Thursday, February 20, 2014

Observations: Transforming the Firm from a Sales Culture to a Fiduciary Culture

Twice a semester I take a group of students in a 15-passenger van on visits to local financial services firms. My financial planning program (undergraduate) students benefit from exposure to different practice models, learn about "day-in-the-life" of a financial advisor, and some even make connections leading to future internships or jobs. They obtain a real picture of the environments they may join, and upon their return most become more committed to their studies and to joining this emerging profession.

Yesterday I undertook another of these trips, visiting four different firms over the course of six hours. Of interest to me was the apparent transformation of two of these firms from commission-based sales to fee-based businesses over the past few years. Both firms indicated that a primary motivation was to secure recurring revenue. And both firms stressed improved relations with clients.

In one firm I got the real sense that the fiduciary culture was being implemented throughout the firm, from the top down. The firm had long utilized the platform of an independent BD firm, and they had sold a variety of insurance products. Yet, several years ago they formed an RIA firm, owned by the principals of the firm, and began to transition their clients to it.

In so doing, I got the real sense, from the principals of the firm, that a true fiduciary culture had been embraced. From principals of the firm to junior advisors, each spoke of the devotion to act in the client's best interests at all times and to avoid conflicts of interest where possible. This transformation must not have been easy, but it was well underway and, it appeared, was being successfully implemented..

However, in another firm my students and I visited I encountered another firm. This firm also had a BD and RIA, but the RIA was not owned by the principals but was instead an affiliate of an insurance company. While the firm touted its "fee-based" philosophy, and their movement toward AUM fees over the past two years, it became apparent quickly that the firm lacked leadership in instilling a true fiduciary culture.

One indication of this was when a principal of the firm touted how wonderful it was to deliver a life insurance proceeds check into the hands of a surviving spouse. I often hear life insurance salespeople talk of this "moment" with some pride - as if it justified all of their past recommendations (often to buy cash value life insurance).

Yet, as a fee-only advisor, I assisted many a surviving spouse claim life insurance benefits for policies (mostly term life) I had recommended be taken out years before, but I never felt "pride" in that moment. I just felt that the planning had worked out, as it should have.

Other statements made by the principal of the second firm visited led me to believe that no true fiduciary culture was being implemented. Investments recommended in the investment advisory accounts were often proprietary funds, or resulted in additional compensation to the financial services firm and its employees.

I would note that the transition from a sales culture to a fiduciary culture is a difficult one. Even for brokers who seek to move to RIA-only platforms, I've often heard it said: "You can take the advisor out of the brokerage firm, but you can't take the brokerage firm (i.e., sales culture) out of the advisor."

At the firm-wide level, when firms attempt this shift, it appears that many firms will fail to embrace a true fiduciary culture. In all likelihood their leadership fails to understand the breadth and depth of the fiduciary obligation, and/or fails to communicate the new core values of the firm correctly.

While the shift from commission-based compensation to fee-based compensation is a positive one, in my view, abuses will continue (as seen in my article last year about the abuses seen by the client of a dual registrant). [See] There are many advisors, thanks to lax oversight by the SEC, who state that they operate as "fiduciaries" to their clients but who, in fact, disclaim away their core fiduciary obligations through disclosure. [See]

I have also previously written that I believe large warehouses can undertake the shift to a fiduciary culture, but only if they create separate entities and install certain firewall and other protections. [] Yet, the wirehouses are highly unlikely to move in this direction. Why not? As a recent survey indicates, the firms would become less profitable (although the clients would certainly benefit from such a shift). [See] In fact, I gave a presentation to the "big firms" at a conference last year; my suggestion that they embrace a fiduciary culture and fiduciary principles, by altering their business methods, was met with incredulity. How, they asked, could they choose their clients interests over those of their shareholders? (My reply was simple and direct - your market share continues to shrink; what will your shareholders think when your firm is but a footnote in history, 20 years from how, if you don't change?)

The shift of the two firms we visited - from mainly commission-based to mainly fee-based compensation over the past few years - is a noteworthy development. I suspect, from the various reports I read from Curulli Associates and others, that the shift to fee-based accounts which has been underway for several years will continue to occur.

Yet, at least in one instance, the shift to a fiduciary culture was far from complete.

To get it done right, a fiduciary culture must be embraced fully by the principals of the firm. The fiduciary duties must be understood. Many systems of the firm, from investment strategy selection, to investment product due diligence, to client intake processes, to documentation needs, and much more, must be re-designed. The fiduciary culture must then filtered down to everyone in the firm through robust education and values leadership.

I can only hope that more firms, as they make the move of their clients from BD platforms onto RIA platforms, move all the way and embrace a true fiduciary culture, rather than only partway.

I hope that financial planners and investment advisers are on the path of becoming a true profession, and not a pseudo-profession composed of "pretend fiduciaries."

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