Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a new industry study from PIABA that finds a whopping 1/3rd of all FINRA arbitration settlements went unpaid, often because the related brokerage firms were undercapitalized and underinsured to be able to make good on any client harm that might have been caused (which is, notably, an issue for many RIAs as well!). Also in the news this week is a recap on the total merger and acquisition (M&A) activity for independent RIAs in 2015, which found a 37% jump in deals and a veritable 'explosion' of mega-RIA ($5B+ AUM) transactions (as well as a growing number of small-to-mid-sized advisory firm acquisitions).
From there, we have several practice management articles this week, including: a discussion of the slowly growing trend of compensating employees in advisory firms with equity as compensation; how to grow an RIA firm with formal paid-solicitor referral agreements (and the applicable compliance rules to consider); the importance of considering not just what your advisory firm value proposition is, but whether you're effectively demonstrating and reminding clients that you're actually delivering on it; and a look at the growing issue of advisory firms struggling to deal with their clients impacted by dementia (and how ultimately the advisor may be in the best position to help clients and their families through such situations).
We also have a couple of technical articles this week, from a discussion of how many Social Security Administration offices are mishandling or outright refusing to process file-and-suspend requests ahead of the looming April 29 deadline before the rules change (such that the SSA had to issue an "Emergency Release" last week to provide guidance for its field offices), to a deep dive into Fidelity's Health Care Cost Estimate for retirees, and how the growing demand for securities lending for hedge fund short sellers is becoming so profitable that a number of small-cap ETFs are now beating their indices and effectively have a negative expense ratio (where the short-sellers "pay" the investor a positive fee just to invest in the index fund!).
We wrap up with three interesting articles: the first looks at a time management strategy of deliberately scheduling meetings and conference calls to last 30 minutes (where possible), as the compressed time can actually force people to be more productive and focused; the second is a look at the growing volume of research suggesting that "dressing up" for work can actually help you be more successful (as it both increases our self-confidence, and may positively impact others' perceptions of us); and the last is a nice remidner that just as many of us have morning rituals to get our days started, it's equally important to have an evening wind-down ritual to wrap up the end of your day in a positive way!
Enjoy the "light" reading!
Weekend reading for February 27th/28th:
Investors Owed Millions In Arbitration Awards Getting Stiffed (Christine Idzelis, Investment News) – According to a report released this week by the Public Investor Arbitration Bar Association (PIABA), of the 225 FINRA arbitration awards that were handed down in 2013, a whopping 1/3rd of them went unpaid. This resulted in about $62M of arbitration award money that was never paid to damaged consumers (nearly 25% of the total owed that year). PIABA suggests the problem is driven in part by the fact that brokerage firms have such small net capital requirements – more than half of the 4,400 broker-dealers out there maintained less than $500,000 in net capital at the end of 2012 – that often the brokerage firms can’t make good on the arbitration awards even if they wanted to. Accordingly, PIABA suggests that FINRA needs to consider increasing the capital requirements for broker-dealers, and given that FINRA does not require broker-dealers to carry insurance to cover arbitration awards, also advocates that FINRA member firms should be required to pay into a collective “national recovery pool” that would be used to help back arbitration damages against them. Notably, while PIABA’s advocacy is targeted primarily at FINRA-regulated broker-dealers, there are arguably similar concerns about whether the typical RIA has sufficient capital (or insurance coverage) to pay a significant arbitration or other damages award in the case of malfeasance as well.
2015 A Banner Year For RIA M&A (Jeff Schlegel, Financial Advisor) – According to DeVoe and Company, in 2015 there were a total of 123 merger and acquisition deals for RIAs, a jump of 37% over the all-time of high 90 M&A deals for RIAs done in 2014, and despite the market turmoil in 2015 that typically slows acquisition activity for advisory firms. The acceleration of acquisitions in 2015 was driven in part by a significant uptick in private equity investors (including the purchases of Edelman Financial, NorthStar Financial Services Group, Wealth Enhancement Group, and Mercer), and in fact the number of “mega-deals” for $5B+ AUM firms exploded in 2015, with a whopping 13 such deals (compared to two in 2014 and only three in 2013). Industry consolidators also played an active role in advisor M&A activity, with firms like United Capital and Focus Financial accounting for 42% of all acquisitions. Also notable is the fact that banks are starting to enter the RIA M&A space again, especially since banks were actually the dominant acquirers a decade ago (with 60% of all purchases). Notwithstanding all this activity, though, DeVoe notes that the number of deals “should” still be double or even triple the current pace just to keep up with the number of advisors who should be retiring (given the industry’s age demographics), suggesting that a “surprisingly” large number of advisors are still choosing to hold onto their firms, rather than sell.
