This is the final piece of a four-part blog mini-series where I discuss the current and future status of financial services (and financial planning) as a profession. Briefly, the first three parts discussed:
Part 1 - financial services is not a profession
Part 2 - financial planning is not a profession
Part 3 - recent events that impede both from becoming a profession
In this post, I outline a reorganization and reorientation of financial services. Out of the ashes of a failed status quo arises a financial planning profession. This will require radical shift in how we as practitioners present ourselves to the public, how we are regulated, and the services we provide.
The Road to Professionhood
This deep, systemic problem within financial services requires infrastructural change—a complete recharacterization of various roles, responsibilities, and remunerations. The current system contains the SEC as the regulator for financial advisors, and financial planners (a subset of financial advisors) may choose to become CFPs and join the FPA. Obtaining the CFP marks and seeking membership within the FPA are also mutually exclusive—an advisor may become affiliated with one, both, or neither.
Note: This scheme is overly simplistic since advisors who manage assets less than $25 million must register with their state’s securities board, and advisors may choose between the state and the SEC when managing assets between $25 million and $100 million. Advisors must register with the SEC if they manage over $100 million. Presently, the SEC also regulates products themselves unless they are not securities, with some exceptions. I do not wish to go into these, but suffice to say they exist. In fact, financial advisors must pass an entire examination on federally-versus-non-federally covered securities.
In addition to the issues discussed above, there are several problems with this taxonomy. Little, if any, differentiation exists between client-facing and non-client-facing advisors and planners. Persons who operate trade desks, for example, often deal exclusively with advisors and other licensed individuals who are not considered members of the general public. Should these trade desk operators require licensure and, if so, should they obtain the same certification that client-facing advisors do? Also, should the same entity regulate every aspect of the industry? This has been the case for the better part of a century, and some would argue it hasn’t worked out with the lack of ability to identify systemic risk, which caused (or at least contributed to) the 2008 global meltdown as well as failing to stop Bernard Madoff from absconding with $65 billion over 20 years, at least 10 of which, on an annual basis, the SEC was warned that something was awry.
Deep, infrastructural change must occur if the financial industry ever hopes to rise to the level of a profession. In Figure 1 below, I introduce the triangle of financial services of which financial planning occupies one section: “advice.” Spoiler: That is the opportunity zone for planners to elevate themselves to a profession. The other two sections are products and sales. I now discuss each section of the triangle in turn.
Figure 1. The Financial Services Triangle
Products
Investment and other products must be created to satisfy consumers’ financial goals, wants, and needs. Most issues within financial services that prevent financial planning from elevating to the status of profession are investment-related. Financial planners advise clients on many different subjects, from budgeting to retirement to risk management to estate issues. Products constitute the backbone of solutions to help clients reach their financial goals. Technically speaking, a checking account is a product as is a life insurance policy or a living trust. Products must meet regulatory specifications and are structured to meet client needs. Within my model above, developers of products would be responsible for creating products and ensuring that they meet all legal and industry standards and specifications. They could be compensated in a number of ways depending on the product. Clearly, a mutual fund would be structured differently from a private annuity. For ease, non-advisory services would also be included in products such as filing a tax return or drafting a will.
Sales
Products alone are worthless without people to market them and broker their transactions. A significant amount of investment problems in the U.S. stem from recommending products to clients. Using my model, the sales arm of the industry would be made up of marketers and brokers who would introduce the products they sold to those who advise clients. Currently, registered representatives, insurance agents, and others market products to clients. This would change with my model because sales representatives would connect planners with the products themselves. In other words, salespeople would never interact with clients directly. Planners or advisors would serve as a buffer to ensure the client’s best interests were being met. Product developers would be held to legal standards in developing the product while sales reps would be held to the suitability standard to ensure that the client information provided by the planner qualified the client for the recommended product. This is because most planners, whose range of services and expertise go well beyond investments, simply do not have enough time in the day to stay abreast of product specification changes in addition to discharging the rest of their responsibilities.
Currently, sales are often wedded to products. Under this model, at least with respect to financial products, sales would be divorced from the product arm. FINRA currently regulates the sale of securities as well as variable insurance policies but not indexed or fixed products. Sales reps would be responsible for communicating material changes in products as well as product-specific disclosure requirements to the advisors/planners, who would then communicate this information to the client. Alternatively, so long as there was no back-and-forth dialogue, the sales reps could send the necessary disclosures to the client directly for review. Ideally, all sales would be regulated by a single, interstate/federal body such as FINRA because salespeople, advisors, and clients can all reside in different states, making it difficult for state authorities to enforce existing laws. Under this scheme, the federal agency would regulate the marketing and sale of all products within financial services except for clients purchasing them directly from vendors. Naturally, this would effectively end the federally covered securities distinction.
Advice
This is the area where financial planners would practice. Those giving advice would never make revenue off of product development or sales but would instead charge clients fees in exchange for advice. Planners, then, would be held to a fiduciary duty because they would always be expected to act in the client’s best interests, meaning at all times (no more changing hats). Because sales reps could not interact with clients directly, the planner would step into the client’s shoes, relying on the sales rep to choose suitable products, and then select the one that would best help the client meet his or her goals. There should be no conflict of interest here because planners could not receive referral fees or commissions, split charges, or overrides of any kind from sales representatives. Furthermore, a wall would be put-up similar to the Glass-Steagall Act that divided commercial and investment banking activities within the same firm. On this model, however, no firm could be in the business more than one section of the triangle—developing products, selling products, and offering advice. Moreover, no company in the business of any of these three could own or merge with a company of the other two areas. Lastly, no company or individual could own companies from different triangles or even more than a certain percentage of the shares of companies in two or more triangles (the specific amount to be determined).
