For those of us that have been watching the decimation of much of the banking and finance industry, it has become clear that finance-related firms’ compensation arrangements and ethical standards are being called into question through a blanket labeling of all finance industry professionals with some permutation of the word “crook.” The rapacious practices of real crooks, like Bernard Madoff et al., and the over-compensation of the officers of bailed-out financial institutions have clearly left a bad taste in the mouths of the public. This negative perception of the finance industry as a whole has in large part rubbed off on all individual professionals in the financial services, whether such gross agglomeration for the purposes of labeling is warranted or not.

Against this backdrop, it has become immensely important for those institutions that utilize best practices with regards to compensation and objectivity to make it known to their prospective and current clients that this is the case. But simple communication of this ideal is not enough. With impending regulatory changes on the near horizon, those financial services organizations that are able to preemptively adapt (to innovate) will be far better positioned relative to their competition, and better able to serve their clients and constituents through the coming regulatory tumult strictures.

When it comes to financial planning through Registered Investment Advisers (RIAs), there are several means by which to institute organizational-level objectivity through self-policing. We have always found it best to observe internal operations from the perspective of a CPA or accounting firm that is seeking a partner firm in the financial planning or investment advisory arena. Some of the most basic organizational means by which to ensure objectivity in a financial planner are:

1. Ensure that fees are charged by the advisor for the development of financial plans:

Although this statement is counterintuitive to the uninitiated, it is actually the most basic way to ensure that the recommendations to clients that come out of a financial plan are truly aligned with the interests of the client, and not just with those of the recommending advisor. True Financial Planning professionals are generally compensated through flat fees for work performed in much the same way that an accountant or lawyer may bill on an hourly or per-job basis. However, Financial Planners may or may not supplement this planning fee income through the implementation of financial plans in fee-based investment management programs, insurance commissions, or other means. The eventual implementation of the plan recommendations are at the discretion of the client.

The point here is that Financial Planners generally act as their own business owners, and do not earn a salary.

This means that if they are doing work for a client without charging a fee for financial plan development, they have an intrinsic incentive to forcefully recommend plan implementation through various products. If implementation does not occur when a planner is not charging a fee, there is no way for the planner to be compensated. Thus although clients may initially balk at the mention of an upfront planning fee, in reality the fee is in their own best interest in that it ensures the high quality of the plan to be developed. After all, if a “planner” is providing a plan to a client without charging a fee for it, the client should recognize that economic law dictates that “you get what you pay for.” If the client is paying nothing, the plan is probably worth nothing.

2. Align the compensation incentives of an investment advisor with the goals of the client:

The creation of fee-based investment advisory programs (as opposed to transactional accounts) was an important industry step towards ensuring that investment managers were acting in the best interests of clients. Whether it is in a true wrap fee account or in a fee-based account that charges additionally for internal transactions (specifically those that do not provide additional comp to the manager for transactions), an account market value percentage fee is assessed by the investment manager for the ongoing management of the client account.

Under this arrangement advisor incentives are more directly tied to client goals because if the value of the client’s account decreases, so does the income to the advisor, and likewise if the account value increases the advisor’s income does as well. Thus the advisor has an incentive to seek optimal risk/return performance results. They are penalized on the downside if they take excessive risks, and are rewarded on the upside for seeking appropriate returns for the client.

3. Question the motives of firms with proprietary products:

Firms with a proprietary mutual fund, hedge fund, underwriting department, or insurance product may have an incentive to utilize their own products with clients regardless of their appropriateness because of higher potential profit margins or commissions on sales. A firm with an open architecture investment plan implementation platform or insurance brokerage may have greater flexibility to find the right solutions for the client. However, it should be noted that just because a firm has a proprietary product does not mean that the product will be misused. For some clients the product may be appropriate, where for others it may not be. The question will ultimately fall on the shoulders of any fiduciary providing oversight on the account as to whether such products are appropriate. The flip side to this is that a firm that has a proprietary product or solutions will likely have a greater knowledge of their proprietary tools and perhaps better experience and training on implementing their use properly, which could benefit the client if the solution is appropriate. The net takeaway here is that if a partner firm has a proprietary product of any kind, monitoring the firm will require additional due diligence on the part of fiduciaries that would not be necessary with a pure open-architecture firm that does not issue its own products.

4. Consider the pitfalls of transactional accounts or commission-only investment accounts:

With traditional investment accounts (generally brokerage), investment managers (or stockbrokers) have a compensatory incentive to churn accounts by recommending unnecessary transactions in order to generate higher compensation. Although an ethical broker will not actually do this, the compensation structure of such an arrangement means that the investment professional will not even be paid unless some transaction occurs in the account, as there is no management fee. There are not too many people out there who like to work for free. Thus, all things being equal, the incentives of such traditional broker investment professionals are geared towards recommending transactions.

However, this does not mean that transactional investment accounts are never appropriate for clients. In fact, sometimes they may be more appropriate than a wrap fee investment account or other fee-based managed account. Examples of such instances are when specific investment vehicles are not available in fee-based accounts but are available in brokerage accounts; if the investment professional’s intention is to reduce the long term costs of investing for a client through the use of A-Share mutual funds; or if the client wishes to be able to make periodic speculative individual securities trades. These are three of the most common examples of appropriate uses of transactional accounts.

5. Implement ethically and with internal controls: 4Thought has always maintained a focus on planning as on organization when working with our end user private clients.

However, the mere development of a financial plan is insufficient to achieve client goals. 4Thought has always found that it is necessary to aid clients in the implementation of financial plans, as without the aid of fiduciary professionals who are intimately familiar with the intentions of the plan itself, implementation will inevitably be botched, and the likelihood of client goal achievement is greatly diminished. Therefore we have instituted means to go about implementation if the client wishes to proceed. Under these general circumstances, the advisory team responsible for implementation (Potentially composed of a CPA, third party advisor, 4Thought advisor, and the 4Thought portfolio management team) may be compensated through investment advisory fees, insurance commissions, or other product implementation means. To facilitate this in a manner that is in the best interests of the client, 4Thought has created strict ethical standards and internal implementation controls to prevent the recommendation of inappropriate product/solution uses. An internal system of checks and balances along with vigilance in updating and enforcing internal controls is an important function for a firm that both develops and implements financial plans.

The above are a few basic best practices for promoting the objectivity of financial planners in creating and implementing financial plans for clients. However, the opportunities for fostering objectivity are not limited for those organizations that wish to take the client experience to a higher level.