Second Public Comment Letter To CFP Board On Revised CFP Professional Standards Of Conduct

Michael Kitces Second Public Comment Letter To CFP Board On Revised Proposal For New Standards Of Conduct

Dear CFP Board,
I am writing to share my comments and feedback on the second revision re-proposed Code of Ethics and Standards of Conduct for CFP Professionals.

Overall, I continue to commend the CFP Board and its Commission on Standards on their efforts to advance a fiduciary standard for all CFP certificants, and for taking feedback and attempting to integrate such a diverse range of over 1,300 public comment responses to the first proposal (including the lengthy one from yours truly!). The Commission and supporting CFP Board staff also deserve commendation for providing an effective red-lined version of the proposed changes, and a thorough explanatory letter of “commentary” with reasoning for the proposed revisions, and its willingness to engage in a second public comment period to begin with.

And while it’s notable that the CFP Board did “concede ground” regarding a few aspects of proposed expansion of the fiduciary rule and its related disclosures, I believe it was fair and reasonable to acknowledge real-world regulatory-overlap conflicts (such as the concern that a CFP professional disclosure document could be deemed advertising under FINRA Rule 2210). The decision to at least issue a voluntary disclosure template for Initial Disclosures is a positive step forward, and hopefully the requirement for Initial Disclosures will be revisited in the next future revision in the Standards in the coming years.

That being said, the revised version of the re-proposed Standards of Professional Conduct – and the changes therein – do introduce certain new concerns and issues that must be addressed, particularly regarding the elimination of the rebuttable presumption that CFP professionals are doing financial planning (and the associated expansion of the implicit category of non-financial-planning financial advice, with its own separate disclosure requirements). In addition, I believe that certain aspects of the new proposed standards could be refined and clarified in key areas, particularly with respect to certain compensation-related disclosures and terminology.

I hope that the CFP Board will take this (and other stakeholder input) and consider making further refinements to the Proposed Standards of Professional Conduct before they are submitted to the Board of Directors for final approval.

Non-Financial-Planning Financial Advice And The Rebuttable Presumption Of Financial Planning

The original proposal for the new Professional Standards of Conduct introduced the concept of a rebuttable presumption that when a consumer engages a CFP professional, the CFP professional will provide financial planning, and be held accountable for following the CFP Practice Standards, unless the CFP professional limits the scope of engagement and/or can otherwise demonstrate that the client was not engaging financial planning services.

Commenters objected to the rebuttable presumption of financial planning, on the grounds that it would limit consumer choice or require all CFP professionals to provide financial planning (even if the client didn’t want it, and/or if it wasn’t appropriate to the situation). However, as the Commission on Standards notes in its commentary response, a rebuttable presumption that financial planning will be provided does not limit consumer choice, as the proposed standards explicitly stated this was a rebuttable presumption, and more generally already provide the requirement that a CFP professional define the scope of engagement with the client. If financial planning is not to be provided, the CFP professional could reasonably limit the scope of the engagement accordingly, and document why a full-scope financial planning relationship was not necessary to render financial advice.

In this context, the removal of the presumption of financial planning is problematic for three primary reasons.

Two Types Of Financial Advice?

First and foremost, the removal of the rebuttable presumption effectively codifies two types of “financial advice” – financial advice that is financial planning, and non-financial-planning financial advice (which, per the Glossary of the Proposed Standards, would essentially be recommendations regarding the purchase of various “Financial Assets” products, the management of Financial Assets, or the selection of third-party providers that provide such solutions). In essence, the elimination of the rebuttable presumption, and the open ability to provide non-financial-planning financial advice, simply reconstitutes “financial planning” vs “product sales and investment management”, while euphemistically calling the latter “(non-financial-planning) financial advice”.

This is problematic because even the CFP Board’s own public awareness campaign advocates to consumers that “for financial planning, [consumers should] work with a CERTIFIED FINANCIAL PLANNER professional”. In other words, even according to the CFP Board itself, engaging with a CFP professional is synonymous with engaging financial planning services, to which CFP Professionals are “held to the highest standard.”

Except in reality, under the revised Standards, those CFP professionals are not actually accountable to the CFP Board’s Practice Standards, nor are they required to honor the financial planning process when providing non-financial-planning financial advice.

Even more problematic, under the new Section 10(b) of the revised proposal, a CFP professional providing financial planning services is required to have a written document that establishes the terms of engagement and the scope of engagement. However, under Section 10(a), those providing non-financial-planning financial advice are not required to disclose the (by definition more limited) scope of engagement. Which means, quite literally, that those who provide financial planning must define the scope of their financial planning advice, but those who provide non-financial-planning financial advice are not required to disclose and explain to the consumer that they will not be providing financial planning advice!

