BROKERAGE COMPENSATION PLANS CAN PRESENT CONFLICTS OF INTEREST
Several e-articles published today describe the 2010 broker/advisor pay plan for Morgan Stanley Smith Barney producers. These articles describe the merging of the two compensation plans from each of Morgan Stanley and Smith Barney since the joint venture recently combining the two firms. However, this information provides good insight into the industry’s compensation models. While the articles compare and contrast the two firms legacy plans and the new combined program from the potential impact to the producer, I want to focus on how these compensation plans can potentially impact the advice investors may receive from their brokers and/or advisors.
The articles explain that producers can receive a pay-out between 28% for those producing less than $200,000 in annual production, 42% for those producing between $600,000 and $999,999, and as much as 47% for those producing in excess of $5 million annually. I assume there is a scale for those producing between $200,000-$599,999 as well. This annual “production” is typically based on the Gross Dealer Concession generated by a broker/advisor. Gross Dealer Concession (GDC) is the amount generated for the firm by the sale of an investment product. For example, a mutual fund sale of $10,000 with a 4.5% sales charge, after break points, would generate $450 in Gross Dealer Concessions to be shared by the brokerage firm and the broker on a basis determined by their “grid”. Therefore, with the information described above, the producer would receive between 28% and 47% of the $450 in GDC depending on where they fell within the grid, and the firm would retain the remainder.
A quick review would indicate that it is in the brokerage firm’s and broker/advisor’s best interest for each producer to produce as much as possible. The firm wins by increased revenue and the producer earns a higher pay-out percentage as (s)he produces more. We can’t fault them for wanting to perform well and produce as much as they can. Under this type plan, we would too. However, when compensation plans reward producers on a graduated scale and give them incentive to receive higher compensation as their sales increase, there is at least the potential for a conflict of interest as extra sales will trigger higher pay-out.
One article also explains that the new 2010 plan will also offer four possible “deferred” incentive plans, based on length of service, revenue growth, net new assets brought onboard and the number of new $1 million-plus households. Another writer describes them as “supplemental” compensation. Either way, it has been my experience that current compensation such as that generated from the grid will usually take priority over supplemental compensation, and certainly is a greater focus than deferred compensation that may take years to realize. Maximizing broker pay-out from the grid is absolutely the focus of the broker and their sales manager. The sales manager is typically compensated on the production of the broker/advisors within his group. I can assure you that the broker has ample incentive to maximize the opportunity presented within the grid.
Another observation from this analysis is that it supports my position, as described in another post (Why Many Brokers And Advisors May Neglect Their Clients) that the industry focus is on acquiring new clients with large assets and not necessarily focusing on serving those existing clients that simply don’t have any more to invest or are unwilling to agree to additional commission-based transactions. Let’s call them neglected investors.
Admittedly, I have not seen or reviewed the plan discussed in these articles but the description set forth is consistent with other firm’s plans and past plans that I have reviewed or worked under. Additionally, I am not passing judgment on the the plan or making a general statement regarding the type of compensation plan used in the industry. But as an investor, you should know how the broker or advisor that you are working with is compensated. This knowledge can only assist you in determining if your broker or advisor’s interests are aligned with yours. They may not be, and that may be totally acceptable, but you need to know, and education is the key.
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