The wave of reform designed to enhance trust in the financial services industry through new disclosure requirements is threatening to bury financial planners under an avalanche of paperwork–sometimes to the detriment of consumers, argue some planners.

Consider the changes on the regulatory front just in 2004 that affect financial planners:

• The Securities and Exchange Commission (SEC) approved amendments under the Investment Advisers Act of 1940, requiring registered advisers to adopt a code of ethics and appoint a chief compliance officer.
• The National Association of Securities Dealers also implemented a number of investor-focused proposals, including variable annuity suitability requirements; mandates for securities firms to establish emergency preparedness plans; and new rules to ensure that firms monitor the activities of their employees.
• The NASD now requires chief executive officers of securities firms to implement and annually review written compliance policies.
• And, in the bigger picture, the USA PATRIOT (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism) Act of 2001 and the U.S. Banking Privacy Act as amended in 2001 involve anti-money-laundering initiatives and increased "know your customer" requirements.
   

Planners support the goals of new regulations, and many routinely disclosed their method of compensation and conflicts of interest before the regulatory emphasis on disclosure. Today, however, the flood of paper made up of fund prospectuses, fee agreements, ADVs, letters for switching investments, reports on transactions that involve a fee or commission, breakpoint disclosures, privacy notices, and so on, makes disclosure a major drain on planners' time. So there is some grumbling. Planners complain that they are paying the price for others' misdeeds or that they are being treated like criminals. One planner jokes that soon she may have to disclose her children's birthdays because that may somehow influence her choice of investments.
 
John Carr, J.D., is a senior partner at Carr & Schwartz LLP, a law firm in Lake Oswego, Oregon, servicing compliance and regulatory needs of registered investment advisers. Carr notes that the frustration many planners feel about the time they spend on compliance issues is perhaps born of the fact that over the last five years, financial planners went from flying under the radar to working in the spotlight. "There's been regulation by the Investment Advisers Act of 1940, but with all the shenanigans in corporate board rooms and what Eliot Spitzer and others have uncovered, new regulations to make things more transparent for the customer have come to the forefront," he says.
 
Whatever the level of angst, the overload of paper created by new disclosure requirements is changing the very nature of the financial planning business–from the clients planners feel they can serve effectively and profitably to their expectations of the firms they deal with. Ironically, in some cases, planners say new disclosure requirements may ultimately prevent the very people our government seeks to protect from getting top-quality professional financial advice.
 
Explains Grace M. Worley, CFP®, of Worley Financial Group in Indianapolis, Indiana: "Because of the staff and dollar cost of compliance, advisors will be forced to limit services to those who can afford to pay for them. Over time, the complexity and cost of compliance with regulations designed to protect the public will result in fewer planners working with less cost-efficient clients, which is the bulk of middle-class America. In the regulators' efforts to protect the public through paperwork, they are actually limiting most Americans' access to broadly qualified, personalized financial advisory services."

Moving from Commission-Based Products to Fee-Only Asset Management

Perhaps the most visible change resulting from greater disclosure is that many advisors are moving from commission-based financial products to fee-based services. "Fee-based advisors have a lower threshold for compliance than those with securities/ insurance licenses even though the service and products look the same to the public," says Worley.
 
The practice of Michael Boone, CFP®, CFA, of MW Boone and Associates in Bellevue, Washington, has been a combination of fee-only financial planning and commission-based securities work. "There are times, particularly with small accounts, when using C shares makes the most sense," he says. "It is inefficient and awkward to charge a management fee on an account under $25,000."
 
Yet Boone's broker/dealer limits the C shares held in each individual client's account to $500,000. He explains, "Even if we didn't buy the C shares–if they were transferred in from another broker/dealer–once the account reaches $500,000, we can't add C shares to it. We have to buy a different share class for the client. So, we are left paying a front-end load on an A share or trying to figure out some other compensation method."
 
