Sell Financial Products Wisely

Manage your risk in this new niche.
BY ANTHONY SARDIS AND EDWARD MENDLOWITZ

  

 
 

 

EXECUTIVE SUMMARY
Many CPA firms now provide insurance and investment services to their clients in addition to core services. This can be an attractive avenue to growth that increases client retention and firm revenues, but it carries certain reputational, legal and economic risks.


To limit liability the firm should offer planning and/or investment products through a separate, genuinely independent legal entity. An LLC, for example, can keep liability for product activities separate from the firm’s core business and partners’ personal assets, and it offers some tax benefits.

Firms must adhere to the rules and regulations imposed by additional governing bodies, including state laws, securities laws, GAO regulations and PCAOB regulations. Regulatory oversight and licensing are complicated, involving specialized education, testing and recurring compliance obligations.

Ideally, planning services and products should complement the firm’s core business. For example, life, disability and long-term-care insurance and annuities are planning products for preserving wealth or income (core). Health, auto and homeowners’ insurance are designed to protect clients against unanticipated losses (noncore). Investment products to accumulate wealth are noncore.

Brokers generally receive sales commissions for insurance products. Those commissions may be less than half of what the insurance or investment company pays to move its products. The CPA firm’s affiliate entity should negotiate brokerage fees based on the complete compensation the service provider gets from insurance and investment companies. Service and transaction contracts for insurance and investment products should include the CPA firm affiliate to protect future business.

Anthony Sardis, JD, LLM, is president of Insurance and Investment Advisory Group, New Brunswick, N.J., a consulting firm specializing in financial product distribution. His e-mail address is sardis@iiagllc.com . Edward Mendlowitz, CPA/ABV/PFS, a partner in WithumSmith+Brown, is the author of several books and articles on tax, estate planning and CPA practice and a JofA Lawler Award winner. His e-mail is emendlowitz@withum.com .


Providing insurance products and other investment advisory services to clients is an attractive avenue to growth for many CPA firms. The key to minimizing risk and maximizing client satisfaction and the firm’s financial returns is thoughtful, informed preparation. Don’t let a rush to expand into new practice areas lead you to overlook important implementation decisions. What you learn on the following pages can help you avoid reputational, legal and economic exposure.

PRINCIPAL PRINCIPLES
CPA firms that specialize in personal financial planning say two important reasons to sell investment products, including insurance, are being able to tailor planning implementation to individual clients’ needs and, of course, revenue growth. Clients like being able to conveniently obtain advisory services, products and administration in one place, and they stay with firms that provide easy access to them. The firm benefits because financial planning products can potentially provide large fees.

But one risk to CPA firms is that the rules governing how they may accept compensation for insurance and investment advisory products are not yet fully tested. Practitioners are bound by professional ethics in their client dealings and must exercise utmost propriety and caution in interpreting all relevant ethics rules. Failure to comply can result in censure or decertification. To avoid potential conflict of interest some firms take the step of creating affiliate business entities through which to offer clients financial planning products (see “Growing PFP Services”).

   Case Study: Growing PFP Services

CPA firm Janover Rubinroit, LLC (www.jrllc.com), with offices in Garden City, N.Y., and New York City, in business since 1938, has grown into an 80-person family of affiliates via careful mergers that have brought together new markets and services. In the PFP arena, the group now encompasses JRF Asset Advisors, LLC, which provides full-service planning and advisory services; JRS Financial Services, LLC, which handles compliance and administrative functions; and JR Benefit Services, which provides life, health, disability and long-term care insurance.

Janover managing partner Mark K. Goodman, CPA, and JRF partner Jay H. Freeberg, CPA, tailor investment planning to maximize returns and minimize the effects of income taxes and inflation as well as the risk and liabilities inherent in a securities portfolio. Their insurance planning advice is designed to help clients understand the correct amount and type to keep their net worth in place.

Goodman and Freeberg’s best practices for managing risk while implementing PFP growth have been to

Choose the best regulatory lawyers to advise on ownership structure. “The form of ownership is an issue for any type of business. In professional services the potential for malpractice is always an issue,” says Goodman.

Have at least two partners familiar with every client’s account.

Know the products and for whom they are best suited. “I’m aware of clients’ insurance needs and tax brackets,” says Goodman. “Knowing all the puzzle pieces helps us give clients better service.”

