Expect policy on embedded commissions to be published in early 2018.
So said John Mountain, the OSC’s director of investment funds and structured products, at Monday’s roundtable discussion on the proposal to ban embedded fees. Maureen Jensen, OSC chair, specified springtime.
Though the roundtable focused on three alternatives to banning embedded fees, Jensen made clear that, so far, no option has been chosen. But she also reiterated that the status quo isn’t an option.
“We are not here to debate whether the harms from embedded compensation warrant regulatory action, but to discuss what that action could be,” she said.
Regardless of that statement, some panellists clearly didn’t agree that the debate is over.
Here are highlights from the panel discussions.
Some panellists said DSCs ensure smaller investors get advice, and discontinuing those fees would result in an advice gap.
Sonny Goldstein, president of Goldstein Financial, described a client investing $250 per month in an RESP. You can’t serve that client outside the DSC model, he said, describing the advisory work involved, for which an advisor would be paid only a few dollars. “The alternatives are worse,” he said, referring to clients forced to use bank branches or scholarship funds because of the resulting advice gap.
He said DSCs pose no problems when used appropriately — for example, outside leveraged accounts or accounts with short time horizons. Further, he described the DSC as a deterrent to investors tempted to pull their investments in downturns.
When asked if the elimination of DSCs would result in an advice gap, Marian Passmore, COO and director of policy at the Canadian Foundation for Advancement of Investor Rights (FAIR), responded that an advice gap already exists.
“Canadians often do not get objective, professional advice in their best interest today,” she said, adding that advice should be high-quality and efficient, without being subject to financial incentives.
If DSCs were eliminated, she’s concerned investors would simply be put in mutual funds with similar charges, like those with front-end loads. On the plus side, investors wouldn’t face redemption fees if they wanted to leave a poorly performing fund, she said.
“Fees are per fund company,” countered Goldstein, saying investors can always switch funds within a fund company without incurring DSC fees. “In over 30 years, I have never yet had any single client pay a DSC fee, and yet 90% of my funds are sold that way.”
Investors want results, he said, adding that clients aren’t concerned about his fee. Further, advisors are obliged to give investors choice. “People should be allowed to choose how they want to pay.” That sentiment was widely expressed by panellists.
John Adams, CEO of PFSL Investments Canada, whose firm services mostly small accounts less than $100,000 (median account size is below $12,000) described the challenge to dealer business models like his if DSCs are discontinued.
“Economies of scale, account structure and significant investments in technology enable us to maintain a reasonable cost per account,” he said. If DSCs are discontinued, dealers and advisors who service such small accounts — and offer a broad shelf — might not raise the required initial revenue to compensate them for upfront work, he said. Further, the DSC model attracts new entrants to an aging industry.
If DSCs remain in place, suggested enhancements include suitability of time horizon and client age, as well as disclosure of redemption charges and procedures to oversee trading in DSC funds — items described in the MFDA’s 2015 DSC sweep report. Other suggestions put forth by panellists: consideration of asset thresholds, more fulsome disclosure and restrictions on sales to seniors.
To this list, Goldstein added POS information, a separate disclosure form for DSC funds and refraining from investing in TFSAs. “We do not do any [TFSAs] on a DSC basis, because we want that money to be available,” he said.
Capping or standardizing trailing commissions
Capping is defined as setting a maximum rate, while standardizing means prescribing a rate to which manufacturers must adhere.
Warren Collier, managing director and head of Canada iShares at BlackRock Asset Management Canada, said he’s seen no evidence that either option is better than a ban. He noted several associated problems, including that price-setting is outside regulators’ mandate. He also said a one-size-fits-all approach doesn’t recognize differences among investor needs nor between the business models of large, integrated firms and those of smaller independents.
Further, standardizing could potentially increase fees paid by some or all investors, and capping would likely do so, he said. That’s because research shows that, over time, fees rise to a cap. With standardizing, he said that unless all funds across all segments are standardized at the lowest fee level, some investors would face fee increases.
He also noted conflicts wouldn’t be removed, because advisors would still be incentivized to offer products with trailers over other products.
“Standardization is already in place,” said Nicole Lee, assistant general counsel at RBC, referring to the typical 1% trailing commission. She’s in favour of enhanced disclosure instead of a cap, to “bring standardization to a close.” Standardization further promotes competition among dealer service levels, she said.
Neil Gross, president of Component Strategies Consulting, offered an opposing view. “Neither standardization nor more disclosure will ever put dollars that investors pay for advice under investors’ control,” he said. “And that’s what we should be driving at.”
When asked if he ever recommends funds with no trailing fees to mass market clients, Scott Findlay, president and chair of Independent Financial Brokers of Canada, said his clients can choose between trailing commissions and fee-for-service, with about 80% of clients choosing trailers.
Collier said if advice is deemed important, it should be offered “in a transparent and upfront way,” not through the back door.
Lee, an advocate for choice, noted that direct pay poses logistical challenges that increase barriers for small investors, including managing their own tax deductions for advice costs — currently done through embedded commissions.
Addressing the advice gap, Gross said if an informed investor doesn’t want to write a cheque, “that problem speaks more to a failure to advance a convincing value proposition than anything else.” He noted the discussion assumes advice can be offered economically and efficiently only through trailers.
Caps aren’t the answer, he said, because they make no functional difference, as fees will remain similar to what they are now and won’t address conflicts. And caps that limit the maximum amount advisors receive overall might seem a better choice, but advisors would still be incentivized to switch funds as soon as a product reaches its maximum payout.
Enhancing disclosure and investor choice
If embedded compensation remains in place, one suggestion is to have dealers provide a minimum level of service for that compensation — through a service agreement, for example.
Independent from structural changes to the existing compensation model in the MFDA channel, Sandra Kegie, executive director at the Federation of Mutual Fund Dealers, said her organization opposes the idea. “Service agreements unnecessarily increase the regulatory burden, […] with the addition of prescriptive rules and oversight, additional supervisory controls and amended policies and procedures — all with little or no corresponding value.”
However, she would support such agreements if embedded compensation were banned, and said the agreements should include all services, mandatory and otherwise.
She also noted that, when it comes to paying for services, research shows mass market investors don’t tend to choose those services that are key to achieving long-term investing goals.
Dan Hallett, vice-president and principal at HighView Financial Group, supports service agreements regardless of compensation models, saying that reviewing services with clients, in plain language, “doesn’t seem like anything to be debated.”
Another option is offering clients a direct pay model alongside embedded compensation.
We have this today, said Kegie, who is supportive. But she doesn’t support dealers being required to change their business models. “Our research shows investors prefer choice in how they pay for their investments,” which increases feelings of control.
Hallett questioned the validity of appealing to choice, saying clients often depend on what their advisors choose.
If no alternative is deemed viable, banning embedded commissions remains an option, said Jensen.
A transcription of the roundtable will be posted, when available, on the OSC website.