OSC's decision to ban controversial compensation scheme creates obstacle for advisor succession, says industry veteran
Last week, the Ontario Securities Commission made the stunning and unanticipated announcement that it will ban the deferred sales charge (DSC) option on sales of mutual funds in the province.
With that move, the regulator brought itself in line with other members of the Canadian Securities Administrators (CSA), which in February last year declared a ban on the practice of fund companies paying companies an upfront sales commission effective June 1, 2022.
Around that time, Ontario proposed a watered-down version of a DSC ban, with restrictions such as prohibiting DSC sales to investors over 60 years old, banning the use of leverage in DSC purchases, putting a $50,000 ceiling on such sales, and various limits with respect to redemption schedules and investment time horizons.
Since then, the province has received numerous calls for a total prohibition on DSCs from various stakeholders. Industry representatives cited the burden of two-tiered regulation created by Ontario’s holdout position, while advocates were concerned about the continued harmful impact on vulnerable investors.
To one veteran advisor, the OSC’s ultimate decision to institute an outright ban on DSCs makes all the regulatory sense in the world – but it will come at a steep cost for the industry.
“I think it's going to get harder and harder for newer advisors to break into the industry,” said Sean Harrell, partner and senior advisor at Howe Harrell & Associates in Manitoba. “Sometimes that upfront revenue is what keeps the doors open until you build up your practice.”
Harrell recognized that numerous improprieties related to the use of DSCs have been documented over the years, leading to growing public pressure for stiffer investor protections and sanctions for abusers. Given all the issues that regulators have to contend with – with even more coming down the line as the financial industry becomes more complex – doing away with the DSC option naturally came up as an elegant solution.
“I think [the decision to ban DSCs] was coming from a good place,” Harrell said. “I just wish that the industry would have taken more of an individual approach to reprimanding people rather than just going with a clean sweep.”
While he acknowledged that DSC funds contain an element of danger, he maintains that if used properly, they’re a good tool for young advisors working their way up. As a young advisor himself 20 years ago, he said he offered clients the choice to incorporate DSC funds into their financial plans, making sure they were informed of the potential risks and costs associated with them.
“If it worked out you could use a fund company’s money to pay for your plan, that was smart to me,” Harrell said. “Back in the day, I had commissions and the ability to get an upfront hit of compensation from DSCs, and that allowed me to eat for a month.”
Nowadays, DSC funds are a non-issue at Harrell’s firm. Following a business-model overhaul, the team at the firm now work as referring agents to an asset management company they joined two years ago. The practice has welcomed a fair number of greenhorns, giving Harrell a clear idea of what it takes to support young advisors just starting out today.
As an example, he talked about a new hire whose typical client has a $50,000 account – the natural market for an aspiring advisor fresh out of university. With a 1% trailing commission, they would get $500 a year, or roughly $40 a month. That means for anyone who wants to strike out and build their own independent practice from scratch without DSCs, the math doesn’t work.
“I'm not going to say we won’t see any young people building their own practice. But they would need serious funding behind them,” Harrell said. “But even with backing, they will have to sink that into leasing equipment, leasing office space, hiring people … in all likelihood, it will just take too long to get the revenues rolling in. So what do they do? Burn through their life savings? Can they really afford that risk?”
That leaves many young advisors two options, in his view. The first is to look for an independent advisory firm, likely one with an eye toward succession, that they can eventually go in and buy as a ready business with scale. The other is to start at a bank-owned firm where they can get a salary.
Within that context, Harrell says the banks have an edge in the competition for young talent. Independent advisory firms like Harrell’s may be able to offer hybrid compensation consisting of a modest base salary plus commissions. But because the majority of fresh graduates coming out of university are burdened with student debt, and most don’t understand commissions, he said they would be more attracted to the immediate security of a steady paycheque.
“I just think we need some sort of mechanism for us to get younger people into the individual advice channel, and it seems to me like those options are slowly being dwindled down,” Harrell said. “It would be nice to see an organization come up with a plan, and maybe support from a regulatory body, so we can innovate on ways to bring young people into the industry. I would love to see an initiative like that.”