The independent adviser profession–or “investment counseling,” as it was originally called–owes its existence to a convergence of events and influences in the first quarter of the twentieth century. It was shaped by a few tireless, visionary individuals who saw beyond traditional investment services to a new model that valued the client relationship more than the financial product. And it was tested and strengthened by a series of investigations and reforms that grew out of President Franklin D. Roosevelt’s New Deal.
Some background is useful here. In the early years of the twentieth century, corporate America was barely emerging from the era of the robber barons–bankers and industrialists whose great achievements were often matched by equally great abuses of power. As late as the 1920s, investing in most American companies was viewed as a highly risky activity. Pioneering investment adviser Theodore T. Scudder wrote in The History of Scudder, Stevens & Clark that “prior to 1900 corporate morals were so low that common stocks of practically all publicly held companies could be considered nothing more than outright speculations.”
Investment bankers, insurance companies, and professional trustees dominated the investment profession; none allowed individual investors much control over their investments other than to say yes or no to a recommendation. The firms that offered investment advice were the same firms that sold investment products.
In 1912, Ars??ne Pujo, a Democratic congressman from Louisiana, received authorization to form a House committee to investigate the “money trust”–a group of financial leaders who were abusing the public trust to consolidate their control over many industries. The committee’s findings lent support to a number of reforms, including the Sixteenth Amendment to the Constitution, which authorized a national income tax and was ratified in 1913; the Federal Reserve Act, also in 1913; and the Clayton Antitrust Act in 1914. The imposition of the federal income tax in particular stimulated interest in investment counsel.
Then came World War I and a second major influence on investment patterns: the issuance of huge numbers of bonds to finance the war effort. The liberty loans, as they were known, were the largest bond issues of their time; by 1919 more than $21 billion in bonds were sold, in denominations of $100 each. Ordinary Americans who had never been “speculators” responded to the U.S. Treasury’s exhortations to buy them. By 1919 more than eleven million Americans had invested in liberty loans.
A brief, severe recession followed the 1919 Armistice. But by 1922 the United States had made a striking recovery. The country experienced a surge in business activity that raised living standards, generated entrepreneurial wealth, and opened the door to a deluge of securities issuance on Wall Street. Between 1919 and 1929, the annual rate of corporate securities issuance nearly quadrupled. The flood of securities coming to market in those boom years overwhelmed amateur investors. They needed expert help to identify investments with good prospects amid the mass of new issues. Moreover, the boom was playing out against a backdrop of economic uneasiness.
It was in this environment that a small number of independent advisers–then self-styled as “counselors”–got their start. In general, their clients weren’t speculators trying to cash in on a stock tip overheard at a speakeasy. Instead, they tended to be business owners, corporate executives, and members of the professions–knowledgeable individuals of means looking for ongoing advice in a challenging investment environment. Rising prosperity had given them the assets to meet the minimum account size required by independent advisers, typically $1 million or more in today’s dollars. The two new breeds–the independent adviser and the affluent client willing to delegate investment management to a trusted professional–emerged together. Both prospered as a burgeoning economy and a bull market created unprecedented new wealth. Though small in overall numbers–the SEC in its Seventh Annual Report in 1942 reported just 753 registered advisers–independent advisers represented a significant change in the status quo and an influence much greater than their size would suggest.
The new independent financial advisers differed in striking ways from their predecessors and competitors. First, they focused on their clients’ unique needs rather than on selling a particular product. Second, they styled themselves as professional practitioners, emulating lawyers and accountants in the way they dealt with clients. To reduce conflicts of interest, many offered no services other than investment advice. Typically, they helped clients identify investment goals, set priorities, and prepare a formal investment plan. Investments were continuously monitored and supervised. Their fees, usually based on assets under management, were fully disclosed and paid directly by the clients. This method of charging fees required advisers to value client portfolios regularly and helped direct the attention of investment professionals to the performance of the client’s total holdings.
A third innovation was financial planning. As a discipline and a profession, financial planning would not be recognized until the early 1970s. But these early independent advisers pioneered some of the essential tools of the financial planning process.
Above all, independent advisers believed that ethical standards, professional objectivity, and trust were the keys to their success. When the Investment Counsel Association of America (predecessor to the Investment Adviser Association), the industry’s first trade group, adopted its code of professional practice in 1937, an important provision was that “neither the firm nor any partner, executive or employee thereof should directly or indirectly engage in any activity which may jeopardize the firm’s ability to render unbiased investment advice.”
Bright Spots in the Depression
The 1929 stock market crash and the Great Depression that followed brought misery to millions of Americans. In contrast, independent advisers fared relatively well as a group and even managed to expand their business. Because they charged fees based on assets under management and tended to follow conservative investing strategies–with a focus on investment-grade fixed-income securities–independent advisers could keep their clients, and themselves, afloat. Then, as now, asset allocation made all the difference in investing, and asset allocation–not yet called by that name, but known rather as “don’t put all your eggs in one basket”–was what independent advisers specialized in. Whatever pain they suffered from the stock market crash, independent advisers’ clients benefited because their money was being professionally managed.
However, that did not minimize the overall bleakness of the economic landscape. The shrinking economy left one in four workers jobless in 1933. Between 1930 and 1932, industrial stocks lost 80% of their value, and even blue-chip stock investors suffered painful losses.
The nation’s economic woes were not the consequence of unseen global forces, as some apologists tried to argue. Real people and their misdeeds were at fault. In angry response, reformers wanted new laws to regulate the securities markets and prevent fraud. After Franklin D. Roosevelt’s landslide presidential victory in 1932, they got their wish: public investigations and hearings continued throughout the decade and exposed a scandalous record of abuse.
First in the dock were the bankers. In hearings before the Senate Banking Committee, which commanded the whole country’s attention, chief counsel Ferdinand Pecora (see sidebar) avoided economic complexities. Instead, he dragged in top financiers and grilled them relentlessly about Wall Street’s misdeeds during the 1920s.
For weeks, Pecora put on a mesmerizing show while building a copious record to support fundamental reforms being prepared by the new administration. “The Pecora findings created a tidal wave of anger against Wall Street,” financial historian Ron Chernow wrote in his 1990 book The House of Morgan (Atlantic Monthly Press). Congress responded with waves of reform legislation (see sidebar, Depression-Era Financial Reforms).