Investor groups push regulators to ban chargebacks and review principal distributor commissions model
Investor advocates and industry groups are calling on regulators to ban advisor chargebacks and revise the principal distributor model in Canada’s mutual fund market, citing ongoing conflicts of interest and a lack of regulatory alignment.
According to The Globe and Mail, principal distributors are investment dealers that receive exclusive rights to sell mutual funds from a single fund family.
In return, some fund companies offer upfront commissions to advisers who lock in clients for a typical term of about three years. If clients redeem funds before the term ends, advisors must repay part of the commission.
During a recent Canadian Securities Administrators (CSA) consultation, investor advocates said these commissions, known as chargebacks, create an “inherent conflict of interest.”
Michael Thom, managing director of CFA Societies Canada, stated that the model may incentivize advisors to discourage redemptions in order to avoid repaying commissions, even if holding the funds no longer suits the client’s portfolio.
CFA Societies Canada warned in a consultation letter: “Chargebacks carry the negative potential that advisors may consider their own interests above that of their clients.”
The CSA is now considering a potential ban on chargebacks. The regulator also proposed amendments to close a loophole that exempts principal distributors from the 2022 ban on deferred sales commissions (DSCs).
While DSCs were prohibited after a decade of consultations due to high penalties for early redemptions, the ban did not apply to principal distributors, who were excluded from certain regulatory provisions.
Investor advocate Ken Kivenko told The Globe and Mail he was “shocked” to learn chargeback fees were still being used, despite efforts to eliminate DSCs and enhance investor protections.
He said asset managers have adapted by finding alternative incentives, including chargebacks.
“The entire principal distributor model is a slap in the face to the client-focused reforms,” said Kivenko.
“How is it in the best interests of clients to limit their choice to one fund family? How is it in the best interest of clients to have an advisor who will be disincentivized to tell you to sell a fund if it is no longer working for your portfolio?”
Though chargebacks do not penalize clients directly—only advisors pay back commissions when early redemptions occur—Kivenko argued: “Chargebacks are evidence that advisers are in the business of sales, not advice.”
The chargeback issue dates back to 2023, when regulators first raised concerns about potential conflicts in the insurance industry.
Now, the topic is under renewed scrutiny in the broader CSA consultation.
Kivenko criticised the slow pace of reform, writing in a public comment letter that regulators have taken “no action other than yet another consultation on the obvious.”
“We cannot begin to express our frustration with this glacial speed of investor protection compared with the quick reaction the CSA takes to reduce industry regulatory burden,” he said.
Thom echoed concerns about the lack of oversight.
He questioned why the principal distributor model continues to operate without a “more fulsome review,” particularly following the rollout of client-focused reforms in 2023.
“Most Canadians don’t know what regulatory regime they are facing when they seek investment advice,” said Thom.
“But for some reason, those rules seem to be partially suspended within the principal distributor model. And we don’t know why.”
The CSA also proposed limiting principal distributors to selling mutual funds from a single fund family.
The regulator said in its consultation that this restriction would make conflict-of-interest concerns “less acute.”
In response, some dealers warned that further narrowing product options could exacerbate existing problems.
The Canadian Independent Finance and Innovation Counsel (CIFC), which represents investment dealers, rejected the CSA’s view.
CIFC chief executive Annie Sinigagliese said in a comment letter that limiting distributors to one fund family could “significantly reduce” investor choice and “in fact may increase the potential for conflicts of interest.”
Sinigagliese challenged the continued relevance of the model, even under the proposed single-family limitation, and warned of potential consequences.
“We would like to highlight potential negative effects on investor retirement savings, noting that reduced competition could result in higher fees and fewer investment options for retail investors,” she added.
The CIFC, alongside investor advocates and CFA Societies Canada, urged the CSA to broaden the scope of its review to include a “more extensive evaluation” of the principal distributor model.