Why Ownership Is The Best Form Of Compensation (Charles Paikert, Financial Planning) – While there has been an uptick in the number of external mergers and acquisitions amongst advisory firms, the pace of internal succession plans has barely budged, with the recent FA Insight 2015 “People & Pay” study finding that just 13% of firms surveyed had a new owner… which is the same 13% rate from 2011, too. A 2015 Fidelity RIA Benchmarking Study similarly found that the median number of owners for all advisory firms surveyed was only two. And all of this is despite the fact that the number of advisory firm owners reporting they plan to leave in the next 3-7 years is on the rise. In some cases, it appears that owners are simply reluctant to transfer any of the equity they have spent so much time and effort building, although Inveen notes that the problem seems exacerbated by the fact that many founding owners have “a not-so-healthy fixation on looking for successors who are just like them”, which unnecessarily limits the already narrow field of potential buyers (given that only 20% of all advisors are under the age of 35 to begin with). Another blocking point to internal succession plans has been obtaining financing – as most commercial banks don’t provide loans to RIAs that have little or no hard assets as collateral – although the entrance of specialist lenders for RIAs like Live Oak Bank appears to be improving the situation slightly. Notwithstanding these challenges, though, a growing number of advisory firms are looking at opening up access to equity, and distributing earned equity as part of an incentive compensation plan is becoming popular. Others are making more ownership buy-in opportunities available, albeit subject to a consistent set of quantitative and qualitative criteria to qualify (e.g., revenue contributions, leadership in the firm, community involvement, etc.). Notably, the largest advisory firms, as embodied in a recent aRIA white paper, suggest that more widely distributing ownership equity is crucial to effectively motivate and engage the next generation of advisor-owners.
How To Grow An RIA Firm By Utilizing Formal Alliances And Solicitors (RIA In A Box) – While financial advisors have long built their businesses through informal referral arrangements, some wish to go to the next level and actually formalize the referral relationship by actually paying the referrer for soliciting the client. However, the introduction of a solicitor fee does create additional regulatory and compliance issues to be considered. First of all, under SEC Rule 206(4)-3, the terms of the fee to be paid for a solicitation must be documented via a written agreement, and the solicitor must provide a solicitor disclosure brochure to prospective clients (along with copy of the RIA’s Form ADV disclosure documents as well). And the RIA must obtain written confirmation from the client that these disclosures were received prior to establishing the client relationship. The solicitor themselves will also typically be required to quality as an Investment Adviser Representative (IAR) of the advisory firm, which means he/she must be registered with the firm itself, and either pass the Series 65 (or in some states, hold a qualifying professional designation that waives the Series 65). In some states, the solicitor must not only be an IAR, but actually form his/her own RIA in order to receive the solicitor fee payments, and even a “solicitor-only” RIA firm must still comply with the general compliance requirements for RIAs, including adoption of policies and procedures, keeping proper books and records, and maintaining advertising and correspondence files, along with filing annual Form ADVs. Which means that while solicitor relationships can be rewarding, to say the least they should not be entered into lightly… though it’s important to verify the exact requirements for the solicitor’s individual state, particularly regarding whether it’s sufficient to “just” be an IAR of the advisory firm receiving the client, or whether the solicitor needs his/her own RIA to participate financially as well.
Prove Your Value Proposition Through What You Deliver (Stephen Wershing, The Client Driven Practice) – The cornerstone of a financial advisor marketing plan is being able to articulate your value proposition: the unique benefit of working with you, that differentiates you from all the other financial advisors out there. Yet Wershing points out that ultimately, it’s not just about whether the firm has a unique value proposition, but whether the firm effectively delivers on it, in a way the client understands. For instance, one firm that prided itself on the sophistication of its financial plans discovered in a client survey that a large number of top clients said they “didn’t know” if their financial plan was regularly updated – because the firm was doing so much behind the scenes to keep the plan updated without ever articulating to the client what was being done so the client would realize the value and make the connection! In some cases, the solution to closing the gap may be simple – the advisory firm in question simply started to add “plan update” at the top of each document that adjusted client projections, to cement in the client’s mind that this was being done. Still, the point remains that if the client doesn’t receive a deliverable that connects directly to the advisor’s articulated value proposition, the clients may fail to realize the unique value they actually are receiving. Accordingly, Wershing suggests several improvements advisors might consider to improve this issue of communicating (and reinforcing) the advisor’s value proposition, including: consider how client documents are titled (really!); show clients a checklist of everything you evaluated in constructing the plan (which conveys not just what you did recommend but everything you didn’t recommend, but still considered, as well); create a graphic that shows your financial planning process (e.g., as a mind map), or a schedule of the services you will provide throughout the year, to reinforce all the work that you do; or use a unique tool in your process that other advisors don’t, ideally one which gives clients a unique tangible deliverable they can take home with them (e.g., Financial DNA).
