Managing Client Assets

Investments are an integral part of the financial planning process.
BY PETER D. FLEMING

EXECUTIVE SUMMARY
  • A NUMBER OF CPA-FINANCIAL PLANNERS have expanded their practices to include investment management services. As the CPA profession prepares to move into the next century, more accountants are likely to realize there is a market for providing such services to their clients.
  • CPAs WHO WANT TO BE INVESTMENT managers face a number of issues, including making changes to their fee structures, licensing and regulatory concerns, ethical issues and in some cases a complete redefinition of what it means to be a CPA.
  • MIKE RUFF IS IN THE PROCESS OF MAKING a transition to full-time investment management. As such, he considers the move as "retiring from the practice of public accounting." Ruff believes CPAs have the knowledge, background, training and client trust to be "superstar financial advisers."
  • AFTER 15 YEARS WITH HIS OWN investment firm, Lewis J. Altfest still uses his CPA skills. He believes the CPA's understanding of financial statements and innate conservatism are useful in evaluating investment options. With their image changing to that of a personal financial adviser, Altfest believes CPAs are well positioned to do more in the investment area.
  • MARJORIE MEYER HAS BROUGHT HER practice full circle. After two years of providing investment management to her clients, she is phasing out that part of her practice. Investment management is in her words "a full-time job" and Meyer feels she can no longer devote the time necessary and still pursue her personal life.
Peter D. Fleming , CFP, is a senior editor with the Journal Mr. Fleming is an employee of the American Institute of CPAs and his views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.



During last fall's stock market turmoil, when millions of frenzied investors were calling their brokers on "Blue Monday" for reassurance and guidance, many Americans were on the phone with their CPAs. Why? Because a number of CPA­financial planners have expanded their practices to include investment management services. The services CPAs can provide are as varied as the professional issues they face. Ultimately, individual circumstances will dictate if or how a CPA decides to expand his or her practice into the growing area of investment management.

Investments have always been an integral part of the financial planning process. For many years, however, CPA­financial planners only recommended what classes of investments a client should have, stopping short of recommending specific investments. And most CPAs did not offer implementation assistance. As traditional barriers begin to fall, CPAs today are going well beyond asset allocation and referring clients to investment managers, recommending specific securities—stocks, bonds or mutual funds—and in some cases even earning fees or commissions on the sale of these products.


Framing the Issues
As the CPA profession moves into the next century, Phyllis J. Bernstein, director of the American Institute of CPAs personal financial planning division, says she believes more CPAs will realize that the market wants them to provide investment services. "At the end of the engagement, the client has always asked, 'What do I do with my money?' The CPA's response has evolved from 'We can find someone to help you' to 'I can help you.'" CPAs who want to offer investment advisory services must deal with a number of issues, including changes to their fee structure, licensing and regulatory concerns, ethical issues and, for some, a complete redefinition of what it means to be a CPA.

CPAs who compete with other financial planning or investment professionals may need to charge for their services in a different way. Instead of billing by the hour, most investment managers are compensated based on a percentage of the assets under management. Bernstein says some state boards consider that a "contingent fee." If a CPA firm has an attest client—one for which it provides audit, review or compilation services—state law forbids the firm from receiving a contingent fee from that client. (See the sidebar for information on how CPAs are compensated for providing investment services.)

Some states allow CPAs to accept commissions. Under AICPA ethics rules, CPAs can accept commissions and contingent fees from nonattest clients as long as the compensation is disclosed to the client. But, Bernstein cautions, some gray areas remain. For example, if a CPA provides attest services to a corporation and offers investment services to its owner on a contingent fee or commission basis, is this the same client—effectively prohibiting the arrangement? The PFP division and the AICPA professional ethics division are working on issues involving contingent fees and commissions. The current position is that an individual can receive a commission or contingent fee from an officer, director or shareholder of a client company.

