Sales conflicts under review

The planned review does not spring from a particular sales practice that has regulators worried; rather, the impetus is more a sense that incentives are at the heart of issues that may lead to poor client treatment and bad financial advice.

“The way in which sales incentives influence the sale of products is an area of concern to regulators,” says Debra Foubert, director, compliance and registrant regulation, at the OSC.

Indeed, the Canadian Securities Administrators (CSA) recently commissioned research from York University professor Douglas Cumming that examined the distorting effects of mutual fund commission structures on fund sales and, ultimately, fund performance. That research, which looked at 10 years of detailed data from many of the major fund companies, detected an impact on sales and performance that was attributable to funds’ fee structures.

Not just Canada

IIROC carried out its own research into investment dealers’ handling of conflicts of interest last year. According to Wendy Rudd, senior vice president, member regulation and strategic initiatives, at IIROC, that review found that while “firms generally have adequate governance and oversight processes, [they] were not as effective at supervisory monitoring of potential compensation-related conflicts.”

As a result, IIROC wants to examine the oversight and monitoring of compensation-related conflicts more closely, Rudd says.

This potential conflict isn’t an issue just in Canada, either. Karen McGuinness, senior vice president, member regulation, compliance, at the MFDA, notes that regulators in the U.S. and the U.K. have been focusing on sales incentives and conflicts of interest in recent years.

In late 2015, the U.S. Financial Industry Regulatory Authority (FINRA) launched an ongoing, targeted examination of retail brokerage firms. The FINRA study is looking at the conflicts that can arise, both through firms’ basic compensation structures and when selling proprietary products or products that provide third-party compensation to dealers. FINRA’s review is slated to be completed later this year.

In the U.K., the Financial Conduct Authority (FCA) published a report in 2012 that indicated that a review of retail sales incentives found that “…most firms had incentive schemes that were likely to drive mis-selling without effective controls in place to manage the risks.”

The FCA issued guidance designed to focus financial services firms’ attention on these conflicts and help to improve their structures for managing those conflicts. But, the FCA’s followup research found that although there was some improvement, firms still need to do more to address the risks to consumers posed by inherent conflicts.

“Those [FINRA and FCA] reviews were focused on the same types of practices we are concerned with, which are compensation and incentives that create conflicts of interest and may lead to unsuitable advice,” says McGuinness. “It has been on our radar for a while, as it’s an area in which regulators continue to hear of concerns.”

Three regulators

Although Canadian regulators agree that conflict of interest is an issue that warrants their attention, they have still to determine just how to approach it.

The OSC’s Foubert says that the provincial regulator is in “preliminary discussions” with IIROC and the MFDA about a joint effort to review this area.

McGuinness says that although the three regulators have agreed to examine the issue, co-ordinate their efforts and share information, each regulator still may take its own approach regarding the specific areas being looked at and the ways in which information is collected from firms.

The MFDA’s approach probably will be to request initial information from investment dealers about their compensation structures and incentives and reward programs, then to follow up this work by seeking more specific information from certain firms, McGuinness suggests. The MFDA expects to issue that initial request some time this spring; beyond that, the schedule for any followup work or for reporting on the research project’s findings has yet to be determined.

McGuinness notes that this research is the sort of inquiry that could benefit from knowledgeable insiders bringing dubious practices to the regulators’ attention directly.

“Another way that these issues are uncovered is through whistleblowers,” she says. “The MFDA does have a whistleblower program if anyone has information to provide to us and wants to remain anonymous.”

Indeed, both the MFDA and IIROC have confidential whistleblower programs, which are designed to allow industry insiders to report possible systemic issues – such as perverse incentive structures – to the regulators.

The OSC is contemplating the introduction of its own whistleblower program, which possibly would pay for tips about misconduct. That program has yet to be adopted; and, if it is, the program would reward whistleblowers only in cases that lead to large enforcement penalties.

The review being contemplated by the regulators regarding conflicts of interest is more of a compliance exercise than an enforcement effort.

Although, as McGuinness points out, any compliance initiative can lead to enforcement action and/or the development of new regulatory policy – depending on what the regulators uncover in the course of their review.

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