CSA Staff Notice 81-323
Status Report on Consultation under CSA Discussion Paper and
Request for Comment 81-407 Mutual Fund Fees
December 17, 2013
Introduction
On December 13, 2012, the Canadian Securities Administrators (CSA or we) published for
comment CSA Discussion Paper and Request for Comment 81-407 Mutual Fund Fees (the
Discussion Paper). This notice provides a summary of the key comments received on the
Discussion Paper through the comment process and subsequent in-person consultations.
Background
The Discussion Paper identified a number of investor protection and fairness issues that may
arise from the mutual fund fee structure in Canada. The issues we identified related primarily to
the fees for advice, otherwise known as trailing commissions, that are embedded in the mutual
fund fee structure, and included:
•
investors’ limited understanding of fund costs and control of embedded advisor
compensation;
•
the potential conflicts of interests that embedded advisor compensation gives rise to at the
mutual fund manufacturer and advisor levels;
•
the potential for cross-subsidization by a mutual fund’s investors of the different advisor
compensation costs associated with different purchase options;
•
the alignment of advisor compensation and the services provided to investors in
exchange; and
•
the limited low-cost mutual fund options available to do-it-yourself investors.
The Discussion Paper solicited comments on a range of potential regulatory options to address
these issues, including:
•
defining the services that dealer firms and advisors must provide in exchange for trailing
commissions;
•
requiring the offering of a low-cost class of fund securities for do-it-yourself investors;
•
unbundling the trailing commission component of the management fee and charging it to
the fund as a separate asset-based fee;
•
requiring a separate class of fund securities for each purchase option;
•
capping commissions;
•
implementing a best interest duty for advisors; and
•
discontinuing the practice of advisor compensation being set by mutual fund
manufacturers and embedded in the fund product.
We also stated our intention to consult with investors and industry participants to help us
determine what, if any, regulatory responses might be appropriate. We received 99 comment
letters from a range of stakeholders, including investors, investor advocates, mutual fund dealers,
mutual fund manufacturers, industry advocates, academics, law firms and professional
associations.
1
Several CSA jurisdictions held consultations with stakeholders over the course of the Summer
and Fall of 2013 in order to probe deeper into themes emerging from the comment letters.
The Ontario Securities Commission (OSC) held a public roundtable on June 7, 2013, featuring
three panels with panellists representing investors, mutual fund manufacturers, mutual fund
dealers and other financial industry stakeholders. The panel topics included:
•
the role embedded advisor compensation plays in access to advice for small retail
investors in the Canadian market;
•
the nature and scope of the services received for trailing commissions; and
•
the impact of current disclosure initiatives and whether regulatory action beyond
disclosure is warranted at this time.
A transcript of the roundtable discussion is available on the OSC’s website.
2
The British Columbia Securities Commission (BCSC) held consultations with BC-based mutual
fund dealers and mutual fund manufacturers on June 24 and 25, 2013. The Autorité des marchés
financiers (AMF) held a consultation with retail investors on September 4, 2013, a consultation
with both the Canadian Foundation for Advancement of Investor Rights (FAIR) and the
Mouvement d’éducation et de défense des actionnaires (MÉDAC) on September 5, 2013,
followed by consultations with mutual fund dealers, mutual fund manufacturers and other
industry stakeholders on September 17 and October 3, 2013.
We thank all those who contributed to this consultation process by responding to our request for
comments or by participating in the OSC, BCSC and AMF consultations. We are using the
information we gathered through this process to inform our approach on this initiative going
forward.
Themes from the Consultation
We have identified a number of key themes emerging from the comment process on the
Discussion Paper and the subsequent consultations. The themes are largely split between
industry stakeholder viewpoints and investor stakeholder viewpoints.
The key themes from industry stakeholders are:
1
The list of commenters and copies of the comment letters are available online at:
http://www.osc.gov.on.ca/en/38419.htm.
2
Canadian Securities Administrators Roundtable Discussion re: Discussion Paper and Request for Comment 81-
407 Mutual Fund Fees, June 7, 2013 available at: http://www.osc.gov.on.ca/en/SecuritiesLaw_rpt_20130607_81-
407_mutual-fund-fees-roundtable.htm.
