More important than tax planning

“A rising tide carries all ships” – Dave Mallach, my boss and mentor at Merrill Lynch in the early 1980s

A group of accountants discussed a financial planning strategy using a cash value life insurance policy to accumulate wealth for a variety of family and charitable purposes. These strategies often incorporate the use of a charitable trust to further leverage the financial benefits. Midway through the discussion it became clear to me that tax accountants can easily lose track of something that is more obvious to investment advisers. The merits of any such financial planning strategy are only as good as the performance of the underlying assets. In other words, it really doesn’t matter if the tax aspects are optimized if the investment flops.

Is is likely true that some individuals have built wealth through such a strategy. Certainly the strategy is tax effective. However, it makes more sense for us to focus on the large number of individuals who have been financially hurt by the collapse of cash value life insurance in the past two decades of falling interest rates.

My own family is among those that planned a multi-generational trust based on 8% interest rate assumption only to have a life insurance policy collapse with disastrous consequences when rates of return fell dramatically. Many clients have been similarly affected.

Investment professionals know that a rising market makes all financial planning strategies look good and a falling market makes even genius tax planners look like idiots. Of course, we only like to talk about the first case. My mentor at Merrill Lynch instilled this lesson in my first year of working at his firm. I was studying portfolio management in an MBA program and he was explicit in his opinion that all this education was ultimately worthless in a declining market.

The message should be clear: focus on solid investment strategies first, then look at tax efficiency and other financial planning factors as secondary goals.

Choosing a financial adviser

It seems that most people choose professional service providers based on the recommendation of a friend or other professional. This is a “tried and true” method to help ensure similar results as the referrer and minimize the risk of choosing a bad provider. A personal recommendation, for example, works well when choosing a dentist. A friend who had a pleasant experience with a tooth cleaning and checkup is a good source of information about your choice of provider. It is reasonable to assume that your needs (i.e. cleaning and checkup) and outcome may be similar. In this case a personal referral makes sense.

But does this same logic apply to choosing a financial adviser? Today’s  financial service industry, the range of services that are offered by various providers and the results obtained by their clients are so widely varied that a comparison from one person’s experience to another rarely makes sense. It’s clearly not like choosing a dentist. More important, setting a goal of achieving the status quo of financial advice is simply not good enough anymore. Shooting for the same level of service as attained by a friend could be seriously selling yourself short. The fact is that average experience with financial advisers falls far short of the level of service that is possible. While most advisers are honest, hardworking and operate within the law, that is just not good enough. In these days, no one should want to hire a “typical” financial adviser.

Finally, of course, the effects of trusting a disreputable adviser can be disastrous. Most of the high profile adviser scams we read about in the news share a common thread that the adviser was highly praised and referred from client to client. Without the support of well-intentioned referrers, these scams would not have been possible.

I conclude that selecting a financial adviser should be more carefully considered than taking a personal recommendation from a friend. Personal referrals may be insufficient. Instead, I suggest that investing some time to learn about the internal workings of advisory process, the overall financial services industry and the specific details about the individual adviser will prove to be well worth the effort. These five points highlight some of the most important considerations facing financial advisory clients today.

1. Understand the basics of the financial service industry. Realize that the
majority of people who call themselves financial advisers are really not advisers but sellers. Most earn their living from commissions of fees built into the financial products you buy from them. Many advisers earn additional fees by “managing” investment assets, regardless of whether the investment performance benefits from this additional management (usually it does not) and even if the assets just sit there with no impact from the adviser. (For example, this is called a “12(b)(1) fee” in mutual funds). The more the advisers sell, the more they earn. That is not advising, that is selling – no matter what title is placed on the business card.

There is no connection between the adviser’s compensation and the quality of the advice given to the client. In fact, the Securities Exchange Commission has recently undertaken a publicity campaign to inform the public on an issue known as “the Merrill Lynch rule” of the difference between an adviser who is a fiduciary (a person who is held legally accountable to act in your best interest) and an adviser who is a registered representative for a broker (whose primary legal responsibility is to the employer) who is only required to avoid
unsuitable recommendations to clients.

