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Status quo on embedded commissions not an option, OSC chair says

OSC chair and CEO Maureen Jensen says the committee’s core issue with embedded commissions ‘is with conflicts of interest,’ but various industry professionals continue to debate possible alternatives.

Fred Lum/The Globe and Mail

The debate on whether regulators should ban the use of embedded commissions continues to rattle the investment community and the chair of the Ontario Securities Commission says the status quo is not an option.

During a roundtable discussion held in Toronto on Monday afternoon, Maureen Jensen, chair and chief executive of the OSC, was quick to address the audience that no decision has been made by the Canadian Securities Administrators on pursuing an outright ban on embedded commission. But as part of the process, regulators needed to explore a variety of alternatives that may, individually or in combination, address the CSA's concerns and lessen the risk of potential negative consequences a ban could bring.

"As regulators, we are very concerned about the conflicts that arise from embedded compensation," Ms. Jensen said during her opening remarks.

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"At the same time, we have heard compelling comments about unintended consequences, including that an outright ban could result in no access to advice for small investors and reduced competition in the marketplace."

Earlier this year, the CSA – an umbrella group for all provincial securities commissions – released a paper seeking industry comment on the topic of discontinuing embedded commissions. The paper, Consultation on the Option of Discontinuing Embedded Commissions, also asked the investment community what the potential effects of a ban would have on Canadian investors. More than 140 submissions were received by the CSA as of June 9.

One of the most controversial costs is the mutual fund trailer fee, also known as trailing commissions. This fee is a portion of a fund's management expense ratio (MER) and has been the topic of much controversy over the past two decades. These commissions are paid out to investment advisers for the length of time an investor holds a fund and depending on the type of investment fund, can range from 0.5 per cent up to 1.5 per cent. (Both the investment firm and its adviser who sold the fund share in these commissions.)

On Monday, investment-fund managers, industry associations, advocacy groups and financial advisers debated over a number of alternatives to an outright ban of embedded commissions including capping or standardizing trailing commissions and discontinuing the use of the deferred sales charge purchase option in mutual funds. A DSC fund includes a back-end redemption fee that an investor may be charged if he decides to take out his funds early (typically within the first seven years of the investment.)

If no viable alternative to embedded commissions is found, an outright ban remains an option, Ms. Jensen said.

"We know that changing the long-standing embedded compensation structure would involve significant disruption to many business models," Ms. Jensen said. " It would mean shifts in culture and ways of doing business. It's not easy. What we're looking for is a practical solution that addresses the harms and lessens the negative consequences. One that makes it better for investors."

But many investors are not aware these fees are paid out to an adviser when purchasing a mutual fund, which could create a conflict of interest when it comes to advisers recommending which funds their client should buy.

"Our core issue is with conflicts of interest," Ms. Jensen said. "We cannot ignore the evidence that the current model isn't working for many investors. We know that when commissions are embedded in an investment product, advisers may be incented to recommend products that maximize compensation over the interests of their clients. And conflicts of interest under the current embedded compensation structure aren't just limited to the adviser."

The CSA announced it has plans to present policy options and recommendations to the industry next spring.

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