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With Friends Like These....

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A friend recently told me about a meeting he had with his firm’s custodian. It was with the custodian’s representative for its referral program, and with just under $1 billion under management, my friend’s firm had to be one of their largest advisors. Yet the young referral rep, who was clearly very junior, acted like she’d never heard of my friend’s firm and proceeded to describe the myriad hurdles they’d have to jump through to “qualify” for referrals.

The editors won’t let me print what I suggested my friend tell his custodian–instead I’ll refer you to Crash Davis’s (Kevin Costner) great line in the movie Bull Durham: “I’ve been a professional ballplayer for 12 years; I don’t try out.” Don’t get me wrong, I have no problem with custodians conducting due diligence on advisory firms before they start handing over retail customers. In fact, I’d like to see custodians go even further, marketing the high standards they set for their network of advisors (of course their lawyers won’t like it, but guess what, they have liability for those advisors anyway).

But what really grinds my kiester is the way custodians continue to treat even their largest advisory firms. Imagine how this meeting would have gone if it were handled a little bit differently. For one thing, there must be a regional VP somewhere for whom this advisory firm is a big client. Perhaps she should have sat in on the meeting. Then the referral rep might have done a little homework, reviewing what’s in the custodian’s database, so she could act like she knew something about the firm. Finally, the meeting might have taken a different tone, perhaps as if the custodian were trying to recruit the advisor: “You’re one of our top advisory firms, and we’d really like to be able to refer some of our larger and more complex portfolios to you. Naturally, we need to do some due diligence….”

I’m just a writer, but this seems like client management 101 to me. Unfortunately, this story is far from an isolated incident. All you have to do is hang around the bar at any gathering of advisors to hear horror story after horror story about how custodians treat advisory firms. Sometimes you can chalk it up to one hand simply not knowing what the other hand is doing, which in my book equates to bad management. Other times, troubling actions stem from the fact that servicing advisors isn’t really the custodian’s core business. From an advisor’s perspective, however, the reasons are far less important than the frequency with which these incidents occur. Of course, each of the big three custodians–Schwab, Fidelity, and Waterhouse–will tell you that the other guys are the perpetrators. But you don’t have to look very hard to find plenty of stories about each firm.

The mystery is why financial advisors put up with being treated as if their custodians are doing them a favor by taking their clients’ assets. Is it just me, or is there something seriously wrong with this picture? Sooner rather than later, advisors are going to realize that the tail is wagging the dog here–and the dog is getting pretty big. By my quick and dirty estimate, independent financial advisors manage some $3 trillion in client assets. What’s more, custodians and broker/dealers are waking up to find their share of that pie represents a substantial part, if not a majority, of the assets they manage. Yet these financial services companies have been very slow to translate this new reality into practices that reflect the importance of financial advisors to their businesses. Perhaps it’s time advisors gave them a wake-up call. Here are three areas that are just begging for improvement.

  • Referral programs. If I understand the economics of the situation, they go something like this: Custodians that also have retail clients (that is to say all of them, except DATAlynx) are increasingly finding that these retail clients want and need advice. Not coincidentally, these tend to be their larger clients. Quite often, these clients solve their problem by moving their portfolios to a wirehouse such as Merrill, Smith Barney, or Morgan Stanley.

    As you might expect, this is not good for the custodian. So each devised programs in which they could refer clients who need them to their affiliated independent financial advisors. This seems like a no-brainer, but apparently it took a considerable amount of internal gut-wrenching to make it happen. In any event, the result is that the assets stay at the custodian, which as you might imagine is good for business. Still with me? Okay, here’s the tricky part. Not only do the custodians treat their advisors as if they are doing them a favor by referring retail clients, but–dramatic pause–they charge the advisors to participate in the referral program. Ya gotta admit, that takes some chutzpah.

    In my book, it also qualifies for a kiss-my-assets response. Furthermore, it also strikes me as counterproductive. To maximize the odds of keeping their assets in-house, custodians should want to refer their large retail clients to their best advisors. Yet I’m willing to bet that while they might be happy to take on new clients, the best advisors (or at least the most successful) probably aren’t going to pay to get them. Now I’m not suggesting that advisors who join these referral programs aren’t good at what they do. In fact, I highly recommend to young planners that such referrals can be the path to great success. But these pay-to-play programs seem designed to exclude top advisors, while sending the bizzaro-world message that custodians are doing the advisors a favor.

