~ or What Other Advisors Don’t Want You to Ask ~
In order to provide financial planning services, planners or their firms must be registered with either their state or the SEC as a Registered Investment Advisor (RIA). Because regulators want all financial planning advice to be objective, anyone claiming to be providing financial planning services must be registered as an RIA and is held to a Fiduciary Standard for those services.
This means that all of us are required to act solely in the best interest of our clients, even if that interest is in conflict with our own financial interest. RIAs must disclose any conflict of interest, or any potential conflict of interest, to our clients before and throughout a business engagement.
This includes making a full disclosure of all compensation received, both the amount and the source. This includes not only asset management fees or financial planning fees, but any form of commission, any “soft-dollar” arrangements, or any special incentives to recommend one product or service over another.
In order to use the term, fee-only, an RIA cannot accept any compensation that does not come directly from the client for services provided. This means no referral fees from third parties, no upfront, back-end, or 12b-1(mutual fund marketing) fees, no insurance or annuity commissions, no award trips, or any other material or significant incentives.
It also means that RIAs who describe themselves as fee-only must adhere to this standard for all services provided to all clients. You can’t be fee-only with one financial planning client and collect commissions from another.
Fee-Based or Dually-Registered Advisors
When advisors describe themselves as fee-based, it means that some of their compensation comes directly from their clients as fees, but not all. They still sell financial products to their clients for commission or accept referral fees to refer their clients to other professionals.
Many RIAs are also registered as a broker or registered representative with a broker-dealer. These dually-registered advisors are held to a fiduciary standard while providing financial planning services, but once they switch hats to being an employee of their broker-dealer, they are only held to the much lower “sales suitability” standard of conduct.
A typical scenario sees the dually-registered advisor prepare a financial plan for a client as an RIA fiduciary, but when it comes to discussing which investments to use, the advisor becomes a salesperson for their securities employer. Broker-dealers must disclose that they and their salespeople are not necessarily acting in your best interest. In fact, the SEC requires them to add the following disclosure to your client agreement:
“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you including the extent of our obligations to disclose conflicts of interest and to act in your best interest [these are much more limited than the fiduciary standard described above]. We are paid both by you and, sometimes by people who compensate us based on what you buy. Therefore, our profits and our salespersons’ compensation may vary by product and over time.”
In fact, when advisors are functioning as salespeople, they are required to act in the best interest of their employer, not yours.
Three Ways to Distinguish Fee-Based From True Fee-Only Advisors
- If the client agreement has the SEC disclaimer language above, you are not working with a fee-only advisor.
- If the advisor’s business card or web site has the term, “securities offered by XYZ, a broker-dealer”, you are not working with a fee-only advisor.
- If your advisor is a member of the National Association of Personal Financial Planners (NAPFA), then you can rest assured that your advisor is a true fee-only advisor who is required to sign a fiduciary oath annually as a condition of membership.