April 17, 2008 CFP Board Standards of Professional Conduct Raise Serious Concerns for Independent Financial Advisors and Broker-Dealers

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1 Page 1 of 6 MEMBER BRIEFING CFP Board Standards of Professional Conduct Raise Serious Concerns for Independent Financial Advisors and Broker-Dealers Executive Summary The Certified Financial Planner Board of Standards 1 (CFP Board) has adopted updated Standards of Professional Conduct (Updated Standards) which take effect on July 1, The Updated Standards require additional client disclosures, a written agreement with clients, and imposes a fiduciary duty of care on any person who has earned the CFP designation (CFP Certificants) who provides his or her client financial planning services or performs material elements of the financial planning process. These material elements are defined as including some or all of the following six elements: (1) Establishing and defining the client-planner relationship; (2) Gathering client data including goals; (3) Analyzing and evaluating the client s current financial status; (4) Developing and presenting recommendations and/or alternatives; (5) Implementing the recommendations; and (6) Monitoring the recommendations. Although well intentioned, the Updated Standards will increase the liability exposure of CFP Certificants and the broker-dealers with which they affiliate by imposing a heightened standard of care and establishing detailed disclosure and contractual requirements. We are also aware that the Financial Planning Association has announced it is considering applying the Updated Standards to all FPA members, including those who are not CFP Certificants. Although the UpdatedStandards have been declared final by the CFP Board and will take effect on July 1, we believe that FSI members should express concerns directly to the CFP Board. Therefore, we encourage you to raise the following concerns in a comment letter to the CFP Board: The Updated Standards establish a baseline standard of care that is inappropriate for the non-financial planning activities engaged in by CFP Certificants. The Updated Standards define the term material elements of the financial planning process so broadly as to impose a fiduciary standard of care on activities for which the standard is inappropriate. The disclosure obligations imposed by the Updated Standards are onerous and are likely to prove impractical to comply with in practice. The contractual obligations imposed by the Updated Standards are difficult in practice to implement. 1 You can learn more about the Certified Financial Planner Board or Standards, Inc. at 2 See the CFP Board s Standards of Professional Conduct (October 2007) at

2 Page 2 of 6 CFP Certificants, and the broker-dealers with which they affiliate, will be subject to significant additional liability exposure because of their efforts to comply with the Updated Standards. Introduction The CFP Board was founded in July of 1985 as a professional regulatory organization acting in the public interest by fostering professional standards in personal financial planning. The CFP Board establishes and enforces education, examination, experience, and ethics requirements for CFP Certificants. The CFP Board periodically updates its standards and procedures to reflect the current business and regulatory environment. The CFP Board began its most recent intensive review of its ethical requirements in This review process recently culminated in the adoption of the Updated Standards by the CFP Board. The Updated Standards are intended to maintain CFP Board s high ethical standards, strengthen them in several important ways, and present the standards in a manner that will be easily understood by CFP certificants and the public they serve. 4 The Updated Standards make the following significant changes to CFP Certificants ethical obligations: The baseline duty of care for CFP Certificants has been raised from the current "reasonable and prudent professional judgment" standard to a requirement that a CFP Certificant "shall at all times place the interest of the client ahead of his or her own." 5 The duty of care for CFP Certificants providing material elements of financial planning services has been raised from the current duty to "act in the interest of the client" to the "duty of care of a fiduciary," which is partly defined as acting "in the best interest of the client." 6 Once a CFP Certificant has established a financial planning relationship with a client, all future services he or she provides to that client are likely to be considered to be part of the financial planning engagement and, therefore, subject to the duty of care of a fiduciary. 7 Detailed requirements for disclosures to clients and prospective clients, and requirements for documentation of client relationships have been adopted. These new requirements apply to the performance of financial planning services or performance of material elements of the financial planning process. The Updated Standards also clarify that the disclosure requirements for CFP Certificants apply to clients as well as prospective clients. 8 3 The CFP Board published two exposure drafts of the Updated Standards. The first was released in the summer of The second exposure draft was released in the spring of Each exposure draft offered a comment period for concerned parties to offer their feedback. 4 See CFP Board s Revised Standards of Professional Conduct: Frequently Asked Questions (Feb. 20, 2008) at 5 See Rule 1.4 of the Updated Standards. 6 See Rule 1.4 and Terminology of the Updated Standards. 7 See Question 20 of the CFP Board s Revised Standards of Professional Conduct: Frequently Asked Questions (Feb. 20, 2008). 8 See Rules 1.2 and 2.2 of the Updated Standards.