  • The profitability stick. How many times do we have to hear that custodians just don’t make any money on their advisors? In fact, I heard that one regional VP’s solution to this problem was to suggest to one of his advisor/clients that he should move substantial client assets into the firm’s proprietary products. I’m not sure I even know where to start on this one. For one thing, it’s just plain insulting to suggest that a firm doesn’t make money, lots of money, on hundreds of billions of advisors’ clients’ assets. If that is indeed the case–if the custodian is too dumb to make a fortune on those assets–then perhaps the advisor should move the assets to a custodian who can.

    In either case, this isn’t really the advisors’ problem. In addition to just being a convenient tool for bullying advisors, I suspect the notion that the profitability of their custodian is somehow the advisors’ concern stems from the larger group-think that affiliated advisors, like company employees, are all part of a collective effort to ensure the success of the custodian, or even part of its crusade against Wall Street.

    Get real. A financial advisor’s concern is for the welfare of her clients. Period. Custodians are merely vendors that advisors use to benefit their clients. If a custodian fails to benefit the client, it’s an advisor’s duty to find a new custodian. Sure, custodians offer services and systems that help advisory firms to run more efficiently. That enables the advisors to better serve their clients, not to line their pockets. At least, not the advisors I know. If they wanted to do that, they’d go to Wall Street.

    Frankly, in my experience independent broker/dealers understand advisors far better than custodians. Perhaps it’s because the B/Ds started as small businesses (even if they aren’t anymore), with an intimate relationship with their advisors. But custodians seem to be mired in a corporate mentality that often is at odds with the real business of financial advice: helping clients. Advisors need to demand more.

  • Practice transitions. This is an issue that despite my, and others’, best efforts ranges from a grudging obligation to a complete blind spot on the part of custodians and B/Ds. True, Schwab has a transition program designed by my client, Mark Tibergien, and Fidelity recently rolled one out that I had a hand in structuring. But I’ve discussed this in depth with executives from the three big custodians (including Waterhouse), and my sense is that none of them truly grasps the reality of the situation. Here’s why:

Again, by my estimate, about half of today’s financial advisors will retire within the next 10 years or so. That means close to $2 trillion in client assets will change hands (more than half the assets since the older firms tend to have more AUM). Thanks to FP Transitions (more disclosure: FP is a former client of mine), there is an independent marketplace that makes it relatively painless to find a buyer and transfer those advisory practices. So the biggest economic question facing those who service the independent advisory world over the next decade is: Where will those assets go?

The existing two custodian programs fail to address this question. While Fidelity’s program goes a bit further than Schwab’s by offering to actually facilitate transactions, both are largely informational–providing how-to and valuation resources. Of course, Schwab charges its advisors to attend their workshops, partly for the service of learning how to sell their practices to other Schwab advisors, thereby keeping the assets at Schwab.

Consequently, both programs lack several elements. With more than half the assets managed by independent advisors up for grabs, wouldn’t you think that someone would offer financial incentives to sell their practices to in-house buyers, or conversely, for firms to buy other in-house practices and those at other custodial systems? In my view, those incentives would include: systems and information that maximize the value of in-house practices; discounted transition fees for practices retained or brought in-house (those fees can run as high as 10%, which on a $1 million or $2 million practice can add up to real money; the economics work for the custodian even if those fees are discounted to zero); and a lending program that help buyers finance the 34% average down payment at favorable rates. Sooner rather than later, someone will offer such a program, and with it attract hundreds of billions of dollars in client assets. To do that, however, they’ll have to change their corporate mentality from “doing favors for advisors” to spending their own money to retain assets under management.

Indeed, as far as I can see, today’s custodians need a radical attitude adjustment. Independent financial advisors will continue to play an increasingly dominant role in the financial services landscape. To continue servicing those advisors and custodying their clients’ assets, firms will have to treat advisors as clients, not employees. Because if they don’t, someone else surely will. And perhaps advisors might point that out to them.

Bob Clark, a former editor-in-chief of this magazine, sagely surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at [email protected].


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