Executive Summary
The turning of the New Year brings a fresh set of both opportunities and challenges, and 2016 looks to be no exception to the rule.
Last year the dominant themes included the pivot of "robo" technology from being a direct-to-consumer solution to instead becoming robo-advisor-for-advisors platforms (which spurred an explosion of FinTech acquisitions), the ongoing crisis of differentiation for advisors leading to more and more discussions of whether it's time to reinvent the advisor business model (or perhaps just finally get more focused into niches and specialization), and the growing pressure of regulatory reform as President Obama threw his full support behind the Department of Labor's proposed fiduciary rule and the anti-fiduciary lobbyists spent all year trying (and failing) to stop it.
In fact, with a final failed effort to stop the DoL proposal by trying attach a rider to the recent omnibus spending legislation last month, it now appears that the pending release of the Department of Labor's fiduciary rule will be the hot issue for financial advisors in 2016. The rule has the potential to completely reshape the landscape of financial advice, force broker-dealers to reinvent themselves (into turnkey financial planning platform [TFPP] solutions instead?), and force financial services product manufacturers for the first time ever to compete solely on the merits of their products rather than the size of the commissions they can pay.
While in the long run I would still maintain that a fiduciary rule for financial advisors is absolutely critical as a protection for consumers, there seems little doubt that 2016 will be a seminal transition year that sets the stage for how financial advice will be delivered in the coming decades - a tremendous opportunity for advisors (and the companies serving them) who are prepared for the change, and the beginning of the end for those companies who have not positioned themselves for an advice-centric future.
A Recap On The Top Issues Of 2015
Last January, I had predicted that the top advisor issues of 2015 would be the shift from “robo-advisors” to “robo-advisors-for-advisors”, new developments in the regulation of financial advisors, and an emerging breaking point in the ongoing crisis of differentiation impacting most advisors today.
Regarding the shift from robo-advisors to technology tools for advisors, the trend certainly did show up in force in 2015, expressed not only in robo-advisor tools like Jemstep pivoting squarely towards becoming a B2B solution for advisors as Jemstep Advisor Pro, but an explosion of FinTech mergers and acquisitions. While at the beginning of the year when I made my prediction there had been no acquisitions of advisor FinTech companies by established financial services firms, within just months Envestnet acquired robo-advisor-for-advisors Upside Advisor, and then Fidelity acquiring eMoney Advisor to deploy its technology across the Fidelity enterprise, followed by Northwestern Mutual acquiring LearnVest to leverage its technology tools for their own advisors, John Hancock acquiring Guide Financial, and the M&A FinTech activity culminated in the end-of-year “blockbuster” deals when Blackrock acquired FutureAdvisor to deploy the robo solution to broker-dealers and insurance companies, and Envestnet acquired Yodlee to complete its full technology stack for advisors. While 2014 had been all about robo-advisors disrupting advisors by going directly to consumers, 2015 revealed that the real opportunity (and big money) is for existing financial advisors and financial services firms to leverage the technology themselves. Now, as predicted, it’s the robo-advisors that are on the defensive and trying to validate their relevance in a world where Schwab Intelligent Portfolios is “free”, and Vanguard Personal Advisor Services offers an entire human advisor experience for only 5bps more than the cost of “just” an automated investment service.
In terms of the regulatory environment for advisors in 2015, this too proved to be a hot topic throughout the year. While the CFP Board’s lawsuit fortunately ended with a whimper, the Department of Labor’s second draft of its proposed fiduciary rule hit with a bang. The re-proposed rule came out as expected in early 2015, and set off a flurry of anti-fiduciary lobbying activity, making the question of whether advisors should be required to act in the interests of their clients – or whether they already do – the hot topic of the year, culminating in a final (failed) attempt to block the DoL’s final fiduciary rule via a rider to the end-of-year tax extenders and omnibus spending legislation.
And as expected, the ongoing “crisis of differentiation” for advisors started coming to a head in 2015 as well, as slower growth rates for advisors firms were compounded on top of lackluster markets and left many advisor firms with flat revenue and profits for the year. This was manifested as growing questions of whether advisors need to cut their AUM fees to compete against robo-advisors – even though the reality is that robo-advisors sitting at 0.02% market share aren’t taking material business from advisors in the first place – and some even musing whether the “AUM fee is toast” altogether. Yet the real problem for most advisors remains not that their AUM fees are too high to compete – in fact, some advisor consultants are still suggesting that advisory firms aren’t charging enough! Instead, the problem is that when advisory firms are not focused on a target niche clientele and providing them a unique and differentiated service offering, the only things left to compete on are pricing model and brand, where most advisory firms lack the size and scale to really compete at all. And the problem only looks to get worse in 2016, as major asset managers and custodians are increasingly hiring up their own financial advisors to compete directly against independent financial advisors.