Individual state laws allow or prohibit a CPA from receiving a contingent fee or commission. An up-to-date list of state regulations is available on the AICPA fax retrieval service (dial 201-938-3787 from a fax machine, document #604). According to Bernstein, now that the AICPA and the National Association of State Boards of Accountancy have adopted the uniform accountancy act model, more states are adopting rules that permit fees and commissions.

Why should CPAs who manage client assets abandon the traditional hourly rate structure? Bernstein says, "With everyone else's charges based on assets under management, it's important for CPAs to be competitive. If we want to be on a level playing field, we should change our compensation structure." It's difficult for CPAs to allocate the time they spend learning about and keeping up-to-date with investments and what's going on in the financial markets to a specific client. All clients benefit. As Bernstein points out, "This represents a big mind-shift for many CPAs, from delivering services to a specific client in a particular amount of time to doing something that benefits all clients."

Many CPAs are still concerned about the regulatory aspects of investment advising. A CPA who offers investment management generally no longer will qualify for the so-called accountant's exclusion and must register as an investment adviser with the Securities and Exchange Commission or his or her state securities department. (See the sidebar ) Registered investment advisers are subject to periodic on-site audits. Some CPAs are hesitant about having an SEC investigator or a state regulator come to their office, Bernstein says. But more CPAs seem to be overcoming their fears. Five years ago, Bernstein says, only 5% of PFP section members were registered as investment advisers. As of last year, about 20% were registered.

CPAs who want to earn commissions on product sales can become registered representatives with a broker/dealer and obtain a series 6 or 7 securities license (and a series 63 if their states require it). Bernstein says this often is the case when the CPA has smaller clients with few assets and a fee based on the client's income or assets is not practical—the only way the CPA can be compensated for providing investment services is by collecting commissions on product sales. Bernstein says most CPAs today are registering independently as investment advisers rather than affiliating with a broker/dealer. The benefit, Bernstein notes, is increased flexibility because CPAs who register on their own can recommend any investment product rather than being limited to those offered by their broker/dealer.

The addition of investment services to their practices causes many CPAs to reevaluate their status as "accountants." Many consider themselves more personal advisers than public accountants. To avoid ethical conflicts, CPA—financial planners must give up performing audits or restructure their fees. Bernstein comments: "Once they give up auditing, many CPAs no longer feel as much a part of the profession." And that, Bernstein says, is a challenge the AICPA has as an organization—to "broaden the concept of what a CPA is in the public eye." Even as financial planners, the CPA designation remains an important credential. As Bernstein says, "The public understands the ethical considerations we have as CPAs—in public practice or in financial planning." That's why she thinks CPAs still want to be known as CPAs, even though they may be involved mostly in investment or financial planning.

To see how CPAs have integrated investment management into their practices, the Journal spoke with three CPA/PFS designees who have different perspectives on a growing trend.


Tax Season Veteran Changes Directions
After 20 tax seasons, Mike Ruff of Pampa, Texas, is making some big changes in his life. He and his partner have sold their oil and gas tax practice to a large regional CPA firm. Ruff's partner has accepted a job in industry and Ruff himself plans to become a full-time financial adviser (something he has been doing part-time since 1989). He will remain in his current office to help with the transition but thinks of the move essentially as "retiring from the practice of public accounting." Ruff says, "I will work with my clients solely on tax control and wealth management issues."

Ruff will be doing fee-based investment management—based not on an hourly rate but, rather, on assets under management. In the securities area, Ruff focuses primarily on managed money. "I do very few individual securities and then generally only in estates that include individual stocks and bonds." If Ruff has a client with $1 million or more to invest in stocks and bonds, he will introduce them to a private money manager. "I don't have enough time to follow the market on a daily basis." Ruff also does mutual fund wrap accounts where the client pays a single management fee with no additional transaction costs.

Fees, Commissions and Other Compensation

The enormity of the financial services marketplace today has resulted in a wide variety of different compensation arrangements, often creating confusion for both CPAs and their clients. Some of the more typical arrangements are described below.

Fees. Under a fee-only arrangement, the CPA­financial planner is compensated for the professional services he or she provides solely by the client and not as a result of the purchase or sale of any financial product. The American Institute of CPAs personal financial planning executive committee considers the following to be fee arrangements:

  • Hourly, fixed or flat fee.

