Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the news that the battle over the CFP Board's expanded fiduciary standard is heating up, with both SIFMA and FSI (lobbying firms for broker-dealers) calling for the CFP Board to postpone their fiduciary proposal until at least next year to see what the SEC does, and the CFP Board responding that it still intends to move forward (and putting to rest the criticism that CFP Board is solely beholden to its large-firm broker-dealer stakeholders).
Also in the news this week is the announcement that administration of the Broker Protocol is being shifted to a new law firm called Capital Forensics (after complaints arose that the prior law firm Bressler Amery & Ross sat on the news that Morgan Stanley was leaving the protocol and failed to communicate it to the other protocol participants in a timely manner), and a look at how despite the de-regulatory agenda of President Trump the financial advisory industry is facing a slew of new and additional regulatory activity in the coming year from both the SEC and FINRA (not to mention what is already underway with the Department of Labor's fiduciary rule).
From there, we have a series of practice management articles this week, including: a look at some of the new additions on Form ADV that will be required in the coming weeks as firms do their annual updates; the regulatory and compliance issues to consider when hiring non-advisor employees (who still must be overseen by the firm); why fiduciary compliance does not actually require advisors to always use the absolute lowest cost solution for clients; the rise of the "quasi-independent" model of breakaway brokers who join existing independent RIAs that provide solutions to the advisors who often become partners of the firms; the various Millennial archetypes (beyond the increasingly popular "HENRYs") that financial advisors should consider working with; and how to think about developing a special treatment program to deepen your relationship with your top clients (and what we can learn from the airline industries about how to provide differentiated service to your most valuable clients/customers).
We wrap up with three interesting articles, all around the theme saving and spending habits: the first looks at how, in a world of retargeting ads and email marketing, often the best way to save and buy less is simply... to buy less in the first place (which keeps you from being signed up for all those lists in the first place, and helps you get more comfortable in simply enjoying what you already have); the second is a look at how sometimes the best strategy to succeed is simply by using brute force, which can apply to everything from investing (don't try to pick stocks, and instead just own all of them with an index fund) to accumulating for retirement (if your savings rate is aggressive enough, it hardly matters what you actually generate in investment returns!); and the last is an interesting exploration into what is worth spending a little more money on, particularly for those who may be financially successful (or fully financially independent) precisely because they lived a lifetime of frugality... and now can't find out how to flip the switch and actually try to enjoy the money they have!
Enjoy the "light" reading!
Weekend reading for January 27th – 28th:
Major Brokerage Trade Groups To CFP Board: Slow The Effort To Raise Mark's Fiduciary Standard (Mark Schoeff, Investment News) - As the CFP Board's proposed Standards of Conduct (which would expand the fiduciary duty for all CFP professionals) finishes their second public comment period next week, the major lobbying organizations for broker-dealers are pushing the CFP Board to step back from its fiduciary push. While both SIFMA (which represents the brokerage industry broadly) and FSI (Financial Services Institute, which represents independent broker-dealers) both claim to support the idea that advisors should act in the best interests of their clients, they are claiming that it would be better for the CFP Board to wait for the SEC to issue a fiduciary rule instead (which is rumored to be coming soon, although notably it was the CFP Board that originally lobbied for the SEC to adopt a strict fiduciary rule over 6 years ago, which the brokerage industry opposed at the time!). Arguably, there is a legitimate concern that the overlapping patchwork of regulations that apply to financial advisors already may be even more complicated by the CFP Board inserting its own set of rules... yet at the same time, after organizations like SIFMA and FSI were successful in stalling the SEC from rulemaking for years, it was only the movement of the Department of Labor, states like Nevada, and now organizations like the CFP Board, that seems to finally be stirring the SEC to action in the first place, for which the CFP Board can obviously adjust their rules in the future (if necessary or desirable) to conform to whatever fiduciary rule the SEC ultimately issues. In fact, the CFP Board publicly responded that it does still intend to forge ahead with its own fiduciary rule, and has been engaging in several public efforts to build momentum for its rule, including a full-page ad in the Wall Street Journal last month, and another that will run in Investment News next week highlighting an open letter from 21 academicians leading programs at universities around the country that they support the higher standards of CFP certification. To say the least, though, for all those CFP Board critics who claim that the CFP Board bends its will to the demands of large (broker-dealer) firms, this should be definitive proof that while the organization does appropriately recognize them as stakeholders (and did make some concessions in its revised proposal of the standards), it is clearly not beholden to them.
