More On Legal & Compliancefrom The Advisor's Professional Library
- The New and Improved Form ADV Whether an RIA is describing its investment strategy in advertisements or in the new Form ADV Part 2, it is important the firm articulates material risks faced by advisory clients and avoids language that might be construed as a guarantee.
- Preventing and Dealing with Client Complaints Although the SEC has not provided specific guidance on how client complaints should be handled, a firms policies and procedures should provide clear direction how to do so, as neglecting complaints can exacerbate a bad situation.
After almost a year of often-public discussions, the CFP Board recently delivered its decision to financial planner Rick Kahler that, because he owns a (commission-based) real estate brokerage firm to which his financial planning clients are sometimes referred, he will no longer be permitted to label himself as "fee-only."
Instead, he must describe his compensation as "commission and fee,” in light of the commission-based related party. In response, Kahler has declared that he will likely drop his CFP certification (after being the first advisor in South Dakota to earn the CFP certification over 30 years ago). He may even file a lawsuit with the CFP Board over the issue, after failing to find any other remedy to the situation in more than 10 months of talks with CFP Board staffers.
Update: On July 29th, the day after publication of the original version of this article, the CFP Board and Rick Kahler issued the following joint statement:
"CFP Board and Rick Kahler, CFP® continue to have ongoing conversations in which CFP Board is providing Mr. Kahler with guidance about how to properly identify his compensation. Until CFP Board provides the guidance Mr. Kahler has requested, CFP Board will not take any disciplinary action related to identification of his compensation."
In point of fact, though, the CFP Board's "related party" rules were arguably designed to catch situations precisely like Kahler's. The whole point of the rule is that a planning firm cannot make itself "fee-only" by simply splitting its commission-based work into a separate business still owned by the CFP certificant. To allow such behavior would render compensation disclosure meaningless, as all advisors could be both "fee-only" and "commission-only" by just hanging two shingles! As a result, it appears that this time the CFP Board may have really gotten its ruling right.
However, the reality that the CFP Board has yet to come to an amicable resolution with Kahler about how to unwind the situation highlights what is still the CFP Board's fundamentally flawed interpretation of its own compensation disclosure rules. Kahler offered to cease providing referrals to the real estate firm, or even to outright bar any of his financial planning clients from doing business with the real estate firm, yet the CFP Board still insists that the mere fact that he owns the private-held firm "taints" his fee-only status. Even if Kahler can prove that 100% of his clients pay only 100% fees from this day forward, forever, Kahler is still required by the Board to "disclose" client commissions that wouldn't actually exist or face potential sanction.
Instead, the CFP Board insists that the only solution is for Kahler to divest himself of his non-majority stake in a family firm he has owned for over 40 years, for what would surely be a significant personal financial loss to Kahler in trying to sell an illiquid closely held business.
But should the CFP Board really be allowed to dictate to fee-only CFP certificants what are and are not "permissible" investments to own for personal investment purposes apart from their financial planning clients? Ultimately, Kahler's dilemma about how to come back into compliance with the fee-only rules—and his inability to do so without divesting himself of a family business that he is willing to legitimately run separately from his financial planning clients—emphasizes the continued absurdity of how the CFP Board is interpreting its own three-bucket doctrine for determining compensation to disclose.
Understanding the Kahler Situation
Rick Kahler is a long-standing CFP certificant who first got his CFP marks in 1983 (and was the first in South Dakota). Over his career, he has been involved in both a family real estate business (since 1972) and his advisory practice (founded in 1981), though in recent years his efforts have been focused primarily in his advisory firm, Kahler Financial Group.
While Kahler is not involved in selling real estate or the day-to-day management of the real estate brokerage business, he does still own a 50% stake in the family firm with his brother, and the business is an entity that is compensated by commissions (as is common for real estate brokerage). Since his advisory firm does not directly accept any real estate, insurance or securities-related commissions, Kahler refers to his business as “fee only”, and has also been an active member of NAPFA (which affirmed his “fee-only” status under their approval process).
