Biggest controversy with financial advisor commissions has nothing to do with advisors

Type the phrase “financial advisor commissions” into Google and the results will be less than flattering to the financial advice industry.  Understandably, regulators and the media are focused on full service brokers or financial advisors when this issue arises.  But there is a good reason for both parties to cast their eyes on another closet door concealing a well-kept secret.

Advisor Commissions

Financial advisors that are licensed to sell mutual funds usually receive ongoing commissions known as ‘trailing’ or ‘service’ fees.  They are paid out of a fund’s management fee to financial advisors and their firms in return for – at a minimum – servicing investor accounts and – ideally – for providing ongoing advice and ‘hand holding’ in tough times.

Much of the media exposure in recent years has centred on the global trend toward banning commissions and, in Canada, the battles to pull the veil on trailing and other commissions through better disclosure.  All of the articles are consistent with the industry in calling trailing commissions payments for ongoing advice – hence the term ‘service fee’.  And yet I rarely see articles questioning why discount brokers – which provide the most basic service – enjoy the same level of ‘service fees’ as their full service brethren.

Advisory Fees Without Advice

Investors buying load funds through discount brokers are paying for the services of a full service advisor.  But they’re doing so through brokers that are prohibited from offering advice and that enjoy an exemption from the suitability assessment, which full service advisors are responsible for completing.

It’s clear, however, that such do-it-yourself investors aren’t buying these funds because they want to pay for advice that they’ll never get.  They’re doing so because they want to invest in certain funds – often because of dazzling performance – and load funds are not available with a lower, commission-free MER.

So investors shoulder some blame for this situation.  Indeed I argued in an older blog post that investors should stop buying pricey funds if they want lower fees.  But there is a bigger problem with discount brokers.

I suspect that they’ve become accustomed to generous mutual fund trailer fees for providing basic execution and reporting.  And they want to maintain the status quo.  My recent experience with a big bank discount broker is a case in point.

My Discount ‘Advice’

I look after a few investment accounts as a favour to some friends and family members.  For one such account, I went online to enter a trade to buy a fund that pays no trailing commission.  I expect trading fees to apply when buying and/or selling such funds – as is the case with stocks and exchange traded funds.  But my trade was rejected, so I phoned the brokerage.

I was told that the fund could only be purchased with a commission of 2% – $200 on the trade in question.  I refused to complete the trade, expressing to the gentleman on the phone my preference for a similarly-cheap fund with no hefty purchase commission.

The so-called mutual fund expert on the phone proceeded to say that there are many good funds like the one I wanted.  While acknowledging my desire for a lower fee he countered with, “Fees are important but if the returns are good, what do you care what the fees are”.  When I kindly rebuffed his claim, he offered – without badgering from me – that the fund company in question had no “special arrangement” with the brokerage (read: they don’t pay us trailers) and, as such, is subject to what amounts to a front end load.

The Next Regulatory Priority

In the mid-1990s, AGF Limited fought to pay TD Waterhouse Discount (then bearing the “Greenline” moniker) a reduced trailer or nothing at all on its funds given that they provided no advice.  While AGF wasn’t offering the savings to its end investors, it had a point.  But they lost that fight.

Regulators are understandably and justifiably pressing the full service advisory industry for improved transparency – an important priority.  But surely regulators want to curb efforts of discounters to point investors toward fully loaded funds so they can collect advice fees when they have neither the desire nor obligation to offer advice.