Amid Broker Protocol Fireworks, Industry Shifts Administrators (Mason Braswell, AdvisorHub) - Late last fall, as Morgan Stanley and then UBS departed the Broker Protocol, lawyers that represent breakaway brokers (most prominently, Brian Hamburger of MarketCounsel) called foul over the way Protocol administrator Bressler, Amery & Ross (which, notably, often represents large brokerage firms as their own clients) only gave four days' notice after the major wirehouses had already delivered notification that they were leaving the protocol (despite the fact that Protocol rules require firms to give 10 days' notice). Accordingly, administration of the Broker Protocol is now being transferred to an expert-witness consultancy firm, Capital Forensics Inc., which going forward will provide updates of new and exiting Protocol members twice weekly (rather than the current once-per-week freshening). However, the decision to transition control of the Broker Protocol from Bressler, Amery & Ross to Capital Forensics appears to have been facilitated by SIFMA, and MarketCounsel's Hamburger is once again raising concerns that it's not entirely clear whether SIFMA had the authority to make the decision, nor even what selection criteria were used to arrive at choice of Capital Forensics. In the meantime, though, buzz around the steady unraveling of the Broker Protocol continues, as Morgan Stanley continues to pursue Temporary Restraining Orders against departing brokers, and now Wells Fargo has announced that it will begin to permit its employee brokers to shift to its FiNet independent channel for free (which may be a precursor to Wells Fargo finally leaving the Protocol as well, as once it's "free" to become an independent with FiNet, the next step would be dropping out of the Protocol so it becomes the "only" way for Wells Fargo advisors to become "independent"!), even as consumer groups are raising concerns about the potential client harm that may result.
Cutting Through The Red Tape Of Adviser Regulation Is Tricky (Mark Schoeff, Investment News) - While the Trump administration has stated that rolling back regulations is a top priority, the reality is that "deregulation" is quite difficult in practice given the rules of Washington, especially in the context of financial advisors. In fact, the SEC is anticipated to introduce a proposal for new fiduciary regulations this year (albeit as a way to harmonize what are now disparate fiduciary and suitability regulations across the SEC, FINRA, and the Department of Labor), along with a developing a new special unit whose agenda includes searching for hidden advisory fees. The SEC is also making a push to increase RIA exams, which in recent years was as low as 10%/year (i.e., being examined once every 10 years), but has now risen as high as 14%, and SEC Chairman Clayton has indicated he hopes to push it as high as 20% (a once-per-5-years regulatory exam cycle). At the same time, FINRA is also gearing up for new regulations this year, on issues ranging from cryptocurrencies to business continuity planning, along with a renewed focus on so-called "high-risk" (i.e., repeat offender) brokers, and an ongoing push on cybersecurity. And a new FINRA rule is scheduled to go into effect next month that will require more of brokers who may identify situations of elder financial abuse. In the meantime, the Department of Labor is expected to issue a new fiduciary exemption of its own sometime this year – likely one that will expedite the fiduciary compliance process for brokerage firms that adopt so-called "clean shares" (that don't carry any commissions but are still technically brokerage products). As a result, even with a "deregulatory" emphasis, financial advisors actually reported in a recent Investment News Outlook survey that "regulatory overload" is the top issue we face in 2018!
Meet The New Form ADV (Charlie Paikert, Financial Planning) - Over the next two months, RIAs (that operate on the calendar year for their fiscal year) must complete their annual Form ADV update process... which for most will be the first time they see the "new" version of Form ADV that was approved last October. And while the bulk of the Form ADV disclosure and reporting requirements remain the same, a number of new and important categories and details were added this year, including: Item 5.D now requires a more detailed breakdown of the number of clients and amount of assets in various categories (e.g., individuals vs high-net-worth individuals vs business/institutional accounts, and several other types); web and social media presence details (including the advisory firm's Twitter, Facebook, and LinkedIn accounts, although employees' personal social media accounts do not need to be disclosed); further detail about the location of various "branch" office locations (as the SEC has indicated it plans to focus more on large RIAs with multiple office locations to affirm that each/every branch has the proper compliance oversight controls in place); and new disclosure categories for separately managed accounts (i.e., advisory accounts that are not pooled investment vehicles), along with the breakdown of the different types of assets in SMAs (e.g., ETFs, government bonds, corporate bonds, derivatives, cash, etc.), which must be reported annually for firms with less than $10B of regulatory AUM and updated semi-annually for larger firms (which may be challenging for firms that don't currently have the technology infrastructure to easily generate those reports).
