July 23, 2010

Jeff Spears Reveals the 'Zero Sum Game:' The Weekend Interview

Will new fiduciary regulation 'shine the light' for retail investors? Some are afraid it will; others welcome it.

Jeff Spears, CEO of Sanctuary Wealth Services, helps wealth managers who have decided to leave "captive wealth management" at a bank or insurance firm to form an independent firm--typically a registered investment advisor (RIA). His background as national sales manager at Bank of America Private Bank, head of Montgomery Securities Private Client Group, and then as a partner in RIA Presidio Financial Partners informs his thinking and his candor.

Sanctuary provides "support and set-up...systems integration," Spears said in a recent interview. Most of his clients, he says, are leaving wires for the RIA side of the business. Spears helps them "make the transition" and set up compliance, and he works with them on the due diligence function with Fortigent, a service provider to independent wealth managers.

Sanctuary, according to Spears, was founded to address the sea change that he believes will continue in wealth management from "sort of captive brand-name wealth managers that are conflicted--whether it be Wall Street or even trust banks" to an independent business model that serves clients as well as advisors. "We support them in that move, to get set up in that business as an independent wealth manager and help them to run it...something that [requires] expertise that most don't typically possess."

Spears spoke to WealthManagerWeb.com Editor in Chief Kate McBride on July 16.

WM: So, then, you're a third-party provider of outsourced services?

JS: We would be comparable to a systems integrator in technology or a vendor services company.

WM: And your firm doesn't manage wealth itself?

JS: We are entirely a support organization.

WM: And you work with the broker/dealer and RIA wealth managers?

JS: Many of the people that we help start their businesses--and we don't advocate this long-term--are dually registered.

WM: So is the bulk of your business helping with the move from wirehouse to independent wealth manager of one kind or another?

JS: That is a significant part of it because that requires some heavy lifting; however the ongoing demands of running that business are significant. We remain very involved with our clients that we help transition, in running their business.

WM: What is the biggest piece you do for firms after transition?

JS: I'll start with compliance, which is pretty topical...and a selection and vetting of myriad investment options, software for reporting, that type of stuff.

WM: Is it a due diligence kind of function--and are people actually making you the fiduciary in terms of money manager selection?

JS: We partner in the due diligence function--most of the due diligence function--with Fortigent; however we also have our own internal due diligence for alternative managers that might not be covered by Fortigent.

WM: When you say alternatives do you mean hedge funds, limited partnerships, or do you mean oil and gas and off-traded REITs?

JS: All of the above.

WM: You'd mentioned [in an e-mail] the new financial legislation: derivatives on exchanges lowers costs, more transparency, fees going down--all of that, are there any drawbacks about derivatives on exchanges?

JS: The positives [are] just dramatic--the price discovery against over-the-counter [derivatives]. The price of an over-the-counter derivative that shows up on you statement comes from the over-the-counter derivative's dealer.

WM: So the price of, say a Goldman ABACUS deal--the underlying mortgages could be anything Goldman decides it to be?

JS: Yes, we're saying the exact same thing, so that is, to me, a huge win for the consumer, to take something from the shadows--an oblique pricing structure of an instrument--and take it onto the public exchange.

WM: Just to have a tracker of the prices?

Sure, then the market is deciding what that price is, not some conflicted computer model.

WM: Still, it's challenging to be able to price those exotic pools of securities--there will be some models going into those pricings anyway if you're looking at 1,000 or 100,000 underlying mortgages, right?

JS: Yes--that will be the initial price, correct? By the originating firm: "This is why we think it's worth par." Then, minute two, it's going to be worth...

WM: Forty!

JS: (Laughing) There's no doubt that the embedded sales fees come right out of it, and then you get on a public exchange, the buyer or seller is going to set the price. The originator might be involved but they're minimized. It's analogous to decimalization on over-the-counter stock market--[when it] went to decimalization, and you really started to see more customer-friendly pricing. It's a good thing, unless you're a broker/dealer-wealth manager that was making 3% selling those over-the-counter derivatives.

The revenue and profits [after decimalization of OTC stocks] went down significantly. You've got to assume the same will happen in over-the-counter derivatives.

WM: And that lines up with the kind of protests that we're hearing.

JS: The complaints, to me, have been pretty transparent, from Wall Street--and they've all been around, "Yeah we're going to make less money, and we were able to make so much money because we were doing things that might not have been in your best interest, Mr. or Miss Client."

WM: And that brings me to fiduciary: what will the firms that you have that are dually registered going to do about that?

JS: My hope is that the incredible conflict of dual registration, in essence, goes away. So you're going to have to be fish or fowl. It looks like that's where it's going.

It's eerily similar to Gramm-Leach-Bliley--[which was] only applicable to a few firms in the wealth management space. [At] Bank of America--where I was--it was very applicable. In Gramm-Leach-Bliley you had to disclose yourself to the client as, "I'm either a fiduciary or a broker," when you went out and talked to them. And you had the dual-sided card or whatever. My experience was that might work well on paper--but it was an incredibly confusing discussion with the client.

