Broker-Dealers Can’t Compete Treating Advice As A Liability


Executive Summary

Notwithstanding their commission-based roots as a product distribution intermediary, this year’s Financial Planning magazine survey of the top 50 independent broker-dealers showed that in the past year they generated more revenue from fees than from commissions. Yet even as broker-dealers transition from their commission-based roots to the fee-based model and provide more and more advice, the challenge remains that when historically broker-dealers went out of their way to not provide advice (to avoid the RIA registration requirements and advice liability that may result), too many broker-dealers still treat the growing volume of advice from their advisors as a liability to control and minimize, rather than a value-add to enhance… which will make it increasingly difficult for them to compete, even as they transition to the fee-based model.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1 PM EST broadcast via Periscope, we explore the roots of why broker-dealers historically have tried to prevent their representatives from providing advice, the ways that broker-dealers have tried to limit the scope of their representatives giving advice (from centralized planning departments to tech-delivered financial plans), and why the future of broker-dealers managing the liability exposure of providing advice is not about limiting the ability of their representatives to give advice but rather about investing in the training and education of their advisors to ensure they have the knowledge to give the right in the first place!

The trend of broker-dealers towards fee-based advice has been incredibly strong over the past decade, as the top-50 independent broker-dealers have risen from having fee-based revenue that is just 1/3rd of commissions, to surpassing it in the past year. And the trend appears to only be accelerating, due to both the simple realization that recurring AUM fees is just a much more stable and sustainable (and higher-valuation) business model, and the emerging trend of both US-based and global fiduciary regulation that threatens to curtail commission-based compensation and its conflicts of interest anyway.

The caveat, however, is that too many broker-dealers still don’t treat advice itself as a valuable service to amplify, but instead manage it as a liability exposure to be minimize. In order to mitigate that risk, some broker-dealers have created centralized planning departments, which often aren’t just about leveraging advisor efficiency, but instead are built to produce standardized “financial plans in a box” with formulaic advice that the “advisor” then (just like a pre-packaged product that they’d sell) “presents” to the client customer (removing the actual advisor from the advice equation!). And more are now looking to adopt technology that can further “standardize” the advice their advisors provide, eliminating the ability of the advisors to actually create more value-add with client-specific advice!

Which means broker-dealers risk unwittingly amplifying the breakaway broker trend to RIAs, even as they adopt their own fee-based models, not because their advisors want to transition to fee-based advice, but simply because their advisors want the freedom to actually give advice, customized to their individual clients. Especially as competition increasingly pressures advisors to move towards niches and specializations beyond mere “cookie-cutter” comprehensive financial plans.

Ultimately, though, the key point is simply to recognize that for firms that actually want to build value in an advice-centric future, advice should be treated as a value-add, rather than a liability. Which means the path to minimizing liability exposure is not to limit the ability of advisors to give advice, but to invest into their training and education with CFP certification and advanced post-CFP designations to ensure that they give the right advice in the first place, and form specializations (from student loan planning to retirement distribution planning) that further enhances their domain expertise and thereby reduces the risk of giving the “wrong” advice that creates liability for the firm!

(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)

#OfficeHours with @MichaelKitces Video Transcript

Well, welcome, everyone. Welcome to Office Hours with Michael Kitces.

For today’s Office Hours, I want to talk about a shift that I see underway in the large broker-dealer community. And that’s the shift from products to advice and from commissions to fees. Because there was a major news event that occurred earlier this year that I think was very underappreciated. In the latest “Financial Planning Magazine” survey of the top 50 independent broker-dealers, more revenue was generated from fees than from commissions. That’s right, independent broker-dealers whose fundamental reason to exist in the first place was to be an intermediary for the distribution of products for which they received commissions, are now doing more fee-based revenue than commission-based revenue, when just 10 years ago, fees from broker-dealers were barely a third of their commission revenue. In fact, Aite Group predicts that across the entire industry of broker-dealers, fee-based assets are now up to about 40% of the total, and wirehouses in the largest independent broker-dealers have been leading the way on the change.

Which is just an absolutely incredible shift and one that I think you’ll actually only see accelerate from here. And in part because firms are discovering that fee-based revenue is just more stable and sustainable of a business model than commissions, fee-based firms are literally valued at more than double the revenue multiple of commission-based firms, and in part because Department of Labor’s fiduciary proposal and what now seems to be a global trend of fiduciary rulemaking that often includes a curtailment or outright ban on commissions is driving the leading broker-dealers to realize they have to reinvent as fee-based advisory firms before the regulators do it for them, or to them.

