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The word that sets off regulators

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For years, I’ve been predicting that the planning profession is eventually going to have to convert its revenue model from AUM to retainer fees — for a lot of good reasons.

People push back when I say that retainers entail fewer conflicts of interest than asset management fees. But I have personal experience with trying to hire an adviser, only to have this well-respected professional immediately bury his nose in my portfolio statements. Every time I would try to redirect his attention to my financial planning questions, he would guide the conversation back to the importance of having him manage my assets. I’ve always thought it was interesting that consumers who hire AUM-compensated planners just happen to always need that planner to also manage his or her retirement account.

Retainers have other advantages. They can be more precisely aligned with the actual work or value the advisory firm provides. Every planning firm I’ve talked with has a few clients with the happy combination of a large portfolio and an undemanding nature, which makes them extremely profitable.

Other clients with smaller portfolios may require a lot of hands-on work helping them move through important life transitions. Is it fair that the one should be subsidizing the other?

Most important, retainers allow you to be paid for providing advice to Gen X and millennial clients who wouldn’t otherwise meet your AUM minimums. If you paid attention to Financial Planning’s January survey of large advisory firms, you know that the profession’s growth rate has suddenly and dramatically declined. I think a big reason is that the advisory firms that have portfolio minimums and are compensated exclusively through AUM fees are forced to turn away young accumulators with plenty of cash flow.

Few advisory firms have a model that lets them market their services to the enormous Gen X and millennial client pool at a time when the wealthy baby boomers are either decumulating or dying off. Is that any way to foster dramatic future growth?

But now, alas, it looks as if I’m going to have to change my tune about retainers.

On my Inside Information website, I asked readers to tell me their best horror stories about state regulators who completely misunderstood their fiduciary business model or otherwise came back with examination results that made no sense. I heard from fee-only advisers who were asked where they were hiding their commissions.

I also heard from firms whose examiners didn’t believe it was ethical for state-registered RIAs to bill clients for planning work or any other service than managing assets. In Hawaii, some advisers have been deemed to have custody over client assets because the client and custodial agreements permitted them to bill their fees directly from the accounts.

In the end, I handed out Regulators Amok awards to Vermont, North Carolina and Arkansas for, among other things, requiring advisory firms to stop billing for financial planning services, and for insisting the firms change their revenue model to something that would cost citizens more money than they had been paying before the regulators walked in the door.

In all, it was a sobering exercise. What I learned is that even though the profession has been around for more than three decades, many regulators still don’t quite understand the value of financial planning advice, or the transparency of a fiduciary client relationship.

It seemed to them that the regulators had a weird prejudice against the whole idea of retainers.

But, in the process, something very interesting came up about retainers. Many advisers who bill their clients quarterly based on total assets or the complexity of the client situation said that they were getting pushback on their retainer fees. It seemed to them that the regulators had a weird prejudice against the whole idea of retainers.

As I was digging deeper into the whys and wherefores, I heard from Michael Kitces, a Financial Planning contributing writer, who is also a co-founder of the XY Planning Network, a turnkey practice model that has processed the state registration paperwork on behalf of almost 200 state-registered investment advisers. Kitces said that in his experience, the states are almost uniformly pushing back on the retainer model.

And here’s the kicker: the states may actually have a point.

To see why, consider for a moment what the word “retainer” means in the common vernacular. Lawyers request an upfront retainer before they start work on your behalf. This money is carefully put in escrow, to be drawn out in pieces to pay for services the lawyers provide at various times in the future. If the lawyers don’t spend as much time on your case as they originally estimated, then some of that original retainer fee may be returned to you.

That, of course, is not how the retainer model works in the financial planning world. But when a state regulator sees a planning firm charging fees that it refers to as retainers, it’s not unreasonable for that person to assume that the advisers are collecting, every month or quarter, an amount of money that will be set aside to pay for services that may or may not be rendered. And then the advisers put that retainer money in their pockets and charge a new retainer the next month or quarter — and so on.

You can, of course, explain to your state’s on-site examiner that this retainer thing is nothing more than a quarterly fee for providing ongoing asset management services and doing a lot of financial planning work. But to the regulator, isn’t it interesting that the amount of work you do just always happens to eat up that ever-replenished upfront retainer you’re collecting?

We should probably just switch to a different term.

And if you charge a retainer that is based on a client’s total wealth, this really seems to set the state regulators off. Why? Because, hey, are you also managing that client’s house? How much supervision are you providing over the beach house? Are you doing hands-on management of the assets in the 401(k) plan?

What to do? The solution, I think, is not to try to bend the meaning of retainer to our liking, and convince state regulators that the word refers to something very different for us than for the far more established legal profession. Instead, we should probably just switch to a different term, before the word retainer gets too deeply lodged in our profession’s lexicon.

The XY Planning Network has taken “retainer” off of its members’ Form ADV and replaced it with a lengthier, but more palatable, phrase: “fixed annual fee, payable monthly, for financial planning services.” I recommend that, if you’re state-registered, you also base the size of this fixed annual fee on something other than a client’s total assets. Clunky? Of course it is. But it’s a revenue model description that the regulators could much more easily relate to the services you actually provide.

Meanwhile, this exercise tells me that the profession has a lot of work to do educating the states on what, exactly, planners do for clients — and especially helping them understand that the most valuable part of that service is advice about retirement preparedness, goal planning, taxes, tax-aware distribution in retirement and all the other things that are lumped under the confusing term financial planning.

The National Association of Personal Financial Advisors has recently started doing that work on a state-by-state basis and is addressing the issue of retainer fees as well. Will the CFP Board and FPA join the effort? If not, why not?

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