Fidelity executive forum raises issues about where the industry is headed.

    It's no longer a secret that independent registered reps and fee-only advisors are the fastest-growing segments in the money management business. But mushrooming competition amid stifling regulatory scrutiny, and an increasing population of high-net-worth baby boomer retirees, worried many attendees at the Fidelity Executive Forum in Palm Beach, Fla. in early April.
    The conference comes at a time when Fidelity itself is expanding its commitment to the independent advisor marketplace. Ellen McColgan, president of Fidelity Brokerage Services, told attendees that the Boston-based financial services giant is serious about displacing Schwab Institutional as the top custodian for advisors.
    But advisors had more concerns closer to home than the struggle between Fidelity and Schwab. One advisor, who asked not to be identified for fear of coming to the attention of regulators, worried about the mounting costs of added regulation. His four-man shop, with just $75 million under management, had gotten a price quote of $15,000 for hiring a former SEC staff lawyer to handle compliance. He cut that cost down by setting up a compliance manual from an $800 template instead.
    But he hadn't quite figured out how to avoid the $1,500 set-up fee and $3,300 annual fee to archive all e-mails that examiners might wish to see. Even an assurance by another advisor that his own recent audit only required him to show three months' worth of archived e-mail failed to satisfy him.
    One major dilemma many advisors are wrestling with: How to provide immediate annuities, an essential offering to a retiring population, in a fee-based business. Providing that service means immediately losing as much as 30% of a client's assets under management, noted Harold Evensky, of Evensky and Katz in Coral Gables, Fla. "We're working on that right now," Evensky said.
    The importance of the independent advisor and broker-dealer markets was evident everywhere at the conference, held at the plush Breakers hotel in Palm Beach. Attendance at the invitation-only conference was 250, up from 185 the prior year, and had a breakdown of 55% registered investment advisors vs. 45% broker-dealer clients. "The independents are outgrowing the wirehouses," declared Chip Roame, principal with Tiburon Strategic Advisors, San Francisco.
    Expect to see changes in financial products and the way professionals are compensated to reflect this, according to a study by Tiburon. The report also says:
        Assets under management by independent financial advisors increased 16% last year. Independent financial advisors include independent brokers and fee-only professionals. By contrast, full-service brokerage assets under management increased 11%.
        In addition, fee-only advisors' average account is larger than accounts of other groups. The average account size of independent financial advisors and wirehouse advisors is $142,000 and $330,000, respectively. By contrast, the average fee-only advisor account is $510,000 in assets.
        In the wake of the 2000 stock market crash, consumers were unhappy with the guidance they received from brokers who charge commissions, Roame explained. The scandals involving Wall Street, mutual funds and variable annuity issuers motivated people to hire financial advisors that charge asset-based fees.
    "The Eliot Spitzer scandal is driving the growth," he said.
    Some 400,000 financial advisors are battling for $17 trillion in assets. But by 2010, when the baby boomers retire, $30 trillion in investable assets will be up for grabs. A large percentage of those dollars represent retirement assets.
    "You are looking at the reliquification of assets," Roame said. "Advisors will be managing assets for retirement income."   
    Today there are 76,230 wirehouse brokers, 10,421 bank trust departments, 30,024 independent and fee-only advisors, 21,308 bank advisors, 51,607 insurance agents and 24,265 registered broker dealers. They are competing for several sectors of the market that include: 25 million households with assets of $100,000; 8 million households with $1 million or more in assets; and 255,000 households with at least $5 million in assets.
    Although a lot of money is up for grabs, Roame said, the financial services industry is doing a poor job helping clients set up a financial plan. "Only 18% of all financial advisors do financial plans," he said, adding that only "1% of financial advisors do client satisfaction surveys even though half their referrals come from their existing clients."
    Scott Dell'Orfano, executive vice president of Fidelity Investments' Investment Advisor Group in Boston, told attendees that his company's advisor business is strong. Fidelity has $132 billion in advisory assets, up 26% over 2004 and 188% over the past five years. Meanwhile, there are 2,609 clients, representing a 220% increase over five years ago. The average advisor using Fidelity's services manages $125 million in assets.
    One reason for the growth: Fidelity has modernized its trust service/wealth management delivery. In fact, at the conference, it unveiled "Channel," a system developed with Microsoft Corp., which is expected to take the place of most other software applications advisors use. In development for the last two years, the system, according to Fidelity officials, is key to increasing its assets under management to $500 billion over the next few years. The company boldly predicts that it expects the system, slated to be offered to advisors in September, to put it one step ahead of its chief competitor for advisor business-Schwab Institutional.
