The Department of Labor’s fiduciary standard rule for advisors who serve up retirement-plan advice is here, all right. And plenty of FAs are bewitched, bothered and bewildered as to what it augers for the financial services industry.
But not Ric Edelman. The candid founder-executive chairman of Edelman Financial Services, one of the nation’s largest RIAs, sees the handwriting on the wall. And from his angle of vision, the message is exquisitely clear. In an interview with ThinkAdvisor, the industry critic shares his views, including a bold-face forecast about what he gauges as the rule’s most alarming aspect, plus a withering critique of the industry lawsuits seeking to vacate the rule.
Broadly, Edelman projects that within a decade, half of all financial advisors will have exited the industry, to a great extent because of the DOL rule. He predicts, too, that before the January 2018 implementation date, many firms, too, will have quit the business. Edelman, ranked No. 1 independent advisor nationwide by Barron’s three times, deems wirehouses the channel most vulnerable to the rule’s repercussions.
As for his own king-size national financial planning practice, with $16 billion in AUM, Edelman is vigorously recruiting advisors seeking to join a big RIA that has indeed successfully established itself as abiding by the fiduciary standard. Thus far in 2016, EFS has added 15 planners and seeks to bring on 35 more by year’s end.
With a total 125 planners in 42 offices serving 30,000-plus clients, Edelman has long positioned itself as the Starbucks of financial planning: the firm’s framework for providing investment advice is highly consistent and systematized. A typical EFS client has $500,000 to invest, but EFS’s minimum account size is just $5,000. A key goal in 2016: to significantly expand the firm’s client base coast to coast.
To be sure, EFS is in major growth mode and in the last nine months, has undergone a few major changes.
First, David Bach – advisor-turned-motivational speaker and bestselling author – who joined as a partner and vice chairman in June 2014, left the firm in August 2015.
Two months later, EFS agreed to be acquired by affiliates of private equity firm Hellman & Friedman. They are now owners with senior management and Lee Equity Partners, who were EFS existing partners. Ric Edelman remains the largest individual shareholder.
Then, last month, following a year-long nationwide search, Edelman turned over day-to-day company responsibilities to Ryan Parker, most recently LPL Financial’s managing director for investment and planning solutions. He’s EFS’s new C.E.O.
(Related on ThinkAdvisor: Finke: DOL Rule May ‘Drop Bomb’ on Asset Management Industry)
ThinkAdvisor recently interviewed Edelman, on the phone from firm headquarters in Fairfax, Virginia. The provocative independent opined on where the financial services industry is headed now that the DOL rule will likely kick off further rules that, he says, will “radically alter” the advisory field during the next decade. Here are excerpts from our conversation:
ThinkAdvisor: What will happen to traditional financial advisors under the new rule?
Ric Edelman: I believe that within 10 years, half the advisors in the industry will be gone. And the DOL rule is a big part of the reason. For advisors whose value proposition is price and performance – sales pitch is “I’ll make you more money, and I’ll do it cheaper” – those guys are likely to become extinct. They won’t be able to deliver higher returns and charge less. Therefore, to justify their existence, they’ll have to find a different value proposition because consumers will find other practitioners who can deliver.
Safe to say that the DOL rule is a very big deal.
Yes. And here’s why: The element that’s perhaps the scariest for the industry is that the rules are going to allow lawsuits. Arbitration will no longer be the only recourse that consumers have. Arbitrations are case-by-case and confidential. Lawsuits are not only public but they can be converted into class action suits. Arbitration insulated companies from those. We believe that, to protect themselves against the risk of lawsuits, many firms will sharply reduce the products they allow their reps to sell.
Which types of firms will be most vulnerable?
A number of people in the industry are fearful that class actions could destroy many brokerage firms. Some would argue, especially wirehouses because they tend to be the ones that are selling the most of all the products affected by this rule – such as, many annuity products, non-traded REITS, gas MLPs. These will no longer be considered appropriate under the fiduciary standard.
But non-traded REITS, for example, aren’t prohibited under the rule.
Right, but anyone who sells one will have to conform to the fiduciary standard. There’s no way that someone selling a product that’s illiquid for seven to 10 years and has a 10% upfront commission is going to be deemed in compliance with the fiduciary standard. So for that reason, many products, including closed-end funds, are going to be removed from the marketplace or dramatically altered.
What impact will the rule have on the financial services landscape overall?
Many firms will go out of business. Many will be replaced by brand-new companies with entirely new business models created and designed to succeed in the new regulatory environment, where the older companies couldn’t operate. Look at Betterment, Wealthfront, Uber, Tesla. These are new companies that are thriving in an environment that didn’t exist in the past. It’s likely that by the time the rule is implemented, we’ll see [more] similar new entrants in our industry.
What types of firms, in general, will be most heavily affected by the new rule?
Brokerages that generate a majority of revenue from commissioned products. Some [derive] 100% of their revenue from products such as non-traded REITS, life insurance or equity-indexed annuities [fixed-index annuities], which pay 8% commissions. It’s highly unlikely that these products will survive the fiduciary standard. This would have an impact not merely on the advisor but the firm they’re registered with. So entire brokerage firms may see a dramatic reduction in revenue as high-commissioned products are no longer being sold to the degree they once were.
What will happen with FAs’ indirect compensation and revenue-sharing arrangements?
