John Lefferts' Blog

Monday, August 16, 2010

Dear Bob...

Back in June I wrote a post that spoke to the "Carnac's" of financial services about the financial industry writers who are predicting the future. One of the writers I referred to was Bob Veres who wrote an excellent white paper on how he sees the future unfolding for the investment advisory segment of the business (see web site to download a free copy: Last week I jotted down a response to Bob's paper and sent it to him. While we agree on most points, my point of view differs where it refers to the large retail sales oriented shops, largely due to my upbringing in the business. Anyway, in case you have a sleepless night and need some reading material, I thought I'd post my comments here:

Bob Veres

1804 Garnet Avenue, Suite 510
San Diego, CA


Over a month ago I read your latest epistle “The future of the financial advisory business” and found it to be extremely helpful as we all try to anticipate where the business is headed. You’ve solicited feedback from your readers and I thought I’d give you my “two bits” here. The seminal event of the Great Recession has, as you pointed out, accelerated the evolution of the business. The business had already been evolving with trends towards the independent models and fees. Whether you call it a “Big Bang” event or a “Perfect Storm”, whatever name we want to place on this uniquely harsh recession, it has set in place drivers of change that will shape and mold the business in ways unforeseen or expected just a few years ago.

As a quick frame of reference, let me tell you about my background since I may not fit the typical mold of your readership who, from what I can tell, are highly academic, passionate about their fee only-RIA slice of the business and very protective of their sacred fiduciary turf: I started my career with an insurance based company, The Equitable, in the early 80’s in my hometown of San Diego. While I was definitely in a sales driven-product push system, I was drawn early on towards the needs based approach of gathering info-setting goals, preparing financial modeling to meet those goals and making recommendations across all lines of products to achieve the financial/life goals of the client. I guess today we would call that financial planning. I earned my CFP in ’87, moved to Texas to run a branch in the system in ’89 and secured my ChFC in ’90 and CLU in ’91. Through the 90’s I built a branch of 300+ professionals with the same needs based approach, albeit on a sales based platform. Then in the late 90’s, under a new moniker of AXA Advisors, LLC, I headed up a pilot program throughout the state of Texas to scale out “fee-based” financial planning changing our licensing from series 6/L&A to series 7, 65 and 24 for managers. We also changed their product set (asset management accounts/fees), recognition, compensation, and training away from the sales driven culture towards process based planning. I recall reading your newsletter back then in your “early warning“ section citing the apocalyptic event of a bunch of AXA insurance sales guys attempting to highjack the financial planning business. I knew we must be doing something right if we had hit your radar back then, even if it was less than complimentary.

Anyway, the planning pilot worked famously. We invested about $30 mill in huge state of the art (archaic by today’s standards) mainframe computer and operational infrastructure known as “The Financial Planning Center” to centralize the back-office and provide quality control. It was highly successful in Texas, so we decided to roll it out nationwide. A new incoming CEO asked me to come to NYC in ’01 to be Pres. /CEO of AXA Advisors and keep the ball rolling. But as we all know, a big event occurred on 9/11/01 that changed everything. The focus of the business moved from pursuing a growth strategy via financial planning to survival through cost cutting and re-focusing the field force on profitable products and services (read proprietary sales) during this challenging economic period. We spent the next several years taking down the planning infrastructure we had built with the marching orders to cut over $50 mill from the system. Some in the business think AXA dropped the Financial Planning strategy because it didn’t work…not so. It was dropped because it was an easy save in a post 9/11 environment while the CEO moved towards a more profitable product driven strategy, namely moving variable annuities through as many distribution channels as possible. Throughout this past decade, AXA has reverted back to the old days of product push (although there are some planning holdouts) and in ’09, I decided to separate as I no longer saw eye to eye with the leadership.

