I’d like to weigh in on the debate so eloquently captured yesterday by Gil Weinreich (Should Brokers Be Forced to Disclose Their Bonuses to Clients?). The issue in question is whether recruiting bonuses paid to brokers ultimately harm their clients, and while I don’t have much of an interest in how much brokers get paid, this discussion is important in that it clearly illustrates the inherent flaw in the commission compensation system.
First, the debate. “If an advisor had additional benefits or services from a third-party money management firm, all that would have to be disclosed to clients,” Beverly Hills, Calif.-based securities attorney Patrick Burns told Weinreich. “If [registered investment] advisors have that level of obligation, shouldn’t brokers have an obligation to disclose these bonuses? Our clients who are investment advisors would like to see the playing field leveled in terms of disclosures.”
Nay, nay, responded veteran broker recruiter Mark Elzweig, the New York-based principal of Mark Ezweig Co. “This idea was kicked around by Arthur Levitt’s SEC back in the ’90s and then tossed,” Weinreich quotes him. “Nobody was able to show that the payment of lucrative signing bonuses to advisors harmed clients in any way. If [brokers] are required to publicize their compensation, why shouldn’t attorneys, doctors and other service professionals operate under the same strictures? Such an unjust, foolish rule would harm investors by encouraging talented individuals to seek careers elsewhere.”
Here’s my two cents: Much as I believe that investors everywhere would benefit from a level the playing field between RIAs and brokers, Ezweig is right. The disclosure of recruiting bonuses would be over the top. That’s their deal with the firm that employs them. Sure, commissions maybe higher to pay for them, but commission revenues also pay for executive salaries and bonuses and perks, fees to recruiters, cutting-edge technology, and all those huge, shiny office buildings. Should all those be disclosed as well?
Perhaps the best argument is that annual or performance bonuses paid by RIA firms to RIA reps aren’t required to be disclosed to clients. Why not? Don’t they factor into the size of the AUM fees? I agree it’s an absurd example. Except that it illustrates the fundamental difference between fee-compensated advice and commission-compensated sales: commissions on trades and/or products creates an irreconcilable conflict between the firm and the client—and because brokers work for their BDs, between them and their clients.
The reason that disclosing RIA bonuses would be ridiculous is that they don’t matter. If a firm charges a 1% AUM fee and a client agrees to it, the compensation to any specific advisor is irrelevant: when investment assets grow, firm revenues go up; when portfolios shrink, so do revenues. But that’s not how it works in the brokerage world. Why do firms pay those big recruiting bonuses—and usually higher commission payouts—in the first place? Obviously, they expect to make a return on their investment. Yes, recruited brokers bring some of their clients with them, but they also tend to generate higher revenues per similar sized client. And that means the client and the broker/BD have divergent interests.
In the RIA world, that’s just not possible: fees are what they are. So the only recruiting bonuses for RIAs would be based on investment acumen, a specialty such as taxes or financial planning, or the ability to attract new clients. And the only way for RIA firms to recoup those “investments” would be out of fee revenues, which the clients agree to up front. Which is why we don’t see a lot of recruiting bonuses in the RIA world.