More On Legal & Compliancefrom The Advisor's Professional Library
- Risk-Based Oversight of Investment Advisors Even if the SEC had a larger budget and more resources, it is doubtful that the Commission would have the resources to regularly examine all RIAs. Therefore, the SEC is likely to continue relying on risk-based oversight to fulfill its mission of protecting investors.
- Meeting and Exceeding Clients and Regulators’ Expectations Although it can be difficult, there are ways for RIAs to meet or exceed client expectations, increase customer satisfaction, and help firms retain current clients and attract new ones.
After a sudden resignation last fall, Alan Goldfarb, the former chairman of the Board of Directors of the CFP Board, has been found to have violated the CFP Board's Rules of Conduct.
The CFP Board said he failed to properly disclose his compensation, after he claimed on FPA's PlannerSearch that he was "fee-only" and later "salaried" when in reality a "related party" was eligible to receive commissions from Goldfarb's clients. As a result, the CFP Board's Ad Hoc Disciplinary and Ethics Commission that investigated the matter has issued a public Letter of Admonition for Goldfarb's conduct.
Yet the details of the case suggest that the matter was not as clear as the initially reported findings suggested; Goldfarb's ties to the "related" broker-dealer were through a parent accounting firm that owned both his RIA and the broker-dealer, and Goldfarb himself held only a small 1% equity interest in the firm and was otherwise not compensated.
Even NAPFA guidelines dictate that less-than-2% interests are de minimis, yet the CFP Board declared that because of these related interests Goldfarb should not have labeled himself as "fee only" even though all of his clients in reality only ever did in fact pay him fees through his own RIA.
At a higher level, though, the real issue in the Goldfarb case is that such a strict interpretation of what does and doesn't constitute "fee only" could cause even many large and well-known RIAs to "fail" the test, renders the definition of "salary" almost moot, and is a problematic reminder of how opaque the CFP Board's adjudication process can sometimes be due to its privacy obligations as a private entity.
In addition, taking such an extreme position regarding "fee only" will arguably result in so many financial planners being classified as receiving both commissions and fees — regardless of whether the commissions constitute 0.1% or 99.9% of total compensation — as to render the disclosure relatively useless as a consumer protection. Furthermore, the Goldfarb result also leaves us unclear about where to draw the lines on what constitutes "trivial" or immaterial compensation conflicts, related parties, overlapping ownership of holding company subsidiaries, and complex real-world arrangements that could unwittingly render advisors on the wrong side of the line.
In the end, a strict interpretation of the Goldfarb conclusions about what constitutes "salary" and "fee only" could mean that thousands of current CFP certificants are not complying properly with the rules, and that many need to update their information immediately! But perhaps ultimately, the best outcome for this whole situation is to hope that it can serve as a catalyst for better clarification on the rules for compensation, and an improvement in the transparency of CFP Board's enforcement process to allow clearer (and better?) precedents to be set for the future.
According to the CFP Board's Ad Hoc Disciplinary and Ethics Commission (formed to investigate the matter separate from the standard Disciplinary and Ethics Commission members to avoid any conflicts of interest, given Goldfarb's history and leadership with the organization), Goldfarb misrepresented his compensation by claiming he was "fee only," later revised (when his fee-only status was questioned) to a claim of compensation via "salary," when disclosing his method of compensation on FPA's PlannerSearch website.
At issue was the fact that the accounting firm that owned Goldfarb's RIA also owned a broker-dealer subsidiary, for which Goldfarb had some form of employment relationship and in which he also held an ownership interest. As a result, the CFP Board concluded that Goldfarb "and related parties" (i.e., Goldfarb's employer, the accounting firm, and his partial ownership of the broker-dealer) could potentially receive a commission related to Goldfarb's clients, and that as a result he was not "fee-only" as stated (and that because Goldfarb and/or his firm received fees paid by his clients, his compensation was not "salary," either). Given these conclusions, the CFP Board issued a public letter of admonition to Goldfarb for failing to properly disclose his compensation.
