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Beauty Is in the Eye of the Discloser: Suggestions for CFP Board’s New Standards

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To follow up on my blog last week (“Board to Death: Is the CFP Board’s New Fiduciary Standard Really Better than No Standard at All?”) about the CFP Board’s recently released proposed changes to its Code of Ethics and Standards of Conduct, I’ve been reading reactions to those proposals across the various industry sites, posts and publications. While most reviewers are applauding the proposals, one point that the more astute observers are consistently making (including the Institute for the Professional Standard’s President Knut Rostad in his new blog on ThinkAdvisor) is that they take a rather soft stand on conflicts of interest; far softer than the ’40 Act and subsequent case law does for RIAs.

Conflicts of interest are important to the fiduciary duty discussion because they create incentives — usually financial — to act in other than the clients’ best interests. That’s why the ’40 Act requires RIAs to avoid conflicts when possible, and failing that to mitigate their effects. Only when those first two remedies prove impossible, are they required to disclose the remaining conflicts to the client. For instance, the instructions for the SEC’s Form ADV note: “As a fiduciary, you must also seek to avoid conflicts of interest with your customers, and, at a minimum, make full disclosure of all material conflicts of interest between you and your clients that could affect the advisory relationship.”

(Related: CFP Board Seeks to Impose ‘Strengthened’ Fiduciary Standard on All Advice)

Yet in its new recommendations, the CFP Board only requires simple disclosure, as it states in Section A, Part 9, “Duties Owed to Clients”:

“Disclose Conflicts. When providing financial advice, a CFP professional must make full disclosure of all material conflicts of interest with the CFP professional’s client that could affect the professional relationship. This obligation requires the CFP professional to provide the client with sufficiently specific facts so that the client is able to understand the CFP professional’s conflicts of interest and the business practices that give rise to the conflicts, and give informed consent to such conflicts or reject them. A sincere belief by a CFP professional with a material conflict that he or she is acting in the best interest of the client is insufficient to excuse failure to make full disclosure.”

Notice the lack of any mention of avoiding or even mitigating conflicts, whether they be large or small. Instead, this is simply a reiteration of the FINRA standard for brokers to “disclose and manage” any all conflicts. At least the board had the decency to require these unmitigated conflicts to be disclosed in a manner that the client is likely to understand.

Yet I must confess that the lack of insight of the average retail client into either investments or the workings of the financial services industry, combined with the huge financial incentives the industry has to make sure that clients continue to fail to understand these workings, leads me to be skeptical that these disclosures will lead to any increased understanding, or resulting change in behavior, of many clients.  

Consequently, it seems to me that if the CFP Board is truly interested in increasing the likelihood that more CFPs will act in the best interests of their clients, it must take two steps in the area of conflicts. First, it should add the requirement to avoid all conflicts of interest when possible (to be determined by an independent panel rather than the CFP in question); and to mitigate said conflicts when avoidance is not possible.

Second — and most importantly — to help CFPs in those cases in which conflicts are not avoidable or able to be mitigated, the board should publish a comprehensive list of all the conflicts that are likely to arise, along with the specific language that CFPs are required to use when describing and explaining these conflicts to their clients.

After all, there really aren’t so many possible conflicts in retail financial advice that most of them couldn’t be easily enumerated by anyone reading this blog. Having pre-written disclosures would not only make it easier for CFPs when these conflicts arise, they will eliminate any debate over whether any given CFP adequately disclosed a specific conflict in question.

Just to get the ball rolling on these pre-packaged disclosures, I’ve taken the liberty of writing up a few for some common conflicts:

1) Loaded mutual funds: “It’s important that I tell you the funds I’ve recommend for your portfolio are what’s called ‘managed mutual funds,’ and they charge significantly higher management fees than some index funds or ETFs that hold essentially the same stocks. While it’s true that they might outperform the less expensive funds, chances are that the ones we sell won’t. The higher costs will significantly reduce the size of your portfolio by the time you reach retirement. But my firm gets paid a pretty hefty sum to push these funds, and I get a higher payout percentage and some additional perks if I can convince you and others like you to buy them.”

2) An annuity in an IRA. “Before you sign that consent form, I should tell you that while a variable annuity does offer significant tax benefits, you already get the same benefits from your IRA, so it really isn’t worth the extra fees you’ll pay. While the VA does have investment guarantees, the 20 years you have until you expect to retire should sufficiently reduce your market risk. But my firms gets a big cut of these VA sales, so I push them whenever I can.”

3) A proprietary bond fund. “Now let me just add that as a young couple, your long investment time horizon, combined with your need for substantial portfolio growth, would suggest a balanced portfolio of low-cost equity investments. But our firm underwrites a lot of corporate bond issues, and we can charge more for doing that if we can promise to sell the majority of those bond issues into our own bond funds. So, it will be a lot better for my career if we can use at least a couple of our funds in your portfolio. The projected effect on your portfolio at retirement won’t be more than a $100,000 loss.”

Or something like that. I’m sure you could write some much better disclosures so clients will fully understand what those conflicts really mean to them — in dollars and cents. Maybe the CFP Board could hold a disclosure writing contest.

— Read DOL Gave the Gift of Time. Use It Wisely on ThinkAdvisor.