Amid ongoing investor protection concerns involving the sale of proprietary mutual funds, securities regulators are proposing reforms to the sales practices rules around “principal distributor” arrangements.
Earlier this week, the Ontario Securities Commission (OSC) and the Canadian Investment Regulatory Organization (CIRO) announced that they are undertaking a review of bank branch-based fund sales, citing concerns about the prevalence of “high pressure” sales tactics in that segment of the industry.
On Thursday, the Canadian Securities Administrators (CSA) proposed revisions to the mutual fund sales practices rules that are designed to boost investor protection around the sale of proprietary funds generally.
“The proposed amendments address the principal distributor model for mutual funds and seek to improve investor protection and maintain investor confidence,” the CSA said in a notice outlining its proposals.
In its version of that notice, the OSC indicated that it “considered banning principal distributors,” but it concluded that model “continues to have a place in today’s mutual fund industry.”
However, the OSC also said that for the model to continue to exist, there need to be changes to the sales rules, which currently carve out certain provisions for principal distributors on the basis that these kinds of dealers typically face less severe conflicts of interest than independent dealers that sell funds from a variety of fund families — and that investors understand that their choices are limited when dealing with a firm that only offers one fund family.
The OSC said the basis for these carveouts isn’t specifically captured in the sales practices rule — and, as a result, reform is needed.
The proposals “provide principal distributors and managers with greater clarity, offer a level playing field to participating dealers and improve investor protection,” the regulator said.
Specifically, the CSA is proposing rule changes to clarify that dealers can only act as a principal distributor for funds that are in the same mutual fund family. They would also require these dealers to disclose their compensation arrangements to investors.
As well, the CSA clarified that the ban on the use of deferred sales charges (DSCs), which was adopted in 2022, also applies to principal distributors.
In its notice, the CSA said that while it isn’t aware of principal distributors selling DSC funds, the rules don’t explicitly prohibit it, so the proposed reforms would close a potential loophole in that area.
Alongside the proposed changes, the CSA is also seeking feedback on principal distributors using chargebacks — the practice of dealers requiring reps to pay back some of their upfront commissions when investors redeem securities before a specified date.
“The CSA is of the view that the use of chargebacks raises a significant conflict of interest for principal distributors in the distribution of mutual fund securities and we are considering the appropriate regulatory steps,” the notice said.
Stan Magidson, chair of the CSA and chair and CEO of the Alberta Securities Commission, said investor protection “is at the heart of these proposed changes.”
“By clarifying the principal distributor model and ensuring greater clarity in compensation, we aim to foster a more transparent and fairer marketplace for all participants,” he said in a release.
The proposals are out for a 90-day comment period, which closes on Feb. 27, 2025.