Commission-Based Advice

Overview

Financial advisors that are compensated on a commission-based structure make money when their clients purchase or utilize a specific product or service. It’s important to note that commission-based financial advisors operating under fiduciary rules must still maintain the absolute best interest of the client; however, the products and services they offer will be directly linked to a commission.

For example, commission-based financial advisors may receive compensation from financial corporations when new clients open an account or on the sale of a financial product. These financial advisors receive their compensation exclusively from the sale of various financial and insurance products. These can take the form of upfront sales fees, or loads, on mutual funds, commissions from the sales of annuities or insurance policies, and all sorts of trailing commissions including 12b-1 fees and surrender charges on certain products if the investor sells them before a specified time period.

Commission-based advisors charge nothing to their clients and are compensated solely through commissions. By contrast, fee-based advisors charge a flat fee directly to their clients for their services. This fee can be structured in multiple ways, such as an hourly rate, a monthly retainer, a flat annual fee, or a percentage of assets under management (AUM).  These commissions come from accounts they open and financial products they sell.

There has been some backlash against compensation-based advisors in recent years, based on an assumption that they have the potential to be biased towards selling their clients the most lucrative product — lucrative for them, that is. It is important to recognize, however, that not all advisors are the same. They don’t all have the same motivations or predilections.

Regulation

The Securities and Exchange Commission (SEC) regulates investment advisers, primarily under the Investment Advisers Act of 1940, and the rules adopted under that statute. One of the central elements of the regulatory program is the requirement that a person or firm meeting the definition of "investment adviser" under the Advisers Act register with the Commission, unless exempt or prohibited from registration.

Generally only larger advisers that have $25 million or more of assets under management or that provide advice to investment company clients are permitted to register with the SEC. Smaller advisers register under state law with state securities authorities.

Section 202(a)(11) of the Advisers Act generally defines an "investment adviser" as any person or firm that: (1) for compensation; (2) is engaged in the business of; (3) providing advice, making recommendations, issuing reports, or furnishing analyses on securities, either directly or through publications. A person or firm must satisfy all three elements to be regulated under the Advisers Act.

The U.S. Department of Labor’s so-called Fiduciary Rule, which came into effect on 9 June 2017, requires advisors to act in the best interests of their clients, and to put their clients' interests above their own (see Fiduciary Duty).  The rule leaves no room for advisors to conceal any potential conflict and states that all fees and commissions must be clearly disclosed in dollar form to clients. The definition has been expanded to include any professional making a recommendation or solicitation — and not simply giving ongoing advice. Previously, only advisors who were charging a fee for service (either hourly or as a percentage of account holdings) on retirement plans were considered fiduciaries.

Advisors who wish to continue working on commission will need to provide clients with a disclosure agreement, called a Best Interest Contract Exemption (BICE), in circumstances where a conflict of interest could exist (such as, the advisor receiving a higher commission or special bonus for selling a certain product). This is to guarantee that the advisor is working unconditionally in the best interest of the client. All compensation that is paid to the fiduciary must be clearly spelled out as well.

 

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