Which means as a bare minimum, the revised proposal needs to be amended to expand the requirement for defining the Terms of Engagement and Scope of Engagement under Section 10(b)(ii) to apply to all of Section 10 (and/or that Section B.6 of the Practice Standards apply to all engagements of the CFP professional, not just financial planning engagements to which the Practice Standards apply), which ensures that those who provide non-financial-planning financial advice are actually required to disclose and define the scope of engagement to not include financial planning.

And arguably, given that the very act of holding out as a CFP professional implies financial planning will be provided – including by the CFP Board’s own public awareness campaign – the delivery of non-financial-planning financial advice should entail a specific, clear, and concrete disclosure that financial planning advice will not be provided. For instance, most large firms already provide clear disclosures to clients that “[Firm] does not provide tax or legal advice, and clients should consult their own tax and legal advisors before engaging in any transaction.” A similar disclosure for non-financial-planning financial advice from a CFP professional might similarly disclose “[Advisor] is not providing financial planning advice, and clients should consult their own comprehensive financial planner before engaging in any transaction.”

Key point: To the extent that CFP professionals will be permitted to provide non-financial-planning financial advice, in conflict with the CFP Board’s own public awareness campaign that consumers should seek a CFP professional for financial planning, the delivery of non-financial-planning financial advice should require an explicit disclosure of the limited (non-financial-planning) scope of engagement, which could be provided to firms as simple template language for those that don’t want to make their own lengthier initial disclosure documents.

Murky Evidentiary Standards For Enforcement Of Non-Financial-Planning Financial Advice

The second issue that arises with the CFP Board’s elimination of the rebuttable presumption of financial planning for CFP professionals, is the related introduction of the “CFP Board Evaluation” in a disciplinary proceeding of whether the CFP professional was required to comply with the Practice Standards (and an implicit evidentiary presumption at that time that the standards should have applied).

First and foremost, this is problematic because it should be a matter of whether the client alleges that the CFP professional was providing financial planning (and therefore should have followed the Practice Standards), not the CFP Board itself. Why would the CFP Board and its staff be making allegations against a CFP professional in any circumstance? Does the CFP Board now intend to investigate and potentially discipline CFP professionals based on the CFP Board’s own allegations, in the absence of a client allegation?

Second and even more important, it still remains unclear when and under what circumstances the CFP Board will allege that the Practice Standards should have applied? What standard will the CFP Board use to make such a determination? In theory, this is why the rebuttable presumption of financial planning was appropriate in the first place; because it would have created the presumption of financial planning, to which the CFP Board could then evaluate. In the absence of a rebuttable presumption, it’s entirely unclear when and how the CFP Board can “allege” that the Practice Standards “should have” applied, how often they should apply, and under what circumstances.

Of course, all of this hinges on the stipulation under the Practice Standards that the CFP professional must adhere to the standards when providing financial planning, financial advice that requires financial planning, or because the client has a reasonable basis to believe the CFP professional will or has provided financial planning.

Yet isn’t the mere fact that a CFP professional holds out as such, combined with the CFP Board’s own public awareness campaign that consumers should work with a CFP professional to receive financial planning, already create a reasonable basis that any consumer engaging a CFP professional will receive financial planning? Why would a CFP professional represent the CFP marks to the public on their business card, website, and other marketing materials, if not to imply something about the depth and scope of the advisor’s services pertaining to financial planning (as substantiated by the CFP Board’s own public awareness campaign to that effect)?!

In other words, at what point can we acknowledge that the mere holding out the CFP marks by a CFP professional creates a reasonable basis for expecting to receive financial planning advice, such that the practice standards must apply to that CFP professional (unless the Scope of Engagement is specifically limited to non-financial-planning financial advice)? And if the CFP Board already intends to apply the rules in this manner, then why is the presumption of financial planning reduced to the evidentiary stage, instead of providing clearer upfront guidance to CFP professionals themselves about when they will be held accountable (rather than simply letting them find out after the fact in a disciplinary process?).

Simply put, if the presumption of financial planning will be shifted to a standard based on what the CFP Board alleges, then the CFP Board needs to clarify the circumstances in which it can make such an allegation (as opposed to the client), what situations constitute a “reasonable basis for the client to believe the CFP professional will provide financial planning”, and consider more formally codifying that holding out as a CFP professional itself, combined with the CFP Board’s own public awareness campaign, is creating such an expectation in the mind of the consumer.

Key Point: The proposed standards stipulate that the CFP Board can still allege the Practice Standards should apply, which the CFP professional must rebut, based on various Integration Factors and the expectations of the client. But if the CFP Board’s own public awareness campaign links CFP professionals to the delivery of financial planning advice, shouldn’t the act of holding out as a CFP professional already create the presumption of financial planning? And if so, why don’t the Standards formally codify this – allowing those who wish to not be subject to the standards to avoid it by either not holding out as a CFP professional, and/or by providing Terms of Engagement and a written Scope of Engagement that clearly limits the Engagement to non-financial-planning financial advice.

