We recently submitted another comment paper to the Canadian securities regulators regarding the ongoing consultation over the future of embedded compensation.
We remain steadfast in our advocacy of choice and transparency in the marketplace, and believe that a ban on embedded compensation would cause more harm than good.
I believe there are regulatory changes that would still achieve the regulators’ goal while avoiding throwing the industry into disarray.
In our latest submission to the Canadian Securities Administrators (CSA), we suggest that the regulatory concerns set out in the CSA’s paper can be addressed with the following:
- Prohibit the deferred sales charge (DSC): This purchase option was created with good intentions, but while the industry and commission structures have evolved, the DSC has not. The DSC can help maintain investment discipline, but it remains open to abuse – whether by using it with elderly clients or clients with shorter-term goals. It can also create a compensation conflict when assets at the end of the DSC schedule are re-characterized as front-end load assets that pay a higher trailing commission. These conflicts of interest are very difficult, if not impossible, to overcome simply through better disclosure. For these reasons, the CSA should prohibit the DSC.
- Set (rather than cap) trailing commissions at 1%: Setting commissions at 1% would remove the perception of conflict – the notion that an advisor may choose one fund over another due to higher compensation. This measure would be as effective as a ban, which would effectively set the commission at 0%.
We also challenge certain issues in the CSA’s consultation paper. For example:
- The CSA’s consultation paper suggests that advisors only focus on funds that pay a trailer, but I believe this presumption is mistaken. In fact, in today’s market, we know that fee-based accounts generate more revenue on a more consistent basis.
- We question the CSA’s assertion that investors do not know what they are paying for investment advice. The consultation paper was written and released before CRM II statements became mandatory. This suggests that the CSA lacks confidence in CRM II, which mandates full disclosure on costs and performance. Not only is this premature but since the publication of the consultation paper we have seen evidence that suggests CRM II has been quite successful on this point. I believe CRM II was (and will continue to be) a regulatory success and provides clients with good disclosure on the cost of their investments.
- The CSA’s assertion that investment fund managers rely on trailing commissions for sales, rather than performance, is demonstrably untrue.
- The regulators’ belief that fee-based investors with smaller accounts will pay less by negotiating lower fees is dubious speculation.
- The notion that embedded compensation raises unfair barriers to entry in the industry is virtually unsupportable, as demonstrated by the proliferation of ETF providers and robo-advice platforms. These new entrants have not found embedded compensation to be a “barrier”.
It’s also somewhat disappointing that regulators, in their consultation letter, suggested that smaller investors should limit themselves to passive strategies. While passive investment strategies certainly provide many benefits, we believe actively managed strategies also play a vital role for many investors in pursuing their long-term financial goals. I believe the endorsement of one approach over the other is unprecedented and, frankly, paternalistic.
In my opinion, banning embedded compensation would lead to the further consolidation of the financial services industry, with control of Canadians’ savings concentrated into the hands of fewer and fewer companies.
Destroying competition is certainly not in the best interest of investors.