Not Legal Advice - Seek Counsel

This document is intended as educational information and is not intended as legal advice. Examples given in this text are for explanatory purposes only and do not represent a finding of legal fact based on the circumstances. Nor are they an exhaustive list of all potential scenarios. Individuals should consult their own attorney regarding whether their activities expose them to legal liability or other issues including criminal or civil actions.

Investment ADVISERS Act

The main focus will be on the Investment Advisers Act and when financial coaching activities could potentially put you in violation of the law. Additional liability concerns should also be taken into consideration such as giving legal or tax advice.

 Sources:

• (1) Investment ADVISERS Act of 1940

  • https://www.govinfo.gov/content/pkg/COMPS-1879/pdf/COMPS-1879.pdf

    
    

• (2) Regulation of Investment Advisers by the U.S. Securities and Exchange Commission

  • https://www.sec.gov/about/offices/oia/oia_investman/rplaze-042012.pdf

Punishments and Liability

We will discuss the law in detail later, but first let’s talk about what happens if you break the law. Violating the IAA carries with it some hefty penalties, including fines, civil liability, or jail time.

Fines & Prison Time

Violating the IAA (offering investment advice illegally) carries with it a fine up to $10,000 and up to 5 years in federal prison, as outlined in § 217. Notice this is ‘and’ not ‘or’, meaning you could face both the financial fine and the prison time.

If this wasn’t bad enough, advice given to each of your clients could theoretically be seen as separate counts of violating the act, meaning the full prison sentence could be more than 5 years. So giving the same advice to 10 clients could, in theory, result in a 50 year prison sentence. While this is theoretically possible, only an attorney could tell you if it is likely or realistic. If you are someone who is comfortable spending 5 years in prison but not 10 or more years, consult with an attorney on this point. If you are like me, 5 years is more than enough of a deterrent.

SEC Civil Liability

In addition to the SEC fines, you could have civil liability imposed by a court case brought against you by the SEC for harm you did to clients or others. As explained in § 209, the damages start relatively small at $5,000 for natural persons or $50,000 for other persons. The issue, of course, is that if you operate your business as an LLC, S-Corporation, or other legal entity; you would fall into the natural persons category and your business would fall into the other persons category.

You may be thinking that $50,000 doesn’t sound like a small amount, so why did I say the damages start relatively small? Depending on the facts and circumstances of the case, the damages can rise to up to $100,000 for the natural person and $500,000 if you have an LLC/Corporation. And the damages under the law are theoretically unlimited as the damage cap can be increased to whatever pecuniary gain (e.g. compensation or business profit) you received through the offering of advice.

Personal Civil Liability

Beyond all of this, you may also be liable for civil penalties from a court case brought against you by your clients, their children, or any other person who has legal standing; such as those who could have had a right or future interest in the money. A person could sue you for damages if you offered advice illegally and then:

• the portfolio halved in a market crash

• the portfolio was lost to a lawsuit because your advice left the investments more open to creditors

• the assets were transferred to someone other than who was in the will due to your advice

• or one of many other scenarios which are possible (and often given as advice on radio shows or podcasts)

The IAA defines an investment advisor as “a person who, for compensation, engages in the business of advising others, either directly or through publications, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities or . . . who promulgates analysis or reports concerning securities . . . .” (1)

You can read more detail about the definition in § 202, but the core aspect of the definition is represented in this sentence and the SEC focuses heavily on this line in much of their explanation and commentary. Whether you are an investment advisor (or rather illegally acting as an investment advisor) comes down to the above three criteria. So let’s break down the three aspects of this definition in detail.

For Compensation - Check

As a financial coach, you are definitely going to meet this requirement. For compensation is considered broadly and the SEC has interpreted it as any economic benefit regardless of how that benefit is received. The benefit doesn’t even need to be paid directly by the person receiving the advice and doesn’t need to be solely for the purpose of getting the advice.

“The term “compensation” has been broadly construed. Generally, the receipt of any economic benefit, whether in the form of an advisory fee, some other fee relating to the total services rendered, a commission, or some combination, satisfies this element. The person receiving the advice or another person may pay the compensation.” (2)

Is Engaged in the Business of - Check

As a financial coach, you also definitely meet the second criteria of being an investment advisor, which is that you are engaged in the business of advising others. You hold yourself out to the public through your website, your social media posts, flyers, and any other marketing/communication methods as someone who can advise on finances. Changing terminology doesn’t change the nature of the advice and the courts tend to lean toward what the consumer believed rather than what the business claims they intended.

