We have reached a tipping point

Financial Planning Association (FPA) chief executive Jo-Anne Bloch's repeated warning that the financial planning industry needed to review its practices or the matter would be taken out of our hands has been fulfilled; we now face a Parliamentary inquiry. 

I feel a divided attitude towards the development of this inquiry. 

The prospect of being subjected to the combative, point scoring, partisan, political process induces dismay. 

On the other hand, public scrutiny of any practice almost inevitably leads to a lifting of standards - and the lifting of some standards is necessary. 

In any case, we are dealing with other people's money, so it is naive to imagine that we can or should avoid public scrutiny. 

What we should do is adopt practices that stand up to scrutiny, yet foster the development of a healthy, profitable industry. (I use the term 'industry' rather than 'profession' despite the existence of many first class professionals within it because a large number are still in the business of selling a product, like any other retail industry.) 

It goes without saying that this requires the adoption of a fee-for-service model. I won't bother setting out the arguments against commission, as this has been done so often. The terms of reference for the inquiry will ensure the commission versus fees debate receives a thorough airing, which is unlikely to result in a resounding conclusion that commission is the ideal remuneration for planners.

In order to ensure our inquiring politicians are not confused by vested interests, I'll propose a set of conditions for a sound remuneration model for a financial planning business. Revenue for a financial planning firm should meet four conditions:

1. It must come, directly or indirectly, from the client, not from a third party;

2. It must be clearly disclosed to the client every time it is paid;

3. It must not vary depending on the investments recommended; and

4. It must cease immediately on the termination of the client's relationship with the planner.

Trail commission may arguably meet the first condition, in that the client's investment does ultimately fund it. 

However, it would not meet the second condition, though it could if fund managers' statements showed clients' gross distribution before trail payment, the amount of trail paid to their planner and the net distribution received. Wrap accounts do report this way, but most master trusts and retail funds do not. 

Trail would meet the third condition if it was paid by a master trust or wrap account on all the assets in a client's portfolio, irrespective of the particular securities held. It would not meet the condition if it was paid by a particular managed fund, as the recommendation of a different fund could have resulted in a different rate of trail. 

It would not meet the fourth condition, as trail payments do not automatically cease when clients leave their adviser. This creates the anomaly that the most profitable situation for an adviser (at least for a period) can be to receive trail but neglect clients, thereby incurring no servicing costs. 

I have gone into this detail in order to forestall the allegation that trail commission is no different from ongoing fees if both are a percentage of assets. Defenders of commission sometimes claim this, as if they have failed to notice the material differences just detailed. (However, I stress that I do not mean to imply that all commission-based planners are, ipso-facto, unethical.) 

To my mind, any form of fee that meets the above conditions is acceptable (eg, hourly, asset-based, flat fee, etc). Each of these can be appropriate for different functions for various clients. 

Some advisers have adopted an asset-based ongoing fee that is charged on all assets except cash. This fails condition three above and is flawed as a business model. 

One of the problems with commission is that it rewards the recommendation of growth funds more than cash, raising concerns about bias. 

Such a fee model also discourages recommendations of cash. The best possible investment advice that could have been given in this cycle would have been to move to cash (and bonds) in 2007. However, if fees were not charged on cash, the giving of sound advice would have reduced the planner's revenue - an absurd outcome for outstanding service. Cash and all other assets should be charged for equally.

Planners, and parliamentarians, need to recognise that it is in both clients' and their advisers' interests for the quantum of ongoing fees to be adequate to profitably provide high-quality ongoing service. If not, clients will not get the service they need. The first step in developing a fee model should be for the planners to determine what this quantum is and then how their fee model should be structured.

The critics of asset-based fees seem to imply it would be cheaper for clients if another method was used. There is no basis for this as the level of flat fees could be set at a higher or lower level than asset fees would produce. I have known planners to calculate their asset-based fee and offer the client the option of paying it as a flat amount or varying the cost in accordance with changing asset values. 

An asset-based fee has an obvious attraction for the portfolio management component of client service, as the planner's revenue parallels the health of the portfolio - a genuine alignment of interests. 

On the other hand, this model can reward a bias in favour of gearing (ie, more gearing equals more funds under advice equals more fees). 

There is also much to be said for a flat-fee model.

Certain tasks can be charged on the basis of hourly fees, though it has overwhelming drawbacks as a sole revenue method. If a planner is ever tempted by this, they should ask a lawyer or accountant about the drawbacks of living under a billable hours regime.

This article began with a reference to Jo-Anne Bloch. Historically, the FPA has faced a dilemma: its leadership is focused on lifting 

standards yet its membership contains many who do not want those higher standards imposed.

