“Greed has been allowed to overtake integrity, decency and right decisions for too long and in too many areas from the various mis-sellings to the current debacle. What the financial sector needs is a complete overhaul.” These are the angry words of an ordinary British investor commenting on the “train wreck” that is the capitalist world’s financial system.
In response to this and many other similarly bitter remarks from members of the public, Lord Turner, recently appointed chairman of the UK’s Financial Services Authority, concluded: “What has gone wrong with the world’s financial system is not just a few minor things and it can’t be tidied up by a little more disclosure or a little more transparency. At an international level we need to work out what went wrong and what are the integrated set of actions to make sure this doesn’t happen in the future”.The investor’s comments show considerable perception, noting that the disaster did not occur overnight and without warning. The reality is that a day of reckoning has been coming since the 1980s.
Its cause was an increasingly unstable financial system built on foundations of gluttonous debt. The uncomfortable truth is that structural conflicts of interest (fuelled by a highly lucrative short-term, transaction-based culture) corrupted the industry and blinded it to the long-term consequences of its actions.
The industry was always going to crash and burn. It was only a matter of when.
As for Lord Turner’s response, it doesn’t need a “rocket scientist” (or even a Royal Commission) to work out what went wrong, although official enquiries will take place throughout the western world. The results of those enquiries (Turner’s “integrated set of actions”) are likely to be based on heavier and more prescriptive regulation.
This outcome will be expected and demanded by an aggrieved public that is unlikely to accept the continuity of the predominant free market doctrine of the last 30 years. Unfortunately, history shows that more regulation may not substantially improve the position of consumers of financial products and services.
This does not mean to suggest that reforms are unnecessary or undesirable; however, the community must recognise that regulation cannot force people to think ethically.
This is a much harder and more subtle process. It requires strong moral leadership within the financial services industry, especially by those who claim to offer financial advice to the public. This will involve acceptance of some unpalatable “home truths”.
It is something that the financial services industry must do voluntarily, led by individuals who are concerned about the public interest, rather than about making money for the sake of it. So, for example, lenders must voluntarily adopt and enforce proper lending criteria. And financial planners, whether they are arranging loans or assisting with clients’ wider planning needs, must voluntarily minimise conflicts of interest, thereby putting themselves in a position of demonstrable and genuine trust (not just creating the appearance of it).
Perhaps the current crisis of confidence in the financial services sector might convince well-intentioned industry leaders that the critics may have a point, and that the problems of the industry will not be resolved by “a little more disclosure and a little more transparency (sic)”. Here is an opportunity for the industry to comprehensively and dispassionately examine why financial planning as an occupation has failed (on a world-wide basis) to achieve the professional recognition that it so passionately desires. It’s time for the industry to stop dismissing its critics as “anti-advice”, ignorant, or promoting vested interests.
The truth is that most of the critics are very much pro-advice, so long as the advice is also (first and foremost) independent and pro-consumer. Regrettably, the harsh reality is that financial planning is an integral part of the financial services industry and of its powerful product distribution networks. Therefore, most planners cannot mitigate their personal involvement in the current crisis by suggesting that it was caused by a few rogues “overseas”.
The financial planning industry is part of a seriously flawed and failed system, and must take some responsibility for that failure, and for its reform.
The same fundamental forces that caused the problems in the USA were (and remain) at work in Australia. These forces influence the actions of most planners, to a greater or lesser extent.
This point must not be minimised. It explains why the financial planning industry is not accepted as a profession, and never will be until these structurally embedded forces are removed.
Like it or not, the principal force that corrupts advice in the financial planning industry and constantly destroys any attempts by it to achieve lasting professional status, is the industry’s predominant remuneration structure that relies on the sale of products and the accumulation of funds under advice/management (FUA/FUM) (be they commissions, percentage fees for service, trails and/or production bonuses).
Until this impediment to professionalism is removed, the frustratingly poor image of the industry will remain. No doubt, laudable reforms surrounding disclosure and transparency will continue; but nothing will change fundamentally until the only issue that really counts is addressed, namely, remuneration.
Defenders of the industry’s status quo who have persevered in reading this story so far may now offer their usual criticisms.
These can be summarised as:
a) Consumers should be given a choice about how they pay their advisers;
b) Consumers should be encouraged to seek advice, and they won’t do so if they have to pay fees; and
c) It is offensive to suggest that financial planners could be improperly influenced by remuneration; and
d) The alternative system (hourly rates) is just as bad as commissions and percentage fees for service because lawyers and accountants pad their time sheets;
e) Financial planners can’t survive on hourly rates.
