Money for nothing and your cheques for free

The just published FCA thematic review on ‘Inducements and Conflicts of Interest’, a result of last year’s Dear CEO letters”, does a lot to recognise that in the RDR world, support that networks and national advisers first requested many years ago, expected, then demanded and got from providers, is no longer compatible with the RDR ethos.

The FCA notes that the review has “highlighted serious concerns” that the agreements with over half the firms sampled had the potential to“inappropriately” influence and the resulting “conflict of interests” were just not being managed effectively.

How did it get to this? Here are some waypoints (I may have missed a couple due to the passing of time) to assist with some historical navigation:

  • From the late eighties increased commission levels from larger distribution channels were being sought after the OFT got rid of the Maximum Commission Agreement (MCA) as it was seen to be anti-competitive. Well done OFT.
  • Smaller directly regulated firms demanded the same treatment as these big producers and got it, albeit mostly via service providers, commission uplifts were paid as long as you had a relationship with that firm, for example Portfolio Member Services (PMS} that became part of Bankhall
  • Broker consultant face-to-face relationship management started to go in the late 90’s and this trickle became a torrent in the first five years of the new millennium. Providers entering the new ‘Millennium’ low cost world could no longer support smaller directly regulated firms as they used to and would like to.
  • Provider firms greatly valued intermediated distribution as the solution (in MTV terms) to  “move those refrigerators”, but to do it at the same time as reducing costs and having margins squeezed meant that networks corralled, really well, a much needed distribution channel into a receptive space.
  • And in return for the ‘corralling’, those ‘fences’ and their maintenance was paid for by providers who in return had access to all these advisers in one place via the ‘rancher’, in this case the network.
  • Enhanced commission and special rates of allocation and charges were no longer considered good enough in the late 90’s and into the millennium, a tail chasing exercise ensued with networks wanting, demanding ever higher commission enhancements and they got them in return for that much needed distribution.
  • Then that was no longer good enough and we saw the arrival of the restrictive advice panel. Pay to play. This did not mean that network members could not use firms not in the newly created ‘VIP’ area, but it was much less likely those in the queue outside the roped barrier’ would see their products get a look in.
  • The money paid to ‘corralling ranchers’ for all the laudable business reasons explained became an addiction, fiscal heroin or cocaine by bank transfer, that enabled networks to thrive, indulge, play, expand, influence and above all control.

Like all drug addiction, the need for a way to further fuel the habit had to be found and that was by networks creating ‘preferred partners’, those who paid the ticket price, and those who paid to be in the VIP seats.

The addicts needed the fix but increasingly the suppliers were not seeing the return on investment, often because the addicts changed ‘supplier’ for better more powerful ‘fixes’, some died because their body corporate could no longer tolerate the toxic mess they found themselves in.

Established providers were becoming unhappy at the increasing mixture of demand and expectation linked to fickle reciprocal allegiance, but, commercial pressures saw them in effect ‘hog tied’ and on average, a traditional provider firm could be paying around £3m a year each to an array of networks.

New firms took the view that to get “down and dirty’ required lot’s of cash if they were to have some of the action.

And then came the “Dear CEO “ letter. This was not a pretty situation.

Remember that with some networks, demands of £500k pa were not unusual and that was on top of special commission rates and many other freebies such as the FCA highlight, like conferences at exotic locations.

As the song goes that aint workin’. And it was not fair on smaller directly regulated firms either.

In the eagerly awaited FCA consultation, they document examples of payments to secure distribution:

Example 1 – securing placement on a restricted advice panel

An advisory firm had secured substantial payments from a number of life insurers for providing support services, such as the promotion of their products and arranging training events; these life insurers (and no others) had also been selected for inclusion on the advisory firm’s restricted advice panels for investment products.

The process the advisory firm had used for panel selection gave it significant leeway to select life insurers who were purchasing services, and to discount those life insurers that offered suitable products but did not purchase the support services it offered.

