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Nic Cicutti: The less ethical approach is winning on advice charges

Nic Cicutti

When I worked full-time for a newspaper many moons ago, one of my jobs involved poring over screeds of reports and other documents from a variety of sources, including financial providers and regulators.

Not only was it important to keep up with developments in the area I was covering, as often as not a careful study of these reports meant it was possible to tease out some interesting news items buried in the small print of these papers.

So, hats off to Money Marketing news editor Justin Cash, who performed an excellent piece of work recently in his story about restricted advice firms charging their clients the same as fully independent ones.

All the more so as I worked my way through the same FCA data bulletin a few weeks ago and did not spot that little nugget tucked at the bottom of the page. Memo to self: read these things more carefully.

Justin is, of course, also completely right in his follow-up question: if it is true that, generally, compliance and other costs for restricted businesses will be less than for independent ones, why is it the case the former feel able to charge their clients as much as the latter?

A time-honoured trouble

A few weeks ago, I wrote about the process of advice firms gobbling each other up, then breaking apart, only to reconstitute themselves under different guises or ownership. My conclusion, back then, was this was a practice that had been taking place within the financial services industry since time immemorial.

To an extent, the same applies to charges. Some 20 years ago, I recall the Personal Investment Authority, the financial services regulator of the day, ordering a clean-up of the £2bn broker bond market.

Back then, more than 130,000 savers placed their money into some 1,300 broker funds, life funds or unit trusts specially created by advisers and “badged” in their name. In addition to fund management fees, usually 1 to 1.5 per cent a year, clients paid their advisers and additional premium of 1 per cent or more.

Unsurprisingly, the PIA found these funds were underperforming the indexes they were matched against by, on average, the additional annual management fee taken out of their clients’ total investment.

Yet for years clients themselves were unaware of what was being done to their money. Why? Because, despite angry campaigning by journalists such as Jeff Prestridge at the Mail on Sunday, as Justin elegantly describes the current position in his MM article, there was “a lack of price sensitivity that clients show to advice firms and their business models.”

Inelastic demand

The reality is the charges market in the advice sector is inelastic. That is to say, the demand for the service by those who use it is largely unaffected by the price charged for it. Consumers have only a limited idea of what they are being charged, what those charges relate to and what they get for the money they pay their advisers.

Always assuming they understand they are paying advisers at all: if the charges relate to leftover trail commission from pre-RDR days, they may not even realise they are handing over a slice of the overall fund management fee.

The key, then, is that of what happens as a result of this disclosure by the FCA, which Justin was able to ferret out so well. Back in July 2013, the FCA commissioned the adviser charging and scope of service report, from NMG Consulting, which identified a large number of barriers to consumers understanding what they were being charged.

A significant number of those barriers lay in basic matters of typography, such as font sizes; the use of colours and boxes to make statements stand out or, alternatively, to bury them; the use of industry-specific language to obfuscate matters; the use of percentages instead of numbers, of graphs and charts; all technical points that have an effect on consumer behaviour.

One of the most important points made in the report was not so much that the language or the design directly prevented people from understanding the impact of charges but that it acted as a powerful disincentive to that process of learning.

In other words, the report suggested people are not stupid: they “get it”, but the way information in a document is presented can serve as a “disruptive moment” – making it less likely they will want to know more.

The FCA will argue it is almost impossible for it to be prescriptive in terms of what suits some people better in terms of understanding the question of charges, compared to other alternatives.

Ultimately, like so many issues affecting the industry, this is one where the FCA is acting as an impotent ringmaster in the debate rather than seriously trying to affect what happens on the ground.

“The way information in a document is presented can serve as a ‘disruptive moment’ – making it less likely people will want to know more.”

The regulator should at least offer some basic guidance of the best ways of communicating charges to clients, perhaps by organising regional workshops with examples of what works well and what does not.

As for restricted advisers themselves, they seem caught between the desire to make as much money as possible from their clients, no matter how, and an understanding that the proper way to do it is ethically. Right now, for many, the less ethical approach is winning.

Nic Cicutti can be contacted at nic@inspiredmoney.co.uk

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Comments

There are 15 comments at the moment, we would love to hear your opinion too.

  1. I am an independent adviser but don’t believe that it is unethical for advice to be more or less expensive purely because it is restricted or independent. I think your high horse needs dismounting nic.

