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3 issues in disclosure of conflicts of interest and compensation
By David Mannaioni
For the past few years, I have presented as part of CFP Board’s ethics continuing education program, including most recently at NAPFA’s spring and fall conferences. For the most part, the training is what one would expect from a required course on ethics— treat your client fairly, remember to fulfill your fiduciary duty, and comply with the Code and Standards and rules your firm may have in place.
However, the new expectations from CFP Board on conflicts of interest and compensation disclosure consistently generate conversation and questions in my presentations. On the surface, it seems simple: When a conflict of interest arises, it is the CFP® professional’s duty to disclose the conflict and obtain informed consent from the client. But it’s not so easy when we look at real-world situations. And it’s become a little more complicated due to the new guidelines that include the expectation that the conflict must also be managed the way a fiduciary should manage it—in the best interest of the client. While planners operating as fiduciaries may have already been doing this, CFP Board emphasizes this in the latest version of its ethics course.
Disclosing conflicts of interest: an example
Consider a client approaching retirement age who asks about investing in a REIT, which is the topic of a case study in CFP Board’s ethics training course. To invest in the REIT, the client would need to liquidate investment assets the CFP® professional currently manages and from which she is earning a fee. The compensation from the purchase of the REIT would be less than what she is currently earning. The case study asks what the CFP® professional should do.
The answer, of course, is that this situation creates a conflict of interest so the CFP® professional must make full disclosure of the conflict to the client and obtain the client’s consent before or when making any recommendations. Furthermore, she needs to manage the conflict in the client’s best interest. While evidence of oral disclosure may be adequate, a best practice would be to document this in writing, either in a memo or as a note in the customer relationship management system.
Use of “fee-only” versus other terms
Another compensation-related topic that sometimes arises in my presentations involves the terms “fee-only,” “fee-based,” and “commission and fee.” Of course, NAPFA members don’t accept commissions, but you may be interested in how your commission-accepting colleagues are supposed to handle this.
CFP Board is neutral on which method of compensation a planner chooses for their business, but it is very clear that clients need to clearly understand their planner’s compensation model. Because “fee-only” and “fee-based” sound a lot alike, they can confuse a client who really doesn’t know the difference. CFP Board’s stance is that a planner can use the term “fee-based” as long as they explain that the client is charged fees (e.g., AUM fees) and commissions (e.g., front-end loads on mutual funds). For this reason, I instruct planners that it is best to avoid using the term “fee-based” and instead use “commissions and fees” to differentiate from “fee-only.”
Most compensation as a conflict of interest
Compensation is almost always a conflict of interest, and therefore it must be disclosed, informed consent must be obtained, and the conflict must be managed in the client’s best interest. Fee-only planners generally take care of this at the outset of the client relationship and then every year upon renewal of the engagement. Planners using the commission-and-fee compensation model and commission-only planners will have conflicts every time they help a client purchase a financial product that helps them reach their goals and generates income for the planner. Accordingly, they must disclose these conflicts at each transaction.
In my own small planning practice, I operate as a commission-and-fee planner. As such, I share exactly how much a transaction is going to cost the client and how much goes to the product provider, to my firm, and to me whenever a fee or commission will be charged to the client. This is the “disclose and obtain informed consent” part of the expectation. The disclosure of the conflict needs to be presented so the client clearly understands the conflict and can give informed consent or object. In all my years of planning, not one client has ever objected to me being compensated for helping them reach their goals. I’m sure the same is true for you.
But, if a client ever objects to me being paid for the work I do, they may not be the kind of client I want. At that point I would probably quote Val Kilmer as Doc Holliday in Tombstone and say, “It appears we must redefine the nature of our association.”
Why ethics matter
In one of the classes I teach at the College for Financial Planning, I explain how noble the work we do is and that without us, people will likely do all the wrong things. They’ll buy high and sell low. They’ll have too much or not enough insurance or maybe even the wrong kind. And they won’t take care so that everything they worked so hard to build up over their lifetime is passed along the way they want it to be. Without competent financial advice, it is unlikely people will reach their financial goals.
And that is why doing business with high ethical standards is so important. A competent financial planner who discloses conflicts of interest when they arise, obtains the client’s informed consent, and then manages that conflict going forward in the client’s best interest is rising to the high calling we have as CERTIFIED FINANCIAL PLANNER™ professionals and as fiduciaries.
David Mannaioni, CFP®, MPASSM, is the dean of academic programs and a professor at the College for Financial Planning. Contact him at firstname.lastname@example.org.
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