The Application Of A Fiduciary Standard To Non-Financial-Planning Financial Advice (i.e., Product Sales)

The third challenge that the CFP Board and its Commission on Standards must consider, with the elimination of the rebuttable presumption of financial planning, is how it will adjudicate what may potentially be a substantial volume of cases that apply its new fiduciary standard to non-financial-planning financial advice.

In the context of applying a fiduciary standard to financial planning advice, the Practice Standards themselves provide a valuable template for how to evaluate whether the CFP professional followed an appropriate fiduciary process. And when the rebuttable presumption was present, most cases before the Disciplinary and Ethics Commission would have likely hinged on whether: a) the Practice Standards were met; or b) whether the Practice Standards should be applied (i.e., whether the presumption of financial planning could be rebutted, or not).

With the expansion of the category of non-financial-planning financial advice, and an implicit declaration by the CFP Board that such advice by CFP professionals is expected to commonly occur (why else eliminate the rebuttable presumption?), the question now arises: by what standards will the CFP Board’s Disciplinary and Ethics Commission adjudicate the application of a fiduciary duty to non-financial-planning financial advice?

The question is significant, both because of the implied increase in the frequent of non-financial-planning financial advice, and because even related fiduciary rules already present in the industry – such as the fiduciary duty under ERISA, or the fiduciary for RIAs – have never been applied to the full range of anything and everything that CFP professionals do (especially outside their scope of financial planning advice itself).

This could include a fiduciary evaluation of tax advice, estate planning advice, the sale of various types of annuity products, the sale of life insurance, the sale of a wide range of “standalone” investment products from mutual funds and ETFs to individual securities and private placements and alternative investments, to “fiduciary” budgeting, fiduciary recommendations on when to claim Social Security, fiduciary long-term care insurance, and more. All of which currently exists in a fiduciary vacuum, for which no standards have been applied in any public disciplinary forum.

To take just one common case-in-point example in the current environment, at what point will the sale of a standalone commission-based annuity product be deemed a permissible sale that meets the CFP professional’s fiduciary duty? Absent Practice Standards, what due diligence process is the CFP professional expected to satisfy to meet his/her fiduciary duty? To what extent can the CFP professional rely on the representations of the annuity company? Or the CFP professional’s insurance marketing organization? What range of products must be considered? What level of commission is or isn’t deemed to be a manageable conflict of interest? And what disclosures of that compensation are required? What if it’s also a hybrid annuity/long-term care product? At what point does the CFP professional also need to evaluate long-term care insurance as well? And under what framework, given the CFP professional is not doing financial planning?

As it stands, the CFP Board’s disciplinary process risks facing a never-ending stream of “first impression” cases, around which such “case law” (or in the CFP Board’s context, Anonymous Case Histories) will be established. Which may ultimately establish a reasonable framework to evaluate the most common problem situations. But rule-making via the disciplinary process is not fair to the majority of CFP professionals who may be attempting to comply in good faith, albeit with a total absence of guidance and standards to which they can safely adhere.

Simply put, it’s all well-and-good for the CFP Board to claim “all fiduciary, all the time” when it comes to CFP professionals providing financial planning advice and non-financial-planning financial advice. But how effective can the fiduciary duty really be for the latter group, when there’s absolutely no framework to even evaluate what constitutes a non-financial-planning financial advice fiduciary process? And is it really fair to subject CFP professionals delivering non-financial-planning financial advice to such Standards of Practice without even defining them, first?

Key Point: If the CFP Board intends to formally codify the widespread existing of non-financial-planning financial advice, it needs to promulgate the non-financial-planning Practice Standards that will apply, and issue further guidance about the framework that will be used to adjudicate such cases before they actually occur.

Establishing A Formal Process For Issuing CFP Board Guidance (On Reasonableness)

One of the greatest concerns raised in the originally proposed changes to the Standards of Professional Conduct is the substantial reliance of the Commission on Standards that in the future, the Disciplinary and Ethics Commission will come up with definitions of what “reasonable” behavior of CFP professionals actually is.

In fact, in the latest version of the standards, there are a whopping 28 instances where the DEC would be required to interpret whether a situation was “reasonable” or whether the CFP professional “reasonably” discharged their duties to the client. Reasonableness is applied in situations ranging from whether information about a conflict of interest was Material enough to be disclosed (based on whether a “reasonable” client would have considered it material), to the requirement that CFP professionals diligently respond to “reasonable” client inquiries, the obligation to take reasonable steps to protect client information, using reasonable care to select technology vendors, and that CFP professionals must adopt business practices “reasonably” designed to prevent Material conflicts of interest (which, again, are only Material based on their own reasonableness standard).

