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Here We Go Again

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Charles Schwab & Co. is at it again, expanding advice to high- net-worth individuals. Schwab maintains that its new Private Client Services (PCS) division does not compete directly with the 6,000 independent advisors who use its clearing services. But will advisors buy the Schwab company line? It’s anyone’s guess.

Schwab consultants will advise PCS clients but not have discretion over their assets, a distinction that Schwab says is important because PCS clients will be more involved in managing their assets than clients of investment advisors who custody assets at Schwab. The great majority of those assets are managed by advisors on a discretionary basis.

For years, advisors have talked tough and threatened to pull their client assets away from Schwab, but little has happened and Uncle Chuck still dominates the business with about 75% of independent RIA assets.

Transferring assets to another custodian is an enormous hassle for an advisory firm because it requires so many permissions from clients and back-office maneuvers. A more likely scenario is that advisors might start to put new assets at Schwab competitors, especially Fidelity Investments Brokerage Services, which has beefed up its sales force in recent months and is making a big push for advisors’ dollars. So now that the PCS offices are likely to start popping up over the next year in a major wealthy neighborhood near you, advisor defections are a development to watch for. But there’s just one problem with that: according to most of the advisors I know, Schwab Institutional still offers the best service, product suite, and technology to advisors. It’s going to get interesting.

Of course, Schwab for years has walked a fine line by competing with advisors for retail clients. Five years ago, when Schwab was strictly a discount brokerage that gave no advice, it did not compete directly with advisors. But Schwab has reinvented itself over the past decade and reshaped the financial services industry and, in doing so, the publicly-held company with a duty to its shareholders has been forced to go where the profits are: high-networth individuals. Now that means giving advice to those same individuals, and it has put Schwab in direct competition with advisors.

The PCS offices are a shrewd business move for Schwab, sure to please the ailing stock’s shareholders. Schwab stock traded recently at about $15 a share, down from about $40 a year ago, and its share price has fared much less well than its old rival Merrill Lynch & Co. In June, a front-page story in The Wall Street Journal painted an ugly picture of Schwab, detailing how the firm had dramatically expanded its workforce just in time for the market meltdown. Schwab management, just 18 months ago hailed as heroes for reinventing the discount brokerage into a new kind of full-service firm, is under pressure these days.

About one of every three dollars of assets at Schwab is managed by the 6,000 advisors using the firm’s custodial services, and an estimated one-fifth of the broker’s profits come from Schwab Institutional, headed by Chief Operating Officer Gerald Graves. Schwab has long maintained that its advisor business is too important to the company to be cannibalized, all the while launching more and more services aimed at reaching the high-

net-worth market seeking advice.

Eighteen months ago, the firm acquired U.S. Trust in a frontal assault on the super-affluent. Last year, it opened up its “Signature Services” branches to give high-net-worth retail clients special treatment. Now Schwab is opening the finely appointed PCS offices staffed with professionals to dispense investment advice and financial planning.

This is sure to become a national rollout. In July, Schwab opened three new PCS offices and it expects to continue to expand this retail program. The PCS program already has six branches. The first three, opened in May, are in Los Angeles, Houston, and Atlanta. The three new ones are located in Burlingame, California, just south of San Francisco; Boca Raton, Florida; and Santa Clara, California, in the heart of Silicon Valley.

The offices will be staffed with CFPs, CPAs, former wirehouse brokers, and other professionals with at least eight years of experience in financial services, according to Schwab. According to one advisor, a senior Schwab executive expected the average PCS consultant to be paid $75,000 and get a bonus of between $75,000 to $125,000 annually.

Here’s the deal PCS offers clients: For a fee starting at 55 basis points, an individual with less than $1 million can receive advice from a Schwab consultant on an equity portfolio composed of Schwab OneSource mutual funds or Schwab’s family of funds. The fee drops to as little as five basis points on accounts of $5 million or more. If the individual wants a stock portfolio or wants to use transaction-fee funds, the management fee starts at 75 basis points for an account under $1 million and drops to 25 basis points on accounts of more than $5 million. There is no asset-based fee on cash or fixed-income and options. The minimum account size for PCS advice is $500,000.

If a client wants a Schwab consultant to advise him on constructing a portfolio of separate account managers, the fee starts at 1.75% for accounts of less than $1 million, and again a $500,000 PCS minimum applies. On $3 million or more, the fee for a wrap account drops to 1.20%. While the Schwab Managed Account Select separate account package is sold through advisors, it has not before been available to retail clients and, at least for now, it will only be available to retail accounts through PCS.

