From the October 2003 issue of Investment Advisor • Subscribe!

Shades of Gray

Planners are bedeviled with ethical issues, and ethics-challenged clients, all the time. How do they handle these thorny issues?

Once upon a time, the staff at a local United Way office realized that it had never received a donation from the town's most successful doctor. "Our research shows that out of a yearly income of at least $500,000, you give not a penny to charity," a staff member told him. "Wouldn't you like to give back to the community?" "Did your research also show that my mother is seriously ill and has medical bills of several times her annual income?" the doctor shot back angrily. "Or that my brother, a disabled veteran, is blind and confined to a wheelchair?" Stricken, the charity worker tried to stammer an apology, but was cut off as the doctor charged on. "Did your research also show that my brother-in-law died in a traffic accident," he cried, "leaving my sister penniless with three children?" Again, the charity worker tried to apologize. "I had no idea ..." A final time, the doctor cut her off. "So if I don't give any money to my own family," he bellowed, "why should I give any to you?"

In most situations, it's not too hard to divine the ethical choice at home or work: give to charity, care for our families, obey the law. Ethical decisions in an advisor's workplace are also often clear-cut:

Treat your clients fairly, be honest, quit ogling that intern, and don't cheat or steal.

Yet many issues that advisors face don't have black-and-white answers. Instead of having a little devil with a pitchfork whispering into one ear and a little angel whispering into the other, planners sometimes find themselves with an array of seemingly defensible options propounded by a host of respectable-looking consultant elves attired in sixteen shades of gray.

And, let's be honest, there are unethical people in the world of finance, and there are even (gasp!) unethical financial planners. Consider the most recent investigation by New York Attorney General Elliot Spitzer regarding mutual fund companies and market timers; consider the number of CFPs who lose their right to the CFP mark because they transgressed legal and ethical bounds.

Make no mistake: The gray-area guys have a lot to whisper about. For starters, there are the clients who want you to manage a pot of money and keep it a secret from their spouses, the clients who want you to help them transfer assets in order to gain Medicaid eligibility, and the clients who want you to help them disinherit one of their children. There are also the clients who want you to ignore the fact that they cheated on their taxes, are paying their child's nanny under the table, or regularly employ shady employment practices in their businesses. These are not the kinds of issues that can be solved by pasting your firm's well-worded commitment to ethics to your forehead and proclaiming how fair you are. Indeed, many fee-only advisors may be surprised to find that they face a whole slew of ethical dilemmas; fee-only is not a free pass into the never-never land of moral perfection. Forget fee disclosure arguments for a minute; this is about the truly complicated, puzzling issues where even a good, upstanding planner trying to do the right thing may have to stop, scratch her head, and ponder how to proceed.

The CFP Board's code of ethics requires that its certificants base their actions on the principles of integrity, objectivity, competence, fairness, confidentiality, professionalism, and diligence. The FPA's code, since it's based on the CFP Board's, is virtually identical, and NAPFA's code adds only one item: full disclosure. NAPFA's fiduciary oath requires its members to "act in good faith and in the best interests of the client"--a phrase that many planners, NAPFA members or not, love to bandy about in reference to themselves.

But think about it: What happens when the client wants you to do something unethical, but arguably "in his best interests," on his behalf? Is there a point where your duty to put the client's interests first ends, and your duty to be an ethical person takes over? Or what if the client has done something illegal in the past? Should you confront him, report him, cajole him to change? And would reporting him be ratting on him, or being a good citizen?

Ernest Hemingway was on to something when he wrote, in his 1932 novel, Death in the Afternoon, "What is moral is what you feel good after, and what is immoral is what you feel bad after." But we figured our readers deserve a more thoughtful examination of the issue that includes consideration of these gray areas. So we asked a variety of planners to tell us how they would respond to five difficult ethical dilemmas.

ETHICAL DILEMMA #1:

Your client is a small-business owner, and he recently bragged to you that he saved himself some serious bucks by firing an employee just after she became pregnant. Hooray, he says, now he doesn't have to pay her while she's on maternity leave. How do you respond?

For Bonnie Hughes of A&H Financial Planning and Education in Rome, Georgia, the answer is easy: Boot him. Who wants to work with a guy like that? "The 'hooray' would have done it for me," she says. If he's willing to treat his employees like dirt, chances are that "he would eventually treat our relationship the same way at some point," she says. "That kind of callous attitude is not changeable through an advisory relationship."

Todd Black of Dogwood Capital Management in Cumming, Georgia, agrees that he, too, would tell the client to hit the road. "I work with honorable people," he says. "Someone who does this kind of thing is not my kind of people. We don't need to work together."

