John, Mary and Sam, partners in practice together, were trying to develop a policy on how to select financial products they can recommend to their clients. They’d been thinking about this since the last compliance audit, during which two recent product implementations were questioned on suitability grounds.
Commission compensation is not a conflict of interest if the planner can maintain high-quality professional judgment.
Clients come first
“The client’s needs and desires should always be the controlling factor in our implementations, and the policy should clearly state this,” Sam said.
“That gets us as far as amount and type of product, although here we’re mixing in some art with the science,” Mary replied.
Sam continued: “If the client’s need drives an amount and type of product, what determines where we go to get it, other than relying on companies we have contracts with on our own and through the broker-dealer? We’ve usually chosen the specific products based first on standard of quality and then on competitive performance. If products do well by these criteria, then we usually consider how we’re compensated.”
“We have no standard for how we relate competitive performance and our compensation, however,” John pointed out. “It’s always been a judgment call, where we’ve decided two mutual funds, money managers or life insurance policies were very competitive, and then we chose whoever paid us the most. And, we haven’t gone much beyond our existing contracts to get our choices.”
“So, John, how would you balance choosing a specific product competitively while considering compensation?” Mary asked.
“I don’t exactly know. I’m sure of two things. First, the client should come first, as long as we are fairly paid. If we’re fairly paid, I will vote the best performer, even if it costs us some compensation.”
“What is ‘fairly compensated?’” asked Mary, frustrated. “We have a fee schedule for our fee-related business, but we have no standards for our commission compensation business, which still makes up the bulk of how we get paid. We need to set some standards for fair compensation.”
An ethical solution
“Why not use our fee rates as a basis for a reasonable hourly rate?” she continued. “We always log in the time spent on each case, so we could consider the commissions paid by a company for the product we’re likely to recommend, divided by the recorded time we’ve invested, to see if our rate is comparable to what we charge for fee-only work. If it is, we’re being paid fairly and that product can then be viewed on its performance alone.”
Mary felt relieved, as they were approaching a standard they could agree upon and incorporate into their planning firm’s policy statement. “We can use this equivalent hourly rate as a benchmark. If the product reaches the benchmark, we can then consider it solely based on its competitive performance position. And if we don’t have access to a product that reaches the benchmark rate, we can consider those that come closest,” she concluded.
Know your standard
These three partners first discussed the amount and type of product they would recommend to clients. They agreed that these decisions should be determined by client need and desire, which puts the client’s situation first and is certainly ethical.
From the discussion, these advisors felt that fair commission compensation was essential for any products they recommend, especially because commissions pay for the majority of their work. Commission compensation is not a conflict of interest if the planner can maintain high-quality professional judgment. The financial planners in our example established a standard of fair compensation, using the schedule they created for fee-compensated service, and filtered out potential recommended products that did not meet this standard.
Frank C. Bearden, Ph.D., CLU, ChFC is a field manager, financial advisor and agent in San Antonio, Texas, and a member of NAIFA-San Antonio. You may reach him at firstname.lastname@example.org.