Schwab’s PCS offering is likely to stir lots of controversy among advisors. Some will say Schwab has coldly calculated the numbers and figured out that going head to head with its advisors makes good business sense. Why, after all, let all those advisors get those fees when Schwab can have them? Other advisors will continue to defend Schwab. They will say Schwab is capable of segmenting the market finely enough to pick out the wealth individuals who want some guidance but not an advisor.

I don’t believe either side will be right, and that the truth will lie somewhere in between. I think Schwab will have its cake and eat it, too. It will compete with you for new clients while it continues to serve you, and you will continue to be faithful to Schwab and put up with it as a competitor as long as Schwab remains the best service provider. But what I think doesn’t matter much.

What matters is what you think. To help you decide, here is the summary of a one-hour interview with Schwab spokesman Glen Mathison. I learned that Schwab was planning a wider rollout of the PCS offices just one day before my monthly deadline, and Schwab could not get a top executive to be interviewed about PCS on 24 hours notice. While Mathison is one of the most combative PR people I’ve ever worked with, he’s also one of the most knowledgeable, and his words in the past five years have always accurately reflected the thinking of top management at Schwab.

What is Schwab aiming to accomplish with this new business? We are aiming to better retain and attract high-net-worth investors, who are for the most part in charge of their portfolios and involved in their portfolios but who want a greater degree of handholding and advice than Schwab has traditionally provided. These are very much the sort of investors we see emerging out of the baby boom generation. They have significant wealth, and are either not ready or would prefer not to hand this money over to someone they hire. They want to be involved in it, and want to be very much a part of the management of their portfolio. They want tailored advice from someone helping them with investment decisions but they still want to be in charge of the portfolio. About 80,000 Schwab retail clients have assets of $1 million or more, and PCS is both a retention tool and way to expand Schwab’s brand into an area we have not been in before. These offices will continue providing referrals through AdvisorSource and continue to offer independent investment advisors as an alternative. Certainly, if you look across the financial services landscape, virtually every firm is seeking to position itself as a trusted advisor. Everyone is seeking to provide investors with more advice. In particular, when you look at other firms competing with us in the advisor business, they have active retail brokerage arms engaged in serving investors directly. Fidelity, for instance, has very active programs for investors, and they are actively engaged in serving the high-net- worth market.

Who are your target clients? They’re people who have at least $1 million in assets who are still making their own investment decisions but are looking for more market wisdom and advice, and buy-sell recommendations, in their relationship with Schwab. They like their relationship with Schwab but want more service and guidance. And, if we don’t provide it, they will go elsewhere. They could be different from investment advisor clients in a variety of ways. Perhaps in terms of their net worth–advisors often target higher-net-worth clients–or in the level of comfort these folks have with delegation. For the most part, clients of advisors have delegated to advisors to handle everything for them, and make investment decisions for them. PCS clients also may be different in their comfort level with large nationally known brands. Some people would prefer to do business with a big, established name brand.

You say Schwab retail clients are asking for these services. What do you mean? We have increasingly done a good job as a firm in terms of our share of new millionaires, and our average retail account size is just over $100,000. We have been told by people with these levels of assets that they need to go to traditional Wall Street firms because they feel they don’t get what they need from us. We’ve been told by these folks that they want more advice and more of a sounding board for investment decisions and a greater degree of customization and services. While AdvisorSource [a referral system in Schwab retail branches that sends clients to advisors] has steadily improved its conversion ratio to gain advisors clients, there are still a lot of people who go through AdvisorSource, decide that’s not the solution for them, that an advisor is not what they want. It could be highly personal. Investors have a variety of reasons and to suggest they will be satisfied being limited to a narrow range of choices is not realistic. People are choosing solutions for their investing needs from a variety of columns. Some people want to do some of their investing online and others want to do some at the branches. We have people with accounts with advisors and with Schwab retail branches. The advisor solution is a good one for a lot of people, but not for everyone.

Tell me about the PCS branches and how a client might wind up in one. There is a brochure, and we are testing a direct mail campaign in some markets. But it’s localized and directed by the [local] office. There is no broad national advertising campaign for PCS now. The strategy is that they are not walk-in offices and not street-level as are typical Schwab retail offices. PCS [branches] will work by appointment only and are for clients who are willing to pay a fee. The offices look a lot different than Schwab branches. They are typically better appointed. You’d only get referred to one if you’re in a market where there is one. Initially, you’ll only know about it because of an article in the local press or if you receive a direct mail piece. You could possibly hear about it in a Schwab branch but only if you have the level of assets required, and then that’s a discussion that will occur in the context of a discussion about all of the services we offer–including a referral to an advisor. There is no incentive for a front-line employee to do anything but help get an investor the right solution, whether it’s U.S. Trust, Schwab retail, or an advisor.

