Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the big announcement that FPA National has dissolved its affiliation agreement with its New York chapter and spun up a new alternative FPA chapter entity in its stead, in what started out as a dispute about whether certain local chapter board members were inappropriately using lists of consumer contacts from the chapter's public awareness events to prospect for clients, but has now turned into concerns about whether FPA National is taking too much control of its independent chapter entities.
Also in the news this week is a look at how state efforts on fiduciary standards appear to be slowing (now that the Department of Labor's fiduciary rule is in limbo, and the SEC is expected to propose their own in the coming months), the announcement of a class action lawsuit against Edward Jones alleging that the firm was too aggressive in shifting clients out of commission-based accounts and into fee-based advisory accounts (compounded by the fact that those advisory accounts may have been investing into Edward Jones' own proprietary products), and a discussion of some of the talking points that other advisors are using when talking clients through the recent market volatility.
From there, we have several practice management articles this week, including: a review of advisor compensation (and the rising impact of the young-advisor talent shortage) from the latest Schwab and Fidelity benchmarking surveys; tips on how to properly structure partner compensation (broken into base compensation, incentives, and profit distributions) for firms that must transition into more formal partner roles given their growth; how employee turnover can cause poor performance (and how to get control of a turnover problem with clearer definitions of the work, the worker, and the workplace); why advisory firms should be more specific about their vision, mission, and strategy, to avoid what sound like "phony" slogans; and a hard look at the consequences of taking "too much" cash out of your advisory firm instead of reinvesting for growth.
We wrap up with three interesting articles, all looking at the changing landscape of broker-dealers in an increasingly fiduciary future: the first is a review of the latest 2018 Financial Advisor magazine broker-dealer survey, with interviews from most of the leading B/D executives who themselves note that the entire broker-dealer model is going through a big "rethink" for the future; the second looks at how broker-dealers need to re-engineer their technology for managing broker commissions into a more holistic "advisor compensation management" platform that provides business intelligence and workflow support as well; and the last explores how, ironically, it was the independent broker-dealer movement that really helped financial planning to first gain traction 20-30 years ago, even as it's now the fiduciary financial planning movement that is forcing broker-dealers to reinvent entirely in order to survive (or, alternatively, to simply become giant national RIAs instead!?)!
Enjoy the "light" reading!
Weekend reading for April 7th – 8th:
FPA Terminates Relationship With New York Chapter Amid Allegations Of Ethical Lapse & Retaliation (Greg Iacurci, Investment News) - Two weeks ago, incoming FPA New York chapter president Devika Kamboh filed a complaint with the NY Attorney General's Office alleging that members of the chapter's Executive Board were using the chapter's consumer education events to prospect for new clients. Specifically, Kamboh alleges that some current and past board members and officers (including the current chair) conducted "prohibited solicitations of clients" at public-awareness events, including using post-event attendee surveys for themselves for potential client prospecting (and circumventing the chapter's existing client referral program), and that when she reported the issues to other officers of the FPA New York Executive Committee and then FPA National, she was told that she shouldn't pursue the matter "in order to avoid ill-will and hostility" and to use the matter as a "learning experience to set more robust FPANY guidelines" in the future and later claims the chapter executive committee tried to vote her off the board for raising the issues. Ultimately, the conflict led to the intervention of FPA National, which after calling for a mediation process (which failed), decided to terminate the chapter's affiliation agreement (as FPA National cannot technically shut down a separate chapter entity, but it can cut off FPA National resources and support, and prohibit the chapter from representing itself as being affiliated with the FPA), and has now spun up a new legal entity to represent the roughly 600 members of the FPA of New York with a new affiliation agreement, and FPA National appointed previous chapter board president Scott Kahan to lead the "new" chapter and committed to funding the chapter directly (as the existing $80,000 of FPA of New York assets are tied up in the no-longer-affiliated defunct entity). Yet ultimately, what started out as a problematic local chapter issue is now raising concerns across other FPA chapters about whether FPA National is taking too much control of its independent chapters and whether its takeover of FPA New York, along with its recent movement towards a centralized state-wide chapter in Florida (funded by FPA National), will risk removing the "localness" of the FPA chapter system even as FPA National expresses hope that the centralized efficiencies (given the resource limitations of most small chapters) will allow it to finally begin to stabilize and even start reclaiming its declining market share of CFP certificants.
