More On Legal & Compliancefrom The Advisor's Professional Library
- Privacy Policies and Rules Whether an RIA is SEC or state-registered, the firm must have policies and procedures in effect to protect clients privacy. Policies and procedures should explicitly require an RIA to send out its privacy notice each year.
- Proxy Voting RIAs are not required to vote proxies on behalf of their clients. However, when an RIA does assume responsibility for voting proxies, the firm’s policies and procedures should help to ensure that votes are cast in the best interest of clients.
After a sudden resignation last fall, Alan Goldfarb, the former chairman of the board of directors of the CFP Board, had been found to have violated the CFP Board's Rules of Conduct.
The first part of our post explained the (extremely interesting) details of the case. We’ll now turn to a discussion of what needs to happen from here.
The last troubling issue from the CFP Board's ruling is the declaration that Goldfarb could not characterize his income as a salary because the client paid the firm with some combination of fees and/or commissions, and that accordingly Goldfarb should have characterized his compensation as fee-only, commission-only, or a blend, but not salary. Yet isn't this true for all planners? Salaries are paid by firms, not clients; is there ever such a thing as an advisor being paid a salary directly from a client, and not from an employing firm? How is that even possible?
Perhaps an employee of a firm that has no responsibilities for engaging with clients—i.e., in a purely administrative capacity—might be salaried (but then that person isn't working with clients!), or a full-time employee in a family office with a single client who really does engage the planner on a salary basis. Yet people in those positions won't be found on a "Find a Planner" website like FPA's PlannerSearch or the CFP Board's "Find A CFP Professional" because they are in a limited salary capacity and therefore wouldn't be soliciting clients in the first place!
So it would seem that by basing the compensation methodology off of what the client pays, the only three categories in the context of planners making themselves available to the public should ever be fee-only, commission-only, or a commission-and-fee blend? Yet if that's the case, why has the CFP Board even put forth a potential category of "salary" in its compensation disclosure rules and on its own Find A CFP Professional website, if it's not actually possible for a client to hire an advisor on that basis without at some point paying a fee, or a commission, or a combination of the two?
What We Need From Here
Ultimately, what Goldfarb's case illustrates is that if as an emerging profession we're going to go further down the road of compensation disclosure—which I'd certainly argue is a plus for consumers in the long run—that we need to craft some clearer lines and tests for what really constitutes non-trivial materiality in determining types of compensation for which disclosure (and consequences for failure to disclose) are necessary. Otherwise, not only is there ongoing risk of more advisors unwittingly finding themselves in error and subject to CFP Board sanctions, but beyond that it would appear that huge numbers of planners are already in non-compliance with the current rules.
Just run a search for CFP Professionals in your local city and then narrow the search to see how many advisors claim they're compensated by salaries when they clearly work at firms where clients pay fees (or commissions or both), or how many claim to be fee-only when they clearly work for an employer that is (or has a related) broker-dealer. Is the CFP Board really intending to sanction thousands of its own advisors across the country for running afoul of the rulings set forth in Goldfarb's case?
If not, how does the CFP Board intend to distinguish between why Goldfarb was sanctioned, but the dozen/hundreds/thousands of advisors labeled as "Fee-Only" yet outright employed by a broker-dealer are within the rules? Or is the reality simply that thousands of CFP certificants really are out of compliance with the CFP Board rules and need to change their compensation disclosures as soon as possible, to no longer be characterized as "salary" or "fee only" at all? (Note: The point here is not to say that advisors who have a non-fee-only employer can't operate their personal business as fee-only; instead, the point is to say that if advisors truly conduct their own client business on a fee-only basis, and hold themselves out as such, why isn't that acceptable?)
Similarly, where exactly is the line for materiality in outside ownership interests in non-fee entities? If Goldfarb's 1% non-compensating equity interest is still a conflict, even if none of his clients ever actually did any business with the entity, and his compensation for a particular client transaction might truly amount to no more than a dollar or two, then does that mean any/every advisor who owns any interest in a broker-dealer—even if it's just a stock that's part of the S&P 500—is running afoul of the rules? And how many other fee-only firms and RIAs would fail this test when rules regarding small overlapping equity interests, or parent companies that also hold commission-based subsidiaries, can be deemed "related parties?"
Does the Advice Consumer Benefit?
Moreover, is that really a positive for consumers to take these definitions to a degree of potential irrationality that even NAPFA doesn't believe is necessary? At some point, we're no longer simplifying the complexity with disclosure, but making relatively simple situations into complex ones, due to the lack of a clear line about what constitutes a "non-trivial economic benefit" associated with a potential commission.
In addition, while I absolutely applaud the principle that fee-only should really mean fees only, to lump every other advisor into the broad category of "fee and commission" seems to limit the effectiveness and relevance of compensation disclosures.
After all, in a world where someone can't be fee-only because of $1 of commissions, and cannot be commission-only because of $1 of fees (any AUM or financial planning fee?), then the overwhelming majority of CFP certificants will all fall into the same broad classification of fees and commissions.
Yet is it really helpful when an insurance agent who once offered an hour of advice for a fee falls into the same category as, well, Alan Goldfarb and his RIA firm that only ever charged clients fees but had a 1% ownership interest in a separate small broker-dealer? Are we really helping consumers understand the compensation of their advisors to put every advisor into the same giant bucket, regardless of whether their compensation is 99.9% fee, 99.9% commission, or anything in between?
A Proposal on Finer Gradations of Compensation
Perhaps it’s time for some finer gradations...at the least, to recognize "fees and commissions" versus "commissions and fees" depending on which forms the majority of the advisor's compensation, if not to simply standardize the breakdown of compensation on the website of a regulator or a third-party service like BrightScope with a pie chart that explains exactly what proportion (and type) of compensation comes from various sources.
