Weekend Reading For Financial Planners (April 6-7)

Reg BI Client Claims Double In 2023 As FINRA Arbitrations Jump 12%

(Tracey Longo | Financial Advisor)

The SEC's Regulation Best Interest, issued in June 2019 and implemented in June 2020, requires brokers to act in their clients' best interests when making an investment recommendation by meeting 4 core obligations: disclosure, care, conflicts of interest, and compliance. While this represented a higher benchmark than the preceding "suitability" standard imposed by FINRA on its members, it fell short of a full fiduciary obligation (creating a gap between the obligations to customers of broker-dealer representatives and the clients of advisers at RIAs). Nevertheless, with Reg BI now being in force for a few years (and public awareness of it increasing), the number of Reg BI-related customer arbitration claims has risen.

According to FINRA, customer arbitration claims against broker-dealers and their registered representatives related to an alleged breach of Reg BI rose to 408 in 2023, almost double the 216 claims seen in 2022. Overall customer arbitration claims increased by 12% in 2023, with breach of fiduciary duty claims up 13% to 1,891 cases and suitability claims increasing from 1,220 to 1,580 cases. Other areas seeing jumps of at least 12% included misrepresentation, fraud, churning, unauthorized trading, and elder abuse. In terms of the products cited in arbitration claims, mutual funds saw a large hike from 159 to 294 cases in 2023 (perhaps as the performance of some actively managed mutual funds in client portfolios lagged the broader market?). Claims related to corporate bonds were flat year-over-year at 236 cases, but this number remains significantly higher than the 59 fixed-income claims seen in 2021 (possibly reflecting losses in client fixed-income portfolios in the rising interest rate environment).

Altogether, the increasing number of Reg BI-related arbitration cases potentially reflects increasing consumer awareness of the regulation and its requirements (though it remains to be seen how many of these arbitration cases will fall in the customers' favor!). And for RIAs (which have a fiduciary duty), the types of arbitration claims being made against their broker-dealer counterparts could serve as a warning of potential client complaints (e.g., potential client concerns about the performance of the fixed income portion of their portfolios, perhaps creating an opportunity for advisors to review the appropriateness of these allocations and the risks involved with clients?).    

SEC Fines 2 Firms For Bogus AI Claims

(Austin Weinstein | ThinkAdvisor)

The recent flood of interest in applications that use Artificial Intelligence (AI) technologies has led a number of companies to advertise how their use of AI can benefit customers. The potential upsides of leveraging AI have come to the financial industry as well, with the use of AI becoming a popular talking point among asset managers and financial technology companies. Perhaps expectedly, given the emerging use cases of AI (and the potential to make exaggerated claims regarding their benefits), regulators appear focused on investigating whether some of these claims are misleading.

Last month, the SEC announced that it had settled charges against 2 investment advisers for making false and misleading statements about their purported use of AI, with the firms agreeing to pay a total of $400,000 in civil penalties (without admitting or denying their guilt). The SEC said Toronto-based investment adviser Delphia claimed on its website that it "put[s] collective data to work to make our artificial intelligence smarter so it can predict which companies and trends are about to make it big and invest in them before everyone else", but, in reality, did not have the AI and machine learning capabilities that it claimed (notably, the firm was also charged with violating the SEC's Marketing Rule, which prohibits an RIA from including untrue statements of material facts in advertisements). According to the SEC, the second firm charged, San Francisco-based Global Predictions, falsely claimed to be the "first regulated AI financial advisor" and misrepresented that its platform provided "[e]xpert AI-driven forecasts".

Ultimately, the key point is that a time of significant hype surrounding AI technologies, the SEC appears to be focused on investigating firms that are "AI washing" (i.e., making false or exaggerated claims about how a firm incorporates AI in its processes and the claimed benefits of doing so). Which suggests that while AI does offer potential opportunities for advisers to operate more efficiently (whether by helping craft draft emails and marketing content or to create "Custom GPTs" to help speed workflows), conducting additional due diligence when using AI to generate client recommendations (or using AI-enabled software products), and especially advertising their use in marketing materials, could help firms avoid regulatory scrutiny.