It may come as a surprise that most people classified as advisers are not even legally required to act in your best interest. Of course,
that certainly does not mean that all of the advice is bad, but rather it means that the financial adviser is motivated by something other than providing you the best information available. For example, you will rarely if ever hear a financial adviser mention that a competing firm’s services are less expensive than those of the adviser’s firm. If you want to avoid this conflict of interest Jon Clements, them personal finance columnist for The Wall Street Journal wrote on 5/31/06, “your best bet is to use fee-only advisers who charge an hourly fee”. Since your financial future is likely to be affected on your selection, it makes sense to spend the time to find an adviser who is not compensated for anything other than providing you advice.

If you decide to go this route, this means filtering out more than nine out of every ten people who call themselves financial advisers. It is not always easy to find an hourly-fee adviser who does not accept commissions or asset-based fees.

Once you locate a candidate, ask to see a copy of the advisers “Form ADV Part 2” to be sure that the information reported to you is the same as what is reported to the government.

2. Aim high. Of course you have to make sure that the adviser is credible and knowledgeable. Some people look for a CFP designation or a CPA with a CFS credential. But if you really want your money’s worth, knowledge and designations are not enough. When making in this important decision, it makes sense to set your sites higher. How about finding an adviser who is recognized as a leader or an expert within the financial industry? How about an adviser with a long list of endorsers? How about someone who is well-connected in the business community and in the financial services industry? How about someone who has made a mark as a well known teacher, writer or lecturer in the financial planning topic? In other words, why not look for an adviser who makes an impression that “knocks your socks off”? Put another way, if you choose an “average” financial adviser, then you should expect average results.

In the end, you can expect exceptional results only after you have taken the time to seek out an exceptional adviser.

3. See the big picture. Consider that there is far more to managing finances today than picking stocks and mutual funds. You might also want help with lowering your mortgage costs, handling college costs, improving your accounting system, online transactions, banking, evaluating insurance, tax strategies and return preparation, trust accounts, wills and estate planning. A positive contribution in any of these areas will far outweigh the contribution made by choosing investments. In fact, economists would argue that the task of picking specific investments play an insignificant role – perhaps is the least important factor – in your overall long term financial success. Make sure that your adviser is experienced and willing to help you with the broad range of financial planning issues.

Also, consider this issue in relation to the two points in #1 and #2 above. Most advisers do not have a broad-based knowledge and experience in the important topics outside of investing. An adviser who is primarily paid to sell or manage your investments has no incentive to help with taxes, loans, college tuition bills or other concerns that are equally important to you. And even if the adviser was motivated to help, few would be qualified to offer broad-based services.

4. Consider the impact of the Internet. The Internet has changed the way all of us do business and has dramatically impacted the products, services and fees in the financial services industry. It is now possible to conduct financial transactions faster and far lower price than almost anyone would have previously dreamed to be possible. This has generally been good news for consumers, at last for those who are able to filter through the many offerings and separate the good from the bad that cohabitate on the Web.

Unfortunately, it seems that for every great deal or service on the Web there are also a handful of scams. Just keeping up with this changing field of online services has become an area of specialization in the financial service community. Most financial advisers avoid online services simply because they do not pay commissions – that is one of the ways they save consumers money. Financial advisers are just beginning to embrace the Internet. Few have invested the time to become well-educated on the benefits, and few firms are willing to adapt technologies that allow clients to benefit from the latest technology. Many cite concerns over regulatory issues. The few advisers that do offer this full internet-based service add significant value for their clients.

The other impact of the Internet is the breakdown of geographic barriers. In the old days, we chose professionals in our own town. Now people are more likely to have a financial adviser across the country. Today’s Internet-savvy adviser is able to utilize video conference technology, document sharing capabilities that improve the efficiency and lower the costs of providing personal services. Even the simple technology of sequential telephone call routing now allows an adviser to answer more calls from clients on the first dial, rather than relying on voicemail
tag. This allows clients to select a financial adviser with whom they feel a connection – based on the things that are really important like communication, expertise and a matching of personalities – rather than choose among the advisers located within the same physical address.

