In part one of this series of blogs on the CFP Board’s compensation disclosure rules, we discussed the problems with the rules when it came to which advisors are ‘fee-only’ under those rules, along with those who are ‘fees-and-commissions’ compensated and even ‘commission only.’
To illustrate the sheer ridiculousness of how the CFP Board's overly expansive interpretation of its own rules is creating problems for advisor compensation disclosure and a lack of clarity for consumers, imagine a prospective financial planning client who goes to interview six different prospective CFP-certificant advisors, and reviews their compensation disclosures as a part of the prospective relationship:
- This advisor works for major insurance firm, offering financial plans for free and selling life insurance for 100% of his (commission) compensation. However, because the insurance company has advisors who could provide a financial plan to clients for a fee (regardless of whether this one does), the advisor must also disclose fee compensation. As a result, even though the advisor works exclusively on a commission basis, always has and always intends to, his compensation disclosure is "commission and fee."
- Advisor Number Two works for wirehouse, selling certain proprietary investment solutions on a commission basis. However, the advisor can refer clients to the firm's financial planning department, to which clients pay a fee, and for which the advisor receives a bonus based on financial planning fees paid. Last year the advisor referred one client to the program, and as a result her compensation was 99% commissions and 1% fee. Advisor Number Two's proper compensation disclosure is "commission and fee."
- This advisor works as an independent contractor at an independent broker-dealer, regularly providing financial plans for a fee, and implementing the solutions on a commission basis. Last year, the advisor's compensation was fairly evenly split 50%/50% between commissions and fees. Advisor's compensation disclosure is "commission and fee."
- Advisor Number Four works for an independent RIA, but also has an insurance arrangement with a local general agency to receive a revenue share of commissions when younger Gen X and Y clients implement necessary term insurance. Last year, the insurance commissions amounted to less than 1% of the advisor's revenue, and the remaining 99% was composed entirely of fees. Advisor Number Four must disclose her compensation as "commission and fee."
- This advisor works for a large, established RIA that operates exclusively on a fee basis with clients. However, the firm's founding partners sold a minority interest in the firm to a large national bank, which also offers (unrelated) mortgage lending services (for which mortgage brokers are compensated on a commission basis). Even though 100% of the firm's compensation is from fees (and always has been), and they have never referred any clients back to the bank (and never intend to), because the firm's ownership includes a bank that also owns a commission-paying entity, all of the RIA's advisors must disclose their compensation as "commission and fee."
- Advisor Number Six is self-employed under a small state-registered RIA, providing financial plans for a fee and charging for assets under management. Because the advisor's compensation is 100% fees, and the advisor has no financial interest in any other businesses that generate commissions, and no portion of the advisor's firm is owned by another person or entity that also has a financial interest in any other businesses that generate commissions, the advisor can disclose their compensation as "fee-only."
The above scenarios highlight how ineffective the CFP Board's current compensation disclosure rules are at actually providing clarity for consumers, which ostensibly is the whole purpose of compensation disclosure. None of the advisors can include the "commission-only" compensation disclosure, even the advisor who generates 100% of his income from commissions, and must instead disclose "commission and fee" instead (as in the Advisor One scenario above). Some of the advisors who generate 100% of their compensation from fees must declare themselves "commission and fee" as well (see Advisor Number Five above). Advisors who generate 1%, 50% and 99% of their income from commissions (with the large-or-small remainder from fees) must all disclose themselves as "commission and fee" as well.
The reality is that there's an incredible range of actual compensation and business arrangements characterized by the six scenarios above. The fact that the CFP Board's current compensation disclosure rules puts 5-out-of-6 into the same category—including advisors whose actual compensation ranges from 0% to 100% commissions— highlights how useless compensation disclosure has become in disclosing actual compensation and its associated conflicts of interest to clients.
At least if advisors disclosed what clients actually pay, Advisor Number One would be commission-only, Advisors Number Five and Six would be fee-only and only the middle three would fall into the same "commission and fee" bucket.
