What’s in store for comp?

Implementation of CRM II has left some advisors scratching their heads, in part because phase two of the client relationship model calls upon advisors to only disclose certain fees.

“CRM II will do away with the illusion of free as it applies to mutual funds,” says Michael Hadford, branch manager, dealer at Assante Financial Management Ltd. in Calgary. “I don’t have a problem with that—I just wish it applied equally to segregated funds, GICs; everything. As long as other investment products can carry on with the illusion of free, advisors dealing in mutual funds will be at a disadvantage.”

Perhaps the biggest concern with CRM II and the proposal of other fiduciary standard requirements, such as those on invest-ment dealers, is that they are unclear.

UK rules for advisors

The application should:

• Must complete certain disclosures to the client about the nature of the service and charges
• Cannot solicit or accept commissions
• Must have appropriate charging structure for clients
• May not vary according to product type or provider
• May not be influenced by provider facilitating payment
• May not receive payments spread over time, unless there is an ongoing service (agreed to by the client)

Source: Julie Patterson, director, authorized funds and tax, Investment Management Association

“[CSA] wants to improve the nature of advice in the industry, but I’m just not sure that all of the outcomes and implications have been totally considered,” says Rebecca Cowdery, partner at BLG in Toronto.

“To be fair, I don’t think they’ve thought of everything. That’s why [CSA has] put out the [consultation] paper. They need to get the industry’s input.”

So, as the industry fumbles its way toward a fiduciary standard, what does this mean for advisor compensation?

“If clients feel they’re not getting value for their money, they may put pressure on advisors by singling out commissions. It will make advisors targets,” says Hadford.

“I’d like to see fund management fees put directly on statements in dollars, instead of only as a pre-trade disclosure. Total costs matter, not just trailer or advisory fees.”

Also, it’s up to advisors to explain the regulatory changes to clients, says Cowdery. “It’s not enough to hand a paper to the client and tell them to read it. A good advisor will be able to communicate that information, figure out what’s important for that client, and explain it.”

6 tips to get ahead of the rules

Did you earn all your badges?

• Advisors need to discuss all fees and expenses with clients, if they haven’t already done so. The first client statement that arrives with cost disclosures shouldn’t be a surprise.

• Articulate and deliver on your value proposition. For instance, if you’re fee-based, give new clients a list of what you’ll do for them, along with the fee agreement, before they open the account.

• Give clients a breakdown of who gets paid how much and for what; provide total costs, and not just advisory fees and trailers. This includes management fees, GST, HST and trading expenses.

• Document all client interactions for compliance purposes. Keep the notes in the client’s file.

• Explore ways to reduce total client costs without reducing advisor take-home. Consider lower cost index funds or ETFs for the core of a client’s portfolio, institutional classes of actively managed funds, or moving to fees where appropriate.

• Remember that people don’t shop based on price. They shop for value. Most clients don’t have a problem paying a fair price for a premium product or service. If you’re just selling a commodity, then you’d better be cheaper than the next guy.

A bull market should make it easier for advisors to switch to fee-based. Clients are more amenable to paying fees when they are making money. However, advisors who market themselves on the basis of investment performance or picking winning funds will be in trouble when the market goes down.”

– Michael Hadford, branch manager, dealer, Assante Financial Management Ltd.

How it works down south

U.S. advisors are paid based on a percent of their AUM and/or a performance fee, which is a percent of the profits, says Richard Marshall, partner at Ropes & Gray LLP in New York.

“This aligns the interests of the advisor and client,” he says. “So if assets go up or performance is good, then fees go up.”

And this model has been effective since 1940. This was when the SEC imposed a federal fiduciary obligation on all investment advisors.

“The SEC has said when a client has a relationship with an advisor, the fiduciary responsibility extends to all activities related to the client, even if the activity isn’t related to securities (e.g., a real estate transaction),” says Marshall.

Aegis Frumento, partner at Stern Tannenbaum & Bell LLP in New York, notes the issue of advisor compensation has always dovetailed with the question of disclosure.

“If you fully disclose the nature of the compensation you receive, and the potential conflicts of interest that may come out of that compensation,” he says, “then your customer is the one who has the choice as to whether or not your advice might be biased.”

Like Canada, the debate in the U.S. is about whether brokers, who serve primarily as order takers there, should be held to the exact same standard as advisors. Marshall argues the broker-customer relationship is different, so the same standards shouldn’t apply.

“If I go on an online trading platform and put in an order to buy 100 shares of Apple stock [with a broker], in no sense is that a fiduciary relationship. It’s an ordinary transaction for services.”

Suzanne Sharma is the associate editor of Advisor Group.