In these situations, Boone says his compensation isn't dictated by what would best meet the client's needs, but solely by the regulators. "Ultimately, the people who need help the most, those with the lower account sizes, will no longer be welcomed at financial planning firms," he says. "I don't know of anyone who is doing an asset management program for a $3,000 account. So, our profession will shut the door on those people. If a client trusted me 20 years ago with $300, he is going to be my client no matter what and I realize that I pay a price for that. But to have the regulators dictate whom I can work with in the future is really sad. All these changes have been made in the name of the consumer, but the regulations can actually hurt those they were designed to protect."
 
Adds Worley: "Commission-based products have allowed us to serve a market that cannot absorb our fees. If someone wants to put $3,000 in an IRA, I can't charge a $1,000 planning fee or $200 an hour to do it. But selling a $3,000 IRA on a commission basis compensates me for the paperwork. A trail of 12(b)-1 fees may not pay me enough to keep the file, but at least there is some compensation and my hope has always been that the IRA will be in the context of other future investments."
 
Worley continues, "If the door is shut on the C-share option, I am not optimistic that lower-level clients will get along well on their own. Sure, anyone can call a mutual fund company directly and buy a no-load fund, but when you don't know anything about investments you are going to make mistakes. I've given people names of specific funds to buy and still they make errors. They might buy a fund that sounds like the one I recommended, but is quite different."
 
Jeffrey Heitzman, CFP®, ChFC, CSA, of Heitzman & Associates in Grand Rapids, Michigan, is in the process of switching his commission-based business to the fee-only model. So far, he says it's working well. He likes the broader base of funds he has access to and in the last six months, he's moved $15 million.
 
Heitzman has used the recent scandals in the fund industry as a springboard for discussing his business plan with clients. "I tell my clients that I want my relationship to be exclusively with them, that I prefer a direct relationship with them rather than being compensated by mutual fund companies," he says. "My clients are reacting well to the change, although they are not too interested in the details. I'm gratified by that because it illustrates their level of trust."
 
Yet Heitzman, too, acknowledges that while his move to a fee-based model will be better for his business by drawing his focus to higher net worth clients, he regrets having to turn his back on people he could have helped under the commission-based model.
 
Carr thinks planners will continue to move their business away from commissions. "Many planners are adamant that they don't want anything to do with commissions due to the misdeeds of the fund companies that have been in the news. Planners want to show that they're above all that," he says.

Time Spent on Compliance Difficult for Small Firms

Just as the small client could be squeezed from the planning picture, disclosure requirements could spell particular trouble for small financial planning firms. Clearly, with some planners estimating that new disclosure requirements take up 20 percent of their time and others saying they deal with 40 percent more paper than they did just a few years ago, profit margins are shrinking. And planners say software providers have been slow to respond to their compliance needs.
 
"Like most financial planning practices, ours is not staff heavy," says Worley. "I have one employee who probably spends a day a week dealing with compliance issues. It takes a lot of time to make sure that we have complied with all the new regulations, that our code of ethics and compliance procedures are up-to-date and complete. Often, we have to spend time figuring out what we have to do to comply because that is not always clear."
 
"If anything will drive me out of this business, it will be compliance," Heitzman adds. "I've been in the business for 15 years. Now paperwork takes up 25 percent of my day. All this work to prove that I'm not a crook and leave a paper trail gives me less time with clients. Instead, I'm spending more time filling out applications and researching whether they qualify for breakpoints."
 
Bryan Sadoff, of Sadoff Investment Management in Milwaukee, Wisconsin, recently named a chief compliance officer to write policies and review them yearly. "In a small shop like ours, it is the same person writing the policy and reviewing the policy. The commitment is significant because it's an ongoing process. You can't just write your code of ethics. All policies, personal trading, gifting, and so on, have to be reviewed at least once annually to ensure they comply with federal regulations and that employees understand. That takes up time we would rather be out servicing clients or generating new business."
 
While the compliance burden is felt to a greater degree in smaller firms like his, Sadoff sees a silver lining in remaining small. "National headlines about scandals have helped fuel the small-firm relationship movement. I see many people moving away from the big firms and toward the small, independent advisor," he notes.
 