5. Keep a lid on total costs. All of the adviser’s fees plus all other costs
including commissions, built-in charges, account fees, “hidden” expenses and other financial charges play a role in your long term overall financial well-being.

If this amount grows much past 1% of your invested assets, the rate of growth becomes impaired. Within 401(k) plans alone, some investors pay $25,000 more than others in mutual fund charges alone over their working careers. This means that there is $25,000 less in the investment account on the date of retirement that would otherwise be available to the client. Of course, it is equally important to evaluate non-investment-related costs. An adviser who is experienced with helping to reduce overall financial expenses can be far more valuable than an adviser who helps boost your investment returns. An adviser who shows you how to cut out mortgage points, for example, can reduce your cost of borrowing
by thousands of dollars.

A client should expect to see a direct tangible net result from the adviser’s efforts and should evaluate the adviser’s return on investment in the same way as any other investment. The “investment” in this case, is the adviser’s fee. An adviser who charges a $2,000 fee, for example, but immediately saves you $3,000 in taxes and another $2,500 in mortgage loan expenses has clearly proven to be a good return on your investment; far more so than an adviser who is able to boost investment results on a client’s typical-sized portfolio from, say, 7% to 9%.

In summary, choosing a financial adviser should be a bit like choosing a spouse. We should be cautious and go slow at first, do our homework, test the relationship, and not make a hasty decision about any long term commitment. It takes some work to seek out the right financial adviser, but the long term benefits are worth the extra effort.

About the Author
Tony Novak is a consumer finance writer, speaker and adviser based in the
Philadelphia area. He can be reached at

Code of conduct for a Certified Public Accountant acting as personal financial adviser

This short article of explanation followed by the reproduced guidance from the AICPA are most likely to directly affect relationships between a client and financial adviser when the adviser is a Certified Public Accountant.

The rules are designed to reduce the risk of potential conflict of interest and usually relevant under four common scenarios:

1) The adviser prepares financial statements that may be used by a bank or other third party. For example, a bank asks for a financial statement as part of a loan application. The purpose of the rule is to ensure that the third party is aware of any potential conflict of interest.

2) The adviser receives compensation from a third party like a commission or referral fee. For example, the adviser handles an insurance transaction. The intent is to provide disclosure about the compensation.

3) The adviser uses a third party service to help with work. For example, an online tax preparation service. The intent is to protect private information.

4) The adviser participates with third parties in compiling information that does not identify the client. For example, the adviser publishes “case studies” as educational material without identifying the client. The purpose is to ensure that the client gives permission to disclose any non-public information.


ET Section 302 – Contingent Fees

.01 Rule 302—Contingent fees.

A member in public practice shall not

  1. Perform for a contingent fee any professional services for, or receive such a fee from a client for whom the member or the member’s firm performs,
    1. an audit or review of a financial statement; or
    2. a compilation of a financial statement when the member expects, or reasonably might expect, that a third party will use the financial statement and the member’s compilation report does not disclose a lack of independence; or
    3. an examination of prospective financial information;or
  1. Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.

The prohibition in (1) above applies during the period in which the member or the member’s firm is engaged to perform any of the services listed above and the period covered by any historical financial statements involved in any such listed services.

Except as stated in the next sentence, a contingent fee is a fee established for the performance of any service pursuant to an arrangement in which no fee will be charged unless a specified finding or result is attained, or in which the amount of the fee is otherwise dependent upon the finding or result of such service. Solely for purposes of this rule, fees are not regarded as being contingent if fixed by courts or other public authorities, or, in tax matters, if determined based on the results of judicial proceedings or the findings of governmental agencies.

A member’s fees may vary depending, for example, on the complexity of services rendered.

[As adopted May 20, 1991.]

Interpretation under Rule 302

—Contingent Fees

.02 302-1—Contingent fees in tax matters.

This interpretation defines certain terms in rule 302 [ ET section 302.01] and provides examples of the application of the rule. When practicing before the IRS or other taxing authorities, members should ensure compliance with any requirements that are more restrictive.

