There has been comment in the media lately about banning commissions on financial transactions following an Australian example where legislation is to be introduced in 2012 to make all payments to financial advisers fee only.
New Zealand is expected to follow Australia's example.
In New Zealand this possible legislation is aimed at companies which bought business by offering incentives greater than normal.
Media reports specifically mentioned Bridgecorp, which was known to provide incentives for larger volumes of business.
It is also aimed at advisers who do not disclose what they are being paid when offering advice.
Legislation which has been in place since February 2009 makes it compulsory for advisers to disclose all fees and charges in a "disclosure statement", which has to be given to potential investors before giving advice.
The statement sets out the details of the advisers' experience, how they are paid and declarations concerning bankruptcy and dishonesty.
I have recently seen a disclosure statement from a major bank employee which in my opinion does not comply with the law because of its brevity.
All finance companies have always paid brokerage, which has come from the company's margins, not from the investors' capital.
The companies lend out investors' money at 2%-3% or more above the amount they are paying the investor such that the brokerage payment is from within the company.
The industry norm is 0.5% of the capital for each year of investment term (a term of two years on $20,000 would be $200 brokerage).
It is understood that Bridgecorp paid 1%-2% depending on the amount of bulk funds invested by advisory firms.
Managed funds' initial front-end fees can be charged, ranging from 0%-5%.
This fee comes off an investor's capital.
This fee is paid to the adviser, who has the discretion in most cases to rebate it to whatever level they choose.
Very few advisers nowadays would charge the full 5% fee.
There has always been much grumbling from investors about the Manager Expense Ratio (MER) on managed funds, whereby the provider charges fees for managing the fund.
An average MER would be 1.5%-2.5%.
From the MER many providers pay advisers a trailing fee.
The industry norm for trailing fees is 0.25% per annum.
I believe complaints about MER to be a red herring, as an investor is employing a fund manager to manage their investment.
Fund returns are usually reported after fees and/or tax such that the MER has already been deducted.
If a fund manager is not performing then find another who is returning above the industry average.
If trailing fees are removed then MER should reduce as well.
I am not aware of any KiwiSaver provider charging an upfront fee for joining, although I understand some advisers are charging a fee.
Several KiwiSaver providers are paying a trailing fee but because of the small amount per person paid into KiwiSaver, providers and advisers are actually taking a loss providing the service.
I doubt if any provider will make any money from KiwiSaver for about five years.
If trailing fees are scrapped then many financial advisers will have to increase their fees to clients.
The trailing fees allow for administration of a practice for a large amount of work that cannot necessarily be charged directly.
As a result, advisers are able to operate on a low fee structure such that many of our clients do not pay a direct fee.
The outcome of having to charge directly a fee for service will be interesting.
It will not improve advice given to investors. I expect many investors will resist direct fees.
Those who are not prepared to pay will continue to do their own thing and get themselves into trouble by not paying for professional advice as has happened in the past.
• Peter Smith is a certified financial planner and is the principal of Peter Smith Financial Services Ltd, Dunedin.
Email: finance@petersmith.co.nz.
A disclosure statement is available on request and free of charge.
