The financial services industry is rife with acronyms and buzzwords, so much so that it makes the average person’s head spin. MERs, TARP, ETF, DSC, etc. As if it didn’t sound like the industry had its own language before, consider the lingo that exists within the industry that you don’t know about.
One of the concepts familiar to those working in retail financial services, but one not often shared with clients, is the “Commission Grid,” sometimes referred to as the “Payout Grid” or just “The Grid” for short.
Here’s a nutshell explanation of what a grid is all about: financial advisers don’t work for free, and their sponsoring dealers (the firms) don’t work for free either. Everybody has to get paid. Account fees represent a very small amount of overall revenues for either group – as you know, this business is heavily based on commissions and advisory fees. For example, if you have a mutual fund that includes embedded commissions, or you are charged a commission to buy and sell a stock, this commission “hits the grid.” For argument’s sake, let’s assume the commission generated is $1,000. The grid is essentially a formula that determines how much of that $1,000 commission goes to the firm and how much goes to the adviser.
Some firms have complex grid structures which compensate advisers differently depending on the product, the size of the transactions or their overall “production level.” (Production level refers to the total amount of commissions generated by that adviser per year.) That $1,000 could be split on a 30%/70% basis, or it could be split on a 60%/40% basis (or almost any split you can imagine) – it all depends. It’s common knowledge in the industry that these types of grids are designed to encourage certain behaviours. You shouldn’t assume that simply because your adviser works under a complex grid system, it means they are influenced by it. Most advisers put the client’s interests first and then figure out how to deal with the effect on their income after. (Barry Ritholtz had a great example of this in his blog post “Big Firm Conflict of Interest: The Penalty Box” – note that this is a U.S.-based blog referring to a particular situation in the U.S.).
Other firms have a flat grid which has a fixed payout no matter the transaction. For example, the payout to the adviser might be fixed at 70%. From the above example, the adviser would be paid $700 and the firm would receive $300.
There are even 100% payout models in which the adviser keeps every penny, but pays a flat annual fee to the dealer to cover the basic compliance and administrative expenses incurred by the dealer to provide the adviser with the means to run their practice.
There are pros and cons to each model and we’ll explore them in more detail as we continue our discussion on “the grid” over the next few weeks.
A word of caution: the purpose of explaining these grids is to educate the consumer as to the potential conflicts of interest that arise from them. Think about your own vocation and what conflicts of interest lie there. Every industry has issues like these and every industry has people working within them that rise above these conflicts.