3 Page 3 of 6 While the CFP Board s Updated Standards do not have the force of a regulatory provision, they govern the conduct of CFP Certificants, whether or not they advertise or publicize their CFP designation. Therefore, a violation of the Updated Standards could subject a CFP Certificant to disciplinary proceedings before the CFP Board's Disciplinary and Ethics Commission. We are also aware that the Financial Planning Association has announced it is considering applying the Update Standards to all FPA members, including those who are not CFP Certificants. The Updated Standards clearly state that they are are not designed to be a basis for legal liability to any third party. 9 Nevertheless, there are reasons for independent financial advisors and independent broker-dealers to be concerned about additional liability exposure resulting from the Updated Standards. The Updated Standards require CFP Certificants to describe the nature of their client relationships in a written contract. Among other things, the agreement must include a discussion of the specific legal standard of care that applies to the relationship. In addition, the client must be provided with a written disclosure document that provides a description of the ways in which the CFP Certificant may be compensated along with a general summary of potential conflicts of interest. Plaintiff s attorneys can be expected to use the heightened duty of care, as well as the enhanced disclosure and contractual requirements, of the Updated Standards as a basis for additional theories of recovery in complaints or arbitration matters involving CFP Certificants. Since the broker-dealer is often considered the deep pocket in these cases, we can also expect clever plaintiff s attorneys using these fiduciary standards as an argument to obtain higher settlements and arbitration awards from broker-dealer firms who traditionally are not considered fiduciaries under federal law. The CFP Board has long been aware of industry concerns about the impact of the Updated Standards. In fact, on November 9, 2007, the CFP Board sponsored an Ethics Standards Implementation meeting in Washington, DC with representatives of industry groups and approximately thirty (30) broker-dealers in attendance. The session was designed to provide the firms in attendance an overview of the Updated Standards and the CFP Board s disciplinary process. The meeting also provided a forum for broker-dealer firms to share their thoughts about the Updated Standards with the CFP Board and members of its staff. Several participants expressed concerns that the Updated Standards will create additional and unwarranted liability exposure for financial advisors and their broker-dealers by applying a heightened duty of care where it should not exist. Representatives from these broker-dealer firms suggested various changes to the text of the standards to reduce this exposure. Unfortunately, the CFP Board members in attendance expressed extreme reluctance to consider further changes to the Updated Standards citing their organization s mission as requiring the adoption of strong ethical requirements for CFP Certificants. Staff members at the CFP Board have since indicated a willingness to consider clarifications to the Frequently Asked Questions that accompany the Updated Standards, but have indicated that the Updated Standards will become effective as written on July 1, See Introduction to Rules of Conduct and Financial Planning Practice Standards at 10 See the Frequently Asked Questions at

4 Page 4 of 6 Analysis of Updated Standards The specific concerns raised by the Updated Standards are described in detail below: Baseline Standard of Care: The Updated Standards burden CFP Certificants with a fiduciary standard of care for activities that do not involve financial planning by requiring a CFP Certificant to at all times place the interest of the client ahead of his or her own. 11 While this sounds good in theory, in reality it creates unnecessary liability without adding real protection for clients. This baseline standard of care is clearly higher than the legal standard of care applied to other activities commonly engaged in by independent financial advisors (e.g., sales of insurance, preparation of tax returns, securities order processing). Plaintiff s attorneys who bring court and arbitration cases against CFP Certificants and their business partners will likely cite this heightened standard. Clearly, the CFP Board has created additional liability exposure for CFP Certificants and the broker-dealers with which they affiliate. Financial Planning Activity Standard of Care: Under the Updated Standards, a CFP Certificant providing financial planning services or material elements of the financial planning process owes his/her client a fiduciary duty of care. A fiduciary is defined by the CFP Board as [o]ne who acts in utmost good faith, in a manner he or she reasonably believes to be in the best interest of the client. 12 Unfortunately, the CFP Board has a very expansive view of activities that involve material elements of the financial planning process. The material elements of financial planning are defined as including some or all of the following six elements: (1) Establishing and defining the client-planner relationship; (2) Gathering client data including goals; (3) Analyzing and evaluating the client s current financial status; (4) Developing and presenting recommendations and/or alternatives; (5) Implementing the recommendations; and (6) Monitoring the recommendations. In fact, most securities sales activities engaged in by CFP Certificants will likely be subject to the fiduciary standard of care rather than the suitability standard applicable under federal law. For example, the sale of a variable annuity to a client would almost certainly involve material elements of the financial planning process in light of the data gathering, analysis, recommendation, implementation, and monitoring activities inherent in the sales process. Holding registered representatives to a fiduciary standard of care, rather than to a suitability standard, would increase independent broker-dealers litigation risk, because principals are typically held strictly liable for their financial advisor s breach of their fiduciary duty. The fiduciary duty of care also extends to insurance sales activities. For example, most estate planning services are categorized as a financial planning activity. As a result, a CFP 11 See Rule See definition of Fiduciary contained in the Terminology of the Updated Standards.

