Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the big news that UBS has exited the Broker Protocol, just three weeks after Morgan Stanley... but not before spiking the ball at Merrill Lynch and recruiting away several big Merrill teams as they left, which may just accelerate Merrill Lynch's departure from the Protocol as the entire agreement unravels (to the detriment of both brokers and their clients).
Also in the news this week is the final and official announcement of the 18-month delay of the Department of Labor's fiduciary rule... which may kick off a new spate of lawsuits by fiduciary advocates aimed at halting the delay (to compel the rule to take effect at the beginning of 2018 after all), and a surprise withdrawal of support from the White House of the SEC's Administrative Law Judges, raising the possibility that the Supreme Court make take Ray Lucia's case and strike down the SEC's ability to appoint its own ALJs.
From there, we have several articles about life insurance, including a look at how life insurance companies are trying to develop new extension riders to avoid the otherwise taxable event of policyowners who reach age 100 (though it's not clear that they can do so under the tax code), the issues with "guaranteed" whole life and why many common whole life strategies are not actually fully guaranteed (even though old-fashioned traditional whole life was/is), and a primer on the concept of "Private Placement Life Insurance" (PPLI) as a strategy to use the tax-deferral wrapper of life insurance to minimize the tax drag on high-income alternative investments for high-net-worth investors.
We also have a few practice management articles, including: a look at the rise of "predatory buyers" of advisory firms, who often leverage the limited closed market of their broker-dealer or RIA custodian to persuade advisory firm owners to sell on less-than-ideal (valuation or tax) terms; a reminder that growing a billion dollar (of AUM) advisory firm will require founders to transition from "just" being advisors into actually being "leaders" of their advisory firms (which in practice is a very uncomfortable transition for many!); and a look at how automation tools can be used to better engage clients and prospects... because even though the advisor knows it may have been automated, as long as the client receives value, they likely won't care about how it was achieved!
We wrap up with three interesting articles, all around the theme of our rapidly changing world: the first is a fascinating in-depth look at the blockchain, the underlying technology that powers Bitcoin (and other cryptocurrencies), and why even if Bitcoin turns out to be a bubble or a fad, the blockchain technology itself is likely here to stay and could revolutionize a wide range of industries; the second explores the "dying art of disagreement", and the idea that democracies are founded on our ability to have productive discourse with those we disagree with (which has become increasingly challenging with the polarization of today's modern world); and the last raises the interesting question of whether the fiduciary debate has already be co-opted to the point that being a fiduciary is no longer a meaningful differentiator, and whether it's time for leading advisors to take up a new battle to push the envelope around concepts like "integrity" or "stewardship" instead.
Enjoy the "light" reading!
Weekend reading for December 2nd – 3rd:
UBS Exits Broker Protocol Following Morgan Stanley's Lead (Andrew Welsch, Financial Planning) - In the most widely anticipated "surprise" of the year, UBS revealed this Monday that it was leaving the Broker Protocol, a mere three weeks after Morgan Stanley made a similar blockbuster announcement. Notably, though, the change was actually filed last week - during Thanksgiving - but Broker Protocol administrator Bressler, Amery & Ross allegedly suppressed the news until this Monday, given UBS brokers just 5 days (until today, December 1st) to leave under the cover of the Broker Protocol (despite the fact that Protocol departures are normally supposed to be announced 2 weeks in advance). With UBS out as well, it's now widely viewed as a virtual fait accompli that Merrill Lynch will announce its own departure from the Broker Protocol by the end of the month, especially since UBS broke away multiple Merrill Lynch teams this week just as they announced they were leaving the Protocol (which is the wirehouse equivalent of spiking the ball right in the other team's face in the endzone!). And with major wirehouses leaving sequentially, it seems increasingly likely that the entire Broker Protocol will unravel, as while a subset of firms are calling for it to remain in place, they are notably all the firms that were already using the Protocol to take brokers away from wirehouses (and thus have a recruiting self-interest to see it remain). The end result is a prospect return to the "dark days" of broker breakaways before the Broker Protocol, where it was common to have Temporary Restraining Orders (TROs) and outright lawsuits flying, as wirehouses both sought to retain their brokers' clients, and to strike a fear of leaving into the other brokers that remained. In fact, this week already witnessed the first lawsuit that Morgan Stanley filed against a departing broker (who left shortly after the wirehouse left the Protocol), and once the broker was hit with a $750,000 lawsuit and a Temporary Restraining Order that would prevent him from contacting his (former) clients, his new firm fired him just one week into the job for the lack of revenue (given that he would be unable to bring any of his clients after the TRO)... which sends a chilling message to any other brokers considering whether to leave their wirehouse in a post-Protocol world. Of course, the reality is that brokers did leave wirehouses before the rise of the Broker Protocol, and at least some will continue to do so going forward; nonetheless, the reality is that the ins and outs of breaking away from a wirehouse just got a lot more complex in a post-Protocol world. And there's a risk that the Broker Protocol defections could soon spread to other regional and independent broker-dealers as well, particularly those who are already seeing broker outflows and may hope that stepping away from the Protocol will stem the tide.
