Over the past year, a series of revelations about the CFP Board's compensation disclosure requirements have significantly shifted the landscape in how CFP certificants must explain their compensation to prospective and current clients. While the CFP Board maintains that "nothing has changed" since its rules were formally enacted more than five years ago, the fact that large numbers of advisors continued to find themselves out of compliance—with another potential shoe soon to drop—suggests that whether the organization admits it or not, the CFP Board has changed the rules of the game.
In fact, the CFP Board's current framework is so expansive in the compensation that must potentially be included that virtually all advisors in today's environment end up being in one broad bucket labeled "commission and fee." That bucket includes advisors for whom commissions account for only 1% of their income along with those who earn 99% of their income from commissions (despite the clear difference in actual business model). However, that bucket also includes "commission-only" advisors who earn 100% of their income from commissions because they work for a firm that "could" generate a fee. The rules also require advisors whose entire income comes from fees to declare themselves "commission and fee" if they "could" earn a commission as well. The end result: when nearly all advisors must use the same compensation disclosure label of "commission and fee" to define a wide range of actual compensation structures from 0% commissions to 100%, the very purpose of compensation disclosure begins to lose its meaning, value, and clarity for the public that the CFP Board purports to serve.
While the CFP Board maintains that it cannot "fix" or change its rules without a long, drawn-out rulemaking process, it has already changed its rules without such a process. In addition, the Board’s elimination of its "salary" compensation category just over six months ago makes it clear that when it comes to interpreting and adjusting its own definitions, the CFP Board does have latitude to fix its own mistakes. Yet, mysteriously, the CFP Board has yet to be held accountable for the problematic definitions it is now using.
With CFP certificant stakeholders reporting behind the scenes that they are afraid to speak out for fear of retribution (justified or not), and the FPA and NAPFA apparently abdicating their advocacy roles on behalf of members to take a back seat to the CFP Board, it remains unclear what will finally push the issue. Will someone have to file complaints against 1,000 CFP certificants in violation of the CFP Board's own problematic rules, effectively throwing those CFP certificants under the bus, just to force the CFP Board to pay attention? Will its Board of Directors finally take a more active accountability role to intervene and preserve the enforcement integrity of the organization?
Compensation Disclosure Requirements for CFP Certificants
Under the CFP Board's Rules Of Conduct, CFP certificants are required to disclose compensation to prospective and current clients. The key rules include that the certificant shall provide/disclose:
Rule 1.2(b): Compensation that any party to the agreement or any legal affiliate to a party to the agreement will or could receive under the terms of the agreement; and factors or terms that determine costs, how decisions benefit the certificant and the relative benefit to the certificant.
Rule 2.2(a): An accurate and understandable description of the compensation arrangements being offered. This description must include:
Information related to costs and compensation to the certificant and/or the certificant’s employer, and
Terms under which the certificant and/or the certificant’s employer may receive any other sources of compensation, and if so, what the sources of these payments are and on what they are based.
For the purpose of these rules, the key term "compensation" is defined under the "Terminology" section of the CFP Board's Standards of Professional Conduct as: any nontrivial economic benefit, whether monetary or nonmonetary, that a certificant or related party receives or is entitled to receive for providing professional activities.
Within this framework, advisors are expected to disclose that they work either on a "fee-only," "commission-only" or "commission and fee" basis, depending on what compensation they receive, or are entitled to receive, from one of three "buckets" as shown below. If each of the three buckets are only capable of paying fees, the advisor may call themselves fee-only. If the buckets are only capable of paying commissions, the advisor is commission-only. In all other cases, the advisor is commission-and-fee.
The Board's Problematic Application of Compensation Disclosure Rules
While the above set of rules for disclosing compensation would seem relatively straightforward, the CFP Board's application of the rules in recent years has created a tremendous amount of confusion. The starting point was the CFP Board's sanctioning of former Board Chairman Alan Goldfarb, who had stated that he was "fee only" because, logically, all of his clients only paid fees (to him or his company) for services. However, because Goldfarb's RIA was owned by an accounting firm that also owned a broker-dealer (used primarily to facilitate small-business merger transactions), and because Goldfarb himself owned a 1% interest in the broker-dealer, the CFP Board declared that Goldfarb should have declared himself "commission and fee" because he could indirectly receive a commission under bucket #3 above. That applied regardless of whether any client was doing business, had ever done business or was ever intended to do business with the broker-dealer in the first place.
