David O'Leary, CFA, MBA is managing partner at Eden Valley Partners, a wealth management practice in Toronto
The Canadian Securities Administrators recently took another step closer to banning embedded sales commissions to financial advisers. My colleagues and I celebrated this news, since we believe a ban on commissions would be a huge win for both investors and our industry. Surprisingly, many industry stakeholders still argue against a ban.
Here's why they're wrong.
Embedded sales commissions (also known as trailer fees) have two contentious problems: They create a conflict between the interests of adviser and clients, and they obfuscate the fees investors pay.
Embedded commissions present a conflict of interest because the adviser is being paid by the very provider of the investments they are recommending to clients. It would be like your doctor getting paid by pharmaceutical companies for prescribing their drugs to you. Even worse is the fact that different investments pay different commission amounts to advisers. So as an investor, you don't know whether your investments are the very best ones out there, or just the ones that rewarded your adviser most handsomely.
The second problem with commissions is that they are embedded within a larger fee (known as the MER, or management expense ratio) that bundles together all sorts of fees to various parties. This makes the amount a client pays the adviser far less transparent. In my experience, most clients don't realize their adviser receives any part of the MER – if they're even aware they are paying an MER.
Those who object to a ban on commissions are almost exclusively people who stand to profit from them. And they offer a variety of disingenuous arguments to defend them.
One common argument is that banning commissions would hurt investors since it would reduce the amount of choice they have in how they pay for financial advice. Portfolio manager John De Goey has been quoted with an excellent response to this: "Today, most restaurants offer a choice between tap water and carbonated water. Would adding a third option – toilet water – make for better outcomes?"
Another common argument claims that Britain banned commissions to disastrous effect. Claims are made that banning commissions created an advice gap, where smaller investors can't find advisers willing to serve them. This is blatant disinformation. No one knows precisely what impact the banning of commissions has had there. There are two reasons for this. First, we don't have enough data yet. The British ban came into effect just more than three years ago. And second, banning commissions was just one part of a sweeping set of changes known as the Retail Distribution Review.
Britain's Financial Conduct Authority has attempted to measure the impact of these changes and published a number of reports. Everyone admits their conclusions are tenuous, though, given how little data we have . Moreover, these changes were made against the backdrop of an evolving technological and sociological landscape, so that it may never be possible to isolate the effect of banning commissions from all the confounding variables.
More important, we have good reasons not to fear a dramatic advice gap in Canada. We have a healthy and robust banking system that gives the vast majority of us access to advice at a reasonable cost. And we have been a beneficiary of the trend toward robo-advisers.
Instead of fighting a commissions ban, let's promote financial literacy. That starts with clear information about what investors are paying for advice, and a system of adviser compensation that allows investors to trust they are receiving objective advice.
If we're successful, the industry won't have to hide the true cost of financial advice, because Canadians will see its full value and willingly pay a reasonable fee for it.