FaceOff: Advisor commissions debated

Welcome to FaceOff which features a discussion from two advisors on a hot-button topic. This month, we hear from opposite ends of the country about how advisors are paid and whether fees and commissions are scrutinized fairly.

Originally moderated by Deanne Gage

Participants:

• Brad Brain, registered financial planner, Brad Brain Financial Planning, Fort St. John, B.C.
• Steve Thrower, financial consultant, Madoc, Ont.

How they’re paid

Brad Brain: In our practice, when it comes to mutual funds and segregated funds, we use DSC but also low-load, front end and fee for service. Although we offer fee for service, we don’t really get a lot of uptake on the idea. The ones who use it typically have larger portfolios, and we can save them some money by using F-class funds. We can’t always save the client money with F-class funds on smaller portfolios. Generally speaking, I work with people with good incomes but many of them are still in the accumulation phase.

I’ve struggled with how to handle the tire kickers, the ones who come in and want to pick your brain for an hour and consume your valuable resources and then you don’t hear from them again. We’ve experimented with different things, but we’ve stuck with “the first appointment is on us.” Although people take advantage of that from time to time, I haven’t found a better solution because until we get into a discussion we don’t know whether we will be a good fit for them, and vice versa.

Steve Thrower: I’ve been offering fee for service for eight years now. The first meeting is offered on an hourly basis to interview the client and offer my services that may or may not meet their criteria in what they’re looking for in an advisor. I don’t offer any free consultations unless in extreme circumstances. If the potential client feels we’re compatible, then a second appointment is made at their request. At this time I require all current investment statements, real estate values, group plan benefits and its investment statement, current debt structure, two years’ worth of income tax statements and current information of all life insurance policies. During the third meeting, the assessment of their current situation is presented in plain-language written form. If the client needs more time to access this information, it’s still billed hourly.

During the fourth appointment, by request from the client, we usually discuss, “Where do we go from here?” The client now has the option of total hourly or a percentage of total assets with an increment increase for all provided services. I don’t normally have anything to do with DSC or front ends, except in extreme circumstances such as a locked-in LIRA plan. I use all front-end load funds with a trailer fee. This is to appease any dealer; you must produce a commission or something in order for them to stay in business. This business is still oriented toward commission.

DSC: Outdated or necessary?

Steve: My biggest reason for not using DSC is lack of disclosure. There are many advisors out there who tell clients these products don’t cost them anything, there are no fees. Even the banking system offers that statement. Where did the trailer fee go then? The problem with commissions, DSC in particular, is how they get misconstrued. If it’s a level playing field, there’s full disclosure and clients understand who gets paid a commission and who gets paid a fee, fine. But that’s not what happens. Getting paid 5% to the dealer – then down to the rep – is unheard of these days if it was disclosed. It is a vicious cycle: the dealer needs money to survive, the mutual fund company has to deliver the product and the rep has to live. I just hope in the future that there will be fewer variables for all to work. This would also include with life insurance companies, segregated funds, which have very similar trailer fees and DSC and front-end loads.

Brad: DSC can be a convenient scapegoat for a guy’s bad choices. If you buy the wrong product, and want to get out shortly after, then don’t blame the DSC schedule. If there is a lack of disclosure about how a DSC schedule works, that isn’t the fault of the DSC schedule. It’s the fault of the rep. In my practice, most everyone who has $100,000 or less in investable assets and a long timeframe goes under a DSC model. What that does is compensate me for my time and what I’m bringing to the table. I like that the DSC schedule allows me to work with people who don’t have $250,000 in their RRSP and I like that it puts people’s attention on taking a long-term perspective with long-term investments. It’s a model that allows smaller investors to be serviced by guys like me rather than get tossed on the scrap heap.

Trailer fees: ethical conflict?

Steve: I’ve tried switching clients over from a front-end fund at no switch fees to an F-series fund. The price of an F-series fund provides no advantage to the client, as the price has been increased versus a front-end load of the same objectives. It’s the same return. If you were investing in an F series with no trailer fee, then your fee based on a percentage of assets would be higher as the dealer still needs to be paid. If you’re using a trailer-fee model, the percentage of your asset fees will be lower by the full point of the trailer versus F series. That’s the way I do it. So in either sense, both are exposed.

Brad: I’m not at all conflicted about receiving trailers. I just can’t believe the political naiveté that goes with the perception that trailers are a problem with the industry. Commissions are not a four-letter word. Whenever there is a question of ethics it’s easy to place the blame on the compensation model, but that’s wrong. It’s the ethics that are the problem, not the compensation model, and every compensation model can be abused by someone so inclined. The bottom line is there’s never going to be a way to legislate good behaviour. Restricting how clients engage with their advisor certainly won’t stop crooks, it will only impair the ability of the vast majority of advisors, who are honest and ethical, to serve their clients. More rules won’t deter crooks because crooks don’t follow the rules. We’ve had unimaginable frauds and deceptions despite IIROC and the MFDA increasing their levels of scrutiny. Nothing good will come out of banning trailers. On the contrary good advisors will be forced to rethink their business model and clients will suffer for that. What we need is principles-based regulation, not more and more rules. Rules can always be circumvented, but principles are not ambiguous.

Steve: Trailer fees are just the module set up by investment companies. If they try and take it away, it’s going to cost the client more.

Brad: Yes, there’s no doubt about that in my mind. If the costs to the client did not increase, it would not be affordable for a professional financial planner to work with the average client who has $50,000 in his RRSP, a mortgage and a couple of kids he wants to put through school. So 95% of those types of clients will be abandoned. They will end up being served by glorified clerks who have poor training, no E&O insurance and no credentials such as a certified financial planner designation. And these clerks don’t tend to stick around. How can you fully understand a client if there’s a new “advisor” every six months and zero incentive to service the client? Trailers, in my mind, are the perfect scenario – if you don’t service your client, you won’t have him for long. What can be more pure than that? If I don’t take care of my clients, they’re going to walk, that’s the reality of it.

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