Weekend Reading For Financial Planners (December 2-3)

Case Questioning The Constitutionality Of SEC's Internal Judges Hits Supreme Court This Week

(Matthew Sellers | InvestmentNews)

When a person in the U.S. is charged with violating the law, they generally have the constitutional right to a jury trial. But in SEC cases involving violations of securities regulations, what often happens in practice is that the case is heard by an in-house Administrative Law Judge (ALJ), who ultimately rules on the case themselves (although an ALJ's rulings can be subsequently appealed within the traditional Federal judicial system).

However, a case being heard by the Supreme Court this week, SEC v. Jarkesy, challenges the SEC's use of ALJs on the grounds of infringing on the constitutional right to a jury trial. But while that point is significant enough on its own – since moving all SEC-related cases into the regular court system rather than its in-house arrangement could result in less favorable rulings, and potentially fewer cases overall, for the SEC – another argument being made in the case has the potential to significantly increase the scope of the court's ruling beyond just the use of ALJ's.

That's because the appellants in this case are arguing that the SEC's practice of deciding whether or not to use in-house ALJs was unconstitutional because Congress didn't specifically authorize the SEC to make that decision. Which if interpreted sufficiently broadly, could call into question broad swathes of regulations and practices created by government agencies to fill in gaps where Congress was insufficiently specific about how to carry out laws. Put another way, in the purest version of this argument, if Congress passed a law directing the SEC to carry out a certain policy but didn't give it specific guidelines on how to carry it out (which is essentially what it did in passing the Dodd-Frank Act in 2008 that authorized the use of ALJs but didn't specify when they could be used), the agency would simply need to wait for Congress to act to provide further guidance, rather than rely on their own interpretation of the law – which would reverse decades of established practice on rulemaking by government agencies.

Although it seems unlikely that the Court will rule that broadly against government agencies' ability to make regulations, the implications – not only for the SEC but also other agencies like the IRS and Social Security Administration – make the outcome of SEC vs. Jarkesy worth paying attention to.

New DOL Fiduciary Rule Could Rein In Use of Advisor-Like Titles

(Melanie Waddell | ThinkAdvisor)

A title can be a straightforward description of what someone does (i.e., musician, carpenter, or pilot), but it can also be something a person uses to frame how they want people to understand what they do or offer. In the financial industry, which often involves making decisions over significant portions of a client's life savings, titles can be a powerful tool to convey the nature of a professional’s services: Consumers formulate very different expectations depending on whether you say you are a retirement expert, or a divorce specialist, or an annuity agent, or a stockbroker. 

But despite the professional-sounding veneer of titles like "financial consultant", "financial planner", and "wealth manager", the underlying reality is that none of these titles has a fully agreed-upon meaning about the exact scope of services they do or don’t entail, much less any regulatory definition attached to them (to ensure that the people who use such titles really provide the services associated with them). As a result, a consumer who engages with someone holding out as a "financial planner" might not know whether that person is providing them with actual financial planning, or if they are going through the financial planning process simply to facilitate a sale as a product salesperson – which ultimately creates confusion and erodes trust in "real" planners as their titles potentially get misused by those with ulterior motives.

The most recent effort to hold those who use certain titles to a specific standard was way back in 2005, when the SEC released a rule requiring anyone holding out as a "financial planner" to register as an RIA (and subsequently be held to an RIA's fiduciary standard); however, that rule was vacated shortly thereafter by a court ruling (for reasons unrelated to the financial planner title restriction), and while a similar rule was proposed again in 2007, it was never made official. More recently, the SEC’s Regulation Best Interest rule in 2020 prohibited those acting only as broker-dealers (and therefore only in a product sales capacity) from using the title “financial advisor”, but significantly, dually-registered broker-dealer/RIA representatives (who make up the majority of broker-dealer reps) were still allowed to call themselves financial advisors despite not always being in the business of giving advice. Furthermore, pure insurance/annuity agents with no brokerage licenses, who aren't covered by the SEC’s Regulation Best Interest rule, can and often do use the title of "financial advisor" as well. And so to this day there is no title (other than the antiquated "investment counsel" that was specified in the original Investment Advisers Act of 1940) that definitively conveys a fiduciary status for the person using it.

