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When Bernard Madoff was carted off to jail, he left track marks on the whole financial advisory community. Even today, his shadow hovers over the advisor/client relationship, at the core of which is that all-important ingredient-trust. Following the Tiburon CEO Summit XX in New York City in April 2011, six leaders in the wealth advisory profession presented their views in a roundtable discussion. The 90-minute conversation was a spirited debate. Financial Advisor magazine Contributing Editor Bruce W. Fraser moderated the discussion. Part One of this transcript ran in the June 2011 issue of Financial Advisor magazine.  Part Two, which follows, provides additional insights and observations.

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Financial Advisor:  Should there be a self-regulatory organization for investment advisors? 

Stuart DePina, CEO, Tamarac Inc:  The industry needs to develop a self-regulatory organization. The reality is similar to what happened in the accounting profession in 2001 when the Sarbanes-Oxley Act was put into place. 

As John Brackett said earlier in today's conversation, the industry needs to start the process, expand the dialogue, and give us a clear system of rules to follow. If we can't do that, then others who think they understand what goes on within this industry will start to define the rules we need to follow.  In the end, the investor will suffer from our lack of ability to provide clear, consistent advice.

John Brackett, partner, BAR Financial LLC:  I couldn't agree more.  We know.  We know.  And when we bring in an outside entity to regulate this business they focus on the wrong things - even though they believe they are doing the right thing for the consumer, but they harm that person. 

The reason we have so many rules is that there are not as many good guys as we would hope there are. Once you get outside of this room, where we see ourselves as good guys in white hats, it's a different story.  So I believe regulation needs to come from inside, not outside. 

Scott Hanson, CFP, co-founder, Hanson McClain Advisors: I too think an SRO would be good for advisors.  The way FINRA regulates registered representatives today is so rules-based; every time an issue arises, there's another 10 sets of rules. I almost feel like in an audit no one's actually looking at what the business is. I'd rather see a principles-based system on both sides.  

Michael Kay, CFP, president, Financial Focus LLC: The idea of a self-regulating organization is necessary and important, just as in the accounting industry, where best practices are tested and looked at by other firms.  I'm not arrogant enough to suggest the right structure, but some kind of tiering based on the type of business would probably be appropriate.

Skip Schweiss, president, TD Ameritrade Trust Company: In the ideal world, the SEC should continue to be the oversight body for investment advisors. They understand investment advisors, they created the rules, and have overseen registered investment advisors for 71 years now.  I feel they know what they're doing.

Now let's switch to real world.  The SEC says, "We're only getting out to see these advisors once every 10 or 11 years."  I think everybody agrees that's not often enough. 

So that's where an SRO like FINRA comes in and says: "Hey, we can do this.  We go into our regulated firms every other year, which feels better to the industry and to investors." Should we have an SRO?  I'm not sure. Are we going to?  I think we're going to because of the economics involved. 

Brackett:  The biggest fear is when you say self-regulatory.  Does the investor -- or do we -- believe we will be as stern with ourselves as somebody from the outside?  I believe we would.

BAR Financial is the single largest asset of mine.  I am not going to allow anybody to affect it negatively.  We're going to do this business clean, right, and appropriately or someone's going to leave the firm.  So I believe in the self-regulatory bodies.  We understand our business and we do it right. 

Randal Langdon, president, Lindner Capital Advisors: There's a challenge in terms of the public's perception of self-regulation.  Look at the recent occurrences at Berkshire Hathaway. When Warren Buffet was faced with his dear friend (David Sokol) and likely successor doing something that...does not pass the smell test, and says emphatically, "There is nothing wrong with this..." That's something we have to deal with and, unfortunately, may become a big hurdle for everyone in the industry. 

FA:  Let's talk about the emerging Department of Labor regulations regarding disclosure and advice to retirement plans and how that impacts the financial services industry. 

Schweiss: This issue is near and dear to my heart. Part of my responsibilities at TD Ameritrade is overseeing our 401(k) platform. There are four key rule makings now at the DOL. 

One is: any service provider and ERISA plan is going to have to disclose their services and their fees in writing, and their compensation in writing, as well as 12(b)1 fees, spreads from deposit products, you name it.  

Also, plan administrators, that is, employers, are going to have do more disclosures to participants related to investment options in the plan, expenses in those options, estimated returns, and fees the employee is being charged.