Mutual funds with 12b1 fees may be inconsistent with the fiduciary standard. So advisors who now recommend them may discover that their practices are severely disrupted, and the products they’ve been selling are no longer allowed to be sold under the new rule [because their firms won’t permit it]. It’s possible that they may still be allowed for taxable accounts and non-retirement accounts, which is why everyone is waiting for the S.E.C.’s version of the rule [Dodd-Frank’s fiduciary component], which will be more encompassing.
What if advisors are making their living from products that will be curtailed or eliminated?
They’re going to have to find other products to sell or other services to provide – or start selling used cars.
[Not long after our interview, industry groups filed lawsuits seeking to vacate the DOL rule. We went back to Edelman for comment on the action, which follows:]
The industry has already lost – in the court of public opinion. By launching these lawsuits, the industry has declared that it does not want to be required to serve the best interests of the consumers who buy the products it manufactures. It has declared that it wants to continue selling the high-commission, risky, illiquid investments that enrich it and its sales reps – at the expense of hard-working Americans…
What could be the upshot?
The only result the industry will experience from its continued self-serving demands is increased animosity from the investing public, followed by the very increased legislation and regulation the industry seeks to avoid…I am appalled by the industry’s position, behavior and tactics regarding this issue.
If advisors are anxious and worried about the impact of the rule, what should they do?
The solution is simple: adopt the behaviors associated with the fiduciary standard. Don’t engage in sales practices that place you or your firm at risk.
The rule will necessitate taking on huge compliance costs.
Yes. The industry is projecting this is going to cost billions of dollars in compliance.
But many firms won’t be able to afford a whole new compliance apparatus.
That’s another reason many of them will go out of business – and maybe before [implementation in] 2018. We’ve already seen firms terminate selling agreements with certain products. We’ve already seen firms changing their commission schedules. We’ve already seen firms eliminating certain product from their approved lists. And this is only the beginning.
In the shakeout that you foresee, what’s the probability of firms being acquired?
Substantial. We believe there will be a dramatic increase in M&A activity as a result of [the rule]. We’re exploring possibilities [of acquiring firms] ourselves.
Do you expect to see heightened fee-based business; and if so, will fees go up?
There will be an increase in fee-based; but I’m not convinced that fees will rise [overall], though perhaps [they will] for some. The market will control that. An increase in fee-based business doesn’t necessarily translate into a cost increase. I believe that [several] robo advisors will ultimately experience a fee increase. Others may experience a fee decrease. But that doesn’t have to mean a decrease in profit. You don’t’ live on revenues; you live on income.
What’s your overall forecast for robo advisors in light of the rule?
Robos may go out of business if they can’t maintain the regulatory approval required to operate. The S.E.C. questions whether some robo advisors are capable of adhering to the fiduciary standard. The State of Massachusetts has declared that robos are unable to.
What’s the future, then, of your own robo, Edelman Online? The rule isn’t a problem for us because clients have available to them full access to our financial planners. That gives us an advantage that pure robos don’t offer. We believe that in the future, there won’t be a distinction between robo advisors and brick-and-mortar [firms].
How have things changed at Edelman since the Hellman & Friedman acquisition?
We’re focused 100% on the growth of our business -- and we have very aggressive growth plans. Hellman has provided us with substantial financial resources and depth of talent.
Was the Hellman deal part of your succession plan?
No, because they’re just an investor; they aren’t management. And I’m still the largest single shareholder of the company.
[In the interim between this interview and publication, Ryan Parker joined EFS as CEO. Here is what Edelman said about why he was seeking someone to take over from him in that capacity]:
Our firm has grown so large that I need to bring in a talented, experienced executive who can manage the firm day to day so that I can focus on other aspects of the company to help sustain its growth.
So you’re not easing yourself away from the firm?
Not at all.
Couldn’t David Bach -- who joined you as a partner in 2014 -- have become CEO?
David’s role was to help grow the company by generating new clients and assets. That was the purpose of that effort. Unfortunately, it didn’t produce the result we were hoping for; and that’s why the relationship ended.
What’s positive about the DOL rule for Edelman Financial Services?
The nice benefit is that we’re busy recruiting advisors into our practice because many are going to be struggling with complying with the new rules in working with clients, and we’ve already established ourselves as a successful RIA.
What’s your ideal recruit?
Someone with at least five years of experience, preferably more, who wants to serve clients’ best interest and is likeminded in terms of our financial planning and investment management approach. Our advisors meet with and serve clients -- they don’t do back-office work or trading or compliance or marketing or prospecting. We take care of all of that for them.
Is there an aspect of the new rule that’s positive for the industry as a whole?
Yes. It will help weed out the bad players – people selling products because they make a lot of money without any regard to what’s best for the customer. Those who are left will be the type who want [only] to provide advice. This will result in an improvement in the industry’s reputation, which currently is terrible. As its reputation improves, the industry’s profits will rise. So for the most part, [the rule] is great news for the industry long-term.
How will clients become aware of all the changes brought by the rule?
I’m not sure they will directly know or understand. Advisors are simply going to change what they say and what they sell. So if a non-traded REIT is no longer available on the marketplace, consumers will suddenly see there are no more free lunch seminars being offered to pitch non-traded REITS.
-- Related on ThinkAdvisor:
- Finke: DOL Rule May ‘Drop Bomb’ on Asset Management Industry
- 6 DOL Fiduciary Tasks to Tackle Before First Deadline
- Ric Edelman: What’s Wrong With IRAs, 401(k)s, and the Industry That Sells Them
- Edelman: What’s Top of Mind for Advisors? Technology, Recruiting Women
-- Check out more coverage on the DOL Fiduciary Rule's impact on advisors