Advisor Innovation And Client Dementia (Steven Starnes, Financial Advisor) – As advisors increasingly serve an aging baby boomer and retiree population, it is increasingly common for advisors to find their clients falling victim to age-related dementia issues. And while this is a significant challenge for many advisors, Starnes suggests that financial advisors may be uniquely well suited to fill the void and be the ones who coordinate and converse with the range of family, caregivers, and other professionals that may have to be involved in dementia situations. Of course, the first challenge is simply figuring out how to recognize signs of client cognitive impairment (e.g., is the client suddenly more disorganized than in the past, or making new decisions that don’t fit with the existing plan and values?); Starnes recommends guides like “How To Protect And Help Clients With Diminished Capacity” from the Journal of Financial Planning, and “The Advisor’s Guide To Financial Planning In The Shadow Of Dementia” from Transamerica as resources. Next, consider how your approach might have to change, such as always capturing notes from a meeting and sending a brief summary to the client afterwards, to ensure that everyone is still on the same page (and that key details from the meeting are not forgotten). Other best practices that Starnes suggests include: asking clients to sign an advocate designation form, so you have permission to reach out to someone else in the family if necessary (without breaching client privacy); consider tools like EverSafe to help family members monitoring an elderly client’s situation to avoid financial abuse; and know how to report suspected elder fraud or abuse to the state’s adult protective services (which increasingly can be done in most states without being a breach of privacy). Although ultimately, the most basic protection is simply to ensure that other family members are involved in the conversation in the first place, which is a process the advisor can encourage the client to engage in. Starnes suggests “The Other Talk” by Tim Prosch as a helpful tool for clients to read in figuring out how to engage this conversation with their adult children effectively.
Some Local Social Security Administration Offices Refuse To Process [File And Suspend] Benefits Applications (Mary Beth Franklin, Investment News) – When Congress passed the Bipartisan Budget Act of 2015, it eliminated the so-called File and Suspend rules and gave consumers only 6 months (until April 29 of 2016) to be grandfathered under the prior/existing laws. However, a number of consumers – including the clients of advisors – are finding that when they try to go into the Social Security Administration local offices to engage in a file-and-suspend process, the Social Security representatives are refusing to accept the requests, due to their own misunderstandings of the rules and how they work. (In fact, the day after this article was published, the Social Security Administration issued an “Emergency Release” to its field offices explaining/reminding employees how the rules work, and that voluntary suspension requests remain valid under existing rules prior to April 30!) Nonetheless, with confusion continuing to abound at the local offices, Frankly suggests the best path is simply to have clients file for their Social Security benefits online (via SSA.gov), stating that they want their benefits to start at age 66 (or as soon as possible if they’re already over full retirement age), and then in the Remarks box at the end of the application have them write “I want to suspend my benefits” and someone from SSA will contact them within a few days to verify the information and process the application.
About Fidelity’s Health Care Cost Estimate For Retirees (Dirk Cotton, The Retirement Café) – Every year, Fidelity releases a widely cited report about the estimated total cost of health care for couples in retirement (including deductibles and co-pays, premiums for optional coverage for doctor visits and prescription drugs, and out-of-pocket expenses for prescription drugs [but not long-term care or most dental care]. The Fidelity estimate rose to a whopping $245,000 in the latest 2015 release. Notably, though, the average alone doesn’t necessarily speak to how widely those costs are distributed (which Fidelity doesn’t publish). Cotton looks to other retirement studies, and finds a Center for Retirement Research study cited (back in 2009) an average cost of $197,000 and a 95th percentile cost of $311,000 (again excluding long-term care costs). The Society of Actuaries estimates the average at $292,800 for a married couple, and HealthView estimates it at $266,589 in various Medicare Parts B and D policies with a Medigap supplemental policy (or up to $394,954 for total health care, including dental, vision, and all out-of-pockets). And EBRI estimates the average cost at just $150,000 (or up to $220,000 for those with high-usage of prescription drugs), but with a 90th percentile of $255,000 to $360,000, respectively. Notably, while these costs are significant, the estimates from one study to the next are actually remarkably consistent, emphasizing the fact that medical costs are actually rather stable and ‘easy’ to predict in retirement (given that the costs are dominated by Medicare coverage, premiums, and out-of-pockets), though long-term care needs remains a significant wild card (and the thing that may ultimately be most likely to break the bank if the retiree lacks long-term care insurance).