Of his own volition, Goldfarb has subsequently provided further detail regarding the nature of the arrangements at issue in the case, with several important distinctions, including:
— Goldfarb's financial interest was a mere 1% equity ownership in the accounting firm's broker-dealer and insurance agency subsidiaries, in exchange for Goldfarb serving nominally as president (as the only person in his firm with a securities principal's license) in a purely oversight function. He was not otherwise compensated for his role beyond his small ownership interest.
— All actual billing activity for Goldfarb's clients was done through Goldfarb's RIA, Weaver Wealth Management, and all clients were charged only hourly, project-based, or assets-under-management fees. At no point did any of Goldfarb's clients actually implement any products or solutions with the broker-dealer, nor did any of them ever actually pay any commissions at all.
— The relationships between Goldfarb and his RIA and these other businesses were fully disclosed in his Form ADV materials; they were not disclosed on the FPA website, due to the simple fact that the FPA's website had no space to allow further explanation of such details. But all clients received full disclosure of all these relationships before doing any business with Goldfarb.
Thus, from Goldfarb's perspective, he contends that because his broker-dealer relationship was minimal and non-compensating beyond a de minimis ownership stake, and that all of his clients only actually paid fees of various forms, that all of his other business relationships were disclosed in his firm's own materials, and/or that if the CFP Board intended to criticize his compensation disclosures even though no clients ever actually paid a commission for anything, that it should have been done with a private caution and not a form of public discipline.
Ultimately, what's really notable about the Goldfarb case is not just the facts and conclusion of the case itself, but the reasoning that the CFP Board used in coming to its conclusions, and the potentially broad and significant implications that it has for any/all other financial planning practitioners.
On the one hand, the CFP Board is taking a strong position that "fee-only" really means compensation must be fees ONLY, period, which seems entirely reasonable at face value given the language itself. However, the matter at hand is not simply a function of how the CFP Board interprets fee-only as it applies to an individual practitioner, but how it applies in the context of "related parties" to a financial planner and his/her employer(s) or other business(es), which the CFP Board appears to have construed rather broadly. The CFP Board states in key parts of the ruling:
- CFP Board’s definitions of “compensation” and “fee-only” prohibit a CFP® professional from referring to his or her practice as “fee-only” if any of the compensation received by the CFP® professional and any related party, such as the CFP® professional’s employer, is comprised of compensation other than the types of fees identified in CFP Board’s definition of “fee-only.” (emphasis original)
- Based on public regulatory filings and information received from Mr. Goldfarb, the Ad Hoc Commission determined that the RIA and the broker-dealer received or were entitled to receive compensation such as commissions and 12b-1 fees. (emphasis mine)
- The Ad Hoc Commission determined that Mr. Goldfarb misrepresented his compensation model as “fee-only” because he and/or his employer received or were entitled to receive compensation that did not come from clients exclusively in the form of fixed, flat, hourly, percentage or performance-based fees. (emphasis mine)
- The Ad Hoc Commission determined that when Mr. Goldfarb changed his compensation method from “fee-only” to “salary”, “salary” was not “an accurate and understandable description of the compensation arrangements being offered,” as is required by the Standards. The Ad Hoc Commission determined that Mr. Goldfarb’s clients paid commissions and/or fees and not a salary for services rendered by Mr. Goldfarb and/or his employer. (emphasis mine)
Nature of Employer Taints Fee-Only Status?
The reason these definitions matter is that, according to the CFP Board's conclusions in the Goldfarb case, every financial planner working at a hybrid RIA cannot claim to be fee-only, regardless of whether 100% of their clients pay 100% of compensation in fees (nor any advisor who works outright for a broker-dealer but operates his/her personal business on a fee-only basis anyway); the fact that the CFP professional's employer (which is or includes a broker-dealer) receives compensation other than fees would apparently be enough to taint the relationship, even if that bears no relationship to how the planner actually conducts his/her own business with his/her own clients.
And given that any employer having an interest in a broker-dealer (or other entity capable of paying a commission) invalidates the relationship, even those working for some large RIA fiduciary-centric firms could potentially be tainted given the breadth of this ruling.
For instance, HighTower Advisors (which is owned by HighTower Holding, which also owns HighTower Securities) cannot claim they are fee-only. Granted, I'm not aware of any information to suggest that clients of HighTower have ever actually paid a commission for any services, but apparently the fact that there is a broker-dealer-related party that is capable of receiving commission compensation is enough to render all Hightower advisors ineligible to claim they are fee-only (as was the case of Goldfarb)!
