Contingent Clash - What effect will Eliot Spitzer's campaign against brokers have on the future of the industry?

Leader's Edge
January/February 2005

Leader’s Edge invited four experts—all contributing writers to the magazine—to talk about the implications of New York Attorney General Eliot Spitzer’s campaign against commercial insurance brokers. An economist, two investment bankers and an attorney all bring different perspectives to Spitzer’s probe of the brokerage industry. Over the course of two hours, they discussed the future of contingent commissions, alternative economic models, the future of mergers and acquisitions, and the business fallout. In these excerpts from that conversation, they also give their personal (and differing) views on what brokers should do next. —Editor  

Keith J. Crocker, economist
Crocker joined the Smeal College of Business at Pennsylvania State University in 2003 as the William Elliott Chaired Professor of Insurance and Risk Management. He holds a bachelor’s degree in mathematics and economics from Washington and Lee University and a master’s and a doctorate in economics from Carnegie Mellon University. Prior to his current position at Penn State, Crocker was the Waldo O. Hildebrand Professor of Risk Management and Insurance and professor of business economics and public policy at the University of Michigan Business School. Crocker has served as an expert witness in cases involving antitrust and insurance concerns, including captive taxation and workers compensation.

Robert J. Lieblein, investment banker
Lieblein, founder and managing principal of WFG Capital Advisors, has more than 20 years of experience providing advisory services to the insurance and financial services industry. He earned degrees in accounting, mathematics and computer science from Shippensburg University in Pennsylvania. Prior to founding WFG, he spent 13 years with the international accounting and professional service firm KPMG. He is a licensed CPA and holds NASD Series 7 and 63 licenses.

Scott A. Sinder, attorney
Sinder, The Council’s outside general and legislative counsel, is a member of the Washington, D.C., law firm Collier Shannon Scott. He is on the firm’s executive committee and a member of its Litigation and Government Relations and Public Policy practice groups. Sinder is a commercial and public law litigator who represents trade associations and companies on a wide range of issues in state and federal trial and appellate courts, in state legislatures and Congress, and before federal regulatory agencies.

Steve S. Wevodau, investment banker
Wevodau, managing principal of WFG Capital Advisors, is an investment banking specialist with extensive experience in the insurance distribution channel. Wevodau is often called upon as an industry expert in complex civil litigation and other industry-related matters. He was senior vice president of finance of The BISYS Group and vice president, chief financial officer and treasurer of Millers Capital, a national property and casualty insurer. Wevodau has attended Pennsylvania State University.

LEADER’S EDGE: Let’s start with Eliot Spitzer. What gives the New York State attorney general the power to go after insurance brokers nationwide?

SINDER: He has the right because it affects what is done in New York. That is his direct power. The complaint he filed against Marsh strictly concerns New York laws, but his power is much broader, as a practical matter, because there is such a concentration of the brokerage business in New York.

Over the last five to seven years, attorneys general have become a collective force. When one does something—usually Mr. Spitzer—the others don’t want to be left out of the party. I expect most of the states to jump in before we’re all done.

LEADER’S EDGE: Do you think the Securities and Exchange Commission and the National Association of Insurance Commissioners are going to step up their investigations?

SINDER: The NAIC is the private trade association whose members are the state insurance commissioners. They will come up with a model regulation to address the Spitzer concerns, and they will try to have a more uniform, unified process where you don’t send slightly different responses to different states.

The only power the SEC really has is to go to publicly traded firms and to make sure any statements they have made in their required filings with the SEC are true and current. They may have power beyond that—should this controversy expand into the benefits arena— with any securities-oriented product.

WEVODAU: We’re just seeing the tip of the iceberg. There has been some onslaught into the benefits market. The one missing key component is the life insurance end of the business. It is still at the very early stages.

SINDER: California Commissioner Garamendi announced his focus is benefits and group life products. He has formalized an agreement with a plaintiff’s law firm to assist him, and that firm has filed the first benefits-related lawsuit with respect to the contingent commission issue.

CROCKER: I suspect where this story will really get legs is if the path leads into benefits, life insurance, any personal lines property-casualty areas where one can argue that not commercial but regular consumers were disadvantaged by some behavior. And that’s where you get to class action lawsuits and some serious money. If it goes down that path, this will be going on for quite awhile.

