Could Fee Hurdles Come Down Everywhere? Commissions on popular investments like mutual funds will be banned in Australia, Netherlands, following UK

Jun 21, 2013

The Intelligent Investor: Going Dutch — Could Fee Hurdles Come Down Everywhere?

By Jason Zweig

With markets in turmoil, investors need good advice even more than usual. But investing advice remains confusing, costly and opaque—and that needs to change.

New rules in the U.K., the Netherlands and Australia show one drastic way to tackle the problem. Starting this coming week, commissions on popular investments like mutual funds will be banned in Australia. Later this year, the Dutch government will finalize a law that will ban commissions as of Jan. 1, 2014. A similar prohibition already went into force in Britain as of Dec. 31, 2012.These changes provide a glimpse of one possible future for U.S. investors: a market in which “what the adviser gets paid is no longer linked to which product the adviser sells to the client,” as Mark Wiedman, global head of iShares, the largest manager of exchange-traded funds, puts it.

Consider the Netherlands, the birthplace of the very idea of “individual investors,” with a 400-year history of middle-class citizens committing their capital to the financial markets.Today, most Dutch investors get their financial advice from a handful of big banks.

In Holland, as in the U.K. and Australia, investors have long paid for advice through a form of commission known as a “retrocession”—a payment routed to the adviser by the manager of a fund that the adviser sells to a client. All three countries are generally banning these payments, requiring advisers instead to charge fees, disclosed upfront, directly to their customers.

The Dutch are disarmingly honest in calling retrocessions “kickbacks.” In the U.S., roughly equivalent payments go by such anodyne names as “revenue sharing,” “distribution fees” or “12b-1 fees.”

The problem has been the same in Holland, the U.K. and Australia as it remains in much of the U.S. market. An adviser’s fees should be a function of how good his advice is. Instead, in many cases, every adviser who sells a given mutual fund earns an identical fee determined by the fund company, which has no way of knowing whether the adviser’s recommendations to his clients are brilliant or idiotic.

That can lead to perverse incentives.

Theodor Kockelkoren is the acting chairman of the Authority for the Financial Markets, or AFM—the Dutch regulatory agency that is comparable to the Securities and Exchange Commission in the U.S. Over “a couple of dozen” investigations in the past few years,

Mr. Kockelkoren says, the agency has found evidence that financial advisers were persistently recommending funds that paid them the highest commissions instead of cheaper alternatives that were clearly in the clients’ best interests.

“Whether it’s true or not, the perception in the market has been that the banks choose the funds that pay them the best,” says Dick van Ommeren, a managing director at ABN Amro MeesPierson, the largest private bank in the Netherlands, with $100 billion under management.

“Changing the way we are paid is beneficial to the customers, and we believe it is also beneficial to us,” Mr. van Ommeren says, “because it takes away any negative perception about the intentions and incentives of the institution and its employees.”

Pim Mol, director of private banking at Rabobank, which manages some $40 billion for individuals, estimates that total investing costs for many of his firm’s clients will drop by 25% to 75% under the new rules. Furthermore, advisers at Rabobank already have moved nearly $3 billion into lower-cost index funds in recent months, now that the managers of more-expensive funds will no longer be kicking back fees to them.

“The industry will take some time to adapt to it, and there will be disruption along the way,” says Hester Borrie, head of sales and marketing at Robeco, one of the biggest asset managers in the Netherlands, with $247 billion in assets. But the commission ban “will probably trigger more transparent competition in the end,” she says, because investors will find it easier to compare prices.

“What you could create is a two-tiered marketplace,” warns Terry K. Headley, a financial adviser in Omaha, Neb., and past president of the National Association of Insurance and Financial Advisors, who has been monitoring the international changes.

“The middle- and lower-income markets, who are equally entitled to qualified investment advice, could be disenfranchised.”

Without commissions, he says, financial advisers won’t have enough incentive to sell investments and insurance to clients with limited assets.

The Dutch don’t agree. “We are getting incredible inspiration for new concepts and new ways to serve clients,” says Mr. Mol of Rabobank. “I don’t see [the ban] as a constraint on the free market. Maybe the old way of doing things was a constraint on the free market.”