Editor's Note: In early October, Deborah McWhinney, president of Schwab Institutional, was interviewed by Financial Advisor Editor-in-Chief Evan Simonoff about the myriad issues confronting the firm and its relations with advisors during the turbulent bear market of the last 30 months. A 17-year veteran of BancOfAmerica, the Montana-born McWhinney describes herself as a "cowgirl," a term fans of the Washington Redskins, New York Giants and the late Houston Oilers reserve for a pro football team in northern Texas. As the interview makes clear, McWhinney is a fresh face who isn't wedded to old ideas.

Simonoff: Thirty months ago, many providers of custodial services to advisors expanded their own proprietary advice platforms and marketed them aggressively to investors. For many advisors, it's been viewed as a competitive onslaught and they've been frustrated. Do you have any ideas of why some people have singled Schwab out?

McWhinney: While there may be conversation about what we're doing, our [affiliated] advisors continue to just vote by bringing more and more assets. So if you look at this same timeframe, I think we've been able to have our advisors bring about $75 billion in net new assets during that same time. So you look at that, and then you say in the same time we have worked with them to come up with the Schwab Advisor Network, which is a referral program to advisors. While we are moving to help all consumers understand that getting advice-and really getting good, credible, unconflicted advice-is good for them, the solution that we choose, or that the investor would choose, might be what we're offering in [Schwab] retail. It might be what an advisor gives them, or it might be what U.S. Trust gives them.

We believe, and certainly our advisors I believe understand, really what we're doing is [leaving] it up to the investor, and it's really important that the investor have multiple choices of what they would want. Because at one point in their life, they may want low-level help and advice. As their financial needs become more complex-they inherit money, they change jobs, they now have control over a 401(k) plan, things like that-all of a sudden they need more sophisticated help and advice, and they want to delegate that money management to one of our advisors.

Simonoff: Many independent advisors are long accustomed to doing business with people they also compete with. What worries them about Schwab is that they feel that Schwab is constantly changing the rules of engagement. When they see the [Schwab] advice platform out there and all of the promotional material, it appears more threatening. Do you think saying that Schwab is changing the rules of engagement is a fair charge?

McWhinney: I can understand how an advisor could see what we're doing as changing, but if you look at the bigger picture together, all of the Schwab advisors, all of U.S. Trust, all of our retail [network] only represent less than 9% of the affluent assets in the United States. So I look at this and say 91% of the affluent assets are out there with the wirehouses, the banks, and there is a lot of business to go get. So from Schwab's perspective, we really believe that the multiple choices that we have for advice give investors a place to come where they really can find what they need when they need it. In the end, what's most important is what is right for the individual investor.

So when you say that we're changing the rules, the reality is I think that it's been an unprecedented shift in consumer belief and feelings about their own ability to manage money, and Schwab's a very vibrant company. When you've got a vibrant company, you've got to change with what investors want. A lot of times I use the analogy-because I come out of different businesses where during my career I've watched how consumers have changed-of how they use ATMs, point of sale, you know things like that.

To me, one of the best things Schwab can do for the investment advisor business is to teach the average investor that you should pay for good, credible, unconflicted help and advice, which is exactly what the advisors do. So as new investors come to Schwab, we have the opportunity to not just explain what we do in retail, but we've trained all of our employees in retail to understand what we offer in retail, what we offer with our Schwab Advisory Network, and what we offer with U.S. Trust, and then find the right place for that investor.

Simonoff: You said that consumers' belief about their ability to manage their own money has changed significantly. How has it changed?

McWhinney: Oh, overwhelmingly. Are you as good at managing your money as you were in the '90s? It's just a huge shift in the average investor saying, "You know, I'm very good in a bull market. I'm not so good in a bear market, and I need more help." And it's not just help on the investments-there's tax issues and changes in tax laws, there's issues with passing money between generations.

There's all sorts of issues that make investing far more complex, and it's a big piece of what people have in terms of their overall assets. So it is more complex, and people need help. They've been asking us. In fact, we would have been negligent had Schwab not responded to what our investors were telling us. Frankly, I wouldn't say we were fast to respond. I think that we would even say that we were slow to respond, that we should have reacted to the help and advice need of our clients faster than we did.