- 2 -
•
There is no evidence of investor harm that warrants a change to the mutual fund fee
structure in Canada;
•
A ban on embedded compensation will have unintended consequences for retail investors
and the fund industry, including:
o
a reduction in access to advice for small retail investors,
o
the elimination of choice in how investors may pay for financial advice, and
o
the creation of an unlevel playing field among competing products and
opportunities for regulatory arbitrage; and
•
We should observe and assess the impact of domestic and international reforms before
moving ahead with further proposals.
The key themes from investor stakeholders are:
•
Embedded advisor compensation causes a misalignment of interests which impacts
investor outcomes and should be banned;
•
Investors should at a minimum have the true choice to not pay embedded commissions;
•
We need to implement a best interest duty for advisors; and
•
We need to increase advisor proficiency requirements and regulate the use of titles.
Below, we discuss each of these key themes in detail. The themes underscore that the issues
surrounding mutual fund fees are complex and that some of the issues are interrelated with those
identified in the separate CSA consultation on the appropriateness of introducing a best interest
duty for advisors initiated on October 25, 2012 (Best Interest Duty Consultation).
3
a.
Key themes from industry stakeholders:
1.
There is no evidence of investor harm that warrants a change to the mutual fund fee
structure in Canada
The vast majority of industry stakeholders express the view that there are no substantive
regulatory problems in the industry that warrant the potential reforms discussed in the Discussion
Paper. Only a marginal number of industry stakeholders believe the current mutual fund fee
structure raises sufficient investor protection concerns to require regulatory action at this time.
Some industry stakeholders submit that the trend away from transaction-based sales
commissions towards a greater reliance on embedded trailing commissions has supported the
development of aligned advisory relationships between dealer firms/advisors and investors.
Previously, advisors may have had an incentive to recommend that their clients switch funds in
order to receive a sales commission. With trailing commissions, the advisor’s interest are better
aligned with the investor’s objectives since the advisor’s compensation is ongoing over the life
of the investment and will increase as the value of the investor’s portfolio goes up and decline if
it decreases.
3
See CSA Consultation Paper 33-403 The Standard of Conduct for Advisers and Dealers: Exploring the
Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients (October
25, 2012). See also the transcripts of the related investor roundtable, industry roundtable and panel discussion held
June 18, June 25 and July 23, 2013, respectively, available at: http://www.osc.gov.on.ca/en/37838.htm.
- 3 -
In response to claims that mutual fund fees in Canada are among the highest in the world
4
, some
industry stakeholders point to a recent research report comparing mutual fund ownership costs in
Canada and in the United States which finds that, for investors helped by a financial advisor, the
overall cost of management and distribution of mutual funds in Canada is similar to the overall
cost in the United States.
5
Some industry stakeholders submit that there is an absence of directly related research and
empirical evidence that the conflicts of interest examined in the Discussion Paper exist at all or,
to the extent they do exist, impact investor outcomes to a degree that warrants a complete
overhaul of the mutual fund fee structure in Canada.
While some industry stakeholders acknowledge that trailing commissions have the potential to
incent advisors to sell a particular mutual fund over another comparable mutual fund with lower
commission, they submit that the incidence of such a conflict is minimal in the Canadian market
since trailing commissions are largely comparable across types of mutual funds as a result of an
open and competitive market. They believe that any variance from the current industry standard
trailing commission of 1%
6
is small and unlikely to provide an incentive to offer one fund over
another similar fund. In their view, this lack of disparity amongst trailing commissions suggests
that competitive market forces are working well and that regulation is therefore not required.
This view is however challenged by some mutual fund manufacturers who submit that the
standard trailing commission of 1% has been established by an oligopoly of large dealer firms
who command this fee to provide placement on their product shelf.
Certain industry stakeholders point out that the recent prohibition of conflicted advisor
remuneration for the distribution of and advice on retail investment products in the United
Kingdom (U.K.)
7
and Australia
8
are responses to unique consumer protection gaps and situations
in those jurisdictions, including a series of financial mis-selling scandals causing harm to
investors, which are not present in Canada. They say it would be wrong for the CSA to follow
suit with similar reforms as there has been no evidence of client harm arising from advisor
compensation on mutual fund sales in Canada that would justify similar regulation here.
Some industry stakeholders say that less extensive regulatory changes could be made to help
improve the Canadian retail investor experience. They suggest interim steps such as more
vigorous enforcement of existing regulation (e.g. suitability requirements for advisors), enhanced
4
These claims are based on studies examining fund fees in Canada and around the world, including: D. Phillips,
Why the trend in Canadian fund fees can only be down, Morningstar Canada (August 13, 2013); B. N. Alpert, J.