Make sure partners have licenses appropriate to the functions they perform. Freeberg, an MBA and CFP who sells investment products, holds Series 7, 24, 27, 63, 65 securities licenses, for example. Three staff people have insurance licenses and accompany Freeberg on sales calls.

Take your time developing a financial services niche. Besides education and licenses, it’s important to get experience, Freeberg says: “Pay particular attention to a full up-and-down market cycle—three to five years—to learn how to perform well in a poor market.”


Payment involves two general requirements. First, a firm may not accept commissions from audit or attest clients. Second, if a firm does accept commissions from a nonrestricted client, the client must acknowledge in writing his or her understanding of the fee policy before any services are rendered (see exhibit and “Risk Management Checklist”).

    Sample Disclosure Statement
Receipt of Commissions Acknowledgement

Our firm has referred you to [service provider] for product consulting (and/or sales). Our firm shares commissions and fees through its affiliation with the service provider. Neither the firm nor its employees are responsible for or participate in the service provider’s recommendations.

Please sign below to indicate your understanding of the fee policy. Feel free to ask [service provider] for additional details or solutions.

Thank you for your business.

Client signature ___________________________________________________________

Date __________________________________________________________________


Firms also must adhere to the rules and regulations imposed by other governing bodies, including state laws, securities laws, GAO regulations and PCAOB regulations. Regulatory oversight and licensing are complicated, involving specialized education, testing and recurring compliance obligations. While those requirements reinforce many that are covered by CPA professional ethics, they must be satisfied independently.

  Risk Management Checklist

Did you obtain the client’s written acceptance of commission payments before making a recommendation? This consent is required whenever the firm receives commissions, even it uses an independent broker to write an engagement transaction.

Did you follow a due-diligence process for product offerings? A firm should offer only products from reputable sources. While a firm may be able to use an independent expert as a quality control process for product, the firm must monitor its product portfolio.

Did you perform due-diligence for sales suitability? Sales activities are subject to ethics requirements whenever a firm receives commissions, even if the firm uses an independent broker. Carefully monitor the suitability of the products sold and the associated sales activities.

Do you have at least two licensed members with tenure? This will ensure continuity in the event one of them becomes unavailable for any reason, including death, disability or retirement. A gap in licensing could void a product sale or affect commissions.

Did you obtain your errors and omissions insurance provider’s approval? Confirm that activities relating to financial products are covered and describe the extent of exclusions, if any.

Do you have distributions and sales contracts in place? Define the rights and responsibilities of the firm and its providers in written agreements. (See “Contract Essentials.”)

Do you regularly assess activities? A firm should periodically review its product platform and sales activities to ensure they remain consistent with the firm’s standards and ethical requirements.


CLOSE BUT SEPARATE

Financial planning products can include life insurance, derivative transactions, variable annuities and private equity investments, among others. The scope of products a firm chooses to offer can be all-inclusive or limited to a select type of product. In other words, a firm may choose to offer life insurance, but not stocks. The final offering is known as a product platform.

To limit liability, a CPA firm can offer a product platform through a separate legal business entity that employs appropriately licensed sales representatives. Closely integrating the new entity with the CPA firm gives the two a unified appearance that’s reassuring to clients.

The proximity of the two businesses also permits cost-effective sharing of resources and makes new expenses in salaries, marketing and overhead easier to manage. It is, however, essential to strictly observe all corporate formalities to ensure the new entity’s genuine independence.

The form of business entity is a very important decision. An LLC can segregate liability for product activities from the firm’s core business and partners’ personal assets, and it offers some tax benefits, but options vary by state. Choosing the best form for an affiliate financial products business ultimately depends upon a range of factors and the jurisdictions in which operations take place. The decision can be complex and legal counsel is advised.

  Contract Essentials

Nonsolicitation. Prohibit agents and service providers from soliciting firm clients, employees and related parties.

Vesting. All compensation should be 100% vested (paid to the firm).

Sales practices. The agent or service provider should comply with all regulatory requirements and adhere to additional firm standards.

Terminations. Require that the agent or service provider facilitate the transfer of client assets to a new agent upon termination.

E&O. Require agents or service providers to carry and provide proof of an errors and omissions insurance policy.