Regulatory Considerations When Hiring A Non-Advisor Employee Or Independent Contractor (Chris Stanley, Beach Street Legal) - When an RIA hires a new advisor who will become an IAR (Investment Adviser Representative) of the firm, there are a series of steps to complete in order to register him/her with the firm. However, Stanley notes that even when hiring non-registered employees or independent contractors, there are still regulatory considerations to be aware of. First and foremost is the fact that for unregistered employees, there will be no U-4 record to check on IAPD, which means it's necessary to engage in a third-party background check to verify that there are no major issues of concern (and be certain to comply with the Equal Employment Opportunity Commission's rules on proper background check protocol!). Other issues to consider include: will the employee be an "access person" for the purposes of reporting personal securities transactions and holdings (anyone who has access to nonpublic information about what investments the clients are buying or selling, or are making those recommendations to clients); will the employee be signing agreements for confidentiality and/or non-disclosure regarding client information; and will the individual actually be designated as an employee or independent contractor (given the legal requirements for each). And of course, it's also important to really affirm that the employee doesn't need to be registered as an IAR in the first place, as NASAA notes that an IAR includes anyone who: makes recommendations or otherwise renders advice regarding investments; manages accounts or portfolios of clients; determines which recommendations or advice regarding investments should be given; solicits, offers, or negotiates the sale of investment advisory services; or supervises employees who do any of those tasks... which means that registration is required for more than just those who are lead advisors with clients, and since IARs are registered by the state (not the SEC), the exact requirements for determining IAR status may vary from one state to the next!
Why Fiduciary Compliance Doesn't Necessarily Require The "Lowest Cost" Mutual Funds (Fred Reish) - The common interpretation of the DoL fiduciary requirement to act in the "best interests" of the client is that the financial advisor must find the absolute lowest cost investment solution(s) for the client. But as Reish points out, this isn't actually a requirement of the law, both because it's permissible to have a higher cost fund if there are other "relevant factors" that lead to it being appropriate (e.g., a higher cost manager who is deemed to provide value, or a higher cost product that provides additional worthwhile guarantees), but also because advisors are entitled to get paid as well. Which matters because many products effectively include two components of cost: the first is the "true" underlying cost of the fund/product (e.g., the portion of the expense ratio that goes to the investment manager); and the second is the "distribution" cost that compensates the advisor themselves (e.g., the 12b-1 fee). Which matters because the Department of Labor is focusing primarily on advisors managing the "true" underlying costs, not to minimize their own compensation (which must be "reasonable" but certainly doesn't have to be the lowest cost available). In other words, when advisors document their due diligence on a fund to determine that its costs were appropriate, they should look at the costs not including 12b-1 and other commission/distribution charges (though they must still separately affirm that their compensation is reasonable). This also means that it's not always necessary to use a lowest-cost advisory share class (and stack an advisory fee on top), as using a higher-cost share class that pays the advisor is a permissible way to get paid (as long as the "true" cost, excluding the advisor's compensation, is still comparable to the other share class options).
Quasi-Independence: The Super-Sophisticated Boutique Model Taking The Industry By Storm (Mindy Diamond) - The early adopters of the independent RIA model often had a hunger for true independence, and reveled in the opportunity to have full flexibility to make any decision they wished about how the firm would be structured, what technology it would use, and how it would deliver its services. As the RIA model has grown, though, it's become increasingly clear that a material subset of advisors would likely prefer something more akin to "quasi-independence", closer to the experience of working for an independent broker-dealer rather than being responsible for running their own. Over the past decade, a number of firms have stepped up to fill this void, starting with HighTower back in 2008, and more recently including firms like Dynasty Financial, Snowden Land, and Steward Partners, in a movement that Diamond dubs "quasi-independence", for those who want more autonomy than a broker-dealer, but don't necessarily have a need for (or want the responsibility of) total independence. As it stands now, these quasi-independent advisor platforms have a number of common traits, including: they offer W-2 employee models; they pay aggressively in recruiting deals (often a mix of cash and equity); they typically offer partnership equity (and thus a meaningful seat at the table for building the firm); they provide third-party custody services via an institutional custody (e.g., Schwab or Fidelity); they have access to more boutique investment solutions; they help arrange and provide "cutting edge" technology; they have strong balance sheets (often backed by private equity or affluent founders); and they replace the compliance and back-office support that wirehouse advisors are already accustomed to relying on. The biggest caveat is simply that there are so many new entrants approaching the space, that there's a risk that not all the newcomers will successfully survive and thrive, leading some advisors to at least focus on the more experienced and established firms that have already reached critical mass (though obviously even if the support firms fail, the advisors themselves still have a relationship with a custodian and their client relationships to rebuild around). But with more wirehouse brokers breaking away towards independence, but not necessarily wanting the burden of "total" independence as a standalone RIA, the quasi-independent movement appears to be a growing trend.