So given how all these trends played out last year, what’s in store for 2016?
Department Of Labor Fiduciary Rule Rolling Out, And CFP Board Updates Its Standards Of Professional Conduct
After a series of unsuccessful efforts by anti-fiduciaries to block the Department of Labor’s fiduciary proposal – culminating in a failed attempt to attach a rider to the end-of-year omnibus spending bill that could have fatally delayed it – it looks like the biggest issue for financial advisors in 2016 will be the issuance of a "final" version of the DoL fiduciary rule sometime during the first half of the year. And while the rule will almost certainly have a transition period for the industry before it will be enforced – rumored to potentially be as long as 3 years – expect to see it begin to drive changes almost immediately.
Signing A "Best Interests Contract" To Earn Commissions Or Higher Fees Under The Best Interests Contract Exemption (BICE)
The most controversial provision of the rule is the requirement that advisors engaging in IRA rollovers of funds coming out of an employer retirement plan will be prohibited from earning any commissions on the transaction (or even charging a higher AUM fee than the existing 401(k) plan fees), unless the advisor signs with their clients a “Best Interests Contract” (BIC). If the BIC is signed the commission (or higher fee) is permitted (i.e., the Best Interests Contract is an exemption to what would otherwise be a prohibited transaction). But obtaining protection from this "Best Interests Contract Exemption" (BICE) commits the advisor to act as a fiduciary and demonstrate that the recommended solution was really in the best interests of the client (i.e., proving why it was appropriate despite the associated advisor compensation and its inherent conflict of interest).
At best, following the BICE requirements is expected to curtail the use of many types of high-commission products (in addition to prohibited altogether some types of alternative investments, like non-traded REITs, which wouldn't be permitted even if there is a signed Best Interests Contract). At worst, some commentators like Morningstar are suggesting that it could be the beginning of the end of commissions for advisors altogether (and notably, many other countries around the world have already been banning advisor commissions in recent years). Either way, the rule is expected to introduce a new layer of compliance oversight for advisors, to meet the new higher standard regarding the recommendations they give to their clients.
Will The DoL Fiduciary Rule Make Broker-Dealers Irrelevant?
The significance of the Department of Labor’s fiduciary rule is not just its potential to reform commission compensation for advisors, though, but all the ‘secondary’ effects that will occur in response.
For instance, in a world where most advisors are no longer being paid commissions for the sale of securities products within an IRA, most will naturally be driven even further towards the AUM model. Which in turn raises the question of whether the breakaway broker trend towards RIAs will just accelerate further.
After all, if the advisor doesn’t need the broker-dealer to facilitate securities commissions (because they're greatly diminished or the advisor just moves to AUM anyway), what role does the broker-dealer serve, to justify the slice of the advisor’s grid revenue that the B/D takes? Will broker-dealers be relegated to the domain of “just” selling commission-based investment products in non-retirement brokerage accounts? Or will the Department of Labor rule lead/force some broker-dealers to reinvent themselves for the modern era, refocusing on true financial planning and becoming a turnkey financial planning platform (TFPP) that facilitates the success of advisors who get paid for advice (as opposed to advisors who get paid to distribute product)?
Will Annuity And Invesment Companies Be Forced To Compete On The Merits Of Their Products Instead Of The Commissions They Pay?
Similarly, many financial services product companies, from asset management firms to annuity providers, will also be compelled to reinvent themselves in a new DoL fiduciary world where at least the highest commission (if not all commission) products are limited. From the perspective of the companies that manufacture these financial services products, commissions are the mechanism used to “sell” and distribute their products. Without the ability to pay a commission on those products, nor the ability to incentivize “advisors” to use their products by offering more generous compensation than their competitors, financial services product manufacturers may actually be forced to compete on the merits of their products! In other words, in a DoL fiduciary world, if financial services product manufacturers want to get fiduciaries to use their products, the companies issuing them would have to actually create products that are simple, practical, compelling, and reasonably priced, such that a fiduciary would use choose to use them.
If you’re wondering how this might play out, just look at the world of investment management amongst RIAs today – where low-cost ETFs have exploded, turning Vanguard, Blackrock’s iShares, and State Street into multi trillion dollar behemoths, while the vast majority of active managers who weren’t delivering value are being squeezed out altogether, and only a small subset of truly unique and high-quality active managers are surviving. This has been the impact of converting the selection of mutual funds from a commission-based distribution model into a meritocracy.
The transition to a ‘meritocracy’ for investment solutions amongst the remainder of advisors (who may still be swayed by the mutual fund commissions from some companies in today's environment), along with the introduction of the meritocracy dynamic for annuities, could drastically alter the product landscape – arguably for the better, but it remains unclear whether many financial services firms that manufacture products today have really prepared for how to distribute their products in a no-commission meritocratic future.
