While chargebacks are not yet widely used in the fund industry, Canadian regulators are seeking to stamp out the practice before its use grows.
The Canadian Securities Administrators (CSA) is proposing rule changes to ban chargebacks — the practice of requiring reps to pay back some or all of an upfront sales commission when a client redeems a fund before a certain date — citing the inherent conflict of interest in this compensation model.
The now-banned deferred sales charge (DSC) model posed similar conflicts, the regulators said in a notice outlining their proposals.
“In both scenarios, the interests of different parties, such as the interests of the client and those of a registrant, are inconsistent or divergent,” it said, as a rep may be incentivized to discourage a client from redeeming an investment to avoid paying back their commission.
“The conflict of interest from the use of chargebacks increases as the amount of the upfront commission increases and the duration of the chargeback period increases,” the CSA noted.
While the use of DSCs was nearly ubiquitous, the regulators indicated that chargebacks remain limited — only one fund dealer and a handful of scholarship plan dealers are known to use the model — so they are moving to eliminate the practice before it becomes more popular.
The CSA first raised the issue of chargebacks in June 2023 when it announced a review of the practice amid conflict of interest concerns.
“We are of the view that it is important at this time to address this significant investor protection issue before chargebacks become entrenched and a widespread industry practice,” the CSA said.
As a result, the regulators are proposing a ban on chargebacks that would apply to all registered reps, investment fund managers, dealers, advisers and their affiliates when selling funds offered under a prospectus.
“Prohibiting the use of chargebacks in the distribution of investment fund securities can further align investment advice with a client’s best interest,” said Stan Magidson, chair of the CSA and chair and CEO of the Alberta Securities Commission (ASC), in a release.
“The proposed amendments prioritize investor protection and foster fairer compensation practices,” he added.
The proposals are out for comment until Sept. 24.
The notice indicates the ban would take effect six months after final rules are adopted.