Weekend Reading For Financial Planners (July 16-17)

Investors Have Filed 37 Reg BI Claims Against Brokers This Year, FINRA Says

(Tracey Longo | Financial Advisor)

The Securities and Exchange Commission (SEC)’s Regulation Best Interest (Reg BI), issued in June 2019 and implemented in June 2020, requires brokers to act in their clients’ best interests when making an investment recommendation, by meeting four core obligations: disclosure, care, conflicts of interest, and compliance. But because regulations need to be enforced to change the behavior of market participants, industry participants have been eagerly awaiting enforcement actions that will help ensure brokers comply with the regulation.

The SEC brought its first enforcement action under Reg BI in June, and it now appears that Reg BI-related arbitration cases are on the rise at broker-dealer regulator FINRA, about two years after the rule was implemented. In fact, Reg BI-related cases have broken into the top 15 controversy types of arbitration cases filed this year through May, with 37 such cases (the most common categories are breach of fiduciary duty, negligence, failure to supervise, and breach of contract). In one of these cases, a group of 18 complainants alleged that Cabot Lodge Securities LLC violated Reg BI’s care and conflict of interest obligations when it sold retirees in their 60s and 70s high-risk L bonds (the same products cited in the SEC’s first Reg-BI enforcement action) between 2020 and 2022.

And so, these arbitration cases, combined with the SEC’s first (and potentially future) enforcement actions, are likely to increase public awareness of Reg BI and encourage broker-dealers and their brokers to abide by its measures. Nevertheless, because the SEC has yet to define what “best interest” means, what conflicts need to be mitigated, or how to mitigate them (although additional guidance might be on the horizon), brokers and investors will continue to await further clarification of what Reg BI means in practice! Though, in the meantime, to the extent that the SEC does not clarify – and more aggressively enforce – the ‘Best Interest’ standard under Reg BI, it appears that aggrieved clients and their attorneys are increasingly taking the matter into their own hands, instead!

High-Income Business Owners Are At Center Of Fight Over Biden's Tax Plan

(Laura Litvan and Laura Davison | Bloomberg News)

Since 2013, advisors and some of their clients have had to grapple with the Net Investment Income Tax (NIIT), a 3.8% income 'surtax’ (whose proceeds are used to bolster Medicare) on certain net investment income of individuals (and estates and trusts) above certain thresholds, along with a 0.9% surtax on employment income (which, coupled with the 2.9% Medicare tax on employment income above the Social Security wage base, also adds up to 3.8%). However, S corps – and specifically, the dividends from S corporations – have enjoyed a unique exemption from these taxes, being treated neither as “investment income” (since the dividends pertain to a pass-through entity), nor as “employment income” (as S corporations distinguish between owner wages taken as salary and owner dividend distributions).

President Biden’s “American Families Plan” tax proposal, released last September, sought to change this by including S corp profits for owners whose income exceeds their applicable threshold (originally Modified Adjusted Gross Income exceeding $400,000 for single filers and $500,000 for joint filers) in the NIIT calculation, subject to a phase-in range. And while several other aspects of the “American Families Plan” have been dropped in the course of negotiations (e.g., raising the top tax bracket and increasing capital gains rates), the extension of NIIT to S corp profits has remained in play (along with other proposed measures, such as a 5% surcharge on incomes over $10 million, and an additional 3% tax on incomes over $25 million).

While still under consideration, the proposed extension of the NIIT to S corp income appears to be facing hurdles to being included in the final legislation. Opposition has come from business groups, which argue that the change would harm many small and family businesses that operate on a pass-through basis. Because Democrats will likely need the votes of all 50 of their senators to pass the measure (and related taxation and spending provisions in the plan), any defection could scuttle the legislation. Democratic West Virginia Senator Joe Manchin, who has served as a swing vote on many issues, said this week that the S corp proposal should be analyzed to make sure it does not fuel inflation or harm taxpayers (though more recent comments suggest that he now opposes the measure).

While it remains to be seen whether the S corp measure and other tax-related proposals will make it into the final legislation, the Democrats’ ability to fast-track the bill in the Senate expires on September 30, suggesting that advisors and their clients will have a better idea of potential changes to tax laws by then. And while it might be premature to take action given the uncertainty surrounding the legislation, advisors can consider which of their clients might potentially be subject to the change to the NIIT and what income-planning measures (e.g., using retirement plans and other tax-advantaged mechanisms to remain below the income thresholds) could be used to reduce their potential future tax burden!

