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Financial Planning > Trusts and Estates > Trust Planning

The New Meaning of Trust

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The notion of trust is occupying people’s minds these days. Open newspapers, turn on a cable news show, or attend an industry event and you’ll be reminded that investor confidence in our nation’s financial system is critically low. In this year alone, a bear market, corporate accounting fraud, questionable stock research methods, and the threat of war with Iraq have systematically eroded investor confidence. And Harvey Pitt’s resignation in early November as chairman of the Securities and Exchange Commission doesn’t help matters. For Wall Street, restoring confidence is now priority No. 1.

Charles Schwab Institutional’s annual conference for advisors, Impact 2002, kicked off in Washington in late October with Daniel Leemon, Schwab’s chief strategy officer, saying that the meaning of trust is changing. And with that change comes opportunity. “Trust,” he told the 2,500 attendees, of which 1,000 were advisors, is now “a competitive differentiator.”

Investors, he said, want more “direct evidence” that they can trust the companies and people handling their money. Investors also want more information on such things as performance, how an advisor is compensated, and the advisor’s objective, he said. So now is the perfect time for independent advisors to capitalize on investors’ preference for their open architecture platforms, as well as investors’ displeasure with brokerage firms hawking high-margin products to make up for losses, he said.

In fact, a new survey by the Securities Industry Association reveals that investors’ overall ratings of the brokerage industry are down; one survey response found that only 45% of investors are “very satisfied” with their brokers, a 14% drop from last year’s 59% satisfaction rate.

For advisors, maintaining clients’ trust will depend on how well they manage their own practices, Leemon said. To gain a competitive edge, he counseled advisors to outsource services so they can spend more time with clients, to increase their revenue sources, and to serve a niche clientele.

No Conflicts Here, Folks

Schwab has been devising its own plan to win back individual investors. When news broke about conflict-ridden research by Wall Street analysts, Schwab was the first brokerage firm to unleash advertisements trumpeting the fact that no such conflicts with investment bankers exist at the San Francisco-based firm. During an onstage chat with Co-CEO David Pottruck at Impact, Chuck Schwab voiced his disapproval of the current negotiations among the SEC, New York Attorney General Eliot Spitzer, and seven of Wall Street’s investment banks to remedy the research dilemma, saying it’s hard to fathom that an acceptable solution is “being crafted by the top seven perpetrators.” Pottruck concurred, saying the negotiations are “ludicrous” and that “the right solution is disclosure.”

Schwab predicted independent advisors’ –and Schwab’s fee-based model–of doing business will be “more successful” throughout the tough market environment (which he predicts will “go back to normal” in several years) than “the old brokerage model.” Pottruck opined that the “fee-based, no conflicts” model is the right way to go, and predicted the competition for the wealth market “is going to become very intense.”

Leemon said Schwab would continue to vie for individual investors’ business–and their trust–by “delivering services based on their needs.” He specifically noted services offered directly to retail investors and advisors, including Schwab’s own equity ratings, which offer grades of A through F on thousands of stocks; the Advisor Network referral program; Schwab’s Private Client Service; the Advisor Web Center, which now offers account aggregation; as well as portfolio software through Centerpiece, which Schwab renamed Portfolio Center.

During a separate conversation with Leemon, he told me that Schwab’s “four-legged” approach to serving investors distinguishes it from competitors. The first leg is marketing scale, he said. “We were the first [brokerage firm] to use advertising to draw in clients instead of outbound selling and cold calling,” he said. Second is technology. “Our ability to not just run an efficient back office, but to have really good tools for our reps and our clients spread across a lot of volume gives us an advantage; we can take the scale advantage and invest it in growth for the future.” The third approach, he said, is combining people and technology, which “is the oldest piece of Schwab’s heritage.” And fourth is “building a model that has the individual investor smack in the center of the universe,” he said. “We want to be, over time, the firm for the individual investor–second to none.” And ironically, he said, before the “crisis of trust” among investors took hold this year, Schwab had “set a goal of becoming the most trusted firm in the investments industry.”

The revamped Advisor Network referral program is also becoming a crucial component of Schwab’s corporate strategy. Robert Klapper, senior VP in charge of Advisor Network, noted that his unit “is one of the critical parts to Schwab’s strategy going forward; we couldn’t have said that about Advisor Source,” the previous referral program.

