A reader asks: “Can a series 7/66 rep who works for a regional dually registered (broker-dealer and RIA) firm claim to be fee-only, fee-based, and commission-based at the same time?”
Short Answer: No. The terms “fee-only,” “fee-and-commission” and “commission-and-fee” should be used properly. If a person claiming to be “fee-only” or the person’s firm receives material third-party compensation (in the form of commissions, 12b-1 fees, payment for shelf space, etc.), then the use of the term "fee-only" likely violates one or more federal or state securities laws or other consumer protection laws. Additionally, the term “fee-based” should never be utilized to describe an advisor, as it is inherently misleading.
The term “fee-based” apparently arose to describe “fee-based brokerage accounts” – which were permitted for nearly a decade by the SEC under the ill-fated “Merrill Lynch Rule.” The SEC’s rule was overturned in 2007 by the D.C. U.S. Court of Appeals in Financial Planning Ass’n v. SEC, as violative of the “no special compensation” requirement for brokers to be exempt from registration under the Advisers Act.
Following that 2007 decision time was permitted for brokers to change the fee-based accounts to either commission-based brokerage accounts or to investment advisory accounts. Many registered representatives (RRs) of broker-dealer firms converted the accounts to investment advisory accounts, and many of these representatives secured their Series 66 (or 65) licenses in order to be qualified to be an “investment adviser representative” (IAR).
Unfortunately, during this time the term “fee-based” became more widely used to describe the dual registrant (RR/IAR), rather than the account. Some speculate that this was in response to the marketing success fee-only advisors possessed. In particular, hundreds of thousands of consumer inquiries proceed each year through the find-an-advisor web site hosted by the National Association of Personal Financial Advisors (www.NAPFA.org), resulting in many referrals of consumers to its 2,500 or so fee-only members.
The term “fee-only” was apparently coined by NAPFA many, many years ago. Currently NAPFA’s definition of “fee-only” states: “NAPFA defines a Fee-Only financial advisor as one who is compensated solely by the client with neither the advisor nor any related party receiving compensation that is contingent on the purchase or sale of a financial product. Neither Members nor Affiliates may receive commissions, rebates, awards, finder’s fees, bonuses or other forms of compensation from others as a result of a client’s implementation of the individual’s planning recommendations. ‘Fee-offset’ arrangements, 12b-1 fees, insurance rebates or renewals and wrap fee arrangements that are transaction based are examples of compensation arrangements that do not meet the NAPFA definition of Fee-Only practice.”
In contrast, the Certified Financial Planner Board of Standards, Inc. defines a fee-only certificant (i.e., Certified Financial Planner™) as follows: “A certificant may describe his or her practice as ‘fee-only’ if, and only if, all of the certificant’s compensation from all of his or her client work comes exclusively from the clients in the form of fixed, flat, hourly, percentage or performance-based fees.” It should be noted that the CFP Board’s application of this definition takes into account the specific facts and circumstances of the certificant.
While the major online dictionaries don’t apparently yet provide a definition for “fee-only,” “The Free Dictionary by Harlex” defines “fee-only compensation” as “Payment to a financial adviser of a set hourly rate, or an agreed-upon percentage of assets under management, for a financial plan. Under this arrangement, the adviser receives no commissions on any transactions to implement the plan.”
What is the perception of consumers? This is important, because a commonly held understanding by consumers could establish a definition of the term that could result in a securities law violation if the term was misused. However, it is unclear, in my mind, whether consumers would even recognize the “fee-only” term and know what it means, the majority of the time.
But some consumers, whether through readings about fee-only advisors (consumer media writers often caution their readers to seek out “fee-only advisors”) or just through commonly accepted meanings of “fee” and “only” might achieve a understanding of the term “fee-only” in alignment with the definitions provided by either NAPFA or the CFP Board, or both.
(Of course, we must ask how many consumers can articulate the difference between a stock, a mutual fund, and a bond. A low level of financial literacy among consumers excuses neither deceit nor fraud.)
Consumer understanding is not the sole test of the proper use of a term. A commonly held use of the term “fee-only” within the securities industry itself, with dissemination of the term to consumers through marketing and promotional efforts, could also provide the foundational meaning of the term. Any subsequent misuse of the term could then be the foundation for a securities law violation.