LICENSE TO SELL

Licensing is a critical part of offering financial products. A firm and its sales agents in the affiliate entity must conduct client-based activities in a licensed format. The person soliciting sales must always be licensed as must anyone who receives commissions. If the new entity is paid commissions by a third party, the entity itself must be licensed. In most cases, state insurance laws allow a licensed corporation to receive commissions and subsequently distribute profits upstream to unlicensed shareholders. SEC regulations are stricter; anyone receiving securities-based compensation must be registered.

Licensing requirements vary by product or service; generally speaking, the four categories are

Life and health. Licensing is based on a state insurance department exam.

Property and casualty. Licensing is based on a state insurance department exam.

Securities. Licensing is based on the SEC exam; candidate must be sponsored by a broker-dealer.

Registered investment adviser. Licensing is based on examination by either state or federal securities regulators.

  Quick-Start Guide to Selling Insurance and Investments

Interview clients about their needs.
Build a three-year business plan with financial projections.
Consult with errors and omissions insurers regarding coverage requirements.
Solicit bids for sales and distribution rights.
Form a separate business entity and obtain required licensing.
Develop standard operating procedures (SOPs).
Train employees in the process.
Announce new product offering to clients.
Monitor activities for compliance with ethics rules and other applicable laws.


BUILD A COMPLEMENTARY PORTFOLIO

Most CPA firms don’t consider financial services their core business strategy, yet many want to provide every product their clients request. It’s a good idea to resist that impulse and limit investment products and services to only those that complement core offerings. Overdiversifying can dilute the value of core services, and products that aren’t a good fit may create significant risk.

These are common product categories.

Planning products. They are designed to preserve wealth or income and include life, disability and long-term-care insurance and annuities. Recommended products complement core offerings such as estate, business or financial planning.

Service products. These products are designed to protect clients against unanticipated losses. They include health, auto and homeowners’ insurance, for example. Such product recommendations do not result from a firm’s core offering.

Investment products. These are designed to accumulate wealth. This category is transactional—based on market trades—and as such the most removed from a firm’s core services.

Before making a decision to offer a product, carefully consider the type and amount of service you will have to provide with it. Failure to service a product can lead to client dissatisfaction—a direct conflict with the firm’s goals.

SELLING WELL
To do the actual selling, a firm can insource, outsource or use a combination of the two. If selling is insourced, the CPA firm’s employees (trained and licensed as noted) recommend products the affiliate entity provides. This option can provide a high level of control, equity and compensation, but it does have higher fixed expenses, opportunity costs and risk exposure than outsourcing.

In outsourcing, the firm hires independent contractors such as stock brokers and insurance agents to sell products, and they pay the firm a portion of the revenue. This option reduces the firm’s exposure to liability, has no or low fixed expense and provides diverse product expertise. In a merger, those professionals may even become the affiliate entity.

Some firms develop a hybrid method. Certain products lines are insourced and others outsourced. The lines can be divided based on portfolio. For example, a firm could insource planning products that complement core offerings and outsource service and investment products as a way to limit liability exposure and ongoing service obligations.

To sell well the firm needs

Expertise. The success of a product platform depends in large part on a CPA firm’s apparent and actual depth of knowledge (expertise). Besides obtaining the education, experience and licenses discussed earlier, CPAs can get a Personal Financial Specialist (PFS) credential. It is unique to the profession, and in most states it meets Registered Investment Advisor (RIA) requirements. Information about the PFS designation is available from the AICPA (see the resources box).

Objectivity. Professional ethics require a CPA to objectively serve the client’s best interests at all times. Other authorities such as NASD have standards to similarly ensure that investment products are suitable for the clients who buy them. Firms should develop operating procedures to manage their own and their affiliate entities’ sales activities to ensure that all transactions serve the client’s best interests. For example,

Limit compensation. When compensation for a product is too high, salespeople will feel pressure to try for sales that aren’t wholly in the client’s best interest. Limiting the selling party’s salary or commission to the lowest rate for the product class helps lessen the risk.

Separate the planning from the product. Some sophisticated planning concepts have been designed for generating sales more than for fulfilling clients’ true needs. Your priority is, of course, to ensure that every product your firm recommends legitimately fits the client’s financial plan.

Examine several product options for each engagement. Document a recommendation to verify that it has been based on examining several suitable products and choosing the option with the best features for the client.

