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Paying Cash For Client Referrals: The Patchwork Of State & Federal Solicitor Rules

May 27, 2019 07:08 am 10 Comments CATEGORY: Regulation & Compliance

With the increasingly competitive environment to attract new clients – especially those with sizable portfolios available to manage – more and more advisory firms are beginning to spend money on their business development efforts. Either to engage in outbound marketing and advertising, to run “client appreciation events” that encourage existing clients to bring a friend to refer, developing relationships with centers of influence who can provide referrals… or just outright paying for referrals with upfront cash or ongoing revenue-sharing agreements.

The challenge, however, is that paying for referrals can potentially work too well – creating a conflict of interest for the referrer themselves, that may cause them to recommend the advisor regardless of how appropriate the fit is for the person being referred, or even the quality (or lack thereof) of the advisor themselves. Accordingly, the SEC instituted Rule 206(4)-3, which places relatively stringent regulatory requirements on solicitor relationships, from the disclosures that must be provided to potential clients, and the fact that solicitors themselves often must become "registered persons" as well.

In this guest post, compliance attorney Chris Stanley provides an in-depth look at the evolution of the SEC’s Solicitor Rule, the exact requirements for someone to qualify as a solicitor, what must be disclosed to prospective clients (and when, and how) when there is a solicitor arrangement, and the patchwork of state rules for determining when the solicitor themselves must also become registered as an Investment Adviser Representative (IAR).

The starting point is simply to understand that the Solicitor Rule may apply anytime someone is paid for a referral and applies even if the person being referred doesn’t actually become a client (i.e., is only ever a prospect). In order to be a referrer, the individual must not already have a problematic regulatory history (e.g., no felonies or misdemeanors involving investments), and the arrangement itself must be commemorated into a written agreement (though the exact requirements vary depending on whether the solicitor is only for a newsletter or other “impersonal” advisory service, is an “in-house” solicitor of the firm, or is a third-party solicitor). In the case of third-party solicitors, in particular, substantial disclosure requirements also apply, in addition to providing the RIA’s Form ADV Part 2, at the time the solicitation occurs.

In the meantime, most states will also require that the solicitor themselves become registered as an IAR, potentially necessitating a Series 65 exam, though notably, even for SEC-registered investment advisers, it’s ultimately a state determination of whether the solicitor must become registered. Which means even for the same RIA, solicitors in some states may have to be registered, while solicitors in other states do not. The rules also sometimes vary depending on the type of solicitor, and some other professionals – e.g., attorneys and accountants – may have additional requirements (or prohibitions) for soliciting based on their own professional standards of conduct as well. In addition, state-registered investment advisers must also look to their individual states for guidance, as the entire framework of the Solicitor Rule 206(4)-3 itself is a federal rule for SEC RIAs, and doesn’t actually apply to state RIAs that must follow their own state’s rules instead.

Of course, the caveat to this all is that revenue-sharing agreements for referrals can actually be a very “expensive” way to market for new clients in the first place. Nonetheless, for those who want to engage in the practice, it is permitted for RIAs to pay solicitors to refer clients… but there are a number of specific rules that apply and additional disclosures that must be provided. And with a recent SEC Risk Alert highlighting the SEC’s concern that RIAs are not fully complying with the disclosure requirements, in particular, it’s especially important for firms that are using (or are considering the use of) solicitors to comply with the rules.

Weekend Reading for Financial Planners (May 25-26)

May 24, 2019 03:11 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with a slew of major industry news, including details of the SECURE Act that just passed the House and may implement a number of significant changes to retirement accounts (including an increase in the RMD age to 72 and the elimination of stretch IRAs), an updated agenda from the SEC stating that it will release an updated version of Regulation Best Interest for a vote of the SEC Commissions in two weeks, and an announcement that the Department of Labor is working on its own re-proposed fiduciary rule that will be out later this year as well (likely after the SEC's rule is finalized so the DoL can make its own fiduciary rule conform to it).

Also in the news this week is the revelation that Vanguard is looking to build out an RIA custody platform on the back of its internally-successful Personal Advisor Services platform to compete with Schwab, Fidelity, TD Ameritrade, and Pershing, and the announcement that LPL has bought a small employee-model broker-dealer called Allan & Company that is viewed as a major shift from LPL to get into the captive-employee broker-dealer model alongside its existing independent model (akin to Ameriprise and Raymond James, and anticipated as a pathway both to attract employee-style wirehouse advisors and potentially to even acquire and roll up other smaller employee-style broker-dealers).

