Weekend Reading for Financial Planners (Aug 19-20)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

Weekend reading for August 19th/20th:

LPL’s Big National Planning Holdings Buy Is A High-Stakes Bet (Tobias Salinger, Financial Planning) - This week, LPL Financial announced a blockbuster deal to buy National Planning Holdings from its parent company Jackson National Life, including all four of its subsidiary broker-dealers National Planning Corporation, Invest Financial, SII Investments, and Investment Centers of America. The total acquisition would add 3,200 advisors to LPL's existing headcount of more than 14,000 advisors, which would allow it to surpass Morgan Stanley's 15,777 advisors and become the largest broker-dealer in the country. The purchase price of NPH was a whopping $325M (as long as NPH retention is at least 72%), plus up to another $123M on top in contingent payments if at least 93.5% of production transfers over, though notably NPH broker-dealers had a total of more than $900M in revenue last year (and about $120B of total AUM), which means the broker-dealers were collectively purchased for a mere 0.5X revenue (in a world where independent RIAs sell for nearly 2X revenue!). For LPL, though, the opportunity is not merely to grow its advisor headcount and revenue by about 20% (as NPH is a little over 1/5th the size of LPL), but to potentially convert NPH into a more profitable business, given that most NPH broker-dealers used Pershing as a third party for custody and clearing, but LPL's self-clearing platform introduces new back-end possibility for broker-dealer revenue generation (particularly if NPH brokers increasingly shift to fee-based accounts as LPL reps have in recent years, as LPL has 45% of assets in advisory accounts, compared to only 25% at NPH). Of course, this is still contingent on NPH brokers actually coming over to LPL, but the process should be expedited by a straightforward large-scale negative consent process that is typical of broker-dealer acquisitions (without any need to re-paper accounts), and LPL may be able to offer a wider range of capabilities and better payouts to NPH reps, in addition to LPL reportedly setting aside another $100M to offer forgivable loans as retention deals for key NPH advisors as well. From the broader industry perspective, though, the notability of the acquisition is not just that LPL was interested in buying and becoming the largest broker-dealer in the country, but that NPH's parent company Jackson National was interested in selling, in what was rumored to be a spin-off of the broker-dealer division as a part of an emerging trend of insurance companies shedding their subsidiary broker-dealers to avoid conflicts with the Department of Labor's fiduciary rule (as MetLife and AIG engaged in similar spin-off sales of their broker-dealers in 2016 as well).

Kestra Financial Acquires 600-Rep H. Beck (Bruce Kelly, Investment News) - Continuing the theme of broker-dealer acquisitions, this month also witnessed the announced acquisition of H. Beck Securities by Kestra Financial (formerly NFP Advisor Services). The 600-rep H. Beck was previously owned by Securian Financial Group (which also owns insurers Securian Life and Minnesota Life), and the transaction represents yet another instance of an insurance company selling off its subsidiary broker-dealer in the face of the DoL fiduciary rule (and given the very limited profitability of the subsidiary broker-dealer model, compared to the superior margins of their insurance parent companies). The terms of the deal were not disclosed, but Kestra Financial produced $423M in total revenue last year, as contrasted with $110M in revenue from H. Beck, which means similar to the LPL-NPH deal, the acquisition will boost Kestra's size by about 20% - 25% or so (and also similar to the LPL-NPH deal, Kestra will likely try to convert H. Beck's small fee-based business of just $2.4B in advisory assets into a larger revenue stream (as Kestra has $16B in advisory assets). For the time being, H. Beck will continue to operate under its own name and remain an autonomous entity, and for the time being H. Beck's clearing relationship will remain in place with Pershing (and not switch to Fidelity's National Financial Services, where Kestra clears), though H. Beck President Loyall Wilson is retiring and the search for a new President is underway.

$7.7B IBD Joins Cetera Advisor Networks In 'New Era' For Sector (Tobias Salinger) - Girard Securities was a subsidiary independent broker-dealer under the Cetera Advisor Network, but this week announced that it would be shutting down as an independent B/D, and instead fold itself into Cetera's own parent-company broker-dealer and become the equivalent of a super-OSJ instead. As a part of the shift, Girard Securities itself will be renamed to the "Girard Region", with Girard's CEO becoming the regional director of the new OSJ, though the rest of Girard's broker-dealer operations staff will likely be consolidated into Cetera. The upside of the shift for the $7.7B broker-dealer is that it will no longer be fully responsible for its own compliance and technology, and instead can better leverage the substantial investments that Cetera is making into its own new Advice Architect platform, and is part of an ongoing trend of Cetera slowly converting many of its subsidiary broker-dealers into OSJ regions (including J.P. Turner in 2015, VSR Group and ICC Capital in 2016, and HBW earlier this year). More broadly, though, the conversion of the broker-dealer subsidiary to an OSJ is part of the even larger consolidation underway amongst independent broker-dealers right now, as everything from the looming impact of DoL fiduciary, changes to the economics of the broker-dealer model, and the fact that the overall broker-dealer ecosystem is facing a net decline in revenue puts more and more pressure on finding better economies of scale and eliminating the 'redundancies' of being a standalone broker-dealer subsidiary entity.