The more controversial rules coming could upend this industry. One concerns the definition of "fiduciary," which basically broadens who's going to be considered a fiduciary to a retirement plan.

At the Tiburon CEO Summit, some executives told me this could spell the end of the brokerage business with respect to retirement plans.
The last proposal is that if you provide advice to a retirement plan, including an IRA, it can either be on a level fee basis, meaning a flat annual retainer, or a percentage of assets under management. Or you need to select investments for that retirement plan account owner using an independent computer model like Morningstar, not your proprietary model. They want to completely remove the conflicts in investment advice to retirement plan owners. 

Hanson:  It would be nice if the Department of Labor actually helped encourage savings. People aren't utilizing their 401(k)s well enough and they make poor investment choices. 

Brackett:  Another problem: when you're competing in the 401(k) space it is generally about the fees ... and the fees ... and the fees.
Say you have a 100-person company. You're going to be required to meet with everyone up to the CEO. Then you find that employees on the lower end of the spectrum can only put in $25 a month. The margins are gone and you just can't afford to do that business. It doesn't make economic sense.

Hanson:  The smaller firms will be hurt the most. The large firms will pay for everything.  The small firms say, "I can't afford it, but if it's bundled in..."

Brackett:  If you're talking about Chevron they will pay for the service, but we're in the smaller space with fewer than 200 or maybe even 100 people. Most of that business is approached as brokerage business.

Hanson:  Fidelity and Vanguard and Schwab are all in that space. And they're not brokers.

Brackett: That's right. The consumer will lose because there isn't advice available there. It's not about the money; it's about the money and the brokers will walk away if they can't get paid.  

Schweiss:  In this industry we're now realizing it's not about which funds you pick, it's about how much the employee is putting away for retirement.  And if it's $25 a month, sorry, you're not going to get there.  If it's $25 a week, you're not going to get there. We can have a greater impact in this industry influencing how much money they put away than which funds they pick.

A proposal in President Obama's budget proposal will create payroll IRAs, and if it becomes law will require that a company at least offer access to its payroll system for all employees to contribute to an IRA through the payroll system. 

Kay:  This all leads back to the point of education; that consumers need better education to understand what they need to do to make good choices.

When clients in their 50s and 60s come in and their financial education is zero, and they've cobbled together some assets, and also people in their 20s wanting financial guidance, they need to be pointed in the right direction. As stewards, we need to impress upon our clients, fellow advisors and the general public the need for financial education. They need to take ownership and responsibility.  
FA: Let's talk about the switch from the SEC to State Registration.  Will that drive advisors to consolidation? 

Kay:  I desperately hope this switch will be a driver for consolidation of the industry.   It's important for advisors to gain scale as businesses. But also clients and consumers should not have to rely on the solo practitioner because if something happens to them, they've lost their source (for guidance). The risk that clients or consumers take by dealing with solo practitioners is huge.

Hanson:  The idea of States regulating advisors scares me because I was registered through the State for years and I never saw or heard from anybody.  I don't know why we have a dollar number as the threshold as opposed to some other criteria or maybe a combination of some criteria.

DePina: I agree with Scott and Michael that one of the key catalysts of consolidation amongst advisors will be firms hitting a limit in terms of scalability, which will impede their ability to be profitable. Investors are confused with regard to which advisors are holding themselves to a fiduciary standard or not.

They don't know enough to ask if someone is registered by the SEC or by the State.   Many investors are not going to flock to those entities for advice if they think the states are providing inconsistent regulation, which will likely occur as a result of 50 jurisdictions providing different forms of oversight.

Langdon:  Unless there's something besides just pure registration that is not in some way transparent to the consumer, it's a moot point.   

FA: Let's tackle this whole thing about scale and technology and the size of the practice. How is technology changing the way advisors work and build trust?

DePina: What's preventing many firms from taking their efficiency to the next level is the lack of true integration between disparate systems that comprise an advisor's technology ecosystem.  When a client calls in with a request, you don't want to say, "I'll have to get back to you," because that doesn't support one of the first tenets we spoke about-trust. 

Advisors are now looking to integrate their back-offices to drive new levels of efficiency and customer service. And custodians in turn are leveraging their reach, saying an integrated system will enable advisors to easily take action on certain transactions on behalf of their clients, generate performance reports that clients can understand, provide clients with the transparency, and clearly communicate information.

