Compliance March 30, 2011

Agencies Issue RFI Regarding Incentive Compensation Proposal

Financial regulatory agencies are requesting public comment on a proposed rule that would ensure regulated financial institutions design incentive compensation arrangements to take account of risk. 
Reported by

A Federal Reserve news release said the proposed rule, which is being issued pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, would apply to financial institutions with more than $1 billion in assets. It also contains heightened standards for the largest of these institutions. 

In prohibiting incentive compensation arrangements that could encourage inappropriate risks, the proposal would require compensation practices at regulated financial institutions to be consistent with three key principles–that incentive compensation arrangements should appropriately balance risk and financial rewards, be compatible with effective controls and risk management, and be supported by strong corporate governance. The proposed rule complements guidance previously issued by the agencies, including guidance on sound incentive compensation policies issued by the banking agencies last year. 

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The agencies are proposing that financial institutions with $1 billion or more in assets be required to have policies and procedures to ensure compliance with the requirements of the rule, and submit an annual report to their federal regulator describing the structure of their incentive compensation arrangements. The agencies are proposing that larger financial institutions, generally those with $50 billion or more in assets, defer at least 50% of the incentive compensation of certain officers for at least three years and that the amounts ultimately paid reflect losses or other aspects of performance over time. 

The agencies request comments on the proposed rule within 45 days of its publication in the Federal Register, which is expected soon. The proposal is at http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20110330a1.pdf.

In Practice March 30, 2011

Low Fees at the Outset Can be hard to Overcome

Advisers who offer lower fees to attract clients are finding it difficult to raise the fees to acceptable levels, contends a report from PriceMetrix.
Reported by

PriceMetrix, a software firm for retail wealth management firms and their advisers, found that many financial advisers are foregoing an average of $20,000 in fees because they are under pricing their fee-based business when compared to other advisers in the industry.

PriceMetrix research shows that the fee and managed account business has become a key source of recurring revenue for retail wealth management advisers and the segment continues to grow. Assets in fee-based accounts make up almost 25% of total assets under administration and 37% of total revenue. From 2007 to 2010, the average adviser’s assets in fee-based accounts have increased by 24%, while transactional assets have declined by 1%. Further, advisers are opening a growing number of fee-based accounts each year. The average adviser opened 11.5 new fee-based accounts in 2008, 13.5 in 2009, and 14.5 in 2010.

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At the same time, however, advisers are earning less in terms of return on assets in their fee-based accounts, found PriceMetrix. The average return on assets declined from 1.47% in 2007 to 1.32% in 2010. PriceMetrix says this is because firms publish fee-based price schedules that range from simple flat fees to tiered pricing based on asset type or account size. Actual fees charged by individual advisers, however, are usually discounted with most ranging from 72% to 79% of scheduled prices.

“Clients will pay for value, the data clearly show that,” said Doug Trott, President and CEO of PriceMetrix. “Firms need to provide advisers with a credible reference for setting their prices and advisers need to understand what is achievable and confidently communicate their value and prices to clients.”

The report also highlighted differences between individual advisers. The top 25% of advisers charge an average fee of 2.01%; the bottom 25% charge an average of 0.81%.

“When sharing this information with advisers, we get challenged with the assertion that the higher priced advisers must be losing business to lower priced advisers,” said Trott. “We have found little evidence of this, however, and instead find that clients are willing to pay for a strong value proposition.”

PriceMetrix suggests that advisers control their pricing from the very beginning of their client relationships because they will find it almost impossible to raise prices once they are set. PriceMetrix found that only 5% of advisers were able to raise their prices by more than ten basis points on existing accounts over a three-year period. On the other hand, many advisers are now charging more for new accounts and are thus able to raise their overall return on assets. And advisers who charged more initially were able to open 25% more accounts than those who lowered their fees.

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