RIA Buyers Attracted To Firms With Planning Focus, Tailored Services: Report 

(Ali Hibbs | Wealth Management)

Following a period of significant growth in RIA Mergers and Acquisitions (M&A) activity, 2023 saw a pullback in deal flow – with the number of RIA M&A transactions declining to 321 transactions from a record-high 340 in 2022, according to investment bank Echelon Partners – amid rising interest rates (that can increase the cost of financing deals) and other headwinds. Nonetheless, many market participants have remained positive that underlying factors driving M&A activity (e.g., infusions of Private Equity [PE] capital into large buyers and a large number of retirements among RIA founders) would mean that deals could soon pick up.

According to consulting firm Advisor Growth Strategies' "2024 RIA Deal Room" report, RIA M&A activity is likely to remain resilient going forward, with transaction volumes in 2024 expected to see a similar or better result compared to 2023 due to continued high demand among buyers, a steady supply of sellers, and the continued flow of outside capital to help finance deals. According to the report, the most popular acquisition targets in 2023 had Assets Under Management (AUM) ranging from $200 million to $500 million (providing a potential valuation premium for firms in this AUM range) and had a distinct focus on financial planning, while the least popular targets were those with poor organic AUM growth or were hybrid advisory firms that brought in more than 20% of their revenues from commissions. Further, Advisor Growth Strategies found that firms that offered enhanced services aimed at specific client segments and conducted business in desirable geographical locations were increasingly attractive to buyers as well.

Amid the increasing cost of financing cash deals, the report found that equity played a larger role in transactions in 2023, equity consideration increasing to 31% of total valuation from 21% in 2021 and cash representing 64% of total valuation (down from 77% in 2021). Which presents an opportunity for sellers to partially monetize their firm in a sale while sharing in the potential upside of the combined firm (with the exact percentage of cash and equity [as well as contingent payouts] likely varying based on the buyer's ability to generate cash and the seller's tolerance for a valuation that could change depending on the performance of the combined firm).

In the end, these findings suggest that while the total number of RIA M&A transactions might have dropped in 2023 (from record highs in previous years), there remains continued appetite from both buyers and sellers for further deals. Further, the characteristics of the most attractive M&A targets identified in the report suggest that firms focused on comprehensive planning (rather than 'just' investment management) and offering tailored services to specific client segments (as opposed to a more general value proposition for a wide client base) not only could see improved client growth going forward, but also could better position themselves for a future sale (if that is the owner's desired succession plan!). 

Buffer ETFs May Protect Against Some Losses, But Come With A Cost

(Elaine Misonzhnik | Wealth Management)

Investing in the stock market offers the potential for significant long-term returns at the 'cost' of volatility along the way. For long-term investors (particularly those with strong risk tolerance), such short-term volatility might be less of a concern, as they can remain invested long enough for the market to recover. However, for those with a shorter time horizon (e.g., individuals about to retire, for whom sequence of return risk is a potential threat to their spending in retirement), being highly exposed to sharp market downturns might be less palatable.

To meet the needs of investors looking to participate in equity market gains while limiting their exposure to market losses, a number of products have emerged in recent years that offer (at least some) downside protection in return for capping the upside return from investing in equities. One particularly popular set of products are buffer ETFs (a group that has grown to $37.99 billion in assets under management, spread across 159 ETFs), which use options strategies to provide a "buffer" against losses, while an upside 'cap' is put in place to pay for the cost of providing the downside protection. For instance, a particular buffer ETF might provide for a 15% buffer (i.e., investors will not experience losses if the index being tracked (e.g., the S&P 500) falls less than 15% during the period of the ETF series [often 12 months]) with a 15% cap (i.e., investors will participate in gains of the target index up to 15%, but will not receive additional gains if the index appreciates beyond that point). 

