It is possible that all commission-based compensation involving the sale of investment products, life insurance products, and annuities could be eliminated.
And it would be right and just to do so.
Every commission can be transformed into a clearly understandable fixed fee that would be paid directly by the consumer. There is no need today for product-based compensation, and the conflicts of interest posed thereby.
Indeed, all commissions and all 12b-1 fees could easily be converted to either a fixed fee or an ongoing asset-based fee, paid directly by the customer/client. In this way the fee would be wholly transparent, and consumers would more easily understand the amount as well as the impact of such fees.
We should also end soft dollar compensation arrangements, and revenue-sharing arrangements.
Why should commissions be eliminated?
An early judicial decision stated: “It is well settled as a general principle, that trustees, agents, auctioneers, and all persons acting in a confidential character, are disqualified from purchasing. The characters of buyer and seller are incompatible, and cannot safely be exercised by the same person. Emptor emit quam minimo potest; venditor vendit quam maximo potest. The disqualification rests, as was strongly observed in the case of the York Buildings Company v. M’Kenzie, 8 Bro. Parl. Cas. 63, on no other than that principle which dictates that a person cannot be both judge and party. No man can serve two masters. He that it interested with the interests of others, cannot be allowed to make the business an object of interest to himself; for, the frailty of our nature is such, that the power will too readily beget the inclination to serve our own interests at the expense of those who have trusted us.” Carter v. Harris, 25 Va. 199, 204; 1826 Va. LEXIS 26; 4 Rand. 199 (Va. 1826).
In S.E.C. v. Capital Gain Research Bureau, 375 U.S. 180 (1963), the U.S. Supreme Court explained further why conflicts of interest – such as commissions, 12b-1 fees, soft dollar payments, and revenue-sharing, should be eliminated, stating that in 1935 “the [U.S. Securities and Exchange] Commission made an exhaustive study and report which included consideration of investment counsel and investment advisory services. This aspect of the study and report culminated in the Investment Advisers Act of 1940. The report reflects the attitude – shared by investment advisers and the Commission – that investment advisers could not ‘completely perform their basic function-furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments – unless all conflicts of interest between the investment counsel and the client were removed‘ … This concern was not limited to deliberate or conscious impediments to objectivity. Both the advisers and the Commission were well aware that whenever advice to a client might result in financial benefit to the adviser other than the fee for his advice -‘that advice to a client might in some way be tinged with that pecuniary interest [whether consciously or] subconsciously motivated’… The report quoted one leading investment adviser who said that he ‘would put the emphasis … on … subconscious’ motivation in such situations. It quoted a member of the Commission staff who suggested that a significant part of the problem was not the existence of a ‘deliberate intent’ to obtain a financial advantage, but rather the existence ‘subconsciously [of] a prejudice’ in favor of one’s own financial interests.’ The report incorporated the Code of Ethics and Standards of Practice of one of the leading investment counsel associations, which contained the following canon: ‘[An investment adviser] should continuously occupy an impartial and disinterested position, as free as humanly possible from the subtle influence of prejudice, conscious or unconscious; he should scrupulously avoid any affiliation, or any act, which subjects his position to challenge in this respect.’”
It is time for all plan sponsors, and all institutional and retail (individual) clients, to demand that all third-party (product-based) commissions and 12b-1 fees be eliminated from both investment as well as life insurance and annuity insurance products.
The broker-dealer world, and that of insurance producers, is a dinosaur. It is long past time for a extinction event to occur.
Demand an end of product-based compensation in the form of commissions or 12b-1 fees or other forms of revenue-sharing. And, of every firm or person seeking to deliver to you advice about investments, ask these ten tough questions.
This blog post represents the views of Ron A. Rhoades, JD, CFP(r), and are not necessarily the views of any institution, organization, firm, gang, cult, or motley crew to which he now belongs or has ever been kicked out of.
Dr. Rhoades serves as Associate Professor of Finance, and Program Director for the Personal Financial Planning Program, at Western Kentucky University. He teaches and has taught courses in retirement planning, estate planning, applied investments, advanced investments, securities regulation, capital markets and financial institutions, and financial plan development (capstone).
Ron is also the principal and financial advisor for Scholar Financial, LLC. He has been an investment adviser since 2001, and a Certified Financial Planner(tm) since 2005. He has served on a variety of boards and task forces in various professional organizations and fiduciary advocacy groups.
To contact Ron, please email: ron@scholarfinancial.com. Thank you.