State Efforts On Fiduciary Standards Slow (Mark Schoeff, Investment News) - Back in February, Maryland proposed legislation that would have required brokers to act in the best interests of their clients, but the final version of the legislation approved on March 19th was rolled back to merely direct the Maryland Financial Consumer Protection Commission to "study" the outcome of Federal fiduciary efforts (e.g., from the Department of Labor and the SEC) and then determine whether Maryland should enact its own law. And similarly, after Nevada enacted a law last July that would extend the state's existing fiduciary laws beyond just financial planners to include brokers and other sales representatives, advisors in the state are still working on a formal regulatory proposal about how the law will be enacted. In the meantime, other states, including New York, New Jersey, and Illinois, that have been considering rules that would expand fiduciary duty (or at least disclosure requirements) to brokers and/or insurance and annuity agents, have also seen their efforts stall. At this point, the delay appears to be driven by the controversial split decision from the 5th Circuit Court of Appeals against the Department of Labor's fiduciary rule, combined with the anticipated release of an SEC fiduciary rule, which has created uncertainty about whether states even need to intervene if ultimately a uniform Federal regulation from the SEC will put the matter to rest anyway (which is arguably preferable simply to avoid a patchwork of not-always-uniform state laws). Nonetheless, the fact that state-level fiduciary activism gained as much momentum as it did, so quickly, in the face of a potentially threatened DoL fiduciary rule, suggests that if the SEC's proposal is less stringent, that a resurgence of state fiduciary proposals may re-emerge in 2019?
Edward Jones Sued For Shuttling Customers To Fee Accounts (Mason Braswell, AdvisorHub) - In a class-action lawsuit complaint filed last week in California, four Edward Jones customers are alleging that the firm pressured its more-than-16,000 brokers to switch their clients' commission-based accounts into advisory accounts charging as much as 2%/year in AUM fees (including underlying fund expenses, which sometimes included Edward Jones proprietary mutual funds), even for clients who others "engaged in very little trading" with their existing investment portfolios (for which per-transaction commissions would have been less expensive). The lawsuit alleges that the firm "orchestrated the strategy... under the guise of complying with the Department of Labor's fiduciary rule", but that much of the money was actually just being channeled to proprietary mutual funds in the advisory accounts that Edward Jones had first introduced back in 2013 (allowing Edward Jones to earn both the advisory fee for the account, and the expense ratio of the underlying proprietary funds). Edward Jones leadership maintains that it has offered both fee-based and commission-based accounts in a manner consistent with regulatory requirements, but the available data does show that Jones' advisory programs (Advisory Solutions and Guided Solutions) more than doubled to $265B of AUM in 2017 up from just $101B in 2013. Even without the complication of the proprietary mutual funds, though, the issue highlights how "reverse churning" is becoming a growing issue as the industry transitions from commission-based to fee-based accounts without necessarily having the advisor depth to actually provide the necessary ongoing value (which FINRA declared is now an examination priority in 2018).
Advisors Answer Common Investor Concerns About Volatility With These Talking Points (Jeff Benjamin, Investment News) - With the rise in stock market volatility in 2018, more clients are calling or emailing advisors to ask whether it's time to "do" something, which means the pressure is on us as advisors to allay client concerns and nervousness to help them stay the course. Benjamin provides direct quotes and talking points that a number of advisors are using to address these exact issues with clients, including: Question: "Should I get out of the market and move to cash?" (Answer: You already have sufficient cash reserves to cover your spending needs, and your portfolio is globally diversified specifically to avoid too much risk exposure to one asset class like U.S. stocks!); Question: "Why are the markets suddenly so volatile?" (Answer: Because 2017 was unnaturally calm, the above-average volatility this year seems much worse than it is, and while there have been four weeks that produced lower performance than any week of 2017, there have already been five weeks that produced higher performance than any week in all of 2017!); Question: "Is recent stock market volatility related to the threat of an international trade war?" (Answer: Yes, but that's irrelevant if you're focused on long-term investing, given that the underlying economy still looks good and the job market is fantastic!); Question: "What are you doing to protect my portfolio in this environment?" (Answer: Exposure to a truly global and diverse portfolio is the most important component of reaching long-term financial goals and objectives while minimizing risk, and diversification reminds us how important it is for investors to resist the urge to put all their eggs in one basket...); and Question: "What should I do with new money going into my account?" (Answer: The right plan expects and plans for periods of decline to occur. The worst thing clients can do is ask me, or any advisor, to tell them when to get into the market... so don't let market noise or current events dictate investment selections, and stick with the plan!").
