Fee-Only Financial Advisor | Fee-Based Advice Boston

Financial Advisor

Having been a financial advisor and financial planner for over thirty years, I have witnessed many financial advisors’ changing compensation structure. For example, according to a review of their financial situations, most personal financial advisors were paid commissions from selling a financial product or investment when I started.

Fee-Based Advice

About midway through my career, the compensation in the marketplace began changing. More and more advisors began moving to a fee-based or fee-only financial planning compensation arrangement. So, instead of charging commissions from the sale of an investment, life insurance, or some other financial product, the financial advisor usually charges an ongoing fee, a percentage of the client’s investment for financial planning services.

The hope is that by disconnecting the compensation from the product or services, the client would receive better advice. However, another concern was that the planners were less inclined to provide ongoing advice and services when compensated from an initial product sale.

Regulation of Financial Advisors

Three federal acts regulate financial advisors: The first is the Securities Exchange Act of 1934, the second is the Investment Advisers Act of 1940, and the third is the 1974 retirement protection law called ERISA. The 1934 act regulates broker-dealers, the 1940 act regulates investment advisers, and ERISA governs retirement plans. (State laws also regulate them, and most insurance products are regulated at the state level.)

A broker-dealer (B/D) is a firm that buys and sells securities, operating as both a broker and a dealer, depending on the transaction. Fidelity, Charles Schwab, and TD Ameritrade are the three largest B/Ds. In addition, many regional and independent B/Ds exist, such as LPL Financial, Ameriprise, Cambridge Investment Research (my broker-dealer), and Raymond James. 

Their advisors are called registered representatives, who are usually paid a commission for selling financial products. They are not fiduciaries, but they are required to sell their clients a suitable product. 

Investment advisers are an alternative to broker-dealers. Moreover, investment advisers are fiduciaries. They have a different business model regulated under the 40 Act than that of B/Ds. They are usually paid fees as compensation, as opposed to commissions.  

Fee-Only Financial Planner

Around the time advisors were switching to fee-based, the financial industry began embracing personal computers. As a result, some firms started charging clients fees to develop a comprehensive financial plan. First, the client filled out a lengthy questionnaire. Second, the financial planner inputted the data into a software program and then printed the client’s financial plan, usually presented in a fancy binder. 

Most plans presumably ended up in the filing cabinets of clients, recalling President Eisenhower’s line about plans: ‘I have always found that plans are useless in preparing for battle, but planning is indispensable.’

Also, after paying a fee for the plan, some firms would then implement the plan’s recommendations using commission proprietary products, acting as a fiduciary under the Advisers Act but as a registered representative under the Securities Act or, more importantly, acting as a fiduciary while developing, but not while implementing, the plan.

Fee-Only Financial Advisors

In 2015, the U.S. Department of Labor proposed the so-called Fiduciary Rule, which aimed to reduce or eliminate conflicts of interest in retirement plans, rollovers of retirement plans, and IRAs. As a result, most financial advisors who work with these plans must be a fiduciary and receive only level compensation for their services. 

A fiduciary has a legal requirement to act in good faith, requiring advisors to reduce and disclose all conflicts of interest when providing council. Level compensation meant the advisor received the same compensation no matter the product.

Supporters claimed that rules about IRAs needed updating. In 1974, when Congress wrote the current rules, nobody contemplated the amount of money moving into IRAs. Cerulli Associates, a Boston-based research firm, estimates that individuals willroll over $2.1 trillion from 401(k)s into IRAs.

The Department of Labor was the point agency because they oversaw the Employee Retirement Income Security Act (ERISA). Most IRAs, however, are not regulated by ERISA; instead, they fall under the jurisdiction of the Internal Revenue Service (IRS). But the IRS uses the DOL’s definition of ‘investment advice,’ so IRAs most likely will get covered if the government prevails. 

The 2015 rule as proposed was never fully implemented. Instead, it got bogged down in legal challenges. The 5th Circuit Court of Appeals ruled in 2018 that the DOL had overstepped its bounds in creating the so-called Fiduciary Rule, parts of which had gone into effect the year before.

There was talk that the SEC and/or FINRA, both of whom regulate advisors and brokers, would pick up the ball from the DOL to implement a retirement advice rule. Because they regulate brokers and advisors, some think these organizations are better suited than the DOL, which governs retirement plans to apply a new standard.

What’s the Difference Between a Financial Advisor and a Financial Planner?