From there, we have several investment-related articles, from the SEC's approval (finally!?) of the first non-transparent actively-managed ETF (that may lead to a huge wave of other asset managers offering active ETFs in the coming year), to some of the emerging risks of "free" no-fee ETFs, how "core" bond holdings are actually not very effective diversifiers of traditional stock portfolios (and why government bonds, even at today's low interest rates, are better), and a look at the looming rise of "Direct Indexing" as the next big thing that could disintermediate ETFs (and as ETFs continue to disrupt mutual funds).

We wrap up with three interesting articles, all around the theme of ongoing industry and regulatory change: the first looks at how, even as regulators continue to propose fiduciary rules that drive the industry towards fee-based accounts, there is concern that some investors may be getting shifted to fee-based accounts with ongoing AUM fees when, as buy-and-hold investors, they would be better served to simply remain in traditional commission-based brokerage accounts (and pay nothing since they're not trading anyway); the second looks at some of the research on conflicts of interest being discussed in Australia as regulators there consider the next steps to expand the fiduciary duty of Australian advisors; and the last looks at the looming choice coming for CFP professionals at broker-dealers, who will become subject a CFP-Board-based fiduciary duty on October 1st that not all broker-dealers may be willing to tolerate, and raising the question of whether an industry recruiting battle will be ignited if certain broker-dealers ban their advisors from using the CFP marks after October 1st, where suddenly CFP certificants at those firms will have to agree to either drop the marks they worked so hard to earn and stick with the broker-dealer, or instead simply drop their current broker-dealer and switch to alternative platforms who recruit them with the promise of being more supportive of financial planning and letting them keep their CFP certification.

Enjoy the "light" reading!

Kitces & Carl Ep 8: What Would You Do With Your Time If You COULD Be More Productive As A Financial Advisor?

May 23, 2019 07:03 am 4 Comments CATEGORY: Kitces & Carl Podcast Personal/Career Development

Last fall, Kitces Research published its first study measuring how financial advisors actually spend their time. The analysis revealed that advisors in the aggregate work an average of about 43 hours per week… yet when we asked about the time they spend on all the various task that they have to accomplish during the week, the total came out to a whopping 52 hours, suggesting that perhaps we’re far more buried in our work than we realize. Yet that shouldn’t be terribly surprising, since humans tend to be notoriously bad about making aggregate estimates, like the amount of time we spend looking at our phones or the number of calories we take in on any given day.

In our eighth episode of “Kitces & Carl”, Michael Kitces and financial advisor communication guru Carl Richards sit down to discuss how financial advisors are spending their time, strategies that can help advisors focus more on what they’re best at… and what might be accomplished by increasing your business (and personal) efficiency in the first place.

For instance, despite being a business that’s all about serving clients, a deep dive into the data reveals that advisors actually only spend about 20% of the time meeting with clients. Which could mean that, despite all the great technology that’s come online in recent years, it hasn’t accomplished its most important task: to actually reduce the time we spend on all the other things that we do when we aren’t sitting across the desk from our clients. As in practice, beyond the 20%-time in client meetings, advisors still spend significant time on such activities as meeting prep and follow-up (30%), business development (20%), and investment management (11%)… with the remaining time being spent on operations, professional development, and various administrative duties.

Of course, there are some challenges around spending more than 20% of your time with clients (since we tend to reach our mental capacity once we’re serving somewhere between 100-150 clients in the first place, and clients will only meet “so many” times per year), there’s still an opportunity to get better at spending more time at the things that only we can do, and handing off the remaining responsibilities for those tasks that don’t need our unique expertise, to begin with. Because the reality is that the chances that we’re really good at all those “other” things that take up the majority of our time as advisors are about zero anyway! In fact, the data shows that when advisors have someone they can delegate tasks to (e.g., a paraplanner or associate advisor), they have (on average) 64% more clients and have 80% more take-home pay than advisors that don’t… simply due to the fact that they end out using the extra time to spend with more clients!

Ultimately, though, we do still need to ask ourselves, “to what end?” Do we really want to become so efficient and have so many clients that we can’t even remember who they are when we meet with them? Or instead, is perhaps the point of greater efficiency less about doing more stuff, and more about spending time on things that are important to us instead? In other words, we spend so much energy and time helping our clients find their “why” and focus on what matters most to them… so maybe we should do the same for ourselves, too.

