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Securities regulators' latest initiative – Customer Relationship Model phase II or CRM2 – is well under way. After mid-July 2016, CRM2 will require investment dealers to report personalized performance, charges and commissions annually to each client. To their credit, many dealers are now providing performance reports.

But two disturbing trends are brewing beneath the surface in an effort to skirt the reporting of charges and commissions.

Escaping securities regulation

Compliance obligations of investment dealers and their individual financial advisers (i.e. registered salespeople) have ramped up over the past decade. Over that time, I've heard many stories of financial advisers giving up their investment licenses to focus on the sale of insurance products. Firms and individuals licensed to sell insurance are regulated by provincial insurance regulators (e.g., Financial Services Commission of Ontario or FSCO) but are out of reach of provincial securities regulators.

With July 2016 just over a year away, I'm hearing from multiple sources that an increasing number of advisers are treading down this path to escape the enhanced reporting of performance and costs. As this rule kicks in for all advisers regulated by securities regulators, insurance-only advisers will be Teflon as far as CRM2 is concerned.

Churning ahead of commission reports

In a similar effort to minimize the impact of CRM2's cost reporting component, many advisers are initiating dubiously-clever transactions. CRM2's cost report will show a list of amounts charged directly to clients and commissions received on behalf of the client's investments. But this only starts after mid-July 2016 – which means that the first report won't be issued to clients until 2017.

In the meantime, I'm told by a variety of sources that many advisers are pushing through what's been described to me as "a boatload" of mutual fund sales under a deferred sales charge (DSC) option. When an adviser sells a mutual fund on a front-end load (FEL) basis, she generally receives no up-front commission payment and an ongoing trailing commission of 0.5 per cent to 1 per cent per year based on the value of the investment. (Commissions are paid to the dealer, of which 25 per cent to 100 per cent is paid to the individual adviser).

Clients investing in a DSC fund trigger a bigger up-front commission – i.e. usually 4 per cent to 5 per cent of the value of the investment – plus a trailing commission of 0.25 per cent to 0.50 per cent per year. So advisers who are able to sell a pile of DSC funds will be paid significant up-front commissions prior to 2016 – which won't show up on any cost and commission report because it's not currently required.

And by the time that cost reporting is a requirement, the clients of advisers that rushed through its DSC sales will only see a trailing commission amount that is half the size of the more ethical advisers that use FEL funds, were paid nothing up front but are paid higher trailing commissions. The DSC commission will be excluded from the commission report if it was paid more than a year prior to the first report in 2017.

Compliance officers of dealer firms should watch for evidence of these troubling trends.

Investors should similarly watch out for advisers changing firms or recommending moving portfolios to segregated funds or other DSC mutual funds that may trigger a new set of commissions. (New DSC purchases will also have you pay a fee to exit the funds within the next 6-7 years.)

Both trends are worrying and exemplify the type of ethically-challenged advisor that gives the entire industry a bad name.

Investment counsellors are more transparent

The antidote, of course, is to deal with a firm that is already held to a fiduciary standard. It has long been the norm for investment counselling firms – which are usually registered as Portfolio Managers – to be more transparent. They tend to deal with higher net worth clients, who are more sophisticated and demand greater transparency. In response, most investment counselling firms have been providing this in the absence of a legal requirement. But then being held to a fiduciary standard creates a different mindset with respect to transparency.

So it's no wonder that securities regulators continue to study whether to impose this standard on all advisers under their jurisdiction. Let's just hope that securities regulators are able to persuade their insurance counterparts to hold insurance-only licensed advisers to higher standards.

Dan Hallett, CFA, CFP is a principal with Oakville-Ont.-based HighView Financial Group, which acts as an outsourced chief investment officer for wealthy families and foundations. He also contributes to The Wealth Steward blog.

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