Giving consumers choice

It may come as a surprise that someone in compliance would step into the debate regarding commissions with a less than negative approach.

The concern that I have is that the current debate is losing its focus because of a fear of the impact of continuing to allow commission, within the context of the current desire to emphasise and enhance the professional image of financial planning.

However, the first and underlying question is whether a thing, or an action, is intrinsically bad, or whether in fact it is the way in which it is used, which is bad. A motor vehicle is intrinsically a good thing. The fact that it is driven too fast, or under the influence of alcohol, does not change its intrinsic quality. It only requires that we regulate the situations in which if can be used in the wrong way.

And so it is with commissions. The first part of the debate should decide whether the commission structure within financial products is intrinsically a bad thing, or whether it is actually the way the advice can be influenced, or the effect upon remuneration arrangements, which is a bad thing.

Commissions: intrinsically bad?

If we think that the payment of commissions in the financial services industry is intrinsically a bad thing, then the only way to deal with it is to level the playing field completely, and to regulate against a product structure permitting its payment.

This would result in an entirely different level of competition amongst product providers. It would also remove the inequity in product cost against direct investors, who, for example, bear the cost of full entry fees when investing without the involvement of a financial planner.

Interestingly however the life companies and fund managers remain silent on this debate.

Alternatively, if we decide that the payment of commissions is not, per se, intrinsically bad, but it is the way in which they affect the client relationship which is the concern, then we should entirely discard the “fee for service vs. commission “type of debate.

It is far too simple, and misleading, to approach it that way. It assumes that there is a divergence in the industry between those who calculate their fee according to the service provided, and those whose fee rate is set equivalent to the commission rate.

This is how the industry may have operated many years ago, when sole operators selling life insurance and similar products were prevalent, but it does not reflect the financial services landscape now.

An alternative method of payment

Financial planning is a business of giving professional advice. As in any business, you firstly have to calculate the cost of the service to be provided to the range and number of clients which you anticipate.

The second step in any business model is to determine how you will be paid for those services, knowing that some clients will not be able to afford a lump sum payment.

So, while you might calculate your charges on a “fee for service” model, you may decide to offer your clients “terms” by which that fee can be paid by instalments. And that is where the receipt of commission comes in. Commission should be treated as a payment which is used on behalf of the client, as one alternative method of payment.

In the business in which I operate, I do not mind if any of our representatives receive the payment of their fees by commission provided that there are certain safeguards in place. The client must understand how commission is paid, and how it will affect the level of effective cost to that client.

Clear closure to clients

I expect our representatives to explain, in the Statement of Advice, the total cost. That is, the “fee for the service”, and then what the options are for the client in respect of how the fee will be paid.

If the client makes a fully informed decision to have that fee paid through the invested funds, including payment by installment through ongoing trail, then the client has equal bargaining power in determining how fees are to be paid.

If a client, who is fully informed about commissions, does not agree to the level of remuneration, or the terms of remuneration which are offered, then obviously the client could proceed to implement the advice without going through the adviser.

The reality being, of course, that this will not necessarily be cheaper.

Then, of course, we are left with the contentious issue of the ongoing trail commission.

Some commentators have suggested that the receipt of ongoing trail requires that ongoing advice must be given.

This might be an arguable proposition where an adviser has not explained the relationship between the initial cost, the ongoing trail and the service options which the client can take. In those circumstances a client could assert that because you have been receiving an ongoing payment, you should have been providing an ongoing service.

The client/planner relationship

However, it all goes back to the contractual relationship which you establish at the outset with the client.

If, as part of the initial advice and services, you offer the client an ongoing service, you will set out the cost of that service to the client. A financial planner should then explain the relevance of the receipt of initial and ongoing commission to the fees applied– that is whether commission will be rebated, or deducted from those fees.

And what if commission is to be received, even if the client does not take up an ongoing service? If this is the case, it should be explained when the client is given the initial advice. After all, it is for the client to agree the rate before signing a managed fund application form. If the full effect of the receipt of commission has been explained at the outset, then the client is in an equal position to be able to negotiate fee or payment arrangements for the service.

If you have told the client that commission will be received even if an ongoing service is not taken up, then the client is in a position to determine how to proceed with your services, if at all, and to negotiate the cost, and the method of payment.

Indeed, the client can determine not to proceed any further with your services, and simply pay for the services to that point.

Then, if an adviser is receiving trail commission because of previous advice given, but not giving ongoing advice, then these people are not “clients” at all in the professional sense. An adviser should then be receiving commission as a form of payment by instalments for services previously given.

Moreover, the receipt of trail commission will usually be factored into the business model of the financial planning firm, as a form of ongoing cash flow, enabling it to control its fees, and subsidise the average cost of its services to its clients.

When we start to view commission as one of the means of payment of the cost of financial services advice, instead of assuming it equates to the calculation of the cost, then the industry will find a constructive solution.

It is in our interests to offer alternate methods of payment. Otherwise we risk marginalizing the many who need financial planning advice, but cannot afford a lump sum payment from limited resources. Those who need superannuation advice, as a result of fund choice, are an obvious client group.

And what does the public itself want?

The 2005 Credit Suisse Investor Experience Report (Nov.2005, undertaken independently by Investment Trends) drew on a sample of 621 responses in the period August to November last year. One of the conclusions was that clients have switched away from paying an hourly fee, favouring a fee deducted from their account. 46% preferred the fee to be deducted as a percentage of the assets invested, whereas only 16% wanted a flat fee.

Our debate on commission should be a little more realistic, and it needs to work towards a solution that is equal on all counts of fairness, transparency, practicality and suitability for the client.

Let the client decide, by providing alternative methods of payment, rather than forcing a debate that does not necessarily have the client’s best interests at the forefront.