In recent months, the CFP Board has been buffetted by criticism of its compensation disclosure rules. Those rules were built on a series of definitions that the CFP Board insists have changed since its Practice Standards were approved after a public comment process more than five years ago. However, they appear to be impacting so many advisors that it’s difficult to understand how the current way the CFP Board is interpreting its rules is anything but a change from how things once were.
The key point of dispute appears to revolve around the CFP Board’s use of its so-called “three buckets” approach to determining the types of compensation an advisor receives. That approach looks at what clients pay to the advisor, to related parties, and how the advisor himself generates income from his employment and ownership interests. In the process, the definition of what constitutes “compensation” has stretched so far that advisors can now be disciplined for failing to disclose types of compensation that don’t actually exist because no client has ever actually paid it to anyone, ever!
Accordingly, it’s time for the CFP Board to “clarify” its three buckets approach to recognize that the fundamental starting point for all types of compensation disclosure should always be what clients actually pay in the first place. The fact that no client has ever actually paid a commission to anyone, ever, should always be a valid defense for an advisor to claim that she is fee-only (and the same should apply to commission-only advisors whose clients have never paid fees, and who are equally in “violation” of the CFP Board’s current rules). By fixing its confused and problematic rule, the CFP Board can start to move past its recent compensation disclosure debacles and move the definitions in line with a clear and logical rule that consumers can actually understand, and eliminate the absurd requirement for advisors to disclose (and potentially be punished for failing to disclose) client compensation that doesn’t actually exist!
What Are the Three Buckets?
The basic principle of the CFP Board’s three-bucket approach is relatively straightforward, as articulated in the CFP Board’s update on fee-only disclosure webinar.
In essence, the approach states that to determine the nature of a CFP certificant’s compensation, the CFP Board looks at three different buckets: money that goes from the client to the CFP certificant; money that goes from the CFP certificant to a related party; and money that goes from the related party to the CFP certificant. This is illustrated in the graphic below.
Accordingly, if the client pays a commission to the advisor, clearly the advisor must disclose the compensation. If the client pays a commission to a related party to the advisor, likewise the advisor must disclose the commission compensation. And if the advisor has a relationship to a related party (e.g., is employed by or has an ownership interest in) that receives commissions, then the advisor must disclose commissions. In other words, simply put: if commissions are associated with the compensation derived from any of the three buckets, the CFP certificant cannot be fee-only, and must disclose commission-and-fee compensation.
The Problem With the Three Buckets
While the three-bucket approach above may appear to make sense, it creates some very illogical and questionable outcomes in certain circumstances, particularly when the CFP Board looks only to the relationship between the CFP certificant and related parties (bucket No. 3) in the absence of bucket No. 2 and the overall situation.
For example, assume the CFP certificant generates personal income in two ways: fees paid directly from a client, and dividend distributions from a separate property-and-casualty insurance agency in which the advisor owns a small interest inherited from a parent (the P&C agency is a family business). Under the three-bucket approach, the advisor’s compensation types would be as shown below; since there is both a portion that is fees and a portion that is commissions (the compensation that leads to the bucket No. 3 dividends), the advisor would be required to disclose “commission and fee” compensation.