Key Differences between fee only advisors & distributors

For Public at large, they are just not aware as to who is an advisor, as everyone uses the appellation of Advisor. Hence, the investing public has the wrong notion that distributors who are actually selling products are advisors.

This wrong perception makes them engage with them & seek “advice” from them. The “advice” which they offer is tailored to sell the product. Also, since these distributors are remunerated by way of commission & do not charge a fee, investors tend to think they are getting free service!

A true adviser who offers client-centric, conflict-free advice, does not sell any product and acts in a Fiduciary capacity to their client. These fee-only advisers do not get a commission and charge a fee. They are registered with SEBI under Investment Adviser Regulations, 2013.

There are many differences between a fee-only, conflict-free adviser & someone who is merely distributing products.

Representation – A fee-only adviser represents only the client. They have the client’s interest at heart. Their advice & recommendations are entirely in the interest of their client. 

As opposed to this, product distributors represent their Principals as their agents. They get their remuneration from their principals and are controlled by them. They have an incentive to sell products that offer them the maximum incentive as opposed to fee-only advisers who are product agnostic and suggest what is good for the client.

Remuneration – The way one is paid hugely affects outcomes. A commission earning product distributor recommends products that pay him/her the biggest commission.

A fee-only adviser is remunerated by the client & their focus and loyalties lie only with them. This will mean that the right kind of products truly aligned with the client’s needs are suggested.

Hence, even though the outgo from the client’s side may be the same, the outcomes for the client can be completely different.

Control – When the remuneration is embedded in the product, the distributor gets their commission even if they do not provide any service. For instance, an insurance agent who sold a policy will continue to get commissions for the lifetime of the product, even if s/he is no longer giving any service to the client.

In the case of a fee-only adviser, the payment for service rendered is given directly by the client as long as they receive the service and are happy with it. However, if they want to stop receiving the service, he can also stop.

There are several instances where we use consultants… we consult doctors, lawyers, Architects, CAs etc., as may be necessary.

For instance, we go to a doctor when there is some bodily ailment & confide in him about the problems we are experiencing.  He would question, examine, analyse and arrive at a conclusion about the possible cause of the sickness. Then he would prescribe medicines. A fee is paid for his advice and the patient goes to a chemist and buys the medicines.

Let’s look at the alternate scenario. Everything is the same;  but doctor does not charge his fee. Instead, he 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 is used here to illustrate true, unconflicted advice vs advice where conflict is inherent and fully present.

There is a debate in financial services industry which goes like this – Distributors give advice and sell products that their clients need and are remunerated indirectly through commission embedded in the product. Fee-only advisors offer advice and charge a fee directly.

The argument goes that the “only difference” between the two is the way they are remunerated for their advice. But are these the same ? They are not!

Representation – Distributors represent their principal. They sell products of their principal to clients based on their own “advice”.

They represent their principals ( as their agents ) and would most probably do what is expected from their principals. Their own remuneration is going to come from their principal based on the products sold.

A fee-only advisor represents only the client & is independent.

Conflict of interest –  In such a scenario, there is certainly a possibility that they may sell the product which is most remunerative to them. They offer “advice” and also sell the products to the clients. Such a product may or may not be the best from the client’s viewpoint.

So how they get their remuneration is not the problem, but the omnipresent conflict of interest is.

A fee only advisor on the other hand offers advice for a fee. Hence, his judgement would only be based on what is in the client’s best interest as he is paid only by them.

Is that all? No, there is more.

They follow different standards – As Distributors they need to follow the suitability standard, where they can sell the product of their principal if it is broadly suitable to the client’s requirements. By this standard, they have done their job even if the product suggested is from their principal and is not the lowest cost products in the category or offers lower benefits in comparison to others in the category. Also, they need not worry about some other category of products that may be more suitable to the clients.

Fee-only advisors, who are RIAs registered with SEBI, on the contrary follow the fiduciary standard. In Fiduciary Standard the advisor is expected to put the client’s interest above everything, including their own self-interest. They are bound to suggest such products that would best suit their client’s interests. They also follow higher standards of education, certification, documentation and compliance requirements which again is in client’s interest.

Clear difference – It is hence clear that the difference between a distributor and a fee-only advisor is not just a matter of how they are remunerated, as the various financial services intermediaries tend to argue in every conference/event. That is pure obfuscation of facts for pecuniary ends.

Some veterans also opine that the regulator does not understand that and other “Ground Realities”. I would argue that the regulator is fully cognizant of the ground realities and that is precisely why they are tightening the regulations. Self-regulation, I have heard, does not work very well globally.

Regulators need to protect investors from being taken for a ride. They may rub the entrenched participants the wrong way as the tightening may affect incumbents adversely. But regulators have to play their role in the larger interests. They have their jobs cut out for them.

In a nutshell – Distributor ( agent ) represents the Principal (not client) , has inherent conflict of interest and follows a lower suitability standard. Fee-only advisors represent their client, have no-conflict or lower conflict of interest and follow a Fiduciary standard.

Those are the differences and they are very significant from the investor’s viewpoint.