Review and monitor recommendations. Periodically check to determine the types of products sold, the planning concepts underlying the sales and the percentage of sales by the product provider. Concentrated positions can indicate bias, creating an objectivity exposure.

RESEARCH THE REVENUE STRUCTURE
Another conspicuously complex aspect of providing financial products and services is compensation. When CPA firms sell insurance and investment products through a separate legal entity (broker), that entity contracts with agents or general agents (service providers) of insurance and investment companies to access products. As compensation for selling insurance products, brokers generally receive sales commissions. In fact, those commissions are only one chunk of what the insurance or investment company pays to move its products. In some cases commissions may be less than half the available compensation.

To get the best payment terms for its affiliate entity the firm should negotiate fees from an informed position. Make sure you learn all the types of compensation the service provider gets from insurance and investment companies (see “ Compensation Glossary”).

  Compensation Glossary

As brokers, CPA firms receive a direct share of the sales commissions the insurance and investment companies pay to agents and third-party service providers. Firms also can negotiate to obtain a share of the standardized fees the insurance and investment companies pay general agents or service providers.

Bonuses. Many insurance and investment companies pay agents bonuses for reaching certain production levels. Those bonuses will not be shared with CPA firms unless it is specified in contract negotiations.

Distribution allowances. Insurance and investment companies also pay distribution allowances to the processing entity—often the general agent with whom the CPA firm has a contract. The allowances can represent an additional 50% of the annual premium; if negotiated some of this may be shared with high-volume brokers.

Renewals. Many insurance and investment products pay income to agents on a recurring basis, often annually. Unless specified, broker firms may not receive any part of the renewal fees even though renewals are a result of the continued client-CPA/broker relationship.

Sales compensation. Life insurers pay two forms of sales compensation: a commission that usually ranges from 50% to 70% of first-year premiums, and an expense allowance that generally is from 30% to 60% of commissions. Investment transactions may be based on a gross number, while the broker’s percentage of premiums depends on production levels.

Soft dollars. Insurance and investment companies also pay agents for expenses unconnected to a specific transaction or product. These payments offset marketing costs, software licenses or other costs of doing business.


Define and document compensation terms in both service and transaction contracts (see “Contract Essentials”). Whenever possible, make sure the name of the firm or affiliate financial-products entity appears on applications and contracts. Arrange to have the insurance or investment company pay the firm’s share directly to the firm rather than to a general agent or other intermediary. Doing this documents the firm’s right to continuing compensation (in other words “vests” it), reduces payment delays and serves to secure the client’s ongoing business in the event the relationship with the broker of record ever terminates.

WATCH THOSE MOVING PARTS
Many firms have made the strategic decision to sell insurance and investment products to their clients. Offering financial products and services provides a range of competitive and economic opportunities for CPA firms, but with those opportunities come risks. Entering the market too quickly can lead to a failure to carefully assess and limit those risks.

To keep from undermining long-term objectives, your firm or its affiliate should follow the advice it gives clients—account for and audit each element of insurance and investment offerings. It’s a process with many “moving parts.” You need to pay attention to all of them.

 
 
AICPA RESOURCES

Publications
AICPA Professional Standards, Code of Professional Conduct.

“Caveats to Selling Financial Services,” JofA, Jan.05, page 29.

Investment Fiduciary Responsibility: Understanding the CPA’s Role (webcast archived on CD-ROM, # 780011HSJA).

Management of an Accounting Practice Handbook (# 090407JA); e-MAP, electronic version (# MAP-XXJA).

The New Fiduciary Standard: The 27 Prudent Investment Practices for Financial Advisers, Trustees, and Plan Sponsors (# 017242JA).

For more information or to order, go to www.cpa2biz.com or call 888-777-7077.

Web sites
PCPS Firm Practice Center, www.aicpa.org/pcps.

Personal Financial Planning Center, www.aicpa.org/pfp.

Personal Financial Specialist (PFS) Information, http://pfp.aicpa.org/Memberships/Personal+Financial+Specialist.htm.

OTHER RESOURCES

Fiduciary handbooks
Prudent Practices for Investment Stewards (U.S. edition).

Prudent Practices for Investment Managers (worldwide edition).

Prudent Practices for Investment Advisors (U.S. edition), and Prudent Practices for Investment Stewards and Investment Advisors (worldwide edition).

To order, visit www.fiduciarystore.com.

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