The Canadian Securities Administrators (CSA) is launching a review of the use of chargebacks in the mutual fund industry. The CSA is undertaking this review due to concerns about potential conflicts of interest associated with this practice.

A chargeback involves an upfront commission paid directly by a life insurer or other provider to s financial advisor on the sale of a segregated fund. They occur when investors redeem their securities before a fixed schedule as determined by the dealer firm, and the dealing representative is required to pay back all or part of the upfront commissions and fees.

The review is aligned with the CSA’s 2022-2025 CSA Business Plan, which includes assessing whether additional mutual fund sales practice rule modernization is needed to improve investor protection and maintain investor confidence in Canadian capital markets. The review will include a survey of securities registrants on their use of chargebacks. It will also involve Canadian Investment Regulatory Organization (CIRO) staff participation.

On September 8, 2022, the Canadian Council of Insurance Regulators (CCIR) and the Canadian Insurance Services Regulatory Organizations (CISRO) released for public consultation a discussion paper on upfront compensation paid for the sale and servicing of segregated funds and individual variable insurance contracts, which identified chargebacks as possible conflicts of interest. On May 15, 2023, the CCIR and CISRO published a news release indicating that there is a risk of customer harm with the use of chargebacks and that they will develop guidance on the controls that need to be in place. While the use of chargebacks is not as common for the distribution of mutual funds relative to the distribution of segregated funds, chargebacks raise the same conflict of interest concerns for mutual fund distribution.

The review of chargebacks follows, and complements, the review of the practices of mutual funds that have principal distributor relationships with registrants to distribute their securities, announced in September 2022. The CSA will use the information obtained from both reviews to determine whether regulatory amendments to National Instrument 81-105 Mutual Fund Sales Practices or other instruments are needed now that the Client Focused Reforms have been implemented.

For more information, please call Barbara Hendrickson at BAX Securities Law (647) 403-4606.

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