But Ken Frenke, of Kenneth Frenke & Co. in Arden, North Carolina, is willing to cut the client a bit more slack--at least for a while. Frenke says he would probably voice his own concerns, and "give him some time to rethink his actions." If a change of heart didn't ensue, however, "I would end the relationship if this remains a pattern of thinking."

As for talking to the client about the legality of his action, you have to be very, very careful, warns Nigel Taylor, of Taylor & Associates in Santa Monica, California. Unless you're a lawyer, you must not say anything that could be construed as practicing law without a license, he says. "When you apply the law to a specific [situation] and conclude that what someone has done is or is not illegal, that is the practice of law, and we as advisors should not be offering solid legal opinions," he says. "We should not be telling the client, 'That was illegal' or 'you shouldn't have done that.' There's only one thing to say [to the client in these situations], and that's, 'Get a lawyer.'"

"I'm not an employment lawyer, and although I can guess that this is illegal, I shouldn't be giving advice about it," concurs Bob Glovsky of Mintz Levin Financial Advisors in Boston. "My role is to say, 'Look, you could potentially have some serious problems here. Why don't you get to an employment lawyer, and we can make sure you've got that 'T' crossed."

A strong dose of diffidence can often help the advisor walk the line between guiding the client and actually providing legal advice, notes Phyllis Ernst, an advisor with Paradigm Financial Advisors in Des Peres, Missouri. "In our practice, we are very careful not to say 'This is illegal' or 'That is against the law.' We say 'It may be considered illegal' and 'You may want to think about thus-and-so' and 'It's possible, so please contact your attorney,' so as not to be actually practicing law."

To rectify the situation, Ernst says she'd also try speaking the greedy client's language, pointing out to the client that if he were to be sued by the fired employee, the lawsuit--not to mention the accompanying negative publicity--would hurt his business financially and damage its reputation: Becoming known around town as "that guy who fired the nice lady with the baby" won't exactly make the business owner Mr. Popularity at the local Rotary Club, or bring customers to his business in droves. Beyond that, Ernst would also try some casual nudging: "I would inquire occasionally as to the status of the situation, in an attempt to help him realize that he should correct his illegal action."

As a lawyer and a planner, Ken Robinson of Practical Financial Planning in Cleveland says that he's obligated as an attorney to "counsel his client against breaking the law, and keep the client's confidences and secrets." Thus, his response would be to tell the client he was breaking the law, note his advice in writing, and leave it at that. "It's a lawyer's answer," he says, "but it's what I'd do."

As a non-lawyer, planner John McFarland of Midlothian, Virginia, says he'd make sure the client understood that his secrets weren't entirely safe with him; while the planner would honor the CFP Code of Ethics' rules about confidentiality, every planner's pledge of confidentiality "disappears the minute a court becomes involved," says McFarland. Since non-lawyers have no equivalent of attorney-client privilege, it would only take one subpoena for McFarland to have to spill the beans about his slimy client in court.

ETHICAL DILEMMA #2

Your clients, an aging parent and an adult child, want you to help them transfer or "spend down" assets so that the parent can become eligible for Medicaid. Their proposed plan will not technically violate any laws relating to lookback periods, etc.; it will shelter the adult child's inheritance and allow the parents to have their long-term care paid for by Medicaid. Should you, as an ethical planner, help them achieve this plan?

First, a little background. In 1997, Congress passed a law making it a crime to advise others about how to transfer or spend down assets in order to gain Medicaid eligibility. The following year, then-Attorney General Janet Reno stated that the law violated the right to free speech and would not be enforced. Today, most advisors agree that what is called "Medicaid planning" is at least technically legal, provided that the client complies with applicable laws, such as those governing eligibility lookback periods. For instance, there's a three-year lookback period for the transfer of most assets, which means that Mrs. Jones cannot give away $47 million today and become eligible tomorrow; she must give it away at least three years prior to the day she wishes to become eligible.

Second, a caveat: The aforementioned cautions about not practicing law without a license also apply, in many states, to Medicaid planning advice. In Texas, for instance, it is a Class A misdemeanor for a non-attorney planner to advise a client for a fee about Medicaid planning, warns Clyde Farrell, an attorney and planner in Austin, Texas. Non-attorney planners would do well to find out what is legal in their own states before talking about Medicaid planning with clients at all. Another alternative is to refer the client to an attorney, and then ask the attorney to farm out the financial analysis of the situation to you.