Michael Kitces, a widely-respected financial planning industry commentator, summarized past controversies over the term “fee-only” in his recent Nerd’s Eye View blog post (found online at https://www.kitces.com/blog/9-out-of-top-10-cnbc-fee-only-advisory-firms-not-actually-fee-only-according-to-cfp-board-compensation-disclosure-rules/):
Nonetheless, the fact that the companies acknowledged the existence of the commissions and disclose them in the Form ADV means, almost by definition, these firms are not fee-only! In fact, holding out as a "fee-only" advisor while the advisor (or his/her parent firm) has a related entity that is an insurance agent is the exact issue that brought about the complaint with the CFP Board against Jeff and Kim Camarda, and the subsequent Camarda vs CFP Board lawsuit that has ensued. Similarly, an advisor holding out as being "fee-only" while working for a company with a related entity that generates commissions was what led to the resignation and subsequent public admonition of former CFP Board chair Alan Goldfarb. And after an article on this blog pointed out that under the related-party rules, any advisor working for a broker-dealer is in violation of the "fee-only" rules simply by the fact that they work there, the CFP Board had to reset the compensation disclosures on its own website after a follow-up story in Financial Planning magazine revealed hundreds were in violation of the "fee-only" disclosure rules.
As Michael Kitces’ blog also pointed out, the term “fee-only” continues to be a point of controversy and continues to snag advisors and firms, sometimes through no fault of their own. As James Dornbrook reported in the Kansas City Business Journal on June 10, 2015:
Leawood-based Creative Planning was recently named as the nation's No. 1 fee-only wealth management firm by CNBC for the second year in a row. Creative Planning didn't apply for the award. It was thrust upon the firm unknowingly, and it ended up in the national media.
Soon after CNBC announced its list, Michael Kitces, a well-known commentator and editor of the Journal of Financial Planning, skewered it by questioning whether nine of the 10 firms recognized truly have a fee-only structure. His criticism included Creative Planning, which Kitces said refers clients to insurance affiliates the firm owns, so it shares in those insurance commissions.
Creative Planning founder Peter Mallouk said that when it comes to making any types of investments, his firm is certainly impartial and fee-only, focused entirely on getting clients into the best investments that fit their risk profile and goals.
That said, Creative Planning does have affiliates that offer insurance coverage. However, most of the coverage is group coverage, such as health insurance and property and casualty insurance for businesses. The company does offer insurance policies for individuals, such as term life, health, home and auto, but the offerings do not include any insurance that could be considered an investment vehicle, such as variable life or variable annuities.
The CNBC list required that all firms be fee-only when it comes to investments. It also required that the firms on its list be able to advise on insurance because it wanted to recognize firms that offered a full suite of wealth management services. Creative Planning offers money management, financial advice, legal and tax services, and insurance. So it's got the full package and serves clients well in each area, which is why it got recognized.
Should Creative Planning and similar firms be considered a pure "fee-only" firm when only a small part of their business makes commissions on clients for insurance sales? CNBC thinks so …
It should be noted that in a 2007 state securities administrator proceeding involving an investment adviser representative who also sold insurance products, the use of the term “fee-only” was found to be misleading and violative of state securities anti-fraud laws. See IN THE MATTER OF: MICHAEL G. GRIMES; and FINANCIAL SOLUTIONS & ASSOCIATES, INC., Case No. AP-07-04 (State of Missouri, Office of the Secretary of State) (available at http://www.sos.mo.gov/securities/orders/AP-07-04a.asp). The State Securities Administrator’s sanctions were upheld on appeal to the Missouri Court of Appeals (Financial Solutions and Associates v. Carnahan (Case No. WD71332 (July 20, 2010). I provide this extended excerpt from the appellate decision:
At the time of the investigation, Grimes [licensed as an insurance agent, not as an investment adviser representative] was acting as a solicitor for Barrington and had his own business, FSI. Grimes was licensed to sell life insurance, variable contracts, accident, and health insurance coverage. Barrington was a federally covered investment adviser. Between March 31, 2005, and June 30, 2006, Grimes received over $150,000 in compensation from Barrington. FSI's website, maintained by Grimes, contained a section called “Fee-Only Planner.” That section clearly stated:
“[FSI] is a fee-only planning firm committed to assisting client[s] to reach their financial goals. Fee only planners, like us, are compensated solely by fees paid by their clients and do not accept commissions or compensation from any other source.”
“The main difference between a Stockbroker and us is that they make a living by charging their clients commissions.”
“We do not earn any money from commissions, trailers, or markups.”
At the hearing before the Commissioner, Janet Ellingson, an account manager for LiveOffice, who Grimes used to build and house his website, testified that when Grimes gave the information for his initial questionnaire, he stated that he was a fee-only investment advisor. Grimes testified that it was his responsibility, knowing what licenses they had, to build the site and select the proper pages that would equal the services they were licensed to offer. Grimes also admitted that he was a solicitor for Barrington at the same time he maintained his website and would receive 60% of the management fee that Barrington received when they managed the clients Grimes brought to them.
After a review of the record on appeal, particularly the evidence presented regarding the website and the commissions the Appellants received at the same time the website proclaimed they were “fee-only,” we conclude the Commission's finding is supported by competent and substantial evidence.