Hedge Funds Will Pay For You To Own Small-Cap ETFs (Eric Balchunas, Bloomberg) – In theory, an ETF should closely track its underlying index, and underperform by roughly the amount of its fee to investors. However, ETFs that are structured as investment companies are allowed to lend out as much as 33% of their equity holdings to short sellers, in return for a small fee, and use that revenue to offset the expense ratio. And in the case of small caps, the demand from short sellers – and the lending fees that they’re willing to pay – are so significant, that a number of small-cap ETFs are more-than-offsetting their entire expense ratio with their securities lending revenue, resulting in tracking ETFs that are beating their underlying benchmarks! For instance, the SPDR Russell 2000 ETF (ticker: TWOK) is beating its benchmark by 0.21% (net of fees), while the iShares Russell 2000 ETF (ticker: IWM) is up 0.07% over its benchmark, and the Vanguard Small-Cap ETF (ticker: VB) is up by 0.03%. Of course, the caveat is that being up by a few basis points over the index isn’t all that “great” in a world where small-cap ETFs are down more than 17% in the past year. Still, for those who are committed to holding more-volatile small-caps for their presumed-to-be-greater risk premium in the long run, it’s certainly appealing that the demand from short-term short-sellers (particularly hedge funds) is actually subsidizing the entire cost of the index ETF, making some small-cap ETFs “free” to hold!
The Magic Of 30-Minute Meetings (Peter Bregman, Harvard Business Review) – A growing volume of research is revealing how multi-tasking can destroy productivity, but Bregman notes that one side-effect of deliberately focusing and not multi-tasking is that wasteful long meetings or conference calls are now even more intolerable (if you’re not going to pass the time but multi-tasking instead!). The solution: force meetings into a more compressed 30-minute time slot. The virtue of this “compressed time” approach is that it forces a greater focus, as the other people on the calls, aware of the time constraint, are more thoughtful when they speak, and more careful not to follow useless tangents. In addition, Bregman notes that everyone seems to listen better, too – as when the calls are abbreviated and moving faster, we tend to be more alert. With the added side benefit that when we’re more engaged and more alert, the calls are actually more fun and enjoyable, too! Other benefits of focusing on 30-minute meetings include: people are more likely to actually show up (because the compressed time slot is easier to schedule around and less likely to have conflicts); everyone is more likely to be on time (as missing 5 minutes is now a big chunk of the meeting!); and people tend to get to the point quicker, asking more provocative or productive questions. In fact, Bregman suggests that if you’re going to try 30-minute meetings, you’ll find yourself forced to prepare a little more for meetings beforehand, and decide what you’re really trying to get out of it (given the limited time window)… which, again, just increases the likelihood that the meetings will actually be productive! And of course, shorter meetings also means you’ll have more time in your schedule for other commitments as well… or to just have more time to relax!
Why Dressing For Success Leads To Success (Ray Smith, Wall Street Journal) – A number of recent studies are finding that dressing up for work – for instance, in a suit or blazer – can actually enhance an employee’s productivity, from going into negotiations, to making sales calls, or even participating in a videoconference with business associates. For instance, one Yale study by Michael Kraus found that those who wore clothes with high social status increased their dominance and job performance in “high-stakes” competitive tasks, as the clothing itself appeared to impact both the self-confidence of the wearer, and the likelihood that others would defer to him (and that the perceived deference tends to further accentuate the confidence of the wearer). Another study by Michael Slepian from the journal Social Psychological and Personality Science found that those who dressed up engaged in higher levels of abstract thinking as well. Of course, what constitutes “higher status” fashion will itself vary by industry (and between men and women), but for men seems to include a full suit (or at least sport coat and tie), and for women means a tailored jacket and even heels.
The 7 Step Evening Ritual That Will Make You Happy (Eric Barker, Barking Up The Wrong Tree) – Many people have morning rituals to get their days started off right, but Barker makes the case that an evening ritual to end the day is equally important. The starting point is actually to have a “shutdown ritual” simply to help your mind transition from the work day to your personal time in the evening – whether it’s simply about straightening up your desk, backing up your computer, or making your end-of-day to-do list for tomorrow. Next, make sure that you spend your evening time socially with friends and family – in fact, research finds that the primary reason we enjoy weekends more than weeknights is because we end out spending more time socially with others. Other tips to make your evening routine happier include: spend time actively engaged in a hobby, or some kind of “mastery experience” (where you’re doing something you’re good at and trying to get better), which engages us more than just sitting in front of the TV; as you approach the end of the night, wind down (rather than just collapsing), particularly by eliminating your screen time in the final stages before bed (it’s been estimated that ten minutes with a smartphone in front of your nose is the equivalent of an hour long walk in bright daylight, which confuses your brain’s sleep time!); don’t go to bed angry (so let go of whatever your problem was and kiss-and-make-up with your spouse before you go to sleep!); take a few minutes at the end of each evening to write down some of the good things that happened for you that day (which has been repeatedly found to lift our mood and spirits); and make sure that you always have something scheduled in the future that you can look forward to (whether it’s a simple meal with a friend, or a fancier vacation, as the anticipation itself can enhance our happiness and well-being).
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.