Yet in the absence of any guidance about what are “reasonable” in these various situations – especially in already-recognized-to-be-challenging areas like the mitigation of conflicts of interest – the reliance on “reasonableness” standards is tantamount to creating a process of rulemaking by enforcement, where such standards will only become known in after-the-fact (Anonymous) Case Histories that may or may not have been the result of prosecuting well-intentioned CFP professionals who simply disagree with the DEC about what was “reasonable” in the first place. In point of fact, this is exactly what was alleged in the case of Camarda vs CFP Board, and I have heard numerous ongoing complaints for years that even after the Camarda case, CFP professionals cannot get interpretations from the CFP Board in advance of whether their particular situations do or do not comply with the CFP Board’s requirements (in the absence of sufficient existing guidance).

Accordingly, to the extent that the Commission on Standards is committed to the currently proposed documents, it is incumbent upon the CFP Board to establish and formalize a process for drafting and issuing guidance, including both a framework for CFP professionals to request guidance in advance on specific situations (akin to the Ethics Committees of many state bar associations that provide attorneys with guidance on how to meet their professional conduct obligations in presented situations), a means to formalize Anonymous Case History results into formal guidance (so CFP professionals aren’t obligated to read every new disciplinary case just to find out how the standards are being applied), and a proactive structure to issue guidance in known-to-be-ambiguous situations (starting with how the CFP Board expects CFP professionals to manage common conflicts of interest, and interpreting all 28 of the “reasonableness” instances currently included in the proposed standards).

Key Point: If the proposed standards will rely on 28 instances of subjective “reasonableness”, the CFP Board must establish a formal framework to issue guidance, both to clarify the reasonableness standards already being codified, to communicate new interpretations of the standards that emerge from disciplinary matters, and to provide a timely response to CFP professionals who proactively reach out and request interpretations for specific client situations.

Limiting The Scope Of Financial Advice To Compensated Advice

A key aspect of any code of conduct for professionals is to define when a professional engagement actually begins. Otherwise, even a cocktail party conversation with a professional services provider could expose the professional to legal liability for a breach of professional standards.

In the context of financial services, it is well established that professional financial advice only occurs when there is both an agreement (which may be written or oral in various circumstances), and for which there is compensation. Thus, the Section 202(a)(11) of the Investment Advisers Act of 1940 stipulates that an advice relationship only exists if the investment adviser engages in the business of advising others for compensation. And the Department of Labor’s recently introduced fiduciary rule also limits the scope of fiduciary duty to situations where the advisor “renders investment advice for a fee or other compensation…”

Of course, clearly an individual can give very bad “free” advice as well. But there is at least an implicit understanding from consumers that uncompensated advice may not be specific to their situation, especially if it’s not also pursuant to an explicit contractual agreement to engage advice. In other words, the point of requiring compensation for an advice engagement is not to shelter free advice from standards, but to establish a crystal clear line of when advice unequivocally will be subject to professional standards. In addition, from a legal perspective, the exchange of consideration (i.e., compensation) is a requirement for a contract to be enforceable in the first place.

Yet the CFP Board’s standards have neither a requirement for a contract, nor a requirement for compensation or other consideration to be exchanged, in order to bind the CFP professional into a fiduciary relationship. Instead, a “Client” is simply defined as “any person… to whom the CFP professional renders Professional Services pursuant to an Engagement” where “Engagement” is defined to be as little as an “understanding” of the client.

In other words, a conversation as simple as a person asking a CFP professional at a cocktail party “what do you think of Bitcoin”, where the CFP professional responds “We’re not investing in Bitcoin for clients due to concerns that it might be a bubble” would amount to fiduciary financial advice. Because it suggests a course of action (which constitutes Financial Advice), and that makes it an engagement (since the person who asked the question had an understanding that the advisor was a CFP professional who should be knowledgeable about financial matters). The fact that the CFP professional didn’t intend it as advice, nor asked any specific questions about the client, wouldn’t even be germane, because such non-financial-planning financial advice wouldn’t have been subject to the Practice Standards anyway!

Simply put, when a client’s interpretation (or “understanding” that misinterprets the situation) can impose a fiduciary duty on a CFP professional, without any contractual agreement, nor any exchange of consideration to bind such an agreement, the CFP Board will literally be enforcing a full-scale fiduciary duty against CFP professionals in situations that wouldn’t even constitute legal contractual agreements nor invoke any other fiduciary duty (all of which require an exchange of consideration to be contractual and fiduciary).

The CFP Board’s desire to protect consumers from anything that might possibly come out of a CFP professional’s mouth in the form of “free” advice (or commentary not even intended as advice) is laudable. But from a real-world perspective, an exchange of consideration is a fundamental element of contract law, and every other fiduciary duty that applies to financial advisors; it is essential to be included in the CFP Board’s Standards of Professional Conduct, most easily by simply redefining a “Client” as:

Client: Any person, including a natural person, business organization, or legal entity, to whom the CFP® professional renders Professional Services for compensation pursuant to an Engagement.

Key Point: The CFP Board’s definition of what constitutes a “Client” and a contractual fiduciary relationship is inconsistent with every other regulatory fiduciary standard that applies to financial advisors by excluding a requirement that services be rendered for compensation; in addition, it is inconsistent with basic contract law, that a contract cannot be binding without an exchange of consideration. The Standards of Professional Conduct should be updated to stipulate that a “Client” is one who engages the CFP professional ‘for compensation’.