And this is why there’s been such an explosive shift towards dual-registered advisors over the past decade, because if you want to get paid for advice in financial planning at a broker-dealer, you have to be registered as an investment advisor. And so more and more broker-dealers are running hybrid platforms and dual-registering their advisors in both the broker-dealer legacy business and the RIA platform, where they’re building this fee-based revenue into the future. And we’ve seen this trend with a growing number of hybrid broker-dealers reaching out to adopt AdvicePay as well. Because if broker-dealers are going to increasingly shift towards AUM fees for advice, the next natural step is to allow their advisors to offer other types of fee-for-service financial planning advice arrangements as well, and then they need a way to bill financial planning fees for those clients.

But there’s a fundamental problem in this shift in the broker-dealer community that I’m starting to see crop up both in some of the enterprise I consult with directly and the advisors I hear from at broker-dealers who are trying to implement tools like AdvicePay to get paid for financial planning. And I can only characterize it as a mindset problem in the broker-dealer community. And the problem simply is this. Broker-dealers aren’t actually treating advice as a value-add. They’re treating advice as a liability.

How Broker-Dealers Treat Advice As A Liability [02:40]

Now, perhaps the most classic example of this is the infamous disclaimer associated with virtually all advice-related communication under a broker-dealer, where the advisor makes a recommendation that has some tax consequences or tax benefits, and then provides that statement at the bottom, “This is not tax advice. Please consult your tax advisor.” And the client goes, “Wait, you literally just gave me advice about a strategy that has tax benefits and provided a recommendation about what to do for tax purposes, and now you’re saying it’s not tax advice.” From the client’s perspective, it’s sort of nonsensical. You can’t give a recommendation to open an employer retirement plan or save in an annuity or buy a tax advantage master limited partnership and discuss the tax benefits of the recommendation, and then say you’re not giving a tax-related recommendation. You just gave a tax-related recommendation.

And if the client trusts you in the first place, they’re usually not going out for a second opinion on the tax outcome because you already told them what the outcome would be, and they trust you as their advisor. And if they don’t trust you, they’re probably not going to become an advisory client or stay a client much longer in the first place. You can’t give what’s clearly advice, and then just try to disclaim away that it wasn’t advice, except maybe if you’re trying to do it to just protect your own liability in the event that you get sued.

And I understand that that’s why broker-dealers do this. You know, historically, broker-dealers tried to avoid fiduciary liability for their advice in the first place by claiming that advice was solely incidental to the sale of brokerage products. And technically, most broker-dealers still rely on that exemption for at least some of their advice, notwithstanding the fact they write titles like “financial advisor” on their business cards.

But beyond the broker-dealer just trying to avoid needing to register as an RIA, the other reason broker-dealers have stayed away from advice is because I think they know deep down that not all their registered reps necessarily have the training and expertise to give that advice. After all, you can become an advisor with a relatively simple three-hour regulatory exam that you can prepare for in a few weeks. CFP certification takes most people 9 to 18 months, but that’s optional.

Which means as a broker-dealer, if any of your advisors are giving tax advice or other advice, it’s crucial to oversee that advice, which is difficult and cost-prohibitive for a large broker-dealer with lots of reps and lots of clients giving lots of different types of advice, so the end result instead is a form of what I call lowest common denominator or LCD compliance, which is that the firm writes the compliance rules to protect the firm against whatever the one biggest idiot in the entire organization might do. And since the bar to get hired at most broker-dealers is pretty low, the lowest-quality rep at most firms is pretty low quality. And so, how do you oversee a low-quality rep who has no training and experience in giving advice? You ban that person from giving advice.

Never mind that it ties the hands of dozens or hundreds or thousands of good advisors who have training and experience to give good advice. The firm’s liability and the compliance processes are built based on the lowest common denominator, the worst few reps who are the least trained and the harm they might cause by not even knowing what advice they’re giving when they give advice. And because they can’t come up with a way to effectively oversee all those undertrained advisors, the end result is that broker-dealers tend to ban and limit advice. Or stated more simply, broker-dealers essentially are treating the delivery of advice as a liability exposure that has to be controlled.