August 2017 SEC RIsk Alert Outlines RIA Cybersecurity Best Practices (RIA In A Box) - Back in 2015, the SEC conducted a Cybersecurity exam sweep and announced a series of potential cybersecurity concerns for broker-dealers and investment advisers, later in 2015 the SEC announced a second Cybersecurity initiative coming in 2016 as part of its examination priorities. And now, the SEC's Office of Compliance Inspections and Examinations (OCIE) has announced a new round of cybersecurity observations as a part of its latest round of exams, highlighting what it continues to see as ongoing issues and concerns after focusing on everything from governance and risk assessment to access rights and controls, data loss prevention, vendor management, cybersecurity training, and firms' preparedness for an incident response. The good news is that the SEC observed that all broker-dealers and funds (and "nearly all" investment advisers) now have written policies and procedures for cybersecurity when it comes to the protection of customer records. However, the SEC noted that while many firms are hiring experts to help conduct penetration tests or vulnerability scans on their systems, those firms aren't necessarily making all the changes necessary to actually remediate the concerns once identified; similarly, most firms had a standard policies for "the installation of software patches to address security vulnerabilities", yet some firms didn't actually have all their software security patches installed! More generally, the primary concerns of the examiners were that cybersecurity policies and procedures were not reasonably tailored to the needs of the firm (i.e., the advisory firm had simply obtained a templated "cybersecurity policies and procedures manual" and not actually adapted it to their firm!), or that the firms were not actually executing all of the policies and procedures listed in their cybersecurity manual (e.g., not actually implementing software patches, not actually conducting annual cybersecurity reviews, not actually executing their planned cybersecurity training, etc.). In other words, it's not enough to just have cybersecurity policies and procedures... firms need to actually put processes in place to execute them as written, if they want to pass muster with SEC examiners!

Advisers Get More Breathing Room To Make Form ADV Changes (Mark Schoeff, Investment News) - Last year, the SEC finalized Advisers Act Release No. 4509, which introduced new requirements on Form ADV for investment advisers to begin reporting everything from additional details on their separately managed accounts and wrap-fee programs, to new filings about the firm's social media accounts, whether the firm uses an outsourced Chief Compliance Officer, and details about (a larger RIA's) branch offices. And while the new reporting details must be included when firms do their annual ADV updates in early 2018, a new Investment Management Information Update, from the SEC clarifies that RIAs will have some relief if they are filing other-than-annual amendment updates to their ADVs between now and then. Specifically, in situations where the RIA is updating its form ADV (before its next annual update, such as to file updated amendments to an existing Form ADV Part 2 brochure), the firm will not be required to report regulatory AUM of separately managed accounts and wrap fees under the new Item 5 (and related Schedule D sections), and instead can simply enter "0" as a placeholder in those sections of the form. The "good" news of the reporting relief is that for firms making intra-year Form ADV updates, they won't need to go back and retroactively calculate the required reporting amounts for last year, although the reporting will still be required for all firms updating their Form ADVs during the annual update process in the first quarter of 2018, and all of the other ADV updates (e.g., for social media accounts, branch offices, etc.) must still be added to Form ADV for any intra-year updates made after October 1st (when the new rules formally take effect).