Further Refinements To Compensation Disclosure Rules

One of the most contentious areas in recent years has been the CFP Board’s enforcement of its compensation disclosure rules, and accordingly it is not surprising that the Proposed Standards have aimed to modify and specifically to clarify the disclosure of compensation, and characterizations of the CFP professional’s compensation model.

However, while the latest Proposed Standards are an improvement in several key areas in this regard, additional refinements are necessary for both consumer protection, and to clarify (and in some cases, simplify) the latest revision.

Providing Specific Details Of Compensation Disclosure At The Time Of Advice Or Implementation

One of the issues raised in the original proposal of the new Standards of Professional Conduct is that the CFP Professional was required to disclose, both in Initial Disclosures to a Prospect, and at the time of engagement, how the CFP professional would be compensated. However, this framework raised the question what “how” means – is the CFP professional obligated to disclose exactly how he/she will be compensated (e.g., a $1,000 fee, a 0.75% AUM fee, and a 2.5% commission on certain investments), or simply the nature of the compensation (e.g., “the CFP professional will be compensated with a combination of commissions and fees”).

The subsequent commentary from the Commission on Standards clarified that the expectation is not that the CFP professional disclose exact dollar amounts, and instead simply disclose the general nature of the advisor’s compensation, under the auspices that a CFP professional might not even know the final dollar amount of compensation at the time of engagement.

It is a fair point to recognize that in many situations, a CFP professional may be engaged initially for a financial plan, in order to determine appropriate recommendations for implementation, and thus won’t know what will ultimately be recommended until the plan is subsequently completed.

Nonetheless, it’s not clear why the Standards of Professional Conduct cannot simply extend the disclosure requirement to stipulate that, at the time of implementation, a CFP professional shall disclose the exact nature of their compensation, after making a recommendation and before the client signs to implement. Alternatively, the implementation stage – at the point the client signs additional documents to literally engage the CFP professional in the subsequent implementation step – could simply be recognized as a separate and additional engagement, subject to its engagement standards at the time.

Otherwise, the reality is that the CFP Board’s compensation disclosure requirements are rendered largely meaningless. Any CFP professional could effectively avoid virtually all compensation disclosure requirements by simply engaging each new client in a mini-planning stage, which could be as little as a single meeting for a nominal fee, and then obscure all subsequent compensation disclosures by simply declaring that they were unknown at the time of initial engagement. Moreover, simply requiring an open-ended disclosure “the CFP professional is compensated by fees and commissions” utterly fails to distinguish between advisors whose compensation is 99% commission, from those who are compensated 99% by fees, despite the real-world differences in potentially material conflicts of interest those entail.

Thus, to the extent that the CFP professional cannot fully disclose compensation that might be received for implementation after a financial plan, when the client is just initially engaging the advisor for the plan, the Standards for Professional Conduct should simply require supplemental disclosures, at the time of implementation, that disclosures the nature of the compensation in either dollar (e.g., for actual dollar fee compensation) or applicable percentage terms (e.g., for commission compensation).

Key Point: When CFP professionals are compensated for implementation of a financial plan, they may not know what will be recommended until after the plan is completed. This should not alleviate the CFP professional of compensation disclosure obligations, though; instead, the CFP professional can simply be obligated to disclose how he/she will be compensated at the time of initial engagement, and subsequently be required to disclose the exact nature of compensation (in dollar or appropriate percentage amounts) at the time of actual implementation!

Changes In Compensation – From Fee-Only To Commissions (And Back Again)

The rising popularity of the “fee-only” compensation model, especially amongst the media, has created real-world marketing incentives for advisors to hold themselves out as being fee-only. Yet at the same time, commission-based compensation can still be very lucrative, especially when working with ultra-high-net-worth clientele (where very sizable life insurance policies are sometimes used for estate planning or business purposes).

As a result, some “fee-only” CFP professionals have taken to marketing themselves as fee-only financial planners, but in situations where a sizable commission-based opportunity arises, they “switch” to become “commission-and-fee” advisors for the time it takes to implement a commissionable insurance policy with the client, and then “switch back” to being fee-only again.

While the CFP Board’s proposed standards would require the CFP professional to disclose at least to that particular client that he/she will be compensated with commissions and fees, the ability to switch compensation models away from fee-only and back again raises challenging issues about the accuracy of the “fee-only” label for such advisors, whether or to what extent such compensation model changes should be disclosed to all clients, and/or how often a CFP professional can make such changes without being required to disclose to all clients.

After raising this issue in the prior comment letter, the Commission on Standards suggested that such compensation model changes would be subject to the general Integrity clause that “requires CFP professionals to provide material facts that are necessary to make prior statements not misleading.”