It's notable, then, that the U.S. Department of Labor, which last month released a new Proposed Rule to replace its previously-vacated Fiduciary Rule, is requesting comments on whether "advisor-like" titles such as "financial counselor", "financial planner", and "wealth manager" imply that the person using them is holding themselves out as acting in a position of trust and confidence. Which may suggest that the Final Rule will include some type of stipulation that individuals using those titles would by default be treated as ERISA fiduciaries for advice relating to retirement plans.

The DOL's exploration of regulating specific titles is welcome after decades of inaction on meaningful title protection by the SEC, though it is likely to receive significant pushback from members of the product sales industry, who played a large role in having the original DOL Fiduciary rule vacated by arguing that broker-dealer representatives who used the "advisor" title were not actually holding themselves out as having a relationship of trust with their clients. Which raises the question that if that argument was successful in defeating the original fiduciary rule, could the new DOL rule have more staying power by making it clear that if the industry wants to claim it’s not acting in an advisor relationship with clients, it can’t use the advisor title (or associated titles like "financial planner") either?

Young Advisors Welcome AI, But Regulatory Concerns Restrict Its Use

(Mark Schoeff | InvestmentNews)

After years of being on the fringes of technology, artificial intelligence (AI) burst into the mainstream in 2023, with the enthusiasm over generative AI tools like DALL-E and ChatGPT spurring numerous AdvisorTech providers to roll out AI features within their own solutions.

Although advisory firms are traditionally reluctant to quickly jump on board with new technology, a recent study released by technology provider Advisor360 suggests that "next gen" advisors are more enthusiastic about adopting AI. According to the survey, which polled about 300 advisors with an average age of 36.5, 64% of the respondents consider generative AI to be a help to their practice, while 59% consider a lack of AI-enabled capabilities to be one of their top technology-related challenges. But when asked what was holding them back from using AI to collaborate with clients, advisors were relatively split between firmwide restrictions on use of technology (31%), data security and privacy concerns (27%), and compliance or regulatory issues (25%).

Which tracks with the reasons that many firms have been slow to adopt AI tools to begin with. Most AI tools are effectively a "black box" where it's nearly impossible for an advisor to vet the data or calculations that went into a given output, which is a challenge for assessing whether an AI-generated recommendation is actually in the client's best interest – a concern which the SEC is considering codifying into rules that would require RIAs to eliminate or neutralize conflicts of interest posed by AI or similar technology. And at a broader level, advisory firms may be slow to adopt AI simply because they don't tend to switch out their technology very quickly in the first place, with the most recent Kitces Research on Advisor Technology finding that only around 5% of advisors plan to make a change to their tech stack in the next 12 months.

Ultimately, then, although many younger advisors may be excited about the possibilities of AI for aiding with client communications and back-office support, they may be stuck waiting until their firms can build out policies to comply with the still-developing regulations.

What Makes A High-Performing RIA?

(Angie Herbers | Citywire RIA)

In trying to gauge the performance of an advisory firm, it's natural to compare against what other firms are doing – and in particular, to compare with the most "successful" firms to see what they may be doing differently that led them to prosper. And there is no shortage of data for comparison, with industrywide benchmarking surveys such as the InvestmentNews Advisor Benchmarking Study, RIA custodian benchmarking surveys as those held by Schwab and Fidelity, and our own Kitces Research studies that report on industry trends regarding technology, the financial planning process, marketing, and advisor wellbeing.

