The Ontario Securities Commission (OSC) hosted a roundtable discussion on September 18, 2017 (the Roundtable Discussion) to help evaluate potential regulatory changes to discontinue embedded commissions in investment funds. The term “embedded commission” refers to the remuneration of dealers and their representatives for mutual fund sales through a commission paid by investment fund managers (for example, deferred sales commissions and annual trailing commissions). The Roundtable Discussion built on the Canadian Securities Administrators’ (CSA) Consultation Paper 81-408, released January 10, 2017, which identified a number of investor protection and market efficiency issues resulting from the practice of dealer compensation through embedded commissions:
- embedded commissions raise conflicts of interest that misalign the interests of investment fund managers, dealers and representatives with those of investors;
- embedded commissions limit investor awareness, understanding and control of dealer compensation costs; and
- embedded commissions paid generally do not align with the services provided to investors.
We have written more extensively about Consultation Paper 81-408, and the potential regulatory changes contemplated therein, here.
The release of Consultation Paper 81-408 spurred a groundswell of input from stakeholders, with the OSC ultimately receiving an unprecedented 142 comment letters in response. At the Roundtable Discussion, the OSC assembled three panels comprised of key stakeholders, including financial advisors, investment firms and advocacy groups, to reflect more extensively on whether alternatives to an outright ban on embedded commissions might be capable of sufficiently mitigating the OSC’s concerns surrounding the current practice.
Panel 1: Capping or Standardizing Trailing Commissions
This panel considered whether the imposition of either a capped or a standardized rate for annual trailing commissions could sufficiently mitigate the conflicts of interest associated with such fees. The panel was largely skeptical of this approach, suggesting that even with a standardized or capped rate for trailing commissions, conflicts of interest would persist: investment dealers would still be incented to sell mutual funds carrying trailing commissions as opposed to other investment vehicles. The panel also expressed concerns that a price-setting function was outside of the OSC’s mandate and would result in undue regulatory burden.
Panel 2: Discontinuing, or Implementing Additional Standards for the Use of the Deferred Sales Charge Purchase Option
This discussion explored whether the elimination of the deferred sales charge (DSC) purchase option for dealer compensation could meaningfully mitigate bias in investment recommendations. The panel focused extensively on the rationale for the DSC model, and potential consequences of its discontinuance. Viewpoints on this topic diverged significantly. Detractors of the DSC model opined it serves no real purpose in the current market, suggesting instead that the model is simply a relic from days when front-end commissions were typically much higher than they are now. Conversely, proponents countered that the DSC model promotes better access to financial advice, particularly for investors with smaller accounts, and noted that the DSC model encourages saving and a long-term investment strategy.
Panel 3: Enhancements to Disclosure and Choice for Investors
This discussion considered whether enhanced awareness and choice for investors, including through offering alternative payment options such as a direct fee arrangements, might be the appropriate way forward. Many panellists felt strongly that investors should be afforded the opportunity to pay through either embedded commissions or a direct fee model according to their circumstances, and that that the elimination of choice would lead to diminished access to advice (particularly for smaller investors). Others noted that the Client Relationship Model 2, which imposes additional disclosure standards on dealers, remains in its infancy, and encouraged the OSC to adopt a “wait and see” approach to whether such disclosure standards might assuage concerns associated with embedded commissions.
Despite the diversity of viewpoints expressed at the Roundtable Discussion, the OSC has made very clear that regulatory change with respect to embedded commissions is coming. What that change will look like, however, remains largely unknown. Moving forward, the OSC has indicated that it intends to make recommendations regarding regulatory adjustments to the CSA in early 2018; dealers, fund managers, and other stakeholders should be aware of these impending changes and keep apprised of the CSA’s progress in this area.
 A trailing commission is an annual commission paid by investment management companies to financial advisers usually calculated as a percentage of the value invested by client.
 A DSC is a commission paid by an investment fund to a dealer at the time of purchase. Under the DSC model, an investor may or may not later be required to by a redemption fee to redeem his or her investment; the longer an investment is held, the lower the redemption fee becomes, eventually reducing to zero after a predetermined number of years (usually seven).