Accountants and Financial Planning: Structuring for Success.

By Thomas R. Manisero and Fred N. Knopf

In Brief

Making the Right Choice

The accounting profession is abuzz with the prospect of developing robust, commission-driven financial planning practices. The barriers are coming down, and broker/dealers are developing all sorts of affiliations and relationships to tap into the accumulated wealth of CPA clients.

Thoughtful CPAs will proceed with caution and explore all the options. They will not want to turn the whole investment advisory responsibility over to an unknown broker who may be more concerned about fees than the long-term financial goals of the client.

Accountants are advised to consider the panoply of issues inherent in any new business venture. The best advice is to explore all the options, consult with appropriate advisors, and proceed with caution.

It has been said that the number of accountants entering the financial planning field during the early '90s could best be described as a trickle that has become a flow and will soon be a torrent. Some estimates conclude that over the next 10 years almost 6,600 accounting firms will enter financial planning ventures of one form or another.

These conclusions certainly have not gone unnoticed by the securities industry. With increasing aggressiveness, constituent members of the securities industry have developed and implemented marketing efforts designed to access accountants, their firms, and their clients' money. Accountants are being deluged with all forms of information concerning financial planning and other securities opportunities.

After all, given the natural relationship between accountants and their clients' financial affairs, the overwhelming profitability of the financial markets this decade, and the fact that in many states accountants are now permitted to accept commissions from their clients' securities activities, who can blame the securities industry for attempting to tap this significant market? Indeed, recent affiliation efforts by the personal financial planning (PFP) division of the AICPA and various state societies only underscore the significance of this market.

Accountants, in increasing numbers, are now giving serious thought as to what entering the financial planning market would mean to their practices. They are advised, however, to consider the panoply of issues that might arise. Like any new business venture, developing and implementing a financial planning or securities investment practice is fraught with pitfalls.

Initial Issues and Licensing

The first question facing CPAs that wish to provide financial planning services is how to enter the marketplace. A natural first impulse is to enter into an arrangement with a securities broker/dealer as a means to start the flow of commission income. But caution is in order. Broker/dealers are offering CPAs a wide range of referral opportunities. The "right" broker/dealer will depend upon the type of financial planning in which the accountant is engaged. As a practical matter, CPAs just starting out should not expect to attract the attention of major broker/dealers.

Accountancy laws and professional association codes of ethical conduct are another issue CPA financial planners must address. The Uniform Accountancy Act (UAA), which sets the tone of accountancy statutes at the state level, permits the receipt of commissions on behalf of clients for whom the accountant does not provide attest services. But the definition of "client" is still at times unclear. Can a CPA provide financial planning services, possibly receiving commissions, for an officer or shareholder of a company for which the CPA provides audit or other attest services? The AICPA is in the midst of examining the code of conduct to clarify this and other issues. State accountancy laws will also need clarification.

Most CPAs, however, report that the potential pitfalls are outweighed by the professional satisfaction of resolving clients' financial problems and seeing them achieve their long-term financial goals.

Licensing and Registration Requirements

Of course, providing sound financial planning advice requires specialized knowledge. Accordingly, CPAs must regularly attend financial-planning seminars and read widely. Many now are turning to the Internet to conduct research, get stock prices, and communicate with clients (some useful sites are listed in the Exhibit).

Many CPAs are now also CFPs (certified financial planners), PFSs (personal financial specialists), and RIAs (registered investment advisors). The AICPA estimates that between 65,000 and 90,000 of its 330,000 members presently offer financial-planning services. This estimate is based on the number of members that attend financial-planning conferences and CPE courses and purchase AICPA materials on the subject.

The number of CPAs certified by the AICPA as PFSs has doubled in the past two years and tripled in the past three. About 20% of the 2,500 PFSs accredited by the AICPA have also registered with the SEC as RIAs. In general, if a financial planner manages more than $25 million in assets, registration is required with the SEC. If the number is less than $25 million, state registration rules apply.