Regulatory Considerations When Bringing On A New [Experienced] Advisor (Chris Stanley, Beach Street Legal) - As advisory firms grow, they hire staff, but the legal and compliance ramifications of hiring administrative and operational staff are not the same as the dynamics when a firm actually hires a second/new advisor for the first time. First and foremost, Stanley suggests that part of an advisory firm's due diligence process should be checking out the existing advisor's own regulatory disclosure history, which can be looked up on the Investment Adviser Public Disclosure (IAPD) website using either the advisor's name or his/her CRD number – which is important not only to spot any potential red flags before hiring, but also in recognizing that once hired, an individual with regulatory disclosures is now going to be affiliated with your advisory firm (and in fact must explicitly be disclosed on your Form ADV Part 1, Item 11). Another point of due diligence is checking out the advisor's prior Form U5 – the termination form filed by his/her prior firm – to see if the advisor's departure was voluntary or not. It's also important to recognize that because there is no substantive regulation of the terms that financial advisors use, there's also a possibility that the person you're hiring who's already a "financial advisor" doesn't actually have a Series 65 license, which means they can't even work as an adviser in an RIA until they pass the exam (and/or unless they can waive out of it in your state by having CFP certification instead). Assuming the advisor is properly licensed and eligible to become an Investment Adviser Representative (IAR) of your RIA, the next step is to file Form U4 through the Investment Adviser Registration Depository (IARD), which effectively "links" the advisor (and his/her CRD number) to your RIA business (and it's also necessary to register or file notice for the advisor in any states where there is a de minimis number of clients). Beyond the registration process, other important points to consider when hiring a new advisor include: will the advisor be treated as a W-2 employee or a 1099 independent contractor (in general, factors that weigh towards employee status include if the advisor is required to work certain hours, from a certain location, using prescribed methods, and whether the firm reimburses the advisor's business expenses and provides a benefits package); update the Form ADV Part 2B Supplement to note the new advisor (who is now a new "supervised person"); add the advisor to Form ADV Part 1 Schedule A if he/she will control 5%-or-more of the advisory business; and be certain the new advisor receives a copy of your internal compliance policies and procedures manual (and a training on the key points!). And don't forget to update your business E&O insurance for the new advisor (which often requires additional paperwork to add the advisor, even if the firm already has an existing E&O policy!).

Custodians Are Charting FinTech's Future (Liz Skinner, Investment News) - As the growth of the RIA custody business drives down trading and other platform costs, custodians themselves are increasingly compelled to compete on the merits of their platform technology (instead of pricing and execution alone). Accordingly, the big four RIA custodians – Schwab, Fidelity, TD Ameritrade, and Pershing Advisor Solutions – are leading a form of technology arms race against each other, in an attempt to compete for RIA business, and in the process are spurring forth the development of advisor FinTech solutions. And given the risks that startups may go out of business, an increasing number of advisors are looking to RIA custodians to provide the technology directly, or at least to select their integration partners (and therefore be responsible for conducting basic due diligence on the viability of the company as a prospective partner to the firm). Beyond simply increasing the number of integrations for existing advisor technology tools, Skinner highlights how several RIA custodians are aiming to add in "new" technology solutions to the advisor stack as well; for instance, TD Ameritrade is looking at rolling out "chatbots" that advisors can interact with directly to quickly expedite basic tasks and requests, Pershing is partnering with IBM's Watson Client Insights to obtain predictive analytics tools (e.g., software that might identify in advance client behaviors that suggest the client is about to leave and is shopping for a new advisor), and Schwab is making a substantial push to expand and automate its digital check-deposit tool and facilitate electronic authorization software for client wire requests. Other notable highlights include: About 800 advisors have signed up to use Schwab's Intelligent Institutional Portfolios (its "robo-advisor-for-advisors" solution) since it rolled out 2 years ago; and Fidelity is deepening its integrations with eMoney Advisor since acquiring the company in 2015, to weave together the custody, asset management, and financial planning aspects of the advisor-client interaction, and later this year is rolling out its own robo-advisor-for-advisors called Automated Managed Portfolio (or AMP), with pilot testing underway now.

Quick Takes: An Update On Capitect (Joel Bruckenstein, T3 Tech Hub) - Capitect launched several years ago as a standalone investment portal for clients, which used Yodlee account aggregation to show account balances, performance, and automatic categorization of asset allocation using Morningstar data (along with a vault for storing client reports). In the past year, though, Capitect's capabilities have expanded further; the solution now has its own performance reporting engine to calculate returns (at the account, client, or household level), and is working on building its own rebalancing engine to help with trading (initially for just account-level rebalancing, with a plan to eventually offer automated tax optimization and asset location, similar to other rebalancing software). Capitect also makes it easy to create and illustrate model portfolios for clients, including using sliders to adjust the risk exposure of the model to the client's risk tolerance, or to otherwise dial up or down certain customized segments of the portfolio and have the rest of the model adjust automatically (producing a final target model that will eventually integrate directly to the planned rebalancing software capabilities). The software also includes the ability to design customized glidepath models for clients, and/or to set guardrails to limit the maximum variation of the models (akin to tolerance-band-based rebalancing).