However, last year the CFP Board ruling on Alan Goldfarb came out, followed shortly thereafter by the announcement of the lawsuit with the Camardas (and that Goldfarb was just the tip of the compensation iceberg). The CFP Board publicly stated and embraced its “new” view (which had never been ruled upon in this manner before) that the mere ownership of a commission-paying entity is sufficient to require a CFP certificant to state that he/she is compensated with “commissions and fees” (and not as “fee-only”) regardless of whether any clients even do business with the entity. After the CFP Board sent a notice to CFP certificants “clarifying” these rules last year, Kahler realized that his ownership of the real estate business could run afoul of the CFP Board’s position, both due to his ownership interest, and the fact that clients of the advisory firm actually are sometimes referred to the family-owned real estate business. Kahler says that his policy when asked for a real estate broker referral is to give the client the names of three firms in the area, one of which is his family-owned firm.
Given the potential issue, Kahler voluntarily approached the CFP Board with his concern that he might be out of compliance with the “new” policy. And for much of the past year, Kahler has been engaged with the CFP Board regarding his compensation disclosure. That is, whether he can declare himself to be “fee-only,” and if not (due to his ownership and relationship to the family real estate business) what he can do to remedy the situation and maintain his status as fee-only. It’s important to recognize that the “forced” sale of a non-majority interest in a family-owned business could have significant financial ramifications on its value as a personal asset.
After approximately 10 months of conversations, during which Kahler has also been vocal in the industry media regarding his situation and the problem that it presents, the CFP Board recently announced its final decision to Kahler that his ownership and compensation arrangement do in factconstitute a commission-and-fee structure, and that Kahler must cease marketing his business as “fee only” or risk being sanctioned by the CFP Board for a misleading compensation disclosure.
In addition to this conclusion, Kahler indicates that his alternative proposals, including transferring his ownership interest of his family real estate business to his spouse or a blind trust, or agreeing to cease making any referral to any real estate brokerage firm when asked (including his own or any other), or even agreeing to bar any clients of his advisory firm from doing business with the real estate entity at all (so they truly operate “independently” of each other), were rebuffed by the CFP Board as not resolving the issue regarding his claims of being “fee-only”.
In light of the outcome, Kahler has now announced that he is considering whether he will renounce his CFP certification (so that he can continue to market himself as “fee-only” without risk of a public sanction from the CFP Board), and that he may sue the CFP Board regarding the matter and how the organization has handled the situation.
The Issues at Stake
To me, the Kahler situation ultimately comes down to two important but separate issues:
1) Should Kahler have been allowed to define himself as “fee only?”
2) If he cannot define himself as “fee only,” what should Kahler do to “rectify” the situation so he can call himself fee-only if he wishes to appropriately characterize his financial planning services that way?
Regarding the first matter, I have to admit that the CFP Board’s conclusion seems entirely appropriate, not merely because Kahler owned a real estate business, but because – by his own admission, and the disclosure on his own Form ADV – there were referrals of clients from the advisory firm to the family real estate business to which commissions were paid and Kahler received economic benefit (though Kahler indicates the amounts had been "negligible" in recent years).
In other words, Kahler was in a position to refer an advisory client to a (related) business that would generate a commission that financially benefitted him as a material owner of both firms. Whether the real estate business shared the commission directly, paid out as a dividend or merely accrued it as profit on its books, the fact remains that a business Kahler owned was being enriched by commissions being paid by clients of Kahler’s advisory firm.
The whole point of these related-party rules was to ensure that situations like this are recognized as being commission-and-fee, and that advisors cannot turn a commission-and-fee business into a “fee-only” firm simply by creating a separate-but-related-and-co-owned entity to gather all the commission income that flows back to the same person.
Of course, the most common such situation is a separate business that collects insurancecommissions – as was the issue in Camarda – and not real estate commissions, but it’s difficult to see why they would be treated differently. Real estate is still a financially related business, other forms of real estate commissions (e.g., from the sale of REITs) are clearly commissions, and the real estate business was viewed as being material enough of a relationship that it was disclosed on the Form ADV in the first place.
If the related party was related enough (and the commissions it generates were material enough) to be disclosed on the ADV, the “commission and fee” compensation should have been the required disclosure for Kahler as a CFP certificant, too. That’s what the CFP Board correctly concluded in its decision.
No Way Out From Related Party Ownership
On the other hand, the more problematic issue was that Kahler’s proposals to resolve the issue, including transferring ownership (albeit to other “related” parties), and especially the offer to just completely bar clients from doing business with both entities, was not sufficient to rectify the issue.
As long as Kahler was going to continue referring clients to the real estate business, and he—or a party/entity clearly related to him—was going to continue to be enriched by the commission compensation the client paid, the compensation disclosure should still have been “commission and fee.”