Rekenthaler and S. Suh, Morningstar Global Fund Investor Experience 2013 (May 2013); B. N. Alpert, J.
Rekenthaler, Morningstar Global Fund Investor Experience 2011 (March 2011); J. Rekenthaler, M. Swartzentruber,
C. Tsai, Morningstar Global Fund Investor Experience 2009 (May 2009); A. Khorana, H. Servaes, P. Tufano,
Mutual Fund Fees Around the World (July 23, 2007); and K. Ruckman, “Expense ratios of North American mutual
funds”, Canadian Journal of Economics (March 2003), p. 192-223.
5
Investor Economics and Strategic Insight, Monitoring Trends in Mutual Fund Cost of Ownership and Expense
Ratios, A Canada-U.S. Perspective, November 2012.
6
Typical trailing commission for an equity fund sold on a front-end load basis.
7
U.K. Financial Conduct Authority, Retail Distribution Review - Adviser Charging, rules in effect as of January 1,
2013.
8
Australian Securities and Investments Commission, Future of Financial Advice, reforms in effect as of July 1,
2012, with compulsory compliance required from July 1, 2013.
- 4 -
proficiency requirements for advisors and the regulation of advisor professional titles to ensure
that investors aren’t misled by deceptive titles. They also call upon the CSA to undertake
investor education initiatives in an effort to improve financial literacy and help investors become
more savvy consumers of financial products and advice.
2.
A ban on embedded compensation will have unintended consequences for retail investors
and the fund industry
Overwhelmingly, industry stakeholders think eliminating embedded advisor compensation
would be detrimental to all participants in the fund industry, including and especially retail
investors. They urge the CSA, before doing anything, to conduct a robust cost-benefit analysis
to determine the impact that removing embedded commissions would have for investors and the
fund industry.
Many industry stakeholders believe a ban on embedded commissions would have a number of
unintended consequences, including (i) a reduction in access to advice for small retail investors,
(ii) the elimination of choice in how investors may pay for financial advice, and (iii) the creation
of an unlevel playing field among competing products and opportunities for regulatory arbitrage.
We discuss each of these potential consequences below.
(i)
A reduction in access to advice for small retail investors
Several industry stakeholders submit that embedded advisor compensation provides Canadians
with affordable access to advisory services. Many of them point out that these advisory services
include not only the advisor’s advice
9
, but also important dealer firm services
10
and advisor
operating costs
11
, all of which are funded from the trailing commission. We are told that the
embedded nature of these costs enables advisors to provide up-front counselling to clients with
small amounts to invest where a fixed fee or transaction-based commission model might
otherwise deter clients from seeking advice.
These industry stakeholders submit that this affordability of financial advice has allowed for the
significant use of advice by Canadian households, which certain industry studies find has
9
We are told that the portion of the trailing commission that the advisor receives compensates the advisor for the
provision of various advice services, including but not limited to: suitability reviews, reviews on transfers, reviews
of material changes in client circumstances, responses to client questions, general financial advice that can be
unrelated to mutual funds, the rebalancing of portfolios, advice on registered products, the setting up of savings
programs and the encouragement of good investment discipline.
10
We are told that the portion of the trailing commission that the dealer firm receives helps fund the daily operation
of the dealer firm’s business. This includes satisfying client reporting obligations, general compliance obligations,
supervision requirements, regulatory fees, operational costs and product due diligence.
11
We are told that the portion of the trailing commission that the advisor receives does not operate solely as income
for the advisor, but rather may also be used to cover the cost of administrative staff for which they are responsible,
rental payments, marketing, travel, other costs of doing business, regulatory fees, and work associated with
satisfying compliance obligations.
- 5 -
resulted in the creation of a strong savings culture and investment discipline and the
accumulation of more wealth for retail investors in Canada.
12
Several industry stakeholders submit that smaller investors (sometimes referred to as “mass
retail”) benefit financially from the current embedded commission structure due to economies of
scale. Under such a fee structure, the cost of providing advice and services to smaller investors
is subsidized by the larger investors in the fund who pay more on account of their larger assets
under management. We are told that the mandated use of a fee-for-service model would
eliminate this pooling of fees from both larger and smaller investors and cause the price of
servicing smaller accounts to increase. Faced with having to raise the price to service smaller
investment accounts, many advisors would either cease to service those accounts or raise prices
beyond which those investors would be willing to pay.