Link to RIAs Is Most Compelling Angle Of The KWAC SPAC Deal

(Bruce Kelly | InvestmentNews)

Special-Purpose Acquisition Companies (SPACs) have received significant attention during the past few years, thanks in part to the dramatic rises (and sometimes equally dramatic falls) in their value. SPACs are publicly listed companies whose aim is to merge with a private company, thereby making it public without going through the Initial Public Offering (IPO) process. SPACs have acquired companies in a range of industries, and a broker-dealer aggregator appears to be the latest target.

Wentworth Management Services, an aggregator of small-to-midsize broker-dealers, said last week that it intends to go public by merging with the SPAC Kingswood Acquisition Corp. (ticker symbol: KWAC) and operate under the new umbrella of Binah Capital Group. A spokesperson for Kingswood said taking Wentworth public would allow the company to take advantage of industry consolidation, though further details of the company’s plans are sparse. Kelly suggests that one of the notable aspects of the deal is that one of Wentworth’s subsidiary broker-dealers, Purshe Kaplan Sterling Investments, has been active in working with breakaway brokers that start their own RIA, providing these advisors with a place to hold their commission-based brokerage assets (e.g., variable annuity contracts) that cannot easily be placed in an RIA’s fee-based account. This suggests that in addition to purchasing broker-dealers outright, the newly merged company could use public market capital to further attract assets from breakaway brokers.

As the number of brokerages continues to decline amid consolidation and the transition of many registered representatives to the RIA model, broker-dealers and consolidators could be looking for fresh capital to build their businesses. And while traditional capital-raising techniques (e.g., an IPO or issuing debt) remain possibilities, the relative success of the upcoming Wentworth SPAC merger could give firms a window into the viability of another outlet for raising cash (and potentially give brokers additional options for breaking away!).

The Advantage In Bear Markets Of Having Tiered Advisory Fees

(Scott Hanson | InvestmentNews)

The current bear market has taken a significant bite out of investor portfolios, but it has also negatively impacted revenue at many advisory firms. In particular, firms that charge clients on an Assets Under Management (AUM) basis can see significant declines in fee revenue when the value of client portfolios decline (of course, many of these firms benefited from the dramatic market gains of the past decade!). In recent years, the volatility of AUM-based revenue has steered some firm owners to consider alternative fee structures to help soften the blow of future market downturns, though Hanson notes that simple changes to the structure of AUM fees can also help to manage the impact.

In its early days, the AUM-based advisory firm simply charged a fixed percentage fee on all of a client’s assets it managed. For example, a firm might charge a fixed 1% fee on all client AUM. In this scenario, a client with a $1 million portfolio would pay 1% X $1,000,000 = $10,000 per year. But this means that a 10% drop in the value of the client’s portfolio to $900,000 would lead to a proportional 10% decline in the fee they pay (1% x $900,000 = $9,000).

In more recent years, it’s become increasingly common to set AUM pricing ‘tiers’ based on certain levels of client assets, in large part to recognize that a client with double the assets doesn’t necessarily require double the work (and therefore shouldn’t be charged double the fee). But as it turns out, tiered fee structures have a secondary benefit: they help to mitigate the revenue impact of bear market declines.

For instance, a firm might charge 1.5% on a client’s first $500,000, and 0.5% on any assets above $500,000. A client with a $1 million portfolio would pay the same $10,000 fee as under the single fee structure (1.5% x $500,000 + 0.5% x $500,000 = $10,000). But now, if their portfolio declines by 10% (to $900,000), their fee would ‘only’ decrease to 1.5% x $500,000 + 0.5% x $400,000 = $9,500, bringing the firm an ‘extra’ $500 of revenue compared to charging a 1% fee on all assets (although this works in reverse as well, as an increase in the portfolio’s value would have a smaller positive impact on the fee under a tiered structure compared to a fixed percentage basis).

Another option for firms to insulate themselves from market downturns is to operate on a retainer fee basis, at least for a base ‘minimum’ level of fees (and the associated minimum level of service that every client receives). For example, a firm might charge a $5,000 annual retainer fee no matter the client’s assets, or instead at least charge a $2,500 retainer plus 0.75% of all client AUM (which would still amount to $10,000 of revenue for a $1M AUM client), or even combine a fixed retainer with a tiered AUM structure! By using the retainer as a form of minimum fee, which remains the same no matter the performance of client portfolios, firms can insulate at least a portion of their revenue from market swings.

