The Murky Waters of “Fee-Only” Advisors and Commissions
Posted by fi360 Team on September 11, 2013
>>>>In today’s financial marketplace, how a “fee-only” advisor is defined has become somewhat of a hot topic. (Read a recent Investment News article here.) Given the high variance that can be found in scope of services, types of affiliations, and compensation arrangements, we’re seeing loose interpretations of the term.
We relate this issue back to Practice 1.4 (The Investment Advisor identifies conflicts of interest and addresses conflicts in a manner consistent with the duty of loyalty) and Criteria 1.4.4 (When an unavoidable conflict of interest exists, the conflict is explained and informed written consent is obtained from the client). Under that context, conflicts must be clear and the advisor should receive an acknowledgement, or even a waiver, demonstrating the client is fully aware of and understands the conflicts, and agrees to proceed in spite of the conflicts.
The situation described below demonstrates how ambiguity – especially when fees and commissions are concerned – can be a dangerous thing.
The Set-Up
An investment advisory firm describes itself as “fee-only” on its Form ADV. The firm’s owner is also the sole owner of a licensed insurance agency with a different name. Agents from the fee-only RIA can receive commissions from the sale of recommended insurance products, necessary for risk management, from this insurance company.
These commissions are fully disclosed by the RIA in the ADV, and they are in addition to the fees charged for investment services. They are also disclosed verbally, at the time of the purchase of the insurance products. The client has the option to go wherever he wants to purchase the insurance products, thereby fulfilling his risk management needs. He can also purchase the insurance through the fee-only firm.
Should this firm be claiming “fee-only” status on its Form ADV?
The Firm’s Take
When a client is interested in purchasing an insurance product, the agent tells the client that the product may be purchased from whomever the client chooses. The agent then inquires if the client has someone from an agency with whom they would like to work. If not, the affiliated insurance company is suggested. The agent informs the client that this purchase will generate a commission, separate from advisory fees, for the agent. Though this generates a conflict of interest for the agent, it is managed by full disclosure to the client.
fi360’s Take
When the firm’s owner became affiliated with the licensed insurance agency, the owner created a conflict of interest by offering clients a product from which the owner received, directly or indirectly, a commission. Though this conflict can be managed by disclosure, it could have been avoided completely. We believe that by choosing to receive both fees and commissions for services, the owner should not describe the firm as “fee-only.”
Furthermore, if the advisor in question is a CFP® certificant or member of NAPFA, they are subject to related professional guidelines. A CFP Board webinar earlier this month focused on the differences in how CFP Board and NAPFA define “fee-only.” NAPFA permits members to hold ownership stakes of less than 2% in broker-dealers, banks, or other financial institutions. The owner in our example above does not meet the NAPFA requirement. CFP Board’s definition is even narrower; certificants may not call themselves “fee-only” if their employers or any other “related parties” receive commission income at all. Our owner doesn’t pass muster here either. Even if these affiliations do not apply, the guidelines are helpful as a source of best practices.
Our owner made an intentional choice to become involved with an insurance agency. Undoubtedly, one of the incentives in taking this step was to become eligible to receive commission income from the sale of insurance products, and not to remain purely “fee-only.”
An Alternative
In our opinion there are ways to properly use the “fee-only” descriptor if the advisor wants to ‘broker’ or sell insurance products in his investment planning program. The advisor could have helped the clients obtain the insurance policies by negotiating on their behalf, or assisting them in selecting the coverage. For this activity, the advisor could charge additional fees and still rightfully label him or herself ‘fee-only’.