A number of industry stakeholders further submit that a mandated move to a fee-for-service
model may impact the financial viability of certain advisors, especially independent financial
advisors (as trailing commissions constitute the bulk of their revenues), and cause many to leave
the business as a result. Such a change may also deter individuals from becoming advisors and
consequently add to the industry’s challenge in recruiting new advisors. We are told that this
potential for a reduction in the number of advisors under a fee-for-service model, combined with
the potential for higher costs for small retail investors, would cause those individuals to not be
served and create an “advice gap”.
Industry stakeholders further submit that small retail investors would lack the bargaining power
to negotiate advisory fees in a fee-for-service model due to their generally low levels of financial
literacy and the relatively small accounts they own. They would be at an information
disadvantage as they would have no frame of reference as to what is reasonable. Consequently,
small investors would be left with the choice of either incurring the potentially higher advice
costs (including higher investment thresholds) imposed on them or, to the extent they are unable
or unwilling to pay the costs, losing access to advisory services.
In support of their submissions, these industry stakeholders point to research suggesting that a
fee-for-service model would result in higher advice costs and potentially higher overall
ownership costs for small retail investors (i.e. those with less than $100K to invest) relative to
the current embedded compensation model. Looking to U.S. data on mutual fund-centric fee-
based advisory programs
13
, some industry stakeholders suggest that advice costs for smaller
investors would be in the range of 1.5% of assets under management.
14
This would exceed what
the fund industry submits is the current industry standard trailing commission of 1% embedded
in the cost of the mutual fund product.
12
See The Investment Funds Institute of Canada (IFIC), The Value of Advice Report 2012. See also C.
Montmarquette, N. Viennot-Briot, Econometric Models on the Value of Advice of a Financial Advisor, The Centre
for Interuniversity Research and Analysis on Organizations (CIRANO), Montreal, July 2012.
13
Strategic Insight, A Perspective on the Evolution in Structure, Investor Demand, Distribution, Pricing, and
Shareholders’ Total Costs in the U.S. Mutual Fund Industry (November 2012), p. 35.
14
According to analysis from Strategic Insight on advisory fees charged by client asset size under U.S. fee-based
programs (2011), 70% of U.S. investors with account sizes of $100,000 are charged advisory fees higher than 1.25%
and 31% are charged over 1.50%. Ibid, p. 34.
- 6 -
Some industry stakeholders cite research in the U.K. which finds that investors generally have a
low willingness to pay a separate fee for financial advice and that most would not opt to use
advice if they had to pay for it separately.
15
They further cite related research in Australia finding
that there is a significant gap between what investors are willing to pay for advice versus what it
costs to provide it.
16
Other industry stakeholders also point to early surveys on the impact of the
ban on conflicted advisor remuneration in the U.K. as an indication that many advisors in
Canada would either abandon small retail investors to focus on a higher wealth segment or leave
the business altogether, and access to advice would be reduced as a consequence.
17
One industry
stakeholder however points out that while there appears to have been an initial drop in the
number of advisors in the U.K., this is in part due to a new proficiency standard introduced as
part of the U.K.’s reforms and which some advisors failed to initially meet.
18
(ii)
The elimination of choice in how investors may pay for financial advice
Several industry stakeholders say that Canadian retail investors should have the option to choose
among various fee structures and select the one they prefer. In their view, regulation should
provide flexibility and facilitate the broadest access to financial advice for individuals.
Accordingly, industry stakeholders are of the view that investors should have the freedom to
choose whether they want the convenience of paying for advice embedded in the cost of a mutual
fund or paying it separately to their advisor. They point out that Canadian retail investors
currently have this flexibility by way of being able to select either Series A fund units (that pay
an embedded trailing commission) or Series F fund units (that do not pay an embedded trailing
commission but instead provide for a negotiated fee-for-service to be paid directly by the
investor to the advisor). They submit that prohibiting embedded advisor compensation would
eliminate this flexibility and choice for investors, to their detriment.
Many industry stakeholders submit that some investors specifically want to pay for advice
through an embedded trailing commission as a matter of convenience and a matter of
preference.
