Weekend Reading for Financial Planners (Feb 12-13)

Course Correction: FPA Sharply Defines CFP Professionals As Its 'Core Member'

(Dennis Moore and Patrick Mahoney | Financial Planning)

The Financial Planning Association (FPA) has served as the largest membership association within the financial planning community since it was created in 2000, born from the merger of predecessor associations, the International Association for Financial Planning and the Institute for Certified Financial Planners. Yet while Certified Financial Planner (CFP) professionals have always made up the vast majority of FPA members, the fact that historically many advisors simply “did” at least some level of financial planning without the CFP marks (or any professional designation), the FPA had long focused on a “big tent” strategy of serving the broader financial planning industry and trying to grow membership with a wider range of those who deliver or support the financial planning industry, rather than focusing on CFP professionals in particular. Ironically, though, the FPA’s push over the past 15 years to be more inclusive of CFP and non-CFP professionals has only led to an ongoing steady decline in membership (from nearly 30,000 when FPA was formed in 2000, to barely 24,000 a decade ago, and just over 18,000 today), as the organization managed to simultaneously be just CFP-centric enough to limit its appeal to non-CFPs, while still not being CFP-centric enough to attract the rapidly growing ranks of CFP professionals.

And so, the FPA has now clarified that CFP professionals are their “core members”. While the FPA will continue to accept other members engaged in the financial planning process, the leadership and FPA Board of Directors is stating that it plans to rally around the CFP credential to help build the financial planning association, and the broader profession, around a set of requirements and standards in the profession’s and the public’s best interest.

Notably, another related question swirling around FPA and its growth struggles for the past several years has been the future of its local chapters, after an initial attempt to consolidate them in 2018 (the “OneFPA Network” plan) led to significant pushback from many FPA members. Moore (FPA’s President) and Mahoney (FPA’s new CEO) are now reiterating the importance of the FPA’s 80-chapter network and that it is no longer looking to consolidate, as instead are now citing the important role of the OneFPA Advisory Council (a new group of chapter representatives that provides feedback from chapters to the National leadership, which grew out of the scuttled chapter consolidation plan) as a mechanism for chapters, the FPA NexGen community, and the FPA Diversity and Inclusion Committee to have a voice on issues of importance to the FPA and the profession.

And so, the FPA appears to be going back to its roots of primarily serving CFP professionals (whose numbers continue to be on the rise, jumping 3.8% in 2021 to 92,000) and re-empowering its local chapters, as financial planning continues to develop into a profession and amid a debate over professional titles and the fiduciary requirements of individuals who hold themselves out as financial advisors.

SEC Outlines Cyber Rules, New Form For Advisors

(Melanie Waddell | ThinkAdvisor)

As more aspects of financial advising have moved online, so too have the risks that client data could be compromised in a cyberattack. And while the Securities and Exchange Commission (SEC) currently has regulations concerning data privacy and identity theft, it does not have rules that explicitly require investment advisers to adopt and implement comprehensive cybersecurity programs.

Amid this backdrop, the SEC on February 9 proposed a new rule that would require advisors and fund companies to draft cybersecurity policies and procedures that would include an assessment of the firm’s risks, controls to prevent unauthorized access to systems and data, and an incident-response plan detailing the mechanisms in place to detect, mitigate, and respond to a breach. Firms also would be required to notify the SEC about “significant” cyberbreaches in a confidential “Form ADV-C”. In addition, firms would also have to publicly disclose cybersecurity risks and significant cybersecurity incidents that occurred in the last two fiscal years in their brochures and registration statements.

Notably, thus far, the proposed rule is only that – a proposal – and it remains to be seen whether it will be implemented in its current form, modified, or not finalized at all. Either way, though, advisors are still responsible for protecting client data, making it important to have a plan that covers the major areas of potential cyber vulnerability, including email, mobile technology, and document storage. And as more advisory firms operate with remote staff, ensuring that new employees and contractors working virtually are meeting the firm's cybersecurity requirements will increasingly be important as well. The key point is that while the proposed SEC rule would add formal cybersecurity requirements for advisory firms, it is always a good time for firms to ensure that they are practicing good cyber hygiene anyway, as the consequences of a cyber-breach on client trust are significant (regardless of any potential additional regulatory consequences)!