But overall, we have got such a good strategy within Schwab [because] it's so inclusive, and we've got very strong policies on how our retail branches work with our [affiliated] investment advisors to protect those clients of investment advisors. I think that's a fabulous strategy.

Simonoff: Some of your competitors say privately that Schwab has made only one mistake in dealing with its clients: That a decade ago several officials from Schwab said publicly that there is a line that they would never cross. Since then, the environment has changed dramatically, and the direct investing boom has fizzled out. It looked like it was going to take over the world 10 years ago. If your position was essentially that Schwab simply came out and said that its retail arm's new emphasis on advice represents a necessary response to changing competitive conditions, the whole issue might recede to its proper perspective. Do you think your competitors have a point?

McWhinney: I think we've said that. I think Dave [Pottruck] and Chuck [Schwab] have been very clear in saying that we're responding to investor needs; we need to give help and advice. We are giving it in the branches. But coming back to this 91% of investors who aren't doing business anywhere in the Schwab family, our goal is to help provide all of the solutions for investors, and this company is going to grow and change and respond to what the investors need. The reason we started discount brokerage is that there was a huge need out there. There still is a need, and there still are a lot of our clients who are self-directed clients.

Right now, they're not doing a lot of trading, but they still want to manage their money themselves, and there's a huge group of clients out there who continue to want to do that. But there's also this huge amount who are saying, "I wasn't as smart as I was in the '90s, I need more help," and responding to that is really important, and we will evolve the model. But we won't evolve it just at the retail end.

Schwab Institutional is a huge and really important part of the overall corporation. At our competitors, [advisor business] is still maybe less than 10% of what happens in their company; we're between 30% and 40%, depending on the measure you're using.

Simonoff: People would have estimated 10 years ago that the direct investor market was maybe 40% of the total. Research from Schwab in the last few years shows that it's a lot smaller, maybe 10% to 20% of the total investment market. I can't believe that it's grown in the last two years. Do you have any feel on the size?

McWhinney: It would be so great if we could put people in boxes, and we could say that these people fit here, and these investors fit here. At different times of their lives, in different markets, people will be a self-directed investor; then they'll be validators-they just want to get some advice or a second opinion. Then there are people who want to delegate the responsibility. There are people who want to delegate it fully, and there are people who want to delegate part of their investment portfolio.

So to try to pretend that all investors can be put into these nice little buckets or clusters, I think really underestimates the intelligence of the investor. We would be very well served by understanding that they're looking for multiple things. A husband and wife may manage their money very differently. Same household, but one may be "I want to do it myself" and the other one would be "I want to delegate it."

Trying to put people in these buckets, I think, is really counterproductive. What we need to do is give people a better understanding of the solutions available to them so that they understand the difference between a wirehouse solution and a solution that is unconflicted.

Simonoff: Do you think some advisors have failed to understand the implications of changes in the direct investor marketplace? The implications that it has for Schwab's retail business?

McWhinney: I think that, for the most part, advisors understand why Schwab makes the moves we do. Certainly a year ago, it was more talked about, but that isn't what our clients are talking to me about now. They're much more focused on how they're going to bring their clients in. They're much more focused on their business model, how to really compete against the wirehouses.

The really good [advisory] firms know that there's a lot of investors out there that we can go get. Schwab really wants them to succeed, and the investments that we've made in all of our products and our service help them grow, help them compete, help them succeed in their business model, and [they know] that they aren't losing business to Schwab retail. What they want to do is focus on getting the clients that are at their real competitors.

Simonoff: Advisors can see there's a lot of new prospects in the last 12 months. But right now, a lot of people we talk to, their problem is trying to keep their margin. A lot of people are growing their business; it's just they're having to add services, and there are some margin problems, but almost every business in America right now is having margin problems.