19
They go on to suggest that the current limited use of fee-for-service accounts by
retail investors is evidence that investors are generally not interested in the fee-for-service model.
15
A. Clare, The Guidance Gap - An investigation of the UK’s post RDR savings and investment landscape, Cass
Business School, January 2013.
16
Australian Securities and Investments Commission, Access to financial advice in Australia, Report 224,
December 2010.
17
Deloitte LLP, Bridging the Advice Gap: Delivering investment products in a post-RDR world. November 2012.
18
On August 15, 2013, the U.K. Financial Conduct Authority (FCA) released figures showing that financial advisor
numbers in that country, which initially dropped with the coming into force of the Retail Distribution Review
reforms which banned third party commissions and increased proficiency requirements, are now rebounding as more
advisors meet the higher level of qualification. The FCA’s research shows that there were 32,690 retail investment
advisors working in the UK in July 2013, up from 31,132 in December 2012, the last time the numbers were
officially counted. Six months after the introduction of the new rules, the FCA reports that 97% of advisors have the
appropriate level of qualification, and the other 3% are recent entrants to the industry who are still studying for full
qualification within the time periods permitted by the rules. See the FCA’s press release at:
http://www.fca.org.uk/news/adviser-numbers-in-line-with-expectations.
19
In support of this submission, on September 30, 2013, the Investment Funds Institute of Canada published the
results of a survey finding that half of mutual fund investors (51%) prefer their advisor be compensated through an
embedded fee. See POLLARA Inc., Canadian Investors’ Perceptions of Mutual Funds and the Mutual Fund
Industry 2013, Report Prepared for the Investment Funds Institute of Canada.
- 7 -
(iii)
The creation of an unlevel playing field among competing products and opportunities
for regulatory arbitrage
Industry stakeholders generally submit that mutual funds should not be unfairly targeted for
having embedded commissions since advisor compensation is typically embedded in the prices
(whether directly or through a spread) of other financial products, not just mutual funds.
Some industry stakeholders point out that embedded compensation is the standard in
approximately three quarters of the total assets of all Canadian households, including deposits,
fixed income, segregated funds, and insurance.
20
They say that to require mutual funds to move
away from this widely accepted broader financial industry practice would create an unlevel
playing field between mutual funds and competing financial products. Specifically, advisors
who are dually licensed, and who already face greater regulation and compliance burdens in
connection with the distribution of mutual funds
21
, may have an incentive to instead sell banking
and insurance investment products that some think are less regulated, less transparent, and
possibly more expensive. Some industry stakeholders note that such opportunities for regulatory
arbitrage have not arisen in the U.K. and Australia because their reforms
22
have been uniformly
applied across competing products – securities, banking and insurance investment products.
Many industry stakeholders therefore urge the CSA to focus on initiatives that can be applied to
the entire universe of financial products rather than solely target the mutual fund industry.
3.
We should observe and assess the impact of domestic and international reforms before
moving ahead with further proposals
Most industry stakeholders are of the view that if the main concern with embedded advisor
compensation is that investors aren’t aware of it and therefore don’t understand it, then the
solution should be to pursue initiatives that improve their understanding of such fees rather than
focus immediately on prohibition. Accordingly, they think that the CSA should first assess the
benefits resulting from the recent implementation of point of sale (POS) delivery of the new
Fund Facts disclosure document
23
and the Client Relationship Model (CRM2) reforms to cost
disclosure and performance reporting
24
, and determine whether these disclosure changes
improve investor understanding and decision-making before proceeding with additional
regulatory reform.
20
Investor Economics, Household Balance Sheet 2012.
21
The industry points to the Client Relationship Model reforms (Phases 1 & 2) under National Instrument 31-103
Registration Requirements, Exemptions and Ongoing Registrant Obligations, and the new Fund Facts document
delivery requirements under National Instrument 81-101 Mutual Fund Prospectus Disclosure.
22
Supra notes 7 and 8.
23
See the amendments to National Instrument 81-101 Mutual Fund Prospectus Disclosure made September 1, 2013
which, as of June 13, 2014, will require delivery of the Fund Facts document instead of the simplified prospectus in
satisfaction of the prospectus delivery requirements under securities legislation.
24
See the amendments to National Instrument 31-103 Registration Requirements, Exemptions and Ongoing
Registrant Obligations made July 15, 2013 which, as of July 15, 2016, will require registered firms to annually
disclose to their clients the dollar amount of trailing commissions and other compensation they received in
connection with securities owned by the client.
