The Canadian Securities Administrators (CSA) launched a lengthy consultation period in January on their proposal to eliminate embedded commissions – that is, commissions paid to those selling investment products that are built into the product's price or annual fee.
In making their case, the CSA presented several supporting pieces of research – both CSA commissioned and other academic work. The consultation period allowed anyone to share their thoughts on this proposal and the CSA's many specific questions. The consultation ended on June 9, 2017. Here is a summary of my 30-page response to the CSA's proposal:
Embedded commissions create a conflict between the adviser selling the product and the investor buying it
Before I started in the industry, the Ontario Securities Commission asked securities lawyer Glorianne Stromberg to research the then high-growth mutual-fund industry; and to make recommendations to improve how it was regulated.
Ms. Stromberg responded in early 1995 with 294 pages of thorough research and recommendations. One of her key findings: "Sales representatives" (financial advisers) generally recommend mutual funds paying higher commissions over those that pay less. I have seen this dynamic at work. It is my impression that proportionately fewer advisers today base recommendations on commission levels but it still occurs too often. And this conflict is compounded by the many products that offer higher-than-normal commissions. It is most striking that regulators are still grappling with this issue more than 22 years after Ms. Stromberg's landmark report.
The industry has failed to even try to manage this conflict
Just a couple of years after Ms. Stromberg's first report (she wrote a second one in 1998), I worked for a firm that created the type of transparency that is still lacking today – even under CRM2. (CRM2, which stands for Client Relationship Model – Phase 2, refers to new rules requiring disclosure of personalized performance, adviser compensation and other charges – excluding embedded product costs.) We built online portfolio analysis tools that, among other things, broke out total fees in percentage and dollar terms for a total portfolio – not just for a single product. It went live in the fall of 1997.
In subsequent years, I created simply-worded explanations of fees and adviser compensation – with dollar totals of costs and commissions. I highlight this to demonstrate that individuals and small innovative firms created the type of transparency clients deserved, but this never grew into any large-scale initiatives. Meanwhile, the industry – companies that created products and those that sold them – comfortably sat on the status quo. And, as my HighView colleague Adam Laird pointed out in our series of CRM2 seminars over the past couple of years; a series of raging bull markets gave the industry enough momentum to keep pushing regulatory proposals off of the table. That trend ended this decade.
After years of fighting consumer-friendly proposals, the industry has left regulators no choice
For more than two decades, the investment industry had an opportunity to figure out how to treat clients better and give them the transparency they have always deserved. It could have had real influence in retaining commissions as a way to compensate for advice. And it could have helped – voluntarily – to design meaningful disclosure. But its failing on both counts only highlighted that neither was an industry priority. Rather than work constructively with regulators to create solutions, the industry put up roadblocks to too many of the regulators' client-friendly proposals.
Failing to demonstrate that it cared about treating clients better left regulators with no choice, I believe, but to force the industry's hand by proposing new rules and regulations. It happened with disclosure through the implementation of CRM2. And it looks poised to happen again with the proposed ban on embedded commissions. Only this year has the industry recommended alternatives to a ban on embedded commissions. But these efforts are politically motivated, not client-driven.
I think a commission ban is inevitable but the CSA is expected to make a final decision later this year.
Dan Hallett, CFA, CFP, is a principal with Oakville, Ont.-based HighView Financial Group.
Dan Hallett