The Canadian Securities Administrators (CSA), the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) have each published reports on Thursday that examine the various compensation arrangements in the retail investment business and the conflicts they can create, including a bias for proprietary products and incentives to sell products that may violate suitability standards.
To varying degrees, the regulators also delve into the specific features of these systems, ranging from traditional payout grids to deferred compensation arrangements, and identify how compensation arrangements can (both directly and indirectly) create conflicts of interest, such as incentivizing financial advisors to sell proprietary products instead of third-party products, and lead advisors to sell products that aren’t in clients’ best interest, or even suitable.
The MFDA’s bulletin reports that the self-regulatory organization’s (SRO) review of compensation structures uncovered arrangements that appear to violate the mutual fund sales practices rule by providing incentives for advisors to favour in-house funds, or a particular mutual fund family.
“These cases have been referred to our enforcement department,” the MFDA’s bulletin says, adding that the firms in question are also changing their compensation systems to eliminate these incentives.
In addition, the MFDA found practices that increase the risk of mis-selling and unsuitable advice, such as arrangements that particularly favour mutual funds with deferred sales charges.
The MFDA also reports some compensation practices for certain products, such as exempt-market securities, would not be allowed under the sales practices rule, which only applies to mutual funds.
The SRO will refer these issues to the provincial regulators and will participate in discussions relating to compensation reform, including whether the restrictions contained in the mutual fund sales practices rule should also apply to other types products.
IIROC’s review also singles out concerns with firms using compensation models that favour proprietary products. In addition, the review flags the risks associated with advisors being encouraged to move clients to fee-based accounts from commissions-based arrangements, even when it’s not in clients’ best interest, and the risks that heftier commissions for new issues encourage advisors to push these products in cases in which they may not be suitable.
IIROC’s review also indicates that the compensation arrangements for supervisors or branch managers that are tied to sales or revenue could also “result in sales behaviour that is not in the best interests of clients.”
In addition to identifying concerns with certain compensation models, IIROC’s notice also spells out some best practices, including supervisory efforts to root out and deal with potential conflicts; product due diligence practices; and training programs for advisors that focus on compensation conflicts and clients’ best interest.
Meanwhile, the CSA’s staff notice says that managing compensation-related conflicts of interest is a fundamental regulatory obligation. Thus, the CSA suggests it may issue further guidance, or introduce new rules, targeting compensation arrangements and incentive practices.
IIROC notes that it’s continuing to conduct targeted reviews of firms’ compensation models and says it will publish a more detailed report on its results in early 2017.
Moreover, the regulators indicate that their research into these compensation issues will inform their consultations on possible reforms that are already under consideration, such as a possible ban on embedded commissions, the introduction of a best interest standard and a series of proposed targeted reforms to client/advisor relationships that are still under way.
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