The Canadian Securities Administrators (CSA) say there is enough evidence that embedded commissions result in conflicts of interest to warrant regulatory action.

In a staff notice (81-327) released on June 29, the CSA argue that the practice of paying commissions to dealers and advisors for mutual fund sales "raises a number of investor protection and market efficiency issues that suggest a need to consider change".  Among other things, the CSA points to reports prepared by the Brondesbury Group and York University professor Douglas Cumming which they believe substantiate "the detrimental impact of conflicts from embedded commissions on investors and market efficiency."

While the second phase of the Client Relationship Model (CRM2) reforms and new point of sale disclosure requirements for mutual funds address some of their concerns, the regulators have decided to proceed with consultations on discontinuing embedded commissions and transitioning to direct pay arrangements.

The CSA plan to issue a paper on the subject

The CSA say they plan to issue a paper on the subject in the fall which will:

• evaluate the extent to which the adoption of direct pay arrangements would address the investor protection and market efficiency issues that have been identified;
• provide an overview of existing tools and related regulatory initiatives underway and consider the extent to which they respond to the issues identified;
• assess the potential impact of discontinuing embedded commissions on both market structure and business models, as well as access to advice for investors;
• review the progress of similar regulatory reforms in other jurisdictions and assess how those markets are similar to or different from Canada’s; and
• identify various transition options that could be employed to implement a move to direct pay arrangements.

"Discontinuing embedded commissions would be a significant change for investors and the mutual fund industry," reads the notice. "Therefore, before considering any rule proposals on mutual fund fees, the CSA wish to consult on the impact such a change could have on Canadian investors and market participants and on the ways in which any negative impacts could be mitigated through the design and implementation of potential transition measures."

The industry finds it “deeply troubling”

In its response to the announcement, the Investment Funds Institute of Canada (IFIC) urged regulators to give current initiatives and consultations (such as the one on the best interest standard for advisors) an opportunity to run their full course before beginning a new set of reforms. IFIC says the industry finds it “deeply troubling” that regulators do not appear to have a plan that shows how all of the recent and proposed reforms will fit together.

"The regulators are taking the industry and investors on a bumpy ride without any kind of road map or even a clear or agreed upon destination," commented IFIC president and CEO Joanne De Laurentiis.