Yet the actual application of this clause remains ambiguous to situations like the one presented here. The actual client who paid commissions received appropriate disclosures. But what are the CFP professional’s obligations to other clients? The explanation to the other clients was that the CFP professional was fee-only, and with those other clients he/she was. In addition, if the CFP professional is “commission-and-fee” for just the single day it takes to implement the insurance application with the new client, the CFP professional can allege that it didn’t impact any prior disclosures to other clients.

Still, when such compensation model changes occur repeatedly and systematically, the CFP professional is substantively fee-and-commission (not “fee-only” with most clients, except-when-not-and-then-switching-back-again).

Given that such matters are already arising in the marketplace, it is essential for the Commission on Standards to further clarify when changes in compensation methodology for a single client do or do not necessitate disclosure of a switch in compensation methodology for all clients on an ongoing basis.

Key Point: Compensation-model-switching is already occurring in the current marketplace, for which CFP professionals disclose to the current client that there will be a commission, but continue to hold out as fee-only because they are “only commission-based for a day” to implement the commissionable-product. Yet repeated compensation-model-switching undermines effective disclosures, and the application of the Integrity standard alone is insufficient where prior clients actually continue to only pay fees. Further notification requirements about changes to compensation methodology are an important necessary for disclosure continuity.

Changes In Compensation – From Commission Trails To Fee-Only

Another lingering issue when it comes to advisors changing compensation models are those who are aiming to switch from commissions (and ongoing commission trails for servicing) to become fee-only.

The Standards as proposed require that the fee-only CFP professional receive no sales-related compensation, even and including trailing commissions for prior products implemented with clients in years past. Thus, even if a CFP professional receives only 100% fees from every client he/she engages with, the mere presence of a single dollar of prior trails eliminates the advisor’s ability to hold out as fee-only.

This is highly problematic for advisors aiming to serve clients on a fee-only basis going forward, because current law simply doesn’t allow prior brokers and insurance agents to terminate their own commissions if they are now being compensated by fees. Nor do most firms have any way for a non-commission-based fee-only RIA to even remain as broker-of-record or agent-of-record on an existing insurance policy or investment product that the advisor themselves implemented in the past.

The commentary of the Commission on Standards notes that “trailing commissions offer an economic incentive to retain the product that is inconsistent with a fee-only representation”; yet if the incentives of receiving ongoing AUM-based commission trails for servicing clients is deemed such a problematic compensation incentive, then why is all other AUM-based advisory fees permitted!? How is it that retaining a 0.25% trail on a prior investment recommendation is deemed unduly conflicted, but 1% ongoing AUM fee for all of the RIA’s other clients requires no special handling as fee-only compensation?

In addition, the reality is that under the law, the first 0.25% of a 12b-1 fee is technically a “shareholder servicing fee” anyway, and not actually a distribution (sales) charge; insurance companies similarly provide both upfront commissions for sales, and ongoing trails for servicing. In some cases, advisors do choose levelized commissions – which make ongoing trails a blend of both commission-based and servicing fees. But this means a transition safe harbor could simply be established for “only commission trails that are 0.25% or less”, consistent with industry-established servicing fee standards. In fact, ironically, switching most 0.25% commission trail products to a fee-only relationship would increase the cost to the client (given that the typical advisory fee is far higher than the typical servicing commission trail).

Furthermore, while the Commission on Standards suggests that the client could be switched to another broker-of-record or agent-of-record, this does not terminate the existence of the shareholder servicing trail commissions – which will simply be paid to that other broker or agent – even as the CFP professional must still charge for their own ongoing services. Which amounts to a mandate that CFP professionals switching from commissions to fees must compel their clients to be charged twice for servicing – once to the newly assigned broker or agent of record, and again to the CFP professional – because there is typically no way for prior-sold products to terminate their existing servicing fee payments to the broker or agent of record.

And it’s important to recognize that in many cases, products with commission-based trails cannot be replaced in a manner that serves the clients’ best interests. In some cases, existing guarantees on old products are not available on new ones, life insurance rates rise as clients age, and changes in products often entail substantive tax consequences. Which means in practice, clients are often compelled to keep existing products, which will pay servicing trails to a broker or agent of record, and the only way the CFP professional can be paid is to double-charge the client – an advisory fee on top of the servicing fee already being paid – or be induced to make product changes against the client’s interests, just to hold out as a fee-only CFP professional.

The end result of the rules as currently proposed is that CFP professionals who genuinely wish to serve clients on a fee-only basis in the future are actually being induced by the CFP Board’s Proposed Standards to increase costs to clients and/or try to justify potentially questionable product replacements, because the reality is that there is no way to convert old existing products paying servicing trails into fee-only alternatives that don’t adversely impact the client’s tax situation or contractual product guarantees.

