There is an ongoing debate in our industry that ethics are driven by compensation—that if we control how advisors are paid, then their ethics will fall in line with the regulatory and public's expectations and behave in an ethical manner. In fact, advisors and planners often become embroiled in heated debates over their ethical standards as it relates to their compensation. If one earns commissions, one is inherently unethical but if one is paid a fee, one is ethical—nothing is further from the truth. And so, advisors argue this point to ad nauseum. Advisors have never been in charge of their compensation per se: companies have. Advisors have never designed products: companies have. Advisors have never promulgated the rules and regulations that companies have used to design their products or to determine their payouts: Congress, Federal regulations and regulators have. But as soon as the compensation is thought to be “outlandish” or “unworthy,” then let’s blame it on the advisor for being unethical.
To be sure, unethical practices have been and will continue to be committed and those people need to be either fined or punished—or both. But to think that being paid a commission is the root cause of this behavior is foolish. Bernie didn’t earn commissions, Kenneth Lay didn’t either, neither did Arthur Anderson’s CPAs, nor the Rating Agencies. The largest portion of the blame is with the regulators and the supervisors within the financial companies (broker dealers, mutual funds, insurance or investment banks) that have accepted and approved of these business practices by their employees. Those supervisors were the ones responsible to enforce the suitability standards and to assure their clients that their employees were acting ethically. If you want the unethical behavior to stop, fine those companies and punish those officers who have supervisory oversight. If an advisor writes business that is wrong for the client, then it is wrong for the company and should be refused by that company. But that is not typically done, especially if the one writing the business is a big producer for the company. As is typical in many of these issues, it all comes down to the money. How much money does the company stand to earn if it doesn’t get caught? Or, if they do get caught, will the punishment or fine be substantially less than the added profits to the company? Let’s be clear, if the CEO had to do jail time every time a fine—especially when it hurts the client no matter the size of it—is levied against their company, behavior would change throughout the company.
Let’s review how a financial advisor is compensated: salary, salary plus bonus, commissions, fee for services and fees for managing assets. Someone who is paid a salary can either be paid an hourly rate or an annual salary. Someone who is salary plus bonus receives a salary plus a bonus based upon achieving specific company objectives. Those objectives vary with the job assignment but can include: assets transferred into the company or assets saved from leaving it; appointments made with new prospects or appointments with clients where new products are sold. Commissions are determined by the company where the financial advisor is placing their business and varies by the company. These commissions are approved by the regulators and cannot exceed specific maximums. Fee for service usually means that the financial advisor will not sell you anything but will provide you a plan for a fee, which the client pays. A fee for managing assets is one that the financial advisor charges to the client for managing their assets.
The public may, and often does, view all these forms of compensation differently. Perhaps the public believes that merely paid a salary is the most honest, trustworthy and ethical of all forms of compensation? But we know that is not true. Salaried employees have acted just as unethically as others who are paid differently. Is a financial advisor who is merely commission-based less trustworthy, honest and ethical than one that is fee for service? Of course not. Compensation, in-and-of-itself is not the means to ensure that the client will have a more ethical, honest and trustworthy financial advisor. Can any one of these compensation methods be used in a dishonest or unethical way? Yes, they all can. When a company or advisor states how they are compensated (Company: Our advisors are not commission based but are paid a salary; or advisor: I am not commission based but paid a fee), they are stating something about themselves to distinguish themselves from their competition. It is used as part of their marketing campaign. It is a way to get the consumer through the door and into their firm, plain and simple. It does not mean that that company or that advisor is more honest, trustworthy or ethical than their counterparts who earn a commission. For that, we would have to review how that company is paid when a consumer becomes a client of that firm or advisor. Perhaps they sell annuities and mutual funds and the issuing company pays the owners of the firm a commission but the owners pay the advisor a salary. If the firm uses only those companies that pay the highest commissions regardless if those products meet the needs of the client, then the client is better off working with a commission financial advisor who seeks to match the needs of the client with the features of the product regardless of the product’s commission. We know that a firm can state they have access to all company products but if their core business is consistently done with three of the highest commission paying companies, the consumer has their answer.
I fully understand why compensation surfaces as one of the culprits regarding unethical conduct in our profession but I submit it is not the root cause as to why clients are at times placed into products that are inappropriate for their investment objectives: that happens because the regulators have approved the product for sale to the public and the issuing company incentivizes it to the advisor. If we want to manage someone’s ethical behavior then begin with, as Steven Covey states, the end in mind. And that end is the regulating bodies that approve these products. The financial advisors are not to blame, nor are they the root cause, for this malaise of unethical behavior afflicting our industry.
No matter what profession in our society we inspect, we will find those individuals that will cheat and circumvent the rules and the boundaries of those rules in the hopes of increasing their own profits. If the regulators won’t stop approving these unsuitable products then we, the public, need to insist that when companies break the law those at the top, they pay the price with their own money and their own life in jail. Place the highest-paid officers of companies in jail and you will have better-suited products to meet the client needs. In other words, put the client’s interests and needs first always.
One’s ethics are not determined by how one is paid, or by a plaque on their wall, or a Code of Ethics they have signed, or an oath they have sworn to uphold, because ethics are not what one says but what one does. It is that end result with their client that will ultimately determine if the advisor thought of them or of themselves; did the advisor determine their client’s needs and objectives and match the product to their suitability or not? If they did, does it really matter how they were paid? I don’t think so.