I think the Attorney General of New York is already trying to push it that way. He’ll be looking into benefits, fishing into the life and health area, trying to see if he can hook onto something that gets Fred in Peoria interested.

LEADER’S EDGE: Do people see state regulators as not doing their job by allowing all this to happen?

SINDER: I think they are going to be depicted that way. However, there was a federal regulator for the securities industry, and they weren’t able to stop a much smaller universe of firms in the mutual fund industry from engaging in practices that were a lot worse, so I don’t think a federal regulatory agency’s going to change anything.
 

Bid-rigging Allegations

LEADER’S EDGE: There is an allegation in New York of some pretty appalling activities—fraud, bid rigging. There also have been suggestions that other top brokers are going to be facing charges soon. The brokerage industry seems to be defending itself by claiming that bid rigging has nothing to do with contingent commissions. Is that a viable industry response?

WEVODAU: You have got to go back to the genesis of the Spitzer probe, which started last April. He immediately honed in on the conflict of interest with contingent commissions. Yet what he brought forth was bid rigging and other criminal acts. I think the industry has overreacted to the probe. To my knowledge, there have not been any criminal indictments that specifically involve contingent commissions.

There is the “inherent conflict” argument. However, the industry, as a whole, has opted to retreat—aggressively retreat—from Spitzer and other state AGs who have focused attention on criminal acts. You need to be able to separate those two issues.

It starts at the manufacturing level as to the long-term viability of contingents and whether they do, in fact, act as a financial inducement to maneuver and manipulate business. Do they actually compromise the service of the broker, who is acting on behalf of the client, or is it a matter that this is a long-standing practice and is this simply a transparency issue for disclosure?

The whole industry has gone from one end of the spectrum to the other, rather than dealing with the criminal act itself. You look at four of the top eight brokers. They totally disbanded contingent commissions, which I think sends the wrong message.

CROCKER: The attorney general’s case is a civil case. My understanding is that there have been several individuals who have pleaded to criminal actions, in terms of the bid rigging, but the complaint against Marsh is a civil complaint.

WEVODAU: Right.

Contingent Commissions

CROCKER: We have a situation where the potential conflict-of-interest has been there for a long time, whether this is a long-standing business practice or not. This is a train wreck that’s been waiting to happen. To be quite frank, the response by brokers is entirely appropriate because they need to be purer than Caesar’s wife from this point forward. They have lost a lot of trust, even though a very few have been engaged in this. This is very serious business. You don’t lose $10 billion worth of market capitalization unless a lot of other people think it is serious, too.

I would take issue with the idea that they have overreacted. I suspect if Marsh hadn’t done what it’s done, we would be looking at a company with a criminal indictment.

SINDER: I think there is a big difference in how Marsh responded and how everybody else responds.  A few Marsh employees allegedly engaged in criminal behavior that may have had a relationship to the contingent arrangements. But the contingent commissions are not the source of the criminal conduct.

The first part of the question is, do these commissions remain viable? As a legal matter, they remain wholly viable. There is no legal problem with contingent commission arrangements. In fact, the New York superintendent of insurance reviewed this issue and issued a letter on the necessity of disclosure when you’re acting in a broker role, which is an endorsement of their use.

I think there are bigger questions concerning whether contingent arrangements are politically viable. Are they viable as a business matter going forward, given what the market leaders have already done?

CROCKER: Precisely.

SINDER: One of the huge problems I have with the Spitzer complaint is it presumes an adverse relationship between the client and the carrier and the broker’s role is to solely represent the client. I don’t believe that is a fair reflection of the nature of the business.

The other problem I have is that we talk about this small slice of contingent income and we say it creates this rampant conflict. The truth is that 95% of the clients in the business pay nothing to the producer. They pay indirectly because all the costs are covered by their premiums, but for most clients 100% of the revenue to brokers comes from commissions and other carrier-provided compensation based on contracts between the broker and the carrier.

Clients rely on the fact they don’t have to pay out of their pocket. It feels better. When you challenge the viability of this system, you are not just challenging this small slice; you are really challenging the entire system, which clients have all accepted—not only accepted, I think they have insisted upon. There have been movements to try to do more fee-based business, and clients rejected them.