New Millennial Archetypes Advisors Should Keep In Mind (Christopher Robbins, Financial Advisor) - With at least some advisory firms looking to start serving "next generation" clients, there has been an increasing focus on finding the so-called "HENRY" client... short for one who is a High Earner [but] Not Rich Yet. The idea is that such clients will at least be capable of saving aggressively over time, and accumulating the kind of dollars that make them "good" advisory clients in the future. Yet in a recent study of Millennial investors from SEI, it turns out there are several other Millennial archetypes worth considering as well (who may have different needs than the HENRYs). One is MARG (the Mom-Assisted Recent Grad), who may actually be earning a healthy (and upwardly mobile) income, but won't be putting money into any investment products for a while to come, as they're still working down substantial levels of (typically-student-loan) debt... yet the firm could perhaps still begin to connect with them by providing some group programs that help MARGs to develop a budget, pay down their debt, and begin to build their net worth. The next archetype is CHIP (Career-focused High Income Potential), who is an older Millennial (e.g., 30-something) in a mid-career stage with a growing net worth (e.g., $100k to $250k in investable assets) who historically was likely self-directed but may be starting to feel the pressures of family, career, complexity, and the big life events that start to come (and in fact, they're more likely to want advice about those life events, from starting a family to starting a business, than what to do with their investment portfolio). The last archetype is DREW (Debt Ridden Emerging Wealth), who may have more assets and higher income than Marg or Chip, but is also carrying a much larger debt load (e.g., a 30-something high-income doctor or lawyer who already has accumulated material assets but may also still have 6-figure debt balances), and would be best served with an ongoing retainer model (that might convert to an AUM model later as debt is repaid and assets accumulate further).
Three Steps To Dramatically Happier Clients: Lessons From The Airline Industry (Dan Richards, Advisor Perspectives) - All advisory firms have some subset of clients that are their "best" clients... the ones who are the most profitable, or most influential and able to help drive the growth of the business, to whom the firm would be well served to provide special treatment and additional services to deepen the relationship (and hopefully better retain and/or generate more referrals from them). Yet Richards notes that most advisory firms do a poor job of clearly identifying who their top clients are, much less effectively grouping them together in order to give them special treatment, and figuring out what would be a valuable and differentiated experience for them. When it comes to identifying the best clients, Richards notes that it is about more than just their AUM or the revenue they generate, as other relevant factors could include their age (how long will they likely be a client?), whether they're growing or shrinking (i.e., still saving or already withdrawing), are they a center of influence that could drive additional referrals (and/or have they already provided referrals), are they very demanding in terms of time (or a compliance risk?), and are they engaging you for deeper services (e.g., financial planning) in the first place? Ultimately, you may even end out with a matrix of relevant factors, to which clients can receive scores in various categories in order to determine who falls into which tier and begin to segment them. Once that's done, you can then really focus on the common factors that fit your top 10% of clients, and really try to differentiate and elevate the experience you provide them. For instance, the airline industries have recently taken a renewed focus on this, rolling out automatic upgrades and by-invitation VIP lounges for their very top tier flyers, shuttles to take them directly from the lounges to their planes, along with other special concierge services. By contrast, for many advisors, even when they run "client appreciation" events, their top clients are often the no-shows. So consider what you need to do to really connect with your most valuable clients... such as: drive to meet them at their business or home (instead of making them come to your office); add concierge services (e.g., bill paying for elderly clients, or even their elderly parents); offer programs for their kids or grandkids; express gratitude by giving charitable donations (or charitable matching) to their charity of choice (which can avoid the otherwise-applicable compliance gift limitations since the client never receives the money); or consider doing a more high-profile event that brings in a special guest speaker (but only for your select group of top clients).
Wanting Less By Buying Less (Michelle Richmond, Medium) - The great boon of the internet is that it makes it so much easier to buy things... with the caveat that the moment you do, you're on the retailer's mailing list, which often gets shared with other retailers, and means that the decision to buy something is often also an indirect commitment to receive dozens of solicitation emails to buy even more for the indefinite future (which means even if you resist 99% of those emails, you'll still be prompted to buy a lot as one sale offer after another comes through). And of course, the process is also time-consuming (or time-wasting!?), perhaps expedited by the willingness of the company to "conveniently" save your credit card information online (which ultimately just exacerbates the impulse-buying problem). In fact, it's important not to underestimate the time-consuming aspects of buying online, from the time to find your old password and log in, to the time it takes when you end up wanting to return the item anyway (with even the friendliest free return policies still requiring you to package the return, print the label, and drop it off at the post office, where you'll likely wait in line to make sure you get a receipt in case the return is "lost"). Thus, Richmond suggests that the best option to break the cycle is simply to stop buying online in the first place; after all, once you don't buy online, you save both the time of shopping (and returning), and reduce the ongoing bombardment of more email sales solicitations to repeat the process. Or stated more simply, the less you buy, the less you'll be tempted to buy more. And of course, the less you focus on finding enjoyment from other areas besides shopping, the less you may even feel you need to buy in the future anyway. Which means in essence, the less you buy, the less you may find you even want in the future anyway?
