Advisor groups fight potential ban on embedded commissions

By Susan Yellin | February 21 2017 07:00AM

Advocis has issued a call to arms to its members, urging them to connect with their clients to participate in a consumer campaign aimed at halting any regulatory steps that would remove choice in how financial advisors are paid.

The “Financial Advice for All” campaign comes after the release of a consultation paper by the Canadian Securities Administrators (CSA) asking for recommendations on the future of investment fund fee structures, including banning embedded commissions in mutual funds, and asking how this could affect access and affordability of advice for Canadian investors.

In the almost five-minute video, Advocis president and CEO Greg Pollock calls on the organization’s 12,000 members to get their clients involved in the issue by having them get in touch directly with their provincial legislators.

Contact legislators

“It’s their voice in the conversation that will stop this direction in its tracks,” Pollock says in the video. “It will give them an opportunity to directly connect with their MLAs and their MPPs to tell their stories, to tell their story of how important it is that you continue to provide the kind of advice – the kind of access to advice – that you’re providing today.”

In an interview, Pollock said not enough advisors and consumers are paying attention to what he called the CSA’s “ill-conceived proposal,” which he predicts would lead to two-tiered financial advice.

The campaign “is going to be stepped up two, three or possibly four times or more than what you have seen us saying over the past two or three years,” said Pollock. “We have been taking a modest approach trying to have a constructive dialogue to convince people that the position we have taken on these issues is one that should be considered. We get the sense that there are a lot of people not hearing us – in many cases this is the CSA – and continuing to push in the direction they believe they should be pushing in and I find that problematic.”

Conflicts of interest

One of the major issues regulators raise in the paper is conflicts of interest that “misalign” the interests of investors with those of investment fund managers, dealers and advisors. Instead, investors need a compensation model that empowers them and better aligns all their interests, it states.

The CSA suggest that rather than embedded commissions, mutual fund firms offer direct pay arrangements such as upfront commissions, flat fees, hourly fees and fees based on a percentage of assets under administration.

The regulators turned down suggestions by the industry that they should wait to see the results of CRM2 and its push for more transparency and disclosure first, saying ending embedded commissions would be complementary to CRM2.

Even though the CSA paper does not point to the insurance industry’s segregated funds, Advocis is fully in favour of disclosing fees, Pollock said. He also noted that the Canadian Life and Health Insurance Association (CLHIA) is exploring the potential of disclosing all fees in the MER – not just those paid to the dealer, but also to portfolio and investment managers. “We would be in support of that.”

Ian Russell, president and CEO of the Investment Industry Association of Canada (IIAC) said one issue his group will raise is the possibility of regulatory arbitrage between the mutual fund and insurance industries. Segregated funds may be an insurance product, but is basically sold as a mutual fund with embedded fees.

"What’s good for the goose is good for the gander. So if you do not have equivalents in the rule, it makes a mockery of the CSA rule where it says we will prohibit embedded fees on mutual funds and yet nothing on segregated funds. I think it then becomes important to have an equivalent in the rule.”

Advisors’ reaction

Individual advisors were quick to respond to the CSA paper on how changing current sales methods could affect them and their clients.

Rick Bashista, an independent advisor with RWB Financial in Burlington, Ont., said he signs a duty of care and disclosure form with all clients, so they already know how much he earns.

He said he works about 50 hours a week, often nights and weekends, travelling frequently to investors’ homes, most of whom have portfolios of $50,000 to $100,000. “On a $100,000 account, my service fee/renewal/commission – whatever you call it – is about $400 gross. I then pay taxes and expenses and have $200 net.”

Bashista said he likes to work with young people, getting to know them on a personal level and then providing them with other products as they get older and the need arises.

He recently signed up three young people in the same family aged 22, 19 and 15, who could only put in $50 each to a fund. “I can’t send a bill to those kids for $125 for travel time and a couple of hours spent of my time. This whole thing about writing a cheque – they don’t want to do that,” he said.

“The system will never be perfect, but we have to offer Canadians choice, it has to be reasonable, disclosure is paramount, break down the fee and show the tax and the corporate fee, show what I get as a percentage.”

Without the embedded commissions, he said many people – like these clients – will go without advice.

“Personally, I’m not looking for the next client with $1 million in investable assets. I’m looking for someone I can help.”

Brad Brain, an investment advisor with Aligned Capital Partners Inc. in Fort St. John, B.C., said he moved a client last year from an embedded commission-based model into a fee-for-service model, only to move her back a year later.