“A person must be engaged in the business of providing advice.  This does not have to be the sole or even the primary activity of the person.” (2)

Providing Advice to Others or Issuing Reports or Analysis Regarding Securities - Check?

So now the big question comes into play: Are you offering investment advice? Obviously if you advise people on their portfolios, telling them what to buy and sell, you are in trouble. And you likely are smarter than that. In fact, you are definitely smarter than that because you are reading this document which shows you care and are aware. But the tricky part isn’t the obvious stuff, it’s the non obvious and grey areas that most coaches. So let’s delve deeper.

“The more difficult questions arise with less specific advice, or advice that is only indirectly about securities.  The SEC staff has stated in this regard:

• (i) advice about market trends is advice about securities;

• (ii) advice about the selection and retention of other advisers is advice about securities;

• (iii) advice about the advantages of investing in securities versus other types of investments (e.g., coins or real estate) is advice about securities;

• (iv) providing a selective list of securities is advice about securities even if no advice is provided as to any one security; and

• (v) asset allocation advice is advice about securities.”

What are Securities?

As we discuss investment advice, the term securities will be used regularly. A security is not just a company stock. The IAA defines a security as pretty much anything you can invest in other than owning the actual tangible asset (such as owning a house or an actual bar of gold). So stocks, bonds, variable annuities, mutual funds, ETFs, and everything else we generally relate to investing is likely going to be viewed as a security under the IAA.

“The term “security” is defined . . . . to mean . . . any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit or a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of deposit) or any group or index of securities (including any interest therein or based on the value thereof), or any put, call straddle, or privilege entered into on a national security exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.’”(1)

Advice about market trends is advice about securities

Advice about market trends can include advice related to the overall trend of the stock market but may also refer to advice about your thoughts on the future of the economy, the likelihood of a recession, or whether you think the U.S. stock market is a good place to invest with the subtext being it is a better place to invest than foreign markets or other investments.

Discussing your view of the market or your view of the economy places you in a precarious position if you are not licensed as an advisor.

Advice about the selection and retention of other advisers is advice about securities

Some coaches may want to ‘hire’ an investment advisor to handle the investments. Unfortunately, this would fall under the auspices of recommending advisors. Coaches should advise clients to work with a licensed financial advisor, and may provide a list of referrals, but should avoid advice about retaining a specific advisor (or firm). Instead, two or three licensed advisors should be referred and the client encouraged to engage with the advisor who the client feels most comfortable with.

A key aspect is to avoid accepting compensation for making the referral. Once you accept compensation from a financial advisor for the referral, you open up a bunch of problems including receiving compensation specifically for the selection and retention of the chosen advisor. Additionally, most states have laws which ban Registered Investment Advisors from paying referral fees to others unless certain conditions are met. One of the conditions is the referrer, called a Solicitor, is a registered investment advisor.

Advice about the advantages of investing in securities versus other types of investments (e.g., coins or real estate) is advice about securities

A coach who suggests clients invest in the stock market because it has beaten other investment alternatives over the long term is offering investment advice. Similarly, a theoretical case could be made that offering advice about paying off the mortgage or credit card debt rather than investing in stocks could be construed as investment advice.

Providing a selective list of securities is advice about securities even if no advice is provided as to any one security

Even if you don’t offer advice on specific securities, talking about any specific security or list of securities can be viewed as providing investment advice. The typical advice to invest in an S&P 500 index fund is potentially investment advice, as it implicitly offers a list of securities the client should choose from. Similarly, offering a group of ETFs or Mutual Funds by a specific company, such as you ‘should invest with Vanguard funds’, could be viewed as offering investment advice.

Again, a theoretical case could be made that even offering advice that a client should invest in index funds verses active funds is investment advice because the term ‘index funds’ does represent a selective list of securities.

Asset allocation advice is advice about securities.

