New York—Canada’s new brokerage commission regulation is less ambitious than originally proposed, reducing the amount and nature of commission disclosure required. Reflecting concerns from investment advisors and securities firms—and the lack of a commission disclosure regime in its large neighbor to the south—Canada’s proposed soft dollar regulation places greater emphasis on narrative disclosure while significantly reducing the amount of quantitative disclosure. Nevertheless, the new Canadian regulation may offer a preview of what we might expect from the SEC, when (and if) it proposes its own brokerage commission disclosure guidelines.
The disclosure requirements of the soft dollar rules proposed by the Canadian Securities Administrators (CSA) in July 2006 were by far the most controversial element. The original rules went beyond the standards imposed by the Financial Services Authority (FSA) in the UK, requiring client-level and security-level disclosure of the commission amounts spent on research services and order execution services. This unleashed a firestorm of protest. Commenters argued that this would be extremely difficult if not impossible, very costly, and of little value to clients. Further, many argued that Canada should put a higher priority on harmonizing with the US (which has no commission disclosure standards) than with the UK (which has had commission disclosure standards in place since the beginning of 2006).
In its revised rules, the CSA acknowledges that it went too far:
Due to the lack of precision regarding costs for bundled services, as well as timing differences between the trades that generate the commissions and the payment with those commissions for the goods and services, we agree that the detailed disclosure would be difficult to make with any degree of accuracy.
The new disclosure requirements are primarily narrative, similar to Part II of the SEC’s Form ADV. The CSA has added three new narrative requirements:
- <!–[if !supportLists]–> <!–[endif]–>a description of the process for, and factors considered in, selecting dealers to effect securities transactions;
- <!–[if !supportLists]–>the procedures for ensuring that, over time, clients receive reasonable benefit from the usage of the brokerage commissions charged to them; and
- <!–[if !supportLists]–><!–[endif]–>the methods by which the determination of the overall reasonableness of client brokerage commissions paid in relation to order execution services and research services received is made.
The CSA also requires quantitative disclosure. Each client must receive an estimate of “the total client brokerage commissions paid by the client during the period reported on [periods will be annual]”. Also, the advisers must estimate on an aggregate basis, across all clients, the portion of commissions paid for goods and services other than execution: “on an aggregated basis, where the level of aggregation has been determined by the adviser, the total client brokerage commissions paid during the period reported upon, along with the adviser’s reasonable estimate of the portion of those commissions that represents the amounts paid or accumulated to pay for goods and services other than order execution during that period.” In other words, Canada’s disclosure requirements will be much closer to current FSA requirements, rather than breaking new ground.
The new rules exclude principal trades where commissions are difficult to determine, focusing primarily on equity commissions. It also clarifies the temporal standard for order execution services, diverging from the US definition, which, as a practical matter, may mean that some products are eligible in Canada as order execution services rather than as research services in the US. The definition of research is expanded to allow seminars, raw market data, trade journals, expert networks, and analytic software, provided the services are used in the investment decision and benefit clients. Unlike the US, connectivity hardware/lines are not eligible. Eligible services do not need to benefit specific clients and can benefit clients generally. Commission Sharing Arrangements are fine and the new rules explicitly support independent research. The comment period is open until April 10th, and the new rules will go into effect 6 months after adoption, placing the likely implementation around year end 2008.
The reality is that it would be very difficult for Canada to diverge too far from US practices. It would not be practical to require client level disclosure when the US currently has no commission disclosure. As it is, the CSA are diverging from the US in technical elements (such as the temporal standard or specific items which are eligible) and most materially in the disclosure requirements. This raises the question whether the Canadian disclosure standards, which are modeled on those adopted by the FSA two years ago, will be the fore-runner of the SEC’s own guidelines. Rumors continue that the SEC is close to proposing its own commission disclosure rules, but clearly the Canadians decided not to wait around for their colleagues in Washington.
The link to the new regulation can be found at http://www.osc.gov.on.ca/Regulation/Rulemaking/Current/Part2/rule_20080111_23-102_rfc-proposed.pdf