Will DoL Fiduciary Rule Exacerbate RIA Marketing Woes?
From the perspective of today’s existing RIAs, many of which have lauded the coming fiduciary rule as an opportunity to cull the commission-based advisors they must compete with today, there seems to be little doubt that many pure salespeople who were never really true advisors in the first place will be driven out of the financial services industry once they can no longer earn the ‘easy’ big dollars with high-commission products.
Yet the irony is that the DoL’s new fiduciary obligation for advisors could ultimately exacerbate their competitive threats. The simple reason is that in today’s marketplace, RIAs that operate on an AUM basis as fiduciaries with fewer conflicts of interest have used this as a differentiator against their commission-based brethren – a differentiation that will no longer exist when, under the DoL rule, any/all advisors who stay in the industry will just be driven towards the same business model with the same fiduciary standard (at least when it comes to retirement accounts)! In other words, if it felt like there was a “crisis of differentiation” for (fiduciary) advisors before the DoL fiduciary rule, it will only be even worse afterwards! This will likely just accelerate the drive even further towards advisors exploring new segments of clients to serve, experimenting with new business models for new clientele, finding a niche to focus on, and pursuing CFP certification and other post-CFP designations to further specialize themselves.
The Next Fiduciary Battleground - Competency Standards For Advisors
In fact, once the DoL imposes a consistent fiduciary duty of loyalty on advisors with its "best interests" standard, the question of what competency level an advisor must have to meet the fiduciary duty of care will likely become the next battleground.
In other words, it doesn’t help consumers to require that advisors deliver advice in the best interests of their clients when the advisors have no training to ensure they are competent enough to know what is in the best interests of their clients!
In turn, as the competency standard eventually gets lifted, even more pure salespeople will be driven out of the business (arguably to the benefit of consumers, but further squeezing the headcount of “financial advisors” until they’re replaced by true advisors).
CFP Board To Update Its Own Standards Of Professional Conduct, And The SEC Prepares For 2017
In the meantime, it’s notable that running in parallel with the DoL’s fiduciary rule rollout in 2016 will be the CFP Board’s own recently announced process of forming a Commission on Standards to update its Standards of Professional Conduct in the coming year.
This update to the rules – the first in nearly a decade – will likely see improvements to the CFP Board’s problematic compensation disclosure rules and its flawed definition of “fee-only” advisors. But the update process for the Rules of Conduct a CFP certificant must follow could see a refinement or lifting of its fiduciary standard as well, including the controversial requirement that a CFP certificant is not required to act as a fiduciary when holding out as a financial planner, only when actually doing financial planning (which creates the potential for advisors to hold out as CFP professionals and imply a fiduciary duty but then switch to “only” sell products and not be held to the standard). At a minimum, given the CFP Board’s laudable process of trying to engage CFP certificants in public forums and a public comment period, expect to hear a lot of buzz about proposed updates to the Standards in the coming year.
And of course, it’s also worth noting that the SEC is not silent in the changing regulatory environment either. SEC Commissioner Mary Jo White has indicated that the SEC’s own efforts on a fiduciary rule are becoming a priority in 2016 – an issue that will likely just be further pressured once the DoL rule is released, and the industry seeks/asks for conformity between SEC, FINRA, and DoL standards. On the other hand, expect that FINRA in particular will utilize this as an opportunity to lobby the SEC for a “uniform fiduciary standard” for all advisors – which is code for a uniform standard that would give FINRA the opportunity to become the regulator for all advisors, both broker-dealer and RIA, which will likely become the battleground issue of 2017!
In next week's Monday blog post, we'll discuss the other two top issues for advisors in 2016 - an emerging war over who controls and has access to client data, and the unanticipated secondary effects of the first rising interest rate environment in nearly a decade!
So what do you think? Will the DoL fiduciary rule reshape the world of financial advisors in 2016? Are you making any changes in anticipation, or waiting to see what the final rule will hold? Is there another issue that you think will impact your practice even more in 2016 than the new fiduciary rule?
Michael,
With respect to RIAs that might be subject to a BICE for charging “higher fees” in a rollover IRA relationship than in the existing 401k, is it the overall, all in fees that determine whether the new fee structure is “higher”? Or is it just fees for investment advice? (Btw, what part of the fee tree in a typical 401k structure is going toward “advice” to the participant? That’s usually an additional charge under a separate and fairly atypical “advice” arrangement.)