The caveat, however, is that while benchmarking studies can be a useful way to compare an advisory firm's performance against industry averages across a multitude of data points, the one question they definitely do not hold the answer to is "Is my firm performing successfully?". Because what might represent success for one firm – say, a certain rate of client or revenue growth per year, or a minimum profit margin – might be completely irrelevant, or even a hindrance to success, for another. So for instance, when the most recent Schwab Benchmarking Study states that "Top Performing Firms" have a 12.8% 5-year compound annual growth rate in clients, that might be a reasonable metric for a firm whose goal is to bring in a high flow of net new clients every year. But a firm that provides high-touch service for ultra-high net worth clients might not need anywhere near a 12.8% client growth rate to achieve their own goals for success, and approaching that number might well strain the firm's ability to adequately onboard and serve new clients, making it counterproductive to what they actually want to achieve.

Ultimately, a firm's best measuring stick as a comparison for success is its own goals. That's why it can be helpful to define a set of Key Performance Indicators (KPIs), tailored to whatever it is the firm leaders want to achieve – high growth, profitability, a set number of days off every year, and so on – against which the firm can track its own numbers over time. As advisors, we often stress to clients the pitfalls of comparing their situation with others who don't share their goals, values, or priorities when it's the client's own goals that really matter; the same holds true for advisory firms, where the definition of success for a firm comes from that firm's leaders – not those of the firm down the block.

Founders Beware: Younger Advisors Are Leaving

(Stacey McKinnon and Philip Palaveev | Financial Advisor)

For years, the implicit or explicit promise to new advisors joining advisory firms was that, while the starting compensation may not be all that high (at least compared with that of the senior advisors and firm owners), their salary would rise as their lead advisor and business development responsibilities grew over time. At some point down the line, too, there could be an opportunity for an ownership stake in the firm (or even to take over for the firm's founder when they decide to step away). 

But the reality for many younger advisors who were hired under these premises has not lived up to the vision they were sold: Salaries for non-owner advisors have seen weak growth over the last five years (rising at just 3.4% per year, less than the 3.9% average increase in Social Security payouts over the same time period!), while ownership opportunities have been sparse – either because firm owners have been hesitant to hand over the reins to the next generation, or because the private equity-fueled mergers and acquisitions boom of the last few years made it much more attractive to sell to an external buyer than to carry out an internal succession plan.

As a result, many of those younger advisors have begun to jump ship on the firms where they were originally hired, betting (often correctly) that with 3-5 years of experience they can find better opportunities to advance their career on the open market than at their current firm. Leading many advisory firm leaders to bemoan a "talent crisis" that in reality was often caused by their own firms not paying enough attention to what was needed to get their employees to stay.

Ultimately, the promise of future fulfillment isn't enough for firms to keep their employees from leaving – the firms need to be willing actually follow through and provide some of those opportunities. Through a fair salary (that grows at more than the rate of inflation each year), as well as some participation in the firm's profits, but also through investments in training and building skills so the employee can see some concrete evidence of their growth as an advisor as the years go on. Because the reality is that a growing number of firms (particularly PE-funded mega-RIAs) do offer these benefits – meaning that employees who see these opportunities elsewhere have little reason not to head out for greener pastures if they aren't being well-served by their current firm.

Facing The Dreaded Non-Compete Clause? There Are Remedies

(Jennifer Lea Reed | Financial Advisor)

A first job at an advisory firm can encompass several significant steps in an advisor's early-career growth curve. First, while working in a paraplanner or support advisor role, they build up practical knowledge and skills in the subject matter of financial planning that they can put to use over their entire career. Later, they may begin to take on their first "lead advisor" responsibilities, taking the primary role in managing client relationships. And then they might start to have their own business development expectations, finding prospects and bringing in new clients for the firm to serve. While the advisor puts in a lot of work to reach these milestones, there is also a significant investment of resources by the advisory firm – first to train the new advisor, then to furnish their first few clients, and later to provide the branding and marketing apparatus to assist the advisor in bringing in their own clients. And so it has become common (though not universal) for advisory firms to protect that investment by including non-compete or non-solicitation clauses into their employment contracts that restrict advisors' ability to switch firms and bring their existing clients with them.

