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Does a Commission Ban Actually Help Consumers?

By Michael Snowdon, CFP 

In case you have missed the trend, financial regulators are on the move. While this is not true everywhere, it is becoming increasingly prevalent around the world. One of the big areas of concern  is how financial folks, including planners, get paid. Seems many regulatory bodies believe financial professionals have been somewhat less than transparent, perhaps even moving into the realm of receiving unreasonable amounts of money from clients. Regulators think this ought to be different, and have started creating rulings to make it so. Specifically, there seems to be an emphasis that those who are paid to give advice should not profit from its implementation. Read: if you provide financial advice, you should not also collect a commission on transactions when that advice is followed.

As I said, this trend is not universal . . . yet, but it seems to be a growing movement. So, is it fair? Does it help or harm consumers? How will it impact financial planners, especially those whose primary income source is commissions?

Does One Size Fit All? 

I want to focus on whether banning commission helps or harms consumers. From my perspective, the answer is a definite . . .  well, maybe or maybe not. Let’s take a look. Another way to ask the question is whether fee-based advice (or financial planning) is the better option. In my opinion, the answer is yes, sometimes. See, there’s a problem with a “one size fits all” solution.

Let’s say that I need to receive a minimum of US$5,000 per client to cover business expenses – including client services – and provide me with an income. Maybe the figure for you is closer to half that amount; maybe twice that amount; but we will use $5,000. For a client with AUM or net worth of $500,000 or more, that $5,000 represents a reasonable percentage. This is not true for someone with a net worth of only $50,000 – $100,000. For them, $5,000 represents up to 10% of their AUM or net worth – every year. Over a ten-year period, they would pay $50,000. Clearly unreasonable!

Let me add that the lower-asset client will often require a similar time commitment as the higher-asset client. So, if we switch the fee arrangement from annual to hourly fees, the situation gets no better. If I am the client with $50,000, I am quite correctly going to start questioning the amount I am paying for the services I am receiving. A reasonable question to ask is whether someone with this level of net worth needs ongoing financial planning. Although there is not one answer for all, in many cases, without good financial planning, they will not be able to substantially raise their net worth or achieve their financial goals.

Here’s my problem with requiring that all advice be provided with no option for transaction-based earnings. If I have a planning practice, it has to be financially viable. To do that, I have to charge a large enough fee to make it worth my time. Unfortunately, there is little way I can charge a lower-net worth individual a fee that works for everyone.

The Dilemma 

So let’s get back to the question of whether the fee-only requirement benefits consumers. The answer, as I mentioned earlier, depends. One criteria is the client’s net worth, along with how much service will they require each year. I do not think that it’s too much of a stretch to say that charging a client with low assets an annual fee of $5,000 can actually approach being a violation of the “client-first” principle. Yet, if I do not charge a reasonable fee, I will put myself out of business. Therefore, I will likely make the business decision to work only with clients who have higher minimum levels of net worth (or AUM, or however else you want to categorize). Who then, will provide quality financial planning/advisory services to those with lower levels of wealth? And, if qualified, experienced planners cannot afford to work with clients of lesser means, does this really benefit the consumer?

Here’s my point. I don’t know that a one size fits all approach is best. Why? I do not think it necessarily serves the very people it is intended to protect. Yes, I recognize the potential ethical problems resulting from commission-related conflicts of interest. However, I would say that a fee-only planner can have similar conflicts of interest, because they, too, have to earn a living. If regulations serve to limit (or eliminate) access to truly qualified financial professionals, is the public really being served? At the same time (on the other side), a penchant to earn what could be categorized as excessive commissions, should not be tolerated.

Would it not be a better solution to require full compensation disclosure, and allow the individual to decide whether it is in their best interest to work with a given financial professional? At the same time, perhaps limits could be placed on the amounts that can be charged (either as a percentage or in absolute monetary terms). Would this allow all concerned to make reasonable choices on client-planner relationships? Or, is it really better to eliminate transaction-based earnings for anyone providing financial advice?

I would like to hear your thoughts below. It’s an important topic, and one that ultimately, will have a significant impact on the financial planning profession.

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