Although regulators in other countries are banning certain compensation practices in their financial industries, Canadian regulators have resisted that temptation. However, domestic regulators’ efforts to shine a brighter light on compensation is being met with dogged resistance from the industry.
Financial advisors in Britain are preparing for the abolition of embedded commissions, which takes effect in January. Advisors in other countries also have seen measures introduced to restrict how they can be paid. But in Canada, regulators have been reluctant to interfere with compensation models.
That said, the Investment In-dustry Regulatory Organization of Canada (IIROC) did propose new guidance this past August that would require advisors to consider the suitability of various compensation arrangements for their retail clients and ensure those arrangements are transparent; and for firms to supervise this activity.
In general, the IIROC draft guidance aims to ensure that the basic decision about whether a client uses a commission-based account or a fee-based account is guided by suitability considerations. Nevertheless, this seemingly modest proposal has touched off a flurry of protest within the industry.
For example, the Investment Industry Association of Canada’s (IIAC) comment has some “significant concerns.” The comment complains that it appears as though IIROC is trying to regulate through guidance rather than through its rules — introducing new requirements for advisors and dealers without going through the standard rule-making process.
The IIAC’s comment also complains that the guidance puts too much weight on client cost as a factor in determining whether an account type is considered suitable. And the comment suggests that the initiative is poorly timed, coming just as the new client relationship model (CRM) rules are being implemented and just as the Canadian Securities Administrators (CSA) is finalizing its own new compensation-disclosure requirements.
The IIAC comment warns it would be “extremely challenging and impractical” to require firms to deal with both the new CRM regime and new compensation suitability requirements at the same time.
Moreover, the IIAC comment suggests the CSA’s new rules are likely to resolve most of the issues IIROC is trying to deal with: “Once the CSA performance reporting requirements have been finalized, the industry will be in a better position to assess the effectiveness of the CSA disclosure requirements.” If there are still concerns, it adds, they can be dealt with at that point.
For now though, the IIAC comment argues that the new guidance is premature and potentially duplicative, and also warns that the imposition of additional obligations could push dealers to reduce the range of services they offer, thereby limiting client choice.
Indeed, several firms, both large and small, express support for the IIAC’s position in their own comments. These also say the dealers worry that they will be expected to move clients back and forth between commissions-based accounts and fee-based accounts in an effort to ensure ongoing suitability. More important, the firms insist the guidance will have the effect of further pressuring their already stressed bottom lines.
Toronto-based Altus Securities Inc.’s comment says the guidance will “make it more difficult for small, independently owned Canadian brokerage firms to operate,” adding that the proposal suggests regulators expect firms to work out how to charge clients as little as possible, thereby curbing their own revenue: “In the end, the very investing public IIROC strives to protect will ultimately suffer due to a lack of competition and brokerage alternatives.”
Yet, investor advocates suggest the regulators are being too timid. The comment from the Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada) says the organization is worried that regulators are content to rely on disclosure of conflicts of interest when what they really should be focusing on is avoiding and managing conflicts.
To that end, the comment says that the idea of banning embedded commissions should not be off the table: “While we recognize that such a ban would provoke strong pushback from industry, we note that this is the approach that has been taken by other leading jurisdictions and should not be ruled out as one option for dealing with conflicts of interest inherent in such commission structures. In FAIR Canada’s opinion, this option should be open for discussion.”
The FAIR Canada comment also points to the absurdity of discount brokers receiving trailer commissions, which theoretically are meant to pay for ongoing advice, when such brokers don’t provide ongoing advice.
The comment from the Canadian Advocacy Council for Canadian CFA Institute Societies takes a somewhat softer line, saying it’s not in favour of banning third-party commissions yet. However, the council wants to see vastly improved disclosure of all forms of compensation.
Its comment says that clients should receive plain-language disclosure of all charges that affect the value of their portfolio, including trailer fees, new-issue commissions, fund loads and other sorts of charges, along with so-called “hidden” revenue sources, such as soft dollars, co-operative marketing expenses and referral fees. And clients should be required to acknowledge, in writing, that they have received this disclosure. IE