Delay Of DoL Fiduciary Rule Enforcement Mechanisms Now Final (Mark Schoeff, Investment News) - Also in the news this week was the official, final announcement of the Department of Labor's 18-month delay to the full enforcement of its fiduciary rule and the Best Interests Contract Exemption, which is now scheduled to take effect on July 1st of 2019. Notably, though, the rule's Impartial Conduct Standards - that advisors serving retirement investors must give best interests advice, for reasonable compensation, while making no misleading statements - is in effect, and the DoL has indicated that it still expects good faith compliance with the rule, albeit without its most stringent components (the actual best interests contract that formally binds the advisor to legally accountable fiduciary advice). The real question, though, is what will happen during the 18-month interim period. The DoL is widely expected to issue a new streamlined exemption, similar to current one for Level Fee Fiduciaries, that may ease the transition for broker-dealers using so-called "Clean Shares". In addition, the DoL's delay is viewed as an industry tactic to allow time for the SEC to formulate its own coordinated fiduciary rule, which may or may not end out superseding the DoL's version. At the same time, though, the Consumer Federation of America has raised the concern that the DoL may not have fully complied with the Administrative Procedures Act in justifying the 18-month delay, and that there is ample case law to support judges overturning the action of a regulator that ignores a prior rulemaking process, portending the possibility that the CFA will file a lawsuit to formally seek to have the delay paused with a Temporary Restraining Order (which in turn would make the original January 1st, 2018 effective date official once again). Stay tuned for further news in the coming weeks?
Trump Administration Switches Sides on Challenge to SEC Judges (Greg Stohr, Bloomberg) - In a legal filing this week as a part of the case of Lucia v SEC, the White House administration declared that it would no longer defend a Federal Appeals Court decision that upheld the SEC's use of in-house Administrative Law Judges, stating that the judges should be treated as "officers" (rather than "employees), which would make them subject to constitutional requirements for how they can be appointed. The announcement raises the possibility that the Supreme Court will take up the issue, to evaluate whether the SEC should be permitted to continue appointing its own internal administrative law judges, in what many have alleged is an opaque process and one that makes the SEC's internal judges unduly beholden to (i.e., more likely to rule in favor of) the SEC. In other words, if the White House stepping back from defending the SEC's administrative law judges ultimately leads the Supreme Court to rule against the SEC, advisors who are defending themselves from the SEC may have better options to defend themselves against future SEC actions by judges viewed as being more neutrally appointed and selected.
The Age 100 Problem: An Update (Joseph Belth) - One of the ironic challenges of increasing life expectancies is the fact that more and more people are "outliving" their permanent life insurance policies, as historically most permanent life insurance was actually designed to mature (i.e., pay out its death benefit as a living lump sum endowment) at age 100 (or often age 96 for policies purchased in the mid-1900s), and it's only since 2001 that life insurance policies had mortality tables that extended to age 121. The problem with the age-100 maturity issue is not merely that the insurance death benefit pays out as a living benefit, though, but the fact that the payout is fully taxable as ordinary income (to the extent it exceeds premiums paid), as only a death benefit actually paid as a result of death is tax-free under IRC Section 101. Consequently, in recent years lawsuits have begun to appear against life insurance companies - most recently, the Lebbin case against Transamerica - alleging that the insurers misrepresented their coverage as "permanent" for the "whole life" of the insured, when in fact it becomes taxable at age 100 (causing financial damages to the policyowner in the amount of taxes paid). Accordingly, Belth notes that some insurers (most recently, Lincoln National) are beginning to contact policyowners in the months before they turn age 100 and offering them the opportunity to extend the policy. However, not only is not unclear whether all insurers will offer such extensions, but given that the original contract explicitly stipulated maturity at a specified age (e.g., age 96, or age 100), it's technically unclear whether insurers even can offer extensions now (years or decades after the original sale of the policy) to avoid the unfavorable tax consequences for the policyowner.
