Special Feature

The end of embedded commissions? How we got here

The Canadian Securities Administrators (CSA) published a consultation paper on Tuesday in which it proposes to consult with stakeholders for an extended comment period of 150 days on the option of discontinuing embedded commissions and making a transition to direct pay arrangements.

 

The move to consider a ban on embedded fees follows research the CSA commissioned from York University professor Douglas Cumming in 2015, which showed that these compensation structures distort sales and impact investment performance.

 

Included in this special feature are the notable developments in this area over the past few years highlighting how we got to the release of the CSA's consultation paper. Photo copyright: cherezoff/123RF.

Industry News

The association notes that the CSA’s and the self-regulatory organizations’ rules already address compensation-related conflicts of interest

By Jade Hemeon |

The Investment Funds Institute of Canada (IFIC) is calling on the Canadian Securities Administrators (CSA) to consider whether there's sufficient evidence of market failure to justify prohibiting embedded commissions and recommends that the CSA review other options.

IFIC, the voice of Canada's investment fund industry, is reacting to the CSA's mid-December release of a review of industry compensation practices and incentives. The CSA has also announced that a consultation paper on the possible prohibition of embedded commissions, such as trailer fees, will be released on Jan. 10, followed by an extended comment period of 150 days.

"Until now, CSA members have pointed to academic research here and abroad as their evidence of a market failure sufficient to justify restricting Canadian investors' choice of fee payment methods," says Paul Bourque, IFIC's president and CEO, in a statement. "The review's results confirm the industry's position that almost every form of compensation holds the potential for conflict of interest but that, in the case of investment funds in Canada, actual compensation-related conflicts of interest that could result in client harm are already thoroughly addressed through CSA and SRO rules."

The CSA's review identified 27 compensation and sales incentive practices currently in use in Canada, including bonuses, cross-selling arrangements, product promotions and deferred sales commissions. The CSA found that in every one of the 18 practices that housed a potential for conflict of interest, the conflicted activities are already prohibited under existing rules — either as an unsuitable investment recommendation, a contravention of the duty to act honestly, fairly and in good faith, or a contravention of industry sales practice rules.

IFIC cites the Mutual Fund Dealers Association of Canada's (MFDA) paper, Review of Compensation, Incentives and Conflicts of Interest, which found few violations and acknowledged that the concerned firms responded to follow-up from the MFDA's enforcement department. Similarly, the Investment Industry Regulatory Organization of Canada (IIROC) said in a recent notice that it expects any issues could be addressed through additional guidance or amendments to existing rules.

IFIC says it's "noteworthy" that one of the three chief concerns IIROC identified in its review was the potential that higher advisor compensation for fee-based accounts could lead representatives to move clients to fee-based accounts from commissions-based accounts, even when that may not be in the client's best interest. IFIC says this concern is the exact effect that regulators would produce were they to proceed with a ban on embedded commissions.

"None of the findings of these compensation reviews support the case for a band on embedded commissions," Bourque says. "If regulators have concerns about specific sales misconduct, existing rules give them the enforcement tools they need to address the concerns they have identified. As a result, we are asking the CSA to reconsider whether a prohibition on embedded commissions is the only option."

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