Ultimately, the key point is that while charging based on AUM can be an attractive fee model when portfolio values are rising, it can lead to a frustrating drop in revenues during periods of weak market performance (especially considering the amount of work for advisors often increases during periods of market stress!). With this in mind, while the midst of a bear market isn’t necessarily the best time to re-price with clients, firms can consider changing their fee structure in the future to better smooth revenues, whether it is using a tiered AUM model, using retainer fees to set a minimum base fee for all clients, or even other fee structures!

Inflating Cost Or Service? How To Survive The Margin Squeeze In Your Advice Business

(Carl Woodward | IFA Magazine)

The current period of weak market returns and high inflation has been a double-whammy for many advisory firms: at a time when fee revenue has taken a hit from declining portfolio values, expenses have risen, tightening firm profit margins. To weather the storm, some advisory firms might be tempted to reduce labor costs (typically the largest expense line item for firms) by cutting staff. But given that client demands often increase during market downturns (whether it is fielding calls from worried clients or implementing strategies to take advantage of the situation), reduced staffing could severely degrade client service levels (and hinder firm growth in the long run). Instead, Woodward suggests that firms focus on three key activities: servicing clients in the most efficient way; being compliant and operationally robust; and simplifying the firm’s client value proposition.

Increasing client service efficiency could mean embracing digital capabilities (reducing the time needed to process physical paperwork), adhering to a mantra of doing tasks right the first time (to prevent costly re-work), and/or removing ‘process waste’ (activities that aren’t adding value). In addition, by focusing on a culture of compliance, firms can reduce the risk of costly regulatory infractions. Also, ensuring that the firm’s operations are resilient can help prevent a loss of client confidence (and potentially revenue) were an emergency to occur.

Firms can also consider simplifying their client value proposition to focus on the activities that drive revenue and client satisfaction. This could include removing any areas of the client proposition that are complex or difficult to administer; ‘firing’ clients who are not cost effective for the firm; and ensuring that client interactions (both written and verbal) are easy to understand so that they do not need to be repeated.

The current market and inflationary environments have been stressful for both advisors and clients alike. And while some margin deterioration might be inevitable for firms, those that best improve their operational efficiency and compliance while focusing on the elements of the firm’s value proposition that drive profits while maintaining a high standard of service could be the most likely to not only make it through the current period but also thrive when market and inflationary conditions (hopefully) improve!

Too Many Clients

(Morgan Ranstrom | The Value Of Advice)

Whether it is an advisor starting their own firm or an established firm looking to grow, it can often be tempting to take on as many clients as are willing to sign on the dotted line. And while advisors are likely to consider the time and monetary costs of bringing on a new client, new clients can take a psychological toll as well.

The concept of “Dunbar’s number” refers to an estimated psychological limit to the number of people with whom someone can maintain personal relationships. Based on research on human social groups and non-human primates, British anthropologist Robin Dunbar estimated that humans can only handle maintaining close, personal relationships with up to about 150 people (after that, our brains can’t keep track of everyone). For example, even if someone has 1,000 Facebook ‘friends’, it’s unlikely that they will be able to have a close relationship with most of these individuals.

For financial planners, building and maintaining relationships with clients is a key part of success. But because advisors are not immune to Dunbar’s number, this means that each close client relationship potentially means that an advisor will be able to maintain one fewer personal relationship outside of work. This suggests that advisors can strike a balance between their number of client relationships (which are necessary to earn a living, and can be rewarding on their own) and personal relationships (which make life more enjoyable).

One potential solution for advisors is not just to limit the number of clients they have, but to reduce the types of clients they have. Because while operating as a generalist opens the door to a broader pool of potential clients, it also expands the range of issues they face. Instead, focusing on a niche can reduce the mental strain required to work through client issues, opening up psychological space for relationships outside the office. In the end, because advisors (who are humans too!) can only handle so many close connections, working with clients with similar issues can help create a positive balance between work and personal relationships!