However, if Kahler was willing to create a total prohibition that would limit clients of the advisory firm from doing business with the real estate business—rendering the two businesses independent and unrelated with respect to clients—then why would the CFP Board still require Kahler to declare his advisory firm to be “commission and fee?”
At that point, it would no longer be possible for that client to pay a commission, directly or indirectly, to Kahler or his businesses, in any way, shape, or form. Kahler would be required to disclose commissions that literally wouldn’t exist.
Granted, Kahler would still own the real estate business conducting real estate transactions with other people where commissions occur (and generate dividends back to Kahler as the owner), but that’s also true of any advisor who owns a financial interest in a private business, or a public one like the companies in the S&P 500. Advisors aren’t required to report to their clients the commissions paid by unrelated non-clients to unrelated businesses just because it’s a public or private stock that happens to be in their personal portfolio. So if Kahler was willing to create the same relationship with his own family real estate business, why was that still not acceptable… beyond the CFP Board’s ongoing arbitrary and problematic view that the mere ownership of commission-based businesses, even if unrelated to any actual client work, can still “taint” the fee-only status of an advisory firm that is otherwise fee-only in the business it conducts with clients.
Apparently, being able to prove that 100% of financial planning clients paid only 100% in fees, ever, to anyone, is still not a legitimate defense to a claim that the advisor is “fee-only” under the CFP Board’s rules!
Is it really appropriate for the CFP Board to have the right to dictate the private ownership of a CFP certificant’s stock portfolio and investments in companies unrelated to their actual financial planning clients? In Kahler’s situation, the CFP Board’s response was that the only way Kahler could possibly remain “fee-only,” regardless of whether his financial planning clients were barred from the real estate firm, was to actually fully divest his stock ownership!
Ongoing Problems With The CFP Board's Three Buckets
As noted earlier, while I believe the immediate conclusion of the CFP Board regarding Kahler’s situation was right—clients of the advisory firmwere being referred to a related entity for financial transactions that resulted in commissions providing a financial benefit for the CFP certificant—the CFP Board’s inability to come to an amicable resolution with Kahler highlights the significant ongoing flaws that remain in how the CFP Board applies its fee-only definition, as well as the related definitions of the key terms that are used to apply the rules.
For instance, as the Kahler case highlights—and Kahler himself expresses in frustration after having requested clarification for months—there is still no clear definition of what constitutes “ownership” for the purpose of determining a related party. For instance, does spousal ownership count? What about the use of a [blind] trust?
There are cases to be made for allowing or disallowing either, but the CFP Board should have a clear, publicposition on this so CFP certificants understand the rules, and don’t find themselves in the position of being forced to divest ownership of illiquid assets on short notice.
Similarly, there is still no definition of “related party” in the first place, what constitutes a “related party”, and how significant of an ownership stake is required. Notably, the lack of definition on what constitutes a “related party” was a key factor in the Goldfarb case—where a mere 1% interest that paid a $2,000/year dividend was a fee-only “taint,” even though many advisors receive far more than this from the financial services stocks in their own investment portfolios.
Of course, Goldfarb’s stock was in a smaller, privately held company, and not a publicly traded stock on the S&P 500. But surely the CFP Board’s definition of “related party” is not going to hinge on whether a company has decided to do a public markets IPO, right?
In addition, the CFP Board’s rules for “fee-only” state that only compensation “from [the CFP certificant’s] client work” is supposed to count, yet the CFP Board is now stating that a party is related due to mere ownership even if there is no work done for clients. (That would be the case if Kahler barred advisory clients from his real estate business, and just as Goldfarb’s advisory clients were not actually doing business with his 1%-owned broker-dealer, either).
Furthermore, the CFP Board has still not defined what constitutes “non-trivial economic benefit ”from a related party, a factor that seems poorly considered in the Goldfarb case, may be a potential factor in the Kahler situation, and is possibly an issue in the Camarda scenario as well.
Does “non-trivial” mean the compensation has to constitute a certain portion of the advisor’s income? Or a certain portion of the business’ income? Does the related party entity have to be profitable, or does materiality depend on just the revenue provided to the business? If a client pays a $5,000 commission to a business that has $10,000 in expenses (so the business has a loss) and the advisor makes $600,000/year, is the compensation trivial because it’s <1% of the advisor’s income. Is it trivial because the business shows a loss, or non-trivial because $5,000 is still a big chunk of change for the client themselves?