Pay Day: Breaking Down Advisor Salary And Perks (Charlie Paikert, Financial Planning) - In the latest Fidelity RIA Benchmarking study, over 90% of RIAs reported giving salary increases as well as bonuses last year, with almost half reporting compensation increases of 4% - 10% in the past year, as the labor market for financial advisors continues to tighten, both for experienced advisors, and even for new advisors (as new college grads are also getting compelling job offers from other industries fighting for young talent as well). As a result, Schwab's 2017 RIA Benchmarking Survey found that 2/3rds of RIAs with more than $250M of AUM (and virtually all firms with $1B-or-more in AUM) are making talent acquisition a priority, and starting salaries for entry-level advisors are coming in at $50,000 - $60,000/year (although significant regional variability still exists, for both advisor and operations staff jobs). In fact, the labor market for advisors is getting so competitive, that firms are being compelled to compete with more than just compensation alone, as employees increasingly demand that they want to feel more inspired, empowered, and energized when they go to work. In turn, this is also leading to the rise of more "creative" benefits as well; some firms are creating so-called "fun committees" (which have their own budget to plan fun events for employees, and/or to facilitate off-site get-togethers), while others are getting more generous with vacation time (even offering "unlimited" vacation time as long as employees behave responsibly and get otherwise are getting their work done), more generous family leave policies for new parents, and other perks like partially reimbursed gym memberships (but fully reimbursed if they go at least 3 times per week!), and extra days off for employees to volunteer for their favorite charities.
How To Compensate Partners To Keep Your Firm On Track (Kelli Cruz, Financial Planning) - Determining an appropriate compensation plan for employees can be difficult, but arguably determining an 'equitable' way to carve up compensation amongst partners of an advisory firm can be even more challenging, given the ever-evolving needs of the business and the partners who lead it and the strategic implications of choosing one partner compensation approach versus another... not to mention the fact that early on, partners usually just split "whatever is left" of the profits, and it's only after the firm grows that it becomes necessary to transition to a more "formal" partner compensation structure in the first place. Cruz suggests that partner compensation in most advisory firms should be comprised of several consistent components: 1) Base compensation, which is typically a salary based on the market rate for the partner's current role and responsibilities (which for partners, might be a blended salary based on blended roles such as 35% rainmaker, 40% relationship management, and 25% business management, plus additional responsibilities for "C-suite" roles); 2) Incentive compensation, which is variable and based on whether the partner meets or exceeds goals tied to key strategic initiatives of the firm (which is important, despite the fact that partners share in the firm's profits pool, because not all partners impact the bottom line in the same way, which risks leaving some partners feeling slighted relative to the contribution of others); and 3) Ownership distributions, which is the return on the owner's own investment in the business (but not for working in or on the business, as those elements are compensated by the base and incentive compensation). The essence of the approach, though, is simply to recognize that owner compensation plans need to define the role of the owners and the value of the jobs that they do in the business... to effectively separate the rewards for their labor, from their rewards of ownership (and recognize that as jobs and roles evolve, so too should the base and incentive components of compensation!).
High Turnover Creates Poor Performance (Mark Tibergien, Investment Advisor) - While all businesses have at least some level of annual employee turnover, high levels of turnover can trigger significant cynicism and distrust of leadership, impairing both the ability of the business to attract and retain good employees, and even spill over into distrust from clients (who themselves see the revolving door of talent and begin to question whether there's a deeper problem hidden from view). Tibergien suggests that firms with high turnover, who want to regain control of the problem, need to think about three key factors: 1) clearly define the nature of the work (which include clear job descriptions that include a definition of success in the role, which helps to create a clearer picture of what type of individual would perform well there); 2) clearly define the nature of the worker (i.e., what kind of person would be the best fit to the role... for instance, don't put a multi-tasker in a role that requires repetitive daily processes, or put a "people person" into a role where they don't get much interaction with colleagues or clients); and 3) clearly define the nature of the workplace (so you can at least be clear that if the firm is a fast-paced intense environment, people should only apply if they want to be in that kind of environment!). In addition, Tibergien suggests that it's important to clearly articulate your firm's Core Values, which help to define the culture of the firm, and ultimately become the criteria by which an employee may be terminated – as even those who otherwise have some "special gifts" that bring value to the firm will ultimately drag the team down if they don't fit the firm's culture and Core Values, too!