FINRA Finds Brokerages Fall Short On Reg BI Compliance

(Mark Schoeff | InvestmentNews)

In 2019, the SEC issued Regulation Best Interest (Reg BI), which required brokers to act in their clients’ best interests when making an investment recommendation, while still allowing the broker (and their broker-dealer) to earn commissions from the sale of products implemented pursuant to that recommendation. While falling short of a full fiduciary standard, Reg BI sought to, among other goals, at least try to ensure that brokers were making the best recommendation they could at the time and set an expectation that broker-dealers would attempt to mitigate any conflicts of interest (at least within the constraints of whatever products their broker-dealer platform made available to sell). The SEC also implemented a newly required Form CRS for broker-dealers and RIAs, that provides prospects with information about the nature of the firm’s services and relationship, their fees and costs, and their standard of conduct and conflicts of interest.

However, a year and a half after Reg BI went into force, FINRA on February 9 released a report explaining how brokers and broker-dealers have fallen short on meeting these requirements. Among other findings, FINRA found that: broker-dealers and brokers were still making investment recommendations not in the best interest of a particular client based on the client’s investment profile and the characteristics of the investment product; firms either did not identify or failed to mitigate conflicts of interest, including revenue sharing and other payments from product providers; and that firms were not accurately disclosing their brokers’ disciplinary histories, as well as how the firm is compensated and potential conflicts of interest, on their Form CRS.

So while Reg BI raised the standard of conduct for broker-dealers, it appears that not all firms have followed through with its requirements, to the detriment of consumers, who also can have a more difficult time differentiating between fiduciary advisors and brokerage salespeople who only have to act in the consumer’s best interest at the time of an investment recommendation as a result of Reg BI. Which continues to raise questions about whether broker-dealers will ever be able to deliver advice within a fiduciary framework, or whether in the end fiduciary advice and brokerage sales simply need to be separated altogether?

Broker-Dealers With Shady Pasts Told To Reform Or Face 'High-Risk' Label

(Tracey Longo | Financial Advisor)

In September 2021, FINRA adopted Rule 4111, which targets broker-dealer firms with a “significant history of misconduct” and imposes new regulatory obligations on firms that hire disproportionate numbers of ‘problem brokers’. The rule officially went into effect on January 1, 2022, and this week FINRA announced that the rule’s first “evaluation date” will occur on June 1, 2022.

At its core, Rule 4111 establishes an annual process to identify certain broker-dealers as “Restricted Firms” (based on exceeding thresholds for the number of regulatory disclosures reported by the firm and its registered representatives). After the June 1 evaluation date, broker-dealers that preliminarily meet the criteria for Restricted Firm status will undergo an initial evaluation to further investigate the firm’s disclosures and the level of risk it represents (e.g., firms with higher levels of sales-practice-related disclosures will be deemed higher-risk than those where disclosures were primarily non-sales-related, like failure to maintain books and records).

If the broker-dealer is deemed to pose a high enough risk, it will be identified under Rule 4111 as a Restricted Firm. The firm is then given a one-time choice to either reduce the firm’s staff to bring its total number of disclosures below the threshold (in other words, to ‘clean out’ its most problematic representatives with extensive histories of regulatory violations), or deposit additional cash or securities into a segregated account to maintain greater capital reserves, with any withdrawals subject to FINRA approval.

The question now is whether or not Rule 4111 will have its intended effect of incentivizing broker-dealers to purge their ranks of their worst actors (who, as studies have shown, are significantly more likely to go on to repeat their problem behavior). Because, while the rule theoretically raises the cost of doing business for the small number of firms deemed high-risk by requiring them to put aside additional funds ‘on the sidelines’ (where they can’t be used to generate revenue), it does not require those firms to actually get rid of their problem employees – meaning that some firms may simply choose to make the deposit and retain their problem brokers in the hopes that they can make even more from problematic sales practices than it costs them in a financial set-aside. So while the rule represents a step in the right direction of flushing out the small number of brokers who do disproportionate damage to clients and the reputation of the industry as a whole, it will only start to achieve that aim if it truly makes it untenable for broker-dealer firms to retain those employees. Time will tell?

