While it is common shorthand to say that financial advisors are paid based on commissions, this is not strictly the case. Rather, their cash compensation equals their accumulated production credits times a payout ratio. production credits may be equal to, less than, or even more than the actual revenue earned by the firm on a given transaction executed by the financial advisor on behalf of a client. With stock trades executed on the New York Stock Exchange, production credits typically equal the amount of commission paid by the client.
For this reason, and because such NYSE-listed equity trading traditionally formed the bulk of the revenue stream (and production credits) generated by most financial advisors, it became commonplace to conflate production credits with commissions in common usage.
Production credits normally equal, or at least closely approximate, the sales charges embedded in a given securities transaction. These include, for example:
Commissions paid by the client on a transaction where the brokerage firm acts as an agent, either executing the trade on a securities exchange or with another firm that makes a market in that security. In the case of clients who pay by assets, rather than by commissions on individual transactions, production credits normally will equal those asset-based fees.
The markup or markdown paid by the client on a transaction where the brokerage firm acts as a principal, fulfilling the order from an inventory of securities that it holds and manages. Markups on client purchases and markdowns on client sales typically are computed in the same fashion as commissions on agency transactions.
Selling concessions in new issues of securities. The price of a new issue of equity or debt typically includes a selling concession and an underwriting fee that are layered on top of the net amount that the issuer will receive. The selling concession compensates sales persons (such as financial advisors) for finding investors willing to buy into the issue. The underwriting fee compensates the investment bankers and securities underwriters who structured the deal, and who may be assuming some degree of risk if it does not sell out at the stated price.
Sales charges embedded in the pricing of mutual funds. Some mutual funds are sold with explicit sales charges that the client can readily see, and some are not. In the realm of mutual funds, sales charges traditionally have been called sales loads. Since the 1980s, mutual fund companies increasingly have been turning to so-called back end loads that are charged to the client at the time of sale, rather than at the time of purchase. There also are so-called level load funds in which the sales charge (often called a 12b1 fee, after a regulation that allowed it) is embedded in the fund’s annual operating expenses.
These schemes were devised to counter the growing popularity of no-load funds that are sold directly to the investor by the mutual fund company, rather than through securities brokerage firms and sales persons such as financial advisors. By replacing front end loads (the traditional loads assessed at the time of sale) with delayed loads, mutual funds with sales charges have found a way to overcome investor resistance.
Other Production Credit Awards: Production credits also may be awarded for non-transactional work done by a financial advisor, such as for persuading a client to have a formal financial plan prepared by the firm.
Flavor of the Month: Firms regularly have special marketing drives that vary from month to month, for which extra production credits, above and beyond the usual, are awarded for participation. Such campaigns often are called “flavor of the month” specials, with some touch of disdain, since financial advisors rarely see any long term value in participation, but will do so to maximize their compensation. In the case of firms that also act as market makers, they might add bonus production credits in order to stimulate sales of certain securities with which they have become saddled with excess inventory.
Also Known As: Commissions
Alternate Spellings: PCs
Examples: The financial advisor earned 250 Production Credits on this trade.