The Latest Gabfest On Embedded Commissions Ends

In a process that seems to be taking an eternity, the Ontario Securities Commission (OSC) held their latest Roundtable discussion in mid-September 2017 on the subject of possibly discontinuing embedded commissions. Followers of this lumbering process may recall that the original paper on the subject, Consultation Paper 81-408, was released in January 2017 with comment letters due by June 2017. Part way through that exercise, the OSC also held an “outreach” session where the paper’s principal authors presented a Powerpoint presentation about what the paper entailed followed by a Q&A session to make sure that all interested stakeholders were on the same page. The predecessor concept known as the “Fair Dealing Model” (FDM) is well over a decade old now – although, in fairness, a few relatively modest elements of FDM have already been enacted.

Regulators noted that a whopping 142 submissions were presented on the subject of trailing commissions, which is an informal record of sorts. What they ultimately do about embedded compensation is a matter of supreme concern, it seems. The original venue was overbooked in mere hours, so a larger venue was secured and it, too, was filled to capacity.

Maureen Jensen, the CEO of the OSC, kicked off the event by emphasizing that the status quo was not an option while allowing that no decision had been made regarding what policy direction regulators might take. Jensen went on to say that the preliminary policy direction would be released by the spring of 2018. If past experience is any guide, observers will note that the regulatory lawyers know that since summer officially begins on June 22, they will likely release their proposal in the third week of June – just in time for everyone to bring it to the cottage as they leave for their summer holidays.

Jensen went on to say that the objective of the initiative was to address the harm that is perceived to exist in the current system while simultaneously minimizing negative consequences. She said regulators remain open to alternative solutions provided that those alternatives addressed regulatory concerns about harm – the most notable of these being the perceived conflicts of interest that are part and parcel with embedded compensation. She went on to say that embedded compensation doesn’t seem to align with the needs of investors and that we all need to “make it better for the investors”. Before moving on to the three separate panels on related topics, Jensen noted that Canada is a jurisdiction with only modest penetration of low-cost products, while OSC lawyer Chantal Mainville stressed that regulators were keenly aware of the possible threat posed by triggering “unintended consequences”.

The first panel dealt with options around capping or standardizing trailing commissions. The options of both capping (i.e. setting a maximum rate) and standardizing (i.e. setting a specific rate) on trailers was discussed. The context was whether any of these alternatives could be implemented in a way that might sufficiently mitigate the conflict created by trailing commissions. The panel also explored the impact that these alternatives might have in regards to access to advice and competition in the marketplace. Consultant Neil Gross noted that neither standardization nor capping put the cost of advice in the investors’ control, saying that neither option responded to the primary problem of advisor conflict.

The second panel looked expressly at the possibility of discontinuing the deferred sales charge (DSC) option. Once again, the panel looked at what might happen to access to advice and competition in the marketplace, but also delved a bit further into dealer business models. As you might expect, some participants were more persuasive than others.

I was pleasantly surprised to hear comments from John Adams, President and CEO of PFSL Investments Canada Inc, who noted that his firm has instituted a one-time commission policy, so that funds on an expiring DSC schedule cannot be re-invested into a new (typically seven-year) redemption schedule. I also noted that 3 of the 4 panelists suggested that the DSC option was about choice – even as they made no direct comments regarding bias and conflict.

Marian Passmore of The Canadian Foundation for the Advancement of Investor Rights (FAIR) suggested that we already have an advice gap in Canada, since it is her view that investors are “not getting objective advice now – and not getting advice that is in in their best interests”. In so doing, Passmore turned the question from one of access to advice for small investors to one of quality of advice. You might say that Passmore was more worried about a “good advice gap” that was already baked into the system than a mere “advice gap” caused by reduced access to advice.

After a short break, the third panel convened to discuss Enhancements to Disclosure and Choice. The topics of discussion included ways to increase investors’ awareness, understanding and control of embedded commissions and related conflicts of interest. This included the possibility of alternative payment options in addition to embedded commissions. Interestingly, despite study after study showing that most Canadian mutual fund investors still don’t know how and how much their advisor is being paid, 3 of the 4 panelists insisted that the current system is good enough.

Sandra Kegie, the Executive Director of the Canadian Federation of Mutual Fund Dealers made the point that there could be additional disclosures made at the point when accounts were being opened where investors could be offered a choice between minimal (mandatory) services at a lower price and additional, value-added enhanced services at a higher price. Note that if this were to be implemented, those choosing the latter option would need to pay the difference through some form of direct payment.

Dan Hallett, a Vice-President at Highview Financial Group was clear that the terminology used by many panelists (including those on earlier panels) that the notion of small investors having to “write a cheque” is simply untrue, since the prevailing methodology for payment would be by doing either monthly or quarterly redemptions to pay the advisor and her firm. Hallett also asked why so many people were suggesting that paying directly was bad for business when, in fact, the fastest-growing segment of the mutual fund industry was F-Series funds where embedded compensation has been expressly stripped out.

The overall impression seems to be that the industry mostly thinks things are just fine the way they are. My rough count would put the score at four panelists in favour of change and nine in favour of leaving things alone. Of course, Maureen Jensen was entirely clear that leaving things as they are was simply not in the cards. After all, even organizations that consult for over a decade must do something eventually.

John De Goey is a portfolio manager with Industrial Alliance Securities (IAS) and the author of The Professional Financial Advisor IV. The views expressed are not necessarily shared by IAS, which is a member of the Canadian Investor Protection Fund.