LEADER’S EDGE: Fees paid by the client?

SINDER: Yes. Marsh has these arrangements, as do most brokers. In addition to or in lieu of carrier-based compensation, the broker receives a fee from the client. Almost every state regulates those, and they require disclosures and written agreements if you are collecting fees. Many of our members use these, but even for them, it’s with a very small percentage of their clients.

CROCKER: But a lot of money.

WEVODAU: When you put it in relative perspective to the top line of the industry, contingent commissions represent a fairly small percentage, but when you look at the dynamics of how an insurance brokerage actually operates during the course of the year, this becomes a fairly significant component to the overall viability of earnings.

You have to look at how these organizations are engineered to sustain a reasonable amount of profitability on an incremental, ongoing basis. These additional sources of revenue are substantial, and they are based on the quantity and qualitative measures of their overall focus of business. When you start carving that out, you are taking a huge bite out of the economic food chain of the product.

LEADER’S EDGE: Isn’t it easy to attack these because you can’t match costs against your contingent commissions?

WEVODAU: Correct. When you look down to the middle segment where many of our clients operate, many of them operate their businesses on a break-even basis, living for the contingents.

LEADER’S EDGE: Isn’t that an issue of allocation, though?

CROCKER: It is, but, ultimately, the customer pays for everything. Because if the brokers don’t get the contingent commissions, they will have to charge higher brokerage fees.

LEADER’S EDGE: Or get more guaranteed commission up front from the carriers?

SINDER: The question presumes that people got a static level of commission, and hence, the contingent commission is like an extra incentive. That is not my understanding of their development. Commissions were a certain rate, and over time they fell and were replaced with contingent income.

LEADER’S EDGE: Weren’t contingent commissions originally introduced to drive down overall commissions?

SINDER: Sure. They drive down the guaranteed cost for carriers and create incentive and accountability mechanisms for brokers when presenting business to the carrier.

LEADER’S EDGE: So do contingent commissions actually drive down the cost of insurance?

WEVODAU: They absolutely do, without a doubt.

CROCKER: Given the lack of transparency, I find that very, very hard to believe.

LEADER’S EDGE: But if contingent income is an incentive for front-end underwriting by the broker for the carrier and the actual risk is well-presented and, supposedly, well-priced, then isn’t that a benefit to the consumer? Otherwise, isn’t the price going to have to go up?

WEVODAU: Exactly, my point.

CROCKER: But the consumer can still benefit from the broker’s ability to identify these risks by having a relationship with the carrier, where the carrier then quotes lower rates to the customer at the end of the day. The broker is supposed to work for the customer.

SINDER: And what does it mean to represent the client? This plays right into the adversarial nature of the business if the argument is that you are selling a commodity and your job is to gouge the carrier. The broker is supposed to represent the client. I think they do, but part of that representation is carrier relationships. Most clients can’t go to the carrier and get the deal themselves.

CROCKER: I wasn’t insinuating that the customer shouldn’t use brokers, only that the customer should pay the brokers directly for the services they receive.

SINDER: That would be great, but they don’t want to.

WEVODAU: Typically, contingent commissions are two mechanisms built on a matrix: one is underwriting profitability and the other is growth. If the carrier can grow profitably and manufacture a block of business that sustains lower loss ratios, that’s going to manifest itself in lower consumer product costs.

We’ve got a client that has a very substantial benefits operation, and approximately 60% of their client base is unwilling to pay fees. So I think it’s an issue where you’ve got to look at what the consumer demands are and balance them.

I fail to understand, fundamentally, how contingents create a conflict with the consumer.

CROCKER: I think what is alleged in the case of Marsh indicates clearly that there is a potential downside when the brokers don’t necessarily pay attention to the interests of their customers and respond to the contingent commissions instead. I admit that is just a very small number of people who engaged in this, but only having a few people do this has cost Marsh shareholders $10 billion.

WEVODAU: But it was the criminal acts. It was not the contingents.

SINDER: And it’s also a service business. These are professionals, and you have to be able to rely on what they are doing. In Marsh’s case, at least three people allegedly breached that trust, but the idea that you can regulate this—I don’t see how you get there.

