Advisers vs distributors: there’s more to it than only remuneration
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There are several instances where we use consultants—we consult doctors, lawyers, architects, chartered accountants, and many others, as may be necessary. For instance, we go to a doctor when there is some bodily ailment and confide in her the problems we are experiencing. She would question, examine, analyse and arrive at a conclusion about the possible cause of the sickness. Then she would prescribe medicines. A fee is paid for her advice and the patient goes to a chemist and buys the medicines.
Let’s look at the alternate scenario. Everything is the same, but the doctor does not charge her fee. Instead, she asks the patient to buy certain medicines from a particular chemist. The doctor would get a cut on the price of medicines prescribed. Which doctor would you want to use, even if what you may pay overall is the same? The answer is self-evident. This example has been used to illustrate true, unconflicted advice versus advice where conflict is inherent and fully present.
Distributors have a role to play in the financial services ecosystem. There would be many customers who are looking at a basic level of engagement, which can be met by a distributor. However, a distributor is not the same as an adviser, and this is the distinction that consumers at large need to understand.
Distributors of financial instruments generally give advice and sell products that their clients need and are remunerated indirectly in the form of commission, which is embedded in the product they sell. On the other hand, fee-only advisers offer advice and charge a fee directly to the client. The argument is that the “only difference” between the two is the way they are remunerated for their advice. But are these two the same? They are not. Here’s how they are different.
Representation: Distributors represent their principal. They sell products of their principal to clients based on their own “advice”. Their remuneration is going to come from their principal, based on the products sold. A fee-only adviser represents only the client and is independent in this regard.
Conflict of interest: In such a scenario, there is certainly a possibility that distributors may sell the product that is most remunerative to them. Since they offer advice as well as products, there is a possibility that the product is not the best from the client’s viewpoint. So the issue is not how distributors get their remuneration, but the conflict of interest.
A fee-only adviser, on the other hand, offers advice for a fee. Hence, the judgement would only be based on what is in the client’s best interest as the client is the paymaster in this case.
Different standards: As distributors they need to follow the suitability standard, where they can sell the principal’s product if it is broadly suitable to the client's requirements. By this standard, they have done their job even if the product suggested is not the one with the least cost in the category or offers lower benefits in comparison to others in the category. Also, they need not worry about other categories of products which may be more suitable to the clients.
Fee-only advisers, who are registered investment advisers (RIAs) with the Securities and Exchange Board of India (Sebi), follow the fiduciary standard. The adviser is expected to put the client’s interest first, even above their self-interest. Thus, such advisers are bound to suggest products that best suit their client’s interests. They also follow higher standards of certification, documentation and compliance requirements, which again is in client’s interest.
It is, hence, clear that the difference between a distributor and a fee-only adviser is not just a matter of how they are remunerated, as various financial services intermediaries tend to argue in every conference or event. Doing so is obfuscating facts for pecuniary ends. Some veterans also opine that the regulator does not understand this and other “ground realities”. I would argue that the regulator is fully cognizant of the ground realities and that is precisely why it is tightening regulations. Self-regulation, I have heard, does not work well, globally.
Regulators need to protect investors from being taken for a ride. They may rub the entrenched participants the wrong way as tightening rules may affect incumbents adversely. But regulators have to play their role keeping in mind the larger interests. (To read the Sebi consultation paper on investment adviser regulations, go here: http://bit.ly/2sX9amO).
In a nutshell, distributors (or agents) represent the principal and not the client. This leads to an inherent conflict of interest. Also, they follow the lower suitability standard, which as we have seen, is not in investor's best interests. Fee-only advisers represent their clients, have no or lower conflict of interest, and follow a fiduciary standard. Those are the differences and they are significant from the investors’ view point.
Suresh Sadagopan is founder, Ladder7 Financial