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Mar 1, 2023

Discount Brokers In The Information Age

by Ken Kivenko

A discount brokerage facilitates securities trading at a much lower cost (some securities are even commission-free) than a full-service broker. Discount stock brokerages make it easy to invest from virtually anywhere, since you can execute trades online or via mobile apps. The largest discount brokerages are bank owned, so potential conflicts-of-interest exist.

The last few years have seen tremendous interest toward discount brokerages. According to research firm Investor Economics, there were 10.6M accounts as of June 2022. Discount brokerages are appropriate for Do-it-Yourself (DIY) investors who have ample knowledge and are comfortable with making their own decisions without the assistance of a financial advisor.

Regulators refer to discount brokers as Order Execution Only (OEO) brokers because these brokers are prohibited from providing personalized investment advice to clients. Unlike a full-service broker, the Know Your Client (KYC) regulation is more limited and there is no requirement to effect a suitability determination for trades. Discount brokers provide a low-cost alternative for those Canadians willing to take on the effort, challenges, and risks of non-advised investing. The Investment Industry Regulatory Organization of Canada (IIROC, now New SRO) regulates the discount brokerage industry.

IIROC’s current guidance for discount brokers, while well intentioned, could inhibit the use of innovation because its intention is to keep the “advice” silo as clear as is reasonable. To support the guidance, IIROC has defined recommendation and advice to align with their approach to constrain certain discount brokers service offerings bordering on advice. Yet innovation, technology and societal changes keep pushing the envelope. It’s time to face reality; today, investment “advice” can be democratized by giving Canadians the market information and online tools and education to be self-advised if that is what they can afford and/or prefer.

The online channel is remote from the traditional face to face advice/sales model, a model where the tools and the models used to be on the advisor’s side of the desk and the investor was invariably without. Nowadays, the models, the tools, the education and much more is available to the retail investor on the other side, opening up options for those who want to take control and avoid the additional costs and risks of conflicted advice. This is especially so where the integrity, quality and the cost of advice have been found wanting, and/or the strategy and personalization desired is not generally economically available for Main Street investors.

The current regulatory regime around what constitutes “advice” seems outdated in the information age-especially as the lines blur between what constitutes investing advice and where Canadians seek it out. Securities regulation must evolve past the two silos of advice and non-advice channels. Regulators and financial institutions must consider how much supervisory and regulatory touch is needed for discount brokers. The regulation must be proportionate to the risks and benefits to investors, a difficult task to be sure.

Millions of retail investors are denied access to personalized financial advice due to high minimum account sizes, high advice costs and/or lack of trust in full-service firms. A 2019 OSC Investor Advisory Panel research report found that significant questions were raised about whether most small and mass-market investors actually have access to advice that is comprehensive and timely enough to effectively meet their needs, even though they pay for it, often through embedded compensation schemes, such as trailing commissions, that have been shown to create harmful conflicts-of-interest. Nearly half (49%) of mass-market investors said their advisor spent less than an hour, in total, communicating with them during the past year or didn’t communicate at all.

Discount brokers have matured in step with technology advancement and continue to do so. Artificial intelligence (AI) /machine learning is evolving at a fast clip in the fintech sphere—it is to trading what fire was to the cavemen. The modern discount broker provides online access to investment research reports, model portfolios, trading tools, educational materials, self-assessment tools, predictive tools, calculators, educational materials, hyperlinks to other sites etc.

Does a posted analyst research report with a Buy rating amount to an improper advisory to the DIY investor? By providing a snapshot or a sense of the selections of professional money managers, model portfolios allow small investors to make inferences based on evidence and their own personal circumstances and reasoning. Are available model portfolios personalized “advice”? That may not be personalized advice, but it could present conflicts-of-interest if the portfolio is stacked with products of an affiliate. To be unconflicted information, a brokerage must not be permitted to nudge a client to consider any particular security. Information (“Advice”) must be consistent and available for a broad range of securities of the same class.

There are generally understood interpretations of technical and fundamental analysis that provide possible indications of price movements or other valuation outcomes. Notwithstanding the fact that technical and fundamental analysis informative tools may qualify a situation as “bullish”, “undervalued” or “bearish” or “overbought” or “oversold”, and notwithstanding the fact that calculations may include levels to assist with the client’s own planning for future objectives, such as target prices for entry or exit decisions, should such quantitative tools be considered “predictive” or personalized advice recommendations? Could a discount broker issue an investor warning or alert without it being considered some form of advice?

