Still Selling

In a tough marketplace, folio companies shift gear

All signs indicate that folios are on their way out, right? Advisors and retail investors are still harboring a wait-and-see attitude about these baskets of stocks that can trade online. Folio providers are cutting staff and at least one has shut its doors to individual investors. But don't count out these new-fangled products just yet.

After all, it took 15 years for the idea of discount brokerages to catch on, and nearly a decade for index mutual funds to hit the mainstream. "It used to be that it would take decades to build up new companies and new concepts," says Steve Wallman, CEO and founder of Foliofn. "We've now gotten used to the notion that we can condense what otherwise would take 20 years into at most 10 or 20 months, and if something doesn't occur in that time frame then we get a little bit concerned about it."

Turmoil in the economy and markets, along with investors' reluctance to allocate any more cash to equities, have all played a hand in Foliofn's recent spate of layoffs. The Vienna, Virginia-based financial services firm recently issued pink slips to 50 of its 140 workers, 36% of its staff, and cut executives' salaries. Netfolio recently closed its doors to retail investors. "The markets have not been as cooperative as one might like in regards to growing a new kind of financial services product," Wallman says.

Wallman admits that Foliofn's growth is coming from a "small base" of customers, but he says the firm's "week-over-week" growth is evidence that consumers "understand the benefits of this new kind of investing, and they will embrace it." It will just take time for consumers to trust this new investing concept, he says.

Sameer Shah, a CFA with Shah & Associates in Tampa, Florida, who conducts a monthly virtual discussion group on new investments, says folios dramatically lower transaction costs for small- volume trades. And, he says, Foliofn's technology platform allows investors to effectively and efficiently manage a large number of security positions, especially in terms of tracking cost basis.

But it's hard for most retail investors to grasp folios because some have the investor owning units instead of shares, others have ownership of partial shares, and some only allow trading a couple of times per day. Shah says investors and advisors also question whether the companies offering folios have staying power. "If one implements a strategy based on the advantages of folios, and then has to move the funds to another custodian (because the company fails), they would first probably earn the ire of their clients, but they also would have a hard time transacting and monitoring the accounts going forward on a strategy based on the availability and costs of the folio platform," Shah says. Advisors would be much more receptive to folios, he says, "if Schwab or Waterhouse would offer them, though the companies may fear cannibalization of their current commission revenues."

Since retail investors remain skittish about folios, companies like Foliofn are relying more on investment professionals to keep their businesses afloat. Wallman says the nascent Foliofn is relying on its original growth strategy of "providing underlining services to other [companies in financial services] who can leverage off of their trusted brand name." Foliofn is marketing its platform to the nation's credit unions through an alliance with CUNA Mutual Group, a credit union trade group; Brinker Capital, an independent provider of managed account services for independent advisors, is now using Foliofn as a back-office trading, custody, and accounting platform; and Quick & Reilly inked a deal with Foliofn in September, and a product launch is expected soon. And Foliofn is now in talks with RunMoney Corp., a turnkey asset management provider.

Wallman says Foliofn intends to be cash-flow positive next year, and has lots of new products on the drawing board, maybe even one involving hedge funds.--Melanie Waddell


Rolling Out The Carpet

All are welcome to contributeto the economic stimulus bills percolating in Congress

Christmas has come early this year, and no one's happier than President Bush. His present tax stimulus initiatives are holdovers from his early days in office, which he entered espousing four major priorities via the Economic Growth and Tax Relief Reconciliation Act of 2001. To wit: 1) marginal tax rate reductions; 2) relief in the form of tax credits and/or rebates for low- and moderate-income taxpayers; 3) enhanced expensing of capital expenditures by businesses; and 4) repeal of the corporate AMT (Alternative Minimum Tax). The House acted on these wishes in late October, passing H.R. 3090, a $100 billion economic stimulus package. The tax breaks were first married to a time frame extending to 2006. After the events on September 11, however, some of these initiatives, in some yet undetermined form, will be law for tax year 2002. At press time, the Senate was still deliberating.

"New lower tax rates for consumers and entrepreneurs will show up in paychecks on the first day of the next year--of the new year, if we can get that passed out of the Senate," said President Bush on October 24. "The tax rebates for low- and moderate- income folks would begin to arrive soon, if we can get it out of the Senate."

There are some 72 different possible amendments to stimulate the economy, as put forth in early November by Senate Republicans. The Bush administration is trying to hold the line against proposals calling for increased government expenditure, with the President sticking to his original priorities. He's not expected to comment until Senate action is taken, becoming involved when the House and Senate hash out their differences--which was expected by Thanksgiving.