Example 2 – significant increases in payments with little justification

A life insurer significantly increased its spending on support services offered by an advisory firm with little justification of the business benefit obtained and the steps taken to ensure a reasonable amount was being paid. Also, the terms of the service agreement provided for a sizeable increase in the services purchased in successive years. We considered the life insurer’s motivation was likely to be to secure sales of its products. 

Example 3 – a joint venture arrangement creating conflicts of interest

This involved a proposed agreement between a provider and advisory firm to jointly establish a new investment proposition. Under the proposed terms the provider would have paid a substantial upfront payment to the advisory firm. The advisory firm would have also received a greater proportion of the profits from the venture compared to its input into the arrangement, and its entitlement to profits would increase the more business that was channelled to the joint venture.

Given the inherent conflicts of interest involved, we also questioned whether the advisory firm could fulfil the requirements to be considered independent if it recommended funds it had a role in manufacturing.

As with similar joint venture-style agreements we reviewed, we prevented the arrangement going ahead in that form.

So networks were ingesting vast amounts of cash, charging the advisers who were part of them sizeable retentions and yet, if many ex and current network advisers are to be believed, value for them was not always fully understood or appreciated and the sums being received from providers was not made too clear.

Networks have many benefits for providers, they also greatly benefit small advisers; but they come with many downsides. especially if they go out of business as we have seen happen over the years. Network collapses are a fiscal version of the 9/11 twin towers collapses, businesses are lost, livelihoods and value destroyed, consumers affected and often there is no way out of the rubble for many.

The costs of the collapse clear up falls to the FSCS and then ultimately back to the reducing amount of surviving adviser firms. Any indemnity commission debt falls to the provider.

RDR has been a wake up call for advisers. It is a challenge to providers and a potential problem for the financial stability of networks that mostly seem to see losses, not profits.

Challenges for advisers are very well known and are endlessly discussed.

Challenges for providers are not so clear to advisers but I can assure you that RDR for them has been extremely costly in fiscal as well as human terms with massive job losses.

They also face the problem that as ‘manufacturers’ of product, albeit intangible, they still need to “shift those refrigerators”, get products to market. To do that they need a route to market and a delivery vehicle. Pre and post RDR that is mostly by way of intermediated distribution and it seems to be the case that it will continue that way for some time to come.

But unlike before RDR, the manufacturer cannot pay the distributor who cannot be on the receiving end of ‘sweeteners’ to make their products stand out above the rest. A conundrum as well as a challenge in the form of a level playing field.

Networks and smaller directly regulated firms can now ‘play nicely together’ with those smaller directly regulated firms knowing that their network counterparts have not got the benefit of better commercial terms, special rates and subsidy by way of tenuous or blatant links to support organisations set up to ‘launder’ their ‘protection money’ coming in the form of provider cash.

The FCA makes it clear in Principles for Businesses – Principle 8 (Conflicts of interest) that states “We expect all firms that we regulate to undertake their business in line with our eleven Principles for Businesses. Principle 8 requires that a firm must manage conflicts of interest fairly, both between itself and its customers and between one customer and another. SYSC 10 sets out specific rules in relation to the identification and management of conflicts of interest.

This was not so much about ‘buying’ distribution (after all that is what providers are in business for, to see their products fly off the shelf) it was to make sure they were not blocked from a valuable distribution source.

What we now have is a level playing field for providers too where distribution success is determined by traditional values of service, charges, performance, rate, and product features.

And not by who pays the most ‘protection money’ or bulk buys all the ‘best seats’.

Regarding us, when starting Panacea, a key driver was that smaller directly regulated firms did not get the support that networks benefitted from. That was not fair and we wanted to correct that in a way that was not distribution driven and created a level playing field. We are supported by providers in an RDR friendly way, by any provider in fact who wishes to support the ethos of seeing the ‘little guy’ helped along toward creating their own business success. So far we have 42 firms supporting a community of some 17,000 that has produced up to the end of Q2 some £4,046,912,909 of premium income.

Not bad for smaller directly regulated firms, and a shining example of how a community driven by agnostic support for adviser firms can help create better consumer outcomes.

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