Regulations, Fiduciaries And Other Things
As the debate over financial services industry regulation rages, groups such as the National Association of Personal Financial Advisors (NAPFA) are taking their case to Congress. Diahann Lassus, the group's outgoing national chair and president of Lassus Wherley & Associates in New Providence, N.J., and Bill Baldwin, incoming chair and president of Pillar Financial Advisors in Waltham, Mass., recently sat down in New York City to talk about NAPFA's goals and the possible shape of regulation.
Q: What's your most pressing issue?
A: [D.L.] The financial planning coalition [NAPFA, The Financial Planning Association and The CFP Board of Standards Inc.] is putting a lot of our focus on making sure that financial planning is regulated as a profession.
[B.B.] To be regulated imparts an image that being a financial planner means something. It implies professional status. It doesn't have to be omnipresent. I'd be perfectly happy with a set of regular regulations and some sort of government mandate for disciplinary action.
Q: Has financial
planning arrived as a profession?
A: [D.L.] It's close. I think people recognize what financial planning is to some extent. But in terms of seeing it as a profession I don't think we're quite there yet because many consumers know from past experience that some people who call themselves financial planners aren't really qualified to do planning. I think having planners regulated would help make it more of a profession in people's eyes.
Q: So, you're one of the few people who actually wants to be regulated?
A: [D.L.] A congressional leader last week said we're the only group he's ever met who says, "regulate me."
Q: What are some other important priorities?
A: [B.B.] The desire not to be regulated by FINRA. That's largely an RIA issue. Another is that consumers are confused about the differences between the fiduciary standard and the suitability standard.
Q: Do you think the public really cares?
A: [B.B.] I think the public cares if they're misled or not properly treated. They understand about fairness and honesty. Given the compensation structure of brokerage firms, it's probably inconsistent to expect them to put clients' interests first. It's difficult to be a fiduciary when you're on the sell side and you underwrite things.
Q: Is that necessarily a bad thing? Do advisors always have to be fiduciaries?
A: [B.B.] No. I see
the retail and production side of brokerage firms being two different shops that could be set apart with different compensation models.
Q: Where do you see the debate over the fiduciary standard going?
A: [D.L.] Our sense is that they [suitability standard proponents] endorse a fiduciary standard to some degree by redefining it so that it's watered down from the current standard. The folks from SIFMA talk about harmonizing, which essentially means taking the fiduciary and suitability standards and averaging them together. That's not good for consumers. They're willing to raise the bar of the suitability standard to something else, but still not high enough for brokers giving advice. And it doesn't reach the bar for what we're trying to do with financial planning.
Q: You're probably aware that some on the other side of the issue see NAPFA as holier
than thou?
A: [B.B.] For many years they referred to us as Napfakrishnas. But we're trying to break down that image. Our large-firm initiative aims to make membership appealing to larger firms. I think our education programs are outstanding, and we want to promote the NAPFA brand as a place firms can go for educational resources.
Breakaway Broker Trend Slowing?
One of the industry's big stories of late has been the anticipated wave of wirehouse advisors heading over to the independent side of the business. The trend got a lot of hype during the heat of the financial meltdown when big Wall Street firms saw both their finances and reputations clobbered. Of late, though, there are differing opinions on the pace of the breakaway broker trend.
"The trendline is real," says Bing Waldert, a director at Cerulli Associates, a Boston-based financial services industry research firm.
"It's easier than ever for advisors to go independent. But I think the industry as a whole underestimates the cultural leap from being an employee advisor to being an independent advisor. When advisors peel back the onion and start understanding everything that goes into it is where they become reluctant."
In a recent report, Cerulli examined the financial, logistical and psychological realities faced by wirehouse brokers pondering whether to leave the mother ship for life at an independent broker-dealer or registered investment advisor firm. For wirehouse advisors accustomed to payout ratios in the 20% to 50% range, the prospect of earning 70% to 100% payouts as an independent is hard to ignore. But Cerulli points out that costs associated with setting up and maintaining an office can cut the net payout to 60% to 70%. And with that comes all of the risk and responsibility of owning your own business.
"I think it's a limited subset of advisors who can operate in the independent model," Waldert says. "Are they comfortable being a business owner?" He says the number of wirehouse brokers leaving that channel is only in the single-digit range.
Waldert adds there was unprecedented advisor movement within the wirehouse channel in late 2008 and early 2009. As a result, there are a lot of wirehouse advisors in the early stages of multiyear retention packages. "One of the things we're watching is the effect retention packages have on wirehouse brokers moving into the independent channel."
Others view if differently. "We're seeing a lot more wirehouse people coming our way, and bigger producers in the $1 million-plus category are doing the math and really looking into it," says Bob Whalen, president of Brewer Financial Services, a Chicago-based independent broker-dealer. "Our pipeline is the biggest it's ever been, and it's up significantly in terms of average GDC (gross dealer concession).
Whalen agrees that the cost of running an office cuts the average payout rate among independent advisors to roughly 70% to 75%. But, he says, "One of the things people often leave out when considering jumping to the independent side is the equity they can build up within their practice."