The securities licensing process is important to consider when affiliation with a licensed broker/dealer is a viable option. Many advisors are encouraged to obtain the Series 7 general securities registration administered by the National Association of Securities Dealers, Inc. (NASD). This credential allows a financial advisor to recommend and sell virtually any investment product (e.g., stocks, bonds, and mutual funds). The Series 7 grade does not, however, permit the sale of options or futures contracts, which are rarely used in typical financial planning. The Series 7 examination typically involves approximately 50 hours of study time, and applicants are given almost a full day to complete the test. The examination and the scope of topics tested are rigorous and comprehensive. If CPAs are not inclined to sit for this examination, an alternative is the Series 6 credential, which limits the holder to the sale of mutual funds. The Series 6 may encompass as much as 75% of the products typically sold by CPA financial planners, but being able to provide full service to potential clients is a significant reason to seek the full Series 7 qualification.

Most states require that planners obtain a basic knowledge license along the lines of the Series 63 exam, otherwise considered a regulatory ethics exam for the securities industry. Additionally, CPAs that plan to offer fee-based asset management may be required by state law to take the Series 65 exam. This examination covers the 1940 Investment Advisors Act, considered a uniform securities law exam. Recently, NASD began to offer a Series 66 examination that encompasses both the Series 65 and the Series 63.

Apart from the securities aspect of financial planning, potential advisors should consider obtaining an insurance broker's license, because the ability to offer insurance products is an integral part of the financial planning process. Many states require 40 hours of classroom study before an applicant can sit for the insurance license examination, which in most states is not considered a rigorous test.

Compensation Issues

One of the trickiest questions facing accountants turned financial planners is exactly how to tap into the financial rewards of a financial planning practice.

Recent developments have broadened the choices. First, the barriers to accepting commissions are coming down. As noted earlier, the UAA, with its permissive provisions for CPAs not providing attest services, is framing the debate over the public accounting scope of practice. In New York, two bills are under consideration to clarify accountancy regulation there. One statute, patterned after the UAA, would allow CPAs to accept commissions from clients for whom no audit or assurance services (attest) are provided. The other, to the chagrin of many CPA financial planners, would prohibit all CPAs holding out as providing services to the public from accepting commissions and referral fees from all clients.

On a separate issue, the securities industry is steering many financial planners away from commissions to fee-based or fee-only practices. As the bull market continues relatively unabated and as mutual funds continue to grow in number and funding, financial planners increasingly are positioning themselves as "asset managers," directing clients' investments into assorted mutual funds and charging a percentage of their value. Recently, a number of major brokerage firms have restructured their broker compensation to give incentives for fee-based asset management and for moving brokers away from traditional commission arrangements. Therefore, in the broader market, accountants starting financial planning ventures have several options for compensation.

Hourly Fees. Many accountants prefer to charge hourly fees, especially when starting out, mainly because they are accustomed to working on a fee basis. As a practical matter, hourly fees are also easier to administer. Moreover, some clients are more comfortable being charged hourly fees by professionals, given their prior experience paying lawyers and accountants on this basis. If a client's financial affairs are generally in order and only a few hours of annual planning to update pertinent investment strategy and overall financial performance are needed, the client may ultimately benefit by paying by the hour.

Flat Fees. In the securities industry, however, financial planners prefer not to bill by the hour because, by their nature, financial planning engagements lend themselves to flat fees. Flat fees tend to be based on the projected amount of time needed to service an account, and the resulting income is a function of the time devoted to a client. In reality, however, most financial professionals find little difference between billing by the hour and flat fees.

Percentage of Assets Managed. What is generally referred to as "fee leverage" results when CPAs charge their clients a financial advisory fee based on assets under management. As assets grow, the time needed to monitor the account does not necessarily grow proportionately. For example, management of $1 million in assets for a 1% annual fee results in $10,000 per year. But, if assets under management grow to $2 million and the fee doubles to $20,000, it is unlikely that twice as much time would be required, making this an enhanced revenue stream for the planner.