Why Independent Broker-Dealers Are Changing Their Recruiting Deals

(Jeff Berman | ThinkAdvisor)

Independent Broker-Dealer (IBD) firms have traditionally offered ‘transition assistance’ as a tactic to recruit experienced advisors to their platform. The ‘assistance’ is really an incentive in the form of a forgivable loan to help the advisor fund the process of moving client assets and onboard their team onto the IBD’s systems, which the IBD then subsequently tries to recover through the profitability of its core business in providing a platform and products for advisors to use with their clients. With many IBDs, the value of the transition payment is calculated based on the amount of product sales generated by the advisor over the past 12 months (i.e., trailing 12-month GDC). Recently, however, several large IBDs – including LPL Financial and Commonwealth Financial Network – have begun to adjust their transition payments to be calculated instead as a percentage of the advisor’s assets under management instead.

The change reflects the IBD industry’s broader shift in focus from product sales to advice. At one time, fee-based advisory services made up only a small percentage of the revenue at broker-dealers, but that share has increased over time, reaching 57% in 2015 and 70% in 2019. And as more and more of the firms’ total revenues has come from advisory assets rather than commission-based product sales, it follows that the most ‘productive’ advisors have become those with the most assets under management—so it only makes sense that IBDs would adjust their recruitment incentives to align with what would draw in the advisors whose own revenue model is most aligned with the evolving revenue model for independent broker-dealers themselves.

Ultimately, while the change in incentive structure may be based on what is profitable for IBD firms, there could be effects in the broader industry if more firms follow Commonwealth’s and LPL’s example. For instance, wirehouse advisors with substantial advisory assets might be increasingly tempted to go “independent” by affiliating with an IBD offering an asset-based transition payment. And brokers looking to switch firms might also be less incentivized to ‘churn’ assets in client accounts to generate commissions and maximize their potential transition payment. Ultimately, amidst the growing demand for advisor talent – in the industry in general but especially within the fee-based model – the shift mainly represents IBDs doing what they need to do to compete for that talent (both against other IBDs offering their own transition payments, and the RIA-only channel which puts more of the burdens of building on the advisor but can offer advisors greater independence and the potential to keep more of the revenue they earn and/or the enterprise value they create).

What's Your True Net Payout?

(Chuck Failla | InvestmentNews)

Advisors who are affiliated with Independent Broker-Dealer (IBD) firms are typically paid based on a stated percentage (sometimes as high as 85%-90%, on a graduated ‘grid’ schedule) of the gross revenue they generate. This ‘headline’ percentage represents the advisor’s pay after deducting the portion of their revenue that the IBD keeps for being affiliated with the IBD (and the compliance oversight, practice management support, and technology solutions it provides), but there are other costs not included in that headline percentage (e.g., platform fees, technology fees, and E&O insurance) that can mean the amount that actually ends up in the advisor’s bank account may be significantly lower. To understand the percentage of gross revenue that they actually get to keep, Failla suggests that IBD-affiliated advisors can calculate and track their “True Net Payout” (TNP) percentage.

On its face, TNP is a simple calculation: Total dollar amount deposited into the advisor’s bank account, divided by total fees that were ultimately charged directly to the client. As while it is easy to see how expenses charged to the advisor result in a lower TNP by reducing their total take-home pay (the numerator in the equation), fees charged to clients by the IBD firm also reduce TNP by increasing the client’s total fees paid (the equation’s denominator) – but because these “ancillary” fees are often buried in the firm’s disclosure statements, and come directly from the client’s pocket (not off the advisor’s grid), they can be opaque and difficult to account for, making the TNP calculation trickier than it would initially seem. In practice, this can include ticket charges, increased expenses for no-transaction-fee ETFs or NTF mutual funds, and asset management surcharges (e.g., on the underlying fees of TAMP and SMA providers) are all common ancillary fees charged to clients – sometimes adding 25 to 50 bps or even more, most or all of which is generally paid to the IBD firm (which adds up to far more than the 10%-15% stated in the advisor’s headline payout rate).

