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On Tuesday, the Canadian Securities Administrators (CSA) released a much awaited consultation paper, “Consultation on the Option of Discontinuing Embedded Commissions.”
We say “much awaited” half tongue-in-cheek. Much in the same way that a large number of Canadians have no idea how or how much they pay for investment products / advice, we expect even fewer are aware of the potentially seismic shifts that are taking place in the regulation of investment advice and advisor compensation practices!
As the title of the paper suggests, the regulators are considering banning the practice whereby investment advisors are compensated by investment product dealers directly through the payment of commissions embedded in fees charged on products such as mutual funds, structured products and others. Conflict of interest is the key issue that the paper’s summary highlights, as follows :
1.) Embedded commissions raise conflicts of interest that misalign the interests of investment fund managers, dealers and representatives with those of investors;
2.) Embedded commissions limit investor awareness, understanding and control of dealer compensation costs;
3.) Embedded commissions paid generally do not align with the services provided to investors.
The discussion is moving past “if” and heading towards “how” embedded commissions should be banned
To date the industry has vociferously protested the adoption of such a commission ban on the grounds that it will have adverse outcomes for the very investors it aims to protect; specifically, that it will result in a drop in the availability of advice and that new initiatives at a time when other major changes are happening threaten to undermine and confuse the industry’s best efforts to adapt.
The paper is quite clear that the regulators are less interested in revisiting arguments previously put forth and are looking for fresh ideas to contribute to the debate. Furthermore, the paper indicates that the commission ban proposal is considered to be complimentary to current measures designed to increase transparency and investor awareness generally.
Increased likelihood of ban on embedded commissions
Reading between the lines, there is an increased likelihood we’ll be seeing a ban on embedded commissions in Canada. The debate is moving past whether or not a ban would work and is now focusing on the potential adverse consequences for investors that might arise and the best way to mitigate those consequences.
Will banning embedded commissions on mutual funds and other securities products drive the financial industry to push insurance-based products that are subject to different regulation? The paper acknowledges this concern and asks for consultation. Will indirect compensation practices such as sales competitions fall under the umbrella of embedded commissions?
At Chalten, we have previously written that we would prefer a market-based solution to conflict of interest issues: transparency and investor education should, in theory, encourage the market to favour solutions that serve investor interests. We actually believe the regulators feel the same way but the evidence they’ve seen so far hasn’t convinced them it’s possible. “Buyer beware” is clearly not the kind of market-based solution they’re looking for!
Change takes time – don’t wait to educate yourself
Of course, if such proposals were adopted, implementation would take time, even years. In the meantime, it is logical to conclude that sales practices that gave rise to the regulator’s concern in the first place are still occurring. It is imperative, therefore, for investors to continue to educate themselves and if they find themselves considering an advisory relationship that isn’t 100% transparent and aligned with their best interests, they should be asking questions and thinking about alternatives.
We don’t recommend all investors read the consultation paper (165 pages!) but all investors should certainly be interested in its implications!
Graham Bodel is the founder and director of a new fee-only financial planning and portfolio management firm based in Vancouver, BC., Chalten Fee-Only Advisors Ltd. This blog is republished with permission: the original ran on January 11th, here.
Editor’s Note: (Added Jan. 13th). Here is Jon Chevreau’s blog on this topic, which appeared on his Motley Fool blog today. Click on the highlighted title, Banning Trailer Commissions Could Give Canadian Investors a Wealth of Lower-Cost Products.
