NAPFA Under Ethics Spotlight
After drawing unwanted attention when some of its members were recently accused of fraud, the National Association of Personal Financial Advisors is wrestling with ways to ensure that members abide by the organization's ethical standards.

The public image of NAPFA, the Arlington Heights, Ill.-based membership group of fee-only advisors that has long held itself out as a beacon of ethics and probity, got a black eye this spring when three of its members were charged by the Securities and Exchange Commission with cheating clients. In April, the agency charged Julie Jarvis, a planner with Crossroads Financial Planning Inc. in Columbus, Ohio, with stealing more than $2 million from two elderly clients and using the money to buy property in Ohio and the Caribbean.

In May, the SEC charged former NAPFA president James Putman, the founder, majority owner and CEO of Wealth Management LLC in Appleton, Wis., and Simone Fevola, Wealth Management's former president and chief investment officer, with each accepting $1.24 million in undisclosed payments in a kickback scheme involving unregistered investment pools they managed. Putman was NAPFA president in 1996 and '97.

And in June, the SEC charged Matthew Weitzman, a co-founder and principal of AFW Wealth Advisors in Purchase, N.Y., and Natick, Mass., with stealing more than $6 million in client funds for personal use, including funds from terminally ill and mentally impaired clients.

"Our members are angry about it, and so are we," says Diahann Lassus, NAPFA's national chair. "We're all asking the question, 'Is there something we can do differently?' "

"I think it puts a stain on the organization, although it's probably only temporary because we'll deal with it quickly," adds Lassus, who is also president of Lassus Wherley, a wealth management firm in New Providence, N.J., and Bonita Springs, Fla. "But anytime you hold yourselves to a higher standard and some of your members are found lacking, people pay attention to that."

The plight of NAPFA's wayward members got a national stage after a couple of articles this spring by New York Times writer Ron Lieber, a Weitzman client whose account wasn't affected. The online reader comments following one of his articles are enough to make any advisor cringe. "The added value of most financial planners is negative," one reader remarked.

"How do you know when your financial planner is lying? Is his mouth moving?" wrote another.

And perhaps most cutting of all: "You're better off with Suze Orman. She's free, and funny."

A small, very unscientific sampling of NAPFA members found that at least some advisors don't believe the organization should be blamed for a few bad apples. "I don't feel the organization is at fault," says Faye Doria, a planner with Financial Guidance Associates in Dover, N.H., who counted Putman and Weitzman among her professional acquaintances. "I think it's unfortunate some people didn't follow the rules, but it's just inevitable that it's going to happen."

Pat Collins, a principal at Greenspring Wealth Management in Towson, Md., says the timing couldn't be worse, given the hit the entire financial services sector has taken to its reputation during the past couple of years. "We're now lumped in there with other organizations who maybe aren't as ethical, and now we have to dig our way out," he says.

NAPFA currently has roughly 2,100 members. To attain membership, applicants pay $475, submit for review a recent comprehensive plan for a client, agree to offer comprehensive financial planning and sign a fiduciary oath. Members also must complete 60 hours of continuing education. On January 1, 2010, all NAPFA members will be required to hold the Certified Financial Planner designation.

But CFP certification and vows of fiduciary fidelity don't provide ironclad protection for clients. "As one of our members said, criminality isn't something you can protect against," Lassus adds. "What you can do is set the bar very high, monitor behavior and make sure those folks don't remain as members."

Compliance Concerns
There's a lot of buzz these days about potential changes in compliance rules and the impact on advisors. Perhaps the most pressing concern centers on the Securities and Exchange Commission's proposed amendments to the custody rule that would require all SEC-registered investment advisors to hire an accounting firm to perform an annual surprise audit. The rule would apply to all investment advisory accounts where the advisor has any form of custody, including the ability to deduct advisory fees directly from client accounts.

"It will be burdensome, particularly on smaller firms," says Jarrod James, vice president at RIA Compliance Consultants in Omaha, Neb. He notes that a firm with $500 million in assets under management and 100 high-net-worth clients would be less affected than a $100 million firm with 1,000 client accounts that need auditing. "That's where accounting costs could get into the tens of thousands of dollars every year," he says.

"I've talked to people who aren't even aware of the rule," James says. The commentary period closes July 28, and as of mid-June he says only about 50 people had posted comments on the proposal, most of those coming from consulting or legal firms. "Now is the time to tell the SEC that the costs [of the custody rule amendment] are too high," he says.

Elsewhere, a recent report by TowerGroup predicts a new regulatory structure that would include FINRA audits of registered investment advisors, which in turn would mean higher compliance costs.  The report, Broker vs. Advisor Regulation: It's the Principle of the Thing, anticipates dramatic changes in the rules governing brokers and advisors-in large part because regulators can't keep up with the rapid growth of the RIA market as breakaway brokers bolt to the independent, fee-based side of the business. There isn't a self-regulatory organization (SRO) for the roughly 11,000 RIAs, and their oversight body, the SEC, "has proven to be outmatched by their sheer number," says the report. 

