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Beware Financial Planners are Not Regulated (Interviewed Video) Thumbnail

Beware Financial Planners are Not Regulated (Interviewed Video)


You recognize how difficult it is to find a financial advisor you can trust but do you know why it is so difficult?  The reasons are plentiful and complex.  We are going to try to do our best to unravel the complexity and it starts at the top with how financial advisors are regulated.

Although the financial services industry is heavily regulated, no regulation for comprehensive financial planning exists. Instead financial planners are regulated piecemeal by the various component services they provide. In fact, there is no restriction on the title “Financial Planner,” anyone can call themselves one. The two primary federal regulations affecting financial planners are delineated based upon definitions of investment advisers versus broker-dealers.

Many financial planners are regulated under the Investment Advisers Act of 1940, revised in 1996 to coordinate federal and state regulation. The Advisor Act includes broad antifraud provisions, which entail a fiduciary relationship consisting of three major duties: due care, loyalty and good faith. The fiduciary duty of loyalty requires the financial planner to fully disclose any conflict of interest. These fiduciary provisions are based upon the SEC’s belief that investment advisers could not properly do their job unless all conflicts of interest between them and their clients were removed.

The Securities Exchange Act of 1934 requires brokers who effect transactions in securities for other people and dealers who buy and sell securities for their own account to register with the SEC. The SEC and the broker-dealer industry jointly formed what is now known as FINRA to regulate broker-dealers. Unlike investment advisors, broker dealers are not required to operate as a fiduciary toward clients. Broker Dealers have no obligation to monitor customer’s accounts. The significant FINRA rule governing broker dealers was the suitability rule, requiring recommendations to be reasonable based upon what facts the client reveals. FINRA’s Conduct Rules require the broker to “observe high standards of commercial honor and just principals of trade” which was purposefully vague with the intention of allowing FINRA, akin to a private club, determine appropriate enforcement under an arbitration process, not available to an advisor under the fiduciary standard. Brokerage firms are now offering fee-based accounts that have sparked confusion and controversy over regulation and the standard of care given to consumers.

In an attempt to ameliorate the confusion, the SEC adopted Regulation Best Interest (Reg BI) under the Securities Exchange Act of 1934 this past June. While this new regulation is a step in the right direction, many believe it confuses the public even more since it falls short of the higher fiduciary standard and is too subjective and misleading.   Even U.S. Sen. Elizabeth Warren voiced opposition saying the new rule would be more effective if it enforced an actual fiduciary standard on brokers, rather than the looser “best interest” language used in this new regulation.  For example the regulation doesn’t ban sales contest or quotas at brokerage firms where what is “best” is in the context of what the broker is limited to sell.

Now if all of this craziness doesn’t have your head spinning, financial planning as an activity is completely overlooked in this entire regulatory scheme. Financial planning provides ability to comprehensively regulate consumption and savings over one’s lifecycle, maximizing happiness and alleviating burden from the government. Yet there is no regulation to monitor this critical process. Financial planning is done by disparate types of firms using different formats, sometimes as the primary product and other times as a tool to sell additional products. Consensus of a universal definition of financial planning within the financial services industry is nonexistent. 

In a recent Rand study, broker-dealer participants indicated financial representatives in their firm were not held to any educational requirement. The confusing regulation and lack of financial planning regulation makes it difficult for consumers to identify high quality professionals from low-quality planners creating mixed signals. Without appropriate regulation, the financial planning industry has experienced fraud, abuse, incompetency and conflicts of interest, costing clients millions of dollars.

In addition to lack of regulation for financial planners, the existing regulatory structure between broker-dealers and investment advisor results in different standards of care by individuals that appear similar. Investors fail to distinguish between broker-dealers and investment advisers as they are defined by federal regulations. Focus groups have shown that individuals don’t understand the differences in standards of care and doubt that fiduciary versus suitability standards differ in practice. Yet these different standards have quality implications.  The suitability standard even with the new Reg BI requirement still creates boundaries within the rules where brokers are permitted to maximize rent extraction from client.  The fiduciary standard is principals-based, disallowing any leeway in quality.  

Aggressive marketing practices, using “financial planner” and “financial consultant” to describe brokers and advertisements alluding to how the broker’s actions are in the clients interests, further blur the demarcation.

In the absence of financial planning regulation, the CFP Board certifies and regulates financial advisors. The CFP® qualification is a rigorous process which provides a signal of competency and ethics.  Designation proliferation, of varying quality results in murky signals, confusing consumers however the CFP® is known to be the gold standard signal. To become a CFP® professional, you must:

  • Complete a CFP® Board-registered education program. 
  • Sit for the CFP® exam. 
  • Hold or earn a bachelor’s degree from an accredited university or college (although the actual degree type is not specified).
  • Demonstrate financial planning experience with a minimum of 4,000 hours
  • Pass CFP® Board’s Candidate Fitness Standards adhering to their ethical standards and disclosing any criminal or employment termination history and pass a background check. 

During 2019, the CFP Board adopted new, more stringent standards that require all CFP’s to act as Fiduciaries when they are providing financial advice to a client, in contrast to the old requirement that made the trigger the creation of a financial plan. This is a major improvement in guiding the behavior of financial advisors, though it still allows a CFP to act in their own interests if they are not providing financial advice. Enforcement of this is heavily dependent on consumers complaining to the CFP Board if they suspect their advisor has failed to act properly. Additionally, to be a true fiduciary many believe that the advisor should fully disclose the source and amount of compensation they may receive for products they sell.

Assuming regulation improvement is not forthcoming; the CFP® certification provides at least a minimum signal of human capital investment and ethical standards.  While not perfect you can be confident that the financial advisor has undergone some minimum requirements of how one should conduct the financial planning process.  Of course there are other concerns, which can obscure the benefits of the CFP® designation but it is a good place to start when seeking a financial planning professional.