While buffer ETFs can provide a level of downside protection for interested investors, they do come at a cost. To start, the upside cap limits potential returns in years of particularly strong performance (further, buffer ETFs typically track the price level of the target index, so an investor would not benefit from dividends that would be received if they bought a traditional ETF tracking the same index). In addition, investors (and advisors using buffer ETFs with clients) are not guaranteed to receive the advertised upside cap and buffer if they invest in a buffer ETF series after it is launched (e.g., if a 15% cap buffer ETF runs from January-December, and an investor buys it in March after the index has risen 10%, they potentially will only participate in up to 5% of additional upside if the market continues to rise, not the full 15%!). Also, Morningstar has found that buffer ETFs tend to have fees that are about 70% to 80% higher than regular ETFs, indicating that there are costs beyond the upside cap. Finally, investors will need to be aware that their while their upside is not capped, they could still experience significant drawdowns in years when the performance of the index exceeds the buffer level (e.g., an investor in a 15% buffer index would experience a 20% loss if the index falls 35%).   

Ultimately, the key point is that while buffer ETFs can provide some downside protection for investors, it is no 'free lunch', given the upside cap and fees involved. Which provides an opportunity for financial advisors to add value for clients interested in these products by explaining the full implications of these investments and, if they are determined to be a useful addition to their portfolio, to invest in them so that the client receives the full benefits of these products (i.e., by buying the product at launch and holding through the entire defined outcome period) or, otherwise, finding alternative solutions (e.g., a more conservative asset allocation using traditional funds) to mitigate their downside risk!        

The Questions To Answer For Structured Notes

(David Townsend | Advisor Perspectives)

Investors nearing retirement today who have invested throughout their careers have experienced some wild ups and downs in the market, from the tech-fueled boom of the '90s and the subsequent bust in the early 2000s to the market crash spurred by the 2007-2008 financial crisis and the bull market that followed. Given this volatility, some of these investors might seek investment options that provide income to fund their retirement spending needs while mitigating their potential losses.

One potential option for these individuals is to invest in structured notes, an investment vehicle comprised of a bond and a derivative component, offering a risk-return profile between (higher risk-higher potential return) stocks and (lower risk, lower potential return) bonds. Income-seeking investors might be attracted to the potential to receive yields greater than traditional bonds as well as the buffer that provides a level of downside protection if the target index of the derivative component (e.g., the S&P 500) falls in value.

While structured notes might appear to be an attractive offering for income-hungry investors willing to take some risk, they come with a range of potential downsides. To start, the products are complex and can be difficult to manage (e.g., it can be difficult and/or expensive to sell a structured note after it is purchased). In addition, those buying structured notes in taxable accounts will pay taxes at ordinary-income rates on the income generated by the note. Further, in addition to the risk of financial loss (if the underlying index falls beyond the buffer level) and liquidity risk (i.e., the potential challenges of selling a note before it matures), structured notes face a variety of other risks, including reinvestment risk (i.e., if market conditions are unfavorable when the note matures or is called) and credit risk (i.e., if the issuing bank faces default, noteholders might not receive a coupon payment for a given period and potentially could lose the principal amount). 

In sum, structured notes could represent a viable solution for those looking to boost their investment income while receiving some downside protection. Nonetheless, given the complexity and risks of these products, financial advisors are well-positioned to offer guidance on whether they might be an appropriate fit in a client's portfolio and, if so, ensuring that they are purchased in a way that maximizes the benefits while mitigating some of the downsides (e.g., potentially investing within a tax-advantaged account like an IRA given the tax treatment of income received), or otherwise suggesting an alternative strategy that provides similar outcomes!

One Of The Most Infamous Trades On Wall Street Is Roaring Back

(Lu Wang and Justina Lee | Bloomberg News)

While volatility is an inherent part of investing in the equities, the stock market can go for extended periods without major swings. During these periods, some investors can be tempted to bet on continued dampened volatility through the use of various options or funds that engage in them. And while this "short volatility" strategy can pay off if markets remain calm, a shock can lead to significant losses (as occurred during the "Volmageddon" incident in early 2018, when a market decline and volatility spike led to massive losses in many short-vol funds, including one ETF whose assets shrank from $1.9 billion to $63 million in one session). 