WM: And the evolution has been for banks to go broker--not to stay fiduciary--except for the trust department, right? And clients have been totally lost, don't get that evolution?

JS: Right. The firsthand experience I had with clients around this issue was the response of:

"Wait a second, aren't you always acting in my best interest?" Well, not when I turn my card over.

WM: That's real clear.

JS: Nevertheless, if you're the client, it's, "Well, why are we going through this dance here? I'm going to make it very clear: I want you to take care of me."

WM: And, of course, a big part of that has been the evolution of titles--from stockbroker or registered rep. or investment advisor, to everybody being a financial advisor or some kind of counselor or consultant?

JS: Exactly right. It totally obfuscates the issue; and the client--it gets down to trust, right? They've got to get down to a level of trust with their advisor--whatever we're going to call the person, and the advisor has to comfort them, sometimes, that they're protecting them from their firm--which--why do you even have that? Let's just legislate it so that it's black and white.

WM: A study by the Committee for the Fiduciary Standard (of which I am a member), and SEI found that the majority of brokers want to put their clients' interests first. But when they do that they have to do it on the sly because their legal obligation is to their firm.

JS: I agree with you--they are out there. There are a lot more ethical people than unethical people; unfortunately the unethical people really [make it tough] for the rest of us. Those ethical people would love the protection of tighter regulations, I believe. When I say tighter I mean better defined.

WM: If you're following a fiduciary process, wouldn't it follow that your liability is decreased because you are following that process? If you've taken the time to learn the process, and the principles?

JS: Yes.

WM: Obviously there might be people that might not want to do that, and of course they could stay on the sales side, be titled as such, work on distribution and that would be a different thing--but then they shouldn't be titled as advisors?

JS: I agree and would take it a step further. If there's a person that will stay on the B/D sales side of the business, there's no more collaborative team calling--if I was the broker and you were the fiduciary and we went out to call on a client.

WM: So, I'm the fiduciary introducing you the broker to the client--that client trusts me so they're going to trust you?

JS: It's back to my Gramm-Leach-Bliley experience. People jump to the conclusion, "Well Kate's introducing me to this person, and I trust Kate--so they must be okay." And that person is compensated and has sales goals to do everything that isn't almost trustworthy. And there are huge behind-the-scenes battles between the fiduciary person and the broker.

WM: This is when you were at B of A?

JS: Exactly, and this has gone on. And other professional acquaintances have lived the same dynamic--if they were at U.S. Trust to come into Morgan Stanley to do the team-based approach that we're talking about, and it didn't work. You're either a fiduciary--or you're not. If there's gray area--everyone loses, in my opinion--especially the client.

WM: Do you have a sense from the independent broker/dealers--they're a special case because so many of them don't have their own product but maybe they are getting a payment for having a fund on a platform or something like that?

JS: Exactly!

WM: Do you have a sense what they are going to do about this--so many are dually registered, some are married to--even of they don't have proprietary product--getting this vig from whoever they have on the platform. How do they make a transition to a fiduciary business?

JS: It's going to be tough decision-making. This is a grotesque generality, but I would say that, in the independent space, the dual registration exists for the 12b-1 fee. They couldn't really exist to sell stocks or bonds. It's on ongoing hit. You also read--talk about people finding out--it's saddening to read about when independent wealth managers go after [protest] taking away the 12b-1 fee--I don't see how you can make a credible argument, if you're a fiduciary.

WM: And of course this whole part of the fiduciary [duty] meaning you have to control costs for your clients and disclose the fees--not that you can't have commissions--but you have to disclose all that so, if you're disclosing all of it, then water's going to seek it's own level, right?

JS: It is, and the other side of disclosing all of it is the clients getting comfortable with: "We're going to show you every fee you're paying," which is what a true fiduciary should do. And the clients should be okay with that. However, sometimes there is an element--and maybe it's through the salesmanship of the non-fiduciary--that the client becomes okay with not thinking that they're paying any fees.

WM: Well, not that they're okay with it--that they just don't know--they think that it's cheaper--what they see at a broker/dealer that they're being charged may appear way lower than the revelation of full costs from an RIA firm.

JS: That's right, and there's been my education, aha moment--doing what we're talking about. "Okay we're going to take you from a wrap account; we're an independent RIA. We're going to break down what the money manager charges, what the custodian charges, and then, what I'm charging as your advisor. And the headline number--to your point--looks higher.

WM: Right. But it's the full-cost RIA number--versus the partial-cost number at a B/D.

JS: Exactly! And a partial cost number really doesn't manifest itself until you really look at your returns over a cycle. And then they'll go: "Why am I doing so poorly?" Well, might be, because the fees you didn't see are taking 2% a year out of your return. Because it is a zero-sum game.

Hopefully what will come out of this will shine the light--just like it will on derivatives--on all of these things within the fiduciary side that will allow a client to make a better-informed decision about what all the costs are. Maybe I've gotten idealistic in my old age, but that will be great.

Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.

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