Robert MC Brown argues that a trusted profession wouldn’t touch asset-based fees with a barge pole.
Unqualified trust is the foundation of every true profession. It is earned by occupational groups (such as accountants, lawyers and doctors) that claim to act, firstly, in the public interest and secondly, in their clients’ interests, to the extent that their clients’ best interests are consistent with the public interest.
This order of priority is important. That’s because in its absence, accountants (for example) could justify selling aggressive tax avoidance schemes to their clients without regard for the wider public interest, on the basis that doing so is in their clients’ interests.
As a result, accountants would not be trusted by the community to act in the public interest. Accordingly, the community would not endow them with the valuable privilege of self-regulation, irrespective of their claims to act in their clients’ interests.
This lack of trust would lead to a heavy burden of legislative regulation, as is currently the case with the financial planning industry. This burden of regulation is about to become considerably heavier by courtesy of the proposed Future of Financial Advice (FoFA) legislation, indicating that the industry has not yet earned a level of trust from the public which would warrant the privilege of self-regulation.
Fundamental to the earning of unqualified trust is the removal and avoidance of conflicts of interest – not just their management and disclosure. This is a potentially uncomfortable standard for most financial planners who have become used to the idea of satisfying their professional obligations by extensive disclosures in Statements of Advice and in Financial Services Guides (on the basis of which their clients are encouraged to make life-changing decisions).
‘Firstly, asset fees require clients to own assets on which to charge a percentage’
One could surmise that after all of this disclosure, the financial planning industry should have earned unqualified trust from the public; but it hasn’t. Why not? Contrary to the frustrated views of some people in the industry, the answer is not that commentators are “anti-advice” or that there is a conspiracy by the “forces of darkness” in industry superannuation funds.
The answer lies simply in the fact that in a truly professional environment, disclosure is not enough. Indeed, even the open disclosure of conflicts of interest is not enough. Clients will not give advisers unqualified trust unless advisers act without conflicts of interest. That is, conflicts must be removed and avoided (not just disclosed). This includes the removal and avoidance of both the reality and the perception of conflicts of interest.
Take the case of a doctor who proposes to his patients that instead of charging flat fees, his new basis of charging will be to calculate his professional fees based on a percentage of the value of the drugs he prescribes. Clearly, that would not be acceptable to the public (nor to his professional body) on the basis that he would have real and perceived conflicts of interest in so doing.
Even though he might be eminently qualified, respected by his patients, provide detailed disclosure of his new charging methodology and its potential for conflicts of interest, he would not be given the unqualified trust of his patients. There would always be a niggling suspicion that he may be tempted to over-prescribe drugs. Many of his patients would be aware of this real and perceived conflict of interest when consulting him. Their potential for doubt, suspicion and qualified trust would not be overcome by all the disclosure in the world. The only way the doctor could overcome this concern by his patients would be to revert to his old flat-fee methodology. This would both avoid and remove the reality and perception of conflicts of interest and it would gain the unqualified trust of his patients, who would feel assured that he would advise them in their interests without regard for his own commercial interests.
And yet, this percentage-based “fee for service” offered by our fictitious doctor (often referred to in the financial planning industry as “asset fees”) is exactly the basis of charging preferred by many financial planners who simply cannot understand why the industry suffers constant criticism and threats of legislative control.
Supporters of asset fees argue that they are simply a convenient fee-pricing mechanism, and that they do not give rise to real or perceived conflicts of interest.
There are four principal reasons why this analysis is fundamentally flawed.
Firstly, asset fees require clients to own assets on which to charge a percentage. Many clients do not own significant assets, and yet they are in much need of financial planning advice in areas such as budgeting, estate planning and taxation, none of which give rise to the ability of a planner to charge asset fees.
In the worst cases of abuse prior to the global financial crisis, clients with very little in so-called investible funds were convinced to take out margin loans, thus artificially creating funds under management on which asset fees could be levied. In one sense, this is worse than commission-based selling, because it presents an appearance of independence without actually being so. The compromised FOFA legislation will ban asset fees, but only in geared arrangements (clearly conceding the conflict problem); however, for political reasons, it will not ban asset fees in un-geared situations.
Secondly, it is not commercially feasible to charge asset fees on all types of assets. For example, asset fees cannot be charged on investments in cash, on direct real estate, on a client’s principal residence or on assets in an employer-sponsored superannuation fund. As a result, conflicts of interest are created, leading planners into either avoiding such clients altogether, seeking to create funds under management through gearing, convincing clients to liquidate assets to invest in managed funds, or selling insurance on which commissions can be earned.