Brain said the all-in costs for A and F class funds were the same in both models, but his client “hated the complexity and inefficiencies of the fee-for-service model,” he wrote in the online forum For Advisors Only (FAO).

In an interview, Brain, who said his views were his own and not necessarily those of his firm, noted his client had all of the hassles and none of the benefits of the fee-for-service model. 

Structural conflicts

While there now may be transparency and disclosure up front, they do not address structural conflicts that can exist between clients, advisors and mutual fund dealers, says Marian Passmore, director of policy at the Canadian Foundation for Advancement of Investor Rights (FAIR Canada).

“Disclosure simply says that there may be a conflict, but it doesn’t address the conflict,” Passmore said in an interview.

“Other research has shown that not only are investors harmed by embedded commissions but so is market efficiency and that’s why we think the status quo is not acceptable and that the research and information that we have today demands that there be a regulatory response.”

Unlike others who believe that modest investors would be hurt the most by a ban on embedded commissions, Passmore said the opposite is true. Ending embedded commissions would “create a direct pay arrangement so people will know what they’re paying for the product and that will allow people to shop around more,” she said. “It will allow for better transparency between what’s product and what’s advice and it will also simplify the disclosure of mutual fund costs.”

The CSA regulators believe MERs would fall after a ban on embedded commissions as new, lower-cost providers enter the market with a range of both actively managed and passive mutual funds.

An analysis regulators conducted suggests that the new entrants could price MERs for index funds up to 40 bps lower than average index fund costs today. MERs for actively managed funds offered by new entrants could be up to 75 bps lower than current average actively managed fund costs.

But some mutual fund companies are already lowering their fees and this should be taken into account in terms of evaluating the entire issue of banning embedded commissions, says Susan Allemang, director, policy and regulatory affairs with the Independent Financial Brokers of Canada (IFB).

Advisors are not in charge of the cost of the product, said Allemang, so anything to reduce costs at the manufacturer and dealer levels help make their funds more affordable to more clients.

Allemang said IFB is most concerned that choice remains in the marketplace, noting that the organization’s members already use a number of different models of compensation, including commission- and fee-based.

“We support choice and the changes that have been brought about to date as well as some of the things that are on the table that have made significant strides in disclosure and transparency across the board,” said Allemang. “A lot of our members have said their clients already know that they are being paid and how they are being paid.

“We don’t want to see regulatory initiatives that would push clients to get other platforms and away from getting the kind of independent, personalized, consistent advice that they get from their chosen advisor.”

While there has been a sharp focus on mutual fund fees for a number of years now (Canadians were said to be paying the highest MERs in the world), Paul Bourque, president and CEO of the Investment Funds Institute of Canada (IFIC) said MERs have been coming down and more of its members are issuing lower-cost ETFs. “So I think the industry has been responding to client demands for lower fees,” Bourque said in an interview.

Small investors

He said IFIC members have a wide range of views on how advisors should be compensated, but for some investors, especially those with smaller portfolios, embedded commissions is a good purchase option.

Surveys indicate that 54% of investors prefer to pay for their mutual funds through embedded fees, and another 37% prefer a direct fee, he said. “Obviously, both options are popular.”

But he said it should be up to investors to make up their own minds as to how they want to pay. “Having choice and having access is important.”

Like other organizations, the Canadian Association of Independent Life Brokerages Agencies (CAILBA) said it is preparing a submission to the CSA proposal, due June 9, said Earleen Moulton, compliance – regulatory affairs chair with CAILBA and vice president, compliance, with BridgeForce Financial Group.

“CAILBA is very concerned about the impact banning embedded commissions would have on independent advisors, given the increase in their regulatory obligations in the past few years, and ultimately the negative impact this will have on consumers’ ability to obtain financial advice.” 

Pollock said if Canadians move to direct fees rather than embedded commissions, there will be a large number of Canadians who will no longer have access to financial advice. Advisors will drop these clients and concentrate on more affluent people who can pay their fees.

United Kingdom and Australia

Embedded commissions have already been banned in the United Kingdom and Australia and have had mixed reactions. While there were some negative consequences of those moves, especially in the UK, the CSA paper suggests that the potential impacts from a similar reform here “might not be the same [in Canada].”

“Our goal is to ensure that any regulatory action we may decide to take will provide a Canadian solution to challenges specific to the Canadian market,” state the regulators.

Pollock said he expects the “Financial Advice for All” campaign to become more active over time as Advocis takes its message to social media and puts client and advisor video testimonials on its public website.

“We want to ensure that the greatest number of Canadians possible have access to financial advice. Banned [embedded] commissions will not do that, it will reduce that.”