McWhinney: Welcome to the real world. That's a good point though. I really think that the tide has turned on the channel conflict at Schwab. How can I, talking about Schwab Institutional, really help them evolve their business model and do business more efficiently? They love the service that we offer. In a way, we're the back office for these clients, so when they're bringing a new account in, if we can do it really better than anybody else, if the service that we offer is better than anybody else, it makes it easy for them. If we make a mistake and they have to correct it, and they have to pacify their investors, that's hard on them.

Simonoff: You have many more competitors today than you did five years ago. Waterhouse and Fidelity were very small. Many are trying to get into the business now. Has that changed your business?

McWhinney: I have a very strong belief that you always watch the competition, but that our job is to serve the investment advisor. Our job is to figure out what they need and then to do it better than anyone in the marketplace. I would say that the results that we've got would absolutely prove that we're doing the right thing.

All the initiatives to help the advisor business, [like] the Schwab Advisor Network, which is very, very important to them, and is setting another record this year. Those are clients that were in our retail system, or new clients to Schwab, and we refer them to the 330 firms that are in the Schwab Advisor Network. So when you look at the cumulative effect of that, we will really change a lot of these firms over the years with Schwab Advisor Network. That's a win/win solution.

Simonoff: The latest numbers I saw show that despite all the competition, you still have around a 70% share. Four years, five years ago, it was 85% with much less competition. Do you think the 70% level is sustainable?

McWhinney: I don't even look at those numbers, because what's important to me is doing business with the right clients in the right way. What I'm most concerned about is really helping the firms that I do business with grow. So what I look at is how happy are the clients that are doing business with me? What share of wallet do I have? Are they bringing more assets to my competitors or are they bringing more to me? And the numbers that I want say that the investment managers are very happy with the service we provide.

Simonoff: If you were an advisor today, how would you position yourself to compete against, not only Schwab retail, but Merrill Lynch, Morgan Stanley, Fidelity and Waterhouse? How would you emphasize your competitive strengths?

McWhinney: The first thing I would do is really understand my company's business model so that I know how to grow and leverage myself and become scalable. A lot of the concerns that people have right now are [with] their margins, how they're making money. So number one, I would want to have a very good sense of my company's business model. Secondly, what's my value proposition? How do I differentiate myself and what do I really do better? And at the end of the day, what virtually every one of our clients do better is give great expert, customized service.

The third thing that I would do is continue to evolve. To really understand what the needs of your investors are in an up market [and] in a down market, so that you're retaining the clients you've got and that your firm is doing the things that will help it grow.

Simonoff: How would you evaluate the value propositions of Merrill Lynch, Morgan Stanley and the retail arms of Schwab, Fidelity and Waterhouse? Just what their strengths and weaknesses are if your sister wanted advice, or your brother? What would you tell them the strengths and weaknesses of those businesses are?

McWhinney: I think the strengths of all of those companies would be that they do have good employees, and they do have lots of products that they offer, so that the investor has choices. The weaknesses of more the traditional wirehouses are their proprietary products and the issues that we've seen over the last several months on the conflicting parts of the firm.

And Chuck Schwab has been talking for years about how that was going to impact investors at some point in time, and I think now we've seen that come home. That needs to get sorted out far more aggressively than they have done in the Merrill Lynch case, but at the end of the day, the position that Schwab has is that we don't do those things.

Investment [advisors] don't have those kinds of conflicts, and the more that we get the message out with our advertising and help the average investor understand the differences, the more those conflicts will become apparent, and the more the average investor will understand what alternatives they have.

For the most part, the average investor didn't know those things, and they just weren't aware that those kinds of conflicts went on. So by understanding it, by seeing what's playing out in the press, it helps them know that they have an alternative.

Simonoff: Some people think Schwab's advertising recently has gotten a little heavy handed. Do you feel that it's fair, particularly the commercials?

McWhinney: I think the fact that it's gotten as much visibility as it has speaks for itself. It has hit a chord, and the people who are uncomfortable with the advertising probably deserve to be uncomfortable.

Simonoff: A lot of people knew there were some conflicts but they didn't know how pervasive a lot of these conflicts were.