    From a desktop PC, financial advisors will be able to access individual client information and sales information about Fidelity Investment products. Simultaneously, it will let them manage their practice's operations and growth. "The biggest concern of the independents is time management," Dell'Orfano said. "Technology is the solution."
    To meet future demands for fee-based advisors with a large client base of retirees, Dell'Orfano said Fidelity is developing a line of fee-only insurance products, including immediate annuities, to provide income during retirement. In addition, as more advisors go into the wealth management business, he expects to see them getting compensated by retainer fees because they will do more than just manage money.
    Dell'Orfano's greatest concern: Automated services will have to keep up with the growth of their advisory business.
    Arthur R. Miller, a Harvard University law professor who once had New York Attorney General Eliot Spitzer for a pupil, offered a chilling picture of the scrutiny advisors are under. "This is not an era to operate with a wink and a nod," he declared. "Maybe next year. It's not an era to figure out how to do things in the cleverest ways."
    As Miller put it, "What you don't know can hurt you."
    "Watching you is the usual cast of characters at the SEC," he said. "But it goes beyond that. Eliot Spitzer is watching you. Also watching you are the media."
    "The former student of mine is a well-meaning, socially motivated person," he said. "Those of you from New York can elect him as governor. That'll get him out of your way."
    Besides the media, advisors also are under scrutiny by the "plaintiff's bar-a collection of ambulance chasers, parasites, specialists in sham and frivolous litigation."
    The old model for plaintiffs' attorneys, Miller said, was semi-passive. They would go out and find someone and sue. But the Private Securities Litigation Reform Act of 1995 changed all that. The law, he said, made it more difficult to conduct finance-based class-action lawsuits. It federalized all significant class-action lawsuits before an often sympathetic judge.
    "That's the good news."
    The bad news is that there is a natural affinity between the plaintiff's bar and union-operated pension funds. "They have convinced those entities there's money on the table. They have a cadre of forensic accountants, analysts and private investigators," Miller noted wryly. "They know they can count on the media telling the story."
    The keys to compliance, he says: Financial advisors have a fiduciary duty based on law. "Your first job is to serve your client-not the portfolio manager," Miller continued. "They're looking for pay to play, kickbacks, undisclosed compensation and overt or covert allowance of people to share in deals. They're also looking at appearances-self-dealing-even if self-dealing doesn't hurt the client."
    Advisors, he warned, are getting blind-sided by new duties. Example: "You owe it to your clients to have a disaster recovery and contingency plan. Why? You're holding their assets."
    The SEC, he says, "is going nuts. Maybe it's overregulation. Maybe it will pass like a bad dream. But right now you have to watch. The SEC is expanding its tentacles."
    In the past, there were fewer institutions that fell into neat categories.
    Now, he says, institutions have blended together. "You can't tell a broker-dealer from an investment advisor. The SEC is saying we've got to assert ourselves. Look at hedge funds. They're doing stuff that if it were done by others would be regulated. Maybe we should have them registered."
    We haven't seen the end of hedge fund regulation, Miller warned. He dubbed compliance rules, "an instrument of torture."
    Under the rules, he says, you must engage in an extraordinary level of introspection-figuring out "who the hell you are, what risks you're confronted by, what your people are doing, and potential conflicts of interest." After the evaluation, advisors must write up a set of rules-which, he says, can hang them.
    They must do "practice and procedures," followed by an "aspirational" code of ethics. "If you don't live up to them, you're dead meat. You can face sanctions, bad publicity or liability."
    Advisors also need to have a chief compliance officer, which he termed the "eyes and ears of the SEC."
    Another responsibility: There's a fiduciary duty on handling clients' data with confidentiality. JetBlue, he notes, was among those sued for giving out security data.
    In other sessions:
    Janice M. Morris-Hatch, executive vice president, Fidelity Investments, noted that Social Security reform is the highest legislative priority for this year. "We remain neutral on this issue," she said. "We have formed a team to study it. We will determine at a later date whether to get involved." Instead, she said, Fidelity is concentrating on building products-including, she hinted, a high-deductible health savings account. The second legislative priority: Extending tax cuts.
    Stacey Haefele, executive vice president of HNW Inc., in New York, revealed startling new data indicating that the chief reason high-net-worth clients leave their financial advisor is "performance." And persons with assets of at least $5 million often expect a 15% return or better. It is critical, therefore, that advisors review with their clients a definition of performance that they are seeking.

Gail Liberman and Alan Lavine are contributing editors to Financial Advisor.