The Medicaid Debate

The argument against Medicaid planning is hard to dispute: Medicaid is a government welfare program designed to help the poor, and if you're not poor, you shouldn't get Medicaid. Right? "Most people would not think of hiding assets in order to secure welfare payments or food stamps, yet they somehow do not find it wrong to do the same thing to have public monies pay for their nursing home care," writes Catherine May, executive director of Elder Services of Berkshire County in Pittsfield, Massachusetts, in her organization's online newsletter. "Why is it that people who have accepted the responsibility for their own health care costs throughout a long life, either out of pocket or through health insurance, upon contemplating the costs of long-term care decide that it is time to quit being responsible and self-sufficient, and time to let taxpayers pay for their nursing home care?"

What's more, Medicaid funds aren't a bottomless resource. If you transfer your assets and make yourself "look poor" in order to qualify, what you're actually doing is taking away resources intended for the truly poor--kind of like cutting in line at a soup kitchen when you still have a fridge full of steaks at home.

Ah, but I want to give some of those steaks to my children for their inheritance, says the client. As long as I give them away at least three years before I get in line for Medicaid benefits, it's legal, right? And aren't you, as my advisor, supposed to be putting my interests first?

It's a sticky issue, says Dr. Somnath Basu, director of the financial planning program at California Lutheran University in Thousand Oaks, California. Basu says he can understand the advisor's argument that he must do everything within the law to benefit his client. But it's still fraud, he says, because you're still taking money intended for poor people, and you're not legitimately poor. He says he wouldn't be comfortable doing Medicaid planning for himself: "I would want to give my children the values and the education so that they could stand on their own feet instead," he says. But in dealing with clients, should he put his responsibility to his clients' interests above his conscience? It's a slippery slope, he says. "You're drawing a line in a gray area, and the danger is: If I'm going to help someone perpetuate a fraud to benefit him, then what's to stop me from doing one to benefit myself?" he says. "And then if I'm okay with that, then what [philosophically speaking] is stopping me from committing other frauds, too?"

But other planners are less certain about the directions to the high road. "If you as an advisor strongly disagree [with the idea of Medicaid planning], your job is to point that out, and if it's intolerable to you, you need to walk away and just resign as their advisor," says Alan Goldfarb, a planner with Weaver and Tidwell in Dallas and a financial planning professor who teaches an ethics course at the University of Dallas. "And if it is tolerable, then your job is to point out all of the alternatives." "Maybe it's unfair for the citizens to bear the price," says Joel Weiner, of the Palatine, Illinois-based CFP training firm Professional Training Services, "but if it's legal, and it makes sense for my client, why wouldn't I want to do it?"

Goldfarb does point out the ethical implications of Medicaid planning to his clients and encourages clients to discuss them, but "in the end, it's up to the client," he says. In his mind, he says, Medicaid planning is a matter of positioning the client's assets to benefit that client, and as such is no different than arranging a doctor's finances to protect his assets from litigious patients, or arranging a family's assets to maximize their chances of receiving college financial aid. "Is [the latter] a fraud on the system that funds higher education?" he asks. Some might say yes, but Goldfarb says no--"and I see Medicaid planning along those same lines," he says. Goldfarb cites an old quotation about how politicians think about the next election, while statesmen think about the next generation. Given the choice between benefiting their own children and benefiting the next generation of Medicaid recipients (or the integrity of the Medicaid program), "most clients feel more strongly about their own families than they do about the U.S. government," he says.

As an attorney and planner, Farrell says his job is "to advise clients about the options that are legally available to them, and I think it would be highly unethical to substitute my judgment for that of my clients by telling them they shouldn't do something the law allows." When asked if he himself would ever transfer or spend down assets to qualify for Medicaid, however, he laughs lightly, then says, "My wife and I have purchased long-term care insurance, and I'm doing everything I can to avoid having to answer that question for myself and my family."

Interestingly, several planners we spoke to disagreed with the concept of Medicaid planning--not for the ethical "it's intended for poor people" reasons we anticipated, but simply because it's not good for the aging parent. Robert Barnhill, an advisor and adjunct professor of financial planning at Texas Tech University in Lubbock, Texas, teaches the students in his ethics course to first question whether it's the child or the parent who is pushing Medicaid planning. "If it's the child promoting it, then generally I say no," he says, because usually the child is promoting it because it will protect her inheritance, not because it will somehow benefit her parent.

As John Rossi, a planner and professor of financial planning at Moravian College in Bethlehem, Pennsylvania, puts it, "What it really comes down to is this: Should your plan be to preserve the assets, or should your plan be to get the best possible care for a loved one? I think your goal should be to get the best possible care. And to do that, you need to have your own financial resources [and not depend on Medicaid], because then you can decide where you want to go." Not all nursing homes smile upon Medicaid patients, and the more posh the facility, the less likely it is to accept Medicaid applicants at all.