CROCKER: I don’t believe in regulating this. My only point is Marsh made a good business decision when they said they weren’t going to take contingent commissions, and I think the other brokers made a good business decision when they made that decision. It’s going to be tough to come back and reinstitute them now, given the bad press.

Fees vs. Commissions

LEADER’S EDGE: At least part of the problem appears to be the result of brokers failing to charge adequately for their services. If that’s the case, where do we go from here?

SINDER: There’s two ways you get money up front—through fees and through commissions. This business has been built on the commissions model. Fees are relatively new. Most clients have never paid fees.

What the commission and contingent system allow is for the client to spread payment over time because the commission payment comes every year. With commissions, the broker gets paid each year through the premium payment, so in year one, they are under compensated for their services. In years two and three, they are overcompensated for their services in a way in which you hope over time you get to where you’re supposed to be.

If you go for a fee-based system, you’re going to do that through a fee—the same thing every year. Some years brokers are not going to have as much work to do. Clients are going to feel like they are not getting a good deal, or brokers are going to require a huge fee in year one to compensate.

One of the things that a commission system does effectively is it allows clients to spread that cost over time. It removes any incentive for the client to switch from broker to broker strictly on the basis of fees.

LEADER’S EDGE: So you’re saying a fee-based system could be a disincentive to switching brokers because clients would have to pay so much in the first year to compensate for the actual upfront service involved in underwriting?

SINDER: If you were going to do it that way.

LIEBLEIN: When you talk about the large clients who pay fees, that is such a small slice. What we’re talking about—big picture—is changing the whole economic model of the industry. You’re talking about middle America, small to midsized companies, and obviously, brokers who work in that market niche don’t have the ability to influence the markets.

LEADER’S EDGE: We had the big brokers say they no longer are going to take contingent commissions. What does that mean to the rest of the brokerage industry? Can we have a dual system or are we going to no longer see contingent commissions?

WEVODAU: There is no widespread, unilateral decisions across manufacturing lines. If we’re going to toe the line, we’re going to totally re-engineer the compensation structure. When you look closely at the big boys and their strategies, setting aside any admissions of why they did it, Marsh has come out with what I perceive to be a fairly assertive position. They believe they cannot only maintain their clients, but they can extend their services and reconfigure to generate more fee income out of these clients. I think they are greatly overestimating the customer. The renewal cycle will tell us how that ultimately affects them during the next year.

LEADER’S EDGE: Isn’t Willis decentralized, so they don’t have the same sort of buying power?

WEVODAU: Yes, but there are other things that may affect them. [CEO] Joe Plumeri has said he’s going to undertake an aggressive acquisition strategy to replace that income, and he’s going to aggressively recruit to help organically grow the business. That is a bit more pragmatic approach to responding to the lost revenue.

LEADER’S EDGE: When Willis talks about organic growth, are they taking away disaffected clients of Marsh?

WEVODAU: Yes.

LEADER’S EDGE: If the top brokers won’t take contingent commissions, can other brokers continue with business as usual?

SINDER: There was no reason, as a legal matter, for anyone to give up contingents. They made a business judgment to do so. I believe the industry has made two huge mistakes. It hasn’t done a good job explaining to clients what it is we do and what role we play, and we have not done enough in terms of disclosure.

CROCKER: I think brokers have wanted to have it both ways. They want the customers to think they are brokers, but then they want the financial benefits of having an agency relationship with the carrier. I agree with Scott. There is absolutely no legal reason you can’t have contingent commissions as long as they are fully revealed, but I do think that perception is important here.

LIEBLEIN: What we’re getting back from our broker clients is that they are not overly concerned. Our clients are saying, “We’re not going to sit back and let the carriers decide what is going to be our fate.” They are taking the position they are going to be talking to carriers, and if carriers want to reduce contingents, you have got to pay a higher upfront commission.

LEADER’S EDGE: So the producer doesn’t have a problem, regardless of what happens?

LIEBLEIN: I think the problem is defined short-term vs. long-term. I think there is a lot of anxiety about what is going it happen over the next six months to a year. But, ultimately, the economics of the industry will come back the same. You can’t have firms suddenly laying off 5% or 10% of the workforce without consequences. You have to fill that bottom line void one way or the other. You can’t say, “I’m going to give up that income and no big deal.”