The Truth Behind Whole Life Premiums (Bill Boersma, Wealth Management) - With the steady multi-decade decline in interest rates, policies sold years ago when rates were much higher (e.g., in the 1980s and 1990s) are now facing surprise or even "skyrocketing" premiums, primarily universal life policies where the original premiums were based on an assumption of certain interest (i.e., growth) rates that didn't actually occur as rates declined. As a result, some have advocated for a resurgence of good old-fashioned traditional "whole life" policies, given their premiums that are guaranteed for life. However, Boersma points out that not all whole life policies are as secure as their guarantees may imply. The early days of traditional whole life policies really were guaranteed, with "no moving parts" associated with the policy - so simple that a life insurance agent could (literally) pull out a rate book and a slide rule to calculate premiums and guaranteed cash value in any future year. However, in today's world, it's not uncommon to sell "blended" whole life that includes a component of term insurance; the good news is that it can bring down the cost of the premium (and also favorably reduces the cost of commissions to the consumer), but the bad news is that it introduces a crucial non-guaranteed element to the policy. The typical plan is that over time, dividends from the whole life policy will be used to buy paid-up insurance that replaces the term coverage, such that at some point down the road, the policy really will be a purely guaranteed whole life policy. But that also introduces the risk that, if dividends do not perform as projected, the policy may never become fully guaranteed. Similarly, some insurance agents have sold whole life policy as a form of "vanishing premium" policy, where the future dividends were expected to fully replace the premium (thus "vanishing" the premium), yet in practice this has often not turned out, given the collapse of interest rates as Whole Life policies crediting 11% to 13% back in the 1980s may "only" be crediting 5% today. And in some cases, the problem is only compounded by the fact that, because whole life policies have required premiums, if the premium isn't actually paid, and it turns out the dividend is insufficient, an Automatic Loan Provision (APL) will borrow the premium to pay it, which in turn can lead to life insurance loans that spiral out of control in the later years. The key point: traditional old-fashioned whole life insurance really is as guaranteed as they say it is, but the common use of non-guaranteed dividends to support premiums or replace the term of a blended policy means that whole life policies in practice may be much less guaranteed than their name implies (which means, at a minimum, that ongoing monitoring is crucial, even for a "guaranteed" insurance policy!).
Private Placement Life Insurance: A Primer (Steven Zeiger & William Waxman, Investment News) - With the rise of High Net Worth (HNW) "alternative" investments like direct lending, private equity credit, and mezzanine funds, has come the adverse tax consequences of these strategies: that they are typically taxed at ordinary income rates, which for HNW investors can be a top tax rate of 39.6%, plus the 3.8% Medicare surtax, plus state income taxes on top. As a result, some advisors for HNW clients are wrapping these kinds of alternative investment strategies inside of the tax-deferral wrapper of life insurance - but structured as a "private placement" policy, that allows the HNW investor more control over how the dollars are invested (to ensure they're placed into the desired alternative strategies). Notably, Private Placement Life Insurance (PPLI) is still designed to be life insurance, but is treated as an unregistered securities product (as opposed to traditional retail variable life insurance policies that are registered) that is only available to accredited investors or qualified purchasers. However, the close connection between the investor and the sponsoring life insurance company allows significant latitude in how it is designed, typically including the smallest possible death benefit (to minimize cost-of-insurance charges in what is intended to be an investment-first vehicle), no surrender charges, and ultra-low net interest rate charges for policy loans. In addition, some insurance companies will sign agreements with the advisory firm directly to be a sub-advisor to the policy, effectively allowing the advisory firm to be paid to manage the cash value inside the PPLI policy. Because there are significant fixed setup costs just to establish a PPLI policy, it is typically only appealing for ultra high net worth investors (e.g., those with $25M+ of net worth), but for those who have the capital to put into the policy, the tax-efficient compounding of high-return alternative strategies can be very appealing, especially given the tax drag that applies to HNW investors.
