors with smaller accounts, especially at the beginning of the advisor-client relationship because it provides some compensation up front for the advisor, said John Adams, chief executive officer of PFSL Investments Canada Ltd.
“If the DSC structure is banned, dealers and advisors that service smaller accounts and offer a broad shelf of products may not be able to generate enough additional revenue to compensate them for their up-front work. This may result in fewer accounts,” said Adams.
But Marian Passmore, director of policy and chief operating officer at the Canadian Foundation for the Advancement of Investor Rights (FAIR Canada), dismissed any claims that DSC fees were an advantage to clients. “In fact,” said Passmore, “many people who are placed in DSC are not given any other alternative because of the incentives at play – the advisor gets an immediate commission up front. That’s why we have 20 per cent of mutual fund assets in Canada in DSC as opposed to less than 1 per cent in the U.S. and Europe.”
She said the industry needs to remove both DSC and embedded commissions to ensure investors have objective advice at a reasonable price.
A number of submissions suggested that regulators wait to see if CRM2 and its efforts to provide more cost disclosure and performance reporting are working before taking any actions against embedded commissions.
While some regulators wonder just how long they are supposed to wait, Paul Bourque, president and chief executive officer of the Investment Funds Institute of Canada (IFIC), said a number of provincial regulators have already found greater investor awareness of investment fees thanks to CRM2.
“It’s not conclusive, but I think it shows that things seem to be working in the right direction,” said Bourque.
“I think disclosure can work if it’s framed in the right way and I think it is probably less impactful or has fewer unintended consequences than some of the other proposals.”
The third topic of potentially introducing enhanced disclosure of embedded commissions and their potential conflicts didn’t fly with the Federation of Mutual Fund Dealers (FMFD).
The mutual fund dealer channel is already heavily inundated with rules and oversight, said FMFD executive director Sandra Kegie and introducing a service level agreement will simply increase the regulatory burden “with little or no corresponding value.”
“We agree that while disclosure requirements are what they are at the moment this would get buried in a plethora of incomprehensible account opening documents clients receive.”
Jensen acknowledged that there is no “perfect solution” to the issues. “But we are looking for a solution that best addresses the harm and lessens the negative consequences.”
However, she also said that if no viable alternative is found, banning embedded commissions remains an option even if it means disruption to business models, shifts in culture and ways of doing business.
“It’s not easy. What we’re looking for is a practical solution that addresses the harms and lessens the negative consequences. One that makes it better for investors.”
Jensen said the Canadian Securities Administrators (CSA) hope to have policy options and recommendations in the spring.