Diana Clement: Self-servers undaunted by regulation

Regulation is finally on the horizon in New Zealand but it's not going to tame the commission salesman.

Both the United Kingdom and Australia have had enough of the self-interested advice that comes when commission is dangled before an adviser, and are on the path to banning commissions.

I've been in Australia and have been reading with great interest the flood of articles about a company called Storm Financial.

As many as 14,000 investors have lost up to A$90 million ($115 million) as a result of investing through Storm. Storm's commission-based advisers encouraged clients to raise mortgages against their homes to secure margin loans to invest in share funds.

Margin loans amplify gains and, as these investors found, losses as well. When the fund prices crashed in the credit crunch, the investors were left with loans they couldn't afford to pay back.

It was an extreme case, but the fallout resulted in an inquiry by the Australian parliamentary joint committee for corporations and financial services that drew thousands of submissions, many calling for a ban on commissions.

The committee has this week called for government officials to work with the financial services industry to develop the "most appropriate mechanism by which to cease (commission) payments".

In the UK, commission on investment products will be banned within three years by the regulator, the Financial Services Authority. That includes up-front commission and new trail commission payments. These are annual commissions paid if investors hold on to the product they were sold.

Commissions and financial inducements come in various guises. Up-front commissions are paid for selling a managed fund or superannuation, which can be as much as 7 per cent of the cost of the investment, and trail commissions are a smaller figure.

If you're buying a product that involves premiums or regular payments being made the adviser usually gets a percentage of that money - often a large percentage in the first couple of years. That commission can be more than 50 per cent of the premiums.

Some financial professionals also charge monitoring fees or a funds-under-management charge. This is the reason, cynics say, some want you to take sums of money from bank and term deposits and put them in funds - even cash funds.

Financial service providers may also offer other incentives, such as bonuses for reaching certain targets or overseas holidays to top salespeople. Banks' financial planning staff are given incentives to sell products or given quotas to sell, which can have the same blurring effect that commission does.

Suzanne Edmonds of the group EUFA (Exposing Unacceptable Financial Activities) says that over 90 per cent of cases her organisation has seen resulted from advisers making recommendations based on the commissions they would receive.

"We believe it has been quite a scurrilous campaign by advisers to sign people up for their own advantage. They never disclosed that they were getting higher commissions from the (products) they were recommending."

If you consider the cessation of commissions to be a good thing for investors then New Zealand is well behind the UK and Australia. Banning commissions brings advantages to both individuals, who should be able to trust the integrity of their advisers more, and also the economy because once individuals begin to trust the industry more they should save and invest more as a result.

It's often said that the financial advisory industry would cease to function if commissions were banned. However, a report published by Ernst & Young in the UK in September predicted that 15,000 of the 35,000 advisers would leave the business.

Of the remaining 20,000, half would remain independent, giving advice across the entire spectrum of investment and pension products and the remainder would give what is called "restricted advice" in a particular area.

There are growing numbers of advisers in New Zealand who charge fees. Some are "fee only", which means they take neither up front commissions nor trail commissions. Others rebate the up-front charges, but still receive trail commissions.

Financial planner Phil Ashton of Rutherford Rede has worked for fees only for the past 12 years and says contrary to opinion in his profession he earns a "rewarding income" from fees.

Ashton's clients understand exactly what they're paying for advice and can judge the returns for themselves. "You avoid the inferences that you are skewed towards certain products (because of the commission they pay)," he says.

Regulation is about to shake some advisers out of the profession, by making it more expensive for them to practice. Ashton says commission-based advisers ought to question the long-term viability of their current business models.

The most obvious examples of commission and inducements skewing advice in recent years have been the sale of ING's Diversified Yield Fund and Regular Income Fund by ANZ's financial advisers and recommendations by many financial planners to invest in less-than-secure finance companies that just happened to be paying good commissions.

In the ANZ/ING case many of the investors were conservative, nearing retirement, and didn't want to risk their capital - which was exactly what happened.

But the advisers were under pressure to sell these funds by the ANZ, which owned 49 per cent of ING New Zealand, and therefore had an additional financial benefit if customers bought these products.

Just how much pressure becomes obvious when you look at the Banking Ombudsman's case notes from some of the complaints. In many cases the majority of people's money was invested into the two offending products and the advisers emphasised the safety of the products. Many investors were told the funds were "like a term deposit".

In the case of "Mr and Mrs K", for example, the couple invested $621,000 in a single fund on the advice of the ANZ adviser and the ombudsman concluded that this adviser had:

Failed to properly explain the nature of the investments it was recommending and about the risks associated with both funds.

Misrepresented the rates of return as guaranteed rather than variable.

Failed to recommend a full financial plan with a proper assessment of their risk profile.

Failed to recommend a prudent diversification of investments to spread risk.

And continued to assure Mr and Mrs K that their investment decisions were sound, even after they had expressed their concerns to the bank on a number of occasions.

The ombudsman has completed investigations into 194 of the ANZ/ING complaints and has another 202 in progress.

Commission doesn't just skew the advice given for investment products. It affects mortgages and insurance as well. In the case of insurances, brokers have an incentive to "churn" - which means every few years find a "better" policy to replace the existing one. That way the broker gets another bite at the commission cherry.

Plenty of financial sales people, be they called advisers, planners, brokers or a number of other titles, who are on commission will sell you the best product for you from a range that pay commission. But they rarely sell products from a company that doesn't offer commission.

A case in point is mortgages. Virtually no commission-based mortgage brokers will suggest you get a Kiwibank or BNZ mortgage because they don't pay commission. They may, however, have the best mortgage for you. But you're not going to find out from a broker.

In the case of health and life insurance, churning customers isn't often in their interest. The Insurance & Savings Ombudsman's database is littered with cases where people were advised to change health or life insurer, but conditions they'd developed in the meantime, and sometimes didn't even know about, weren't covered under the new policy.

For example, Mr C claimed he was told by the insurance broker that he would be covered "no exclusions", but when he claimed for a gastroscopy, had his claim declined because he had failed to disclose his relevant medical history. Mr C argued that the broker "chose to interpret [his] answers to suit her agenda, which was to sign [him] up in order to gain a commission".