And so, the question becomes: if you’re spending 20% of your time as an advisor serving your clients, what would you do if you could free up more of the other 80%?

Navigating The Social Security Earnings Test When Only One Spouse Is Retired

May 22, 2019 07:02 am 8 Comments CATEGORY: Retirement Planning

The decision of when to begin taking Social Security benefits is one of the most important questions for many retirees. Unfortunately, thanks to the maze of Social Security rules individuals must navigate, it is often also one of the most complex. And while many retirees are aware that claiming Social Security benefits “early” can lead to a reduced benefit, research has shown that fewer individuals understand the Earnings Test rules that can also impact benefits when a young (pre-Full-Retirement Age) worker decides to claim benefits while also still working.

Under the Earnings Test rules, if an individual is under their Full Retirement Age for all of 2019, then Social Security will withhold $1 of benefits for every $2 of earnings over the annual $17,640 limit. Similarly, if an individual reaches their Full Retirement Age in 2019, then the annual Earnings Limit threshold is increased to $46,920, and Social Security will withhold “only” $1 of benefits for every $3 of earnings over that amount. And notably, only earnings attributable to work performed before an individual reaches their Full Retirement Age counts toward that total.

When benefits are withheld due to the Earnings Test, the Social Security Administration will withhold such benefits starting at the beginning of each year (or immediately when benefits begin midyear) and continue to not pay benefits every month until the full amount has been withheld. Furthermore, Social Security does not pay partial benefits for any month, so for those impacted by the Earnings Test, no benefits are paid until a full month’s Social Security check can be paid.

Individuals who retire midyear often benefit from special “Grace Year” rules, which apply in the first year in which an individual is entitled to a Social Security benefit and earns less than the “monthly limit” in at least one month. Under these rules, an individual is entitled to receive an unreduced-by-the-Earnings-Test benefit for any month in which they did not earn more than the monthly limit. The monthly limit is 1/12 the annual limit.

Notably though, while the Earnings Limit can reduce (or even eliminate entirely) a pre-Full-Retirement-Age worker’s monthly benefit, no similar restrictions apply to other types of income. Thus, a young Social Security recipient can have substantial retirement distributions, portfolio income, and/or other non-earned-income without having any benefits withheld due to the Earnings Test.

It’s also important to note that the Earnings Test impacts different types of Social Security benefits differently. An individual’s retirement benefit or survivor’s benefit, for instance, is only impacted by the Earnings Test based on that individual’s own earnings. By contrast, spousal benefits can be “hit” with the Earnings Test if either the spouse receiving the benefit is young and working, or if the spouse on whose earnings record the benefit is being paid is young and working!

Thankfully though, benefits “lost” to the Earnings Test aren’t generally lost forever. Instead, when an individual reaches Full Retirement Age, the Social Security Administration will recalculate the individual’s Earnings-Test-reduced-benefit, reducing the actuarial reduction for claiming early by the number of months in which no benefits were received due to the Earnings Test.

There are, however, some situations in which benefits withheld by the Earnings Test truly are lost forever. Such scenarios include situations in which a Social Security recipient does not live long enough to reap the benefits of an actuarial reduction, and those where an individual who is already past their Full Retirement Age is eligible for spousal benefits, but has spousal benefits withheld due to a younger working spouse’s earnings.

#FASuccess Ep 125: The Upside Opportunity Of Finding Out Your Advisory Firm Is Being Sold, with Sabrina Lowell

May 21, 2019 07:09 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Welcome back to the 125th episode of Financial Advisor Success Podcast!

My guest on today's podcast is Sabrina Lowell. Sabrina is an advisor and principal with Private Ocean, an independent RIA in the San Francisco area that oversees $2.2 billion of assets under management for nearly 1,000 affluent clients.

What's unique about Sabrina, though, is the path that she took to becoming a partner with Private Ocean, when it was decided last year that the firm she had worked at for the preceding 16 years was going to be sold to an external buyer, and they began the collaborative process of trying to identify what buyer would both be ready and willing to buy out the firm's original founder and give Sabrina and other next-generation leaders at the firm an opportunity to move up and grow in the new firm.