Even worse, says Rossi, what's to prevent the government from slashing the Medicaid program as the aging population puts an increasing strain on its funds? "Do you trust the government to take care of you for the rest of your life?" says Rossi. "I don't!" To determine whether Medicaid planning is ethical, he argues, "You've got to say, 'What's the outcome? Is the person going to receive the same quality of care?' I think the answer is no, and I think that answers your ethical question."

Another concern, says Barnhill, is that the aging parent simply doesn't fully understand what she's being asked to do. "If the elderly client is sitting there asking about this, I say, 'Have you ever been to a Medicaid-supported nursing home? Have you ever seen what one looks like? And do you understand that you're going to have to make yourself poor?'" he says. "She's always had that little nest egg that was going to take care of her so she wouldn't have to move in with her kids, or become a burden, and could maintain her independence ... but you're taking that away, and you're taking it away more than three years out."

And what happens, asks Barnhill, if after waiting three years and reaching poverty level, the elderly parent feels fabulous and doesn't need a nursing home at all? Well, guess what--that nest egg is gone. "If the parent doesn't mind becoming poor, and doesn't mind not having any money after the three-year period whether or not she's in a nursing home, then fine, we'll do what you want, Mom," says Barnhill. "But often I don't feel that the aging parent really understands what's being recommended.

"It just doesn't seem right to impoverish the parent just so the kids get an inheritance," adds Barnhill. "Why not use Mom and Dad's money to support Mom and Dad?"

ETHICAL DILEMMA #3

A client wants you to manage a stash of money and keep it a secret from his wife. Both spouses are your clients. How do you respond?

Only one of the planners we spoke to indicated that she would manage the secret stash as requested, no questions asked. "Each person is my client, and I have clients who do keep money from one another for many reasons," says Linda Gadkowski, a Cape-Cod-based planner who teaches CFP Board ethics courses. "The reason would be their reason, and as long as it broke no laws, I see nothing wrong with it."

For Ernst, however, the answer depends on whether the husband is planning to use the money to set up his mistress in a penthouse suite, or to take his wife to Tahiti. "Depending on the value involved and the reason for keeping it a secret--say, a surprise present or trip for his wife--I might consider maintaining secrecy for a short time," says Ernst. If no specific reason were given, however, she would encourage the client to tell his wife about the money, and would advise him that "the effective management of his finances depends upon open communication with both parties."

Perhaps fighting the urge to assume the worst about hubby's secret stash, Hughes says she would "encourage discussion between the spouses" about the possibility of each partner having a small account to spend as he or she wishes, "with the bulk of their assets [still] connected to mutual goals." Hughes would also document all such conversations in detail.

The key to this issue, say several planners, is that an advisor must act in the best interests of both spouses, and that's pretty hard to do when you're keeping pertinent secrets from one of them. "I would advise the client that I cannot act for one client in any way adverse to the other client, and that I owe his wife full disclosure," says Robinson. If urging the client to tell his wife about the money didn't work, Robinson would invite the client to fire him, document the conversation in writing, and recommend that the client contact a Certified Divorce Planner. (He would not, however, mail a record of the conversation to the clients' home.)

"My agreement clearly states that I represent both parties," says McFarland, "so I would have to give him a choice"--the client could either agree to tell his wife about the money at a joint meeting, or he could have McFarland fire him. Of course, the latter choice, as McFarland points out with a chuckle, would probably set off warning bells in the wife's head and arouse her suspicion, so she'd be likely to find out either way. "But it's all about choices," says McFarland. "I lead the horses to water, and they decide if they want to die of thirst."

While McFarland says he would be unlikely to represent one or both spouses should they choose to divorce, Glovsky argues that it is possible, and he's done it himself in several cases. As long as both spouses want to continue working with him as their advisor, there's little conflict, since he's not caught in the haggling over who gets what; he simply helps them invest what they're left with once the tug-of-war is over. "We're not in the middle of the divorce," says Glovsky. "We're saying, 'Okay, when you guys come back and tell us how the assets have been divided, we'll sit down with you and talk about how to invest them to meet your particular needs.'"

Still, advising fractious spouses isn't for everyone. "We have learned to distrust spouses who do not trust one another, and try to avoid working with them if issues can't be resolved," says Frenke. "Too much tension!"

ETHICAL DILEMMA #4

Your client has a full-time, live-in nanny for his child, but pays the nanny under the table. When you ask him about this, he winks and says, "Well, you know how it is." How do you respond?