  • Percentage fee, based on some aspect of the client's financial profile, such as assets under management or earned income.

  • Performance-based fee, tied to the profitability of the client's invested assets.

  • Contingent fee, as the term is defined in the AICPA Code of Professional Conduct.

Other compensation arrangements. There are a variety of arrangements under which a financial planner is paid, either directly or indirectly, by someone other than the client for recommending or referring a product or service. The most common third-party compensation methods include

  • Commissions generated from the purchase or sale of a financial product or service. This may include so-called 12(b)1 fees, trailing commissions, surrender charges and back-end fees.

  • Fee offset arrangements under which compensation is initially derived from fees. The fees are subsequently reduced by commissions generated from the purchase or sale of a product or service.

  • Referral fees that compensate the planner for recommending or referring a product or service provided by another person or entity.

  • Other types of indirect compensation such as rewards, purchase points, travel credits or other benefits received from a third party for recommending a product or service to the client. This also includes eligibility for sales prizes and so-called soft-dollar benefits.
"Fee-only" vs. "fee-based." To avoid confusion among consumers, the PFP executive committee believes the term fee-only should be used only to describe practices or firms where advisers are compensated solely by fees in all engagements. A "fee-based" planner would therefore be one who is compensated by fees but who also may choose to accept commissions or other third-party compensation.

—Phyllis J. Bernstein, CPA,
director, AICPA personal financial
planning division.

Rather than register himself as an investment adviser, Ruff is a registered investment adviser (RIA) agent under the corporate RIA of his broker/dealer. He chose this option so he could concentrate on what he calls his "real job, gathering and managing client assets." Ruff's broker/dealer handles the often complex administrative details of being an RIA in exchange for a small percentage of his investment advisory fee income.

Ruff encounters a wide range of reactions among clients to a CPA managing investments. "Some people don't like it." At the other end of the spectrum, Ruff says his clients "just love it." In his view, the most difficult thing for a CPA offering investment services is that "you don't know what you don't know." CPAs, he says, are accustomed to having all the answers. "We are used to billing our clients for spending time to find the correct answer." Ruff says CPAs are not necessarily qualified to be investment advisers because of their CPA training. "The truth is," he says, "investment advising is a completely different discipline." And, Ruff cautions, "a competent and trustworthy CPA should not even attempt to give investment advice until he or she has completed the appropriate training."

In Ruff's opinion, experience and training are best obtained with the backing of a competent broker/dealer. "You need a broker/dealer who is used to taking accountants and training them. You can't do it alone." According to Ruff, two of the best known CPA broker/dealer firms are 1st Global Partners and H.D. Vest, both in Dallas.

CPAs should select a broker/dealer, Ruff says, who understands how to integrate investment planning into an existing accounting practice. Ruff advises asking how many CPA firms the broker works with and how many CPA registered representatives it has. CPAs should also ask for a description of the firm's training program. That training, Ruff says, should be specific: "How do I recognize situations where I can help clients, what types of solutions are realistic and how do I implement them?" He says the right broker/dealer should offer beginners hands-on training and have CPAs in the field to conduct regional training workshops.

Unlike some CPAs, Ruff prefers to suggest specific investments to his clients. And by offering investment management services, he can make sure clients acquire the investments they need to achieve their goals and objectives. Previously, Ruff says, "I would send a client who needed equity investments to a broker and he or she would come back with limited partnerships." Ruff says CPAs who think they can get into the investment business and charge a fee solely for asset allocation advice are kidding themselves. "They need to take a more active role in selecting investments. You need to be able to pull the trigger and help the client go the full route." Because Ruff can offer his clients a full range of products and services, he doesn't have to risk putting them in someone else's hands to implement his recommendations.

As consumer software gets better for both accounting and tax work, Ruff believes the pool of work for CPAs will continue to dwindle. Ruff himself says that "gradually over the last eight years I had gotten to the point where I didn't do any traditional accounting work. I finally recognized that by retiring from that side of the business."