Success By Exhaustion (Nick Maggiulli, Of Dollars And Data) - Despite the common focus on the importance of strategy and execution, many challenges are often overcome by sheer brute force. From World War II (where the Allies won in part because they had 38 gallons of gasoline for every one the German did, and therefore simply could do more in the battles), to the fact that IBM famously won an antitrust case with the Department of Justice by just sheerly overwhelming them by paper and a brute force ability to do more and work harder than their opponent, often it's just the ability to engage in a sheerly overwhelming effort that leads to success... or what Maggiulli calls "success by exhaustion" (i.e., exhausting the resources of the enemy, or more generally making whatever it is that opposes you overwhelmed to the point of irrelevance). Which is a principle that can actually be applied in the context of personal finances as well. A classic case-in-point example would be the decision to stop trying to buy the "right" stock that goes up, and just own all of them instead (i.e., by buying an index fund, which is effectively a brute force methodology to picking the "right" stocks). Another example is the impact of saving more on your necessary rate of return to retire. For instance, those who "only" save 10% of their income, it takes almost 75 years to retire with a 4% return, but only 40 years to retire with an 8% return, and about 32 years with a 10% return, which makes it crucial to invest successfully; however, for those who save 50% of their income, it takes only about 20 years to retire with 4% returns, and 12 years to retire with 10% returns, which means the higher savings rate literally makes the return less relevant in the first place (and for those who can save 80% of their income, the difference in returns barely moves the retirement date by more than a few years). Of course, not everyone has the capability to engage in such "success by exhaustion" brute force strategies; yet on the other hand, for a subset of "extreme early retirement" advocates, these kinds of brute-force approaches (with frugal living and extremely high savings rates) are precisely how they're able to find early and rapid retirement success (and a growing number of advisors adopt the approach, at least when it comes to stock-picking-via-index-funds).
Things Worth Spending Max Money On For A Better Life (Financial Samurai) - One of the benefits of frugality is that it facilitates extremely high savings rates, along with reducing retirement savings needs, which in turn makes it possible to retire relatively early. And the frugal behavior often continues into retirement, whether driven by a fear of running out of money, or simply because the "habit" of frugal living can be very difficult to break. Yet as Sam points out, a lifetime of frugal living may ultimately reduce your happiness, as eventually there's more than enough money to ensure a secure retirement, and while money doesn't equal happiness, there is evidence that at least some types of spending can actually improve our happiness (even if it reduces your money/account balance a little!), particularly when it comes to spending on experiences. Yet the reality is that arguably, there may be a little happiness to be derived by buying some "things", too, and at least upgrading a little on quality... including: your mattress (if you're going to spend about 1/3rd of your lifetime sleeping, do it on the most comfortable and supportive mattress you can afford!); your work clothes and shoes (and then wear them often, which both reduces your clutter, and higher quality clothes tend to last longer anyway); baby care products (make them comfortable, as we live in amazing times!); sports equipment (if you're serious about enjoying a sport, get the equipment that gives you the best chance to actually succeed at it!); prime property (given how much time you spend in your home, you should enjoy it, and in practice prime property at least tends to hold its value better anyway); home appliances (from shower heads to your bath tub or hot tub); your home theater system (which you might make back on the money you never spend by going to the movies anymore!); your mobile phone (you check it 80 times a day, you may as well have a good one!); quality food (you only get one chance with the body you have!); car safety; and health and wellness. And when you get around to taking a vacation, spend what you can for the best adventures, because those really are the experiences that tend to bring the most happiness, too! Stated more simply, though, the key point is simply that once you do have enough, it's time to start letting go of sheer frugality, and at least considering an attitude of focusing more on quality than just price alone.
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.
The purpose of affluence is to be able to buy, without inhibition: eyeglasses, snow tires and dental implants.
Great, article Michael. Perhaps you can check out my article that was just published in the February 2018 Issue of the Journal of Accountancy on how clients should approach managing education planning and retirement planning simultaneously.
https://www.journalofaccountancy.com/issues/2018/feb/retirement-and-education-planning.html