On January 10, 2017, the Canadian Securities Administrators (CSA) published for a 150-day comment period CSA Consultation Paper 81-408 - Consultation on the Option of Discontinuing Embedded Commissions (the Paper). The Paper proposes to discontinue the prevailing practice of remunerating dealers and their representatives for mutual fund sales through embedded commissions paid by investment fund managers, and recommends transitioning to fee-based, "direct pay" arrangements between investors and their dealing representatives. While the Paper presents the initiative as a "proposal", it is apparent that CSA action is likely, as it seeks input on two proposed approaches toward implementing the transition to direct pay arrangements over a 36 month period once the new rule becomes effective.
The Paper presents evidence that embedded commissions, including trailer fees and upfront commissions for purchases made under a deferred sales charge (DSC) option, give rise to conflicts of interest that misalign the interests of investment fund managers, dealers and representatives with those of the investors they serve. The CSA expresses the view that these conflicts cannot be fully addressed by other regulatory initiatives such as point-of-sale disclosure, CRM 2 reporting and CSA Consultation Paper 33-404 - Proposals to Enhance the Obligations of Advisers, Dealers, and Representatives toward their Clients. The Paper dismisses many arguments made by industry in favour of maintaining embedded commissions, including the predicted reduction in access to advice for lower-wealth investors, elimination of choice for investors in how to pay for advice and opportunities for regulatory arbitrage. The Paper acknowledges that the change will impact dealer compensation models, but suggests that these challenges can be overcome through innovations in technology, and by permitting investment fund managers to collect and remit direct pay compensation from the investor's fund investment to the dealer on the investor's behalf.
The Paper poses 34 questions for public comment on topics ranging from the proposed scope of the prohibition on embedded commissions, the impact of the proposal on the Canadian fund market and specific stakeholders and measures that could mitigate the potential impacts and unintended consequences to investors and the fund market of discontinuing embedded commissions. The CSA is holding a longer than normal comment period and is encouraging data-driven responses specific to the Canadian market. Comments should be submitted in writing on or before June 9, 2017.