A recent development in Great Britain could presage a major change in how investments are sold here. In June, the Financial Services Authority (FSA), the United Kingdom’s principal investment regulator, moved to ban financial advisers from receiving commissions. In a paper describing the changes, the FSA said:
“The proposals bring to an end the current commission-based system of adviser remuneration…. We propose to ban product providers from offering amounts of commissions to secure sales from adviser firms and, in turn, to ban adviser firms from recommending products that automatically pay commissions.”
The proposed rules would cover all investment products, as well as life insurance products other than those like term insurance that offer “pure protection.” The new rules will take effect at the end of 2012. Similar changes are taking place in India and Australia.
What would the investment world look like if a similar ban on advisers taking commissions were imposed here?
For starters, according to Wikipedia, there are more than 660,000 registered representatives of some 5,000 broker/dealer firms in the United States regulated by the Financial Industry Regulatory Agency (FINRA). The vast majority of these representatives offer products and services that generate commissions for their broker/dealers from which their compensation is derived.
United States broker/dealers and their representatives have made a major effort in recent years to hold themselves out to the public as acting in the clients’ interest, sporting titles such as “financial adviser” and “financial consultant.” Under the British scheme, these representatives would be known as “tied agents” and could only offer products and services of the broker/dealer they represent. Further, these representatives could no longer hold themselves out to be independent and would have to disclose at the outset the fact that any products or services purchased through them would produce commission revenue for the broker/dealer to which they’re tied.
Assuming the average registered representative in the United States generates $150,000 in commission revenue for the broker/dealer to which he’s tied, we’re looking at a threat to $100 billion in annual revenue for a major segment of the financial services industry. That’s why I’m surprised there’s been so little notice of or comment on regulatory developments in the United Kingdom on this front.
Let’s look at how a purchase of a variable annuity, an investment product masquerading as an insurance policy, might work today. Joe Investor’s financial adviser recommends he put $100,000 into a variable annuity. His adviser will almost certainly not disclose to Joe that his buying the variable annuity will generate a sales commission for the adviser that may range as high as 7 percent, or $7,000. In effect, Joe’s only putting $93,000 of his $100,000 to work.
If the United States adopted the proposed British changes, Joe’s adviser could not receive a commission unless the adviser worked for the insurance company issuing the annuity and disclosed that fact and the amount of the commission in advance. And Joe would have to agree in writing in advance to have the commission paid out of his investment. Putting these conditions in place would likely have a significant impact in reducing sales of variable annuities. That would be fine with me—I’ve never been persuaded that variable annuities hold any benefits for investors, only for the insurance companies issuing them and the reps selling them.
So far, no one has publicly advocated for a change in the United States similar to that in the works in Great Britain, but with Congress and the Obama administration considering changes to financial services regulation, a ban on commissions is entirely possible.
The thrust of the British regulators is counteracting the inherent conflict of interest in registered representatives giving financial “advice” when what products and services the representatives recommend to investors affects their take home pay, vacations, health benefits and the like under the present system of compensating reps in the United States.
Whether the British approach is workable here, let alone politically feasible, it seems to me there’s a simpler solution. If you want to receive a commission when an investor purchases a product or service, then you must call yourself a “sales agent” for the firm you represent, nothing else. If you want to use any title such as “adviser,” “consultant” or “counselor,” or in any way hold yourself out as acting on behalf of or representing the client, then you must openly accept full fiduciary responsibility to your client, including full disclosure of all compensation you receive from any investment recommendations you might make.
The Pollyanna in me sees such a simple suggestion as easy to implement and highly effective in curbing sales of financial products driven by the inherent conflict of interest of commissions. The cynic in me says FINRA and the SEC have been in bed with the large broker/dealers for so long it’ll never come to pass.