And Carr is optimistic that once a firm develops and implements a system, compliance won't be that difficult. He explains, "Although the code of ethics is so detailed it requires documentation of your personal trades, that's not that difficult with some of the software available–and consultants will continue to focus in this area."
 
Mark Furman, CSA, LIC, of Integrated Financial Services in Uniondale, New York, and Boynton Beach, Florida, is also hopeful that life with disclosure will improve. "The government implemented new regulations so quickly that the industry didn't really have time to gear up for compliance. I think we're in the worst of it now and that our situation will improve once technology catches up. I hope that happens because without help we are doomed to fail."
 
Of course, technology may not be much help when it comes to managing a client's reaction to receiving what is often a one-inch stack of disclosures. David R. Bergmann CFP®, EA, CLU, ChFC, of The David R. Bergmann Group in Marina Del Rey, California, says new clients accepting document after document are a little overwhelmed. "I'll explain the PATRIOT Act and the other issues, that we live in a different world," he says. "In spite of the push for greater transparency in the industry, I think people are less trusting of financial professionals than they were before the headlines. We have to work harder to gain the trust of a new client."
 
Ironically, in a regulatory environment that seeks full disclosure, Christopher Morris, CPA, CFP®, of CMA Financial Services in Atlanta, Georgia, is stymied by compliance red tape when he seeks to provide his clients with educational materials. He explains, "There is a lot of misleading information out there....When I write articles to logically deal with some of this misinformation, I am often prohibited by my compliance department or the NASD from exploring the truth with my clients. Regulators make it difficult for me to publish articles I feel would be helpful to clients. The compliance department argues with everything I say. They question whether I am an authority and yet I have my CPA and CFP designations, and am a university professor. What's frustrating is that the talking heads on TV can say anything they want to. The SEC doesn't care if they are spouting off about how it's time to put your money in gold or commodities. It's wrong that the TV people can say whatever they want to and I am hogtied in a way that often leads clients to believe the talking heads are the experts, not me."

Should Planners Expect the Same Transparency They Provide to Clients?

As paper engulfs financial planning practices, Bergmann points to a relatively unexplored avenue in the area of disclosure. How should planners assess the level of due diligence that is being done for their firms? He explains, "When my broker/dealer says these are the 3,000 mutual funds you have to work with, must I tell clients that I have personally selected every fund? Of course, you presume your broker/dealer has done the appropriate due diligence, but as practitioners, how can we be sure that appropriate due diligence has been done on the products and services we offer? What assurance do we have that a fund company is not buying shelf space?"
 
Bergmann continues, "I am very confident in the firm I work with. They are very compliance-oriented, and I am confident they are doing the right thing. When I ask questions about the funds, there is always someone willing to talk. I'm not ignored, but we often talk about the selection process."
 
Minimally, Bergmann says, although he feels the need to disclose to his clients the universe of funds he chooses from, he cannot do that. He explains, "Operating under a broker/dealer's umbrella, you use the products they make available to you. In my case, it's a good list; there are no deficiencies at all. However, I can't disclose to my clients that I operate within that universe; it seems I absolutely should be required to do that. I feel if I am somehow restricted, I should inform my clients. On the other side of the equation, it would be important for clients to know that I choose from a significant number of funds, not a list of ten."
 
Bergmann acknowledges that the advisor community doesn't have the wherewithal to personally complete due diligence on all mutual funds, but he believes advisors should at least be questioning the due diligence their vendors go through to ensure the selection process is free of conflicts.
 
Stanley Hargrave, CFP®, of IFA LLC in Riverside, California, also is concerned about getting the whole truth from vendors he deals with. "Most vendors, if they want to keep their jobs, will tell you the downside of their products. However, in order to protect yourself and fulfill your fiduciary responsibility to your clients, you need to do some serious analysis among products on your own. If I'm considering one product, I might call the competition to hear the pitch of how that firm thinks its product compares."
 