First of all, remember that the IRS won't be winking about any of this. If caught, your client could face penalties of up to $100,000 and could even go to jail, says Tim Harmes, an IRS spokesman. Given the seriousness of the consequences, it's important to make sure the client knows what he's up against, says Mark Berg of Timothy Financial Counsel in Wheaton, Illinois. After setting the record straight, Berg says that he would strongly encourage the client to correct his filing practices immediately.

Beyond the risk to himself, the client should also be made to understand that his actions are also hurting his employee. "Not only is he defrauding the IRS by not reporting the wages on a W-2, he is preventing the household employee from becoming eligible for Social Security benefits in the future by not withholding and paying his share of the FICA tax," says Ernst. "The nanny would also not be eligible to collect unemployment benefits, because her employer had not paid federal and state unemployment taxes." After an initial conversation to lay out the rules and potential penalties, Ernst recommends inquiring periodically about the situation. After all, she says, "it is my function as an advisor to protect him from illegal actions."

Several planners suggest refusing to serve the client until he rectifies the situation, and firing him if he won't change his ways. It's also important, says Black, to document your advice to the client in writing.

And, as always with legal issues, remember to draw the line between stating what the law is (stating a fact) and applying the law to a specific situation (practicing law), admonishes Taylor. If you're unsure, it's best to tread carefully and involve a lawyer.

ETHICAL DILEMMA #5

Your elderly client is hell-bent on disinheriting one of her four children because she thinks he's an irresponsible jerk. Nothing you have said has dissuaded her. How do you respond?

While it's tempting to rush to the phone and call the children, you really shouldn't, says Glovsky. "If she's the client, and the kids aren't, it would be a breach of confidentiality" to discuss her affairs with them, he says. And even if the kids are your clients, you shouldn't share information between family members without asking just because they're family. "I wouldn't disclose between generations just as I wouldn't disclose between two clients just because they're best friends," he says. "If I thought it was an integral part of the planning process, I'd have to ask [the family members] first, 'Is this all right to share?' They'd have to bless it."

Yet there is one case where Ernst says she might notify someone else. "If we realize that the parent is not mentally capable any longer of making decisions, then someone else has to be involved," she says. In that case, however, she says her first phone call would be to the client's attorney, not to the children.

All of the planners we spoke to agree that, in the end, if the client wants to disinherit her son, she can disinherit her son. As Berg puts it, "An inheritance is not a right, it is a privilege." Adds Black, "It's her money. My job is to give her prudent advice, not dictate to whom her money goes when she dies."

But the client's ultimate control of the funds shouldn't keep advisors from trying to make their prudent advice sink in, planners say. You could suggest family counseling for the parent and child, says Robinson. You could point out that the slighted child has the right to sue, says Hughes. If you wanted to be passive-resistant, says McFarland, you could fail to mention using contract law to avoid probate; if the client uses a will, he notes, "the kids will have a chance to duke it out in probate court."

Perhaps the most persuasive arguments are those that address the long-term impact of the act on the family. "Of course it's their money to do with as they please, but we remind them that it's only money after all," says Frenke. "The risk of causing emotional problems for the child, regardless of age, could be much greater than the risk of 'wasting' the money you leave them." Frenke urges clients not to make such decisions in anger, and reminds them that there's usually some middle ground between leaving the child everything and leaving them nothing.

Disinheriting one child can poison the relationships among all of the children, not just the one who lost out on the family silver, says Marilyn Steinmetz of Money Matters in West Hartford, Connecticut. "It destroys a family forever--not a good legacy to leave behind," she says. Steinmetz recently had a client who wanted to shut one of her children out of her will, and Steinmetz, along with the client's husband and attorney, spent several months working to persuade the client to include the child. "I knew it was ultimately her decision, but I felt I needed to help her see the ramifications, the friction it would cause among her children for years on end," she says. "It wasn't just one child she was spiting; she was spiting them all by destroying the relationships between them."

These are just a few of the ethical dilemmas financial advisors face, and just as there are two sides to every story, there are at least two sides to most ethical quandaries. Few ethical questions are black and white, and it is up to advisors to come to their own conclusions, armed with their professional code of ethics and their own consciences.

Perhaps the best way for advisors to determine the ethical response in any situation is to treat every day as "Bring Your Child to Work Day." If you could comfortably explain to your child every decision you made during the workday, and wouldn't mind having her build her standards of playground ethics based on what she saw and heard in your office, you're probably all set. But if, instead, you think you'd hear yourself saying, "Well, honey, I don't really like to call it fraud, exactly," and "Gosh, Sweetpea, it's not really cheating, per se," maybe you should think about bringing Sweetpea to work tomorrow.

Reach Assistant Managing Editor Karen Hansen Weese at khansen@ia-mag.com.

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