However, even that disclosure is of limited effectiveness. Are we really trying to suggest that consumers are best served with a compensation disclosure framework that states it's more important to distinguish between 100% commissions and 99% commissions (commission-only versus commission-and-fee) than to distinguish between 99% commissions and 1% commissions (both commission-and-fee)? Why is it so important to clarify the difference between 100% and 99% commissions, but it's okay to lump together 99% commissions and 1% commissions?
Sadly, even these 100%/99%/1% distinctions are more effective than the actual current state of affairs, where the CFP Board would require five out of the six advisors above to use the exact same compensation disclosure of "commission-and-fee." Current rules would reserve "fee-only" for only a tiny subset of small RIAs that are entirely independently owned but haven't been around long enough for their founders to sell to a larger entity that might also have ownership, somewhere in its holding company structure, of an otherwise-unrelated-to-clients entity that could, possibly, someday, somehow, generate a commission (even though there's no intention to ever do so).
Where Do We Go From Here?
Perhaps the first step to a solution is simply to acknowledge that there's a problem... which the CFP Board has thus far refused to do. While CFP Board CEO Kevin Keller maintains that the organization is "fully engaged" on the issue, the organization has also not taken a single overt action in nearly six months now, beyond the dissemination of its Notice To CFP Professionals and its webinar on compensation disclosure. The organization has not otherwise even publicly acknowledged that anything needs to be changed, much less opened up a process about how to do so; even a rumored FAQ (Frequently Asked Questions) document that would have provided clarification on a number of murky issues has failed to materialize.
A previous article on this blog suggested at least one way out, where the CFP Board could refine its interpretation of its own three-bucket rule to recognize that compensation disclosure is about what a client actually pays to the advisor, or to the advisor's employer or other related party, and that payments from a related party back to an advisor should only count if they are ultimately sourced from the client.
Accordingly, the three-bucket approach to compensation disclosure would become a two-bucket approach, where the bucket to related parties has two sub-parts:
a) was something paid by the client to the related party or
b) was a payment then made from the related party back to the advisor, such that the advisor was receiving indirect compensation.
Such an approach would appropriately acknowledge, per the Advisor Number One and Advisor Number Five scenarios above, that an advisor can still be ‘commission-only’ or ‘fee-only’ even if the employer has other ways to do business that may involve other forms of compensation, as long as the actual advisor and his/her clients have never actually paid the other type of compensation, directly or indirectly, to the advisor (and don't intend or hold out that they plan to do so).
Sadly, the response from the CFP Board so far has been that its compensation definition rules "can only be changed by an elaborate process of proposal, notice, comment and subsequent adoption by the board." Of course, this explanation completely ignores the fact that last August the CFP Board staff unilaterally chose to alter the compensation disclosure definitions by eliminating the "salary" category from its website, Its staff did so after it was pointed out on this blog that "salary" is an invalid compensation disclosure, as it describes a way that firms pay advisors, and not a way that clients pay advisors.
In fact, when the CFP Board eliminated its salary compensation disclosure, it did so with the specific explanation "...salary does not provide an accurate and understandable description of the compensation arrangement being offered by a CFP® professional because it does not describe how the client will pay the CFP professional and any related party." (emphasis mine)
So if the CFP Board has the power to eliminate the ‘salary’ compensation category altogether, and declares that compensation disclosure should be based on "how the client will pay the CFP professional and any related party" (not just how a firm compensates the advisor in the absence of what the client actually pays), then why can't the CFP Board apply the same clarifications of their problematic interpretation of the ‘three bucket’ approach?
In other words, when it came to removing "salary" from its compensation definitions, the CFP Board showed that it has the power to do so and the definition was all about "how the client will pay the CFP professional and any related party.” However, when it comes to defining ‘fee-only’ or ‘commission-only’ that same interpretation no longer applies and the CFP Board staff suddenly declares it is powerless to fix the problem.
At this point, it's not entirely clear whether the CFP Board staff doesn't even realize it is inconsistently interpreting its own rules, is misinterpreting its own powers to fix them, or is deliberately stonewalling to avoid a public perception of backtracking in the midst of a lawsuit. Regardless, the longer the situation goes unremedied, the more the CFP Board's brand is potentially damaged.