Right now, the only way an advisor will know is after the fact, when they’re found guilty and publicly admonished for being in the wrong, because there is no definition and no bright line safe harbor. Worse, is it only a matter of time before fee-only financial planners owning shares of an S&P 500 index fund risk being sanctioned by the CFP Board for claiming to be fee-only when they are actually "commission and fee" because they own shares of commission-based financial services stocks within the index funds in their portfolio?
Such an outcome may sound absurd, but it is exactly what is prescribed by a strict application of the current precedent for the CFP Board's flawed interpretation of its rules, when there is no clear threshold about what percentage of a firm is "too small" and what amount of income is "too little" to actually be trivial or not. Remember, Goldfarb received a public sanction for failing to disclose commissions that his clients never actually paid, simply because he had a 1% ownership interest that generated a $2,000 annual dividend. That's it.
The Kahler situation also highlights the confusion about what types of “income” even count as commissions in the first place. Kahler clearly thought that “commissions” should refer to insurance and securities/investment commission, and not real estate commissions.
While I have sympathy for the CFP Board’s viewpoint that real estate commissions probably should be included, it still raises the question of where to draw the line. Would a store that sold furniture for the client’s house also count? If any commission-based entity or income can run afoul of the rules, does that mean an advisor must disclose themselves as “commission and fee” for also holding a Tupperware party for clients?!
As I’ve written before, the most fundamentally flawed aspect of the CFP Board’s definition is its failed "three buckets" approach to identify compensation, when an advisor must disclose “commissions” because the advisor owns a commission-based entity that no clients ever actually do business with in the first place. If Kahlercould show going forward that no advisor client ever does business with the real estate entity again, being able to prove that 100% of clients have only ever paid 100% fees is still not a legitimate defense to claiming that he is fee-only, merely because he still owns what at that point really would/should be an unrelated party.
After all, the technical definition from the CFP Board is that the advisor cannot be fee-only unless “all compensation from his/her client work comes exclusively from the clients in the form of... fees” (emphasis mine). Yet if none of Kahler’s financial planning clients does any workwith the real estate entity, how can Kahler receive compensation for client work? How can Kahler be compensated by financial planning clients who didn’t actually receive services, and how can he disclose commissions that wouldn’t actually exist?
Of course, the reality is that there may still be other people who could receive services with the real estate business, but if they work solely with the real estate business, they would not be financial planning clients in the first place, as the CFP Board has taken pains in recent years to emphasize that financial planning has a limitedscope and that a financial planning relationship (and therefore, associated compensation disclosure requirements) only exists when the advisor does a financial plan or provides material elements of financial planning.
So if clients of the real estate firm don’t get financial planning, and Kahler was willing to restructure his practice so financial planning clients really wouldn’t work with the real estate firm at all… why exactly would Kahler still be required to describe his compensation for financial planning work as “commission and fee” where there really would be no work done for his financial planning clients from his commission-based entity?
In fact, when the CFP Board eliminated its salary compensation category from its own "Find a Professional" tool last year, it did so with this 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 had the power to eliminate the "salary" compensation category altogether, and declare 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?
Where Does the CFP Board Go From Here?
Ultimately, I will admit that I am still hopeful the CFP Board will “come to its senses,” clarify its key definitions and resolve the flaw in its three-bucket rule by recognizing that client work must be delivered before a party is related, and that commissions must actually be paid and exist before they need to be disclosed.
Unfortunately, though, given that the CFP Board is already embroiled in a lawsuit with the Camardas, it’s not clear that the situation will be resolved any time soon, as the court case could take years to complete. However, clarifying these rules, particularly regarding related parties, would not necessarily impact the Camarda case at all, as in that scenario clients were receiving services from a related party and paying commissions to it.
Sadly, the reality is that the CFP Board could fix its rules any time it wants to, because the problem is not with the rules as they are written. The problem is that the CFP Board either has refused to define the key words in those rules—creating ambiguity and confusion—or worse has taken a nonsensical interpretation of the words in those rules, such as claiming the rules require advisors to disclose commissions that don’t actually exist in the first place from a “related” party that has no relationship to the client because no client work was rendered.
Fixing the situation is not about rewriting the rules, but reinterpreting them (perhaps with the assistance of Merriam-Webster!). The “change” that kicked off this series of problems was a faulty judicial interpretation of the rules by the inexperienced ad-hoc disciplinary committee established to rule on the Goldfarb case, which set a flawed precedent that has sent the CFP Board down a problematic path. And the “change” to fix it is issuing a clarification to the words in the current definition that recognizes the interpretation of the words in the prior precedent were faulty. Since these issues are unrelated to the key factors in the Camarda case, the resolution need not wait for the Camarda case to end, however many years down the road that may be.
