Back in early 2015, the White House directed the Department of Labor to propose and implement a new rule that sought to impose a fiduciary standard on broker-dealers… or as the President’s administration put it, “Wall Street brokers who benefit from backdoor payments or hidden fees and don’t put the best interest of working and middle class families first.” At the time, the Administration argued that “bad incentives and bad advice” meant that consumers were losing upwards of $17 billion per year to their retirement accounts, implying that any compensation that was based on the sale of a financial product was unduly expensive and inherently “bad”, especially when contrasted against (good) “firms who choose instead to put their clients’ interests first [under a fiduciary assets-under-management model].”

But, as is often the case, such black and white distinctions are rarely so cut and dry, as no fee model is completely without some underlying conflict of interest between a business that wants to get paid and the consumer trying to decide if their services are worthwhile. Especially since in practice, the cumulative costs for clients of advisors who charge under the AUM model can add up to far more than even the most expensive, conflict-ridden financial product.

Yet, at the end of the day, while a client who pays a 1% annual fee over the course of seven years on the assets that an advisor manages will end out paying the same amount as someone who pays a 7% upfront commission on an annuity, the reality is that the fee on the annuity is a “sunk cost” (i.e., it’s paid up front to the salesperson and can’t be recovered by the client after the fact), while the client paying 25 basis points every quarter can “fire” the advisor at any time, and simply stop paying the fee if/when they are no longer happy with the level of service they’re getting. Which is why it’s not surprising (and the actual data shows) that advisors under the AUM fee model spend far more time servicing their clients than sales-based brokers. In other words, since the fees under the AUM model are more “severable”, the advisor has a natural incentive to provide more and ongoing service, and the consumer enjoys better protection by being able to terminate the service as soon as it’s not up to snuff.

However, in many cases, there are still hoops that a client has to jump through to sever themselves from the AUM-based advisor, including going through the process of finding a new advisor, opening new accounts, and transferring their money to a new firm. Which can create inertia, and could be one of the contributing factors to the fact that AUM-based advisors have such a high client retention rate (even sometimes in the face of mediocre service)… because in some cases, it’s not that the advisor provides such great service, but simply because leaving is such a pain.

For even more “severable” fee structures, consumers can turn to the newer retainer and subscription fee models. Though perhaps the model with the greatest fee severability is the hourly model, where there are no ongoing or recurring fees and which, by definition, terminates at the end of any meeting where the client doesn’t engage the advisor for any subsequent meetings or service.

All of which leads to the question of whether or not (state-level or Federal) regulators are scrutinizing retainer, subscription, and similar fee-for-service compensation models for advisors (i.e., those models with higher fee severability) properly and, in turn, underappreciate the added consumer protections such models naturally provide. Which, ironically, can end up pushing advisors back towards those models with lower fee severability and less consumer protection, where it’s easier for advisors to charge more and get away with doing less.

Ultimately, the key point is that, if the objective of regulation is to better protect consumers, then it’s important to recognize the role that fee severability plays in the process, as certain types of models (e.g., fee-for-service models which have been gaining traction in recent years) already have more of those key protections naturally built in. And while regulators continue to struggle with finding ways to make the more traditional sales-based models less conflicted and more transparent and severable, perhaps the focus for regulators when looking at the fee-for-service models is simply keeping them that way?

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For almost half a decade now, the United States has tried to implement Federal-level regulations requiring that those who are in the business of providing financial advice to serve as fiduciaries and be required to put their clients’ interests ahead of their own. Thus far, however, these regulatory reforms have failed to hold, as financial services industry product manufacturers and distributors have vehemently argued that such rulemaking would end out preventing consumers from receiving their (conflicted) financial advice in the first place, due to the “cumbersome” requirements inherent in any such fiduciary regulation.

The irony, however, is that despite all this tumult about the potentially adverse impact of fiduciary regulations in the U.S., another set of fiduciary regulations have been established and operating for the past six years in Australia, and are far more comprehensive and disruptive than anything proposed (or even hinted at) in the U.S.

In this guest post, Ashley Murphy, founder of Arete Wealth Strategies (a fee-only financial planning and investment management firm serving Australian/American expatriates), discusses the background and impact of Australia’s fiduciary reforms to its financial services industry, some recent developments as the Australian government evaluates the effects of their fiduciary efforts, and what the implications might be for the U.S. fiduciary movement going forward.

Originating in the aftermath of the Great Recession and first passed by the Australian Parliament in 2012, the Australian “Future of Financial Advice” (FoFA) reforms, which went into effect the following year, sought to address pervasive problems in an Australian financial services industry, which, at the time, lacked oversight and was rife with poor “advice”, scandal, and even outright fraud. It was against that backdrop that lawmakers passed two separate acts – the Corporations Amendment (Future of Financial Advice) Act 2012, and Corporations Amendment (Further Future of Financial Advice Measures) Act 2012 – which (among other things) sought to require financial advisors to act in their clients’ best interest, place a general ban on any payment that might influence any advice or recommendation, and require advisors to provide clients ongoing fee and engagement disclosures, at levels far beyond what the SEC has required of broker-dealers under Regulation Best Interest.

Despite ongoing criticism and intermittent tweaks to the original Acts, there is evidence that FoFA has (at the very least) accomplished some its original goals, as the number of complaints against advisors has decreased, and despite concerns that regulation would reduce access to advice in reality more and more Australians are seeking out financial advice after FoFA (suggesting a general increase in the public’s confidence in and therefore willingness to engage with the industry).

Nonetheless, a subsequent formal inquiry to investigate misconduct in the banking and financial services industry, known as the Hayne Commission, found that up to 90% of advisors who worked for firms that manufacture and sell financial products were still giving conflicted advice that wasn’t the in the best interest of their customers… even though the advisors were compensated solely by fees and/or salaries (because the advisors were still largely controlled by their product-manufacturing employers). Moreover, even when banks were found to be in violation of FoFA rules, the penalties were so lax that misconduct continued to be remarkably profitable.

Notwithstanding the industry condemnations from the Hayne Commission, critics feel that the final report fell short and failed to include some key recommendations, including a once-discussed outright ban on asset-based (i.e., AUM) fees and a potential breakup of vertically integrated financial services firms (to force a separation between products and advice). Nonetheless, the findings did throw light on the need for further regulation and enforcement in Australia’s financial services industry, and industry consultant Rice Warner suggests that Australians are receiving better advice at a lower cost and are experiencing better financial outcomes after Australia’s fiduciary reforms.

Ultimately, the key point is that the ongoing evolution of the reformation of Australia’s financial advice industry could serve as a model in the U.S., as regulators struggle with implementing a fiduciary standard. Because, while the SEC’s Regulation Best Interest, which is slated to take effect at the end of June, 2020, is a step in the right direction, it’s possible that the rule will only lead to further confusion among consumers who can’t tell the difference between salespeople and advisors, leaving the proverbial door open for increased regulation in the years ahead. While Australia’s experience shows that lifting fiduciary standards actually can result in an increase in the levels of advice delivered to consumers, as eliminating low-quality advisors and reducing the level of conflicted advice leads to an increase in trust that ultimately creates more opportunity for financial advisors to survive and thrive.

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