The parliamentary inquiry into financial products and services in Australia has closed, receiving nearly 400 submissions from industry organisations and from individuals. Unsurprisingly, one of the most common recommendations from submissions to the inquiry was to phase out commissions as a form of remuneration to financial advisers.
It's a recommendation that has few dissenters within the SMSF advice industry. The Self-Managed Super Fund Professionals' Association of Australia (SPAA) says the proposal is a natural progression for an industry that should have weaned itself off product-related remuneration long ago. "I doubt that many of our members are charging commissions anyway," says SPAA director and vice chair Graeme Colley. "It just hasn't been part of the professional culture they've come out of."
Some submissions have suggested that one way of removing the temptation for advisers to gravitate towards the highest commission-paying product is to rule that every financial product pays the same level of commissions. But that solution still fails to remove other conflicts of concern in the adviser-product-client nexus, Bluepoint Consulting director Tony Bates points out. "The fact is that an adviser earns more commission the more clients he sells product to, he earns more commission if he gears the product, and he earns no commission if his advice is to do nothing."
The essence of the problem is that while commissions may be the easiest way to earn a lot of money in the financial advice business, they don't engender the giving of good advice, says Puzzle Financial Advice principal Bruce Baker. "Commissions reward you for the wrong things - making a quick sale with no effort or research. And they don't reward you for doing the right thing - conducting careful research into a broad range of investment options."
There has also been a lot of attention paid to the failure of disclosure to achieve the transparency necessary to overcome possible conflicts of interest. "The way fees and charges are abstracted from investment products, and the way it is split between adviser, dealer, platform and investment house, is very complex," says Gordon Black, of Advisersure Financial Consultants. "So even with full disclosure, the vast majority of clients will be confused, leaving a great deal of room for the unscrupulous to blur the truth."
No such thing as free advice
Indeed, Black points out that many clients believe they are getting a free service when their adviser receives a commission, not realising that the cost is built into the product and ultimately deducted from their investment balance. That perception undermines the ability of other advisers to charge fees based on service, says Leenane Templeton director Andrew Frith.
"In effect, what that means is that advisers are not operating within a level playing field," he says. "We are competing with advisers whose clients believe they are getting a free service."
However, others have argued that there is no point in banning commissions as long as fund managers have a stranglehold on the advice industry. Other incentive-based rewards and kickbacks such as volume overrides, profit sharing and even white-labelling all compound the close relationship between advisers and the managed fund and financial product industry, Bruce Baker says.
"There is very little price competition in this industry because the way that fund managers compete is by controlling distribution channels or through incentives that bias the system," he says. Black says: "The dealership structure and particularly the close link between dealers and product, especially platforms, results in enormous pressure being applied to advisers to sell particular products."
The pressure starts with the approved product list, he says, which have a preponderance of in-house product backed up by "support" related to those products "which makes it easy and comfortable for the adviser to promote those particular products".
The adviser may receive non-cash benefits from the dealer that are effectively paid for by the product manufacturer, who pays "volume" or "marketing" incentives to the dealer. "None of this is disclosed of course and it takes a peculiar kind of adviser to buck the system."
Defence of commissions
However, there are some within the SMSF industry who argue that commissions are not necessarily the evil they are portrayed to be. Strategic Wealth Management director Nick Moustacas believes commissions simply provide another option to clients on how to pay. "We give the client the choice on the fee arrangement. Any commissions are disclosed in both dollar and percentage terms to clients in the SOA (statement of advice). Our practice is to work through the SOA with clients page by page and discuss the fees section when we get to it." However, Moustacas acknowledges that is not a practice that all planners may employ.
Blueprint Planning director David Powell says commissions help subsidise his practice to provide his clients with the education and the awareness they need, but are not necessarily prepared to pay for. "You need to create an incentive for financial planners to give their clients information they are indifferent to the importance of. What service could we provide if we didn't have that retainer in the form of commissions?" Powell says that even though his Perth firm was one of the pioneers in charging fees for service, it couldn't survive purely on that basis. "You have to understand that this is a marketing business. We have to find people and we have to protect people and clients need ongoing service and how are you going to pay for that?"
Even so, for most in the SMSF industry, if a ban on commissions was to succeed it would make little difference to their operations. With many coming out of the accountancy and administration side of the profession, where there is more of a culture of fee for service, and with a greater emphasis on strategic advice and investments in direct shares and exchange-traded funds, SMSF advisers have long been less reliant on commissions for their remuneration.
Support for asset-based fees
However, ASIC's recommendation in its submission - to ban asset-based fees that are levied as a percentage of funds under advice - appears to be another matter altogether, engendering strong debate within the SMSF adviser community.
Asset-based fees are totally different to commissions, argues Frith. "Commissions have a sales-based aspect, in that you are paid solely as a result of a sale, whereas asset-based fees are a good incentive in that the adviser shares in the downside as well as the upside." Unlike commissions, a client can turn off an asset-based fee if they're unhappy with their service, he adds.