So, for example, say the the client’s existing 401k has an average of 85bps in mutual fund expenses, maybe some 12b1 fees, sub accounting fees, custody fees, adviser to the plan fees of 50bps that all add up to 1.75%. If the new RIA advisor charges a 1% AUM fee that includes ongoing financial planning and uses mutual funds with an average 25bps, is this a higher fee case requiring a BICE or a lower fee case, not requiring a BICE?
Steve,
Ultimately I’d wait to see what the final rule says on this provision. There were many proposed changes to the BICE rules, including this provision in particular (with one proposal simply suggesting that it be eliminated altogether for any rollover going to an RIA that’s already a fiduciary).
When the final rule is released, you’ll see a lot more coverage on the blog about what’s coming, including this provision (if it’s still in the same form in the final rule).
– Michael
Thanks, Michael. will be interesting.
I’m not sure I understand the assumption that pure salespeople will be forced out of the industry under a fiduciary standard. If these salespeople are highly skilled (as many are), why should we think they can’t sell AUM services?
B/Ds are already pushing producers hard to ditch commission-centric models since the ROAs are generally much higher on AUM accounts. Certain advisors have resisted this change for various reasons, but at the end of the day, many of these advisors within B/Ds are simply better salespeople than their fee-only RIA brethren. I see little reason to believe the highly skilled salespeople will be leaving the industry any time soon.
Highly skilled salespeople have skills that translate across industries (not just financial services).
So the issue is that if you’re a salesperson used to selling 7% commission annuities and now you “have to” sell 1% AUM fees, or you could just switch and sell something else (e.g., real estate for 6% commissions), I suspect a lot of those salespeople forced out of 7% commission products will simply find other higher-commission industries rather than sell the AUM fee. Yes, I suspect many really could “sell” AUM fees and do fine, but those attracted to high-commission products tend to stick with them.
Notably, this appears to be exactly what’s happened in the UK. Commissions were banned, AUM fees (or flat planning fees) are required, and “sure enough” about 20% of advisors have left in the first 3 years. And from what I’m hearing from boots on the ground over there, the departures include both “bad” salespeople, and many of the top salespeople, who are both transitioning to industries with “better” commission opportunities.
– Michael
I don’t personally know anyone practicing in the UK, so my information on their situation is limited, but can we be sure advisors are leaving due to compensation preference and not a reduced opportunity to reach certain segments of the market?
Isn’t it possible a 5.75% front-end sales charge could justify the client acquisition cost of a $50,000 client whereas a 1% AUM might not?
Given industry retention rates (at least here in the US) as high as 97% for RIAs, the 1% AUM fee arguably justifies an even HIGHER client acquisition cost compared to front-end sales charges (thus VC investments into robo-advisors at a mere 0.25% AUM fee!).
Admittedly the revenue is levelized, and that can present cash flow challenges to the transition (at least for those dependent on high upfront commissions). I’m sure that will be an issue for at least some advisors (and broker-dealer platforms that serve them). Though I haven’t seen any good data one way or the other to dissect how much that has really been a factor in advisor attrition in the UK.
Notably, the UK also raised some of the qualifying standards for advisors overall, and that may have also driven out the headcount. I’m not familiar with their exact regulatory standards, but imagine a scenario where everyone who had the Series 6 had to go get the Series 7 going forward – and inevitably not all advisors will be able to pass the higher standard exam. That ‘standards’ aspect of advisor qualifications is likely impacting their advisor headcount as well (though again I haven’t seen any good data to segment sources/causes of attrition amongst higher standards, cash flow issues of advisors, preference for commission compensation in other industries, etc.).
– Michael
Hi Michael,
I enjoyed your article. Two thoughts on the DOL thing:
First, I wish it applied to ALL humans out there offering advice on retirement accounts. Given the large 7%+ commissions on fixed indexed annuities, there are plenty of “advisors” that are putting older clients into ill-liquid products that generally do not make much money– even though they can’t go backwards. Isn’t the point of investing to make money? I would be tarred & feather if I put my older folks into ill-liquid anything– including EIA’s. Who is policing the non-securities licensed guys? I will bet there will be many more joining their ranks in the near future.
Second, and to echo Steve Smith’s comment, I do not feel it is accurate to compare a DIY 401K with a .90bp average cost to an advisory account, as there is NO advice component on the 401K. If there was, Steve is correct in pointing out that there would be an advisory agreement, and corresponding fee, to pay for the advice on the 401K. We charge 1% and the average portfolio is another 30bps– not a big difference in cost, but much more value received by client.
I think that the DOL, and people in general, are getting hung up on what it costs, without first defining what it is. I am quite certain that most folks would be better off in the long run, if they had someone to call and get them off the roof when the next financial crisis ensues.
Perhaps you could pull together some studies that show the average return of the market in contrast to the average DIY investor’s return.
Richard
How soon can the average retail customer expect to see completely transparent fee schedules before they choose a financial planner?