1. Donna Spagnolo Neda Bizzotto
Show me the money: Regulatory Changes and Embedded Compensation IFB Toronto Fall Summit November 5, 2014
Donna Spagnolo
Neda Bizzotto

2. PAST

3. 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

4. CSA Paper – Mutual Fund Fees Paper
Issues raised:
Prevalence of mutual funds within investment portfolios of 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

5. 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

6. 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 to re-evaluate how advisors work with their clients.

7. CSA – Best Interest Duty
Principal concerns with current regime
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

8. 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.

9. 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.”

10. 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

11. 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”?

12. 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?

13. 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

14. Other jurisdictions: United Kingdom - FSA Retail Distribution Review (RDR)
United Kingdom - new rules ended commission-based system of advisor compensation
January 1, implementation of an ‘Adviser Charging’ 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

15. 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, 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

16. PRESENT

17. Referral Fees/Compensation – Securities Issues
All registrants
National Instrument
IIROC
MFDA
MFDA rules

18. Referral Fees/Compensation – Other Than Securities
Insurance
Provincial rules
Mortgage brokers
Bank products
Securities?

19. Mutual Fund Fees - Status
Disclosure is not enough:
Series with default rate
DSC as default

20. FUTURE

21. Mutual Fund Fees: Regulatory Initiatives - CRM2
To provide investors with clear and meaningful information on the costs and performance of their investments

22. 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

23. Questions? Donna Spagnolo & Neda Bizzotto Borden Ladner Gervais LLP
 (416) / (416)
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