He takes issue with three words in the proposal’s title: “discontinuing embedded commissions.”
Why not ask for comment on whether fund managers are allowed to pay dealers too much, he asks — a less incendiary suggestion than a potential ban and one that perhaps better reflects the issue. Instead, “Choice of phrase has created a politicized environment that now threatens the existence of the mutual fund industry in Canada and the global stature and viability of Canadian exchanges and debt markets,” he says.
Further, by using the phrase “embedded commissions,” regulators conflate sales commissions and the trailing commissions paid to dealers, rolling both into an evocative phrase to elicit support for the proposal, he says.
The regulators state in the proposal that they’ve gathered evidence showing “embedded commissions encourage the sub-optimal behavior of fund market participants, including that of investment fund managers, dealers, representatives and fund investors.”
Indeed, Appendix A is chock full of research, including that from York University showing that flows increase to funds with embedded commissions regardless of past performance.
But Goldberg doesn’t find the research convincing, saying the proposal fails to provide monetary analysis of systemic harm and abuse to investors, as well as data from resulting enforcement actions.
“The underlying conflict-of-interest issue was publicly identified during the 1980s,” he says. “Certainly, during the intervening three decades, the industry should have produced ample fact sets and records of enforcement that could have been referenced in [the proposal].”
Instead, the proposal suggests Canadian investors are unwitting victims, he says, which he calls a mischaracterization.
As for asset managers gaining systemic advantage, as the research on fund flows suggests, the proposal doesn’t present a single fund that has outperformed its peers in the accumulation of assets due to a conflict, says Goldberg.
Further excluded by the regulators, he says, is a reference to KYC. “If one starts with the primacy of KYC under Canadian regulation and the expected long-term amortization of a fund’s purchase cost at Point of Sale (POS), it becomes exceedingly difficult to construct a scenario of systemic investor harm,” he says.
Not acknowledging the POS initiative is also “a glaring omission,” he adds, noting that other industries have embedded fees that investors and consumers would not likewise be made aware of. For example, he asks, are investors and consumers aware of manufacturers’ sales agreements for retail goods or telecom services? He suggests the industry already goes above and beyond.
The complexity of fee-for-service
Goldberg sees the proposal as advocating a fee-for-service model, the problems with which he details at length in his letter.
For example, fee-for-service at the dealer level would comprise not only product prices but myriad other costs, including those for services, compliance, back-office practices and more. That’s because trailing commissions paid to dealers encompass more than the costs of investment selection, says Goldberg.
“None of these unique pricings [for each dealer] can ever be directly compared by the investor or regulator at reasonable cost,” he says.
Goldberg also chastises regulators for ignoring the time, cost and additional systems and processes required for firms to change business practices.
Investors pay more
In the end, the proposal doesn’t demonstrate that investors can reasonably expect an increase in their net investment performance as a result of the ban, says Goldberg.
In fact, he expects investors will incur more costs as they “see more and higher charges from dealers and higher total costs toward maintaining their managed investments, without observing measurably superior investment results from these assets.”
For instance, dealers will start directly charging investors who own managed funds, and fund managers won’t necessarily eliminate the former amount of trailing commissions from their MERs when faced with reorganizing sales and marketing, as well as with other increased costs.
The proposal could also prevent portfolio reviews, says Goldberg, explaining that sales commissions motivate advisors to recommend clients regularly consider culling the worst performers. With fee-for-service, investors will have to pay for reviews, the costs of which cannot be defined “because it is inherently unknown as to how many services will be provided within the review, until after the review is completed,” says Goldberg.
And don’t assume advisors aren’t incentivized in a fee-for-service model. For example, Goldberg asks, at what point is an advisor unduly incentivized by fees for suggesting yet another investment or service?
His message to regulators: “Canadian investors deserve a report, in dollar terms, of both the benefits they can expect to receive and the costs they will bear from the proposal.”
Advisor.ca has summarized other comment letters: