Financial planning trail commissions in a post-FOFA world
Mike Taylor writes that the sale of client books entailing trailing commissions will look utterly incongruous in a post-FOFA world unless financial planners are actively seeking to work those clients.
Let us be absolutely clear. There was nothing contrary to the rules in a Melbourne-based financial adviser spending over $650,000 to purchase a large book of clients.
It is a continuing fact of life in the financial planning industry that such purchases occur and have, over many years, represented a significant element in determining the underlying value of financial planning businesses.
What needs to be acknowledged, however, is that in an environment in which the major financial planning organisations have eschewed commission-based remuneration and in which the Future of Financial Advice (FOFA) bills specifically preclude such arrangements, such transactions will continue to occur.
The same planner will be just as entitled to spend $650,000 on a book of clients after the FOFA changes take place on 1 July 2013, as he is today.
It is and will be incongruous, but it is nonetheless a fact.
While thousands of planners will be obliged to sign up to a code of conduct or adhere to the requirements of fee disclosure and a two-year opt-in, thousands of others will be continuing to accept trailing commissions based on clients who everyone acknowledges have not seen an adviser in more than a decade and very likely cannot be contacted.
Beyond imposing the clumsy and annoying reality of a two-year ‘opt-in’, the legal obstacles to actually eliminating trailing commissions were regarded as too imposing by the Government.
In a very real sense, the imposition of opt-in was intended to be a proxy for eliminating trails – the enforcement of a mechanism which compelled advisers to communicate with their clients at least every 24 months.
However, the incongruity of having opt-in sit alongside the purchase of client books entailing longstanding trailing commissions is stark and points to just how ineffective the Government’s FOFA changes have been in addressing one of the key issues originally identified by the Parliamentary Joint Committee in the so-called Ripoll Report.
The bottom line is that client books entailing lucrative trailing commissions will continue to exist and be legitimately offered for sale.
This will only change when the planners owning those books and the institutions paying the trailing commissions choose to do something about it.
When Money Management last week published the story about the Melbourne-based financial planner encountering difficulties with two institutions in actually accessing the trailing commissions, the story generated a good deal of debate on www.moneymanagement.com.au, but one of the most pertinent comments from another adviser was that if a client had not been contacted for up to a decade then the relevant institution ought to have dialed down the trailing commission to zero.
The facts of the matter are that trailing commissions are a significant legacy issue for the financial planning industry, and one which needs to be carefully managed because of the potential for the significant reputational damage it will create.
It is a very bad look for a service industry to countenance transactions which involve the transfer of ‘clients’ from one business to another without those clients being aware of that transaction taking place.
It is an even worse look when the industry is prepared to accept that just because a client who has not heard from a planner in 10 years does not respond to a letter within 30 days, that client can be deemed to have granted consent.
Few people will argue about the legitimacy of trailing commissions continuing to be paid where advisers are actually servicing the clients involved, but even before the debate around FOFA had begun there was a broad industry consensus that the days of extracting passive revenue in the form of trailing commissions from unwitting clients had to end.
While the rules emanating out of FOFA will, of course, gradually see trailing commissions wither and die, it will be a long process, and one which will undoubtedly continue to give rise to negative perceptions about financial planners generally.
Money Management has published many stories in recent years about the manner in which new entrants to the financial planning industry have sought to purchase books of so-called ‘C’ and ‘D’ clients, with the practice viewed as legitimate because it has been assumed those new entrants will seek to make contact with those clients and use them as the basis for building their new planning business.
There is nothing illegal about selling books of customers entailing trailing commissions, but those who do so on the basis of simply purchasing a passive income stream should reflect on how such a transaction looks to any objective outside observer.
The institutions paying those trailing commissions might also reflect upon their own duty to the future of the industry.
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