Moreover, to the extent Grimes contends that the Commissioner erred in finding the statements constitute fraud or deceit under § 409.5-502(a), that argument also fails … “[i]t is recognized in Missouri, as well as generally, that the primary purpose of legislation similar to that of the Missouri Uniform Securities Act is that of protecting the buyers of securities.” Garbo v. Hilleary Franchise Sys., Inc., 479 S.W.2d 491, 499 (Mo.App.E.D.1972) (internal quotation and asterisks omitted). To fulfill that purpose, we “embod[y] a flexible rather than a static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”Id. (internal quotation omitted). As noted supra, under § 409.5-502(a):
It is unlawful for a person that advises others for compensation, either directly or indirectly or through publications or writings, as to the value of securities or the advisability of investing in, purchasing, or selling securities or that, for compensation and as part of a regular business, issues or promulgates analyses or reports relating to securities: (1) To employ a device, scheme, or artifice to defraud another person; or (2) To engage in an act, practice, or course of business that operates or would operate as a fraud or deceit upon another person.
The Appellants contend that fraud and deceit under the Missouri Securities Act require the making of a false or misleading statement of material fact, or the failure to disclose a material fact necessary to avoid making another statement not misleading. They contend that the statements from FSI's website do not meet this definition. Fraud and deceit are not defined in the Missouri Securities Act. However, the terms “ ‘[f]raud,” “deceit,” and “defraud” are not limited to common law deceit.” § 409.1-102(9).
When interpreting the meaning of words used in the Missouri Securities Act, we look to other states' interpretations of their securities law as well as federal interpretations. Moses, 186 S.W.3d at 904 (“Missouri courts have often looked to cases decided by courts from other jurisdictions to aid in comprehending the definitional limitations of the Act, particularly when the language of the federal and state securities statutes involved is nearly identical.”); State v. Dumke, 901 S.W.2d 100, 102 (Mo.App.W.D.1995) (“[W]hen construing uniform acts, it must be remembered that the fundamental purpose of a uniform law is to eliminate uncertainty and provide plain and certain the controlling rules of law. It is fitting, therefore, to turn to our sister jurisdictions and examine their solutions to the problem.” (Internal citation and quotation omitted)).
Similar to federal securities legislation, Missouri securities legislation makes it unlawful for persons to engage in practices or a course of business that “operates or would operate as fraud or deceit.” § 409.5-502(a) (emphasis added); cf. 17 C.F.R. § 240.10b-5(c). This language “quite plainly focuses upon the effect of particular conduct on members of the investing public, rather than upon the culpability of the person responsible.” Aaron v. Sec. & Exch. Comm'n, 446 U.S. 680, 697, 100 S.Ct. 1945, 1955, 64 L.Ed.2d 611 (1980). This same approach has been followed in other states, as these states have also relied on the Aaron decision. See, e.g., Secretary of State v. Tretiak, 22 P.3d 1134, 1141 (Nev.2001).
Moreover, when a definition is not present in the statute, “the plain and ordinary meaning is derived from the dictionary.” Cox v. Dir. Of Revenue, 98 S.W.3d 548, 550 (Mo. banc 2003). “Fraud” is defined as “[a] knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment.” Black's Law Dictionary 731 (9 th ed.2009). “Deceit” is defined as “[t]he act of intentionally giving a false impression.” Id. at 465. It is also defined as “[a] false statement of fact made by a person knowingly or recklessly with the intent that someone else will act upon it.” Id. The evidence presented in the record on appeal demonstrates that the FSI website's language meets these definitions.
The Commissioner did not err in determining that Grimes's statements on the FSI website constituted fraud or deceit under the Missouri Securities Act. The Commissioner's decision is in line with other state and federal decisions and meets the definitions given to these terms. We attempt to construe the Missouri Securities Act in a manner that is consistent with the Commissioner's interpretation, Moses, 186 S.W.3d at 899, and we do not find that the Commissioner's interpretation was unreasonable or arbitrary. Point denied.
The Commissioner's decision finding that Appellants engaged in an act, practice, or course of business that operated as fraud or deceit upon persons under § 409.5-502(a) is affirmed.
As seen, representations regarding “fee-only” by a person who does not meet the generally accepted definition of that term (whether such definition is promulgated by industry organizations or has achieved more widespread use in the public jargon) is likely to constitute “fraud” or “deceit” under federal and state securities laws.
Permit me to offer my own opinion as to the likelihood of organizational rules or securities / insurance law violations. Of course, each situation is fact-specific; nevertheless, some general legal conclusions can be offered.