McWhinney: I don't think they understood the distortion that was going on. What we've learned is there were two sets of numbers.

It plays right into the Schwab strategy and right into how investment advisors fit into the picture. The investors need to understand that there are alternatives. When people talk about the fees they pay to an investment manager, I can assure you that on average, the average portfolio with our Schwab-affiliated investment managers is significantly better off than what you see in the market and in the norm. So that 1% fee looks pretty darned good when you compare it to the losses of 60%.

We often say in Schwab that the investment advisor market is the best-kept secret in the financial services industry, and unfortunately it's so true. I feel almost like an evangelist in regard to this industry because it is so positive for the investor. We're not taught in school how to do investments. We've never been taught how to manage money, so this is something that you have to acquire on your own and put a lot of energy into acquiring that skill. Then all of a sudden, you amass a certain amount of wealth. You think, "I'm very good at my day job. But I'm not nearly as good at managing money."

Simonoff: What are Schwab's Institutional's assets right now?

McWhinney: About $230 billion, I think.

Simonoff: And have you had layoffs? I know there have been layoffs in retail.

McWhinney: We've had some slight changes, but overall we're flat on our staffing. We're making moves between some areas and other areas, but we just added 50 people in our service teams to have better service with our larger clients.

Simonoff: Another area where people have just seen changes from Schwab in the last year is the Advisor Network. Schwab may want to build stronger, deeper relationships with its advisor-clients. Many advisors don't mind the referral fee as much as the termination fee. Do you think it's more of a closed architecture platform for many advisors?

McWhinney: I wouldn't call it a closed platform at all. We went out and talked to a lot of advisors before we designed the fees and the entire program. We really addressed what the weaknesses were in the Advisor Source program. The reality is that, let's say this year we do $6 billion of assets to these advisor-clients, and then it will grow next year, and the next year, and the next year. This is real value. Our competitors have referral programs, [but] I doubt any of them even come close to the success that we're seeing.

For participating advisors, it's $15 million or $30 million, or $50 million; it's a significant piece of the value of that firm that they most likely wouldn't have gotten had they not participated. So to an extent, it made sense for Schwab shareholders to share in the value we created in these independent firms.

But when you start moving significant dollars into these firms, and it's a limited number of firms, we're creating a lot of value for them. And I've got a lot more clients wanting in than wanting out.

So while we can talk about the fees, the reality is they absolutely see the value of getting these referrals. Our investment centers in the retail enterprise are real excited about the program and the changes we made. When the investor walks in, they're almost pre-sold on investment management-advisor firms, so that sale goes a lot faster. Already our close rate has gone from 25% last year to 35%, and in some of the areas, it's approaching 40%.

Simonoff: If a client walks in and says, "I want advice. I've got $2 billion, and I don't know whether my needs are appropriate for Schwab Retail, Schwab Institutional or U.S. Trust." What are some of the key tests branch employees try to apply to a client to see where he would best fit?

McWhinney: That's a lot of questions, actually. In order to, what we call "navigate" the investor to the right place, they need to really understand in depth where the psychology of that investor is. So they ask them questions. What kind of things have they been doing in the past? How involved in the investing process do they want to be? Do they want someone who tends to be more of a money manager, where they just turn the portfolio over to them, or are they looking more for wealth management and tax advice and some of the things that are a little bit more complex? Are they looking at something like a trust that they want to set up?

Once they kind of zero in on what that investor's looking for, then they talk to them about the firms that are in the Schwab Advisor Network. Then they suggest that there are eight firms that meet their needs, and then they set up the appointments.

Then they watch what happens with the account. They are paying attention to it. What I need in 2002 may be very different from what I need in 2003 or 2004. Just because someone is in one service model today, it doesn't mean that's where they're going to be their entire investing lifecycle.

Simonoff: What about Centerpiece? Why wouldn't Schwab charge two different prices for Centerpiece-one for people who use Institutional services, and another for other advisors? Schwab could charge more and have non-Schwab-affiliated advisors subsidize those who are affiliated with Schwab.