Differences lay in the details of the proposal released by Finance Committee Republicans on October 25, which would seek to implement the Bush tax cuts plan, and the proposal offered by Democrats. In general, writes Ken Silverberg, a tax specialist and partner at the Washington law firm Nixon Peabody, in his October 30 Washington Tax Update newsletter, the Democratic plan "is far less generous to business taxpayers, but includes tax rebates for low-income individuals and $35 billion of additional government spending."

Regarding the treatment of businesses, the GOP plan, as noted by The Bureau of National Affairs, a Washington-based publisher covering legal and regulatory developments in business and government, would provide for a depreciation "bonus" permitting businesses to expense 30% of their qualified capital expenditures for three years. The Democratic plan would allow businesses to expense immediately 10% of investments in capital and software put in service within the next 12 months, with the remaining 90% depreciated under current rules.

We Brake for HNWs

Of interest to financial advisors and their high-net-worth clients is the proposed acceleration of reductions in the top marginal tax rates. HNWs will be significantly affected, since they will realize lower tax rates as early as next year--not 2006.

Under Bush's economic stimulus plan, persons in the 27% income tax bracket will see a reduction to 25% in 2002. Key items in H.R. 3090 would lower long-term capital gains rates from 20% to 18% for the majority of taxpayers. It also would bestow upon corporations a retroactive elimination of alternative minimum taxes they paid as far back as 15 years, while permitting companies to deduct current operating losses from taxes they paid up to five years ago.

Benefits to low-income individuals, according to The Bureau of National Affairs, would be the provision of tax checks to those who did not receive the full benefits of rebates authorized under Bush's original $1.35 trillion tax cut.

Also significant to advisors with HNW clients is the increase in the amount of capital losses that can be deducted against ordinary income, up from $3,000 to $5,000, effective next year.

And Bush in late October signed into law an anti-terrorism bill (H.R. 3162, called the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001.) In general, the bill gives the Treasury Department more power to monitor bank secrecy and demand reporting of large cash transactions. Section 356 requires the Secretary of the Treasury to publish before January 1, 2002, proposed regulations requiring broker-dealers to submit suspicious activity reports (such as terrorist money laundering schemes). --Cort Smith


Your Kind of Trust Firm

National Advisors Trust Co. is of, by, and for advisors

On October 1, the doors opened at the newly formed National Advisors Trust Company (NATC). The Overland Park, Kansas, firm is a venture on the part of 82 independent advisory practices across the country.

The new trust company will offer only trustee and custody services, allowing the member advisors to continue handling the majority of their clients' financial needs. Such a setup, as well as the recent establishment of two independent trust companies that have similar business plans, is indicative of a long-simmering relationship between advisors and trust companies. As Jeff Metz, of Pinnacle Financial Advisors in Marlton, New Jersey, says, "There are finally some alternatives for advisors in the marketplace."

In the past, says Jeffrey Lauterbach, president of Capital Trust Company of Delaware, advisors would often designate a relative as trustee, employ an accounting firm to handle the tax work, and then custody the assets at a brokerage house. The problem with this approach, however, is that the job of trustee often involves difficult decisions over who will get trust assets. Messy family disputes are commonplace. And the more intricate and large the trust, the more difficult the tax and custody work becomes. "It may seem easy to simply give the money out," says Dave Roberts, president and CEO of NATC, "but many times being trustee involves knowledge of state laws and long-established principles of how these accounts should be run and distributed. At times, it's hard to balance interests among beneficiaries, and in sophisticated documents, it's difficult to interpret the intent of the estate attorney and client."

A preferable alternative would be to employ the services of what Lauterbach says are the over 3,000 trust companies in the country to ensure professionals will be overseeing the maintenance of a client's estate. "Also, corporate trustees do not die, and many trusts are constructed to dispense assets decades into the future."

Using corporate trustees is where advisors have found trouble. Of the 3,000 trust entities in the U.S., only two or three, says Lauterbach, offer only trustee and custody services. The rest do financial and estate planning as well as money management. "This is where the profits are," Roberts says. Because of this, many trust companies, Lauterbach says, refuse to solely do trustee work without having control over the assets.

There are a number of firms that will agree to do only trustee and custody work while also allowing the advisor to stay on as planner and money manager. These firms include community banks with trust departments, the 100 member firms of The National Association of Independent Trust Companies, and a select number of large trust companies that accommodate advisors, such as Charles Schwab-owned U.S. Trust. There is a problem here as well, though. "Many advisors feel like they are steering business to the competition that way,"

says Lauterbach. This concept is evidenced by an advisor focus group Lauterbach says his firm ran: "They said that they flat-out don't recommend using trusts because they hate the idea of steering business to the banks."