Early in the FPA's history its structure was reviewed following a report by John Godfrey, which led to a reconciliation of then warring factions. The debate at that time included much discussion of whether the association's role was as an industry group promoting the interests of planners, or a professional body upholding professional standards. It has played both roles with some internal tension.

Now, through its remuneration consultation paper, the association has made its function clear. The FPA is to be a professional association and it will insist on genuine professionalism from its members. 

This is a turning point for the industry. 

Bloch and her board are to be congratulated for their courage and genuine industry leadership. There is a real risk of defection by members, and the FPA's financial position will be impacted. However, if it succeeds in moving the bulk of financial planners to a less conflicted revenue model, the FPA will have delivered an enduring benefit to the community and to the profession (and this word would then be appropriate).

Before the creation of the FPA there were two associations, neither of which had a meaningful presence in the media nor with the regulators. When they merged into the FPA, planners found they had a voice, and following the Jock Rankin era it was heard by the authorities. 

We could now see the creation of a competitive association for disaffected members, which will be gentler shall we say in the area of professional standards. Its slogan could be, 'Join us - we stand for less.'

However, members who are anxious about changing remuneration models should attempt to rise to the challenge. The direction consumers, regulators and legislators are heading is clear, and the momentum is growing. It makes commercial as well as professional sense to accommodate these forces in business planning. 

The FPA is targeted for criticism whenever anything goes wrong in the industry, as if it has the power to control the actions of all planners, yet it has neither the mandate nor the budget for such an activity. The latest example is Storm Financial. If members want the association to act pre-emptively in situations like this, it is up to us to refer them to the FPA. I understand it received no complaints about Storm before its collapse, but many complained afterwards that it hadn't prevented the situation. 

Of course there are risks in being the whistleblower, not least being defamation. Nonetheless, the association can't act on complaints it doesn't get. 

Another enduring criticism of the FPA is that it is dominated by big dealers, which is ironic given the small dealer/individual practitioner preponderance of its board over the years. This attitude reflects the feeling of many individual planners that big institutional dealer principals are more interested in accumulating funds under advice than providing quality financial planning. 

Some have been, but the chief executive of NAB-owned MLC and ex-director of the FPA, Steve Tucker, has long been a counter example. He recognised years ago that professional standards must rise and has tried to lead rather than oppose it - which is actually a platform for long-term strength. Thus he has introduced a fee-for-service model for NAB financial planners.

Tucker is again trying to play a leadership role, publicly arguing for the stripping out of adviser trail commission payments from management expense ratio calculations. This would be reported separately, as I described above. This proposal also takes some courage as it risks alienating supporters of MLC products and members of NAB-owned dealer groups. 

However, industry funds are having a field day comparing their costs to retail funds and pointing out that retail products are more expensive because they include commission for planners. Three things must be said about this situation:

• the allegation is true;

• the arrangement makes retail funds look too expensive; and

• it makes financial planners look like they get paid under the table.

It is a lose, lose, lose outcome.

If planners were paid a fee (or a repeatedly disclosed, separately itemised trail commission), it would enable retail funds to compete on an equal footing with industry funds, where differences in service levels would become the differentiator. 

The anti-planner element of the campaign would also be neutralised (and, incidentally, it would eliminate both the perception and actuality of any bias by planners against industry funds). 

However, if planners don't want their remuneration openly and repeatedly disclosed to clients whenever it is paid, we have to expect that this will be seen as furtive - because it is. The Parliamentary inquiry is unlikely to enshrine furtiveness as best practice in planner/client relationships, and the FPA has already targeted it.

The great irony is that planners need have no fear about charging openly, if we actually believe we provide value for money. Many planners have no doubt about this. We have now reached a tipping point where all planners need to ask themselves this question.

Important footnote: I was first quoted in a newspaper on the need for planners to charge fees in 1990, so this is a long-held view. 

However, I recognise that other sectors of the financial services industry face different issues. 

For example, corporate (as opposed to personal) superannuation advisers have a three-party relationship. Employers engage their services, but individual employees generate most of the work and receive most of the benefits. Who should pay fees and how they could be agreed to and collected is a complex issue. 

Insurance advisers can perform invaluable service at the point of lodging, and arguing for, a claim. However, contacting a widow/er a couple of days after the death to negotiate a fee to assist would not be tasteful. 

Therefore, those who see financial services through the eyes of financial planners need to proceed carefully lest we create unintended consequences by imposing on all a solution that works for us. This area requires careful thought. 

Robert Keavney is an independent spirit of no fixed industry address, who believes financial planning is a noble profession.