Natural rights and the right to contract on commission

01 November 2013 Robert W Vivian, James Britten, University of the Witwatersrand

In a previous edition of FAnews, I pointed out that the UK outlawed the right of intermediaries to earn an income through commissions paid by the product providers as a consequence of what is known as the Retail Distribution Review (RDR). I mentioned that South Africa’s Financial Services Board (FSB) plans to carry out something with the exact same name, a Retail Distribution Review (RDR).

In the recent past in all other instances where the FSB introduced regulations with the same name as done by the now defunct UK’s Financial Services Authority (FSA), the FSB arrived at the same outcome as its British counterpart. Therefore I predicted that in the future commissions would also be outlawed in South Africa.

Magnus Heystek recently wrote in an article for Moneyweb pointing out that, as a consequence of the outlawing of commissions in the UK, the number of bank advisers fell by 44% and independent advisers by 20%. There are of course other negative consequences flowing from the outlawing, but for the purpose of this article I will examine in greater detail the conceptual implications of outlawing commission.

A strange phenomenon that is difficult to explain has appeared in recent years. Society seems to have forgotten much of what was known to previous generations. Centuries of knowledge seems to have disappeared. This problem applies as much to academia as it does to business.

In the case of academia, the knowledge loss is inexcusable. It is as if society now needs to rediscover all the old forgotten truths. Take for example a recent observation by professor Imad Moosa (RMIT Australia), a banking expert, while discussing the new Basel III liquidity requirements. He noted of this new liquidity standard: "This is ludicrous: for the first 20 years of its life, the Basel Committee could not care less about liquidity. It took the global financial crisis to convince the BCBS that liquidity does matter.”

How can it be that the world’s leading bank regulator did not know that the greatest risk faced by the banking industry and the entire system would be the liquidity risk? It was the liquidity risk that brought down Northern Rock and set in motion the greatest banking crisis in the UK’s history. The importance of the liquidity risk to the banking system should have been understood, especially by the banking regulator.

Lessons forgotten

More than a century ago, understanding the liquidity risk led to the formation of central banks to be the lenders of last resort, specifically to cater for the systemic liquidity risk inherent in banking. A long time ago, 19th-century economist and writer Walter Bagehot set out the way to deal with the liquidity risk. All this seems to have been forgotten or simply never learnt by the modern generation, probably never taught at university.

With the outlawing of commissions it is clear that some fundamental principles of liberty and legislation have clearly been forgotten. These should be recalled. For thousands of years it has been understood that one of the greatest risks facing society comes from the state itself.

The great philosophers devoted much of their time and effort to this issue. John Locke in the 1600s, for example, examined the problem from first principles, and concluded the solution lay in understanding that each individual has unalienable rights to life, liberty and property. These are the natural rights. He noted that the purpose of the state is to protect these rights. By 1776 these principles were so well known that they appear in the US Declaration of Independence and in 1791 in France’s Declaration of the Rights of Man.

Limits to the power

The new world democratic order was to be built on the existence and protection of these natural rights. In 1859 the influential Victorian philosopher John Stuart Mill published his essay On Liberty. By the 1900s these things were well understood. This is no longer true.

Much of the effort in designing the new democratic order was to ensure state power did not once again encroach on natural rights. This was what the new order was supposed to be about. Mill wrote: "The aim was to set limits to the power, which the ruler should be allowed to exercise over the community; and this limitation was what they meant by liberty.”

People should be free to go about their business, especially the business of earning an income by entering into contracts, with very little interference from the state. The state can limit the freedom of others, but only where that freedom violated the natural rights of others. Therefore there are laws that limit freedoms. These include laws against murder, rape, theft, kidnapping and so on. These can be referred to as the Natural Laws.

An attack on natural rights

If the state is to outlaw commissions, then it must be that commission contracts fall within the same category as murder, rape, theft, kidnapping and so on. Clearly commission contracts do not fall within that category. The purpose of regulation cannot be to attack natural rights, such as the freedom of contract, but to regulate the exercise of these natural rights. An example of regulation is to proclaim that all vehicles must drive on the left-hand side of the road. This does not prohibit the freedom of movement, but regulates how this freedom is to be conducted. Outlawing of commissions is not a regulation at all. It is the violation of a fundamental freedom, the freedom to earn a living.

Mill summed up the position as follows: "The only freedom which deserves the name, is that of pursuing our own good in our own way, so long as we do not attempt to deprive others of theirs, or impede their efforts to obtain it. Each is the proper guardian of his own health, whether bodily, or mental and spiritual. Mankind are greater gainers by suffering each other to live as seems good to themselves, than by compelling each to live as seems good to the rest.”

Equality before the law

There is another simple test that can be applied: equality before the law. If commissions are so evil that they should be banned, then all commission contracts are equally evil, not only insurance commission contracts, and should be replaced by negotiated fees from the end user. Murder is murder, theft is theft, and rape is rape. If commissions are banned, all commissions should be banned. Commissions for estate agents and stockbrokers should be banned. Contingency fees for lawyers should be banned. Compulsory levies payable to the FSB should be banned. Everybody, including the FSB, should only get what they can get as a fee negotiated from the other party before the transaction is entered into. The FSB should have to negotiate its annual fee from a committee representing the industry.
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