In other words, even being able to prove that 100% of clients only paid 100% of compensation via fees was not a sufficient defense to claim "fee-only" status. So regardless of whether a commission ever actually occurred or not, the mere presence of an entity in which Goldfarb and/or his employer owned a small interest, and which could generate commission compensation that could be paid, was sufficient to taint the fee-only status.
After the CFP certificant community signaled confusion and concern about this ruling, the CFP Board followed up with a Compensation Disclosure Webinar on Aug. 7, and released an important "Notice to CFP Professionals" regarding accurate compensation disclosure, where it further extended this novel approach to compensation disclosure by declaring that any employment relationship with an entity that can generate commissions for any advisor will taint the fee-only status for all advisors, even if the advisor has never actually done any commissions and never intends to do so. In fact, any common ownership of a commission-related entity by the CFP certificant's employer could taint his or her fee-only status, even if no client even does business or is intended to do business with the entity, as was the case with Goldfarb.
The problem with this approach is that it divorces "what clients actually pay" from what advisors must disclose as compensation, even though the whole point of compensation disclosure is to explain to clients how they will be compensating their advisor! In a world where any affiliation (employment, minuscule ownership, common ownership from an employer's holding company, etc.) to an entity that can collect commissions taints the fee-only label, very few advisors are left being able to call themselves fee-only.
Any advisor who is affiliated by a broker-dealer—even if exclusively charging clients fees, and even if exclusively working for the company's fee-only RIA—cannot describe themselves as fee-only. Nor can any advisor who invests any portion of their personal net worth in a commission-paying entity. Remember, Goldfarb was deemed "commission and fee" in part because he owned a 1% interest in a tiny broker-dealer that paid him less than $2,000 in dividends, a payment that's smaller than what many advisors receive as a dividend from broker-dealers in their S&P 500 index fund, even if no client does business with the entity.
Even advisors working for large RIAs that are partially bought by banks or holding companies lose the right to call themselves fee-only, because banks generate commissions on mortgage products (a problem even if the advisor never refers clients to the bank for any mortgage solutions) and virtually every holding company owns an interest in some broker-dealer or bank somewhere in its portfolio of holdings (e.g., even Fiduciary Network is owned by Howard Milstein's Emigrant Bank, which also owns two bank/mortgage companies in New York, apparently rendering many of Fiduciary Network's large prominent fee-only RIAs as being in violation of the "fee-only" disclosure rules).
Unfortunately, the problems extend further than just fee-only compensation disclosures. Given that just having any form of affiliation to a commission-paying entity is enough to taint the fee-only compensation disclosure for advisors, it would similarly be true that having any form of affiliation to an entity that could charge a fee would taint the "commission-only" compensation disclosure, as first pointed out previously on this blog.
Given that virtually every broker-dealer and insurance company is at least capable of charging a client a fee for something—even if it's one-time standalone advice—this means that just as every wirehouse broker who claimed to be fee-only was in violation of the rules because their company could generate a commission, so too is every "commission-only" advisor at a broker-dealer or insurance company in violation of the rules because their company could generate a fee!
Given that the CFP Board continues to maintain that it is "compensation neutral" and that it treats all compensation models equivalently, it would seem that its failure to enforce its own rules against "commission-only" advisors is just the next shoe to drop, just as it was already publicly embarrassed for failing to enforce its rules against wirehouse advisors who claimed they were "fee-only" but weren't allowed to use the term under the CFP Board's interpretation of its rules after the issue was first raised on my blog.
Ultimately, it's not clear that any advisor has, by virtue of real-world employment relationships, a business where it would actually be legitimate to call themselves "commission-only,” such that the definition may have been rendered entirely irrelevant, just as the "salary" definition was too!
In part two of this series, we’ll look at some ways to break the impasse over and clarify the details of the CFP Board’s compensation disclosure rules.