Regulation business has become a growth industry, warns advisor

Amid the reignited debate over transparency and conflicts of interest in advisor compensation, one financial professional says regulators may be swinging the hammer too hard in its efforts to protect investors.

“I would say we're certainly transparent enough,” says Kelly Smith, private wealth advisor at Top Hat Advisory. “We’re required to disclose our fee structure to clients and have them sign off on it on every transaction, so I don't know what else we could do in the way of transparency.”

Given the regulatory pressures on compensation, disclosures, and other issues, Smith’s impression is that Canadian regulators are assuming advisors are inclined to take advantage of clients. But based on 40 years of experience, he says the vast majority of advisors are not out to exploit the individuals and families they work with.

“The regulation business has become a growth industry, and it's all on the premise of consumer protection. The consumer, in most instances is being delivered good advice by good people,” Smith says. “Every industry has the odd bad apple – they’re the ones that make the news, and kind of taint [the profession] for the rest of us.”

Regardless of the financial product, Smith says his practice maintains a policy of disclosing the method of payment to clients. He estimates that in a long-run timeframe of between 10 and 15 years, advisors end up earning the same income no matter what compensation structure they adopt. Therefore, it is in advisors’ best interest to provide sound advice and guidance to maintain their relationship with the client for the long term.

The contentious deferred sales charge (DSC) structure, which requires clients to pay a certain fee when they redeem certain investments ahead of a specified schedule, was effectively banned for mutual funds across Canada in June last year. Ontario is prohibiting that model from new segregated fund sales on June 1, and insurance regulators across Canada are contemplating how to approach a DSC seg fund ban in their respective jurisdictions.

“As a newer or younger advisor in the business, it was advantageous to use that method because you generated higher revenue. It wasn’t necessarily a bad choice for the consumer, and allowed the advisor to establish themselves in their career,” Smith says. “In our practice, we use the no-load fee structure: we get no compensation upfront, but we get a consistent trailer fee in perpetuity, as long as a client stays in an investment with us.”

Emphasizing that the no-load model isn’t right for everyone, Smith says his team adopted it to minimize the risk to clients. In the event that they need to withdraw their funds, they wouldn’t need to pay extra fees. Because they’re not locked in, it creates added flexibility.

“We believe in establishing long-term relationships with our clients, and the revenue aspect will look after itself,” he says.

He cites a third model, low-load fee schemes, as a middle-ground structure that sits between DSCs and no-load structures. The low-load structure, he says, puts some risk on the client for the first couple of years, and gives advisors a modest amount of upfront compensation; after that, the client will start paying a trailer fee in year three.

“After 40 years in the business, I’m of the humble opinion that the advisor does bring value to the client,” Smith says, noting one published study showing that clients who consistently worked with advisors generated 2.7 times more assets than those who don’t. “We as advisors should be compensated for the advice we deliver – our experience, connections to different carries, and our expertise in different products.”

Multiple studies have demonstrated how people who work with professional advisors are able to accumulate more assets than those who try to go their own way. Like a number of other veteran wealth professionals, Smith is of the opinion that overregulation and excessive restrictions on fees would squeeze advisor compensation to the point where they would effectively get paid nothing for their hard work in helping people invest and save.

“I certainly understand that perhaps certain advisors misused the DSC model, but that’s gone. Regulators and the financial companies have decided it isn’t worth the trouble to keep up, and that’s fine,” he says. “The other methods left on the table minimize or take away the risks to clients from moving their money.

“You never want to have your client handcuffed to the point where they felt they couldn’t move their money – they may have gotten poor advice, or there’s an emergency, or just life circumstances. It’s their choice.”