Why FoFA should have been only the start of reform

In my open letter to Assistant Treasurer Arthur Sinodinos this week in which we at Eureka Report called on him to pull back from repealing key parts of the Future of Financial Advice legislation, I wrote: “There should be a lot more reform … but FoFA is a good start”.

Financial advisers, horrified at FoFA and lobbying Senator Sinodinos to get it changed, might be wondering what that meant, if they’d got that far into the letter. So let me explain.

In my view, the big racket in the financial advice industry, hiding in plain sight, is percentage fees. 

Sales commissions and other forms of “conflicted remuneration” to advisers, which were banned by FoFA, were on the way out anyway. Even the least scrupulous planners understood that the rort couldn’t go on.

The Financial Planning Association and all major “dealer groups” had already moved to “fee for service”, but the problem was (and is) that this almost always involves taking a percentage of each clients’ money (referred to as ”Funds Under Advice”, or FUA) directly instead of being doled out by the product manufacturers as sales commissions.

There are four problems with this system.

1. Those with a lot of money pay far more than those with little money, for a service that costs the same. Socialists would approve since it’s a subsidy for the less well off -- a progressive tax -- but it’s no way to run capitalism, and it’s driving away those with more wealth from getting the advice they need.
2. Advisers are over-rewarded for rises in markets for which they are not responsible. Since 1979 the Australian sharemarket has produced a compound annual total return of 11.6 per cent. Last year it was 19.7 per cent. Percentage fees go up accordingly. Yes, there are years when it falls, but usually investment markets provide advisers with fee increases that are a multiple of their cost increases.
3. Most people don’t understand percentages and compound interest, and think that 1 per cent is not much. The result is a fee structure that is fundamentally higher than it should be.
4. By only being paid for money that’s invested, advisers are naturally inclined to maximise that amount, whether it’s in the client’s best interests or not.

Yesterday I spent time with two fine financial planners who do not charge percentage fees on principle, and who have fast-growing, profitable practices: Catherine Robson and Olivia Maragna.

Maragna was the 2012 Financial Adviser of the Year and has been running her firm, Aspire Retire, with her husband Stephen Degiovanni, for more than a decade. She is Brisbane-based but has clients all over Australia, including Perth.

The couple’s firm has grown 30 per cent a year since it started. They charge a fee for service, which is a dollar amount rather than a percentage of funds, because they believe that’s the only way they can act entirely in their clients’ best interests. Maragna says she has been to many 60th, 70th and 80th birthday parties, often as the only non-family member.

Catherine Robson started her firm, Affinity Private, four years ago after a long career as a financial planner with National Australia Bank, where I first met her. When she was there she used part of her own salary to employ a consultant to help restructure her NAB practice to dollar-based fees. She did that successfully, and then eventually left on good terms to start her own firm.

She charges between about $7500 and $12,000 a year depending on the complexity of the clients’ affairs, either on a monthly retainer or for a particular project.

Robson doesn’t charge a percentage of FUA because she doesn’t think it’s fair or transparent: “A person with $10 million is not costing me ten times as much to look after as someone with $1m. It all depends on the client’s particular needs.”

It’s true that there’s often ‘sticker shock’ on the amount, but that just means she has to explain fully and convincingly why it is justified.

It also means she can look after a client’s entire financial affairs. Recently she had a client returning from overseas with a lot of cash who needed advice on investment strategy as well as what sort of house to buy to live in. She knew that if she were charging a percentage, she would have been inclined to encourage him to buy a cheap house and maximise the investible assets, which wasn’t necessarily the best thing to do.

Both Maragna and Robson talk constantly to their clients: in effect the clients 'opt-in' all the time (the industry has bitterly fought the FoFA requirement that clients opt-in every two years).

By charging each client a dollar amount like a doctor, accountant or lawyer, rather than a percentage, there is simply no question in whose best interests they are acting. For them there is no need for ‘little g’ – the 'general' best interests requirement in FoFA that Senator Sinodinos wants to remove, let alone the other six specific tests that come before it.

And of course there are no commissions, whether the advice is specific or general (Senator Sinodinos wants to allow commissions for general advice).

Most of all, Olivia Maragna and Catherine Robson feel good about themselves as professionals and so do their clients.

Is there likely ever to be a law banning percentage-based financial advice fees? I doubt it, even from a Labor government.

But if the industry was serious about professionalising itself, and ensuring that every Australian got financial advice just as they go to the doctor and use lawyers and accountants, then that is the way it would head.