There is no financial planner in the regulations. Instead, there are investment advisor representatives and registered representatives. ‘Financial planner’ is more of an industry term for someone who looks at your entire financial picture. Some financial planners are fiduciaries, and others are not. Some charge a fee, some are compensated through a commission, and some receive both.

A private organization offers a designation certified financial planner. Since 2018, all holders of that designation are required by the organization to be fiduciary. But the 40 Act determines if someone is acting as a fiduciary, so the organization requires that anyone who wants to hold that designation be willing to fall under the 40 Act.

There is also an organization called the National Association of Personal Financial Advisors (NAPFA), a directory where you can find a fee-only advisor in your area. Financial advisors pay annual dues of $249 to belong to NAPFA, plus a one-time, non-refundable processing fee.

Fee-Only Financial Advisors

The Dodd-Frank law emerged from the 2008 financial crisis. Its main objective was to shore up the banking system so we wouldn’t have another situation like in 2008 when the failing banking system put the world economy at risk.

Dodd-Frank, however, also tasked the SEC with studying whether changes needed to be made to the rules regulating financial advisors. The goal was to ensure the public was benefiting from having two silos’ commissions and fees and if it behooved brokers to become more like investment advisors (fiduciaries).

After much discussion, the SEC promulgated a new rule, Regulation Best Interest, primarily impacting B/Ds. The rule requires them to reduce and disclose conflicts of interest while working in the best interests of their clients. It, however, does not require that they become fiduciaries but moves them very close to that responsibility.

Remember, financial advisors are either registered representatives affiliated with B/Ds or investment advisor representatives working for investment advisors. I am dual-registered—that is, I am a registered representative of a B/D and an investment advisor representative of an investment advisor.

The New Rule from the SEC

Beginning June 30, 2020, B/Ds began operating under that new Regulation Best Interest standard. This requires them to better align their product recommendations and services with their clients’ best interests by eliminating conflicts of interest, such as proprietary product requirements, sales quotas, or sales contests.

Registered representatives will now be called financial professionals. Any advisors who are fiduciaries can continue calling themselves financial advisors. Some critics complain that the new standard does not meet the uniform standard’s original intent.

New Fiduciary Rule

Finally, however, to many people’s surprise, President Trump’s Department of Labor, run by Eugene Scalia, Supreme Court Justice Antonin Scalia’s son, implemented the Fiduciary Rule.

They removed some of the more demanding requirements and possible legal challenges provided to clients. Still, they kept the core tenant that financial advisors advising retirement plans and participants are fiduciaries. Most advisors, when recommending a client roll over their retirement account to an IRA, are also fiduciaries.

Remember, the Rule applies only to private-sector retirement plans, such as 401(k)s, SEPs, SIMPLEs, and 403(b) plans under ERISA. The 403(b) plans of public employees, such as teachers, are not covered by ERISA, so they are not subject to the new law. It only applies to them if they decide to roll over their 403(b) to an IRA. Roths, traditional, and rollover IRAs fall under the new rules.

The Obama administration believed the Rule was needed because conflicts of interest caused 401(k) participants and IRA owners to pay higher financial advisor fees, resulting in smaller account balances.

What do I mean by ‘conflicts of interest’? For example, some firms paid their advisors bonuses and benefits if the financial advisors sold that firm’s proprietary products. This is no surprise, but it is surprising that these conflicts go on with retirement plans—given that ERISA forbids conflicts of interest.

But ERISA stipulated that the prohibition against conflicts applied only on five conditions:

1. The financial advisor must render advice as to the value of securities or other property;
2. The advisor must do so regularly;
3. The advisor must do so under an agreement with the client;
4. That advice will serve as a primary basis for the client’s investment decisions; and
5. The advice is to be based on the particular needs of the investment or retirement plan.

The advice must be given regularly and must be the primary basis for the client’s investment decisions. The DOL believes it allowed financial advisors with conflicts of interest to provide advice without violating ERISA’s prohibition.

Plus, the DOL felt that the 1974 exemptions were put in place when there was no such thing as an IRA or a 401(k), and companies invested the retirement money for their employees. However, now that individuals are responsible for their own investment decisions, new rules are needed.

For example, the DOL believes people are rolling over their 401(k)s into IRAs when it would cost them less if they remained in the 401(k). Moreover, under the old rules, rollover advice never fell under ERISA guidelines because the rollover happened once.

So, the new fiduciary rule reinterprets the five-part test so that now more financial professionals fall under the ERISA standard of who is a fiduciary. It also removed a previous ruling that rollover advice was not fiduciary advice. Instead, it requires that any advisor falling under these standards work in your best interest, including when they recommend a rollover.