By Hal M. Bundrick
NEW YORK (MainStreet) Financial advisors are still working to regain the trust of investors. Understanding how an advisor is paid goes to the heart of the issue. Is an investment recommendation made in the best interest of the client or because of a hefty commission check?
To alleviate the potential conflicts of interest, why not simply eliminate sales commissions? A new study by the CFA Institute says that banning sales commissions would reduce the number of investment choices available to consumers and divide the public "into the few that can afford investment advice, versus those who cannot afford, or are averse, to pay up-front for advice."
"Larger financial institutions appear to be moving away from providing advisory services to smaller clients because of a lack of economic incentive to serve them," the report says. "According to 46% of survey respondents, the main consequence of banning commissions is that distributors will continue to offer advice, but will shrink the product offerings to those they continue to receive fees [from]."
Rather than an outright ban on commissions, greater fee transparency is required, according to the report.
"Complete and comparable disclosure around fees and conflicts of interest would support more informed decision making, and contribute to the restoration of trust in advisors," the CFA Institute says.
"Mis-selling" -- recommending inappropriate investments to clients -- has often been driven by sales and distribution structures with inherent conflicts of interest, according to the CFA Institute. This encourages advisors to put their interests above the needs of their clients.
"In addition, many investors simply do not understand the complex series of costs and fees included in the financial products they purchase -- costs that are not always disclosed in the most transparent manner," the report continues.
Fully 70% of the advisors surveyed said that inappropriate compensation structures, based on sales volume or the recommendation of specific products, were the main cause of "mis-selling."
The three most-mentioned solutions were: 1) Adopting clear standards for fee disclosures, 2) Revising commission structures to eliminate volume sales incentives, and 3) Establishing equal commission levels for all products in the same category.
<"p>Transparency should be part of any solution aimed at addressing mis-selling because simplified disclosures would give investors the information they need to make informed decisions," says Matt Orsagh, director of capital markets policy for the CFA Institute. "It is also important to pursue uniformity in fee disclosures across jurisdictions to allow comparability of fees across markets. Our survey results indicate that CFA Institute members believe a ban on commissions will result in an investment landscape with less choice for investors and a market that underserves, or does not serve, smaller clients."
Written by Hal M. Bundrick for MainStreet