Would you like to work for free?
By Ed Morrow
Intl. Assoc. of Registered Financial Consultants
In many countries, there is a powerful movement to ban commissions, prompted by uninformed media and politicians who take out of context the policies of fee-base asset managers.
Managing a $500,000 portfolio for one to two percent will generate a reasonable fee. But will it cover the costs of helping a client make the wish decision on how to spend or invest a $10,000 bonus?
Banned in Britain
Financial advisor commissions have been banned in Britain, but this action is not unique to Britain. Similar actions have been taken in Australia, India and Canada. In many cases similar legislation has been drafted that would apply to all financial products, including all forms of insurance. Will these waves reach the U.S. and other countries? The answer is, "Probably yes." If similar legislation were adopted, who would continue to sell the products needed by the public? Would the market penetration begin to dry up? Yes, that has already started happening in other countries, according to advisors in Australia and India.
Which organizations in the U.S. might favor this? Possibly those who are already compensated on a fee basis, such as NAPFA's 2,000 members, and those banks and credit unions that compensate their representatives on a salary basis.
What's happened in Britain and why?
The Financial Services Authority (FSA) is to ban financial advisors from receiving commission for selling investment policies from 2012. The change will change radically the sale of financial policies.
The decision is a revolutionary change for the financial services industry. Commission payments have been at the heart of mis-selling scandals involving policies such as mortgage endowments and personal pensions. This is the public motive for the ban.
According to the FSA, "New rules... will remove commission bias from the sale of retail investment products. Firms will have to be upfront about how much they charge for their services, and no longer hide the cost of their advice behind the cost of a product."
The new policy will apply to the sale of investments such as pensions, annuities, and unit trusts, but not (at the present time) to mortgages and insurance policies.
Emphasis on suitable advice
When the new rules start, financial advisors will have to charge their customers directly for their services, and will have to tell them exactly what their charges are. The fundamental point is that consumers will be able to see how much is charged for advice.
Firms will not be able to accept commission in return for recommending specific products.
According to the FSA, "Consumers will know what they are buying upfront, how much it will cost them and also have the peace of mind that it was recommended to suit their needs."
For decades, the financial advice industry has thrived on salesmen earning commission from insurance firms and fund mangers in return for advising clients to invest in their policies. The sale of policies is supposed to always be in the best interest of the customers. But after looking into the matter for the past four years, the FSA has concluded that the system simply does not work.
"The changes also mean firms offering independent advice will have to demonstrate that their recommendations are based on a comprehensive and unbiased analysis of the market, and that any product selection is made in their clients' best interests." This is similar to the expanded fiduciary standards that are advocated in the U.S. by the Financial Planning Coalition (a three-way consortium of fee-only advisors at NAPFA, The CFP Board located in Washington, and the FPA located in Denver).
The FSA spokesperson said, "However, if a firm chooses to limit their product range to certain investments or strategies, then the services they offer are restricted, and this should be clearly set out for customers."
Special treatment for banks
If an advisor's charges are too expensive for a customers to pay in one go, they can be given the option of spreading their payments over time and be included with any other charges that might be levied, for instance by a fund manager. "The fundamental point is that consumers will be able to see how much is charged for advice," the FSA pointed out.
Widespread impact on the economy
The changes may affect more than just the thousands of independent financial advisers (IFAs) who make a living advising on and selling financial policies. Banks and other lenders have also earned billions of pounds in commission from insurers by selling their payment protection insurance policies, designed ostensibly to help people pay credit card bills, personal loans, hire-purchase agreements and mortgages if they fall ill or lose their jobs.
These policies have been denounced by consumer groups for being little better than a protection racket, and their sale is in the course of being severely restricted. These and other "pure protection" policies, such as life and health insurance, can still be sold on a commission basis (for the time being).
But the FSA said it was considering legislation to force salesmen to tell customers that commission was involved and how much they were getting if they sold the policies alongside an investment. The FSA's own consumer advice panel welcomed the regulator's announcement as a huge step forward. "At last, the distortion created by commission will be removed from investment advice," said Adam Phillips, chairman of the Financial Services Consumer Panel.
The FSA Panel contends, "The FSA has stuck to its guns, and really has acted to protect consumers and improve the system. Once the new rules are in place, independent advice will have to be truly independent, and not undermined by any commission paid by the product provider."
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