There is another aspect to this leverage. As illustrated above, a rise in the stock market causes a logical increase in the value of clients' assets and, hence, in asset management fees. Many investment professionals and public investors do not mind this because it aligns the professionals' interests with the clients.' Almost forgotten during the lengthy bull market of this decade is that this leverage cuts both ways. If there is a sharp market correction--such as a reprise of the 1973­74 bear market when stock values plunged 50%--asset management fees would decline while inevitably requiring more stringent analysis. Under these circumstances, more work would be required for less compensation.

For now, the bull market--described by some as a tree growing to the sky--has encouraged the vast majority of financial planners to charge asset management fees. In fact, some major brokerage firms charge a diminishing scale of management fees, typically 2% of assets under management in the first year, when the work of planning is the most intense, later reduced to 1.5% and then 1% in successive years when planning work wanes. This scale of management fees also helps investment advisors better absorb the trading costs associated with revising a client's portfolio, because the actual costs of individually recommended transactions are often included in the advisory fees.

If the CPA wishes to collect a portion of management fees without the full responsibility for investment decisions, a viable alternative is to affiliate with another licensed entity that provides "turnkey" services. There are several turnkey entities that work with accountants. The total fee for such a procedure varies within a range of 60­150 basis points (0.6­1.5%) per year. Typically, the larger the account, the smaller the percentage fee. Of the total fee, anywhere from one-third to two-thirds might be split with the accountant, but the ultimate fee sharing depends largely upon how active a role the accountant plays in the asset management process.

Affiliating with a turnkey program is not the only way to get paid for managing assets. Some accountants practice asset management on their own, relying upon a broker or a mutual fund company for custody and various back office support. Still another approach is to affiliate with a broker/dealer that offers such services.

No matter how it's handled, being compensated for managing assets can provide an annuity-like income stream without the process of billing clients and collecting receivables. Asset management fees are generally sent directly to the planner. Most clients in these programs keep a liquid account, such as a money market fund, from which fees are drawn periodically and forwarded to the planner.

Despite this flexibility, asset management fees may not be appropriate in all situations, such as those where wealth is concentrated in a closely held company, or where most of the portfolio is outside the reach of active management, like in a 401(k) plan with limited choices. Such clients may object to paying annual fees to a planner if their portfolio is stable and requires relatively little work each year.

Conducting Investment Advisory Business

Under Federal law, if anyone provides investment advice involving the buying or selling of securities to at least 10 clients, registration as investment advisor is required.

Merely registering as an RIA, however, is just the beginning. RIAs must comply with multiple record-keeping requirements, like keeping a cash receipts journal, a general ledger, memoranda of security purchases, banking records, financial statements, bills relating to the advisory business, and the like.

Another approach is to keep financial planning incidental to an existing accounting practice and thus qualify for the "accountant's exception" to the RIA rules. This exception generally applies if investment advisory services are incidental to the practice of accountancy, but conduct under this exception needs to be carefully considered and monitored. Another option is to become an advisory agent, covered by another RIA's "umbrella." Not all broker/dealers, however, are willing to share their RIA status, which means assuming responsibility for the agent's actions.

The most common penalty for failure to register is the requirement to register. But, penalties may be more severe in some instances, including the voiding of contracts or the disgorgement of fees collected. Fines may also be imposed. Recently, the SEC turned over regulation of smaller advisors to the individual states.

Thus, it is imperative to take regulatory and legal risk seriously and use internal or external compliance personnel experienced in dealing with the SEC and NASD in securities and advisory matters. The legal and liability risks are easily mitigated when the practitioner focuses on only providing solutions that are in the client's interests.

The best protections involve full disclosure of compensation and securities activities to clients. Another way to help minimize risk is to purchase a comprehensive errors and omissions liability insurance policy that covers all areas of financial planning--security sales, fee-based asset management, insurance sales, and traditional accounting services.

It is also recommended that financial advisors establish a separate financial planning entity, an LLC or a C corporation, through which the financial planning services are provided. There are obvious legal reasons for establishing a separate entity, including 1) protection of accounting firm assets if a client dispute arises, 2) flexibility to sell if a decision is made to separate from the financial services practice, and 3) avoidance of regulatory oversight of the ancillary accounting practice if it becomes commingled with the advisory practice.

