Ethics 101 for Financial Advisors: What You Need To Know For Your Practice
We’ve seen regulations meant to protect consumers and firms implemented in the last decade, and while compliance can sometimes seem like a hassle, the role of regulations is to make the industry fairer for everyone. Xtiva can help with a portion of that equation – software and other tools that make compliance easy. But the […]
speaking, when things leak, it’s not good. And when things leak slowly, it’s typically
know that a slowly leaking pipe or roof is about the last thing they want to
discover. Car owners know that a slow leak in a tire can be the hardest kind to
fix. And you don’t have to be a boat owner to know, as Benjamin Franklin said,
that “A small leak will sink a big ship.”
financial services business is losing revenue and profits in the same way,
through a wide range of seemingly small inefficiencies, poor procedures, misalignments,
and human errors in your compensation system. These leaks are often written off
as an annoyance, rather than a problem that needs immediate fixing. But over
time, the losses pile up and reduce your bottom line.
How Big a Problem is Revenue and Profit Leakage?
– in this context – erupts from the unintended (or unnoticed) loss of revenue
from your business and poorly optimized operations, resulting in a significant
loss in overall profitability.
experience, profit leakage is a considerable and often overlooked problem in
the wealth management industry and has root causes that are behavioral,
structural and operational. Behavioral causes
stem actions that are induced, usually unintentionally, by the compensation,
metrics and sales management program. Operational causes are often the result
of business complexity and fragmented business processes. Finally, structural causes
relate to the design of the business model and/or the technology tools that
support it and insufficient or unreliable data to fuel it.
Each of these areas contribute to significant loss in revenues and profitability impacting the firm on a recurring basis and accumulate over time, if not properly addressed.
We’ve identified the following 25 ways in which your compensation system and procedures are likely allowing profit to leak out of your wealth management business.
1. Compensation plans are not supportive of corporate goals and objectives.
When compensation and reward structures are not supporting your firm’s
business strategy and performance objectives, this results in suboptimal
organizational performance and therefore impairment of profitability. Failure
to align the actions (and results) of the salesforce to the corporate objectives
of your firm in a timely and effective manner is a drag on top-line performance.
2. Compensation plans are inconsistent or not aligned across business units.
Business units that are meant to cooperate will be more successful
when there is alignment of measurement and reward. Bringing multiple compensation
regimes into alignment across multiple lines of business is difficult, but
critical to avoiding counterproductive activities and organizational friction.
Aligned measurement and compensation makes execution smoother and ensures focus
is on value creating activities.
3. Not measuring the profitability of compensation plans.
Not measuring (or inadequately measuring) the profit performance
of the compensation regime hides profit drains. Failure to measure compensation program performance is typically
caused by lack of adequate data or the absence of organizational accountability for performance
and compensation performance ROI.
4. Delays in compensation plan design and rollout
Compensation program changes are often needed to enhance alignment
with corporate objectives, to address shifts in the market and to respond to
changes in the business or conduct of staff. Every day that passes between the
decision to change the program and the implementation of the changes represents
leakage through lost sales and service focus, decreased rep/advisor
satisfaction, sales and service efforts contradicting company investments and operational
burden. Compensation programs must be easily updated or replaced. Time-consuming
requirements for custom programming or technical intervention is costly a
warning sign that your compensation regime is not nimble enough to optimally
support your business. Don’t accept when the capabilities (or lack thereof) in
the compensation system stand in the way of rewarding for the right customers,
the right revenue, or the right performance standards.
5. Over-complexity of compensation plans
Firms that allow their compensation plans to become too complex over
time ultimately find them becoming less effective – and then they swing
back to a more simple structure. Focused and easily understood are the key
design considerations. Overly complex plans make it difficult to be sure that
everything is correct, and paid out appropriately to the right participants.
The errors that spring from complex plans are themselves so complex that they
can only be resolved by implementing time-consuming and costly manual adjustments.
6. An unruly herd of compensation plans
The sheer number of plans in use is not, in and of itself, a
problem. However, how these plans relate and how they are managed can be a
problem and can cause considerable errors and excess compensation. Plans should
be easily create, named, managed, understood and retired, as necessary. Poor
process and oversight in plan selection, deployment and management can give
rise to the wrong compensation plan or the wrong rules being deployed which
results in compensation errors, reporting inaccuracies and contributes to
significant leakage that can compound over time. A clean and organized user
interface, logical workflows process and efficient oversight processes mitigate
many costly errors.