Now is the time, Ruff says, for CPAs to look to the future. He believes investments are a "big part" of that future. Ruff says if you are a highly successful CPA—by any measure—you are an excellent candidate to be a superstar financial adviser. "We have the knowledge, background, training and trust. If we get enough people to commit to doing this on a full-time basis, the CPA profession can own the investment advisory service profession." The public, Ruff says, would love for CPAs to come do this for them. "They are ready to invite us into their businesses and into their homes."


A CPA With an Edge
Lewis J. Altfest of New York City began his accounting career in the traditional way, working for one of the then eight largest accounting firms. Since then, he has followed a less traditional path. After a career on Wall Street, he has had his own investment firm for the last 15 years. Rather than affiliate with a broker/dealer, Altfest has registered on his own as an investment adviser. In practice with his wife, Karen Altfest, a nationally known financial planner, Altfest's staff of 10 includes two other CPAs.

Altfest limits his practice to financial planning and investment management for accounts of $500,000 or greater. All work is done on a fee-only basis; the firm does not accept commissions. The investment management tools Altfest uses are similar to those of other CPAs. "We structure a portfolio using mutual funds and individual municipal bonds." More aggressive accounts may include individual securities. And Altfest buys only no-load mutual funds. "As a fee-only adviser, there's no edge to putting clients in load funds and having them pay a commission," he explains.

In Altfest's view, CPAs have an edge over other investment managers because clients are more likely to trust CPAs. "I find clients are receptive as long as they know I have the right background." He believes the skills a CPA brings to the investment process are important. "The CPA's understanding of financial statements and the innate conservatism are both very useful." Altfest's own investment style, which he characterizes as value-oriented—buy stocks as you would buy a business—comes from his CPA background. He also finds his background helpful in researching mutual fund investments. "When portfolio managers visit us or we visit them, I use those skills every time. I'm known for asking a thousand and one questions."

Altfest practices in New York, one of the world's most competitive markets. While he agrees that he faces considerable competition and other advisers may be better at marketing themselves, many clients prefer Altfest's approach. "A prospective client came in to talk about her investments. A recent widow, she liked the fact that I am a CPA, low key and not salesmanlike. I'm sure that had a lot to do with her decision to sign on the dotted line after only about 15 minutes."

When Altfest decided to get more deeply involved in managing investments, his Wall Street background and knowledge of the fundamentals of investing were tremendous assets. But he still needed to fill some gaps. "When I went off on my own, I had to educate myself about bonds, for example. I had to learn when bonds get called and how to integrate that into investment planning."

Something else Altfest says he had to learn was to understand people. "Some CPAs have difficulty relating to clients on a nonquantitative basis—that is, being able to understand feelings rather than numbers. If a client says to me, 'I don't want real estate investment trusts in my portfolio because my father lost his house in the Depression,' I could say, 'What does that have to do with anything?' Instead, I say, 'I understand your feelings; let's see if we can substitute something else that will diversify your account.'"

Altfest sees the increasing number of CPAs doing investment planning as part of the accountant's changing role and a decreasing market for traditional CPA services. "With the Big 6 about to become the Big 4, the handwriting is on the wall. The CPA image is changing; he or she is becoming more of a personal financial adviser." Altfest believes CPAs are positioned to do more in the investment area. "CPAs who prepare tax returns have an advantage because they already have clients in front of them." In the past, Altfest says CPAs would tell clients: "Your taxes are high; you should have municipal bonds." Today, some CPAs say: "You should have municipal bonds and I can manage them for you." Altfest recognizes that some CPAs may not want to include investments in their practice. In contrast, he refers all tax and accounting work to other CPAs.

What advice does Altfest offer CPAs who want to expand into investment management? "Many CPAs have said to me, 'I can't manage money!' Start with some conservative mutual funds and you'll find you can manage money." He cautions that a distinction should be drawn between mutual funds and individual securities, which require a lot more expertise and full-time, hands-on, day-to-day management. "Mutual funds still require a good deal of attention, but not to the same degree." Nor do they have the same risks, he says. "I think even a conservative CPA can handle them as well as anyone else."


