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The 2% Solution: NAPFA Changes Its Membership Standard

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As you may have heard, last Thursday (June 26), the National Association of Personal Financial Advisors announced a change to its membership standards, involving its definition of “fee only.” Here’s how NAPFA CEO Geoffrey Brown described the change: “The National Association of Personal Financial Advisors (NAPFA) today notified its membership that it will discontinue its policy of allowing members to have up to a 2% ownership interest in a financial services firm that receives transaction-based compensation.” 

Even though Brown estimated the change would affect 125 or so NAPFA members, if myriad reports in the trade press are representative, that small—but apparently quite vocal—minority are more than a little unhappy with the change. 

I find myself in the curious position of agreeing with the NAPFA rule change, and at the same time, agreeing with the advisors who oppose it. [Let me state clearly: I was for it before I was against it.] I’ll try to explain. 

First, keep in mind that the most important criteria for an advisor being accepted as a NAPFA member is that he/she has to meet the organization’s definition of “fee only.” And charging financial services commissions or even owning more than a small portion of a business that charges commissions has always been a no-no under NAPFA rules.  But as Geoff Brown reportedly admitted, NAPFA’s position on how much ownership is permissible has varied over the years: from zero tolerance to as much as 5%, to the 2% ownership stake which was the standard from 2004 until last week.  

As far as I’ve been able to determine, the reason for this ownership exception is to allow for personal investments (such as wirehouse stock in a mutual fund portfolio), or regulatory ownership requirements (such as the 1% stake in his accounting firm’s BD that cost Allan Goldfarb his chairmanship of the CFP Board two years ago).

Yet this history of rethinking the ownership percentage suggests the NAPFA Board has had some uneasiness with member ownership of commission firms for decades. 

Since I came across this rule in the Goldfarb case, I, too, have felt some uneasiness about it. While the rationale behind the rule makes sense to me (that professional advisory firms should be client-compensated, standalone businesses, separate from the financial services industry), the solution of limiting a percentage of ownership seems problematic: 1% of a small brokerage firm is probably not much of conflict of interest; 1% of Fidelity Investments would be quite another matter. On that basis, I applaud NAPFA’s decision to eliminate the rule. 

However, I also have to agree with those advisors who own small stakes in commission businesses and have been NAPFA members in good standing for years, and are now crying foul. Based on my recent inquiries to NAPFA on the subject, there doesn’t seem to be a more formal statement of the rule change beyond what Geoff Brown said above: which in its simplicity ignores the complexities of the issues involved, and the rationale behind the original creation the exemption.

For instance, what about cases where advisors own mutual fund shares in their IRAs or 401(k)s which happen to have positions in Bank of America or UBS? And what’s the definition of a “financial services company” anyway? NAPFA member Rick Kahler has been widely reported voicing concern over his stake in a family real estate brokerage: Is that in violation? Personally, I’d think not, but what do I know? 

Then there’s the timing. According to Brown, the issue of commission-business ownership will be addressed with each NAPFA member at the time of their annual membership renewal. That sounds as if members have at most 12 months to divest their ownership, and in many cases, quite a bit less time than that. Does that sound fair? Business ownership isn’t like owning a bicycle which you could sell on eBay tomorrow. And what kind of price will advisors get when the buyers know they have to sell? Certainly, a longer grace period would seem to be in order—maybe even grandfathering existing ownership stakes. 

The point is that when an organization such as NAPFA, with strictly enforced membership rules, makes a change in one of those rules, it seems only fair that the announcement of those changes include a clear and complete explanation of what those changes are—one that demonstrates clear thinking about how they will be applied.

Hopefully, NAPFA will address these issues fairly in the near future. However, it seems as if they could have avoided the majority of the current member backlash if they’d presented a more comprehensive explanation of how the rule change will work from the start.

As is often true in life, how we do things can be just as important as what we do.


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