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IFIC President /CEO Discusses Case Against Banning Trailer Fees

On July 21, IFIC’s president and CEO Paul Bourque participated in a taped interview with Morningstar Canada’s Christian Charest on the topic of banning trailer fees. This is one of a set of Morningstar Canada interviews to present alternate views. In a separate interview, former Morningstar staff member David O’Leary spoke in favour of banning trailer fees.

In his interview, Paul noted that the CSA’s proposal to ban trailer fees would eliminate the most common way small retail investors pay their advisors. He noted that rules are already in place to achieve the two goals that the regulators want to achieve: CRM2 reporting provides fee transparency. The issue of conflicts is addressed in CSA guidance and SRO rules and can be further dealt with through vigorous enforcement of these rules.

He noted that Canada should learn from the unintended consequences that have resulted from such moves in other jurisdictions.

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Christian Charest: For Morningstar, I’m Christian Charest. The Canadian Securities Administrators, which oversee the provincial regulators across the country, recently sent a very strong message that they intend to ban embedded commissions paid by fund companies to investment dealers. This includes trailer commissions, which remain the most prominent method of compensation for advisors in Canada. One organization has long opposed this measure is the Investment Funds Institute of Canada. To explain why, I’m joined here today by IFIC’s president, Mr. Paul Bourque.

Mr. Bourque, thank you very much for being here with us today.

Paul Bourque: Thank you for having me.

Charest: To start, can you please explain to us what is IFIC’s position on the banning of trailing commissions?

Bourque: Well, IFIC understands the concerns of the regulators. Investors’ knowledge of fees is not good, and conflicts of interest embedded in compensation models is a real concern. What we say is, we have to look at how we’ve addressed those concerns already and then assess whether or not additional regulatory proposals are required.

We know that the regulators understand that investors’ knowledge about fees needs to improved. So they have introduced over the past number of years some significant disclosure reforms. For example, all advisors have to explain to their clients all operational and transaction fees related to the account at the account opening process. All advisors have to give mutual fund purchases a Fund Facts document, which is a summary document that explains the fees that are charged by the mutual fund company, and the portion of that fee that gets paid to the investors’ advisor. And starting July 15, 2016, firms will have to provide to their investors a statement of charges which will include all transactional and operational fees, including trailer fees in dollars and cents. And that report also has to notify the investor that the mutual fund company is paying a trailer fee, the services that are supposed to be provided for that trailer fee, and the impact on returns that the trailer fee will have. So we think those reforms will intensify the conversation between the advisors and the clients, and it will increase the conversations around fees.

Charest: But that doesn’t address the other objection, which is the potential conflict of interest that is inherent in embedded commissions.

Bourque: Sure, and that is a legitimate concern, and one that the regulators are quite properly concerned about. Research done by the Canadian Securities Administrators shows that eliminating embedded commissions will not eliminate compensation-based conflicts. There are conflicts embedded in every compensation model. So the question is how to best manage conflicts.

And we know that there is already a statutory obligation for firms to treat their clients honestly, fairly and in good faith. Obviously, when firms come to resolve conflicts, they have to keep in mind that they need to treat their clients honestly and fairly. The CSA currently has guidance on the books already on how firms should deal with conflicts, and I’ll quote it: They have to deal with conflicts that are “sufficiently contrary to the interest of the client that there can be no other reasonable response.”

So that’s already there as part of CSA guidance, and the SROs that govern the securities industry already have rules that require firms to resolve compensation conflicts in favor of the client. So I think the best way to manage compensation conflicts is to vigorously enforce the current rules.

Charest: Another objection that IFIC has to this measure is the fact that it would only apply to mutual funds, and not to other types of investments that are prominent in Canada, notably segregated funds, which are managed under a different regulatory framework. Can you expand on that a little bit?

Bourque: Well, you’ll have to talk to the regulators about that one, because they are the ones that determine whether or not the regulatory regime between mutual funds and segregated funds will be harmonized or not around disclosure and supervision and the firm obligations. My experience is that there has not been consistent harmonization over the years, but there is a recent consultation paper published by the Canadian Council of Insurance Regulators that is really trying to get input into how the CSA and the CCIR can collaborate more effectively, not only on rulemaking or harmonization, but sharing information around disciplined brokers and sharing investigation information.

Charest: Immediately after the announcement by the CSA, IFIC issued a press release stating its position on it. One of the things the press release said was that banning embedded commissions will result in the CSA regulating fees. Why would that be a bad thing?

Bourque: Well, I think, fundamentally, it’s the role of the marketplace to set the fees for products and services. I think that has been the approach. And I know the CSA has been reluctant to engage in fee regulation, for example, in the regulation of data feeds from exchanges, in the regulation of fees charged by the Canadian Depository for Securities. So they have been reluctant to get into that because they appreciate that’s not their expertise.

Charest: One case that’s often brought up in discussions over the banning of trailer fees is the United Kingdom, which went that route several years ago. What can Canadian regulators learn from the experience in the UK?

Bourque: The most important lesson is not to repeat the mistakes of others. In 2013, the UK banned embedded commissions. The result was that clients with small accounts under GBP100,000 lost access to investment advice. There were a couple of reasons for that. One was the clients didn’t want to pay the higher fees of the fee-based account or, alternatively, the advisor didn’t want to advise the smaller accounts. UK regulators have recently acknowledged that the result of banning embedded commission has been to restrict advice to small retail investors. So we don’t want to repeat that mistake.

I think what we would really like to do is understand the impact of the current reforms, which have just started to be implemented. And to their credit, the CSA has just begun research on the impact of CRM2, and they are going to look at how CRM2 reforms have affected the behavior of clients, of advisors and their firms and of mutual fund companies. So we think we should wait until that research is done and we know what works and what doesn’t and what we can improve.

Charest: So, to summarize, what would be your recommendation to the regulators?

Bourque: First, enforce the current rules. That’s always easier than writing new rules. Second, understand the impact of the current reforms. I think that’s really important and the CSA, is doing that. And finally, my view would be that before proposing new regulations that may have unintended consequences by restricting access to advice and investment opportunities to small retail investors, the regulators should really understand what the impact of their current reforms are.

Charest: Mr. Bourque, thank you very much for taking the time to explain IFIC’s position to us.

Bourque: Thank you.

Charest: For Morningstar, I’m Christian Charest. Thank you very much for watching.