5 Page 5 of 6 Certificant who sells a life insurance policy as part of his/her estate planning services would be subject to the fiduciary standard. Once again the result is increased liability exposure to the CFP Certificant. Increased Disclosure Requirement: The Updated Standards dictate that CFP Certificants disclose certain material information to all clients and prospective clients. Specifically, the disclosure must include: (1) A description of the cost and compensation paid to the CFP Certificant and/or the broker-dealer; (2) A general summary of likely conflicts of interest between the client and the CFP Certificant, the broker-dealer or any affiliates or third parties; (3) Any information about the CFP Certificant or broker-dealer that could reasonably be expected to materially affect the client s decision to engage the CFP Certificant, including information about the CFP Certificant s areas of expertise; and (4) Contact information for the CFP Certificant and the broker-dealer. If the CFP Certificant s services include financial planning or material elements of the financial planning process, the CFP Certificant must provide these disclosures to the client in writing prior to entering into any written agreement. These disclosure obligations present CFP Certificants with a difficult challenge crafting a comprehensive, legally accurate disclosure document that not only describes their compensation and conflicts, but also those of their broker-dealer, for distribution to appropriate clients --a difficult task, to say the least. Broker-dealer firms are also left with a difficult challenge. They can either allow CFP Certificants to draft their own disclosures, or draft the disclosures for the CFP Certificants. The first option subjects the broker-dealer to liability that may arise from poorly drafted disclosures prepared by wellmeaning CFP Certificants. The second option makes the firm directly responsible for the content of the disclosure and may subject the firm to liability for activities that stray from the disclosure document s language. Written Agreement Requirement: If the services provided by a financial advisor to a client include financial planning or material elements of the financial planning process, the CFP Certificant must enter into a written agreement with the client. 13 The written agreement must specify (a) the parties to the agreement, (b) the date of the agreement and its duration, (c) how and under what terms each party can terminate the agreement, and (d) the services to be provided as part of the agreement. This requirement will be easy to comply with when the CFP Certificant is providing investment advisory services because he/she likely already uses such agreements with their advisory clients and are already subject to a fiduciary standard under the Investment Adviser Act of However, when a CFP Certificant engages in material elements of the financial planning process by performing services as a registered representative, the 13 See Rule 1.3.

6 Page 6 of 6 task becomes more complicated. For example, if a CFP Certificant recommends to a client that they establish an IRA account and purchase one or more mutual funds, the CFP Certificant likely engages in material elements of the financial planning process and, therefore, must prepare a client contract to govern this engagement. Once again, the obligations imposed by the Updated Standards present CFP Certificants with a difficult challenge crafting a comprehensive, legally accurate, contractual agreement for each client engagement. Broker-dealer firms are left with another difficult choice: (1) allow CFP Certificants to draft their own contracts for registered representative activities, or (2) draft the contracts for the CFP Certificants. As with the disclosure requirement, the first option subjects the firm to liability that may arise from poorly drafted agreements prepared by a well-meaning CFP Certificants. The second option makes the firm directly responsible for the content of the agreement and may subject the firm to liability for activities that stray from its terms. Conclusion Although well intentioned, the Updated Standards will increases the liability exposure of CFP Certificants and the broker-dealers with which they affiliate by imposing a heightened standard of care and establishing detailed disclosure and contractual requirements on almost all financial advisor activities beyond mere order taking. As a result, independent financial advisors who are CFP Certificants and the independent broker-dealers with which they are affiliated are urged to forward comment letters to the CFP Board that raise these concerns. Financial advisors can submit a comment letter in five minutes or less by visiting FSI s Advocacy Action Center at and selecting the link labeled Financial Advisor Comment Letter on CFP Board's Updated Standards. Independent broker-dealers should forward their detailed comment letters to the CFP Board at standards@cfpboard.org or via postal mail at: Kevin R. Keller, CAE Chief Executive Officer CFP Board of Standards, Inc K Street, NW, Suite 500 Washington, DC If you have any questions, please feel free to contact David Bellaire, FSI s general counsel & director of government affairs, at or david.bellaire@financialservices.org.