Controlling Advice Liability Through Centralized Planning And Technology [05:56]

And doing this with tax advice is really just a case in point example. An even broader example of how broker-dealers tend to treat advice as a liability is the shift in recent years to create centralized planning departments that produce and deliver the financial plans for their reps. Now, as we found in our recent Kitces Research study on the financial planning process, being able to delegate financial plan prep tasks, either to a staff member or a centralized resource, can be a real boost to advisor productivity. I am all for delegation of delegable tasks. But for a number of broker-dealers, their approach is not just that the centralized department helps with plan preparation, it’s that the centralized department creates an entirely standardized financial plan in a box that the advisor just delivers to the client like a product. Or even worse, the centralized planning department itself actually delivers the plan to the client.

Now, I’m not against more consumers getting plans, and I don’t even mean to suggest that centralized planning departments don’t do a good job, they often do, but the approach epitomizes the view of so many broker-dealers that you can’t possibly let the advisor who sits across from the client produce and deliver the plan that you can’t control and oversee. All those plans must be produced in the centralized department in a controlled manner so that we don’t have to worry about those rogue advisors actually saying something to a client that might be construed as advice when they don’t know what the advisor is going to say in advance. In other words, for a lot of large firms, centralized planning resources isn’t just a means to improve the efficiency in the delivery of financial planning advice, it’s actually a system to take financial advice delivery out of the hands of the end advisor and put it into the home office instead where compliance can better manage the liability exposure.

In turn, I think that’s also why there was such a huge boost in technology spending when the Department of Labor’s fiduciary rule came out two years ago. Because firms suddenly realized that they were going to be more legally responsible for all the advice and recommendations their advisors give beyond just product sales that they already supervise. And in fact, I predicted that when the DOL fiduciary rule came out, if it stayed, the biggest risk of a class action lawsuit against large firms was not about whether they met the duty of loyalty to clients and navigated all those conflicts of interest, it was that they might be sued for violating the duty of care by sending out masses of advisors to give advice without any actual education, training, or experience in how to give advice, right? Just imagine the lawsuit when the attorney asks, “So, how would your advisors have known what the best interest advice is to give based solely on a 3-hour Series 65 exam?”

And so what do firms do to limit this massive liability exposure for their advice? They decide that the solution was to use technology to take the advice out of the hands of their advisors. Thus the huge focus on using robo tools and the like that would have taken client-directed risk tolerance questionnaires and linked them to home office designed portfolios. That way the advisors didn’t actually give the advice, minimizing the liability for the firm. And simply, the broker-dealers started [inaudible 00:08:54] more clients-directed data gathering input tools to financial planning software, in part because there was a concern that fiduciary liability would require them to do more comprehensive advice, so they wanted to do it efficiently, and in part because clients entering data directly in a planning software that would then produce plans created entirely by home office staff was another means to cut their actual advisors out of the advice process.

Now, I don’t want to criticize all broker-dealers as engaging in this kind of approach because not all of them have. But I suspect many of you who are listening to this and work under a broker-dealer have experienced this or some form of it, where the home office tried to limit the scope of your advice or limit you from giving advice, or force you to provide disclaimers that you’re not giving advice even though you are, or take other steps that are basically designed to limit the broker-dealer’s exposure to your advice. For which the most straightforward way is for them to simply not let advisors actually construct their own advice. The advisor is just like the human mouthpiece that outputs the software or the home office planning department’s recommendations.

Advice Is A Value-Add, Not A Liability! [09:56]

So here’s why all of this matters. With the ongoing commoditization of basic asset allocation advice, even as broker-dealers are moving towards fee-based accounts where they get paid for asset allocation advice, it’s increasingly necessary for us as advisors to justify our 1% AUM fee by providing real value-add advice beyond just the portfolio. In fact, financial planning advice and the behavior change that goes along with it is increasingly being cited as the primary value-add for financial advisors going forward, especially to justify those fees. Which means at a consumer marketplace, advice is the key value-add, and in the minds of large-firm compliance departments, advice is a liability. And that’s a really problematic mismatch. Because it’s creating an environment where advisors want to give more advice in more areas to demonstrate more value, and their compliance departments don’t see that as a business opportunity, they see it as a liability risk to control.