LEADER’S EDGE: You don’t think the middle-market buyer is going to keep seeing stories on the nightly news and not be affected?

SINDER: You assume none of these folks knew about this. The Council of Insurance Agents & Brokers’ policy has been that you should explain the existence of these arrangements to your clients. I think there is a better understanding about this among the people who actually buy the insurance than folks are giving them credit for.

LEADER’S EDGE: From a macroeconomic standpoint, how long does it take markets to readjust to this sort of a major shock in their economic structure?

CROCKER: It depends on the market. I suspect that in four to six months we’ll know. In terms of contingent commissions, I honestly don’t think Marsh and Aon had any other choice, but the rest of the market will eliminate them if it is a good business decision. If people don’t think the conflict is strong, then there won’t be much fallout.

SINDER: I don’t think you’re going to see one response—contingents either having staying power or firms giving them up. I see them doing several other things both in terms of the needs of the carrier to have the agreements and just in terms of the revenue. Brokers work hard. They need to get compensated for their services. You are going to see a lot of evolution—a lot of different things happen.

CROCKER: I’ll pile onto that. I think this is going to be an exciting time with a lot of experimentation, probably in the middle markets. There is going to be a fair amount of turmoil as folks try different things. But I always thought living in interesting times was a curse, not a blessing.

LEADER’S EDGE: If a broker came to you and said they’d like to give up contingent commissions, what would be your response?

WEVODAU: What does this represent to your firm? I can’t say yes or no. We believe contingents, one way or another, will survive. But if you give them up, what other sequential, tactical objectives do you need to do to replace the income? In a smaller firm, you have got to think through the long-term implications and how you get from here to there.

LIEBLEIN: My first response would be, OK, how? That sounds great, but how are you going to do that and make up the difference in the bottom line with your existing production force? There is only so much business they can drive each year.

Second, we’re in a period of softening rates. How are you going to generate organic growth when product rates are going down? Your producer force hasn’t changed. Organic growth doesn’t seem to be the magical answer. Now, you start getting strategic: going out and buying a book of business, recruiting new producers—whether they are new or from a competitor. Or will you acquire a firm that will not be in a position to survive?

Mergers and Acquisitions

LEADER’S EDGE: What does all of this mean for mergers and acquisitions? Has it changed the multiple?

WEVODAU: It has temporarily slowed. Some of the activity has been disrupted in certain brokerage channels because they are taking a wait-and-see attitude.

We see a lot of brokers in the middle markets with very difficult and stiff competition and broad rate stabilization. Now, add an element of the unknown. The brokers themselves are somewhat concerned about the long-term viability of how this is going to play out. We see this as driving more accelerated consolidation, particularly over the next six to 12 months while the industry sees its way through that.

SINDER: Why is that?

WEVODAU: There is a level of uncertainty. We have got a client that derives 7.5% of their revenues from contingent commissions—that’s $2.5 million. That is a substantial amount of their profitability. Their belief is they are three years away from executing on a succession planning strategy. There is a tremendous amount of personal risk that they have now. What they really should consider doing is teaming up with a larger organization for their own personal benefit.

LIEBLEIN: I think on the valuation side, it will clearly affect the value of firms if you reduce or eliminate contingents and such lost revenue is not replaced. Buyers have always evaluated contingencies closely and now are taking an even closer look at them and, in some cases, stripping them out from the valuation process all together. We don’t know what is going to happen over the next several months. Once it flushes out, then buyers will be able to objectively determine the impact going forward. They don’t know the impact now, so they take a cautious approach.

LEADER’S EDGE: So will the probe ultimately speed up the mergers and acquisitions activity?

WEVODAU: Yes.

LIEBLEIN: Look at 2004 compared to 2003. There were more acquisitions in 2004 compared to the previous year. You had the product rate softening in 2004, so if something happens that continues to affect revenues and profitability, you’re going to have more acquisitions so companies, particularly public companies, can continue to grow. The ones that can’t survive are going to have to sell, and there is going to be a whole new tier of larger, privately held companies that become more active acquirers.

LEADER’S EDGE: Are smaller firms going to get squeezed if you value firms without considering contingent commissions?

