The use of chargebacks in the mutual fund industry is the latest practice to draw the focus of Canadian regulators who have been set on addressing conflict of interest concerns in the Canadian investment industry. On June 1, the Canadian Securities Administrators (CSA) announced that, in conjunction with the Canadian Investment Regulatory Organization (CIRO), it would be undertaking a review of the use of chargebacks in the mutual fund industry.
Chargebacks are a form of compensation structure whereby a dealing representative is paid upfront commissions and/or fees when their client purchases securities. If the client decides to redeem their securities before a fixed schedule expires, the dealing representative is required to pay back all or part of the upfront commission/fee they received. Similar to a deferred sale charge (DSC) structure which was banned in the securities space as of June 1, 2022 (and in the segregated fund space as of June 1, 2023), the chargeback model is predicated on clients maintaining their holdings for a set period of time. The potential conflict embedded in the structure is that dealing representatives may be incentivized to keep their clients in their holdings until the chargeback period has expired. This arguably interferes with a dealer’s obligations to recommend and evaluate investment recommendations influenced only by the best interests of the client.
The CSA’s scrutiny of the use of chargebacks follows a lengthy public consultation conducted by the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organizations (CISRO) which concluded earlier this year that there is a risk of customer harm with the chargeback model in the segregated fund space. Both the CCIR and CISRO indicated they intended to share their findings with the CSA and would monitor the work the CSA undertakes to address similar compensation models on the mutual fund sale side. For now, the CCIR and CISRO have opted to develop guidance and controls with respect to compensation practices, deciding not to ban chargebacks outright.
The CSA has indicated that the results of the review of chargebacks will guide any possible changes to the mutual fund sales practice rules going forward.
June 30, 2023