In other words, the proposed Standards of Professional Conduct actually induce churning for advisors who have no way to change products for clients that were implemented years or decades ago. The most significant conflict of interest is not the inducement to keep a commission, but the inducement to unnecessarily replace an old product for old clients just to hold out as a fee-only CFP professional to new clients! This is a highly anti-consumer policy that fails to recognize the realities of existing products for existing clients being serviced by advisors who are truly committed to serve clients on a fee-only basis in the future, and truly only receive fee-appropriate compensation going forward, including fees from new clients, albeit with servicing fees (in the form of below-advisory-fee-market-rate commission trails).

Simply put, the easiest path forward for commission-based advisors is already to simply keep their commissions. The necessary change is a pathway to fee-only that allows CFP professionals to serve their existing clients without an inappropriate inducement to replace existing products or add duplicative layers of servicing fees.

Key Point: Until existing commission-based products can actually be converted into bona fide fee-based products without causing adverse tax consequences or forfeiting existing contractual guarantees for clients, the Standards of Professional Conduct should recognize the distinction between actual upfront commissions, and trailing servicing fees (that happen to be in the form of “commission” trails), especially when the reality is that trailing commissions for servicing fees are only an ongoing AUM charge – akin to an AUM fee – and are typically lower than what clients would be compelled to pay under a traditional fee-only relationship anyway!

Refining The TAMP Exclusion For Non-Sales-Related Compensation

One issue with the refinement to the definition of sales-related compensation – which renders CFP professionals ineligible to hold out as fee-only – in the originally proposed new Standards was that advisors who choose to outsource investment management could be deemed to receive sales-related compensation, even if they provided substantively identical services to firms that manage portfolios internally.

To address this, the Commission on Standards added a “TAMP exclusion” that permits reasonable and customary fees for Professional Services to be collected by a TAMP and remitted to the CFP professional without being deemed sales-related compensation, as long as the compensation is not for referrals or solicitations.

As a further refinement to this structure, the Commission on Standards should consider more clearly delineating “sub-advisor” versus “third party asset management” TAMP arrangements. The difference is that with a sub-advisor relationship, the CFP professional retains responsibility to determine both the appropriateness of the portfolio recommendation, and to conduct due diligence on the performance and execution of the manager. While with a third-party asset manager, the client typically contracts directly with the TAMP, and the “servicing” advisor is more functionally akin to a solicitor (even if the arrangement isn’t always explicitly characterized this way).

To more clearly make this delineation, the “TAMP exclusion” should be further refined to either explicitly declare that it applies only to “sub-advisor” relationships (and not ones where the client contracts directly with the third-party asset manager who then compensates the advisor), or at least include a rebuttable presumption that when clients contract directly with the third-party asset manager (not in a sub-advisor relationship to the CFP professional) any compensation to the advisor will be sales-related compensation unless proven otherwise.

Key Point: Not all TAMP relationships are the same. Those where CFP professionals use a sub-advisor relationship are more akin to outsourced investment management, while advisors who service the client in parallel while the clients contracts directly with the third-party asset manager are more akin to solicitors. Consider either limiting the scope of the TAMP exclusion to sub-advisor relationships, or create a presumption that when clients contract directly with the TAMP, that any TAMP compensation to the advisor is sales-related (i.e., solicitor) compensation, unless proven otherwise.

Refined Definitions Of Fee-Only Make Fee-Based Moot

To curtail the emergence of “alternative” compensation definitions like “fee-based” – which emerged since the codification of fee-only versus commission-and-fee in the 2008 version of the Standards of Professional Conduct – the proposed Standards introduced a new provision that would explicitly bar the use of “fee-based” as a compensation disclosure to the extent that it (inappropriately) implies fee-only compensation.

However, as noted in my previous comment letter, to just ban the term “fee-based” simply invites the creation of new potentially misleading terms like “fee-oriented” or “fee-compensated” or “fee-for-service” that might still also include commissions. Instead, it was suggested to simply establish concrete categories of “fee-only” and “commission-and-fee” (and “commission-only”) for disclosure, instead of trying to engage in a “whack-a-mole” process of stamping out new terminology that may arise.

To address this, the revised standards still explicitly ban the term “fee-based” to imply fee-only, but expand the limitation to stipulate under Section 12(a)(ii)(b) that the CFP professional should not use the term fee-based “or any other term that is not fee-only” without also disclosing that the CFP professional earns commissions and fees and is not fee-only.

However, at the point that the revised proposal explicitly requires the CFP professional to either be fee-only, or to clearly state that the CFP professional earns commissions and fees and is not fee-only, then the compensation disclosures have already been reduced to simply requiring the two categories of “fee-only” or “commission and fee” (for which CFP professionals may obviously still provide supplemental explanations, but the upfront disclosure of either fee-only or commission-and-fee is already required).