- 8 -
The POS and CRM2 disclosure initiatives are expected to benefit investors by improving their
overall awareness and understanding of mutual fund fees and ongoing advisor compensation
costs, thus enabling them to make better and more informed investment decisions. Those
initiatives will also give advisors an opportunity to have conversations with their clients and to
show how they add value. Many industry stakeholders say that the enhanced transparency that
these reforms will provide should sufficiently address the potential conflicts of interest that
embedded advisor compensation raises as well as improve the alignment between advisor
compensation and the services provided.
These industry participants point out that they are investing significant resources to implement
the POS and CRM2 reforms. They believe that once these are fully implemented, we will have
set a world-class standard in Canada for disclosure and transparency of fund costs.
We are further urged to take the time to carefully monitor relevant international reforms, such as
the recent ban on conflicted advisor remuneration in the U.K. and Australia
25
, and assess
whether those reforms caused unintended consequences for investors, in particular small retail
investors, and industry participants in those jurisdictions before pursuing similar reforms here.
b.
Key themes from investor stakeholders:
1.
Embedded advisor compensation causes a misalignment of interests which impacts
investor outcomes and should be banned
Investor stakeholders generally think that embedded advisor compensation causes advisors to
make investment recommendations that pay them higher compensation, resulting in higher costs
and less optimal investment results for the investor. Most consider that this conflict of interest
cannot be overcome through disclosure initiatives such as POS and CRM2 and consequently see
no reason for the regulators to monitor and assess the effects of these or other reforms
internationally before moving forward with a proposal to ban embedded compensation.
Most investor stakeholders therefore think that banning embedded compensation is necessary to
reduce the misalignment of incentives currently affecting the client-advisor relationship and help
assure investment recommendations that are in the best interest of the client. They say this ban
would benefit investors by giving them greater awareness of and more control over the costs they
pay for mutual funds and financial advice.
26
Investors will know that they pay for “advice” and
will be able to compare the costs and services of different advisors as well as the operating costs
of various mutual funds which will be made more transparent with the elimination of embedded
compensation. This would lead to a more competitive market for both mutual funds and for
financial advice, leading in turn to lower costs and improved returns for Canadian investors, thus
enabling them to accumulate more savings for their retirement or other financial goals.
In response to industry participants’ submissions that a ban on embedded compensation will
reduce access to advice for small retail investors, investor stakeholders believe that if such an
25
Supra note 22.
26
The AMF’s consultation with retail investors revealed that most investors consulted were neither aware of the
embedded commissions nor did they understand the fee structure of mutual funds.
- 9 -
advice gap does indeed emerge, alternative fee structures or business models will develop, both
within the existing institutions and through new entrants to the market, that will deliver advice
tailored to small investors. Banning embedded commissions will lead to innovation and increase
competition which will ultimately drive down costs for investors and improve their investment
outcomes.
Certain investor stakeholders challenge the industry’s “advice gap” argument by pointing out
that a significant portion of small retail investors are currently serviced by the bank branch
advice channel whose advisors are not commission-based. They therefore do not believe that
eliminating embedded commissions would reduce access to financial advice for those investors.
Those investor stakeholders further question the industry’s assertions that overall mutual fund
ownership costs would increase if embedded commissions were banned. While not disputing the
assertion that the cost of advice could be higher for small retail investors under a fee-for-service
model, the absence of product embedded inducements under that model would allow the advisor
to focus on the investor’s best interests and shop the market for lower-cost products, resulting in
overall cost savings and better financial outcomes for the investor over the long-term.
2.
Investors should at a minimum have the true choice to not pay embedded commissions
Some investor stakeholders submit that, in the absence of an immediate ban on embedded
commissions, retail investors should at least have the true choice to not pay embedded
commissions.
These investor stakeholders dispute the industry’s contention that retail investors currently have
choice and that the prevalence of the embedded commission fee model in the Canadian fund
industry is evidence that investors actually prefer that model. They submit that investors can
only make a true choice if they know what the alternatives are and are provided with those
options prior to actually making their decision. They point out that the majority of advisors
today operate on a commission-only basis and therefore do not give their clients the option of
investing in trailing commission-free Series F mutual fund units intended for fee-based
accounts.
