Show me the money: Regulatory Changes
and Embedded Compensation
IFB
Toronto Fall Summit
November 5, 2014
Donna Spagnolo
Neda Bizzotto
PAST
Mutual Fund Fees Paper - Why?
 Perception persists that investors in mutual funds are
among the most “retail” of retail investors
• Financial literacy
• Investor protection
 Concerns:
 Difficult to comprehend disclosure and lack of understanding by
investors, especially on fees and risks
 Conflicts of interest inherent in industry practices (mostly around
compensation)
 Fairness
 Complexity of products
• Other
• Conflict of Interest
• International changes
CSA Paper – Mutual Fund Fees Paper
 Issues raised:
 Prevalence of mutual funds within investment portfolios of
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Canadians, “Canadian fees are among the highest in the world”
Investors do not understand fees, disclosure too complex
Conflicts of interest
Cross-subsidization
Ongoing services to be provided in exchange for embedded
trailer commissions not clear (fees for advice)
Limited low-cost options for DIY investors
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Mutual Fund Fees Paper - Considerations
Possible changes:
• Trailing commissions paid for advisor services
• Standard class for DIY investors
• Unbundling trailing commission component
• Separate series for each purchase option
• Cap commissions
• Additional standards and duties for advisors
• No advisor compensation set by fund manufacturers
CSA – Best Interest Duty
 CSA Consultation Paper “The Standard of Conduct for
Advisers and Dealers: Exploring the Appropriateness of
Introducing a Statutory Best Interest Duty When Advice is
Provided to Retail Clients” – October 2012
 OSC hosted three stakeholder roundtables in June-July 2013
 OSC 2014 Annual Report - The OSC made it a priority in
2013-14 to re-evaluate how advisors work with their clients.
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CSA – Best Interest Duty
 Principal concerns with current regime
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Asymmetry in investment knowledge
Investors believe that best interest duty already present
Suitability standard is not enough
Conflict of interest disclosure requirements not being employed
effectively
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CSA – Best Interest Standard
 Every adviser and dealer (and each of their representatives)
that provides advice to a retail client with respect to investing
in, buying or selling securities or derivatives shall, when
providing such advice
(a) Act in the best interests of the retail client and
(b) Exercise the degree of care, diligence and skill that a
reasonably prudent person or company would exercise in the
circumstances
 Duty would constitute a “fiduciary” duty that would not be open
to contractual variation, and would only apply when “advice”
given to a “retail” client.
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Key Regulatory Theme = Investor
Protection
 OSC 2014 Annual Report – “Investor protection is a
core part of our mandate. This focus has supported
our scrutiny of registrant compliance with suitability
obligations, our examinations of a best-interest
standard for dealers and advisors and the
evaluation of mutual fund fee structures and the
impact of these on investor outcomes.”
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Mutual Fund Fees /Best Interest Standard
• Mutual fund fees and best interest standard are
inextricably linked.
• Mutual fund fee paper: 99 comment letters
• Statutory best interest duty: 93 comment letters
• Plus in-person consultations
Investor Advocate Response
 Key Themes
 Recommend prohibition on embedded compensation
 Misalignment of interests
 Disclosure initiatives are not enough
 Investors should have TRUE choice
 Recommend best industry duty for advisors
 Low advisor proficiency and confusing titles
 What is a “Financial Advisor”?
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Industry Response
• No evidence of investor harm
• Unintended consequences
• Reduction in access to advice
• Elimination of choice regarding payment of financial advice
• Unlevel playing field with competing products
• Efforts already underway to strengthen current regime
(e.g., CRM, fund facts)
• Wait for results of international reforms
• Has potential to make registrants guarantors or insurers
of their advice – who is responsible for investment
decisions?
• How is “best” defined?
Other jurisdictions: U.S.
• Points of differentiation with Canada
• Proposal: Reform of trailing commissions to cap
aggregate sales charges to investors
• “marketing and service fee”
• “ongoing sales charge”
• conversion of share class
• Study: Best interest standard for investment
advisers and broker-dealers
• Current fiduciary standard for advisers
• Current suitability standard + fair dealing for broker-dealers
• Study: Financial literacy
Other jurisdictions: United Kingdom FSA Retail Distribution Review (RDR)
 United Kingdom - new rules ended commissionbased system of advisor compensation
 January 1, 2013 - implementation of an ‘Adviser Charging’
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system, as part of its Retail Distribution Review (RDR)
Advisor and client set rates (fixed, hourly, etc.)
Ongoing fees permitted
Compensation based on level of service (rather than product)
 Restricted advisor
 Independent advisor
New statutory best interest standard for advisors
Code of ethics on advisors
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Other jurisdictions: Australia - Financial
Advice reforms
 Australia - ban on sales commissions and trailer
commissions
 Future of Financial Advice (FoFA) reforms came into effect July 1,
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2012 (compulsory as of July 1, 2013)
Similar to U.K., negotiate fees, ongoing fees permitted
Renew advisory agreements every 2 years (on-going advice)
Concept of “Scaled Advice”
 advice that fits client needs
New statutory best interest duty for advisors
 ‘reasonable steps’ qualification
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PRESENT
Referral Fees/Compensation – Securities
Issues
• All registrants
• National Instrument
• IIROC
•
National Instrument
• MFDA
• MFDA rules
Referral Fees/Compensation – Other
Than Securities
• Insurance
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Provincial rules
• Mortgage brokers
• Provincial rules
• Bank products
• Securities?
Mutual Fund Fees - Status
Disclosure is not enough:
• Series with default rate
• DSC as default
FUTURE
Mutual Fund Fees: Regulatory Initiatives CRM2
To provide investors with clear and meaningful
information on the costs and performance of their
investments
Mutual Fund Fees Paper - Status
Regulatory next steps:
• CSA has awarded two research contracts to review
Canada’s mutual fund fee structure:
• Evaluate extent to which sales and trailing commissions influence fund
sales.
• Evaluate extent to which the use of fee-based vs. commission-based
compensation changes the nature of advice and investment outcomes over
the long term.
• How:
• Data requests
• Literature review
• Due:
• Both due the first quarter of 2015
Questions?
Donna Spagnolo & Neda Bizzotto
Borden Ladner Gervais LLP
 (416) 367-6266 / (416) 367-6066
 dspagnolo@blg.com / nbizzotto@blg.com
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