In this context, the remainder of Section 12(a)(ii) is effectively redundant and moot. The ban on fee-based, or any other term, is irrelevant once the Standards of Professional Conduct already explicitly require one of only two disclosure categories – either fee-only, or commission and fee. If the Commission on Standards is willing to impose a requirement for either of these two categories (or possibly a third, “commission-only”), the proposed standards can and should be simplified, to simply state:

Section 12(a)(ii). Commission and Fee. CFP Board uses the term “commission and fee” to describe the compensation method of those who receive both fees and Sales-Related Compensation. A CFP professional who receives commission and fee compensation must:

1. Clearly state that either the CFP® professional earns fees and commissions, or the CFP® professional is not fee-only; and
2. Not use the term “fee-based” or any other term that is not fee-only in a manner that suggests the CFP® professional or the CFP® Professional’s Firm is fee-only if it is not.

The Commission on Standards might also consider adding a new Section 12(a)(iii) to formally define “Commission-Only” as a CFP professional who receives only sales-related compensation.

Key Point: The revised proposal for the Standards of Professional Conduct have already limited compensation disclosures to either fee-only, or commission-and-fee for those who use fee-based or other similar terms. In this context, it is a clearer and more robust standard to simply declare that the compensation categories are fee-only and commission-and-fee (perhaps also including commission-only), rather than defining commission-and-fee indirectly as a subset of “not-fee-based”.

Formalizing Accountability Under The CFP Board’s Standards of Professional Conduct

Ultimately, the CFP Board’s proposed Standards of Professional Conduct do represent a major step forward for CFP certificants, with the expansion of a fiduciary duty to not just CFP professionals providing financial planning or material elements of financial planning, but all CFP certificants by virtue of being a CFP professional and not just what they are doing.

Yet at the same time, lifting the CFP Board’s Standards of Professional Conduct is name is a moot point without the actual Accountability to follow through on enforcing those standards – and having clear guidance by which the CFP Board will enforce such standards evenly and consistently (and without a rulemaking-by-enforcement process).

Accordingly, it’s crucial to recognize that even as the revised proposal for the new Standards of Professional Conduct are a step forward, they introduce substantial new challenges to the CFP Board in its ability to actually enforce accountability. From a substantial reliance on undefined standards of “reasonableness” without a framework for issuing guidance, to the direction to “manage” conflicts of interest without the actual consumer protection substance of what that entails, and the establishment of two tiers of CFP professionals providing either financial planning advice or non-financial-planning advice (which in turn are subject to two different disclosure requirements, along with different Practice Standards) even as the CFP Board’s own public awareness campaign implies there is only one type of CFP professional “subject to the highest standard”, the CFP Board needs to be cautious not to issue proposed standards that it isn’t ready to – or doesn’t have the tools to – properly enforce to actually achieve its strategic priority of Accountability.

In addition, it’s crucial to recognize that at this point, the CFP Board’s enforcement mechanism of Accountability is purely reactive – in response to complaints filed by consumers or other CFP professionals – and the CFP Board doesn’t even have a mechanism to proactively examine 0.1% of its CFP professionals every year (even as the SEC is criticized for a “low” exam rate that is more than 100X that frequency).

All of which is to simply make the point that in pursuit of the strategic priority of Accountability, I sincerely hope that the CFP Board’s efforts don’t end here with the issuance of new Standards of Professional Conduct. Instead, if the CFP Board is genuine in its desire to bolster Accountability, it’s crucial to extend the new Standards into a framework for issuing Guidance, bolstering its investigative capabilities, and even considering an expansion into periodic examinations (not merely to enforce, but also to better understand potential problem areas for future guidance). Both because it’s important for the advancement of the financial planning profession, but also simply for the CFP Board to make good on the commitment of being made to the public in its own public awareness campaign.

In any event, thanks again to the CFP Board and the Commission on Standards for giving all of us as CFP professionals and stakeholders the opportunity to participate in this process. I hope that, in an effort to bolster its own Accountability to stakeholders, that the CFP Board will consider applying a similar process to future changes it makes to the other 3 E’s of Exam, Experience, and Education in the future as well!

Respectfully,
- Michael Kitces

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For CFP professionals (or members of the public!) who wish to submit their own comments, the official (second) public comment period closes this Friday, February 2^nd. There’s still time!

You can submit your feedback directly through the CFP Board website here, or by emailing [email protected]. Public comment feedback may be used to make final adjustments to the proposed Standards of Professional Conduct before the CFP Board’s Board of Directors votes to finalize them in March.

For those who want to read up on the further details, the CFP Board has provided a number of key documents, including:

Clean copy of the Revised Standards

Annotated version of the Revised Proposed Standards

Side-by-Side Comparison of the Current vs (latest) Revised Proposal for the Standards

Redline of the Initial Proposal versus the latest Revised Version of the Standards

You can also view my prior commentary about the proposed changes here, along with our summary of the latest revisions, as well as my original public comment letter.

So what do you think? Do you think the latest version of the CFP Board’s proposed Standards of Conduct are an improvement? Should there be a presumption that any CFP professional is providing financial planning? Please share your thoughts in the comments below!