  2. Whilst I understand the Regulators reluctance, having ‘industry standard’ disclosure would begin to address a number of underlying issues with regard to clients not only understanding what they pay for financial advice (noting that it’s not simply ‘investment advice’) but also whether they have received advice, whether the investment is regulated, whether the advice is tied, restricted or otherwise and whether commission has been paid (or some other means where there is additional remuneration received by the adviser/sales team / Company) other than simply what the client is paying.

    Whilst clarity is of course important, IMO there are many more ‘bigger’ dangers to consumers that a lack of understanding charges – namely investing in something that is fictitious, the company disappearing and another liability landing on the FSCS or thinking they’ve had advice when they haven’t and the ‘adviser’ pocketing 10% or so commission for not giving the advice.

    Set up a VERY broad definition of what ‘an investment’ is, require everyone who invests in something to receive a disclosure and have that disclosure pre-formed by the regulator and it does away with all the smoke and mirrors that can still exist – even in the regulated financial advice world – in doing so, set out all ongoing charges and in theory consumer protection increases, as does consumer awareness of the cost.

    Having said that – it doesn’t mean their investments will perform any better and that the cost of advice won’t go up as a result.

  3. The poor communication of charges and performance is the core of the issue. But the design of statements or illustrations is focussed on compliance not helping the client the regulators over the years have often mentioned it but taken no action. Until they do prescribe a max number of words and the use of graphics nothing will change

  4. There is always asymmetry of information in all facets of life, but there is an innate responsibility for looking after you and yours (in my opinion living creatures more than lifeless property/assets). If you do not have the information to make an informed decision you are responsible or obtaining it NO ONE ELSE. In the case of fees for financial advice if you are not satisfied with the response from the entity quoting for the job move on until you find one that you are. THIS IS THE INDIVDUALS RESPONSIBILITY WHICH WILL PROBABALY TAKE SOME EFFORT, BUTTHAT IS HOW LIFE IS.

    Re-post from a previous article on fees/profit;

    In A Free Market, No Profit Is “Excessive”

    Authored by Ludwig von Mises via The Mises Institute,

    https://mises.org/blog/free-market-no-profit-excessive

    Profits are never normal. They appear only where there is a maladjustment, a divergence between actual production and production as it should be in order to utilize the available material and mental resources for the best possible satisfaction of the wishes of the public. They are the prize of those who remove this maladjustment; they disappear as soon as the maladjustment is entirely removed. In the imaginary construction of an evenly rotating economy there are no profits. There the sum of the prices of the complementary factors of production, due allowance being made for time preference, coincides with the price of the product.

    The greater the preceding maladjustments, the greater the profit earned by their removal. Maladjustments may sometimes be called excessive. But it is inappropriate to apply the epithet “excessive” to profits.

    People arrive at the idea of excessive profits by confronting the profit earned with the capital employed in the enterprise and measuring the profit as a percentage of the capital. This method is suggested by the customary procedure applied in partnerships and corporations for the assignment of quotas of the total profit to the individual partners and shareholders. These men have contributed to a different extent to the realization of the project and share in the profits and losses according to the extent of their contribution.

    But it is not the capital employed that creates profits and losses. Capital does not “beget profit” as Marx thought. The capital goods as such are dead things that in themselves do not accomplish anything. If they are utilized according to a good idea, profit results. If they are utilized according to a mistaken idea, no profit or losses result. It is the entrepreneurial decision that creates either profit or loss. It is mental acts, the mind of the entrepreneur, from which profits ultimately originate. Profit is a product of the mind, of success in anticipating the future state of the market. It is a spiritual and intellectual phenomenon.

    The absurdity of condemning any profits as excessive can easily be shown. An enterprise with a capital of the amount c produced a definite quantity of p which it sold at prices that brought a surplus of proceeds over costs of s and consequently a profit of n per cent. If the entrepreneur had been less capable, he would have needed a capital of 2c for the production of the same quantity of p. For the sake of argument we may even neglect the fact that this would have necessarily increased costs of production as it would have doubled the interest on the capital employed, and we may assume that s would have remained unchanged. But at any rate s would have been confronted with 2c instead of c and thus the profit would have been only n/2 per cent of the capital employed. The “excessive” profit would have been reduced to a “fair” level. Why? Because the entrepreneur was less efficient and because his lack of efficiency deprived his fellow-men of all the advantages they could have got if an amount c of capital goods had been left available for the production of other merchandise.

