For internal use only

Have you ever asked any of your clients how much they think you get of the commissions and fees they pay? The answers might surprise you.

A while back I asked some of my former clients that question. Most knew that the money was split between the firm and me, and figured it was generally fifty-fifty. Dream on, you say. In fact, the average split is around two-thirds for the firm and one-third for the average experienced broker.

The nasty big secret of the retail full-service business is that the payout policies of most firms still reward production more richly than any of the other things the industry talks about: portfolio management, financial planning, or plain good service. Rookie brokers quickly learn that the way to stand well with the branch manager is to qualify for the list of top producers published monthly in the branch, not by helping clients get the best possible return on their investments.

This works through the so-called cash payout grid. This is a table, usually on one sheet of paper and usually marked "for internal use only," that sets out the percentage split that the firm will pay the individual broker. Down the left side are gross commission and fee production levels in ascending order. Across the top are transaction commission sizes, also in ascending order.

The details vary from firm to firm, but the percentage split for the individual broker starts very small and rises with increased sales production and the size of the order. For example, a typical grid will usually give even a big producer just 20% of a minimum $100 commission. Many firms pay out nothing on an order that generates less than the minimum commission, even to multimillion-dollar producers.

On a larger order generating a commission of, say, $300, a broker producing $300,000 gross a year could still just get 35%. On the same order a broker whose clients paid him a million-dollars-plus in commissions in the past year might receive close to 50%, but only at the more generous firms.

In the training schemes the big brokerage firms run, new brokers are told they will succeed if they look after the long-term interests of all their clients -- conservative investors as well as active traders. They should act as investment advisors, not just commission sales people. They should take the time to get to know their clients' needs, establish an investment strategy and review the accounts regularly to make sure things are going well.

But rookie brokers quickly learn that the grid rules make this very difficult to do. Taking the time to provide long-term financial planning to mostly conservative investors is a fast way to starve. To make a decent income, many brokers take on far more clients than they can service properly -- preferably including some active big-dollar clients who demand a lot of time but whose more frequent transactions provide a larger commission split.

Clients who don't qualify for that degree of attention typically get called by their broker only when one or more of their investments is coming up for renewal. Brokers will also seek to persuade such clients to transfer in any investments they may have elsewhere in order to make them potentially more rewarding.

Some less scrupulous brokers may also resort to a strategy that industry insiders call "churn and burn." This means persuading an unwary client to make a lot of trades. If those trades turn out to be profitable, well and good. If not, it's time to move on to another similar client.

Despite the discouraging environment, I do know that many full-service brokers still do their best to provide good investment services to their clients. If you are one of them, and really only you will know, I salute you.