Similarly, Fiduciary Network is owned by Howard Milstein's Emigrant Bank, and Emigrant also owns Emigrant Funding Corp. and Emigrant Mortgage Co., which pay commissions (for mortgage and lending transactions); if these commission-paying subsidiaries of the holding company that also owns Fiduciary Network are "related parties" does that mean prominent Fiduciary Network partner firms (which include many well-known fee-only RIAs) are actually in violation of the CFP Board's compensation disclosure rules and potentially subject to public censure?
This seems a somewhat extreme conclusion, and I certainly don't mean to call out these firms for doing anything but trying to serve their clients' interests on a fee-only basis, nor do I believe any of these firms in practice are materially impacted by any conflict of associated in recommendations to clients due to the related parties of their parent companies. Yet it's truly not clear why all these firms aren't in violation of the CFP Board's compensation disclosure rules in light of the Goldfarb ruling about "related parties" and the treatment when an employer or a related party by common ownership is capable of and could be paid a commission, even if that particular advisor and/or his entire firm does not actually implement the product and receives no commissions whatsoever.
Ownership of Related Parties and de Minimis Interests?
Alternatively, perhaps a somewhat narrower interpretation of the CFP Board's ruling is that the connection of the broker-dealer subsidiary to Goldfarb's RIA (which was also a subsidiary of the same accounting firm parent) as a related party wasn't a problem; instead, maybe the problem was simply that Goldfarb himself had a 1% ownership interest in the broker-dealer. Yet this, too, seems to raise some concerns.
The CFP Board guidelines stipulate that compensation disclosure rules relate to "any non-trivial economic benefit" (emphasis mine) that a CFP professional (or related party) receives, but there's no clarity as to what "trivial" actually means.
Ironically, as Bob Clark pointed out, even NAPFA's guidelines — arguably the paragon of strict fee-only interpretations — allows up to a 2% ownership interest in an outside financial services industry firm that generates profit from commission compensation before it's deemed material (assuming the advisor otherwise is compensated purely by fees from their own clients)! Yet in the CFP Board's case, even Goldfarb's 1% noncompensating interest was sufficient to be deemed non-trivial?
Goldfarb's 1% interest would entitle him to a whopping $2 of compensation for the $200 of profit for the $5,000 commission for the $100,000 investment. Are we really going to suggest that this "Goldfarb $2" is a material conflict of interest worthy of public admonition for inadequate disclosure (especially when, ultimately, the relationship was disclosed on Goldfarb's Form ADV Part II anyway?)? And given that Goldfarb never actually implemented any commissionable product with a client in this matter!
Overall, Financial Planning magazine reported that Goldfarb's total income from the broker-dealer on a K-1 was less than $2,000, while his total compensation was more than $200,000 from his fee-only business. At that level, Goldfarb could simply take one year of his salary and invest it into an ETF of broker-dealer publicly-traded stocks and receive a dividend larger than his alleged conflicted compensation arrangement! Surely we're not going to allege that owning the publicly traded stock of a broker-dealer that generates a few thousand dollars of stock dividends is a conflict of interest when the advisor otherwise does not do any commissioned business with that (or any other) broker-dealer, or that would even render large holdings in the S&P 500 to invalidate a fee-only advisor!
So where is the line for calling ownership of a privately owned broker-dealer negligible as well? And why isn't the fact that Goldfarb never actually referred clients to the broker-dealer, intended to refer clients to the broker-dealer, or held out that he could/would refer clients to the broker-dealer, germane to the conclusion? At what point can we acknowledge the parties really weren't all that related beyond a common owner with a negligible ownership interest?
Interpreting fee-only as fee ONLY is one thing, but if even NAPFA can acknowledge that there is limits on materiality and when a potential conflict is truly trivial, where is the CFP Board's line if not in a scenario like this? Frankly, it would seem to me that there are fee-only advisors who have "informal" cross-referral relationships with commission-based advisors, with a "you scratch my back with clients and I'll scratch yours" relationship that probably represent a greater conflict of interest than the facts and circumstances set forth here!
In the second part of the post, we’ll examine what’s needed from here.