Moving the referral program into Schwab’s corporate strategy was just one strategic move, he said. Another change was raising the bar on advisors allowed to participate in the program; they must now manage at least $50 million, have at least five years experience as an RIA, and at least seven years managing money. Schwab also streamlined and simplified the process of recommending clients. And fees to be in the program–which some advisors have balked at–jumped as well. Nine months after being revamped, Advisor Network now boasts a 35% conversion rate, compared with the 25% rate garnered through the old Advisor Source. “Of the 100 people that we refer, 35% now hire that advisor,” Klapper said.

I’m Your Partner

To be sure, continuing to build a partnership with advisors–and secure their trust–has become vital for Schwab these days. The contentious atmosphere that plagued last year’s event was noticeably absent this year. During a chat with reporters, Deborah McWhinney, president of Schwab Institutional, noted that the less confrontational mood stemmed from Schwab’s “ramped up services,” and the firm’s “communication [with advisors] going way up.” Pottruck added that advisors are now more accepting of Schwab’s business model. “People have accepted that’s the way it is,” he said. But a couple of advisors I talked to say they still aren’t pleased with it.

Restoring investor trust won’t be easy; especially since investors have watched $8 trillion in portfolio value vaporize this year. Leemon perhaps summed it up best by stating that “restoring trust is not an ephemeral concept; [we] have to actively work to restore” it. And the SEC will certainly play a crucial role. Investor confidence will continue to diminish until replacements are found for Pitt and, to a lesser extent, William Webster, the former FBI and CIA director who, a week after Pitt’s departure, quit as chief of the Public Company Accounting Oversight Board.

Industry officials I spoke with think the Bush administration will move swiftly to replace Pitt. “Having not only a fully funded, but fully staffed, office at the SEC is critical to the public’s trust and confidence in the market,” says Dan Michaelis, a spokesman for the Securities Industry Association in Washington. But Frank Kelly, senior VP and head of Charles Schwab’s government relations office, says investors shouldn’t worry too much about how long it takes to fill Pitt’s spot, considering it’s the first time in years that the SEC has four “highly regarded” commissioners. “The place won’t grind to a standstill.” David Tittsworth, executive director of the Investment Counsel Association of America, agrees the administration won’t dilly-dally. But the more important issue in his mind is who replaces Pitt, not when he’s replaced. “Who replaces Pitt is a very big issue, and it’s the key to how the agency is going to function over the coming months and years,” Tittsworth says.

Now that Pitt is gone, one of the biggest issues affecting investment advisors and mutual funds may get tabled: self-regulatory organizations (SRO) for both groups. “Pitt was definitely considering some kind of an SRO or some additional oversight of the fund and advisor industries,” Tittsworth says. “There was nothing formal on the table; other commissioners had not been brought into it. But I think at least the momentary threat has abated.”

Pitt’s Parting Shot

Even after resigning his post, Pitt kept a keynote speaking engagement at the SIA’s annual conference in Boca Raton, Florida in November–which, by the way, focused on restoring investor confidence–in which he claimed he was the victim of partisan politics during his 15-month chairmanship. “I hope my successor isn’t greeted with the same climate of attack and partisanship,” he said. “In a partisan environment, criticism often devolves into attack. This doesn’t help anyone. In fact, it’s not just unproductive, it’s counterproductive.”

Pitt detractors say his resignation will go a long way in helping restore investor confidence. Even the ICAA’s Tittsworth concedes that it was time for Pitt to bow out when ICAA members started voicing disapproval. As one conservative Republican investment manager wrote Tittsworth after hearing about William Webster’s appointment: “I can tell you the guy [Pitt] is doing nothing for investor confidence.” But still others give Pitt’s SEC credit for acting vigorously on some of the highest-profile scandals. “There were more enforcement actions than ever this year,” says the SIA’s Michaelis, who says not to forget the Sarbanes-Oxley Act, the corporate reform bill now being implemented by Congress.

There are a lot of uncertainties for investors to deal with these days, which makes your role as trusted advisor that more important. Make sure your house is in order.


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