A Return to Financial Planning
The experience of Marjorie Meyer, a sole practitioner in Chestnut Hill, Massachusetts, bears out the idea that investment management is a full-time job. Since she began managing her clients' investments about two years ago, Meyer has been working upward of 60 to 70 hours a week, including many weekends. The pressure has taken its toll. In November of last year, Meyer sold her investment management clients to two local advisers, one a CPA. After she phases out her investment practice, she will return to full-time, fee-only financial planning, leaving implementation of investment recommendations to others.

More About Registered Investment Advisers

A CPA who meets certain criteria may need to register as an investment adviser with either the Securities and Exchange Commission or the appropriate state agency. Congress passed the Investment Advisers Act in 1940 to regulate anyone who manages money for the public. That law requires anyone in the business of giving advice on securities in exchange for compensation to register with the SEC. A 1997 change to the act requires those who manage more than $25 million in client assets and advisers whose principal offices and places of business are in states without an adviser registration statute (Colorado, Iowa, Ohio and Wyoming) to register with the SEC. Those who manage less are regulated by the states.

Whether or not to register is a legal question. CPAs should seek legal counsel for specific questions about how the law applies to their situations. Guidance also can be found in the AICPA Guide to Registering as an Investment Adviser , available from the AICPA by calling 800-862-4272 (product no. 017206JA).

For some CPAs, registering as an investment adviser is clear-cut. For others, it is a tough call. The problem centers around whether the CPA falls within the "accountant's exclusion" from the definition of investment adviser . The SEC interprets the components of the investment adviser definition—receiving compensation, being engaged and providing advice on securities—very broadly, and individual states may do so as well. However, if the accountant's investment advice is solely incidental to the services provided as an accountant, he or she is excluded from the investment adviser definition. In Release no. IA 1092, the SEC staff said the exclusion is not available to "an accountant who holds himself out to the public as providing financial planning, pension consulting, or other financial advisory services." In addition to exclusions from the definition, the SEC also provides for certain limited exemptions from SEC registration.

The state laws governing investment advisers differ from federal law and from each other. To lessen the burden of multiple registrations, a national de minimis standard was created for states without one. It allows an adviser not to register in a state other than his or her home state if the adviser has no place of business there and fewer than six clients residing in the state. Place of business means an office where investment advisory services are regularly provided or where the adviser solicits, meets with or otherwise communicates with clients and any other location held out to the general public as a location where the adviser provides services, solicits, meets with or otherwise communicates with clients.

Investment advisers must make certain required disclosures: how fees are charged and how investment strategies are devised. That starts with Form ADV. CPAs file this form to register as investment advisers and then give a copy to each client. Regulators also try to do surprise audits to determine whether CPAs are doing what they say they are doing.

CPAs who are serious about financial planning—and who see investment advice as the core of what they do—should get serious and register. Trying to squeeze through on an exclusion or exception can make a CPA look like a marginal player. Similarly, trying to back away from giving investment advice to avoid registration also can be a mistake.

—Phyllis J. Bernstein, CPA,
director, AICPA personal financial
planning division.

Meyer began her career working with corporate clients at a large CPA firm. Eleven years ago, she went into personal financial planning, obtaining the certified financial planner and later the personal financial specialist designations. After doing financial and tax planning at a large regional firm, she went out on her own. What was behind her decision to add investment management to her tax and PFP practice? "I would get to a point where a client needed to implement my investment recommendations. I'd take them shopping and spend the day going around Boston speaking to various investment advisers. More and more clients would ask, 'Why can't you do this for me?'

"I realized I was already managing investments for family and friends and doing a good job," Meyer says. She started by registering as an investment adviser with the SEC and in Massachusetts, deciding not to become a broker/dealer registered representative. Meyer also added a part-time administrative employee to handle time-consuming tasks, such as recordkeeping, filing and photocopying. "I briefly spoke to some people who wanted to work for me in an investment decision-making capacity, but I realized I needed to do that myself. Clients were coming to me for my judgment. I could easily get other people to do administrative tasks, but not investment tasks."