Although NATC will only accept clients referred by a shareholder, or member firm, some other companies that solely do trustee and custody work have sprung up in recent years. Capital Trust Company of Delaware, in Wilmington, Delaware, was established 17 months ago, and has amassed $250 million in assets. Preceding it was Santa Fe Trust Company of Albuquerque, New Mexico, founded in 1997, which has $170 million in assets. --Mike Jaccarino


Your Kind of Trust Firm

National Advisors Trust Co. is of, by, and for advisors

On October 1, the doors opened at the newly formed National Advisors Trust Company (NATC). The Overland Park, Kansas, firm is a venture on the part of 82 independent advisory practices across the country.

The new trust company will offer only trustee and custody services, allowing the member advisors to continue handling the majority of their clients' financial needs. Such a setup, as well as the recent establishment of two independent trust companies that have similar business plans, is indicative of a long-simmering relationship between advisors and trust companies. As Jeff Metz, of Pinnacle Financial Advisors in Marlton, New Jersey, says, "There are finally some alternatives for advisors in the marketplace."

In the past, says Jeffrey Lauterbach, president of Capital Trust Company of Delaware, advisors would often designate a relative as trustee, employ an accounting firm to handle the tax work, and then custody the assets at a brokerage house. The problem with this approach, however, is that the job of trustee often involves difficult decisions over who will get trust assets. Messy family disputes are commonplace. And the more intricate and large the trust, the more difficult the tax and custody work becomes. "It may seem easy to simply give the money out," says Dave Roberts, president and CEO of NATC, "but many times being trustee involves knowledge of state laws and long-established principles of how these accounts should be run and distributed. At times, it's hard to balance interests among beneficiaries, and in sophisticated documents, it's difficult to interpret the intent of the estate attorney and client."

A preferable alternative would be to employ the services of what Lauterbach says are the over 3,000 trust companies in the country to ensure professionals will be overseeing the maintenance of a client's estate. "Also, corporate trustees do not die, and many trusts are constructed to dispense assets decades into the future."

Using corporate trustees is where advisors have found trouble. Of the 3,000 trust entities in the U.S., only two or three, says Lauterbach, offer only trustee and custody services. The rest do financial and estate planning as well as money management. "This is where the profits are," Roberts says. Because of this, many trust companies, Lauterbach says, refuse to solely do trustee work without having control over the assets.

There are a number of firms that will agree to do only trustee and custody work while also allowing the advisor to stay on as planner and money manager. These firms include community banks with trust departments, the 100 member firms of The National Association of Independent Trust Companies, and a select number of large trust companies that accommodate advisors, such as Charles Schwab-owned U.S. Trust. There is a problem here as well, though. "Many advisors feel like they are steering business to the competition that way,"

says Lauterbach. This concept is evidenced by an advisor focus group Lauterbach says his firm ran: "They said that they flat-out don't recommend using trusts because they hate the idea of steering business to the banks."

Although NATC will only accept clients referred by a shareholder, or member firm, some other companies that solely do trustee and custody work have sprung up in recent years. Capital Trust Company of Delaware, in Wilmington, Delaware, was established 17 months ago, and has amassed $250 million in assets. Preceding it was Santa Fe Trust Company of Albuquerque, New Mexico, founded in 1997, which has $170 million in assets. --Mike Jaccarino


Wirehouse Rumblings

Two of the nation's leading brokerage firms are modifying the way they compensate brokers in order to pull in more assets from the well-to-do. UBS PaineWebber recently announced that it plans to reward brokers for generating fee-based business. Merrill Lynch said it's overhauling its compensation model to reward brokers who focus on large trades and fee-based accounts. Both take effect in January.

"The rationale was to support the firm's strategy to focus on fee-based accounts and wrap products, with a view toward continuing to gather new client assets and aligning the financial advisors' compensation to that strategy," says Paul Marrone, a PaineWebber spokesman. "The firm's focus is to target the core affluent with $500,000 and more in investable assets. The compensation program has been modified to align with that strategy, and to compensate financial advisors who succeed in implementing that strategy."

The first change, he says, is being made to the brokers' compensation grid. The percentage that PaineWebber pays brokers whose clients aren't in fee-based accounts will be cut 1%.

"Brokers will be paid 4% above the grid for all fee-based and wrap accounts, a 2% increase over what they were paid under the prior grid," Marrone says. "The net effect is that all non-wrap business will be down 1% from current rates and wrap fee business will be paid 2% higher than the current rate."

Marrone says PaineWebber has also eliminated the discount sharing penalty that was levied against brokers who offered their customers a deal on the firm's trading commissions. The firm has instead instituted a $12 ticket charge on all stock and option trades.

PaineWebber has also revised the bonus or asset award to reward brokers who bring in net new assets versus rewarding them for total assets under management, Marrone says. "The focus is on new business versus compensating them for current assets they have under their control."--Melanie Waddell

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