Fees versus commissions is an important debate for the financial planning industry, but having independent research in the first place will take much of the sting out of the debate, says Mark Thomas.
With the obvious caveat that it is a parliamentary report, the inquiry into Financial Products and Services in Australia, headed by Labor backbencher Bernie Ripoll and handed down last November, makes for interesting reading.
The chapters on the implosions at Storm Financial and Opes Prime, which saw thousands of investors lose millions of dollars, could provide raw material for film scripts.
Ripoll and the eight parliamentarians who sat on the committee spent nine months trawling through the debris of Storm and Opes Prime.
And there was no shortage of people wanting to tell them what went wrong; in the case of Storm, more than 200 angry investors used the opportunity to air their grievances.
Those grievances with the financial system were, in many respects, justified. As Ripoll said when releasing the report, there were clearly multiple failures by Storm and lending institutions: “By recommending aggressive leveraged lending strategies to elderly people on low incomes, Storm’s advisers were not providing advice that was appropriate to their clients’ needs.”
“Both Storm Financial and the margin lenders who provided credit to their clients, particularly the Commonwealth Bank, mishandled issuing margin calls when the market was in decline.
"The committee also found that some banks were lax in their lending practices, providing excessive credit to investors with little capacity to repay when the value of their investments declined,” the report said.
It was a damning indictment of Storm and the banks.
Storm and Opes Prime became the inquiry’s cause célèbres. But as the report rightly pointed out, leveraged portfolios and investor ignorance were not the sole causes for so many people losing so much money during the global financial crisis (GFC).
Chapter five of the report identifies the two most important issues:
- The emergence of financial advisers as a sales force for product manufacturers is inconsistent with contemporary expectations that financial advisers provide a professional service that meet their clients’ best interests.
- Is it advice about financial products or the financial products themselves that is responsible for poor investment outcomes? This question is important because the answer dictates whether the focus of regulation needs to be on improving the quality of financial advice or identifying and restricting the sale of poor financial products.
But the committee’s recommendation about how to address these two questions simply falls short.
For Ripoll & Co, the prime solution is to have financial advisers remunerated by fees, not commissions and volume bonuses.
This debate has been as long as it has been heated, and I wasn’t surprised that the committee opted for a fee-based system.
Ripoll said: “The remuneration incentives offered by financial product providers to financial advisers can lead to consumers getting advice that is not necessarily in their best interests. [We] recommend that the Corporations Act be amended to explicitly state that advisers hold a fiduciary duty to put the interests of their clients first.”
But it’s more than an issue of how financial advisers are remunerated. The real issue is the independence of the research upon which financial planners base their recommendations.
Essentially, there are two models on offer. Firstly, there is research on financial products where the product providers pay to get it rated. Quite clearly there must be questions about the independence of this research when product providers are ‘buying’ their ratings.
Secondly, there is research that is totally independent of the product providers and what they offer financial planners. Instead, the financial planners pay for the research, knowing it is independent of the product providers.
In this way the research house acts as an effective gatekeeper for the financial planner when they assess financial products for their clients.
It means the research doesn’t have the footprint of product providers, and financial planners should be prepared to pay for research about financial products to ensure genuine independence.
And if the research is truly independent, then the issue of fees versus commission loses much of its potency.
For financial planners, it means they can put their hand on their heart and say no recommendation to a client has been influenced by commercial considerations.
If a product fails to meet investor expectations — as some products inevitably will — then the financial planner cannot stand accused of having a conflict of interest.
There is one other important aspect to this.
The GFC clearly demonstrated that financial products are becoming increasingly complex. If you don’t believe me, just remember that many of the victims of Bernard Madoff’s massive Ponzi scheme were Wall Street professionals — not ‘mum and dad’ investors.
It’s not to decry the professionalism of financial planners to say every bit of independent research they can access will help them make the best possible investment decisions for their clients.
Only when we have an industry that is underpinned by independent research will financial planners be able to justify Ripoll’s worthy goal: “Putting the interests of their clients first.”
Mark Thomas is chief executive and executive director of van Eyk Research.