So while a 90% stated payout percentage may seem like a good deal for a financial advisor to be affiliated with an IBD, the reality is that the advisor’s ‘true’ payout may end out being much lower. And if ancillary fees charged to clients result in a substantially lower TNP – or if the lack of transparency into those fees makes it is impossible to calculate TNP to begin with – that could be a tipoff that the IBD affiliation may not be working for the advisor or the client. Which is important both because different IBDs have different ancillary costs – which means another platform could result in a lower total cost to the client and thus a higher TNP for the advisor – and also because the additional IBD costs of the TNP are typically not part of the equation when operating an independent RIA, such that a move to the RIA channel could result in lower fees for the client, and a higher percentage of take-home pay for the advisor (in the form of the profit margin for the RIA) – a better outcome for both the advisor and their client.

Billions Are Flowing To Cash-Like ETFs In 'Hunt' Before Fed Hike

(Katie Greifeld | Financial Advisor)

In recent months, with inflation spiking to its highest rate in nearly 40 years, experts predict that the Federal Reserve will increase its target interest rate several times over the next year as a way to combat higher prices. But while the rate hike’s primary goal is to slow down inflation, it is also expected to have broader side effects throughout the economy and the financial markets. The last time the Fed stepped in to fight inflation by raising interest rates – when then-Fed chair Paul Volcker did so controversially in the late 1970s and early 1980s – it accomplished its goal of ending that era’s high inflation, albeit at the cost of driving the economy into a deep recession. And even though the Fed’s action is unlikely to be as dramatic as the 20% raise of the Volcker era, many investors today are expecting continued market volatility and the potential for an economic slowdown as a result of the rate increase.

When investors anticipate volatility in the markets, there tends to be a “flight to safety”; that is, they often pull their funds out of (perceived) riskier assets and put them into assets they feel are safer. Generally, this means investors will sell more volatile stocks, and buy less volatile bonds. Of course, the caveat is that rising interest rates themselves can cause greater volatility and potential outright price declines in bonds as well. Which mean this time, the majority of investors’ money is going into the very shortest-duration bonds, like 1-3 month T-bills, which currently have a yield similar to cash of around 0.05% to 0.4%. As a result, ETFs holding these types of bonds experienced their highest inflows since early 2020, when uncertainty around the beginning of pandemic caused a similar retreat from volatility.

While it may seem strange that investors are piling money into an asset that is currently yielding about seven percentage points behind the rate of inflation itself, the interest rate risk inherent with the prospect of the Fed’s rate hikes means that the shortest-duration bonds are still the least likely to decline in value as interest rates on new debt rise. And as the ETF flow data shows, even bonds that are typically classified as “short-duration” are currently being dumped for what are essentially cash equivalents. All of which signals that, even though the Fed’s rate increase might be the cure for the inflation that has run higher and longer than expected, and ultimately investors may have the opportunity to buy bonds at higher yields, the markets expect the ride ahead to be a bumpy one for both stocks and bonds (at least until the Fed’s meeting on March 15).

Advising The Advisors: Evidence From ETFs On The Conflicts Of Asset Manager Models

(Jonathan Brogaard, Nataliya Gerasimova, Ying Liu | SSRN)

In recent years, model portfolios have become a widely adopted method of asset management, with model portfolio assets totaling an estimated $4.8 trillion dollars as of March 2021. The rise in model portfolios has occurred as an increasing number of financial advisors have sought to provide value to their clients not through superior investment returns but through comprehensive financial planning and advice (reducing the need for advisor-driven more hands-on, actively-managed portfolios in favor of systematized, diversified model portfolios of mutual funds or ETFs). And while some advisors research and create their own proprietary model portfolios, others have increasingly been using pre-selected models via a TAMP, robo-advisor, a fund provider such as BlackRock or Vanguard, or a ‘model marketplace’ through the advisor’s custodian or portfolio management software provider.