Hargrave stresses that once he makes a product recommendation to a client, he expects and values ongoing support from the product vendor. "I want to be kept up-to-date on changes being made–what's going on inside the portfolios. I need to see more than marketing materials. I want to see documents like accounting reports that a company's chief operating officer might share with the fund manager. That's the information I want to share with my clients. I don't want a birthday card or another umbrella from a fund company."
 
Carr admits to a certain extent that planners have to put faith in their vendors. "Planners don't have the horsepower to do the due diligence for every client because thousands of funds could be appropriate. They have to be comfortable with Schwab, or whatever platform they are dealing with. There is really no alternative. Of course, planners could decide to go with a smaller group of funds they know really well, but then that's all they offer and that limitation could hurt clients."

Light at the End of the Tunnel?

Is there light at the end of the disclosure tunnel? Most planners say a match hasn't even been struck. Yet Bergmann hopes that filling out 18 different forms and 3 worksheets for a commissionable product is the result of the financial service industry's overreaction to the many recent lawsuits and wonders if perhaps the world is temporarily compliance mad.
 
"Any time events cause us to question the integrity of our industry, even if it is only the very smallest component of the industry, the reaction from regulators will be swift and severe," he says. "Today, the pendulum has swung far toward regulation, and although that means time spent away from clients, I think we all understand that our business is built on trust and we need to do all that's possible to ensure that bedrock."
 
In the meantime, planners have no choice but to battle with that profusion of paper, a fight Bergmann fully expects will be made easier when software providers "catch up."...
 
It makes sense to explore software options and setup systems, Grace Worley says, because she doesn't see the onerous regulations going away any time soon. "The SEC's fire is burning in other areas. In fact, the question of who is an investment advisor is currently before them. The SEC is still struggling with who should be in the regulated ballgame."
 
Worley also notes that it's not just financial planners who are burdened by disclosure obligations, but all American business. "Everyone is dealing with money-laundering compliance issues. We are trying to make the world safe through paper–and that's not going to work," she says.
 
John Carr says planners had best get used to the new disclosure requirements. "Our mantra to clients is when in doubt, disclose–and more requirements wait in the wings, maybe more from the mutual fund side," he says. "In addition, I assume there will be anti-money-laundering deal requirements for RIAs. In the next year or two we may see more interpretation on the compliance policies and procedures that went into effect last year. The same attention should be focused on the SEC's code of ethics for RIAs, which is basically a super-charged insider trading policy."
 
Although Carr sees more regulations on the horizon, he doesn't expect them to be severe enough to provoke a "sky is falling" response from the industry. To planners who complain about time spent away from clients to deal with compliance issues, and who question where the "value-added" is in all this disclosure, Carr's advice is simply to accentuate the positive. "Sure, it's a daunting pile of paper you hand over to clients, but it is possible to put a positive spin on it. Rather than taking the attitude of ÔHere's what the regulators are making me do,' planners should stress that these materials are intended to provide a thorough education on just how the financial planning business relationship will work. Ultimately, because clients understand more about how you are working, financial planning practices will benefit from an enhanced level of trust."
 
While some relationships may certainly be strengthened, Worley still laments that as planners find commission-based business less attractive due to the increased time spent on disclosure, middle America may slowly fall off the financial planning map. "I once would have said I worked with middle-income families and now I'd say I work with affluent middle-income families. That disturbs me. My fees are not at the high end, so I assume other planners have made the call before I did," she says.
 
Interestingly, planners who charge on an hourly basis may be better able to adapt their business model to the extra time spent on compliance. "Perhaps charging hourly becomes the choice of the future. If the consumer is motivated and willing to pay, I think that could be a viable choice for those who don't meet minimums," says Worley.
 
The bottom line is that while new regulations certainly have changed their work day, planners hope regulations don't have the counter-productive result of ruling out choice in the financial planning arena. Concludes Michael Boone: "I believe in people's ability to use their own money wisely. When consumers have a choice, I have a lot of faith in their ability to evaluate their options and make a wise choice. If our market is controlled only by lawyers and regulators, it is difficult to say what could happen over any period of time."

Nancy Opiela, based in Medfield, Massachusetts, is a contributing writer for the Journal of Financial Planning.