Why shouldn’t advisors see PCS as a threat? I would not presume to tell advisors how to feel. It would be condescending for me. We are highly sensitive to what they are experiencing as small business owners trying to compete in the world today. We are absolutely committed to the advisor business. Their success is strategically important to Schwab. They are a key part of Schwab’s strategy for serving affluent investors and we continue to invest in that business as we have been. We have the biggest investment and the biggest division committed to advisors in the industry. We firmly believe there is enough opportunity out there for both of us to succeed. When you add up the share of the affluent market that U.S. Trust, Schwab, and advisors have, it’s less than 10% of the affluent marketplace of individuals with investable assets of more than $1 million.

There is a huge opportunity out there for all of us to succeed. Schwab’s success in the retail arena does not have to come at the expense of advisors. And we are not seeking to do anything but better serve people who for whatever reason want a different kind of relationship than what they get from an advisor. But we remain committed to making sure they know about advisors and are fully educated and aware of the great services they can get from an independent professional investment manager. Schwab retail and U.S. Trust account for about 5% of the affluent market. Advisors who are using Schwab have total assets under management accounting for about 2% of the affluent market. So there’s 93% of the affluent market that Schwab is looking to attract through U.S. Trust, advisors, and the retail offerings.

All Eyes on

Advisors have a new Web-based application to help with employee stock options

Despite the slaughter in the stock market over the past 17 months and lingering uncertainty, more and more advisors still see stock option planning as an important niche. Yet there aren’t too many software tools aimed at helping advisors serve individuals with employee stock options (ESOs); most advisors still piece together Excel spreadsheets, pricing models, and estimates about tax liabilities to create a vision of the future for a client who owns options.

Over the last two years, I’ve favorably reviewed two stock option products:, a Web site filled with articles about ESOs; and StockOpter, an Excel-based spreadsheet that allows you to model different plans for option exercises. Now advisors have a third tool:, a Web-based application for ESO planning.

“I would characterize it as having three I’s,” says Dick Potter of Antares Capital Management in Chicago. “Innovative, intuitive, and, perhaps of most significance, integrated.” is priced right, at $495 a year, and it is uniquely capable of giving you a global view of all your clients’ option holdings. It is easy to use and efficient–requiring a minimal level of data input to yield a fairly large amount of useful output–and some of its reports can be used for client presentations. contains an options pricing model that will help you assign a value to options even if they are currently under water, and you can set up alerts to avoid nasty surprises, such as getting caught in the AMT squeeze on an Incentive Stock Option. Also, it neatly calculates the cost of holding an option in order to qualify for long-term capital gains treatment.

But–you might have known there would be a “but”– falls short in its bid to be a breakthrough product. Its planning capabilities are wanting. will not replace StockOpter as a long-term planning tool. The fact that it is a Web-based application raises all of the usual issues that advisors have about giving an application service provider sensitive data about client holdings. Some bugs need to be fixed in the application and is a small Internet company, which these days is enough to make many advisors skeptical.

Still, holds great promise and is a great first release. It is the first and best application for managing your clients’ ESOs globally in one screen, and it is designed well.

Four Cheers From Advisors

Of the four advisors who reviewed the product with me, none was more enthusiastic than Dick Potter. His opinion carries weight. Potter’s made a specialty of serving employees of professional services companies whose compensation is heavily skewed toward deferred compensation. Shortly after starting his practice in 1996, Potter determined that ESOs would become an important component of his practice. But even with his University of Chicago MBA in finance, Potter says he felt his background was not deep enough to deal with the complexities of ESOs. Potter took all of the seminars offered by the Chicago Board Options Exchange alongside hedge fund managers and mutual fund managers–surely one of the few financial planners to have done so.

Potter says he currently patches together multiple applications, documents, and services to do stock-option planning. He prices options by getting the risk-free rate of return on Treasury bills and using data from Bloomberg on the stock’s price. He pulls the option grant expiration and strike price right from the documents a client gives him. He then uses Open Interest, a software program from Rocky Point Software ( for modeling, and overlays some Excel plug-ins from other vendors to view different scenarios. Only after putting together all of these unconnected components can he begin to do some planning on each option grant.

“That’s what is so attractive about,” says Potter. “I can save time and money using it. I don’t have to keep all the Excel spreadsheets with all the option strike prices and maturity dates, and go to a second program to reload the data to price the options, and then go to a third program using an Excel spreadsheet to do modeling.”