Meyer manages no-load mutual funds for a percentage of assets under management. She does not deal with individual securities except U.S. Treasury obligations. Meyer continued her tax and financial planning practice after she had added investment management. But she found investment management to be "very time-consuming. You have to make a huge investment in software and publications and keep up with the market. All day long I was watching what was going on with the market. Even though I don't believe in market timing, I wanted to be aware of what was happening." Meyer was also busy reading publications such as the Wall Street Journal , Barrons and the New York Times business section and checking Internet Web sites throughout the day to get investment information.

Meyer also spent a lot of her time educating clients. "Last fall, not one client called me on Blue Monday because I had spent so much time educating them that the market is going to go down, but it will also probably come up again. I called one client and she said she was happy her portfolio hadn't gone down as much as other people's. I called another client, and he said he hadn't bothered calling because he assumed that I was taking care of whatever was happening." Despite her clients' confidence, Meyer still finds herself under considerable pressure. "I wake up at night worrying about clients' accounts because they pay me to do that so they don't have to."

As she calls clients to tell them she is phasing out her investment practice, Meyer says she finds she is "even more successful than I imagined. They were happy with my services and dismayed that I won't be managing their investments anymore." But Meyer cites stress-related illnesses and life-style aims as her main reasons for giving up her investment clients. "I have a life that's happening without me. I'm working nights and weekends. Most clients want to meet at night, so I end up coming in weekends to catch up."

When Meyer decided to give up investment management, she shopped around to find new managers for her clients. "I wanted people who could do the kind of job my clients want done. I found two people—the clients will be split between them, mostly larger clients to one and smaller clients to the other." Her clients will have an opportunity to meet these people and decide if they want to work with them. "There's certainly no obligation." Meyer decided she was in the best position to help them find someone new. "I feel I know who does the best job in town." Even though her clients may feel a little bit unsettled, Meyer thinks they're going to end up better off because the person who's taking over the majority of her accounts will only be managing investments. She points to the fact that the new manager is "not going to have to work 80 hours during tax season, so she'll be more accessible."

Based on her experiences, Meyer has some advice for CPAs who want to be investment managers.

  1. Make a major investment in your own education. "Get the best grounding in investments you can. I found that having an MBA in finance, I didn't have to learn what an option is or a futures contract. Even though I wasn't trading in them, it's nice to know these things." CPAs who don't have the benefit of a similar education will need more training.

  2. Remember it's a full-time job. "Don't underestimate the amount of time and energy that go into investment management. Remember that you'll be dealing with something that's very close to clients—their investments, which represent the money for their children's education or for their own retirement."

  3. Follow the rules. "Register with the SEC or your state securities department."

  4. Don't think this is an easy way to make money. "When I chaired the state society PFP committee, CPAs would call me and say, 'I want to get into this field; I can earn 1% of assets and if I have $10 million under management, I can retire with a $100,000 annuity.' It's not that easy; you have to be prepared to work hard."

  5. Choose your clients carefully. "I really screen my clients. For example, a woman came in and wanted me to handle her investments. After I had put together a plan, she said she needed to run it by her two children first. I told her I didn't want to work for three people. Don't be shy about firing clients if you feel they won't be happy with your services. It's the 80/20 rule—80% of your problems are caused by 20% of your clients."

If she had it to do over again, Meyer isn't sure she would change anything. "I'd probably do the same thing, because it really served a need. I think clients really loved the one-stop-shopping concept." Meyer also has no regrets. "I'm glad I did it the way I did. Personally I could not have done it any other way." She cringes at those who think they can do investment management part-time. "It's a full-time job." Meyer says if she were at a different point in her personal life, she might not mind putting in all the hours because "it's fun for me; I enjoy the market." But she doesn't think it can be done with less energy. "Some people think the portfolios are going to just run themselves." They don't.

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