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9 Compliance Considerations When Switching to Fee-only Financial Planning
• Joe Buhrmann • September 14, 2021
The financial planning industry has been steadily moving away from commission-based product sales for decades. Charging clients a fee based on their assets under management (AUM) for both investment management and financial planning services has gained widespread popularity.
Alternative pricing structures have more recently been emerging, however, as financial professionals attempt to serve historically underserved markets and separate their planning and investment management services.
With this movement towards AUM fees—as well as other hourly, retainer, subscription, project-based, or other type of planning fees—comes a host of new compliance concerns that firms must navigate, especially for those hoping to eschew commissions entirely and be fee-only planners.
The Most Common Types of Fee Compliance Issues
In late 2018, the SEC released an alert that still bears relevance today. The alert outlined the five most common types of compliance issues involving fee-only financial planning. To understand all your compliance considerations when switching to planning fees, it’s important to first understand the most common issues:
- Fee-billing based on incorrect account valuations. Most financial planners use the AUM fee to charge for planning. With fees being tied to assets in this way, an accurate valuation of the assets under management is essential for honest and transparent pricing. The SEC found many instances where firms were valuating assets with a different metric or process than what was outlined in the client’s advisory agreement, leading to incorrect fees being charged.
- Billing fees in advance or with improper frequency. The SEC found several examples of firms charging on a monthly basis instead of quarterly as outlined in their advisory agreement and Form ADV Part 2, as well as firms charging clients in advance when it was stipulated they would charge in arrears. Other discrepancies revolved around proration. Several firms were found to not be offering pro-rated reimbursements when clients left, while others were charging for a whole billing cycle when clients started mid-billing cycle.
- Applying an incorrect fee rate. In this instance, firms were found to be charging a higher amount than what was agreed upon in the advisory agreement, or double-billing clients. Other firms also charged non-qualified client performance fees in violation of Section 205(a)(1) of the Advisers Act.
- Omitting rebates and applying discounts incorrectly. Discounts, bundled fees, rebates, or other pricing changes outlined in the advisory agreement must be followed. The SEC found several instances where this was not the case, such as when not all members of a client’s household had their assets aggregated which would have qualified them for discounted fees, or when a client’s fee rate was not reduced after reaching a pre-determined threshold.
- Disclosure issues involving advisory fees. There are a few different types of common disclosure issues the SEC found. One was when a disclosure in Form ADV was inconsistent with a firm’s practices, such as stipulating a maximum fee but then charging more than that maximum fee for certain clients. Other issues involved failing to disclose collecting fees from third parties, failing to disclose additional compensation earned from asset purchases on client accounts, and the failure to disclose any fee-sharing arrangements the firm had in place.
Understanding these common compliance issues when it comes to fee-only planning is important, but not the whole picture. There are a number of other considerations when it comes to complying with federal and state regulators.
9 Things to Consider for Fee-only Financial Planning Compliance
A switch to fee-only financial planning can be great for the future of your firm and for your clients. Whether you’re moving to AUM fees or newer alternative fee structures, it’s important to consider these nine things.
1. Where Are You Responsible for Compliance?
The first consideration is a simple one: What regulations do you need to adhere to for fee-only planning? This should be your first consideration as there are several federal regulators that may come into play, including but not limited to:
- OCC – Office of the Comptroller of the Currency, an independent branch of the US Treasury (for banks)
There are individual state regulators at play for every firm, as well as the National Association of Insurance Commissioners (NAIC) for cases involving specific solutions and their sales, such as life insurance and annuities. While your Federal obligations may be more straightforward based on your firm’s business model, state regulators vary widely. Utah, for example, has deemed most retainer fees in financial planning as “unreasonable.” As another example, Illinois and Nevada don’t allow for blended fee structures where firms charge a subscription and an AUM fee.
Regardless of where your business is, you may be liable to adhere to multiple state regulations, as they apply based on where clients are located, not where your firm is located. So be sure to account for the wide variance in state-level regulations in financial planning fees, especially with “snowbird clients” and in light of today’s mobile, remote workforce.
2. Considering the Impact on Client
Switching to fee-only financial planning is a big change. One that will require extensive communication with your clients. As with anything in your business, how your clients will be impacted should be a top concern.
Clients will inevitably have questions about your new fee structure. Be prepared to talk to them about why this change benefits them, or at least causes minimal disruption, and is beneficial to your ability to provide objective financial advice. You may even consider grandfathering in certain clients who may leave upon seeing their fees change.