This past year I’ve been on the sideline observing and evaluating the business with the intent to “skate to where the puck is going”, to put it in hockey terms. Aside from reading everything I can find about the business and its direction, I’ve spent most of my time working with several NYC based Private Equity firms evaluating the possibility of a new distribution model that fits a post FinReg environment. Frankly, I’m agnostic as far as the financial services business models are concerned as my point of view is no longer driven from where my paychecks come(compensation definitely does drive behavior). But, I do have my life experiences that mold my point of view which is why I gave you a snapshot here. And while in your paper you intentionally come at it from the fee only RIA perspective, my feedback looks at the business on a more global basis encompassing not only RIA’s, but all other financial services business models such as Independent B/D, Wires, Insurance based B/D’s, Brokerage General Agencies (BGA’s), Fixed Insurance agents and the many combinations in all of the above. I think they are all inextricably linked, good, bad or indifferent. It’s my belief that over time, the business models will shrink in number, grow in size and cut across multiple disciplines (risk mgt, asset mgt, estate transfer, retirement planning, etc) as regulations will finally allow for them to evolve and develop on the same platform without regulatory silo’s.

You refer to Mark Hurley and his 1999 white paper a great deal. I was in Hurley’s office about a year ago to get his point of view on where he sees the business headed on my quest to peek into the future. He’s a freaking brilliant guy, but his ego would not let him admit that he may have gotten it wrong back in 1999. Like many, I bought into the vision that the business would converge into about 20 Citigroup styled players all squashing the little guys. As we now know, it didn’t happen and in my view, while the repeal of Glass Steagal opened the door for financial entities to play in one another’s backyard, the regulatory silos of FINRA, SEC and state insurance departments remained in place preventing any real change in the business models. Regulations remained the same where lines were drawn by product (securities/insurance/advice) that did not enable the convergence to take place as prior envisioned. But that’s all about to change…

Of all the drivers of change the Great Recession has ignited, none will be more impactful than the move to harmonize all those who give “personalized investment advice” to be regulated by the same entity under a fiduciary standard. If this goes down the way it appears to be headed, the wheels of change formerly locked by regulatory silo’s will be in full motion.

So with all this as a backdrop, let me say what I do agree with regarding the white paper:

The emerging landscape will be “alien to their business models”: I find it perplexing how few practitioners, whether they be fee only RIA’s or registered rep’s of large B/D’s, have little interest in and knowledge of the sea change about to occur. They are so entrenched in keeping their head above water to survive with their clients that they haven’t had the opportunity to take a breather and recognize the changing landscape surrounding them. They just keep on-keeping on in hopes that the world will change to fit their particular model since they don’t have the time or energy to transform. Most are simply “whistling through a graveyard” and paralyzed to make any adjustments at all.

The highly fragmented and micro-business element of the RIA world will change: I think I read where over 70% of RIA’s are one person shops. I know RIA’s don’t want to hear it preferring to use a “just trust me” approach, but they’re about to have a whole heap of regulations, paperwork, compliance manuals, etc. thrust on them. I know principal based is different than rules based regulation, but in my view, RIA’s will trend more towards rules based regulations albeit being held to fiduciary rules. These one person shops will either be forced to affiliate with a firm with the compliance infrastructure to handle this (and perhaps supervise it), or decide to close up shop. I agree with the comment “the sole practitioner could meet the same fate as the family doctor”

Where it was once thought that scale provided an advantage for technology, it is now a disadvantage: Totally agree. The $30 mill Financial Planning infrastructure we built in the late 90’s could be done today bigger, better, faster for less than 1% of that cost. Most large firms are handstrapped with legacy systems that don’t communicate with one another and are hesitant to write it off and start over. It’s actually an advantage to start-ups who can buy systems and support off the shelf.

The average age in the profession points to a “Great Transfer”: Not only are owners in these business models reluctant to sell, or give up control, but the business has done a very poor job of grooming the next generation. Frankly, there is hardly a next generation in place since many of the wires and insurance companies have decided to trade “sore arm pitcher” veterans and stop training rookies at an estimated to cost $200,000 per producer to get them to the 5th year successfully. I’ve seen estimates that nearly half of financial advisors expect to leave the business over the next several years. This will quicken the already increasing trend towards fewer and larger entities. But it also points to one of the biggest problems in the business; building the next generation of advisors.