Putting aside (for the moment) the possibility that consumer-friendly reform might be resisted due to the financial services industry’s commercial considerations, here is a (brief ) response to each one of these criticisms:
a) Consumer choice is a superficially attractive point; but in practice, planners will generally (but not always) be conflicted into “selling” the remuneration arrangement that commercially rewards them most. After all, even planners are human!;
b) Many people don’t seek advice, not because they don’t want it, but because they don’t trust it, and therefore, they don’t value it. In addition, most people aren’t attractive sales prospects for planners because they have very few assets on which commissions or percentage fees can be levied. Some planners have overcome this impediment to making money by heavily pushing margin loans;
c) Remuneration drives behaviour (an immutable law of business). If that were not so, this debate would not be happening;
d) Some accountants and lawyers do pad timesheets, proving that conflicts of interest exist in all commercial transactions. The trouble with conventional financial planning is that complex and confusing conflicts exist on several levels, not just one. While time-related charging has its problems, at least the client is assured that the adviser is selling advice, not products, and that a third party is not in the mix influencing the outcome; and
e) In order to avoid the possibility of going broke through charging hourly rates, financial planners can replace trails with an (indexed) annual retainer (the quantum of which is unrelated to FUM/FUA). This is not a difficult “sell” to clients, assuming that enough value-added work has ever been done in order to justify the trailing commissions/ fees that are being replaced.
It is interesting to note that while many financial services industry leaders feel that they must be seen to support the public rhetoric, they also accept privately that the only way for financial planners to gain true professional acceptance is to adopt remuneration models that are “product-free”.
The question then is whether planners will ever do so, and whose decision it is to make (the industry’s or the Government’s).
It seems like aeons ago that Senator Nick Sherry, Minister for Superannuation and Corporate Law, challenged the Australian financial planning industry to propose a structure that would both reduce fees to consumers and effectively deal with conflicts of interest caused by commissions. So far, the industry’s public response has been to drag out old lines about disclosure, transparency, education and choice, combined with surveys proving that everyone loves financial planners.
Well, here’s a serious proposal for the Senator’s consideration. It is the main point of this article. The financial planning industry should accept that all remuneration models are not equal. It should adopt the position that the only acceptable remuneration models are those that do not require product sales or accumulation of FUM/FUA.
The industry’s leadership should then promote that principle strongly and teach financial planners the practicalities of how to make the transition to professionalism. This self-regulatory action requires no legislation.
This will lead to a position where financial planners are trusted by the public at large; resulting in a much lower level of intrusive regulation, thereby reducing the cost of advice, which will eventually provide many more Australians with access to affordable, independent and trustworthy advisory services.
Unless the financial planning industry is willing to take a proactive position of ethical leadership on this matter, government enquiries, intrusive legislation and unco-operative commentators will continue to fill the vacuum.
That would be a great pity, when the solution is so obvious, so simple, so achievable and so beneficial for consumers and financial planners alike. Consumers will get what they need and deserve; and financial planners will get the independence and professional recognition that they want, but hitherto have been unable to achieve.
Based on its track record, it is unlikely that the financial planning industry will willingly move in this new direction, preferring instead to insist disingenuously that the professionalism it seeks can be achieved without removing its greatest source of conflict.
This may result in government trying to force the issue by threatening to ban trailing commissions; however, such is the lobbying power of the funds management industry that doing so may prove to be a “bridge too far”, even for a government bent on reform.
Alternatively, attempts may be made to create some kind of artificially tiered structure, based on a tier of product salespeople and a tier of socalled “professional advisers”.
This is an impractical “workaround” solution. It will not succeed. If the financial planning industry won’t accept the simple solution outlined in this article (and government is not willing to force the issue), then eventually all the stakeholders will be forced to accept that true professionalism will never be achieved.
As a result, the settled position may be some form of “semi-professional” hybrid occupation, based on the selling of products combined with limited advice, prescriptive regulation and harsh penalties.
This would not be in the public interest, nor would it be in the long-term interests of planners who aspire to professional recognition; but it would certainly be in the commercial interests of fund managers and dealer groups that (directly or indirectly) control nearly all of the financial planning industry.
Not a great outcome for consumers, but at least then everyone will know clearly what financial planners do (or don’t do), and the industry can dispense with the ambiguities that currently drive so much of it.