When switching to fee-only planning it’s important to also evaluate your clients’ portfolios and ensure there are no trailing commissions from client assets that would prevent you from truly being fee-only. If you’re only making the switch to being fee-based, then this isn’t a compliance concern.
3. Making a Material Change
One immediate compliance step you can take upon implementing fee-only planning is to make a material change on your Form ADV, as most states consider this a material change. You will have to update your ADV, file an amendment, and disclose the change to clients.
As you’ve seen in the section above, accurately representing your fee structure, frequency, calculations or valuations, and rates is crucial for compliance. Nearly all the SEC’s most frequently found compliance issues regarding fees revolve around discrepancies between a firm’s ADV and the way fees are actually implemented in their practice.
4. Update Financial Planning Contracts
When updating your ADV, you’ll also need to update your financial planning contracts to reflect the new fee structure.
In many cases, it’s beneficial to have separate contracts for financial planning and investment management. It drives home the message to clients that the services are separate, in turn clarifying the fees they’re paying, while also giving them a better opportunity to concretely see the services and value being delivered in exchange for what they’re paying.
For those implementing a tiered fee structure, it’s important to note you may need multiple financial planning contracts for planning services depending on how greatly your services vary at each level.
5. Addressing Reverse Churn
In the past, churning in the industry used to be a problem where financial professionals would intentionally trade in high volumes to collect more commissions. Regulators have done well to stamp out this problem, but now the opposite, though likely less problematic, issue is arising: reverse churn.
This is where financial professionals bring on clients, aggregate assets, and collect an ongoing fee without actively managing the client’s finances. Regulators are now keen on protecting clients from reverse churning.
Once you begin charging fees, be prepared to demonstrate the work that goes into each client’s plan, as well as any investment management discussions or actions you’ve taken, to justify the fee you’re collecting.
6. For RIAs—Do You Need to Give Clients an Audited Balance Sheet?
The SEC requires any registered investment advisor (RIA) who collects a prepayment greater than $1,200 more than six months in advance of services to be delivered to offer additional disclosures to clients.
This includes providing clients with an audited balance sheet of the business, along with further disclosures in your ADV about any financial condition that could impair your ability to meet contractual obligations with clients.
7. Also For RIAs—Dropping Your FINRA Series 6 and Series 7 Registration
While you probably will still need your FINRA Series 65 and 66 registrations, if you’re making the switch to fee-only planning, you’ll likely have to drop your Series 6 (mutual funds, variable annuities, 529s) and Series 7 (individual stocks, bonds, etc.) registrations.
The reason for this is that both Series 6 and 7 registrations involve the sales of primarily commission-based products, which would exclude an RIA from labeling themselves “fee-only.” This is a big decision with potential impacts to your clients’ portfolios and the solutions you offer, but a necessary one for those who desire to market themselves this way.
8. Ensure There Are No Custody Problems with Fee Collection
As financial professionals seek to serve those who traditionally couldn’t be served with financial advice, they’re also looking to new methods of fee collection. In some instances, firms are automatically charging client credit cards for recurring planning fees. Those who do so must be careful.
In some jurisdictions, having access to a credit card, along with the ability to charge it, is seen as a custody violation. Be sure to check with your state regulations on collecting fees for planning and explore other alternatives for fee billing.
9. CFP Board’s Guidelines on Fee-only Planning
Over the years, there have been numerous misuses of the label “fee-only” by CFP® professionals. As such, the CFP Board has developed strict standards for what constitutes fee-only planning. At the highest level, CFP® professionals and their firms must be compensated entirely through fees for advice with no sales-related compensation.
The CFP Board also states that “Related Parties receive no Sales-Related Compensation in connection with any Professional Services the CFP® professional or the CFP® Professional’s Firm provides to Clients.”
This means that any relationship a CFP® professional or their firm has with an entity collecting sales-related compensation would disqualify them from the fee-only label if it’s in connection with the planning services provided.
If you’re a CFP professional hoping to offer fee-only planning, it’s important to take a look at the relationships you and your firm have with other financial services providers to ensure you truly can call yourself fee-only. There is a subtle, but important, difference between “fee-based” and “fee-only.”
Making the Shift to Fee-only Financial Planning
Making a change in your pricing model can be a huge undertaking, but one that secures the future of your firm, offers greater transparency to your clients, and opens up an entirely new market for prospective clients.
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