7. Lack of full visibility and transparency
Ideally a full and completely granular view into plan set-up,
input data and calculations is available to business leaders, managers and
advisors. A lack of this visibility complicates the process of finding and reconciling
errors and resolving disputes. This wastes valuable advisor, front office and
operations time and erodes trust which impairs revenue and adds costs.
8. Product type assignment inconsistencies
Each discrete product (or security) must be associated to a
classification that aligns with the compensation program. Frequently this means
that several new products or securities may need to be assigned within the
classification each day. While frequently supported by an automated process, a
individual typically makes the ultimate assignment using a manual process, that
often lacks proper decision-making and validation controls. Inconsistencies in
product assignments can potentially have a large impact on compensation over
time and can be very time consuming to correct. For organizations with multiple
lines of business where products may be classified a number of times and in a
variety of different ways, these errors have a habit of multiplying.
9. Poor limit management
Where complicated layer split or sharing arrangements are
required, it is not unusual for gross payout and/or minimum house rates to be
inadvertently ignored when rules are set-up. This can result in over-allocations
across multiple payees.
10. Mismanagement of packaged product trailers and marketing fees
Packaged products have a tendency to cause complications in
incentive compensation programs. The revenue and end customer information can
be difficult to integrate and improper controls and poor communication between
systems and complex fee payment structures can result in mismanagement of trailer-based
revenues. Common examples are the mishandling of trailer revenue where they are
meant to be rebated back to the end customer, or where certain asset types are
to be treated differently in fee-billing. Incorrect fees payment can easily be
processed, which can result in over-billing the customer and potentially
overpaying the advisor. These often go unnoticed for extended periods of time,
and their impact (both financially and reputationally) can compound.
In the case of some alternate investments, the firm receives both
a sales commission and marketing fee, and must control how these are managed.
Without proper classification rules and attribution processes, the marketing
fee (which is frequently not shared with the rep) can get incorrectly lumped
into the gross production number used for payout, thereby increasing the payout
to the rep and cost to the firm.
11. Poor control of minimum commissions or fees.
Hard floors related to commissions and fees need to be properly
implemented otherwise they become a soft floor. Claw backs for violation of
hard floors should be automated or at a minimum the subject of transparent
workflow involving reporting escalation.
The compensation regime is typically used as a tool to manage discounting
of services, or more accurately the profit impact of those discounts. Certainly
other price and discount controls can be considered, however in the dynamic
relationship management environment in financial services – and especially
wealth management – compensation is frequently the first and last line of
defense. Without adequate controls within the compensation system, rules may
not be capable of properly stopping (or limiting) discounting behaviors
resulting in potentially both loss of revenue and also additional payroll
13. Lost expenses – not loaded, not charged back
Expenses can only be recovered via a compensation system when they
make their way into the system. In general, regular recurring expenses have a
reasonably robust process related to their identification, set-up and
reporting. As a result, they are generally captured properly and recovered via
the compensation system. We do recommend at least an annual expense audit.
Unfortunately, the one-time or infrequent charges, which can originate from a
variety of sources, and in different formats, are easily overlooked. An email,
voice message or even a scribble on a note pad are easily lost or misplaced
resulting in lost recovery.
14. Unidentified overpayments
Unfortunately, the hard truth about payment errors is that firms
are always told when someone is underpaid, but rarely told when they are
overpaid. An accurate, rules-based, compensation
system with strong reporting capabilities will significantly minimize these
15. Cancel/rebill mismanagement
Transaction that are cancelled and rebilled can contribute to leakage. Typically this arises where the (re)processing doesn’t completely address ‘undoing’ all data that would have resulted from the existence of the erroneous transaction. The most common example is inadequate tracking of compensation or reward tier threshold impact. This can result in significant operation complexity or work to resolve it or can lead to potentially material compensation errors (i.e., overpayment).
16. Inability to monitor Clearing and Custody Schedule A fees
A configurable tool that can accurately calculate and verify the
fees being charged to the firm by their Clearing and Custody partners, firms
are not able to easily identify incorrect fees, erroneous calculations, fees
owed by advisors and/or where over-billing situations arise. For firms with multiple
lines of business, the impact is magnified.
