In public, the investment industry staunchly defends traditional compensation structures. But, privately, some compliance officers (COs) and company executives are marginally in favour of regulatory intervention to separate the costs of advice from the costs of investment products.
Since the Canadian Securities Administrators (CSA) reopened a debate about mutual fund fee structures in late 2012, the industry has consistently supported the status quo. However, the results of this year’s Regulators’ Report Card indicate that top COs and company executives are more willing to entertain the idea of change. By a narrow margin, survey participants said they endorse regulatory action to isolate the costs of advice from the costs of investment products.
In response to a supplementary question in the Regulators’ Report Card survey that asked whether regulators should be taking action to separate these costs, 54% of survey participants who answered would like to see regulatory action to unbundle investment costs. The remaining 46% said that regulators should keep their hands off industry compensation structures.
Although these results can hardly be called an unequivocal endorsement of regulatory intervention, the level of support for the idea of regulatory action nevertheless comes as a bit of a surprise.
In the public debate on this topic over the past few years, the industry has been adamant that regulators should not be interfering with fee structures. Moreover, company executives in the industry have argued that even if regulators believe intervention is needed, forthcoming measures to enhance transparency and conduct standards – such as the second phase of the client relationship model (CRM2) reforms – should be given a chance to work before regulators consider more dramatic measures.
That oft-repeated view continues to be expressed by companies that oppose any action to ban embedded mutual fund commissions or to try to uncouple the costs of advice from product fees.
For example, a chief CO (CCO) with a mutual fund dealer on the Prairies says, “The steps that have been taken on full disclosure [under] CRM2 are adequate to ensure that clients understand where the money is going. Embedded fees aren’t so bad.”
Other company executives recite the industry’s talking points about the risk of lower-value clients losing access to financial advice in a system in which such clients are expected to pay for this advice explicitly.
“Only high net-worth individuals are prepared to pay a fee up front or a separate fee, and it becomes a barrier to entry,” suggests a CCO with an Ontario-based mutual fund dealer. “Embedded fees play an important role, especially for particular [clients]. They can’t have a ‘one size fits all’ solution.”
Yet, a narrow majority of survey participants said that an unbundling of investor costs is foreseeable – with or without the regulators’ involvement. In fact, a CCO with a bank-owned investment dealer in Ontario indicated that several firms are separating out the costs of advice already because regulatory intervention is not desired.
Meanwhile, a CCO with an independent investment dealer in Ontario adds: “We’re going down that road anyway. You can buy a product anywhere. The defining criterion is the advice you get.”
Of course, voluntary action by some of the industry’s more progressive players isn’t likely to be enough to satisfy investor advocates and industry critics who are calling for regulatory action in this area. In fact, pleas from these groups have grown louder in the wake of a report published last year on academic research commissioned by the CSA that concluded definitively that prevailing industry fee structures pose a conflict of interest that both drive mutual fund sales and impact future investment performance negatively.
In light of those conclusions, investor advocates such as the Ontario Securities Commission’s Investor Advisory Panel and the Canadian Foundation for Advancement of Investor Rights are calling on regulators to step in and eliminate embedded commissions.
Now, some executives in the industry also believe that regulators should be prepared to act. For example, a CCO with a bank-owned mutual fund dealer says: “Regulators need to do it. Clients need to know how they’re paying.”
In theory, embedded commissions are supposed to compensate dealers and their financial advisors for ongoing service and advice to clients. But the critics of embedded commissions have long argued that commissions provide little incentive to deliver ongoing advice and make judging the value received for the fees difficult for clients.
Traditionally, the investment industry has maintained that transparency is the answer to concerns about the impact of embedded commissions. Indeed, many survey participants continue to stress the importance of transparency, and some argued that although more disclosure is warranted, direct regulatory intervention with fee structures is not. Yet, the results of this year’s Regulators’ Report Card indicate that a healthy segment of the industry would welcome regulatory action to help eliminate conflicts.
For example, several survey participants indicated that deferred sales charge (DSC) structures should be jettisoned. “DSCs are good for firms, not advisors. I wouldn’t mind seeing them gone,” says a CCO with Ontario-based independent investment dealer.
In addition, a CCO with an independent investment dealer based in British Columbia suggests that commissions should be scrapped altogether: “Commissions should go the way of the dodo bird. Advice should all be fee-based because it removes conflict of interest. It’s best for clients and advisors that commissions be eliminated.”
A CCO with a mutual fund dealer based in Ontario expects that clients will start to complain about existing fee structures once the CRM2 reforms are in full effect and the costs of investing are more clearly reported to clients.
Looking ahead, that CCO suggests that negotiated, upfront fees will be the way to go: “Fee-for-service is a good model. [The] client knows in advance what’s being paid.”
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