Runaway Advisor CEOs: The Billion-Dollar Question (Angie Herbers, Investment Advisor) - As advisory firm owners approach $2M of revenue, they reach a fundamental crossroads: going forward, does the advisor want to be an advisor, or become the CEO of their advisory firm. Because as Herbers notes, being the CEO of a $2M+ revenue firm is a substantively different job than being a financial advisor... and in fact, some advisory firm founders don't enjoy the job once they transition to it, as the CEO role is not so much a "doing" job as one of being strategic in figuring out what all the other employees should be doing (a tough transition for founders who are often "doers" themselves)! Nonetheless, the reality is that if the firm wants to continue the long climb from $2M of revenue to $10M of revenue and become a "billion dollar" firm (i.e., $1B+ of AUM), someone must lead the firm, and Herbers suggests that if even if the founder doesn't want to be the CEO, he/she still needs to be prepared to change his/her relationship with the firm if someone else is going to take on that leadership role. Accordingly, Herbers offers several tips for advisory firm owners to prepare themselves for the path to $1B of AUM and the transition to leadership, including: 1) be prepared for a tough mental transition from advisor to leader; 2) be prepared to step up to the leadership job, and don't run away from it (as tempting as it may be to go back to client work, or play more golf with your newfound flexibility... again, someone must be the leader of the firm!); 3) recognize that the new CEO job is going to be bigger and more complex than the prior job was (as the firm itself gets larger and more complex), which will demand a new focus; 4) understand that "what got you here isn't going to take you there", meaning the nature of what you do, and how you lead, will likely have to change, even if you've already been a successful leader up to this point; 5) realize that the nature of your relationship with your business will change, as it both demands more time, and forces you to make harder decisions (from expensive reinvestments in growth, to the potential need to fire unproductive employees for the sake of the business); 6) remember that you can't do it alone, and building a team around you is essential; and 7) don't forget that it's important to maintain your own social life, and don't get completely sucked into the new demands of the business!
Can Client Engagement Be Automated? (Julie Littlechild, Absolute Engagement) - The generally prevailing view amongst financial advisors is that the key to engaging clients and prospects is personalized one-to-one service and communication; in other words, not using any kind of tools to automate communication with clients or prospects. Yet Littlechild points out that if your client receives an article from you that is of interest (perhaps pertaining to some relevant hobby of the client's), then the client will likely appreciate it... regardless of whether the advisor hand-picked the communication, or whether a piece of technology automatically identified the client interest, notified the advisor, and then sent the article. In other words, the advisor may know that automation was involved, but the client simply sees relevant content, from the advisor, that deepens the connectedness of the advisor-client relationship. And in fact, there are now several platforms in the advisor space that offer this kind of service (albeit with different business models), including AdvisorStream, Grapevine6, and Vestorly. Because the real key to the value is not whether the advisor truly "hand-picked" and manually emailed the article to the client or prospect; what matters is that the article is actually relevant, that it maintains the advisor's brand, and that it includes a mixture of third-party and first-party content that actually demonstrates the advisor's own expertise. The caveat, however, is that "full" automation does rely on the ability of software to identify what will be relevant for your clients, which means you may still want to at least review final content selections before they go out to clients. Or alternatively, segment (or use software to help segment) your clients into relevant groups, and send common articles to client or prospect groups with a common need (to ensure the content will be relevant to them, while being efficient for the advisor).
Blockchains: How They Work And Why They'll Change The World (Morgen Peck, IEEE Spectrum) - With the explosive buzz (and outright explosive price) of Bitcoin in recent weeks, the discussion of cryptocurrencies has gone mainstream, with people lining up on either side to call Bitcoin the future of currency or a bubble that's soon to pop. But to a large extent, the debate over Bitcoin misses the underlying point, which is that Bitcoin is just one particular (albeit the largest and most popular) digital currency for what is really revolution technology underlying it: the blockchain, which can potentially be applied to a wide range of problems beyond just digital currencies. The basic principle is to recognize that cash "works" because physical currency is hard to replicate (i.e., hard to counterfeit), which means it's reasonably safe to assume that whoever has the currency owns the right to use it. However, if you created a system that could perfectly account for who held the money at any particular time, then in theory you wouldn't actually need the cash anymore... just the running ledger of who had the money last. Blockchain is that universally accessible digital ledger - dubbed a "chain" because changes can only be made by adding new information to the end, which ensures the historical transaction record is maintained (which is further replicated across networked computers around the globe, to ensure that no one hijacks and fakes new records in the blockchain). The significance of this structure is that it means there's no central authority required to enforce the rules, because the structure of the blockchain makes it prohibitively expensive (in terms of computing power and electricity) to change prior links in the chain. But the efficacy of the blockchain structure isn't just for maintaining a transaction ledger of digital currency as it changes hands; newer cryptocurrencies, like Ethereum, attaches "smart contracts" to its blockchain - miniprograms that can be triggered to execute under certain conditions, essentially turning any form of software into a decentralized blockchain executing commands. For those distrusting of institutions, the idea of decentralized blockchains is highly appealing, though the challenge is that the lack of a central power also permits anonymity (which may be appealing in some cases, but also supports illicit behavior), and prevents anyone from being accountable if something goes wrong. As a result, newer iterations of the blockchain are exploring a form of "permissioned" ledger, where identities are known, but only by select parties (e.g., banks or governments). And others are trying to figure out how to stack more smart-contract capabilities into the blockchain (without making it computationally unwieldy). Nonetheless, the fundamental point is that regardless of whether Bitcoin itself is the future or not - and regardless of whether its current value is justified or not - the underlying blockchain it's built upon may still be utterly transformative of how everything from banking and currencies, to other technology tools, operate in the future.