If a Certified Financial Planner™ or her/his firm receives any commission-based compensation, 12b-1 fees, or other material third-party compensation, and the certificant uses the term “fee-only” (either on the CFP Board’s find-an-advisor web site, or in any other marketing or promotional materials, or verbally) to describe either: (1) the certificant; (2) the nature of the certificant’s practice; or (3) the nature of her or his firm, then the certificant has probably violated the CFP Board’s rules. If you, the reader, spot such occurring, I would urge you to first contact the certificant, suggest that she or he review the CFP Board’s rules, and permit a reasonable time for corrective action to occur. The appropriate characterization of the practice and/or the advisor and/or the firm should be either “fee-and-commission” or “commission-and-fee” (depending upon which predominates, as a percentage of total revenue). If corrective action by the certificant or the certificant’s firm does not occur, I would urge the reader to file a written complaint with the CFP Board about the certificant.
Regardless of whether the dual registrant (RR/IAR), or perhaps an IAR with an insurance license, possesses status as a CFP®, another issue is whether fraud is occurring under the federal or state securities laws, or common law fraud occurs under state common law. Given the long-standing use of the term “fee-only” within the industry, by both NAPFA and the CFP Board, and given that a significant minority of consumers would likely understand the term “fee-only” as connoting arrangements other than third-party compensation, I would opine that the use of the term “fee-only” would be fraudulent to describe the individual Series 65/66 license holder if that license holder received third-party compensation (such as commissions, 12b-1 fees, etc.).
If the advisor is a registered representative, then FINRA Rule 2210(d)(1)(B) prohibits a firm from making any false, exaggerated, unwarranted or misleading statement or claim in any communication, and prohibits the publication, circulation or distribution of any communication that the firm knows or has reason to know contains any untrue statement of a material fact or is otherwise false or misleading. I would opine that the inappropriate use of the term “fee-only” by a registered representative who also receives commissions or other material third-party compensation, whether from sales of securities or insurance products, is not “fee-only” and that any use of the term “fee-only” would likely violate of FINRA Rule 2210(d)(1)(B). Again, I would urge the reader to contact the registered representative and or her/his firm, and seek that they undertake corrective action within a reasonable period of time. If appropriate action is not appropriately undertaken, I would urge the reader to file a written complaint with FINRA.
If the advisor is not a registered representative, but holds as Series 65/66 license and an insurance licenses, and if the advisor inappropriately use of the term “fee-only” due to receipt of commissions or other material third-party compensation from insurance products, whether through the same firm or through an affiliated insurance firm or even a non-affiliated insurance agency, then I would opine that the advisor is again not “fee-only.” I would note that any use of the term “fee-only” would likely be considered an “advertisement” (any communication addressed to more than one person that offers any investment advisory service with regard to securities) under “the Advertising Rule” — Rule 206(4)-1). Note that an advertisement could include both a written publication (such as a website, newsletter or marketing brochure) as well as oral communications. Under the Advisers Act, advertising must not be false or misleading and must not contain any untrue statement of a material fact. Regardless of whether an “advertisement” exists, all statements made to advisory clients and prospective clients, is subject to the general prohibition on fraud (Section 206 as well as other anti-fraud provisions under the federal securities laws). Again, I would opine that it is likely that a Sect. 206 violation has taken place. I would urge the reader to contact the investment adviser representative and or her/his firm, and seek that they undertake corrective action within a reasonable period of time. If appropriate action is not appropriately undertaken, I would urge the reader to file a written complaint with either the SEC (if the advisor’s firm is registered with the SEC) or with the home state of the advisor’s firm (if the advisor’s firm is not “SEC-registered”).
If the advisor is only an insurance agent, and advertises as a “fee-only” financial or investment advisor, then violations of the anti-fraud provisions of state insurance laws, and/or state consumer laws against unfair or deceptive practices, may have occurred. While this will depend upon that state’s laws, again I would urge the reader to seek corrective action by contacting the insurance agent first, then if correction action is not timely undertaken then filing an appropriate report with either the state insurance commissioner’s office, or the state trade commission, or both.
I believe the term "fee-based" to describe an advisor is intentionally misleading, when utilized. Where both fee revenue (AUM, fixed fees, hourly fees) or commissions (or other third-party compensation) is received, an advisor is properly characterized as either "fee-and-commission-based" or "commission-and-fee-based," depending upon where the majority of the revenue of the advisor is derived. The omission of "and-commission" in either instance, an attempt to obfuscate and gain the consumer's trust inappropriately, and hence in my view constitutes deceit under federal and state securities laws.
These are my conclusions only. Again, these conclusions are based upon the general understanding of the law, and varying sets of facts might lead, in particular cases, to different results. Additionally, while one reported decision exists as to the use of the term “fee-only,” other decisions may exist, and/or new cases may arise, which result in different decisions. Nevertheless, I would caution that only advisors which meet the definition of “fee-only” use that term to describe themselves in any communications with any client or any group of clients, or in any other communication.