17. Insufficient mutual fund trailer revenue detail
Unfortunately the data and reporting on mutual fund assets and
revenues pales to that on many other financial products and services. Managing incomplete
or inaccurate trail information just to support reconciliation to anticipated
or expected revenues consumes valuable time. Additionally, a lack of clarity can
result in incorrect allocations and calculations that can easily go unnoticed
for months. At the root of this problem is asymmetrical information and the use
of a variety of partial ‘fixes’ for that lack of symmetry. For example, fund
holding and trailer information is commonly obtained from multiple sources –
direct from the fund company, from industry data consolidation sources,
in-house databases and frequently augmented through manual entry where there
are delays in data availability.
18. Adjustments applied in the incorrect sequence
Without the ability to apply adjustments (e.g., clearing fees or
E&O charges) at the right point in the compensation process (typically gross vs. net), incorrect
payouts and overpayment situations will occur.
19. Not recovering “out of pocket” expenses to firm
Many expenses are collected and managed via offline processes
either in the distribution network or finance department (e.g., Registration,
FINRA & SIPC costs). These processes tend to be arms-length from the
compensation system because many systems can’t support that particular type of
expense. Many of these expenses should be borne, in whole or in part, by the
advisors. As a result of the system disconnects, these expenses are at risk of
being entered incorrectly or bypassed altogether.
20. Poor audit tracking
Reviews of activity are required on a periodic basis. A compensation
system that does not offer detailed audit tracking (and reporting) of changes
makes it very difficult and time consuming to find, identify, and manage
changes made in error. Additionally, poor audit reporting typically means that
other functions – such as compliance and finance – have to rely on operations
21. Staffing to peak load
A system with automation gaps, poor tools for permanent resolution
of errors or that relies on the manual upload of a number of files each day can
expose compensation operations to highly variable peak loads. Maximizing data
source integrations, rules based decision-making and processes to enable
‘one-and-done’ permanent problem resolution mitigate peak load variance and
enable a consistent and optimized staffing model. This reduces volume based
errors, unintentional omissions caused by uncertainty as to who is responsible and
excess staffing costs.
22. Improper proration and a lack of flexibility in the technology
Mid-period events, such as when a new rep is onboarded, challenge systems
to support the proration of the related revenues and expenses. It can also
impact how average and trailing production levels are determined. The resultant
need for manual calculations and adjustments adds workload burden and
23. Disconnect between fee billing and compensation systems.
Billing and compensation systems should function symbiotically as
they rely on information in each system to enable the other. When billing and compensation
systems don’t “talk” properly, manual changes applied in one system are not
routinely reflected in the other. For example, a compensation solution that
cannot adequately track the metrics required by the billing team (such as
waivers, thresholds, volumes, etc.), results in incorrect billing and compensation
24. Mismanagement of terminated payee agreements
Complicated termination procedures can easily result in
overpayment of incentive compensation.
For example, when there is a lag between when an action is taken (such
as terminating a rep in the compensation system) and when that action should have been taken, this can lead to
payout that incorrectly includes extra days of active time. Depending upon the effort required to correct
it, these issues can sometimes go unnoticed (and not corrected) creating an
overpayment to the rep and a loss to the firm.
25. Errors in managing date-based rules
By failing to properly control effective dates (i.e., not expiring
rules on time), potential overpayments may persist for long durations and not
be recognized. A common example is the failure to expire a ‘new recruit’ plan
that pays higher than the ‘experienced advisor’ plan. The system should, at a
minimum, offer reporting to highlight these conditions.
these 25 points demonstrate, the ways that revenue and profit can leak out of
your business is not merely metaphorical – it’s real.
technology and poor business processes supporting your incentive compensation
and performance management can hurt your bottom line. A modern, adaptable,
technology platform and compensation solution that is flexible, and can be
automated and integrated with necessary data sources and external systems, will
ensure accuracy and give your firm’s management the opportunity to properly
analyze the effectiveness of their salesforce and their compensation programs.
compensation management technology, coupled with strong operational processes
and a commitment to a robust data model, helps to prevent profit leakage. A
system that fully integrates all steps in the compensation and performance
management process is the best tool for helping to grow revenues and boosting
your firm’s profitability.
Is your business leaking profits because of poor incentive compensation processes?