I’ll refresh your memory and present our representative commission grid for a traditional big bank full-service brokerage:
These complex grid structures are designed to influence behaviours of investment advisers. For example, we can see that an investment adviser whose production is less than $100,000 per year is heavily penalized no matter what size the individual transactions are. (Rookie advisers are not subject to the full grid during their first few years.) As another example, an adviser who has a book of client assets totalling $10 million and charges them an average of 1% in commissions per year will generate $100,000 in commissions overall, but keeps as little as $10,000 while the firm takes $90,000. This adviser will either be forced to quit due to lack of income or he/she will have to change the way they do business in order to hit higher production levels.
Generally speaking, advisers will be compensated more richly for producing higher overall annual commissions (as seen by the general increase in payout as you move down the columns). They will also be compensated more richly for generating higher commissions per transaction (as seen by the increasing payouts from left to right). This could be done by trading larger positions or by using higher commission generating products (like Deferred Sales Charge mutual funds).
These pressures can be exacerbated by a clause some brokerages provide in which your production level (left-most column) is normally based on your previous year’s performance. However, if the adviser were to break out into a higher production category during the year, every commission earned for that year would be adjusted to the higher payout rate retroactively. This further puts pressure on advisers close to the high end of a production bracket to generate higher commissions towards the end of the year.
For example, let’s suppose Adviser X generated $375,000 in gross commissions in 2010. That means he will be working off of the $300 – $400K annual production row for calculation of net commissions for himself in 2011. But as we approach the last month of 2011, he has already generated $399,000 in commissions for the firm. If we further assume that all his transactions are in the $0 – 100 range, he will have earned $139,650 in net commissions to date (based on a 35% payout rate). If he were to generate just another $1,001 in commissions to clients, his net commissions increases by a whopping $20,350, as all transactions for the year are now based on a 40% payout rate. This is an incredibly powerful motivator.
Next we will look at commission grids for advisers other than full-service brokerage advisers.