Alan Kohler
Heads I win, tails I win
There is a cancer eating at business ethics, one that has played a crucial part in the crisis that now grips credit markets. But the disease has gone much further than that.
I’m referring to the practice of getting fees from both sides – that is, the pervasive culture of the kickback.
The most prominent and dangerous example of it has been the rating agencies and their ratings of complex structured finance products. They have routinely received fees from issuers for providing advice on the products, as well as from the banks and investors who use their ratings.
A series of articles in Business Spectator last week (read the full commentary) discussed how rating agencies are now coming under intense scrutiny over their conflicts of interest and the role of these in the credit crisis. Investors are preparing class actions and regulators are looking at a raft of new laws and regulations to control their activities.
At the heart of this controversy is the fact that Moody’s, Standard & Poor’s and Fitch’s were apparently not satisfied with the revenue they were getting from one side of the transactions, that is the investors. They discovered they could charge the other side as well – the issuers – and just about double their income.
But they’re not the only ones playing both sides.
I was at a barbecue recently and got talking with someone in the food industry. Her company supplies the raw materials to pizza joints and bakeries, among other things.
She happily told me how her company was picking up a nice line in “commissions” from the food manufacturers.
Traditionally the company’s business model simply involved buying food from manufacturers and then organising the logistics of distributing the right amounts around Australia to a variety of food retailers and fast food chains.
Then the firm discovered that the manufacturers were prepared to kick back some of their margin in return for being chosen as the preferred supplier.
So now my acquaintance is not only getting a margin from selling the food, but also a monthly “commission” cheque from the manufacturers. What could be better?
My own business – publishing – is based around the same idea of getting it from both sides.
Virtually all advertising is placed by media buyers, who help advertisers choose the right media for their campaigns and then negotiate the best price – in return for a fee of course.
And then on top of that most media buyers demand a commission from the media company in return for placing ads with it – typically this is at least 10 per cent of the money spent.
And one of the most well-entrenched examples of getting money from both supplier and customer is the practice of shelf fees in supermarkets.
The supermarket chains long ago discovered they could supplement their grocery margins by charging manufacturers a fee for appearing in the best positions on their shelves. Perhaps it all started with shelf fees – who knows?
These examples – food and media – are just the ones I know about.
Financial services is riddled with the disease, and it’s not just the ratings agencies.
Operators of investment platforms have been taking a leaf out of the supermarkets’ book lately by charging 'shelf fees' to the fund managers for appearing on the platform.
Recently Business Spectator highlighted the practice of stock lending, which involves institutions and custodians lending shares to hedge funds and other traders so they can sell them short without any disclosure (Short and curly, January 24). Other publishers have recently picked up the story.
One reason this has taken off is that the brokers who act as the intermediaries get transaction fees from the borrowers, plus a commission of 30 to 40 basis points from the stock lender in return for finding the borrower. In other words, they get a bit from both sides.
The same goes for margin lending: banks pay stockbrokers a trailing commission for selling the loans to investors. Naturally the brokers push them hard because it’s money for jam – they get brokerage from their client plus trailing commissions on the loans from the banks
Financial planners often get paid by their clients on a 'fee for advice' basis, and in addition to that they pick up commissions from the investment product manufacturers and the platform operators.
It’s the same principle as the food distributor I met at that barbecue, the media buyers, the stockbrokers selling margin loans and the ratings agencies consulting issuers.
I called it a “cancer” at the start of this article because I think that businesses getting paid by both customers and suppliers subtly debauches business ethics, undermining the principle of fiduciary integrity.
There are many examples of it, large and small, egregious and minor. Maybe it’s too late, and we’ll never get back to intermediaries choosing who they work for and just getting paid once.
But I think the conflicts involved are an important promoter of negligence and excess.
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