Regulators have been attempting to live with the addiction for too long: end it in the best interests of all.

ADVOCIS talk with gusto about the need for change and the importance of advice, but when it comes down to the most obvious of all the required changes, removing the conflict that stands in the way of best interests’ advice, they appear blindly intoxicated by the charms of the conflict itself. What would Socrates have said about an organisation that placed commissions at the centre of its reason for being?

The Second of two research pieces commissioned by the CSA, a report titled “A Dissection of Mutual Fund Fees, Flows, and Performance ” prepared by Professor Cumming of York University-Schulich School of Business, as part of its review of “how embedded compensation could give rise to actual or perceived conflicts of interest”, is now out.  

The report is the first of its kind to analyse Canadian mutual fund flows, mutual fund fee structures and performance.   The international body of work in this area is large and it is no surprise that the Cumming’s report conclusions largely reflected this much wider body of work. 

The report confirms that mutual fund flows are impacted by embedded commissions, that where embedded commissions exist flows are much less influenced by past performance and that even performance (at the gross return level) is negatively impacted by progressively higher embedded commissions.  So yes, at a purely impersonal data level, embedded commissions give rise to actual conflicts in fund distribution: these conflicts are highlighted by the sensitivity of flows to compensation as opposed to performance.

No surprise then that the trade body representing financial/investment advisors in Canada, Advocis, cautions against reading too much into the report:

“any decisions with respect to product sales or offerings in the market place must ensure that advice is broadened not restricted”

“it appears that the report does not consider the monetary value of the financial advice provided to client”.

Advocis is a staunch supporter of commissions which they say are integral to the advice industry in Canada: commissions they say allow advisors to service the smaller investor and their removal will restrict the availability of advice for the smaller investor and should not be entertained.  

Advocis is also coincidentally championing an upgrade to financial advice in Canada, promoting higher standards of professionalism and enhanced training as keys to improving financial advice and consumer protection.  In its recent submission to  the “Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives”, it made the following observations:

“We identify and describe four major problems with Ontario’s existing regulatory framework at the level of retail financial services:

1. anyone can call him- or herself a financial advisor and offer financial advice, including planning;

2. existing regulation focuses on product sales, at the expense of proper regulatory oversight on the critical financial relationship between the advisor and the client;

3. there is no firm, clear, and universal requirement for advisors to stay up-to-date in their core areas of knowledge; and

4. there is no effective, industry-wide disciplinary process”

“Regulatory reform in Ontario’s financial advice sector cannot and will not succeed unless the foundational nature and importance of advice is formally recognized at the outset of any reform effort.”

“the various inadequacies of the current regulatory scheme result in unnecessary and avoidable consumer exposure to fraudsters and advisor incompetence;”

“the needs of consumers and advisors have outgrown the existing, largely product-based model which currently regulates Ontario’s financial services industry; and,

“Ontario’s current web of regulatory structures and relationships produce unnecessary complexity for all stakeholders — and needless confusion for consumers.”

The consideration of the impact of commissions on financial advice and the need for higher standards and professionalism is a global phenomenon.   Most other international regulators that have overhauled their financial advice system have recognised that conflicts of interest impact the advice that investors receive and that removing these conflicts are an integral part of upgrading the advice and regulatory landscape.   The transition has been towards a best interest standard investment process that puts the client and advice at the heart of the process. 

Logically, Advocis’ submission to the “Expert Committee to Consider Financial Advisory and Financial Planning Policy Alternatives” covers much the same ground, with the exception that it wishes to retain conflicts of interest.  This is a non sequitur.

They talk with gusto about the need for change and the importance of advice, but when it comes down to the most obvious of all the required changes, removing the conflict that stands in the way of providing advice that is in the client’s best interest, they appear blindly intoxicated by the charms of the conflict itself.  What would Socrates have said about an organisation that placed commissions at the centre of its reason for being?

But, the history of the world is littered with the consequence of the hold of the status quo, yet somehow we do eventually manage to move forward and gradually change the human outcome. 

Regulation in this country is perverse and, yes, only removing commissions from mutual funds is a dumb solution.  Wholesale regulatory change is needed and that is the rub: does Canada have the guts to make the necessary changes? 

Regulators have been attempting to live with the addiction for too long: end it in the best interests of all.

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