In theory, outsourcing the work of model portfolio creation allows the advisor to provide more value by giving them more time to focus on financial planning and advice. But in reality, as this research paper shows, many advisors who rely on model portfolios tend to pay less attention to the fees and performance of the models’ underlying funds. Furthermore, model portfolio providers are often affiliated with the underlying funds in their own models, and as the paper finds, in those cases, model portfolios are more likely to include the asset manager’s own higher-fee and lower-performing funds. As a result, when it comes to ETFs affiliated with a model portfolio provider that put their own ETFs into their advisor models, investors paid on average 6bps higher expense ratios and experienced 67bps lower returns than those in unaffiliated funds.

All of which means that at least part of the extra value that an advisor may provide by outsourcing its portfolio model creation to begin with can be subsequently eroded by high fees or poor performance if the advisor relies on a conflicted model portfolio. Which makes it all the more important for advisors who delegate their investment selection process to a third party (e.g., by selecting models from a model marketplace) to both do due diligence on the underlying funds of the models they employ, and to do sufficient due diligence on (and to understand the potential conflicts of) the model provider themselves, especially if the underlying funds in the models are affiliated with the model portfolio provider.

Legos Prove To Be Better Investment Than Gold, Art, And Financial Securities

(Victoria Dobrynskaya | HSE University)

There has long been a market in alternative assets like art, wine, and exotic cars for people looking to diversify their investments outside of traditional stocks and bonds. But there has been another, more unusual (and perhaps unintentional) investment that, from 1987 to 2015, outperformed the S&P 500 on an annual basis: Legos.

According to a paper published in Research in International Business and Finance, the secondary market price of retired Lego sets grew, on average, by 11% per year during that timeframe. As might be expected, limited-edition sets tended to return even higher, with thematic sets (like movies or famous landmarks) also returning higher than average, and according to BrickEconomy – a site that actually exists that is dedicated to the economics of Lego – the top-performing set theme is Super Mario, which has grown 20.42% annually in the two years since its release.

Of course, the results of the study likely have as much to do with the time frame selected by its authors than the intrinsic value of Legos as an investment. Legos achieved high popularity with Millennials raised in the 1980s and 1990s, and as those kids grew into adults with disposable income, their nostalgia-fueled purchases triggered a boom in prices. A similar phenomenon took place with baseball cards in the 1980s and 1990s, when Baby Boomers who had grown up trading the cards drove up the prices of rare collectibles (and ultimately launched a wild speculative bubble that crashed spectacularly just before the new millennium).

In both cases, however, the increase in prices of baseball cards and Legos was driven by the fact that, in their respective initial waves of popularity, most of their owners didn’t treat them as investments to buy and hold – such that while most sets became worn, destroyed, or thrown away over time, the few remaining ‘mint’ specimens became all the more valuable. So when deciding whether Legos could really be as promising of a future investment as their past performance has indicated, it’s worth considering that many more people are treating them as such today and keeping their sets in mint condition, meaning they will likely not command as high of a price as the comparatively rarer sets of the past.

As the baseball card bubble showed, once everyone treats a static object as a potentially valuable investment, it becomes difficult to find anyone who might want one and doesn’t own it already. It may not be much consolation if, like one of the authors of this Weekend Reading post, you squandered the opportunity to hold on to that 1990 “Forestmen’s Crossing” set (annual growth: 14.43%), but on the plus side, Legos do have some intrinsic value: As a fun toy that can be used and enjoyed across generations, regardless of the price they command on the open market.

Forget America's Great Resignation. It's The Great Upgrade

(Christine Romans | CNN Business)

The pandemic has led to many changes in working life, from the rise of remote work to a reassessment of work-life balance. And amid these changes, many workers have decided that their best option is to leave their current job. As part of the ‘Great Resignation’, more than 2/3rds of job separations in 2021 were voluntary. And in many of these cases, workers have decided to leave their jobs without immediately moving to a new one, with an estimated 800,000 Americans deciding to retire early (perhaps buoyed by strong stock market performance and increasing home equity).