The Dying Art Of Disagreement (Bret Stephens, New York Times) - In recent years, it has become increasingly common for "controversial" speakers to be disinvited from speaking at university campuses, including both "genuinely" controversial individuals, and also simply those who may be of a differing political party or view (liberal or conservative), regardless of how illustrious and bona fide their credentials may be. As Stephens notes, this tendency to disinvite those with opposing views, and avoid moments of disagreement, has the risk to fundamentally undermine democratic society itself. Because while having a commonality of agreement is essential for most communities, having disagreement is also essential to defining our freedom and individuality, to expand our perspective, energize us, and make our democracy real. The irony, of course, is that we seem to be disagreement more than ever in recent years, from racial issues to health care laws, to the President of the United States and even bathroom policies, and surveys have shown a clear trend that both Republicans and Democrats are more right- and left-leaning (respectively) than they were 20 years ago, to the point that interparty marriage has taken the place of interracial marriage as a family taboo. Stephens suggests that the root cause of this is a shift in educational policy. In the past, we were more supportive of the "liberal arts" education, and the idea that it's important to teach people critical thinking and discourse, having them read the "great books" (of multiple philosophies) to better understand the human condition, and the simple fact that "every great idea is really just a spectacular disagreement with some other great idea". The distinction, however, is that the debates of the great thinkers, from philosophy to politics, were never based on a misunderstanding, but always from consistent comprehension of a common set of facts and a clear understanding of the points of the other side (in order to debate them properly). Yet on campuses today, Stephens highlights a world where the majority of students think it is "acceptable" to shout down a speaker with whom they disagree, and an astonishing 20% think it's acceptable to use violence to prevent a speaker from speaking. So what's the solution? Stephens suggests that in the modern world, the challenge is that we rarely actually connect with our "opponents" anymore, seeing them eye-to-eye and trying to find middle ground; instead, we fight digitally and virtually, from separate islands of ideology where we mostly just hear echoes of ourselves. As a journalist, Stephens recommends that the starting point be journalists themselves, fulfilling their ideal roles as the ones who clarify the terms of debate and champion aggressive and objective news reporting in an effort to improve the quality of debate. Though the underlying point is that journalism is grounded in a consistent set of facts, even while some may (respectfully) disagree about what conclusions to draw from those facts - an approach that arguably we need more of across society these days.
It's Time For RIAs To Shift The 'Fiduciary' Debate And Make It About 'Integrity' (Brooke Southall, RIABiz) - As the industry increasingly fights about the potential scope of a uniform fiduciary standard for RIAs and broker-dealers, and what exactly a fiduciary duty should require (or not) based on the letter or spirit of a rules-based or principles-based law, Southall suggests that the fact we're comparing one channel's fiduciary duties to another already means that the differentiating nature of being a fiduciary has passed. In other words, it was one thing when RIAs were fiduciaries and the rest of the world was not; now, RIAs are trying to score points on fiduciary technicalities, a battle for which they are grossly outnumbered (and outlobbied), and for which consumers may never fully appreciate the distinctions anyway (just as few consumers today understand the differences between suitability and fiduciary). So what's the alternative? To find a new, "higher kite to fly" than the fiduciary duty - a new, higher standard that the vanguard of financial professionals can rally around. Southall suggests that since ultimately, it's really meant to be about the spirit of the fiduciary rules (not the letter of the law), that in the end the true measure is the character and integrity of the advisor themselves, and that therefore "integrity" should be the new battleground. (Similarly, fiduciary pioneer Don Trone has suggested that "stewardship" should be the new battleground term.) And notably, if the shift of the current debate, and the muddying of fiduciary definitions, doesn't force the issue, then Southall notes that the non-fiduciary side may only become more desperate in the next few years, as RIAs are projected to surpass the total assets of wirehouses within a decade, which may just make non-fiduciary firms even more desperate to conform to the fiduciary standard themselves, or push even harder to redraw the lines.
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.
I really enjoy the updates on the RIA business. Thank you, Michael!