While the memories of 2018 remain in some investors' heads, the relatively muted volatility experienced during the past year has led to significant inflows into strategies that benefit from continued calm in the broader stock market. For instance, some market observers see potential danger in other short-vol strategies. For example, some hedge funds are engaging in the so-called "dispersion trade" that uses options to bet on volatility in a basket of individual stocks while betting against volatility in a broader index (e.g., the S&P 500). While this trade has worked recently, (as the S&P 500 has risen while certain individual stocks have seen significantly more volatility), a broader market downturn (and the relative opacity of the specific bets being made using this strategy) could lead to a deeper selloff if these investors were forced to sell their positions. 

Ultimately, the key point is that while the "short vol" trade has been successful for investors in recent months, market history suggests that more volatile conditions are likely to return at some point. Which could provide an opportunity for advisors to provide historical context for clients who might see these strategies as 'can't miss' opportunities!   

3 Keys To Building A Leading RIA Brand

(Joe Duran | Citywire RIA)

Having a widely respected brand can help a company maintain strong profitability over the course of many years or even decades. In certain industries, having a strong brand means delivering a consistent product. For instance, a McDonald's hamburger should taste the same no matter the location where it's purchased. However, for service industries like financial planning, building a brand can be trickier.

Duran suggests that in service industries, culture is the biggest single determinant of brand success. But while firm leaders might understand the importance of building a strong company culture conceptually, some might not take the time to define their culture, articulate it to employees, and then maintain those standards. For those firms looking to establish a strong culture (or reassess their current company culture!), Duran offers 3 areas for firms to evaluate. 

First, firm culture will benefit when leaders and employees adopt a "giver", rather than a "taker" environment. While parts of the wealth management industry take an "eat what you kill" approach that can lead advisors to focus on their own needs (to boost their personal bottom line), a team-based approach where advisors and staff look to support each other for the benefit of the firm as a whole can create a more collaborative environment and promote better client service.

Next, firm leaders can positively impact company culture by adopting a "learner" rather than a "knower" mindset. For instance, while it might be tempting for a leader to rely on the strategies that got the firm to where it is today, being open to new ideas (e.g., by bringing creative thinkers on to the team) can help firms thrive amidst a changing industry environment. Finally, firms that adopt a "meritocracy", where strong performance is consistently and objectively rewarded in terms of compensation and promotions, rather than an "aristocracy", where a small group of firm leaders dole out pay and promotions subjectively, can generate more employee buy-in, as they know they will be evaluated based on their output rather than on how well they relate to leaders. 

In sum, while an advisory firm might have expressed values, company culture shows how these values are (or are not) put into practice. And given that a strong firm culture can lead to more satisfied, tenured employees, it can lead to less employee turnover and a more consistent 'product' for clients that can help build the firm's brand. 

How To Use AI Without Compromising Your Brand's Identity

(Lauren Hong | Advisor Perspectives)

Artificial Intelligence (AI) tools have the potential to boost financial advisor efficiency, whether by automating certain client service tasks (e.g., data gathering) or by supporting marketing efforts (by speeding the process of brainstorming ideas for marketing content or even having the tool compose the content itself). At the same time, automating certain functions and/or creating less personalized content could lead a firm to lose what makes it unique in the eyes of clients and prospects.

To reap the benefits of AI tools while not losing what makes the firm special, Hong suggests that firms first decide on (or review) its "brand personality" (i.e., the convergence of its mission and core values) as well as a communications approach (e.g., a formal approach versus a more casual tone). With these established, firms can then consider how they might best take advantage of AI tools. For instance, firms might use a generative AI tool like ChatGPT to brainstorm ideas for webinar topics, blog posts, social media posts, or advertising copy, or scheduling and productivity tools like Clara or Clockwise to make scheduling internal or external meetings more efficiently. The real key, though, particularly when it comes to generative AI tools, is to personalize the output to match the firm's brand personality. For instance, ChatGPT might offer a succinct explanation of how Roth conversions work, but an advisor can take it to the next level by adding their own 'voice' to the content and customizing it for the needs of their specific client base (and fact-checking to ensure any AI-generated content is accurate!).