What The Next Generation Of Millionaires Want From Their Wealth Management Firm

(Tiffany Ap | Quartz)

Estate planning is an important part of the financial planning process and, among other things, ensures that a client’s assets go to their desired recipients upon their death. Because clients often leave significant amounts of money to their children and grandchildren, advisors often view these heirs as prospective clients. But it’s important for advisors to recognize that these younger generations (whether their wealth came from an inheritance or other means) often have different preferences than older clients.

A recent survey by consulting firm Capgemini of nearly 3,000 individuals with at least $1 million of investible assets found that millennials coming into wealth are more sensitive to fees than older generations. This is particularly the case during a bear market, when market losses can make these clients even more aware of their advisor’s fee being taken out of their portfolio. In fact, about half of millennials surveyed said they had changed their primary wealth management firm in the past year, with high fees and lack of digital expertise among the top reasons. According to the report, many of these investors value a ‘hybrid’ approach that combines personal service from humans with advanced digital tools.

Another trend in the evolution of wealth is the increasing amount of wealth controlled by women, the result of a combination of increased earnings for women and the tendency for women to outlive their male spouses and take full control of family finances. This could create an opportunity for firms who are able to focus on the specific needs of female clients (whether they are building wealth or experiencing a major life transition).

Ultimately, the key point is that the needs and preferences of clients across generations can vary significantly. This increases the importance of learning what an advisor’s target client is looking for in the relationship and how advisors can best leverage their strengths and take advantage of technological tools to better serve their clients!

Wealthy Millennials Have High Degree Of Trust In Advisors: Survey

(Michael Fischer | ThinkAdvisor)

Many financial advisors focus their marketing efforts on pre-retirees and retirees, who are often perceived to be in the most need of an advisor’s services and have the assets to pay an advisor’s fees. But the incomes and wealth of younger generations are growing, presenting an opportunity for advisors who best understand their needs.

According to a survey by RBC Wealth Management of 750 millennials with either more than $1 million in investible assets and 250 millennials with household incomes of at least $250,000 or between $100,000 and $999,000 in investible assets, millennials have a high degree of trust in financial advisors. Looking at the data, 59% of respondents reported difficulty finding time to manage their finances while juggling multiple responsibilities (perhaps creating an opening for an advisor to support them). In addition, 72% of participants said that they are unsure what to do next after paying off debt, saving for an emergency fund, and maxing out their 401(k), suggesting there is room for advisors to provide guidance.

Notably, nearly 85% of respondents said it’s important to consider Environment, Social, and Governance (ESG) data as part of their investment decisions and 92% said it is important that their current or future advisor be knowledgeable about how to utilize ESG data while recommending an investment. Further, 84% of those surveyed said they would choose to leave a financial advisor if they were not knowledgeable about ESG.

This survey suggests that wealthy millennials are amenable to working with a financial advisor who is able to take financial management responsibilities off of their plate and in a way that aligns with their values. And so, amid the growth of wealthy, “HENRY” (short for High Earner, Not Rich Yet), and “EWAN” (Earners Wanting Advice Now) demographics among the younger generations, advisors who can meet their needs with innovative fee and service models could build client relationships that last for decades to come!

High-Net-Worth Investors Weigh In On Marketing That Works

(Charles Schwab Advisor Services)

Marketing is a challenge for many advisors, whether it is through their websites, social media, or using paid services. And crafting a message that demonstrates both experience with and understanding of a prospective client’s issues can be particularly challenging. With this in mind, a recent study asked wealthy investors what types of advisor marketing would be attractive to them.

According to Charles Schwab’s 2021 Marketing To High-Net-Worth Investors Study, which surveyed 25 investors with at least $1 million in investible assets, marketing that shows an interest in who the prospects are can be particularly effective (more so than financial models or historical data). This can be accomplished by including questions regarding their personal circumstances (e.g., What keeps you up at night?). In addition, those surveyed preferred a marketing approach that was most interested in their goals rather than the financial transactions potentially needed to get them there. Further, respondents were put off by advisor marketing that included financial jargon (basis points, anyone?), which can be confusing to even sophisticated investors.

The study also found that the word “fiduciary” can be confusing to clients, many of whom assume that their advisor is a fiduciary and that all advisors hold themselves to this standard. This suggests that an advisor noting they are a fiduciary might not be a significant differentiator in the minds of prospects.

In the end, the study suggests that prospects are looking for advisors who put their clients’ interests first and are primarily concerned with helping their clients achieve their goals. This suggests that rather than offering answers upfront, advisors can be more successful in marketing by first asking more questions!