In the meantime, Kahler sadly is “stuck” and will have to either stop being a CFP certificant, or stop calling himself fee-only (even if he otherwise takes steps to completely separate his real estate commission activity). Though it’s worth noting that if Kahler renounces his CFP certification, after 90 days he will be required to pay a $100 reinstatement fee, after more than 1 year he will have to make up for all his missed CE along the way, and after 5 years he will have to sit for the CFP comprehensive exam again (or actually for the first time, since Kahler earned his certification before the comprehensive exam was instituted in 1991). By contrast, if Kahler merely recharacterizes his compensation as commission and fee “for now,” he can at least go back to fee-only in the future if/when the rest of the issues are resolved. In the meantime, perhaps, he can simply state to his clients that he “receives no commissions from insurance and investment products” which remains accurate but does not use the prohibited “fee-only” label.
On the other hand, as I’ve written in the past, I’m not certain that using fee-only as the centerpiece of an advisor’s marketing is necessarily a good idea anyway.
As for whether Kahler will sue the CFP Board over the matter, I have to admit that I hope this does not happen. Though I’m no attorney, I’ll admit it’s ultimately not clear to me on what grounds Kahler could sue. While the Camarda lawsuit also ties back to fee-only compensation disclosures, the crux of the lawsuit is how their case was handled before the Disciplinary and Ethics Commission, not the actual definition of fee-only itself.
In the end, it still appears to me that the CFP Board’s conclusion—that Kahler should disclose commissions that financial planning clients are paying to a related party that Kahler owns—is a proper application of the rules.
On the other hand, if Kahler really does bar his clients from doing business with the real estate entity, establishes documentation that 100% of his clients paid only 100% in fees and no commissions to any (related) entity, holds himself out as fee-only and then gets sanctioned for it, he may have some grounds for claiming that the CFP Board’s Disciplinary and Ethics Commission is ignoring the plain English language of its own rules. To say the least, that would be a rather public and messy (and potentially expensive) fight for Kahler.
Whether it comes from Kahler or someone else, though, it seems clear that until the CFP Board does a better job with its definitions, and fixes the flawed application of the three-bucket rule, the problems will just continue to accrue. While the organization has maintained throughout that its position on compensation definitions is not “new” and that everything is “clear,” if that were the case the CFP Board would not have had to:
2. Remove two members of its own Disciplinary and Ethics Commission for also failing to following the definitions
3. Eliminate its own compensation definition of salary from its "Find a CFP Professional" search engine after acknowledging it doesn't reflect what clients actually pay (yet refusing to hold the definition of commission compensation to the same standard)
4. Issue a standalone notice to members specifically to explain the rules again
5. Produce a new 1-hour webinar further explaining the “already clear” rules
6. Reset compensation definitions for all "fee-only" advisors and issue yet another notice to "clarify" the rules after facing an article in Financial Planning magazine and Wall Street Journal about 468 wirehouse brokers –and apparently thousands of others not studied by the media—were still not applying the compensation disclosure rules appropriately and had to be granted retroactive amnesty (and even though the issue had been pointed out months earlier on this blog as well)
7. Put NAPFA in the position where the current rules are so unusual that as much as 5% of their own membership doesn't qualify, and forced them to redefine their rules to match the CFP Board, despite the role NAPFA has played in defining this very term for 30 years
8. Put certificants like Rick Kahler in a position of divesting the interest in an illiquid non-majority interest in a privately held company while failing to provide clarity about the definitions that could give any other way to remedy the situation
9. Continue to face public and private criticism from industry leaders about a lack of clarity of the rules, including the fact that the CFP Board's current rules render all their commission-only advisors at brokerage firms in the exact same rule violation as fee-only advisors at the same firms (the next shoe to drop?)!
And then, of course, there’s the fact that the CFP Board is in an ongoing lawsuit about the definitions and its process for enforcing them (though ironically, the rules may actually have been clear and properly applied in that particular situation!).
To say the least, this is not a list of outcomes from rules that are “clear” and able to be properly enforced, despite the CFP Board’s public insistence to the contrary. I hope the CFP Board will come to its senses before more damage is done.