Some Advisors Behaving Badly with CRM2 on the Horizon

By Dan Hallett, CFA, CFP on March 16th, 2015

CRM 2After 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 advisors (i.e. registered salespeople) have ramped up over the past decade. Over that time, I’ve heard many stories of financial advisors 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 advisors are treading down this path to escape the enhanced reporting of performance and costs. As this rule kicks in for all advisors regulated by securities regulators, insurance-only advisors 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 advisors 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 advisors 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 advisor 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% to 1% per year based on the value of the investment. (Commissions are paid to the dealer, of which 25% to 100% is paid to the individual advisor).

Clients investing in a DSC fund trigger a bigger up-front commission – i.e. usually 4% to 5% of the value of the investment – plus a trailing commission of 0.25% to 0.50% per year. So advisors 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 advisors that rushed through its DSC sales will only see a trailing commission amount that is half the size of the more ethical advisors 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 advisors 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 advisors under their jurisdiction. Let’s just hope that securities regulators are able to persuade their insurance counterparts to hold insurance-only licensed advisors to higher standards.

(See this February 2015 Globe and Mail article and an older piece from July 2011 on the merits of hiring an investment counsellor.)

>> HighView Financial Group is an investment counselling firm that takes a fiduciary approach to affluent family and foundation wealth. We are transparent and accountable in all that we do. Schedule a complimentary discovery session to see if we’re the right investment stewardship counsellors for you.

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