27
Furthermore, even where the option of investing in Series F units is available, many
investors don’t have the minimum investable assets necessary to access fee-based accounts. The
overall result is that the majority of retail investors today have no choice but to invest in the full
trailing commission fund units.
Several investor stakeholders further point out that even those investors who opt to go it alone
and forgo the advice still must pay for advice. This is because investors who purchase mutual
fund securities through discount brokerages are generally made to purchase the same full trailing
commission fund units that are sold through full-service advisors.
28
While discount brokerages
27
The AMF’s consultation with retail investors revealed that most of the investors consulted were not aware of the
existence of Series F units.
28
The CSA note that following the comment process on the Discussion Paper and the subsequent consultations held
by the OSC, BCSC and AMF, certain fund industry participants have taken steps to address this issue. Up until
recently, only a few Canadian mutual fund manufacturers, all of which are bank-owned, have offered discounted
series units of certain of their proprietary mutual funds through their affiliated bank-owned discount brokerage arm.
These discounted series units intended for do-it-yourself (DIY) investors bear a significantly reduced trailing
- 10 -
receive full trailing commissions for the distribution of mutual funds on their platforms, they do
not provide advice to investors who trade on their platform. Under the current rules, discount
brokers are not permitted to offer advice and are exempt from the suitability assessment which
full-service advisors are otherwise responsible for completing. In view of that, investor
stakeholders submit that mutual fund investors in the discount brokerage channel are overpaying
for their mutual fund investments and do not realize any savings over the investor who uses a
full-service advisor. They further argue that if true savings could be realized in the discount
brokerage channel, it might then become a true market choice that mutual fund investors would
opt for. This lower-cost choice would improve retail investors’ ability to accumulate savings for
retirement or other financial goal.
These investor stakeholders therefore recommend that the payment of trailing commissions to
discount brokers who provide execution-only services be prohibited. They further urge
regulators to require that trailing commission-free mutual fund series be made available to retail
investors, including at discount brokerages and directly from mutual fund manufacturers, to
ensure that investors have the true option of not paying embedded commissions and that those
investors who opt to do it themselves realize true cost savings.
3.
We need to implement a best interest duty for advisors
Investor stakeholders strongly believe that advisors should be required to act in their client’s best
interest and that a statutory best interest duty must be introduced in order to protect investors.
They point out that a best interest duty would be consistent with investors’ general expectations,
as shown by recent investor research that found that most investors believe advisors already have
a legal duty to act in their best interest.
29
In their view, a best interest duty which addresses issues relating to conflicted remuneration,
including embedded commissions, will reduce bias in advisors’ investment recommendations,
thus making recommendations more objective. It would at the same time eliminate much of the
need for conflicts disclosure, which investor advocates submit is ineffective. In this regard, they
cite certain studies whose findings suggest that most Canadian investors do not have the requisite
knowledge and experience to factor disclosed conflicts of interest into their decision-making.
30
They further cite behavioural research showing the perverse effects of disclosure, such as
increased trust and reliance by investors and moral licensing of advisors.
31
Given these findings,
investor stakeholders submit that a “disclose and move on” approach is not acceptable.
Investor stakeholders generally consider that a best interest duty for advisors would improve
outcomes for investors because it would explicitly require advisors to consider the investment’s
commission which recognizes the fact that DIY investors do not receive advice services. On November 27, 2013,
three independent mutual fund manufacturers announced the offering of discounted series units of their mutual funds
to be distributed through a major bank-owned discount brokerage.
29
The Brondesbury Group, Investor behaviour and beliefs: Advisor relationships and investor-decision making
study, (2012), prepared for the Investor Education Fund.
30
Ibid. See also Innovative Research Group Inc., 2012 CSA Investor Index (October 16, 2012).
31
Daylian M. Cain, George Loewenstein, and Don A. Moore, “The Dirt on Coming Clean: Perverse Effects of
Disclosing Conflicts of Interest” (2005) The Journal of Legal Studies, 34 (1), p. 1-25.
- 11 -
costs in determining whether the investment is in the best interest of the investor, whereas the
current suitability standard fails to require this.
Many investor stakeholders however submit that the current embedded advisor compensation
model, with its inherent incentives, is incompatible with a best interest duty. They believe that
absent the elimination of embedded commissions, the profit objectives of advisors and of the
mutual fund manufacturers whose funds they distribute would continue to prevail over the best
interests of investors. These investor stakeholders therefore think that a best interest duty alone
is not sufficient and should include the concurrent elimination of embedded commissions.