McWhinney: I could do that today. The reality is, I have a whole group of clients that I would like to serve with Centerpiece. Over 2,000 of our clients use it today. We're going from an old model of Centerpiece to an upgraded single-server platform, renamed "PortfolioCenter." It's going to take new resources to help those clients upgrade, and then it's a fabulous service that we've built. When we rebuilt it, we really made it very competitive. So if I'm going to invest the resources of Schwab in helping people convert from one platform to another and upgrade from the old Centerpiece to the new one, first and foremost I'm going to help the clients that are doing business with Schwab today.

So that just makes good business sense to me, to help those people who are really helping me grow. From the beginning, I told Nick Georgis, our head of sales, that if he had a prospect that he wanted to sell it to, he could. I've got more demand for the product than resources to convert people. I'm not in the software business; Advent is a software business. Software is a product to me. Centerpiece is a very important product that I offer to our clients, but it's not my core business.

Simonoff: If you could charge nonaffiliated advisors a higher price, would that give you some additional resources to increase your services?

McWhinney: It's not part of my core. It's not the most important thing I do. So getting into the software business is not a thing that I want to do from a strategic standpoint. What I want to do is offer my clients the best service that I can, the best portfolio management service that I can. The best advisor-branded Web services that I can. The best custody and trading services that I can. Right now, I want to stay very focused.

Simonoff: Right now many people are looking for new revenue streams.

McWhinney: It's a distraction; it's not enough new revenue. It's a slow sale, and I want to stay focused on those clients and get them the best custody and trading and give them good service. The reason that I want to build Centerpiece [being renamed PortfolioCenter] and the reason I want to offer [it] to my clients is that if they can have a very competitively priced product from Schwab, then they can grow their business. They can have a much more efficient back office. In the business that Schwab's in, if investment managers grow, we grow. We can't grow if all we have is a software product with them.

Simonoff: Some people think that at some point Schwab might start buying individual advisor practices. I believe you had a consulting group do a study of this and they questioned it. Right now you could probably buy certain people's practices. There are a lot of people in this business who are in their late 50s early 60s, and they could basically keep their job at a good salary. I'm not sure they'd demand fortunes for their firm right now. Why did Schwab's consulting group say this was not a good strategy at this time, and do you think it could change?

McWhinney: I think that I've learned in my career to never say never. But what we learned by really looking at the marketplace is that the firms that were for sale at a given moment in time may not be the firm that you would want to buy if you could just go in and choose the best, or the best fit in the market. So that, in of itself, is one of the major reasons why we chose not to go with that strategy.

There's a more important fundamental issue here, and that is that one of the beautiful things about the investment manager-advisor model is that it is so unique. In a metropolitan area or a small community, there are hundreds or tens or whatever of firms, that all are slightly different. Some are more aggressive; some are more conservative. Some are money managers; some are financial planners. Breaking that model down and turning it into a cookie-cutter model, I believe, is the wrong thing for the industry. What consumers and investors need are different choices.

The entrepreneurial nature of investment managers in growing their firms is really a beautiful model. Leaving as many out there to do business in as many unique ways as possible really serves the investment community way better than having it all become very standardized.

So I really think it's wonderful that in a market in New York or in Bend, Oregon, we can offer different programs and choices to the investor so that they don't just have one model. Having come out of banking and watching the consolidations in banking and then watching boutique banks be turned into the national cookie cutter, I think I probably have a bias toward the individual nature of each one of these firms.

Simonoff: What do you see as your biggest challenge going forward? Is it technology, is it competition, or is it trying to constantly adapt to a very dynamic marketplace?

McWhinney: I think I have one of the best jobs in the financial services industry, and the biggest challenge is that we are really hard on ourselves. We want to keep raising that bar. The service is good; let's make it better. The products are good, and let's make them better. I want the competition looking at where we were two years ago, not where we are today. And just raising that bar and looking at the business model of the investment manager and saying, "How can we help?" Not control. I always want them to have choice.

Simonoff: Thanks a lot for taking the time to talk here.