Finally, advice about asset allocation is also a no-no. Asset allocation refers to how much of a person’s portfolio should be invested in each asset class or sub-asset class. This means advising a client to be in 80% stocks and 20% bonds is blatantly illegal according to the SEC, as is suggesting an asset allocation provided by a third party such as the “all weather” portfolio created by Ray Dalio’s and referenced in Tony Robins’ books. Dave Ramsey’s advice to invest in four growth mutual funds is also asset allocation advice.

But beyond these dangers is more nuanced dangers around advising a client on their finances which ends up being asset allocation advice. Advising a client to diversify their real estate holdings by investing a percentage or a ‘significant amount’ of their wealth in the stock market could be considered asset allocation because you are recommending how much of their wealth should be in securities. Even advice to allocate 10% of their income to retirement and 10% to paying down home mortgage debt (or specific dollar amounts instead of percentages) could theoretically be construed as asset allocation advice because the end result is a net worth that is X% in stocks and bonds (their retirement account) and X% real estate (their home).

Anytime advice is related to a topic in which legal considerations are involved, you are potentially opening yourself to a problem. Clients should be encouraged to seek legal counsel from an attorney who specializes in the specific field of law the client is dealing with.

While it is generally important to be cognizant of when coaching might venture into the law, below are a couple examples of where a financial coach is likely to see overlap. And, of course, many other areas of financial coaching will overlap with other legal issues.

Practicing Estate Law

Advice around coaching is often interconnected with Estate Law practices. As an example: coaches may unknowingly be giving direction around account titling and naming of beneficiaries on savings accounts, banking products, life insurance policies, or other financial instruments either when a client directly asks for advice or asks questions which affect account titling and beneficiaries. Similarly, you may offer advice on whole verses term life insurance. These decisions have potential estate planning implications and could cause a client to pay additional taxes, have their assets pass to people other than the intended heir, lose the assets in a lawsuit, or have other legal or tax consequences.

Practicing Family Law

When clients are contemplating divorce, or have been divorced, many financial planning topics may have legal implications. During a divorce, almost everything becomes subject to the legal proceedings and legal implications may linger for years or decades after the divorce. Consider a divorced client who has an expensive whole life insurance policy with the ex-spouse or children as beneficiaries. If the policy was a part of a divorce agreement, then recommending them to change to a term policy is a major problem for both the client and you. And, of course, the client may not realize or remember the whole life insurance policy was part of the divorce.

Other Areas of Concern

Exception for the Press

Likely due in large part to the First Amendment, there is an exception in the IAA for the media when the advice is distributed through a “publication of regular and general circulation.” This is the exception that media megastars and financial porn publications rely on; and why they are not charged with violating the IAA even when their advice is demonstrably bad or dangerous advice.

But you are not the Press and your coaching activities don’t fall into this category. Even Dave Ramsey couldn’t legally do what he does on the radio every week if he were doing it one-on-one or in groups with clients.

Exception for Teachers

Teachers are also exempted from registration for advice given as part of their teaching activities. This is the one many coaches want to hang their hat on. I can’t tell you how many times I hear coaches say “I don’t offer advice, I just offer education.”

Are you a professional teacher employed by an accredited institution?

But the exception isn’t for offering education. The exception is for when the advice is “solely incidental to the practice of his profession.” This means you must be in the profession of being a teacher and likely would need to be employed as a teacher by an accredited educational institution.

Is the advice given as a minor part of the teaching or is the teaching about investments?

Even if you are a professional teacher, the exception only covers when you are offering advice in the capacity of your profession as a teacher (in front of a classroom) and the advice is incidental to the teaching. Teaching clients about investments, by definition, would not be incidental to the teaching since the investments are the reason for the education and the client is paying you for financial advice (coaching on money is advising on money).

I am a Tenured Professor and I teach personal finance classes, but I could not advise a student on their investments in their 401(k) after class. (Well, I could, but I’m also a Registered Investment Advisor. You get the point, though.)

Exception for Other Professions

Other professions also get an exception including lawyers, accountants, engineers, or brokers/dealers. But again, the advice must be incidental to their professional activities. So a divorce attorney could give advice to a client to switch retirement funds out of stocks and into money market funds while the divorce proceedings are progressing because the attorney is giving advice in their capacity of protecting the client legally during the divorce. That same advice to the same client outside of the divorce context could be viewed as illegally giving investment advice because it now isn’t incidental to the legal advice.