SINDER: I think the small guy gets squeezed because of the burden that comes with any new disclosure. You can see there is an analogy to this in the securities industry in the 1970s when the regulatory environment changed a lot and smaller firms simply were not equipped to deal with the new burdens.

LIEBLEIN: In the last couple of years, the seller has had the leverage in the pricing model. Now the buyers are going to have leverage over the sellers who are not positioned to remain independent. I would definitely see increased acquisition activity, but it is not going to happen probably in the next few months because there is so much unknown right now.

LEADER’S EDGE: Are the sellers concerned there might be troubled buyers out there they might be walking into?

WEVODAU: Without a doubt. We know that firsthand.

SINDER: Not only have the sellers hurt their reputations, but they have bought themselves litigation.

WEVODAU:  There are a couple of things in a typical transaction structure that help safeguard the buyer, such as representations and warranties included in agreements. I think the buyers are much more sophisticated, capable of doing operational due diligence, determining best practices and making that determination.

Conversely, the smaller broker is gravely concerned with the big boys.

SINDER: I think that’s right. But I think the buyers who bought more than a year ago are concerned. What have they bought? What did they buy that wasn’t on anybody’s radar a year ago?

LEADER’S EDGE: How can smaller sellers protect themselves if they are going to be acquired?

SINDER: Quit.

CROCKER: Don’t take stock.

WEVODAU: We have heard that one a lot, too.

CROCKER: Take the money and run.

WEVODAU: The stock they get is restricted usually, and that is problematic.

Industry Reshuffling

LEADER’S EDGE: What happens at the top end of the market?

WEVODAU: I think you definitely see the people fallout. I think there is definitely a vast exodus approaching.

LEADER’S EDGE: And where do those people go?

WEVODAU: Some create a new firm and some join existing firms.

LEADERS EDGE: Do we see less concentration in the top three as we go forward and more of it spread out over the top 20?

WEVODAU: I think you have to. Customer loyalty is greatly overestimated. I think the middle market brokers—the second tier brokers—are greatly underestimated.

LEADER’S EDGE: If one thinks positively, there have got to be huge opportunities. What are they?

CROCKER: Right now, there are huge opportunities for brokers not named by Spitzer. Willis ought to be looking pretty good right about now. It is interesting, if you look at the stock market response to these allegations, Aon took a hit and stayed down. Marsh took a hit, stayed down. Willis took a little hit and went back up. Clearly, the markets have made some judgments about the business prospects.

LIEBLEIN: Probably the biggest issue firms have dealt with over the past several years is the question of where you get the next producer. Where is the talent coming from? That talent is now falling out, so there are going to be opportunities for brokerage firms to hire strong producers who have books of business.

SINDER: This is an incredibly dynamic and exciting time. You have a business that had become very staid at some level. Everybody was doing the same thing. Now it is all wide open. There are incredible opportunities for brokers to differentiate themselves in new ways, to get new talent and even to hold themselves out to clients in new ways. They can come up with creative solutions for the perceived conflict issue.

Carriers

LEADER’S EDGE: Carriers have been extremely quiet. What is going on there?

SINDER: They have a legal problem. They can’t think a lot about this because if they all decide, for example, that they are going to give up contingents, I’ll represent all of our members in filing the very first antitrust lawsuit.

LEADER’S EDGE: Carriers need to market their product and they need brokers to do it.

WEVODAU: You can’t bite the hand that feeds you.

LEADER’S EDGE: So that gets back to the question: Are we going to see higher, upfront commissions in the future?

LIEBLEIN: Several of our clients are taking the first steps to go to the carriers, renegotiate, and see what flexibility is in there to get the higher, upfront commission in lieu of contingents. This potentially presents an opportunity because they also look at it from a cash flow standpoint and receiving more money in the form of commissions vs. the back-end contingent payment.

WEVODAU: Plus contingents are risk. The provisional rate is fixed.

SINDER: There is a reason carriers lowered their rates and placed them on contingents over time. I find it hard to believe they are going to return to those historical levels. They may make up a little bit, but I think you are going to see other approaches.

LEADER’S EDGE: Are risk managers caught in middle—damned if you do, damned if you don’t? If they tell their supervisor they knew about contingent commissions, they might anger the boss. If they say they didn’t know about them, their ignorance may anger the boss.