In the end, while AI tools have the potential to boost advisor efficiency, there is potential for certain functions to become automated to the point where a firm's unique 'personality' is no longer visible. And in an industry where human-to-human interaction is a key part of the value proposition, giving prospects and clients the confidence that they are hearing from a human (even if the human got a productivity 'boost' from AI technology) can help cement this connection and help the firm stand out based on its unique merits!

To Refresh Your Brand, Be "Personal First"

(Janet Levaux | ThinkAdvisor)

Given the high stakes involved in creating financial plans and managing money for clients, it makes sense that advisors would want to emphasize their professional credentials in their marketing, from their education and certifications to their on-the-ground experience working with clients. At the same time, because financial planning is a human-to-human relationship (and not just an engagement with a curriculum vitae), advisors can also attract clients by offering insight into their personality. 

According to financial services marketing expert April Rudin, the role of the 'personal brand' has increased in recent years, merging with one's professional credentials into a combined brand. For instance, at a time when certain credentials are becoming increasingly common in the financial advice industry (e.g., CFP certification or status as a fiduciary), a strong personal brand (in addition to a value proposition tailored to the needs of their ideal target client) can help an advisor stand out. Notably, advisors have many ways to establish and build their personal brand, from the biography on their website (perhaps including a video, which can allow an advisor to further express their personality to prospects) to social media content (as the tone and content of posts can help prospects better understand the advisor's style and expertise). At the same time, content can be too personal, whether because it touches on sensitive topics (e.g., politics, though this could potentially be a plus for advisors whose client niche tends to hold certain views) or because it conflicts with the firm's overall brand (e.g., an advisor sharing memes on social media to demonstrate their sense of humor might conflict with their firm's brand if it tries to express a more buttoned-up vibe).

Ultimately, the key point is that prospective clients often want to work with an advisor who not only has the professional background and expertise to meet their planning needs, but also is someone with whom they would want to work for years to come. Which suggests that advisors who are able to establish a personal brand that combines their credentials with their unique personality could be well-positioned to attract more clients going forward!   

Your Burnout Is Trying To Tell You Something

(Kandi Wiens | Harvard Business Review)

Many professionals will experience burnout (i.e., chronic stress that leaves an individual tired and unable to perform at the best of their abilities) at some point in their career. However, it can take a long time for individuals to realize they are suffering from burnout, which can compound its effects further. With this in mind, doing regular self-check-ins when feeling stressed at work can help an individual identify when they might be headed to (or in) a state of burnout, what might be causing it, and what actions they might be able to take to resolve it. 

One or more workplace factors can contribute to burnout. For instance, a professional might find that they have outgrown their current role, which can lead to feelings of being underutilized and disenchantment with day-to-day responsibilities, a situation that might call for seeking a promotion or new position within their company, or, if unavailable, looking to a different firm or perhaps exploring a new career altogether. Another burnout trigger is when an individual's experience at work does not match their expectations. For instance, a worker's stress levels might increase if they have to work longer hours than expected or are given assignments that are outside of their job description (and do not match their skills); this situation could call for a conversation with one's manager to outline the mismatch and explore potential solutions. Beyond formal work hours (i.e., being in the office for certain hours during the day), the extension of work to one's nominal "off time" (e.g., by being expected to respond to emails in the evening and on weekends) can create stress and lead to burnout as well. 

While the above issues can often be resolved with a conversation with one's manager or a change in roles within the company, other burnout triggers are more difficult to solve while remaining with the same firm. For instance, a mismatch between an employee's values and those of their company (e.g., if the employee thinks the company is engaging in unethical business or marketing practices) can be hard to resolve. In addition, a common source of burnout is toxic workplace behavior (i.e., behavior that leaves an individual feeling belittled, disrespected, unsafe, or undermined), which can lead victims experiencing it (or, according to one study, even those who just witness it) feeling overwhelmed, distrustful, and disengaged.

In sum, employee burnout often is the result of workplace conditions rather than the behavior of the employee themselves. Which means that firm leaders have the opportunity to proactively address potential burnout triggers to prevent chronic stress from developing among employees (and to prevent staff turnover in the process!), whether it is creating a firm culture that does not permit toxic workplace behavior, to holding regular check-ins with employees to ensure that their current roles match their expectations and work capacity! 

