Advisors eager to embrace new fee models had better call their regulator first.

That’s the message state securities administrators stressed while noting the massive jump in deficiencies found earlier this year in their bulked-up examinations of smaller RIAs. Andrea Seidt, the chairwoman of the North American Securities Administrator Association’s Investment Adviser Section, warned advisors about the trend toward new fee setups.

“Increasing creativity in fees” means an “increase in regulatory scrutiny,” Seidt said at the organization’s annual conference last month. “I think you’re going to see a lot more scrutiny of fees and documentation and justification in the future at the state level.”

NASAA exam statistics

State inspectors cited deficiencies relating to fees in more than a quarter of exams in the first half of the year, according to a NASAA survey of agencies’ examinations. In deficiencies relating to contracts, problems with fees represented the ones most frequently noted by examiners.

Regulators’ concerns loom large because prospective NAPFA members now list retainer fees more often in their applications than traditional assets under management fees, according to CEO Geoff Brown. Advisors have reported difficulties with winning state regulators’ support for retainers in some states.

However, regulators just want to ensure advisors provide adequate reasoning for their model, give clients services in return for the fees and confirm the model is in clients’ best interests, Seidt says in an interview. Regulators are focusing on fees in general rather than targeting retainers, she says.

“You need to be able to explain what services you’re providing for that fee,” Seidt says. “We just want to make sure that the retainer fee transfers into some services or benefit to the clients.”

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WHY ADVISORS LIKE FLAT FEES
On the other hand, Seidt acknowledges the merits in certain cases of switching to retainer fees from AUM-based fees. The retainer model has been gaining adherents in recent years as advisors seek to tie planning services to compensation, cut down on conflicts of interest and serve a wider client base.

“I think it’s a better choice for consumers to have a broader range of ways to pay their advisor,” says NAPFA Chairman Scott Beaudin.

“My sense is that the securities regulators just need some education about what we’re trying to accomplish by providing better choices and a broader range of choices for fee structures for clients. There’s nothing that I can see in these fee models that is negative for consumers.”

‘NO DOG IN THAT HUNT’
The models range from a flat monthly, quarterly or annual fee for all clients to charges linked to the level of services and hybrid models involving a menu of specific services. The wide variety poses questions for regulators more accustomed to a simple 100 basis points across the board.

During a presentation of NASAA’s data on state examinations, Mike Huggs, the chairman of NASAA’s Investment Adviser Operations project group, recounted one examination. The examiner asked the advisor why one client paid $14,000 per year and another paid $3,000, Huggs said.

“‘Well, it varies based on the complexities of the individual,’” Huggs recalled the advisor saying. “Well, show me what’s more complex about this individual than the one you’re charging $3,000 for.”

He added that regulators “don’t have a dog in that hunt” when it comes to fees for services other than portfolio management, though.

TIME FOR A MEETING?
Regulators do, however, sometimes wrongly equate advisors’ retainer fees with those collected by lawyers because advisors work all year for their annual fee, Brown, the NAPFA CEO, says. Brown prefers the term “flat fee” to avoid the confusion, he says.

Both Brown and Seidt say they’re open to meeting with each other’s organizations to discuss the issues around fees, although they haven’t done so yet.

“AUM is still there, and in a major way. But I think more advisors are gravitating towards that flat fee model,” Brown says. “So something tells me that we as a membership association and them as regulators, we need to get together to talk about what this means.”

Tobias Salinger

Tobias Salinger

Tobias Salinger is an associate editor of Financial Planning, On Wall Street and Bank Investment Consultant.