Notably, many non-compete clauses (i.e., restrictions on working as a financial advisor at all after leaving the original firm) are legally unenforceable, with multiple states setting restrictions on non-competes and several banning them outright. However, even in the absence of an enforceable non-compete, firms can still make things difficult for advisors after leaving, including using non-solicit agreements (i.e., restrictions on contacting the advisor's former clients after leaving the firm) – and although clients can always leave of their own volition to go work with their former advisor at their new firm, the non-solicit gives the original firm a head start in convincing them to stay, while putting the onus on the client to seek out the advisor at their new firm.

Restrictions such as non-competes and non-solicits can lead to disputes between advisors and their former firms, especially in the case of younger advisors who may not have fully understood what they were signing back when they started at the original firm. And although it's ideal to negotiate the terms for these agreements in advance, it can still be possible to agree on a settlement after the fact, such as the advisor's new firm paying the old firm a percentage of revenue from any clients the advisor brings over (as long as the new firm is willing to sign onto the arrangement as well!).

And ultimately, as the author notes, if the idea of non-competes and non-solicits is to protect the firm's investment in training and developing the advisor's career, contractual restrictions aren't the only way to do so. Rather than focusing on what happens if an advisor does leave, firms can think about what they can do to make it so the advisor doesn't want to leave in the first place – e.g. by offering adequate salaries, incentive bonuses, and profit sharing. Because as in many other cases, the carrot (of creating a firm culture where the advisor feels that they can thrive and reach their maximum potential) is often a more effective motivator than the stick (of punishing advisors who leave to seek out a better situation via non-competes and non-solicits).

What We Fight About When We Fight About Money

(Julia Carpenter | The Wall Street Journal)

Money is a persistent topic of arguments between spouses, as many financial advisors have seen for themselves when these conflicts have spilled over into financial planning meetings. But money itself – whether there's enough of it, and what to do with it – often isn't the root cause of couples' financial conflicts. Instead, it simply serves as kindling to ignite long-smoldering disagreements between spouses, many of which have nothing to do with the family's net worth statement or Monte Carlo results.

According to new research from Carleton University in Ottowa that sifted through over 1,000 Reddit posts on the r/relationships subreddit, the most common underlying factors that led to money-related disputes included perceptions of unfairness or responsibility, imbalances of power, and a lack of shared values. And the deeper these conflicts ran between spouses, the more detrimental they were to the relationship itself. For example, a situation where one spouse feels left out of financial decision making in the relationship could be rooted in (and amplified by) the spouse's feeling of being marginalized in other aspects of the relationship as well. Conversely, however, the researchers found that the opposite was also true: That disagreements over mundane, everyday financial expenses often indicated healthier relationships (since perhaps such disagreements suggests that both partners have a voice in those financial decisions to begin with).

For financial advisors, the key takeaway is that money-related arguments between spouses are often really about much more than what's on the surface. Although financial advisors aren't marriage counselors by training (and there can be times when a couple's need for a trained counselor preempts their need for a financial advisor), couples can work through some of their disagreements around money by talking through them in an open, judgement-free environment. And if the conversation begins to get heated, the advisor can help to lower the temperature by helping the spouses find common ground – such as finding areas for which clients can acknowledge gratitude, or exploring shared values between both spouses. Ultimately, as with so many other areas of financial planning, the numbers on the page are only the beginning of the conversation.

Wealth Chats With Family Members Aren't Always A Good Thing

(Steve Randall | InvestmentNews)

We often hear horror stories about what happens when someone passes away without telling their loved ones about their goals or desires for what they leave behind. Examples have ranged from Prince dying without a will (leading to a 6-year court battle over the distribution of his assets), to Aretha Franklin leaving two separate hand-written wills (one of which was found buried in her couch several months after her death), to – in the fictional realm – the intrigue surrounding the leadership succession of Waystar Royco. Intuitively, it just makes sense that having conversations with family members about wealth – particularly wealth that will be passed from one generation to the next – will make the actual process of transitioning that wealth clearer and less stressful for everyone involved.