Technology has three pillars in what it should do for an advisor. First, technology has to help an advisor support his or her client, plain and simple.  The second involves efficiencies around regulatory issues.  Can your technology help alleviate the pain you have when dealing with regulators and some of the other compliance work that you need to deal with?  The third pillar-the most important-is profitably.  Those are the issues that we're seeing the best-managed firms address when they think about technology.

FA:  Michael, in terms of the way you built trust through the market downturn, did anything happen that was different in your practice? Did you see an erosion of trust?  How did you shore that up with your clients?

Kay:  What this whole concept of building trust comes down to is really very simple.  It starts with understanding your clients' expectations. If you understand concisely what your clients expect from you throughout the process of working with them, and you are able and willing to deliver on that expectation, all you have to do is fulfill it. 

You're not guaranteeing returns. You're telling them you understand what it is they care about; what they're afraid of; what their wants, needs and dreams are; their goals in  life that are musts to them.  If, indeed, you can get your clients to articulate those values, then all you have to do is follow that line consistently. 

If you listen more than you talk and actually hear what they're saying, you're then setting up a road map to continue to build trust because you're doing what you say you're going to do.  Doing what you say you're going to do consistently is what builds trust.  
In our firm, we reach out to clients, meet with them regularly, talk on the phone, meet face to face, send out correspondence, make sure we're attuned to what they need -- and when they need their hands held, we're there to hold their hands and put things into perspective. And the fear that takes over their lives? Our job is to help them push that away and put it into proper perspective. 

FA:  Skip, at TD Ameritrade, you serve as an advisor advocate, which also plays to trust, and how advisors build a good business and build relationships with their clients. What are you hearing from the field?

Schweiss:  We service over 4000 independent advisors. I listen to their concerns, particularly about the regulatory environment. We distill that (information). Then we go to Washington - to legislators, regulators including SEC, the Department of Labor, and deliver that message.  What are financial advisors concerned about?  What are they excited about?  What do they need more clarification about?   So I facilitate that communication between policy makers and financial advisors.  

One thing I'm hearing from advisors is what a custodian can do to support their business better. Stuart made some great points and I just want to build on them. Just processing transactions accurately, and sending out accurate statements, are core things a lot of (custodians) do well.  But now advisors are looking for more than that.  "Help me run my business more efficiently.  Deliver technologies that will help me run my business more efficiently and provide better service to my clients."  But at the same time they're saying, "Don't give me a one-size-fits-all technology application."  One reason they went out on their own is to be able to build their business their way, select the (appropriate) technology applications, charge what they want, work with the clients they want.  So they are looking for help from us in those areas. They really want open architecture.  We've heard that loud and clear.

The second thing we're hearing from (advisors) is "Help me grow my business." That might mean delivering referrals from our branch network or maintaining the integrity of their brand.  I go back to my story about my mother: "Mom, your assets are safe, they're at TD Ameritrade."  Well, she better not see a negative headline about TD Ameritrade or I'm going to get another phone call. Another way we help an advisor is by maintaining a strong national brand that holds the assets for their clients.

Also, regarding this whole regulatory arena we've talked about, advisors are saying, "Look, I don't care if my business card says registered investment advisor, registered representative, certified financial planner or something else. If I am delivering financial advice to consumers, I should be held to a fiduciary standard."  So that's a message we have heard loud and clear and we are conveying it to Washington for them. 

FA: Scott - you work with some 2,800 clients. So efficiency and communication is very important to your business and to your clients. With the erosion of trust, what were you seeing with clients, and what did you do to shore up that trust, build visibility and gain market share as well?

Hanson:  The last couple of years, clients clearly wanted more interaction with our firm. Many individual investors had a hard time judging if their advisor was doing a good job. Thus, when the market's down 30% and they're down 25% or 35%, I don't know how much difference that really makes with their advisor.  They are losing money; everyone is losing money. 

But what a client can judge is the type of service and communication an advisor provides them.  So if an advisor is reasonably competent at what they do, and can communicate well, they will build that level of trust and that client will then follow their advice more readily, which is key to success. 

So one thing we did was increase our level of communication, our random phone calls that really weren't random on our end but appeared so to clients, so they believed they were top of mind with us. We also did things like periodic podcasts, and a couple of special radio programs designed especially for clients.  And recently we began implementing a quarterly video cast that gives some insights on what we feel about the markets. 