A third concern is the fact that unfortunately, it's difficult to even judge the Goldfarb decision and associated punishment relative to the history of other CFP Board compensation infractions, due to the fact that the CFP Board's Disciplinary and Ethics Commission operates in a private environment, with only limited access to its history of disciplinary considerations through its Anonymous Case Histories database (plus any disciplinary actions where results are public), and even then only to the extent that the ruling or summary explains the facts and circumstances of the case.
If we're going to slice the rules of compensation disclosure in a finer and finer matter, with real-world outcomes from certificants bearing legal fees for their defense to the actual consequences of public censure, shouldn't CFP certificants have a substantive body of case history upon which they can rely in crafting their defense, and to which the Disciplinary and Ethics Commission should be reasonably bound as precedent until/unless the facts and circumstances materially differ?
Otherwise, the disciplinary process becomes a random and capricious experience for the certificant, whose punishment may vary depending upon the particular people who adjudicate the matter. (To be fair, the CFP Board has made some efforts to address this with the Anonymous Case Histories and last year's rollout of new Sanction Guidelines, though in retrospect some have suggested that the Sanction Guidelines may have been too narrow or inflexible to handle this matter.)
For those who are simply trying to act in a prudent manner in the first place, who's to know what's permissible or not until suddenly the complaint comes and it's time to defend? That was apparently the unfortunate reality for Goldfarb himself, despite his long history in advocating for and even helping to craft some of the rules which he was found to have violated.
While it is true that the CFP Board is a private entity and not a regulator, and consequently does face real world privacy law issues, surely there is some feasible and reasonable compromise; for instance, the CFP Board could write into its agreements that the decision to use the CFP certification includes permission to disclose further details in any disciplinary action that arises against the certificant, which at least ensures that future disciplinary actions will be open to the light of public scrutiny, and not operate in a black box environment like the oft-criticized FINRA arbitration panel.
Back to the Beginning: Did Goldfarb Deserve His Punishment?
As for the Goldfarb case itself, ultimately I have to admit that it's difficult to conclude that Goldfarb's case really deserved a public Letter of Admonition, especially since in practice his clients really did only ever pay fees to him and never paid any commissions to implement any products with the broker-dealer in which Goldfarb owned a mere 1% interest that was not a very material component of his compensation.
Goldfarb himself notes that in private conversations with former Disciplinary and Ethics Commission members, similar or more severe allegations had been dismissed in the past with a private warning and recommendation-to-fix but no public action. On the other hand, the reality is that Goldfarb did hold a very public position of leadership at the time of the allegation, and it's hard to fault the CFP Board for applying extra scrutiny to the situation. In fact, to maintain the impartiality of the disciplinary process, the CFP Board established an Ad Hoc Disciplinary Committee specifically to review Goldfarb's situation in the first place, which had the perhaps unfortunate side consequence for Goldfarb of putting on the case a group of adjudicators with limited experience and familiarity with evaluating such complex matters and the CFP Board's own prior history in ruling on such matters.
Nonetheless, as I wrote in the past, I think that overall the CFP Board's efforts to handle the process with extra diligence toward impartiality were right, that it's a sign of strength of the organization that it was willing to investigate its own leadership in such a public manner, and that I'm relieved to see the matter concluded in a public matter that maintains some transparency to the process and outcome... even if I'm struggling a bit with whether this particular adjudicated conclusion was right. In fact, the ruling set some incredibly troubling precedents, though there was no doubt extreme pressure on the Ad Hoc Committee to err on the side of a strict ruling and not look like it was protecting its own, especially without any clear public precedents because of the opacity of their own prior rulings!
On the other hand, I will admit that the somewhat unusual ruling itself continues another troubling precedent established last year when NAPFA Chair-Elect Ron Rhoades resigned just before taking his NAPFA leadership position due to a regulatory infraction where he failed to register as an advisor in Florida where he had some clients (even though the State of Florida shortly thereafter issued a letter of warning to Rhoades that acknowledged he had appropriately resolved the relatively minor infraction).
While I do agree with the principle that those in positions of leadership should be held to a higher standard, at the same time such an approach is only viable when there is a clear body of guidance about how to navigate those standards effectively in a world where complexity is a fact of life and mistakes do happen; otherwise, these ongoing problems may leave a chilling effect on the willingness of financial planners to take on what are ultimately positions of purely volunteer leadership that can having adverse business ramifications.
In the end, it still seems to me that the CFP Board made more good decisions than bad ones in this case, especially regarding the process it used, and particularly in the spirit of maintaining the integrity of the organization. Nonetheless, the process and its results also highlight that there are still some real gaps in the CFP Board's framework for functioning as an overseer of CFP certificants, and how to enforce on a fair and consistent basis. And the ruling may have unintentionally set some precedents about compensation disclosure that could be far, far more wide-reaching than just Goldfarb himself.
Hopefully, the CFP Board will take this as a real opportunity to evaluate its own disciplinary and enforcement process and figure out how to improve the transparency further in the future. I hope the CFP Board also seriously considers issuing a statement to further clarify its compensation rules and why Goldfarb's public Letter of Admonition should stand while every CFP professional who notes "salary" shouldn't be disciplined as well (along with every CFP professional who indicates "fee-only" but has an employer that is a broker-dealer or is a related party to one).
Alternatively, if the reality is that thousands of CFP certificants are not complying properly with the compensation disclosure rules regarding "fee-only" and "salary" definitions, I hope that with the CFP Board's latest guidance those professionals will update their compensation disclosures before it lands them in hot water, too!