    In branding profits as excessive and penalizing the efficient entrepreneurs by discriminatory taxation, people are injuring themselves. Taxing profits is tantamount to taxing success in best serving the public. The only goal of all production activities is to employ the factors of production in such a way that they render the highest possible output. The smaller the input required for the production of an article becomes, the more of the scarce factors of production is left for the production of other articles. But the better an entrepreneur succeeds in this regard, the more is he vilified and the more is he soaked by taxation. Increasing costs per unit of output, that is, waste, is praised as a virtue.

    The most amazing manifestation of this complete failure to grasp the task of production and the nature and functions of profit and loss is shown in the popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller. It is this belief that guides governments in controlling prices. It is the same belief that has prompted many governments to make arrangements with their contractors according to which the price to be paid for an article delivered is to equal costs of production expended by the seller increased by a definite percentage. The effect was that the purveyor got a surplus the higher, the less he succeeded in avoiding superfluous costs. Contracts of this type enhanced considerably the sums the United States had to expend in the two world wars. But the bureaucrats, first of all the professors of economics who served in the various war agencies, boasted of their clever handling of the matter.

    All people, entrepreneurs as well as non-entrepreneurs, look askance upon any profits earned by other people. Envy is a common weakness of men. People are loath to acknowledge the fact that they themselves could have earned profits if they had displayed the same foresight and judgment the successful businessman did. Their resentment is the more violent the more they are subconsciously aware of this fact.

    There would not be any profits but for the eagerness of the public to acquire the merchandise offered for sale by the successful entrepreneur. But the same people who scramble for these articles vilify the businessman and call his profit ill got.

    The semantic expression of this enviousness is the distinction between earned and unearned income. It permeates the textbooks, the language of the laws and administrative procedure. Thus, for instance, the official Form 201 for the New York state income tax return calls “earnings” only the compensation received by employees and, by implication, all other income, also that resulting from the exercise of a profession, unearned income. Such is the terminology of a state whose governor is a Republican and whose state assembly has a Republican majority.

    Public opinion condones profits only as far as they do not exceed the salary paid to an employee. All surplus is rejected as unfair. The objective of taxation is, under the ability-to-pay principle, to confiscate this surplus.

    Now one of the main functions of profits is to shift the control of capital to those who know how to employ it in the best possible way for the satisfaction of the public. The more profits a man earns, the greater his wealth consequently becomes, the more influential does he become in the conduct of business affairs. Profit and loss are the instruments by means of which the consumers pass the direction of production activities into the hands of those who are best fit to serve them. Whatever is undertaken to curtail or to confiscate profits impairs this function. The result of such measures is to loosen the grip the consumers hold over the course of production. The economic machine becomes, from the point of view of the people, less efficient and less responsive.

    The jealousy of the common man looks upon the profits of the entrepreneurs as if they were totally used for consumption. A part of them is, of course, consumed. But only those entrepreneurs attain wealth and influence in the realm of business who consume merely a fraction of their proceeds and plough back the much greater part into their enterprises. What makes small business develop into big business is not spending, but saving and capital accumulation.

    Originally Published in Planning for Freedom, Featured in The Mises Reader

  5. Nicholas Pleasure 19th January 2017 at 1:41 pm

    Ultimately the only way you will reduce charges is to have a proper, competitive market where lots of advisers are fighting for the same business. It’s a bit stupid of the regulator to destroy the advice market and then wonder why the few remaining firms feel they can charge what they like.

    Regulate FS in a fair, low cost and ethical way, making it a profession that people will want to enter, and the charges issue will sort itself out. Continue as you are and the charges will rise to cover ever increasing F-pack levies, liability and simply because many of the older advisers will be retiring over the next few years. They are not being replaced;

    Same Demand + Fewer Advisers = Higher Fees.

    Did no-one at the FCA study economics?

  6. Nic, you make some excellent points. It’s also interesting that the assumption is that restricted advisers are charging too much. Perhaps IFAs are not charging enough?

    To suggest that the FCA and regulators before it have acted as impotent ringmasters is to ignore history. MCA, commission disclosure and RDR are all active attempts to address this issue. What they haven’t done is start with some uncomfortable truths and work from there:

    1. The large majority of clients are not cost aware or sensitive however much we’d like to think they are or should be.
    2. Most clients are incapable of comparing costs, charges and associated products and services in a meaningful way even if they wanted to.
    3. The client’s perception of their adviser and the service they see and receive is more important than anything else, including costs, products and services.