Some observers believe that market conditions are primed to fuel an uptick in wirehouse advisors going independent. "At this time last year, the market turbulence was fueling the fire for people wanting to make the change," says John Furey, president of Advisor Growth Strategies LLC in Phoenix and former head of Charles Schwab's breakaway broker program. "But then the markets got so bad that it stopped everybody in their tracks and led to a wave of inertia. What's happening now is that with the markets stabilizing, that advisors are coming out of their shell and making decisions on where to take their books."
The breakaway broker trend won't be a short-term fling, says Furey, who advises brokers contemplating going the independent route. "It might take five to ten years to play out."
Barney Frank Won't Push SRO For Advisors
Congressman Barney Frank, D-Mass., won't push for a self-regulatory organization (SRO) to oversee registered investment advisors (RIAs) unless they want one, according to a published report.
Frank, chairman of the House Financial Services Committee, made his comments during a speech at the National Press Club in late July, reported Complinet, a news service for risk and compliance professionals in the financial services industry. Frank's office couldn't be reached for comment.
One of the debates in the ever-evolving financial services regulatory landscape is whether oversight of RIAs might shift from the Securities and Exchange Commission to an SEC-sponsored SRO. Industry scuttlebutt places the likely candidate as the Financial Industry Regulatory Authority Inc. (FINRA), the organization that regulates brokers.
That suggestion rankles the advisory community. As a result, Frank's comments were taken as a hopeful sign by some in the industry.
"I think it's good news for financial planners, but it's not a total shock," says Duane Thompson, managing director of the Financial Planning Association's Washington, D.C., office. "When you talk to members of Congress and their staff behind closed doors, I think some question whether FINRA would be a good fit as regulator for financial advisors.
"I'm not suggesting there's overwhelming opposition to FINRA," Thompson adds. "But I don't think people should take for granted the inside-the-Beltway talk that it's a slam dunk that FINRA will be the new Big Brother."
In a June speech at the Exchequer Club in Washington, D.C., FINRA chief executive Rick Ketchum cited the disparity between oversight regimes for broker-dealers and investment advisors as a regulatory gap that needs fixing.
Ketchum said that FINRA is positioned to build an oversight program that ensures investment advisors are properly examined and their customers are adequately protected, but added that whether FINRA should be vested with that authority "is ultimately for Congress and the SEC to answer."
CFP Board's Proposed New Education Standard
The Certified Financial Planner Board of Standards Inc. wants to put theory into practice with its proposal to add a financial plan development course to its educational standards.
The proposal would require aspirants to the certified financial planner certification to prepare a written, comprehensive financial plan as part of the established curriculum. Both the written plan and an oral presentation of the plan would be evaluated.
The CFP Board's education standards comprise coursework in the major financial planning areas including general principles of financial planning, insurance planning and risk management, employee benefits planning, investment planning, income tax planning, retirement planning and estate planning.
Under the CFP Board's proposal, all of this would have to be tied together into a cogent financial plan. "The proposed financial plan development course would require individuals seeking to attain CFP certification to demonstrate their ability to integrate and apply the financial planning topic areas to a scenario based on the types of situations a practicing financial planner might be expected to address with clients," said Marilyn Capelli Dimitroff, chair of the CFP Board.
As proposed, the new requirement would require financial planning education programs registered with the CFP Board to offer a financial plan development course by January 2012. The organization is taking written comments on the proposals during a 60-day period that ends October 2.
Comments will be reviewed by the CFP Board's Council on Education and posted in their entirety on the organization's Web site. The CFP Board is particularly interested in comments focused on implementation, assessment and course outcomes related to the proposed requirement.
Inspiration for the proposal came after the CFP Board's international cousin, the Financial Planning Standards Board Ltd., added a comprehensive case study component to its curriculum.
The entire proposal can be found at www.CFP.net/downloads/Financial_Plan_Development_Course_Proposal.pdf. Comments can be e-mailed to [email protected]. Or they can be mailed to: CFP Board, c/o Managing Director of Education, 1425 K Street NW, Suite 500, Washington, D.C., 20005.
M&A Activity Down, But Not Out
As can be expected in the current environment, the pace of mergers and acquisitions within the advisory space is down in 2009. That said, interest in M&A deals remains strong as advisors seek ways to strengthen their practices in a challenging marketplace.
According to Schwab Institutional, there were 36 M&A deals among registered investment advisors through June 30, totaling $54 billion in assets. Projected on a full-year basis, that's 72 deals and $108 billion in assets. Last year, there were 88 deals and $137 billion; in 2007, it was 80 deals and $101 billion.
"Clearly, the steep growth trajectory seen from 2005 through 2008 has slowed," said David DeVoe, managing director of strategic business development at Schwab Advisor Services. "But it's not Armageddon, and the bottom hasn't fallen out of the market."
DeVoe cited two reasons for the slowdown. One is stock market declines that lowered asset levels and revenues, as well as cash flows and valuations that go into calculating deals.
The other is the distraction of intensive client care during the turbulent times. "M&A is usually something you do after 5 p.m.," DeVoe says. "But principals have been spending countless hours hand-holding their clients through the downturn."