Stop With The Phony Slogans (Philip Palaveev, Financial Advisor) - As advisory firms grow, it becomes increasingly necessary to formalize not just what the firm does, but the firm's "Why" and Core Values. Yet unfortunately, in today's environment, such Why and Core Values statements often result in little more than phone empty slogans, exacerbated by the fact that they tend to use the same bland and broad-based words that are undifferentiated from any/every other firm that similar believes in values like "Excellence", "Passion", and "Care" for their clients. Accordingly, Palaveev suggests that firm owners should really push to tackle the tough questions in the business, and answer them with real focus – because ultimately, it's issues like "what will happen to the firm when the founders retire" and "how will we tackle our toughest competitive challenges" and "what gives us confidence that we will continue to grow and be successful" that really define where and how a firm is unique and differentiated from its competition. At the core, the key is that for visions and missions to be effective, they have to be genuine in authentically representing the views and vision of the founders/leaders of the business... and, ideally, provide a filter that helps to determine the right decision when the firm faces a difficult crossroads. In fact, Palaveev suggests that the best vision statements should be fairly concrete – not just a broad-based vision that is 50 years ahead, but something that the firm can truly, concretely pursue today. Similarly, firms should also be clear and concrete about their strategy as well – as David Maister famously wrote, most individuals know exactly what they need to do and change (e.g., to quit smoking or lose weight), but the real challenge is figuring out how to actually do it and ensure it gets done. The fundamental point: if you want your vision, mission, and strategy to really drive the firm, they need to be specific and clear enough to drive results, and not merely bland statements using popular/common words and slogans.
Are You Taking Too Much Cash Out Of Your RIA? (Brent Brodeski, Financial Planning) - While many financial advisors rightfully look at their advisory firm as their largest asset, often they treat it more like a bond (from which they extract steady cash flows) than a stock that is intended to grow with reinvestments. Or stated more simply, often financial advisors milk their business for personal cash flow for their lifestyle, instead of reinvesting into the business and its people, process, technology, and marketing and branding. Of course, such a strategy can produce a substantial cash flow coming out of the business for many years, but eventually results in an entity with relatively little residual value (and often reaches a point of growth stagnation several years prior). Which just makes the problem worse for those who do want to build enterprise value, as a stagnant or shrinking advisory business will struggle to attract good next-generation talent (nor next-generation clients), which just makes the attrition problem worse over time as clients age (and eventually pass away). For firms that want to sustainably grow and create enterprise value, Brodeski suggests that it's best to target 15% annual growth... which in turn means the firm should be spending 20% to 30% on non-advisor employees and 10% to 20% on non-owner advisors (to create opportunities for people who will hopefully eventually become your future partners/owners), 7% to 10% on technology, 4% to 7% on marketing and branding (to be able to sustain growth rates over time), and 2% to 3% on process improvement, in addition to the core compensation for the advisors themselves, all of which represent a reinvestment into future growth and generating operational leverage within the business. Of course, making these reinvestments will reduce the current profits in the business... but bear in mind that buyers ultimately value a business based on its future cash flow potential, which means reinvestments that drive growth in the future still create more enterprise value than "just" trying to run strong profit margins today. Which means at a minimum, if you do want to simply draw out a lot of cash from your advisory firm now, understand the trade-off it implies for limiting the business' future upside potential!
The Big Rethink (Dan Jamieson, Financial Advisor) - As a part of their annual 2018 ranking of all broker-dealers, Financial Advisor magazine interviewed a number of broker-dealer executives to get fresh perspective on the current landscape of (primarily independent) broker-dealers as they attempt to reinvent themselves as "full-bodied wealth management servicing firms" instead... or risk being compelled to sell out, or at least "tuck in" as a branch office of a larger broker-dealer in the future (one that has better scale to compete). And as DoL fiduciary transition costs fade into the background, more and more broker-dealers are now pausing to take a fresh look at what their future will be (as even if the DoL fiduciary rule itself goes away, the trend towards fiduciary advice is clearly here to stay). Because the shift in models not only threatens the transactional broker-dealer model in favor of a more relationship-based one, but also shifts the nature of what products and support services advisors want (as even broker-dealers are seeing a rapid rise in third-party managed accounts over reps who simply assemble and sell their own portfolio of investments), which may be further amplified as more and more insurance and investment product manufacturers roll out alternative lower-cost "advisory" versions of their products. At the same time, most of the largest broker-dealers are firmly focused on getting even larger, and trying to use their size and scale to keep down costs and stay competitive... which means broker-dealer consolidation is likely to continue in the coming years (for which LPL's acquisition of NPH may have just been an early example, and insurance-company-owner broker-dealers seem most likely to be spun off), even as independent broker-dealers also continue to recruit aggressively from the wirehouse channel (which in turn helps to explain why Morgan Stanley and UBS left the Broker Protocol late last year). The smaller broker-dealers that remain independent will likely be forced towards niches, serving particular subsets of advisors that need more specialized help in a particular model (e.g., HD Vest serving tax professionals). Although all firms large and small recognize that a significant technology gap has emerged between what most broker-dealers provide today, and what consumers want (and expect based on their experiences with other industries), which means technology reinvestment remains likely for all broker-dealers both large and small.