Help Your Team (Actually) Work Smarter, Not Harder

(Mita Mallick | Harvard Business Review)

Working hard has long been seen as a positive attribute in American work culture. But working too hard or always striving for perfection (rather than ‘good enough’) can lead to burnout and actually reduce productivity. With this in mind, managers can take several steps to help ensure their employees (and themselves) remain engaged in their work without burning their candles at both ends.

The first step for managers is to scope out the work for big team initiatives. This could include setting clear end dates for large initiatives, assigning approximate hours for key project milestones, and coaching employees if they’re spending too much time on a specific task. And while managers will want to avoid getting so deep in the weeds that they are seen as micromanaging the project, providing helpful guidance and direction can ensure that the team is all on the same page and that deadlines are being met.

Managers can also observe their team members for signs of perfection-chasing that could lead to burnout, health problems, and potentially quitting their jobs. In addition, leaders can set an example for their employees by sharing how they prioritize and focus on working on the things that impact the business the most. Because at the end of the day, ‘done’ is often more important than ‘perfect’.

Leaders can also play a facilitation role, connecting team members with resources and employees in other departments to help them get their work done. This requires managers to both create a work culture where it is ok to ask for help, and to have an awareness of the individuals and resources available in other parts of the company.

Given that financial advising often lends itself to ‘maximizing’ the financial situation for clients, it can be tempting to get plans ‘just right’. And there can be particular pressure on junior employees, who might be seeking opportunities to move into a lead planner role and don’t want to be seen as someone who makes mistakes. For these reasons, leaders at financial planning firms have an important role to play to not only help their teams work smarter for the firm’s sake, but also for their employees’ wellbeing!

You're The Chief "Unblocking" Officer

(Khe Hy | RadReads)

Financial advisory firm leaders often have a range of responsibilities, from managing employees to often serving their own clients. With only so many hours available in a given day, many leaders might wonder what is the best way to prioritize their many potential tasks.

Hy suggests that the most valuable projects a leader can work on are those that are both high-skill and high-leverage. Under this framework, the most important tasks for a manager are those that ‘unblock’ other employees from completing their own tasks. Even if the manager has a project of their own that might be more valuable than any single task of their employees, ‘unblocking’ employees can allow them to get started on projects that can have a combined value greater than the manager’s single project.

For advisory firms that start with a solo owner, adding (and managing) employees can reduce the owner’s ability to concentrate on their own work. But it is important for them to find high-leverage unblocking opportunities that allow the employees to complete their own high-value projects. For example, this could mean that a senior advisor spends an hour reviewing three draft plans prepared by associate advisors so they can be finalized and sent off to clients before preparing a plan for their own client.

The key point is that while leaders will often feel challenged to balance their own work with managing their employees, by finding tasks where their expertise is needed to unblock others to do their own high-value projects they can create a multiplier effect that is likely to ultimately benefit the firm’s bottom line!

Role Model Power

(Matt Oechsli | Oechsli)

Many people have role models they look up to over the course of their lives. Whether it is their wisdom, kindness, leadership, or other attributes, role models can inspire us to be better people ourselves. And taking a structured approach to selecting role models and their admirable attributes can make it more likely that you will make the changes needed to follow in their path.

The first step is to select a role model. This could be an experienced advisor, family member, prominent businessperson, or someone from history. Note that it’s ok for role models to come and go over time; while you might have looked up to a famous singer or athlete as a kid, you might now focus on professional role models (although athletes and singers are still fine role models for adults too!).

The next step is to write down all the qualities and characteristics that make this person special to you. This could be anything from perseverance to compassion to loyalty to a good sense of humor. After you have a thorough list, label each trait as either an inner quality (those acquired from life’s lessons) or school quality (something was learned in the classroom as the result of being taught). Many people find that the majority of their role model’s characteristics are inner qualities, meaning that no special training or skills are needed to achieve them.

Finally, select three qualities or characteristics from your list to improve. While you might have listed 10 or 20 traits, it can be challenging for humans to pursue many objectives at the same time. By selecting three, you can put all of your focus into those, and, once you believe you have mastered them, move on to another three characteristics. In the end, whether you want to be a better leader, advisor, family member, or friend, looking to role models is a great place to start!

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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.