Regulation Scheme
In order to restore and maintain consumer confidence in financial services and financial planning, there must be adequate and efficient oversight. For reasons I discussed in Part 3, the current organizations are unfit to fill this role. The closest in terms of infrastructure is probably the CFP Board. However, major changes must occur within the organization before it could serve in this capacity. Figure 2 below shows the new model’s regulatory scheme; namely, which body(ies) would regulate which activity.
Figure 2. Regulatory Scheme under New Model
Products are currently regulated by the states, and the states also set the appropriate compensation for these products. Granted, for tax, accounting, and legal products, there comes a fair amount of advice with the product (and I seriously doubt that any of these practitioners view their advice as products). From a financial planning perspective, however, these pockets of specific, isolated advice would be folded into the product chassis because, when performed in isolation, they are not considered financial planning.
As it stands now, sales are wedded to products. Under this model, at least with respect to financial products, sales would be separate from the product arm. FINRA currently regulates the sale of securities as well as variable insurance products but not indexed or fixed policies. Sales reps would be responsible for communicating material changes in products as well as product-specific disclosure requirements to the advisors/planners, who would then communicate that information to the client. Alternatively, so long as there was no back-and-forth dialogue, the sales reps could send the necessary disclosures to the client directly for review. Ideally, all sales would be regulated by a single, interstate/federal body such as FINRA because salespeople, advisors, and clients can all reside in different states, making it difficult for state authorities to enforce existing laws. Under this scheme, the federal agency would regulate the marketing and sale of all products within financial services with possible exception when clients purchase them directly from vendors (though that opens up a whole new can of worms).
Presently, a mixture of state and federal authorities regulate advice, and advice is often wedded to product sales which, in my opinion, is the foundational problem with oversight in this industry, particularly the CFP Board. There is a widespread assumption (which I admit is largely true) that all advisors/planners are also investment advisors. With the introduction of financial coaches, paraplanners, and professional fiduciaries, that assumption is becoming less and less warranted. This assumption is also shown in the CFP Board exam where candidates are expected to demonstrate investment advisor knowledge—including the requirements to become one—on a deep level unrivaled by other vocations such as attorneys or CPAs. This material shows up both in the investment planning and professional conduct/regulation topic areas (17% and 7% of exam content, respectively). On this new model, either the CFP Board or a new national agency would become solely responsible for regulating financial planners, who would be the only ones certified to offer financial planning advice. The CFP Board defines financial planning as the integration of two or more areas within financial services (tax, estate, investment, retirement, budgeting, etc.). This would also end the incidental advice given by lawyers and accountants. Assuming they stayed in their lane, those giving legal or tax/accounting advice could continue to do so as long as they did not touch any other area (unless licensed as both attorney and CPA or EA). Even then, this determination would fall within the purview of the body that would oversee all financial planning activities in the United States. While advisors who are licensed as investment advisors, CPAs, and attorneys are able to efficiently address most aspects of a client’s financial plan, it becomes problematic when you add the sale of financial products into the mix. There would be flexibility, under this model, to move such persons who hold all three licenses squarely into the advice section.
Roles
Figure 3 below shows the flow of information regarding potential client solutions. Beginning with product developers, who ensure their wares are up to legal and industry standards, communicate specifications to brokers (which occurs already with insurance and investment-related products). The brokers and marketers, then, discern which of those products are suitable for certain client profiles and then relay that information to advisors/planners, who then filter the best products for their clients. Notice that at each point, the standard of care rises, from a purely legal standard to suitability and terminating in fiduciary duty once the information reaches the client. This is very different from the status quo where there is conflated and even comingling of duties within the same role. Advisors can wear multiple hats each with a different level of care owed to the client (in the case of an investment advisor) or customer (in the case of a broker). While the figure shows unidirectional movement, this reflects the flow of information and the duty of care owed from one party to another. Of course, the industry’s sales force will provide product developers with invaluable feedback, and financial planners will keep brokers apprised of changing client situations so that the list of products discussed between the two remain suitable.
Figure 3. From Product Development to Financial Planning
Concluding Remarks
In the article I co-authored with Eddie Kramer titled, “The forced registration of hedge funds in the United States,” we argued that under the current schema in the United States, hedge funds themselves should not be forced to register with the SEC. Rather, advisors who place client money with hedge funds should shoulder the regulatory burden. There are already rules in place regarding securities themselves (Securities Act of 1933; Investment Company Act of 1940) as well as an entire body of contract common law and statutes for intra and interstate commerce. The new model introduced here extends this line of thinking by dividing products, sales, and advice into three distinct categories, each with its area of operation, standard of care, and regulatory agency to oversee its activities. This is the best—and possibly only—path forward towards professionhood for financial planning. Because professionals necessarily interact with the public, financial services writ large need not rise to that level. Under this new model, financial planners, freed from confusing compensation schemes, conflicts of interest, and conflated roles, could finally evolve together into a distinguished, client-centric profession.