How Folio Forged A 'Connexion' Between Advisors And Robos (Christopher Robbins, Financial Advisor) - Folio Institutional is a niche RIA custodian known for its tech-savvy, and in 2014 it launched its "Advisor Connexion" (AcX) platform, intended to be a "robo-advisor-for-advisors" type of white-labeled solution for its advisors. After all, simplified onboarding and account opening isn't really a value proposition unique to pure robo-advisors; it's equally relevant for human advisors who want to make their businesses more efficient as well, and today AcX helps with everything from digital onboarding, to easing the process of customizing and managing model portfolios. As a solution built for advisors, though, the system is designed to be more modular for advisors to use what they want; thus, for instance, the advisor might use AcX for digital onboarding, but use their own risk tolerance questionnaire, instead of being "required" to use the robo-provided one. In fact, the ability to customize Folio AcX through its APIs means not only is the solution being integrated by several dozen independent RIAs, but is also being used for several direct-to-consumer "robo" solutions, including Sallie Krawcheck's Ellevest, Pacific Life's Swell Investing, and Invest Forward.

What One Company Learned From Forcing Employees To Use Their Vacation Time (Neil Pasricha & Shashank Nigam, Harvard Business Review) - For busy employees, one of the biggest moments of burnout can come in the week after a vacation, and the mountain load of work that can accumulate while someone is out on vacation... and for many, it's so stressful that many employees don't even want to use their vacation in the first place. It's so problematic that even companies with "open" (unlimited) vacation policies don't end up seeing employees take any more vacation! Yet the lack of taking vacations doesn't appear to be any better; instead, most businesses end up simply struggling instead with employees that end up using more sick leave, disability leave, or in some cases "stress leaves" instead. So what's the alternative? To actually create a recurring, scheduled, mandatory vacation approach – which at least one recent study shows might be even more effective. For instance, one firm requires employees to take off one year every seven years, a form of forced sabbatical that, because it is known and planned well in advance, can be managed to navigate what otherwise are the workload "constraints" of taking vacation. More simply, though, firms might simply require people to take some time off every seven weeks, which another company tried and found was a boost to employee creativity, productivity, and happiness. Ultimately, the once-per-seven-weeks schedule might not be the optimal for every business (and even in this experiment, some employees suggested it was a little too frequent), but the fundamental point is that for vacations to really "work", firms have to create the structure and space for them to really function as they're intended!

The Scientific Reason Why 2-Week Vacations Are Actually A Waste (Chris Weller, Business Insider) - While in theory, vacations can make us happy, and longer vacations give us more time to be more happy, in practice research shows that a two-week vacation doesn't make us twice as happy, or even consistently give us twice as many good memories, as simply taking a one-week vacation. Ironically, we tend to think the longer vacation will make us happier, and that our "experiencing self" will get to enjoy it more, but in the long run it's our "remembering self" that actually reflects back on the vacation and brings us subsequent happiness and fond memories... and it turns out one week is more than enough to provide the happy memories, as our brains usually only remember what's novel and new, and by the second week of a 2-week vacation, there's usually not much new to leave additional impressions. Especially compared to the additional new memories that created by taking two one-week independent vacations instead!

How To Have A Great Vacation: 6 Secrets Backed By Research (Eric Barker, Barking Up The Wrong Tree) - One of the reasons vacations "work" as a means of bringing us happiness is that they're personal experiences, and ultimately we derive more happiness from spending money on experiences than we do just spending money on "stuff". The caveat, though, is that because experiences are so much more memorable, bad experiences can leave us with especially bad memories as well! Which means it's not just about having vacation experiences, but making sure they're good ones! So how best to maximize the vacation experience? Barker offers 6 suggestions: 1) Book the trip as early as possible, to build the anticipation (as it turns out more anticipation actually elevates how much we enjoy the vacation itself!); 2) Remember to plan the trip around your personality and what you like to do, and don't just overschedule events or overly focus on getting "value" even if it's not what you really like; 3) Have a structured schedule, even if the "structure" includes allotments for free time, because it turns out that the frequency of enjoyable activities beats the intensity (which means multiple fun things beats a long time at just one fun thing); 4) Savor the experience by finding ways to stay in the moment (which means trying to unplug, at least for some of the time!); 5) Use the "Peak-End" rule, recognizing that what we remember most tends to be what comes at the end (so schedule your most fun and enjoyable items at the end, so they're the last fond memories you leave with!); and 6) Ease back into work, rather than just scheduling yourself to plunge right back in full steam (which can just amplify the stress of the transition, and turn that negative finale into your "peak-end" experience!).

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.