Even beyond fixing the CFP Board's currently problematic and erroneous interpretation of its own ‘three-buckets’" rule, the problem still remains that the advisors described in scenarios Two, Three and Four above are all in the same ‘commission and fee’ bucket, despite the fact commissions comprise from 1% to 99% of their income. This suggests that even beyond just fixing the three-bucket methodology of its definitions, the CFP Board also needs to consider better refinements to its ‘commission and fee’ label (though admittedly, this almost certainly would require a broader discussion with CFP certificants and other stakeholders to refine the rules further). As a starting point, perhaps we could at least make a distinction between ‘commission and fee’ versus ‘fee and commission’ based on which contributes the majority share of the advisor's actual income for services rendered.
In the meantime, though, it remains to be seen what will break this apparent stalemate. The CFP Board does not seem to feel it is beholden to the CFP certificant stakeholders who have complained and objected to this rule, including their former chair Alan Goldfarb. And remember, Goldfarb was publicly admonished for violating the very rules he had a hand in writing himself (perhaps the clearest evidence that the CFP Board is not applying the rules in the way they were originally intended).
While the CFP certificant community has not complained en masse about the issue, many have contacted me directly about the issue stating that they're afraid to take public positions for fear of retribution, as they perceive the CFP Board's rulings thus far—and its roller coaster of public admonitions and widespread amnesties—to be arbitrary and capricious and creating uncertainty about the consequences of public criticism.
I think this fear is overstated, but it does raise the point that the CFP Board may be creating an environment in which stakeholders are afraid to voice concerns publicly because of its own enforcement policies, and then appears to be taking their silence as acquiescence to the current rules.
The membership organizations are capable of arising above this level of the fray, but sadly both the FPA and NAPFA have continued to be remarkably hands-off in pushing the CFP Board to action.
Each organization has stated a need to address the compensation disclosure definitions, but both have indicated that they will wait for the CFP Board to make the first move, despite the fact that the CFP Board has not publicly acknowledged it even believes a change needs to occur and that there is no first move forthcoming. The Board even said last fall that the problem is not about CFP Board changing at all, but about NAPFA and the FPA changing their definitions to comply with the CFP Board.
NAPFA's silence is especially surprising, given its 30-year leadership in pioneering the definition of ‘fee-only’ and the fact that approximately 5% of its own members are in violation of the CFP Board's rules. In turn, NAPFA's apparent refusal to take an active and public role in the process and instead delegate the decision to the CFP Board of when/whether to act at all raises the question of whether NAPFA has abdicated its leadership role in compensation definitions, which would represent a serious shift in how the CFP Board is held accountable.
One way to force this issue would be to file complaints against several hundred or even a few thousand CFP certificants—for instance, every advisor who is commission-only or all advisors at RIAs that are owned by a parent company—to compel the CFP Board to acknowledge the issue and address it. Unfortunately, such a path also threatens to pressure the CFP Board's resources from legitimate violations it should be addressing, would be a public relations humiliation for the organization, and would needlessly throw "innocent" advisors under the bus who would be named in the complaints. It would be a sad resolution to the issue if the CFP Board feels this is the only way it can/should be held accountable for its own rule ambiguities.
It may ultimately be the Board of Directors of the CFP Board that decides to apply the pressure to clarify the rules, especially given that the CFP Board remains embedded in the midst of its litigation with Jeffrey and Kimberly Camarda regarding compensation disclosure. That’s a legal case the CFP Board can ill afford to lose on the back of its ongoing inconsistencies and ambiguities in its compensation disclosure rules.
If the CFP Board wants to ultimately be the long-term enforcer of financial planning on behalf of the profession, and to uphold its mission of benefiting the public by upholding the CFP marks as the recognized standard of excellence for personal financial planning, it should take responsibility for its problematic definitions and inconsistent application of its rules that have rendered compensation disclosure meaningless for consumers.
If it won't do so on its own, its Board of Directors needs to compel it to do so, for the sake of the long-run credibility of the organization and its marks.
Read part one of this blog series.