The ‘noble professions’ of law and accountancy have issues with charging clients and an hourly rate should not be seen as a panacea for professional standards, argues Peter Johnston.
Robert MC Brown should certainly be congratulated for his determined campaign over many years to inject some professionalism into the industry. His views on having an hourly rate-charging regime are fine in theory, but there are some structural aspects that must be taken into consideration.
Firstly, we do not have a perfect industry. The ideal environment of independent, educated advisers charging clients an hourly rate then selecting product/services/strategy from a pool of wholesale-priced commodities/products that do not have their own in-house distribution would be great for consumers and regulators. We do not, however, have that.
What we do have is a market dominated by institutionally owned advisers (85 per cent) selling their owners products and then internally cross-subsidising the practice with profits from the internal platform/product sales.
We then have an emerging market of accountants, establishing self-managed superannuation fund (SMSF) structures for clients, who are taking these administration fees away from the institutions and cross-subsidising their financial-advice practices in much the same way as the institutions do.
With all this cross-subsidising going on, it is then easy to start charging an hourly rate or flat fee to clients knowing that all the software, back office, product insurance cover and research is funded from other indirect revenue sources.
Some accountants have been criticised over the years for selling SMSF structures to get fees that may not be in the best interests of the clients. Conflicts do manifest themselves in many different ways.
Unfortunately the Future of Financial Advice (FoFA) reforms are trying to say that independent advisers cannot have a share of the administration profits to subsidise advice, but institutions and accountants can. Is that fair?
The flaws and façades of an hourly rate
I would like to see how profitable institutionally and accountancy-owned advice practices would be if they tried to survive on an hourly rate without cross-subsidisation.
It is a flawed argument trying to compare the accounting and law professions with a product-driven industry like financial services. Regardless of how you cut and dice our industry, in the majority of instances advisers/accountants are selling an administration service or investment product to clients and are accountable for their selections to the Financial Ombudsman Service (FOS), the Australian Securities and Investments Commission (ASIC) and the courts.
Accountants and lawyers have no choice but to charge an hourly rate as they only have their knowledge to sell. Many accountants tried to branch into commission-based product selling a few years ago by becoming agents of managed-investment schemes out of dissatisfaction with charging hourly rates to survive.
In theory, hourly rate charging is a sound strategy but in reality it is totally conflicted and clients (and those using it) hate it. As former chief justice of the New South Wales high court Jim Spigelman pointed out in his paper, the Tyranny of the Billable Hour, charging in this manner is an incentive to be inefficient and not entirely honest with what you charge.
The front page of the Australian Financial Review over the years has carried many stories of young graduate accountants and lawyers getting pressure from partners to ‘invent hours’ to meet their budgets.
In short, the ‘noble professions’ have maintained this façade of being ‘pursuant to the highest professional standards’ for too long. However, hourly rate charging is simply conflicted and most hate it.
Portfolio percentages and political correctness
The other area where Robert MC Brown is off the mark in my view is on charging clients a percentage of their portfolio. This is very distinct from taking a percentage-product commission, which is conflicted and rightfully abolished under FoFA.
Charging clients directly, say 1 per cent, of the portfolio’s value aligns the interests of both client and adviser. If the adviser succeeds and increases the portfolio’s valuation, they both benefit. If it goes backward they both lose. What can be fairer than that?
Clients actually like this structure, so the government had been wise staying out of this area. Unfortunately the Industry Funds and Choice have far too much to say about this, which is largely based on flawed ideology and hypocrisy.
Finally, the Australian Tax Office, Australian Prudential Regulatory Authority, all service utilities, superannuation funds, industry funds, banks, life companies, councils and state and federal government departments all charge percentages to consumers. So, why can’t advisers do so – as long as it is not tied to selling a particular product?
The political correctness and frowning upon advisers who wish to make a profit and succeed in life has gone too far.
Peter Johnston is executive director of the Association of Independently Owned Financial Planners.
Yes, well, some reasonable arguments, but failing to miss a few points:
1. Percentage fees reward advisers for aspects which are largely outside of their control – markets.
2. Percentage fees reward advisers for increasing the risk their clients take on – just look at the Storm model.
3. Percentage fees tie an adviser’s value solely to the amount of investible assets rather than the total service and, therefore, value they provide. How does your estate planning advice tie to the amount of money a client invests?
4. Percentage fees reward the adviser solely for investing, but ignores the other, crucial aspect of wealth accumulation – debt repayment. The adviser will not be paid a fee for recommending a client discharges their mortgage. I wonder how the advice will therefore be structured.
5. Percentage fees only reward an adviser when they can actually extract the fee from the product. Hence, no industry funds where they may otherwise be appropriate.
Given the percentage fee model that so many people advocate, explain to me the merits of the following, real situation I faced many years ago when I worked at a firm that charged percentage fees:
1. Client had $1 million to contribute and invest in super. Minimal time involved to advise.
2. Client received a redundancy of $500,000 with all the latent tax implications. Significant time involved in modelling outcomes.
The percentage fee model rewarded me more for the first client even though the value provided was significantly less.
Alternatively, why don’t we just take “marketing allowances” from failed super fund providers where one of the directors ends up in jail? I am sure there are associations that can help facilitate such payments?
A well stated, and well thought out commentary. Well done, Peter.
16 years ago, my partners and i set up a planning business with the idea of charging a set monthly fee, and hourly rates. However, we wanted to give people the choice on how they paid our fees, so clients were to choose how they preferred to pay.
The result? Most people did not want to pay a fixed renewable fee, many people did not want to pay a dollar from their own pocket – but were quite happy to see costs deducted from any investment/product they purchased. This was a bit of a problem for us, as we wanted to prepare for the future of financial advice. My years in management had provided me with an insight into the changes then being agitated for. However, philosophically we agreed that people should have the right to choose how they pay for a service.
And so we did what many advisors did, and presented the best advice that we could and accepted that if people wanted to pay us over a longer time frame rather than through an equivalent hourly rate basis “up front” then that was ok. In other words, we accepted significantly lower fees than were common at the time, with the idea that over a long term relationship, we would “balance up”. Much of the work that i have done s with self-directed people, and often i do not even have advisor access to their various accounts – so please spare me any sanctimonious outcries of “bias” or “dinosaur”.
We watched while clients were moved from “high up front” commission products (with MER’s regularly in the 0.4% bracket) to “cheaper, less biased” products with MER’s of 2%+. i know because it was once my job to perform the calculations on these product differences.
And so well-meaning folk brought about a distortion in the marketing of financial advice. It took away one form of bias and replaced it with another.
And the advisors that accepted lower than market up front fees in return for a longer term income stream now find themselves paraded as pariahs of the industry, greedy and biased parasites of unsuspecting clients.
If i sound irritated then i am being misread. i am bemused, angry and frustrated by the hypocrisy and misunderstanding that is paraded in financial media as informed comment.
Peter’s commentary is a breath of fresh air. As a fan of Albert Camus philosophical direction, i firmly believe that people should at all times have choice. Choice imposed from above is not really choice at all, is it? And very rarely in everyone’s best interests.