The combination of workers retiring early and temporarily leaving the workforce has, in turn, led to a tight job market, and has forced many companies to consider how to get these workers back. Many have responded by increasing wages, offering signing bonuses, and adjusting work schedules, or offering additional perks like helping to pay off employees’ student loans. Which increasingly means those who resigned from one job have been able to get another even better job instead!

And so, the tight labor market appears to be leading to a ‘Great Upgrade’ for employees who are able to find new jobs that offer higher pay, improved benefits, and better work-life balance. For financial advisory firm owners, this could be a good time to evaluate whether their employee compensation models and benefits are sufficient to reward their current employees and attract new ones (and for firm employees to consider whether they are being compensated appropriately!). In addition, firms can ensure that employees are on the career track that they desire and see room for advancement in the firm in the future. The key point is that workers are gaining power in the current labor market, but for firms that are ready to hire and can be proactive employers, the prospects have never been better for finding new talent (at least for firms that are positioned to attract and retain talent)!

The Secret To Happiness At Work

(Arthur Brooks | The Atlantic)

Because workers spend a significant percentage of their time on the job, having a job that actually brings happiness can be a boon for overall life satisfaction. But it turns out that finding happiness at work goes beyond picking the right career, or getting paid a hefty salary, and into more qualitative measures of job satisfaction.

To start, just having a job can promote happiness, as unemployment is one of the biggest sources of unhappiness people can face. So the first step is to find a job with reasonable job security to avoid having to always consider what to do if that job was no longer there. Another consideration is how much a given job pays. Though while economists have found that wage increases raise job satisfaction, this is only in the short term, so finding a job that offers the opportunity for regular wage increases (i.e., in a company that is steadily growing, rather than seeking large but infrequent raises) could promote happiness.

Beyond pay, job satisfaction also depends on a sense of accomplishment, recognition for a job well done, and work-life balance. In addition, working at a company whose values match your own can also lead to satisfying work. Ultimately, job satisfaction is an internal metric, which can be developed by a feeling of earned success (where the best employers give clear guidance and feedback, reward merit, and encourage employees to develop new skills) as well as by a feeling of serving others and making the world a better place.

In the case of financial advisors, in particular, it turns out that while financial advisors fare extremely well in measures of wellbeing, this happiness does vary across industry channels, hours worked, and other factors, so while a given advisor might have made a good choice pursuing a career in financial advising, they can consider whether they are currently in the right firm or position for them!

Non-Fungible People

(Fred Wilson | AVC)

When looking at a company from the outside, it could be easy to assume that its most invaluable employees are in upper management making the decisions that are charting the company’s course. However, while these individuals do serve important functions, it is possible that a replacement could be found if they were to leave the company, as ironically, the skills of management are often the most transferrable from one company to the next. At the same time, there might be individuals, often individual contributors rather than managers, who have even more specialized skills and would be incredibly difficult to replace. Wilson argues that companies should work to identify these “Non-Fungible People” (NFP), and do what it takes to retain them in particular.

One important NFP is often the company’s founder, who brings value to the business by creating a long-term vision, setting culture and values, and knowing when something is going wrong in the company. Other NFPs are often technical experts who are intimately familiar with the company’s operations, even though they may not be best suited for management roles. And so, while managers often receive the most compensation in the company, these critical individual contributors should potentially make just as much, if not more, than their managers, because replacing them could be more difficult than replacing a given manager.

For financial advisors, NFPs could be found throughout the firm, from the founder who sets the culture for the firm, to key lead advisors who have built years-long relationships with clients, or a specialized team member in the Operations or Investment teams. And so, designing compensation models that motivate employees and offering perks that help retain them are particularly important for firms who want to retain their NFPs, who would otherwise be difficult to replace!

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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, as well as Gavin Spitzner's "Wealth Management Weekly" blog.