    Offering guidance on the best ways to communicate charges to clients is sticking plaster. Why? Several reasons. Because it fails to address the wider problem of the volume of information that has to be given to the client now (getting worse with MiFID II, PRIIPs, etc.) so it’s always going to get lost. Because the level of financial literacy required simply doesn’t exist – I seem to remember it was the FCA that identified that over 50% of clients don’t understand percentages? Because of point 3 above – human nature is the problem here, so good luck with that. Because the regulatory system itself is unsuitable for the purpose it was created for. This needs a re-think from the bottom up not tinkering as you’re suggesting.

    That’s not to say it’s not worth addressing for the relatively small minority of clients who might benefit. But that’s all you’ll achieve without wider changes.

    Your point about ethics is hollow unless you lay out what that means. Your ethics are no doubt different to others and probably driven by your politics as much as anything else.

  7. I’m a little confused. Advisers have to state in a monetary amount what their charges are, since RDR. This seemed to be in response to the suggestion that an investor could not calculate what 1% meant, which is rather alarming.

    As for confusing documents, illustrations are about as confusing as it gets. Well indended may be but the effect of charges is misleading unless you live in an alternative “free” universe. As for the negative returns in an attempt to show the impact of inflation – again well indended but about as enticing as a locker chat with Donald Trump and Mr Farage…. yet these clients are meant to understand, but cannot work out 1%…. very muddled thinking.

    I certainly appreciate how framing information is important, but the assumption is that the average investor is both Einstein and Frankentein at the same time.

  8. Isn’t it funny that Mr Average Client is perfectly able to understand percentages when they have a positive impact – interest rates, growth rates, 50% extra etc etc, but when the percentages have a negative impact he needs it to be explained.

  9. I believe that all funds should be green, I dunt fink its a gd idea to invest in tobaco & guns and that.

  10. You have to love Nics last paragraph…….. the true meaning of a sweeping statement and his opinion !

    “As for restricted advisers themselves, they seem caught between the desire to make as much money as possible from their clients, no matter how, and an understanding that the proper way to do it is ethically. Right now, for many, the less ethical approach is winning.”

    Personally I express and agree charges and costs in at least 5 different ways; verbally, CIDD, signed agreement, suitability report, illustrations, fund fact sheets…. Ok 6 there could be more

    To the best of my knowledge restricted advisers do the same. So Nic how do you arrive at the presumption that the vast majority of restricted advisers are less that ethical ? or indeed their time is, or should be viewed, less value than any-one else’s ?

  11. @ Nick Wardle
    They actually dont Nick – The press and idiots like Cicutti try to convince them that they don’t understand that 1% of £50,000 is £500.00 (plus all illustrations and suitability letters tell it in % and £s anyway)
    Mr Justin Cash obviously does not understand that most restricted advisers are actually whole of Market and if a client goes to an IFA or An RI for say a personal pension plan the job and time spent on the Job is almost identical !!

  12. To my mind there are four main problems you simply ignore Nic.

    1.) People are responsible for their own actions (much as the politicians and do gooders would have you believe otherwise). All the time you create a system where people aren’t responsible for their own actions, you create a system where those that are responsible (i.e the good) pay for people that either cannot be bothered, are too lazy to ask a question if they don’t understand.

    2.) The quality of advice and service offered within the market varies dramatically, by trying to make everything about charges you are in effect trying to compare apples and concrete on a common scale.

    3.) It’s not up to the regulator, you or anyone else to dictate to any adviser or firm as to how much profit they can make, that’s the markets job.

    4.) What is financial advice? To many, it’s simply a question as to whether a specific product at a specific time is appropriate to their needs. To others, it’s about helping a client achieve their life goals, about helping them plan their financial route through life, adapting along the way and the “products” are a supplement/incidental.

    Unfortunately Nic, you clearly have a major issue with decent advisers/planners earning a decent living. Pray tell, do you have a problem with journalists earning hundreds of thousands of £’s a year?

  13. Hundreds of thousands of £s per year for writing hogwash !!!

  14. Financial services is that strange industry where it is abhorrent for any professional within it to make any money. We should all be giving away all the experience we’ve amassed over years of advising after sitting multiple exams for absolutely nothing……………

    …………………or that’s what half the public think and the majority of the press believe.

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