Firms killing commissions? It may sound far-fetched, but in an effort to become recognized as a genuine profession, the Australian financial planning industry is heading that way.

Canada’s and Australia’s financial services industries have their fair share of similarities. Both are dominated by a handful of banks. In both places, the sector has consolidated, distributors and product manufacturers have merged and dealers are trying to morph from a product-driven business into a profession that’s based on providing advice.

This sort of transition is never easy and compensation issues are inevitably a source of trouble. In the wealth-management business, however, this is particularly true because the front-line troops tend to be highly motivated and production-oriented.

But, as important as compensation can be to advisor motivation, it’s also key to investor credibility. Yet, in the financial services industry, firms often prefer to keep the compensation low-key — complex and embedded in the products they sell. The result is that while most firms claim to add value by dispensing advice, they are paid for selling products. This creates conflicts of interest.

In Australia, the wealth-management industry is coming to the conclusion that this conflict is best avoided. As a result, some of its most prominent players are dumping commissions in favour of fee-for-service arrangements.

At the forefront of this move are a couple of the country’s big banks. Earlier this year, MLC, a subsidiary of National Australia Bank Ltd., announced that its financial planning subsidiary, Godfrey Pembroke Ltd., would move to a fee-for-service model for all new clients as of Oct. 1. Under the revised system, advisors must charge asset-based or flat fees and rebate any embedded commissions. Existing commission arrangements will be maintained unless clients want to change them.

“Given that many GPL advisors are already charging fees for service and that commissions are constantly coming under fire for creating conflicts, advisors felt it was time to make a decision as a group to lead the move away from commissions on investment products,” says Mark Rantall, managing director of GPL.

MLC is the second big financial firm in Australia to move away from commissions and toward fees. In February, another of the Big Four banks, ANZ Bank Group Ltd., began using a fee model for its financial planners in an effort to improve transparency. “Fee-for-service will fundamentally change the way that financial advice is valued,” said ANZ’s general manager of financial planning, Mike Goodall, in announcing the plan. “It involves a change of mindset on the part of our planners as we progressively move away from commissions to fee-for-advice work.”

The decision to do away with commissions in favour of fees is largely aimed at shoring up the industry’s credibility and eliminating the potential for conflicts. Earlier this year, the country’s regulator, the Australian Securities and Investments Commission, released the results of a “mystery shopping” exercise, which found that clients were six times more likely to receive bad advice from the financial industry in situations in which a conflict exists, compared with scenarios in which there are no conflicts.

“Where the advisor had a remuneration conflict, 28% of the advice clearly did not have a reasonable basis, and a further 7% probably did not. In contrast, when the advisor did not have a conflict, the percentages were 5% and 1%, respectively,” reported Jeremy Cooper, deputy chairman of ASIC, in a speech.

Also, poor advice was three times more likely when the advisor recommended a proprietary product rather than a third-party product. “It is clear from the survey that there is a much higher risk of inappropriate advice when the advisor is conflicted,” Cooper concluded.

The idea that more than a third of clients may be getting bad advice and that the advisors’ compensation scheme is to blame has the industry on notice. In response to findings such as these, it is trying to get out in front of the conflicts issue. The Financial Planning Association of Australia Ltd. (which administers the certified financial planner designation in that country) has come out with a set of four principles designed to address these concerns. Among other things, it calls for planners to charge for planning services directly, and to disclose both these fees and all other forms of compensation on a regular, ongoing basis.

@page_break@The effort to push firms toward fees is about putting a value on advice. “Financial planning advice is a service that is valuable in its own right, and consumers should be aware of its cost,” says FPA chairwoman Corinna Dieters. “Separating the cost of advice from other costs highlights the value of the advice.”

In doing so, the FPA defines a financial planning fee as “a fee that is negotiated between the client and his or her planner that can be changed by agreement between them.” It must be disclosed to the client separately from any product-related costs. Charges that can’t be broken out, altered or terminated by agreement must be called a commission and must be disclosed regularly. That means, for example, that advisors would be required to inform their clients every year of the trailer fees collected on their accounts for that year.

Despite the industry’s efforts to address criticism, it’s not clear that enhanced disclosure will satisfy regulators. “Disclosure is not, by itself, always an adequate response if the conflict still leads to advice that is inappropriate or compromises the client’s interests,” ASIC’s Cooper notes.

While disclosure is often preferred by the industry and regulators over an outright ban of certain practices, it appears that in Australia both sides are starting to realize that, even with disclosure, the presence of conflicts can be overwhelming and detrimental to clients.

In a speech this past May, MLC CEO Steve Tucker said, “I agree with ASIC — any system that pays an advisor more for one particular product over another has the potential to influence the advice outcome, and this may not be in the best interests of the client. This practice is wrong and should not be defended.”

Tucker added that disclosure is not enough anymore; the time for a commission-based business has passed: “Conflicts can be removed, but the ongoing use of commissions as payment for advice means the perception of conflicts remains.”

The commission structure helped the industry grow in its early days and, while it remains convenient, he noted: “The commission structure no longer delivers the value to the industry it once did. In fact, it is damaging the industry and preventing advisors from being regarded as members of a fully fledged profession.”

The credibility problem facing the Australian planning industry is not unique. Several years ago Britain’s Financial Services Authority pledged to scrap commissions in its retail investment industry after its research showed strong evidence of significant compensation-related bias in the advice clients receive. However, in the face of industry pressure, it backed down.

In Canada, too, these issues have been uncovered. In the mid-90s, Glorianne Stromberg’s reports on the industry pointed out the distorting effects of the prevailing compensation system. And the Ontario Securities Commission’s progressive attempt to reform retail regulation, the fair-dealing model, has tackled the issue of compensation-related conflicts.

“There is reason to believe advisor compensation — rather than the best interests of investors — is driving asset-allocation choices to a significant extent, even though all the relevant information is publicly disclosed in some form,” the FDM concept paper notes. It also questioned whether existing disclosure was actually useful to investors, and tossed out the idea of eliminating embedded compensation.

“A system of direct compensation for advisors allows the market to operate more freely by enabling compensation to be negotiated between the advisor and the investor, instead of being preset by a third party,” it points out.

MLC’s Tucker says that while he favours shifting to fees, he doesn’t want to ban commissions: “The industry is suffering from what I call ‘corporate gridlock,’ in which the participants are locked into an operating model that no one player wants to break in the fear of losing a competitive advantage.

“This needs to change,” he says. “I believe in a free market and giving people choices. I am urging advisors to consider the long-term benefits of a fee-for-service model and get ahead of the curve.” IE