And that attitude of advice as a liability, not a value-add, is permeating a lot of large firms in really problematic ways. It’s the advisor who wants to do more work with younger clients and studies up on student loans, only to be told by compliance they can’t write any articles or get paid for any advice pertaining to student loans. It’s the advisor who implements increasingly sophisticated tax strategies and client portfolios and then has to give every client a disclaimer saying that’s not their value-add because the compliance department has declared they’re not competent enough to give advice about tax issues. It’s the advisor who wants to customize their financial plans to give even more specific advice to their clients and is told by compliance that they’re not allowed to add anything or modify the standard financial planning software output for MoneyGuidePro or eMoney Advisor in any way that might possibly deviate from the cookie-cutter printout of the software itself.

So what’s the alternative? Simply put, it’s time for large firm broker-dealer leadership from the top to take the attitude that advice is an asset and a value-add, not a liability. Now, I don’t want to downplay the consequences that if you give advice you better be accountable for the consequence of that advice, but if you truly see advice as the future of the industry, the goal shouldn’t be figuring out how to wring all the actual advice out of the hands of your advisors and put it in technology in a home office staff. Your goal should be figuring out how to train and develop and support your advisors to be better, more educated, more trained, more experienced, more confident so you don’t have to worry about them getting sued for bad advice because you train them well enough they don’t give bad advice in the first place.

So what are you doing to get all your advisors enrolled in CFP certification? Are you teaching and training a financial planning process for them to implement on your technology systems? What post-CFP education are you sending them off to learn to further deepen their expertise? In other words, if the future is all about advice, minimizing advice liability in the future isn’t about taking advice out of the hands of advisors, it’s investing into advisors to make them so damn good that their advice is right and then you don’t get sued anyways.

And recognizing that rather than trying to force all your advisors to be generalists so they don’t specialize and give more advice which you treat like a liability, what you should be doing is trying to drive your advisors towards their own niches and specializations where their expertise is so deep and their value-add is so high and they’re so good that they’re not going to get sued for bad advice because they’re actually literally the experts in their subject matter, and clients seek out your advisors in your firm because you’ve got the best advisors with the deepest expertise. And the more that advisors specialize, the easier it actually becomes to limit firm liability both because they’re really good experts in their domain of expertise, and because now it’s easier to limit the scope of their advice to those areas of expertise.

For instance, if all your advisors are generalists, I get it, having one give advice on student loans and another on retirement distribution strategies is terrifying for compliance. Who knows if all those generalists really know their stuff on student loan planning and retirement distribution? But if advisor number one is literally a specialist in student loan advice and number two has a specialized expertise on retirement distribution strategies, you don’t need to scrutinize their advice as much in those areas because they’re literally already the recognized experts at those subjects. The only thing you need to ensure now is that the student loan expert doesn’t give retirement advice and that the retirement expert doesn’t give student loan advice, because that is outside of their domain of expertise, right? Just as the world’s leading orthopedic surgeon can still get sued for operating on my brain and not my knee. Because she may be the best knee doctor in the world, but she’s not certified for brain surgery. I need a brain surgeon for that.

The bottom line, though, is just to recognize this disparity that’s emerged that technically it can occur anywhere but I’m seeing it by far in broker-dealers that have a history of this lowest common denominator compliance approach and the lowest historical standards for hiring reps in the first place who treat their own advisors and any words that come out of their mouths to a client as a potential liability to control and minimize by literally trying to prevent their own advisors from giving advice. Instead of viewing advice as the essential value-add and adopting strategies that maximize the ability of their advisors to give advice and elevate their advisors with the training and the education, CFP certification, post-CFP designations to make sure that they give the right advice in their domains of actual expertise.

Otherwise, I fear the current trend will continue, which is that advisors at broker-dealers who are the most advice-oriented continue to break away to independent RIAs so that they can better control their own compliance and give the advice value-adds they want to give their clients in the first place that you can do as an RIA and is harder as a broker-dealer, not because it’s impossible in a broker-dealer environment, but because it’s impossible the way broker-dealers manage advice as a liability instead of a value-add.

So I hope that helps a little as some food for thought about why I think it’s so necessary that there’s a mindset shift to occur across the industry, particularly in the broker-dealer community, to treat advice as the value-add it is and not as a liability just to control.

This is Office Hours with Michael Kitces. Thanks for joining us, everyone, and have a great day.

Michael Kitces is a co-founder of  AdvicePay, which was mentioned in this article.





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