The case for banning embedded commissions

Do you know how financial advisors get paid? Most investors can’t answer this question or if they can, then there is a good chance they don’t really know how much they are paying. That’s especially true for investors who hold mutual funds due to embedded commissions.

It’s a thorny issue that’s continues to be argued, but the Canadian Securities Association is taking steps to end this debate for good. In January the CSA put out a call for input on a consultation paper that explores discontinuing embedded commissions. Specifically the CSA asked for input on whether killing off embedded commissions would impede investor access to financial advice.

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If you really want to understand the issue and why you hope the CSA finally eliminates these commissions then you have to read the submission by John DeGoey on this issue. DeGoey, a portfolio manager with iA Securities (iAS) in Toronto who is a frequent contributor to MoneySense and a regular critic of embedded commissions.

Here are five key takeaways from his submission:

1. Advisors steer clients into products that pay them the most “The surest way to find your way off the product shelf is to have a product that does not offer embedded commissions,” writes DeGoey. “ If one takes the view that mutual funds, in particular, are sold; not bought, then it should logically follow that registrants will likely prefer those products that are ‘easy to sell’.

2. The notion that killing embedded commissions create an advice gap is rubbish “The amount being paid would be unchanged whether the payment is made via the payment of trailing commissions, the payment of direct and separately charged fees or the liquidation of pre-existing holdings to pay the fees,” argues DeGoey. Charging for advice separately doesn’t make it less attainable, it just makes it more transparent. “People refuse to pay not because they cannot do so (indeed, the cost of advice is unchanged), but because they are now being shown (in many instances for the first time) in a clear, unambiguous way just how much financial advice costs.”

3. Robos will likely help fill the void “Online and “robo” offerings may well gain increased acceptance as people come to understand the importance of managing both product and advisory costs and investor behaviour as primary determinants of investment outcomes,” writes DeGoey.

4. Oblivious investors are in for a rude awakening “Those who “refuse” to pay are largely oblivious to the fact that they have been paying for advice (often at similar or identical dollar amounts) all along,” argues DeGoey.

5. Some advisory firms won’t survive—but that’s not a bad thing “Consolidation is likely a positive development since it will leave only the largest, most well capitalized firms standing. This, in turn, should provide greater stability and possibly even more compelling economies of scale for those people who would use these services (i.e. ordinary investors),” writes DeGoey.

Read DeGoey’s full submission here.

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