Drawing parallels between financial planners and grocery retailers is misleading and misses the point of the necessary industry reform, writes Travis Morien.
At the Financial Planning Association of Australia’s national convention in Sydney in 2007, the recently-retired chief executive of retailing giant Woolworths, Roger Corbett, gave a speech where he warned advisers that the many high-net-worth investors he knew were very concerned about conflicts of interest in the financial planning industry.
Corbett urged advisers who wanted to increase their appeal to high-net-worth clients to abandon commissions and start charging a fee for service. Stung by this criticism, some in the audience hit back. One planner stood up and essentially called Corbett a hypocrite, because Woolworths made money on all the products it sold. The planner challenged Woolworths to adopt a “fee-for-service” approach first, passing on products at cost while charging a fee appropriate to the service provided. Apparently many advisers find this a compelling argument; I’ve seen and heard it repeated many times in various forums. What disturbs me about this incident is what it says about how many advisers see themselves. Woolworths is in the business of selling products. There is not so much as a faint fig leaf of “advice”. And that is fine, because Woolworths is a retailer, not a “groceries adviser” or “provisions planner”.
People go to Woolworths to buy things, not to seek the disinterested counsel of a highly trained consultant. If comparing financial advice with retailing is not an appropriate comparison, what is? Most would agree that the way in which advisers want to be perceived as “professional” is the same way in which judges, lawyers and accountants are “professionals”. If these are more appropriate for comparison purposes, why not consider what those professions would be like if their members worked on a commission basis? Imagine, for example, what it would be like if judges and lawyers in the criminal justice system were paid a commission by the manufacturers of justice “products”, namely prisons. Imagine the judge, prosecution and the defence lawyer all receiving an up-front commission for every person sent to jail, and an ongoing commission for the duration of the convict’s incarceration. Defenders of this system would point out that it allows even the poorest people to obtain legal advice free of charge.
What could be fairer than that? Perhaps wary of the different rates paid by different prisons, and wishing to distance themselves from criticism that they tended to sentence defendants to incarceration at notorious hard-labour facilities which pay more commission but which extract a more severe punishment on prisoners, some judges and lawyers could opt for an “unbiased” form of remuneration – one where they are paid the same basic rate of a set fee for every year the defendant was sentenced to, irrespective of which prison the convict gets sent to. In civil cases, the judge would be entitled to a percentage of any compensation payments awarded to the plaintiff. The problems with such a system should be obvious to anyone. The system creates a strong incentive for judges to favour the prosecution or the plaintiff, and would create a strong temptation to favour harsh sentences. Still, supporters of the system could at the very least argue that people should be given a “choice” and, in particular, that less wealthy people would benefit from it rather than having to pay their lawyers themselves, like the wealthy generally would.
A similar analogy would apply to accountants. Accountants could offer their services for free also, but the Australian Tax Office would pay them a percentage of the tax their clients pay. The bigger the tax bill, the more the accountant receives. The problem with those hypothetical remuneration systems goes beyond the occasional miscarriage of justice or client being given bad tax advice; it casts a cloud over the whole profession. People need to be able to trust the system. The financial advice industry used to be unashamedly a sales business. We have inherited all of the trappings of sales from the past. The realisation that this structure is not optimal is not new, and just as in the hypothetical alternative remuneration structures of legal and tax “advisers”, the realisation that the system creates horrible conflicts of interest is not new either.
It is, however, very firmly entrenched. When the majority of advisers talk about “fee for service”, they are still referring to a charge calculated on a percentage of assets, reducing the bias toward one product over another, but still retaining precisely the same incentive to recommend investments over debt repayments, and geared portfolios over ungeared ones. Merely disclosing conflicts of interest doesn’t fix the problem, because the conflicts remain. Even if a person knows that their adviser’s objectivity has been undermined, the fact is, the adviser’s objectivity has been undermined! Our profession has had too many problems. Conflicts of interest have played a central role in most, if not all, of our most infamous and damaging scandals, and are the reason why many people do not trust us. And that was precisely the point that Mr Corbett was making.
