What Is Retrocession?
Let me explain retrocession directly to you: it's about kickbacks, trailer fees, or finders fees that asset managers pay to advisers or distributors. These payments happen discreetly and aren't disclosed to clients, even though they come from client funds.
You should know that retrocession commission is a fee-sharing setup in finance that's heavily criticized. Money flows back to marketers for pushing a particular product, which questions the advisor's impartiality and potential favoritism. This system can encourage advisors to promote funds or products just to get the fee, not because they're the best for you as the client.
Key Takeaways
Here's what you need to grasp: retrocession fees are kickbacks to wealth managers or other money managers from a third party. This commission is controversial because it sends money back to marketers for advocating specific products. These fees are usually recurring, while one-time kickbacks are called finder's fees, referral fees, or acquisition commissions. They cover areas like custody banking, trading, and financial product purchases.
Understanding Retrocession
I want you to understand that retrocession fees are commissions paid to a wealth manager or new money manager by a third party. For instance, banks pay these to wealth managers who partner with them. The bank encourages and compensates managers for bringing business in. Banks might also get retrocession from third parties like investment funds for distributing or promoting products.
Some view these fees as a dubious model because they can sway a bank or wealth manager to recommend products not in your best interest. Suggesting an investment where the advisor gets retrocession seems problematic. However, the products are often suitable, like high-quality mutual funds. The real issue is motivation—when two similar products exist, one with compensation and one without, advisors might be influenced unfairly.
Types of Retrocession
Retrocession fees usually mean recurring compensations, unlike one-time payments known as finder's fees, referral fees, or acquisition commissions.
Let me break down the three types for you. First, custody banking retrocession fees occur when a wealth manager gets compensated for attracting a new customer who moves funds to the custody institution. If service providers change often, the manager generates fees that benefit them but not necessarily you.
Second, trading retrocession fees come from various trading transactions, like buying and selling securities. More trades mean higher fees, and since you pay brokerage fees per transaction, this can favor the manager.
Third, financial product purchase retrocession fees are part of the recurring total expense ratio (TER) you pay, common with investment funds. These sums flow back to the client acquirer yearly as recurring commissions.
Real World Example
Consider this case: in 2015, JP Morgan settled with the SEC for $267 million. The SEC said JP Morgan chose third-party hedge funds based on managers' willingness to pay fees to a bank affiliate. The bank didn't tell clients it preferred funds sharing royalties and claimed no partiality. According to Forbes, this settlement introduced the term retrocession to U.S. investors.
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