Here are some areas where I have a slightly different point of view:

The demise of the wirehouse retail business model: It’s seems like the fee only RIA community views the large retail firms whether they are wires, insurance or B/D based as the “evil empire”. I totally agree that salespeople holding themselves out as financial advisors/ planners, et al. is wrong and should be curbed as part of the new regulations. The underbelly of the financial services industry bothers me like many others and just as ambulance chasers give the legal profession a bad name, those who operate under the guise of financial advisor while selling high commissioned products stain the entire industry. I think the politicians blew it by letting the states win out on the regulation of indexed annuities which are among the most confusing and misrepresented financial products offered today. They’re just one more 60 Minutes show away from being back in the SEC’s doubt to happen soon. I think an inevitable outcome to better aligned regulation will be to shine light on the imposters and shrink their ranks. But, I don’t think the large retail firms are going away. This is where my upbringing in the business may bend my viewpoint a bit.

The business models that rely almost exclusively on the sale of proprietary products are the ones who are most at risk. This encompasses most sales forces owned by life insurance companies, including my alma mater. The entire value proposition for being affiliated in such a model goes away if one is unable to sell 70%+ of the company manufactured products. No benefits, no recognition, no stock options, no glue to stick around. I think mutual life companies will hang in there since they have always subsidized their field forces without regard to profitability, but the stock firms will more likely continue to starve their distribution platforms to death and end up solely as product manufacturers. The only unique exception to this may be Ameriprise. Unlike most insurance based B/D’s, they actually earn profit from their B/D and investment based platforms as they are self-clearing. And if an insurance company can move its field force towards fee based planning as we did at AXA (and as Ameriprise does), there is a shot at survival. But I don’t see that happening so far.

As for the large wires, yes, many of their producers will go the way of the dodo bird. These are the old timers who cannot adapt to change and are still transaction driven. And some of the large producer groups will continue to find independence more fitting to them as brand is no longer a draw. But most of the large wires catering to high net worth clients have already adopted fee based products and thus the IAA role as a fiduciary. Yes, some proprietary products and services will no longer be in their basket, but don’t underestimate their ability to throw money at a new initiative. My own experience at AXA tells me that this can be done successfully. And remember about 10 years ago when Merrill had fee based plans called “Financial Foundation” as the backbone for their field force requiring each advisor to do 10 fee plans a year. Like AXA, they dropped it since it was in the way of an easier sale, but with the situation being the boss today, it would be very easy for them to dust off that playbook and do it all over again, this time with more conviction and the backing of their banking partner to do it.

“Fiduciary Avoidance” on behalf of the wires”:It may sound like I’m trying to defend the wires…I’m not. It’s just that I don’t view them as the enemy as much of the RIA community does. While a decade ago they did fight and try to re-brand the investment advisory and fee business more to their liking, they’ve come a long way to acquiescing to the fiduciary standard and all that comes with it. With the insurance based B/D I recently left, most of the representatives were IAA’s with a requisite to have FINRA series 7 & 65. And FINRA not only oversaw their “suitability” styled transactions, but the compliance department was as militant about the rep’s adhering to SEC standards for advisory activities. Last year I paid a visit to the CEO of Ameriprise to get his perspective on the direction of the business and asked “Doesn’t the move to a fiduciary standard concern you?”. His response…“Absolutely not, we’re already doing it!”. I think you’ll find that most large FINRA regulated players have already evolved towards the fee business as the marketplace has been demanding it for some time now. I’m sure there is a large population of series 6 and series 7 rep’s with smaller firms that have no desire to move in this direction, but most of the biggies are already there. In my estimation, the large FINRA regulated firms are in a far better position to take on harmonized regulations than the majority of small RIA’s.

