On January 10, 2017, the Canadian Securities Administrators (CSA) published CSA Consultation Paper 81-408 – Consultation on the Option of Discontinuing Embedded Commissions (the Paper). The Paper seeks input on the option of discontinuing embedded commissions and the potential impacts of such a change on Canadian investors and market participants. Here are six key takeaways from the Paper:
1. Embedded commissions would be banned with transition to "direct pay" model. The CSA is proposing to ban embedded commissions (see #3 below) in favour of “direct pay” arrangements (e.g., up-front commissions, flat fees, hourly fees, fees based on a percentage of assets under administration or other arrangements). The direct pay arrangements contemplated by the CSA would require that (i) the arrangement is negotiated and agreed to exclusively by the investor and the dealer (through the representative) pursuant to an explicit agreement, and (ii) the investor exclusively pays the dealer for the services provided under the agreement. Note that investment fund managers could facilitate investors’ direct payment of dealer compensation through payments taken from the investor’s investment (e.g., deductions from purchase amounts or periodic redemptions from the investor’s account).
2. The ban would apply to all investment funds and structures notes, public and private. The ban would apply to all investment funds under securities legislation, as well as structured notes, whether sold under a prospectus or in the exempt market under a prospectus exemption.
3. What would be banned? The CSA envision a prohibition of any payment of money to dealers in connection with an investor’s purchase or continued ownership of an investment fund or structured note that is made directly or indirectly by any person or company other than the investor. The rule would preclude compensation to dealers that is paid or funded by the investment fund (or its IFM) or structured note issuer out of fund assets or revenue, and would include/ban, at a minimum:
- Ongoing trailing commissions or service fees; and
- Upfront sales commissions for purchases made under a DSC option.
4. What would be allowed? Direct pay arrangements (discussed above) would be allowed. In addition, the rule would likely allow the following types of dealer compensation payments:
- referral fees paid for the referral of a client to or from a registrant;
- dealer commissions paid out of underwriting commissions on the distribution of securities of an investment fund or structured note that is not in continuous distribution under an initial public offering;
- payments of money or the provision of non-monetary benefits by investment fund managers to dealers and representatives in connection with marketing and educational practices under Part 5 of NI 81-105; and
- internal transfer payments from affiliates to dealers within integrated financial service providers which are not directly tied to an investor’s purchase or continued ownership of an investment fund security or structured note.
5. The ban would be complementary to other recent CSA initiatives: The CSA consider that a ban on embedded commissions compliments other recent policy initiatives (e.g., CRM2, best interest and targeted reforms, point of sale) but that such initiatives do not (and were not designed to) address most of the concerns identified in the Paper.
6. What transition options are being considered?: The CSA are considering either a three-year transition period or a “phase-in” approach by transitioning dealers’ accounts over multiple periods.
Although the CSA has stated it has not yet decided whether to ban embedded commissions, the amount of detail and analysis provided in the Paper suggests that such a ban is likely and that “direct pay” arrangements will be the new normal governing investor-dealer relationships. In the interim, the CSA is also calling on the fund industry to create market-driven solutions and innovations that address the concerns raised in the Paper.
We strongly encourage our clients impacted by the Paper to carefully review the Paper (including the 36 specific questions posed to stakeholders) and to submit their views to the CSA (including comments on the regulatory impact that the Paper’s proposals have on their businesses). The decisions made as a result of this consultation will reverberate within Canada’s capital markets for decades to come. The CSA has prepared a helpful Backgrounder that summarizes the Paper – it can be found here.
In light of the significance and complexity of the issues raised in the Paper, the CSA is holding a longer than normal comment period of 150 days; comments should be submitted in writing by June 9, 2017. Finally, some CSA members also plan to hold in-person consultations in 2017 to facilitate additional feedback.