4.
We need to increase advisor proficiency requirements and regulate the use of titles
Some investor stakeholders submit that the investor protection concerns that embedded advisor
compensation raise are compounded by other potential areas of concern with the advisor-client
relationship, including confusing advisor titles and low advisor proficiency.
These investor stakeholders accordingly submit that financial advisors should be required to
meet higher proficiency requirements and satisfy continuing education requirements, as well as
adhere to a code of professional and ethical conduct that ensures the client’s interest is put first.
They further urge the CSA to standardize the professional titles and designations that advisors
may use so as to ensure they more accurately reflect the scope of an advisor’s services and do not
denote expertise that the advisor may not have.
Some suggest that the use of the title “Financial Advisor” by a product salesperson, who is
trained solely to deliver trade suitability rather than financial planning and/or ongoing investment
management advice, has resulted in confusion and a distinct disconnect between the level of
service many investors expect from their financial advisor and the actual service provided.
These investor stakeholders therefore submit that title and holding out restrictions should be put
in place to allow the public to clearly distinguish between those who offer advice limited to trade
suitability and those who provide more extensive advice and services, such as financial planning
and/or ongoing investment management advice.
Conclusion
A number of the key messages from industry and investor stakeholders set out above are similar
to those that have emerged from the Best Interest Duty Consultation. We refer you to CSA Staff
Notice 33-316 – Status Report on Consultation under CSA Consultation Paper 33-403: The
Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a
Statutory Best Interest Duty When Advice is Provided to Retail Clients, published concurrently
with this Notice, for an overview of the key themes that emerged from that separate consultation.
The similarity of the feedback received from stakeholders demonstrates a connection between
the two consultation initiatives and suggests a need for CSA staff to coordinate their policy
considerations on these initiatives going forward.
- 12 -
Accordingly, in collaboration with the Best Interest Duty Consultation initiative, CSA staff
continue to consider and discuss the information gathered through our consultative process with
a view to determining next steps. We anticipate communicating in the coming months what, if
any, regulatory actions we intend to pursue, including setting out research initiatives we intend to
undertake to support such actions.
Questions
Please refer your questions to any of the following:
Bob Bouchard
Director and Chief Administrative Officer
Manitoba Securities Commission
Phone: 204-945-2555
E-mail: Bob.Bouchard@gov.mb.ca
Sarah Corrigall-Brown
Senior Legal Counsel, Legal Services Branch
Capital Markets Regulation Division
British Columbia Securities Commission
Tel: 604-899-6738
Email: Scorrigall-brown@bcsc.bc.ca
Rhonda Goldberg
Director, Investment Funds Branch
Ontario Securities Commission
Phone: 416-583-3682
E-mail: rgoldberg@osc.gov.on.ca
George Hungerford
Senior Legal Counsel, Legal Services Branch
Corporate Finance Division
British Columbia Securities Commission
Phone: 604-899-6690
E-mail: ghungerford@bcsc.bc.ca
Ian Kerr
Senior Legal Counsel, Corporate Finance
Alberta Securities Commission
Phone: 403-297-4225
E-mail: Ian.Kerr@asc.ca
- 13 -
Heather Kuchuran
Senior Securities Analyst
Financial and Consumer Affairs Authority of Saskatchewan
Phone: 306-787-1009
E-mail: heather.kuchuran@gov.sk.ca
Stéphane Langlois
Senior Director, Distribution Policies and Compensation
Autorité des marchés financiers
Phone: 418-525-0337, ext. 4811
E-mail: stephane.langlois@lautorite.qc.ca
Chantal Leclerc
Senior Policy Advisor, Investment Funds Branch
Autorité des marchés financiers
Phone: 514-395-0337 ext. 4463
E-mail: chantal.leclerc@lautorite.qc.ca
Chantal Mainville
Senior Legal Counsel, Project Lead
Investment Funds Branch
Ontario Securities Commission
Phone: 416-593-8168
E-mail: cmainville@osc.gov.on.ca
Mathieu Simard
Director, Investment Funds Branch
Autorité des marchés financiers
Phone: 514-397-0337, ext. 4471
E-mail: Mathieu.simard@lautorite.qc.ca
- 14 -
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.