Regulating the regulators

When the Supreme Court ruled that the Canadian Securities Administration had no jurisdictional powers to be Canada’s national securities regulator, most everyone thought that the Canadian Securities Administrator (CSA) was effectively dead and that Canada would never have its own national regulator.

Not so.

It seems the rumours of their death were indeed, greatly exaggerated.

In a brilliant move, the CSA essentially ignored the ruling entirely and continued to hold itself out as Canada’s national securities regulator.

[Editor’s note: jargon alert!]

I spoke with a former Chief Compliance Officer (CCO) of a mutual fund dealer at length and they were completely amazed/appalled that the Self-Regulatory Organizations or SROs (IIROC and MFDA) are “dancing to the tune” of a national regulator with no regulatory authority. I assured the former CCO that although the CSA has no jurisdictional powers, they will eventually likely become Canada’s national securities regulator as each of the provinces “bend the knee” and pledge fealty. Not all provinces or territories are in favour of a national regulator and until they all agree, having a consistent and uniform regulatory environment from shining sea to shining sea is going to be difficult.

[Editor’s note: Legislators in September 2014 are creating yet another national security regulator called the Capital Markets Regulatory Authority (CMRA) which is to be in place by the fall of 2015.]

Therefore, it is with some amazement that the fund companies have come under the baleful watch of the phoenix-like Canadian Securities Administration who suddenly has foreseen problems and issues with the mutual fund industry with respect to fees and commissions.

My personal view is that the CSA can certainly regulate commissions but it is difficult to regulate something that is about to disappear or has already disappeared! Many mutual fund advisers, myself included, have dropped their commissions to zero many years ago and are selling mutual funds at 0% commission.

I can’t speculate why the CSA is investigating my commissions (or lack thereof). Maybe the CSA is worried that some advisers have dropped their overall compensation excessively?

The only remaining “commissions” for the 0% commission advisers (if we can indeed call them commissions), are referred to as “trailers”.

“Trailers” are ongoing asset-under-management fees for the management of existing investment portfolios which is exactly the same as what banks and private money managers have been using for decades, if not for centuries. Some refer to “trailers” as “commissions” but I do not agree with that view. Commissions are usually a one-time charge. For example: you buy 100 shares of Bell, you pay a commission. You sell the shares of Bell, you pay a commission.

However, annual asset-based percentage fees like “trailers” do not fit the traditional definition of a transaction-based commission. In other words, if it is not a transaction, it is not a commission – it is a fee. If it is a fee and it is based on asset values, we should call it what it really is: AUM (asset under management) fees.

In the context used today, fees are ongoing and systematic, and are charged to the client either separately or embedded into the product price. In all cases, all dollar amounts for both fees and commissions are fully disclosed and transparent. Whether or not fees are embedded, it is not important as long as everyone agrees that all fees should be fully disclosed and transparent – with the CRM2 rules, they are.

While the regulators battle it out at the federal and provincial levels, GIC deposit brokers are also dealing with a number of new regulatory regimes. A new SRO (Self-Regulatory Organization) called the RDBA (Registered Deposit Brokers Association) wants to regulate the sale of GICs in Canada, but it has been tough slogging for them. In the opinion of some, like the CSA, they also do not appear to have a mandate to regulate, and they do not seem to have the blessing and encouragement of any other regulatory body. If anything, the existing regulators appear to be reluctant to give up turf for ostensibly an investment product that may or may not be a security. The RDBA might say that they are merely filling in a vacuum as most regulators haven’t paid much (if any) attention to GICs in the past. If GICs are not regulated by a regulatory agency in some manner, the government will do their job for them!

[Editor’s note: The federal government has done exactly that and created a new law called the Deposit Type Instrument Regulation (DTIR) which neatly bypassed all of the existing regulators!]

Guaranteed Investment Certificates (GICs) are unusual investments in that for decades, they were considered non-securities and not part of the National Securities Act. They fell through the cracks from a regulatory viewpoint likely due to their guaranteed nature and low or no risk.

Even the Ontario Securities Commission were not sure when asked if GICs are bone fide securities. GICs fall under the Bank Act, which is separate from the rules governing securities like stocks and mutual funds. Today, some regulators refer to GICs as securities, others do not.

The above background is important to know as the deposit brokerage industry is a relatively new one. In the 1970s, deposit brokers started selling GICs through agency agreements directly with many banks and trust companies. The deposit broker was paid a finder’s fee for placing the proceeds with the bank. A deposit broker could shop at about 40 different financial institutions (banks and trust companies) and obtain the highest interest rates for their client without charging any fees. The “Agent” or deposit broker was paid directly by the bank who issued the GIC certificate.

Deposit brokers were not regulated by the conventional regulators, and no one saw the need to regulate them until about 2007 which was when they decided to form their own organization. Therefore, we now have a new Self-Regulatory Organization called the RDBA to create standards, rules, guidelines, governance, compliance and licensing with respect to the sale of GICs in Canada.

It is my view that all deposit brokers should have their own self-regulatory organization that is independent of the product manufacturer. And that deposit brokers must uniformly, on a national level, pass certain minimum requirements (as in all professions) before calling one’s self a deposit broker.

Also, there needs to be some sort of compliance regime and audit process (including on-site branch audits) to ensure that GIC business is conducted in the best interests of the client at all times. Hopefully, a self-regulatory organization can fulfill all of these considerable mandates, but there is still a long way to go.

Whew! I have barely scratched the topic of securities regulation in Canada. There is something that everyone can agree on: there is more compliance now than ever before in the securities industry and most of it will be of benefit to everyone. But to balance this view, Benjamin Tal, Chief Deputy Economist of CIBC said in a recent speech[1] that too much compliance will bog things down. Too much of a good thing, perhaps?

Related articles:

CRM2 - Big regulatory changes coming to Canada’s mutual fund industry:

Fund Facts - The risk and reward of fluctuation, volatility and standard deviation:


CSA (Canadian Securities Association)

CCO (Chief Compliance Officer)

IIROC (Investment Industry Regulatory Organization of Canada)

MFDA (Mutual Fund Dealers Association)

DTIR (Deposit Type Instrument Regulation)

GIC (Guaranteed Investment Certificate)

RDBA (Registered Deposit Brokers Association)

SRO (Self Regulatory Organization)

[1] Benjamin Tal – Chief Deputy Economist CIBC “The Waiting Game” speech, Sept. 16, 2014 (Waterloo Inn, Waterloo, Ontario)

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