In this episode, we talk in depth about what the process was like of putting Sabrina's prior firm, Mosaic Financial Partners, up for sale. How their management team worked with an investment banker not only to find potential buyers who could afford the acquisition, but who would also be a cultural fit for the firm. The key filters that the firm used to vet its prospective buyers beyond just what buyers were willing to offer financially, including their core values alignment, their compensation philosophy with clients, their investment and financial planning philosophies in serving clients, and the career growth opportunities for staff. And what it's like to actually try to vet a potential buyer to figure out if they're really a good fit or if the firm is just making the mistake of thinking the grass must be greener on the other side.

We also talk about the challenges of trying to execute internal succession plans and why Mosaic ultimately decided to go with an external buyer instead. How Sabrina broke the news to her clients that a transition was going to happen, the way her own role has restructured in a positive way once she had the opportunity to work in a larger firm that had more dedicated resources so she didn't have to wear as many hats, and why next-generation advisors sometimes can find more upside opportunity in having their firm sold to a larger one than becoming the successor themselves.

And be certain to listen to the end, where Sabrina talks about her own challenges in evolution and learning to do business development when she started out as an employee advisor in her early 20s. The structured center of influence strategy her firm uses to cultivate referral relationships that she learned through the Schwab Executive Leadership Program, how her own career path and even what she thought she wanted from her career has changed over time, and Sabrina's key tip for finding out whether a potential advisory firm is really open to adapting and changing as the business grows.

Growing An Advisory Firm’s Org(anization) Chart As The Advisory Firm Grows

May 20, 2019 07:05 am 0 Comments CATEGORY: Practice Management

One of the fundamental challenges in growing an advisory firm beyond just the founder (and a handful of people to support him/her) is that a growing number of employees necessitates a greater amount of organizational infrastructure to support the people. From a human resources person (or eventually team) to the emergence of mid-level management, and the eventual erosion of decision-making efficiency as more partners/owners are introduced… it’s not uncommon for advisory firms that are growing to suddenly lose momentum, precisely because their growth causes the current structure of their organizational chart to break down and lose its effectiveness.

In this guest post, practice management guru Philip Palaveev of The Ensemble Practice shares his perspective on how, exactly, an advisory firm’s “org chart” should change an evolve as the business grows. Because the reality is that when it comes to advisory firms, one size does not fit all when it comes to the proper structure of an org chart… not just because different advisory firms have a different focus and style, but because the needs of the organization itself will vary depending on whether there are 10, 25, or 50+ employees.

The starting point of a formal organizational chart structure typically emerges by the 10^th employee, when it’s not enough to just have “people” who accomplish various roles in the business. Instead, formal (and increasingly specialized) roles begin to emerge in the firm, and the firm begins to set forth “positions” (that certain people may fill), rather than just gather together a growing number of people.

By 15+ employee, the growing specialization of positions within the firm begins to form departments, where multiple employees who share in a certain functional role within the firm (e.g., the investment team, the operations team, the advisory team) begin to form into groups, with multiple tiers of positions within the department that begin to create the future career tracks within the firm.

With continued growth past 25 employees, the advisory firm becomes so large and complex that there is typically a need for “full-time” management of the firm (e.g., a Chief Operating Officer), beyond just having founders who wear the hat of owner, leader, and advisor with clients. In fact, by 25+ employees, it’s not uncommon for ownership and management to begin to separate altogether, as not all partners necessarily can (or need to) have a role in the actual management of employees.

By the 40-employee headcount, the founders are often so distant from the end-employees and the meetings they’re having (both internally, and with clients), that true "culture" begins to emerge… a standardized set of norms that define what typically occurs in the firm even when no one is watching. Which in turn necessitates a growing focus on defining what the firm’s formal culture is… because it’s simply not possible for the founders to fully manage (or have much interaction at all) with everyone in the org chart.

And as advisory firms cross the 50-employee threshold, the size of the firm often mandates a “representative governance” model, as the firm often introduces enough owners/partners that it’s not even effective to give every partner a “seat at the table” anymore. Instead, a Board of Directors tends to form, and decisions are made by the Board and the firm’s management team, which the partners represented by certain members of the Board (but without the direct involvement of them all).

The key point, though, is simply to recognize that advisory firms tend to go through consistent challenges as their employee headcount and “org chart” reach a certain size and complexity thresholds… which, notably, are based not primarily on revenue, but actually on the number of people in the org chart (who must be connected to each other and managed). For which, hopefully, this article will serve as a helpful guide about how advisory firms who are “stuck” on how best to design (or restructure) their own Org Chart can move on to the next level.