Gordon Black says his firm charges asset-based fees to cover the costs of giving quality ongoing advice. "We don't charge by the hour because we want clients to feel completely unimpeded from talking to us as much as they need or want. We want to be able to be proactive - to send emails, letters or call as often as we feel the need in order to deliver positive outcomes and we don't want them to think we are doing these things just to rack up billable hours." The trouble with fee for service is that it creates a purely transactional model that does not support ongoing service, says Multiport technical services director Phil La Greca. "That means that fee for service is necessarily activity driven. And where does the money come from to fund ongoing service and advice? What about the people who don't have a spare few hundred dollars in their pocket every time they need advice?"
Even those SMSF advisers who have come out of the accountancy industry argue that the fee-for-service model doesn't always work well. Andrew Frith says: "We've been moving away from hourly fees as chartered accountants towards an agreed rate that depends on how much value we are providing." Hourly fees make it possible to drag out the time you work on something as long as you like and charge accordingly, he says. "With a fixed price for a service the efficiency of the job falls back on the accountant."
Gordon Black says that over the past 28 years he has rarely known an accountant to be proactive. "Accountants just don't have the time or resources to do what we do, nor do lawyers. All professionals do good things but we do a multifaceted number of complex things and trying to break them apart for billing would be ridiculous - I'd have to charge three times as much to very few clients!"
Aligning client and adviser interests
Asset-based fees generate a cross-subsidy that funds the servicing of all clients, without the behaviour-skewing financial incentives of commissions, says La Greca. "There is nothing wrong with asset-based fees as long as you have appropriate risk balances and as long as it is structured properly to align the interests of the client and the adviser."
The Professional Super Advisers director Kevin Smith charges his clients entirely by fee for service. But while he understands why ASIC might want to ban anything that promotes sales and high-risk, high-growth strategies, he believes to do so with commissions and asset-based fees at once would be a disaster for the industry. A transition from commissions to asset-based fees is viable, Smith says. "But insisting that advisers charge just by hourly fee will probably close up the whole investment shop. A lot will say it's just too hard. And the government has to make sure that the transition of this industry is in the best interests of clients and that they can still get the advice when they need it."
"It's a lot easier to charge a fee for service when you're a start-up. You tell the client this is how I charge. But when you've got an existing client base it's a bit more difficult to tell them you've got to change over now and start paying fees out of your own pocket. To a client, to say you owe us $5000 a year sounds very different than saying we'll deduct 0.7 per cent of your funds under advice each year."
Even Treasury in its submission to the inquiry was concerned that a fee-only structure could make the advice industry less accessible to the less affluent. "Some clients may be unwilling to pay upfront fees, in particular in cases where smaller investments are involved," Treasury's submission stated.
Building a professional service fee model
According to Colley, however, fee for service is simply the way professions operate, "where you are paid for the effort you put in rather than a set amount according to the amount invested or the amount being advised on".
SMSFs lend themselves well to the structure where a trustee is prepared to pay for what they need in areas they don't have the skills for themselves, he says.
And in terms of advisers charging clients for ongoing service, "they need to develop a model where instead of clients having to chase them for service, they will need to give clients a reason to come back to them on a regular basis". SPAA chief executive Andrea Slattery adds that on principle it is inappropriate to be stripping an asset designed for retirement income to fund advice. "And why should someone who has $1 million under advice pay 10 times as much for advice as someone who has $100,000. The idea with SMSFs is that the economies of scale should mean that fees reduce significantly the higher the balance of the asset."
Slattery suggests that if advisers want a retainer to fund ongoing service, they should negotiate a set annual or monthly fee for the provision of advice. "That could be based on how complex a client's affairs are likely to be." Setting a dollar fee rather than a percentage based on assets is just a matter of advisers valuing their professional service, she says.
Tony Bates says he charges clients a monthly retainer, ranging from $500 per month for clients needing only a couple of advice sessions a year, to several thousand dollars per month for larger, more complex entities. "Clients love it because they know what they are paying and they know that there is no meter ticking when we are having a good, long, valuable chat. I am one of very few advisers in the country who would happily advise my client to trade up their home or de-gear or give your kids an early inheritance. It is rare that I have ever had a client fee discussion once the retainer is in place, unless I want to raise it."
The payment system means Bates never has work in progress, or debtors. Fees are collected automatically every month and adjusted to CPI automatically every year. "I love it because mine is a true annuity business where I don't have to worry about monthly cash flow."
However, according to many of the submissions by the adviser industry, the bugbear which still needs to be addressed is the anomaly where commissions are tax deductible, while fees for advice aren't. "If people are paying fees out of their personal accounts, that should be tax deductible," says Slattery. "That's an issue that absolutely has to be addressed."
