By Dan Hallett on July 28, 2017
The Canadian Securities Administrators launched a lengthy consultation period in January on their proposal to eliminate embedded commissions – i.e. 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. My submission can be found on the Advocacy section of our website. Here is a summary of my 30-page response to the CSA’s proposal.
Embedded commissions create a conflict between the advisor 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.
Stromberg responded in early 1995 with 294 thorough pages of research and recommendations. One of her key findings: “sales representatives” (aka financial advisors) 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 advisors 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 Stromberg’s landmark report.
The industry has failed to even try to manage this conflict. Just a couple of years after 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. 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 advisor 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 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 to – voluntarily – 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 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 as I told the Globe and Mail recently, these efforts are politically-motivated not client-driven.
All responses sent to the CSA on this proposal can be viewed online. I think a commission ban is inevitable but the CSA will make a final decision later this year.
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