Beyond Payroll: What Makes Broker-Dealers Successful (Michael Brodeur, Investment News) - The latest J.D. Power Financial Advisor study finds that attrition risk is rising amongst advisors, as year-over-year advisor satisfaction in their own platforms continues to decline, and nearly 17% of employee advisers indicate an inclination to leave their (broker-dealer) firms... and even more ominous, it's the top-performing advisers who are the least satisfied! Brodeur suggests that while part of the challenges are beyond the control of any one firm in the industry, that broker-dealers themselves can help to manage this risk by learning to more effectively manage all their data, as their advisors are increasingly "inundated" by data but lack any way to access and manage it effectively (and consequently struggle to assemble a clear picture of their own advisory businesses), nor do most broker-dealers have very efficient systems to manage and support advisory business workflows (where new solutions are often ad-hoc and conflict with existing/legacy systems). In the meantime, field support for advisors has also attritioned at most broker-dealers, with limited mentoring or training and only low-quality (usually sponsor-driven) continuing education programs. Brodeur suggests that the best path forward is for broker-dealers to re-engineer the "commission calculator" tools of old into more comprehensive "compensation management solutions" that not only determine and track advisor compensation, but tie it directly to business intelligence for the advisor's firm (regarding both their advisors and their clients), while attaching workflows directly into the advisor dashboard, and then use those tools to not only track the success of their advisors, but to measure the ROI of various initiatives to see what actually drives and improves advisor satisfaction. Of course, it's worth noting that Brodeur is responsible for creating an "advisor compensation solution" at Broadridge... but that doesn't make the points about the gaps in today's broker-dealer compensation management systems any less salient!
As Planners Outgrow Their Roots, Hard Choices Lie Ahead For Broker-Dealers (Bob Veres, Financial Planning) - As financial planning increasingly shifts towards an advice-centric fiduciary world, product-based broker-dealers face important (and challenging) choices about their future business models. Notably, it was the rise of independent broker-dealers in the 1980s and 1990s which first gave advisors the flexibility to not just sell their companies' proprietary products of the day, but actually focus on advice and simply implement whatever their clients wanted and needed pursuant to a financial plan (given the greater breadth of product choice and flexibility under the independent B/D model). Yet with more and more advisory firms shifting to a relationship-based AUM model to deliver advice, while eschewing products altogether, the IBDs that helped to spawn the growth of the financial planning movement and now being made irrelevant by it – a situation that is only exacerbated by regulatory changes (e.g., the DoL fiduciary rule) that further hasten the transition. As is, the number of broker-dealers has fallen by nearly 1/3rd in the past 15 years (from 5,374 in 2002 to 3,835 last year), while the total number of broker-dealer reps has declined from 662,311 to 635,902. So where do broker-dealers go from here? Veres suggests two potential paths. The first is to increasingly emphasize fee business (as IBDs like Cambridge Investment Research and Commonwealth Financial Network have done), to the point that someday they may become the equivalent of a national roll-up RIA and secede from and eschew FINRA and the broker-dealer business altogether... dramatically reducing compliance costs in the process, with savings that could pass through to affiliated advisors, as the broker-dealer of the future "just" provides practice management advice, technology, education, and community. Alternatively, some broker-dealers may go back to their roots and refocus on being a "sales house" – a FINRA-affiliated haven for the reps who are determined to remain in sales, and continue to stock the shelves as long as they can and provide sales and marketing support for their reps (while compliance tries to keep the reps out of trouble), albeit while selling into what seems to be a declining overall share of the advisor marketplace (as the next generation of advisors increasingly want to be advisors from the start, and not salespeople). Of course, even these platform directions risk becoming commoditized over time, and Veres notes that ultimately firms pursuing either path will still have to decide how they differentiate themselves, especially in the decision about whether to build in-house technology or negotiate discounts on off-the-shelf solutions (which requires less overhead, but makes it easier for advisors to leave in the future).
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.
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