At the heart of the confusion: disagreement over what signifies proper use of such common terms in the business as "fee-only" and "fee-based"—and whether some advisers and broker-dealers are forthright enough in their disclosures to clients about their compensation.
Generally speaking, the term "fee-only" means that an adviser charges a flat fee or percentage of assets under management annually, an hourly fee or a fee per task. A fee-only adviser might charge 1% of the assets he or she advises on per year, for example.
The term "fee-based," meanwhile, has been adopted by many brokers amid defections of many clients from brokers to registered investment advisers, a flight driven by a perception that RIAs have fewer conflicts of interest than brokers because brokers are paid per transaction, and thus have an incentive to sell products. Fee-based, by industry standards, means the brokers charge a fee in addition to collecting commissions.
Fee Checking
But some in the industry say the term "fee-based" is trying to ride on the "fee-only" coattails, and should be replaced by "fee and commission." They believe "fee and commission" more clearly describes these brokers, who commonly charge commissions on transactions they perform for clients.
"There's been a perpetuation of this notion that fee-only is superior so people are trying to get on that bandwagon," says Kevin Keller, chief executive of the Certified Financial Planner Board of Standards. "That's why the public is confused between 'fee-only' and 'fee-based.' … We believe that 'commission and fee' is a more accurate and understandable term than 'fee-based.' "
The confusion isn't just confined to compensation. In addition, many investors don't understand how their advisers are regulated, an issue that affects whether the adviser is legally required to work in the client's best interest—known as being a fiduciary—and must divulge everything about his or her compensation.
The term "investment adviser" refers to an individual or firm that gives investment advice and perhaps manages a portfolio of investments for clients. Investment advisers operate under a fiduciary duty, requiring them to disclose conflicts of interest and costs to clients. They must register with the Securities and Exchange Commission unless they manage less than $100 million, in which case they must register with a state securities agency.
Not Fiduciaries
In contrast, broker-dealers, businesses that buy and sell securities and that may also give investment advice, are primarily overseen by the Financial Industry Regulatory Authority. Brokers don't operate under a fiduciary duty, except within a few states. As a result, while many are required to ensure that their investment recommendations are suitable for the client, they needn't divulge all compensation arrangements and conflicts of interest.
Broker-dealers are required under certain circumstances, such as when making a recommendation, to disclose material conflicts of interest to their customers, in some cases when a transaction is completed. In addition, federal securities laws and Finra restrict broker-dealers from participating in certain transactions that may present acute potential conflicts of interest.
But even investors who grasp these nuances may be hard-pressed in practice to distinguish between RIAs and brokers. Consider that many fee-only RIAs also have licenses that permit them to receive commissions through a broker-dealer. Such individuals are registered with the SEC and overseen by Finra as a broker. They fall under the fiduciary standard when giving advice, and Finra's rules when doing commission work. It's enough to make an investor's head spin.
"It's really confusing," says Sophie Schmitt, senior analyst on the team that researches wealth management at Aite Group, a Boston research firm. "An adviser might say they're an RIA, but perhaps they're working for a broker-dealer and mostly doing work through the RIA—10% to 20% of their business might be commission."
Industry Squabble
Differences over what it means to be a "fee-only" adviser are at the center of a very public industry squabble.
The National Association of Personal Financial Advisors, an association of fee-only financial advisers, describes fee-only advisers as those who are compensated solely by the client, with neither the adviser nor any related party receiving compensation contingent on the purchase or sale of a financial product. But it does permit its members to own up to a 2% stake in a financial-services company, even one that receives transaction-based compensation.
The CFP Board of Standards, meanwhile, stipulates that advisers may not use the term "fee-only" if they're affiliated with a broker or insurer that charges commissions—even if the adviser doesn't charge a commission. If the adviser has such an arrangement, he or she must describe his compensation as "commission and fee," the board says.
The CFP Board last year found that Alan Goldfarb, its then-chairman, had violated its rules on these issues. Mr. Goldfarb resigned in November 2012, and in June a board disciplinary panel issued a letter of admonition against him. The problem in the board's view was that the accounting firm that owned Mr. Goldfarb's RIA firm also owned a broker-dealer subsidiary, in which Mr. Goldfarb had an ownership interest. Mr. Goldfarb, the accounting firm that employed him and its broker-dealer subsidiary could potentially receive commissions related to his clients, the board found.
Mr. Goldfarb rejects the board's finding. In an interview, he says that the board alleged he made a misrepresentation, and that he and his attorneys were using the definition of "fee only" as they understood it. He says it was inappropriate for the CFP Board to sanction anyone until the definition is cleared up.
The CFP Board says that its rules are clear, and that it's up to each professional to understand them.
Claims and Counterclaims
Meanwhile, in a similar case, a Florida adviser and his wife, both certified financial planners, in June filed a lawsuit against the CFP Board over a disciplinary case the board brought against them in 2011. Jeffrey Camarda, chairman of Camarda Wealth Advisory Group in Fleming Island, Fla., and his wife, Kimberly, the firm's president, described their compensation as fee-only when they also owned Camarda Consultants, a commission-based insurance agency, which the CFP Board asserts is a violation of its rules. The advisory group and the insurance agency had a "mutual referral fee arrangement," the board found.
The Camardas appealed, but the CFP Board found against them.
In their lawsuit, filed in District of Columbia District Court, Washington, D.C., the Camardas claim that the board failed to present or consider any evidence as to whether Camarda Advisors or Camarda Consultants were separate entities and whether any clients of the advisory or the insurance agency were misled.
They charge also that the CFB Board ignored its own governing rules and fashioned its own definition of a fee-only adviser, relying on outdated rules.
The CFP Board denies that Camarda Advisors and Camarda Consultants are functionally separate entities and that it failed to present or consider any evidence as to whether they were and whether any clients were misled. It also denies that it ignored its own governing rules and fashioned its own definition of a fee-only adviser.
Mr. Keller, the board chief executive, says he can't comment on the case.
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