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They say there’s no such thing as a free lunch. That axiom may be even truer today.
The recent trend toward level-fee advisory services has only served to increase scrutiny, as regulators seek to understand how advisors can simply walk away from the revenue historically generated from commissions. Not coincidentally, non-cash compensation is increasingly under the microscope.
Intermediaries who operate as fiduciaries under the best interest contract exemption (BICE) must disclose all fees and non-cash compensation to retirement investors. Non-cash compensation is typically paid by asset managers in the form of meals, entertainment, travel and lodging as well as gifts, prizes and other awards. Regulators are seeking to uncover whether and to what extent non-cash compensation creates a conflict of interest.
Heavier regulatory scrutiny presents new challenges.
The focus on non-cash compensation is making life more difficult for broker-dealers and advisors in the following ways:
Fines. Several prominent financial institutions are receiving inquiries directly related to their supervision of non-cash compensation. The threat of regulatory enforcement has instilled a sense of urgency regarding enhancing the performance, transparency and efficacy of their systems and procedures for non-cash compensation.
Public relations. In the last two decades, public outcry over payments made to doctors by pharmaceutical companies has increased scrutiny in the medical services industry. In response to public pressure, the Affordable Care Act (ACA) requires pharmaceutical companies to disclose all payments (non-cash and cash) made to doctors so that researchers can better understand the effects of these financial relationships. There is, however, an important difference between the two industries: doctors have an effective practice monopoly.
Advisors are not similarly insulated. Robo-advising and self-service platforms already threaten to upend the wealth management industry. If public perception (however unwarranted) is that advisors are getting “kickbacks” from asset managers while at the same time claiming not to receive “commission,” it might further incentivize investors to look for alternatives.
Given the turbulence across the industry, and the precarious position of advisors, broker-dealers must be especially proactive. In particular, broker-dealers will have to be very cautious moving forward with messaging around this issue. It will take creativity and finesse to find ways to disclose non-cash compensation in a way that accurately characterizes the practice but doesn’t alienate investors.
Inhibited productivity. Finally, broker-dealers are struggling to find ways to comply with the new rules without disrupting current sales and administrative practices. Currently, advisors must manually document all forms of non-cash compensation, which involves collecting and archiving paper receipts as well as all communications with asset managers. Compounding matters, advisors can’t always accurately appraise the value of certain benefits (e.g. how do you value a training seminar?). Needless to say, the process is often painstaking and takes too much time away from client service and business acquisition activities.
In an effort to alleviate these challenges, some broker-dealers are encouraging advisors to avoid non-cash compensation as much as possible. Unfortunately, avoidance might initiate its own set of problems. Currently, many advisors rely on relationships with asset managers for continuing education. Asset managers will typically cover travel and lodging expenses associated with attending informational seminar sessions. Without these opportunities to learn about new products and stay abreast of market trends, advisors will not be able to serve clients as effectively.
What’s next for the industry?
The goals for the industry remain straightforward. Broker-dealers need to find better ways to:
Right now, engineers at Broadridge are working to develop an industry utility that plugs into both the asset-management side and the broker-dealer side. The goal is to preserve these valuable relationships while at the same time efficiently tracking non-cash compensation between them. We imagine an industry utility similar to that which is currently employed in the pharmaceutical industry. The ACA requires pharmaceutical companies to document all forms of compensation paid to doctors using a tool called open payments, which is run by centers for Medicare and Medicaid services. That tool, however, only allows input from pharmaceutical representatives.
For the financial advice industry, we imagine a different arrangement would be more prudent. Asset managers would input non-cash compensation information into a shared utility, which would then push a notification to the advisor. From there, the advisor would simply confirm (or ask for a revision). In this respect, both parties can seamlessly maintain precise records, documenting each event, the purpose of the event, along with who attended and the approximate cash value.
We believe this arrangement is most advantageous to advisors, who will see a significantly streamlined workflow around non-cash compensation. Most of the onus for initial documentation will be placed on the asset-management side, where receipts are more readily accessible.
Our work with both asset managers and advisors has made clear the need for a shared utility. Only a shared utility can leverage the scale necessary to link all relevant parties in the industry. And only a shared utility will help preserve the confidence of investors.