Planner wonders whether "regulatory inequality" denigrates commission model. Fee-based compensation models may not be the best-practice models they're cracked up to be, according to an article in last month's Journal of Financial Planning. The study examines the underlying economic incentives and potential conflicts of interest in the three primary financial-planning compensation models: commissions, asset-based fees and hourly and retainer flat fees.

"All three models contain incentives that align adviser and client objectives, and which can create significant conflicts of interest," writes John Robinson, a managing director of Hawaii Wealth Management, an independent financial-planning and investment firm in Honolulu, Hawaii. "The 'fairest' compensation platform may be the one that offers investors the ability to choose from all three models."

Bad wrap

The commission model comes under fire because advisers receive payment regardless of performance and the consequent danger of "churning" or generating transactions for advisor income rather than, strictly, the client's benefit. There's also an economic incentive to steer investors into higher-commission products.

But in a competitive milieu, advisors are more likely to "forgo short-term gratification from commission maximization in order to keep investors happy over the long run so that they will continue to generate revenue and refer other investors," writes Robinson. And high-upfront commissions are usually one-shot deals, so that advisors who push them are constantly prospecting for new clients.

On balance, commission planners show significantly lower return on assets than fee-based planners, according to Robinson. (And in the recent past that has led some firms to encourage advisors to switch clients from comparatively inactive commission accounts to "non-advisory" fee-based accounts.)

But the much-touted asset-based fee model has conflict potential as well. For instance, an advisor might refrain from counseling a client to reduce debt or diversify into assets such as direct real estate -- even though these strategies may be in the client's best interest -- because this would shrink the portfolio under advisory. There's also an economic disincentive for advisors to recommend commission products like long-term-care insurance, disability insurance and some annuities.

Inequality

Proponents of the flat-fee model say it's ethically superior to commissions or asset-based advice because advice is based simply on the planner's hourly time or on an annual retainer. Robinson writes that quantitative evidence such as returns on assets is too sketchy for drawing definitive conclusions, but he notes that attorney retainers have been criticized for their economic incentive to overstate the amount of work they do. And of course hourly fees can always be padded.

Though fee-based models are superior with respect to fiduciary disclosure, Robinson contends that there's little to suggest that regulatory differences lead fee-based advisors to be either more qualified or to act more ethically than commission-based advisors. But "it can be argued that regulatory inequality denigrates the commission model's credibility," Robinson writes.

Here's the whole article.

The Journal of Financial Planning is published every month by the Financial Planning Association, a Denver-based association of financial planners. -FWR

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