The marketing opportunity:RIA’s learning to live with less competition Similar to my points above, I think it’s na├»ve to think that the large retail firms will no longer be relevant and the net result is that the only model left standing is the RIA we know today, leaving a windfall of clients. The RIA’s as they stand today won’t survive either. Everyone has to change. A large majority of RIA’s simply charge fees for assets under management. As the large retail firms move their business further in that direction, what is going to differentiate the smaller RIA? It kind of sounds like Hurley back in ’99, but if the large firms move their focus entirely on the same asset under management approach as the RIA’s (and some are already there), then it’s going to be tough to compete with the level of support, research and service the deeper pocket larger firm can afford. There was a time where the independent RIA was able to differentiate themselves by providing true financial planning , but most have succumbed to the ease in capturing assets under management for a fee over the past decade. Why bother with fact finding, budgeting, setting goals, estate planning, insurance planning, tax planning, etc. when all you have to do is find another retirement account to roll? I think what can differentiate any one player for the future, large or small, is their ability to address the broad based needs of their clientele that includes asset management, but so much more… true financial planning.

Final thoughts: Bob, like you, I do see dramatic and far reaching changes taking place. But I guess I’ve been in the business so long, I tend to get somewhat cynical observing, as the old adage says “the more things change, the more they remain the same”. I hesitate to say “this time it’s different” but there really is a paradigm shift for everyone taking place. RIA’s will have to re-organize and become accustomed to supervision and all that comes with it. And FINRA regulated folks will have to step up their game to the higher standard of a fiduciary or risk spending a great deal of time and expense in court. In the evaluation of winners and losers, it’s not so much where one is positioned today, but their ability to change and adapt that will survive tomorrow. I suppose its human nature to see the landscape from one’s own rose colored glasses which makes for a lively debate. But at some point, we’re going to have to reconcile our differences within the business if we are to be viewed by the outside world as a true profession. I read the comments from Harold Evensky on the RIABiz site about how he believes it’s better to work together and help regulators get it right rather than split camps and risk confusing all. I couldn’t agree more. This isn’t about who wins and loses. Frankly the demand for quality financial advice at all levels is so great, there is no need to turf build. There are more than enough clients and needs to go around for everyone, more than the entire industry at all ranks has the capacity to meet. The professions that are recognized such as the accounting, legal and medical fields have professionals at all levels serving clients at all levels. It isn’t their regulator that differentiates them, but the quality of their service and value proposition offered whether they’re an enrolled agent, high powered attorney or a chiropractor. In fact, it’s the dueling regulators/oversight we now have with SEC, FINRA, State insurance dept’s, CFP board, American College, FPA, NAIFA, SIFMA, etc. that is complicating and confusing not only the general public, but those of us within the financial services business. I suppose that’s all a part of a growing and evolving business, but it’s no wonder the public is confused, because we are too! It’s going to take many variations of financial advisors to bring our industry to the level of professionalism that others have. We shouldn’t have to rely on regulators, but the consumer/clientele who we serve to define who we are as a profession. When we rise to the level of being made fun of with humor like “attorney jokes”, perhaps we may well have made it!

An Idealist would eliminate commission based financial sales and ban non-CFP’s from practicing in the business…wouldn’t that make the world a better place? I don’t know many in the business who really think that’s gonna happen. But it seems like the more some segments of the industry try to make it so, the more elusive the ideal world becomes. The CFP Coalition, while well intended, looked like some sort of extremist cult group in their efforts by visibly (at least to me) excluding the majority of the stake holders in defining the future of the business. I suppose the same could be said for other special interest groups in the business as well. I think that we all need to get real and move forward on what can get done rather than use a “scorch the earth” we win-you lose tact. Taking a “why can’t we all just get along” approach may prove just as elusive and a bit idealist in its own way, but I think erring on the side of inclusiveness stands a better chance of moving the profession forward.

If you’ve read to this point, thanks for hearing me out. I thought feedback from one of your non-traditional (AKA former sales guy) followers would give a varying perspective. Not that it’s right or wrong, just different. We can all attempt to predict the future but as you’ve cited with Mark Hurley a decade ago, it’s very tough to do. Unforeseen events such as 9/11, the housing bubble and resulting great recession greatly changed the outcomes. And I’m sure there will more major events in the coming decade that are equally unforeseen that will impact the business and our country. Thanks for your great work in writing the white paper. Like Hurley’s in ’99, I think yours will be cited for years to come. It will be interesting to watch and participate as the future unfolds.

All the Best,

John Lefferts, CFP, ChFC,CLU