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.