Definition of Terms

  1. Preparation of an original or amended tax return or claim for tax refund includes giving advice on events which have occurred at the time the advice is given if such advice is directly relevant to determining the existence, character, or amount of a schedule, entry, or other portion of a return or claim for refund.
  2. A fee is considered determined based on the findings of governmental agencies if the member can demonstrate a reasonable expectation, at the time of a fee arrangement, of substantive consideration by an agency with respect to the member’s client. Such an expectation is deemed not reasonable in the case of preparation of original tax returns.

ExamplesThe following are examples, not all-inclusive, of circumstances where a contingent fee would be permitted:

  1. Representing a client in an examination by a revenue agent of the client’s federal or state income tax return.
  2. Filing an amended federal or state income tax return claiming a tax refund based on a tax issue that is either the subject of a test case (involving a different taxpayer) or with respect to which the taxing authority is developing a position.
  3. Filing an amended federal or state income tax return (or refund claim) claiming a tax refund in an amount greater than the threshold for review by the Joint Committee on Internal Revenue Taxation ($1 million at March 1991) or state taxing authority.
  4. Requesting a refund of either overpayments of interest or penalties charged to a client’s account or deposits of taxes improperly accounted for by the federal or state taxing authority in circumstances where the taxing authority has established procedures for the substantive review of such refund requests.
  5. Requesting, by means of “protest” or similar document, consideration by the state or local taxing authority of a reduction in the “assessed value” of property under an established taxing authority review process for hearing all taxpayer arguments relating to assessed value.
  6. Representing a client in connection with obtaining a private letter ruling or influencing the drafting of a regulation or statute.

The following is an example of a circumstance where a contingent fee would not be permitted:

  1. Preparing an amended federal or state income tax return for a client claiming a refund of taxes because a deduction was inadvertently omitted from the return originally filed. There is no question as to the propriety of the deduction; rather the claim is filed to correct an omission.

[Revised effective May 31, 2011]

ET Section 391 – Ethics Rulings on Responsibilities to Clients

1. Use of a Third-Party Service Provider to Provide Professional Services to Clients or Administrative Support Services to the Member

.001 Question—A member in public practice uses an entity that the member, individually or collectively with his or her firm or with members of his or her firm, does not control (as defined by in Financial Accounting Standards Board Accounting Standards Codification 810, Consolidation)or an individual not employed by the member (a “third-party service provider”) to assist the member in providing professional services (for example, bookkeeping, tax return preparation, consulting, or attest services, including related clerical and data entry functions) to clients or for providing administrative support services to the member (for example, record storage, software application hosting, or authorized e-file tax transmittal services). Does Rule 301, Confidential Client Information [ET section 301.01], require the member to obtain the client’s consent before disclosing confidential client information to the third-party service provider?

.002 Answer—No. Rule 301 [ET section 301.01] is not intended to prohibit a member in public practice from disclosing confidential client information to a third-party service provider used by the member for purposes of providing professional services to clients or for administrative support purposes. However, before using such a service provider, the member should enter into a contractual agreement with the third-party service provider to maintain the confidentiality of the information and be reasonably assured that the third-party service provider has appropriate procedures in place to prevent the unauthorized release of confidential information to others. The nature and extent of procedures necessary to obtain reasonable assurance depends on the facts and circumstances, including the extent of publicly available information on the third-party service provider’s controls and procedures to safeguard confidential client information.

In the event the member does not enter into a confidentiality agreement with a third-party service provider, specific client consent should be obtained before the member discloses confidential client information to the third-party service provider.

See ethics ruling No. 112 [ET section 191.224–.225] under Rule 102, Integrity and Objectivity [ET section 102.01], and ethics ruling No. 12 [ET section 291.023–.024] under Rule 201, General Standards [ET section 201.01], and Rule 202, Compliance With Standards [ET section 202.01], for additional responsibilities of the member when using a third-party service provider.

