While advisor objectivity is not a new consideration, an SEI Global Wealth Study found that it tops the list of investor concerns. As noted in the last edition and in light of the renewed focus on objectivity, the insights in a 2006 whitepaper by John Robinson may be more relevant than ever, contending that all three compensation models (commission-based, asset-based and flat/fee-based) have inherent incentives that can lead to conflicts of interest. Interestingly, Robinson concludes that all three models offer an optimal choice for certain investor circumstances and thus proposes that “the ideal compensation platform might incorporate all three models,” giving investors the ultimate choice.
We break down the highlights for your consideration in the model summaries below.
Commission-based sales models are often criticized for creating the potential for brokers or agents to seek short-term sales revenue that might be in conflict with the client’s best interest long-term.
With any debate about the effectiveness of the SEC’s Best Interest Rule set aside,
Robinson challenged this simplistic conclusion, arguing (over 15 years ago) that
commission-based advisors have a competing incentive to “forgo short-term
gratification from commission maximization in order to keep clients happy over the
long run so that they will continue to generate revenue, and refer other potential
clients.”
He presented data to support this, arguing that “if commission-based advisors truly
have a greater economic incentive to put their interests ahead of investors, then
one would expect commission-based advisors to have higher returns on assets
(ROA) than their fee-based counterparts. In fact, the opposite is true, and by a
rather wide margin. Industry data regularly report that the average return on assets
(ROA) for registered reps is below 0.75 percent, while the average ROA for
independent RIAs is approximately 1.3 percent and rising. Not only does this
suggest that commission-based advisors as a group are not solely motivated to
maximize commissions, it implies that the commission-based model may have a
significant cost advantage over fee-based investing.” While this purely economic
comparison does not account for differences in additional planning or service
offerings, it strongly offsets the harsh criticism frequently directed at commission-
based professionals.
2. Asset-Based Fee Models are often touted as the most objective, aligning advisor
interest with client interest because both benefit when asset values rise.
Additionally, the fiduciary standard required by the Investment Advisor’s Act of
1940 applies to most advisors who fall within this model.
Robinson argues, however, that there are hidden conflicts inherent in the asset-
based fee model that are worth considering. With advisors’ compensation tied to
invested assets, there is a significant incentive to keep assets invested and a strong
disincentive to suggest complementary strategies that do not involve investment
management like reducing debt, purchasing diversified assets like art or real estate,
strategically holding cash or considering insurance products, which a 2021 E&Y
study found can improve retirement planning outcomes across scenarios when
used strategically.
3. Fee-Based Planning Models are often considered truly objective since the
advisor is paid to present recommendations tailored for the client with no incentive
to make one recommendation over another. One obvious downside is that the
investor may end up paying twice–once for the plan and again for the fees that
come with the execution.
But Robinson also argues that clients of this model could be impacted by incentives
to take planning shortcuts that charge customized fees for efficient, templated
outputs or plans that make simplified recommendations that sound thoughtful
(low-fee index-based investing, as an example) but that may be “penny-wise, but
pound foolish.” Additionally, hourly billing models inherently create incentives to
“pad” billing. Lastly, for advisors with a high percentage of clients who cross over
(starting with a fee-based plan, but then having the same advisor lead the
execution), the planning is often done with this in mind, eroding the barriers that
supported true objectivity to begin with.
At the end of the day, there are opportunities in every industry for conflicts of interest to become problematic when moral character is lacking or incentives are too imbalanced. With heightened attention, regulatory support and model choice, however, there are also opportunities for the vast majority of advisors, who put client outcomes at the forefront, to shine through and succeed, no matter which compensation model they fall within.
Christy Charise, Founder & CEO of Strategic Advisor