Dale Walters, a partner at Keats, Connelly & Associates in Phoenix, was also enamored with “It goes through angles that other software and even advisors have never considered,” says Walters, a user of StockOpter. Walters agrees that all of the data, including current stock prices and charts showing a stock’s 52-week high and low, are available elsewhere, but having it in one place with all of the options grants is useful. “The program requires a small amount of data input, considering the amount of reports it generates,” says Walters.

Milton Kuninsky, a senior planner at Universal Advisory Services in Albuquerque, says one of the most impressive features is the way you can view the cost of holding onto an option to qualify for long-term capital gains treatment. “If you were to exercise an option and hold it for a year, this will show you what price the stock must be in 12 months and a day for you to be in the same position as if you just exercise, sell today, pay the taxes, and reinvest the cash at 7%.” calculates the different tax results, and you can alter the rate of return you get on reinvesting your proceeds for that year.

“So you can say to a client that if you exercise today and hold for two years, the stock will have to appreciate to ‘X’ to make this a worthwhile strategy,” says Kuninsky. “That’s a good feature. It is short-term thinking, but it lets the client see the cost of waiting to get favorable capital gains treatment, and the cost of letting taxes drive decisions.”

Another feature that impresses these advisors is that contains an options pricing model. Basically, it uses an exchange-traded option similar to an option that you might own to assign an approximate value. Assigning a value to an option grant even if it’s way out of the money is useful for estate planning purposes, Walters says, because it looks beyond the worthlessness of today’s value to what its future worth might be.

StockOpter Still Tops

While Kuninsky and Walters are both enthusiastic about, they also say it won’t replace StockOpter. StockOpter, which is published by NetWorth Strategies, has 1,000 users, and the strengths of the program are in its ability to do intricate long-term planning and provide transparency of all its calculations. Since it is Excel-based, planners can go into a spreadsheet and check calculations, tweaking a model for a client when needed. That’s useful with options because client variables–the possibility of losing a job or retiring early, for instance–can alter a plan dramatically.

Walters explains that with StockOpter, when you sell stock after exercising it places your after-tax profit in a hypothetical portfolio. You can run alternative scenarios to see how exercising other options grants might fare. The software has numerous preprogrammed scenarios that make it easy to envision possible future outcomes depending on whether you wait as long as possible to exercise a grant or exercise as soon as possible. And regardless of whether you sell the stock immediately or wait for 12 months, it shows you the tax treatment on the different possibilities–all in preprogrammed calculations. has fewer preprogrammed scenarios.

One of the three pre-programmed scenarios in is based on research by a University of Pennsylvania professor that asserts that it’s wise to start exercising when an option grant can capture more than 75% of its historical value. While all of the advisors seemed captivated by this theory, they also expressed concern about it being a “black box.”

“A lot of advisors right now don’t deal with options because they’re primarily trading mutual funds or they don’t have a client who it would apply to,” explains Potter. “So if all they have to do is input the number of options, strike price, exercise date, and all the rest and then the application comes back and says that because the stock is about a certain price, it’s time to start exercising, that could be troublesome. You need to look at a client’s tax profile, employment situation, age, and a range of other items.”

“Ioptions is still something of a black box and I can’t see how it arrives at its determinations,” says Kevin Gahagan of Boone Financial Advisors in San Francisco. “You get a final answer from the application but you don’t have the ability to test the answer.”

Gahagan keyed in numbers for an option grant vesting in monthly stages over two years, seeking to test’s planning capabilities versus StockOpter. Unfortunately, a bug in the Web application led to his data being deleted. “I hit a button that said ‘exercise’ and it took the vested options I had entered and deleted them,” says Gahagan. Walters, too, found that will need to allow advisors to save their work as they input data. If you have only enough time to partially input a case, you’ll lose the work accomplished and cannot return to it, he says. But such technical glitches are to be expected in any new application, the advisors acknowledge.

Gahagan also expressed concern that is a Web-based application, which means it runs over the Internet and that your client data resides on the ioptions server.

Advisors are just beginning to confront the security and privacy issues of using Web applications. Gahagan and Potter say they routinely hide client names or use code names. But such measures only delay the inevitable decision advisors will ultimately have to face about the liability involved with handing their client data over to a third party.

Using a code name only forestalls the inevitable decision of whether to make the leap of sharing data with a Web application. Eventually, will integrate an options trading platform, and using code names for clients simply won’t work.

But despite these issues, some bugs and criticism of its planning limitations, all four advisors who tested ioptions are enthusiastic about its potential. This is a good new tool and there is no software–online or off–that does all that can do.