[Revised, effective July 1, 2005, except for professional services performed pursuant to agreements in existence on June 30, 2005 that are completed by December 31, 2005, by the Professional Ethics Executive Committee. Revised effective May 31, 2011]

2. Disclosure of Client Information to Third Parties

.003 Question—A member has received a request from a third party (for example, a trade association, member of academia, or surveying or benchmarking organization) to disclose client information or intends to use such information for the member’s own purposes (for example, publication of benchmarking data or studies) in a manner that may result in the client’s information being disclosed to others without the client being specifically identified. May the member comply with such a request or use client information for such purposes without violating Rule 301 [sec. 301 par.01]?

.004 Answer—A member would be in violation of Rule 301 [sec. 301 par.01] if the information is considered to be confidential client information, unless the member has the clients’ specific consent, preferably in writing, for the disclosure or use of such information. The disclosure or use of the information that is available to the public is not subject to Rule 301 [sec. 301 par.01]. The member should be cautious in the disclosure or use of the information so as not to disclose client information that may go beyond what is available to the public or that the client has agreed may be disclosed.

Accordingly, before disclosing confidential client information to a third party or using such information for the member’s own purposes when the use of such information results in disclosure of confidential client information to others, the member should obtain the client’s specific consent, preferably in writing, about the nature of the information that may be disclosed, the type of third party to whom it may be disclosed, and its intended use.

A member is not prohibited from marketing his or her services or advising a third party, such as a current or prospective client, of information based on his or her expertise or knowledge obtained from prior experiences with clients (for example, the nature of services provided to other clients or common practices within a client’s industry). However, in cases when such information may be identifiable to one or more clients, specific consent, preferably in writing, would be required from such client(s). Prior to disclosing confidential client information to a third party, the member should consider whether a contractual agreement with the third party to maintain the confidentiality, or limit the use, of the information is necessary.

In addition, the member should consider whether federal, state, or local statutes, rules, or regulations concerning confidentiality of client information may be more restrictive than the requirements contained in this ethics ruling.

See Ethics Ruling No. 12 of section 291 [sec. 291 par. .023-.024] and Ethics Ruling No. 1, “Use of a Third-Party Service Provider to Provide Professional Services to Clients or Administrative Support Services to the Member,” of this section [sec. 391 par. .001-.002] for guidance when disclosing confidential client information to a third party used to assist the member in providing professional services to clients that will not result in disclosure to others.

[Revised August 2011, effective November 30, 2011]

ET Section 391 – Ethics Rulings on Responsibilities to Clients

24 Investment Advisory Services

.047 QuestionA member or member’s firm (“member”) provides investment advisory services for an attest client for a fee based on a percentage of the client’s investment portfolio. Would the member be considered to be in violation of rule 302, Contingent Fees [ET section 302.01]?

.048 Answer—Yes. However, the fee would not be contingent upon portfolio performance and, therefore, would not be in violation of rule 302 [ET section 302.01] if all of the following conditions are met:

1 The fee is determined as a specified percentage of the client’s investment portfolio.

2 The dollar amount of the portfolio on which the fee is based is determined at the beginning of each quarterly period (or longer period of time as may be agreed upon) and is adjusted only for additions or withdrawals made by the client during the period.

3 The fee arrangement is not renewed with the client more frequently than on a quarterly basis.

When performing such services, the member should also consider Rule 101, Independence [ET section 101.01], especially interpretation 101-3 [ET section 101.05].

25 Commission and Contingent Fee Arrangements With Nonattest Client

.049 Question—A member or member’s firm (member) provides for a contingent fee investment advisory services, or refers for a commission products or services of a nonclient or a nonattest client, to the owners, officers, or employees of an attest client or to a nonattest client employee benefit plan sponsored by an attest client. Would the member be considered to be in violation of either rule 302 [ET section 302.01] or rule 503 [ET section 503.01]?

.050 AnswerNo. The member would not be in violation of either rule 302 [ET section 302.01] or rule 503 [ET section 503.01] provided that, with respect to rule 503 [ET section 503.01], the member discloses the commission to the owners, officers, or employees or to the employee benefit plan. The member should also consider the applicability of interpretation 102-2, Conflicts of Interest [ET section 102.03], and his or her professional responsibility to clients under Rule 301, Confidential Client Information [ET section 301.01].