And if the professional holds themselves out as providing financial planning, the exemption disappears and they must register. The SEC has an extremely broad definition of financial planning and would consider financial coaching as financial planning.

“The exclusion. . . is not available, for example, to a lawyer or accountant who holds himself out to the public as providing financial planning, pension consulting, or other financial advisory services.” (2)

What if I want to refer clients to financial advisors?

Generally, referring a client to a licensed professional is not only going to be ok but will likely help protect you; whether that professional is an attorney, a financial advisor, or a CPA. You will want to make sure the professional is both licensed (I recommend the Series 65 license only) and has credentials (such as a CFP). I recommend considering only referring to fiduciary and fee-only advisors, meaning a Registered Investment Advisors as these are the only financial advisors who are currently held to a fiduciary standard. Reviewing this guide on choosing a financial advisor can also help arm you with important information.

Can I earn referral fees or other compensation for referring to an advisor?

Generally a horrible idea and you would be subject to legal liability and potentially be required to register as an investment advisor anyway. You should refuse compensation for a referral. If you receive a referral fee, you will be considered a Solicitor of the advisor. Most states have enacted laws requiring a Solicitor be registered as an Investment Advisor either under the state or with the SEC, so you would need to register as an Investment Advisor to accept the fee. This requirement is based on the state the Investment Advisor works in, not the state the referrer works in. As a result, you would need to know the laws not only of your state but of every state the referring advisor potentially works in.

“An adviser generally is prohibited . . . from paying a cash fee, directly or indirectly, to a third party (a “solicitor”) unless it meets the requirements of the rule:

• Adviser must be registered under the Act.

• An advisor may not pay solicitation fees to a solicitor . . . subject to a Statutory Disqualification

• Solicitation fee must be paid pursuant to a written agreement

• Solicitor to provide a prospective client a copy of:

  • Adviser’s disclosure statement

  • A separate disclosure statement describing the terms of the solicitation arrangement.”(2)

Is telling a client to keep $1,000 in checking and $10,000 in an emergency fund savings account advice on asset allocation?

Yes - but still ok advice. Keeping cash in checking verses savings is asset allocation advice, but you are working within another exemption in the IAA. Advice on securities which are “direct obligations of or obligations guaranteed as to principal and interest by the United States” is exempted from the IAA. Because you are recommending FDIC insured accounts ONLY, you would be exempted from the regulation. (NCUA insured accounts at credit unions would also qualify).

If, however, you recommend the savings be in a money market fund instead of a money market account, you are now breaking the law. And if the client mistakenly assumes you meant a money market fund, you could still have liability and open to suit. (Anyone who says someone can't sue you for that doesn't understand the creativity of lawyers).

Most states have enacted laws requiring a Solicitor be registered as an Investment Advisor either under the state or with the SEC. This requirement is based on the state the Investment Advisor works in, not the state the referrer works in. As a result, you would need to know the laws not of your state but of every state the referring advisor potentially works in.

Can I recommend a type of investment account such as a 401(k), IRA, or Roth IRA?

Technically this shouldn’t be considered investment advice, but telling a client the investments in the 401(k) aren’t as good as those you could find on your own in an IRA could be a problem. In making that statement you are providing advice as to the relative value of the investments in the 401(k), which is investment advice.

Making this recommendation, however, creates other legal risks. Choosing amongst these accounts has numerous legal and tax implication, which most financial coaches don’t understand. Heck, most lawyers and CPAs don’t understand all the legal and tax implications of making this choice.

Can I educate clients about investing including showing a history of the stock market or general security information?

Be very careful, as you would be skating on thin ice here and it would be very easy to accidentally break the law during the discussion. Showing the history of the stock market is fine as it is historical fact. But why are you showing the history? The implication is to show the benefits of investing in the stock market, which is now entering investment advising territory.

Similarly, discussing the nature of stocks verses bonds will almost invariably lead to a discussion of the relative benefits of each and when each is best. While you likely won’t be trouble at this point, answering the common questions a client would have in general conversation will almost invariably lead you to topics and statement which would be illegal.