Affiliation Options

Many accountants will also consider forming an affiliation with a brokerage firm that already includes seasoned producers. Indeed, many brokerage firms have a professional partners program to help accountants build such alliances. In such programs, accountants are generally paired with a full-time financial advisor. In its most basic form, the accountant will refer a client to the financial advisor, who then handles the client's investment needs. The accountant then monitors the financial advisor's performance and client satisfaction. Under many financial agreements and formulae, accountants are compensated for referrals, usually by sharing in the asset management fee.

The most significant attraction for such arrangements stems from the fact that the brokerage firm directly handles the securities transactions for the financial advisor. Depending upon the program, the broker/dealer may also provide supplemental support services for the accountant, such as marketing materials to explain the partnership and regulatory disclosure forms. Studies show that accountants tend to underestimate the complexity of the regulatory requirements governing financial planners. Indeed, most broker/dealers have compliance departments dedicated to helping affiliates conform to the myriad rules and regulations.

The most significant drawback of such programs is that they have a tendency to operate at the individual registered representative level. Many veterans of such programs report that brokers operating on an individual basis are not inclined to form true partnerships with accountants if the brokers have to share fees and resources. Under such circumstances, it is advisable at the outset to approach the management of the broker/dealer or insist on rights to disassociate with an individual broker if problems arise.

Alternative paths to financial planning also emerge when accounting firms hire individuals that already have experience providing investment advice. Under such circumstances, experienced investment professionals may be able to utilize existing broker/dealer relationships. Such introductions can help an accounting firm develop its financial planning practice quickly.

Another option is to affiliate with a broker/dealer that offers services to beginners. Many firms provide an office set-up kit to help accountants with details not covered in courses on asset allocation or ERISA plans. Such kits contain brochures, posters, and other display materials to help accountants inform clients about these new services, including such seemingly elementary things as client letters that have passed regulatory approval.

As discussed above, many major brokerage firms, and even fund families, are actively recruiting accountants to recommend their products and funds to clients. A few have even developed specialized groups specifically to work with fee-based advisors, including accountants. Some brokerage firms also offer to act as custodian for assets managed by RIAs and to provide service, software, and technical support, including back office services. In fact, at least one has a special trading desk for accountants.

While affiliating with a major financial firm may be an attractive alternative, it's not the only path available to accountants that want to go into financial planning. Increasingly, independent broker/dealers are offering opportunities to accountants that want to work on either a fee or commission basis. Independent broker/dealers insist that they can offer the full range of support to financial planners without any pressure to sell particular products. They offer execution of transactions and a wide range of products, including variable annuities and insurance policies from a variety of sources.

In some cases, a wide range of products can be intimidating. Some firms offer affiliated financial planners access to 2,500 funds, no-load or fee-waived. In order to help planners cope, they provide a number of model portfolios for clients with different risk tolerance and time categories, with one or two funds recommended in each.

As with any business relationship, affiliating with a broker/dealer can have certain risks. Careful attention must be given to the provisions of agreements that establish the affiliations. For example, broker/dealers often use noncompete clauses that may prohibit accountants from contacting their clients for up to a year if the accountant decides to disassociate with the brokerage firm.

Proceed with Caution

The financial markets of the past decade have developed almost limitless opportunities for accountants to enter and profit from the financial services market. Accountants have taken their cue from the market and aggressively entered the market with their clients in tow. Despite the pressure to provide full services immediately, accountants must proceed carefully into one of the most highly regulated and competitive industries in modern business. A conservative, knowledgeable approach will best serve the accountant entering this world at this time. *

Thomas R. Manisero and Fred N. Knopf are partners in the New York City office of Wilson, Elser, Moskowitz, Edelman & Dicker LLP. Both specialize in commercial, securities, and accountants' liability litigation and are actively involved in forming securities industry business units for their clients.

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