As it turns out, however, not all of these conversations, well-intentioned as they are, might have the intended effect. A recent survey by Merrill Lynch of ultra-high net worth families with over $50 million in assets found that, while respondents reported having more conversations with their families about wealth during the pandemic, more than one in four of those ended up regretting those conversations. Often, this was the result of conversations that took place spontaneously – which meant that these families could have perhaps benefited from a more structured approach towards talking about wealth with their families.

The paper's authors suggest taking a "dimmer switch" approach to discussing family wealth: Rather than laying out all of the information in one conversation (which could be anxiety-invoking for the older generation and overwhelming for the younger one), instead having planned, progressive discussions that gradually reveal the scope of the wealth and estate plans to the younger generation. First, having conversations around values and the purpose of money (without getting into any dollar amounts) for laying a foundation for what the family wealth is for; followed by discussions of the structures that the wealth is held in (investments, business assets, real estate, etc.) in order to clarify the roles and expectations for each asset type; and only in the final stage revealing actual dollar amounts, once it's clear that everyone's purpose and expectations are in alignment.

Ultimately, the important thing for many holders of wealth in older generations is to use that wealth for a purpose that continues after their life is over. Which obviously isn't likely to come about if they remain silent about it to their families, but having those conversations intentionally and focused on instilling the purpose and meaning of wealth can help ensure that the next generation is well-equipped to carry out that purpose.

Ultrawealthy Heterosexual Couples Are Living Like The 1950s Never Ended, According To Research Of 30 Years Of Data

(Jill Yavorsky and Sarah Thebaud | Fortune)

The second half of the 20th century saw a nearly uninterrupted rise in the share of women participating in the workforce, with the proportion of women working today sitting slightly lower than its all-time peak of 60% in 1999. In married couples, where it was once the norm for the husband of a heterosexual couple to be the sole breadwinner, the vast majority of marriages today have both spouses earning at least some income.

Digging deeper into the employment data, however, reveals that among "super rich" families in the top 1% of net worth (over $17.6 million), the majority (53%) of heterosexual couples still hold onto that 1950s-style norm of the husband being the only earner in the family – a stark difference from the rest of the population, where even "merely" rich families (with $2.6-$17.6 million in net worth) had men as the sole breadwinner only 27% of the time.

There's no single explanation for this phenomenon – some women may have stopped working after their partner achieved financial success, while others may have stepped back from their careers in order to manage household and child care duties while the demands of their husbands' high-stakes jobs pulled them away from the home. But whatever the reason, the disparity in work-family arrangements in the top 1% versus everyone else creates a kind of feedback loop that amplifies a disturbing trend of wealth inequality between men and women: If moving up the wealth ladder most often leads to women dropping out of the workforce, then fewer women will be in positions that allow them to earn high incomes and accumulate wealth, which leads to the top earning jobs becoming even more male-dominated than they already are, which in turn leads to those men's wives dropping out…and on and on.

Ultimately, while there's no use in judging couples for their work-family decisions no matter their level of income, the data strongly suggests that societal expectations for the roles of men and women still play a significant role in how those decisions play out. Because even though the statistics show that women in super rich households often aren't earning income, what's not in the data is that those women are often still working­ – they're just doing the types of unpaid labor, from household management to child care to social engagements to charitable giving, that society has expected women to take on regardless of whether or not they earn a paycheck.

