Major debt and bankruptcy concerns raised with commission ban
With some advice firms having borrowed significant sums to buy adviser trail books in the past, a decision by the government to ban grandfathered commissions for super products could leave them with “catastrophic” debt levels secured by a worthless asset, warns an industry veteran.
In its final report into superannuation, the Productivity Commission recommended that the government ban trailing commissions as soon as practicable.
While these commissions were banned in 2013 for new accounts under the Future of Financial Advice laws, commissions remain in the system from when they were grandfathered five years ago under transitional arrangements.
In its report, the Productivity Commission stated that during 2017, eleven of the retail super funds collected over $400 million in trailing commissions.
In the current climate, irrespective of which party wins the next election, SMSF Alliance principal David Busoli said it is quite possible that the government would support the banning of grandfathered commissions.
This would leave advisers who previously borrowed large sums of money to buy trail books for the purposes of receiving these grandfathered commissions with an asset that is essentially worthless but a debt that still requires servicing.
Irrespective of what might be claimed, trail books were often marketed to advisers as a type of rent roll that would provide them with an income stream whether they worked for it or not, he explained.
“The underlying theory was that the adviser would talk to the clients and service their business potential. The reality was that these trail books often included so many clients of little economic value to the adviser that this did not happen. So, they were often regarded as a book of passive income with a valuation based on a multiple of income,” he said.
If grandfathered commissions for advisers are removed, suddenly these books will be worth nothing, said Mr Busoli.
“For an adviser without debt the loss of this income may be significant but not fatal,” he said.
“But for someone with a $2 million loan secured by a trail book which has been funding the payments, there is a real problem. The adviser will still be liable for the debt with, probably, no real prospect of servicing it so who will be left ‘holding the can’?”
“The trail books and personal guarantees, have generally been the only security for these loans. The marketing of these geared investments was actively promoted by the adviser’s principal company and funded by a related bank. It is to be hoped, therefore, that responsibility for any resultant loss will not be simply dumped onto the adviser,” he said.
“I know some firms that have $2-3 million in loans. It’s huge, especially if there’s nothing to fund it so the potential loss of trail commissions is far more than just a consumer issue,” he said.
“If grandfathered commissions are stopped where do these people stand? Let’s hope they are supported by the parties that encouraged them into these arrangements in the first place.”