Brokers are governed by more rules than RIAs, entailing more reporting requirements. RIAs, on the other hand, follow the principles-based fiduciary standard that "has an eloquent definition and the requisite altruistic notion of consumer protection," says the report. "In practice, however, it is proving difficult to police."  The solution, at least according to TowerGroup, will be a mix of rules-based and principles-based regulation for both brokers and advisors that would result in FINRA examiners conducting RIA audits, under the oversight of the SEC. 

"What's the alternative [to FINRA audits of RIAs]?" asks Matthew Bienfang, TowerGroup's senior research director of brokerage and wealth management, and the report's author. "RIAs wish to have nothing happen at all, and that won't happen. The next most preferable outcome is to have their own SRO, and that also won't happen because none of them can pay for it."

The brokers' SRO, FINRA, gets its operating budget from its members. Unless Congress, which sets the SEC's operating budget, is willing to fund an agency for the governance and oversight of RIAs, it probably won't come about, Bienfang says.

TowerGroup expects that greater rules-based reporting requirements could add 10% to 20% more compliance costs to RIA firms. And smaller firms will feel the biggest squeeze. The report estimates that RIA firms with less than $100 million in assets under management currently spend between $6,000 and $35,000 annually on compliance costs. And that doesn't include labor and opportunity costs when advisors do their own compliance work.

Ultimately, TowerGroup believes a new regulatory landscape is needed because neither the broker nor the advisor model is going away, and the industry needs to harmonize its rules to quell the confusion between the two camps.   "We don't believe there can be a single standard," Bienfang says. "I believe the principles-based model is superior, but there will always be a need for brokers who sell a product."

6% Withdrawal Rate OK
What's the magic number for client withdrawal rates? Various research has long pointed to around 4%, but research in recent years has nudged that rate to higher levels. At a presentation at last month's national conference for the National Association of Personal Financial Advisors, Jonathan Guyton said a 6% withdrawal rate is appropriate even after the wreckage from last year's financial tsunami.

Guyton, a principal at Cornerstone Wealth Advisors in Edina, Minn., posited five years ago that initial withdrawal rates of 5.8% to 6.2% can sustain a portfolio for 40 years (though it depends on the equity allocation, and it also means following a few rules, such as not boosting withdrawals after a year of negative returns). During his presentation, he said his updated research now pegs the initial rate at 5.2% to 5.5%.

Guyton told the conference there are two ways to set withdrawal rates. The first entails taking out the same amount each year-increased by inflation-no matter what happened the prior year. "When you look at that version, you'll always be fine if you start between 4% and 4.5%," he said.

The second allows for midcourse corrections in withdrawal amounts if they are triggered by some event, for example, when the current year's withdrawal rate rises more than 20% above the initial rate. That can happen in down markets because withdrawal rates rise on a percentage basis when the overall portfolio takes a hit. In that scenario, withdrawals are cut 10% to preserve capital, which becomes the basis for determining the next year's withdrawal amount. "If you allow for these midcourse adjustments," Guyton said, "you have more options than just a raise that's equal to inflation. It's those options that can raise the sustainable withdrawal rate between 0.5% to 1%."

For an existing withdrawal rate of, say, 5.5%, that could mean an adjusted rate of 6.5%. "A rate of 6.5% is fine when the market valuation is in the bottom quintile of historical valuations" such as during the recent market bottom, Guyton said. But he added that the market's rapid rise since early March has boosted its valuation, thus lowering the safe withdrawal rate back to 6%. He said this rate applies to anyone with a 30- to 40-year withdrawal horizon.

Retirement's Health-Care Bite
According to a recent study from the Employee Benefit Research Institute, a 65-year-old man who retires this year will need between $68,000 and $173,000 in current savings to have a fifty-fifty chance of covering health insurance premiums and out-of-pocket costs in retirement. To have a 90% chance, the amount jumps to between $134,000 and $378,000. The variances depend on whether a former employer subsidizes health-care premiums, and whether people without employment-based retiree health benefits supplement Medicare with Medigap (Plan F) and Medicare Part D outpatient drug coverage.

The cost outlook is worse for women because they tend to live longer and need more health care. EBRI found that a 65-year-old woman who retires this year would need between $98,000 and $242,000 to have a fifty-fifty chance to cover health-care related costs. Between $164,000 and $450,000 is needed for a 90% success rate.

On a median basis, the amount needed to cover health-care costs in retirement rose roughly 9% for both men and married couples over last year, and 16% for women.

These projections don't include savings needed to cover long-term care costs. But the study says people can mitigate their savings burden by working longer.