Trading tools such as those provided by Vector Vest (®) ( is widely promoted on TV, are not regulated by IIROC and can be readily accessed by retail investors for a subscription fee. The tool tells clients when to buy, what to buy and when to sell to maximize profits. Why not let discount brokers provide a similar service to Main Street, perhaps as part of a premium service package? Where subjective “advice” might be permitted, it should be offered as a distinct billable service so it is clear that it is a separate service not linked to a KYC.

If discount brokerages do not provide educational data and tools, investors may rely on inaccurate information from unreliable sources to make investment decisions. Of course, investors already can and do obtain free information and tools via reliable, albeit unregistered, sources such as BNN, the Globe and Mail, investment newsletters, established bloggers and other entities not regulated by IIROC or any other securities regulator.

The idea of order execution only is an idea that is obsolete, and regulators need to catch up. Historically, there was a very “bright line” for retail investors when they decided to go on a trading platform knowing it was “unadvised territory”. But that line is really fuzzy now. Going forward, regulators will have to assess whether they’ve drawn the right lines between the two basic categories of advice and so-called OEO channels.

Basic investment advice is being commoditized/made increasingly cost-effective and improved via digitalization, AI and the internet which also expands the reach of advice. Online models and tools will continue to proliferate outside of the regulated frame even if their development is hindered within it. Regulators would be well advised to plan for this eventuality. Why prevent or retard the spread of this evolutionary trend, why fight innovation and why retain regulatory structures that favour an imperfect product-based advice delivery structure? Development of low-cost simplified, but regulated, advisory options offer a viable option and a safe channel for DIY investors who enjoy managing their own money. This might require regulators to create a separate dealer category—“smart” online brokerage.

Although discount brokers have provided DIY investors a great platform to effect low-cost trading, they are not angels. For years, these brokers collected hundreds of millions of dollars in trailing commissions from mutual fund companies embedded in the price to provide personalized advice, knowing that they were not permitted to provide such advice. In 2022, regulators banned the payment of such commissions.

Some discount brokers now utilize a variety of digital engagement practices (DEPs), to connect with a broader array of retail investors, particularly younger investors who grew up with similar design features in other online apps and games on their devices. The concern investor advocates have is that some DEPs, using sophisticated algorithms, and game-like features, may blur the line between solicited and unsolicited transactions. A business model of online brokerages, which is paid for order flow, means that the platform is designed around incentivizing clients to trade, trade more frequently, trade in larger amounts, trade in riskier products and open margin accounts for leverage even when not appearing to recommend a specific security (“gamification”). When do behavioural nudges take on attributes similar enough to advice or recommendations such that regulatory intervention is needed?

The Ontario Securities Commission recently released a study that examined the influence of gamification and other behavioural techniques on retail investor behaviour. The study found that DIY investors make worse decisions when platforms “gamify” trading. “More broadly, we encourage regulators to consider whether any of the gamification and behavioural techniques examined have attributes similar to recommendations and/or result in investor behaviour that is [on average] detrimental to investor outcomes”.

In addition, investor advocates have raised the question: should discount brokers have any responsibility for ensuring the products offered are appropriate for their client base e.g. exotic Exchange-Traded Funds (ETFs)? Should a discount broker be held accountable for its product shelf and business practices? There are also examples where certain products are kept off the platform if they compete with products of a firm affiliated with the discount broker.

Regulators also need to examine the point at which service levels and interrupted access to accounts mutate to a material investor protection issue given the incidence of significant service interruptions experienced by discount brokerage clients and the increasing trend of client complaints. According to the Ombudsman for Banking Services and Investments 2021 Annual report, the overall leading investment issue in 2021 related to technical and non-technical service problems, representing 16% of investment cases, up from 14% in 2020.

Bottom Line

The reality is that the traditional investment industry is not particularly capable of delivering investment advice to smaller accounts. Discount brokers can help democratize investing and allow investors of modest means to participate in the market. As their needs and investable assets grow, they can consider the cost-benefit of paying for financial planning, tax optimization, estate planning and personalized investment advice.

By modernizing rules and approach to regulation, regulators can help reduce the risks associated with innovation and make it easier for discount brokers to deliver the low-cost, quality services and products that Canadians desperately need to satisfy their financial needs.

A key question needs to be asked: Is it in the public interest for a divide to open up in Canada whereby only regulated investment representatives can have access to the tools and models needed by investors to make informed investment decisions?  It’s time to have these conversations so these brokerages can optimize the benefits and challenges of the information age. The regulation of discount brokers is a socio-economic issue that, if resolved, would give many ordinary Main Street investors an opportunity to control their own financial destiny at an affordable price.

Ken Kivenko, Peng (retired), President , Kenmar Associates, Etobicoke, ON (416) 244-5803,,