As a result, he adds, the amount of time it takes to negotiate deals has grown from roughly nine months in past years to about 12 months.
But DeVoe says interest in M&A deals among RIAs has picked up. He noted there were roughly 20 participants during his monthly M&A call in November; in recent months that's grown to about 150 per call.
Among all deals done during the first half, 61% of buyers were RIA firms and 37% were holding companies whose business models are predicated on making acquisitions.
DeVoe says that RIAs are getting more sophisticated in their M&A deals, which include a small but increasing number of management buyouts. He's also seeing more interest in doing deals in order to cut costs and bolster finances in a challenging environment.
Unsafe Harbor
The point of being an independent financial advisor is that you don't have to work for the man (even if you are affiliated with a broker-dealer or RIA firm). But under proposed legislation in Congress, advisors might lose their "independent contractor" status and instead become employees of their affiliated firms.
In late July, Rep. Jim McDermott (D-Wash) introduced legislation in the House that would eliminate Section 530 of the Revenue Act of 1978, the so-called safe harbor provision that lets employers classify workers as independent contractors rather than employees as long as they meet specific criteria.
Critics contend that it's a loophole used by some employers to avoid paying employment taxes and workers' compensation and benefits.
"Our industry isn't a specific target, but we're concerned that it could apply to financial advisors via the law of unintended consequences," says Dale Brown, president of the Financial Services Institute, a membership group representing independent broker-dealers and advisors. "We're concerned this could give the IRS an entrée to question the independent contractor status of advisors."
Should independent advisors become classified as employees, Brown says, it would force broker-dealer firms to pay Social Security taxes, provide benefits and assume liabilities for these advisors. He notes it would also require additional personnel and compliance costs that could be a financial burden for many small- and midsize independent broker-dealers.
It's thought that President Obama favors ditching the safe harbor provision, given that he co-introduced a Senate bill in 2007 to eliminate it.
Advisory Industry Pioneer Jailed
During an emotional court case last month, a federal judge sentenced 71-year-old former planner Judith Zabalaoui to 97 months in prison for using a Ponzi scheme to embezzle millions from clients in the New Orleans area.
Citing the severity of the offenses, Federal District Judge Mary Ann Vial Lemmon also ordered Zabalaoui to pay $3,255,000 in restitution and a $100,000 fine. Zabalaoui also will be under federal supervision for three years after her prison term.
Zabalaoui founded the financial advisory firm Resource Management Inc. in Metairie, La., in 1974. By the time she left the firm in 1991 to set up her own business, Zabalaoui, a certified financial planner, was regarded as one of the pioneers of the financial advisory profession and among the first advisors to transition to a fee-only model in the early 1980s. However, she never joined the National Association of Personal Financial Planners and allowed her CFP license to lapse several years ago. Resource Management has denied any involvement with Zabalaoui since she left the firm and has not been accused of any wrongdoing.
According to a report on the sentencing in The Times-Picayune, Zabalaoui told the judge that she "got hooked as any addict on my drug of choice," but she realized her mistakes after undergoing therapy and "soul searching." It's estimated that 35 people were victims of Zabalaoui's scheme, and many lost their life savings. Actual losses to victims were determined to be about $5 million.
Zabalaoui spent her ill-gotten gains on clothing; credit card balances; mortgages; medical care for her family, her husband's family, her assistant's family and others; rent and living expenses for apartments for friends and family; food for her family and others; and vacations.
From 1993 until late 2007, she created a scheme to defraud numerous clients and guaranteed them between 13% and 26% if they invested in two companies, Paragon Company and Omni Clearing. Unbeknownst to the clients, these companies were both fraudulent. Zabalaoui's sentence is scheduled to start on September 11.
Edward Jones Tops List For Investor Satisfaction
Edward Jones ranked highest in investor satisfaction among full-service investment firms, according to an annual survey released by J.D. Power and Associates.
The company topped the list with a score of 784 on a 1,000-point scale in a study that measures six factors in order of importance: the financial advisor relationship; convenience; investment performance; account offerings; account statements; and fees.
Based in St. Louis, Edward Jones scored particularly well in convenience and account statements. LPL Financial Services, which was second with a score of 773, did well in the financial advisor factor. Charles Schwab & Co. ranked third with 771.
The study found that the financial advisor is the most important aspect, accounting for 30% of overall investor satisfaction in 2009. That's up from 22% in 2008. Investment performance declined in importance in overall satisfaction--to 15% this year versus 24% last year.
"As investors become increasingly uneasy amid current market conditions, they're more often looking to their financial advisors for reassurance and guidance," said David Lo, director of investment services at J.D. Power and Associates. "As investment performance tends to be a relative and subjective measure, it's more important that the financial advisor manages investors' expectations of investment performance."
Raymond James, last year's champ, finished fourth. It, along with Ameriprise Financial and UBS Financial Services, finished in the "better than most" category. The entire list can be found at jdpower.com.
The seventh-annual study was based on responses from nearly 4,500 investors who make some or all of their investment decisions with a financial advisor. It was conducted from March to April 2009. J.D. Power and Associates, a unit of The McGraw-Hill Companies, is a global marketing information company in Westlake Village, Calif.