Everything You Can't Have

(Morgan Housel | Collaborative Fund)

The idea that people often want the things they don't have isn't a particularly new insight, given that desire – for more wealth, power, influence, property, you name it – has been a driving force in human progress since the beginning of civilization. And yet, despite it being well known that desire is often a trap that leads to unhappiness – since acquiring the desired thing usually serves as merely a stepping stone towards desiring another, more unreachable thing – people still more often than not allow themselves to be guided by their immediate wants rather than by what will make them happiest in the long run. Buddha understood this, as did Shakespeare and the Notorious B.I.G. So why does it still happen?

Although volumes have been written on the psychology of desire and the complex role it plays in human behavior and motivation, Housel writes that the answer more simply comes down to dopamine: The hit of neurochemical pleasure that comes from not only getting, but also just thinking about the things we want, keeps us constantly fixated on getting the next thing.

Housel' goes on to suggest that the only thing we really 'get' out of money is simply the desire for more things we can't have, but in truth money can have many different purposes for many different people beyond just the accumulation of more possessions. For some it represents an ideal of self-sufficiency and independence; for others it's about the freedom to live according to their values; for still others it's about ensuring that loved ones are cared for after they're gone.

For advisors, then, a more nuanced takeaway could be that no one needs to be judged for spending money for the occasional thrill of getting something new, especially when they can clearly afford to do so in the first place. Instead, more productive energy can be spent on digging deeper into what higher purpose the client wants their money to serve so they can deploy it effectively over the long term. The good news is that with the proper amount of balance there's often room for both approaches, and so saving for the long term doesn't have to mean denying the smaller joys that money affords in the meanwhile.

Wise Words From Sam Zell

(Novel Investor)

There's no single approach to becoming a great investor. Some, like Warren Buffett, look for fundamentally sound companies trading at attractive prices to buy and hold for the long term. Others, like Bill Gross, take advantage of long-term interest rate trends and ride out the strategy for as long as it works. Still others wait for moments where they see opportunities in investments that everyone else deems too risky…then take massive swings to capitalize on their insight. 

Sam Zell, who passed away earlier this year, was the latter kind of investor, building a fortune in real estate over several decades by jumping on distressed properties that others wouldn't touch. He eventually became an early leader in the publicly-traded Real Estate Investment Trust (REIT) space, but managed to sell much of his real estate investment portfolio in 2007 – just before the housing bubble collapsed and took down much of the real estate market with it.

While not all of Zell's ventures were successful – he's perhaps best known to the general public for his 2007 leveraged buyout of the Tribune Company, which filed for bankruptcy within a year – he had enough of a nose for risk that he protected himself from significant downside when things went bad (case in point: of the $8.2 billion he paid for the Tribune Company, "only" $315 million was his own money).

Ultimately, the point is that success for Sam Zell wasn't simply about taking big risks – it was about seeing where investments could be made less risky, by seeing before everyone else when inefficiencies arise.

9 Of Charlie Munger's Best Investing Lessons And Words Of Wisdom

(Nicole Lyn Pesce | MarketWatch)

Last week's passing of longtime Berkshire Hathaway vice chairman Charlie Munger at age 99 generated countless reminiscences about his legacy and the role he played in building Berkshire into the massive holding company it is today. As Warren Buffett's second-in-command, Munger helped shape the value investing approach that made Buffett one of the world's most successful investors – as Buffett put it, Munger encouraged him to "Forget what you know about buying fair businesses at wonderful prices; instead, buy wonderful businesses at fair prices", leading Buffett to focus on high-quality companies rather than ones that were merely cheaply priced.

Munger was also known as an avid lifelong learner, philanthropist, amateur architect (to the chagrin of many at the University of California, Santa Barbara), and a fount of memorable quotes up until the end.

And so it seems appropriate to end with Munger's own words this week, as spoken at his final Berkshire Hathaway annual meeting in May 2023:

It's so simple to spend less than you earn, and invest shrewdly, and avoid toxic people and toxic activities, and try and keep learning all your life, and do a lot of deferred gratification. If you do all those things, you are almost certain to succeed. If you don't you're going to need a lot of luck.

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

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