Embedded commissions: Is it the beginning of the end?

With the U.K., Australia and, presumably, the U.S. all on one side, Canada seems already stretched to the limit in the fee versus commission tug of war.

The strain was amply evident at a panel discussion during a Financial Planning Week event in Toronto where two Canadian financial professionals locked horns on the issue of compensation.

Fighting for the fee-for-service model was Marc Lamontagne, partner Ryan Lamontagne Inc., while Kevin Regan, executive vice-president, financial services, Investor Group, advocated for commission-based advice, the dominant compensation structure currently under threat in Canada.

“I knew inherently that (fee-based advice) was a better model,” said Lamontagne who made a transition from a commission-based to a fee-based financial planner after feeling a disconnect between the compensation and the actual amount of work he was doing.

He stressed that the trend was gaining momentum as more and more countries moved to ban or cap embedded commissions, also known as third-party compensations. “It’s not just the U.K. and Australia; Finland’s banned commissions, Holland has capped commissions at 50%, (and) India has recently banned front-end and back-end commissions, so the trend is there,” said Lamontagne.

Regan, a strong supporter of commission-based compensation, argued that the current system of commissions worked for the benefit of the client. “I have trouble taking the (Australian or the U.K.) approach to resolving the problem they have into the Canadian context where I’ve yet to see a problem.”

He suggested complete disclosure as an effective tool to guard against advisors taking advantage of their position of trust. “There’s an increasing amount of disclosure going on in Canada, and I’m a very strong proponent of that,” said Regan. “I think an advisor ought to be able to look the client in the eye and tell them how they are paid. If they are embarrassed, or somehow feel they can’t, what does that tell you?”

Regan said the Canadian market had enough room for the commission-based model and other compensation models to exist side by side. “I actually welcome the competition,” he said. “It makes for a way better marketplace.”

Lamontagne conceded there were commissioned advisors who “care deeply” about their clients, but insisted that “in reality there is an inherent bias and conflict of interest built into the (commission-based) compensation system.”

He said if financial planners wanted to be considered true professionals like doctors or accountants, they must abandon commission-based models of compensation, as he himself did, and instead start charging fees for their advice. “Once you leave the commission world, the blinders come off,” said Lamontagne. “You say to yourself, maybe all that research on index funds wasn’t bunk after all.”

Also on the panel were Nick Cann, CEO of U.K.’s Institute of Financial Planning and Deen Sanders, deputy CEO of the Financial Planning Association of Australia, who provided further accent on the issue and shed light on how it will impact the industry when the new rules in the U.K. and Australia ban financial professionals from taking commissions tied to recommending certain investment products.

It may be noted that the U.K.’s Financial Services Authority (FSA) has issued rules codifying a fee model for British investment advisors and banning collection of commissions. The rules will take effect in 2012-13, Cann said.

Australia decided to go down the same route when it found “clear, actual evidence that commission models of advice were biasing placement of particular products,” said Sanders.

In the U.S., the Financial Planning Association (FPA) accepted that it is as a conflict of interest in the case of a financial planner taking compensation from an investment product provider, such a mutual fund company, and also offering advice on investment selection.

The current global trend has clearly put under the scanner an age-old compensation model in Canada where financial planners receive trailing commissions from product providers.

It remains to be seen how long Canada can hold off against the mounting pressure to switch to a fee-for-service model.

Read more about it:

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Trailer commissions under siege (Part 2)

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(10/08/10)