SINDER: I think this is the biggest challenge we face. I think our clients knew everything, but our clients are the risk managers. I think this has always been a line item for CFOs and CEOs. They never focused on it, so they are just learning about this business through Spitzer and The Wall Street Journal.

LEADER’S EDGE: And they are not happy.

SINDER: No, because it looks terrible and we can’t get enough air time to tell the rest of the story. As an industry, that is our biggest challenge.

CROCKER: Unfortunately, the basics of the plot line seem simple. It may not capture all of the nuances, but the potential conflict-of-interest that results when brokers accept payments from parties other than their customers is  pretty straightforward. If somebody has a 60-second attention span, that sort of frames the entire issue.

LEADER’S EDGE: Is transparency the quick answer for brokers? Is that something they can look at as a temporary answer?

SINDER: Transparency removes any legal exposure. So from a legal perspective, transparency does it. As a business matter, I think that is going to be determined in the marketplace.

LEADER’S EDGE: What is your worst-case scenario from the probe?

SINDER: Overzealous regulators and Congress seeing this as a populist initiative and doing things that go well beyond the current problem to try to define the scope of duties a broker owes to a client. To the extent there is a legal problem that should be resolved, but it is on the transparency side. Everything else should be left to the marketplace.

What should brokers do now?  How should they react over the long term?

LEADER’S EDGE: You’re sitting down as a CEO of a brokerage firm who plans to be around for a while. Give me your short-term advice and your long-term advice?

CROCKER: My first advice would be to have a heart-to-heart with my major customers, to explain the contingent commissions to them in excruciating detail and ask if they’ve got a problem.

LEADER’S EDGE: Would you include dollar amounts?

CROCKER: Of course. This is a time when honesty is going to go a long way. It’s a lot better to serve it up front than have it pulled out with pliers one tooth at a time. This is an industry where trust is everything, and if there is any sort of cloud, boom. I think you have got to deal with it.

LEADER’S EDGE: Long term?

CROCKER: Long term, I think pay attention to what the market’s doing. See if these other ways—other tools—are adjusting and can replace contingent commissions. I think that the stock market is very bullish on the brokerage industry as a whole. Willis said they weren’t going to take contingent commissions, which is a significant chunk of their income, and their stock price hadn’t dropped a smidgen as a consequence. I am pretty bullish on the market as a whole.

WEVODAU: My near-term advice to a client would be to basically do nothing for now. You’ve got to be able to respond to clients as the questions are presented. I think the long-term impact is going to be probably reshaping the compensation structure of the industry, and whether that means that contingents become completely quality focused or if the provisional commission rates are adjusted accordingly—I don’t think we’re facing a widespread battle over a significant revenue stream.

Brokers need to position themselves to adjust accordingly and echo the market sentiment. They should disregard this as being an earth-shattering industry-wide change agent.

What will come out of this is some change in the comp structure. This will be pushed from consumer advocacy groups or pushed from the carrier end. But at the end of the day, the economic food chain is not going to be greatly disrupted.

LIEBLEIN: There are too many firms—large firms—who don’t have formal, strategic planning as well as tactical objectives that say if I were to look out over the next several months, what am I going to do to offset A, B and C.

We don’t know the exact impact of the contingent issue, but again, we were with a client recently going through this process and the tactical objectives changed because they were preparing for the potential impact of lower contingents and proactively preparing to more effectively deal with the pending market fallout. It also makes them refocus better on the longer, three-to-five year strategic issues because the industry is going to change.

LEADER’S EDGE: You said be proactive rather than reactive, and your partner said lay low.

LIEBLEIN: We’re differentiating between short-term and long-term. You can’t be proactive to something when you don’t know what is going to happen.

WEVODAU: Exactly.

SINDER: I think it depends a lot upon where you are at the moment. A lot of firms have done a better job at disclosing to their clients, and they are in very good shape with those clients. For them, it is a great marketing opportunity. I liken this to the privacy issues five years ago. A lot of companies took advantage and said “we’re going to protect your privacy the way we always have.” It was a great marketing opportunity. I think there are some firms that are going to be able to do that with disclosure. Other firms, I think are going to be exactly where Steve said they should be— doing nothing—until they figure out where they are.