Perceptions become reality. They best thing an advisor can do for their client is to have that client perceive them as being a trusted, knowledgeable advisor because they will then follow that advisor's advice, and in the long run have much better success. 

FA:  Randal, talk about the research you've done at Lindner Capital Advisors on investment management and portfolio creation and how client risk tolerance has changed, how you're looking at building portfolios.

Langdon:  One thing we observed through this whole credit crunch and financial downturn is that clients and advisors needed to learn more about risk. Trying to minimize the draw downs and fluctuations in portfolios was directly related to a client's ability to sleep at night, and directly related to the number of phone calls the advisor might receive or the amount of hand holding he would have to do. So we helped communicate and educate around risk, and also looked at our portfolios to see whether we were delivering risk-managed solutions. 

What we saw was that there were some clients who completely changed their investment policy statement not just from this amount of risk to a little bit less risk. It was like what Will Rogers said: "I'm not so interested in the return on my money, as I am in the return of my money."  

So as a client-focused organization, one thing we did was to implement a portfolio that preserved capital or had the objective to preserve capital.  We responded in a client focused way to dial down the risk if an advisor and a client came to that particular decision.  At the same time, we married research done at Harvard with traditional investment research done at the University of Chicago to see how to integrate alternatives into a balanced portfolio.

We focused on the integration of managed futures into that equation.  We incorporated work done by Dr. John Lintner at Harvard 25 years ago and extended the research.  We tracked down Lintner's original graduate student who worked on the projects and the investigations.  We re-simulated his research with the new data we had gleaned and came up with a portfolio that, in design, was able to deliver equity type of returns at a lower volatility.  This lower volatility was what clients were really looking for in terms of what happened in the credit crunch.  Now we are taking the work further to complete the cycle in terms of income and other types of solutions. 

I think the big take-away is that during the credit crisis, clients and advisors became more aware of the importance to manage risk.  It became more important for the actual individual investors to be engaged with their advisor in managing their portfolios so that they knew what to expect before reality played out.  They knew what type of volatilities they were exposing themselves to, and our job as an outsourced money manager was to provide the tools so that when a financial advisor prescribed a particular type of portfolio, the client knew the risk associated with what they were doing.  Ultimately the most important thing is not to surprise the client either positively or negatively, but to deliver upon their expectations.

FA:   John, you have 450 advisors in your region, BAR Financial, which is part of Cetera broker/dealer system under the Financial Network Investment Corp umbrella. You coach and mentor those advisors.  How are you working with your advisors on communicating with the clients and engaging them in the planning process in a more effective way this time around?

Brackett:  We have built an organization that started as registered reps and as we grew, they grew.  So currently about 60% of total production within our organization is a fee-based percentage of assets under management.  The other part is focused on moving that to advisory.  Our advisors range from the $3 million book of business down to the $200,000 book of business.

The credit crunch and downfall has helped us assist our advisors to become more efficient and find the time to do the things we've talked about - use technology, manage risk, set up meetings, quality time, touches, outreaches, etc. We refer to those activities as tiered services, and we are teaching the advisors to use the A to D client ranking system as everybody's not the same.  Technology certainly helps clients feel they're getting the same level of touch, even though they're not. 

We also spend a tremendous amount of time working with our compliance people and the regulators on what type of communication should be allowed.  For example, a lot of our advisors want to communicate on Facebook, LinkedIn, and other social media. But there are many things you can't do because of rules and regulations. 

FA: Stuart, if there were only one thing we were to include in this discussion, what pearl from you would it be?

DePina: My one thing? That technology has to enable advisors to support clients more efficiently and equitably. With regard to our portfolio rebalancing application, during the crisis advisors told us, "You solved this problem, which is great. I'm in a position now where I can support my client as I never could before. What else can you do for my back office?" That was our "ah-ha" moment that led us to begin focusing on integration several years ago.

The trend we're seeing now from our advisor clients is they are adding more components to our integrated technology suite, and reporting back increased customer service and ultimate profitability.

Before 2008, technology decisions were based on growing the number of assets under management. When the market is going up, this concept works great, and customers are happy. But now that the market isn't going up every day, you need to be able to provide service and solutions that improve overall customer service.

FA: Thanks everybody.

To read Part One, click here.