Overwhelmed? Just Say "No"

(Arthur Brooks | The Atlantic)

For busy professionals, it can seem like there are a nearly endless number of requests coming in throughout the day, whether from co-workers, clients, or family members. Because these requests take at least some time to address, saying "yes" to all of them can cut into one's capacity to complete everything that was already on their plate. Which means that the ability to say "no" to certain invitations and requests can help prevent an individual from feeling overwhelmed (and, eventually, burnt out). 

Despite the potential benefits of (at least sometimes) saying "no", doing so can be difficult. One reason is because of the tendency for humans to engage in "temporal discounting", or valuing the near-term more than the future. For instance, agreeing to take on a major project next month might feel good in the moment (perhaps to make the requesting manager happy), but the bill will need to be paid later on when it potentially conflicts with other work. Another issue that gets in the way of saying "no" is the fear of future regret. For example, it might be tempting for an individual to agree to attend a networking event even though they have significant work on their plate because they fear that they might miss out on meeting a potential client. Finally, feelings of guilt (i.e., not wanting to disappoint the person making the request) can make it challenging to say 'no' (though some experimental research suggests that people tend to overestimate the negative consequences of turning down a request!).

Luckily, there are several potential ways to overcome the challenge of saying "no". One is to start a "no club", or teaming up with others to hold each other accountable for saying 'no' to large and small requests (perhaps competing to see who can get to 100 "no's" first). Another is to mentally make "no" the default response to requests that come in, only saying "yes" to things that are actually worth doing (as opposed to defaulting to "yes" and having to think of a reason to say "no"). Finally, it's possible to make saying "yes" harder, for example by waiting a day (or, for major asks, a week) before responding to requests so that the pressure to say 'yes' in the moment is reduced (and so that there is more time to consider the consequences of the decision!).

In the end, a mix of "yes" and "no" responses to requests is likely to be the best course of action for most people in order to take advantage of opportunities presented (and to help others) without becoming overwhelmed. And for those who have a hard time saying 'no', adopting strategies that help making do so easier could be the key to achieving better productivity with less stress!

Why We Glorify Overwork And Refuse To Rest

(Tony Schwartz and Eric Severson | Harvard Business Review)

Often, it can be tempting to conflate 'busyness' with 'usefulness', which can lead to taking on more and more projects at work and reducing the amount of time available for relaxation. At the extreme, "workaholism" (a term coined by psychologist Bryan Robinson to describe self-imposed demands to work more and more) can lead to increased stress, reduced effectiveness at work, and, ultimately, burnout. For instance, Kitces Research on Advisor Wellbeing has found that working longer hours is associated with reduced wellbeing. Further, overwork can also lead to negative health outcomes, with one study finding that working 55 or more hours per week is associated with a 35% higher risk of a stroke and a 17% higher risk of dying from heart disease compared to working 35–40 hours per week.

To help combat the potential for overwork, a first step is to take a step back and assess whether you might be pushing your limits. For instance, you might consider whether your effectiveness at work tails off late in the day (or evening), whether you constantly feel fatigued, or whether your relationships outside of work are suffering because of the amount of time spent at work. For those suffering from these symptoms, a potential first step is to prioritize sleep and exercise; not only does a commitment to these activities reduce the time spent at work, but they are 2 of the best ways to boost energy. Next, prioritizing one activity outside of work that brings you enjoyment and committing to it can also 'reserve' time away from work and increase happiness. Finally, increasing awareness of how your body feels (perhaps through meditation, or just regular 'check-ins') can help you identify signs of overwork before the stress builds up too much.  

Ultimately, the key point is that while it can be tempting to work longer and longer hours (whether because of a desire to feel useful, to advance professionally, or for other reasons), doing so can have negative consequences for both your personal and professional lives. With this in mind, reserving time for energy-generating activities (e.g., sleep, exercise, or leisure activities that you enjoy) can help combat the urge to work longer and potentially improve the quality of your work in the process! 

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog.