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Think twice before sending clients to a direct-sold 529 plan
http://www.savingforcollege.com/articles/think-twice-before-sending-clients-to-a-direct-sold-529-plan-961

Posted: 2016-08-16

by Brian Boswell

FINANCIAL PROFESSIONAL CONTENT

Financial advisors are increasingly viewed by clients as their guide to achieving their college savings goals. Financial advisors, however, are challenged by the paperwork-intensive, and sometimes low asset size of 529 plans. To make their lives easier, some advisors have found it simpler to forego the commissions on the asset base of 529 plans and refer their client to a direct-sold plan. However, this can be outright dangerous for both the advisor and client: Here's why.

The story of the angry client and his lawyer

The names of the individuals and firms involved in the following have been changed, but this story is 100% true, and representative of a half-dozen more like it I've heard in my tenure within the 529 industry.

In 2006, Robert Smith at ABC Investment Advisors met with longstanding client and friend Theo Johnson to discuss his request to learn more about his college savings options. Smith had been an advisor for over thirty years, and knew all about 529 plans. His firm, ABC, was a huge, growing, independent broker-dealer with offices nationwide. Johnson had been a client of Smith for many years, and they often went golfing together.

However, Smith thought that the advisor-sold 529 plans available to him were a pain to open and maintain. There was a lot of paperwork, it was difficult to manage accounts since plans were not well-integrated in his firm's system, the account sizes were usually small and his state's direct-sold plan had better investment options than its advisor-sold plan.

Smith had done his research and, knowing he could get his client better investments elsewhere, talked with Johnson at some length. "Look, the state has a direct-sold plan with strong underlying funds at lower cost. I don't get paid on the account, but you're a good client and I'll help you get started." They opened the account online together in about twenty minutes, and Mr. Johnson thanked his advisor for looking out for his best interests.

RELATED: Top 6 advisor misconceptions about 529 plans

Things were great for a while. But three years later, after the bottom fell out of the market in 2008, Johnson was angry. He had lost a lot of money, including assets he felt were the property of his children. Why hadn't his advisor warned him that the 529 plan could lose money (Smith had)? Why hadn't he advised him to use different investments (Smith did)?

Since Smith had directed his client to the direct-sold plan, ABC Investment Advisors was unable to supervise the trades. It could not ensure that the plan was, in fact, the best option available to Theo Johnson. It did not have any disclosure paperwork signed that the investor was aware of all those things of which he needed to be aware. It could not monitor the account for AML fraud and to ensure it met KYC (know-your client) requirements. In short, it had no knowledge of Johnson's ownership of the new 529 account, and the firm could not perform proper oversight.

Without control of the account or his client, and with ABC Investment Advisors ignorant, Johnson sued Smith and his employer for negligence, having recommended an inappropriate investment. After several months of arbitration, ABC Investment Advisors settled out of court for six figures on an account a fraction of that size. ABC might have pressed the client and possibly won in court, but the cost wasn't worth it.

All because the advisor was trying to do right by his client.

It's dangerous to go alone

The vast majority of advisors are just like Mr. Smith: They are trying to help people. Many advisors state with pride that they are giving their clients lower-cost, better investment options by going direct, often adding themselves as an interested-party on the accounts so that they can review the plan with their clients. They have the best of intentions, and they're not alone.

In 2013 a survey conducted by Financial Research Corporation (now Strategic Insight) found that approximately 60% of commissioned advisors surveyed sent clients to direct-sold plans. The top reasons? Lower fees and in-state tax incentives.On top of this, 22% said that the compensation of advisor-sold plans didn't make up for the amount of work involved.

Unfortunately, sending a client to a direct-sold plan may still be considered selling-away. Selling-away is when a broker sells or solicits the sale of securities that are not offered by their employer. Some members of the securities industry mistakenly believe that, because the advisor is not receiving compensation for the sale of the direct-sold 529 plan, it is not considered selling-away and/or they are not liable. But it is against FINRA rules, and could result in censure, fines, and expulsion.

RELATED: 75% of college savers don't know how to invest their 529 plan funds

This is why it is so important that advisors not be intimidated by the extra work sometimes involved in a 529 plan, to do their homework, and sometimes even to petition their home office when they are unable to offer the best 529 plan possible because their firm lacks the necessary agreement(s).

Selling 529s will get easier

Know that 529 plan providers, broker-dealer firms, and other stakeholders are working to improve the lives of advisors by streamlining 529 plan account opening and maintenance. This is being made possible through omnibus processing, better feeds between providers and wealth & performance reporting firms (like Albridge, Advent, Celera Systems, etc.), and the ongoing efforts of the industry to simplify every step of the way.

In the meantime, be patient, and follow the procedures of your firm to ensure compliance with industry rules and regulations. In the long run, following the rules is in the best interest of everyone.

RELATED: Omnibus: What it is and why advisors should care

This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.

FINANCIAL PROFESSIONAL CONTENT

Financial advisors are increasingly viewed by clients as their guide to achieving their college savings goals. Financial advisors, however, are challenged by the paperwork-intensive, and sometimes low asset size of 529 plans. To make their lives easier, some advisors have found it simpler to forego the commissions on the asset base of 529 plans and refer their client to a direct-sold plan. However, this can be outright dangerous for both the advisor and client: Here's why.

The story of the angry client and his lawyer

The names of the individuals and firms involved in the following have been changed, but this story is 100% true, and representative of a half-dozen more like it I've heard in my tenure within the 529 industry.

In 2006, Robert Smith at ABC Investment Advisors met with longstanding client and friend Theo Johnson to discuss his request to learn more about his college savings options. Smith had been an advisor for over thirty years, and knew all about 529 plans. His firm, ABC, was a huge, growing, independent broker-dealer with offices nationwide. Johnson had been a client of Smith for many years, and they often went golfing together.

However, Smith thought that the advisor-sold 529 plans available to him were a pain to open and maintain. There was a lot of paperwork, it was difficult to manage accounts since plans were not well-integrated in his firm's system, the account sizes were usually small and his state's direct-sold plan had better investment options than its advisor-sold plan.

Smith had done his research and, knowing he could get his client better investments elsewhere, talked with Johnson at some length. "Look, the state has a direct-sold plan with strong underlying funds at lower cost. I don't get paid on the account, but you're a good client and I'll help you get started." They opened the account online together in about twenty minutes, and Mr. Johnson thanked his advisor for looking out for his best interests.

RELATED: Top 6 advisor misconceptions about 529 plans

Things were great for a while. But three years later, after the bottom fell out of the market in 2008, Johnson was angry. He had lost a lot of money, including assets he felt were the property of his children. Why hadn't his advisor warned him that the 529 plan could lose money (Smith had)? Why hadn't he advised him to use different investments (Smith did)?

Since Smith had directed his client to the direct-sold plan, ABC Investment Advisors was unable to supervise the trades. It could not ensure that the plan was, in fact, the best option available to Theo Johnson. It did not have any disclosure paperwork signed that the investor was aware of all those things of which he needed to be aware. It could not monitor the account for AML fraud and to ensure it met KYC (know-your client) requirements. In short, it had no knowledge of Johnson's ownership of the new 529 account, and the firm could not perform proper oversight.

Without control of the account or his client, and with ABC Investment Advisors ignorant, Johnson sued Smith and his employer for negligence, having recommended an inappropriate investment. After several months of arbitration, ABC Investment Advisors settled out of court for six figures on an account a fraction of that size. ABC might have pressed the client and possibly won in court, but the cost wasn't worth it.

All because the advisor was trying to do right by his client.

It's dangerous to go alone

The vast majority of advisors are just like Mr. Smith: They are trying to help people. Many advisors state with pride that they are giving their clients lower-cost, better investment options by going direct, often adding themselves as an interested-party on the accounts so that they can review the plan with their clients. They have the best of intentions, and they're not alone.

In 2013 a survey conducted by Financial Research Corporation (now Strategic Insight) found that approximately 60% of commissioned advisors surveyed sent clients to direct-sold plans. The top reasons? Lower fees and in-state tax incentives.On top of this, 22% said that the compensation of advisor-sold plans didn't make up for the amount of work involved.

Unfortunately, sending a client to a direct-sold plan may still be considered selling-away. Selling-away is when a broker sells or solicits the sale of securities that are not offered by their employer. Some members of the securities industry mistakenly believe that, because the advisor is not receiving compensation for the sale of the direct-sold 529 plan, it is not considered selling-away and/or they are not liable. But it is against FINRA rules, and could result in censure, fines, and expulsion.

RELATED: 75% of college savers don't know how to invest their 529 plan funds

This is why it is so important that advisors not be intimidated by the extra work sometimes involved in a 529 plan, to do their homework, and sometimes even to petition their home office when they are unable to offer the best 529 plan possible because their firm lacks the necessary agreement(s).

Selling 529s will get easier

Know that 529 plan providers, broker-dealer firms, and other stakeholders are working to improve the lives of advisors by streamlining 529 plan account opening and maintenance. This is being made possible through omnibus processing, better feeds between providers and wealth & performance reporting firms (like Albridge, Advent, Celera Systems, etc.), and the ongoing efforts of the industry to simplify every step of the way.

In the meantime, be patient, and follow the procedures of your firm to ensure compliance with industry rules and regulations. In the long run, following the rules is in the best interest of everyone.

RELATED: Omnibus: What it is and why advisors should care

This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.

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